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The Female Health Company (NASDAQ:FHCO)

F2Q 2014 Results Earnings Conference Call

May 1, 2014; 11:00 a.m. ET

Executives

O.B. Parrish - Chairman

Karen King - President & Chief Executive Officer

Michele Greco - Chief Financial Officer

Michael Pope - Vice President of U.K. & Malaysia Operations

Analysts

Mark Williamson - Private Investor

Russell Mollen - Bares Capital

George Whiteside - SWS Financial Services

Jack Wallace - Sidoti & Co.

Operator

Hello and welcome the Female Health Company, second quarter fiscal year 2014 conference call.

All participants will be in listen-only mode. (Operator Instructions). Please note, this event is being recorded.

The statements made on this conference call, which are not historical facts, are forward-looking statements based upon the company’s current plans and strategies. Such forward-looking statements reflect the company’s current assessment of the risks and uncertainties related to its business. The company’s actually results and future development could differ materially form the results or developments in such forward-looking statements.

Factors that may cause actual results or developments to differ materially including such things as product demand and market acceptance, the timing of the statement of shipment of large orders, competition, economic and business environment, and the impact of government pressures, currency risks, capacities, efficiency and supply constraints and other risks detailed in the company’s press releases, shareholder communication and Securities and Exchange Commission filings. For additional information regarding such risks, the company urges you to review its 10-Q and 10-K SEC filings.

I would now like to turn the conference over to Karen King. Please go ahead.

Karen King

Good morning to all participants. This is Karen King, President and CEO of the Female Health Company and I would like to welcome you all to The Female Health Company’s second quarter fiscal 2014 conference call.

With me here in Chicago is OB Parrish, the Chairman of the Board of FHC; Michele Greco, our VP and CFO and joining us from his London office is Mike Pope, our VP of our U.K. and Malaysia Operations.

Those of you on last quarters call will remember that I had just joined FHC at the time of the last call, so O.B. kindly led that session. Today I will do so following a similar pattern than O.B. established, first making some general comments and reviewing the financial results for the quarter and half year, then I’ll provide some commentary on key factors that may impact future results and my views on the company outlook. Afterwards Michele, Mike and I will take your questions. Please note that when I refer to years I’m referring to FHCs fiscal year, which ends September 30, unless otherwise stated.

So first some general comments about the quarter and first half-year performance. During the second quarter and first half of 2014, the company experienced a significant decrease in unit volume, revenues and earnings per share, compared to the priors years second quarter and first half yeah results. This decrease can be primarily attributed to the volatility of the ordering patters in the global public sector, which has been experienced throughout the company history and discussed extensively on previous investor calls.

As an example, following a robust full year in 2009, the company had continued profitable positive cash flow years in 2010 and 2011, but also had success of decreases in revenue and volume. This was then followed by a very successful year in 2012 with a record-breaking achievement for the company. We fully expect to continue to see Global Public Sector volatility in purchases in the future. It’s inherent in the market segment in which we operate.

Now lets go to the second quarter results. Unit sales were 7.3 million units, down 56% from the 16.7 million units in the second quarter of 2013. Net sales for the quarter totaled $4.3 million, a 54% decrease from $9.5 million in the prior year quarter. Gross profit decreased 57% to $2.4 million, representing 55% of sales, compared to $5.5 million or 58% of sales in the prior year quarter. The decrease in margin is primarily attributable to lower unit sales.

Operating expenses decreased 26% to $1.6 million compared to $2.2 million for the prior year quarter. Operating income totaled $795,000, a decrease of 76% compared to $3.4 million in the prior year quarter. Net income totaled $375,000 or $0.01 per diluted share, a decrease of 89% from $3.5 million or $0.12 per diluted share in the second quarter of 2013.

Looking at the half-year results, the company sold 19.1 million units, generating $11 million in revenues in the first half of the year. This represents a decline of 43% for both units and revenues from the same period last year.

Gross profit of $6.1 million was achieved, down from $11.5 million in the first half of 2013. Operating income was $2.4 million versus $7 million in the first half 2013, representing a 66% decline. Net income was $1.8 million or $0.06 per diluted share, a 74% reduction over the 2013 value of $7 million or $0.24 per diluted share.

Looking at cash flow, in the first six months of the fiscal year 2014, the company generated $1.2 million in cash from operations, including a negative impact of $1.8 million from changes in operating assets and liabilities. This is compared with the 2013 first half results of $5 million cash from operations, including a negative impact from changed in operating assets and liabilities of $2.7 million.

In the second quarter net cash used in operations was $15,783, including a negative impact of $1.2 million from changes in operating assets and liabilities.

The company ended the first half with $5.9 million in cash versus $6.2 million one year ago, after paying $4.1 million in dividend during the six months period. During the first six months of the year, inventory increased $1.7 million, a 68% increase over the previous periods. This is due to a number of factors, including increased orderly times from a large customer now requiring independent testing on each shipment of product, building some inventory to fulfill replenishment with a major customer and some expected orders experiencing delays in finalization.

On May 7, 2014, FHC will pay investors a dividend of $0.07 per share, its 18th consecutive quarterly dividend. Due to the company’s historic net operating losses and domestic international profit splits, a significant portion of the dividends paid is a return capital and is therefore not taxable. The ratio varies from year-to-year, with the return on capital representing 98% of the dividend in 2012 and 58% of the dividend paid in 2013.

FHC has a tax loss carry forward of $17 million state and $19 million federal in the U.S. and in the UK $63 million and those do not expire. These tax loss carry forwards will be used to reduce cash payments for income taxes in the future.

So in summary, regarding the half-year results, it is important to note that with the decrease in the revenue in the first half of the year, the company has remained profitable with positive cash flow, as has been the case in the past and reflects FHCs advantageous business model. By advantageous business model what I refer to is a company operating with no debt, manufacturing and selling of proprietary healthy margin product to a limited number of public sector customers with a history of prompt payment for global distribution.

Additionally the company has built flexibility in the manufacturing process over the years to address the swings in order patterns of customers. While experiencing up and down periods during the 2005 to 2013 period, FHC had an average compound growth in unit sales of 19% and in gross profit of 20%. We continue to remain very positive about the outlook for continued long-term growth and the sound underlying financial approach the company has employed, which is resulted in multiple years of profitability, positive cash flow generation and a debt free balance sheet.

Now I’d like to address some key factors that will be impacting the need for female condom in the future. There are multiple factors which may influence the demand. First, the continuing feminization of HIV/AIDS which O.B. has discussed with your previously.

According to WHO, for woman aged 15 to 44 years HIV/AIDS is the leading cause of death worldwide with unsafe sex being the main risk factor in developing countries. Adolescent girls and young women aged 15 to 24 are twice as likely to be at risk of HIV infection compared to boys and young men in the same age group.

Second, the continued prevalence of other sexually transmitted diseases in both developing and developed countries. The CDC reported in 2012 that in the U.S. STDs are one of the most critical health challenges with 20 million new infections every year, costing the U.S. healthcare system $16 billion per year. This reporting only includes gonorrhea, chlamydia, and syphilis. It does not include AIDS. The U.S. government spending on AIDS is close to $30 billion per year.

Third, a reinvigorated priority given to family planning services and products in developing countries by governments and non-governmental organizations.

The Global Donor World is prioritizing efforts to educate and empower women to act on their own behalf with regards to contraception and family planning. This new priority is spearheaded by the FP2020 organization, funded by the UK government and the Gates Foundation among others.

The goal of this organization is to reach an additional 120 million women by the year 2020, with reproductive health education, services and products. Condoms both male and female are identified as important components in the contraceptive choices that should be made available to women.

Fourth, the female condom remains the only product where use is initiated by women that provides dual protection, against HIV/AIDS and other STDs and unintended pregnancy.

And fifth, there is continued funding for HIV and family planning. Some highlights of that was the $4.6 billion committed to support the FP2020 program, $12 billion committed to the global fund, including $1.45 billion committed by the UK government over three years for HIV/AIDS, TB and malaria.

I’d also like to take a moment to say a few words about competition. There are some relatively new current or pending competitive entrance in the female condom arena, which I will discuss one at a time.

Cupid Limited is an Indian based public company traded on the Bombay Stock Exchange and they have introduced a natural rubber latex female condom by the same name and has achieved WHO clearance. It does not have FDA approval nor does Cupid appear to be seeking it.

Since achieving WHO clearance in June 2012, we are aware of only modest orders from new in groups, estimated at less than 2 million unites. Cupid was awarded a portion of the last South African tender. The end users acceptance of Cupid has yet to be established as it employs a very different design from FC2. Given its different design, user education may be an important factor. To our knowledge, Cupid does not provide the training and support materials, which FHC has found critical to user acceptance and continued use.

PATH is a not for profit organization that has been developing the women’s condom made of polyurethane. As far as we know it is not been commercially launched anywhere and we are not aware of PATH achieving any regulatory clearances or approval. In 2012 PATH announced that it would submit a PMA to FDA by December of that year. To our knowledge, PATH has not submitted a dossier to FDA to-date.

