Forward Industries, Inc. — Q3 FY2019 Form 10-Q
Reporting period: Three and nine months ended June 30, 2019; fiscal year ends September 30. The company provides product design, development and distribution services through its Distribution and Design segments. IPS, acquired in January 2018, is included in the Design segment.
Financial performance
| Metric | Three months ended June 30, 2019 | Three months ended June 30, 2018 | Nine months ended June 30, 2019 | Nine months ended June 30, 2018 |
|---|---|---|---|---|
| Revenue | $9.91 million | $9.54 million | $28.27 million | $24.89 million |
| Gross profit / margin | $1.89 million / 19.1% | $1.91 million / 20.1% | $4.51 million / 15.9% | $4.69 million / 18.9% |
| Operating income (loss) | $(50,000) | $(210,000) | $(1.61) million | $73,000 |
| Net income (loss) | $(104,000) | $235,000 | $(1.77) million | $1.23 million |
| Basic and diluted EPS | $(0.01) | $0.02 | $(0.19) | $0.13 |
The quarter’s revenue rose about 4%, but gross profit declined slightly and the company recorded a small net loss. For the nine-month period, revenue increased about 14%, while operating and net results deteriorated substantially. The 2018 comparison includes a $510,000 favorable fair-value adjustment and a $747,000 income-tax benefit; neither recurred in 2019. The Design segment’s 2018 nine-month results cover less than nine months following the IPS acquisition.
Cash, liquidity and debt
- Cash was $2.71 million at June 30, down from $4.37 million at September 30, 2018. Management reported approximately $3.3 million of cash as of August 9, 2019.
- Operating cash flow was negative $2.20 million for the nine months, versus positive $618,000 a year earlier. Investing activities used $30,000; financing activities provided $570,000. Cash declined by $1.66 million.
- Current assets were $13.01 million and current liabilities $7.44 million; working capital was approximately $5.6 million. The current ratio was 1.7 and quick ratio 1.5, down from 2.0 and 1.8, respectively, at September 30, 2018.
- Borrowings included $1.10 million drawn on a $1.30 million revolving credit facility and a $1.60 million promissory note payable to related party Forward China. The note’s maturity was extended after quarter-end to October 17, 2019. The balance sheet also reports $1.679 million of short-term notes payable and $86,000 of lease liabilities.
- Management expected liquidity to be adequate for the next 12 months, and planned to repay the related-party note using cash and/or additional credit. It said additional capital may be needed for strategic acquisitions or investments.
Material changes and segment trends
- Distribution: Nine-month revenue fell 7.4% to $17.07 million, mainly because diabetic-product revenue declined 8.1%. Diabetic products represented 88% of total nine-month revenue. Segment operating loss was $880,000 versus income of $34,000. Management cited lower volume, customer pricing pressure, product mix, bad debt and higher expenses.
- Design: Nine-month revenue was $11.19 million, compared with $6.45 million in the shorter prior-year post-acquisition period. Segment operating loss was $725,000 versus income of $39,000. Management attributed the period’s weaker margins and results partly to project overruns and increased bad-debt expense. It said the affected projects were completed in Q2 and expected Design gross margins to exceed 20% for the remainder of FY2019; Q3 Design gross margin was 25.0%.
- Concentration remains high: four Distribution customers accounted for 86.1% of nine-month segment revenue; five Design customers accounted for 56.8%. Management warned that customer order volumes and quarterly results can be variable.
Outlook, risks and unusual items
- The company plans to expand retail distribution of non-diabetic and Mooni smart-enabled products. It had seven manufacturer-representative agreements and anticipated at least two products in retail outlets by Q2 FY2020. These are expectations, not assured results.
- Management expects continued pricing pressure and potential declines in diabetic-product revenue. Other stated risks include customer concentration, tariffs or import restrictions, execution of product sales and IPS integration, and potential need for additional capital.
- The $1.30 million TD Bank credit facility matures May 31, 2020 and is secured by IPS assets. The company disclosed a likely risk of failing year-end debt-service covenant testing, citing IPS’s approximately $780,000 nine-month loss; default could allow the lender to demand repayment. A term-loan lender’s covenants also present a disclosed potential year-end risk.
- FINRA referred its investigation of trading around the January 2018 IPS acquisition announcement to the SEC. The SEC subpoenaed certain executive officers and the CFO in February 2019; they were working with counsel to respond. Related legal costs were significant, and reimbursement under insurance was not assured. The filing separately states there were no ordinary-course legal proceedings believed material as of June 30.
- Related-party arrangements merit attention: Forward China is owned by the CEO and Chairman, acts as exclusive sourcing agent, receives a monthly service fee, and is owed amounts for purchases. The company paid it approximately $1.06 million in service fees during the nine-month period. The $1.60 million note also bears 8% interest.
- The company received $326,941 in customer stock as compensation for design services and recorded the amount as revenue and a cost-method investment. It also paid Mooni $400,000 under a three-year distribution agreement and received an option to acquire a controlling interest, subject to the agreement’s terms.
Most important facts for investors to verify
- Whether the company meets year-end debt covenants and repays or refinances the Forward China note by its October 17, 2019 maturity.
- Whether operating cash burn, customer collections and liquidity develop as management anticipated; the filing recorded higher bad-debt expense and a $729,000 receivable from the customer that provided stock consideration.
- Whether Design margins recover as forecast and retail launches achieve the stated timing and distribution targets.
- How the SEC investigation, related legal costs and potential insurance reimbursement progress.
- The sustainability of Distribution revenue given diabetic-product dependence, customer concentration and ongoing pricing pressure.