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| RJ Falkner & Company, Inc. > Research Reports > Female Health Company |
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Company Profile
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The Female Health Company (“FHCO” or “the Company”) has entered a period of impressive growth in sales and earnings that we believe will drive the Company’s common stock price significantly higher in the upcoming 12-18 months. After spending more than 13 years and investing over $100 million to develop and commercialize its patented, FDA-approved FC Female Condom™, we believe the Company stands at the threshold of realizing the substantial potential of its products as key weapons in the global battle against HIV/AIDS. The female condom has proven highly effective in sub-Saharan Africa, Brazil and many other countries in protecting women against sexually-transmitted infections (“STI’s”), including HIV/AIDS. With the support of HIV/AIDS prevention programs by the World Health Organization, the United Nations, USAID, and other high-profile public health agencies, FC2 Female Condoms are currently available in over 105 countries throughout the world. Going forward, virtually all of the Company’s sales will be derived from shipments of its second-generation FC2 Female Condom, which was approved by the FDA in March 2009 and sells at a lower price than the first-generation FC1, but which generates higher gross profit margins. The Company sold 40.2 million female condoms in FY2009 and increased its annualized manufacturing capacity in Malaysia by over 150% to more than 80 million units, in anticipation of continued increases in global demand. The Company’s business model has been highly successful in delivering value to investors, as evidenced by the fact that the return on beginning shareholders’ equity in FY2009, excluding income tax benefits but including non-recurring restructuring charges, was an outstanding 52%. We believe FHCO’s unit sales can increase at a 20%-25% average annual rate and that yearly earnings can grow at an even faster pace in coming years. While quarterly results can fluctuate significantly due to the timing of orders and shipments, we consider FHCO’s annualized operating results to be relatively unphased by the global economic environment. The Company recently commenced the payment of quarterly cash dividends, further enhancing the appeal of FHCO shares to investors. It is our opinion that FHCO shares have the potential to significantly outperform the general stock market during the next 12-18 months, and we consider the stock attractive for both income- and growth-oriented investors.
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INVESTMENT
DATA
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| Traded |
Nasdaq Capital Market |
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Symbol |
"FHCO" |
| Recent Price |
$5.50 |
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52-Week High: |
$7.79 |
| Fiscal Year Ends |
Sept. 30 |
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Low: |
$3.92 |
| Shares Outstanding |
27,477,930 |
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Beneficial Insider Ownership |
31% |
| Est. Float (shs) |
16,000,000 |
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Average Daily Volume (shs) |
68,600 |
| Total Mkt.
Value |
$151
Mil. |
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Institutional
Ownership |
19% |
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Diluted Adjusted
Earnings Per Share |
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| P/E on TTM
Earnings |
40.3X* |
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12 Mos. Ended
3/31/10 |
$0.27** |
| Annualized
Dividend |
$0.20 |
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Dividend
Yield |
3.6% |
* Trailing 12-months ended 3/31/10
** Excludes non-recurring restructuring costs related to transition from FC1 to FC2.
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CONDENSED BALANCE SHEET (Unaudited)
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March 31, 2010
($000)
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Current
Assets |
$12,774 |
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Current
Liabilities |
$4,332 |
| Other
Assets |
102 |
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Capital Lease
Obligations |
23 |
| Property &
Equip., net |
2,595 |
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Deferred Grant
Income |
145 |
| Deferred
Income Taxes - L.T. |
1,028 |
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Shareholders’ Equity |
12,002 |
| TOTAL |
$16,499 |
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TOTAL |
$16,499 |
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INVESTMENT HIGHLIGHTS:
& The spread of HIV/AIDS continues to worsen in many parts of the world, particularly among less-developed countries, and the disease literally threatens the viability of certain economies and governments in Africa and Asia. Studies by the United Nations (“UN”) and the World Health Organization (“WHO”) have shown that the prevention of HIV/AIDS is critical, because the cost of treatment of the disease on a global scale is unacceptably high. Analysts estimate that it costs approximately 20 times more to treat an HIV/AIDS patient than to save lives through prevention of the disease.
& HIV/AIDS is now the most devastating pandemic in recorded human history, and it is getting worse – not better – in many populous developing nations. More than 70 million people have been infected with the virus, and the United Nations estimates that 33.2 million people worldwide are currently living with HIV/AIDS – 15.4 million of which are women aged 15 years and older. Each and every day, it is estimated that 15,000 people are diagnosed with the disease, and the United Nations (UNAIDS) has estimated that up to 100 million people will have died of AIDS by the year 2020.
& There are currently only two products that prevent the transmission of HIV/AIDS through sexual intercourse – the male condom and the female condom. Worldwide, approximately 10 billion male condoms are distributed by public sector health organizations each year. In the year ended 9/30/09, less than 41 million female condoms were distributed globally by public health organizations, in part due to the higher cost of the female condom relative to male condoms. Studies have shown that when both male and female condoms are available, unprotected sexual activity is reduced 10%-35% when compared with situations where the male condom is the only option. In light of such statistics, we expect demand for the female condom to increase significantly due to lower average unit prices for the second-generation FC2 Female Condom, which is considerably less expensive to manufacture than the FC1.
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& The lower production costs for the patented FC2 have already allowed FHCO to reduce the price of the second-generation female condom, while expanding its gross profit margin from 41.9% of revenue in FY2008 to 58.2% in the first half of FY2010. The lower-priced FC2 should allow The Female Health Company to capture a significantly larger share of the global condom market in coming years, while continuing to expand its gross profit margins and allowing yearly operating earnings to grow at a 30%-plus compound annual rate.
& While the effectiveness and acceptability of the female condom among omen have been proven in recent years, a significant portion of FHCO’s historical sales have been to countries in sub-Saharan Africa. We expect growth in FC2 Female Condom sales to accelerate as FHCO targets new markets in more populous countries, such as India (population: 1 billion-plus). Wider distribution to other countries in Asia will likely follow, and we believe China (1.3 billion people) and Russia (143 million) represent large market opportunities as those nations recognize the economic and social risks posed by HIV/AIDS.
& Government funding for HIV/AIDS prevention and treatment has increased dramatically in the past three years. In July 2008, President George W. Bush signed the U.S. President’s Emergency Plan for AIDS Relief (“PEPFAR”) bill into law, authorizing the U.S. Government to provide up to $48 billion over a five-year period to combat HIV/AIDS, tuberculosis and malaria. We estimate that the vast majority of this funding (approximately $45 billion) will be devoted to the prevention and treatment of HIV/AIDS, including the distribution of male and female condoms worldwide. This represents an approximate tripling in HIV/AIDS treatment and prevention spending by the U.S. Government over the previous program. In addition, the British Government has approved approximately $12 billion in funding over seven years for HIV/AIDS prevention and treatment.
& FDA approval of the FC2 Female Condom in March 2009 opens the door for more aggressive marketing and distribution of female condoms in the United States and allows U.S. government agencies (e.g., USAID) and other countries that require FDA approval (e.g., Republic of South Africa) to increase their unit purchases of female condoms. During the past twelve months, the Company, in conjunction with a variety of non-profit organizations, has launched social marketing campaigns in New York, Chicago, and Washington, DC, that will educate women about HIV/AIDS and boost awareness, availability, and access to the FC2 Female Condom. Similar marketing programs in other U.S. cities will be forthcoming.
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& Although sales and operating income are expanding at impressive rates operating income, excluding non-recurring restructuring costs, rose 95% in FY2009), the Company’s capital expenditure requirements are modest, and the Board of Directors voted to initiate a quarterly cash dividend policy in January 2010. FHCO is currently paying a quarterly cash dividend of $0.05 per share, and we believe the Board of Directors will consider future dividend hikes as the Company’s earnings increase. The current annualized dividend of $0.20 provides a cash yield of 3.6% to investors, based upon a recent share price of $5.50.
& The Company’s balance sheet has improved dramatically in the past few years. As of March 31, 2010, shareholders’ equity approximated $12.0 million, the Company had $5.2 million of cash in the bank, and there was no debt outstanding. By contrast, when we started following the company eight years ago (6/30/02), FHCO had a negative shareholders’ equity of ($833,596) and over $2.3 million in outstanding debt. We believe this improvement in the Company’s balance sheet has significantly reduced the risks associated with an investment in FHCO shares.
& If The Female Health Company can capture just 2% of the approximately 10 billion-unit global public sector condom market, which we consider a realistic goal over a several-year period, its unit sales would increase almost 400% to approximately 200 million FC2 Female Condoms annually. Depending upon the weighted-average unit price per condom, this should translate into yearly revenues well in excess of $80 million, at which level we project the Company would earn over $0.70 per diluted share (fully-taxed).
& Given the proprietary nature of its flagship product (certain of the Company’s manufacturing processes are patented and the FC2 condom itself was recently awarded U.S. patent protection) and the significant regulatory and other competitive barriers to entry in the female condom market, we believe The Female Health Company will at some point become an attractive acquisition candidate for one or more global pharmaceutical/healthcare companies. The Company currently has a $69 million British tax loss carryforward that should be worth nearly $1.00 per diluted share to a potential buyer of the Company, if such acquirer meets the requirements to benefit from the loss carryforward (e.g., profitable British operations, same business). At FHCO’s current price of $5.50, therefore, it appears that the market is valuing the Company’s ongoing business at about $4.50 per share, which is equivalent to less than 6.5X potential fully-taxed earnings per share if The Female Health Company were to capture just 2% of the global condom market.
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& In January 2007, FHCO’s Board of Directors approved a stock buyback program that has been expanded to authorize the repurchase of up to 3,000,000 shares of the Company’s common stock. Through March 31, 2010, the Company had repurchased almost 1.9 million shares for approximately $6.1 million (average price of $3.27 per share) under the auspices of this program. The buyback program has also been extended until December 31, 2011.
& FHCO achieved profitability in FY2006, and its earnings have risen at an impressive rate since that time. Excluding non-recurring restructuring costs related to the transition from FC1 to FC2, operating income increased 95% in the fiscal year ended September 2009, and management has provided guidance that a 35%-40% increase is likely in the current fiscal year. On an intermediate-term basis, we believe the Female Health Company’s ability to increase operating earnings at a 30%-plus average annual rate should eventually allow FHCO shares to achieve a valuation equivalent to at least 15X its earnings potential (at a 2% global condom market share), or approximately $10.50 per share. This suggests that FHCO shares have the potential to rise approximately 100% in price over the next 12-18 months.
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 | Since 1996, The Female Health Company and its predecessors have invested over $100 million in the development and commercialization of the FC Female Condom™. Over the years, the Company has secured marketing approval for its first-generation and second-generation female condoms (FC1 and FC2) from the U.S. Food & Drug Administration (“FDA”); patents in the U.S. and multiple other countries; a CE mark in the European Union; and regulatory approval in a number of other countries, including Brazil, India, Japan and China. Certain critical aspects of FHCO’s manufacturing procedures are also protected by patents. While FDA approval is not necessary for distribution of the FC2 in most of the Company’s international markets, it is required for the second-generation condom to be sold/distributed in the U.S. and purchased by USAID and certain developed countries (particularly for the Republic of South Africa). For this reason, the March 2009 approval of the FC2 by the FDA was considered a “watershed” achievement for the Company. As of the first quarter of 2010, the Company ceased all production of the first-generation FC1 condoms.
The Female Health Company is headquartered in Chicago, Illinois, and its primary manufacturing facility for the FC2 condom is located in Malaysia, where 10 production lines are currently operational at the Company’s plant, with an 11th FC2 production line operating at a strategic partner’s plant in India. The Company installed six new production lines in Malaysia during the past twelve months. This increased its annualized FC2 production capacity in Malaysia and India to approximately 85 million units, which is more than double the 40.2 million female condoms sold by the Company in FY2009. This suggests that management believes demand for its FC2 Female Condoms will continue to expand at impressive rates in FY2010 and coming years. The Company’s common stock trades on the Nasdaq Capital Market under the symbol “FHCO”. There are approximately 27.5 million common shares currently outstanding, and the Company’s total market value approximates $151 million.
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Why a Female Condom?
A typical investor might question the need for a female condom, when male
condoms are widely available at a lower price.
“It will be increasingly hard to sustain (AIDS) treatment programs unless we can turn off the tap of new HIV infections. These AIDS numbers point to a need to do more in prevention.”
Dr. Richard Hays
Professor of Epidemiology
London’s School of Hygiene and Tropical Medicine
To answer that query, we must first confront some very disturbing global statistics. While it is believed by many in the U.S. that HIV/AIDS is “under control” and on the decline, nothing could be further from the truth on a global scale. HIV/AIDS has evolved into the most devastating health pandemic in human history, and experts now forecast that it will take more lives than the Bubonic Plague, which killed almost half the population of Western Europe, along with 35 million people in Asia, during the Middle Ages. UNAIDS and the World Health Organization (“WHO”) now estimate that the number of people living with HIV/AIDS approximates 33 million and more than 15,000 people are diagnosed with the disease each day, while WHO has reported that AIDS is the leading cause of death of women ages 15 to 44 worldwide.
In a number of sub-Saharan countries in Africa, where a majority of HIV/AIDS cases have been reported, the disease literally threatens the social structure and the viability of national economies. More recently, the global health community has become greatly concerned with the exponential growth in HIV/AIDS cases in Asia (particularly India, China and Russia) and Eastern Europe. Even in the United States, HIV/AIDS is a much larger problem than is recognized by the general population. For instance, the proportion of women among people living with HIV infection has tripled, from 8 percent in 1985 to 26 percent in 2006. According to the Centers for Disease Control (“CDC”) HIV/AIDS is the leading cause of death for African American women aged 25-34, and African American women accounted for 61% of HIV infections among American women in 2006. Latino women are also disproportionately impacted by HIV infection and are four times more likely than white women to become infected. Currently, there are only two products that prevent the sexual transmission of HIV/AIDS and other STDs – the male condom and the female condom. UNAIDS has concluded that the most effective way to fight the plague of HIV/AIDS, along with other STDs, is through aggressive education and out-reach prevention programs in which female and male condoms play a critical role.
Organizations that comprise the “global public health sector” currently distribute approximately 10 billion male condoms, mostly free of charge or at a nominal cost, to sexually active people throughout the world, mostly in developing nations. It is estimated that another 3 to 4 billion male condoms are distributed through commercial channels, mostly in developed countries such as the U.S. Japan, and European nations.
The lifetime cost of treating an HIV-positive person exceeds $400,000 and can run as high as $648,000 without discounts on antiretroviral drugs.
The female condom is currently the only available barrier contraceptive method that can be initiated by women and that allows them to protect themselves against unintended pregnancy and STIs, including HIV/AIDS. By using the female condom, a woman can make the critical decision regarding whether or not she will engage in unprotected sex. This is very important, because most men do not like to wear condoms and/or refuse to do so. In addition to being under the woman’s control, the FC2 Female Condom is more convenient to use than the male condom, as it can be inserted hours before sexual arousal. As a result, use of the pre-lubricated female condom is less disruptive during sexual intimacy than the male condom, which requires sexual arousal for application. From an economic perspective, the female condom is also a much more effective approach to battling AIDS than the cost of treating persons infected with the disease.
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 | Market Potential
As noted above, an estimated 10 billion male condoms are distributed by the global public sector each year, with an additional 3 to 4 billion units sold through commercial channels. The female condom is seen as an important component of HIV/AIDS prevention programs, because studies have revealed that the availability of female condoms decreases the amount of unprotected sexual activity by 10%-35% when compared with situations where only the male condom is available. In other words, when women are allowed to determine whether or not sexual intercourse will be protected against STDs, there is a higher likelihood of protected sex than if the decision is controlled only by men.
In the United States, the FC2 is currently marketed primarily to city and state public health clinics and non-profit health organizations. The product is also sold to distributors that make it available to consumers through drug stores, grocery stores, and other retail outlets. We expect the Company’s public sector marketing and distribution of FC2 Female Condoms in the U.S. to increase significantly in the future, as evidenced by the recent launch of social marketing programs with non-profit organizations in New York, Chicago and Washington, DC. The Company also plans to seek out partners to promote FC2 directly to consumers in North America, and discussions with companies that have complementary retail distribution networks are currently underway .
The number of female condoms distributed worldwide in FY2009 approximated 40.2 million units, which was equivalent to less than 0.5% of the public health sector male condom market when measured in unit terms. An important factor impacting growth in the utilization of FC2 Female Condoms involves education, programming and insuring a sustainable supply of product in developing countries. Organizations such as the United Nations Population Fund (UNFPA) have been exceptionally active in the development, testing and implementation of HIV/AIDS prevention programs that include the female condom. FC Female Condoms were available in more than 105 countries in FY2009. FHCO has actively contributed to, and collaborated with, the development and implementation of such programs, which are expected to significantly accelerate the use of FC2 Female Condoms.
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“FC2 became globally available about the same time the World Health Organization (WHO) released a tragic fact: Among women 15 to 44 years of age, HIV/AIDS ranks as the Number 1 cause of death worldwide.
O. B. Parrish, CEO
The Female Health Company
FY2009 Annual Report
One of the reasons for the female condom’s currently minuscule market share, in our opinion, has involved price. The Female Health Company’s first-generation FC1 was available under the UN umbrella program, but even so the cost was more than 14 times the average price of a male condom (about $0.05 US). While we believe public health organizations would be willing to purchase many times the number of female condoms currently distributed each year, at a substantially higher price than the male condom due to strong evidence that female condoms significantly reduce the level of unprotected sexual activity, a price of more than 14X the male condom represented a major obstacle to the widespread adoption of the female condom in global health programs during recent years.
To address this challenge, The Female Health Company developed a second-generation female condom, the FC2, which is manufactured more efficiently from lower cost raw materials and, at high volumes can be sold at a significantly lower price than the FC1. At current volumes, FC2 is being sold at prices approximately one-third less than the FC1’s average sales price. The Company’s goal is to capture at least 2% of the global public sector condom market in the next few years, and we believe this is a realistic objective. At a 2% market share, FHCO’s sales would total approximately 200 million units annually, for an increase of almost 400% relative to the Company’s unit sales of 40.2 million units in the fiscal year ended September 30, 2009. If we assume that, at a yearly volume of 200 million-plus units, the weighted average unit price (including commercial sales at higher prices) declines to $0.40-$0.60, from an estimated $0.74 in FY2006, FHCO’s yearly sales would approximately triple to well over $80 million (vs. $27.5 million last fiscal year). Given the FC2’s much lower raw material (nitrile polymer instead of polyurethane) and labor costs (Malaysia/India vs. London), along with a simpler production process (welding and sealing vs. dipping), we believe the Company can further expand its gross profit margins (49% in FY2009, up from 42% in FY2008 and 37% in FY2007 ) and deliver a very healthy return to investors in coming years.
The introduction of the FC2 dovetails well with the emergence of India as a new market with huge potential, given a population of approximately one billion people and a rapidly worsening AIDS crisis in that country. Recent media articles and public statements by Indian government officials suggest that FHCO may receive significant orders for FC2 Female Condoms from India, and we believe India should eventually become one of the Company’s largest markets. Over time, it may make sense for FHCO to locate additional plants within countries that represent large market opportunities, especially given the fact that each plant should require a relatively modest investment by the Company and/or its strategic partners (Hindustan Lifecare Ltd., majority-owned by the Indian government, is FHCO’s strategic partner in India).
The Company was recently awarded patent protection on the FC2 in the U.S. and has received a CE mark from the European Union. Patents have been issued in a number of foreign countries, and patents are pending in others. The World Health Organization has cleared FC2 for purchase by UN agencies, and the U.S. Food and Drug Administration (FDA) approved the FC2 in March 2009, thereby allowing the second-generation female condom to be sold on a worldwide basis.
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 | Summary and Conclusion
While The Female Health Company successfully commercialized the FC1 Female Condom, thereby proving the efficacy and appeal of its products in developing nations that are trying to cope with a growing HIV/AIDS pandemic, the Company’s ability to increase sales and realize the full potential of the female condom was previously limited by the need for programming and education at the country level and a relatively high FC1 pricing structure. We believe the lower-priced FC2 Female Condom, when combined with a rapid expansion in education and government funding (e.g., the U.S. Government’s PEPFAR program), along with a growing recognition of the AIDS crisis among large-population countries (e.g., India, China, Russia, even the U.S.), has the potential to dramatically expand FHCO’s share of the global condom market, while propelling sales and profitability sharply higher in coming years.
While FHCO shares have significantly outperformed the overall stock market during the past 24 months, at a current price of $5.50, the stock is trading 29% below its 52-week high of $7.79. We believe that a very attractive buying opportunity exists at current prices and expect FHCO shares to move significantly higher as investors develop an appreciation for the potential of FC2 and the prospects for India, Russia, China and the U.S. to emerge as major market opportunities within the next few years. Once comparisons to prior-year revenues that include FC1 sales are no longer a factor (first quarter of FY2011), we expect yearly revenues, which increased 7% in FY2009 (vs. 16% growth in unit shipments) and were flat in the first half of FY2010, to grow at annualized rates more similar to the 20%-25% average annualized growth in unit shipments that we project for the foreseeable future. With gross margins likely to expand further and little need for significant additional corporate infrastructure, earnings should increase at a faster rate than sales in coming years. The Company achieved profitability in FY2006, and its earnings increased at impressive rates during the following two years. During the first half of FY2010, operating income attributable to common shareholders (exclusive of non-recurring restructuring charges related to the FC1-FC2 transition) increased 20% on flat revenues, as gross profit margins widened to 58.2% (vs. 50.0% a year earlier), reflecting a greater contribution by the FC2 to the Company’s sales mix. We expect percentage gains in revenue and operating income to accelerate in the second half of FY2010, relative to the six months ended March 31, 2010.
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 | Earlier in this report, we outlined a scenario that anticipates an earnings power of over $0.70 per diluted share if FHCO can capture a 2% share of the global condom market, along with the reasons why we consider this a realistic objective. We also believe that if the Company were to be acquired by a larger healthcare-related company with global production and distribution capabilities, the female condom could target a market share opportunity much greater than 2%. The Company’s funding requirements for capital equipment are quite modest, give the fact that the cost of each new 7.5 million-unit production line is less than $500,000. As a result, FHCO is generating cash from operations at a faster rate than it can redeploy such cash into its current business (excluding potential acquisitions). In January 2010, the Board of Directors elected to share a portion of the Company’s excess cash flow by instituting a quarterly cash dividend policy. Currently, FHCO pays a quarterly cash dividend of $0.05 per share ($0.20 annually), which provides investors with an approximate 3.6% dividend yield, based on a recent common stock price of $5.50. We believe the cash dividend program will play a key role in expanding FHCO’s shareholder base in the future, by attracting investors for whom income plays an important role in stock selection criteria.
Given the Company’s earnings potential as an independent entity, along with the appeal of its earnings leverage and tax loss carryforward to a larger, acquisition-oriented company, we expect FHCO shares to significantly outperform the overall stock market over the 12-18 months. A multiple of 15X our estimate of the Company’s fully-taxed earnings potential upon capturing a 2% share of the global condom market would allow FHCO shares to almost double in price from current levels. We consider the stock very attractive for both income- and growth-oriented investors.
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