There are two Chinese companies offering versions of female condoms under the trade name Pleasure More and Fonar. Again, we are not aware of these two condoms achieving clearance or approval by WHO or FDA.

The Pleasure More condoms did receive a portion of the last South African tender award. It is also believed that that condom has not yet passed South African own internal testing standards review and as far as we know, the condom has not been distributed to any users in South African. A number of years ago there was another India product entrance using the brand name VA w.o.w. That product is no longer marketed.

FC2 remains the only female condom to achieve both WHO clearance and FDA approval. FC2 is covered by 42 patterns across 56 countries. Over 400 million FC1 and FC2 condoms have been distributed to over 144 countries with no recall. The company provides education, training and programming assistance across many countries, which has been shown to increase awareness and repeat usage. The company is the only entrance with current capacity to fulfill very significant tenders or order quantities with current capacity of 100 million units annually.

As you would have seen in our release this morning we signed a lease agreement for additional space, adjacent to our current Malaysia operations, which will provide the opportunity for further capacity expansions in the future.

Now, some ideas on our outlook. As noted previously, due to the potential volatility in the timing of public sector orders, we do not provide precise revenue and earnings guidance. We do provide general guidance regarding the outlook, based on conditions at the time.

Long term, we believe the market for female condoms will continue to grow and there remains a significant untapped opportunity in usage and demand. It is my expectation that FHC will experience growth and continued profitability due to the following: First, an increase in demand, based on the company being involved in discussion for potentially significant quarters.

Two, the continued incidence and associated cost of sexually transmitted diseases in both the developed and developing countries and with the continuing significance of HIV/AIDS. AIDS is become a disease of woman with a disproportionate incidence and mortality rate among women, particularly with girls and young women.

Three, the increased global focus on family planning, services, programming and product with increased funding lead by the FP220 program.

Four, internal efforts within the company to focus on capitalizing on untapped demand, including hiring and experienced sales, marketing consultant to work with the company in marketing communications, key account management and demand generation activities among several other things. A permanent appointment for this role will be made in the coming months.

Five, further internal initiative on underdevelopment to reduce manufacturing costs and improve margins. And six, FHCs long established track record as a quality supplier of over 400 million female condoms without a recall, the capacity to deliver large orders in the time frame required and the education programming support the company has provided to countries around the globe.

Finally, in addition to efforts in the female condom arena, FHC will actively evaluate opportunity to acquire or add an additional product, technology or business that would build on the current strengths of the company, contribute to our future growth prospectus and reduce the dependence on a single product.

Now, we will open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from Mark Williamson who is a private investor. Please go ahead sir.

Mark Williamson – Private Investor

Good morning. Karen just a quick question relative to some of these larger quarters that maybe haven’t come through for the company yet. What’s the game plan to accelerate or try to bring those fish on the line into a boat? What can the company do to try to move those orders from out there that are significant into the books?

Karen King

So Mark, great question, I can tell you that this is the highest priority for us. We are always working very closely with our distributors and agents in these regions or directly with the customers to try to move these efforts forward.

Tenders are quite a challenge. These large orders that come through tender processes are subject to many influences and factors within the country and we see almost with every tender there is a new experience that’s developed.

What we will try to do to address this for the future is to continue to develop close relationships and mange these accounts on a key account basis where we work very closely to understand their needs and that we’re better positioned to be able to respond in exactly the way that would be most optimal for these tenders. But I can tell you that right now it is our top priority.

Mark Williamson – Private Investor

Okay, just another comment. From a resource standpoint, is there anything that could be done to support getting these bids resolved in the localities of Brazil and South Africa?

Karen King

Well, I think that we already have a team operating that we’ve been working with for a number of years in both Brazil and South Africa for example, who really again, know the processes and procedures and are involved in multiple tenders for multiple products to the government and really are the experts on how to make this happen.

What we’re going to do though as I mentioned in my prepared comments is, we’re adding to our marketing and sales focus. Have brought on a very experienced individual to work with us on a consulting basis right now and are looking to make that a permanent position in the coming months, so that we can put some additional focus on it as well.

Mark Williamson – Private Investor

Thanks Karen. Continue with the success.

Karen King

Thank you.

Operator

And our next question comes from George Whiteside of SWS Financial Services. Please go ahead sir.

George Whiteside - SWS Financial Services

Good morning. First, I wanted to make the observation that it is impressive that you have been able to increase your cash position in this past quarter, given the operational challenges that you faced. Kudos.

Karen King

Thank you.

George Whiteside - SWS Financial Services

On the questions; in the past you, and even now you confirm the fact that you are going to expand your manufacturing capacity in Malaysia and I would be interested in what gives you the confidence at this point that your going to have demand ramped up in order to take advantage of that increased capacity.

Karen King

Yes, okay, thank you George. The basis for us looking to have additional capacity is the figures that I mentioned in terms of the overall growth, if you look at the compounded annual growth rate of female condoms from 2005 to 2013.

So even though we have these swings and obviously we’ve had a down quarter right now, we do continue to see growth in this area and then because of all of the other factors that I mentioned, the importance of HIV/AIDS, particularly in sub-Saharan Africa with women now and other factors like the focus on family planning, we see that there will be a continued and growing need for female condoms.

I also point to this country where we are spending an enormous amount on healthcare costs related to sexually transmitted diseases and I think that could be one of the areas that we could look to see if we can develop increased demand here in the U.S.

George Whiteside - SWS Financial Services

Excellent. Second question, have you started to see or had any indications of orders generated by your FP2020 plan?

Karen King

Yes George, a good question. We definitely have now some better insights into how the mechanism will work around the FP2020, having spent some time meeting its key individuals in the organization and the way this will work is through the normal channels, how programming is established and how procurement of goods will take place, that what will happen related to the family planning efforts as well.

So what we are seeing now is countries that are starting new female condom programming efforts or renewed female condom programming efforts as a result of the FP2020 and I can give you one example. We don’t discuss a lot of things going on individual countries typically, but in Zimbabwe there is a very large new program starting up as a result of FP2020, focusing on education and programming for female condoms. So we are staring to see us in multiple countries.

George Whiteside - SWS Financial Services

So in that particular case, the educational process is being ramped up and you would expect that there would be orders coming out of that particular country as a result of that educational effort.

Karen King

Exactly, yes, exactly.

George Whiteside - SWS Financial Services

Thank you very much.

Karen King

Okay, thank you.

Operator

And our next question comes from Russell Mollen of Bares Capital. Please go ahead sir.

Russell Mollen - Bares Capital

Hi, a couple of questions and maybe they might be for Michele and for O.B. as well, because I know Karen’s only been there for five or six months or whatever its been. But has anything changed in the conversations that you had with some of the big tenders over the past nine months? Obviously we’ve experienced delays in the past and running through that and the long term has done okay and I was just curious on, has anything changed from nine, 10 months ago when things started slowing down and nothing was getting pushed through to today in terms of the conversations your having.

Karen King

Well, I’ll start and then if Michele or O.B. wants to jump in, that’s fine. I am very aware of the last tender processes and have been brought up to speed. I don’t believe anything has changed. I think what we continue to see is very typical developments in how these tenders materializes and a few things.

First is, as I mentioned in my comments, there’s always different factors impacting the tenders. It could be political, it could be in election years or when people are changing office can impact it. There are things regarding budget timing, etcetera that can impact it, so these are very typical things that we have always experienced in the company.

But what we do see is for those countries that have the ability to purchase female condoms through their own tender process, we see a continued use and interest and development of female condoms. So we see no slowdown there in terms of the usage or interests in female condoms.

So either Michele or O.B., anything you wanted to add to that.

O.B. Parrish

I guess just one thing I really have. Based on the historical perspective, we get involved with some of the key countries on these tender projects when they are interested in female condoms and we get involved with this ongoing, some of these issues that Karen has described. We have that (inaudible) where after that process is over, where the initial concept of buying female condoms just disappeared. In other words, the parties ultimately come through with the orders for the female condoms. So the pattern is the same and we haven’t yet experienced cases where people who bought up something that they ultimately decided not to buy at all.

Russell Mollen - Bares Capital

Got it. And how about just the progression from this most recent slowdown or issues with the tender process. Has there been progression from nine months ago when this started happening to today?

Karen King

Now I’m not sure that I can specifically say – progression regarding tenders?

Russell Mollen - Bares Capital

Well, progression regarding, yes the fulfillment of those tenders.

Karen King

Okay. So one thing Russ is that we are not really able to be in a position to discuss too much about tenders until they have been awarded and until we have the okay to speak to them. The countries specifically state they do not want these things discusses while you’re in process. So I think again the best thing that I can describe is just that the countries that have operated and go through a tender process for female condoms continues to be very interested in continuing those programs and supporting them and growing those programs further and that’s probably the only thing I can say.

