Forward Industries, Inc. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with our unaudited condensed consolidated financial statements, and the notes thereto, and other financial information appearing elsewhere in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2021. The following discussion and analysis compares our consolidated results of operations for the three months ended December 31, 2021 (the “2022 Quarter”) with those for the three months ended December 31, 2020 (the “2021 Quarter”). All dollar amounts and percentages presented herein have been rounded to approximate values. Cautionary Note Regarding Forward-Looking Statements This report contains “forward-looking statements”, as such term is used within the meaning of the Private Securities Litigation Reform Act of 1995. These statements include, among other things, statements regarding: · our liquidity; · plans on repaying outstanding debt obligations; · expectations regarding growth in retail as well as other statements regarding our future operations, financial condition and prospects, and business strategies. Forward-looking statements generally can be identified by words such as "anticipates," "believes," "estimates," "expects," "intends," "plans," "predicts," "projects," "will be," "will continue," "will likely result," and similar expressions. These forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties, which could cause our actual results to differ materially and adversely from those reflected in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed under the caption "Risk Factors" in Item 1A of our Form 10-K for the year ended September 30, 2021 and those discussed in other documents we file with the SEC. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements, except as required by law. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements. Business Overview Forward Industries, Inc. is a fully integrated design, development and manufacturing solution provider for top tier medical and technology customers worldwide. As a result of the continued expansion of our design development capabilities through our wholly-owned subsidiaries, IPS and Kablooe, we are now able to introduce proprietary products to the market from concepts brought to us from a number of different sources, both inside and outside the Company. The COVID-19 pandemic continues to impact our business. The increase in global consumer demand, coupled with the global shipping container shortage, dramatically increased demand for both ocean freight and ground transportation. These factors led to a significant increase in freight costs, particularly from the Asia-Pacific region. Labor shortages at US ports and in ground transportation services caused container ships to spend a significant amount of time waiting to be unloaded and to arrive at our warehouses. These factors caused an increase in the demand and cost of ground transportation and delayed consumer availability for many of our products in the first quarter of fiscal 2022. The timing and extent of these COVID-19 related transportation disruptions is still largely unknown but are expected to continue throughout fiscal 2022. COVID-19 may further impact our business in ways we cannot predict, and such impacts could be significant. The current and economic impact may continue to negatively impact our results of operations, cash flows and financial position in future periods as well as that of our customers, including their ability to pay for our services and to choose to allocate their budgets to new or existing projects which may or may not require our services. The long-term financial impact on our business cannot be reasonably estimated at this time. As a result, the effects of COVID-19 may not be fully reflected in our financial results until future periods. 18 Until the pandemic is fully controlled, we expect business conditions to remain challenging. In response to these challenges, we will continue to focus on those factors that we can control: closely managing and controlling our expenses; aligning our design and development schedules with demand in a proactive manner as there are changes in market conditions to minimize our cash operating costs; pursuing further improvements in the productivity and effectiveness of our development, selling and administrative activities and, where appropriate, taking advantage of opportunities to enhance our business growth and strategy. Refer to “Part I, Item 1A — Risk Factors” included in the Company’s Annual Report for the year ended September 30, 2021 for a description of the material risks that the Company currently faces in connection with COVID-19. Variability of Revenues and Results of Operations A significant portion of our revenue is concentrated with several large customers, some of which are the same and some of which change over time. Orders from some of these customers can be highly variable, with short lead times, which can cause our quarterly revenues, and consequently our results of operations, to vary over a relatively short period of time. Critical Accounting Policies and Estimates We discuss the material accounting policies that are critical in making the estimates and judgments in our Annual Report on Form 10-K for the fiscal year ended September 30, 2021, under the caption “Management’s Discussion and Analysis—Critical Accounting Policies and Estimates”. There has been no material change in critical accounting policies or estimates during the period covered by this report. Recent Accounting Pronouncements For information on recent accounting pronouncements and impacts, see Note 2 to the unaudited condensed consolidated financial statements. RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED DECEMBER 31, 2021 COMPARED TO THE THREE MONTHS ENDED DECEMBER 31, 2020 Consolidated Results The table below summarizes our consolidated results of operations for the 2022 Quarter as compared to the 2021 Quarter: Consolidated Results of Operations 2022 Quarter 2021 Quarter Change ($) Change (%) Revenues, net $ 11,614,000 $ 9,718,000 $ 1,896,000 19.5% Cost of sales 8,995,000 7,455,000 1,540,000 20.7% Gross profit 2,619,000 2,263,000 356,000 15.7% Sales and marketing expenses 738,000 603,000 135,000 22.4% General and administrative expenses 1,667,000 1,827,000 (160,000 ) (8.8% ) Income/(loss) from operations 214,000 (167,000 ) 381,000 (228.1% ) Other expense/(income), net 34,000 (1,366,000 ) 1,400,000 (102.5% ) Provision for income taxes – – – – Net income $ 180,000 $ 1,199,000 $ (1,019,000 ) (85.0% ) 19 The discussion that follows below provides further details about our results of operations for the 2022 Quarter as compared to the 2021 Quarter. Net revenues increased primarily due to higher revenues in the retail segment coupled with an increase in revenues in the design segment. Revenues in the OEM distribution segment remained relatively consistent with the prior year quarter. Our gross profit increased, primarily driven by the increase in revenues, but gross margin declined from 23.3% in the 2021 Quarter to 22.6% in the 2022 Quarter. The higher cost of importing products from overseas drove retail margins down, while lower utilization in the design segment contributed to the remainder of the margin decline. Gross margin for the OEM distribution segment improved slightly from the prior year quarter. Management believes there will be continued volatility in cost of sales for the remainder of fiscal 2022. Sales and marketing expenses increased in the 2022 Quarter primarily due to higher advertising costs and sales commissions related to our retail distribution segment. Sales and marketing as a percentage of revenues increased to 6.4% in the 2022 Quarter from 6.2% in the 2021 Quarter. As we continue to invest in the retail business and as it grows to represent a larger component of the overall business, management expects sales and marketing costs, both in total and as a percentage of revenues, to increase in future periods. General and administrative expenses declined in the 2022 Quarter, primarily related to lower personnel related costs and lower bad debt expense in the design segment. These declines were partially offset by higher corporate expenses, primarily related to a reduction in certain foreign tax credits received for research and development activities. Management continues to monitor the various components of general and administrative expenses and how these costs are affected by inflationary and other factors. We intend to make adjustments to these costs as needed based on the overall needs of the business. We reported other expense of $34,000 in the 2022 Quarter as compared to net other income of $1,367,000 in the 2021 Quarter. The decrease is primarily due to the forgiveness of note payable related to the PPP loan in the 2021 Quarter, which did not recur in the 2022 Quarter. In the 2022 Quarter, we generated net income of $180,000. In the 2021 Quarter, we generated net income of $1,199,000, primarily resulting from the $1,357,000 forgiveness of note payable related to the PPP loan, which was not recognized as taxable income per the CARES Act. We maintain significant net operating loss carryforwards and do not recognize income tax expense or benefit as our deferred tax provision is typically offset by a full valuation allowance on our net deferred tax asset. Consolidated basic and diluted earnings per share were $0.02 and $0.12 for the 2022 Quarter and the 2021 Quarter, respectively. Segment Results The discussion that follows below provides further details about the results of operations for each segment as compared to the prior quarter. Due to the growth of our retail division, we determined it to be a separate reportable segment in the fourth quarter of fiscal 2021. The results of operations for the 2021 Quarter for each segment discussed below have been reformatted from what was previously disclosed to segregate the retail distribution segment and exclude general corporate expenses from segment operating income to show them as a reconciling item so that results are comparable to the current year presentation. Segment Results of Operations OEM Distribution Retail Distribution Design Corporate Expenses Consolidated 2022 Quarter revenues $ 5,242,000 $ 1,392,000 $ 4,980,000 $ – $ 11,614,000 2021 Quarter revenues 5,214,000 392,000 4,112,000 – 9,718,000 Change $ 28,000 $ 1,000,000 $ 868,000 $ – $ 1,896,000 2022 Quarter operating income/(loss) $ 497,000 $ (228,000 ) $ 585,000 $ (640,000 ) $ 214,000 2021 Quarter operating income/(loss) 417,000 (179,000 ) 177,000 (582,000 ) (167,000 ) Change $ 80,000 $ (49,000 ) $ 408,000 $ (58,000 ) $ 381,000 20 OEM Distribution Segment Net revenues in the OEM distribution segment increased slightly from the 2021 Quarter to the 2022 Quarter as the increase in revenue from other products was mostly offset by declines in the sale of diabetic products. Revenues from other products increased $260,000 and revenue from diabetic products decreased $232,000. As consumer demand increases for diabetic testing products which require no carrying case, we expect diabetic product sales to represent a smaller portion of our OEM distribution revenue. The following tables set forth revenues by product line of our OEM distribution segment customers for the periods indicated: OEM Revenues by Product Line 2022 Quarter 2021 Quarter Change ($) Change (%) Diabetic products $ 4,234,000 $ 4,466,000 $ (232,000 ) (5.2% ) Other products 1,008,000 748,000 260,000 34.8% Total net revenues $ 5,242,000 $ 5,214,000 $ 28,000 0.5% Diabetic Product Revenues Our OEM distribution segment manufactures to the order of, and sells carrying cases for, blood glucose diagnostic kits directly to OEMs (or their contract manufacturers). The OEM customer or its contract manufacturer packages our carry cases “in box” as a custom accessory for the OEM’s blood glucose testing and monitoring kits, or to a lesser extent, sells them through their retail distribution channels. Revenues from diabetic products decreased primarily due to lower revenues from one major diabetic customer. The lower revenue from this customer was due to the timing of shipments near the end of the 2022 Quarter compared to the 2021 Quarter and was partially offset by higher revenue from other diabetic customers, which were less significant. As mentioned above, management believes that revenues from diabetic customers will continue to decline in future periods. Revenues from diabetic products represented 81% of net revenues for the OEM distribution segment in the 2022 Quarter compared to 86% in the 2021 Quarter. Other Product Revenues Our OEM distribution segment also sources and sells cases and protective solutions for a diverse array of portable electronic and non-electronic products (such as sporting and recreational products, bar code scanners, GPS location devices, tablets and firearms) on a made-to-order basis that are customized to fit the products sold by our OEM customers. Revenues from other products increased due to an increase in customers and higher sales volume. We will continue to focus on our sales and sales support teams in our continued efforts to expand and diversify our other products customer base. Revenues from other products represented 19% of our OEM distribution revenues in the 2022 Quarter compared to 14% in the 2021 Quarter. Operating Income Operating income for the OEM distribution segment increased and operating income margin improved to 9.5% in the 2022 Quarter from 8.0% in the 2021 Quarter. The higher gross margins derived from other products was mostly offset by declining margins on diabetic products due to pricing pressures from customers, resulting in a slight increase in gross margin as compared to the prior year quarter. Operating income was further enhanced by a reduction in selling and marketing expenses. 21 Retail Distribution Segment Net revenues increased due to new product offerings and the continued expansion of our retail distribution network; revenue derived from new retail partnerships as well as an increase in volume with certain existing retailers. We will continue to focus on our sales and sales support teams in our attempt to expand and diversify our retail product offerings. Although revenues increased, the increase in operating loss was driven by higher cost of sales caused by supply chain issues and higher sales and marketing expenses driven by higher sales commission resulting from the increase in revenue. Design Segment The increase in net revenues in the design segment was driven by new customers and an increase in projects from certain existing customers, which was partially offset by declines in revenues from certain prior year customers. Operating income for the design segment increased and operating income margin improved to 11.7% in 2022 Quarter from 4.3% in the 2021 Quarter. The increase in gross profit, driven by higher revenues, was further enhanced by a decrease in general and administrative expenses due to lower personnel costs and a reduction in bad debt expense. LIQUIDITY AND CAPITAL RESOURCES Our primary source of liquidity is our operations. The primary demand on our working capital has historically been (i) operating losses, (ii) repayment of debt obligations, and (iii) any increases in accounts receivable and inventories arising in the ordinary course of business. Historically, our sources of liquidity have been adequate to satisfy working capital requirements arising in the ordinary course of business. At December 31, 2021, our working capital was $4,229,000 compared to $5,587,000 at September 30, 2021; the decrease primarily due to the note payable to Forward China becoming current at December 31, 2021 as compared to long-term at September 30, 2021. At January 31, 2022, we had $2,200,000 cash on hand and $1,300,000 available under our line of credit which matures May 31, 2022. Although we can provide no assurance, we plan to renew this line of credit with the bank through May 31, 2023. Additionally, Forward China, an entity owned by our Chairman of the Board and Chief Executive Officer, holds a $1,600,000 promissory note issued by the Company which matures on December 31, 2022 (see Note 8 to the condensed consolidated financial statements). The balance of this promissory note was reduced to $1,550,000 after the Company made a principal payment of $50,000 in December 2021. Although this promissory note has been extended on multiple occasions to assist us with our liquidity position, we plan on funding the repayment at maturity using existing cash balances and/or obtaining an additional credit facility as deemed necessary. Forward China, our largest vendor, has extended payment terms on our outstanding payables due to them when necessary. We can provide no assurance that (i) Forward China will extend the promissory note again if we request an extension, (ii) Forward China will continue to provide favorable payment terms when we need them, or (ii) any additional credit facility will be available on terms acceptable to us or at all. We anticipate that our liquidity and financial resources for the 12 months following the date of this report will be adequate to manage our operating and financial requirements. If we have the opportunity to make a strategic acquisition (as we have in the past with the acquisitions of IPS and Kablooe) or an investment in a product or partnership, we may require additional capital beyond our current cash balance to fund the opportunity. If we seek to raise additional capital, there is no assurance that we will be able to raise funds on terms that are acceptable to us or at all. Although we do not anticipate the need to purchase additional material capital assets in order to carry out our business, it may be necessary for us to purchase equipment and other capital assets in the future, depending on need. 22 Cash Flows During the 2022 Quarter and 2021 Quarter, our sources and uses of cash were as follows: Operating Activities During the 2022 Quarter, cash provided by operating activities of $1,138,000 primarily resulted from operating income of $214,000, an increase in accounts payable, accrued expenses and amounts due to Forward China of $1,276,000, an increase in deferred income of $565,000 and non-cash expenses of $112,000 for depreciation, amortization and share-based compensation, partially offset by an increase in inventories of $910,000, an increase in prepaid expenses and other current assets of $70,000 and the net change in other operating assets and liabilities of $49,000. During the 2021 Quarter, cash used in operating activities of $511,000 primarily resulted from an operating loss of $167,000, a decrease in deferred income of $315,000, an increase in accounts receivable of $204,000, a decrease in accounts payable, accrued expenses and amounts due to Forward China of $176,000, partially offset by non-cash expenses of $213,000 relating to depreciation, amortization, share-based compensation and bad debt expense, an increase of $125,000 in prepaid expenses and other assets and the net change in other operating assets and liabilities of $13,000. Investing Activities Cash used in investing activities in the 2022 Quarter and the 2021 Quarter of $66,000 and $30,000, respectively, resulted from purchases of property and equipment. Financing Activities In the 2022 Quarter, cash used in financing activities of $50,000 consisted of principal payments on the promissory note held by Forward China. In the 2021 Quarter, cash used in financing activities of $51,000 consisted of repayments of notes payable and capital leases of $52,000, partially offset by proceeds from stock options exercised. Related Party Transactions For information on related party transactions and their financial impact, see Note 8 to the unaudited condensed consolidated financial statements contained herein. 23 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable.