Friday, December 3, 2010

Female Health ( Nasdaq - FHCO ) - Follow-up Report

Female Health (FHCO $5.75) reported excellent on target Q4 results.  Revenues declined 1% to $7.80 million.  Fully taxed earnings advanced 40% to $.07 a share.  Unit volume expanded by 19%.  Female Health's second generation product line comprised 100% of shipments in the period.  That new design has a 30% lower selling price but generates more absolute profit per unit than its predecessor.  The old design accounted for approximately one third of business in the year earlier quarter.  For the entire fiscal year (September) income finished at $.14 a share on sales of $22.2 million.  Two large contracts that originally were expected to start contributing in Q3 remained delayed.  Other business actually was stronger than expected in the September period, enabling Female Health to hit its performance targets.  Those deals are likely to be signed before long, which should bolster fiscal 2011 results.

Even with those contracts, results probably won't attain our estimates for the coming year.  The company suggested that sales are likely to expand 15%-20% to provide a 10%-15% increase in earnings.  We'd anticipated a stronger sales showing combined with some margin expansion to drive fully taxed earnings into the $.35 a share range.  As it is, $.20 a share now looks like a more realistic target.

Female Health enjoys substantial tax loss carryforwards in the United Kingdom.  Those benefits can be transferred without penalty in the event ownership of the company changes hands.  In America, significant restrictions typically are imposed, making those tax benefits less valuable.  The downside is that the tax situation might limit the kinds of deals which would be viable in the event of a merger.  Even so, share price risk is moderated by the tax benefits.  Female Health remains cash flow positive and its business is poised to keep expanding in future years, fueled by AIDS prevention programs and a lack of direct competition.  Growth has begun to moderate, though, and that trend may continue if funding sources tighten.  A contemplated diversification into the commercial market hasn't gained momentum to date.  Government funding is likely to remain the company's main source of revenues well into the decade.  With the shares trading at a premium valuation (40x trailing twelve month earnings) and growth slowing down, our advice to aggressive investors is to close out positions and reinvest the proceeds in a higher potential issue.  Value investors can realistically maintain their holdings.  Soros Capital Management recently purchased a 5% holding.  Other socially responsible funds may get involved, as well.

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