Forward Industries — One-stop shop for outsourced services

Forward Industries’ distribution division (67% of Q320 revenues) designs, sources and distributes protective carry cases for handheld electronic devices, primarily blood glucose diagnostic kits. During FY19 the division added channel management to its offer. The design division (33% of Q320 revenues) provides design and engineering services for the development of industrial, medical and consumer electronic devices. While the division primarily develops IoT enabled electronic products for third parties, it is developing two products for the group: a sputum washer cup and anti-tremor gloves to help people suffering from Parkinson’s disease.

Forward Industries reported a Q320 revenue decline of 3.6% y-o-y to $9.5m. This drop was the result of a 10% drop in revenues from the distribution of glucose monitoring carry cases and a 19% decline in design revenues, which were partially offset by one-off sales of personal protective equipment (PPE). Reported operating losses widened slightly to $0.2m. The group moved from $0.1m net cash (ie cash less line of credit, promissory notes and capital leases) at the end of FY19 to $0.9m net debt at end Q320, primarily reflecting adverse working capital movements.

Our estimates and DCF analysis assume that revenues from carry cases will decline at an average of 10% y-o-y between FY20 and FY23. Following management guidance, we model a sharp ramp-up in revenues from distributing Mooni and Koble products for third parties ($0.3m in FY20 and $5.5m in FY21) and treat sales of its own products and any revenues from cross-selling between divisions as upside. We assume that gross margins in the carry-case business will be maintained during FY21 at the levels achieved so far in FY20 and that gross margin on design services will increase further in FY21. On this basis, we see group revenues growing at a 5% CAGR between FY19 and FY23, and the group returning to profitability in FY21. Our sensitivity analysis shows that the group should still be profitable if sales of diabetic products decline more quickly than this or if margin compression is substantially more severe, but it is critical to maintain the design gross margin gains achieved during FY20 thus far and for the Koble/Mooni initiative to succeed.

We believe the key risks to Forward Industries’ business are: 1) high client concentration; 2) reliance on Forward APAC, which is its sole supplier of carry cases (51% of Q320 revenues); 3) sourcing from China: currently all the carry cases are imported from China so there is a risk of tariffs being imposed; 4) liabilities: our estimates show that Forward does not have enough cash to repay the promissory note held by Forward APAC by 30 December 2020, requiring the lender to grant yet another extension to the loan; 5) coronavirus related recession: this may reduce the amount of cash third parties have available for investment in innovation; and 6) FX fluctuations, as a significant portion (42% FY19) of Forward Industries’ revenues are generated outside of the US.

Our DCF analysis gives an indicative valuation of $1.73/share, which is 16% higher than the current share price. This analysis assumes that management is able to improve on the design gross margin gains achieved so far in FY20 and the Koble/Mooni distribution initiative is successful.

Forward Industries is an international group of companies with more than 60 years of experience designing, manufacturing and supplying high-quality products to world-leading companies. The ‘distribution’ division (67% of Q320 revenues) designs, sources and distributes carry and protective cases for handheld electronic devices, primarily blood glucose diagnostic kits. Customers include one of the global leaders in diabetes management (not publicly disclosed). During FY19 the division added channel management to its offer, signing an agreement with Swedish company Mooni to launch a range of smart enabled lightning and sound retail products into the US market. The ‘design’ division (33% of Q320 revenues) was formed through the acquisition of New York-based Intelligent Product Solutions (IPS) in January 2018 and of Kablooe Design in August 2020. This division provides design and engineering services for the development of industrial, medical and consumer electronic devices. Customers include AB Inbev, Boston Scientific, Colorplast, Google, Medtronic, Motorola, PepsiCo and Stryker. While the division primarily develops IoT enabled electronic products for third parties, it is developing two products for the group: a sputum washer cup and anti-tremor gloves to help people suffering from Parkinson’s disease.

Manufacturing is contracted out. The carry cases are all sourced from Asia through Forward APAC, which is majority owned by Forward Industries’ CEO and major shareholder Terence Wise. The group has started to source electronic products from global contract manufacturer and electronic systems supplier Scanfil.

As of 12 December 2019, Forward Industries had 73 full-time employees. Most of these were employed by the design business in New York, which is where the group is headquartered. There is also a small team based in Switzerland to serve European headquartered OEMs. The Kablooe Design business adds around another 10 people, who are based in Minnesota.

The majority (77% in Q320) of the distribution division’s revenues are derived from the development and distribution of protective carry cases for glucose monitoring kits. These are sold to multi-national original equipment manufacturers (OEMs) of glucose monitoring kits. These cases are customised with the manufacturer’s logo and designed to hold an electronic blood glucose monitor, testing strips and lancets. The selling prices range from $0.60/unit to $7.00/unit, with the average price close to the bottom end of the range. Most of the OEMs package the case with diabetic kits, but a few are sold as an accessory to the consumer through internet retailers. Four OEMs accounted for 93% of Forward Industries’ diabetic business in Q320 (see Exhibit 2).

The remaining revenues in this division (23% in Q320) are typically derived from the sale of cases and protective solutions to OEMS for portable electronic devices such as bar code scanners, cellular phones, GPS devices, tablets and cameras and other products such as sporting and recreational products and firearms. Unusually, in Q320, the division sold $0.8m PPE it had sourced from a US manufacturer for supply to a US hospital. This opportunistic activity represented 15% of divisional revenues.

Forward Industries does not manufacture the carry cases itself and sources them from independent producers in Asia through Forward APAC. Management states that this is substantially less expensive than maintaining its own sourcing operation. It also reduces working capital requirements. Under a Buying Agency and Supply Agreement contract which ends in October 2020 and is likely to be extended, Forward Industries purchases products at Forward APAC’s cost in addition to paying to Forward APAC a monthly service fee equal to the sum of: 1) $100,000; and 2) 4% of ‘adjusted gross profit’. This is defined as the selling price less the cost from Forward APAC. The service fees paid totalled $338k in Q120, equivalent to 7.2% of distribution revenues (6.4% in FY19 and 5.9% in FY18). Since the proportion of fixed payments as a percentage of total fees is high, the agreement compounds margin compression when revenues decline and margins are under pressure as has been the trend for the last few years.

During FY19 the division added channel management to its offer, signing a distribution agreement with Swedish company Mooni to launch a range of smart lighting and sound products into the US market. It also has an agreement to launch smart furniture from Koble into the US market. (Koble is a brand owned by Justwise, which Terence Wise is chairman of.) While the division has secured listings with several major US retail chains including BestBuy, BJ’s Wholesale Club, Costco and Staples, and the initial response in Q120 was favourable, roll-out in stores has been delayed by the coronavirus pandemic. We expect that divisional revenues will include material fees from distribution to retailers from Q121 onwards. The group is minimising the additional fixed costs associated with the new distribution capability by appointing commission only manufacturer’s representatives who have existing relationships with the big box retailers that it is targeting in the US and Canada.

The design division was formed through the acquisition of IPS in January 2018 and augmented through the acquisition of Kablooe Design in August 2020. IPS was founded in 2008 by two former executives of Symbol Technologies (now Zebra Technologies). It now employs over sixty people, primarily software and hardware engineers. It generates revenues from the provision of design and engineering services for businesses developing industrial and consumer electronic devices. It does not capture any royalties on sales of any products it works on or any licence fees for its IP. The division offers both full hardware and software product development from ideation, design and engineering through to manufacturing support as well as targeted design and engineering support for clients to complement their in-house development teams. Volume manufacturing is outsourced to multi-national contract manufacturer Scanfil. While all the clients currently are based in the US, they range from large multinationals to mid-sized companies and start-ups. The markets served are also diverse: automotive; retail; consumer; biomedicine; field service; construction; logistics; security; entertainment; government and defence, with a common thread of adding interfaces and wireless connectivity to add intelligence to objects. Projects include:

Although the division boasts an impressive list of clients, it suffers from relatively high client concentration. In Q320 the top four clients generated 55% of revenues. This means that new large contracts or the termination of existing ones may result in short-term performance volatility.

Although the division primarily helps develop electronic products for third parties it is developing two products for the group. These are a sputum wash cup and anti-tremor gloves to help people suffering from Parkinson’s disease. The sputum wash cup is scheduled for launch in early FY21. No details are available yet as this is commercially sensitive. The sputum wash cup may need FDA approval, the anti-tremor gloves will not.

Kablooe Design provides research, design and development services to customers in the medical and consumer sectors. It is very similar to IPS with regards to the services it offers and financial model but differs in that its focus is on medical devices with clients including Medtronic, Boston Scientific, Coloplast, AtriCure, Cega Innovations and Rapid Diagnostek. Kablooe is located in Minneapolis, which is the US’s third largest medical device development hub. It employs around 10 people.

Historical revenue and profits have not been disclosed. The total consideration payable is up to $1.6m. This consists of an initial payment of $0.35m cash and 300,000 shares (equivalent to $0.42m at the share price at the time of completion), conditional deferred consideration of up to $0.6m and the assumption of $0.27m of liabilities.

One example of work that Kablooe has undertaken in the medical devices sector is for NxThera (now owned by Boston Scientific), a then start-up medical device firm that had invented a revolutionary tissue ablation technology using steam to treat benign prostate enlargement. NxThera partnered with Kablooe to take it from a concept to a saleable device, improving functionality and usability along the way. It created a solution that incorporated a needle actuated by a trigger that protruded at a perpendicular angle to the main catheter. In addition, the handle of the device incorporated the ability to flush the treatment area, as well as including a radio frequency (RF) coil to create the steam for the ablation procedure. This enabled the hand-held portion of the system to perform all the necessary functions of the procedure without removing it from the patient. This results in a shorter, simpler medical procedure, thus creating a significant competitive advantage for NxThera while saving patients and insurers time and money in medical costs and recovery time.

The combination of the group’s carry case distribution business and the design businesses has created a one-stop shop for smaller companies that do not have sufficient scale or financial resources to develop products internally and are looking for integrated product design and manufacturing solutions with attractive pricing. Importantly it reduces the group’s exposure to the diabetes carry case market, which is declining (see below) by taking it into diverse markets utilising IoT capability. Management is keen to promote cross-selling opportunities between the two divisions, with non-healthcare distribution clients potentially using IPS’s and Kablooe’s design services and IPS’s and Kablooe’s clients benefiting from the distribution business’s ability to manage outsourced manufacturing in low-cost production regions. Two years on from the IPS acquisition, customers are discussing cross-selling opportunities, but this activity has not yet generated material revenues. Similarly there is no evidence as yet of new customers that have been attracted by the integrated service offer. Our estimates treat any cross-selling as upside.

The move into channel management during FY19 also augments the original service offer. However, we note that it is difficult to assess how successful this additional service will be in attracting new customers because one of the first two brands to use, Koble, is are linked to CEO Terence Wise’s Justwise operation and because the coronavirus pandemic has reduced retail footfall.

The design division reported a $1.7m operating loss in FY19 because of project overruns and an increase in bad debt provision. Management intervention transformed this situation to a $0.4m operating profit in Q120 and enabled the division to break even in Q320, despite the decline in revenues related to the coronavirus pandemic.

Forward Industries currently imports all of its carry cases from China through Forward APAC through an agreement that stipulates that Forward APAC acts ‘as the company’s exclusive agent to arrange for sourcing, manufacturing and exporting the Company’s distribution products.’ While Forward Industries was not affected by the US raising tariffs on c $1bn of med-tech imports from China (ie around one-fifth of US med-tech imports) in July 2018, it remains very exposed to the potential of additional international tariffs resulting from the ongoing trade war between the US and China. Higher tariffs would be particularly damaging because if Forward Industries decided to absorb the higher procurement costs to retain customers, this action would further compress margins. Forward APAC is currently seeking alternative manufacturers in Vietnam and Cambodia.

While the increasing number of diabetic patients worldwide should result in more units of diabetes monitoring units being sold, pricing pressure on carry cases is, in our view, likely to continue. Moreover, technological advances in the monitoring units themselves are likely to reduce the proportion of units needing dedicated carry cases.

The division operates in a competitive environment with low barriers to entry. The ability to differentiate the product offering is low. The division competes through provision of a product design capability (albeit out-sourced), rapid response time to customer requests for proposals and product shipment, reliable product delivery and product quality and competitive pricing. The division benefits from its relationship with Forward APAC, which is able to source product from manufacturers in Asia on attractive terms. Additionally, since Forward APAC has a local presence in China it is well placed to monitor quality and product shipments and to identify suppliers. Management estimates that it has around 20% share of the global market for diabetes test kit cases.

IPS’s capabilities place it in a good position to benefit from strong growth in the IoT, wearables and security/screening products. The large size and strong growth of these sectors mean that even a small participation in the growth represents a substantial revenue opportunity for IPS. Some of the key industry growth trends IPS is exposed to include:

The barriers to entry for the design division are significantly higher than the distribution division and are based on engaging staff with the appropriate expertise. There are numerous competitors offering design, engineering and product development services. These include Embien Technologies, Optimal Design, Alloy, Kinneir Dufort, IDC and Bluefrog Design. However, IPS is unusual with regards to the range of technologies offered: software engineering, user interface design, mechanical engineering, electrical engineering, embedded systems, manufacturing services, industrial design, systems architecture and marketing. It is able to offer this range of capabilities because of the size of its engineering team. Being able to offer this range of skills means that, if required, it can take responsibility for all aspects of a product’s design and manufacture. This speeds up the development process and simplifies any bug fixing. An example of this is shown in Exhibit 9. The division also benefits from its track record of past projects with globally recognised companies. We note that the decision to develop products for the group as well as developing products for third parties presents significant scope for launching differentiated devices.

Terence Wise was appointed CEO of Forward Industries in June 2015 following a public battle with the previous board. He has introduced the strategy discussed previously, which is intended to deliver medium-term growth in revenues and profits despite the structural decline in demand for diabetes carry cases.

Terence Wise, CEO and chairman of Forward Industries: Mr Wise founded Justwise, an international sourcing company that supplies furniture and lighting products to numerous UK High Street chains, in 1977 and remains its principal and chairman. In addition, he has significant shareholdings in two furniture manufacturing plants in China and is a principal of Forward APAC, a buying and supplier agent based in the Asia-Pacific region.

Anthony Camarda, CFO: Mr Camarda was appointed in June 2020, following the board’s decision to relocate the company’s finance and ancillary administration to Long Island, New York. Prior to his appointment Mr Camarda served as executive accounting support at Drive DeVilbiss Healthcare, where he provided accounting and business strategy services. From October 2013 until August 2019 he held various leadership positions at The Nature’s Bounty Co., including vice president of financial planning and analysis. Prior to that, he occupied various leadership roles in finance and accounting at Motorola Solutions (formerly Symbol Technologies).

In our opinion the key risks to Forward Industries’ business are:

Forward Industries reported a Q320 revenue decline of 3.6% y-o-y to $9.5m. Continued pricing pressure and reduced underlying demand from most of its major diabetic product customers resulted in a 10% drop in revenues from the distribution of glucose monitoring carry case customers. This was offset by opportunistic sales of PPE worth $0.8m, giving a 6% increase for the division as a whole to $6.4m. Revenues from the design division dropped by 19% as demand for its services were reduced and anticipated projects delayed.

Reported group gross profit decreased by 6% y-o-y to $1.8m, with gross margin decreasing by 0.5pp to 18.6%. Continued pricing pressure and a shift to lower margin cases was partly mitigated by higher gross margins on PPE, resulting in a 0.6pp reduction in divisional gross margin to 14.7%. Design gross margin rose from 25.0% to 26.5% reflecting continued efficient management of projects.

Reported operating losses widened by $0.1m from Q319 to $0.2m. Operating losses from the distribution division narrowed by $0.1m to $0.2m because of lower sampling and prototype costs. Conversely the design division moved from a $0.2m operating profit in Q319 to break-even as a result of the lower revenues and increased payroll related costs.

The group moved from $0.1m net cash (ie cash less line of credit, promissory notes and capital leases) at the end of FY19 to $0.9m net debt at end Q320. The key elements of this movement were a $1.4m increase in accounts receivable and a $0.2m deferred consideration payment, partly offset by $0.9m inventory reduction. Capex was minimal, as in the prior year period. While the balance sheet at the end of Q320 showed $3.1m cash, this was offset by $1.0m drawn on the line of credit, $1.6m of promissory notes agreed with Forward APAC and a $1.4m loan under the Paycheck Protection Program (PPP). At the end of Q320 the effective rate of interest on the line of credit was 4.0% and in early August the company had $0.3m credit available. This facility has been extended to end May 2021. Repayment of the $1.6m promissory note agreed with Forward APAC to finance the IPS acquisition has been extended again, this time to 30 December 2020. This promissory note has an interest rate of 8% pa. Although the maturity date of this note has been extended on several occasions to assist liquidity, management plans to fund the repayment on maturity using existing cash balances and/or obtaining an additional credit facility at a lower interest rate than the promissory note. The company intends to apply for forgiveness of the PPP Loan.

Our estimates and DCF analysis make the following assumptions:

Based on these assumptions, our estimates project group revenue growing at a 5% CAGR between FY19 and FY23. The improvement in gross margin in the design division helps return the group to profitability in FY21, generating $0.07 EPS for the year. We expect free cash to be positive in FY21. We believe that there is scope to extend the maturity date of the promissory note to Forward APAC further if required, and model repayment of the promissory note in FY22 and of the line of credit in FY20. On this basis we do not expect the need for additional financial resources to finance ordinary activity.

We present a sensitivity analysis to show the impact of varying some of these assumptions. This shows that the group should still be profitable if revenues from sales of diabetic products decline at 20% per annum and if margin compression in this product category is more severe than our model. It shows that a return to profit is predicated on the success of the Koble/Mooni retail initiative, and while recovery is not dependent on the own products (sputum washer cup and anti-tremor gloves) initiative, outperformance in this higher-margin (30% gross margin) product category has a marked impact on profitability. The analysis demonstrates how important it is to avoid a recurrence of project overruns in the design division with the associated reduction in gross margin.

We have adopted a DCF valuation approach to capture the long-term evolution of profitability of Forward Industries. Our indicative valuation of $1.73 per share is based on a WACC of 9.7% (risk free rate of 3%, beta of 1.0, cost of debt of 8%, equity risk premium 6%, gross debt/assets 39%) and a terminal growth rate of 1.5%. We have not included any tax cash outflows during FY20–23 because of significant cumulative losses ($11.3m accumulated deficit at FY19 year-end), but we include a 20% tax rate for the purpose of the terminal value calculation. As shown in Exhibit 15, using a WACC range of 6.7–10.7% (with terminal growth rate unchanged) would provide an equity valuation range per share of $1.53–2.78. Similarly, maintaining the WACC at 9.7% and varying the terminal growth rates from 0.5–2.5% would yield an equity value of between $1.56 and $1.94.

Noting the findings of our sensitivity analysis, we believe the key catalysts for raising the share price towards our indicative valuation should be confirmation that management is able to maintain design gross margins at the levels achieved so far in FY20 and evidence that the initiative to distribute smart furniture is being successful.

The nature of Forward Industries’ business model and the niche businesses in which it operates mean we have not been able to identify a listed entity that is fully comparable. Instead we present several competitors that are engaged in either distribution/sourcing or in design/engineering. UK-based Bunzl supplies items such as food packaging, cleaning and hygiene materials and personal protection equipment to businesses. Benchmark Electronics, Celestica, Flex, Halma, Jabil, Plexus and Sanmina all provide design and engineering services to the electronic industry, though, unlike Forward Industries, they also own volume manufacturing capacity.

Forward Industries trades on similar FY2 EV/EBITDA multiples to the distribution company Bunzl. It is broadly in line in terms of prospective EV/sales multiples with other companies focused on design, engineering and manufacturing, but is more expensive when its prospective P/E and EV/EBITDA multiples are compared. This suggests potential for an uplift in the share price once the design division is generating sustainable profits.