FORWARD INDUSTRIES, INC. The following discussion and analysis should be read in conjunction with our consolidated financial statements and related notes appearing elsewhere in this report on Form 10-K. The following discussion and analysis compares our results of operations for the year endedSeptember 30, 2022 ("Fiscal 2022") with those for the year endedSeptember 30, 2021 ("Fiscal 2021"). All dollar amounts and percentages presented herein have been rounded to approximate values. In addition to historical information, this discussion and analysis contains forward-looking statements that involve risks, uncertainties, and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including but not limited to those set forth under "Risk Factors."
Cautionary statement regarding Forward-Looking Statements
This report includes "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 the effect of the pandemic and inflation on our business, 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 in this Annual Report on Form 10-K, and in particular, the risks discussed under the caption "Risk Factors" in Item 1A of this report and those discussed in other documents we file with theSEC . 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. 18 Business OverviewForward Industries, Inc. is a global design, manufacturing, sourcing and distribution group serving 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, the Company is now able to introduce proprietary products to the market from concepts brought to it from a number of different sources, both inside and outside the Company. Our design division provides hardware and software product design and engineering services to customers predominantly located in theU.S. Our 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. Our retail distribution division sources and sells smart-enabled furniture, hot tubs and various other products through various online retailer websites to customers predominantly located in theU.S. 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 theAsia-Pacific region and most notably in Fiscal 2022. Labor shortages atU.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 Fiscal 2022. The timing and extent of these COVID-19 related transportation disruptions are still largely unknown but are expected to continue into Fiscal 2023. 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 retaining our employees, particularly in the second half of Fiscal 2022. The timing and extent of future inflation is difficult to predict, but we expect these rising costs to continue into Fiscal 2023. The effects of COVID-19 may further impact our business in ways we cannot predict, and such impacts could be significant. The current economic conditions 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 products and services and to choose to allocate their budgets to new or existing projects which may or may not require our products and 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. 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 and inventory levels; 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.
Additionally, see Part I, Item 1A "Risk Factors" for a description of the material risks we currently face 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.
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Critical Accounting Policies and Estimates
We have identified the accounting policies and significant estimation processes below as critical to our business operations and the understanding of our results of operations. The discussion below is not intended to be comprehensive. In many cases, the accounting treatment of a particular transaction is specifically dictated byU.S. GAAP, with no need for management's judgment. In other cases, management is required to exercise judgment in the application of accounting principles with respect to particular transactions. The impact and any associated risks related to these policies on our business operations are discussed throughout this "Management's Discussion and Analysis of Financial Condition and Results of Operations" where such policies affect reported and expected financial results. For a detailed discussion of the applications of these and other accounting policies, see "Item 8. Financial Statements and Supplementary Data" in this report. The preparation of our consolidated financial statements requires us to make estimates and assumptions that are believed to be reasonable under the circumstances. There can be no assurance that actual results will not differ from those estimates and such differences could be significant. Revenue Recognition OEM Distribution Segment The OEM distribution segment recognizes revenue when finished goods are shipped to its customers (in general, these conditions occur at either point of shipment or point of destination, depending on the terms of sale and transfer of control); (ii) there are no other deliverables or performance obligations; and (iii) there are no further obligations to the customer after the title of the goods has transferred. If the Company receives consideration before achieving the criteria previously mentioned, it records a contract liability, which is classified as a component of deferred income in the accompanying consolidated balance sheets. Retail Distribution Segment The retail distribution segment sells products primarily through online websites operated by authorized third-party retailers. Revenue is recognized when control, as defined in Accounting Standards Codification ("ASC") 606, "Revenue from Contracts with Customers", of the related goods is transferred to the retailer, which generally occurs upon shipment to the end customer. Other than product delivery, the retail distribution segment does not typically have other deliverables or performance obligations associated with its products. Revenue is measured as the amount of consideration expected to be received in exchange for the products provided, net of allowances taken by retailers for product returns and any taxes collected from customers that will be remitted to governmental authorities. When the Company receives consideration before achieving the criteria previously mentioned, it records a contract liability, which is classified as a component of deferred income in the accompanying consolidated balance sheets. Design Segment The design segment applies the "cost to cost" and "right to invoice" methods of revenue recognition to its contracts with customers. The design segment typically engages in two types of contracts: (i) time and material and (ii) fixed price. The Company recognizes revenue over time on its time and material contracts utilizing a "right to invoice" method. Revenues from fixed price contracts that require performance of services that are not related to the production of tangible assets are recognized by using cost inputs to measure progress toward the completion of its performance obligations, or the "cost to cost" method. Revenues from fixed price contracts that contain specific deliverables are recognized when the performance obligation has been satisfied or the transfer of goods to the customer has been completed and accepted. Recognized revenues that will not be billed until a later date, or contract assets, are recorded as an asset and classified as a component of accounts receivable in the accompanying consolidated balance sheets. Contracts where collections to date have exceeded recognized revenues, or contract liabilities, are recorded as a liability and classified as a component of deferred income in the accompanying consolidated balance sheets. 20 Segment Reporting We have three reportable segments: OEM distribution, retail distribution and design. The OEM distribution segment sources and distributes carrying cases and other accessories for medical monitoring and diagnostic kits and a variety of other portable electronic and non-electronic devices directly to OEMs or their contract manufacturers worldwide. The retail distribution segment sources and sells smart-enabled furniture, hot tubs and a variety of other products through various online retailer websites to customers predominantly located in theU.S. The design segment consists of two operating segments (IPS and Kablooe, which have been aggregated into one reportable segment) that provide a full spectrum of hardware and software product design and engineering services to customers predominantly located in theU.S. Our chief operating decision maker ("CODM") regularly reviews revenue and operating income for each segment to assess financial results and allocate resources. For our OEM and retail distribution segments, we exclude general and administrative and general corporate expenses from their measure of profitability as these expenses are not allocated to the segments and therefore not included in the measure of profitability used by the CODM. For the design segment, general and administrative expenses directly attributable to that segment are included in its measure of profitability as these expenses are included in the measure of its profitability reviewed by the CODM. We do not include intercompany activity in our segment results to be consistent with the information that is presented to the CODM. Segment assets consist of accounts receivable and inventory, which are regularly reviewed by the CODM, as well as goodwill and intangible assets resulting from design segment acquisitions (see Note 15 to the consolidated financial statements). Inventory Valuation
Inventories consist primarily of finished goods and are stated at the lower of cost (determined by the first-in, first-out method) or net realizable value. Based on management's estimates, an allowance is made to reduce excess, obsolete, or otherwise unsellable inventories to net realizable value. The allowance is established through charges to cost of sales in the Company's consolidated statements of operations. In determining the adequacy of the allowance, management's estimates are based upon several factors, including analyses of inventory levels, historical loss trends, sales history and projections of future sales demand. The Company's estimates of the allowance may change from time to time based on management's assessments, and such changes could be material.
We review goodwill for impairment at least annually, or more often if triggering events occur. We have two reporting units with goodwill (the IPS and Kablooe operating segments) and we perform our annual goodwill impairment test onSeptember 30 , the end of the fiscal year, or upon the occurrence of a triggering event. We have the option to perform a qualitative assessment to determine if an impairment is more likely than not to have occurred. If we can support the conclusion that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then we would not need to perform a quantitative impairment test for the reporting unit. If we cannot support such a conclusion or do not elect to perform the qualitative assessment, then we will perform the quantitative impairment test by comparing the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, no impairment charge is recognized. If the fair value of the reporting unit is less than its carrying amount, an impairment charge will be recognized for the amount by which the reporting unit's carrying amount exceeds its fair value. A significant amount of judgment is required in performing goodwill impairment tests including estimating the fair value of a reporting unit. There were no indications of goodwill impairment in Fiscal 2022 or Fiscal 2021. Our intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In assessing the recoverability of our intangible assets, we must make estimates and assumptions regarding future cash flows and other factors to determine the fair value of the respective assets. These estimates and assumptions could have a significant impact on whether an impairment charge is recognized and the magnitude of any such charge. Fair value estimates are made at a specific point in time, based on relevant information. These estimates are subjective in nature and involve uncertainties and matters of significant judgments and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. If these estimates or material related assumptions change in the future, we may be required to record impairment charges related to our intangible assets. There were no indications of impairment of intangible assets in Fiscal 2022 or 2021. 21
Recent Accounting Pronouncements
InNovember 2019 , theFinancial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2019-11, "Codification Improvements to Topic 326, Financial Instruments - Credit Losses." ASU 2019-11 is an accounting pronouncement that provides clarity to and amends earlier guidance on this topic and would be effective concurrently with the adoption of such earlier guidance. This pronouncement is effective for us for fiscal years beginning afterDecember 15, 2022 and interim periods within those fiscal years. We are currently evaluating the effects of this pronouncement on our consolidated financial statements. InDecember 2019 , the FASB issued ASU 2019-12 "Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes." This guidance removes certain exceptions to the general principles in Topic 740 and provides consistent application ofU.S. GAAP by clarifying and amending existing guidance. The effective date of the new guidance for public companies is for fiscal years beginning afterDecember 15, 2020 and interim periods within those fiscal years. Early adoption is permitted. We adopted this guidance in the first quarter of fiscal 2022 with no material impact to our consolidated financial statements.
RESULTS OF OPERATIONS FOR FISCAL 2022 COMPARED TO FISCAL 2021
Consolidated Results
The table below summarizes our consolidated results of operations for Fiscal 2022 as compared to Fiscal 2021:
Consolidated Results of Operations
Fiscal 2022 Fiscal 2021 Change ($) Change (%)
Net revenues $ 42,337,000 $ 39,022,000 $ 3,315,000 8.5%
Cost of sales 33,969,000 30,888,000 3,081,000 10.0%
Gross profit 8,368,000 8,134,000 234,000 2.9%
Sales and marketing expenses 2,855,000 2,503,000 352,000 14.1%General and administrative expenses 6,753,000 6,396,000
357,000 5.6% Loss from operations (1,240,000 ) (765,000 ) (475,000 ) 62.1% Other expense/(income), net 135,000 (1,289,000 ) 1,424,000 (110.5% ) Income tax provision 3,000 - 3,000 -
Consolidated net (loss)/income
The increase in net revenues in Fiscal 2022 was primarily driven by revenue growth in the design segment and to a lesser extent, revenue growth in the retail segment, which was partially offset by a decline in revenue in the OEM distribution segment.
Gross profit increased$234,000 , but gross margin declined from 20.8% in Fiscal 2021 to 19.8% in Fiscal 2022. 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. Due to inflation and the continued uncertainty surrounding supply chain stability, management believes there will be continued volatility in OEM and retail distribution cost of sales in Fiscal 2023. Sales and marketing expenses increased due to higher advertising and promotional costs, primarily in the retail segment. Sales and marketing expenses as a percentage of revenue increased from 6.4% in Fiscal 2021 to 6.7% in Fiscal 2022. If revenues from the retail segment grow to comprise a larger portion of the overall business, management expects sales and marketing costs, both in total and as a percentage of revenue, to increase in future periods. General and administrative expenses increased in Fiscal 2022, primarily related to an increase in payroll costs and non-employee board members' cash and equity compensation due to the cost cutting measures taken in Fiscal 2021 which were not implemented in Fiscal 2022. These increases were partially offset by lower bad debt expense. 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. 22 We reported other expense of$135,000 in Fiscal 2022 as compared to other income of$1,289,000 in Fiscal 2021. The variance is primarily due to the$1,357,000 forgiveness of note payable related to the Paycheck Protection Program loan ("PPP loan") and to a lesser extent, driven by a decrease in interest income on a note receivable from a customer which was fully reserved for in Fiscal 2019. In Fiscal 2022, we recorded a tax provision of$3,000 , generated a loss before income taxes of$1,376,000 and had an effective tax rate of (0.2%). In Fiscal 2021, we recorded no tax provision or benefit, and we generated income before income taxes of$524,000 , primarily resulting from the$1,357,000 forgiveness of note payable related to the PPP loan. The forgiveness of the PPP loan was not recognized as taxable income per the Coronavirus Aid, Relief and Economic Security Act (the "CARES Act"). We maintain significant net operating loss carryforwards and do not recognize a significant income tax provision or benefit as our deferred tax provision is typically offset by maintaining a full valuation allowance on our net deferred tax assets.
Consolidated basic and diluted earnings/(loss) per share was
Segment Results
The discussion that follows below provides further details about the results of operations for each segment as compared to the prior year.
Segment Results of Operations
Retail Corporate
OEM Distribution Distribution Design Expenses Consolidated
Fiscal 2022 revenues $ 18,036,000 $ 4,130,000 $ 20,171,000 $ - $ 42,337,000
Fiscal 2021 revenues 19,290,000 3,183,000 16,549,000 - 39,022,000
Change $ (1,254,000 ) $ 947,000 $ 3,622,000 $ - $ 3,315,000
Fiscal 2022 operating
income/(loss) $ 905,000 $ (1,809,000 ) $ 2,148,000 $ (2,484,000 ) $ (1,240,000 )
Fiscal 2021 operating
income/(loss) 1,479,000 (779,000 ) 603,000 (2,068,000 ) (765,000 )
Change $ (574,000 ) $ (1,030,000 ) $ 1,545,000 $ (416,000 ) $ (475,000 )
OEM Distribution
Net revenues in the OEM distribution segment declined due to reduced revenues in
the sale of diabetic products and, to a lesser extent, a decline in other OEM
product revenue. Revenues from diabetic products declined $1,185,000 and
revenues from other products declined $69,000 . As consumer demand increases for
diabetic testing products which require no carrying case, we expect diabetic
product sales to represent a smaller portion of our OEM distribution revenue.
