The Female Health Company's (FHCO) CEO Karen King on Q4 2014 Results - Earnings Call Transcript

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The Female Health Company (FHCO) Q4 2014 Earnings Conference Call December 2, 2014 11:00 AM ET

Executives

Karen King - President and CEO

Michele Greco - CFO

Analysts

Eric Weinstein - Chancellor Capital

Peter McMullen - IPC Global

George Whiteside - SWS Financial Services

Operator

Hello and welcome to The Female Health Company, Fourth Quarter 2014 Fiscal Year Operating Results Conference Call. All participants will be in listen-only mode [Operator Instructions]. After today’s presentation, there will be an opportunity to ask questions.

Please note, the statements made on this conference call that are not historical in nature 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 developments could differ materially from the results or developments in such forward-looking statements.

Factors that may cause actual results or developments to differ materially include such things as product demand and market acceptance, the timing of receipt and shipment of large orders, competition, the economic and business environment, and the impact of government pressures, currency risks, capacity, efficiency and supply constraints, the ability to execute on new business strategies and on other risks detailed in the Company’s press releases, shareholder communications 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. Please also note this event is being recorded.

I would now like to turn the conference over to Ms. Karen King, CEO. Ms. King the floor is yours ma’am.

Karen King

Thank you, Mike. Good morning everyone. This is Karen King, President and CEO of The Female Health Company, and I would like to welcome all of you to The Female Health Company’s fiscal 2014 fourth quarter and full year conference call.

Joining me on the call today are the company's Chairman, OB Parrish and our CFO, Michele Greco. As we did on the last call, I will ask Michele to review the financial results for the fourth quarter and fiscal year ended September 30, 2014. Then I will discuss the implementation progress of our new strategic initiatives and comment on key factors that may impact future results. Afterwards, Michele and I will take your questions.

Please note that when we refer to years, it's to FHC's fiscal year which ended September 30th unless otherwise stated.

I will now turn the call over to Michele.

Michele Greco

Thanks Karen. We will start with the fourth quarter fiscal 2014 results. During the fourth quarter of 2014, the company recorded significant increases in unit volumes and revenues when compared with the prior year fourth quarter.

Unit sales totaled 9.7 million, up 16% from 8.4 million units in the fourth quarter of 2013. Net revenues for the quarter totaled $5.6 million, an increase of 16% from $4.8 million in the prior year fourth quarter.

Gross profit increased 27% to $2.9 million, which represented a 52% of net revenues compared with $2.3 million or 48% of net revenues in the prior year quarter. Operating expenses were $3.4 million compared with $0.5 million for the prior year quarter. The significant change year-to-year has two primary contributors.

First, in fiscal 2013 fourth quarter, the company reversed an accrual of incentive payment, and second, payment became due in the fourth quarter of fiscal 2014 to our Brazil distributor for programing related to the previous 2012 Brazil tender and for management services related to the recently announced 2014 tender.

An operating loss of 0.5 million was posted in fourth quarter of 2014 compared with 1.7 million in operating income for the prior year quarter. This change in operating income is primarily driven by the change in operating expenses that I just discussed.

Now turning to our full year results. For fiscal 2014, net revenues totaled $24.5 million, an increase of 22% from $31.5 million for fiscal 2013. Gross profit decreased 25% to $13.1 million, which represented 54% of net revenues compared with $17.5 million or 56% of net revenues in fiscal 2013.

Operating expenses increased 19% to $9.2 million compared with $7.7 million in fiscal 2013. Operating income totaled $3.9 million, a decrease of 60% when compared with $9.8 million in the prior year.

This decrease was primarily due to lower unit sales and the increased spending and sales marketing, training, and educational activities. The majority of such increased spending related to the payments for the company’s Brazilian distributor for programming related to the 2012 tender and for management services related to the recently announced 2014 tender.

Net income was $2.4 million or $0.08 per diluted share compared with $14.3 million or $0.50 diluted share in the prior year.

Now our cash flows, for fiscal 2014, the company generated $3.7 million in cash from operations which included the negative impact of $1.3 million from the changes in current assets and liabilities. In the previous fiscal year, FHC generated $11.8 million in cash from operations which included the positive impact of $1.4 million from changes in current assets and liabilities.

At September 30, 2014, the company's cash and equivalents totaled $5.8 million after paying $6.1 million in dividends during the first eight months of fiscal 2014. This compares to cash and equivalents of $8.9 million on the same date in 2013.

Our inventory totaled $3 million at the end of our most recent fiscal year, a 21% increase over the 2013 value of $2.5 million. The increase primarily reflects longer lead-times as many orders now require additional testing that can add up to four weeks in delivery time.

The tax loss carry-forwards. FHC has significant tax loss carry-forwards that maybe used to offset the cash payments of taxes on future earnings. These include $17 million in state and $17.3 million in Federal carry forwards in United States and $62.9 million in the U.K. The losses in the U.K. do not expire.

In summary, as has been the case since 2006, the company has remained profitable with positive cash flows generated during quarters of increasing and decreasing volumes and revenues.

I will turn it back to Karen.

Karen King

Thank you, Michele. Our fiscal 2014 was down in revenues and operating income when compared to the previous fiscal year. However, it was also a year with no purchase activity from one of our four largest clients, the Brazilian Ministry of Health. That will change in fiscal 2015 with the award of the recent tender. Operating increases related to -- primarily to previous programing commitments and the initiation of new sales and marketing efforts.

From a strategic perspective, 2014 was a watershed year for The Female Health Company as we identified a number of strategic initiatives that we fully expect to benefit all of the company's stakeholders in 2015 and in future years. I would like to review these strategic initiatives and the progress we are making to achieve our objectives.

As we announced in July and discussed on the third quarter conference call, we are implementing a growth strategy with two critical components. The first priority is to increase the demand for FC2 Female Condom. We're attacking this priority on several fronts.

First in our existing global public sector channel, we have focused extensively on relationships and approaches with our four key customers, which include UNFPA, USAID, the Brazil Ministry of Health, and the South African National Department of Health.

With regards to Brazil, we have already been able to demonstrate success winning the recent tender for up to 50 million units. For that tender, the Brazilian Ministry of Health has requested that we not speak to the specific orders under the tender until the product is delivered to their warehouse.

So, for now, I will just say that we're currently manufacturing for Brazil orders and we have added staff to our Malaysia production facility. We intend to announce our orders as the soon as possible time.

We have also begun redeploying a portion of our training and programing budget to focus on demand generation through sales and marketing activity. Susan Ostrowski, our new Executive VP of Sales and Marketing, was charged with transitioning our training organization to include a sales and marketing capability.

She has brought in two experienced sales and marketing professionals from the healthcare and global public sectors without adding to our current headcount. We're also carefully examining the performance of our distributors and have brought on several new distributors to drive greater female condom activity in targeted regions.

We expect all these initiatives to further build on the positive momentum and success we have already shown in Brazil. We're also evaluating how best to drive an increased consumer awareness of FC2 in the U.S., a market we have not previously focused on, but believe may have significant potential.

We have completed an analysis of data to assist us with defining our target population and are starting a series of studies and focus groups with those target populations to understand their motivations, purchase drivers, affective messaging, and the optimal avenue to reach them.

We're also consulting with outside experts in the area for advice on successful approaches. We believe there is an unmet need in the U.S. market for this product, due in part to the alarming incidence of sexually transmitted infections in young people here and the consequences of not using protection. We're doing our research upfront in order to more efficiently allocate our efforts, our resources, and investments.

The second critical element of our growth strategy is portfolio diversification. For the most of the company's 20 plus year history, we have been a single product company with great success since becoming profitable in 2006.

However, there are inherent risks associated with being a single product company, particularly when that product is subject to substantial volatility and customer purchasing pattern. The initiative to broaden our offering will drive company growth and depending on the products brought in, may also assist in fulfilling our FC2 strategies.

We have engaged to 35-year industry M&A veteran, with extensive deal experience in medical devices and pharma, to help us identify and evaluate potential acquisition candidates.

Together, he and I had examined dozens of opportunities and are currently in active discussions with several of high interest. While I am optimistic that we will find the right products to add to our portfolio, I cannot specifically predict a time for completion of the first deal. We are very actively engaged in these activities and have found several strong candidates in the field of women's reproductive and intimate health.

In summary, strategically, we're taking the right steps, we're building the right team, and we're beginning to show progress against our plans.

Now, turning to an outlook on FC2 and factors that could impact demand. There have been no changes in these demand drivers. HIV AIDS continues to be a serious challenge in many parts of the world, particularly among women who can benefit from a protection method under their control.

Other STI incident is soaring all around the world including the U.S. and disturbingly, it is most often among people, aged 15 to 24. While treatable STI can impart lasting consequences including infertility, the female condom is the only method initiated by a woman that can provide protection against unwanted pregnancy, STIs and also address this growing concern about STI impact on fertility. The global public sector world is continuing to support the importance of prevention through procurement of condom.

I'd like to provide a brief update on the competitive landscape. Cupid Ltd., an Indian-based public company introduced a female condom by the same name and has achieved WHO clearance. It does not have FDA approval.

We are aware that Cupid was awarded a portion of the last South African tender, but has only received very limited orders from UNFPA. We know that Cupid bid on the recently awarded Brazil tender through their local distributor, and that tender, as you know, was awarded exclusively to FHC through its distributor, Semina.

The other three female condoms in development, I have previously mentioned, the women's condom developed by PATH, and the Pleasure More and Fonar condoms developed by Chinese companies, continue to have no regulatory clearance by either WHO or FDA.

We're aware of another Indian product seeking WHO clearance. It is a sponge-based product similar to Cupid in design that had entered the market briefly about 10 years ago.

FC2 remains the only female condom to achieve both FDA approval and WHO clearance. FC2 is covered by 38 patents across 50 countries, more than 460 million FC1 and FC2 condoms have been distributed to more than a 144 countries with no recalls or customer rejected lots.

The Female Health Company has the capacity to produce up to a 100 million units annually making it the only manufacturer with the current ability to fulfil very large tenders.

We do not provide revenue and earnings guidance, though over the long-term, we believe the market for FC2 will continue to grow and there remains a significant untapped opportunity in demand and usage.

We believe The Female Health Company will experience growth and continued profitability due to the following factors. First the increased incidents and associated cost of sexually transmitted diseases in both developed and developing countries, the continue insignificance of HIV AIDS and the increased global focus on family planning. Donor support continues for both HIV AIDS prevention and family planning.

Second, internal efforts within the company to focus on untapped demand through more conventional sales and marketing initiatives, developing relationships with critical customers and marketing the unique features and benefits of FC2 directly to Ministries of Health. Additionally, efforts to create more demand in the U.S. are under investigations.

Third, Semina, our Brazilian distributor has been awarded an exclusive contract under a public tender to supply up to 50 million FC2s to the Brazilian Ministry of Health. This contract is valid through August 20th, of 2015 and the Ministry of Health will place orders against this tender at their discretion.

And fourth, commitment of our resources and focus on a growth strategy to drive demand for existing product increased our growth opportunities through product diversification and improve our predictability and consistency of our revenue and earnings.

To summarize we continue to drive sales of FC2 which includes a multi-facetted sales and marketing efforts. We are implementing a new strategic plan designed to drive future growth for the company and we're actively searching for product candidate that have the ability to grow sales, diversify our offering and deliver long-term value to our shareholders.

I also want to point out that Michele and I will be presenting at the LD Micro-Cap Conference in LA this week. So, any of you planning to attend the conference, I hope you will be able to join in our session.

This concludes our formal comments. Operator, we would now like to take questions.

Question-and-Answer Session

Operator

Yes ma'am. We will now begin the question-and-answer session. [Operator Instructions]

The first question we have comes from Eric Weinstein at Chancellor Capital. Please go ahead.

Eric Weinstein

Thanks. Sales were up -- this is one of the first operating losses, I think I've seen in quite some time. Obviously, it is a lot going on with the OpEx number for the fourth quarter; I'm hoping you could normalize it for us and walk us through what's recurring and what's not?

So, like I say we have a situation where we know you've been investing in business development activities, but at the same time -- we should bring it up, but at the same time, you’ve got these other things related to the 2012 Brazilian tender as well as the 2014 Brazilian tender that is impacting the number, but we're not sure exactly how. Can you give us a sense of what that number was for the quarter and what to expect going forward?

Karen King

Yes, absolutely Eric, I'm going to ask Michele to take us through that.

Michele Greco

Sure. Eric, yes, we haven’t had a loss in the quarter since 2010, in Q1 of 2010 and probably back in Q1 of 2007 since we've been -- become profitable. Looking at the fourth quarter, half of the increase in the operating expense is due to the reversal of the incentive compensation that happened in 2013, and that incentive compensation was reversed in the fourth quarter of 2013 because the company hadn’t achieved its target.

So, that's half of the increase. A third of the increase relates primarily to the costs associated with the Brazil -- the tender in 2014 and the programming in -- for 2012. Looking at it on a going forward basis, we're going to have programming costs related to the Brazil tender that will continue during 2015 and into 2016 as well, and we will have some ongoing management charges related to the 2014 tender.

Eric Weinstein

Okay. So, it seems like you sort of explained away 83% of the increase, so it went up -- sounds like more or like 17% on a normal basis, but there may be some other.

Michele Greco

Right. And the majority of that increase, Eric, is related to costs related to our new strategy and then just some other expenses.

Eric Weinstein

Sure. Congratulations on Brazil. Curious if there are any other public tenders out there of material size that have been announced and you are sort of just waiting for results, good or bad at this point?

Karen King

So, I think as you probably know Eric and probably most of the people who have frequently listened into our conference calls, we're not really able to speak to tenders while they are ongoing or while we're participating in the process until they have been awarded. So, I really couldn’t speak to if there's something else happening right now.

Eric Weinstein

Got it. And then last one with respect to M&A opportunities, can you talk to balancing -- what you're doing for strategic purposes in terms of diversifying the business, where is your focus on the financial profile of any acquisition targets with respect to whether or not they -- both in terms of size and to what extent they would be accretive?

Karen King

Yeah. So, I'm definitely -- all of those factors are definitely being taken into consideration along with other factors that you would expect us to be looking at like what competencies we would bring to bear or some benefits that we would be able to bring or what these products or opportunities conversely would have in terms of benefits for us.

But I am being a very conscious of the type of first deal that we do. Again, strategically wanting to stay within the target area of women's reproductive health and intimate health if possible, very much looking for things that can enhance all elements a very strategic focus and then of course, as you say Eric, really being conscious of where they are in their revenue generating model. Are they early in development or later stage and certainly for the first one, we're focusing more on those that would be marketed products or very soon to market.

Eric Weinstein

Okay. One of the great things about the business model, particularly if you are looking at sort of normalized OpEx, is that whether if you have a high volume for the quarter or low volume for the quarter, you are usually generating profits because it was high variable costs , low fixed costs. Do you see yourself venturing away from that model or trying to be consistent with it?

Karen King

Yeah. No, I don’t expect us to venture away from that model. You are absolutely right, but that is one of our strengths that has led to the financial stability of the company and we absolutely would want to be in a position to try to continue that going forward.

Eric Weinstein

Great. Thanks.

Operator

Next, we have Peter McMullen of IPC Global.

Peter McMullen

I just wonder if you could remind me what factors go into the incentive comp for the management? Has that changed going forward?

Karen King

So, I will speak to it and then Michele can jump in as well. Incentive comp for management is directly tied to the results of the company. So it’s based on achieving certain financial goals that are set for the company and executive comp is directly tied to that and actually to that alone, anything to add to that Michele?

Michele Greco

No, that’s it.

Peter McMullen

And why where there differences between this year and last year, again I think?

Karen King

Well, then the difference that Michele was talking about was more related to why we saw operating expenses in the fourth quarter of 2014 vary so much from the fourth quarter of 2013 and so what she was pointing to was that, what happened in the fourth quarter of 2013 was a reversal of an accrual for incentive comp because at that time not all of the objectives that had been met and this decision was made to reverse that accrual. So that contributed quite significantly to the very large change in fourth quarter operating expense.

Peter McMullen

So there was no accruals this year?

Karen King

For 2014, no. No, we didn’t hold on to it until the fourth quarter for an accrual, no.

Peter McMullen

Okay, understand. Thank you.

Operator

[Operator Instructions]

Next with George Whiteside of SWS Financial Services.

George Whiteside

Good morning. I would like a better understanding of your income tax expense and the fact that I have thought that you benefited on a quarter- by-quarter basis depending on your profitability. Could you give us some further detail on why deferred tax assets were realized versus taking it on to quarter-by-quarter basis?

Karen King

We’re doing analysis annually to look at the projection for the company and that was done again this year and at that time we determined how much of the NOLs can be recognized or how much need valuation allowance against them. And what happened in 2014 was through 2013 the majority of the NOLs have been recognized, so the valuation allowance was released over the years which resulted in a large benefit that you saw in the past in the income statement and that always occurred in the fourth quarter in the past.

And this year we are to the point where we have a small amount related to an entity in the U.K. that still has a valuation allowance left against it and currently it’s going to stay there until we determine that is reasonable and okay to recognize it. So, you’re going to see a continuing P&L charge for tax expense. However, we still have the NOLs and we will utilize the NOLs when we go to pay our taxes so it will reduce the amount of cash and say -- and conserve cash for the company.

George Whiteside

So in other words you in the past have recognized, in other words you bring a portion of the NOL through the income statement and…?

Karen King

Right…

George Whiteside

Excuse me?

Karen King

Right. A portion of the allowance against that NOL?

George Whiteside

Yes.

Karen King

Because we had determined in the past that we were more and more assured that we would be able to recognize it in the future. So as we were assured we could recognize it we reduced the valuation allowance and so the asset is sitting on the book. And to reduce that valuation allowance it increased income -- it was a benefit in the tax expense.

George Whiteside

In the past?

Karen King

In the past and that will not be recurring.

George Whiteside

Even though the NOL is still there…

Karen King

Can we get the cash balance…?

George Whiteside

You’re saying that you will not bring additional NOL into the income or through the income statement in the future in spite of profitability and your ability to control your tax liability?

Karen King

What will happen in the future is, we will use the NOL to reduce our tax liability and we will save the cash, but it will not come through the P&L.

George Whiteside

So that basically is a policy issue whereas in the past you would bring a portion in -- through the income statement and you've made a strategic decision that you will no longer do that?

Karen King

No its accounting rule.

George Whiteside

All right.

Karen King

And so that’s just how the accounting works. We've gotten to the point where all the valuation allowance came down because we are confident we will use the NOLs. The NOLs are sitting on the balance sheet as we use them to reduce our tax liability we will conserve cash. But from a P&L perspective, going forward, the company will always have a normalized tax charge. We just will be paying -- we will not be paying out the cash.

George Whiteside

Very good.

Karen King

And if you want to discuss this further, I would be happy to do that offline.

George Whiteside

Right. Another question would be in relationship to dividends. If I understand correctly, you anticipated higher expenses in terms of internally generated opportunities versus acquisitions that would give you diversity of a product? Is that the rational for reducing the dividends?

Karen King

I would say it little bit differently. It wasn’t necessarily that we anticipated higher expenses it was that I and the Board took a decision that we wanted to deploy our capital in future growth of the company in two areas, one, increasing FC2 demand and secondly in product diversification.

So a conscious decision was made that would be a better use of our capital and create greater shareholder value for everyone going forward.

George Whiteside

And I think the result of that was an adverse reaction of the market and is there any way to overcome those concerns on the part of shareholders?

Karen King

So I agree with you. That would be my assessment also for as far as how the market reacted. The best thing that we can do is continue to show progress against our plan. So we've outlined a very specific plan for how we are going to drive growth. We've started to show results of that. I considered the Brazil tender to be one of the first elements that we've been able to demonstrate success in our strategy and we will continue to do that and that’s the best way for us to assure the markets that we are on the right course.

George Whiteside

Thank you very much.

Karen King

Thank you.

Operator

At this time we will go ahead and conclude our question-and-answer session. I would now like to turn the conference call back over to Ms. King and management for any closing remarks. Ma’am?

Karen King

Okay. Thank you. Well, thank you all very much for joining us today and if anyone does want to have an individual discussion with Michele or I please give us a call. And also we hope to see some of you at the LD Micro-Cap Conference this week. So, thank you very much. Bye, bye.

Operator

And we thank you ma'am for your time today and the rest of the management team. To access a digital replay of this conference you may dial 1-877-344-7529 or area code 412-317-0088 beginning at about 1 o'clock P.M. Eastern Time today.

You will be prompted to enter a conference number, which will be 10056171. Again that conference number is 10056171. You will be prompted to record your name and company when joining. The conference is now concluded. Again we thank you all for attending today’s presentation. At this time you may now disconnect your lines. Thank you, and have a great day.

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