U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-QSB
(MARK ONE)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended June 30, 2003
[_] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
For the transition period from __________ to ____________
Commission File Number 1-13602
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THE FEMALE HEALTH COMPANY
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(Exact Name of Small Business Issuer as Specified in Its Charter)
Wisconsin 39-1144397
--------- ----------
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
515 North State Street, Suite 2225, Chicago, IL 60610
----------------------------------------------- -----
(Address of Principal Executive Offices) (Zip Code)
312-595-9123
------------
(Issuer's Telephone Number, Including Area Code)
Not applicable
--------------
(Former Name, Former Address and Former Fiscal Year,
If Changed Since Last Report)
Check whether the issuer: (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the issuer was required to file such reports) and (2) has
been subject to such filing requirements for the past 90 days.
YES X NO _
-
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practical date:
Common Stock, $.01 Par Value - 19,232,951 shares outstanding
as of August 13, 2003
Transitional Small Business Disclosure Format (check one):
YES _ NO X
-
FORM 10-QSB
THE FEMALE HEALTH COMPANY AND SUBSIDIARIES
INDEX
PART I. FINANCIAL INFORMATION AND MANAGEMENT'S
DISCUSSION AND ANALYSIS: PAGE
----
Cautionary Statement Regarding Forward Looking
Statements ........................................................ 3
Unaudited Condensed Consolidated Balance Sheet -
June 30, 2003 ..................................................... 4
Unaudited Condensed Consolidated
Statements of Operations -
Three Months Ended June 30, 2003
and June 30, 2002 ................................................. 5
Unaudited Condensed Consolidated
Statements of Operations -
Nine Months Ended June 30, 2003
and June 30, 2002 ................................................. 6
Unaudited Condensed Consolidated
Statements of Cash Flows -
Nine Months Ended June 30, 2003
and June 30, 2002 ................................................. 7
Notes to Unaudited Condensed
Consolidated Financial Statements ................................. 8
Management's Discussion and Analysis ................................ 16
Controls and Procedures ............................................. 26
PART II. OTHER INFORMATION
Items 1 - 5 ......................................................... 27
Exhibits and Reports on Form 8-K .................................... 27
SIGNATURES .......................................................... 29
2
CAUTIONARY STATEMENT REGARDING
FORWARD LOOKING STATEMENTS
Certain statements included in this quarterly report on Form 10-QSB
which are not statements of historical fact are intended to be, and are hereby
identified as "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. The Company cautions readers that
forward-looking statements involve known and unknown risks, uncertainties and
other factors that may cause the actual results, performance or achievements of
the Company to be materially different from any future results, performance or
achievement expressed or implied by such forward-looking statements. Such
factors include, among others, the following: the Company's inability to secure
adequate capital to fund operating losses; working capital requirements;
advertising and promotional expenditures and principal and interest payments on
debt obligations; factors related to increased competition from existing and new
competitors including new product introduction; price reduction and increased
spending on marketing; limitations on the Company's opportunities to enter into
and/or renew agreements with international partners; the failure of the Company
or its partners to successfully market, sell and deliver its product in
international markets; and risks inherent in doing business on an international
level, such as laws governing medical devices that differ from those in the
U.S., unexpected changes in the regulatory requirements, political risks, export
restrictions, tariffs and other trade barriers and fluctuations in currency
exchange rates; the disruption of production at the Company's manufacturing
facility due to raw material shortages, labor shortages and/or physical damage
to the Company's facilities; the Company's inability to manage its growth and to
adapt its administrative, operational and financial control systems to the needs
of the expanded entity and the failure of management to anticipate, respond to
and manage changing business conditions; the loss of the services of executive
officers and other key employees and the Company's continued ability to attract
and retain highly-skilled and qualified personnel; the costs and other effects
of litigation, governmental investigations, legal and administrative cases and
proceedings, settlements and investigations; and developments or assertions by
or against the Company relating to intellectual property rights.
3
THE FEMALE HEALTH COMPANY AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEET
June 30,
2003
-------------
ASSETS
Current Assets:
Cash .............................................................. $ 784,399
Restricted cash ................................................... 119,008
Accounts receivable, net .......................................... 1,798,454
Inventories ....................................................... 982,698
Prepaid expenses and other current assets ......................... 422,075
-------------
TOTAL CURRENT ASSETS ................................................. 4,106,634
-------------
Certificate of deposit ............................................... 95,443
Intellectual property rights, net .................................... 316,723
Other assets ......................................................... 162,284
-------------
574,450
-------------
PROPERTY, PLANT AND EQUIPMENT ........................................ 4,283,856
Less accumulated depreciation and amortization ....................... (3,812,748)
-------------
Net property, plant and equipment ................................... 471,108
-------------
TOTAL ASSETS ......................................................... $ 5,152,192
=============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Note payable, related party, net of unamortized discount .......... $ 780,474
Accounts payable .................................................. 381,703
Accrued expenses and other current liabilities .................... 648,799
Current maturities of obligations under capital leases ............ 25,838
Preferred dividends payable ....................................... 8,711
-------------
TOTAL CURRENT LIABILITIES ............................................ 1,845,525
-------------
Note payable, bank, net of unamortized discount ................... 1,242,908
Obligations under capital leases .................................. 36,327
Deferred gain on sale of facility ................................. 1,271,025
-------------
TOTAL LONG TERM LIABILITIES .......................................... 2,550,260
-------------
STOCKHOLDERS' EQUITY:
Convertible preferred stock ....................................... 560
Common stock ...................................................... 192,330
Additional paid-in-capital ........................................ 56,004,308
Unearned consulting compensation .................................. (88,175)
Deferred compensation ............................................. (131,116)
Accumulated deficit ............................................... (55,556,725)
Accumulated other comprehensive income ............................ 367,301
Treasury stock, at cost ........................................... (32,076)
-------------
TOTAL STOCKHOLDERS' EQUITY ........................................... 756,407
-------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ........................... $ 5,152,192
=============
See notes to unaudited condensed consolidated financial statements.
4
THE FEMALE HEALTH COMPANY AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended
June 30,
----------------------------
2003 2002
------------ ------------
Net revenues ..................................... $ 3,010,911 $ 1,991,287
Cost of products sold ............................ 1,991,990 1,073,929
------------ ------------
Gross profit ..................................... 1,018,921 917,358
------------ ------------
Advertising & promotion .......................... 9,698 12,725
Selling, general and administrative .............. 801,089 790,426
Litigation settlement ............................ --- 1,289,397
Stock compensation ............................... 206,625 1,331,238
------------ ------------
Total operating expenses ......................... 1,017,412 3,423,786
------------ ------------
Operating income (loss) .......................... 1,509 (2,506,428)
Interest, net and other expense .................. 250,045 294,581
------------ ------------
Net loss ......................................... (248,536) (2,801,009)
Preferred dividends, Series 1 .................... 2,902 32,910
------------ ------------
Net loss attributable to common stockholders ..... $ (251,438) $ (2,833,919)
============ ============
Net loss per common share outstanding ............ $ (0.01) $ (0.18)
Weighted average common shares outstanding ....... 19,228,896 16,035,261
See notes to unaudited condensed consolidated financial statements.
5
THE FEMALE HEALTH COMPANY AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Nine Months Ended
June 30,
----------------------------
2003 2002
------------ ------------
Net revenues ..................................... $ 6,939,144 $ 5,921,756
Cost of products sold ............................ 4,347,545 3,390,849
------------ ------------
Gross profit ..................................... 2,591,599 2,530,907
------------ ------------
Advertising & promotion .......................... 32,671 33,800
Selling, general and administrative .............. 2,700,477 2,225,084
Litigation settlement ............................ --- 1,289,397
Stock compensation ............................... 722,739 1,415,392
------------ ------------
Total operating expenses ......................... 3,455,887 4,963,673
------------ ------------
Operating loss ................................... (864,288) (2,432,766)
Interest, net and other expense .................. 763,843 706,449
------------ ------------
Net loss ......................................... (1,628,131) (3,139,215)
Preferred dividends, Series 1 .................... 8,711 98,734
------------ ------------
Net loss attributable to common stockholders ..... $ (1,636,842) $ (3,237,949)
============ ============
Net loss per common share outstanding ............ $ (0.09) $ (0.20)
Weighted average common shares outstanding ....... 18,910,689 15,967,922
See notes to unaudited condensed consolidated financial statements.
6
THE FEMALE HEALTH COMPANY AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended
June 30,
--------------------------
2003 2002
----------- -----------
OPERATIONS:
Net loss ........................................................... $(1,628,131) $(3,139,215)
Adjustment for noncash items:
Depreciation and amortization ..................................... 391,323 382,863
Interest added to certificate of deposit .......................... (3,443) (4,186)
Amortization of discounts on notes payable ........................ 521,886 463,317
Amortization of unearned consulting fees .......................... 255,838 106,534
Common stock issued for bonuses ................................... 128,700 ---
Litigation settlement ............................................. --- 1,289,397
Stock compensation ................................................ 466,901 1,308,858
Changes in operating assets and liabilities ....................... 408,175 (373,765)
----------- -----------
Net cash provided by (used in) operating activities ................ 541,249 (33,803)
----------- -----------
INVESTING ACTIVITIES:
Decrease in restricted cash ........................................ 71,901 ---
Capital expenditures ............................................... (44,907) (42,398)
----------- -----------
Net cash provided by (used in)investing activities ................. 26,994 (42,398)
----------- -----------
FINANCING ACTIVITIES:
Proceeds from note payable, bank ................................... - 500,000
Dividends paid on preferred stock .................................. (104,396) (95,825)
Payments on capital lease obligations .............................. (19,379) -
Proceeds from issuance of common stock ............................. - 60,000
----------- -----------
Net cash (used in) provided by financing activities ................ (123,775) 464,175
----------- -----------
Effect of exchange rate changes on cash ............................ (37,377) 8,867
----------- -----------
INCREASE IN CASH ................................................... 407,091 396,841
Cash at beginning of period ........................................ 377,308 406,766
----------- -----------
CASH AT END OF PERIOD .............................................. $ 784,399 $ 803,607
=========== ===========
Schedule of noncash financing and investing activities:
Common stock issued for payment of preferred stock dividends
and convertible debenture interest ................................ $ 40,777 $ 73,389
Common stock issued for conversion of convertible debentures ....... 450,000 ---
Preferred dividends declared, Series 1 ............................. 8,711 98,734
Issuance of warrants on notes payable and credit facility .......... 278,400 681,137
See notes to unaudited condensed consolidated financial statements.
7
THE FEMALE HEALTH COMPANY AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - Basis of Presentation
The accompanying financial statements are unaudited but in the opinion of
management contain all the adjustments (consisting of those of a normal
recurring nature) considered necessary to present fairly the financial position
and the results of operations and cash flow for the periods presented in
conformity with generally accepted accounting principles for interim financial
information and the instructions to Form 10-QSB and Article 10 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements.
Operating results for the nine months ended June 30, 2003 are not
necessarily indicative of the results that may be expected for the fiscal year
ending September 30, 2003. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Company's annual
report on Form 10-KSB for the fiscal year ended September 30, 2002.
Principles of consolidation and nature of operations:
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries, The Female Health Company - UK and The Female
Health Company - UK, plc. All significant intercompany transactions and accounts
have been eliminated in consolidation. The Female Health Company ("FHC" or the
"Company") is currently engaged in the marketing, manufacture and distribution
of a consumer health care product known as the female condom, "FC," in the U.S.
and "femidom," "femy" and "the female condom" outside the U.S. The Female Health
Company - UK, is the holding company of The Female Health Company - UK, plc,
which operates a 40,000 sq. ft. leased manufacturing facility located in London,
England.
Stock-Based compensation:
The Company accounts for its stock-based compensation plans under the
recognition and measurement principles of APB Opinion No. 25, Accounting for
Stock Issued to Employees, and related interpretations. The following table
illustrates the effect on net income and earnings per share if the Company had
applied the fair value recognition provisions of FASB Statement No. 123,
Accounting for Stock-Based Compensation, to stock-based employee compensation.
Nine Months Ended June 30
-----------------------------
2003 2002
------------- -------------
Net loss, as reported ............................ $(1,636,842) $(3,237,949)
Add: Stock option repricing, net of previously
recognized expense of $1,308,858 under APB 25 ... -- 404,690
Deduct: Total stock-based employee
compensation expense determined
under fair value based method for all awards,
net of related tax effects ...................... (157,839) (35,649)
----------- -----------
Pro forma net loss ............................... $(1,794,681) $(2,868,908)
=========== ===========
Loss per share:
As reported .................................... $ (0.09) $ (0.20)
=========== ===========
Pro forma ...................................... $ (0.09) $ (0.18)
=========== ===========
8
NOTE 1 - Basis of Presentation - (Continued)
New accounting pronouncements:
On November 2002, the Financial Accounting Standards Board (FASB) issued
FASB Interpretation (FIN) No. 45, Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness to
Others. FIN 45 elaborates on the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under certain
guarantees that it has issued. It also clarifies that a guarantor is required to
recognize, at the inception of certain guarantee contracts, a liability for the
fair value of the obligation undertaken in issuing the guarantee. FIN 45 also
incorporates, without change, the guidance in FIN 34, Disclosure of Indirect
Guarantees of Indebtedness of Others, which is being superseded. FIN 45 is
effective for financial statements issued for fiscal years ending after December
15, 2002. FIN 45 has no effect on the Company's financial statements.
In December 2002, the Financial Accounting Standards Board (FASB) issued
FASB Interpretation (FIN) No. 46, Consolidation of Variable Interest Entities.
FIN 46 establishes standards for identifying a variable interest entity and for
determining under what circumstances a variable interest entity should be
consolidated with its primary beneficiary, including those to which the usual
condition of consolidation does not apply. FIN 46 applies immediately to
variable interest entities created after January 31, 2003 and applies to
existing variable interest entities in the first fiscal year or interim period
beginning after June 15, 2003. Management does not anticipate that the adoption
of FIN 46 will have a significant effect on the Company's financial statements.
In May 2003, the FASB issued SFAS 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. SFAS 150
requires that certain freestanding financial instruments be reported as
liabilities in the balance sheet. Depending on the type of financial instrument,
it will be accounted for at either fair value or the present value of future
cash flows determined at each balance sheet date with the change in that value
reported as interest expense in the income statement. Prior to the application
of SFAS 150, either those financial instruments were not required to be
recognized, or if recognized were reported in the balance sheet as equity and
changes in the value of those instruments were normally not recognized in net
income. The Company is required to apply SFAS 150 for the interim period
beginning on July 1, 2003. Management does not anticipate that the adoption of
SFAS 150 will have a significant effect on the Company's financial statements.
Reclassification:
Certain items in the financial statements for the three and nine months
ended June 30, 2002 have been reclassified to be consistent with the
presentation shown for the three and nine months ended June 30, 2003.
NOTE 2 - Earnings Per Share
Earnings per share (EPS): Basic EPS is computed by dividing income
available to common stockholders by the weighted average number of common shares
outstanding for the period. Diluted EPS is computed giving effect to all
dilutive potential common shares that were
9
NOTE 2 - Earnings Per Share - (Continued)
outstanding during the period. Dilutive potential common shares consist of the
incremental common shares issuable upon conversion of convertible preferred or
convertible debt and the exercise of stock options and warrants for all periods.
Fully diluted (loss) per share is not presented since the effect would be
anti-dilutive.
NOTE 3 - Comprehensive Income (Loss)
Total Comprehensive Loss was $(136,021) and $(1,485,783) for the three and
nine months ended June 30, 2003 and $(2,627,922) and $(3,017,099) for the three
and nine months ended June 30, 2002.
NOTE 4 - Inventories
The components of inventory consist of the following:
June 30, 2003
-------------
Raw Material and work in process ............................. $ 558,295
Finished goods ............................................... 454,333
-----------
Inventory, gross ............................................. 1,012,628
Less: inventory reserves ..................................... (29,930)
-----------
Inventory, net ............................................... $ 982,698
===========
NOTE 5 - Financial Condition
The Company's consolidated financial statements have been prepared on a
going concern basis which contemplates the realization of assets and the
settlement of liabilities and commitments in the normal course of business. The
Company incurred a net loss of $1.6 million for the nine months ended June 30,
2003 and as of June 30, 2003 had an accumulated deficit of $55.6 million. At
June 30, 2003, the Company had working capital of $2.3 million and stockholders'
equity of $0.8 million. In the near term, the Company expects operating and
capital costs to on occasion exceed funds generated from operations due
principally to the Company's manufacturing costs relative to current production
volumes, quarterly variations in the timing and shipment of orders and the
ongoing need to commercialize the Female Condom around the world. As a result,
operations may on occasion use working capital The Company may also need to
raise capital to repay outstanding debt as it comes due. Management recognizes
that the Company's continued operations may depend on its ability to raise
additional capital through a combination of equity or debt financing, strategic
alliances and increased sales volumes.
At various points during the developmental stage of the product, the
Company was able to secure resources, in large part through the sale of equity
and debt securities, to satisfy its funding requirements. As a result, the
Company was able to obtain FDA approval, worldwide rights, manufacturing
facilities and equipment and to commercially launch the Female Condom.
10
NOTE 5 - Financial Condition - (Continued)
Management believes that developments, including the Company's agreement
with the UNAIDS, a joint United Nations program on HIV/AIDS, and various
distribution partners in major countries, provide an indication of the Company's
success in broadening awareness and distribution of the Female Condom and may
benefit future efforts to raise additional capital and to secure additional
agreements to promote and distribute the Female Condom throughout other parts of
the world. On May 18, 2001, the Company entered into an agreement with Heartland
Bank providing for a $2,000,000 credit facility. The unpaid balances on the
credit facility are due May 18, 2004, and bear interest payable at a rate of 10%
per year. The agreement contains certain covenants which include restrictions on
distributions and on the issuance of warrants, which the Company was in
violation of at March 31, 2003. Under the terms of the agreement, Heartland Bank
would have had the right to demand payment of the entire balance of the credit
facility as a result of this violation. On May 14, 2003, the Company obtained a
waiver from Heartland Bank of its right to demand payment of the credit facility
as a result of the violation through the entire fiscal year ending September 30,
2003. The Company may borrow under the credit facility from time to time subject
to a number of conditions, including obtaining personal guarantees of 125% of
the amount outstanding under the credit facility. As of June 30, 2003 the
Company had paid down $100,000 of the $2,000,000 borrowed under the credit
facility. The credit facility is recorded at June 30, 2003, net of unamortized
discount of $1,242,908.
On June 1, 2001, the Company issued an aggregate of $200,000 of convertible
debentures to two accredited investors. The debentures were due May 30, 2004,
bore interest payable at a rate of 10% per annum and were convertible into the
Company's common stock based on a price equal to $0.50 per share. The Company
did not issue warrants in connection with the issuance of the convertible
debentures. On December 5, 2002, the investors converted their debentures into
an aggregate of 400,000 shares of the Company's common stock.
On March 30, 2001, the Company issued a $250,000 convertible debenture to
one accredited investor. The debenture was due March 30, 2004, bore interest
payable at a rate of 12% per annum, and was convertible into the Company's
common stock based on a price equal to $0.50 per share. The Company did not
issue warrants in connection with the issuance of the convertible debenture. On
January 12, 2003, the investor converted his debenture into 500,000 shares of
the Company's common stock.
While the Company believes that its existing capital resources will be
adequate to fund its currently anticipated capital needs, if they are not, the
Company may need to raise additional capital until its sales increase
sufficiently to cover operating expenses.
If internally generated funds are not sufficient to meet cash requirements,
FHC will need to generate sufficient capital from outside sources. While
management believes that revenue from sales of the Female Condom will eventually
exceed operating costs and that ultimately operations will generate sufficient
funds to meet capital requirements, there can be no assurance that such level of
operations will be achieved or sustained. Likewise, there can be no assurance
that the Company will be able to source all or any portion of its required
capital through the sale of debt or equity or, if raised, the amount will be
sufficient to operate the Company until sales of
11
NOTE 5 - Financial Condition - (Continued)
the Female Condom generate sufficient revenues to fund operations. In addition,
any funds raised may be costly to the Company and/or dilutive to stockholders.
If the Company is not able to source the required funds or any future capital
which becomes required, the Company may be forced to sell certain of its assets
or rights or cease operations.
NOTE 6 - Stock Compensation
In September 2001, the holders of exercisable stock options waived their
rights to exercise their options until the Company amended its articles of
incorporation to increase the number of shares of common stock authorized for
issuance. To obtain this waiver, the Company agreed to re-price these options at
$0.56 per share once the amendment was approved. The Company's common stock was
trading at less than $0.56 per share when the waivers were obtained. The total
number of options that were waived at September 30, 2001, was 2,659,800.
On May 8, 2002, the shareholders approved an amendment to the Amended and
Restated Articles of Incorporation to increase the total number of authorized
shares of common stock from 27,000,000 to 35,500,000 shares. Since the amendment
was approved, the stock options have been re-priced to $0.56 per share. The
Company has accounted for all of these stock options in accordance with variable
plan accounting guidance provided in APB No. 25 and related interpretations. The
reduction in the exercise price of the re-priced options and the increase in the
stock price of the Company's common stock as of September 30, 2002, resulted in
$1,720,322 of stock compensation expense due to the repricing for the year ended
September 30, 2002.
Effective September 2002, the holders of outstanding options to purchase a
total of 2,365,980 shares of common stock agreed to exchange their options for:
- a total of 469,000 shares of restricted common stock in the case of
U.S. option holders or the right to receive a total of 122,495 shares
of deferred common stock in September 2003 in the case of U.K. option
holders; and
- the right to receive a grant of new options to purchase a total of
2,365,980 shares of common stock on the first business day that is at
least six months and one day after the effective date of the exchange.
The shares of restricted common stock and the right to receive the shares
of deferred common stock are subject to forfeiture if the participant
voluntarily resigns or is terminated for cause on or before September 26, 2003,
and may not be transferred on or before September 26, 2003. As of September 30,
2002, the Company had issued the restricted common stock to U.S. option holders
and accrued for the issuance of deferred common stock to U.K. option holders.
The restricted and deferred shares have been recorded as deferred compensation
within stockholders' equity as of September 30, 2002, and will be amortized over
the employees' one-year service periods.
The new options will have an exercise price equal to 100% of the fair
market value of the common stock on the grant date and a vesting schedule of
1/36 per month for each of the first 36
12
NOTE 6 - Stock Compensation - Continued
months after the date of grant. The new options which were granted on April 22,
2003, at an exercise price of $1.40 are being accounted for in accordance with
fixed plan accounting guidance provided in APB No. 25. Options to purchase a
total of 320,000 shares of common stock did not participate in the exchange. As
of June 30, 2003 10,000 of the 320,000 share total were still outstanding and
will continue to be accounted for in accordance with variable plan accounting
guidance.
NOTE 7 - Preferred Stock
During September 2002, the Company offered the holders of the outstanding 8
% cumulative convertible preferred stock (Series 1) the right to convert their
shares of Series 1 Preferred Stock into shares of common stock based on a price
of $1.80 per share. This resulted in a conversion rate of approximately 1.39
shares of common stock per share of Series 1 Preferred Stock rather than the 1
to 1 conversion rate set forth in the Company's Articles of Incorporation. As of
June 30, 2003, a total of 604,000 shares of Series 1 Preferred Stock were
converted into a total of 838,799 shares of common stock.
The Company has 56,000 outstanding shares of Series 1 Preferred Stock. Each
share of Series 1 Preferred Stock is convertible into one share of the Company's
common stock on or after August 1, 1998. Annual preferred stock dividends will
be paid if and as declared by the Company's Board of Directors. No dividends or
other distributions will be payable on the Company's common stock unless
dividends are paid in full on the Series 1 Preferred Stock. The Series 1
Preferred Stock may be redeemed at the option of FHC, in whole or in part, on or
after August 1, 2000, subject to certain conditions, at $2.50 per share plus
accrued and unpaid dividends. In the event of a liquidation or dissolution of
the Company, the Series 1 Preferred Stock would have priority over the Company's
common stock.
13
NOTE 8 - Industry Segments And Financial Information About Foreign and Domestic
Operations
The Company currently operates primarily in one industry segment which
includes the development, manufacture and marketing of consumer health care
products.
The Company operates in foreign and domestic regions. Information about the
Company's operations by geographic area is as follows:
(Amounts in Thousands)
Net Sales to
External Customers
For the Long-Term Assets
Nine Months Ended As of
June 30, June 30,
------------------------------------- -------------------------------------
2003 2002 2003 2002
---------------- ---------------- ---------------- ----------------
United States ...................... $ 1,721 $ 2,131 $ 130 $ 154
Brazil ............................. 1,107 1,049 - -
France ............................. 381 * - -
South Africa ....................... 1,108 594 - -
United Kingdom ..................... * * 916 1,291
Zimbabwe ........................... 671 786 - -
Other .............................. 1,951 1,362 - -
-------------- ------------ ----------- ------------
$ 6,939 $ 5,922 $ 1,046 $ 1,445
* Less than 5 percent of total net sales
NOTE 9 - Contingent Liabilities
The testing, manufacturing and marketing of consumer products by the
Company entail an inherent risk that product liability claims will be asserted
against the Company. The Company maintains product liability insurance coverage
for claims arising from the use of its products. The coverage amount is
currently $5,000,000 for FHC's consumer health care product.
Note 10 - Accounting Change and Acquired Intangible Asset
The Company adopted SFAS 142, Goodwill and Other Intangible Assets,
effective October 1, 2002. At the date of adoption, the Company reassessed the
estimated useful lives of its definite life intangible assets, and found the
previously determined lives to be appropriate. The following is a summary of
acquired intangible assets at June 30, 2003:
Gross Carrying Accumulated
Amount Amortization
---------------------- ---------------------
Subject to amortization:
Patents .......................... $1,123,214 $806,491
Amortization expense recognized on all amortizable intangible assets
totaled $71,439 and $57,586 for the nine months ended June 30, 2003 and 2002,
respectively.
14
Note 10 - Accounting Change and Acquired Intangible Asset - (Continued)
Estimated aggregate amortization expenses for each of the next following
years is as follows:
Year ending September 30:
------------------------
2003 $ 30,651
2004 122,602
2005 122,602
2006 40,868
---------------
$ 316,723
===============
15
THE FEMALE HEALTH COMPANY AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS
GENERAL
The Female Health Company ("FHC" or the "Company") manufactures, markets
and sells the female condom, the only FDA-approved product under a woman's
control which can prevent unintended pregnancy and sexually transmitted diseases
("STDs"), including HIV/AIDS.
The female condom has undergone extensive testing for efficacy, safety and
acceptability, not only in the United States but also in many countries around
the world. Certain of these studies show that having the female condom available
allows women to have more options, resulting in an increase in protected sex
acts and a decrease in STDs, including HIV/AIDS.
The product is currently sold or available in various venues including
commercial (private sector) and public sector clinics in over 100 countries. It
is commercially marketed in 21 countries by various FHC country specific
partners, including the United States, United Kingdom, Japan, Canada, Holland,
France, Venezuela and Brazil.
As noted above, the female condom is sold to the global public sector. In
the U.S., the product is marketed to city and state public health clinics as
well as not-for-profit organizations such as Planned Parenthood. The product is
available to developing countries under the umbrella of an agreement with
UNAIDS. This agreement facilitates the availability and distribution of the
female condom at a reduced price based on the Company's cost of production. The
current price per unit is approximately 0.38 (Pounds), or approximately $0.63.
Currently 87 developing countries purchase the female condom under the terms of
this agreement.
Product
The female condom is made of polyurethane, a thin but strong material
which is resistant to rips and tears during use. The female condom consists of a
soft, loose fitting sheath and two flexible O rings. One of the rings is used to
insert the device and helps to hold it in place. The other ring remains outside
the vagina after insertion. The female condom lines the vagina, preventing skin
from touching skin during intercourse. The female condom is pre-lubricated and
disposable and is intended for use during only one sex act.
Raw Materials
Polyurethane is the principal raw material the Company uses to produce the
female condom. The Company has entered into a supply agreement with Deerfield
Urethane, Inc. for the purchase of all of the Company's requirements of
polyurethane. Under this agreement, the parties negotiate pricing on an annual
basis. The original term of the agreement extended to December 31, 1995, and
thereafter automatically renews for additional one year periods unless either
party gives at least 12 months prior written notice of termination.
16
Global Market Potential
It is more than 20 years since the first clinical evidence of AIDS was
noted. HIV/AIDS is the most devastating pandemic that humankind has faced in
recorded history. UNAIDS and the World Health Organization ("WHO") estimate that
more than 60 million people have been infected with the virus and that, at the
end of 2002, 44 million people globally were living with HIV. Women now comprise
the majority of the new cases. AIDS is not the only sexually transmitted disease
that the global public health community is battling. In the United States, the
Centers for Disease Control and Prevention noted that 1 in 5 Americans over the
age of 12 has Herpes and 1 in every 3 sexually active people will get an STD by
age 24.
Currently there are only two products that prevent the transmission of
HIV/AIDS through sexual intercourse--the latex male condom and the female
condom.
Male Condom Market: It is estimated the global annual market for male
condoms is more than five billion units. However, the majority of all acts of
sexual intercourse, excluding those intended to result in pregnancy, are
completed without protection. As a result, it is estimated the potential market
for barrier contraceptives is much larger than the identified male condom
market.
Advantages Versus the Male Condom
The female condom is currently the only available barrier contraceptive
method controlled by women which allows them to protect themselves from
unintended pregnancy and STDs, including HIV/AIDS. The most important advantage
is that using the female condom, a woman has a prevention method she controls as
many men do not like to wear male condoms and may refuse to do so.
The polyurethane material that is used for the female condom offers a
number of benefits over latex, the material that is most commonly used in male
condoms. Polyurethane is much stronger than latex, reducing the probability that
the female condom sheath will tear during use. Unlike latex, polyurethane
quickly transfers heat, so the female condom immediately warms to body
temperature when it is inserted, which may result in increased pleasure and
sensation during use. The product offers an additional benefit to the 7% to 20%
of the population that is allergic to latex and who, as a result, may be
irritated by latex male condoms. To the Company's knowledge, there is no
reported allergy to date to polyurethane. The female condom is also more
convenient, providing the option of insertion hours before sexual arousal and as
a result is less disruptive during sexual intimacy than the male condom which
requires sexual arousal for application.
Cost Effectiveness
Various studies have been reported in the literature on the
cost-effectiveness of the female condom. The studies show that making the female
condom available is highly cost effective in reducing public health costs in
developing countries as well as in the U.S. Further studies show that including
the female condom in prevention programs to high risk groups is not only
cost-effective but cost-saving.
17
Female Condom Reuse
A new website funded by the UK's Department for Institutional Development
(DFID) has been established "to enhance the capacity of female condom
programmers to make appropriate decisions about reuse of FC female condoms." The
site is managed jointly by JSI (UK) in partnership with the Female Health
Foundation. Limited availability of FC has led women to reuse the FC female
condom. Given this, the World Health Organization (WHO) and United States Agency
for International Development (USAID) funded research on the safety of reuse.
The website presents the WHO protocol and guidelines as well as offering
the opportunity for discussion. The website is located at www.femalecondom.org.
Worldwide Regulatory Approvals
The female condom received Pre-Market Approval ("PMA") as a Class III
Medical Device from the U.S. Food and Drug Administration ("FDA") in 1993. The
extensive clinical testing and scientific data required for FDA approval laid
the foundation for approvals throughout the rest of the world, including receipt
of a CE Mark in 1997 which allows the Company to market the female condom
throughout the European Union ("EU"). In addition to the United States and the
EU, several other countries have approved the female condom for sale, including
Canada, Russia, Australia, Japan, South Korea and Taiwan.
The Company believes that the female condom's PMA and FDA classification
as a Class III Medical Device create a significant barrier to entry. The Company
estimates that it would take a minimum of four to six years to implement,
execute and receive FDA approval of a PMA to market another type of female
condom.
The Company believes there are no material issues or material costs
associated with the Company's compliance with environmental laws related to the
manufacture and distribution of the female condom.
Strategy
The Company's strategy is to act as a manufacturer, selling the female
condom to the global public sector, United States public sector and commercial
partners for country-specific marketing. The public sector and commercial
partners assume the cost of shipping and marketing the product. As a result, as
volume increases, the Company's operating expenses will not increase
significantly.
The Company recently announced that it has filed a patent on a second
generation female condom (FC2). If safety studies are successful, the Company
anticipates a meaningful reduction in cost to manufacture FC2 and a significant
extension of its proprietary market position.
Commercial Markets
The Company markets the product directly in the United Kingdom. The
Company has distribution agreements with commercial partners in 17 countries
including the United States,
18
Japan, Canada, Brazil, Venezuela, Denmark, Holland and France, and signed a
non-binding memorandum of understanding with Hindustan Latex Limited in India.
The agreements are generally exclusive for a single country. Under these
agreements, each partner markets and distributes the female condom in a single
country and the Company manufactures the female condom and sells the product to
the partner for distribution in that country.
Relationships and Agreements with Public Sector Organizations
Currently, it is estimated more than 1.5 billion male condoms are
distributed worldwide by the public sector each year. The female condom is seen
as an important addition to prevention strategies by the public sector because
studies show that the availability of the female condom decreases the amount of
unprotected sex by as much as 25% over male condoms alone.
The Company has an agreement with UNAIDS to supply the female condom to
developing countries at a reduced price which is negotiated each year based on
the Company's cost of production. The current price per unit is approximately
0.38 (pounds), or approximately $0.63. Under the agreement, UNAIDS and the
Company cooperate in education efforts and marketing the female condom in
developing countries. Sales of the female condom are made directly to public
health authorities in each country at the price established by the agreement
with UNAIDS. The term of the agreement currently expires on December 31, 2003,
but automatically renews for additional one-year periods unless either party
gives at least 90 days prior written notice of termination. The female condom is
available in 87 countries through public sector distribution. Twenty-seven
countries have significant programs and are using The Female Condom - the Guide
To Programming and Planning, published by UNAIDS and WHO with the Company's
input. This is up from eight countries the previous year.
In the United States, the product is marketed to city and state public
health clinics, as well as not-for-profit organizations such as Planned
Parenthood.
State-of-the-Art Manufacturing Facility
The Company manufactures the female condom in a 40,000 square-foot leased
facility in London, England. The facility is currently capable of producing 60
million units per year. With additional equipment, this capacity can be
significantly increased.
Government Regulation
In the U.S., the female condom is regulated by the FDA. Pursuant to
section 515(a)(3) of the Safe Medical Amendments Act of 1990 (the "SMA Act"),
the FDA may temporarily suspend approval and initiate withdrawal of the PMA if
the FDA finds that the female condom is unsafe or ineffective, or on the basis
of new information with respect to the device, which, when evaluated together
with information available at the time of approval, indicates a lack of
reasonable assurance that the device is safe or effective under the conditions
of use prescribed, recommended or suggested in the labeling. Failure to comply
with the conditions of FDA approval invalidates the approval order. Commercial
distribution of a device that is not in compliance with these conditions is a
violation of the SMA Act.
19
Competition
The Company's female condom participates in the same market as male
condoms but is not seen as directly competing with male condoms. Rather, the
Company believes that providing the female condom is additive in terms of
prevention and choice. Latex male condoms cost less and have brand names that
are more widely recognized than the female condom. In addition, male condoms are
generally manufactured and marketed by companies with significantly greater
financial resources than the Company. It is also possible that other parties may
develop a female condom. These competing products could be manufactured,
marketed and sold by companies with significantly greater financial resources
than those of the Company.
Patents and Trademarks
The Company currently holds product and technology patents in the United
States, Japan, the United Kingdom, France, Italy, Germany, Spain, the European
Patent Convention, Canada, The People's Republic of China, Brazil, South Korea
and Australia. Additional technology patents are pending in Japan. The patents
cover the key aspects of the female condom, including its overall design and
manufacturing process. The Company has the registered trademark "FC Female
Condom" in the United States. The Company has also secured, or applied for, 12
trademarks in 22 countries to protect the various names and symbols used in
marketing the product around the world. These include "femidom," "femy" and
others. In addition, the experience that has been gained through years of
manufacturing the female condom has allowed the Company to develop trade secrets
and know-how, including certain proprietary production technologies that further
secure its competitive position.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2003 COMPARED TO THREE MONTHS ENDED JUNE 30, 2002
The Company had net revenues of $3,010,911 and a net loss attributable to
common stockholders of $(251,438) or $(0.01) per share for the three months
ended June 30, 2003 compared to net revenues of $1,991,287 and a net loss
attributable to common stockholders of $(2,833,919) or $(0.18) per share for the
three months ended June 30, 2002.
Gross profit increased $101,563, or 11%, to $1,018,921 for the three
months ended June 30, 2003 from $917,358 for the three months ended June 30,
2002. The increase was a result of expanding net revenues partially offset by a
more than proportionate increase in cost of products sold.
Net revenues increased $1,019,624 in the current quarter, or 51%, compared
with the same period last year. The higher net revenues occurred because of
higher unit sales shipped to global public customers offset slightly by a
reduction in domestic public sector customers and a reduction of the average
selling price per unit. Overall, unit sales in the current quarter increased 58%
from the same period last year. Unit sales for the three months ended June 30,
2003, were the highest in the Company's history.
20
The results for the third fiscal quarter of 2003 reflect a significant
quarterly variation due to the timing and shipment of large orders and not any
fundamental change in the business. The Company routinely notes the potential
for such quarter to quarter variations in its press releases and SEC filings.
Cost of products sold increased $918,061, or 85%, to $1,991,990 in the
current Quarter from $1,073,929 for the same period last year. The rise in cost
of products sold is a result of higher indirect production, direct labor and
research and development costs for the current quarter compared to the same
period last year. Higher employment and maintenance costs were the primary
factors causing the rise in indirect production costs. Direct labor grew as a
result of an across the board 3% raise for hourly labor in fiscal 2003 whereas
no such raise was provided in the prior fiscal year. The higher research and
development costs related to efforts to develop a second generation product.
Advertising and promotional expenditures decreased $3,027 to $9,698 in the
current quarter from $12,725 for the same period in the prior year.
Selling, general and administrative expenses increased $10,663, or 1%, to
$801,089 in the current quarter from $790,426 for the same period last year. As
a percentage of net revenues, selling, general and administrative expenses
decreased to 27% for the three months ended June 30, 2003 from 40% for the three
months ended June 30, 2002, due to the fixed nature of the majority of these
costs.
Non-cash litigation settlement costs were incurred in the three months
ended June 30, 2002. The former holders of the $1,500,000 convertible debentures
issued on May 19, 1999 and June 3, 1999, alleged that the Company was in default
with respect to perfection of the former holder's security interest in the
Company's assets. On July 23, 2002, the Company and the former holders settled
the dispute out of court. The Company issued 450,000 shares of the Company's
common stock to the former convertible debenture holders and to extend the
expiration dates of 2.25 million warrants held by the former holders until 2007.
No such settlement resulted in the three months ended June 30, 2003.
Non-cash stock compensation costs decreased $1,124,613 to $206,625 for the
current quarter compared to $1,331,238 for the same period last year. As
explained in Note 6 in the Notes to Unaudited Condensed Consolidated Financial
Statements section, the reduction of the exercise price of the repriced stock
options and the increase in the stock price of the Company's common stock as of
June 30, 2002, resulted in the Company recording $1,308,858 for the three months
ended June 30, 2002. Neither of these costs were incurred for the three months
ended June 30, 2003, resulting in the decrease. The three months ended June 30,
2003 stock compensation costs are comprised of deferred compensation costs and
compensation provided to outside investor relation consultants.
Net interest and other expenses decreased $44,536 to $250,045 for the
current period from $294,581 for the same period last year. The decline resulted
from a reduction of interest expense paid related to $450,000 convertible
debentures that were converted in the first half of fiscal 2003 and because the
Company had a smaller amount of non-cash expenses incurred from the amortization
of discounts on notes payable and credit facility than the third quarter of the
prior year.
21
NINE MONTHS ENDED JUNE 30, 2003 COMPARED TO NINE MONTHS ENDED JUNE 30, 2002
The Company had net revenues of $6,939,144 and a net loss attributable to
common stockholders of $(1,636,842) or $(0.09) per share for the nine months
ended June 30, 2003, compared to net revenues of $5,921,756 and a net loss
attributable to common stockholders of $(3,237,949) or $(0.20) per share for the
nine months ended June 30, 2002.
Gross profit increased $60,692, or 2%, to $2,591,599 for the nine months
ended June 30, 2003, from $2,530,907 for the nine months ended June 30, 2002.
The increase was a result of an increase in net revenues partially offset by an
increase in cost of products sold and a 10% reduction of the average realized
sales price per unit.
Net revenues for the nine months ended June 30, 2003, increased $1,017,388
or 17%, compared with the same period last year. The higher net revenues
occurred because of higher unit sales shipped to global public sector partially
offset by a decrease in domestic public sector shipments. Overall unit sales for
the nine months ended June 30, 2003, increased 19% compared to the same period
last year.
Cost of products sold increased $956,696, or 28%, to $4,347,545 for the
nine months ended June 30, 2003, from $3,390,849 for the same period last year.
The increase resulted from an increase in indirect production, direct labor and
research and development costs between the current and prior fiscal years.
Higher employment and maintenance costs were the primary factors for the rise in
indirect production costs. Direct labor costs grew as a result of an across the
board 3% raise for hourly labor in fiscal 2003 whereas no such raise was
provided in the prior fiscal year. The higher research and development cost
related to efforts to develop a second generation product.
Advertising and promotional expenditures decreased $1,129 to $32,671 for
the nine months ended June 30, 2003, from $33,800 for the same period in the
prior year.
Selling, general and administrative expenses increased $475,393, or 21%,
to $2,700,477 for the nine months ended June 30, 2003, from $2,225,084 for the
same period last year. As a percentage of net revenues, selling, general and
administrative expenses increased to 39% for the nine months ended June 30,
2003, from 38% for the nine months ended June 30, 2002. Increases in UK rates,
insurance, outside legal, accounting and consulting costs as well as a $128,700
fiscal year 2002 non-cash bonus provided to senior management were the primary
causes for the 21% increase. The higher rates were due to a combination of a
rent increase effective in fiscal 2003 and a rent rebate which was experienced
within the first six months of the 2002 fiscal year. The additional legal fees
were largely related to services related to the development of the second
generation product. The rise in accounting costs stems from research provided
primarily related to employee stock option plans. The bonuses were approved by
the board of director's compensation committee on February 12, 2003.
Non-cash litigation settlement costs were incurred in the nine months
ended June 30, 2002. The former holders of the $1,500,000 convertible debentures
issued on May 19, 1999, and June 3, 1999, alleged that the Company was in
default with respect to perfection of the former
22
holder's security interest in the Company's assets. On July 23, 2002, the
Company and the former holders settled the dispute out of court. The Company
issued 450,000 shares of the Company's common stock to the former convertible
debenture holders and to extend the expiration dates of 2.25 million warrants
held by the former holders until 2007. No such settlement resulted in the nine
months ended June 30, 2003.
Non-cash stock compensation costs decreased $692,653 to $722,739 for the
nine months ended June 30, 2003, compared to $1,415,392 for the same period last
year. As explained in Note 6 in the Notes to Unaudited Condensed Consolidated
Financial Statements section, the reduction of the exercise price of the
repriced stock options and the increase in the stock price of the Company's
common stock as of June 30, 2002, resulted in the Company recording $1,308,858
for the nine months ended June 30, 2002. Neither of these costs were incurred
for the nine months ended June 30, 2003, resulting in the decrease. The stock
compensation costs for the nine months ended June 30, 2003 are comprised of
deferred compensation costs and compensation provided to outside investor
relation consultants.
Net interest and other expenses increased $57,394, or 8%, to $763,843 for
the nine months ended June 30, 2003, from $706,449 for the same period last
year. The increase occurred primarily because the Company had a larger amount of
non-cash expenses incurred from the amortization of discounts on notes payable
and credit facility.
It should be noted that the Company has been able to operate without any
cash infusion and has experienced a positive cash flow from operations of $0.5
million for the nine months ended June 30, 2003.
Factors That May Affect Operating Results and Financial Condition
The Company's future operating results and financial condition are
dependent on the Company's ability to increase demand for and to
cost-effectively manufacture sufficient quantities of the female condom.
Inherent in this process is a number of factors that the Company must
successfully manage in order to achieve favorable future results and improve its
financial condition.
Reliance on a Single Product
The Company expects to derive the vast majority, if not all, of its future
revenues from the female condom, its sole current product. While management
believes the global potential for the female condom is significant, the product
is in the early stages of commercialization and, as a result, the ultimate level
of consumer demand around the world is not yet known. To date, sales of the
female condom have not been sufficient to cover the Company's operating costs,
on an annual basis.
Distribution Network
The Company's strategy is to act as a manufacturer and to develop a global
distribution network for the product by completing partnership arrangements with
companies with the necessary marketing and financial resources and local market
expertise. To date, this strategy has resulted in numerous in-country
distributions in the public sector, particularly in Africa,
23
Latin America and recently in India. Several partnership agreements have been
completed for the commercialization of the female condom in private sector
markets around the world. However, the Company is dependent on country
governments as well as city and state public health departments within the
United States to continue their commitment to prevention of STDs, including
AIDS, by including female condoms in their programs. The Company is also
dependent on finding appropriate partners for the private sector markets around
the world. Once an agreement is completed, the Company is reliant on the
effectiveness of its partners to market and distribute the product. Failure by
the Company's partners to successfully market and distribute the female condom
or failure of country governments to implement prevention programs which include
distribution of barrier methods against the AIDS crisis, or an inability of the
Company to secure additional agreements for AIDS crisis, or an inability of the
Company to secure additional agreements for new markets either in the public or
private sectors could adversely affect the Company's financial condition and
results of operations.
As part of this strategy the Company has entered into two agreements in
the year ended September 30, 2002.
On November 29, 2001, the Company signed a non-binding memorandum of
understanding with Hindustan Latex Limited ("HLL"), an Indian government
Organization and India's largest male condom manufacturer. HLL distributes to
public sector customers including government and non-government organizations
and to consumers through 160,000 retail outlets. Jointly with HLL a marketing
strategy will be developed for the country of India. Over time, the Company
anticipates that HLL and the Company will explore manufacturing options within
India.
On December 18, 2001, the Company announced the appointment of Total
Access Group ("TAG") as the exclusive distributor for public sector sales within
a 15 state region in the western United States. TAG is a privately held national
distributor to the United States public sector and serves over 2,500 customers,
which include state and local health departments, community based organizations,
HIV/STD prevention organizations, Planned Parenthood clinics and family planning
organizations. TAG is a full service distributor and will provide marketing,
education and customer service support. TAG is required to purchase 2,190,000
units within a three year period to retain exclusive distribution rights.
Inventory and Supply
All of the key components for the manufacture of the female condom are
essentially available from either multiple sources or multiple locations within
a source.
Global Market and Foreign Currency Risks
The Company manufactures the female condom in a leased facility located in
London, England. Further, a material portion of the Company's sales are in
foreign markets. Manufacturing costs and sales to foreign markets are subject to
normal currency risks associated with changes in the exchange rate of foreign
currencies relative to the United States dollar. To date, the Company's
management has not deemed it necessary to utilize currency hedging strategies to
manage its currency risks. On an ongoing basis, management continues to evaluate
its commercial transactions and is prepared to employ currency hedging
strategies when it
24
believes such strategies are appropriate. In addition, some of the Company's
future international sales may be in developing nations where dramatic political
or economic changes are possible. Such factors may adversely affect the
Company's results of operations and financial condition.
Government Regulation
The female condom is subject to regulation by the FDA, pursuant to the
federal Food, Drug and Cosmetic Act (the "FDC Act"), and by other state and
foreign regulatory agencies. Under the FDC Act, medical devices must receive FDA
clearance before they can be sold. FDA regulations also require the Company to
adhere to certain "Good Manufacturing Practices," which include testing, quality
control and documentation procedures. The Company's compliance with applicable
regulatory requirements is monitored through periodic inspections by the FDA.
The failure to comply with applicable regulations may result in fines, delays or
suspensions of clearances, seizures or recalls of products, operating
restrictions, withdrawal of FDA approval and criminal prosecutions. The
Company's operating results and financial condition could be materially
adversely affected in the event of a withdrawal of approval from the FDA.
Liquidity and Sources of Capital
Historically, the Company had incurred cash operating losses relating
to expenses incurred to develop and promote the Female Condom. During the nine
months ended June 30, 2003, cash provided by operations totaled $0.5 million.
The Company was able to fund capital expenditures, and payments of preferred
stock dividends and capital lease obligations during the nine months ended June
30, 2003, without any debt or equity financing.
At June 30, 2003, the Company had current liabilities of $1.8 million
including a $1.0 million note payable due March 25, 2004, to Mr. Dearholt, a
director of the Company. As of June 30, 2003, Mr. Dearholt beneficially owns
4,735,305 shares of the Company's Common Stock.
On January 15, 2003, the Company entered into a line of credit
agreement with Heartland Bank. The line of credit facility allows the Company to
borrow up to $1,000,000 in $100,000 increments and matures on December 1, 2004.
Interest is due monthly at the prime rate plus 1 percent (prime was 4 % on June
30, 2003) and it is collateralized by the Company's inventory and letter of
credit backed by accounts receivables. As of June 30, 2003, the Company has not
borrowed any portion of the line of credit facility.
In the near term, the Company's management expects from time to time
operating and capital costs may exceed funds generated from operations, due
principally to the Company's fixed manufacturing costs relative to current
production volumes and the ongoing need to commercialize the Female Condom
around the world. For the first nine months of fiscal year 2003 the Company had
a positive cash flow from operations.
While the Company believes that revenue from sales of the female condom
will eventually exceed operating costs, and that, ultimately, operations will
generate sufficient funds to meet capital requirements, the Company can make no
assurance that such level of operations can be achieved or sustained. Likewise,
the Company can make no assurance that the Company
25
will be able to source all or any portion of its required capital through the
sale of debt or equity or, if raised, the amount will be sufficient to operate
until sales of the female condom generate sufficient revenues to fund
operations. In addition, any funds raised may be costly to the Company and/or
dilutive to its shareholders. If the Company is unable to raise adequate
financing when needed, the Company may be required to sharply curtail the
Company's efforts to promote the female condom, to attempt to sell certain of
its assets and rights or to curtail certain of its operations and may ultimately
be forced to cease operations. Currently, the Company is focused on growing its
business and, therefore, the Company has made no plans to sell any assets nor
has it identified any assets to be sold or potential buyers. In the event that
the Company lacks sufficient capital to continue its operations, neither the
Company nor its shareholders may be able to realize any significant value from
the Company's assets.
IMPACT OF INFLATION AND CHANGING PRICES
Although the Company cannot accurately determine the precise effect of
inflation, the Company has experienced increased costs of product, supplies,
salaries and benefits, and increased selling, general and administrative
expenses. Historically, the Company has absorbed increased costs and expenses
without increasing selling prices.
CONTROLS AND PROCEDURES
As of the end of the period covered by this report, the Company carried
out an evaluation, under the supervision and with the participation of the
Company's management, including the Company's Chief Executive Officer and the
Company's Principal Accounting Officer, of the effectiveness of the design and
operation of the Company's disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 1934, as
amended). Based on this evaluation, the Company's Chief Executive Officer and
Principal Accounting Officer concluded that the Company's disclosure controls
and procedures were effective in timely alerting them to material information
relating to the Company required to be included in the Company's periodic
filings with the Securities and Exchange Commission. It should be noted that in
designing and evaluating the disclosure controls and procedures, management
recognized that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control
objectives, and management necessarily was required to apply its judgment in
evaluating the cost-benefit relationship of possible controls and procedures.
The Company has designed its disclosure controls and procedures to reach a level
of reasonable assurance of achieving desired control objectives and, based on
the evaluation described above, the Company's Chief Executive Officer and
Principal Accounting Officer concluded that the Company's disclosure controls
and procedures were effective at reaching that level of reasonable assurance.
There was no change in the Company's internal control over financial
reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities and
Exchange Act of 1934, as amended) during the Company's most recently completed
fiscal quarter that has materially affected, or is reasonably likely to
materially affect, the Company's internal control over financial reporting.
26
PART II - OTHER INFORMATION
ITEMS 1-5
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit
Number Description
------ -----------
3.1 Amended and Restated Articles of Incorporation. (1)
3.2 Articles of Amendment to the Amended and Restated Articles of
Incorporation of the Company increasing the number of authorized shares
of common stock to 27,000,000 shares. (2)
3.3 Articles of Amendment to the Amended and Restated Articles of
Incorporation of the Company increasing the number of authorized shares
of common stock to 35,500,000 shares. (3)
3.4 Articles of Amendment to the Amended and Restated Articles of
Incorporation of the Company increasing the number of authorized shares
of common stock to 38,500,000 shares. (4)
3.5 Amended and Restated By-Laws. (5)
4.1 Amended and Restated Articles of Incorporation (same as Exhibit 3.1).
4.2 Articles of Amendment to the Amended and Restated Articles of
Incorporation of the Company (same as Exhibit 3.2).
4.3 Articles of Amendment to the Amended and Restated Articles of
Incorporation of the Company increasing the number of authorized shares
of common stock to 35,500,000 shares (same as Exhibit 3.3).
4.4 Articles of Amendment to the Amended and Restated Articles of
Incorporation of the Company increasing the number of authorized shares
of common stock to 38,500,000 shares (same as Exhibit 3.4).
4.5 Articles II, VII and XI of the Amended and Restated By-Laws (included
in Exhibit 3.5).
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
27
31.2 Certification of Principal Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer and Principal Financial
Officer pursuant to 18 U.S.C. Section 1350 (Section 906 of the
Sarbanes-Oxley Act of 2002) (6)
-----------------------------
(1) Incorporated herein by reference to the Company's Registration
Statement on Form SB-2, filed with the Securities and Exchange
Commission on October 19, 1999.
(2) Incorporated by reference to the Company's Registration Statement
on Form SB-2, filed with the Securities and Exchange Commission on
September 21, 2000.
(3) Incorporated by reference to the Company's Registration Statement
on Form SB-2, filed with the Securities and Exchange Commission on
September 6, 2002.
(4) Incorporated by reference to the Company's Quarterly Report on
Form 10-QSB for the quarter ended March 31, 2003.
(5) Incorporated herein by reference to the Company's Registration
Statement on Form S-18, as filed with the securities and Exchange
Commission on May 25, 1999.
(6) This certification is not "filed" for purposes of Section 18 of
the Securities Exchange Act of 1934, as amended, or incorporated
by reference into any filing under the Securities Exchange Act of
1933, as amended, or the Securities Exchange Act of 1934, as
amended.
(b) Report on Form 8-K - No reports on Form 8-K were filed during the
quarter ended June 30, 2003.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE FEMALE HEALTH COMPANY
DATE: August 13, 2003 /s/ O.B. Parrish
-----------------------
O.B. Parrish, Chairman and
Chief Executive Officer
DATE: August 13, 2003 /s/ Robert R. Zic
-----------------------
Robert R. Zic, Principal
Accounting Officer (Principal
Financial Officer)
29