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, 2023. The following discussion and analysis compares our condensed consolidated results of operations for the three months ended December 31, 2023 (the “2024 Quarter”) with those for the three months ended December 31, 2022 (the “2023 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, our beliefs and our plans regarding gaining Nasdaq compliance, 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. These risks include the inability to expand our customer base, loss of additional customers, pricing pressures, lack of success of our sales people, failure to develop products at a profit, failure to commercialize products that we develop, continued supply chain issues, a significant decrease in our stock price upon effectuating a reverse stock split, inability of our design division’s customers to pay for our services, unanticipated issues with our affiliated sourcing agent, issues at Chinese factories that source our products, and failure to obtain acceptance of our products. No assurance can be given that the actual results will be consistent with the forward-looking statements. Investors should read carefully the factors described in the “Risk Factors” section of the Company’s filings with the SEC, including the Company’s Form 10-K for the year ended September 30, 2023 for information regarding risk factors that could affect the Company’s results. 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 global design, sourcing and distribution company serving top tier medical and technology customers worldwide. The Company’s design division provides hardware and software product design and engineering services to customers predominantly located in the U.S. The Company’s original equipment manufacturing (“OEM”) distribution division sources and sells carrying cases and other accessories for medical monitoring and diagnostic kits as well as a variety of other portable electronic and non-electronic devices to OEMs, or their contract manufacturers worldwide, that either package our products as accessories “in box” together with their branded product offerings or sell them through their retail distribution channels. The Company does not manufacture any of its OEM products and sources substantially all of these products from independent suppliers in China, through Forward Industries Asia-Pacific Corporation, a British Virgin Islands corporation (“Forward China”). Discontinued Operations Considering the recurring losses incurred by the retail distribution segment, in July 2023, the Company decided to cease operations of our retail distribution segment (“Retail Exit”) and we are presenting the results of operations for this segment within discontinued operations in the current and prior periods presented herein. The discontinuation of the retail segment represents a strategic shift in the Company’s business. The primary assets of the retail segment are inventory and accounts receivable. The Company expects to sell, liquidate, or otherwise dispose of remaining retail inventory by June 30, 2024, and to collect remaining retail accounts receivable by the end of fiscal 2024. After this time, we expect to have no further significant continuing involvement with the retail distribution segment. The inventory of the retail segment is presented as discontinued assets held for sale on the balance sheets at December 31, 2023 and September 30, 2023 and the results of operations for the retail segment have been classified as discontinued operations on the condensed consolidated statements of operations for the three months ended December 31, 2023 and 2022. 21 COVID-19 On May 11, 2023, the U.S. Department of Health and Human Services declared the end of the Public Health Emergency for COVID-19; however, the effects of COVID-19 continue to linger throughout the global economy and our businesses. Though the severity of COVID-19 has subsided, new variants, or the outbreak of a new pathogen, could interrupt business, cause renewed labor and supply chain disruptions, and negatively impact the global and US economy, which could materially and adversely impact our businesses. 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 discussed 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, 2023, under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations—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, 2023 COMPARED TO THE THREE MONTHS ENDED DECEMBER 31, 2022 Consolidated Results The table below summarizes our consolidated results from continuing operations for the 2024 Quarter as compared to the 2023 Quarter: Consolidated Results of Operations 2024 Quarter 2023 Quarter Change ($) Change (%) Revenues, net $ 7,152,000 $ 9,753,000 $ (2,601,000 ) (26.7 %) Cost of sales 5,509,000 7,787,000 (2,278,000 ) (29.3 %) Gross profit 1,643,000 1,966,000 (323,000 ) (16.4 %) Sales and marketing expenses 369,000 411,000 (42,000 ) (10.2 %) General and administrative expenses 1,654,000 1,683,000 (29,000 ) (1.7 %) Loss from operations (380,000 ) (128,000 ) (252,000 ) 196.9 % Other (income)/expense, net 1,000 (37,000 ) 38,000 (102.7 %) Provision for income taxes – – – – Loss from continuing operations $ (381,000 ) $ (91,000 ) $ (290,000 ) 318.7 % 22 The discussion that follows below provides further details about our results from continuing operations for the 2024 Quarter as compared to the 2023 Quarter. Net revenues declined significantly in the OEM distribution segment and, to a lesser extent, in the design segment. Our gross profit decreased across both segments, but our gross margin increased from 20.2% in the 2023 Quarter to 23.0% in the 2024 Quarter. The gross margin increase was driven by our OEM distribution segment due to a change in the mix of revenue and a reduction in our sourcing fee with Forward China, partially offset by lower utilization rates in our design segment. Sales and marketing expenses decreased primarily due to lower marketing related overhead in our OEM distribution segment. Sales and marketing as a percentage of revenues increased from 4.2% in the 2023 Quarter to 5.2% in the 2024 Quarter. General and administrative expenses decreased in the 2024 Quarter, primarily related to a decline in design segment and corporate expenses. These decreases were primarily driven by lower payroll costs. 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 adjust these costs as needed based on the overall needs of the business. We recorded net other expense of $1,000 in the 2024 Quarter compared to net other income of $37,000 in the 2023 Quarter. The variance is due to fair value adjustments of $40,000 in the 2023 Quarter to reduce to the fair value of the earnout consideration related to the Kablooe acquisition, $18,000 of net duty drawback income received in the 2023 Quarter, offset by interest income from interest bearing deposits in the 2024 Quarter and a decrease in interest expense resulting from a reduction in the amount of debt outstanding. We generated a loss from continuing operations of $381,000 and $91,000 in the 2024 Quarter and 2023 Quarter, respectively. We maintain significant net operating loss carryforwards and do not recognize a significant 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 from continuing operations were $0.04 and $0.01 for the 2024 Quarter and the 2023 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. Segment Results of Operations OEM Distribution Design Corporate Expenses Consolidated 2024 Quarter revenues $ 2,010,000 $ 5,142,000 $ – $ 7,152,000 2023 Quarter revenues 4,377,000 5,376,000 – 9,753,000 Change $ (2,367,000 ) $ (234,000 ) $ – $ (2,601,000 ) 2024 Quarter operating income/(loss) $ 41,000 $ 266,000 $ (687,000 ) $ (380,000 ) 2023 Quarter operating income/(loss) 112,000 433,000 (673,000 ) (128,000 ) Change $ (71,000 ) $ (167,000 ) $ (14,000 ) $ (252,000 ) 23 OEM Distribution Segment Net revenues in the OEM distribution segment decreased from lower sales volume from diabetic customers, partially offset by increased volumes with other OEM customers. As consumer demand increases for diabetic testing products which require no carrying case, we expect diabetic product sales to continue to represent a smaller portion of our OEM distribution revenue. In March 2023, a contract with one of our major diabetic customers expired. Due to increased pricing pressures, we did not extend our contract with this customer. Revenue from this customer represented 13% of our consolidated net revenues in the 2023 Quarter. We expect the loss of this customer to continue to cause a significant decline in OEM distribution segment revenues in future periods. The following tables set forth revenues by product line of our OEM distribution segment customers for the periods indicated: OEM Revenues by Product Line 2024 Quarter 2023 Quarter Change ($) Change (%) Diabetic products $ 1,424,000 $ 3,985,000 $ (2,561,000 ) (64.3 %) Other products 586,000 392,000 194,000 49.5 % Total net revenues $ 2,010,000 $ 4,377,000 $ (2,367,000 ) (54.1 %) Diabetic Product Revenues Our OEM distribution segment sources 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 the loss of one of our major diabetic customers whose contract expired, lower volumes in the 2024 Quarter related to timing of orders relative to our fiscal quarters and the loss of one product to a competitor. As mentioned above, management believes that revenues from diabetic customers will decline in future periods. Revenues from diabetic products represented 71% of net revenues for the OEM distribution segment in the 2024 Quarter compared to 91% in the 2023 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 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 new customers and higher sales volume with several existing customers, partially offset by reduced demand from other 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 decreased and operating income margin decreased from 2.6% in the 2023 Quarter to 2.0% in the 2024 Quarter, driven by lower revenues and lower gross profit. Operating expenses decreased, but at a lower rate than revenue. This was partially offset by higher gross margins driven by a decrease in revenues from lower margin diabetic customers. 24 Considering the loss of a significant diabetic customer, management reduced its OEM distribution segment sales and marketing personnel in March 2023 and reduced its sourcing fee with Forward China. Effective April 1, 2023, the Company and Forward China agreed to reduce the fixed portion of the sourcing fee from $100,000 to $83,333 per month for the remaining term of the sourcing agreement. The Company and Forward China signed a new Supply Agreement effective October 2023, which further reduced the fixed portion of the sourcing fee to $65,833 per month. See Note 9 to the condensed consolidated financial statements for more information on the sourcing agreement with Forward China. Design Segment The decrease in net revenues in the design segment was driven by declines in revenues from certain prior year customers, a shift in timing of projects with some customers, partially offset by projects from new customers. Operating income for the design segment decreased and operating income margin decreased from 8.1% in the 2023 Quarter to 5.2% in 2024 Quarter. This decrease was driven by lower utilization rates and higher direct labor costs driven by inflationary pressures, partially offset by lower sales and marketing expenses and increased billing rates on some projects. 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, 2023, our working capital deficit, which excludes discontinued assets held for sale, was $949,000 compared to working capital of $26,000 at September 30, 2023. The decrease was primarily due to the Forward China promissory note of $850,000, which matures on December 31, 2024 and is now included in current liabilities, an increase in payables due Forward China and lower accounts receivable balances. At January 31, 2024, we had approximately $3,200,000 cash on hand and $1,300,000 available under our line of credit with a bank which matures May 31, 2024. There are no assurances this line of credit will extend beyond May 31, 2024. 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 (the “FC Note”) issued by us which matures on December 31, 2024 (see Note 9 to the condensed consolidated financial statements). The balance of the FC Note was reduced to $850,000 after we made principal payments of $750,000 through December 31, 2023. Although the FC 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 additional extensions as deemed necessary. Additionally, Forward China has extended payment terms on our outstanding payables due to them when necessary. At December 31, 2023, our accounts payable due to Forward China was approximately $8,894,000. In order to preserve our current and future liquidity, Forward China agreed to limit the amount of outstanding payables it would seek to collect from us to $500,000 in any 12-month period, which we agreed to pay within 30 days of any such request. This agreement pertains only to payables that were outstanding at October 30, 2023 of $7,365,000. Purchases from Forward China made after October 30, 2023, are not covered by this agreement and are expected to be paid according to normal payment terms. We can provide no assurance that (i) Forward China will extend the FC Note again if we request an extension, (ii) Forward China will extend additional payment terms on any payables not covered by the agreement, if needed, 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. In the current environment of rising interest rates, any future borrowing is expected to result in higher interest expense. 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. 25 Cash Flows During the 2024 Quarter and 2023 Quarter, our sources and uses of cash were as follows: Operating Activities During the 2024 Quarter, cash provided by operating activities of $116,000 resulted from an increase in accounts payable and amounts due to Forward China of $522,000, a decrease in accounts receivable of $445,000, a decrease in discontinued assets held for sale $372,000 and non-cash expenses of $121,000 related to depreciation, amortization, share-based compensation and bad debt expense, partially offset by a decrease in accrued expenses and other current liabilities of $863,000, a net loss of $354,000 and the net change in other operating assets and liabilities of $127,000. During the 2023 Quarter, cash used in operating activities of $149,000 resulted from a net loss of $430,000, an increase in accounts receivable of $994,000, an increase in inventories of $289,000, an increase in discontinued assets held for sale $49,000, a decrease in accrued expenses and other current liabilities of $459,000 and the net change in other operating assets and liabilities of $73,000, partially offset by an increase in accounts payable and amounts due to Forward China of $2,070,000 and non-cash expenses of $75,000 related to fair value adjustments, depreciation, amortization, share-based compensation and bad debt expense. Investing Activities Cash used in investing activities in the 2024 Quarter and the 2023 Quarter of $20,000 and $45,000, respectively, resulted from purchases of property and equipment. Financing Activities Cash used in financing activities in the 2024 Quarter and the 2023 Quarter of $250,000 and $50,000, respectively, consisted of principal payments on the promissory note held by Forward China. Related Party Transactions For information on related party transactions and their financial impact, see Note 9 to the unaudited condensed consolidated financial statements contained herein. 26 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable.