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 and six months ended March 31, 2022 (the “2022 Quarter” and “2022 Period”, respectively) with those for the three and six months ended March 31, 2021 (the “2021 Quarter” and “2021 Period”, respectively). Additionally, the twelve months ending September 30, 2022 are referred to as “Fiscal 2022.” 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 and plans on repaying outstanding debt obligations 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 Securities and Exchange Commission. 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 effects of the COVID-19 pandemic continue to impact the retail and OEM distribution segments of 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 and most notably in the second quarter of Fiscal 2022. Labor shortages at U.S. ports and in ground transportation services caused container ships to spend a significant amount of time waiting for goods to be unloaded and to arrive at our warehouses. These factors caused an increase in the demand for and cost of ground transportation and delayed consumer availability for many of our products in the first half 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. The effects of the pandemic had a lesser impact on the design segment of our business. Rising inflation caused an increase in the cost of acquiring and maintaining our employees. The timing and extent of future inflation are difficult to predict, but we expect these rising costs to have a more significant impact in the second half of Fiscal 2022. The effects of COVID-19 may further impact our business in ways we cannot predict, and such impacts could be significant. The current 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 effects of the pandemic have fully receded, 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 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. 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 MARCH 31, 2022 COMPARED TO THE THREE MONTHS ENDED MARCH 31, 2021 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 $ 10,315,000 $ 8,395,000 $ 1,920,000 22.9% Cost of sales 8,063,000 6,652,000 1,411,000 21.2% Gross profit 2,252,000 1,743,000 509,000 29.2% Sales and marketing expenses 704,000 578,000 126,000 21.8% General and administrative expenses 1,871,000 1,981,000 (110,000 ) (5.6% ) Loss from operations (323,000 ) (816,000 ) 493,000 (60.4% ) Other expense, net 33,000 19,000 14,000 73.7% Provision for income taxes – – – – Net loss $ (356,000 ) $ (835,000 ) $ 479,000 (57.4% ) The discussion that follows below provides further details about our results of operations for the 2022 Quarter as compared to the 2021 Quarter. 19 Net revenues increased across all segments, with the most significant growth coming from the IPS component of the design segment. Our gross profit increased, primarily driven by the increase in revenues, and gross margin improved from 20.8% in the 2021 Quarter to 21.8% in the 2022 Quarter. Higher utilization rates coupled with an increase in the average bill rate drove design segment margins higher. However, higher importation and logistics costs drove margins down in both the OEM and retail distribution segments. Management believes there will be continued volatility in OEM and retail distribution 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 remained relatively flat at 6.8% in the 2022 Quarter. As we continue to invest in the retail segment 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 bad debt expense in the design segment. These declines were partially offset by slightly higher corporate expenses, primarily related to an increase in non-employee board members’ equity compensation. 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. Other expense, net increased due to a decrease in interest income on a customer note receivable, partially offset by lower interest expense due to a reduction in the average amount of debt outstanding. We generated a net loss of $356,000 and $835,000 in the 2022 and 2021 Quarter, respectively. 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 loss per share were $0.04 and $0.08 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 year 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 $ 4,676,000 $ 649,000 $ 4,990,000 $ – $ 10,315,000 2021 Quarter revenues 4,254,000 229,000 3,912,000 – 8,395,000 Change $ 422,000 $ 420,000 $ 1,078,000 $ – $ 1,920,000 2022 Quarter operating income/(loss) $ 326,000 $ (356,000 ) $ 389,000 $ (682,000 ) $ (323,000 ) 2021 Quarter operating income/(loss) 302,000 (210,000 ) (288,000 ) (620,000 ) (816,000 ) Change $ 24,000 $ (146,000 ) $ 677,000 $ (62,000 ) $ 493,000 OEM Distribution Segment Net revenues in the OEM distribution segment increased due primarily to an increase in sales of diabetic products, while an increase in revenues from other products comprised a lesser portion of the increase. 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. 20 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 $ 4,159,000 $ 3,836,000 $ 323,000 8.4% Other products 517,000 418,000 99,000 23.7% Total net revenues $ 4,676,000 $ 4,254,000 $ 422,000 9.9% 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 increased in the 2022 Quarter primarily due to logistical delays caused by limited cargo capacity in the first quarter of Fiscal 2022 which were resolved in the 2022 Quarter. This increase was further enhanced by a slight increase in demand for some products. As mentioned above, management believes that revenues from diabetic customers will continue to decline in future periods. Revenues from diabetic products represented 89% of net revenues for the OEM distribution segment in the 2022 Quarter compared to 90% in the 2021 Quarter. The remaining revenues from our OEM distribution segment are described below. 