YUNHONG GREEN CTI LTD. 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations   Forward Looking Statements   This Quarterly Report on Form 10-Q includes both historical and “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. We have based these forward-looking statements on our current expectations and projections about future results. Words such as “may,” “should,” “could,” “would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “continue,” or similar words are intended to identify forward-looking statements, although not all forward-looking statements contain these words. Although we believe that our opinions and expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements, and our actual results may differ substantially from the views and expectations set forth in this Quarterly Report on Form 10-Q. We disclaim any intent or obligation to update any forward-looking statements after the date of this Quarterly Report on Form 10-Q to conform such statements to actual results or to changes in our opinions or expectations. These forward-looking statements are affected by factors, risks, uncertainties and assumptions that we make, including, without limitation, those discussed in Part I, Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2020 under the heading “Risk Factors.”   Overview   We produce film products for novelty, packaging and container applications. These products include foil balloons, latex balloons and related products, films for packaging and custom product applications, and flexible containers for packaging and consumer storage applications. We produce all of our film products for packaging, container applications and most of our foil balloons at our plant in Lake Barrington, Illinois. We produce all of our latex balloons and latex products at our facility in Guadalajara, Mexico. Substantially all of our film products for packaging and custom product applications are sold to customers in the United States. We market and sell our novelty items and flexible containers for consumer use in the United States, Mexico, and Latin America. We also market and sell Candy Blossoms and party goods.   17 Table of Contents   Summary of Subsequent Events   On July 30, 2021, Yunhong CTI Ltd. (the “Company”) entered into an agreement (the “Agreement”) whereby it agreed to the redemption of all of its equity interests in Flexo Universal S DE RL DE CV, a Mexican corporation (“Flexo”), in a transaction whereby Kingman Distributions, S.A. DE C.V, a Mexican corporation (the “Buyer”), will become the majority owner of Flexo (the “Transaction”).   In connection with the Transaction, Flexo will purchase and redeem all of the Company’s equity interests in Flexo in return for a purchase price of Five Hundred Thousand Dollars ($500,000), of which One Hundred Thousand Dollars ($100,000) is to be paid at the closing of the Transaction, and the remainder is to be paid in installments over twelve months following the closing date (the “Installment Obligations”). The Installment Obligations are to be secured by a pledge of the assets of Flexo, as well as by guaranties provided by the Buyer and Pablo Gortazar, an individual with an ownership interest in Flexo, pursuant to a Guaranty and Security Agreement to be entered into among the Company, the Buyer, Flexo and Mr. Gortazar at the closing.   The closing is conditioned on, among other things, (i) the Company being released from all obligations in connection with its guaranty of the real property lease for Flexo’s operating location in Guadalajara, Mexico, and (ii) the Company repaying its obligations in full to PNC Bank, National Association pursuant to the terms of the Revolving Credit, Term Loan and Security Agreement, dated as of December 14, 2017, as amended between the Company and the bank. The Transaction will close when all of the closing conditions set forth in in the Agreement have been satisfied.       Comparability   In July 2019, management and the Board engaged in a review of CTI Balloons and CTI Europe and determined that they are not accretive to the Company overall, add complexity to the Company’s structure and utilize resources. Therefore, as of July 19, 2019, the Board authorized management to divest these international subsidiaries. These actions were taken to focus our resources and efforts on our core business activities, particularly foil balloons and ancillary products based in North America. The Company determined that these entities met the held-for-sale and discontinued operations accounting criteria. Accordingly, the Company has reported the results of these International operations as discontinued operations in the Consolidated Statements of Comprehensive Income and presented the related assets and liabilities as held-for-sale in the Consolidated Balance Sheets. These changes have been applied for all periods presented. The Company divested its CTI Balloons (United Kingdom) subsidiary in the fourth quarter 2019, its Ziploc product line in the first quarter 2020, and divested its CTI Europe (Germany) subsidiary in the second quarter 2021.     Results of Operations   Net Sales . For the three month periods ended June 30, 2021 and 2020, net sales were $6,325,000 and $5,745,000, respectively.   For the three-month period ended June 30, 2021 and 2020, net sales by product category were as follows:       Three Months Ended                       June 30, 2021     June 30, 2020                          $     % of       $     % of                   Product Category   (000) Omitted     Net Sales     (000) Omitted     Net Sales     Variance     % change                                                     Foil Balloons     4,573       72 %     3,372       59 %     1,201       35.6 %                                                   Latex Balloons     609       10 %     1,115       19 %     (506 )     -45.4 %                                                   Film Products     505       8 %     371       6 %     134       36.0 %                                                   Other     638       10 %     887       16 %     (249 )     -28.1 %                                                   Total     6,325       100 %     5,745       100 %     580       10.1 %     For the six month periods ended June 30, 2021 and 2020, net sales were $13,741,000 and $12,813,000, respectively.   18 Table of Contents   For the six month period ended June 30, 2021 and 2020, net sales by product category were as follows:       June 30, 2021     June 30, 2020                         $     % of       $     % of                   Product Category   (000) Omitted     Net Sales     (000) Omitted     Net Sales     Variance     % change                                                     Foil Balloons     9,606       70 %     7,864       61 %     1,746       22.2 %                                                   Latex Balloons     1,306       10 %     2,698       21 %     (1,392 )     -51.6 %                                                   Film Products     950       7 %     586       5 %     364       62.1 %                                                   Other     1,879       14 %     1,665       13 %     214       12.9 %                                                   Total     13,741       100 %     12,813       100 %     932       7.3 %       Foil Balloons . Revenues from the sale of foil balloons increased during the three months period from $3,372,000 ending June 30, 2020 compared to $4,573,000 during the three month period of 2021. Revenues from the sale of foil balloons increased during the six month period from $7,864,000 ending June 30, 2020 compared to $9,610,000 during the six month period of 2021. Due to COVID-19 related issues, graduation season did not occur as it normally does during 2020. This is the third strongest event in our annual sales period.   Latex Balloons. Revenues from the sale of latex balloons were $609,000 and $1,306,000 during the three and six month periods ended June 30, 2021, compared to $1,115,000 and $2,698,000 during the same periods of 2020. Latex balloons encountered a COVID-19 constraint, as production activities were severely limited by the Mexican government.   Films . Revenues from the sale of commercial films were $505,000 and $950,000 during the three and six month periods ended June 30, 2021, compared to $371,000 and $586,000 during the same periods of 2020.   Other Revenues . Revenues from the sale of other products were $638,000 and $1,879,000 during the three and six month periods ended June 30, 2021, compared to $887,000 and $1,665,000 during the same periods of 2020. The revenues from the sale of other products during the first six months of 2021 and 2020 include (i) sales of a line of “Candy Blossoms” and similar products consisting of candy and small inflated balloons sold in small containers and (ii) the sale of accessories and supply items related to balloon products.   Sales to a limited number of customers continue to represent a large percentage of our net sales. The table below illustrates the impact on sales of our top three and ten customers for the three month periods ended June 30, 2021 and 2020.       Three Months Ended June 30,       % of Sales       2021     2020                     Top 3 Customers     71 %     66 %                   Top 10 Customers     82 %     83 %   19 Table of Contents       Six Months Ended June 30,       % of Sales       2021     2020                     Top 3 Customers     73 %     65 %                   Top 10 Customers     87 %     81 %     During the three and six months ended June 30, 2021 and 2020, there were two customer whose purchases represented more than 10% of the Company’s consolidated net sales. Sales to these customers for the three and six months ended June 30, 2021 and 2020 are as follows:       Three Months Ended     Three Months Ended       June 30, 2021     June 30, 2020   Customer   Net Sales     % of Net Sales     Net Sales     % of Net Sales   Customer A   $ 3,421,000       54 %   $ 2,508,000       43 % Customer B   $ 812,000       13 %   $ 947,000       16 %         Six Months Ended     Six Months Ended       June 30, 2021     June 30, 2020   Customer   Net Sales     % of Net Sales     Net Sales     % of Net Sales   Customer A   $ 7,344,000       53 %   $ 5,675,000       44 % Customer B   $ 2,106,000       15 %   $ 2,110,000       17 %     As of June 30, 2021, the total amounts owed to the Company by these customers were approximately $2,202,000 or 42% of the Company’s consolidated net accounts receivable. The amounts owed at June 30, 2020 by these customers were approximately $4,012,000 or 56% of the Company’s consolidated net accounts receivable.     Cost of Sales . During the three and six month period ended June 30, 2021, the cost of sales was $5,459,000 and $11,782,000, compared to $5,136,000 and $10,722,000 respectively for the same period of 2020 due to higher sales volume.    General and Administrative . During the three and six month period ended June 30, 2021, general and administrative expenses were $1,257,000 and $2,378,000 compared to $1,484,000 and $2,186,000 respectively for the same period in 2020.   Selling, Advertising and Marketing . During the three and six month period ended June 30, 2021, selling, advertising and marketing expenses were $107,000 and $247,000 as compared to $108,000 and $282,000 respectively for the same period in 2020.   Gain on Sale of Assets . On April 23, 2021, the Company sold its facility in Lake Barrington, Illinois and as a result of the sale recognized a gain amounting to $3,357,000.   Other Income (Expense) . During the three and six month period ended June 30, 2021, the Company incurred interest expense of $181,000 and $413,000 compared to interest expense of $337,000 and $778,000 respectively during the same period of 2020.  Interest expense decreased due to the reduction of the Company's senior debt facility.     For the three and six month period ended June 30, 2021, the Company had a foreign currency transaction gain of $36,000 and $9,000 as compared to a loss of $30,000 and $184,000 respectively during the same period of 2020.   Financial Condition, Liquidity and Capital Resources   Cash Flow Items.   Operating Activities . During the six months ended June 30, 2021, net cash used in operations was $631,000, compared to net cash used by operations during the six months ended June 30, 2020 of $1,028,000.   Significant changes in working capital items during the three months ended June 30, 2021 included:     ● A decrease in accounts receivable of $162,000 compared to a decrease in accounts receivable of $1,154,000 in the same period of 2020.   ● An increase in inventory of $457,000 compared to a decrease in inventory of $1,682,000 in 2020.   20 Table of Contents     ● An increase in trade payables of $43,000 compared to a decrease in trade payables of $1,832,000 in 2020.   ● A gain on sale of assets of $3,357,000 in 2021 and nil in 2020   ● A decrease in prepaid expenses and other assets of $219,000 compared to a decrease of $38,000 in 2020.    ● An increase in accrued liabilities of $314,000 compared to an increase in accrued liabilities of $11,000 in 2020.   Investing Activity . During the six months ended June 30, 2021, cash provided by investing activity was $3,454,000, compared to cash used in investing activity for the same period of 2020 in the amount of $72,000. Investing activity consisted principally of the cash flows from the sale and leaseback of our Lake Barrington, Illinois facility, as further described below under the heading "Liquidity and Capital Resources"..   Financing Activities . During the six months ended June 30, 2021, cash used in financing activities was $2,695,000 compared to cash used in financing activities for the same period of 2020 in the amount of $346,000. Financing activity consisted principally of changes in the balances of revolving and long-term debt.   Liquidity and Capital Resources .   At June 30, 2021, the Company had cash balances of $273,000 compared to cash balances of $104,000 for the same period of 2020.     21 Table of Contents   The ability of the Company to continue as a going concern is dependent on the Company obtaining adequate capital to fund operating losses. Management’s plans to continue as a going concern include raising additional capital through sales of equity securities and borrowing, continuing to focus our Company on the most profitable elements, and exploring alternative funding sources on an as needed basis. However, management cannot provide any assurances that the Company will be successful in accomplishing any of its plans. The COVID-19 pandemic has impacted the Company’s business operations to some extent and is expected to continue to do so and, in light of the effect of such pandemic on financial markets, these impacts may include reduced access to capital. The ability of the Company to continue as a going concern is dependent upon its ability to successfully secure other sources of financing and attain profitable operations. There is substantial doubt about the ability of the Company to continue as a going concern for one year from the issuance of the accompanying consolidated financial statements. The accompanying consolidated financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.   The Company’s primary sources of liquidity have traditionally been comprised of cash and cash equivalents as well as availability under the Credit Agreement with PNC (see Note 4). As of March 2019, October 2019 and January 2020, we entered into forbearance agreements with PNC. We encountered subsequent compliance failures with covenants during 2020 and we were out of compliance with the terms of our credit facility, as amended, as of March 31, 2021.    On April 23, 2021, the Company entered into a Purchase and Sale Agreement (“PSA”) with an unaffiliated purchaser (the “Purchaser”) pursuant to which the Company sold its facility in Lake Barrington, Illinois (the “Lake Barrington Facility”), in which our headquarters office, production and warehouse space are located, to the Purchaser. The sale price for the Lake Barrington Facility was $3,500,000, consisting of $2,000,000 in cash and a promissory note with a principal amount of $1,500,000, due and payable on May 3, 2021 (the “Purchaser Promissory Note”). Concurrently with the closing under the PSA, the Company and the Purchaser entered into a lease agreement pursuant to which the Company agreed to lease the Lake Barrington Facility from the Purchaser for a period of ten years. The annual base rent commences at $500,000 for the first year of the term and escalates annually to $652,386 during the last year of the term of the lease. Concurrently with the entry into the PSA and the Lease, the Company entered into a Consent, Forbearance and Amendment No. 6 to Revolving Credit, Term Loan and Security Agreement (the “Amendment Agreement”) with PNC for itself and for the other participant lenders thereunder (collectively, the “Lender”). Prior to entering into the Amendment Agreement, PNC had notified the Company that various events of default had occurred under the Loan Agreement (the “Existing Defaults”) and were continuing. Pursuant to the Amendment Agreement, the Lender consented to the transactions contemplated by the PSA and the Lease, as required under the Loan Agreement.  As a condition to the Amendment Agreement, the Company agreed that the full $2,000,000 in cash proceeds from the sale of the Lake Barrington Facility would be applied to repay the $2,000,000 term loan owed to the Lender pursuant to the Loan Agreement. The Company further agreed that $1,500,000 in proceeds from the Purchaser Promissory Note will be applied to amounts due and owing to the Lender under revolving credit advances made pursuant to the Loan Agreement (the “Revolving Loans”). Pursuant to the Amendment Agreement, the Lender agreed to forbear from exercising its rights and remedies with respect to the Existing Event of Defaults under the Loan Agreement for a period ending on the earlier of September 30, 2021, the occurrence of a new event of default under the Loan Agreement, or the occurrence of a Termination Event (as defined therein). Additionally, certain additions and amendments to the Loan Agreement were set forth in the Amendment Agreement, including:     ● The Maximum Revolving Advance Amount is reduced from $18,000,0000 to $9,000,000;   ● The Termination Date of the Loan Agreement is revised from December 14, 2022 to December 31, 2021;   ● On or before June 30, 2021, or such later date as the Lender agrees in its sole discretion, the Company shall receive an equity investment of at least $1,500,000 and apply 100% of the proceeds to a reduction of the Revolving Credit Advance under the Loan Agreement (the “Equity Investment”);   ● On or before August 15, 2021, or such later date as the Lender agrees in its sole discretion, the Company shall deliver to Lender (i) a binding term sheet, in form and substance acceptable to Lender, from a financing source that provides for the refinance and payment in full, in cash, of the obligations owing under the Loan Agreement on or before September 30, 2021, or (ii) evidence, in form and substance satisfactory to the Lender, that certain equity holders of the Company have available and identifiable funds that are on deposit with a depository institution that are sufficient to pay in full, in cash, all of the Company obligations under the Loan Agreement on or before September 30, 2021;   ● On or before September 30, 2021, the Company will cause all of the amounts owing under the Loan Agreement to be paid in full in cash;   ● The Forbearance Reserve (as defined in Amendment No. 5 to the Loan Agreement) shall be increased from $1,025,000 to $2,525,000;   ● Effective August 1, 2021, accounts receivable from Wal-Mart Stores and its affiliates shall no longer be considered eligible receivables;   ● Modifications will be made to the budget, testing and variance provisions of the Loan Agreement.   In consideration for entering into the Loan Amendment, the Company agreed to pay the Lender a Forbearance Fee of $1,000,000. Provided, however, that, so long as no Event of Default under the Loan Agreement has occurred (including as a result of a failure of the Company to pay down the Revolving Loans by $1,500,000 with the proceeds of the Purchaser Promissory Note, (i) if the Company consummates the Equity Investment by June 30, 2021, the Forbearance Fee shall be reduced by $250,000, to $750,000, and (ii) if the Company causes all of the obligations under the Loan Agreement to be paid in full, in cash, on or before September 30, 2021, the Forbearance Fee shall be reduced by an additional $500,000, to $250,000.   22 Table of Contents   Seasonality   In the foil balloon product line, sales have historically been seasonal with approximately 40% occurring in the period from December through March of the succeeding year and 24% being generated in the period July through October in recent years.   Please see pages 11-13 of our Annual Report on Form 10-K for the year ended December 31, 2020 for a description of policies that are critical to our business operations and the understanding of our results of operations. The impact and any associated risks related to these policies on our business operations is discussed throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations where such policies affect our reported and expected financial results. No material changes to such information have occurred during the three and six months ended June 30, 2021.   Item 3. Quantitative and Qualitative Disclosures Regarding Market Risk   Not applicable.