NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -
Basis of Presentation
The accompanying condensed consolidated 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-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by United States generally accepted accounting principles for complete financial statements.
Operating results for the
three months ended December 31, 2016
are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 201
7
. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the fiscal year ended September 30, 201
6
.
Principles of Consolidation and Nature of Operations
The Female Health Company is a
pharmaceutical and
medical
device
company, with an initial focus on the development and commercialization of pharmaceuticals for men’s and women’s health and oncology that qualify for the U.S. Food and Drug Administration's (FDA) 505(b)(2) accelerated regulatory approval pathway
as well as the 505 (b)(1) pathway
. The Company also has a Consumer Health and Medical Devices Division and Global Public Health Sector Division. The Company does business as both "Veru Healthcare" and "The Female Health Company."
The consolidated financial statements include the accounts of The Female Health Company (FHC or the Company) and its wholly owned subsidiar
ies
,
Aspen Park Pharmaceuticals, Inc. (APP) and
The Female Health Company
Limited
, and
The Female Health Company Limited’s
wholly owned subsidiaries, The Female Health Company
(
UK
)
plc and The Female Health Company (M) SDN.BHD. All significant intercompany transactions and accounts have been eliminated in consolidation.
Prior to the completion of the merger transaction with APP (the APP Merger) (see Note
3
, APP Merger Transaction), t
he Company
had been a single product company engaged in the
marketing, manufactur
ing
and distributi
ng
a consumer health care product, the FC2 female condom (FC2). The Female Health Company
Limited
, is the holding company of The Female Health Company
(
UK
)
plc, which is located in a 6,400 sq. ft. leased office facility located in London, England (collectively the U.K. subsidiary). The Female Health Company (M) SDN.BHD leases a 45,800 sq. ft. manufacturing facility located in Selangor D.E., Malaysia (the Malaysia subsidiary).
The Company headquarters is located
in Miami, Florida
in a 2,600 sq. ft. leased office facility
.
The Company is organized as follows:
|
·
|
|
Veru Healthcare manages:
|
|
o
|
|
The Pharmaceuticals Division
, which develops and commercializes pharmaceutical products for men's and women's health and oncology.
|
|
o
|
|
The Consumer Health and Medical Devices Division
, which is focused on commercializing sexual healthcare products and devices for the consumer market, including the Company’s
FC2
Female Condom
®
(FC2),
as well as PREBOOST
®
(benzocaine 4%)
medicated individual wipes which is a male genital desensitizing drug product that helps in the prevention of premature
ejaculation
.
The
Affordable Care Act mandates coverage of the female condom by prescription and FC2 is the only female condom approved for the U.S. market. Likewise, 28 States prior to the Affordable Care Act already had State laws in place that require some form of coverage for female contraception
.
|
|
·
|
|
The Female Health Company manages
the Global Public Health Sector Division
, which is focused on FC2 in the global public health sector business. This division markets FC2 to public health entities, including ministries of health, government health agencies, U.N. agencies, nonprofit organizations and commercial partners, that work to support and improve the lives, health and well-being of women around the world.
|
FC2 has been distributed in either or both commercial (private sector) and public health sector markets in
144 countries. It is marketed to consumers through distributors, public health programs and retailers in 16 countries.
The Company's standard credit terms vary from 30 to 120 days, depending on the class of trade and customary terms within a territory, so accounts receivable is affected by the mix of purchasers within the period. As is typical in the Company's business, extended credit terms may occasionally be offered as a sales promotion or for certain sales. The Company has agreed to credit terms of up to 150 days with our distributor in the Republic of South Africa. For the most recent order of 15 million units under the Brazil tender, the Company has agreed to up to 360 day credit terms with our distributor in Brazil subject to earlier payment upon receipt of payment by the distributor from the Brazilian Government.
For the past twelve months, the Company's average days’ sales outstanding has averaged approximately
385
days. Over the past five years, the Company’s bad debt expense has been less than 0.02 percent of product sales. The balance in the allowance for doubtful accounts was $
38,000
a
t
both
December 31, 2016
and
September 30, 2016
.
Restricted cash
Restricted cash relates to security provided to one of the Company’s U.K. banks for performance bonds issued in favor of customers. The Company has a facility of
$250,000
for such performance bonds. Such security has been extended infrequently and only on occasions where it has been a contract term expressly stipulated as an absolute requirement by the funds’ provider. The expiration of the bond is defined by the completion of the event such as, but not limited to, a period of time after the product has been distributed or expiration of the product shelf life. Restricted cash was $
127,782
and $
134,443
at
December 31, 2016
and
September 30, 2016
, respectively, and is included in cash on the accompanying Unaudited Condensed Consolidated Balance Sheets.
Foreign Currency and Change in Functional Currency
The Company recognized a foreign currency transaction loss of $
11,939
for the
three months ended December 31, 2016
, compared to a
loss
of
$
44,944
for the
three months ended December 31, 2015
. The consistent use of the U.S. dollar as functional currency across the Company reduces its foreign currency risk and stabilizes its operating results. As a result of the U.S. dollar being the functional currency of the Company and all of its subsidiaries, comprehensive income is equivalent to the reported net income.
Business Combinations
The Company accounts for acquisitions using the acquisition method of accounting which requires the recognition of tangible and identifiable intangible assets acquired and liabilities assumed at their estimated fair values as of the business combination date. The Company allocates any excess purchase price over the estimated fair value assigned to the net tangible and identifiable intangible assets acquired and liabilities assumed to goodwill. Transaction costs are expensed as incurred in general and administrative expenses. Results of operations and cash flows of acquired companies are included in the Company's operating results from the date of acquisition.
Goodwill and Intangible Assets
Goodwill represents the excess of the consideration transferred over the estimated fair value of assets acquired and liabilities assumed in a business combination. Intangible assets with indefinite useful lives are related to acquired in-pr
ocess research and development
projects and are measured at their respective fair values as of the acquisition date. Goodwill and intangible assets with indefinite useful lives are not amortized but are tested for impairment on an annual basis or more frequently if the Company becomes aware of any events or changes that would indicate the fair values of the assets are below their carrying amounts. Intangible assets related to
in-process research and development
projects are considered to be indefinite-lived until the completion or abandonment of the associated
research and development
efforts. If and when development is complete, which generally occurs if and when regulatory approval to market a product is obtained, the associated assets are deemed finite-lived and are amortized based on their respective estimated useful lives at that point in time. The Company has not recorded an impairment of goodwill or
in-process research and development
since inception.
Intangible assets with finite useful lives are amortized over their estimated useful lives,
either
on a straight-line basis
or over the projected related revenue stream
.
Impairment of Long-Lived Assets
The Company reviews its long-lived assets, including property and equipment and definite-lived intangible assets, for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Recoverability of assets held and used is measured by comparison of the carrying amount of an asset to the future undiscounted cash flows expected to be generated from the use of the asset and its eventual disposition. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount exceeds the fair value of the impaired assets. Assets to be disposed of are reported at the lower of their carrying amount or fair value less cost to sell. The Company has not recorded an impairment of long-lived assets since inception.
Accrued Research and Development Costs
The Company records accrued liabilities for estimated costs of research and development activities conducted by third-party service providers, which include the conduct of preclinical studies and clinical trials and contract manufacturing activities. These costs are a significant component of the Company’s research and development expenses. The Company accrues for these costs based on factors such as estimates of the work completed and in accordance with agreements established with its third-party service providers under the service agreements. The Company makes significant judgments and estimates in determining the accrued liabilities balance in each reporting period. As actual costs become known, the Company adjusts its accrued liabilities. The Company has not experienced any material differences between accrued costs and actual costs incurred. However, the status and timing of actual services performed, number of patients enrolled and the rate of patient enrollments may vary from the Company’s estimates, resulting in adjustments to expense in future periods. Changes in these estimates that result in material changes to the Company’s accruals could materially affect the Company’s results of operations.
