Yunhong CTI Ltd. — Q1 2020 Form 10-Q
Business and period: This quarterly report covers the three months ended March 31, 2020. The company makes balloons, films and related products. CTI Balloons and CTI Europe, along with the Ziploc-branded vacuum-sealer line, are reported as discontinued operations. The company filed on June 29, 2020, after delaying its filing under SEC COVID-19 relief; it said remote work by key accounting staff delayed the financial review.
Financial performance and position
- Revenue: Continuing-operations net sales were $7.07 million, down 19% from $8.68 million a year earlier. Metalized balloon sales fell 19%, latex balloon sales 9%, and film sales 72%; other product sales rose 67%.
- Profitability: Gross profit was $1.48 million versus $1.96 million; gross margin was about 21.0%, compared with 22.5%. Operating income was $630,000, versus an operating loss of $909,000. Continuing-operations loss was $7,000, compared with $1.78 million. Including discontinued operations, net loss was $494,000 versus $2.56 million. Net loss attributable to Yunhong CTI shareholders, after preferred-stock deemed dividends, was $3.02 million, or $0.76 per common share, versus $2.49 million, or $0.67 per share.
- Discontinued operations: These contributed a $487,000 net loss in Q1 2020, including an $804,000 loss from the Ziploc product line, partly offset by a reported CTI Europe gain.
- Cash flow: Operating activities provided $842,000, compared with $665,000. Investing used $19,000; financing used $1.70 million, including $4.34 million of net revolving-credit repayments and $3.63 million of stock proceeds. Cash declined $685,000 to $160,000. Cash-flow statements include discontinued-operation cash flows.
- Liquidity and debt: Current assets were $23.82 million and current liabilities $21.46 million at March 31; reported working capital was approximately $2.36 million. The revolving line balance was $10.11 million. Current notes payable were $3.20 million, with $1.32 million of notes payable shown as long-term and $1.07 million owed to officers. Total liabilities were $24.29 million. Approximately $2.0 million of long-term bank debt was reclassified as current because of covenant noncompliance.
- Equity and foreign exchange: The company issued Series A preferred stock and raised $3.63 million in cash during the quarter, with $478,000 of debt converted to preferred shares. A $2.38 million deemed dividend and preferred-stock conversion-feature amortization materially increased the loss attributable to common shareholders. Foreign-currency translation reduced comprehensive income by $1.36 million, which management linked mainly to a sharp Mexican-peso decline.
Changes, outlook and key risks
- Revenue declined amid COVID-19 disruption, including postponed or missed graduation-season demand and closures among smaller customers. Management believed some balloon orders were delayed rather than canceled, but gave no quantified guidance. Film sales also fell after a major customer restructured its program.
- Customer concentration is significant: one customer represented 45% of sales and 29% of net receivables. The top three customers represented 56% of sales.
- Going concern and bank default: Management stated that recurring losses and financing constraints raised substantial doubt about the company’s ability to continue as a going concern. It said financing and other plans might fund operations through 2020, but success was not assured. PNC had agreed to forbear from remedies through no later than December 31, 2020, subject to terms. On June 15, 2020, after quarter-end, PNC notified the company of a further default for failing the March fixed-charge coverage covenant and said it could exercise remedies, including stopping advances or accelerating amounts due.
- Management’s plans included working with investors and the bank, relocating operations to lower-cost locations, considering a transaction involving its Lake Barrington facility, focusing on profitable products and markets, and seeking alternative funding. The filing identifies supplier, shipment and demand uncertainty from COVID-19.
- Vendor claims filed or threatened for nonpayment exceeded $0.5 million in aggregate; they were disputed, outcomes were uncertain, and no related contingencies were recorded. Management also disclosed material weaknesses in financial reporting controls and concluded disclosure controls were ineffective, citing limited accounting expertise for unusual transactions and reliance on the CFO and Controller in a highly manual environment.
- After quarter-end, the company received a $1.048 million PPP loan at 1% interest, due April 2022, with forgiveness subject to approval and requirements. Additional preferred-stock closings and board changes also occurred after quarter-end.
Investor verification points
- Confirm PNC facility status, covenant compliance, available borrowing capacity and any exercise of lender remedies following the June 15 default notice.
- Assess cash runway, seasonal working-capital needs, and whether management’s financing, cost-reduction and relocation plans were executed.
- Review preferred-stock dividend, conversion, voting and liquidation terms, potential dilution from conversion and warrants, and the accounting for deemed dividends and offering costs.
- Track COVID-19 effects on orders, supply availability, the major customer and discontinued-operation exits, including the planned CTI Europe disposition.
- Monitor the disputed vendor claims, potential PPP forgiveness, and remediation of the disclosed control weaknesses.