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 primarily due to higher sales volume with existing customers. 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. Operating Income Operating income for the OEM distribution segment increased and operating income margin remained relatively consistent at 7.0%. The higher gross margins derived from other product revenue was offset by declining margins on diabetic products due to higher freight and other importation costs and pricing pressures from customers, resulting in a decrease in gross margin as compared to the prior year quarter. The decline in gross margin was mitigated by lower selling and marketing costs resulting from a reduction in contract sales personnel, which improved operating income and helped maintain the operating income margin. Retail Distribution Segment Net revenues increased due to new product offerings and the continued expansion of our retail distribution network; revenue derived from new retailers 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 higher freight and other importation costs, supply chain issues and higher sales and marketing expenses driven by higher sales commission resulting from the increase in revenue and higher advertising and promotion expenses. 21 Design Segment The increase in net revenues in the design segment was driven by an increase in projects from new and 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 from (7.4%) in the 2021 Quarter to 7.8% in 2022 Quarter. The increase in gross profit, driven by higher revenues and better utilization and billing rates, was further enhanced by a decrease in general and administrative expenses primarily due to a reduction in bad debt expense. RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED MARCH 31, 2022 COMPARED TO THE SIX MONTHS ENDED MARCH 31, 2021 Consolidated Results The table below summarizes our consolidated results of operations for the 2022 Period as compared to the 2021 Period: Consolidated Results of Operations 2022 Period 2021 Period Change ($) Change (%) Revenues, net $ 21,928,000 $ 18,113,000 $ 3,815,000 21.1% Cost of sales 17,057,000 14,107,000 2,950,000 20.9% Gross profit 4,871,000 4,006,000 865,000 21.6% Sales and marketing expenses 1,442,000 1,181,000 261,000 22.1% General and administrative expenses 3,538,000 3,809,000 (271,000 ) (7.1% ) Loss from operations (109,000 ) (984,000 ) 875,000 (88.9% ) Other expense/(income), net 67,000 (1,348,000 ) 1,415,000 (105.0% ) Provision for income taxes – – – – Net (loss)/income $ (176,000 ) $ 364,000 $ (540,000 ) (148.4% ) The discussion that follows below provides further details about our results of operations for the 2022 Period as compared to the 2021 Period. Net revenues increased across all segments, most notably in the design and retail distribution segments and to a lesser extent, in the OEM distribution segment. Our gross profit increased, primarily driven by the increase in revenues, but gross margin remained relatively consistent at 22.2%. Better utilization and higher billing rates in the design segment were mostly offset by higher importation and logistics costs, which drove OEM and retail distribution margins down. Management believes there will be continued volatility in OEM and retail distribution cost of sales for the remainder of Fiscal 2022. Sales and marketing expenses increased in the 2022 Period primarily due to higher advertising and promotional costs coupled with sales commissions related to our retail distribution segment. Sales and marketing as a percentage of revenues increased slightly to 6.6% in the 2022 Period. 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 Period, primarily related to lower bad debt expense in the design segment. These declines were partially offset by higher corporate expenses, primarily related to an increase in non-employee board members’ equity compensation and 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. 22 We reported other expense of $67,000 in the 2022 Period as compared to net other income of $1,348,000 in the 2021 Period. The decrease is primarily due to the forgiveness of note payable related to the PPP loan in the 2021 Period, which did not recur in the 2022 Period. A decrease in interest payment on a customer note receivable contributed to the balance of the change. In the 2022 Period, we generated a net loss of $176,000. In the 2021 Period, we generated net income of $364,000, 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 (loss)/earnings per share were $(0.02) and $0.04 for the 2022 Period and the 2021 Period, respectively. Segment Results The discussion that follows below provides further details about the results of operations for each segment as compared to the prior year period. 