Yunhong CTI Ltd.
Q3 2014 Earnings Call Transcript

Published: 13 Nov 2014

[Operator:]

Good day and welcome to the CTI Industries Corporation Third Quarter and Year-To-Date 2014 Financial Results Conference Call. Today's conference is being recorded. Certain statements contained in this conference call that are not descriptions of historical facts are forward-looking statements. As such term is defined in the Private Securities Litigation Reform Act of 1995; because such statements include risk and uncertainties actual results may differ materially from those expressed or implied by such forward-looking statements. Factors that could cause results to differ materially from those expressed or implied by such forward-looking statements include but are not limited to those discussed in filings made by the company with Securities and Exchange Commission. Many other factors that will determine the company's future results are beyond the ability of the management to control or predict. Listeners should not place undue reliance on forward-looking statements, which reflects management's views only as of the date hereof. The company undertakes no obligation to revise or update any forward-looking statements or make any other forward-looking statements, whether as a results of new information, future events or otherwise. At this time, I would like to turn the conference over to Stephen Merrick, President. Please go ahead, sir.

[Stephen Merrick:]

Good morning and welcome to CTI Industries earnings conference call for the third quarter 2014 and for the nine months ended September 30. My name is Stephen Merrick, I am the President of CTI, and I will be presenting our report with Tim Patterson, our Chief Financial Officer. At the conclusion of the report, there will be an opportunity for those of you who would like to ask questions of us. First let me say, we are pleased with the results of the third quarter, as they reflect our return to profitability after a couple of quarters in which we did not achieve the bottom line results we would like. As we have reported over the past two years, we invested significantly in the development of our new branded vacuum sealer product line, and in the introduction and marketing of that line. This investment resulted in increased operating expenses during that time. While we have always believed, these expenses were a good and justified investment in the product line and our future, they did impact our bottom line results. This year, we have been working to convert the increased revenues we have achieved into bottom line results, by continuing sales growth, managing our operating expenses, and improving our margins. On a sequential basis, we are seeing some positive results from those efforts. For the third quarter this year, we had net sales of $14,570,000 and net income of $210,000; compared to net sales of $13,159,000 and a net loss of $122,000 for the second quarter, and net sales of $14,920,000 and a net profit of $45,000 in the first quarter. In the third quarter, our income from operations was $519,000 compared to a loss from operations of $56,000 in the second quarter. So sequentially, over the course of this year, we are definitely seeing some improvement. Comparing to last year, our net sales for the third quarter were up slightly over net sales of $14,480,000 in the third quarter last year. Net income was slightly below net income for third quarter, net income last year of $234,000. On a per share basis, net income for the third quarter was $0.06 compared to $0.07 in the third quarter last year. For the nine months ended September 30, 2014, net sales were $42,649,000, compared to $40,859,000 for the same period last year, this is an increase of 4.4% for that period. Net profit for the period still reflecting the lower results for the first two quarters this year, was $132,000 compared to net income of $309,000 for the nine month period in 2013. Income per share for the nine months was $0.04 compared to $0.10 for the same period last year. A significant factor in our stronger performance in the third quarter this year has been the improvement in gross margins. In the third quarter this year, gross margins were 25.7%, probably the highest we have reported in a number of years, compared to 22.8% for the same period last year. For the nine months ended September 30, the gross margin rate was 24.1% compared to a rate of 21.4% for the same period last year. This improvement in gross margin is attributable principally to three things, first sales by the company of products carrying generally a higher gross margin rate. Second, sales of higher margin products by a variable interest entity, which markets home container products and is now consolidated with our financial results. And third, an increase in the gross margin rate at our Mexico subsidiary, which produces principally latex balloons. Turning to our product lines, we have experienced strong growth in the sales of foil balloons during the third quarter and the nine month period. Net sales of foil balloons in the third quarter this year were $5,657,000 compared to $4,679,000 in the same period last year, an increase of almost 21%. For the nine months ended September 30, 2014, net sales of foil balloons were $19,045,000 compared to $17,021,000 in the same period last year, an increase of 11.9%. The increase in revenues from the sale of foil balloons has occurred in the United States, the United Kingdom, Europe and Mexico. Most of this increase is represented in sales to five major chains located in the United States, the United Kingdom and Germany. Revenues from the sale of vacuum sealing systems have continued to improve at a moderate pace so far this year. In the nine months ended September 30, 2014, revenues of this product line have increased to $6,684,000 from $6,454,000 in the same period last year. Recently, we have introduced several new models of vacuum sealing machines, which we are now actively marketing, and we have also introduced a line of vacuum sealing canisters which work with our vacuum sealing machines. So we anticipate continued improvement in the sales of vacuum sealing machines over the next quarter and during 2015. While revenues from the sale of latex balloons has remained steady this year, the gross profit generated from the sale of latex balloons has increased as our gross margin rate on this product line has improved this year. Revenues from the sale of a mix of other products have also increased this year. These other products include first, sales of home container products by variable interest entity, which the company now consolidates with our financial results. Second, sales of Candy Blossoms and Candy Loons which consist of candy and small inflated balloons which we sell to retail outlets in small containers; and then third, the sale of accessories and supply items related to balloon products. For the nine months ended September 30, 2014, revenues from the sale of these other products were $2,655,000 compared to $1,955,000 for the same period last year. Our working capital remained strong, working capital balance as of September 30 this year was $11,285,000 and we had $900,000 in cash and availability on our line of credit. While we do not provide specific guidance, we expect a strong fourth quarter in terms of sales, particularly in foil balloons and in our vacuum sealing product line. We believe that our margins will continue to be strong during that period, and we expect that we will experience relative improvement in our operating expenses. So we are looking forward to a good fourth quarter. That completes our report, and at this time we will open the call for questions. Operator, may we have your assistance please?

[Operator:]

[Operator Instructions]. We will take our first question from Todd Brady with Oppenheimer.

[Todd Brady:]

Hi, can you guys hear me alright?

[Stephen Merrick:]

We hear you fine.

[Todd Brady:]

Okay great. Good morning. Listen, congratulations Steve on a nice quarter. Couple of questions; can you break out the difference in gross margin out of the three areas you talked about, the growing gross margins, especially the home container unit, and what are your thoughts as we get ready for calendar year 2015 on that particular unit, and what type of growth we could see for the company there? Second question, is there any update you can provide us on the loan the company has, and what management is doing to improve net interest expense, which would obviously benefit shareholders across the board? Thank you.

[Stephen Merrick:]

Sure Todd, that's a mouthful. On the margins, we broke it down into three categories there in terms of our report. One was the margins on the sale of general products by the company, and in general -- in part, I think because of the growing significance through our business of the vacuum sealing business, the general gross margin that we achieve company-wide has increased, and that's reflected in those products as well as some others. In the associated business of the home container lines, the gross margins on that business are actually quite high and considerably higher than our average margin that we have in our general product line. We expect that that business has grown fairly significantly over the past year and a half, and we expect it to continue to grow in 2015. With regard to the Flexo, our Mexican subsidiary on latex products, our margins have steadily increased over the past several years. In part, that's because of the moderation in the cost of raw material latex. We were at a point when latex was $6 a kilo three or four years ago, where our gross margins were down below 15%, and over the past year, we have been well above 20% and often I think more recently in 25% margin levels, and which obviously result in significantly improved gross margin rates on that latex product. And also in Flexo, we have expanded our volume significantly over the past couple of years, that makes our production more efficient. So for both of those reasons, our margins have improved. And I think in all of those cases, there is reason to expect that the margins that we are reporting now, at obviously improved levels from where they were a couple of years ago should continue. I think your second question was on our loans; as we have recorded, we have been engaged in efforts to do some refinancing related to our outstanding loan. We have in particular, a loan, that mezzanine loan at $5 million, which carries an interest rate of 11.5%, and also due to the warrants that were issued in connection to that we have to expense the amortization, there is a discount that's associated with those warrants, and we have to expense that discount as interest is current basis. We have been evaluating and looking at, as we have reported, the potential for doing some form of refinancing that would deal with that, and potentially result in a reduction of the interest burden that we will have to carry. We continue to work on that, but we do not have any specific things to report on that yet, and as soon as we do, we will certainly make it known.

[Todd Brady:]

Okay, fantastic. Just two quick follow-ups, you have really done a very-very good job of bringing your operating expense line down, your revenues are growing, you sound a little bit more confident about the tone of the business. I know like domestically, but internationally, should we -- I know you guys don't give guidance, but should we assume that you guys will be keeping a tight lid on the OpEx line, as your revenues continue to grow? How should we be thinking about the operating expense line, versus growth of the business; because it sounds like the business is growing? And secondly, are you guys seeing any benefits from the sort of broad recorrections and revaluation of commodities globally? Thank you.

[Stephen Merrick:]

Well on the operating expense side, I can tell you that it has been a very significant part of our efforts over the past several months, and it's going to continue to be so. As we have reported, we did invest significantly in the development of our new product line, particularly the vacuum sealing line, which resulted in fairly significantly increased operating expense, and we think that was a good investment to make. We are glad we made the investment, we think it will pay off. However, we recognize that we needed to rationalize the operating expense in relation to revenues, and we have been working very hard at doing that. I can tell you that we have gone through a very intensive process here, among all levels of the company, to address our operating expenses, and I think that you will -- should begin to see, when you compare -- in the fourth quarter for example, when you compare operating expenses in the fourth quarter this year to operating expenses in the fourth quarter last year, you should begin to see some significant results related to that. It has been -- as I said, a very important part of our efforts over the past several months. I think the other thing you asked about was on commodities; certainly on latex, that has been a huge change. Latex prices went from three years ago, at $6 a kilo, and I think they are now down around just a little over $3 a kilo. So literally, half from where they were. So that obviously has had an important effect on margins in the latex business. I know that the price of foil has come down, and one might expect there would be changes in some of our raw materials costs. We haven't seen significant increases in our film costs over the past year; although we also have I would -- we have seen significant declines either. One thing to recognize is, that in some good part of the film that we purchased, it's actually made from natural gas rather than from oil, and so in that arena, you haven't seen all that significant a reduction in the commodity. Commodities pricing generally has been positive for us, particularly because of the latex reduction, but the other part of it is, we really haven't seen significant increases in any of our commodities costs.

[Todd Brady:]

Okay. And then once again, I don't mean to be hogging up your Q&A time, but one final quick question. Steve, business looks good, you sound confident, what's your biggest fear over the next two to three quarters in your business? Thank you.

[Stephen Merrick:]

I don't fear anything. I think that, probably our biggest challenge is being effective at moderating and controlling our expenses, to a level at which we can be consistently and significantly profitable. That is our challenge and that is our goal, and we are working very hard to achieve it.

[Todd Brady:]

I appreciate the update. Keep up the good work. Thank you.

[Operator:]

[Operator Instructions]. We will go to John Banks with BG Capital.

[John Banks:]

Hey Steve, just two quick questions. Just one, you touched on operating expenses, we saw pretty sequential decline over last year, a pretty big jump, and with gross margins so high, we are hoping operating expenses go down, you should -- dramatic [ph] about leverage in the earnings per share and cash flow going forward, are we correct on that?

[Stephen Merrick:]

Well I think -- a couple of things on that John. First, I think as a percentage of revenues, you should see considerable moderation in terms of operating expenses as a percentage of revenues. In the fourth quarter and in the first quarter next year, if we are successful in our efforts here, you should see some absolute moderation in operating expenses as well. I have spent a good part of the last several months working very hard at that, and I could -- probably we make this call go on a long time, if we did give you a [indiscernible] list, it would be barely long of all of the specific items that we have acted on to control or reduce or eliminate some expenses. And so, we are working very hard at that, I think we will be successful.

[John Banks:]

And my second one, I know, we have been a long term shareholder, and we saw prices with latex were kind of swimming downstream now with the price of latex, can we hedge it at these prices, are you looking to hedge it at these levels; because again I remember two or three years ago when latex did the opposite and hurt the company pretty dramatically. So you guys are looking at -- are you looking to hedge it going forward [ph], or you think latex prices will stay down?

[Stephen Merrick:]

Well I am glad I am not a trader in latex futures, because predicting that would be very difficult. We have done some -- a limited amount of hedging, where we brought a few futures contracts on latex. Over the past six months, eight months or so, that has tended to -- the price of the futures contracts has tended to decline. Now in that sense probably the hedge was good, because even though there was decline in the futures, it was also a decline in the physical costs, so they offset each other. We do maintain a moderate level of hedging contracts, future contracts, and we are going to look at that very carefully. Recently, in the last six weeks or so, latex has begun to go up. Now whether that's a longer trend or not, I don't know, but we do have some hedging on it, and one of our issues is the extent at which we right now are hedging only a very small percentage of our total commitment to latex and one of the questions will be, whether we want to increase that or not, that's one of the not so easy questions that we are going to look at carefully and try to make a good decision.

[John Banks:]

Okay. My final question, the vacuum sales are down, can we see growth on that that you expect for next year?

[Stephen Merrick:]

Yes. I think that we expect fourth quarter to be good in that line and we have introduced some new models and a new line of canisters, and we are working hard to market them, I think that we should see some increase.

[John Banks:]

Okay. Thanks for your time.

[Stephen Merrick:]

Thank you.

[Operator:]

We will go next to Vincent Gargano, a private investor.

[Unidentified Analyst:]

Just wanted to congratulate you guys on a really strong turnaround, also to acknowledge the margin expansion, which is obviously going in the right direction. Couple of my questions are already hit on, as far as oil and a lower product for us. Could you touch on the shelf filing and where the process of that is at, at this point? Thanks again.

[Stephen Merrick:]

We did file a registration form S3. It was effective in -- I think late August or September. So the registration is there, it is effective, the number of shares that are -- as to which the registration is involved is 700,000 shares. There has been no transaction under the registration yet.

[Unidentified Analyst:]

Okay. And as far as refinancing that loan, which seemed to really be hampering the bottom line, I may have missed that early, I don't know if you touched on that earlier, could you just go through that again if you have? Thank you.

[Stephen Merrick:]

We are looking at -- we have been evaluating the process and the possibility of doing some form of refinancing, particularly on the mezzanine loan, which -- were we successful at that, would result in lower interest costs on a going forward basis. In fact, in the registration statement, we state that a purpose of the transaction to the extent that we go forward and conclude it, would be to utilize proceeds for the purpose of reducing the mezzanine loan. So to the extent that that occurs at some point, that would be -- our plan and intent would be to review the proceeds to reduce the mezzanine loan.

[Unidentified Analyst:]

All right, great. I just again want to congratulate you guys on a really strong turnaround and profitability, and things look good. I am good at averaging that. Yeah, no it looks good, the results are there. Appreciate it.

[Stephen Merrick:]

Thank you.

[Operator:]

We will go next to Michael Zavicka, private investor.

[Unidentified Analyst:]

Just a couple of quick questions, one most kind of touched on, on the hedging. Do you have any idea of the percentage that you're hedging with those futures contracts? Is it less than 25% of your --

[Stephen Merrick:]

It is -- I don't know the number, I haven't calculated it in terms of our total purchases of latex, but I would say that it's probably somewhere between 5% and 10%.

[Unidentified Analyst:]

5% and 10%. Now that you have righted the ship and returned to profitability, you'd signup for latex to stay at these levels right, if you could take 100% of your exposure at these prices, you'd probably say that'd be a good do for the company, would you agree with that?

[Stephen Merrick:]

The latex prices where they are, are very effective for us, in terms of having good margins on the product line. So in that sense, you are right. If they stayed where they were, the business works well.

[Unidentified Analyst:]

And you feel like it’s a solid hedge? Do you feel like it’s a struggle with -- is there something else going on, where you can't directly hedge your exposure to latex in the futures market? Or is it --

[Stephen Merrick:]

No its not that you can't -- there is a cost associated with the hedging, that you also have to take into account, I mean, because if you maintain and when you do futures contracts, you have to roll them over and there is a cost of rolling them over. So there are elements of cost that go into a hedging program, and obviously there is also, at some level, some risk as well, some market risk that you take. So it's something that we are trying to look at carefully and evaluate and do a responsible job of addressing that. And your question is a good one, its one we are asking ourselves, and we are looking at it pretty carefully. There is the potential, if you read the reports, there is the potential that the report suggests that there still is a massive oversupply of raw latex, and so there is the potential that you could see further price declines. But that's very difficult to predict, and one of the things I think we are trying to do carefully, is to become effective at managing that process, that is the pricing of latex, the potential hedging on latex, and all the ramification to that.

[Unidentified Analyst:]

You could also have not a doomsday hedge, but a hedge against prices really getting away from you, and doing it through options, which should give you a cheaper route, more leverage for your costs. I don't know if you guys are --

[Stephen Merrick:]

Options on the futures, you mean?

[Unidentified Analyst:]

Yes. Just if you are worried about latex really getting away from you, you could do some cheaper hedging in the options market. My other question was, there are no call -- are there call features on the mezzanine that are prohibiting us from -- if we came into cash, we could pay off as much of that loan as we wanted to?

[Stephen Merrick:]

No prepayment. Well there is a prepayment penalty, but at this point, it's very small. And so there is nothing that would prevent us from paying the mezzanine -- the principle of the mezzanine off, if we were in a position to do that.

[Unidentified Analyst:]

Okay, that's it. Thank you.

[Stephen Merrick:]

Thank you.

[Operator:]

[Operator Instructions]. It appears there are no further questions at this time. I'd like to return the conference back to Mr. Stephen Merrick for any additional remarks.

[Stephen Merrick:]

Thanks everyone. Appreciate your interest and being on the call. We are pleased to be able to give you the report that we did, and look forward to doing the same at the beginning part of next year. Thanks again and have a good day.

[Operator:]

This concludes today's conference. Thank you for your participation.