The following tables set forth revenues by product line of our OEM distribution segment customers for the periods indicated:
OEM Revenues by Product Line
Fiscal 2022 Fiscal 2021 Change ($) Change (%)
Diabetic products $ 15,403,000 $ 16,588,000 $ (1,185,000 ) (7.1% )
Other products 2,633,000 2,702,000 (69,000 ) (2.6% )
Total net revenues $ 18,036,000 $ 19,290,000 $ (1,254,000 ) (6.5% )
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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 declined due to lower revenues from all major
diabetic customers due to a reduction in the volume of orders from most major
diabetic customers. An increase in competition and continued pricing pressures,
driven by inflation and in some cases a transition to lower cost carrying cases,
drove diabetic revenues down further. These declines were partially offset by a
net increase in revenue from other diabetic customers which were less
significant. As mentioned above, management believes that revenues from diabetic
customers will continue to decline.
Revenues from diabetic products represented 85% of net revenues for the OEM distribution segment in Fiscal 2022 compared to 86% in Fiscal 2021.
Other Product Revenues Our OEM distribution segment 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 decreased due to a decrease in sales volume from certain existing customers, which was offset by increases in business from other customers. We will continue to focus on our sales and sales support teams in our attempt to expand and diversify our other products customer base. Operating Income Operating income for the OEM distribution segment declined and operating income margin declined to 5.0% in Fiscal 2022, compared to 7.7% in Fiscal 2021, primarily due to rising material and importation costs and continued pricing pressure from our major diabetic customers. The cost of importing all products fromChina has increased and both the diabetic and other OEM product lines have experienced pricing pressures from customers, resulting in a decrease in gross margin as compared to the prior year. The decline in gross margin was partially mitigated by lower selling and marketing costs related to OEM sales commissions. We continue to work on expanding our product offerings to include higher margin products and enhancing our sales efforts to grow revenue and increase gross
profit. Retail Distribution Segment
Net revenues increased in Fiscal 2022 due to an increase in sales volume on certain products with two retailers. As the cost of products increases and inflation continues to reduce consumer spending, profitability becomes more challenging in the retail segment. We plan to focus our sales and sales support teams on efforts to match our product offerings with consumer demand, strategically increase the volume of revenue from more profitable products and expand these product offerings through additional retailer websites. The rising cost of freight, storage and other logistics services outpaced the increase in revenue, which, when coupled with additional expense associated with increases in other inventory related costs, led to a decrease in gross profit from Fiscal 2021 to Fiscal 2022. This was further exacerbated by higher sales and marketing expenses related to sales commissions, and advertising and promotional expenses necessary to support the growth in revenue, which increased the operating loss margin from 24.5% in Fiscal 2021 to 43.8% in Fiscal 2022. 24 Design Segment
The increase in net revenues 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 increased and operating income margin improved from 3.6% in Fiscal 2021 to 10.6% in Fiscal 2022. The increase in gross profit, driven by higher revenue 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, partially offset by higher payroll costs.
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. AtSeptember 30, 2022 , our working capital was$4,362,000 compared to$5,587,000 atSeptember 30, 2021 , the decrease primarily due to higher payables and accrued expenses, partially offset by higher inventory levels. AtNovember 30, 2022 , we had approximately$3,200,000 cash on hand and$1,300,000 available under our line of credit with a bank which maturesMay 31, 2023 . ForwardChina , 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 onDecember 31, 2024 (see Note 13 to the consolidated financial statements). The balance of the FC Note was reduced to$1,400,000 after we made principal payments of$200,000 in Fiscal 2022. 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 an additional credit facility as deemed necessary. Additionally, 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 FC Note again if we request an extension, (ii) Forward China will continue to extend payment terms on outstanding payables 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. 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 any 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 Fiscal 2022 and Fiscal 2021, our sources and uses of cash were as follows:
Operating Activities During Fiscal 2022, cash provided by operating activities of$1,535,000 resulted from an increase in accounts payable and amounts due to Forward China of$1,856,000 , a decrease in accounts receivable of$953,000 , non-cash charges for depreciation, amortization, share-based compensation and bad debt expense of$775,000 , an increase in accrued expenses of$624,000 and the net change in other operating assets and liabilities of$443,000 , partially offset by the net loss of$1,378,000 and an increase in inventories of$1,738,000 . 25
During Fiscal 2021, cash used in operating activities of$528,000 resulted from an operating loss of$765,000 , an increase in accounts receivable of$1,665,000 , an increase in inventories of$787,000 , a decrease in deferred income of$297,000 and the net change in other operating assets and liabilities of$223,000 , partially offset by an increase in accounts payable and amounts due to Forward China of$2,306,000 and non-cash expenses of$903,000 related to depreciation, amortization, share-based compensation and bad debt expense.
Investing Activities
In Fiscal 2022 and Fiscal 2021, cash used for investing activities of
Financing Activities
In Fiscal 2022, cash used in financing activities of
In Fiscal 2021, cash used in financing activities of$919,000 consisted of net repayments under our line of credit of$1,000,000 , repayments of notes payable and finance lease liabilities of$187,000 , partially offset by proceeds from stock options exercised of$268,000 .
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