Series 4
Preferred Stock
The Company
issued
546,756
shares of Class A
C
onvertible
P
referred
S
tock
– Series 4 (the Series 4 Preferred Stock)
in
connection
with the
completion of the
APP Merger
on October 31, 2016. The Series 4 Preferred Stock
is
classified as temporary equity in the balance sheet
due
to the requirement that the Company redeem the Series 4 Preferred Stock for cash upon certain events
, including liquidation
or
sale of the Company
or the 20
th
anniversary of the date of issuance of the Series 4 Preferred Stock
. The carrying values of the
Series 4 P
referred
S
tock were not adjusted to
the cash redemption price
of such shares because it
is not considered probable that the shares will be redeemed for cash
. The outstanding shares of
Series 4
P
referred
S
tock
will be
automatically converted into shares of the Company’s common stock upon
receipt of the shareholder approvals
described in Note
3
,
APP
Merger
Transaction
.
Recently Issued Accounting Pronouncement
In November 2015, the Financial Accounting Standards Board (FASB) issued A
ccounting Standards Update
2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes
, which
require
s
deferred tax liabilities and assets
to
be classified as non-current
in the consolidated balance sheet
. Current accounting principles require an entity to separate deferred income tax liabilities and assets into current and non-current amounts in a classified statement of financial position. ASU 2015-17 will be effective for the Company beginning on October 1, 2017.
Early adoption of the standard is permitted, and the Company adopted this standard during the current reporting period and applied it to all periods presented. Adoption of this standard resulted in presenting current and prior period deferred tax assets and liabilities as non-current and net of one another on the balance sheet.
The
se non-current deferred tax assets and liabilities are netted by tax jurisdiction.
Current deferred tax assets totaling
$
2,025,000
at September 30, 2016
were reclassified to non-current and presented net with non-current deferred tax liabilities.
NOTE 2 –
(Loss) Income
per Share
Basic
(loss) income per common share
is computed by dividing net
(loss)
income by the weighted average number of common shares outstanding for the period. Diluted
(loss) income per share
is computed by dividing net income by the weighted average number of common shares outstanding during the period after giving effect to all dilutive potential common shares that were outstanding during the period. Dilutive potential common shares consist of the incremental common shares issuable upon the exercise of stock options
, warrants,
and unvested shares granted to employees and directors.
|
|
|
|
|
|
|
Three Months Ended
|
|
December 31,
|
Denominator
|
2016
|
|
2015
|
Weighted average common shares outstanding - basic
|
|
30,976,140
|
|
|
28,633,372
|
Net effect of dilutive securities:
|
|
|
|
|
|
Options
|
|
—
|
|
|
17,043
|
Unvested restricted shares
|
|
—
|
|
|
343,528
|
Total net effect of dilutive securities
|
|
—
|
|
|
360,571
|
Weighted average common shares outstanding - diluted
|
|
30,976,140
|
|
|
28,993,943
|
(Loss) income per common share – basic
|
$
|
(0.04)
|
|
$
|
0.05
|
(Loss) income per common share – diluted
|
$
|
(0.04)
|
|
$
|
0.05
|
Options to purchase
297,500
shares of
common stock
, warrants
to purchase 2,585,379 shares of common stock
, and
207,500
unvested restricted shares
that were outstanding during the
three months ended December 31, 2016
were not included in the computation of diluted net
loss
per share because their effect was anti-dilutive.
Series 4 Preferred Stock
is
convertible into common stock; however, there are not sufficient common shares for conversion and therefore the Series 4 Preferred Stock is not included in the calculation.
Options to purchase approximately
90,000
shares of common stock at an exercise price of
$3.92
that were outstanding during the
three months ended December 31, 2015
were not included in the computation of diluted net income per share because their effect was anti-dilutive.
All other outstanding stock options and unvested
restricted shares were included in the computation of diluted net
in
come per share for the
three months ended December 31, 2015
.
Note
3
–
APP
Merger
Transaction
On October 31, 2016, as part of the Company's strategy to diversify its product line to mitigate the risks of being a single product company, the Company completed a merger transaction (the APP Merger) with APP. APP is a company focused on the development and commercialization of pharmaceutical and consumer health products for men's and women's health and oncology. For men, product and product candidates are in the areas of benign prostatic hyperplasia, male infertility, amelioration of side effects of hormonal prostate cancer therapies, gout, sexual dysfunction, and prostate cancer. For women, product candidates are for advanced breast and ovarian cancers and for female sexual health.
The
merger transaction with
APP
, a Delaware corporation,
was
pursuant to an Amended and Restated Agreement and Plan of Merger, dated as of October 31, 2016, (the Amended Merger Agreement), among
the Company
, APP, and
the Company
’s wholly owned subsidiary Blue Hen Acquisition, Inc. (APP Merger Sub). Pursuant to the Amended Merger Agreement, on
October 31, 2016
, APP became a wholly-owned subsidiary
of FHC through the merger of APP Merger Sub with and into APP with APP continuing as the surviving corporation. Consummation of the APP Merger did not require the current approval of FHC’s
shareholders.
Under the terms of the Amended Merger Agreement, pursuant to the APP Merger, the outstanding shares of APP common stock and preferred stock were converted into the right to receive in the aggregate
2,000,000
shares of
the Company’s
c
ommon
s
tock and
546,756
shares of Series 4 Preferred Stock.
The terms of the Series 4 Preferred Stock include the following:
|
·
|
|
Each share of Series 4 Preferred Stock will automatically convert into
40
shares of the Company's common stock upon receipt by the Company of approval by the affirmative vote of the Company's shareholders by the required vote under the Wisconsin Business Corporation Law and the NASDAQ listing rules, as applicable, of (i) an amendment to the Company's Amended and Restated Articles of Incorporation to increase the total number of authorized shares of the Company's common stock by a sufficient amount to permit such conversion and (ii) the conversion of the Series 4 Preferred Stock pursuant to applicable NASDAQ rules.
|
|
·
|
|
Upon a Liquidation Event, the holders of the Series 4 Preferred Stock will be entitled to a liquidation preference equal to the greater of (a)
$1.00
per share (or
$546,756
in the aggregate for all of the shares of Series 4 Preferred Stock), or (b) the amount holders would have received if the Series 4 Preferred Stock had converted to the Company's common stock. A "Liquidation Event" includes any voluntary or involuntary liquidation, dissolution or winding up of the Company and certain transactions involving an acquisition of the Company (which are referred to as Fundamental Changes).
|
|
·
|
|
The Series 4 Preferred Stock is redeemable on the first to occur of (i) the 20th anniversary of the date of original issuance or (ii) a Fundamental Change, at a price equal to
$1.00
per share, unless converted into the Company's common stock prior to such redemption.
|
|
·
|
|
The Series 4 Preferred Stock is senior to all existing and future classes of the Company's capital stock upon a Liquidation Event, and no senior or additional pari passu preferred stock may be issued without the consent of the holders of a majority of the outstanding shares of Series 4 Preferred Stock.
|
|
·
|
|
The Series 4 Preferred Stock participates in dividends paid to holders of the Company's common stock on an as converted basis.
|
|
·
|
|
The Series 4 Preferred Stock has one vote per share and will generally vote with the Company's common stock on a one share to one share basis
.
|
Each of Harry Fisch, M.D., Karen Fisch, K&H Fisch Family Partners, LLC and Mitchell Steiner, M.D., has entered into an Amended and Restated Lock-Up Agreement (the Lock-Up Agreements)
with FHC
which generally prohibits each such holder from transferring
75%
of the shares of
the Company’s
c
ommon
s
tock and Series 4 Preferred Stock the holder is entitled to receive in the APP Merger for a period of
18
months following the closing of the APP Merger.
The shares of
the Company’s
c
ommon
s
tock and Series 4 Preferred Stock that
are
subject to the Lock-Up Agreements will be held in escrow for a period of
one
-year after the closing of the APP Merger as the sole remedy for APP’s indemnification obligations set forth in the Amended Merger Agreement pursuant to the terms of an Escrow Agreement.
Seventy-five
percent of the shares held in escrow are eligible for release from escrow
six
months after the closing of the APP Merger, although any shares released from escrow will remain subject to the Lock-Up Agreements until the end of their term.
In connection with the APP Merger, FHC entered into a Registration Rights Agreement (the RRA) with the former APP stockholders granting them certain “Demand” and “Piggyback” registration rights for a period of up to
5
years. The Company will pay for the expenses of registration and related costs but not the selling expenses related thereto. FHC is only required to use its best efforts and in the event the registration does not occur, the Company is not required to pay any compensation to the former APP stockholders. The Company has evaluated the RAA under ASC 825-20, Registration Payment Arrangements, and determined accounting recognition
is not required
.
The allocation of acquisition consideration for APP is based on estimates, assumptions, valuations and other studies which have not yet been finalized in order to make a definitive allocation.
A summary of the total purchase consideration on October 31, 2016 is as follows:
|
|
|
|
|
|
Common stock
|
$
|
1,826,097
|
Series 4 Preferred Stock
|
|
17,981,883
|
Total purchase consideration
|
$
|
19,807,980
|
The total estimated purchase price of approximately
$19,807,980
is based on the issuance to the APP stockholders of a total of
2,000,000
share
s
of
the Company’s
c
ommon
s
tock and
546,756
shares of
Series 4
Preferred Stock.
The common stock issued was valued based on the share price of the Company’s common stock on October 31, 2016 less an 8 percent discount on the shares subject to the Lock-Up Agreements, due to the lack of liquidity since the shares are not freely tradeable for a set time period. The Series 4 Preferred Stock were valued using an as-converted basis based on the share price of the Company’s common stock on October 31, 2016 less a 12 percent discount since the shares are not registered and inherently difficult to sell prior to the conversion to common stock. A 5 percent discount was also applied
in the valuation
due to the probability
that
the Series 4 Preferred Stock will never be converted to common stock.
After giving effect to the conversion of the
Series 4
Preferred Stock to
c
ommon
s
tock, which is wholly dependent upon future shareholder approval, the former APP
s
tockholders will own
23,870,240
shares of
the Company’s c
ommon
s
tock in total, constituting approximately
45%
of the outstanding shares of
the Company’s c
ommon
s
tock as of October 31, 2016.
The results of operations and the provisional fair values of the acquired assets and liabilities assumed have been included in the accompanying consolidated financial statements since the acquisition date.
The Company incurred
$826,370
in acquisition-related costs which were recorded within operating expenses for the three months ended December 31, 2016
compared to
$15,245
for the three months ended December 31, 2015
.
The following table summarizes the fair value of assets acquired and liabilities assumed on October 31, 2016:
|
|
|
|
|
|
Recognized amounts of identifiable assets acquired:
|
|
|
Cash
|
$
|
43,118
|
Inventory
|
|
141,041
|
Prepaid expenses and other
|
|
7,314
|
Equipment, furniture, and fixtures
|
|
1,290
|
Intangible assets:
|
|
|
In-process research and development
|
|
18,000,000
|
Developed technology - PREBOOST
®
|
|
2,400,000
|
Covenants not-to-compete
|
|
500,000
|
Total intangible assets
|
|
20,900,000
|
|
|
21,092,763
|
Recognized amounts of identifiable liabilities assumed:
|
|
|
Accounts payable
|
|
(1,087,212)
|
Accrued expenses
|
|
(276,503)
|
Deferred tax liabilities
|
|
(6,800,000)
|
|
|
(8,163,715)
|
Total identifiable net assets acquired
|
|
12,929,048
|
Goodwill
|
|
6,878,932
|
|
$
|
19,807,980
|
APP has a
developed technology in PREBOOST
®
. I
n-process research and development
represents incomplete research and development projects at APP. The fair value of
the developed technology
and
in-process research and development
were determined using the income approach, which was prepared based on forecasts by management.
Purchase price in excess of assets acquired and liabilities assumed is recorded as goodwill. Goodwill is not deductible for tax purposes.
Pro Forma Financial Information
The amounts of pro forma, unaudited net revenues and net income (loss) of the combined entity had the acquisition date been October 1, 2015 are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
Period
|
Net revenues
|
|
Net income (loss)
|
October 1, 2015 - December 31, 2015
|
$
|
8,233,543
|
|
$
|
1,240,860
|
October 1, 2016 - December 31, 2016
|
$
|
3,244,743
|
|
$
|
(1,933,536)
|
In connection with the APP Merger,
two
complaints have been filed against the Company and its directors alleging breach of fiduciary duty and/or wasting of corporate assets. The Company intends to vigorously defend these lawsuits.
NOTE
4
-
Inventory
Inventory consists of the following components at
December 31, 2016
and
September 30, 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2016
|
|
September 30, 2016
|
FC2
|
|
|
|
|
|
Raw material
|
$
|
482,454
|
|
$
|
670,802
|
Work in process
|
|
52,656
|
|
|
—
|
Finished goods
|
|
1,855,305
|
|
|
1,834,958
|
Inventory, gross
|
|
2,390,415
|
|
|
2,505,760
|
Less: inventory reserves
|
|
(9,175)
|
|
|
(13,116)
|
FC2, net
|
|
2,381,240
|
|
|
2,492,644
|
PREBOOST
®
|
|
|
|
|
|
Finished goods
|
|
141,041
|
|
|
—
|
Inventory, net
|
$
|
2,522,281
|
|
$
|
2,492,644
|
NOTE
5
–
Line of Credit
On December 29, 2015, the Company entered into a Credit Agreement (the Credit Agreement) with BMO Harris Bank N.A. (BMO Harris Bank). The Credit Agreement provides the Company with a revolving line of credit of up to
$10
million with a term that extends to December 29, 2017. Borrowings under the Credit Agreement bear interest, at the Company’s option, at a base rate or at LIBOR plus
2.25%
. The Company is also required to pay a commitment fee at the rate of
0.10%
per annum on the average daily unused portion of the revolving line of credit. The Company's obligations under the Credit Agreement are secured by a lien against substantially all of the assets of the Company and a pledge of
65%
of the outstanding shares of The Female Health Company Limited
and all of the outstanding shares of APP
. In addition to other customary representations, covenants and default provisions, the Company is required to maintain a minimum tangible net worth and to not exceed a maximum total leverage ratio. Among the non-financial covenants, the Company is restricted in its ability to pay dividends, buy back shares of its common stock, incur additional debt and make acquisitions above certain amounts.
The completion of the
APP M
erger
(see Note
3
,
APP
Merger
Transaction
) resulted
in a default in FHC's compliance with certain covenants in the Credit Agreement and constitute
d
an "event of default" under the Credit Agreement.
On November 28, 2016, FHC, Badger Acquisition Sub, Inc.,
wholly owned subsidiary of FHC,
APP and BMO Harris Bank entered into a Third Amendment to the Credit Agreement (the Amendment). Pursuant to the Amendment, BMO Harris Bank waived the defaults in FHC's compliance with the covenants in the Credit Agreement as a result of the completion of the merger transaction with APP and APP became a co-borrower under the Credit Agreement. As a result, the revolving line of
credit remains in effect under the terms of the Credit Agreement until the end of its term on December 29, 2017.
No
amounts were outstanding under the Credit Agreement at
either
December 31, 2016 or
September 30, 2016
.
NOTE
6
–
Share-Based Payments
In March 2008, the Company’s shareholders approved the 2008 Stock Incentive Plan which is utilized to provide equity opportunities and performance–based incentives to attract, retain and motivate those persons who make (or are expected to make) important contributions to the Company. A total of
2
million shares are available for issuance under this plan. As of
December 31, 2016
,
a total of
1,824,802
shares had been granted under the plan
and not forfeited or are subject to outstanding commitm
ents to issue shares under the p
lan
,
of
which
29
7,500
shares
were in the form of stock options and the remainder were in the form of restricted stock or other share grants.
Stock Options
T
he
Company
granted
190,000
options
at an exercise price of
$0.95
to
an
outside director and
a
n employee
under the 2008 Stock Incentive Plan
during
the three months ended December 31, 2016
.
Options issued under this plan expire in
10
years with vesting over a
one
-year period
from the
grant date.
The Company did not grant any options during the
three
months ended
December 31
,
2015. Based on the Company’s history of prior forfeitures and future expectations it was determined that there would be no forfeiture rate used.
Compensation expense is recognized only for share-based payments expected to vest.
S
tock compensation expense related to options
was approximately
$
15
,
936
for
the
three months ended December 31, 2016
.
No
stock compensation expense related to options was recognized for the
three months ended December 31, 2015
.
The following table outlines the weighted average assumptions for options granted
during the
three months ended December 31, 2016
:
|
|
|
|
|
Three months ended
|
|
December 31, 2016
|
Weighted Average Assumptions:
|
|
Expected Volatility
|
43.76%
|
Expected Dividend Yield
|
0.00%
|
Risk-free Interest Rate
|
1.62%
|
Expected Term (in years)
|
6
|
Fair Value of Options Granted
|
$ 0.41
|
During the
three months ended December 31, 2016
, the Company used historical volatility of our common stock over a period equal to the expected life of the options to estimate their fair value. The dividend yield assumption is based on the Company’s history and expectation of future dividend payouts on the common stock. The risk-free interest rate is based on the implied yield available on U.S. treasury zero-coupon issues with an equivalent remaining term.
The expected term of the options represents the estimated period of time until exercise and is based on the simplified method. To value options granted for actual stock-based compensation, the Company used the Black-Scholes option valuation model. When the measurement date is certain, the fair value of each option grant is estimated on the date of grant and is based on the assumptions used for the expected stock price volatility, expected term, risk-free interest rates and future dividend payments.
There were
90,000
stock options granted under the 1997 Stock Option Plan
that
expired during the three months ended December 31, 2016.
The 1997 Stock Option Plan expired on December 31, 2006, and
no
more options are outstanding under the plan.
No
stock options were exercised during the
three months ended December 31, 2016 or 2015
.
The following table summarizes the stock options outstanding and exercisable at
December 31, 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options
|
Weighted
|
|
|
|
|
|
Options
|
Weighted
|
|
|
|
|
|
|
Outstanding
|
Average
|
|
Weighted
|
|
Aggregate
|
Exercisable
|
Average
|
|
Weighted
|
|
Aggregate
|
|
at December
|
Remaining
|
|
Average
|
|
Intrinsic
|
at December
|
Remaining
|
|
Average
|
|
Intrinsic
|
|
31, 2016
|
Life (years)
|
|
Exercise Price
|
|
Value
|
31, 2016
|
Life (years)
|
|
Exercise Price
|
|
Value
|
Total
|
297,500
|
7.56
|
|
$
|
1.90
|
|
$
|
—
|
90,000
|
2.42
|
|
$
|
3.92
|
|
$
|
—
|
The aggregate intrinsic value in the table above is before income taxes, based on the closing price of the Company’s common stock
of $
0.91
per
share as of the last business day of the period ended
December 31, 2016
. As of
December 31, 2016
, the Company had
unrecognized compensation expense
of
$
71
,
506
relat
ed
to
unvested
stock options
. These
expenses will be recognized over approximately
1.
2
5
years
.
Restricted Stock
The Company issues restricted stock to employees, directors and consultants. Such issuances may have vesting periods that range from
one
to
three
years. In addition, the Company has issued stock awards to certain employees that provide for future issuance
contingent on continued employment for periods that range from
one
to
three
years.
The Company granted a total of
190,000
shares of restricted stock or shares issuable pursuant to promises to issue shares of common stock during the
three months ended December 31, 2016
. The fair value of the awards granted was approximately $
181,000
. All such shares of restricted stock vest and all such shares must be issued
pursuant to the vesting period noted
, provided the
grantee has not
voluntarily
terminated
service or been terminated for cause prior to the vesting or issuance
. There were
no
shares of restricted stock forfeited during the
three months ended December 31, 2016
.
On October 31, 2016,
vesting was accelerated in connection with the closing of the APP Merger as to
152,717
restricted shares and the right to receive
68,832
shares, or at the holder’s election
c
ash based on the fair market value of the shares,
h
eld by employees and directors
. Holders elected to receive
42,332
shares in common stock and
the value of
26,500
shares in cash based on the stock price at the time of vesting of
$0.95
per share
.
The Company granted a total of
43,250
shares of restricted stock or shares issuable pursuant to promises to issue shares of common stock during the
three months ended December 31, 2015
. The fair value of the awards granted was approximately $
71,000
. All such shares of
restricted stock vest and all such shares must be issued at the end of the applicable period, provided the grantee has not voluntarily terminated service or been terminated for cause prior to the vesting or issuance date. There
were
no
shares
of restricted stock forfeited during the
three months ended December 31, 2015
.
The Company recognized share-based compensation expense for restricted stock or promises to issue shares of common stock of
approximately
$
255,000
and
$
123,000
f
or
the
three months ended December 31, 2016 and 2015
, respectively,
$
0
and $
26,000
of which was included in accrued expenses at the
three months then ended
since the related shares had not yet been issued at
December 31, 2016 and 2015
, respectively.
This compensation expense was included in operating expenses on the accompanying Unaudited Condensed Consolidated Statements of
Operations
for the
three months ended December 31, 2016 and 2015
. As of
December 31, 2016
, there was approximately $
170,000
, representing approximately
169,000
unvested shares, of total unrecognized compensation cost related to non-vested restricted stock compensation arrangements granted under the Company’s equity compensation plans. This unrecognized cost will be recognized over the weighted average period of the next
0.86
years
.
Common Stock Purchase Warrants
In connection with the closing of the APP Merger, the Company issued a warrant to purchase up to
2,585,379
shares of the Company's common stock to Torreya Capital, the Company's financial advisor (the Financial Advisor Warrant). The Financial Advisor Warrant has a
five
-year term, a cashless exercise feature and a strike price equal to
$1.93
per share, the average price of the Company's common stock for the ten-day period preceding the original announcement of the APP Merger on April 6, 2016. The fair value of the Financial Advisor Warrant
is
based on the closing price of the Company's common stock
on
October 31, 2016 of
$
0.95
.
The fair value of
the
Financial Advisor Warrant
of
$
542,930
was estimated at the date of grant using the Black-Scholes option pricing model assuming expected volatility of
47.2
percent, risk-free interest rate of
1.
31
percent, expected life of
five
years, and
no
dividend yield.
The Financial Advisor Warrant vested upon issuance.
Half of the
shares subject to the
Financial Advisor Warrant
,
or
1,292,690
shares,
are locked-up for
a
period of
18
months from the issuance date.
The Financial Advisor Warrant is recorded as a component of additional paid-in-capital and the Financial Advisor Warrant expense is included in selling, general and administrative expenses.
At December 31, 2016, the warrant
detail
s were as follows:
|
|
|
|
Warrants Outstanding
|
2,585,379
|
Warrants Exercisable
|
1,292,690
|
Exercise Price
|
$ 1.93
|
Weighted Average Remaining Life
|
4.83
|
Weighted Average Exercise Price
|
$ 1.93
|
Restricted Stock Units
In connection with the closing of the APP Merger, t
he Company
issued
50,000
and
140,000
restricted stock units
to a
n employee
and
an outside director
, respectively,
that vest on
October 31, 2018.
The restricted stock units w
ill be settled in
the Company’s
c
ommon
s
tock if, prior to the vesting date,
the Company
receives shareholder approval under NASDAQ Rule 5635(c) to increase the number of authorized shares under the 2008 Stock Incentive
P
lan sufficient to issue such shares
or adopt a new plan under which such shares would be issued. If
approval is not received by the vesting date, such awards will be settled in cash based on the fair market value of
the Company’s
c
ommon
s
tock on the vesting date
. The restricted stock units will be revalued monthly using the Company’s current stock price on the last business day of the month during the vesting period of
two
years.
Stock compensation expense related to the restricted stock units was approximately
$15,000
for the three months ended December 31, 2016
and is recorded as a component of accrued expenses and other current liabilities
.
The fair value of the restricted stock units is approximately
$173,000
as of December 31, 2016.
Stock Appreciation Rights
In connection with the closing of the APP Merger, the
Company issued stock
appreciation rights based on
50,000
and
140,000
shares
of
the Company’s
c
ommon
s
tock
to a
n employee
and
an outside director
, respectively,
that vest on
October 31, 2018. The stock appreciations rights have a
ten
-year term. Exercise price per share
was
$0.95
, which was
the
closing price of a share of
the Company’s c
ommon
s
tock as quoted on NASDAQ
on the trading day immediately preceding the
date of the completion of the
APP Merger
. The stock appreciation rights will
be settled in
the Company’s
c
ommon
s
tock if, prior to the vesting date,
the Company
receives shareholder approval under NASDAQ Rule 5635(c) to increase the number of authorized shares under the 2008 Stock Incentive
P
lan sufficient to issue such shares
or
adopt a new plan under which such shares would be issued
.
If approval is not received by the
exercise
date, such awards will be settled in cash based on the fair market value of
the Company’s
c
ommon
s
tock on the
exercise
date
. The stock appreciation rights will be
measured using the option-pricing model (Black-Scholes) to estimate the fair value. The fair value will be updated monthly based on current information over the vesting period of
two
years
.
Stock compensation expense related to the stock appreciation rights was approximately
$7,000
for the three months ended December 31, 2016
and is recorded as a component of accrued expenses and other current liabilities
.
The fair value of the stock appreciation rights is approximately
$82,000
as of December 31, 2016.
NOTE
7
-
Stock Repurchase Program
The Company’s Stock Repurchase Program was announced on January 17, 2007. At initiation, the program’s terms specified that up to
1,000,000
shares of its common stock could be purchased during the subsequent twelve months. Subsequently, the Board has amended the program a number of times to both extend its term and increase the maximum number of shares which could be repurchased.
The program allowed
for a maximum repurchase of up to
3,000,000
shares through the period ending December 31, 2016.
The Company did not extend the Stock Repurchase Program
, and as a result it terminated as of December 31, 2016
.
From the program’s onset through
December 31, 2016
, the total number of shares repurchased by the Company
was
2,183,704
with an average price paid per share of
$3.57
and a total cost of treasury stock of
$7,806,605
.
The Stock Repurchase Program authorize
d
purchases in privately negotiated transactions as well as in the open market. In October 2008, the Company's Board of Directors authorized repurchases in private transactions under the Stock Repurchase Program of shares issued under the Company's equity compensation plans to directors, employees and other service providers at the market price on the effective date of the repurchase request. Total repurchases under this provision
were
limited to an aggregate of
450,000
shares per calendar year and to a maximum of
50,000
shares annually per individual. There were
no
repurchases of any kind under the program for the
three months ended December 31, 2016 or 2015
.
NOTE
8
-
Industry Segments and Financial Information About Foreign and Domestic Operations
The Company currently operates 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 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Revenues to External Customers for
|
|
Long-Lived Asset As Of
|
|
the Three Months Ended December 31,
|
|
December 31,
|
|
September 30,
|
|
2016
|
|
2015
|
|
2016
|
|
2016
|
Cameroon
|
$
|
891
|
(1)
|
$
|
*
|
|
$
|
—
|
|
$
|
—
|
South Africa
|
|
636
|
(1)
|
|
*
|
|
|
—
|
|
|
—
|
Zimbabwe
|
|
516
|
(1)
|
|
826
|
(1)
|
|
—
|
|
|
—
|
Brazil
|
|
*
|
|
|
4,755
|
(1)
|
|
—
|
|
|
—
|
United States
|
|
358
|
(1)
|
|
815
|
|
|
35,767
|
|
|
7,963
|
Malaysia
|
|
*
|
|
|
*
|
|
|
715
|
|
|
796
|
United Kingdom
|
|
*
|
|
|
*
|
|
|
85
|
|
|
93
|
Other
|
|
843
|
|
|
1,835
|
|
|
—
|
|
|
—
|
Total
|
$
|
3,244
|
|
$
|
8,231
|
|
$
|
36,567
|
|
$
|
8,852
|
*
Countries with l
ess than
5
percent of total net revenues.
(1) Countries exceeding
10
percent of total net revenues.
At
December 31, 2016
the Company
had
one
customer whose
current
accounts receivable balance
represented
3
5
percent of current assets. At
September 30, 2016
the Company had
one
customer whose
current
accounts receivable balance
represented
4
9
percent of current assets.
No
other single customer’s
current
accounts receivable balance accounted for more than
10
percent
of current assets as of
December 31, 2016
or
September 30, 2016
. There was
one
customer whose accounts receivable
and other long-term receivables
balance represented
81
percent and
85
percent of
accounts receivable and other long-term
receivables at December 31, 2016 and September 30, 2016, respectively.
There
were
three
customers who
each
exceeded
10
percent of net revenues for the
three months ended December 31, 2016 and 2015
.
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
$
10
million for FHC's consumer health care product.
NOTE
10
–
Income Taxes
The Company accounts for income taxes using the liability method, which requires the recognition of deferred tax assets or liabilities for the tax-effected temporary differences between the financial reporting and tax bases of its assets and liabilities, and for net operating loss and tax credit carryforwards.
The Company completes a detailed analysis of its deferred income tax valuation allowances on an annual basis or more frequently if information comes to our attention that would indicate that a revision to our estimates is necessary. In evaluating the Company’s ability to realize its deferred tax assets, management considers all available positive and negative evidence on a country-by-country basis, including past operating results
,
forecast of future taxable income
, and the potential Section 382 limitation on the net operating loss carryforwards due to a change in control
. In determining future taxable income, management makes assumptions to forecast U.S. federal and state, U.K. and Malaysia operating income, the reversal of temporary differences, and the implementation of any feasible and prudent tax planning strategies. These assumptions require significant judgment regarding the forecasts of the future taxable income in each tax jurisdiction, and are consistent with the forecasts used to manage the Company’s business. It should be noted that the Company realized significant losses through 2005 on a consolidated
basis. Since fiscal year 2006, the Company has consistently generated taxable income on a consolidated basis, providing a reasonable future period in which the Company can reasonably expect to generate taxable income. In management’s analysis to determine the amount of the deferred tax asset to recognize, management projected future taxable income for each tax jurisdiction.
As of
December 31, 2016
, the Company had U.S. federal and state net operating loss carryforwards of approximately $
11,705,000
and $
11,425,000
, respectively, for income tax purposes expiring in years
202
1
to
20
34
. The Company’s U.K. subsidiary has U.K. net operating loss carryforwards of approximately $
60,863,000
as of
December 31, 2016
, which can be carried forward indefinitely to be used to offset future U.K. taxable income. With the demand for and profitability of FC2, the Company expects
utilization of its net operating losses in both the U.K. and the U.S. will continue.
The Company’s net operating loss carryforwards will be utilized to reduce cash payments for income taxes based on the statutory rate in effect at the time of such utilization.
A reconciliation of income tax expense and the amount computed by applying the statutory federal income tax rate to income before income taxes
is as follows
:
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
December 31,
|
|
2016
|
|
2015
|
Income tax (benefit) expense at statutory rates
|
$
|
(645,000)
|
|
$
|
789,000
|
State income tax (benefit) expense, net of federal benefits
|
|
(96,000)
|
|
|
119,000
|
Non-deductible business acquisition expenses
|
|
111,000
|
|
|
—
|
Non-deductible expenses - other
|
|
1,000
|
|
|
2,000
|
Effect of AMT expense
|
|
—
|
|
|
30,000
|
Effect of lower foreign income tax rates
|
|
81,736
|
|
|
(107,125)
|
Other
|
|
17,195
|
|
|
(3,422)
|
Income tax (benefit) expense
|
$
|
(530,069)
|
|
$
|
829,453
|
Significant
components of the Company’s deferred tax assets and liabilities are as
follows
:
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
September 30,
|
Deferred Tax Assets
|
2016
|
|
2016
|
Federal net operating loss carryforwards
|
$
|
4,434,601
|
|
$
|
2,756,000
|
State net operating loss carryforwards
|
|
441,728
|
|
|
400,000
|
AMT credit carryforward
|
|
489,000
|
|
|
489,000
|
Foreign net operating loss carryforwards – U.K.
|
|
11,058,764
|
|
|
10,955,000
|
Foreign capital allowance – U.K.
|
|
112,000
|
|
|
112,000
|
Other, net - Malaysia
|
|
9,850
|
|
|
9,850
|
Restricted stock – U.K.
|
|
1,000
|
|
|
1,000
|
Share-based compensation
|
|
51,304
|
|
|
101,000
|
Warrants
|
|
212,367
|
|
|
—
|
Deemed dividend - Malaysia
|
|
942,000
|
|
|
942,000
|
Other, net - U.S.
|
|
(21,800)
|
|
|
25,000
|
Gross deferred tax assets
|
|
17,730,814
|
|
|
15,790,850
|
Valuation allowance for deferred tax assets
|
|
(2,299,000)
|
|
|
(2,299,000)
|
Net deferred tax assets
|
|
15,431,814
|
|
|
13,491,850
|
Deferred Tax Liabilities:
|
|
|
|
|
|
Intangible assets
|
|
(8,157,200)
|
|
|
—
|
Foreign capital allowance – Malaysia
|
|
(111,110)
|
|
|
(119,919)
|
Gross deferred tax liabilities
|
|
(8,268,310)
|
|
|
(119,919)
|
Net deferred tax assets
|
$
|
7,163,504
|
|
$
|
13,371,931
|
The deferred tax amounts have been classified in the accompanying consolidated balance sheets as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
September 30,
|
|
2016
|
|
2015
|
Long term deferred assets
|
$
|
8,872,764
|
|
$
|
13,482,000
|
Long term deferred liabilities
|
|
(1,709,260)
|
|
|
(110,069)
|
Total
|
$
|
7,163,504
|
|
$
|
13,371,931
|
Note 1
1
–
Goodwill and Intangible Assets
Goodwill
The gros
s carrying amount of goodwill i
s as follows:
|
|
|
|
|
|
Balance at September 30, 2016
|
$
|
—
|
Goodwill arising from APP Merger
|
|
6,878,932
|
Balance at December 31, 2016
|
$
|
6,878,932
|
Intangible assets
The gross carrying amounts and net book value of
intangible assets a
re as follows
at December 31, 2016
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Carrying
|
|
Accumulated
|
|
Net Book
|
|
Amount
|
|
Amortization
|
|
Value
|
Intangible assets with finite lives:
|
|
|
|
|
|
|
|
|
Developed technology - PREBOOST
®
|
$
|
2,400,000
|
|
$
|
14,824
|
|
$
|
2,385,176
|
Covenants not-to-compete
|
|
500,000
|
|
|
11,905
|
|
|
488,095
|
Total intangible assets with finite lives
|
|
2,900,000
|
|
|
26,729
|
|
|
2,873,271
|
Acquired in-process research and development assets
|
|
18,000,000
|
|
|
—
|
|
|
18,000,000
|
Total intangible assets
|
$
|
20,900,000
|
|
$
|
26,729
|
|
$
|
20,873,271
|
Intangible assets are carried at cost less accumulated amortization. Amortization is over
the projected related revenue stream
for the PREBOOST
®
developed technology
over the next
10
years
and
7
years for the
covenants not
-
to
-
compete
,
and the amortization expense is recorded in operating expenses.
Amortization expense was
$
26,729
for the three months ended December 31, 2016 and
$0
for the three months ended December 31, 2015. Based on finite-lived intangible assets
recorded as of December 31, 2016
, the estimated future amortization expense is as follows:
|
|
|
|
|
|
|
Estimated
|
Year Ending September 30,
|
Amortization Expense
|
2017
|
$
|
120,280
|
2018
|
|
275,262
|
2019
|
|
309,234
|
2020
|
|
316,368
|
2021
|
|
323,706
|
Thereafter
|
|
1,528,421
|
Total
|
$
|
2,873,271
|
Item 2.
Management’s Discussion and Analysis of
Financial
Condition and Results of Operations
Overview
The Female Health Company is a
pharmaceutical and
medical
device
company, with an initial focus on the development and commercialization of pharmaceuticals for men’s and women’s health and oncology that qualify for the U.S. Food and Drug Administration's (FDA) 505(b)(2) accelerated regulatory approval pathway
as well as the 505 (b)(1) pathway
. The Company also has a Consumer Health and Medical Devices Division and Global Public Health Sector Division. The Company does business as both "Veru Healthcare" and "The Female Health Company." The Company is organized as follows:
|
·
|
|
Veru Healthcare manages:
|
|
o
|
|
The Pharmaceuticals Division
, which develops and commercializes pharmaceutical products for men's and women's health and oncology.
|
|
o
|
|
The Consumer Health and Medical Devices Division
, which is focused on commercializing sexual healthcare products and devices for the consumer market, including the
Company’s
FC2
, as well as PREBOOST
®
(benzocaine 4%)
medicated individual wipes which is a male genital desensitizing drug product that helps in the prevention of premature ejaculation.
In the United States, FC2 is available by prescription which is required in order to obtain reimbursement.
The Affordable Care Act mandates coverage of the female condom by prescription and FC2 is the only female condom approved for the U.S. market. Likewise, 28 States prior to the Affordable Care Act already had State laws in place that require some form of coverage for female contraception.
|
|
·
|
|
The Female Health Company manages
the Global Public Health Sector Division
, which is focused on FC2 in the global public health sector business. This division markets FC2 to public health entities, including ministries of health, government health agencies, U.N. agencies, nonprofit organizations and commercial partners, that work to support and improve the lives, health and well-being of women around the world.
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On October 31, 2016, as part of the Company's strategy to diversify its product line to mitigate the risks of being a single product company, the Company completed a merger transaction (the APP Merger) with Aspen Park Pharmaceuticals, Inc. (APP). APP is a company focused on the development and commercialization of pharmaceutical and consumer health products for men's and women's health and oncology. For men, product and product candidates are in the areas of benign prostatic hyperplasia, male infertility, amelioration of side effects of hormonal prostate cancer therapies, gout, sexual dysfunction, and prostate cancer. For women, product candidates are for advanced breast and ovarian cancers and for female sexual health. APP was originally formed on June 9, 2014, has not had significant revenues and has incurred losses since inception.
On August 12, 2016, the FDA agreed that the Company's Tamsulosin DRS product, a proprietary medication for the treatment of benign prostatic hyperplasia (BPH), a $3.5 billion market, qualifies for the accelerated 505(b)(2) regulatory approval pathway and with APP's plans to conduct a single bioequivalence study to support the filing of a new drug application (NDA). The Company plans to initiate bioequivalence clinical study
by
the first quarter of 2017, submit an NDA for Tamsulosin DRS in 2017 and, if approved, launch the product in early 2018.
On October 31, 2016, the Company completed an interim analysis of the double-blind, randomized placebo controlled clinical trial of its novel PREBOOST® product. The Company
announced the launch of
PREBOOST® in the United States
on January 9, 2017
.
The Company accepted an invitation from the FDA to present at the meeting of the Bone, Reproductive and Urologic Drugs (BRUD) Advisory Committee on December 6, 2016.
The Company presented an overview of its drug candidate for male infertility, MSS-722.
The FDA uses advisory committees to obtain independent expert advice on scientific, technical and policy matters. At the meeting, the committee discussed appropriate clinical trial design features, including acceptable endpoints for demonstrating clinical benefit, for drugs intended to treat secondary hypogonadism (low testosterone levels) while preserving or improving testicular function, including spermatogenesis. At the meeting, the FDA Advisory Committee provided guidance for clinical trial design and endpoints. The committee agreed with the intended patient population to treat, recommended a short-term study, and supported the use of improvement of semen quality for such clinical endpoints as avoidance of aggressive assisted reproductive procedures such as
in vitro
fertilization or pregnancy. Based on this advice, the Company plans to file an investigational new drug application (IND) in 2017 and advance MSS-722 into Phase 2 clinical trial in men with testicular dysfunction [severe oligospermia (low sperm count) and secondary hypogonadism] as a cause of male factor infertility.
Prior to the completion of the APP Merger, the Company had been a single product company, focused on manufacturing, marketing and selling the Female Condom (FC2). FC2 is the only currently available female-controlled product approved for market by the FDA and cleared by the World Health Organization (WHO) for purchase by U.N. agencies that provides dual protection against unintended pregnancy and sexually transmitted infections (STIs), including HIV/AIDS and the Zika virus.
Nearly all of the Company’s net revenues for the
three months ended December 31, 2016
were derived from sales of FC2.
FC2’s primary use is for disease prevention and family planning, and the public health sector is the Company’s main market
for FC2
. Within the public health sector, various organizations supply critical products such as FC2, at no cost or low cost, to those who need but cannot afford to buy such products for themselves.
FC2 has been distributed in 144 countries. A significant number of countries with the highest demand potential are in the developing world. The incidence of HIV/AIDS, other STIs and unwanted pregnancy in these countries represents a remarkable potential for significant sales of a product that benefits some of the world’s most underprivileged people. However, conditions in these countries can be volatile and result in unpredictable delays in program development, tender applications and processing orders.
FC2 has a relatively small customer base, with a limited number of customers who generally purchase in large quantities. Over the past few years, major customers have included large global agencies, such as
the United Nations Population Fund (
UNFPA
)
and
the United States Agency for International Development
(
USAID
)
. Other customers include ministries of health or other governmental agencies, which either purchase directly or via in-country distributors, and
non-governmental organization
s
.
Purchasing patterns for FC2 vary significantly from one customer to another, and may reflect factors other than simple demand. For example, some governmental agencies purchase FC2 through a formal procurement process in which a tender (request for bid) is issued for either a specific or a maximum unit quantity. Tenders also define the other elements required for a qualified bid submission (such as product specifications, regulatory approvals, clearance by WHO, unit pricing and delivery timetable). Bidders have a limited period of time in which to submit bids. Bids are subjected to an evaluation process which is intended to conclude with a tender award to the successful bidder. The entire tender process, from publication to award, may take many months to complete. A tender award indicates acceptance of the bidder’s price rather than an order or guarantee of the purchase of any minimum number of units. Many governmental tenders are stated to be “up to” the maximum number of units, which gives the applicable government agency discretion to purchase less than the full maximum tender amount. Orders are placed after the tender is awarded; there are often no set dates for orders in the tender and there are no guarantees as to the timing or amount of actual orders or shipments. Orders received may vary from the amount of the tender award based on a number of factors including vendor supply capacity, quality inspections and changes in demand. Administrative issues, politics, bureaucracy, process errors, changes in leadership, funding priorities and/or other pressures may delay or derail the process and affect the purchasing patterns of public sector customers. As a result, the Company may experience significant quarter-to-quarter sales variations due to the timing and shipment of large orders of FC2.
In October 2014, the Company announced that Semina
Indústria e Comércio Ltda (Semina), the Company’s distributor in Brazil,
was awarded an exclusive contract under a public tender. The contract was valid through August 20, 2015, allowing the Brazil Ministry of Health to place orders against this tender at its discretion. Through the end of the contract, the Company received orders for 40 million units of FC2 in fulfillment of the tender,
9
million of which were shipped during the
three months
ended
December 31, 2015
.
Details of the quarterly unit sales
of FC2
for the last five fiscal years are listed below:
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|
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|
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Period
|
2017
|
2016
|
2015
|
2014
|
2013
|
October 1 – December 31
|
6,389,320
|
15,380,240
|
12,154,570
|
11,832,666
|
17,114,630
|
January 1 – March 31
|
|
9,163,855
|
20,760,519
|
7,298,968
|
16,675,035
|
April 1 – June 30
|
|
10,749,860
|
14,413,032
|
13,693,652
|
12,583,460
|
July 1 - September 30
|
|
6,690,080
|
13,687,462
|
9,697,341
|
8,386,800
|
Total
|
6,389,320
|
41,984,035
|
61,015,583
|
42,522,627
|
54,759,925
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Revenues.
The Company's revenues have been derived from sales of FC2, and are recognized upon shipment of the product to its customers.
The Company is working to further develop a global market and distribution network for FC2 by maintaining relationships with public health sector groups and completing partnership arrangements with companies with the necessary marketing and financial resources and local market expertise.
The Company’s most significant customers have been either global public health sector agencies or those who facilitate their purchases and/or distribution of FC2 for use in HIV/AIDS prevention and/or family planning. The Company's four largest customers currently are UNFPA
, USAID, Sekunjalo
Investments Corporation (PTY) Ltd
and Semina.
We sell to the Brazil Ministry of Health either through UNFPA or Semina. In the U.S., FC2 is sold to city and state public health clinics as well as to not-for-profit organizations such as Planned Parenthood.
Because the Company manufactures FC2 in a leased facility located in Malaysia, a portion of the Company's operating costs are denominated in foreign currencies. While a material portion of the Company's future sales are likely to be in foreign markets, all sales are denominated in the U.S. dollar. Effective October 1, 2009, the Company’s U.K. and Malaysia subsidiaries adopted the U.S. dollar as their functional currency, further reducing the Company’s foreign currency risk.
Expenses.
The Company manufactures FC2 at its facility located in Selangor D.E., Malaysia. The Company's cost of sales consists primarily of direct material costs, direct labor costs and indirect production and distribution costs. Direct material costs include raw materials used to make FC2, principally a nitrile polymer. Indirect production costs include logistics, quality control and maintenance expenses, as well as costs for electricity and other utilities. All of the key components for the manufacture of FC2 are essentially available from either multiple sources or multiple locations within a source.
RESULTS OF OPERATIONS
T
HREE MONTHS ENDED DECEMBER 31, 2016 COMPARED TO THREE MONTHS ENDED
DECEMBER 31, 2015
The Company generated net revenues of $
3,243,599
and
net
loss
of
$
1,366,181
,
or
$
(0.04)
per
basic and
diluted share, for the
three months ended December 31, 2016
, compared to net revenues of $
8,230,659
and net income of $
1,490,363
, or $
0.05
per
basic and
diluted share, for the three months ended
December 31, 2015
.
