YUNHONG GREEN CTI LTD. - Quarter Report: 2019 September (Form 10-Q)

 

 

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

---

 

 

FORM 10-Q

 

(Mark One)

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2019

 

 OR

 

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from _________to_________

 

Commission File Number

000-23115

CTI INDUSTRIES CORPORATION

(Exact name of Registrant as specified in its charter)

                                                 

Illinois	36-2848943
(State or other jurisdiction of  incorporation or organization)	(I.R.S. Employer Identification Number)

 

22160 N. Pepper Road
Lake Barrington, Illinois	60010
(Address of principal executive offices)	(Zip Code)

               

(847) 382-1000

(Registrant’s telephone number, including area code)

 

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common	CTIB	NASDAQCM

 

 

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ☑     No ☐

 

Indicate by check mark whether the registrant has submitted electronically, every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☑     No ☐

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, smaller reporting company, or an emerging growth company. See definition of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer	☐		Accelerated filer	☐
Non-accelerated filer	☐		Smaller Reporting Company	☑
			Emerging Growth Company	☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ☐     No ☑

 

The number of shares outstanding of the Registrant’s common stock as of November 1, 2019 was 3,835,950.

 

 

 

INDEX

 

PART l- FINANCIAL INFORMATION
Item No. 1.	Financial Statements
	Condensed Consolidated Balance Sheets at September 30, 2019 (unaudited) and December 31, 2018	1
	Condensed Consolidated Statements of Comprehensive Income (unaudited) for the three and nine months ended September 30, 2019 and September 30, 2018	2
	Condensed Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2019 and September 30, 2018	3
	Condensed Consolidated Statements of Shareholders Equity (unaudited) for the nine months ended September 30, 2019	4
	Notes to Condensed Consolidated Financial Statements (unaudited)	5
Item No. 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
Item No. 3	Quantitative and Qualitative Disclosures Regarding Market Risk	20
Item No. 4	Controls and Procedures	20
PART ll - OTHER INFORMATION
Item No. 1	Legal Proceedings	20
Item No. 1A	Risk Factors	20
Item No. 2	Unregistered Sales of Equity Securities and Use of Proceeds	21
Item No. 3	Defaults Upon Senior Securities	21
Item No. 4	Submission of Matters to a Vote of Security Holders	21
Item No. 5	Other Information	21
Item No. 6	Exhibits	21
	Signatures	22
	Exhibit 31.1
	Exhibit 31.2
	Exhibit 32

 

 

 

		September 30, 2019				December 31, 2018
		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents (VIE $12,000 and $57,000, respectively)		$	126,647			$	428,150
Accounts receivable, (less allowance for doubtful accounts of $112,000 and $85,000, respectively)			8,134,291				10,830,555
Inventories, net (VIE $237,000 and $340,000, respectively)			18,345,406				20,007,488
Prepaid expenses (VIE $96,000 and $127,000, respectively)			556,594				858,158
Other current assets			1,293,899				886,383
Total current assets			28,456,837				33,010,734
Property, plant and equipment:
Machinery and equipment			23,883,267				23,807,985
Building			3,374,334				3,367,082
Office furniture and equipment (VIE $303,000 and $303,000, respectively)			2,692,423				2,649,280
Intellectual property			783,179				783,179
Land			250,000				250,000
Leasehold improvements			409,347				409,188
Fixtures and equipment at customer locations			518,450				518,450
Projects under construction			189,795				150,272
			32,100,795				31,935,436
Less : accumulated depreciation and amortization (VIE $107,000 and $104,000, respectively)			(28,865,571	)			(28,120,455	)
Total property, plant and equipment, net			3,235,224				3,814,981
Other assets:
Goodwill (VIE $440,000 and $440,000, respectively)			1,473,176				1,473,176
Net deferred income tax asset			1,051,128				135,094
Operating lease right-of-use			1,711,812
Other non-current assets			(3,000,000	)
Other assets			(31,086	)			326,849
Total other assets			1,205,030				1,935,119
TOTAL ASSETS		$	32,897,091			$	38,760,834
LIABILITIES AND EQUITY
Current liabilities:
Checks written in excess of bank balance (VIE $0 and $7,000, respectively)		$	244,829			$	636,142
Trade payables (VIE $54,000 and $62,000, respectively)			8,522,419				6,679,670
Line of credit (VIE $214,000 and $267,000, respectively)			12,774,347				16,582,963
Notes payable - current portion			3,787,533				4,432,320
Notes payable affiliates - current portion			11,789				10,821
Operating Lease Liabilities			1,268,257				0
Accrued liabilities (VIE $28,000 and $89,000, respectively)			1,550,238				1,866,796
Total current liabilities			28,159,412				30,208,712
Long-term liabilities:
Notes payable - affiliates			221,362				199,122
Notes payable, net of current portion (VIE $30,000 and $27,000, respectively)			868,707				399,912
Operating Lease Liabilities			443,555
Notes payable - officers, subordinated			1,042,766				1,597,019
Deferred gain (non current)			214,074				100,340
Deferred income tax liability			-
Total long-term debt, net of current portion			2,790,464				2,296,393
Total long-term liabilities			2,790,464				2,296,393
Equity:
CTI Industries Corporation stockholders' equity:
Preferred Stock -- no par value, 3,000,000 shares authorized, 0 shares issued and outstanding			-				-
Common stock - no par value, 15,000,000 shares authorized, 3,879,608 shares issued and 3,835,950 shares outstanding			13,898,494				13,898,494
Paid-in-capital			3,481,838				2,506,437
Accumulated earnings			(8,007,958	)			(2,865,486	)
Accumulated other comprehensive loss			(6,034,745	)			(6,050,347	)
Less: Treasury stock, 43,658 shares			(160,784	)			(160,784	)
Total CTI Industries Corporation stockholders' equity			3,176,845				7,328,314
Noncontrolling interest			(1,229,630	)			(1,072,585	)
Total Equity			1,947,215				6,255,729
TOTAL LIABILITIES AND EQUITY		$	32,897,091			$	38,760,834

