Yunhong CTI Ltd. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. Financial statements are unaudited. The company designs, manufactures and distributes balloons, films and related packaging products. Results distinguish continuing operations from discontinued operations, including CTI Balloons, CTI Europe and the Ziploc product line.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Continuing net sales | $5.981 million | $6.365 million | $18.794 million | $24.259 million |
| Gross profit | $261,000 | $81,000 | $2.352 million | $3.334 million |
| Gross margin | 4.4% | 1.3% | 12.5% | 13.7% |
| Operating loss | $(907,000) | $(993,000) | $(1.239) million | $(2.429) million |
| Net loss, including discontinued operations | $(1.029) million | $(2.225) million | $(2.982) million | $(6.542) million |
| Basic and diluted loss per share | $(0.21) | $(0.51) | $(1.32) | $(1.48) |
- Cash flow: Nine-month operating cash flow was $995,000, versus $4.172 million in 2019. Investing used $140,000 and financing used $2.237 million. Cash and cash equivalents were zero at September 30, 2020, excluding cash in discontinued operations.
- Balance sheet and liquidity: Current assets were $19.505 million and current liabilities $17.604 million, including a $1.5 million investor advance. Total assets were $21.949 million, total liabilities $20.216 million and stockholders’ equity $1.733 million. Accounts receivable was $5.298 million and inventory $10.644 million.
- Debt: The balance sheet reported a $5.613 million line of credit, $2.468 million current notes payable, $1.446 million long-term notes payable and $1.107 million subordinated notes payable to officers, among other smaller obligations. The company remained in default under its PNC credit facility and reclassified $1.4 million of long-term debt to current liabilities.
Changes versus the prior comparable period
- Continuing sales fell 6% in Q3 and 23% for the first nine months. Q3 gross profit improved, but nine-month gross profit and gross margin declined.
- For the first nine months, foil balloon sales declined to $12.380 million from $13.325 million; latex balloon sales fell to $3.712 million from $5.640 million; and film sales fell to $664,000 from $1.475 million. Management cited COVID-related production constraints in Mexico and disruption and restructuring at a major film customer.
- Operating expenses declined year over year, including lower general and administrative and selling and marketing costs, primarily attributed to headcount reductions. Interest expense also decreased to $1.033 million from $1.493 million for the nine-month period.
- Discontinued-operations losses were $1.200 million for the first nine months, compared with $2.106 million in 2019. Discontinued sales also declined substantially.
Outlook, risks and unusual items
- Going concern and financing: Management stated that substantial doubt exists about the company’s ability to continue as a going concern. PNC had continuing default rights, including the ability to stop advances or accelerate obligations, but continued discretionary advances. The company said it had met the lender’s equity-funding request. Management’s plans include further financing, resolving bank covenant issues, relocating operations to lower-cost locations, evaluating a facility transaction and focusing on more profitable products and markets. No quantified operating guidance was provided.
- Equity financing and dilution: The company raised approximately $5.4 million through Series A preferred stock in 2020; the related beneficial conversion feature and deemed dividends materially affected shareholder-attributable loss. In September it received a $1.5 million advance toward a proposed Series B preferred offering. The stock purchase agreement was finalized after quarter-end, on November 17, subject to customary closing conditions. A further $1.5 million advance was received in October for another proposed equity financing whose terms were not finalized in the filing.
- PPP: The company recorded $1.048 million of PPP-related income as an anticipated grant/forgiveness for qualifying payroll, rent and utility costs. The filing cautions that forgiveness is subject to approval.
- Other risks: COVID-19 may disrupt demand, production, supply and shipments. One customer represented 50% of nine-month sales and 33% of net receivables; the top three customers represented 71% of nine-month sales. Management disclosed approximately $760,000 in disputed vendor claims outstanding at September 30; a separate FedEx matter was settled after quarter-end for $100,400. The Mexican peso’s decline contributed to a $1.292 million nine-month foreign-currency translation loss.
- Controls: Management concluded disclosure controls and internal control over financial reporting were ineffective at September 30 due to material weaknesses: insufficient accounting expertise for complex or unusual transactions, and excessive reliance on the CFO in a highly manual control environment.
Investor verification priorities
- Confirm PNC’s current forbearance, covenant-default and discretionary-advance status, and the timing and amount of debt maturities or any refinancing.
- Verify the closing, terms and proceeds of the Series B and subsequent equity financings, including conversion, dividend and dilution effects.
- Assess cash availability and the company’s ability to fund operations given zero reported cash, working-capital needs and the going-concern warning.
- Monitor the major customer’s sales and receivable exposure, along with recovery in Mexican production and demand after COVID-related disruption.
- Review progress remediating the disclosed material weaknesses and the outcomes of disputed vendor claims and other contingencies.