Veru Inc.
Q2 2015 Earnings Call Transcript

Published: 2 May 2015

[Operator:]

Hello and welcome to The Female Health Company, Second Quarter Fiscal Year 2015 Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. Please note that this event is being recorded. The statements made on this conference call that are not historical in nature are forward-looking statements based upon the Company’s current plans and strategies. Such forward-looking statements reflect the Company’s current assessment of the risks and uncertainties related to its business. The Company’s actual results and future developments could differ materially from the results or developments in such forward-looking statements. Factors that may cause actual results or developments to differ materially include such things as product demand and market acceptance, the timing of receipt and shipment of large orders, competition, the economic and business environment, and the impact of government pressures, currency risks, capacity, efficiency and supply constraints, also the ability to execute on new business strategies and other risks detailed in the Company’s press releases, shareholder communications and Securities and Exchange Commission filings. For additional information regarding such risks, the Company urges you to review its 10-Q and 10-K SEC filings. I would now like to turn the conference over to Karen King. Please go ahead.

[Karen King:]

Thank you, Robert. Good morning everyone. This is Karen King, President and CEO of The Female Health Company, and I would like to welcome you all to The Female Health Company’s fiscal 2015 second quarter conference call. Joining me on the call today are the Company’s Chairman, OB Parrish and our CFO, Michele Greco. I will ask, Michele to review the financial results for the second quarter and six months ended March 31, 2015. Then I will discuss the progress we have achieved in implementing our strategic initiatives and comment on key factors that may impact future results. Afterwards, Michele and I will take your questions. Please note that when we refer to years, such references are FHC’s fiscal year, which ends September 30 unless otherwise noted. I’ll turn the call over to Michele now.

[Michele Greco:]