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 Period 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 Period revenues $ 9,917,000 $ 2,041,000 $ 9,970,000 $ – $ 21,928,000 2021 Period revenues 9,467,000 621,000 8,025,000 – 18,113,000 Change $ 450,000 $ 1,420,000 $ 1,945,000 $ – $ 3,815,000 2022 Period operating income/(loss) $ 823,000 $ (584,000 ) $ 974,000 $ (1,322,000 ) $ (109,000 ) 2021 Period operating income/(loss) 719,000 (389,000 ) (112,000 ) (1,202,000 ) (984,000 ) Change $ 104,000 $ (195,000 ) $ 1,086,000 $ (120,000 ) $ 875,000 OEM Distribution Segment Net revenues in the OEM distribution segment increased primarily due to higher sales of other OEM products coupled with a smaller increase in diabetic product revenue. Revenues from other products increased $362,000 and revenue from diabetic products increased $88,000. As consumer demand increases for diabetic testing products which require no carrying case, we expect diabetic product sales to represent a smaller portion of our OEM distribution revenue. The following tables set forth revenues by product line of our OEM distribution segment customers for the periods indicated: OEM Revenues by Product Line 2022 Period 2021 Period Change ($) Change (%) Diabetic products $ 8,393,000 $ 8,305,000 $ 88,000 1.1% Other products 1,524,000 1,162,000 362,000 31.2% Total net revenues $ 9,917,000 $ 9,467,000 $ 450,000 4.8% 23 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 increased due to higher revenues from one major diabetic customer. The higher revenue from this customer was due to a short-term increase in demand for certain products that are being phased out, coupled with delays in placing orders near the end of Fiscal 2021 which resulted in more revenue being recognized in the first half of Fiscal 2022. These increases were partially offset by lower 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 85% of net revenues for the OEM distribution segment in the 2022 Period compared to 88% in the 2021 Period. The remaining revenues from our OEM distribution segment are described below. 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 sales volume from existing customers. 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. Operating Income Operating income for the OEM distribution segment increased and operating income margin improved to 8.3% in the 2022 Period from 7.6% in the 2021 Period. 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 decrease in gross margin as compared to the prior year quarter. The decline in gross margin was mitigated by lower selling and marketing costs related to OEM sales commissions. Retail Distribution Segment Net revenues increased due to new product offerings and the continued expansion of our retail distribution network; revenue derived from new retailers 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. The increase in gross profit driven by higher revenues was offset by higher sales and marketing expenses related to sales commissions, advertising and promotional expenses to support the growth 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 from (1.4%) in the 2021 Period to 9.8% in 2022 Period. The increase in gross profit, driven by higher revenues and better utilization and billing rates, was further enhanced by a decrease in general and administrative expenses primarily due to a reduction in bad debt expense. 24 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 March 31, 2022, our working capital was $3,899,000 compared to $5,587,000 at September 30, 2021; the decrease primarily due to the remaining $1,500,000 balance on the note payable to Forward China becoming a current liability at March 31, 2022 as opposed to a long-term liability at September 30, 2021. At April 30, 2022, we had $1,900,000 cash on hand and $1,300,000 available under our line of credit which matures May 31, 2023. Additionally, Forward China, our largest vendor and 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 $1,500,000 after the Company made principal payments of $100,000 in Fiscal 2022. 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 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 extend payment terms when we need them, or (iii) 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. Cash Flows During the 2022 Period and 2021 Period, our sources and uses of cash were as follows: Operating Activities During the 2022 Period, cash provided by operating activities of $360,000 primarily resulted from an increase in accounts payable, accrued expenses and amounts due to Forward China of $1,836,000, an increase in deferred income of $433,000 and non-cash expenses of $321,000 for depreciation, amortization, share-based compensation and bad debt expense, partially offset by an operating loss of $109,000, an increase in inventories of $1,835,000, a decrease in prepaid expenses and other current liabilities of $255,000 and the net change in other operating assets and liabilities of $31,000. During the 2021 Period, cash used in operating activities of $398,000 primarily resulted from an operating loss of $984,000, a decrease in deferred income of $348,000, an increase in inventories of $874,000, a decrease in accrued expenses of $161,000, partially offset by non-cash expenses of $748,000 relating to depreciation, amortization, share-based compensation and bad debt expense, a decrease of $757,000 in accounts receivable, an increase of $395,000 in accounts payable and amounts due to Forward China and the net change in other operating assets and liabilities of $69,000. Investing Activities Cash used in investing activities in the 2022 Period and the 2021 Period of $130,000 and $38,000, respectively, resulted from purchases of property and equipment. 25 Financing Activities In the 2022 Period, cash used in financing activities of $100,000 consisted of principal payments on the promissory note held by Forward China. In the 2021 Period, cash used in financing activities of $960,000 consisted of net repayments of the line of credit of $1,000,000, repayments of notes payable and finance leases of $104,000, partially offset by proceeds from stock options exercised of $144,000. 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. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable.