Business context and reporting period
Yunhong CTI Ltd. (formerly CTI Industries Corporation) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2020. Its continuing business designs, manufactures and distributes foil and latex balloons, films and flexible packaging products. The company is exiting its UK and German subsidiaries and has classified those operations, along with its Ziploc-branded vacuum-sealer product line, as discontinued operations. The UK subsidiary was divested in 2019; the company expected to divest the German subsidiary in September 2020.
Financial performance and condition
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Net sales (continuing operations) | 2020: $5.75 million; 2019: $9.20 million | 2020: $12.81 million; 2019: $17.88 million |
| Gross profit / margin | 2020: $0.61 million / 10.6%; 2019: $0.07 million / 0.7% | 2020: $2.09 million / 16.3%; 2019: $2.02 million / 11.3% |
| Loss from operations | 2020: $0.96 million; 2019: $1.87 million | 2020: $0.33 million; 2019: $2.79 million |
| Net loss | 2020: $1.46 million; 2019: $1.76 million | 2020: $1.95 million; 2019: $4.32 million |
Net loss attributable to Yunhong CTI shareholders was $1.53 million for Q2 and $2.17 million for the first half. After preferred-stock deemed dividends and beneficial-conversion-feature amortization, the reported loss attributable to common shareholders was $1.70 million for Q2 and $6.08 million for the first half, versus $1.18 million and $3.44 million, respectively, in 2019. Basic and diluted loss per share were $0.41 for Q2 and $1.14 for the first half.
At June 30, 2020, cash and cash equivalents were $103,668, total current assets were $21.57 million and current liabilities were $18.60 million. Total assets were $24.26 million, total liabilities $21.50 million and shareholders’ equity $2.76 million. The balance sheet reported an $8.48 million line of credit, $2.75 million of current notes payable and $1.69 million of long-term notes payable. The company reclassified $1.7 million of long-term bank debt to current liabilities because of covenant noncompliance.
The cash flow statement reports $1.03 million of cash used in operating activities, $72,000 used in investing activities and $346,000 used in financing activities for the first half; foreign exchange increased cash by $705,000, and cash decreased by $741,000. Management’s discussion instead reports operating cash use of $228,000 and financing cash use of $949,000. The filing text does not clearly reconcile these differences. The cash flow statement says discontinued-operations cash flows are included and not separately presented.
Material changes versus the prior comparable period
- Continuing-operations sales declined 38% in Q2 and 28% in the first half year over year. Metalized-balloon sales rose in Q2 but declined for the first half; latex balloons, film products and other sales declined for both periods.
- Management attributed weaker sales to COVID-19 disruption, including delayed graduation-season orders, closures of smaller customers and restrictions on production in Mexico. A major film customer also restructured its program.
- Gross margin improved despite lower sales. Cost of sales declined, which management attributed partly to the discontinued vacuum-sealer line and subsidiaries, as well as reduced COVID-related orders.
- First-half operating results included no long-lived-asset impairment charge, compared with $1.51 million in 2019. Interest expense also declined to $778,000 from $1.10 million.
- Preferred-stock financing raised approximately $5.43 million gross during the first half, before $1.02 million of issuance costs. On June 5, LF International, controlled by Chairman Yubao Li, held approximately 57% of voting control. Series A preferred shares carry an 8% annual dividend and were convertible into common shares; the filing says 2020 preferred issuances were convertible into an aggregate 5,908,600 common shares.
Outlook, risks and unusual items
- Liquidity and going concern: The company disclosed substantial doubt about its ability to continue as a going concern. PNC had declared continuing defaults and was making advances at its discretion. In July 2020, PNC required a commitment for at least $3 million of third-party equity by July 31 or said it might stop discretionary advances. Chairman Li committed to provide necessary funding if the company did not obtain at least $3 million by August 31; the filing does not establish whether that funding was ultimately received. Management said financing and operating plans could support operations through 2020 and mitigate the doubt if successfully executed.
- Bank covenants: The company failed the fixed-charge-coverage covenant for the first quarter of 2020 and remained out of compliance. The filing describes a forbearance period ending no later than December 31, 2020, but also says the June default notice ended that period. The status and terms therefore merit review. Covenant failures could raise interest costs and jeopardize credit availability.
- COVID-19: The company cited uncertain demand, supplier and shipment disruptions, customer closures and production constraints. Management said the effects could exceed the $1 million in Paycheck Protection Program (PPP) funds received.
- PPP: The company received a $1.05 million PPP loan at 1% interest, with a two-year maturity and potential forgiveness subject to approval and program requirements. It recognized approximately $800,000 of other income in Q2 based on anticipated grant treatment; forgiveness was not assured.
- Discontinued operations: These generated a $600,000 loss in Q2 and a $1.09 million loss in the first half, including losses from the Ziploc product line and costs associated with businesses being exited.
- Other exposures: Outstanding or threatened vendor claims exceeded $500,000. One customer accounted for 44% of first-half sales and 25% of net receivables. Foreign-currency translation produced a $1.30 million first-half loss, primarily associated with the Mexican peso.
- Controls: Management concluded disclosure controls and internal control over financial reporting were ineffective at June 30, 2020, citing insufficient accounting resources for unusual transactions and excessive reliance on the CEO and CFO in a highly manual environment.
- Preferred-stock presentation: The filing reports $800,146 of PPP-related income and a deferred other-income liability of $246,854 on the balance sheet, while the note text gives a liability of $264,854. The filing text does not clearly resolve the difference.
The filing provides no quantified full-year earnings or revenue guidance. Management described plans to focus on profitable products and markets, relocate operations to lower-cost locations, evaluate a Lake Barrington facility transaction, work with PNC and seek additional financing.
Most important facts for investors to verify
- Whether the required equity funding was obtained, whether Chairman Li funded any shortfall, and whether PNC continued discretionary advances or amended the credit terms.
- The reconciliation of the cash-flow figures in the statement and management’s discussion, and the company’s current cash and borrowing availability.
- The status of covenant defaults, debt maturity or acceleration rights, and the company’s going-concern plans and financing needs.
- The potential dilution, voting impact and dividend obligations of Series A preferred shares, warrants and subsequent conversions.
- Customer concentration, collection of the large customer receivable, and the resolution of vendor claims exceeding $500,000.
- Progress on the planned German subsidiary divestiture and the remediation of the disclosed material weaknesses in financial reporting controls.