Notes to Unaudited Condensed Consolidated Financial Statements
Note 1 - Basis of Presentation
The accompanying condensed (a) consolidated balance sheet as of June 30, 2021 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 six months ended June 30, 2021 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2021. 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, 2020.
Principles of consolidation and nature of operations:
Yunhong CTI Ltd, its Mexican subsidiary (Flexo Universal, S. de R.L. de C.V.), its German subsidiary (CTI Europe GmbH) and its subsidiary 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 the business formerly conducted by CTI Europe GmbH (“CTI Europe”). Accordingly, the operations of this entity are classified as discontinued operations in these financial statements. The entity has been fully disposed of in the second quarter of 2021.
The condensed consolidated financial statements include the accounts of Yunhong CTI Ltd., 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.
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.
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 and inventory valuation, and assumptions used as inputs in the Black-Scholes option-pricing model.
5
Earnings per share:
Basic income (loss) per share is computed by dividing net income (loss) attributable to Yunhong CTI Ltd shareholders by the weighted average number of shares of common stock outstanding during each period.
Diluted income (loss) per share is computed by dividing the net income (loss) attributable to Yunhong CTI Ltd shareholders by the weighted average number of shares of common stock and equivalents (stock options and warrants), unless anti-dilutive, during each period.
As of June 30, 2021 and 2020, shares to be issued upon the exercise of options and warrants aggregated nil and 792,660, respectively. As of June 30, 2021, shares to be issued upon the conversion of Series A, Series B, and Series C Preferred Stock was 5,000,000, 1,700,000, and 1,700,000, respectively. For the three months ended June 30, 2021, the dilutive effect of 8,400,000 shares was included in the determination of earnings on a diluted basis. For the six months ended June 30, 2021, no assumed conversions were included in the determination of earnings on a diluted basis, 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, 2020. There were no significant changes to these accounting policies during the three and six months ended June 30, 2021.
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.
6
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 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 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 and divested its CTI Europe subsidiary in the second quarter of 2021.
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 had a major effect on our operations and financial results. Therefore, this product line has been presented as discontinued operations.
CTI Europe recorded a gain from discontinued operations, net of taxes of $45,000 and $146,000 for the three and six month periods ended June 30, 2021, respectively. The net gains, net of taxes, were $92,000 and $241,000 for the three and six month periods ended June 30, 2020, respectively.
Our Ziploc product line recorded a loss from discontinued operations, net of taxes of nil for the three and six months ended June 30, 2021. The loss, net of taxes, was ($746,000) and ($1,550,000) for the three and six month periods ended June 30, 2020, 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 Unaudited Consolidated Statements of Comprehensive Income for the three months ended:
|
|
|
June 30, 2021
|
|
|
June 30, 2020
|
|
|
Income Statement
|
|
|
|
|
|
|
|
|
|
Net Sales
|
|
$
|
7
|
|
|
$
|
615,388
|
|
|
Cost of Sales
|
|
|
75,496
|
|
|
|
941,230
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Loss
|
|
|
(75,489
|
)
|
|
|
(325,842
|
)
|
|
|
|
|
|
|
|
|
|
|
|
SG&A
|
|
|
34,884
|
|
|
|
330,446
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Income
|
|
|
(110,373
|
)
|
|
|
(656,288
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Other Expense
|
|
|
(87,204
|
)
|
|
|
9,233
|
|
|
|
|
|
|
|
|
|
|
|
|
Pretax loss from discontinued operations
|
|
|
(23,169
|
)
|
|
|
(665,521
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Gain from classification to held for sale
|
|
|
68,059
|
|
|
|
65,565
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Income (loss) from discontinued operations
|
|
|
44,890
|
|
|
|
(599,956
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Non-controlling Interest share of profit/loss
|
|
|
21,547
|
|
|
|
70,576
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Loss
|
|
$
|
23,343
|
|
|
$
|
(670,532
|
)
|
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 Unaudited Consolidated Statements of Income for the six months ended:
|
|
|
June 30, 2021
|
|
|
June 30, 2020
|
|
|
Income Statement
|
|
|
|
|
|
|
|
|
|
Net Sales
|
|
$
|
79,840
|
|
|
$
|
1,672,445
|
|
|
Cost of Sales
|
|
|
202,402
|
|
|
|
2,115,275
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Loss