Thanks Karen and hello everyone. First, for the second quarter results. During the second quarter of 2015, the Company recorded the highest level of unit volumes and corresponding net revenues, for a single in the company’s history. Unit sales totaled 20.8 million up 71% from 12.2 million units in the previous quarter, and up 184% from the second quarter of 2014. Net revenues for the quarter totaled $11 million, an increase of 153% from $4.3 million in the prior year’s second quarter. Gross profit increased 168% to $6.4 million, which represented 58% of net revenues compared with $2.4 million or 55% of net revenues in the prior year quarter. Operating expenses totaled $3.4 million, compared with $1.6 million for the prior year quarter. Approximately, 60% of the increased operating expenditures related to payments to our Brazilian distributor for ongoing programming related to the 2012 tender and for marketing and management fees for the 2014 tender. Approximately, 30% of the increased spending related to an accrual for fiscal year-end incentive compensation, as compared with a reduction in the accrual for incentive compensation in the prior year period when it was determined that fiscal 2014 performance goals would not be achieved. The remaining 10% of the operating cost increase is due to modest product development cost associated with the FC2 strategy and business development consulting costs associated with the portfolio diversification strategy. Such costs not incurred in the prior-year period. We also want to discuss another expense related to the Brazilian Ministry of Health tender. A tax reduction that had been in place for many years in Brazil for both male and female condoms was unexpectedly removed as of April 1, 2015. Units that shipped in our second fiscal year quarter and were therefore booked as revenue has been arriving in Brazil after April 1, and were subjective to the unplanned incremental tax. Semina, our Brazilian distributor and Female Health Company are sharing the cost of the incremental tax, which will appear in our fiscal Q3 financials and their operating expenses. FHC’s total cost for this will be approximately $600,000. Operating income increased 271% in the second quarter of 2015 to $2.9 million compared with $800,000 in operating income for the prior year quarter. Net income increased 345% to $1.7 million or $0.06 per diluted common share from $375,000 or $0.01 per diluted common share in the second quarter of 2014. Now for the results for the first six months. Unit sales increased 72% to $32.9 million. Revenues increased 60% to $17.6 million. Gross profit increased 68% to $10.2 million from $6.1 million in the first six months of 2014. Operating expenses increased 58% to $5.8 million from $3.7 million in the first six months of 2014. Operating income increased 85% to $4.4 million in the first half from $2.4 million in 2014. Net income increased 34% to $2.5 million or $0.09 per diluted common share from $1.8 million or $0.06 per common diluted share in the first half of 2014. We believe that adjusted EBITDA is useful for investors as a supplemental measure to evaluate our overall operating performance. Adjusted EBITDA represents net income before interest income or expense, income tax expense, depreciation and amortization, and share-based compensation. One of the key reasons we believe adjusted EBITDA is a useful measure is because adjusted EBITDA excludes the impact of income tax expense on net income which has a smaller impact on cash flows, because the company has significant US and UK net operating loss carry-forwards that can be used to reduce cash payments for income taxes. Adjusted EBITDA totaled $5.1 million in the six months ended March 31, 2015 compared with adjusted EBITDA of $3.1 million in the same period last year. Adjusted diluted earnings per share increased to $0.18 in the six months ended March 31, 2015, compared with $0.11 in the same period last year. Now for an update on cash flow. As of March 31, 2015, accounts receivable increased $9.5 million to $12.5 million from $2.9 million at September 30, 2014. As a result of orders received under the awarded Brazil 2014 tender. Our distributor has payment terms of 120 days and when we pay the products receipt of payment from the Brazilian government. Currently, due to economic issues in Brazil, the government has been slower in paying vendors although payment for our product is guaranteed by the Brazil Ministry of Health and they have recently started making payments. At March 31, 2015, our ending cash balance was $2.9 million compared with $5.8 million at September 30, 2014. The decline was primarily due to the longer payment terms for our Brazilian distributor and our cash balances are increasing as payments are being received from Brazil. Now to the tax loss carry-forwards. FHC has significant tax loss carry-forwards that may be used to offset the cash payments of taxes on future earnings. These tax loss carry-forwards include $17 million in state and $17.3 million in federal carry-forwards in the US and $62.9 million of non-expiring carry-forwards in the UK. The company is no longer recognizing an income tax benefit associated with reducing the Company's valuation allowance on its deferred tax assets related to net operating loss carry-forwards. During the period between October 1, 2006 and December 31, 2013, the Company was reducing the valuation allowance on its deferred tax assets related to net operating loss carry-forwards, which resulted in income tax benefits in its P&L. During the period ended December 31, 2013, the valuation allowance on the Company's deferred tax assets was fully reversed and, as a result, the Company does not expect to recognize such income tax benefits to any significant extent in its P&L for periods after December 31, 2013. However, the Company's net operating loss carry-forwards will still 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. While the Company recorded an income tax expense of $1,976,875, in the first half of 2015, in its P&L, the amount of tax actually paid was $155,629, less than 10% of the reported expense. In summary, it has been a case since 2006 the Company has remained profitable during quarters of increasing and decreasing volumes and revenues. Now I will turn it back to Karen.

[Karen King:]

Thank you, Michele. Our second quarter and first half results were very strong in all aspects including revenues and operating profits. A significant portion of the volume in the second quarter was from the orders we have received from the Ministry of Health in Brazil against the tender we announced in October, 2014. FHC is able to very quickly ramp up operations and deliver high quantities of products in a short timeframe. We are unique in that ability as a female condom supplier. We will continue to produce and deliver to Brazil against their outstanding order in the third quarter. We also anticipate the outcome of a new South African tender sometime in the third quarter. We typically do not mention tenders until they are awarded, primarily at the request as a country involved. However, so many of you have seen this tender and commented on it to us, I felt I should point it out to everyone. Both Brazil and South Africa have demonstrated growth of their female condom programs at every subsequent tender issued has been for a higher number of units relative to previous tenders. As we executed on delivering these first half year results, we did not lose focus on our critical growth strategy which also continues to move forward. The first element of our strategy is driving FC2 growth. I have previously explained that in our existing global public sector markets, we shifted our approach from primarily training and education, to include the addition of more traditional sales and marketing activities. And this includes relationship building and calling directly on ministries of health to assure they know the full humanitarian and economic value proposition for incorporating FC2 into their public health program. It also has meant reviewing our distributor relationships and making changes or additions where needed. We have transitioned our own internal capabilities to strengthen our ability to drive sales and marketing efforts, while not adding to our headcount. The other area we are working on to drive FC2 growth involves the consumer sector. I’ve already discussed with you that the need for this product is not just in the developing world. This is a product that can offer great benefits to women in the US and in all developed countries. However, marketing the product to consumers requires a very different approach. We first have to do the homework to understand who the product would resonate with and what would be the motivation to purchase. Our focus for research led us very clearly to key target user groups. Our model growth control is by far the most significant contraceptive method employed in the US. Many women take these products for years and are generally very unhappy with the side-effects. Some women have serious issues or reasons they must avoid hormonal birth control. For others, it is simply dissatisfaction with effects like weight gain or moodiness. The traditional alternative has been male condoms which many users believe lessens the pleasure of the activity. Couples who try female condom are pleasantly surprised and often report a more natural feeling and more enjoyment. It is actually the feature of the product that makes it a little unusual looking, the large lift fitting sheet as well as the nitro material that leads to a more natural feeling experience. Next we nee the right brand name, look and feel to attract target users along with the right messaging. We have engaged in agency and are working on those aspects now. I’ve also explained that we are getting the basic infrastructure ready by preparing for products reimbursement through health insurance plans initiating authorized online sites including our own and bringing on new distributors among other activities. For awareness creation, we intend to primarily utilize a digital approach relying heavily on social media. The target groups we have identified are digital media users and this product category has a strong online purchase base. I recently announced that FC2 female condom is reimbursable under the major health plans including the affordable care act. We believe this will be an important element in supporting growth of a consumer product. We also have a strategy for how to reach healthcare professionals, particularly the OBGYN doctors and nurses. Here we are forming an advisory panel and anticipate that our outreach to large practices across the country will include sampling and promotional materials. Again, we are building a team internally that has the requisite consumer products good background without adding headcount. I have previously managed a consumer goods business and we recently announced a great addition to our Board of Directors, Sharon Meckes, who has an extensive background in marketing consumer product goods in the healthcare sector including contraceptives. An activity we discovered as we have been working on infrastructure preparation is that unauthorized online retailers have been selling FC2 products converted some public sector start. This product is not correctly labeled for consumer use. The FDA requires the product registration holders to use best efforts to stop this type activity and we have completed several measures to do so. Our US sales in 2015 maybe negatively impacted as it appears that a meaningful volume of products was moving through this channel. On one hand, it could be a positive indicator that consumers were finding the product online and will again through multiple authorized sites, particularly when we begin promoting FC2 through social media. On the other, it might – may mean a short-term negative impact on the existing US sales activity. A second critical element of our growth strategy involves portfolio diversification. For most of the Company’s 20 plus year history, we have been a single product company with success since becoming profitable in 2006. However, there are inherent risks associated with being a single product company, particularly when that product is subject to substantial volatility in customer purchasing patterns. The initiative to broaden our product portfolio will drive the company’s growth and depending on the products brought in may also assist in fulfilling our FC2 strategy. I have two full-time industry M&A veterans working with me and we have examined a significant number of opportunities and are in ongoing discussions with certain parties. Our goal is to close the first deal in calendar 2015. While we have been looking at areas across the women’s health spectrum, we have a particular focus on women’s reproductive health. I fully expect that this strategy could be transformative for the company and it should move us towards the desired path of consistent and sustainable growth. I will now speak to the general environment for our current FC2 business. HIV AIDS continues to be a serious challenge in many parts of the world, particularly among women who can benefit from a protection that is under their control. With regard to other sexually transmitted infections or STIs, incidents soaring all around the world including in the US and disturbingly it is most often among young people aged 15 to 24. While treatable STIs can interact lasting consequences including infertility, the female condom is the only method initiated by a woman that can provide protection against unwanted pregnancy, HIV and other STIs and also address this growing concern about STI impact on fertility. Importantly, the global public sector world continues to support the importance of STI and unwanted pregnancy prevention through the procurement of condoms. We have seen no significant change in the competitive situation which we monitor very closely. Cupid, the Indian company continues to be the only other female condom manufacturer who has achieved WHO approval. No other company aside from FHC has achieved FDA clearance, so we are the only female condom product that can be marketed in the US. FC2 remains the only female condom to achieve both FDA approval and WHO clearance. FC2 is covered by 38 patents across 50 countries. More than 475 million FC1 and FC2 condoms have been distributed in more than 144 countries with no recalls or customer rejected lots. The Female Health Company has the capacity to produce up to 100 million units annually, making it the only manufacturer with a current ability to fulfill very large tenders. We do not provide revenue and earnings guidance. However, over the long-term we believe the market for FC2 will continue to grow, and there remains a significant untapped opportunity in demand and usage. We believe the Female Health Company will experience growth and continued profitability due to; first, the continued incidents and associated cost of sexually transmitted diseases in both developed and developing countries, the continuing significance of HIV AIDS and the increased global topics on family planning, also, the only support continues for both HIV AIDS prevention and family planning. Secondly, internal efforts within the company to benefit on untapped demand through more conventional sales and marketing initiatives in our existing markets and a development of a consumer market presence here in the US and other developed countries. Third, the consistent entries of each subsequent tender from both Brazil and South Africa as evidence of the growth of female condom usage in those respective countries. And fourth, commitment of our resources and focus on a growth strategy to drive demand for our existing products increase our growth opportunities through product diversification and improved predictability and consistency of our revenue and earnings. To summarize, we continue to drive sales and FC2 both by a multi-faceted sales and marketing effort. We are implementing a new strategic plan design to drive future growth for the company and we are actively searching for product candidates that have the ability to grow sales, diversify our offerings and deliver long-term value to our shareholders. This concludes our formal comments. Operator, we would now like to take questions.

[Operator:]

Okay, we will now begin the question-and-answer session. [Operator Instructions] The first question comes from Mark Robins of Catalyst Research.

[Marc Robins:]

Thank you. First of all I’ve got, I think, it’s two-and-a-half question. So forgive me. First one is, is there going to be a predator published transcript of this presentation. I got in late and I’d like to make sure I have the details down.

[Karen King:]

Yes, absolutely, Mark and the operator Robert will give the details on that at the end of the questions session.

[Marc Robins:]

Okay, great. The second thing is, is there either any other major country markets, other than Brazil and South Africa that we have sold to in the past or there is a good likelihood that we might sell to in the near future?

[Karen King:]

Oh yes, there is quite a number of countries that come directly to us through the tender process we have in the past served and we continue to in the future. We always highlight Brazil and South Africa, because they are largest countries in terms of usage and their tender procurements.

[Marc Robins:]

And that was the reason for my question. I mean, could there be an opportunity for – and this is a stupid kind of example that China or India or something of that nature where the size of the tender could be as large or larger than the South Africa and Brazilian tenders?

[Karen King:]

Yes, so interesting question, Mark. These are things we are always evaluating countries all around the world. And I’ll tell you, in particularly we are focused on China and what our opportunity might be there and at this moment, we think that the opportunity might be more on the consumer approach as opposed to a public sector approach. So we are continuing to follow-up on that. I don’t have anything specific to say, but, we are always looking for those opportunities.

[Marc Robins:]

All right, then again, forgive me for being a male, but that’s what I am. I am not familiar with how one markets female reproductive products, but, I am working with couple of other companies that have – these were discovered that the major drug retailers and even the major grocery stores now have essentially consulting studios or rooms where minor procedures, shots injections that kind of thing, or consultations could occur. Is there a possibility that a female health company could use this advisory position, it seems to be being created in the retailers to help promote the product? Is that’s something that is feasible? Is the gross margin to the stores significant enough that it could be used as a way to market your product?

[Karen King:]

Yes, absolutely, I think this type of product would be an excellent candidate for that type of service. This area is obviously well studied and research has shown that, when a woman is in a retail pharmacy store, she is willing only spend about eight seconds looking at the product category related to products – to condoms or closely related products, because it’s such an uncomfortable feeling to be doing that. And that’s why online is actually a very significant outreach to this area because women are more comfortable going online for information or ordering the product online. However, we do know that the pharmacy is an important channel and so, if there is something being done like this with the privacy center, I think this would be an ideal product for us.

[Marc Robins:]

That’s just now what I expected. That’s very interesting. I didn’t think that women only would spend an average of eight seconds. I would have thought they would be more thoughtful about it compared to men. Okay, well, that’s great. So you’ve answered the question and maybe that’s an opportunity that you could really take advantage region-by-region or city-by-city. Thanks, so much. I’ll get in line.

[Karen King:]

Thank you, Mark.

[Operator:]

The next question comes from Rashid

[Rishabh Jain:]

Hi, so you guys have mentioned quite a few times being the need to diversify the products by acquiring companies in the [Indiscernible] female reproductive [Indiscernible] space. So what deal size are you guys looking at with regard to potential acquisitions? And will those acquisitions be financed with operating cash flows or outside debt or equity financing?

[Karen King:]

Excellent question, Rishabh, a question that we get quite often and what I generally indicate in this, and all I can indicate at this time is that we are open to all possibilities depending on the ultimate acquisition that we do. We do have some cash reserves that we would be able to employ if we need to go beyond those cash reserves. We will look at all the options available to us and select the one that makes the most sense at the time.

[Rishabh Jain:]

Can you give us a ballpark estimate of the deal sizes though?

[Karen King:]

So, I also can’t give that estimate at this time. We are not being bound by particular deal size. We are looking more at the strategic significance of what it can do and as soon as we are able to announce that, we will come with the full information.

[Rishabh Jain:]

Okay and – are you in correction about the tax rate on the pre-tax income, so I noticed that it’s usually higher than 45% the tax rate. So is that because you guys pay higher taxes because you are paying taxes in multiple to fixing or because it’s higher than the Q3 tax rate of 40% in the United States. So I am assuming it was about 54% and FY 2014 and 45% in quarter 1 2015. So just wanted to know why it’s higher than the usual or the Q3 tax rate? Is that because of taxation in marketable through existing including the United States?

[Karen King:]

Regarding the tax rate and the reason that our effective rate is higher than the statutory rate is really due to some of the AMT tax that we pay in the US, which is added on top of that. But, there is a few other items that are not allowed in permanent items. But one of the things I want to point out is, even though the effective tax rate that we note in the notes there, we really don’t pay that high of a tax. As you can see from the cash flow, because of our NOLs, we actually only pay the AMT tax and tax on income in Malaysia which is a small percentage of our income and that tax rate is 25%. That’s why you see the difference between the tax expense and the actual tax in the cash flow and what we pay the $155,000.

[Rishabh Jain:]

Okay, sounds good. And, my last question is, I know that, you guys have some time to Brazil, as Brazil have accounted as your biggest customers now. In the past, you guys also sold quite a bit to UNFPA. So, how the demand at governmental and global agencies like UNFPA as the demand picking up, how is the feedback from such organizations are they placing huge orders just like Brazil? Or are they slowing down a little bit when it comes to procuring female condoms?

[Karen King:]

So our four largest customers are Brazil, South Africa and then UNFPA, the United Nations Population Fund and also the AID branch of the US government, USAID. And in the case of USAID and UNFPA, what we’ve seen over the years is a little bit more consistency in terms of the overall volume purchased and procured, but also still this volatility and the timing on when it occurs, but certainly in the last several years, we have seen increasing or very similar type purchase patterns from both USAID and UNFPA.

[Rishabh Jain:]

All right. Actually, I have a few more questions, I guess, I’ll just take a break and give others a chance. I guess, just come back in five minutes later.

[Karen King:]

Okay, thank you.

[Rishabh Jain:]

Yes.

[Operator:]

[Operator Instructions] The next question will come from George Whiteside of SWS Financial. Go ahead.

[George Whiteside:]

Good morning. Certainly, you had good growth and improvement in your financials. However, in the cash for stimulation area has the terminated dividend program been used for current operations to any extent?

[Karen King:]

So, George, thank you for your question. We are, as we announced, we - our intention is to use the accumulated cash from our operations to support our growth strategy which will be the diversification and then also growth of FC2 in existing markets and in the consumer markets. At this point, we have not had to spend any appreciable amounts against those, but we are progressing with both and of course, when announce an acquisition, then you would see utilization of that cash and when you see a launch of our rebranded FC2, you would see a utilization of that cash. So, to this stage, we have not utilized a significant amount in our new strategy but that is the intention.

[George Whiteside:]

My second question is related in terminating the dividend program. I am sure you are acutely aware of the fact that the stock has been crushed in terms of price. What efforts do you anticipate can be put in place to build confidence on the part of existing shareholders and hopefully additional shareholders?

[Karen King:]

Yes, thank you. We definitely believe that and this is a decision by the full Board as well as I, that the right thing to do for everyone including our shareholders was to invest in our growth. And that’s what’s our approach is, and our strategy that we are working to implement here. We think that that will create greater long-term value for our investors in the future. So, I think the key thing that we can do is to continue to progress that strategy to show that we are making progress in implementation and continue with announcements on the progress.

[George Whiteside:]

Thank you, very much.

[Karen King:]

Thank you.

[Operator:]

The next question comes from Mr. Peter Mcmullin of IPC Global. Go ahead.

[Peter Mcmullin:]

Hey good morning, Karen.

[Karen King:]

Good morning.

[Peter Mcmullin:]

Under the second quarter results, second paragraph, I read the two lines and we just ask you to extend on the – with respect to January 1, 2015 FC2 unit prices and reduced for all major public sector purchases to replace the previous 5% no cost for product policy. The company’s volume purchasing incentive program that FC2 average sales price per unit decreased 11.2% compared with the same period last year due to changes in sales mix and the public sector price adjustment. I guess, the first thing is, it doesn’t say who initiated this, was this Brazil or just, your company and what does it mean that this just seems like a large reduction in average sale price? And does that mean that every other order gets the same thing? Could you just, could you tie then as to what the previous 5% no cost product policy is? I just don’t understand that those two senses.

[Karen King:]

Sure, thanks for your question Peter. So, the company had a policy of providing 5% free goods based on the number of units purchased within the calendar year for our public sector clients. So, we would look at the total number of units that they purchase during a year and then shortly after the beginning in the next year, we would let them know the number of units that they could get, which represented 5% of their total purchase. Now what we’ve heard for many years from customers is that basically, this is a real challenge for them. It’s more of a hassle than anything else to deal with the free goods, just based on how their systems are. And some of our customers flat out can’t handle free goods at all. So, while we identified it as a very nice benefit for our customers, it really wasn’t working out that way. So, this was at our own initiation, we said, okay, we hear you, we are listening to the issues that you have and we are going to make a change and we’ll eliminate the 5% free goods and instead just make it a 5% reduction in price across the board. So, to us, it has very minimal impact in doing that and listening to our customers and giving them a better solution for how to handle this.

[Peter Mcmullin:]

So, how this 5% equate with an increase of 11.2%? I guess, that’s where I am confused in my knowledge of the unit price.

[Karen King:]

And that’s just related to our product mix. So, Michele, can you comment?

[Michele Greco:]

Right, again, we had a significant change in the product mix for this quarter versus last quarter in this half versus last half. Our units are significantly skewed to the significant units with Brazil which is public sector pricing versus non-public sector pricing which we get a higher cost per unit.

[Peter Mcmullin:]

Okay. Thank you.

[Karen King:]

Thank you.

[Operator:]

The next question comes again from Rishabh Jain of Singular Research.

[Rishabh Jain:]

Well, yes, so I also noticed that, in the past few quarters, a lot of folks creating expenses composed of a bit percentage of the operating expense is that we comment on the commissions paid to the Brazilian distributors, insulation tools, the Brazilian tender offer. So, is this distribution fee basically a percentage of the total order? Or is that a fixed distribution fee that’s paid to the Brazilian distributors?

[Karen King:]

So, it’s a fixed fee for the management and marketing of female condom in the country and it’s paid based on the number of units achieved.

[Rishabh Jain:]

Okay, okay. And I also understand that the initial tender offer with Brazil was for procuring female condoms and they have placed an order for 25 million condoms so far. Is there any indication of potential orders for the next 25 million condoms as well?

[Karen King:]

We really have no way of knowing. The way a tender works is a country puts out a request for bids related to a certain number. We bid against that and we won the tender. But they have a discretion to order as much or as little as they like. They can order no product against it. They can order the full amounts. So we have no way of knowing exactly what Brazil will order.

[Rishabh Jain:]

Okay, thanks a lot.

[Operator:]

This concludes our question and answer session. I would like to turn the conference back over to Mrs. King for any closing remarks.

[Karen King:]

So, I’ll just say, thank you all for joining us today. We know that many of you like to talk individually with Michele and I. So please just contact Michele and we are happy to set up sessions for further private discussions. And, we look forward to speaking to you again at the end of next quarter.

[Operator:]

To access the digital replay of this conference, you may dial 1-877-344-7529 or 1-412-317-0088 beginning at 1