---

 

		For the Three Months Ended September 30,								For the Nine Months Ended September 30,
		2019				2018				2019				2018
Net Sales		$	8,537,475			$	11,525,469			$	33,480,704			$	41,489,372
Cost of Sales			7,729,851				9,336,935				28,139,175				32,636,925
Gross profit			807,624				2,188,534				5,341,529				8,852,447
Operating expenses:
General and administrative			1,466,830				1,509,804				5,054,028				5,074,340
Selling			377,577				728,303				1,230,181				2,545,635
Advertising and marketing			222,061				302,985				766,297				931,475
Gain on sale of assets			(23,054	)			(24,061	)			(70,263	)			(71,474	)
Total operating expenses			2,043,414				2,517,031				6,980,243				8,479,976
Income from operations			(1,235,790	)			(328,497	)			(1,638,714	)			372,471
Other (expense) income:
Interest expense			(486,636	)			(471,268	)			(1,549,703	)			(1,586,108	)
Interest income			99				5,423				435				16,467
Other Expense			-				-				(3,000,000	)			-
Foreign currency loss			(28,420	)			35,528				(27,568	)			53,311
Total other expense, net			(514,957	)			(430,317	)			(4,576,836	)			(1,516,330	)
Net income before taxes			(1,750,747	)			(758,814	)			(6,215,550	)			(1,143,859	)
Income tax expense			(511,823	)			(212,589	)			(916,033	)			(332,791	)
Net income			(1,238,924	)			(546,225	)			(5,299,517	)			(811,068	)
Less: Net (loss) income attributable to noncontrolling interest			(71,559	)			13,072				(157,045	)			(38,968	)
Net income attributable to CTI Industries Corporation		$	(1,167,365	)		$	(559,297	)		$	(5,142,472	)		$	(772,100	)
Other Comprehensive Income (Loss)
Foreign currency adjustment			(281,817	)			231,827				15,603				(110,605	)
Comprehensive Income (Loss)		$	(1,449,182	)		$	(327,470	)		$	(5,126,869	)		$	(882,705	)
Basic income per common share		$	(0.30	)		$	(0.16	)		$	(1.34	)		$	(0.22	)
Diluted income per common share		$	(0.30	)		$	(0.16	)		$	(1.34	)		$	(0.22	)
Weighted average number of shares and equivalent shares of common stock outstanding:
Basic			3,835,950				3,530,227				3,835,950				3,530,227
Diluted			3,835,950				3,530,227				3,835,950				3,530,227

---

 

		For the Nine Months Ended September 30,
		2019				2018
Cash flows from operating activities:
Net income		$	(5,299,517	)		$	(811,068	)
Depreciation and amortization			835,302				981,449
Operating cash flows from operating leases			606,356				-
Amortization of deferred gain on sale/leaseback			116,277				(83,394	)
Provision for losses on accounts receivable			27,362				(40,924	)
Provision for losses on inventories			(157,243	)			14,250
Deferred income taxes			(916,033	)			(347,725	)
Loss on disposition of asset			17,480
Change in assets and liabilities:
Accounts receivable			2,626,396				1,717,018
Other non-current assets			3,000,000
Inventories			1,685,411				(819,293	)
Prepaid expenses and other assets			228,389				(776,294	)
Trade payables			1,846,575				385,715
Accrued liabilities			(23,878	)			(267,938	)
Net cash provided by (used in) operating activities			4,592,877				(48,204	)
Cash flows from investing activities:
Purchases of property, plant and equipment			(144,222	)			(323,785	)
Net cash provided by (used in) investing activities			(144,222	)			(323,785	)
Cash flows from financing activities:
Change in checks written in excess of bank balance			(391,313	)			149,447
Net change in revolving line of credit			(3,808,012	)			821,390
Repayment of long-term debt			(913,855	)			(697,040	)
Proceeds from issuance of stock			975,401				139,450
Cash paid for deferred financing fees			(82,763	)			(32,805	)
Proceeds from issuance of long-term debt			125,000
Net cash provided by (used in) financing activities			(4,095,542	)			380,442
Effect of exchange rate changes on cash			(654,616	)			84,360
Net increase/(decrease) in cash and cash equivalents			(301,503	)			92,813
Cash and cash equivalents at beginning of period			428,150				181,026
Cash and cash equivalents at end of period		$	126,647			$	273,839
		$	-			$	-
Supplemental disclosure of cash flow information:
Cash payments for interest			1,558,817			$	1,381,149
Supplemental Disclosure of non-cash investing and financing activity
Property, Plant & Equipment acquisitions funded by liabilities		$	33,251			$	39,319

---

 

		CTI Industries Corporation
																		Accumulated
																		Other				Less
		Common Stock								Paid-in				Accumulated				Comprehensive				Treasury Stock								Noncontrolling
		Shares				Amount				Capital				(Deficit) Earnings				Loss				Shares				Amount				Interest				TOTAL
Balance December 31, 2018		$	3,578,885			$	13,898,494			$	2,506,437			$	(2,865,486	)		$	(6,050,347	)		$	(43,658	)		$	(160,784	)		$	(1,072,585	)			6,255,729
																																			-
Note conversion - Schwan			180,723								600,000																								600,000
Stock Issued			120,000								303,000																								303,000
Stock Option Expense											72,401																								72,401
Net Income															(5,142,472	)															(157,045	)			(5,299,517	)
Other comprehensive income, net of taxes																																			-
Foreign currency translation																			15,603																15,603
Balance September 30, 2019		$	3,879,608			$	13,898,494			$	3,481,838			$	(8,007,958	)		$	(6,034,744	)		$	(43,658	)		$	(160,784	)		$	(1,229,630	)		$	1,947,216

---

 

Note 1 - Basis of Presentation

 

The accompanying condensed (a) consolidated balance sheet as of December 31, 2018, which has been derived from audited consolidated financial statements, and (b) the unaudited interim condensed consolidated financial statements have been prepared and, in the opinion of management, contain all the adjustments (consisting of those of a normal recurring nature) considered necessary to present fairly the consolidated financial position and the consolidated statements of comprehensive income and consolidated cash flows for the periods presented in conformity with generally accepted accounting principles for interim consolidated financial information and the instructions to Form 10-Q and Article 8 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States of America. Operating results for the three months ended September 30, 2019 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2019. It is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the Company's annual report on Form 10-K for the fiscal year ended December 31, 2018.

 

Principles of consolidation and nature of operations:

 

The condensed consolidated financial statements include the accounts of CTI Industries Corporation and its wholly-owned subsidiaries, CTI Balloons Limited and CTI Supply, Inc., its majority-owned subsidiaries, Flexo Universal, S. de R.L. de C.V. and CTI Europe gmbH, as well as the accounts of Venture Leasing S. A. de R. L., Venture Leasing L.L.C and Clever Container Company, L.L.C. (the “Company”). The last three entities have been consolidated as variable interest entities. All significant intercompany transactions and accounts have been eliminated in consolidation. The Company (i) designs, manufactures and distributes balloon and related novelty (candy and party related) products throughout the world, (ii) operates systems for the production, lamination, coating and printing of films used for food packaging and other commercial uses and for conversion of films to flexible packaging containers and other products, and (iii) distributes vacuum sealing products and home organization products in the United States. We have announced our intention to divest our interests in Clever Container and the two European Sales entities, and ultimately remove them from our group. As we held equity interests in those entities as of both the reporting and filing dates of this report, they remain consolidated. We have recognized non-cash charges in excess of $3 million during 2018 and 2019 to reflect that determination and in anticipation of ultimate deconsolidation.

 

Variable Interest Entities (“VIE’s”):

 

The determination of whether or not to consolidate a variable interest entity under U.S. GAAP requires a significant amount of judgment concerning the degree of control over an entity by its holders of variable interest. To make these judgments, management has conducted an analysis of the relationship of the holders of variable interest to each other, the design of the entity, the expected operations of the entity, which holder of variable interests is most “closely associated” to the entity and which holder of variable interests is the primary beneficiary required to consolidate the entity. Upon the occurrence of certain events, management reviews and reconsiders its previous conclusion regarding the status of an entity as a variable interest entity. There are three entities that have been consolidated as variable interest entities.

 

Use of estimates:

 

In preparing condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amount of revenue and expenses during the reporting period in the condensed consolidated financial statements and accompanying notes. Actual results may differ from those estimates. The Company’s significant estimates include reserves for doubtful accounts, reserves for the lower of cost or market of inventory, reserves for deferred tax assets and recovery value of goodwill.

 

Earnings per share:

 

Basic earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding during each period.

 

Diluted earnings per share is computed by dividing the net income by the weighted average number of shares of common stock and equivalents (stock options and warrants), unless anti-dilutive, during each period.

 

As of September 30, 2019, and 2018, shares to be issued upon the exercise of options and warrants aggregated 471,000 for each period. 

 

 

Significant Accounting Policies:

 

The Company’s significant accounting policies are summarized in Note 2 of the Company’s consolidated financial statements for the year ended December 31, 2018. There were no significant changes to these accounting policies during the three or nine months ended September 30, 2019, except for the adoption of Accounting Standards Codification (ASC) Topic 842, Leases.

 

On January 1, 2019, we adopted ASC Topic 842 (Leases). The adoption of this standard significantly increased our assets and liabilities and further discussed in Note 12. ASC 842 requires a lessee to recognize assets and liabilities related to leases with terms in excess of 12 months. Such assets are typically considered Right-Of-Use (“ROU”) assets. Prior information has not been restated and continues to be reported under the accounting standards in effect for those periods.

 

On January 1, 2018, we adopted ASC 606 using the modified retrospective method. The adoption of ASC 606 did not have a material impact on our consolidated financial position or results of operations, as our revenue arrangements generally consist of a single performance obligation to transfer promised goods at a fixed price.

 

Net sales include revenues from sales of products and shipping and handling charges, net of estimates for product returns. Revenue is measured at the amount of consideration the Company expects to receive in exchange for the transferred products. Revenue is recognized at the point in time when we transfer the promised products to the customer and the customer obtains control over the products. The Company recognizes revenue for shipping and handling charges at the time the goods are shipped to the customer, and the costs of outbound freight are included in cost of sales, as we have elected the practical expedient included in ASC 606.

 

The Company provides for product returns based on historical return rates. While we incur costs for sales commissions to our sales employees and outside agents, we recognize commission costs concurrent with the related revenue, as the amortization period is less than one year, and we have elected the practical expedient included in ASC 606. We do not incur incremental costs to obtain contracts with our customers. Our product warranties are assurance-type warranties, which promise the customer that the products are as specified in the contract. Therefore, the product warranties are not a separate performance obligation and are accounted for as described herein. Sales taxes assessed by governmental authorities are accounted for on a net basis and are excluded from net sales.

 

Auditor Replacement Process:

 

During April 2019, our independent registered accounting firm, Plante & Moran PLLC, resigned as auditor. This quarterly report on Form 10Q is being prepared without the benefit of auditor review, and we would look to amend this filing upon the hiring of a replacement independent registered accounting firm.