|
|
|
(122,562
|
)
|
|
|
(442,830
|
)
|
|
|
|
|
|
|
|
|
|
|
|
SG&A
|
|
|
127,150
|
|
|
|
854,995
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Income
|
|
|
(249,712
|
)
|
|
|
(1,297,825
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Other Expense (Income)
|
|
|
(77,242
|
)
|
|
|
22,453
|
|
|
|
|
|
|
|
|
|
|
|
|
Pretax loss from discontinued operations
|
|
|
(172,470
|
)
|
|
|
(1,320,278
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Gain from classification to held for sale
|
|
|
318,722
|
|
|
|
233,685
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (Loss) from discontinued operations
|
|
|
146,252
|
|
|
|
(1,086,593
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Non-controlling Interest share of profit/loss
|
|
|
70,201
|
|
|
|
222,670
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Income (Loss)
|
|
$
|
76,051
|
|
|
$
|
(1,309,263
|
)
|
8
Note 3 – Liquidity and Going Concern
The Company’s financial statements are prepared using accounting principles generally accepted in the United States (“U.S. GAAP”) applicable to a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. The Company has a cumulative net loss from inception to June 30, 2021 of over $13 million. The accompanying financial statements for the three and six months ended June 30, 2021 have been prepared assuming the Company will continue as a going concern. The Company’s cash resources from operations may be insufficient to meet its anticipated needs during the next twelve months. The Company will require additional financing to fund its future planned operations.
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 June 30, 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:
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●
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The maximum revolving advance amount is reduced from $18,000,000 to $9,000,000
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|
●
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The Termination date of the loan agreement is revised from December 14, 2022 to December 31, 2021
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|
●
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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 line of credit advance under the loan agreement (the Equity Investment)
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|
●
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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
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|
●
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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
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|
●
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The Forbearance Reserve (as defined in Amendment No. 5 to the Loan Agreement) shall be increased from $1,025,000 to $2,525,000
|
|
●
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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.
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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.
Note 4 - Debt
During December 2017, we terminated a prior credit arrangement and entered in new financing agreements (as amended to date, the “PNC Agreements”) with PNC Bank, National Association (“PNC”). The PNC Agreements, included a $6 million term loan and a $9 million revolving credit facility, with a termination date of December 2021.
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:
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●
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Negative Covenants: Negative covenants under which we are prohibited from, or restricted in our ability to:
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|
o
|
Pay dividends and make distributions;
|
|
|
o
|
Make certain investments;
|
|
|
o
|
Use assets as security in other transactions;
|
|
|
o
|
Enter into affiliate transactions;
|
|
|
o
|
Merge or consolidate; or
|
|
|
o
|
Transfer and sell assets.
|
|
|
●
|
Financial Covenants: Financial covenants we are required to meet including:
|
|
|
o
|
We are required to maintain a "Fixed Charge Coverage Ratio", which is defined as the ratio of (a) EBITDA for such fiscal period, minus Unfinanced Capital Expenditures made during such period, minus distributions (including tax distributions) and dividends made during such period, minus cash taxes paid during such period to (b) all Debt Payments made during such period. The highest values allowed for each quarterly calculation are as follow:
|
10
|
Fiscal Quarter Ratio
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2020
|
|
|
0.85
|
to
|
1.00
|
|
|
September 30, 2020
|
|
|
0.95
|
to
|
1.00
|
|
|
December 31, 2020
|
|
|
1.05
|
to
|
1.00
|
|
|
March 31, 2021
|
|
|
1.15
|
to
|
1.00
|
|
|
June 30, 2021 and thereafter
|
|
|
1.15
|
to
|
1.00
|
|
The PNC Agreements provides for interest at varying rates in excess of the prime rate, depending on the level of senior debt to EBITDA over time.
