Yunhong Green CTI(YHGJ) - 2018 Q4 - Annual Report

Part I Item 1. Description of Business CTI Industries Corporation develops, produces, and distributes consumer products, primarily flexible film-based items like novelty balloons and vacuum sealing containers, across the U.S. and over 30 other countries Business Overview and Product Lines The company's business is centered on developing and manufacturing consumer products using flexible films, with Novelty Products constituting the majority of 2018 revenue - The company's main product lines include novelty balloons, vacuum sealing containers, and flexible films for commercial use[13][14] 2018 Revenue Breakdown by Product Line | Product Line | Percentage of 2018 Revenues | | :--- | :--- | | Novelty Products | 61% | | Vacuum Sealing Containers and Devices | 16% | | Flexible Film Products | 4% | | Other Products | 19% | Business Strategies and Developments CTI is implementing significant strategic changes in response to financial pressures, focusing on core profitability, cost reduction, and divestment of non-strategic interests - In November 2018, Jeffrey Hyland became CEO and President, succeeding Stephen Merrick who retired as CEO[26] - The company failed to comply with financing requirements twice in 2018 and entered into a short-term Forbearance Agreement with its bank in March 2019, classifying all related debt as current[29] - Management is focusing on core product lines and has eliminated approximately $3 million in annualized operating costs during 2018, with more cuts planned for 2019-2020[29] - The company announced its intention to divest its interest in Clever Container in November 2018 to focus on core assets[29] Products and Markets The company is a major manufacturer of foil and latex balloons, sold globally, and also produces vacuum sealing systems under the Ziploc® brand, facing highly competitive markets - CTI believes it is the second largest manufacturer of foil balloons in the United States[32] - The company manufactures and sells vacuum sealing bags and machines under the Ziploc® Brand Vacuum Sealer System through a license agreement with SC Johnson, which was extended to December 31, 2019[54] - The company announced its intention to divest its interest in Clever Container, a direct-sales home organization company, in November 2018, reaching an agreement in February 2019 to exchange its equity for a larger stake in its German subsidiary, CTI Europe GmbH[36] Production, Operations, and Raw Materials CTI operates from facilities in Illinois, Mexico, England, and Germany, with profitability sensitive to fluctuations in raw material costs and helium availability - The company's principal raw materials are petroleum/natural gas-based films and resin, latex, and printing inks, with fluctuations in these costs materially affecting profitability[64] - During 2018, the availability of helium declined and its cost increased, which could adversely affect future sales of foil balloons[65] Competition and Intellectual Property The company operates in highly competitive markets for all its product lines, relying on its intellectual property, including 8 U.S. and 3 foreign patents expiring in the 2020s - The balloon and novelty industry is highly competitive, with key foil balloon competitors including Anagram International, Inc., Pioneer Balloon Company, Convertidora International S.A. de C.V., and Betallic, LLC[66] - As of December 31, 2018, the company held 8 issued patents in the United States and 3 in foreign countries, scheduled to expire at various times during the 2020s[72] Employees and International Operations As of December 31, 2018, CTI had 457 full-time employees globally, with significant international operations and reliance on its Mexico plant for latex balloon production - As of December 31, 2018, the company had 99 full-time employees in the U.S., 16 in England, 336 in Mexico, and 6 in Germany[77] - The company experienced severe difficulty and higher costs in securing adequate seasonal workers in its US operations starting in November 2018[78] Sales and Assets by Geographic Area (2017-2018) | Geographic Area | 2018 Sales | 2017 Sales | 2018 Total Assets | 2017 Total Assets | | :--- | :--- | :--- | :--- | :--- | | United States | $40,554,000 | $41,165,000 | $25,355,000 | $27,784,000 | | United Kingdom (UK) | $1,438,000 | $1,908,000 | $879,000 | $923,000 | | Europe (Excluding UK) | $4,731,000 | $4,142,000 | $3,052,000 | $2,989,000 | | Mexico | $8,868,000 | $9,022,000 | $9,476,000 | $8,288,000 | | Consolidated | $55,591,000 | $56,237,000 | $38,761,000 | $39,984,000 | Item 1B. Unresolved Staff Comments The company reported no unresolved comments from the staff of the Securities and Exchange Commission as of the filing date of this Form 10-K - The company had no unresolved comments from the SEC staff[87] Item 2. Properties CTI owns its 68,000 sq. ft. principal plant and offices in Lake Barrington, Illinois, and leases several other facilities globally, which management deems adequate for current needs - The company owns its main 68,000 sq. ft. facility in Lake Barrington, Illinois[88] - The company leases significant properties in Lake Zurich, IL (118,000 sq. ft.), Guadalajara, Mexico (73,000 sq. ft.), Rugby, England (9,000 sq. ft.), and Heusenstamm, Germany (13,000 sq. ft.)[90][91][92] Item 3. Legal Proceedings A specific legal action filed in July 2017 by God's Little Gift, Inc. over disputed compensation was resolved by mutual agreement in January 2019 - A legal action with God's Little Gift, Inc. was settled in January 2019, including issuing 20,000 shares of CTI stock, $5,000 cash, and a minimum monthly royalty of $7,667 from March 2019 to August 2021[95] Part II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The company's common stock trades on the NASDAQ Capital Market under the symbol CTIB, with no cash dividends paid in 2017 or 2018 due to loan agreement restrictions - The company's common stock trades on the NASDAQ Capital Market under the symbol CTIB[97] Quarterly Stock Price Range (2018) | Quarter | High ($) | Low ($) | | :--- | :--- | :--- | | Q1 2018 | 5.09 | 3.95 | | Q2 2018 | 4.95 | 3.56 | | Q3 2018 | 4.42 | 2.93 | | Q4 2018 | 4.31 | 2.75 | - No cash dividends were paid in 2018 or 2017, and dividend payments are limited by the terms of current loan agreements[99] Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations In 2018, CTI's consolidated net sales decreased by 1% to $55.6 million, resulting in a net loss of $3.7 million, driven by higher costs and interest expenses, raising substantial doubt about the company's going concern ability Overview and Results of Operations Consolidated net sales for 2018 were $55.6 million, a 1% decrease from 2017, with a significant 14% drop in foil balloon sales and a net loss of $3.7 million Net Sales by Product Category (2017-2018) | Product Category | 2018 Sales (in thousands) | 2017 Sales (in thousands) | % Change | | :--- | :--- | :--- | :--- | | Foil Balloons | $24,962 | $29,103 | -14.2% | | Latex Balloons | $8,793 | $9,400 | -6.5% | | Vacuum Sealing Products | $8,820 | $7,866 | +12.1% | | Film Products | $2,006 | $2,602 | -22.9% | | Other Products | $11,010 | $7,266 | +51.5% | | Total | $55,591 | $56,237 | -1.1% | Principal Customer Sales (2017-2018) | Customer | 2018 Sales | % of 2018 Revenues | 2017 Sales | % of 2017 Revenues | | :--- | :--- | :--- | :--- | :--- | | Wal-Mart | $13,610,000 | 24.5% | $9,524,000 | 16.9% | | Dollar Tree Stores | $13,772,000 | 24.8% | $15,481,000 | 27.5% | - Cost of sales increased from $42.5 million in 2017 to $44.2 million in 2018, driven by higher labor costs in late 2018, negative impact from lower sales volume on fixed cost absorption, and a product quality initiative[114] - Net interest expense increased to $2.1 million in 2018 from $1.6 million in 2017, due to higher total borrowings, rising interest rates, and a 2% penalty interest rate from a financial covenant violation[117] Financial Condition, Liquidity, and Capital Resources The company's liquidity is severely constrained due to covenant breaches on its PNC credit facility, leading to a forbearance agreement and reclassification of long-term debt to current liabilities, raising going concern doubts - Cash used by operating activities was $1.2 million in 2018, a significant reversal from $1.3 million cash provided by operating activities in 2017[121] - The company violated financial covenants on its PNC credit facility as of March 31, 2018, and again failed to meet an amended covenant to raise $7.5 million in equity by November 15, 2018[125] - In March 2019, the company entered into a Forbearance Agreement with PNC, and due to remaining out of compliance, long-term bank debt was reclassified to current liabilities, posing a risk to the company's ability to continue as a going concern[126][136] - Working capital decreased significantly to $2.8 million at year-end 2018 from $9.6 million at year-end 2017, largely due to the reclassification of $3.5 million of debt to current liabilities[136][135] Critical Accounting Policies The company's critical accounting policies involve significant management estimates, particularly concerning revenue recognition, inventory valuation, and a substantial valuation allowance for deferred tax assets due to going concern issues - The company adopted ASC 606 for revenue recognition on January 1, 2018, using the modified retrospective method, which did not have a material impact[141] - The inventory reserve for obsolescence, marketability, or excess quantities was $450,000 as of December 31, 2018, down from $500,000 in 2017[145] - Due to non-compliance with its credit facility and related going concern disclosure, the company established a valuation allowance reserve for substantially all of its deferred tax assets, reducing the net deferred tax asset to $135,000 at the end of 2018 from $1,102,000 at the end of 2017[154] Item 9A. Controls and Procedures Management concluded that the company's disclosure controls and procedures were not effective as of December 31, 2018, due to a material weakness in internal control over financial reporting related to financial statement estimates - The Principal Executive Officer and Principal Financial Officer concluded that disclosure controls and procedures were not effective as of December 31, 2018[160] - Management identified a material weakness in internal control over financial reporting because the company's processes for developing financial estimates (e.g., deferred tax assets) were not sufficient to prevent material misstatements[162] - The material weakness resulted in audit adjustments related to investment impairment, inventory reserves, and deferred tax asset valuation allowances for the year ended December 31, 2018[162] - A remediation plan has been put in place, establishing additional closing procedures to more effectively capture the impact of subsequent and other events on financial analyses[163] Part III Item 10. Directors, Executive Officers and Corporate Governance The company's leadership includes John H. Schwan as Chairman and Jeffrey S. Hyland as President and CEO, with a seven-member Board, four of whom are independent, overseeing risk through standing committees - Key executive officers include John H. Schwan (Chairman), Jeffrey S. Hyland (President & CEO), and Stephen M. Merrick (General Counsel)[167] - The Board of Directors has seven members, with four determined to be independent: Stanley M. Brown, Bret Tayne, John I. Collins, and John M. Klimek[182] - The Board has three standing committees: Audit, Compensation, and Nominating and Governance, with all committee members being independent[186][188] Item 11. Executive Compensation Executive compensation for Named Executive Officers, including CEO Jeffrey S. Hyland, is detailed, with Mr. Hyland's 2017 employment agreement including a base salary of $243,000 and significant equity awards, while 401(k) matching contributions were suspended in 2017 2018 Summary Compensation | Name/Title | Salary | Option Awards | Total Compensation | | :--- | :--- | :--- | :--- | | Jeffrey S. Hyland (CEO, President) | $238,578 | $164,806 | $416,771 | | Stephen M. Merrick (General Counsel) | $177,577 | $2,090 | $179,667 | | Frank J. Cesario (CFO) | $147,000 | $ - | $147,000 | | Samuel Komar (VP Sales & Marketing) | $152,000 | $503 | $152,503 | - CEO Jeffrey Hyland's employment agreement includes a base salary of $243,000, a $75,000 signing bonus, and substantial stock and option grants, including 25,000 restricted shares and options for 325,000 shares[203][204] - The company suspended matching contributions to its 401(k) plan during 2017[213] Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters As of April 1, 2019, the company's directors and executive officers as a group beneficially owned 53.8% of the outstanding common stock, indicating significant insider control Beneficial Ownership by Management (as of April 1, 2019) | Name | Beneficial Ownership | Percent of Common Stock | | :--- | :--- | :--- | | John H. Schwan | 1,009,439 | 27.0% | | Stephen M. Merrick | 832,800 | 22.3% | | All Current Directors and Executive Officers as a group (10 persons) | 2,010,681 | 53.8% | Item 13. Certain Relationships and Related Transactions The company engaged in several related party transactions, primarily with entities controlled by Chairman John H. Schwan and General Counsel Stephen M. Merrick, including significant loans and legal fees, all reviewed by the Audit Committee - Chairman John H. Schwan has made loans to the company, with an outstanding balance of $1,597,000 as of December 31, 2018, and interest expense on these loans was $93,000 in 2018[235] - The company paid $88,000 in legal fees in 2018 to a law firm where director and officer Stephen M. Merrick is of counsel[234] - John H. Schwan and Stephen M. Merrick own a 50% aggregate interest in Clever Container Company, a consolidated VIE, which purchased $858,000 in products from CTI in 2018[237] Item 14. Principal Accountant Fees and Services The company's independent registered public accounting firm, Plante & Moran PLLC, billed a total of $269,893 for services in 2018, primarily for audit services, all pre-approved by the Audit Committee Accountant Fees (2017-2018) | Fee Category | 2018 | 2017 | | :--- | :--- | :--- | | Audit Fees | $242,618 | $280,327 | | Other Audit Related Fees | $3,525 | $9,989 | | All Other Fees | $23,750 | $51,581 | | Total Fees | $269,893 | $341,897 | Part IV Item 15. Exhibits and Financial Statement Schedules This section lists the consolidated financial statements, financial statement schedules, and all exhibits filed with the Form 10-K, including key credit and employment agreements - Key exhibits filed include the Revolving Credit, Term Loan, and Security Agreement with PNC Bank and its subsequent amendments, including the Forbearance Agreement dated March 4, 2019[247][248] Consolidated Financial Statements The consolidated financial statements for 2018 and 2017 are presented, with the auditor's report highlighting a material uncertainty regarding the company's ability to continue as a going concern due to recurring net losses and liquidity limitations Report of Independent Registered Public Accounting Firm The auditor, Plante & Moran, PLLC, issued an opinion expressing substantial doubt about the Company's ability to continue as a going concern due to recurring net losses and liquidity limitations - The auditor's report contains a "Going Concern" paragraph, stating that the company's net losses and liquidity limitations raise substantial doubt about its ability to continue as a going concern[256] Consolidated Financial Statements Data The consolidated financial statements detail the company's financial position and performance, showing a net loss of $3.7 million on revenues of $55.6 million for 2018 and cash used in operating activities of $1.2 million Consolidated Balance Sheet Highlights (As of Dec 31) | Account | 2018 | 2017 | | :--- | :--- | :--- | | Total Current Assets | $33,010,734 | $32,291,485 | | Total Current Liabilities | $30,208,712 | $22,660,880 | | Working Capital | $2,802,022 | $9,630,605 | | Total Assets | $38,760,834 | $39,984,038 | | Total Liabilities | $32,505,105 | $29,539,778 | | Total Stockholders' Equity | $6,255,729 | $10,444,260 | Consolidated Income Statement Highlights (Year Ended Dec 31) | Account | 2018 | 2017 | | :--- | :--- | :--- | | Net Sales | $55,591,102 | $56,236,560 | | Gross Profit | $11,428,978 | $13,754,850 | | (Loss) Income from Operations | ($764,473) | $629,761 | | Net (Loss) | ($3,738,724) | ($1,782,857) | | Net Loss Attributable to CTI | ($3,585,709) | ($1,603,103) | | Diluted Loss Per Share | ($1.00) | ($0.44) | Notes to Consolidated Financial Statements The notes provide critical details on liquidity issues, going concern uncertainty, notes payable, the significant increase in deferred tax asset valuation allowance, and extensive related-party transactions - Note 3 (Liquidity and Going Concern) states that due to financial performance in 2016-2018 and credit facility violations, substantial doubt exists about the company's ability to continue as a going concern[298][296] - Note 9 (Notes Payable) confirms the company was not in compliance with its PNC credit facility as of Dec 31, 2018, and entered a forbearance agreement in March 2019, resulting in the reclassification of long-term bank debt to current liabilities[318][319] - Note 11 (Income Taxes) shows the deferred tax asset valuation allowance increased from $0.6 million in 2017 to $2.4 million in 2018, effectively wiping out most of the deferred tax assets due to uncertainty of their realization[329] - Note 14 (VIEs) discloses the consolidation of Clever Container, an entity partially owned by key CTI officers, with the company announcing its intent to divest this interest in Nov 2018 and recognizing a $0.2 million impairment on its equity interest[344]