Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

____________

FORM 10-Q

(Mark One)

For the transition period from _________to_________

Commission File Number

000-23115

YUNHONG CTI LTD.

(Exact name of registrant as specified in its charter)

(847)382-1000

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

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, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

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 20, 2020 was 5,783,646 (excluding treasury shares).

Note 1 - Basis of Presentation

The accompanying condensed (a) consolidated balance sheet as of September 30, 2020, which has been derived from unaudited 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 and nine months ended September 30, 2020 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2020. 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, 2019.

Principles of consolidation and nature of operations:

Yunhong CTI Ltd. (formerly CTI Industries Corporation), its former United Kingdom subsidiary (CTI Balloons Limited), its Mexican subsidiary (Flexo Universal, S. de R.L. de C.V.), its German subsidiary (CTI Europe GmbH) and CTI Supply, Inc. (collectively, the “Company”) (i) design, manufacture and distribute metalized and latex balloon products throughout the world and (ii) operate 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. As discussed in Note 2 Discontinued Operations, effective in the third quarter of 2019, the Company determined that it was exiting CTI Balloons Limited (“CTI Balloons”) and CTI Europe GmbH (“CTI Europe”). CTI Balloons has been fully liquidated as of the fourth quarter 2019.Accordingly, the operations of these entities are classified as discontinued operations in these financial statements.

The consolidated financial statements include the accounts of Yunhong CTI Ltd., its wholly owned subsidiaries CTI Balloons Limited and CTI Supply, Inc. and its majority owned subsidiaries, Flexo Universal and CTI Europe, as well as the accounts of Venture Leasing S. A. de R. L., Venture Leasing L.L.C. (“VL”), and Clever Organizing Solutions (formerly Clever Container Company, L.L.C. “Clever”). The last three entities have been consolidated as variable interest entities. All significant intercompany accounts and transactions have been eliminated upon consolidation. The treatment of VL and Clever changed during 2019 as described in the next section.

Variable Interest Entities (“VIEs”):

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.

The Company has variable interests in VL and Clever. Through June 30, 2019, the Company had determined that it was the primary beneficiary of these entities and included them in our consolidated results. In the third quarter 2019, we determined that operationally material changes in our involvement with Clever and VL resulted in us having no power over the decisions which impact their financial performance. Therefore, we are no longer the primary beneficiary of these entities. Effective July 1, 2019, we deconsolidated these entities and their results are not included in our Consolidated Statements of Comprehensive Income subsequent to June 30, 2019. Upon deconsolidation of these entities, we recognized a gain of $219,000. In accordance with ASC 810-10 because the carrying value of the noncontrolling interest of Clever which was eliminated exceeded the net carrying value of the assets and liabilities of Clever. The Company determined that there was no fair value associated with its remaining noncontrolling interest in Clever based on an income approach.

Use of estimates:

In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions that affect the amounts reported of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period in the financial statements and accompanying notes. Actual results may differ from those estimates. The Company’s significant estimates include valuation allowances for doubtful accounts, inventory valuation, deferred tax assets, goodwill and intangible asset valuation, and assumptions used as inputs in the Black-Scholes option-pricing model. In addition, issues pertaining to COVID-19 have added assumptions related to 2020 sales activities well as the timing of recovery and condition of the broader market after COVID-19 related shutdowns and limitations.

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, 2020 and 2019, shares to be issued upon the exercise of options and warrants aggregated 479,802 and 471,144, respectively. The number of shares included in the determination of earnings on a diluted basis for the three months ended September 30, 2020 and 2019 were none, as doing so would have been anti-dilutive.

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, 2019. There were no significant changes to these accounting policies during the three or nine months ended September 30, 2020.

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 (Revenue From Contracts With Customers) 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.

Prior Period Reclassification

Certain amounts in prior periods have been reclassified to conform with current period presentation and had no effect on prior period net loss or stockholders’ equity.

Note 2 – Discontinued Operations

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 of CTI Balloons and CTI Europe. These actions are being 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 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.

In October 2019, we determined that we would not renew our Trademark License Agreement with SC Johnson when it expired on December 31, 2019. Under this Agreement, we were licensed to manufacture and sell a line of vacuum sealing machines and pouches under the Ziploc® Brand Vacuum Sealer System. The terms of the Agreement included a run-off provision which allowed us to sell products under the Ziploc® trademark for 90 days after the end of the Agreement. Our exit of the Ziploc® product line is considered a strategic shift and will have a major effect on our operations and financial results on a go forward basis therefore, this product line has been presented as discontinued operations.

CTI Balloons recorded losses from discontinued operations, net of taxes of ($433,000) and ($996,000) for the three and nine months ended September 30, 2019.

CTI Europe recorded a loss from discontinued operations, net of taxes of $(76,000) for the three months ended September 30, 2020, compared to a gain from discontinued operations, net of taxes of $313,000 for the nine months ended September 30, 2020. The net losses, net of taxes, were ($566,000) and ($1,735,000) for the three and nine month periods ended September 30, 2019, respectively.

Our Ziploc product line recorded a loss from discontinued operations, net of taxes of ($37,000) for the three months ended September 30, 2020, compared to a loss from discontinued operations, net of taxes of ($1,513,000) for the nine months ended September 30, 2020. The net gain, net of taxes, was $340,000 for the three months ended September 30, 2019 compared to a gain from discontinued operations, net of taxes of $625,000 for the nine-month period ended September 30, 2019, respectively.

Summarized Discontinued Operations Financial Information

The following table summarizes the major line items for the operations that are included in the income from discontinued operations, net of tax line item in the Consolidated Statements of Income for the three months ended:

The following table summarizes the major line items for the operations that are included in the income from discontinued operations, net of tax line item in the Consolidated Statements of Income for the nine months ended:

The following table summarizes the carrying amounts of major classes of assets and liabilities of discontinued operations for each of the periods presented:

The cash flows related to discontinued operations have not been segregated and are included in the Consolidated Statements of Cash Flows. The following table summarizes depreciation from discontinued operations for each of the periods presented:

Note 3 – 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”) (the “Credit Agreement”) (see Note 4). As indicated in Note 4, twice during 2018 we violated covenants in our credit facility and during 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 remained 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. On January 13, 2020, we entered into a new forbearance agreement with PNC (“Amendment 5”). PNC agreed to (i) waive the Loan Agreement’s requirement that the Company apply the net proceeds of the Offering first to the Term Loans (as defined in the Loan Agreement), and agreed that the Company shall instead apply the net proceeds of the Offering to the Revolving Advances (as defined in the Loan Agreement) and in connection therewith the Revolving Commitment Amount (as defined in the Loan Agreement) shall be reduced on a dollar for dollar basis by the amount so applied to the Revolving Advances, and (ii) forebear from exercising the rights and remedies in respect of the Existing Defaults afforded to PNC under the Loan Agreement for a period ending no later than December 31, 2020.

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 were subsequently successful in obtaining new financing during 2020. On January 3, 2020 we entered into a securities purchase agreement, as amended on February 24, 2020 and April 13, 2020, (the “LF Purchase Agreement”) with LF International Pte Ltd., a Singapore private limited company (the “LF International”), which is controlled by Company Chairman Mr. Yubao Li, pursuant to which we sold to LF International 500,000 shares of our Series A Convertible Preferred Stock at a purchase price of $10.00 per share and for aggregate proceeds of $5,000,000. Pursuant to the LF Purchase Agreement, we were authorized to sell an additional $2 million shares of Series A to other investors under similar financial terms, approximately $1 million of which has been sold as of September 30, 2020, including to an investor which converted an accounts receivable of $478,000 owed to the investor by the Company in exchange for 48,200 shares of Series A Preferred. There were several closings with the LF International from January 2020 through June 2020. The majority of the funds received reduced our bank debt. We issued a total of 400,000 shares of common stock to LF International and, pursuant to the LF Purchase Agreement, changed our name from CTI Industries Corporation to Yunhong CTI Ltd. During the transaction and subsequent interim closings, LF International had the right to name three directors to serve on our Board. They are Mr. Yubao Li, our Chairman of the Board, Ms. Wan Zhang and Ms. Yaping Zhang.     

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 believe that, during the first three months of 2020, the Company’s standalone US business would have complied with the Credit Agreement’s requirement that the Company maintain a fixed charge coverage ratio of 0.75 to 1.00 for the three-month period ended March 31, 2020 (the “Fixed Charge Coverage Ratio”).The Company, as a consolidated group, however, did not comply with the Fixed Charge Coverage Ratio, resulting in the noncompliance.

The Lender has continued to make advances to the Company (“Discretionary Advances”), although it is not required to do so under the terms of the Loan Agreement due to the Events of Default. On July 17, 2020, the Lender provided the Company notice that multiple previously disclosed events, which each constitute an Event of Default, are continuing to occur. Additionally, the Lender required that the Company obtain a commitment for third-party equity funding in an amount not less than $3,000,000 by no later than July 31, 2020. Absent such commitment, the Lender advised that it may cease making discretionary advances to the Company. On July 22, 2020, the Company’s board of directors authorized the Company to seek such funding and, to ensure that the Company met the Lender’s equity funding commitment deadline. Mr. Yubao Li, the Company’s Chairman, committed that, in the event the Company does not obtain funding of at least $3,000,000, he would provide the necessary funding. In September 2020, the Company received $1.5 million from an unrelated third party as an advance on a proposed sale of Series B Convertible Preferred Stock (the terms of which are currently being negotiated and finalized).  Additionally, in October, the Company received a $1.5 million advance on a separate proposed equity financing for which the terms have not yet been finalized.   The Lender has continued to make the Discretionary Advances throughout this period and has indicated that we have complied with their request.    

In addition to the above, financial performance in 2017, 2018 and 2019, included net losses attributable to the Company of $1.6 million, $3.6 million, and $7.1 million, respectively. While these results included significant charges related to the disposition of subsidiaries, we believe that the result raises substantial doubt about our ability to continue as a going concern one year from the date these financial statements are issued.

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 during 2019. These changes in cash flows have created very significant strain within our operations and have therefore increased our attempts to obtain additional funding resources.

In December 2019, COVID-19 was reported in Wuhan, China. The World Health Organization has since declared the outbreak to constitute a pandemic. The extent of the impact of COVID-19 on our operational and financial performance will depend on certain developments, including the duration and spread of the outbreak, the impact on our customers and employees, all of which are uncertain and cannot be predicted. The preventative and protective actions that governments have taken to counter the effects of COVID-19 have resulted in a period of business disruption, including delays in shipments of products and raw materials. To the extent the impact of COVID-19 continues or worsens, the demand for our products may be negatively impacted, and we may have difficulty obtaining the materials necessary for the production of our products. In addition, the production facilities of our suppliers may be closed for sustained periods of time and industry-wide shipment of products may be negatively impacted, the severity of which may exceed the $1 million in Payroll Protection Program funds received by the Company from the US Federal Government. COVID-19 has also delayed certain strategic transactions the Company intended to close on in the near future and the Company does not know if and when such transactions will be completed.

Finally, claims have been filed in court by certain vendors regarding claims of non-payment pursuant to contractual obligations. While many have been resolved, the sum of the outstanding claims made or threatened exceeds $0.5 million in the aggregate. The cost of defense and potential ultimate resolution increases the strain on our financial resources.

Management’s plans include:

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 2020 and, if successfully executed, may mitigate the substantial doubt about our ability to continue as a going concern.

Note 4 - Debt

During December 2017, we terminated a prior credit arrangement and entered in new financing agreements (the “PNC 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. We entered into a new forbearance agreement during October 2019 which completed January 2020. In conjunction with new equity financing, on January 13, 2020, a Limited Waiver, Consent, Amendment No. 5 and Forbearance Agreement (the “Forbearance Agreement”) between PNC and the Company became effective, pursuant to which PNC agreed to (i) waive the Loan Agreement’s requirement that the Company apply the net proceeds of the Offering first to the Term Loans (as defined in the Loan Agreement), and agreed that the Company shall instead apply the net proceeds of the Offering to the Revolving Advances (as defined in the Loan Agreement) and in connection therewith the Revolving Commitment Amount (as defined in the Loan Agreement) shall be reduced on a dollar for dollar basis by the amount so applied to the Revolving Advances, and (ii) forebear from exercising the rights and remedies in respect of the Existing Defaults afforded to PNC under the Loan Agreement for a period ending no later than December 31, 2020. In addition, on June 15, 2020, we received a notice of noncompliance and reservation of rights letter from the bank related to failing the covenant calculation during the first quarter of 2020. We remain noncompliant 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:

Fiscal Quarter Ratio

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 believe that, during the first three months of 2020, the standalone US business would have complied with the fixed charge coverage ratio, but consolidated group did not result in a new condition of noncompliance.

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 3, 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 2019 or the nine months ended September 30, 2020, with $49,000 and $46,000, respectively, of interest recorded as an expense during the first nine months of 2020 and 2019, respectively.

During 2020, Flexo replaced a $260,000 line of credit with three line of credit totaling $260,000.  Flexo’s total debt instruments are $1.75 million.   

On April 30, 2020, the Company executed a promissory note (the “Note”) with PNC Bank National Association (the “Lender”) evidencing an unsecured loan in the aggregate principal amount of $1,047,700 (the “PPP Loan”), which was made pursuant to the Paycheck Protection Program (the “PPP”). The PPP was established under the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”), which was enacted on March 27, 2020, and is administered by the U.S. Small Business Administration (“SBA”). All the funds under the PPP Loan were disbursed to the Company on April 23, 2020. The Note provides for a fixed interest rate of one percent per year with a maturity date of April 30, 2022 (the “Maturity Date”). Monthly principal and interest payments due on the PPP Loan are deferred for a six-month period beginning from the date of disbursement of the PPP Loan. The PPP Loan may be prepaid by the Company at any time prior to the Maturity Date with no prepayment penalties or premiums. The Note contains customary event of default provisions. Under the terms of the CARES Act, PPP loan recipients can apply for and be granted forgiveness for all or a portion of the loans granted under the PPP. Such forgiveness will be subject to approval by the SBA and the Lender and determined, subject to limitations, based on factors set forth in the CARES Act, including verification of the use of loan proceeds for payment of payroll costs and payments of mortgage interest, rent and utilities. In the event the PPP Loan, or any portion thereof, is forgiven, the amount forgiven is applied to outstanding principal. The terms of any forgiveness may also be subject to further regulations and guidelines that the SBA may adopt. The Company carefully monitored all qualifying expenses and other requirements necessary to attain loan forgiveness; however, no assurance is provided that the Company will obtain forgiveness of the PPP Loan in whole or in part. The Company has used all proceeds from the PPP Loan to retain employees, maintain payroll and make lease and utility payments.  During the three months ended June 30, 2020 the Company recorded $800,000 in other income for the PPP anticipated grant related to payroll utility and rent payment. During the three months ended September 30, 2020 the Company recorded $248,000 in other income for the PPP anticipated grant related to payroll utility and rent payment, which resulted in no deferred other income liability balance as of September 30, 2020.  

Note 5 - Stock-Based Compensation; Changes in Equity