Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Forward Looking S
tatements
This quarterly report 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 to conform such statements to actual results or to changes in our opinions or expectations.
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, Latin America, and Europe. We also market and sell vacuum sealing machines, home organizing and container products, Candy Blossoms and party goods.
As of January 1, 2018, we adopted Accounting Standards Codification (ASC) Topic 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 we expect 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. We recognize 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.
We provide 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.
As of January 1, 2019, we adopted ASC Topic 842, Leases (“ASC Topic 842”). Refer to Note 12 for additional information. Our primary leases relate to the facilities we use in Lake Zurich, IL (USA), Mexico, Germany and the UK. We also have ancillary leases for items ranging from forklifts to printers. The majority of our leases are classified as operating lease right-of-use (“ROU”) assets and related operating lease liabilities. Finance leases are included in property and equipment and related liabilities. ROU assets and lease liabilities are recognized based on the present value of future minimum lease payments over the expected lease term at the commencement date for leases that exceed 12 months. The expected lease term includes options to renew when it is reasonably certain that we will exercise such option.
Operating lease expense is recognized on a straight-line basis over the lease term and is included in the cost of sales or sales, general and administrative expense areas. Finance leases are amortized on a straight-line basis and included in similar areas of expense classification. Variable lease payments, non-lease component payments, and short-term rentals (leases less than 12 months in duration) are expensed as incurred.
Summary of Current Developments and Status
For the quarter ended June 30, 2019, we have reported a loss of $3.1 million and, for the six- month period ended that date, a loss of $4.0 million. The loss of those periods includes a non-cash charge of $3.0 million which we have recognized in the second quarter of 2019, in anticipation of the divestiture or liquidation of our European sales entities and Clever Container. Our management and Board have engaged in a review of these subsidiaries and determined that they are not sufficiently productive to our Company overall, add complexity to our structure and utilize resources. This action is being taken to focus our resources and efforts on our core business activities, particularly in the United States. This charge is a reserve in connection with the divestiture or liquidation and resulting deconsolidation of those entities.
We have operated throughout 2019 out of compliance with the terms of our credit facility. In March 2019, we entered into a forbearance agreement with our bank (the “Bank”) in which we acknowledged continuing violations on our part with respect to loan covenants and the Bank agreed to continue to provide funding to us and to forbear from action on the covenant violations until July 31, 2019 when our compliance with covenants as of June 30, 2019 would be determined. As of that date, we determined that we did not comply with our bank covenants as of June 30, 2019 and, on August 1, 2019, the bank issued a Notice of Default and Reservation of Rights letter to us, under which the Bank communicated that it may, at its sole discretion, continue to provide advances to us under certain conditions. We have no assurance of continued funding from the Bank and the costs and risks of continued financing with the Bank remain very high.
During 2019, we have attempted to complete a major capital event in which a new partner would infuse capital or otherwise provide financing to us. To date, we have not received a commitment for any capital or other funding, in part related to concerns expressed regarding complexity. We continue to seek additional funding in various forms, including debt financing, but there can be no assurance that such efforts will be successful. We are considering potential changes to our corporate structure, including but not limited to, whether to remain a publicly traded company. No conclusions have yet been reached.
During much of 2019 and currently, we have experienced difficulties in maintaining adequate working capital which has been exacerbated by reduced sales due to the helium shortage and excess labor costs.
In these circumstances, we believe that substantial doubt exists concerning our ability to continue as a going concern as of June 30, 2019 and on an ongoing basis, which may be mitigated by obtaining a additional financing and/or executing some form of transaction.
Results of Operations
Net Sales
. For the three and six month periods ended June 30, 2019, net sales were $12,407,000 and $24,943,000, compared to net sales of $15,985,000 and $29,964,000 for the same periods of 2018. For the three month period ended June 30, 2019 and 2018, net sales by product category were as follows:
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Three Months Ended
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June 30, 2019
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June 30, 2018
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$
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% of
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$
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% of
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Product Category
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(000) Omitted
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Net Sales
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(000) Omitted
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Net Sales
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Foil Balloons
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4,927
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41
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%
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6,508
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41
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%
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Latex Balloons
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1,983
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14
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%
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2,333
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14
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%
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Vacuum Sealing Products
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1,912
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12
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%
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1,865
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12
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%
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Film Products
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478
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4
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%
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609
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4
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%
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Other Sales
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3,107
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29
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%
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4,670
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29
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%
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Total
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12,407
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100
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%
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15,985
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100
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%
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For the six month period ended June 30, 2019 and 2018, net sales by product category were as follows:
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Six Months Ended
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June 30, 2019
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June 30, 2018
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$
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% of
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$
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% of
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Product Category
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(000) Omitted
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Net Sales
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(000) Omitted
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Net Sales
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Metalized Balloons
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11,408
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45
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%
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14,274
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48
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%
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Latex Balloons
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3,970
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16
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%
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4,482
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15
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%
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Vacuum Sealing Products
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4,064
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16
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%
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3,453
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11
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%
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Film Products
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1,239
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5
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%
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1,047
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3
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%
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Other
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4,262
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18
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%
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6,708
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23
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%
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Total
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24,943
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100
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%
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29,964
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100
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%
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Foil
Balloons
. During the three and six months ended June 30, 2019, revenues from the sale of foil balloons decreased by 24% and 20%, respectively compared to the prior year period, from $6,508,000 and $14,274,000 during 2018, respectively, to $4,927,000 and $11,408,000 during 2019. Sales to our largest balloon customer decreased from $8,110,000 during the first six months of 2018 to $6,630,000 during the first six months of 2019. As we and others in the industry have reported, the commercial supply of helium has been limited and pricing has increased, while availability has been reduced. We expect the helium market to improve during the next few months, but it remains a negative factor in the sale of helium-based products such as many foil balloons.
Latex Balloons.
During the three and six months ended June 30, 2019, revenues from the sale of latex balloons decreased by 15% and 11%, respectively compared to the prior year period, from $2,333,000 and $4,482,000 during 2018, respectively, to $1.983,000 and $3,970,000 during 2019.
Vacuum Sealing
Products
. During the three and six months ended June 30, 2019, revenues from the sale of vacuum sealing products increased by 2% and 18%, respectively compared to the prior year period, from $1,865,000 and $3,453,000 during 2018, respectively, to $1,912,000 and $4,064,000 during 2019. The new, smaller format machine introduced late during 2018 has sold well, and customers have largely accepted the cost pass-throughs related to tariffs.
Films
. During the three and six months ended June 30, 2019, revenues from the sale of commercial films decreased by 22% and increased 18%, respectively, compared to the prior year period, from $609,000 and $1,047,000 during 2018, respectively, to $478,000 and $1,239,000 during 2019.
Other Revenues
. During the three and six months ended June 30, 2019, revenues from the sale of other products decreased by 33% and 36%, respectively compared to the prior year period, from $4,670,000 and $6,708,000 during 2018, respectively, to $3,107,000 and $4,262,000 during 2019. The revenues from the sale of other products during the first six months of 2019 include (i) sales of a line of “Candy Blossoms” and similar products consisting of candy and small inflated balloons sold in small containers in the amount of $2,217,000, (ii) the sale of accessories and supply items related to balloon products, (iii) sales by Clever Container Company, L.L.C. which engages in the direct sale of container and organizing products through a network of independent distributors in the amount of $263,000 and (iv) sales of party goods in Mexico by Flexo Universal in the amount of $718,000. Clever Container changed its business model to one of both lower costs and revenues compared to its prior business model, reducing the revenues shown in Other Revenues. This business is expected to be divested during 2019.
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 and six months ended June 30, 2019 and 2018.
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Three Months Ended June 30,
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Six Months Ended June 30,
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% of Sales
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% of Sales
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201
9
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2018
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201
9
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2018
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Top 3 Customers
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61.3
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%
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57.5
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%
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57.3
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%
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55.1
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%
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Top 10 Customers
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76.9
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%
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72.5
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%
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75.0
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%
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69.1
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%
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During the three and six months ended June 30, 2019, there were two customers whose purchases represented more than 10% of the Company’s consolidated net sales. Sales to these customers for the three months ended June 30, 2019 were $4,179,000 or 34%, and $2,769,000 or 22%, of consolidated net sales, respectively. Sales to these customers for the three months ended June 30, 2018 were $4,871,000 or 30%, and $3,660,000 or 23%, of consolidated net sales, respectively. The amounts owed at June 30, 2019 by these customers were $2,488,000 or 28%, and $1,044,000 or 12%, of the Company’s consolidated net accounts receivable, respectively. As of June 30, 2018, the total amounts owed to the Company by these customers were $4.808,000 or 54%, and $1,524,000 or 17% of the Company’s consolidated net accounts receivable, respectively.
Cost of Sales
. During the three and six month periods ended June 30, 2019, the cost of sales was $9,869,000 and $20,409,000, respectively, compared to $12,189,000 and $23,300,000 for the same periods ended June 30, 2018. The reduction in cost of sales was largely due to lower sales volume, net of related inefficiencies.
General and Administrative
. During the three and six months ended June 30, 2019, general and administrative expenses were $1,531,000 and $3,587,000, respectively, as compared to $1,680,000 and $3,565,000 for the same periods in 2018. A one-time fee associated with the forbearance agreement in the amount of $250,000 was included in the first three months of 2019 general and administrative expenses.
Selling
, Advertising and Marketing
. During the three and six months ended June 30, 2019, selling, advertising and marketing expenses were $685,000 and $1,397,000, respectively, as compared to $1,290,000 and $2,446,000, respectively for the same periods in 2018. This reduction was primarily due to the full year benefit of cost reduction programs implemented during 2018.
Other Income (Expense)
. During the three and six months ended June 30, 2019, the Company incurred interest expense of $516,000 and $1,063,000, respectively, as compared to interest expense during the same periods of 2018 of $551,000 and $1,115,000. We recognized a $3 million charge during June 2019 in anticipation of deconsolidating Clever Container and our two European sales companies during 2019.
For the three and six months ended June 30, 2019, the Company had a foreign currency transaction gains of $61,000 and $297,000, respectively, as compared to foreign currency transaction losses of $775,000 and $342,000 during the same periods of 2018.
Financial Condition, Liquidity and Capital Resources
Cash Flow Items.
Operating Activities
. During the six months ended June 30, 2019, net cash provided by operations was $2,582,000, compared to net cash used by operations during the six months ended June 30, 2018 of $273,000.
Significant changes in working capital items during the six months ended June 30, 2019 included:
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A decrease in accounts receivable of $2,001,000 compared to an increase in accounts receivable of $671,000 in the same period of 2018.
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●
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An increase in inventory of $475,000 compared to an increase in inventory of $484,000 in 2018.
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●
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An increase in trade payables of $1,921,000 compared to an increase in trade payables of $801,000 in 2018.
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●
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A decrease in accrued liabilities of $477,000 compared to a decrease in accrued liabilities of $286,000 in 2018.
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Investing Activity.
During the six months ended June 30, 2019, cash used in investing activity was $73,000, compared to cash used in investing activity for the same period of 2018 in the amount of $18,000.
Financing Activities
. During the six months ended June 30, 2019, cash used in financing activities was $2,684,000 compared to cash provided by financing activities for the same period of 2018 in the amount of $532,000. Financing activity consisted principally of changes in the balances of revolving and long-term debt.
Liquidity
and
Capital Resources
.
At June 30, 2019, the Company had cash balances of $178,000 compared to cash balances of $453,000 for the same period of 2018.
Also, at June 30, 2019, the Company had a working capital balance of $1,936,000 compared to a working capital balance of $2,802,000 on December 31, 2018.
As of June 30, 2019, the Company was not in compliance with its credit facility, operating under a forbearance agreement. For this reason, $2.9 million of long-term debt was reclassified as current debt as of June 30, 2019. Failure to ultimately regain compliance with the terms of our credit agreement, or enter into a suitable replacement financing vehicle, could negatively impact our ability to carry on our business up to and including our ability to continue as a going concern. Additionally, we have encountered difficulties with seasonal cash flow needs, including increased costs associated with recruiting and retaining workers in the Chicago area. The failure to either regain compliance with the terms of our credit facility or properly manage seasonal cash needs could put a strain on the Company, up to and including our ability to continue as a going concern. See Note 2 for additional discussion.
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. Vacuum sealing product sales are also seasonal; approximately 60% of sales in this product line occur in the period from July through December.
Critical Accounting Policies
Please see pages 24-27 of our Annual Report on Form 10-K for the year ended December 31, 2018 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. Except for the adoption of ASC Topic 842 (Leases) as described herein, no material changes to such information have occurred during the three months ended June 30, 2019.