Item 2.
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Management's Discussion and Analysis of Financial Condition and Results of Operations
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Forward Looking Statements
This quarterly report includes both historical and “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. We have based these forward-looking statements on our current expectations and projections about future results. Words such as “may,” “should,” “could,” “would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “continue,” or similar words are intended to identify forward-looking statements, although not all forward-looking statements contain these words. Although we believe that our opinions and expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements, and our actual results may differ substantially from the views and expectations set forth in this quarterly report on Form 10-Q. We disclaim any intent or obligation to update any forward-looking statements after the date of this quarterly report to conform such statements to actual results or to changes in our opinions or expectations.
Overview
We produce film products for novelty, packaging and container applications. These products include foil balloons, latex balloons and related products, films for packaging and custom product applications, and flexible containers for packaging and consumer storage applications. We produce all of our film products for packaging, container applications and most of our foil balloons at our plant in Lake Barrington, Illinois. We produce all of our latex balloons and latex products at our facility in Guadalajara, Mexico. Substantially all of our film products for packaging and custom product applications are sold to customers in the United States. We market and sell our novelty items and flexible containers for consumer use in the United States, Mexico, Latin America, and Europe. We also market and sell vacuum sealing machines, home organizing and container products, Candy Blossoms and party goods.
As of January 1, 2018, we adopted Accounting Standards Codification (ASC) Topic 606, Revenue from Contracts with Customers, using the modified retrospective method. The adoption of ASC 606 did not have a material impact on our consolidated financial position or results of operations, as our revenue arrangements generally consist of a single performance obligation to transfer promised goods at a fixed price.
Net sales include revenues from sales of products and shipping and handling charges, net of estimates for product returns. Revenue is measured at the amount of consideration we expect to receive in exchange for the transferred products. Revenue is recognized at the point in time when we transfer the promised products to the customer and the customer obtains control over the products. We recognize revenue for shipping and handling charges at the time the goods are shipped to the customer, and the costs of outbound freight are included in cost of sales, as we have elected the practical expedient included in ASC 606.
We provide for product returns based on historical return rates. While we incur costs for sales commissions to our sales employees and outside agents, we recognize commission costs concurrent with the related revenue, as the amortization period is less than one year and we have elected the practical expedient included in ASC 606. We do not incur incremental costs to obtain contracts with our customers. Our product warranties are assurance-type warranties, which promise the customer that the products are as specified in the contract. Therefore, the product warranties are not a separate performance obligation and are accounted for as described herein. Sales taxes assessed by governmental authorities are accounted for on a net basis and are excluded from net sales.
As of January 1, 2019, we adopted ASC Topic 842, Leases (“ASC Topic 842”). Refer to Note 12 for additional information. Our primary leases relate to the facilities we use in Lake Zurich, IL (USA), Mexico, Germany and the UK. We also have ancillary leases for items ranging from forklifts to printers. The majority of our leases are classified as operating lease right-of-use (“ROU”) assets and related operating lease liabilities. Finance leases are included in property and equipment and related liabilities. ROU assets and lease liabilities are recognized based on the present value of future minimum lease payments over the expected lease term at the commencement date for leases that exceed 12 months. The expected lease term includes options to renew when it is reasonably certain that we will exercise such option.
Operating lease expense is recognized on a straight-line basis over the lease term and is included in the cost of sales or sales, general and administrative expense areas. Finance leases are amortized on a straight-line basis and included in similar areas of expense classification. Variable lease payments, non-lease component payments, and short-term rentals (leases less than 12 months in duration) are expensed as incurred.
Summary of Current Developments and Status
For the quarter ended September 30, 2019, we have reported a loss of $1,449,000 and, for the nine-month period ended that date, a loss of $5,127,000. The loss for the nine-month period includes a non-cash charge of $3,000,000 which we have taken during the second quarter of 2019, in anticipation of the divestiture or liquidation of our European sales entities and Clever Container. We are also involved in negotiations for the potential divestiture of our subsidiary in Guadalajara, Mexico (Flexo). Our management and Board have engaged in a review of these subsidiaries and determined that they are not accretive to our Company overall, add complexity to our structure and utilize resources. This action is being taken to focus our resources and efforts on our core business activities, particularly in the United States. The charge taken in the second quarter is a reserve for the estimated net costs we will incur in connection with the divestiture or liquidation and resulting deconsolidation of those entities.
We have operated throughout 2019 out of compliance with the terms of our credit facility. In March 2019, we entered into a forbearance agreement with our Bank in which we acknowledged continuing violations on our part with respect to loan covenants and the Bank agreed to continue to provide funding to us and to forbear from action on the covenant violations until July 31, 2019 when our compliance with covenants as of June 30, 2019 would be determined. As of that date, we determined that we did not comply with our bank covenants and, on August 1, 2019, the Bank issued a Notice of Default and Reservation of Rights letter to us, under which the Bank communicated that it may, at its sole discretion, continue to provide advances to us under certain conditions. On October 18, 2019, we entered into a second forbearance agreement, until January 10, 2020 with respect to CTI Industries Corporation, and not with respect to our subsidiary in Mexico (Flexo).
We have no assurance of continued funding from the Bank and the costs and risks of continued financing with the Bank remain very high.
During 2019, we attempted to complete a major capital event in which a new partner would infuse capital or provide financing to us. To date, we have not received a commitment for any capital or other funding. We continue to seek additional funding, including more limited transactions and debt financing, but there can be no assurance that such efforts will be successful.
During much of 2019 and currently, we have experienced difficulties in maintaining adequate working capital which has been exacerbated by reduced sales due to the commercial helium shortage and excess labor costs. On October 21, 2019, we issued notices under the Worker Adjustment and Retraining Notification Act (“WARN”) and related state laws. The notices indicated that our primary facility, in Lake Barrington, IL, might close in late December 2019 or early January 2020. The possibility of closure required the issuance of these notices, though we continue to seek financing that would permit continued operations.
In these circumstances, we believe that substantial doubt exists concerning our ability to continue as a going concern as of September 30, 2019 and currently, which may be mitigated by obtaining a transaction or additional financing. It is our intention to streamline the business and focus on profitable, growth-oriented segments and product lines, and to stabilize financing. In that light, we are focusing on the core of our business and looking to divest subsidiaries and non-core business areas and assets. We also have an aggressive cost-reduction plan that, if successful, would significantly reduce the cost structure of our core United States-based business.
Results of Operations
Net Sales. For the three months ended September 30, 2019, net sales were $8,537,000 compared to net sales of $11,525,000 for the same period of 2018, a decrease of 26%. For the quarters ended September 30, 2019 and 2018, net sales by product category were as follows:
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Three Months Ended
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September 30, 2019
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September 30, 2018
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$
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% of
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$
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% of
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Product Category
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(000) Omitted
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Net Sales
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(000) Omitted
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Net Sales
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Foil Balloons
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3,091
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36%
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4,576
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40%
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Latex Balloons
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2,201
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27%
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2,466
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21%
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Vacuum Sealing Products
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1,958
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23%
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2,517
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22%
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Film Products
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237
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3%
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320
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3%
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Other Sales
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950
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11%
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1,646
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14%
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Total
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8,537
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100%
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11,525
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100%
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For the nine months ended September 30, 2019, net sales were $33,481,000 compared to net sales of $41,489,000 for the same period of 2018. For the nine months ended September 30, 2019 and 2018, net sales by product category were as follows:
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Nine Months Ended
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September 30, 2019
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September 30, 2018
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$
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% of
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$
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% of
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Product Category
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(000) Omitted
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Net Sales
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(000) Omitted
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Net Sales
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Foil Balloons
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14,500
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43%
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18,850
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46%
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Latex Balloons
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6,271
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19%
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6,949
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17%
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Vacuum Sealing Products
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6,022
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18%
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5,970
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14%
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Film Products
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1,476
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4%
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1,367
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3%
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Other Sales
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5,212
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16%
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8,353
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20%
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Total
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33,481
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100%
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41,489
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100%
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Foil Balloons. During the three months ended September 30, 2019, revenues from the sale of foil balloons decreased by 33% compared to the prior year period from $4,576,000 to $3,091,000. During the nine months ended September 30, 2019, revenues from the sale of foil balloons decreased by 23% compared to the prior year period from $18,850,000 to $14,500,000. During the first nine months of 2019, foil balloon sales to our largest customer decreased to $8,190,000 from $11,030,000 in the first nine months of 2018. The commercial supply of helium was significantly reduced during 2019. While the issue is currently being resolved, with existing producers back to normal supply and new sources coming on line, we continue to be negatively impacted, particularly in sell-through of foil balloons, as most are helium-filled as opposed to air-filled.
Latex Balloons. During the three months ended September 30, 2019, revenues decreased from $2,466,000 to $2,201,000. During the nine months ended September 30, 2019, revenues from the sale of latex balloons decreased compared to the prior year, from $6,949,000 to $6,271,000.
Vacuum Sealing Products. During the three months ended September 30, 2019, revenues from the sale of pouches and vacuum sealing machines decreased 22% compared to the prior year, from $2,517,000 to $1,958,000. During the nine months ended September 30, 2019, revenues from the sale of pouches and vacuum sealing machines increased by 1% compared to the prior year, from $5,970,000 to $6,022,000. As of July 2018, changes in tariffs between the United States and China have negatively impact the cost and other aspects of vacuum sealing machines and related products. Our sales in this area are under a license agreement which is scheduled to expire under its terms on December 31, 2019. This agreement has not been extended and may not be extended.
Films. During the three months ended September 30, 2019, revenues from the sale of laminated film products decreased by 26% compared to the prior year period from $320,000 to $237,000. During the nine months ended September 30, 2019, revenues from the sale of laminated film products increased by 8% compared to the prior year period from $1,367,000 to $1,476,000.
Other Revenues. During the three months ended September 30, 2019, revenues from the sale of various other products decreased by 42% to $950,000 compared to revenues from other products in the same period in 2018 of $1,646,000. During the nine months ended September 30, 2019, revenues from the sale of various other products decreased by 37% to $5,212,000 compared to revenues from other products in the same period in 2018 of $8,353,000. The revenues from the sale of other products during the first nine months of 2019 include (i) sales of a line of “Candy Blossoms” consisting of candy and small inflated balloons sold in small containers in the amount of approximately $2,300,000, (ii) the sale of accessories and supply items related to balloon products, (iii) sales by Clever Container Company, L.L.C. which had engaged in the direct sale of container and organizing products through a network of independent distributors but changed its go-to-market strategy to one of online sales, in the amount of $346,000 and (iv) sales of party goods in Mexico by Flexo Universal in the amount of $1,006,000. Clever Container changed its business model to one of both lower costs and revenues compared to its prior business model, reducing the revenues shown in Other Revenues. This business is expected to be divested.
Sales to a limited number of customers continue to represent a large percentage of our net sales. The table below illustrates the impact on sales of our top three and ten customers for the three months ended September 30, 2019 and 2018.
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Three Months Ended September 30,
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Nine Months Ended September 30,
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% of Sales
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% of Sales
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2019
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2018
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2019
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2018
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Top 3 Customers
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49%
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50%
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55%
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60%
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Top 10 Customers
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69%
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67%
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73%
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74%
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During the three and nine months ended September 30, 2019, there were two customers whose purchases represented more than 10% of the Company’s consolidated net sales. Sales to these customers for the three months ended September 30, 2019 were $1,799,000 or 21%, and $1,559,000 or 18%, of consolidated net sales, respectively. Sales to these customers for the three months ended September 30, 2018 were $2,385,000 or 21%, and $2,686,000 or 23%, of consolidated net sales, respectively. Sales to these customers for the nine months ended September 30, 2019 were $8,136,000 or 24%, and $8,424,000 or 25%, of consolidated net sales, respectively. Sales to these customers for the nine months ended September 30, 2018 were $9,738,000 or 24%, and $10,796,000 or 26%, of consolidated net sales, respectively. The amounts owed at September 30, 2019 by these customers were $1,777,000 or 22%, and $996,000 or 12%, of the Company’s consolidated net accounts receivable, respectively. As of September 30, 2018, the total amounts owed to the Company by these customers were $2,241,000 or 23%, and $1,702,000 or 18% of the Company’s consolidated net accounts receivable, respectively.
Cost of Sales. During the three months ended September 30, 2019, the cost of sales was $7,730,000, a 17% decrease from $9,337,000 for the three months ended September 30, 2018. During the nine months ended September 30, 2019, the cost of sales was $28,139,000, a 14% decrease from $32,637,000 for the nine months ended September 30, 2018. This decrease was the result of the decrease in Sales.
General and Administrative. During the three months ended September 30, 2019, general and administrative expenses were $1,467,000, a decrease of 3% compared to $1,510,000 for the same period in 2018. During the nine months ended September 30, 2019, general and administrative expenses were $5,054,000 and $5,074,000 for the same period in 2018. A one-time fee associated with the forbearance agreement in the amount of $250,000 was included in the first three months of 2019 general and administrative expenses.
Selling, Advertising and Marketing. During the three months ended September 30, 2019, selling, advertising and marketing expenses were $600,000, a 42% decrease compared to $1,033,000 for the same period in 2018. During the nine months ended September 30, 2019, selling, advertising and marketing expenses were $1,996,000, a 43% decrease compared to $3,477,000 for the same period in 2018. This reduction was primarily due to the full year benefit of cost reduction programs implemented during 2018.
Other Income (Expense). During the three months ended September 30, 2019, the Company incurred interest expense of $487,000, compared to interest expense during the same period of 2018 in the amount of $471,000. During the nine months ended September 30, 2019, the Company incurred interest expense of $1,550,000, compared to interest expense during the same period of 2018 in the amount of $1,586,000. We recognized a $3 million charge during June 2019 in anticipation of deconsolidating Clever Container and our two European sales companies during 2019.
For the three months ended September 30, 2019, the Company had a foreign currency transaction loss of $282,000 compared to a foreign currency transaction gain of $232,000 during the same period of 2018. For the nine months ended September 30, 2019, the Company had a foreign currency transaction gain of $15,000 compared to a foreign currency transaction loss of $111,000 during the same period of 2018.
Financial Condition, Liquidity and Capital Resources
Cash Flow Items.
Operating Activities. During the nine months ended September 30, 2019, net cash provided by operations was $4,593,000, compared to net cash used by operations during the nine months ended September 30, 2018 of $48,000.
Significant changes in working capital items during the nine months ended September 30, 2019 included:
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A decrease in accounts receivable of $2,626,000 compared to a decrease in accounts receivable of $1,717,000 in the same period of 2018.
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A decrease in inventory of $1,685,000 compared to an increase in inventory of $819,000 in 2018.
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An increase in trade payables of $1,847,000 compared to an increase in trade payables of $386,000 in 2018.
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A decrease in accrued liabilities of $24,000 compared to a decrease in accrued liabilities of $268,000 in 2018.
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Investing Activities. During the nine months ended September 30, 2019, cash used in investing activities was $144,000, compared to cash used in investing activity for the same period of 2018 in the amount of $324,000.
Financing Activities. During the nine months ended September 30, 2019, cash used by financing activities was $4,095,000 compared to cash provided by financing activities for the same period of 2018 in the amount of $381,000. Financing activity consisted principally of changes in the balances of revolving and long-term debt.
Liquidity and Capital Resources.
At September 30, 2019, the Company had cash balances of $127,000 compared to cash balances of $274,000 for the same period of 2018.
Also, as of September 30, 2019, the Company had a working capital balance of $297,000 compared to a working capital balance of $2,802,000 on December 31, 2018.
As of September 30, 2019, the Company was not in compliance with its credit facility, operating under a forbearance agreement. For this reason, $2.6 million of long-term debt was reclassified as current debt as of September 30, 2019. Failure to ultimately regain compliance with the terms of our credit agreement, or enter into a suitable replacement financing vehicle, could negatively impact our ability to carry on our business up to and including our ability to continue as a going concern. Additionally, we have encountered difficulties with seasonal cash flow needs, including increased costs associated with recruiting and retaining workers in the Chicago area. The failure to regain compliance with the terms of our credit facility and/or properly manage seasonal cash needs could put a strain on the Company, up to and including our ability to continue as a going concern. See Note 2 for additional discussion.
Seasonality
In the foil balloon product line, sales have historically been seasonal with approximately 40% occurring in the period from December through March of the succeeding year and 24% being generated in the period July through October in recent years. Vacuum sealing product sales are also seasonal; approximately 60% of sales in this product line occur in the period from July through December. This traditional seasonality may be impacted by ongoing developments in tariffs between the United States and other parties, particularly China.
Critical Accounting Policies
Please see pages 24-27 of our Annual Report on Form 10-K for the year ended December 31, 2018 for a description of policies that are critical to our business operations and the understanding of our results of operations. The impact and any associated risks related to these policies on our business operations is discussed throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations where such policies affect our reported and expected financial results. Except for the adoption of ASC Topic 842 (Leases) as described herein, no material changes to such information have occurred during the three months ended September 30, 2019.