Russell Mollen - Bares Capital

Got it, okay, okay. Thanks.

Operator

(Operator Instructions) Our next question comes from Jack Wallace of Sidoti. Please go ahead.

Jack Wallace - Sidoti & Co.

Good morning Karen, Michele, O.B., thanks for taking my questions.

Karen King

Good morning.

Jack Wallace - Sidoti & Co.

I just wanted to talk about some of the bigger customers who have historically, again so a little more detail here. Do you think there’s going to be any potential impact with a potential leadership change in Brazil? Ms. Rousseff had been a nice ally of your upsize in the last tender that was ultimately won in Brazil. Would loosing her in Brazil be a potential negative for the company.

Karen King

Well, you’re correct that Dilma Rousseff has been a big supporter of female condoms. The one thing that I can say about Brazil is probably of all of the countries that we deal with, it is the country that is most dedicated to this idea of supporting prevention and promoting prevention to all their citizens and they put up billboards and they do advertisings and they speak to condoms, because they want people to use protections and be safe. So I would not expect that that overall attitude towards prevention would change with a change in leadership, but of course I can’t really speak to what could happen as a result of the elections.

Jack Wallace - Sidoti & Co.

Okay, thank you and then while we’re on the Brazil topic, is there any piece of the elevated inventory levels this quarter that is earmarked for Brazil, potentially in an order specifically for the World Cup.

Karen King

I really can’t speak to that I’m afraid.

Jack Wallace - Sidoti & Co.

Okay. And then how about on this one, who are your 5% or more customers by country this quarter, specifically where Brazil or South Africa won.

Michele Greco

You know we issued the Q Jack. You will see the details there, but the countries will be Angola, South Africa, Tanzania, Uganda, those will be the main countries.

Jack Wallace - Sidoti & Co.

So the U.S. didn’t make the list of store at it.

Michele Greco

Well, and the U.S.

Jack Wallace - Sidoti & Co.

And the U.S, okay.

Michele Greco

And of course the US.

Jack Wallace - Sidoti & Co.

We seem to be on main stage, which is good news.

Michele Greco

Right, right.

Jack Wallace - Sidoti & Co.

Okay great and I think you answered the progress on the organization of 2020 initiative. It looks like – again, a little bit longer than anticipated, but it sounds like they are really starting to get the ball rolling there and I would assume that there are other countries outside of just Zimbabwe that are staring to have more concentrated efforts on education and training and basically sowing the seeds for potential order flow. Is that a pretty fair assumption there?

Karen King

Yes, that’s correct. But again, because we don’t speak to a lot of specific country activities, I just gave Zimbabwe as an example. But yes, there is many others.

Jack Wallace - Sidoti & Co.

Okay great. Thank you and then just a quick accounting question here. The fourth quarter last year, revenues were $4.8 million in operating. SG&A expense was just a touch over $0.5 million. In this quarter we had a little over $4.3 million operating expenses. We’re just underneath $1.6 million.

Now it was discussed in the fourth quarter that there was some incentive based compensation that wasn’t triggered in that quarter and I was wondering if there was a similar or to a lesser extent trigger in this quarter that would have led to higher operating expenses and a lower revenue quarter.

Michele Greco

There’s no incentive compensation expense in this quarter Jack.

Jack Wallace - Sidoti & Co.

Okay, okay. So I guess what expenses were in this quarter from the SG&A standpoint that weren’t in the fourth quarter of last year.

Michele Greco

A lot of it had to do with the timing of our training and education program and in the fourth quarter of last year, some of those programs were trading off versus where some of them are kind of in height right now.

Jack Wallace - Sidoti & Co.

Okay, that’s certainly helpful. Thanks and I’ll take additional questions offline. Thank you.

Operator

(Operator Instructions) As there appears to be no further questions, this concludes our question-and-answer session. I would like to turn the conference back over to Ms. King for any closing remarks.

Karen King

Okay. Well, thank you very much to everyone for your participation today and for your questions. We certainly are available if you have some additional questions that you would like to reach out to us offline, Michele or I today, we’re happy to take those calls and also I wanted to let you know that we will be presenting at the Sidoti Conference on May 9 and the B. Riley Conference in California on May 19. So we hope to see some of you there as well.

Thank you again very much and have a good day. Bye-bye.

Operator

To access the digital replay of this conference you may dial 1-877-344-7529 or 1-412-317-0088 beginning at 01:00 p.m. eastern time today. You will be prompted to enter a conference number, which will be 10044665. Please record your name and company when joining.

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.

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