 

 

 

Note 2 – Liquidity and Going Concern

 

The Company’s primary sources of liquidity are cash and cash equivalents as well as availability under the Credit Agreement with PNC Bank, National Association (“PNC”) (see Note 3). As indicated in Note 3, twice during 2018 we violated covenants in our credit facility and as of March 2019 we entered into a forbearance agreement with PNC. Under the terms of this agreement, financial covenants as of March 31, 2019 were not considered and all previously identified compliance failures were waived, but we remain out of compliance with the terms of our credit facility, as amended, including the covenants as of June 30, 2019 calculated on or about July 31, 2019. On August 1, 2019, PNC issued a Default and Reservation of Rights letter to the Company, in which PNC advised that line of credit advances would continue to be available to the Company at PNC’s sole discretion, and subject to its terms and conditions. On October 18, 2019, we entered into a new forbearance agreement with PNC (“Amendment 4”). Identified events of default were waived until January 10, 2020 with respect to CTI Industries Corporation, but not its Mexican subsidiary (Flexo), subject to its terms and conditions.

 

During 2019 we attempted to execute a major capital event with a partner that would infuse money, among other attributes. That effort was unsuccessful as envisioned. We are currently seeking to execute on one or more smaller transactions, as well as pursue other financing options. There is no assurance that any of these efforts will be successful.

 

In addition to the above, due to financial performance in 2016, 2017 and 2018, including net income/(losses) attributable to the Company of $0.7 million, ($1.6 million), and ($3.6 million), respectively, we believe that substantial doubt about our ability to continue as a going concern exists at September 30, 2019.

 

Additionally, we have experienced challenges in maintaining adequate seasonal working capital balances, made more challenging by increases in financing and labor costs, along with a supply disruption in the helium market. These changes in cash flows have created very significant strain within our operations and have therefore increased our attempts to obtain additional funding resources. On October 21, 2019, we issued notices under the Worker Adjustment and Retraining Notification Act (“WARN”) and related state laws. The notices indicated that our primary facility, in Lake Barrington, IL, might close in late December 2019 or early January 2020. While we continue to seek an appropriate financing structure that would allow us to continue operations, the possibility of closure caused the issuance of these notices.

 

Finally, four claims have been filed in court by vendors, one current and three former, regarding claims of non-payment pursuant to contractual obligations. The sum of these claims is approximately $0.7 million. The cost of defense and potential ultimate resolution increases the strain on our financial resources.

 

Management’s plans include:

 

	(1)	Pursuing a smaller strategically significant capital event.
	(2)	Working with our bank to resolve our compliance failure on a long-term basis.
	(3)	Evaluating and potentially executing a transaction of our facility in Lake Barrington, IL.
	(4)	Simplifying our group structure,
	(5)	Exploring alternative funding sources,
	(6)	Implementing significant expense reductions for benefit beginning 2020, including changes in locations, certain operational functions, and equipment, and
	(7)	Pursue the divestiture of non-performing assets and/or non-growth product lines and businesses.

 

Management Assessment

 

Considering both quantitative and qualitative information, we believe that our plans to obtain additional financing may provide us with an ability to finance our operations through 2019 and, if successfully executed, may mitigate the substantial doubt about our ability to continue as a going concern.

  

 

 

Note 3 - Debt

 

During December 2017, we terminated a prior credit arrangement and entered in new financing agreements with PNC Bank, National Association (“PNC”). The “PNC Agreements” include a $6 million term loan and an $18 million revolving credit facility, with a termination date of December 2022.

 

Available credit under the Revolving Credit facility is determined by eligible receivables and inventory at CTI Industries (U.S.) and Flexo Universal (Mexico). We notified PNC of our failure to meet two financial covenants as of March 31, 2018. On June 8, 2018, we entered into Waiver and Amendment No. 1 (the “Amendment 1”) to our PNC Agreements. The Amendment modified certain covenants, added others, waived our failure to comply as previously reported, and included an amendment fee and temporary increase in interest rate. During September 2018, we filed a preliminary prospectus on Form S-1 for a planned equity issuance. On October 8, 2018, we entered into Consent and Amendment No. 2 (the “Amendment 2”) to our PNC Agreements. Amendment 2 reduced the amount of new funding proceeds that must be used to repay the term loan from $5 million to $2 million and waived the calculation of financial ratios for the period ended September 30, 2018, in exchange for a new covenant committing to raise at least $7.5 million in gross proceeds from our equity issuance by November 15, 2018 and pay an amendment fee. Market conditions ultimately forced us to postpone the offering, and thus no proceeds were received by the November 15, 2018 requirement.

 

We engaged PNC to resolve this failure to meet our amended covenant, and as of March 2019 entered into a forbearance agreement. Under the terms of this agreement, previously identified compliance failures were waived and financial covenants as of March 31, 2019 were not considered, with the next calculation due July 31, 2019 for the period ended June 30, 2019. We received a temporary over-advance of $1.2 million, which declined to zero over a six-week period under the terms of this agreement and paid a fee of $250,000.

 

On August 1, 2019, PNC issued a Notice of Default and Reservation of Rights letter, indicating the end of the forbearance period and continued events of default with our credit agreement, as amended. On October 18, 2019, we entered into a second forbearance agreement and Amendment No. 4 (“Amendment 4”). Amendment 4 provided forbearance to CTI Industries Corporation, and not to its Flexo subsidiary, until January 10, 2020, pursuant to its terms and conditions including a variety of additional reporting obligations.

 

We remain out of compliance with the terms of our facility and have thus reclassified long-term bank debt to current liabilities on our balance sheet. Available credit under the Revolving Credit facility is determined by eligible receivables and inventory at CTI Industries (U.S.) and Flexo Universal (Mexico).

 

Certain terms of the PNC Agreements include:

 

●

Restrictive Covenants: The Credit Agreement includes several restrictive covenants under which we are prohibited from, or restricted in our ability to:

○

Borrow money;

○

Pay dividends and make distributions;

○

Make certain investments;

○

Use assets as security in other transactions;

○

Create liens;

○

Enter into affiliate transactions;

○

Merge or consolidate; or

○

Transfer and sell assets.

 

●

Financial Covenants: The Credit Agreement includes a series of financial covenants we are required to meet including:

○

We are required to maintain a "Leverage Ratio", which is defined as the ratio of (a) Funded Debt (other than the Shareholder Subordinated Loan) as of such date of determination to (b) EBITDA (as defined in the PNC Agreements) for the applicable period then ended. The highest values for this ratio allowed by the PNC Agreements are:

 

 

○

We are required to maintain a "Fixed Charge Coverage Ratio", which is defined as the ratio of (a) EBITDA for such fiscal period, minus Unfinanced Capital Expenditures made during such period, minus distributions (including tax distributions) and dividends made during such period, minus cash taxes paid during such period to (b) all Debt Payments made during such period. This ratio must not exceed 1.1 : 1.0 for any quarterly calculation.

 

The credit agreement provides for interest at varying rates in excess of the prime rate, depending on the level of senior debt to EBITDA over time. We also entered into a swap agreement with PNC Bank to fix the rate of interest for $3 million of the notes over 3 years at 2.25%. This contract was made at market value upon December 14, 2017 execution and accounted for as a hedge. This contract was terminated during 2019 under the terms of the forbearance agreement.

 

Failure to comply with these covenants has caused us to pay a higher rate of interest (by 2% per the Agreements), and other potential penalties may impact the availability of the credit facility itself, and thus might negatively impact our ability to remain a going concern. As described above in this Note as well as in Note 2, we remain out of compliance with the terms of this facility.

 

As of December 2017, Mr. Schwan was owed a total of $1,099,000, with additional accrued interest of $400,000, by the Company. As part of the December 2017 financing with PNC, Mr. Schwan executed a subordination agreement related to these amounts due him, as evidenced by a related note representing the amount owed to Mr. Schwan. During January 2019, Mr. Schwan converted $600,000 of his balance into approximately 181,000 shares of our common stock at the then market rate. No payments were issued to Mr. Schwan during 2018 or the three or nine months ended September 30, 2019, with $15,000 and $45,000, respectively, of interest recorded as an expense.

 

 

 

Note 4 - Stock-Based Compensation; Changes in Equity

 

The Company has adopted Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 718 which requires all share-based payments to employees, including grants of employee stock options, to be recognized in the condensed consolidated financial statements based on their grant-date fair values.

 

The Company has applied the Black-Scholes model to value stock-based awards and issued warrants related to notes payable. That model incorporates various assumptions in the valuation of stock-based awards relating to the risk-free rate of interest to be applied, the estimated dividend yield and expected volatility of our common stock. The risk-free rate of interest is the related U.S. Treasury yield curve for periods within the expected term of the option at the time of grant. The dividend yield on our common stock is estimated to be 0%, as the Company did not issue dividends during 2019 and 2018. The expected volatility is based on historical volatility of the Company’s common stock.

 

The Company’s net loss for the three months ended September 30, 2019 and net loss for the three months ended September 30, 2018 includes approximately $20,000 and $34,000, respectively, of compensation costs related to share based payments. The Company’s net loss for the nine months ended September 30, 2019 and 2018 includes approximately $72,000 and $139,000 respectively, of compensation costs related to share based payments. As of September 30, 2019, there was $118,000 of unrecognized compensation expense related to non-vested stock option grants and stock grants. We expect approximately $18,000 of additional stock-based compensation expense to be recognized over the remainder of 2019, and $56,000 to be recognized during 2020.

 

On April 10, 2009, the Board of Directors approved for adoption, and on June 5, 2009, the shareholders of the Corporation approved, a 2009 Stock Incentive Plan (“2009 Plan”). The 2009 Plan and subsequent awards categorized as inducement of employment authorized the issuance of up to 510,000 shares of stock or options to purchase stock of the Company (including cancelled shares reissued under the plan.) On June 8, 2018, our shareholders approved the 2018 Stock Incentive Plan (“2018 Plan”). The 2018 Plan authorizes the issuance of up to 300,000 shares of our common stock in the form of equity-based awards. Because no registration on Form S-8 was filed for these additional shares within 12 months of approval by our shareholders, those additional shares are not available for issuance in the normal course. As of September 30, 2019, options for 471,144 shares remain outstanding.

 

A summary of the Company’s stock option activity, which includes grants of restricted stock, non-qualified stock options, incentive stock options, warrants and related information, is as follows:

 

 

 

The instruments above have an aggregate intrinsic value of $83,000, which represents the total pre-tax intrinsic value (the difference between the closing price of the Company’s common stock on the last trading day of the quarter ended September 30, 2019 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all the holders exercised their options on September 30, 2019.

 

 

 

Note 5 - Legal Proceedings

 

The Company may be party to certain lawsuits or claims arising in the normal course of business. The ultimate outcome of these matters is unknown but, in the opinion of management, we do not believe any of these proceedings will have, individually or in the aggregate, a material adverse effect upon our financial condition, cash flows or future results of operation.

 

In July 2017, God’s Little Gift, Inc. (d\b\a) Helium and Balloons Across America and Gary Page (“Claimants”) filed an action against the Company based on disputed compensation amounts over several years. This action was resolved by mutual agreement between the parties during January 2019. Mr. Page received 20,000 shares of CTI common stock, $5,000 in cash, and a minimum payout in his monthly royalty calculation of $7,667 beginning March 1, 2019 and ending August 1, 2021. The Company accrued the $0.3 million in committed costs under this settlement in its December 31, 2018 financial statements.

 

During 2019, four claims have been filed against us claiming failure to pay contractually obligated amounts. Three of these claims have been filed by former vendors, and the fourth by a current vendor. The total of these four claims exceeds $0.7 million. All are being actively defended, and the claimed amount is recorded on our balance sheet within liabilities as of September 30, 2019.

 

 

 

Note 6 - Other Comprehensive Income

 

In the nine months ended September 30, 2019, the Company incurred other comprehensive gain of approximately $16,000, all from foreign currency translation adjustments.

 

The following table sets forth the accumulated balance of other comprehensive income and each component.

 

 

 

 

Note 7- Inventories, Net

 

 

 

 

Note 8 - Geographic Segment Data

 

The Company has determined that it operates primarily in one business segment that designs, manufactures and distributes film and film related products for use in packaging, storage and novelty balloon products. The Company operates in foreign and domestic regions. Information about the Company's operations by geographic area is as follows:

 

 

 

 

 

 

Note 9 - Concentration of Credit Risk

 

Concentration of credit risk with respect to trade accounts receivable is generally limited due to the large number of entities comprising the Company's customer base. The Company performs ongoing credit evaluations and provides an allowance for potential credit losses against the portion of accounts receivable which is estimated to be uncollectible. Such losses have historically been within management's expectations. During the three and nine months ended September 30, 2019 and 2018, there were two customers whose purchases represented more than 10% of the Company’s consolidated net sales, respectively. Sales to these customers for the three months ended September 30, 2019 and 2018 are as follows:

 

 

Sales to these customers for the nine months ended September 30, 2019 and 2018 are as follows:

 

 

As of September 30, 2019, the total amounts owed to the Company by these customers were approximately $1,777,000 or 22% and $996,000 or 12%, of the Company’s consolidated net accounts receivable, respectively. The amounts owed at September 30, 2018 by these customers were approximately $2,241,000 or 27%, and $1,702,000 or 21% of the Company’s consolidated net accounts receivable, respectively.

 

 

 

Note 10 - Related Party Transactions

 

John H. Schwan, through an investment entity, and Stephen M. Merrick, also through an investment entity, both directors of the Company, own, in aggregate, a 50% interest in Clever Container Company L.L.C., an Illinois limited liability company (“Clever Container”). During the three months ended September 30, 2019 and 2018, Clever Container purchased various products from the Company in the amount of $11,000 and $259,000, respectively. During the nine months ended September 30, 2019 and 2018, Clever Container purchased various products from the Company in the amount of $74,000 and $442,000, respectively. As of September 30, 2019 and 2018, the balance of accounts receivable from Clever Container to the Company were $1,379,000 and $1,199,000, respectively. The Company owns a 28.5% interest in Clever Container, though has announced the intention to divest its interest in Clever Container. This transaction has not been completed as of the filing of this report.

 

 

 

Note 11 - Derivative Instruments; Fair Value

 

The Company accounts for derivative instruments in accordance with U.S. GAAP, which requires that all derivative instruments be recognized on the balance sheet at fair value. We may enter into interest rate swaps to fix the interest rate on a portion of our variable interest rate debt to reduce the potential volatility in our interest expense that would otherwise result from changes in market interest rates. Our derivative instruments are recorded at fair value and are included in accrued liabilities of our consolidated balance sheet. Our accounting policies for these instruments are based on whether they meet our criteria for designation as hedging transactions, which include the instrument’s effectiveness, risk reduction and, in most cases, a one-to-one matching of the derivative instrument to our underlying transaction. As of September 30, 2019, we had no such instrument. The only derivative instrument, terminated during 2019, was accounted for as a hedge. Changes in fair value for the respective periods were recognized in the consolidated statement of operations.

 

The interest rate swap we entered into December 14, 2017 had a three year term (ending December 14, 2020) and a notional amount of $3 million. The Company purchased a 2.25% fixed rate in exchange for the variable rate on a portion of the notes payable under the PNC Agreements, which was 1.47% at time of execution. The swap was terminated during 2019 as a result of the first forbearance agreement with the bank.

 

 

 

Note 12 - Leases

 

We adopted ASC Topic 842 (Leases) on January 1, 2019. This standard requires us to record certain operating lease liabilities and corresponding right-of-use assets on our balance sheet. Results for periods beginning after January 1, 2019 are presented under Topic 842, while prior period amounts are not adjusted and continue to be reported in accordance with our historic accounting under Topic 840. We elected the package of practical expedients available for expired or existing contracts, which allowed us to carryforward our historical assessments of whether contracts are (or contain) leases, as well as lease classification tests and treatment of initial direct costs. We also elected to not separate lease components from non-lease components for all fixed payments, and we exclude variable lease payments in the measurement of right-of-use assets and lease obligations.

 

Upon adoption of ASC 842 we recorded a $2.4 million increase in other assets, a $1.0 million increase in current liabilities, and a $1.4 million increase in non-current liabilities. We did not record any cumulative effect adjustments in opening retained earnings, and adoption of ASC 842 had no impact on cash flows from operating, investing, or financing activities.

 

We determine if an arrangement is a lease at inception. Most of our operating leases do not provide an implicit rate of interest so we use our incremental borrowing rate based on the information available at the commencement date to determine the present value of future payments. We lease various assets in the course of ordinary business including: warehouses and manufacturing facilities, as well as vehicles and equipment used in our operations. Leases with an initial term of 12 months or less are not recorded on the balance sheet as we recognize lease expense for these leases on a straight-line basis over the lease term. The depreciable life of assets and related improvements are limited by the expected lease term, unless there is a reasonably certain expected transfer or title or purchase option. Some lease agreements include renewal options at our sole discretion. Any guaranteed residual value is included in our lease liability.

 

The table below describes our lease position as of September 30, 2019:

 

 

 

During the three months ended September 30, 2019, we recorded expenses related to

 

 

 

 

During the nine months ended September 30, 2019, we recorded expenses related to

 

 

 

 

 

Note 13 - Subsequent Event

 

During November 2019, our President and Chief Executive Officer, Jeffrey Hyland, announced his intention to retire from CTI Industries Corporation for personal reasons on December 31, 2019 or upon securing his successor, whichever came first. As of the date of this filing, no decision has been made with respect to that position.

 

Also during November 2019, Stanley M. Brown, a director of the Company since 1996, announced his intention to retire from the Board of Directors for personal reasons as of December 1, 2019.

 

 

 

---

---

---

---

---

---

---

---