Net revenues
decreased
$
4,987,060
on a
58
percent
decrease
in unit sales for the three months ended
December 31, 2016
, compared with the same period last year. The principal factor in the decrease is the period to period impact of the tender shipments to Brazil in fiscal 201
6
. The FC2 average sales price per unit
decreased
5.1
percent compared with the same period last year due to changes in sales mix and a unit price reduction for all major public sector purchases effective April 1, 2016.
Cost of sales
decreased
$
1,237,007
to $
1,591,315
in the three months ended
December 31, 2016
from $
2,828,322
for the same period last year. The reduction is due to lower unit sales
and the
reduction of certain costs.
Gross profit
decreased
$
3,750,053
, or
69
percent, to $
1,652,284
for the three months ended
December 31, 2016
from $
5,402,337
for the three months ended
December 31, 2015
. Gross profit margin for the three months ended
December 31, 2016
was
51
percent of net revenues versus
66
percent of net revenues for the same period last year.
The reduction was due to the unit price reduction for all major public sector purchases effective April 1, 2016 and less favorable impact of currency exchange rates upon material purchases in the three months ended December 31, 2016 as compared to the same period last year.
Significant quarter-to-quarter variations in the Company’s results have historically resulted from the timing and shipment of large orders rather than from any fundamental changes in the business or the underlying demand for female condoms.
Two of the largest customers for FC2 operate in markets where the government health ministries are either still under a multi-year tender or have had a multi-year tender recently expire, and as a result significant orders from these customers during the remainder of fiscal 2017 are unlikely. The Company is also currently seeing pressure on spending for FC2 by large global agencies and donor governments in the developed world. As a result, the Company may continue to experience challenges
for unit sales of FC2 in the global public sector for the remainder of fiscal 2017.
Operating expenses
increased
$
517,192
, or
17
percent, to $
3,526,974
for the three months ended
December 31, 2016
from $
3,009,782
in the prior year period. The
in
crease is
primarily
due to
the issuance of
the Financial Advisor
W
arrant, increased employee compensation expense, and increased legal expense. These increases were partially offset by
reduced payments due to our Brazilian distributor for marketing and management fees for the 2014 tender.
Operating
loss
for the three months ended
December 31, 2016
was
$
1,874,690
, compared to
operating income of $
2,392,555
in the
first
quarter of fiscal year 201
6
. The decrease was primarily a result of the factors discussed above.
Interest and other expense, net, for the three months ended
December 31, 2016
was $
9,621
, compared to
$
27,795
for the same period in fiscal year 2016.
The Company recorded a foreign currency transaction
loss
of $
11,939
in the most recent quarter, compared
to
$
44,944
for the same period last year.
The i
ncome tax
benefit
for the
three months ended December 31, 2016
was $
530,069
,
compared to an
income tax expense
of
$
829,453
for the same period in fiscal year 2016.
The effective tax rate was
28
.
0
percent
and
35.8
percent for the three months ended December 31, 2016 and 2015, respectively. The reduction in the effective
tax rate is due to the mix of tax jurisdictions in which the Company recognized
loss
before income taxes
and an increase in the non-deductible business acquisition expenses related to the APP Merger
. The
Company’s net operating loss (NOL) carryforwards will be utilized to reduce cash payments for income taxes based
on the statutory rate in effect at the time of such utilization. Actual income taxes paid are reflected on the Company’s
consolidated statements of cash flows.
The Company's net
loss
was $
1,366,181
for
the three months ended
December 31, 2016
,
as compared to
net income of $
1,490,363
in the same period of the prior year, as a result of the factors discussed above. Net
loss
was
42
percent and
net income was
18
percent of net revenues for the
three months ended December 31, 2016 and 2015
, respectively.
Liquidity and Sources of Capital
The Company's operations generated cash of $
1.
2
million in the three months ended December 31, 2016, which included a positive
impact of changes in operating assets and liabilities of $
2.
1
million
, compared
with using cash of $
0.4
million in the
three months ended December 31, 2015
, which included a negative impact of changes in operating assets and liabilities of $
(2.9)
million
.
Accounts
receivable
and long-term other receivables
decreased
from $
1
8.6
million at September 30, 201
6
to $
16.2
million at
December 31, 2016
.
The decrease is a result of a payment
of $2.8 million
received from Semina for orders shipped in fiscal 2015. Semina’s
total
accounts receivable
and long-term other receivables
balance
represents
81
percent
of the Company’s
accounts
receivable
and long-term other receivables
balance at
December 31, 2016
. Semina normally pays upon payment from the Brazilian Government; however, due to economic issues in Brazil the government has been slower in paying vendors
.
The Company’s credit terms vary from 30 to 120 days, depending on the class of trade and
customary terms within a territory, so the accounts receivable balance is also impacted by the mix of purchasers within the quarter. As is typical in the Company's business, extended credit terms may occasionally be offered as a sales promotion. For the past twelve months, the Company's average days’ sales outstanding has been
approximately
385
days. Over the past five years, the Company’s bad debt expense has been less than
0.02
percent
of product sales.
At
December 31, 2016
, the Company had working
capital of $1
0.7
million and stockholders’ equity of $
3
5
.
2
million compared to working capital of $
18.8
million and stockholders’ equity of $
34.7
million as of
December 31, 2015
The Company believes its current cash position is adequate to fund operations of the Company in the next 12 months, although no assurances can be made that such cash will be adequate.
Depending on the timing of payment of the Company's outstanding accounts receivable and long-term other receivables balance due from Semina and the timing of development activities relating to the Company's drug candidates, the Company may decide to raise additional capital in the near term. If the Company needs additional cash, potential sources of such cash would include the sale of equity, convertible debt or other equity-linked securities.
On December 29, 2015,
the Company
entered into
the
Credit Agreement with BMO Harris Bank. The Credit Agreement provides the Company with a revolving line of credit of up to $10 million with a term that extends to December 29, 2017. Borrowings under the Credit Agreement bear interest, at the Company’s option, at a base rate or at LIBOR plus 2.25%. The Company is also required to pay a commitment fee at the rate of 0.10% per annum on the average daily unused portion of the revolving line of credit.
T
he Company's obligations under the Credit Agreement are secured by a
lien against substantially all of the assets of the Company and a
pledge of
65%
of the outstanding shares of The Female Health Company Limited
and all of the outstanding shares of APP
.
In addition to other customary representations, covenants and default provisions, the Company is required to maintain a minimum tangible net worth and to not to exceed a maximum total leverage ratio. Among the non-financial covenants, the Company is restricted in its ability to pay dividends, buy back shares of its common stock, incur additional debt and make acquisitions above certain amounts. No amounts are outstanding under the Credit Agree
ment at either
December 31, 2016
or September 30, 2016.
As of December 31, 2016, based on the financial covenants in the Credit Agreement, there is a borrowing capacity of $375,950 under the BMO Harris Bank credit facility. The Company is currently in discussions with BMO Harris Bank regarding possible adjustments to the financial covenants to provide the Company with additional borrowing capacity.
The completion of the APP Merger resulted in a default in FHC's compliance with certain covenants in the Credit Agreement and
constituted
an "event of default" under the Credit Agreement. On November 28, 2016, FHC, Badger Acquisition Sub, Inc., APP and BMO Harris Bank entered into a Third Amendment to the Credit Agreement (the "Amendment"). Pursuant to the Amendment, BMO Harris Bank waived the defaults in FHC's compliance with the covenants in the Credit Agreement as a result of the completion of the APP Merger and APP became a co-borrower under the Credit Agreement. As a result, the revolving line of credit remains in effect under the terms of the Credit Agreement until the end of its term on December 29, 2017.