Failure to comply with these covenants has caused us to pay a higher rate of interest (increased by 4% pursuant to the PNC 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 January 1, 2019, the Company had a note payable to John H. Schwan, Director and former Chairman of the Board, for $1.6 million, including accrued interest. This loan accrues interest at 6%, is due on demand, and is subordinate to the PNC Agreements. During January 2019, Mr. Schwan converted $600,000 of the note into approximately 181,000 shares of our common stock at the then market rate of $3.32 per share. As a result of the conversion, the loan balance decreased to $997,019 and Company and Mr. Schwan agreed to increase the interest rate to 6%.
The loan and interest payable to Mr. Schwan amounted to $1,157,906 and $1,123,769 as of June 30, 2021 and December 31, 2020, respectively.
No payments were made to Mr. Schwan since 2019. Interest expense related to this loan amounted to $17,000 and $16,000 for the three months ended June 30, 2021 and 2020, respectively, and $34,000 and $32,000 for the six months ended June 30, 2021 and 2020, respectively.
During 2020, Flexo replaced a $260,000 line of credit with three lines of credit totaling $260,000. Flexo’s total debt instruments as of June 30, 2021 amounted to $2.3 million.
Note 5 - Shareholders' Equity
Series A Preferred Stock
On January 3, 2020, the Company entered into a stock purchase agreement (as amended on February 24, 2020 and April 13, 2020 (the “LF Purchase Agreement”)), pursuant to which the Company agreed to issue and sell, and LF International Pte. Ltd., a Singapore private limited company (“LF International”), which is controlled by Company director, President and Chief Executive Officer, Mr. Yubao Li, agreed to purchase, up to 500,000 shares of the Company’s newly created shares of Series A Preferred Stock (“Series A Preferred”), with each share of Series A Preferred initially convertible into ten shares of the Company’s common stock, at a purchase price of $10.00 per share, for aggregate gross proceeds of $5,000,000 (the “LF International Offering”). As permitted by the Purchase Agreement, the Company may, in its discretion issue up to an additional 200,000 shares of Series A Preferred for a purchase price of $10.00 per share (the “Additional Shares Offering,” and collectively with the LF International Offering, the “Offering”). Approximately $1 million of Series A Preferred has been sold as of June 30, 2021, including to an investor which converted an account receivable of $478,000 owed to the investor by the Company in exchange for 48,200 shares of Series A Preferred. The Company completed several closings with 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. LF International has the right to name three directors to serve on our Board. They are Mr. Yubao Li, our Chairman, Ms. Wan Zhang and Ms. Yaping Zhang.
The issuance of the Series A Preferred generated a beneficial conversion feature (BCF), which arises when a debt or equity security is issued with an embedded conversion option that is beneficial to the investor or in the money at inception because the conversion option has an effective strike price that is less than the market price of the underlying stock at the commitment date. The fair value of the common stock into which the Series A Preferred was convertible exceeded the allocated purchase price fair value of the Series A Preferred Stock at the closing dates by approximately $2.5 million as of the closing dates. We recognized this BCF by allocating the intrinsic value of the conversion option, to additional paid-in capital, resulting in a discount on the Series A Preferred. As the Series A Preferred is immediately convertible, the Company accreted the discount on the date of issuance. The accretion was recognized as dividend equivalents. Holders of the Series A Preferred will be entitled to receive quarterly dividends at the annual rate of 8% of the stated value ($10 per share). Such dividends may be paid in cash or in shares of common stock at the Company’s discretion. In the three months ending June 30, 2021 and 2020 the Company accrued $100,000 of these dividends. In the six months ending June 30, 2021 and 2020 the Company accrued $200,000 and $152,741, respectively, of these dividends.
Series B Preferred
In November 2020, we issued 170,000 shares of Series B Preferred for an aggregate purchase price of $1,500,000. The Series B Preferred have an initial stated value of $10.00 per share and liquidation preference over common stock. The Series B Preferred is convertible into shares of our common stock equal to the number of shares determined by dividing the sum of the stated value and any accrued and unpaid dividends by the conversion price of $1.00. The Series B Preferred accrues dividends at a rate of 8 percent per annum, payable at our election either in cash or shares of the Company’s common stock. Initially, the Series B Preferred, in whole or part, was redeemable at the option of the holder (but not mandatorily redeemable) at any time on or after November 30, 2021 for the stated value, plus any accrued and unpaid dividends and thus was classified as mezzanine equity and initially recognized at fair value of $1.5 million (the proceeds on the date of issuance). In March 2021, the terms of the Series B Preferred were modified to eliminate the ability of the holder to redeem the Series B Preferred. As the Series B Preferred is no longer redeemable, the Series B Preferred is not classified as mezzanine equity as of June 30, 2021. As a result, the carrying value as of June 30, 2021 amounted to $1,646,707 which consists of $1,500,000 original carrying value, $81,206 accrued dividends and $65,500 accretion ($46,932 which occurred in 2021).
Series C Preferred
In January 2021 we entered into an agreement with a related party, LF International Pte. Ltd. which is controlled by the Chairman of the Board of Directors Mr. Yubao Li, to purchase shares of Series C Preferred stock. We issued 170,000 shares of Series C Preferred for an aggregate purchase price of $1,500,000. The Series C Preferred have an initial stated value of $10.00 per share and liquidation preference over common stock. The Series C Preferred is convertible into shares of our common stock equal to the number of shares determined by dividing the sum of the stated value and any accrued and unpaid dividends by the conversion price of $1.00. The Series C Preferred accrues dividends at a rate of 8 percent per annum, payable at our election either in cash or shares of the Company’s common stock. The issuance of the Series C Preferred generated a beneficial conversion feature (BCF), which arises when a debt or equity security is issued with an embedded conversion option that is beneficial to the investor or in the money at inception because the conversion option has an effective strike price that is less than the market price of the underlying stock at the commitment date. The fair value of the common stock into which the Series C Preferred was convertible exceeded the allocated purchase price of the Series C Preferred at the closing dates by greater than the allocated purchase price. Therefore, the BCF was the purchase price of the Series C Preferred ($1.5 million) and was allocated to Additional Paid-in Capital, resulting in a discount on the Series C Preferred Stock. As the Series C Preferred Stock is immediately convertible, the Company accreted the discount on the date of issuance. The accretion to the carrying value of the Series C Preferred is treated as a deemed dividend, recorded as a charge to Additional Paid in Capital and deducted in computing earnings per share.
Advance from Investor
In June 2021, the Company received $1.5 million from an unrelated third party as an advance on a proposed sale of Series D Redeemable Convertible Preferred Stock. As of June 30,2021, the Company was in the process of negotiating and finalizing the terms of the arrangement. As the agreement was not finalized as of June 30, 2021, the $1.5 million advance is classified as Advance from Investor within liabilities on the accompanying balance sheet.
Warrants
In connection with the Series A Offering, in 2020 the Company issued 792,660 warrants to purchase 792,660 shares of the Company’s common stock for $1 per share. During 2020, 597,500 warrants were exercised in cash-less exchange for 391,308 shares of the Company’s common stock. In January and February 2021, the remaining 195,160 warrants were exercised in a cash-less exchange for 103,104 shares of the Company’s common stock.
The Company has applied the Black-Scholes model to value stock-based awards. That model incorporates various assumptions in the valuation of stock-based awards relating to the risk-free rate of interest to be applied, the estimated dividend yield and expected volatility of the Company’s Common Stock. The risk-free rate of interest is the U.S. Treasury yield curve for periods within the expected term of the option at the time of grant. The expected volatility is based on historical volatility of the Company’s Common Stock.
The valuation assumptions we have applied to determine the value of warrants granted in 2020 were as follows:
Historical stock price volatility: The Company used the weekly closing price to calculate historical annual volatility.
Risk-free interest rate: The Company bases the risk-free interest rate on the rate payable on US treasury securities with a similar maturity in effect at the time of the grant, which was a range from .42% - 1.65%.
Expected life: The expected life of the warrants represents the period of time warrants were expected to be outstanding. The Company used an expected life of 5 years.
Dividend yield: The estimate for dividend yield is 0%, as the Company did not issue dividends during 2020 or 2019 and does not expect to do so in the foreseeable future.
Estimated forfeitures: When estimating forfeitures, the Company considers historical terminations as well as anticipated retirements.
A summary of the Company’s stock warrant activity is as follows:
|
|
|
Shares under
Option
|
|
|
Weighted
Average
Exercise
Price
|
|
|
Balance at December 31, 2020
|
|
|
195,160
|
|
|
$
|
1.00
|
|
|
Granted
|
|
|
-
|
|
|
|
1.00
|
|
|
Cancelled/Expired
|
|
|
-
|
|
|
|
1.00
|
|
|
Exercised/Issued
|
|
|
(195,160
|
)
|
|
|
1.00
|
|
|
Outstanding at June 30, 2021
|
|
|
-
|
|
|
|
1.00
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at June 30, 2021
|
|
|
-
|
|
|
$
|
1.00
|
|
Note 6 - Legal Proceedings
The Company may be party to certain lawsuits or claims arising in the normal course of business. The ultimate outcome of these matters is unknown but, in the opinion of management, we do not believe any of these proceedings will have, individually or in the aggregate, a material adverse effect upon our financial condition, cash flows or future results of operation.
In July, 2017, God’s Little Gift, Inc. (dba) Helium and Balloons Across America and Gary Page (“Claimants”) filed an action against the Company based on disputed compensation amounts over several years. This action was resolved by mutual agreement between the parties during January 2019. Mr. Page received 20,000 shares of CTI common stock, $5,000 in cash, and a minimum payout in his monthly royalty calculation of $7,667 beginning March 1, 2019 and ending August 1, 2021. The balance remaining as of June 30, 2021 and December 31, 2020 amounted to $15,324 and $53,659, respectively.
FedEx Trade Networks Transport and Brokerage Inc. v. CTI Industries Corp., Case No. 20 L 46, was filed on January 27, 2020 in the Circuit Court of the 19th Judicial Circuit, Lake County, Illinois. The complaint for breach of contract sought $163,964.75 in damages, plus interest and court costs. On October 15, 2020, the case was dismissed with leave to reinstate pursuant to settlement. The settlement calls for the payment of $100,400.00 in monthly installments of $10,000 per month for a period of ten (10) months and with the last payment being in the amount of $10,400. The first payment came due and was made on October 30, 2020, and payments have been made monthly. The balance remaining as of June 30, 2021 and December 31, 2020 amounted to $10,400 and $70,400, respectively.
Airgas USA, LLC v. CTI Industries Corp., Case No. 01-20-0014-7852 was filed with the American Arbitration Association on or about September 8, 2020. The claim seeks $212,000, plus interest, attorneys’ fees and costs for breach of contract. Claimant agreed to give CTI an extension to respond to the claim so the parties could attempt to resolve. On February 10, 2021, Airgas accepted CTI’s offer to pay $125,000 over 10 months. Airgas agreed to the settlement in March of 2021. The balance as of June 30, 2021 and December 31, 2020 amounted to $100,000 and 125,000, respectively.
On October 19, 2020, Jules and Associates, Inc. sent CTI a demand letter related to the lease of certain equipment. The letter demanded $65,847 for alleged past due amounts under the lease as well as a return of the equipment. Discussions regarding the return of the equipment are ongoing and no lawsuit has been filed. On April 5, 2020, Jules and Associates, Inc. filed and served on CTI a demand for arbitration with JAMS related to the lease of certain equipment. The demand requests $98,245 for alleged past due amounts, plus amounts that Jules alleges continue to accrue under the lease, attorneys’ fees and costs, as well as a return of the equipment or its fair market value. CTI has settled this matter with Jules for $90,000 to be paid in installments as follows: $15,000 upon execution of a settlement agreement, $25,000 on October 15, 2021; $25,000 on November 15, 2021; and $25,000 on December 15, 2021. Additionally, as part of the settlement, CTI is entitled to keep the equipment and Jules will execute a bill of sale to CTI for the equipment upon receipt of the settlement amount. CTI is waiting for Jules to send a draft settlement agreement on those terms.
Benchmark Investments, Inc. v. Yunhong CTI Ltd filed a case in the United States District Court for the Southern District of New York on March 16, 2021 and served on CTI on March 31, 2021. The complaint seeks damages in excess of $500,000. CTI has filed our Answer and Counterclaim to the complaint.
On July 16, 2021, Transportation Solutions Group LLC d/b/a Redwood Multimodal filed a Complaint against CTI for breach of contract or in the alternative quantum alleging damages for unpaid invoices in the amount of $98,661, plus attorneys’ fees and costs. The case is pending in the Circuit Court of Cook County, Illinois, Law Division under Case Number 2021 L 7225. CTI was served on July 30 and its deadline to appear and answer or otherwise plead is August 30, 2021. The Company has reached out to Plaintiff to attempt to resolve this matter.
Note 7 - Other Comprehensive Income
In the three months ended June 30, 2021 and 2020, the Company incurred other comprehensive income of approximately $48,073 and $66,327, respectively, from foreign currency translation adjustments. In the six months ended June 30, 2021 and 2020, the Company incurred other comprehensive income (loss) of approximately $31,806 and $(1,297,176), respectively, from foreign currency translation adjustments. The main contributing factor for the large other comprehensive loss in the six months ended June 30, 2020 was the sudden 25% decline in the valuation of the Mexican peso related to the COVID-19 pandemic and the resulting large-scale, rapid impacts to the world economy.
Note 8 - Geographic Segment Data
The Company has determined that it operates primarily in one business segment that designs, manufactures, and distributes film and film related products for use in packaging, storage, and novelty balloon products. The Company operates in foreign and domestic regions. Information about the Company's continuing operations by geographic area is as follows:
|
|
|
Net Sales to Outside Customers
|
|
|
|
|
For the Three Months Ended
|
|
|
|
|
June 30,
|
|
|
|
|
2021
|
|
|
2020
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
5,711,952
|
|
|
$
|
4,542,484
|
|
|
Mexico
|
|
|
613,289
|
|
|
|
1,202,869
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
6,325,241
|
|
|
$
|
5,745,353
|
|
|
|
|
Net Sales to Outside Customers
|
|
|
|
|
For the Six Months Ended
|
|
|
|
|
June 30,
|
|
|
|
|
2021
|
|
|
2020
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
12,310,942
|
|
|
$
|
9,968,423
|
|
|
Mexico
|
|
|
1,430,467
|
|
|
|
2,844,431
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
13,741,409
|
|
|
$
|
12,812,854
|
|
|
|
|
Total Assets at
|
|
|
|
|
June 30,
|
|
|
December 31,
|
|
|
|
|
2021
|
|
|
2020
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
15,801,575
|
|
|
$
|
12,458,706
|
|
|
Mexico
|
|
|
8,681,668
|
|
|
|
8,798,046
|
|
|
Assets Held for Sale International Subsidiaries
|
|
|
-
|
|
|
|
294,219
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
24,483,243
|
|
|
$
|
21,550,971
|
|
Note 9 - Inventories, Net of Continuing Operations
|
|
|
June 30,
2021
|
|
|
December 31,
2020
|
|
|
Raw materials
|
|
$
|
1,368,781
|
|
|
$
|
1,175,763
|
|
|
Work in process
|
|
|
2,818,869
|
|
|
|
2,799,253
|
|
|
Finished goods
|
|
|
7,418,578
|
|
|
|
7,223,902
|
|
|
In Transit
|
|
|
127,740
|
|
|
|
88,315
|
|
|
Allowance for excess quantities
|
|
|
(228,720
|
)
|
|
|
(317,522
|
)
|
|
Total inventories
|
|
$
|
11,505,248
|
|
|
$
|
10,969,711
|
|
Note 10 - Concentration of Credit Risk
Concentration of credit risk with respect to trade accounts receivable is generally limited due to the large number of entities comprising the Company's customer base. The Company performs ongoing credit evaluations and provides an allowance for potential credit losses against the portion of accounts receivable which is estimated to be uncollectible. Such losses have historically been within management's expectations. During the three and six months ended June 30, 2021 and 2020, there were two customers 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.
Note 11 - Related Party Transactions
John H. Schwan, who resigned as Chairman of the Board on June 1, 2020, is the brother of Gary Schwan, one of the owners of Schwan Incorporated, which provides building maintenance services to the Company. The Company made payments to Schwan Incorporated of approximately $31,000 and $2,700 during the six months ended June 30, 2021 and 2020, respectively. As of June 30, 2021 the payable balance amounted to nil. Jana M. Schwan, Chief Operating Officer of the Company, is the daughter of John H. Schwan.
During the period from January 2003 to the present, John H. Schwan has made loans to the Company which had outstanding balances of $1,157,908 and $1,123,769 as of June 30, 2021 and December 31, 2020, respectively. No payments were made to Mr. Schwan since 2019. Interest expense related to this loan amounted to $17,000 and $16,000 for the three months ended June 30, 2021 and 2020, respectively and $34,000 and $32,000 for the six months ended June 30, 2021 and 2020, respectively.
Items identified as Notes Payable Affiliates in the Company's Consolidated Balance Sheet as of June 30, 2021 and December 31, 2020 include loans by shareholders to Flexo Universal totaling nil and $9,000, respectively.
On July 1, 2019, the Company deconsolidated Clever, and as result the Company recorded a note receivable of $1.3 million. One of owners of Clever is John Schwan from above. In 2020, the Company had reserved $1,277,000 of this receivable. In the three months ended June 30, 2021, the Company has fully reserved this receivable completely. The balance as of December 31, 2020 and June 30, 2021 amounted to $100,000 and nil respectively.
In January 2021 we entered into an agreement with a related party, LF International Pte. Ltd. which is controlled by the Chairman of the Board of Directors Mr. Yubao Li, to purchase shares of Series C Preferred stock. We issued 170,000 shares of Series C Preferred for an aggregate purchase price of $1,500,000. Additional details regarding the transaction are discussed in Note 5.
Note 12 - Derivative Instruments; Fair Value
The Company accounts for derivative instruments in accordance with U.S. GAAP, which requires that all derivative instruments be recognized on the balance sheet at fair value. We may enter into interest rate swaps to fix the interest rate on a portion of our variable interest rate debt to reduce the potential volatility in our interest expense that would otherwise result from changes in market interest rates. Our derivative instruments are recorded at fair value and are included in accrued liabilities of our consolidated balance sheet. Our accounting policies for these instruments are based on whether they meet our criteria for designation as hedging transactions, which include the instrument’s effectiveness, risk reduction and, in most cases, a one-to-one matching of the derivative instrument to our underlying transaction. As of June 30, 2021, we had no such instrument.
Note 13 - Leases
We adopted ASC Topic 842 (Leases) on January 1, 2019. In July 2020, the Company entered into a lease agreement for a building through June 2021 (with no extension options). The monthly lease payments are $38,000. The Company made a policy election to not recognize right of use assets and lease liabilities that arise from leases with an initial term of twelve months or less on the Consolidated Balance Sheets. However, the Company recognized these lease payments in the Consolidated Statement of Operations on a straight-line basis over the lease term and variable lease payments in the period in which the expense was incurred. This lease terminated during 2021 and was replaced with a new lease. In March 2021, the Company entered into a lease agreement for a building through September 2022. The monthly lease payments are $34,000. As a result of this new lease, in March 2021, the Company recorded a right of use asset of $567,950 and a related operating lease liability and used the incremental borrowing rate of 11%. As discussed in Note 3, in April 2021, the Company sold its Lake Barrington Facility for $3.5 million and 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. As the fair value for this property was $3.81 million, the Company recognized a gain of $3,356,794 on the sale and established a prepaid rent of $310,000 for the difference between fair value and transaction price. As a result of this transaction, in April 2021, the Company recorded an operating lease liability of $3,037,914 and a corresponding right of use asset and used the incremental borrowing rate of 13.25%.
Note 14 - 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.
16