Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

____________

FORM 10-Q

(Mark One)

For the transition period from _________to_________

Commission File Number

000-23115

CTI INDUSTRIES CORPORATION

(Exact name of Registrant as specified in its charter)

(847) 382-1000

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ☑☒     No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☑☒     No ☐

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

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ☐     No ☑☐

The number of shares outstanding of the Registrant’s common stock as of NovemberAugust 1, 20182019 was 3,530,227.3,835,950.

INDEX

Note 1 - Basis of Presentation

The accompanying condensed (a) consolidated balance sheet as of December 31, 2017,2018, which has been derived from audited consolidated financial statements, and (b) the unaudited interim condensed consolidated financial statements have been prepared and, in the opinion of management, contain all the adjustments (consisting of those of a normal recurring nature) considered necessary to present fairly the consolidated financial position and the consolidated statements of comprehensive income and consolidated cash flows for the periods presented in conformity with generally accepted accounting principles for interim consolidated financial information and the instructions to Form 10-Q and Article 8 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States of America. Operating results for the three and six months ended SeptemberJune 30, 20182019 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2018.2019. 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, 2017.2018.

Principles of consolidation and nature of operations:

The condensed consolidated financial statements include the accounts of CTI Industries Corporation and its wholly-owned subsidiaries, CTI Balloons Limited and CTI Supply, Inc., its majority-owned subsidiaries, Flexo Universal, S. de R.L. de C.V. and CTI Europe gmbH, as well as the accounts of Venture Leasing S. A. de R. L., Venture Leasing L.L.C and Clever Container Company, L.L.C. (the “Company”). The last three entities have been consolidated as variable interest entities. All significant intercompany transactions and accounts have been eliminated in consolidation. The Company (i) designs, manufactures and distributes balloon and related novelty (candy and party related) products throughout the world, (ii) operates 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, and (iii) distributes vacuum sealing products and home organization products in the United States. We have announced our intention to divest our interest in Clever Container and deconsolidate that entity from our group. As we held an equity interest in Clever Container as of June 30, 2019, it remains consolidated as a variable interest entity. During June 2019, we determined that this and the two European sales subsidiaries should no longer be a part of our group, have begun the active process to eliminate those entities from our group, and have thus recognized a non-cash charge of $3 million during June 2019 to reflect that determination and in anticipation of ultimate deconsolidation.

Variable Interest Entities (“VIE’s”):

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. There are three entities that have been consolidated as variable interest entities.

Use of estimates:

In preparing condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amount of revenue and expenses during the reporting period in the condensed consolidated financial statements and accompanying notes. Actual results may differ from those estimates. The Company’s significant estimates include reserves for doubtful accounts, reserves for the lower of cost or market of inventory, reserves for deferred tax assets and recovery value of goodwill.

Earnings per share:

Basic earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding during each period.

Diluted earnings per share is computed by dividing the net income by the weighted average number of shares of common stock and equivalents (stock options and warrants), unless anti-dilutive, during each period.

As of SeptemberJune 30, 20182019 and 2017,2018, shares to be issued upon the exercise of options and warrants aggregated 471,000 and 205,000, respectively.471,144 for each period. The number of shares included in the determination of earnings on a diluted basis for the three months ended SeptemberJune 30, 2019 and 2018 and 2017 were 25,000 and 282,000, respectively.  For the nine months ended September 30, 2018 and 2017, the same share disclosure was 25,000 and 178,000, respectively. none, as doing so would have been anti-dilutive.

Significant Accounting Policies:

The Company’s significant accounting policies are summarized in Note 2 of the Company’s consolidated financial statements for the year ended December 31, 2017.2018. There were no significant changes to these accounting policies during the three or ninesix months ended SeptemberJune 30, 2018, respectively,2019, except for the adoption of Accounting Standards Codification (ASC) Topic 606,842, Revenue from ContractsLeases.

On January 1, 2019, we adopted ASC Topic 842 (Leases). The adoption of this standard significantly increased our assets and liabilities and further discussed in Note 12. ASC 842 requires a lessee to recognize assets and liabilities related to leases with Customers. terms in excess of 12 months. Such assets are typically considered Right-Of-Use (“ROU”) assets. Prior information has not been restated and continues to be reported under the accounting standards in effect for those periods.

On January 1, 2018, we adopted ASC 606 (Revenue From Contracts With Customers) using the modified retrospective method. The adoption of ASC 606 did not have a material impact on our consolidated financial position or results of operations, as our revenue arrangements generally consist of a single performance obligation to transfer promised goods at a fixed price.

Net sales include revenues from sales of products and shipping and handling charges, net of estimates for product returns. Revenue is measured at the amount of consideration the Company expects to receive in exchange for the transferred products. Revenue is recognized at the point in time when we transfer the promised products to the customer and the customer obtains control over the products. The Company recognizes revenue for shipping and handling charges at the time the goods are shipped to the customer, and the costs of outbound freight are included in cost of sales, as we have elected the practical expedient included in ASC 606.

The Company provides for product returns based on historical return rates. While we incur costs for sales commissions to our sales employees and outside agents, we recognize commission costs concurrent with the related revenue, as the amortization period is less than one year and we have elected the practical expedient included in ASC 606. We do not incur incremental costs to obtain contracts with our customers. Our product warranties are assurance-type warranties, which promise the customer that the products are as specified in the contract. Therefore, the product warranties are not a separate performance obligation and are accounted for as described herein. Sales taxes assessed by governmental authorities are accounted for on a net basis and are excluded from net sales.

Recent Accounting Pronouncements: Auditor Replacement Process:

During April 2019, our independent registered accounting firm, Plante & Moran PLLC, resigned as auditor. This quarterly report on Form 10Q is being prepared without the benefit of auditor review, and we would look to amend this filing upon the hiring of a replacement independent registered accounting firm.

Note 2 – Liquidity and Going Concern

The Company’s primary sources of liquidity are cash and cash equivalents as well as availability under the Credit Agreement with PNC Bank, National Association (“PNC”) (see Note 3). As indicated in Note 3, twice during 2018 we violated covenants in our credit facility and as of March 2019 we entered into a forbearance agreement with PNC. Under the terms of this agreement, financial covenants as of March 31, 2019 were not considered and all previously identified compliance failures were waived, but we remain out of compliance with the terms of our credit facility, as amended, including the covenants as of June 30, 2019 calculated on or about July 31, 2019. On August 1, 2019, PNC issued a Default and Reservation of Rights letter to the Company, in which PNC advised that line of credit advances would continue to be available to the Company at PNC’s sole discretion, and subject to its terms and conditions.

During 2019 we attempted to execute a major capital event with a partner that would infuse money, among other attributes. That effort was unsuccessful as envisioned. We are currently seeking to execute on one or more smaller transactions, as well as pursue other financing options. There is no assurance that any of these efforts will be successful.

In Februaryaddition to the above, due to financial performance in 2016, 2017 and 2018, including net income/(losses) attributable to the FASB issued ASU 2016-02, Leases (Topic 842)Company of $0.7 million, ($1.6 million), aimed at making leasing activities more transparent and comparable. The new standard requires substantially all leases be recognized by lessees on their balance sheet($3.6 million), respectively, we believe that substantial doubt about our ability to continue as a right-of-use assetgoing concern exists at June 30, 2019.

Additionally, we have experienced challenges in maintaining adequate seasonal working capital balances, made more challenging by increases in financing and corresponding lease liability, including today’s operating leases. For public business entities,labor costs, along with a supply disruption in the standard is effective for fiscal years beginning after December 15, 2018, including interim periodshelium market. These changes in cash flows have created very significant strain within those fiscal years. For all other entities, the standard is effective for fiscal years beginning after December 15,our operations, and have therefore increased our desire to obtain additional funding resources.

Management’s plans include:

(1)     Pursuing a smaller strategically significant major capital event.

(2)     Working with our bank to resolve our compliance failure on a long-term basis.

(3)     Evaluating and potentially executing a sale/leaseback transaction of our facility in Lake Barrington, IL.

(4)     Simplifying our group structure, and

(5)     Exploring alternative funding sources.

Management Assessment

Considering both quantitative and qualitative information, we believe that our plans to obtain additional financing may provide us with an ability to finance our operations through 2019 and, interim periods within fiscal years beginning after December 15, 2020. Early application is permitted for all entities. While we are currently evaluatingif successfully executed, may mitigate the potential impact of this new standard, we expect thatsubstantial doubt about our property, plant and equipment will increase significantly dueability to the addition of assets currently under lease, and the lease liabilities will correspondingly increase.continue as a going concern.

Note 23 - Debt

Until December 2017, we had in place a series of credit facility and related agreements with BMO Harris Bank, N.A. and BMO Private Equity (U.S.), (collectively, “BMO”), in the aggregate amount of approximately $17 million. During December 2017, we terminated those agreementsa prior credit arrangement and fully repaid all amounts owed BMO under those agreements, including associated fees and costs related to termination, as we entered in new financing agreements with PNC Bank, National Association (“PNC”). The “PNC Agreements” include a $6 million term loan and an $18 million revolving credit facility, with a termination date of December 2022.

Available credit under the Revolving Credit facility is determined by eligible receivables and inventory at CTI Industries (U.S.) and Flexo Universal (Mexico). We notified PNC of our failure to meet two financial covenants as of March 31, 2018. On June 8, 2018, we entered into Waiver and Amendment No. 1 (the “Amendment 1”) to our PNC Agreements. The Amendment modified certain covenants, added others, waived our failure to comply as previously reported, and included an amendment fee and temporary increase in interest rate. During September 2018, we filed a preliminary prospectus on Form S-1 for a planned equity issuance. On October 8, 2018, we entered into Consent and Amendment No. 2 (the “Amendment 2”) to our PNC Agreements. Amendment 2 reduced the amount of new funding proceeds that must be used to repay the term loan from $5 million to $2 million and waived the calculation of financial ratios for the period ended September 30, 2018, in exchange for a new covenant committing to raise at least $7.5 million in gross proceeds from our equity issuance by November 15, 2018 and pay an amendment fee. As of the date of this filing marketMarket conditions haveultimately forced us to postpone the offering, and thus any ultimateno proceeds would occur afterwere received by the November 15, 2018. 2018 requirement.

We intend to engage our bankengaged PNC to resolve this impending failure to meet our amended covenant. As we expectcovenant, and as of March 2019 entered into a forbearance agreement. Under the terms of this agreement, previously identified compliance failures were waived and financial covenants as of March 31, 2019 were not considered, with the next calculation due July 31, 2019 for the period ended June 30, 2019. We received a temporary over-advance of $1.2 million, which declined to bezero over a six-week period under the terms of this agreement and paid a fee of $250,000.

On August 1, 2019, PNC issued a Notice of Default and Reservation of Rights letter, indicating the end of the forbearance period and continued events of default with our credit agreement, as amended. We remain out of compliance with this requirement, wethe terms of our facility and have thus reclassified long-term bank debt to current liabilities on our balance sheet. See Note 3 for a related discussion of the impact of this event.

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 as amended, include:

Note 3 – Going Concern

The Company’s primary sources of liquidity are cash and cash equivalents as well as availability under the Credit Agreement with PNC (see Note 2).  As noted in Note 2, we initiated an equity issuance process and entered into an amendment with PNC that would have allowed us more flexibility in the use of any equity proceeds, and committed us to raise at least $7.5 million by November 15, 2018.  As we believe that condition will not be met, we expect to be in violation of our Agreement, as amended. 

Management’s plans include:

(1)     Working with our bank to resolve this anticipated compliance failure,

(2)     Exploring alternative funding sources,

(3)     Evaluating and potentially executing a sale/leaseback transaction of our facility in Lake Barrington, IL, and

(4)     Continuing with the equity raise at the first opportunity that we think it likely to be successful.

Management Assessment

Based upon our historical ability to obtain necessary financing and our current expectations of future cash flow from operations, we believe we are likely to obtain necessary amendments and/or financing that will allow us to meet current obligations and to continue operating as a going concern.  We do not have firm commitments from lenders or other investors at this time for a resolution.

Note 4 - Stock-Based Compensation; Changes in Equity

The Company has adopted Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 718 which requires all share-based payments to employees, including grants of employee stock options, to be recognized in the condensed consolidated financial statements based on their grant-date fair values.

The Company has applied the Black-Scholes model to value stock-based awards and issued warrants related to notes payable. 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 our common stock. The risk-free rate of interest is the related U.S. Treasury yield curve for periods within the expected term of the option at the time of grant. The dividend yield on our common stock is estimated to be 0%, as the Company did not issue dividends during 20182019 and 2017.2018. The expected volatility is based on historical volatility of the Company’s common stock.

The Company’s net loss for the three and six months ended SeptemberJune 30, 20182019 and net loss for the three months ended September 30, 20172018 includes approximately $34,000$23,000 and $2,000,$44,000, respectively, of compensation costs related to share based payments. The Company’s net loss for the nine months ended September 30, 2018in 2019 and 2017 includes approximately $139,000$52,000 and $12,000$172,000, respectively, of compensation costs related to share based payments. As of SeptemberJune 30, 2018,2019, there is $225,000was $140,000 of unrecognized compensation expense related to non-vested stock option grants and stock grants. We expect approximately $32,000$40,000 of additional stock-based compensation expense to be recognized over the remainder of 2018, $92,000 to be recognized during 2019, and $56,000 to be recognized during 2020.

On April 10, 2009, the Board of Directors approved for adoption, and on June 5, 2009, the shareholders of the Corporation approved, a 2009 Stock Incentive Plan (“2009 Plan”). The 2009 Plan and subsequent awards categorized as inducement of employment authorized the issuance of up to 510,000 shares of stock or options to purchase stock of the Company (including cancelled shares reissued under the plan.) As of September 30, 2018, all underlying awards under the 2009 Plan had been granted and options for 471,144 shares remain outstanding.

On June 8, 2018, our shareholders approved the 2018 Stock Incentive Plan (“2018 Plan”). The 2018 Plan authorizes the issuance of up to 300,000 shares of our common stock in the form of equity-based awards.

A summary of the Company’s stock option activity, which includes grants of restricted stock, non-qualified stock options, incentive stock options, warrants and related information, is as follows:

Note 5 - 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. (d\b\a) Helium and Balloons Across America and Gary Page (“Claimants”) filed an action against the Company in the North Carolina State Court.based on disputed compensation amounts over several years. This action was removed toresolved by mutual agreement between the United States District Courtparties during January 2019. Mr. Page received 20,000 shares of CTI common stock, $5,000 in North Carolina.cash, and a minimum payout in his monthly royalty calculation of $7,667 beginning March 1, 2019 and ending August 1, 2021. The Company filed an answer and motion to dismissaccrued the $0.3 million in committed costs under this action. The Court stayed the action based upon an arbitration clausesettlement in the agreement on which part of the action was based. Onits December 18, 2017, Claimants filed an arbitration claim against the Company before the American Arbitration Association in Chicago, Illinois. The Statement of Claim includes claims for alleged breach of two agreements among the parties, essentially for alleged failure by the Company to pay disputed commission amounts. Claimants also included counts for alleged unjust enrichment and tortious interference with contract. The Company has filed a response to the Statement of Claim denying all of the claims. The Company believes the claims are without merit and intends to defend all of the claims vigorously. The Company has not accrued any amounts in respect of this matter and cannot estimate the possible loss, if any, that the Company many incur with respect to it.31, 2018 financial statements.

Note 6 - Other Comprehensive Income

In the ninethree and six months ended SeptemberJune 30, 2018,2019, the Company incurred other comprehensive lossincome of approximately $111,000,$297,000, all from foreign currency translation adjustments.

The following table sets forth the accumulated balance of other comprehensive income and each component.

Note 7 - Inventories, Net

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 operations by geographic area is as follows:

Note 9- 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 ninesix months ended SeptemberJune 30, 20182019 and 2017,2018, there were two customers whose purchases represented more than 10% of the Company’s consolidated net sales, respectively. Sales to these customers for the three months ended SeptemberJune 30, 20182019 and 20172018 are as follows:

Sales to these customers for the ninesix months ended SeptemberJune 30, 20182019 and 20172018 are as follows:

Note 10 - Related Party Transactions

Until March 31, 2018, Stephen M. Merrick, Chief Executive Officer of the Company, wasis of counsel to the law firm of Vanasco Genelly and Miller PC which providedused to provide legal services to the Company. Legal fees paid by the Company to this firm for the three months ended SeptemberJune 30, 20182019 and 2017,2018, respectively, were $0none and $29,000.$16,000. Legal fees paid by the Company to this firm for the ninesix months ended SeptemberJune 30, 20182019 and 2017,2018, respectively, were $88,000none and $93,000.$88,000.

John H. Schwan, through an investment entity, and Stephen M. Merrick, Chief Executive Officer of the Company, also through an investment entity own, in aggregate, a 50% interest in Clever Container Company L.L.C., an Illinois limited liability company (“Clever Container”). During the three months ended SeptemberJune 30, 20182019 and 2017,2018, Clever Container purchased various products from the Company in the amount of $198,000$1,000 and $262,000,$259,000, respectively. During the ninesix months ended SeptemberJune 30, 20182019 and 2017,2018, Clever Container purchased various products from the Company in the amount of $640,000$63,000 and $716,000,$442,000, respectively. As of SeptemberJune 30, 20182019 and 2017,2018, the balance of accounts receivable from Clever Container to the Company were $1,278,000$1,379,000 and $924,000,$1,199,000, respectively. The Company owns a 28.5% interest in Clever Container, though has announced the intention to divest its interest in Clever Container. This transaction has not been completed as of the filing of this report.

Note 11- 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 SeptemberJune 30, 20182019 and December 31, 2017,2018, we had one derivative instrument accounted for as a hedge, compared to no suchwith the same instrument accounted for as a hedge as of SeptemberJune 30, 2017.2018. Gains and losses from changes in fair values of derivatives that are not designated as hedges for accounting purposes are recognized in the consolidated statement of operations. We have no such derivative financial instruments as of December 31, 2017.2018. Changes in fair value for the respective periods were recognized in the consolidated statement of operations.

The interest rate swap we entered into December 14, 2017 had a three year term (ending December 14, 2020) and a notional amount of $3 million. The Company purchased a 2.25% fixed rate in exchange for the variable rate on a portion of the notes payable under the PNC Agreements, which was 1.47% at time of execution. The fair value of the swap was insignificant as of SeptemberJune 30, 2018 and December 31, 2017.2018 and June 30, 2019. It is expected that this instrument will be eliminated with no gain or loss to the Company as a result of the forbearance agreement entered into during March 2019.

Note 12-Leases

We adopted ASC Topic 842 (Leases) on January 1, 2019. This standard requires us to record certain operating lease liabilities and corresponding right-of-use assets on our balance sheet. Results for periods beginning after January 1, 2019 are presented under Topic 842, while prior period amounts are not adjusted and continue to be reported in accordance with our historic accounting under Topic 840. We elected the package of practical expedients available for expired or existing contracts, which allowed us to carryforward our historical assessments of whether contracts are (or contain) leases, as well as lease classification tests and treatment of initial direct costs. We also elected to not separate lease components from non-lease components for all fixed payments, and we exclude variable lease payments in the measurement of right-of-use assets and lease obligations.

Upon adoption of ASC 842 we recorded a $2.4 million increase in other assets, a $1.0 million increase in current liabilities, and a $1.4 million increase in non-current liabilities. We did not record any cumulative effect adjustments in opening retained earnings, and adoption of ASC 842 had no impact on cash flows from operating, investing, or financing activities.

We determine if an arrangement is a lease at inception. Most of our operating leases do not provide an implicit rate of interest so we use our incremental borrowing rate based on the information available at the commencement date to determine the present value of future payments. We lease various assets in the course of ordinary business including: warehouses and manufacturing facilities, as well as vehicles and equipment used in our operations. Leases with an initial term of 12 months or less are not recorded on the balance sheet as we recognize lease expense for these leases on a straight-line basis over the lease term. The depreciable life of assets and related improvements are limited by the expected lease term, unless there is a reasonably certain expected transfer or title or purchase option. Some lease agreements include renewal options at our sole discretion. Any guaranteed residual value is included in our lease liability.

The table below describes our lease position as of June 30, 2019: