**UNITED
        STATES**
 **SECURITIES
        AND EXCHANGE COMMISSION**
 **WASHINGTON,
        D.C. 20549**
  
 
 **FORM
        10-K**
  **(Mark
        One)**
  x
              **ANNUAL
                  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
                  ACT OF
                  1934**
  **For
                  the fiscal year ended December 31, 2006****OR**
  o
              **TRANSITION
                  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
                  ACT OF
                  1934**
  For
        the
        transition period from _________to_________
  **Commission
        File Number**
 **000-23115**
 
 **CTI
        INDUSTRIES CORPORATION**
 (Exact
        name of Registrant as specified in its charter)
 Illinois
                36-2848943(State
                    or other jurisdiction of
                (I.R.S.
                    Employer Identification Number)incorporation
                    or organization)
 
 22160
                    N. Pepper RoadBarrington,
                    Illinois
                60010(Address
                    of principal executive offices)
                (Zip
                    Code)
 
 Registrant’s
          telephone number, including area code: (847) 382-1000
 
 Securities
          Registered pursuant to sections 12(b) of the Act:
 
 Title
                    of Each Class
                Name
                    of Each Exchange on Which RegisteredCommon
                    Stock, No Par
                NASDAQ
                    Capital Market
  Securities
        registered pursuant to Section 12(g) of the Act: None
 
 Indicate
        by check mark if the registrant is a well-known seasoned issuer, as defined
        in
        Rule 405 of the Securities Act. Yes o No þ
 
 Indicate
        by check mark if the registrant is not required to file reports pursuant
        to
        Section 13 or Section 15(d) of the Exchange Act. Yes o No þ
 
 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 þ No o
 
 Indicate
        by check mark if disclosure of delinquent filers pursuant to Item 405 of
        Regulation S-K is not contained herein, and will not be contained, to the
        best
        of Registrant’s knowledge, in definitive proxy or information statements
        incorporated by reference in Part III of this Form 10-K or any amendment
        to this
        Form 10-K.  þ
  Indicate
        by check mark whether the Registrant is a large accelerated filer, an
        accelerated filer, or a non-accelerated filer. See definition of “accelerated
        filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
        (Check one):
 
 Large
        accelerated filer o Accelerated
        filer o Non-accelerated
        filer þ
  Indicate
        by check mark whether the Registrant is a shell company (as defined in
        Rule 12b-2 of the Exchange Act).  Yes o No þ
 
 Based
        upon the closing price of
        $2.71
        per share of
        the Registrant’s Common Stock as reported on NASDAQ Capital Market tier of The
        NASDAQ Stock Market on June 30, 2006, the aggregate market value of the voting
        common stock held by non-affiliates of the Registrant was then approximately
        $2,945,014. (The determination of stock ownership by non-affiliates was made
        solely for the purpose of responding to the requirements of the Form and
        the
        Registrant is not bound by this determination for any other
        purpose.)
 
 The
        number of shares outstanding of the Registrant’s Common Stock as of March 20,
        2007 was 2,187,403 (excluding treasury shares).
 
 DOCUMENTS
        INCORPORATED BY REFERENCE
 Document
                
                Part
                    of Form 10-K into Which
                  Document
                    Is IncorporatedSections
                    of the registrant’s Proxy Statement
                
                Part
                    IIITo
                    be filed on or before April 30, 2007 for theAnnual
                    Meeting of Stockholders
  
  **TABLE
        OF CONTENTS**
 
 **INDEX**
  EXPLANATORY
        STATEMENT
 
 FORWARD
        LOOKING STATEMENTS
 Part
                    IItem
                    No. 1
                Business
                1Item
                    No. 1A
                Risk
                    Factors
                13Item
                    No. 1B
                Unresolved
                    Staff Comments
                22Item
                    No. 2
                Properties
                22Item
                    No. 3
                Legal
                    Proceedings
                22Item
                    No. 4
                Submission
                    of Matters to a Vote of Security Holders
                23Part
                    IIItem
                    No. 5
                Market
                    for Registrant’s Common Equity, Related Stockholder Matters and Issuer
                    Purchases of Equity Securities
                24Item
                    No. 6
                Selected
                    Financial Data
                28Item
                    No. 7
                Management’s
                    Discussion and Analysis of Financial Condition and Results of
                    Operations
                29Item
                    No. 7A
                Quantitative
                    and Qualitative Disclosures About Market Risk
                44Item
                    No. 8
                Financial
                    Statements and Supplementary Data
                45Item
                    No. 9
                Changes
                    in and Disagreements with Accountants on Accounting and Financial
                    Disclosure
                45Item
                    No. 9A
                Controls
                    and Procedures
                45Item
                    No. 9B
                Other
                    Information
                46Part
                    III
 
 **Incorporated
          by Reference from the definitive Proxy Statement of the Company, if filed
          on or
          before April 30, 2007 or, if not filed by such date, to be incorporated
          by
          amendment to this Annual Report to be filed on or before April 30,
          2007.**
 
 Part
                    IVItem
                    No. 15
                Exhibits
                    and Financial Statement Schedules
                47
 
 **FORWARD-LOOKING
        STATEMENTS**
 
 This
        annual 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
        annual report. We disclaim any intent or obligation to update any
        forward-looking statements after the date of this annual report to conform
        such
        statements to actual results or to changes in our opinions or expectations.
        These forward-looking statements are affected by risks, uncertainties and
        assumptions that we make, including, among other things, the factors that
        are
        described in “Item No. 1A - Risk Factors.”
  **PART
        I**
 
 **Item
        No. 1 Business**
 
 **Business
        Overview**
 
 We
        develop, produce, market and sell two principal lines of products:
 
 ·
              **Novelty
                  products**,
                  principally balloons, including metalized balloons, latex balloons,
                  punch
                  balls and other inflatable toy items, and
 
 ·
              **Specialty
                  and printed films and flexible containers**,
                  for food packaging, specialized consumer uses and various commercial
                  applications.
 
 We
        focus
        our business and efforts on the printing, processing and converting of plastic
        film, and of latex, into finished products. We:
 
 ·
              Coat
                  and laminate plastic film. Generally, we adhere polyethylene film
                  to
                  another film such as nylon or
                  polyester
 
 ·
              Print
                  plastic film and latex balloons. We print films, both plastic and
                  latex
                  with a variety of graphics for use as packaging film or for
                  balloons.
 
 ·
              Convert
                  printed plastic film to balloons.
  1
 ·
              Convert
                  plastic film to flexible containers. These finished products are
                  used to
                  store and package food and for storage of a variety of personal
                  items.
 
 ·
              Convert
                  latex to balloons and other novelty
                  items.
 
 We
        market
        and sell metalized and latex balloons in the United States and in several
        other
        countries. We supply coated, laminated and printed films to a number of
        companies who generally convert these films into containers for the packaging
        of
        food and other items. We supply flexible containers to companies who (i)
        use
        them for packaging of food or other items or (ii) market them to consumers
        who
        use them for the storage of personal items. We also market containers to
        and
        through retail outlets for use by consumers with sealing devices to store
        food
        items in their homes. In March 2006, we announced that we are completing
        the
        development of, and will produce, market and sell, a line of pouches for
        use by
        consumers to store food items. The pouches include a resealable closure system
        and a valve permitting the evacuation of air from the pouch by a small pump
        device which we will also supply. See Business Strategies below.
 
 In
        1978,
        we began manufacturing metalized balloons (sometimes referred to as "foil"
        balloons), which are balloons made of a base material (usually nylon or
        polyester) having vacuum deposited aluminum and polyethylene coatings. These
        balloons remain buoyant when filled with helium for much longer periods than
        latex balloons and permit the printing of graphic designs on the surface.
 
 In
        1985,
        we began marketing latex balloons and, in 1988 we began manufacturing latex
        balloons. In 1994, we sold our latex balloon manufacturing equipment to a
        company in Mexico and entered into an arrangement for that company to
        manufacture latex balloons for us. Since 1997, we have manufactured latex
        balloons in Mexico through a majority-owned subsidiary.
 
 We
        market
        and sell our metalized and latex balloons and related novelty items directly
        to
        retail stores and chains and through distributors, who in turn sell to retail
        stores and chains. Our balloon and novelty products are sold to consumers
        through a wide variety of retail outlets including general merchandise and
        drugstore chains, grocery chains, card and gift shops, and party goods stores,
        as well as through florists and balloon decorators.
 
 Most
        of
        our metalized balloons contain printed characters, designs and social expression
        messages, such as “Happy Birthday”, “Get Well Soon” and similar items. In a
        number of cases, we obtain licenses for well-known characters and print those
        characters and messages on our balloons. Currently, we maintain licenses
        for
        Garfield ® ,
        Face
        Offs-Tudes ® ,
        Miss
        Spider and Sunny Patch Friends®, Andrea Mistretta and Wow Wow Wubsy®. In the
        United Kingdom, we maintain licenses on Postman Pat ® ,
        The
        Crazy Frog® and Dream Fairies ® .
 
 Balloons
        and novelty items accounted for 65.3% of our revenues in 2006. The remainder
        of
        our revenues is generated from the sale of laminated film products, generally
        intended for use in the packaging of foods, liquids and other materials.
        We
        provide laminated films, and printed films, to a number of customers who
        utilize
        the film to produce bags or pouches for the packaging of food, liquids and
        other
        items. We also produce finished products - pouches and bags - which are used
        for
        a variety of applications, including (i) as vacuumable consumer storage devices
        for clothing and other household items, (ii) as vacuumable pouches for household
        use in storage of food items, and (iii) as “dunnage” items which, when inflated,
        cushion products in a package or container. In 2006, our revenues from these
        products represented approximately 32.4% of our net revenues.
  2
 
 We
        are an
        Illinois corporation with our principal offices and plant at 22160 N. Pepper
        Road, Barrington, Illinois.
  **Business
        Strategies**
 
 Our
        essential business strategies are as follows:
 
 ·
              *Focus
                  on our Core Assets and Expertise*.
                  We have been engaged in the development, production and sale of
                  film
                  products for over 30 years and have developed assets, technology
                  and
                  expertise which, we believe, enable us to develop, manufacture,
                  market and
                  sell innovative products of high quality within our area of knowledge
                  and
                  expertise. We plan to focus our efforts in these areas which are
                  our core
                  assets and expertise - laminated films, printed films, pouches
                  and film
                  novelty products - to develop new products, to market and sell
                  our
                  products and to build our revenues.
 
 ·
              *Develop
                  Operating Efficiencies to Enhance our Profitability*.
                  We have engaged in a program to reduce and control production expenses,
                  as
                  well as selling, general and administrative expenses, in order
                  to increase
                  the efficiencies of our operations and to become profitable at
                  current
                  levels of revenue. During 2006, we reduced our cost of goods to
                  74.9% of
                  net sales from a level of 77.9% of net sales in 2005. In addition,
                  during
                  2006, operating expenses were reduced as a percentage of net sales
                  from
                  19.9% in 2005 to 17.7% in 2006.
 
 ·
              *Develop
                  New Products, Product Improvements and Technologies*.
                  We work constantly to develop new products, to improve existing
                  products
                  and to develop new technologies within our core product areas,
                  in order to
                  enhance our competitive position and our sales. In the novelty
                  line, our
                  development work includes new designs, new character licenses and
                  new
                  product developments. During 2006, we introduced more than 106
                  new balloon
                  designs and obtained one new licensed character design. We also
                  developed
                  and introduced a device to amplify sound through a balloon so that
                  voice
                  and music can be played and amplified using our Balloon JamzTM balloon. In
                  our commercial line, over the past several years we have developed
                  new
                  pouch closure systems and valves and new film methods for liquid
                  packaging
                  applications. We have received 13 patents for these developments
                  and have
                  2 patent applications pending. During 2007, we plan to introduce
                  a line of
                  resealable pouches with a valve and pump system for household storage
                  and
                  vacuum sealing of food items.
  3
  ·
              *Develop
                  New Channels of Distribution and New Sales Relationships*.
                  In order to increase sales, we endeavor to develop new channels
                  of
                  distribution and new sales relationships, both for existing and
                  new
                  products. In March 2006, we entered into a four year agreement
                  with
                  Illinois Tool Works, Inc. (“ITW”) to manufacture certain pouches for them
                  and to provide film to them for their pouch production. In April
                  2006, we
                  entered into a license agreement with Rapak L.L.C. (“Rapak”) (formerly a
                  related party) granting Rapak a license under a patent related
                  to textured
                  film and pouches, and extending the term of an existing supply
                  agreement
                  with Rapak to October 31, 2008.
  **Products**
 
 *Metalized
        Balloons* .
        We have
        designed, produced and sold metalized balloons since 1979 and, we believe,
        are
        the second largest manufacturer of metalized balloons in the United States.
        Currently, we produce over 650 balloon designs, in different shapes and sizes,
        including the following:
 
 ·
              Superloons®-
                  18" balloons in round or heart shape, generally made to be filled
                  with
                  helium and remain buoyant for long periods. This is the predominant
                  metalized balloon size.
 
 ·
              Ultraloons®-
                  34" balloons made to be filled with helium and remain buoyant.
 
 ·
              Miniloons®-
                  9" balloons made to be air-filled and sold on holder-sticks or
                  for use in
                  decorations.
 
 ·
              Card-B-Loons®(4
                  1/2") - air-filled balloons, often sold on a stick, used in floral
                  arrangements or with a container of candy.
 
 ·
              Shape-A-Loons®-
                  shaped balloons made to be filled with helium.
 
 ·
              Minishapes
                  - small shaped balloons designed to be air filled and sold on sticks
                  as
                  toys or inflated characters.
 
 ·
              Balloon
                  JamzTM-
                  20” to 40” round and shaped balloons which emit and amplify sound through
                  a speaker attached to the balloon.
 
 In
        addition to size and shape, a principal element of the Company's metalized
        balloon products is the printed design or message contained on the balloon.
        These designs include figures and licensed characters many of which are
        well-known. We maintain licenses for several characters, including
        Garfield ® ,
        Face
        Offs-Tudes, Miss Spider and Sunny Patch Friends®, Andrea Mistretta and Wow Wow
        Wubsy®, and in the United Kingdom, Postman Pat ® ,
        The
        Crazy Frog® and Dream Fairies.
  4
 
 *Latex
        Balloons* .
        Through
        our majority-owned subsidiary in Guadalajara, Mexico, Flexo Universal, S.A.
        de
        C.V. (“Flexo Universal”), we manufacture latex balloons in 6 shapes and sizes
        and 40 colors. These balloons are marketed under the name Partyloons®. We also
        manufacture toy balloon products including punch balls, water bombs and "Animal
        Twisties."
 
 *Packaging
        Films* .
        We
        produce and sell films that are utilized for the packaging of various products,
        principally food products. We laminate, extrusion coat and print films and
        sell
        them to customers who utilize the films for packaging applications. Our
        customers generally use these film products to convert them to bags or pouches
        for the packaging of food and other products.
 
 *Pouches,
        Bags and Other Custom Film Products* .
        We
        produce a variety of completed film products, generally in the form of a
        bag or
        pouch. These products include (i) valved, resealable pouches for storage
        of
        household items, (ii) vacuum sealable bags for food storage, (iii) resealable,
        valved bags for storage and vacuum sealing of food items in the household,
        (v)
“dunnage” bags (inflatable pouches used to cushion products in packages. During
        2005 and 2006, we marketed our food storage bags under the name Simply SmartTM.
        In March 2006, we announced that we will be offering a line of resealable,
        valved bags for storage and vacuum sealing of food items in the household.
        These
        storage bags will function with a small hand or powered pump to evacuate
        air
        when the bag is sealed. We continue development of this pouch storage system
        and
        plan to introduce a product line during 2007.
 
 **Markets**
 
 *Metalized
        Balloons*
 
 The
        metalized balloon came into existence in the late 1970s. During the 1980s,
        the
        market for metalized balloons grew rapidly. Initially, the product was sold
        principally to individual vendors, small retail outlets and at fairs, amusement
        parks, shopping centers and other outdoor facilities and functions. Metalized
        balloons remain buoyant when filled with helium for extended periods of time
        and
        they permit the printing and display of graphics and messages. As a result,
        the
        product has significant appeal as a novelty and message item. Metalized balloons
        became part of the "social expression" industry, carrying graphic designs,
        characters and messages like greeting cards. In the mid-1980s, we and other
        participants in the market began licensing character and cartoon images for
        printing on the balloons and directed marketing of the balloons to retail
        outlets including grocery, general merchandise, discount and drug store chains,
        card and gift shops, party goods stores as well as florists and balloon
        decorators. These outlets now represent the principal means for the sale
        of
        metalized balloons throughout the United States and in a number of other
        countries.
 
 Metalized
        balloons are sold in the United States and in Europe, several countries in
        the
        Far East, Canada and to an increasing extent in Latin America. The United
        States, however, is by far the largest market for these products.
  5
 
 Metalized
        balloons are sold in the United States and foreign countries directly by
        producers to retail outlets and through distributors and wholesalers. Often
        the
        sale of metalized balloons by the wholesalers/distributors is accompanied
        by
        related products including latex balloons, floral supplies, candy containers,
        mugs, plush toys, baskets and a variety of party goods.
 
 *Latex
        Balloons*
 
 For
        a
        number of years, latex balloons and related novelty/toy latex items have
        been
        marketed and sold throughout the United States and in most other countries.
        Latex balloons are sold as novelty/toy items, for decorative purposes, as
        part
        of floral designs and as party goods and favors. In addition to standard
        size
        and shape balloons, inflatable latex items include punch balls, water bombs,
        balloons to be twisted into shapes, and other specialty designs. Often, latex
        balloons included printed messages or designs.
 
 Latex
        balloons are sold principally in retail outlets, including party goods stores,
        general merchandise stores, discount chains, gift stores and drugstore chains.
        Balloons are also purchased by balloon decorators and floral outlets for
        use in
        decorative or floral designs.
 
 Printed
        latex balloons are sold both in retail outlets and for balloon decoration
        purposes including floral designs. "Toy" balloons include novelty balloons
        sold
        in toy departments or stores, punch balls, water bombs and other specialty
        designs.
 
 Latex
        balloons are sold both through distributors and directly to retail outlets
        by
        the producers.
 
 *Printed
        and Specialty Films*
 
 The
        industry and market for printed and specialty films is fragmented and includes
        many participants. There are hundreds of manufacturers of printed and specialty
        film products in the United States and in other markets. In many cases,
        companies who provide food and other products in film packages also produce
        or
        process the films used for their packages. The market for the Company's film
        products consists principally of companies who utilize the films for the
        packaging of their products, including food products and other items. In
        addition to the packaging of food products, flexible containers are used
        for
        medical purposes (such as colostomy bags, containers for saline solution
        and
        other items), "dunnage" (to cushion products being packaged), storage of
        personal and household items and other purposes.
 
 *Flexible
        Containers/Pouches*
 
 The
        market for flexible containers and pouches is large and diverse. Many companies
        engaged in the production of food items package their products in flexible
        containers or pouches, and, therefore, represent a market for these containers.
        Many of these companies purchase film - often printed film - and convert
        the
        film to pouches or packages at their own facilities while others purchase
        completed containers from suppliers.
  6
 
 Flexible
        containers and pouches are sold and utilized in the consumer market in numerous
        forms. They include simple open-top plastic bags, resealable bags and zippered
        bags. The market also includes containers and pouches of special design or
        purpose, including vacuumable bags for storage of food or household items,
        medical bags, or commercial uses.
 
 **Marketing,
        Sales and Distribution**
 
 *Balloon
        Products*
 
 We
        market
        and sell our metalized balloon, latex balloon and related novelty products
        throughout the United States and in a number of other countries. We maintain
        a
        marketing staff, sales staff and support staff of 10 individuals and a customer
        service department of 3 individuals. European sales are conducted by CTI
        Balloons, the Company's subsidiary located in Rugby, England. Flexo Universal
        conducts sales and marketing activities for the sale of balloon products
        in
        Mexico, Latin America, and certain other markets. Sales in other foreign
        countries are made generally to distributors in those countries and are managed
        at the Company's principal offices.
 
 We
        sell
        and distribute our balloon products (i) by our employed staffs of sales and
        customer service personnel in the United States, Mexico and the UK, (ii)
        through
        a network of distributors and wholesalers in the United States, Mexico and
        the
        UK, (iii) through several groups of independent sales representatives and
        (iv)
        to selected retail chains. The distributors and wholesalers are generally
        engaged principally in the sale of balloons and related products (including
        such
        items as plush toys, mugs, containers, floral supplies and other items) and
        sell
        balloons and related products to retail outlets including grocery, general
        merchandise and drug store chains, card and gift shops, party goods stores
        as
        well as florists and balloon decorators.
 
 Our
        largest customer for balloons during 2006 was Dollar Tree Stores. Sales to
        this
        chain in 2006 represented $8,596,000 or approximately 24.3% of our net
        sales.
 
 We
        engage
        in a variety of advertising and promotional activities to promote the sale
        of
        our balloon products. Each year, we produce a complete catalog of our balloon
        products, and also prepare various flyers and brochures for special or seasonal
        products, which we disseminate to thousands of customers, potential customers
        and others. We participate in several trade shows for the gift, novelty,
        balloon
        and other industries and advertise in several trade and other
        publications.
 
 *Printed
        and Specialty Films*
 
 We
        market
        and sell printed and laminated films directly and through independent sales
        representatives throughout the United States. We sell laminated and printed
        films to companies that utilize these films to produce packaging for a variety
        of products, including food products, in both liquid and solid form, such
        as
        cola syrup, coffee, juices and other items. We seek to identify and maintain
        customer relationships in which we provide value-added in the form of technology
        or systems. Our largest customer for film products is Rapak, L.L.C. (“Rapak”) to
        whom we provide a patented embossed film, as well as other film products.
        During
        2006, our sales to Rapak totaled $7,110,000, representing 20.1% of our net
        sales **.** Under
        our
        continuing agreement with Rapak, through October 31, 2008, Rapak is committed
        to
        purchase at least 65% of its requirements for embossed film from us. We
        anticipate that Rapak will continue to purchase film from us after this date
        but
        we have no contractual commitment from Rapak for such purchases.
  7
 
 *Flexible
        Containers/Pouches* .
 
 We
        market
        flexible containers and pouches to various companies for commercial packaging
        purposes and we market lines of consumer storage packages both to a principal
        customer and to retail chains and outlets.
 
 We
        produce consumer storage bags for ITW Space Bag, a division of Illinois Tool
        Works, Inc. (“ITW”) During 2006, ITW was our largest customer for pouches. Our
        sales of pouches to them in 2006 were $2,526,000, representing 7.1% of our
        net
        sales. In March 2006, we entered into a four-year agreement with ITW under
        which
        we will supply all of their requirements in North America for certain of
        their
        pouches which they market under the name Space Bag® and also are to supply their
        requirements of film for certain of the pouches which they produce.
 
 During
        2005, we introduced a line of universal vacuumable bags for household storage
        of
        food products. These bags are designed to be used with existing vacuum and
        sealing devices. We have announced the planned introduction of a new line
        of
        household food storage systems which will incorporate a re-sealable bag with
        a
        valve and a pump to evacuate air from the bag when the bag is sealed. We
        anticipate that this new product line will be available for sale during the
        second half of 2007.
 
 We
        also
        produce "dunnage" bags (inflatable packaging pouches) which we sell to a
        commercial customer.
 
 **Production
        and Operations** ***.***
 
 We
        conduct our operations at four facilities: (i) our headquarters, offices
        and
        plant at Barrington, Illinois, consisting of a total of approximately 75,000
        square feet of office, production and warehouse space, (ii) a warehouse in
        Cary,
        Illinois, consisting of approximately 16,000 square feet of space, (iii)
        a
        plant, office and warehouse in Guadalajara, Mexico, consisting of approximately
        43,000 square feet of office, warehouse and production space and (iv) an
        office
        and warehouse facility at Rugby, England, consisting of approximately 16,000
        square feet of space.
  8
 
 We
        conduct production operations at our plants in Barrington, Illinois and
        Guadalajara, Mexico. At our plants, our production operations include (i)
        lamination and extrusion coating of films, (ii) slitting of film rolls, (iii)
        printing on film and on latex balloons, (iv) converting of film to completed
        products including balloons, flexible containers and pouches and (v) production
        of latex balloon products. We perform all of the lamination, extrusion coating
        and slitting activities in our Barrington, Illinois plant and produce all
        of our
        latex balloon products at our Guadalajara, Mexico plant. We print films in
        Barrington, Illinois and we print latex balloons in Guadalajara,
        Mexico.
 
 We
        warehouse raw materials at our plants in Barrington, Illinois and Guadalajara,
        Mexico and we warehouse finished goods at our facilities in Barrington,
        Illinois, Cary, Illinois, Guadalajara, Mexico and Rugby, England. We maintain
        customer service and fulfillment operations at each of our warehouse locations.
        We conduct sales operations for the United States and for all other markets,
        except those handled by our Mexico and England facilities, in the Barrington,
        Illinois facility. Sales for Mexico and Latin America are handled in our
        Guadalajara, Mexico facility and sales for the United Kingdom and Europe
        are
        handled at our Rugby, United Kingdom facility.
 
 We
        maintain a graphic arts and development department at our Barrington, Illinois
        facility which designs our balloon products and graphics. Our creative
        department operates a networked, computerized graphic arts system for the
        production of these designs and of printed materials including catalogues,
        advertisements and other promotional materials.
 
 We
        conduct administrative and accounting functions at our headquarters in
        Barrington, Illinois and at our facilities in Guadalajara, Mexico and Rugby,
        England.
 
 **Raw
        Materials**
 
 The
        principal raw materials we use in manufacturing our products are (i) petroleum
        or natural gas-based films, (ii) petroleum or natural gas-based resin, (iii)
        latex and (iv) printing inks. The cost of these raw materials represented
        39.6%
        of our net revenues in 2006. Because much of the raw materials we utilize
        are
        based on petroleum or natural gas, we have experienced fluctuation in pricing,
        in relation to the fluctuation of availability and pricing of these source
        commodities. We have also experienced significant fluctuation in the cost
        of raw
        latex which we use for our latex balloon products. While we currently purchase
        our raw materials from a relatively limited number of sources, films, resin,
        inks and latex are available from numerous sources and, in the past, we have
        generally been able to obtain a sufficient supply of raw materials. However,
        during August and September 2005, the petrochemical industry suffered facility
        damage, production disruptions and transportation shortages due to the impact
        of
        two Gulf Coast hurricanes. As a result, both the price and availability of
        petroleum and natural gas-based products were affected into the first quarter
        of
        2006. For the remainder of the year and through the first quarter of 2007
        both
        price and available returned to levels typical of those before the hurricanes.
        While we were generally able to obtain a sufficient supply of raw materials
        to
        meet our needs during this time, prices of raw materials escalated rapidly
        and
        substantially; hence, the risk of shortages of raw materials supply existed.
        There can be no assurance that the price of such raw materials, and their
        availability, will not be affected similarly in the future and such events
        could
        have a material adverse effect on the business of the Company.
  9
 
 **Information
        Technology Systems**
 
 Our
        corporate headquarters in Barrington, Illinois and our warehouse facility
        in
        Cary, Illinois are serviced by a PC-based local area network. We connect
        the
        facilities via a high speed T1 line that carries both voice and data. The
        PC-based network incorporates both Novell and Microsoft servers. Access to
        the
        network is available to all employees but is secured using password
        authentication. The network allows us to leverage printing resources, create
        shared file areas for cross-departmental functions and allows for a single
        source backup of critical business files. On the network, we run Macola
        financial system software. Macola is a modular software system. We presently
        use
        the general ledger, order entry, inventory management, purchase order,
        electronic data exchange and custom report writing modules of that system
        and
        are engaged in a program to install and use additional modules including
        manufacturing costing and controls and inventory controls. Internal and external
        employee communications are handled by industry standard Microsoft Exchange
        email, allowing us to communicate with customers and vendors all over the
        world.
        We also provide a secure, firewall protected T1 connection to the Internet
        so
        that employees can research issues, support customers and securely move
        data.
 
 At
        each
        of our Mexico and England facilities, we operate server computers and local
        area
        networks, accessible to employees at those facilities. At each of those
        facilities, we operate separate integrated financial, order entry and inventory
        management systems.
 
 **Competition**
 
 The
        balloon and novelty industry is highly competitive, with numerous competitors.
        We believe there are presently six principal manufacturers of metalized balloons
        whose products are sold in the United States including Anagram International,
        Inc., Pioneer Balloon, Convertidora International, Barton Enterprises and
        Betallic. Several companies market and sell metalized balloons designed by
        them
        and manufactured by others for them.
 
 We
        believe there are approximately five manufacturers of latex balloons whose
        products are sold in the United States and numerous others whose products
        are
        sold in other countries.
 
 The
        market for films, packaging and custom products is fragmented, and competition
        in this area is difficult to gauge. However, there are numerous participants
        in
        this market and the Company can expect to experience intense quality and
        price
        competition.
  10
 
 Many
        of
        these companies offer products and services that are the same or similar
        to
        those offered by us and our ability to compete depends on many factors within
        and outside our control. There are a number of well-established competitors
        in
        each of our product lines, several of which possess substantially greater
        financial, marketing and technical resources and have established, extensive,
        direct and indirect channels of distribution for their products and services.
        As
        a result, such competitors may be able to respond more quickly to new
        developments and changes in customer requirements, or devote greater resources
        to the development, promotion and sale of their products and services than
        we
        can. Competitive pressures include, among other things, price competition,
        new
        designs and product development and copyright licensing.
 
 **Patents,
        Trademarks and Copyrights**
 
 We
        have
        developed or acquired a number of intellectual property rights, which we
        believe
        are significant to our business.
 
 *Copyright
        Licenses.* We
        maintain licenses on certain popular characters and designs for our balloon
        products. We presently maintain seven licenses and produce balloon designs
        utilizing the characters or designs covered by the licenses. Licenses are
        generally maintained for a one or two year term, although the Company has
        maintained long term relationships with several of its licensors and has
        been
        able to obtain renewal of its license agreements with them.
 
 *Trademarks.* We own
        12 **** registered
        trademarks in the United States relating to our balloon products. Many of
        these
        trademarks are registered in foreign countries, principally in the European
        Union.
 
 *Patent
        Rights.* We own,
        or have license rights under, or have applied for, patents related to our
        balloon products, certain film products and certain flexible container products.
        These include (i) ownership of two patents, and a license under a third,
        relating to self-sealing valves for metalized balloons and methods of making
        balloons with such valves, (ii) several metalized balloon design patents,
        (iii)
        patents and applications related to the design and structure of, and method
        of
        inserting and affixing, zipper-closure systems in a bag, (iv) patents related
        to
        one-way valves for pouches, (v) a patent related to methods of embossing
        film
        and utilizing such film to produce pouches with fitments, and (vi) patent
        applications related to vacuumable storage bags with fitments.
 
 **Research
        and Development**
 
 We
        maintain a product development and research department of five individuals
        for
        the development or identification of new products, product components and
        sources of supply. Research and development includes (i) creative product
        development, (ii) creative marketing, and (iii) engineering development.
        During
        each of the fiscal years ended December 31, 2006, 2005, 2004, respectively,
        the
        total amount spent on research and development activities was approximately
        $230,000, $224,000 and $246,000, respectively.
  11
 
 **Employees**
 
 As
        of
        December 31, 2006, the Company had 79 full-time employees in the United States,
        of whom 13 are executive or supervisory, 5 are in sales, 43 are in manufacturing
        or warehouse functions and 18 are clerical. As of that same date, we had
        10
        full-time employees in England, of whom 2 are executive or supervisory, 2
        are in
        sales, 4 are in warehousing and 2 are clerical. At Flexo Universal, our Mexico
        subsidiary, as of December 31, 2006, we had 215 full-time employees, of whom
        5
        are executive or supervisory, 3 are in sales, 196 are in manufacturing and
        11
        are clerical. The Company is not a party to any collective bargaining agreement
        in the United States, Mexico or the United Kingdom, has not experienced any
        work
        stoppages and believes that its relationship with its employees is
        satisfactory.
 
 **Regulatory
        Matters**
 
 Our
        manufacturing operations in the United States are subject to the U.S.
        Occupational Safety and Health Act ("OSHA"). We believe we are in material
        compliance with OSHA. The Company generates liquid, gaseous and solid waste
        materials in its operations in Barrington, Illinois and the generation, emission
        or disposal of such waste materials are, or may be, subject to various federal,
        state and local laws and regulations regarding the generation, emission or
        disposal of waste materials. We believe we are in material compliance with
        applicable environmental rules and regulations. Several states have enacted
        laws
        limiting or restricting the release of helium filled metalized balloons.
        We do
        not believe such legislation will have any material effect on our operations.
 
 **International
        Operations**
 
 We
        sell
        balloon products in a number of countries outside the United States. Sales
        of
        these products for the United Kingdom and Europe are handled by our facility
        and
        personnel in Rugby, England, and for Mexico and Latin America are handled
        by our
        facility and personnel in Guadalajara, Mexico. In other countries, we sell
        balloon products through distributors located in those countries. We conduct
        production, packaging, warehousing and sales operations in Mexico and
        warehousing and sales operations in the United Kingdom. We rely and are
        dependent on our operations in Mexico for the supply of latex balloons in
        the
        United States, Mexico, Europe and other markets. Interruption of that supply
        would have a material adverse effect on the business of the Company.
 
 Our
        domestic and international sales and assets by area over the period 2004
        - 2006
        have been as follows:
 **United
                    States**
                
                **United
                    Kingdom**
                
                **Mexico**
                
                **Eliminations**
                
                **Consolidated**Year
                    ended 12/31/06Revenues
                
                $
                28,808,000
                
                $
                2,925,000
                
                $
                6,564,000
                
                
                ($2,869,000
                )
                $
                35,428,000Operating
                    income (loss)
                
                $
                2,116,000
                
                $
                64,000
                
                $
                578,000
                
                
                ($25,000
                )
                $
                2,733,000Net
                    income (loss)
                
                $
                1,544,000
                
                $
                93,000
                
                $
                284,000
                
                
                ($26,000
                )
                $
                1,895,000Total
                    Assets
                
                $
                25,245,000
                
                $
                2,627,000
                
                $
                5,050,000
                
                
                ($6,288,000
                )
                $
                26,634,000Year
                    ended 12/31/05Revenues
                
                $
                23,564,000
                
                $
                2,573,000
                
                $
                4,536,000
                
                
                ($1,483,000
                )
                $
                29,190,000Operating
                    income (loss)
                
                $
                602,000
                
                $
                290,000
                
                
                ($240,000
                )
                
                
                
                $
                652,000Net
                    (loss) income
                
                
                ($342,000
                )
                $
                220,000
                
                
                ($211,000
                )
                
                
                
                
                ($333,000
                )Total
                    Assets
                
                $
                21,343,000
                
                $
                2,122,000
                
                $
                4,818,000
                
                
                ($4,747,000
                )
                $
                23,536,000Year
                    ended 12/31/04Revenues
                
                $
                32,855,000
                
                $
                2,664,000
                
                $
                4,890,000
                
                
                ($3,216,000
                )
                $
                37,193,000Operating
                    (loss) income
                
                
                ($92,000
                )
                $
                121,000
                
                
                ($31,000
                )
                
                ($48,000
                )
                
                ($50,000
                )Net
                    (loss) income
                
                
                ($2,595,000
                )
                $
                223,000
                
                
                ($59,000
                )
                
                ($48,000
                )
                
                ($2,479,000
                )Total
                    Assets
                
                $
                24,072,000
                
                $
                1,989,000
                
                $
                5,319,000
                
                
                ($3,492,000
                )
                $
                27,888,000
 12
 
 **Item
        No. 1A - Risk Factors**
 
 The
        following factors, as well as factors described elsewhere in this Annual
        Report,
        or in our other filings with the Securities and Exchange Commission, could
        adversely affect our consolidated financial position, results of operations
        or
        cash flows. Other factors not presently known to us, that we do not presently
        consider material, or that we have not predicted, may also harm our business
        operations or adversely affect us.
 
 ***Industry
        Risks***
 
 *We
        engage in businesses which are intensely competitive, involve strong price
        competition and relatively low margins.*
 
 The
        businesses in which we engage - supply of films for flexible packaging, supply
        of pouches for flexible packaging and supply of novelty balloon items - are
        highly competitive. We face intense competition from a number of competitors
        in
        each of these product categories, several of which have extensive production
        facilities, well-developed sales and marketing staffs and greater financial
        resources than we do. Some of these competitors maintain international
        production facilities enabling them to produce at low costs and to offer
        products at highly competitive prices. We compete on the basis of price,
        quality, service, delivery and differentiation of products. Most of our
        competitors seek to engage in product development and may develop products
        that
        have superior performance characteristics to our products. This intense
        competition can limit or reduce our sales or market share for the sale of
        our
        products as well as our margins. There can be no assurance that we will be
        able
        to compete successfully in the markets for our products or that we will be
        able
        to generate sufficient margins from the sale of our products to become or
        remain
        profitable.
  13
 
 *Our
        business is dependent on the price and availability of raw
        materials.*
 
 The
        cost
        of the raw materials we purchase represents about
        39.6% of our
        revenues. The principal raw materials we purchase are: nylon sheeting, polyester
        sheeting, polyethylene sheeting, polyethylene resin and latex. Much of these
        materials are derived from petroleum and natural gas. Prices for these materials
        fluctuate substantially as a result of the change in petroleum and natural
        gas
        prices, demand and the capacity of companies who produce these products to
        meet
        market needs. Instability in the world markets for petroleum and natural
        gas
        has, and may, adversely affect the prices of these raw materials and their
        general availability. The price of latex has also fluctuated significantly
        over
        the past two years. Our ability to achieve and maintain profitability is
        partially dependent upon our ability to pass through to our customers the
        amount
        of increases in raw materials cost. If prices of these materials increase
        and we
        are not able to fully pass on the increases to our customers, our results
        of
        operations and our financial condition will be adversely affected.
 
 *The
        loss of a key supplier or suppliers could lead to increased costs and lower
        margins as well as other adverse results.*
 
 We
        rely
        on six principal suppliers for our petroleum, natural gas and latex-based
        raw
        material suppliers. We do not maintain supply agreements with any of our
        suppliers for these materials. The loss of any of these suppliers would force
        us
        to purchase these materials from other suppliers or on the open market, which
        may require us to pay higher prices for raw materials than we do now, with
        the
        result that our margins on the sale of our products would be adversely affected.
        In addition, the loss of the supply of an important raw material from one
        of our
        present suppliers may not be replaceable through open market purchases or
        through a supply arrangement with another supplier. In the event that we
        were
        unable to obtain a raw material from another supplier, we would be unable
        to
        continue to manufacture certain of our products.
 
 ***Company
        Risks***
 
 *We
        have a history of both income and losses and have experienced fluctuations
        of
        operating income, which may cause our stock to fluctuate.*
 
 We
        have
        had a history of losses and of fluctuating income from operations over the
        past
        five years. We have reported net income from operations in three of the past
        five years and losses in two of those years. Our income or loss from operations
        during that time has ranged from a profit of $2,622,000 to a loss of $223,000
        and has been subject to significant quarterly and annual fluctuations. These
        fluctuations can be caused by:
 
 ·
              Economic
                  conditions
 ·
              Competition
 ·
              Production
                  efficiencies
  14
  ·
              Variability
                  in raw materials prices
 ·
              Seasonality
 
 These
        fluctuations make it more difficult for investors to compare our operating
        results to corresponding prior year periods. These fluctuations also cause
        our
        stock price to fluctuate. You should not rely on our results of operations
        for
        any particular quarter or year as being indicative of our results for a full
        year or any other period.
 
 *We
        have limited financial resources that may adversely affect our ability to
        invest
        in productive assets, marketing, new products and new
        developments.*
 
 Our
        working capital is limited. As of December 31, 2006, our current assets exceeded
        our current liabilities by approximately $1,848,000. As a result of this
        limited
        amount of working capital, we may be unable to fund capital investments,
        working
        capital needs, marketing and sales programs, research and development, patent
        or
        copyright licenses or other items which we would like to acquire or pursue
        in
        accordance with our business strategies. The inability to pursue any of these
        items may adversely affect our competitive position, our business, financial
        condition or prospects.
 
 *A
        high percentage of our sales are to a limited number of customers and the
        loss
        of any one or more of those customers could adversely affect our results
        of
        operations, cash flows and financial condition.*
 
 For
        the
        year ended December 31, 2006, our sales to our top 10 customers represented
        61.2% of our net sales and our sales to our top three customers represented
        51.5% of our net sales. Generally, we do not have long term contracts with
        our
        customers. The loss of any of our principal customers, or a significant
        reduction in the amount of our sales to any of them, would have a material
        adverse effect on our business and financial condition.
 
 In
        March
        2006, we entered into a four-year agreement with ITW, one of our top ten
        customers, to provide (i) all of their requirements for a certain kind of
        pouch
        and (ii) all of their requirements, subject to competitive pricing, for film
        for
        their use in the production of certain pouches. In April 2006, we entered
        into a
        license agreement with Rapak, one of our top three customers, granting Rapak
        a
        license under a patent related to textured film and pouches, and extending
        the
        term of an existing supply agreement with Rapak to October 31, 2008.
 
 *We
        rely on intellectual property in our business and the failure to develop,
        acquire or protect our intellectual property could adversely affect our
        business.*
 
 We
        consider patents, copyright licenses and to some degree trademarks, as being
        significant to our competitive position, our ability to obtain and retain
        customers and to achieve acceptable margin levels on the sale of our products.
        With respect to our film and flexible packaging/pouch business, we believe
        that
        developing, acquiring and maintaining patent rights are of significance to
        us
        for those reasons. Over the past five years, we have obtained 12 patents
        related
        to films, pouches, zippers for pouches, the method of inserting zippers in
        pouches and certain valves for pouches. We have 2 patents pending with regard
        to
        such products. With respect to our novelty balloon products, we believe that
        patent rights and trade secrets for product developments and copyright licenses
        for characters and designs are of significance to our ability to compete
        in the
        market and to obtain acceptable margins on the sale of our products. Our
        limited
        financial resources have made it more difficult for us to invest in product
        and
        patent developments and to obtain copyright licenses. If we are unable to
        develop, acquire, maintain or enforce some or all of our intellectual property
        rights, our business, financial conditions and prospects will be adversely
        affected.
  15
 
 *We
        produce all of our products at two plants and damage to or destruction of
        one or
        both of the plants would have a serious adverse affect on our
        business.*
 
 We
        produce all of our film products and pouches at our plant in Barrington,
        Illinois and all of our latex balloon products at our plant in Guadalajara,
        Mexico. In the event of a fire, flood, or other natural disaster, or the
        termination of our lease in Mexico, we could lose access to one or both of
        our
        plants. Loss of, significant damage to, or destruction of, one or both of
        these
        plants would render us unable to produce our products presently produced
        in such
        plants, possibly for an extended period of time and our business, financial
        condition and prospects would be materially adversely affected. While we
        maintain business interruption insurance, the proceeds of such insurance
        may not
        be adequate to compensate us for all of our losses in such an
        event.
 
 *We
        are dependent on the management experience of our key
        personnel.*
 
 We
        are
        dependent on the management experience and continued services of our executive
        officers, including Howard W. Schwan, our President, John H. Schwan, our
        Chairman and Stephen M. Merrick, our Chief Financial Officer, as well as
        each of
        these other executive officers of the Company: Brent Anderson, Sam Komar,
        Steve
        Frank and Timothy Patterson. We have an existing employment agreement with
        Howard Schwan, dated January 1, 1997, which is automatically renewed each
        July 1
        for another year unless terminated by either party. The agreement includes
        confidentiality, inventions, non-compete and other customary provisions.
        The
        loss of any of these executive officers would have an adverse effect on our
        business.
 
 In
        addition, our continued growth depends on our ability to attract and retain
        experienced key employees. Competition for qualified employees is intense,
        and
        the loss of such persons, or an inability to attract, retain and motivate
        such
        skilled employees, could have a material adverse effect on our results of
        operations, financial condition and prospects. There can be no assurance
        that we
        will be able to retain our existing personnel or attract and retain additional
        qualified employees.
 
 *Our
        principal executive officers own a majority of our outstanding common stock,
        have warrants to purchase additional shares, and have significant influence
        and
        control over our business.*
 
 Howard
        W.
        Schwan (our President), John H. Schwan (our Chairman) and Stephen M. Merrick
        (our Chief Financial Officer) or persons affiliated to them, in combination,
        owned approximately 49.3% of the outstanding shares of common stock of the
        Company as of December 31, 2006 and then had options and warrants to purchase
        additional shares which, if exercised, together with the shares owned, would
        aggregate 59.8% of the shares then outstanding. As a result of such ownership,
        these executives have the ability to exert significant influence and control
        on
        the outcome of corporate transactions and other matters submitted to the
        Board
        of Directors or stockholders for approval, including mergers, consolidations
        and
        the sale of all or substantially all of our assets, and also the power to
        prevent or cause a change in control of the Company. **
  16
 
 ***Financial
        Risks***
 
 *We
        have a high level of debt relative to our equity, which reduces cash available
        for our business and which may adversely affect our ability to obtain additional
        funds, and increases our vulnerability to economic or business
        turndowns.*
 
 We
        have a
        substantial amount of debt in relation to our shareholders’ equity. As of
        December 31, 2006, we had $15,015,000 of debt outstanding and $5,102,000
        in
        shareholders' equity. These circumstances could have important adverse
        consequences for our Company. For example they could:
 
 ·
              Increase
                  our vulnerability to general adverse economic and industry
                  conditions;
 ·
              Require
                  us to dedicate a substantial portion of our cash flow from operations
                  to
                  payments on our debt, thereby limiting our ability to fund working
                  capital, capital expenditures and other general corporate
                  purposes;
 ·
              Limit
                  our flexibility in planning for, or reacting to, changes in our
                  business
                  and the industry in which we
                  operate;
 ·
              Place
                  us at a competitive disadvantage compared to our competitors who
                  may have
                  less debt and greater financial resources;
                  and
 ·
              Limit,
                  among other things, our ability to borrow additional
                  funds.
 
 On
        February 1, 2006, we entered into a loan agreement with Charter One Bank
        in
        which, as amended, Charter One Bank provides to us a line of credit totaling
        $13,300,000, including a five year mortgage loan on our principal plant and
        offices in Barrington, Illinois for $2,800,000, a five year term loan secured
        by
        our physical assets in Barrington, Illinois for $3,500,000 and a three year
        revolving line of credit secured by inventory and receivables in the maximum
        amount of $7,000,000. Also, on the same day, Messrs. John Schwan and Stephen
        Merrick, each loaned to the Company the sum of $500,000 in exchange for five
        year subordinated notes and warrants to purchase up to 151,515 shares of
        common
        stock of the Company, each.
 
 *We
        will require a significant amount of cash to service our debt, to develop
        new
        business and to make capital investments and our ability to generate cash
        depends on many factors beyond our control.*
 
 Our
        ability to service our debt and to fund our operations and planned capital
        expenditures will depend on our financial and operating performance and our
        ability to borrow money or raise capital. These matters are, in part, subject
        to
        prevailing economic conditions and to financial, business and other factors
        beyond our control. If our cash flow from operations is insufficient to fund
        our
        debt service obligations, we may be forced to reduce or delay funding capital
        expenditures or working capital, marketing or other commitments or to sell
        assets, obtain additional equity capital or indebtedness or refinance or
        restructure our debt. These alternative measures may not be successful and
        may
        not permit us to meet our scheduled debt service obligations, or to fund
        operations, initiatives or capital requirements. In the absence of cash flow
        from operations, or the generation of cash from such other sources sufficient
        to
        meet our debt service obligations and our other cash requirements, we could
        face
        substantial cash problems.
  17
 
 In
        July
        2006, we entered into a Standby Equity Distribution Agreement (SEDA) with
        Cornell Capital Partners, LP (“Cornell Capital”) pursuant to which we may, at
        our discretion, periodically sell to Cornell Capital shares of common stock
        at a
        price equal to the volume weighted average price of our common stock on the
        NASDAQ Capital Market for the five days immediately following the date we
        notify
        Cornell Capital of our request. See pages 38-39 for a description of the
        agreement. On December 28, 2006, we filed a Registration Statement with the
        SEC
        for the registration of 403,500 shares to be sold to Cornell Capital and
        Newbridge Securities (our placement agent). On January 28, 2007, the
        Registration Statement was declared effective. Through March 20, 2007, in
        connection with the SEDA, we have received $217,000 in net proceedsfrom
        Cornell Capital and Cornell Capital has purchased from us an aggregate of
        45,306 shares of our common stock.
 
 *We
        are subject to a number of restrictive debt covenants that may restrict our
        business and financing activities.*
 
 Our
        credit facility contains restrictive debt covenants that, among other things,
        restrict our ability to:
 
 ·
              Borrow
                  money;
 ·
              Pay
                  dividends and make distributions;
 ·
              Issue
                  stock;
 ·
              Make
                  certain investments;
 ·
              Use
                  assets as security in other
                  transactions;
 ·
              Create
                  liens;
 ·
              Enter
                  into affiliate transactions;
 ·
              Merge
                  or consolidate; or
 ·
              Transfer
                  and sell assets.
 
 In
        addition, our credit facility also requires us to meet certain financial
        tests,
        including (i) maintaining tangible net worth in excess of $3,500,000, (ii)
        maintaining specified ratios of senior debt to EBITDA and (iii) maintaining
        a
        ratio of EBITDA to fixed charges. These restrictive covenants may limit our
        ability to expand or pursue our business strategies.
  18
 
 Our
        ability to comply with the restrictions contained in our credit facility
        may be
        affected by changes in our business condition or results of operation, adverse
        regulatory developments, or other events beyond our control. A failure to
        comply
        with these restrictions could result in a default under our credit facility
        which, in turn, could cause our debt to become immediately due and payable.
        If
        our debt were to be accelerated, we cannot assure that we would be able to
        repay
        it. In addition, a default would give our lender the right to terminate any
        commitment to provide us with additional funds.
 
 ***Market
        Risks and Risks Related to the Offering Described in Our Registration
        Statement***
 
 *Our
        common stock may be affected by limited trading volume and may fluctuate
        significantly, which may affect shareholders’ ability to sell shares of our
        common stock.*
 
 There
        has
        been a limited public market for our common stock and a more active trading
        market for our common stock may not develop. An absence of an active trading
        market could adversely affect our shareholders’ ability to sell our common stock
        in short time periods, or possibly at all. Our common stock has experienced,
        and
        is likely to experience in the future, significant price and volume
        fluctuations, which could adversely affect the market price of our common
        stock
        without regard to our operating performance. In addition, we believe that
        factors such as quarterly fluctuations in our financial results and changes
        in
        the overall economy or the condition of the financial markets could cause
        the
        price of our common stock to fluctuate substantially. These factors may
        negatively affect shareholders’ ability to sell shares of our common
        stock.
 
 *Our
        common stock may be affected by sales of short sellers, which may affect
        shareholders’ ability to sell shares of our common stock.*
 
 As
        stated, our common stock has experienced, and is likely to experience in
        the
        future, significant price and volume fluctuations. These fluctuations could
        cause short sellers to enter the market from time to time in the belief that
        we
        may have poor operating results in the future. The market for our common
        stock
        may not be stable or appreciate over time and the sale of our common stock
        may
        negatively impact shareholders’ ability to sell shares of our common
        stock.
 
 *Future
        Sales of Stock By Our Shareholders May Negatively Affect Our Stock Price
        And Our Ability To Raise Funds In New Stock Offerings*
 
 Sales
        of
        our common stock in the public market, by Cornell Capital in connection with
        our
        sale of stock to Cornell Capital under the Standby Equity Distribution
        Agreement, or by our existing substantial shareholders, could lower the market
        price of our common stock. Sales may also make it more difficult for us to
        sell
        equity securities or equity-related securities in the future at a time and
        price
        that our management deems acceptable or at all. Of the 2,187,403 shares of
        common stock outstanding as of March 20, 2007, 1,055,376 shares of common
        stock
        were held by our “affiliates” and 1,079,389 shares of common stock were held by
        existing shareholders, including the officers and directors, are “restricted
        securities” and may be resold in the public market only if registered or
        pursuant to an exemption from registration. Some of these shares may be resold
        under Rule 144.
  19
  *Existing
        Shareholders Will Experience Significant Dilution From Our Sale Of Shares
        Under
        The Standby Equity Distribution Agreement*
  The
        sale
        of shares pursuant to the Standby Equity Distribution Agreement will have
        a
        dilutive impact on our shareholders.
  Our
        net
        income per share could decrease in future periods, and the market price of
        our
        common stock could decline. In addition, the lower our stock price, the more
        shares of common stock we will have to issue under the SEDA to draw down
        the
        full amount. If our stock price is lower, then our existing shareholders
        would
        experience greater dilution.
  *The
        Selling Stockholders Identified in our Registration Statement Intend To Sell
        Their Shares Of Common Stock In The Market, Which Sales May Cause Our Stock
        Price To Decline*
  The
        selling shareholders identified in our Registration Statement (Cornell Capital
        and Newbridge Securities) are intending to sell in the public market 403,500
        shares of common stock being registered in the offering. That means that
        up to
        403,500 shares may be sold pursuant to the Registration Statement. Such sales
        may cause our stock price to decline. The officers and directors of CTI and
        those shareholders who are significant shareholders as defined by the SEC
        will
        continue to be subject to the provisions of various insider trading and Rule
        144
        regulations. If our stock price declines, the numbers of shares which CTI
        will
        need to issue to Cornell Capital under the Standby Equity Distribution Agreement
        to raise the same amount of funds will increase.
  *The
        Sale Of Our Stock Under Our Standby Equity Distribution Agreement Could
        Encourage Short Sales By Third Parties, Which Could Contribute To The Future
        Decline Of Our Stock Price*
  In
        some
        cases, the provision of a SEDA for companies that are traded on the NASDAQ
        Capital Market (“NASDAQ-CM”) has the potential to cause a significant downward
        pressure on the price of common stock. This is especially the case if the
        shares
        being sold into the market exceed the market’s desire to purchase the increased
        stock or if CTI has not performed in such a manner to show that the equity
        funds
        raised will be used to grow CTI. Such an event could place further downward
        pressure on the price of common stock. CTI may request numerous draw downs
        pursuant to the terms of the Standby Equity Distribution Agreement. Even
        if CTI
        uses the SEDA to grow its revenues and profits or invest in assets which
        are
        materially beneficial to CTI, the opportunity exists for short
        sellers (i.e. sellers who do not actually own our shares at the time of
        their sale) to contribute to the future decline of CTI’s stock price. If there
        are significant short sales of stock, the price decline that would result
        from
        this activity will cause the share price to decline more, which, in turn,
        may
        cause current owners of our stock to sell their shares; thereby contributing
        to
        sales of stock in the market. If there are more investors selling our stock,
        then there are investors desiring to purchase our stock, the market for our
        stock, the price will necessarily decline.
  20
  It
        is not
        possible to predict the circumstances whereby short sales could materialize
        or
        the price to which our stock price could drop.
  *The
        Price Paid by Participants In Our Registered Offering Will Fluctuate And
        May Be Higher Or Lower Than The Prices Paid By Other People Participating
        In This Offering*
  The
        price
        in the offering will fluctuate based on the prevailing market price of the
        common stock on the NASDAQ-Capital Market. Accordingly, the price paid by
        a
        purchaser in our registered offering may be higher or lower than the prices
        paid
        by other people participating in this offering.
  *We
        May Not Be Able To Access Sufficient Funds Under The Standby Equity
        Distribution Agreement When Needed*
  We
        anticipate that a portion of our financing needs will be funded through the
        SEDA. No assurances can be given that our SEDA financing will be available
        in
        sufficient amounts or at all when needed, in part, because we are limited
        to a
        maximum drawdown of $100,000 during any five trading day period. In
        addition, the number of shares being registered may not be sufficient to
        draw
        all funds available to us under the Standby Equity Distribution Agreement.
  *We
        May Not Be Able To Draw Down Under The Standby Equity Distribution
        Agreement If The Investor Holds More Than 9.9% Of Our Common
        Stock*
  In
        the
        event Cornell Capital holds more than 9.9% of the then-outstanding common
        stock
        of CTI, we will be unable to draw down on the SEDA. Although Cornell Capital
        may
        not hold more than 9.9% of the then-outstanding common stock of CTI at any
        one
        time, this restriction does not prevent Cornell Capital from selling some
        of its
        holdings and then receiving additional shares. Therefore, Cornell Capital
        has,
        and may, sell more than these limits while never holding more than those
        limits.
        At the time of the filing of the Registration Statement, Cornell Capital
        had no
        beneficial ownership of our common stock and therefore we would be able to
        make
        limited draw downs on the Standby Equity Distribution Agreement so long as
        Cornell Capital’s beneficial ownership remains below 9.9%. If Cornell Capital’s
        beneficial ownership becomes 9.9% or more, we would be unable to draw down
        on
        the Standby Equity Distribution Agreement.
  *Cornell
        Capital May Sell Shares Of Our Common Stock During An Applicable Pricing
        Period Under the SEDA Which Could Contribute To The Decline Of Our Stock
        Price*
  The
        sale
        of common stock to be acquired by Cornell Capital pursuant to an advance
        request
        made by CTI under the SEDA during an applicable pricing period could cause
        downward pressure on the price of our common stock and, therefore, contribute
        to
        the decline of our stock price.
  21
  **Item
        No. 1B Unresolved Staff Comments**
  None
  **Item
        No. 2 Properties**
 
 We
        own
        our principal plant and offices located in Barrington, Illinois, approximately
        45 miles northwest of Chicago, Illinois. The facility includes approximately
        75,000 square feet of office, manufacturing and warehouse space. This facility
        is subject to a mortgage loan in the principal amount of $2,800,000, having
        a
        term of 5 years, with payments amortized over 25 years.
 
 We
        lease
        a warehouse facility in Cary, Illinois under a two-year lease at the base
        rate
        of $6,000 per month and at a total monthly cost of approximately $8,000.
        The
        lease expires on September 30, 2007 and has been extended to September 2009.
        The
        facility includes 16,306 square feet of warehouse and office space which
        is
        utilized principally for the warehousing of balloon inventory.
 
 The
        Company also leases approximately 15,000 square feet of office and warehouse
        space in Rugby, England at an annual lease cost of $51,700, expiring in 2019.
        This facility is utilized to warehouse balloon products and to manage and
        service the Company's operations in England and Europe.
 
 In
        January 2003, Flexo Universal entered into a 5-year lease agreement for the
        lease of approximately 43,000 square feet of manufacturing, warehouse and
        office
        space in Guadalajara, Mexico at the cost of $18,000 per month.
 
 We
        believe that our properties have been adequately maintained, are in generally
        good condition and are suitable for our business as presently conducted.
        We
        believe our existing facilities provide sufficient production capacity for
        our
        present needs and for our presently anticipated needs in the foreseeable
        future.
        We also believe that, with respect to leased properties, upon the expiration
        of
        our current leases, we will be able to either secure renewal terms or to
        enter
        into leases for alternative locations at market terms.
  **Item
        No. 3 Legal Proceedings**
 
 On
        December 20, 2006, Pliant Corporation filed an action against the Company
        in the
        Circuit Court of Cook County, Illinois. In the action, Pliant claims that
        there
        is due from the Company to Pliant the sum of $245,000 for goods sold and
        delivered by Pliant to the Company as well as interest on such amount. On
        February 21, 2007, the Company filed and answer to the complaint and
        counterclaim denying liability and asserting certain claims against Pliant
        for
        damages for the sale by Pliant to the Company of defective products. Management
        intends to defend the claims of Pliant in this action and to pursue its
        counterclaims and believes that the Company has established adequate reserves
        regarding the claim.
  22
 
 In
        addition, the Company is also 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.
  **Item
        No. 4 Submission of Matters to a Vote of Security Holders**
 
 At
        the
        Company’s Annual Meeting of Shareholders on November 10, 2006, the following
        actions were submitted and approved by vote of its shareholders:
 
 1.  The
        election of seven directors; and
  2.  The
        ratification of the Board’s selection of Weiser LLP as the Company’s independent
        certified public accountants.
 
 A
        total
        of 1,926,458 shares (approximately 90%) of the issued and outstanding voting
        stock of the Company were represented by proxy or in person at the meeting.
        These shares were voted on the matters described above as follows:
 
 1.  For
        the
        directors as follows:
 
 **Name**
              
              **Total
                  Votes For**
              
              **Total
                       Votes Against**John
                  H. Schwan
              
              
              1,904,487
              
              
              21,971Stephen
                  M. Merrick
              
              
              1,904,487
              
              
              21,971Howard
                  W. Schwan
              
              
              1,904,487
              
              
              21,971Stanley
                  M. Brown
              
              
              1,904,487
              
              
              21,971Michael
                  Avramovich
              
              
              1,904,487
              
              
              21,971Bret
                  Tayne
              
              
              1,904,487
              
              
              21,971John
                  I. Collins
              
              
              1,904,487
              
              
              21,971
 
 2.  For
        the
        Ratification of Weiser LLP as the Company’s independent certified public
        accountants as follows:
 
 **Total
                  Votes For**
              
              **Total
                  Votes Against**
              
              **Total
                  Broker Non-Votes and Total Votes****Abstaining**1,904,487
              
              
              21,971
              
              
              0
  23
  There
        were no other matters voted on at the Company’s 2006 Annual Meeting of
        Shareholders, nor was there a submission of any other matter to a vote of
        securities holders at any time during the Company’s fourth fiscal
        quarter.
 
 **PART
        II**
 
 **Item
        No. 5 Market for Registrant's Common Equity, Related Stockholder Matters
        and
        Issuer Purchases of Equity Securities**
 
 Market
        Information. The Company's Common Stock was admitted to trading on the NASDAQ
        SmallCap Market (now the NASDAQ Capital Market) under the symbol CTIB on
        November 5, 1997. Prior to that time, there was no established public trading
        market for the Company's Common Stock.
 
 The
        high
        and low sales prices for the last eight fiscal quarters (retroactively adjusted
        to reflect post-reverse split share and stock dividend values), according
        to the
        NASDAQ Stock Market's Stock Price History Report, were:
 **High**
                
                **Low**January
                    1, 2005 to March 31, 2005
                
                
                3.15
                
                
                1.50April
                    1, 2005 to June 30, 2005
                
                
                4.74
                
                
                0.50July
                    1, 2005 to September 30, 2005
                
                
                7.67
                
                
                1.48October
                    1, 2005 to December 31, 2005
                
                
                5.50
                
                
                2.72January
                    1, 2006 to March 31, 2006
                
                
                3.56
                
                
                2.77April
                    1, 2006 to June 30, 2006
                
                
                3.90
                
                
                2.60July
                    1, 2006 to September 30, 2006
                
                
                4.68
                
                
                2.20October
                    1, 2006 to December 31, 2006
                
                
                8.23
                
                
                3.50January
                    1, 2007 to March 31, 2007
                
                
                10.39
                
                
                4.39
  As
        of
        December 11, 2006, there were approximately 52 holders of record of the
        Company’s Common Stock. The Company believes that its total number of actual
        shareholders is substantially greater than the number of record
        shareholders.
 
 The
        Company has never paid any cash dividends on its Common Stock and does not
        currently intend to pay cash dividends on its Common Stock in the foreseeable
        future. The Company currently intends to retain all its earnings to finance
        the
        development and expansion of its business. Under the terms of its current
        loan
        agreement, the Company is restricted from declaring any cash dividends or
        other
        distributions on its shares.
 
 **Issuer
        Purchases of Equity Shares**
 
 The
        Company made no purchases of its shares on the public market during 2006.
        On
        June 12, 2006, the Company received 38,404 shares of its common stock from
        John
        Schwan as payment at the then market price per share of $3.09 for shares
        being
        purchased by him upon the exercise of a warrant to purchase 79,367 shares
        of
        common stock at the warrant exercise price of $1.50.
  24
  **Recent
        Sales of Unregistered Securities**
 
 During
        February 2003, John H. Schwan loaned $930,000 to the Company and Stephen
        M.
        Merrick loaned $700,000 to the Company, each in exchange for (i) two year
        promissory notes bearing interest at 9% per annum and (ii) five year warrants
        to
        purchase up to 163,000 shares of Common Stock of the Company at $4.87 per
        share,
        the market price of the Common Stock on the date of the Warrants. The proceeds
        of these loans were to (i) re-finance the bank loan of CTI Mexico in the
        amount
        of $880,000 and (ii) to provide financing for CTI Mexico and Flexo Universal.
        Payment of the principal of the notes has been extended by agreement of Mr.
        Merrick and Mr. Schwan and is scheduled to mature on October 1, 2007.
 
 On
        July
        1, 2004, the Company entered into a Standby Equity Distribution Agreement
        (”SEDA”) with Cornell Capital under which Cornell agreed to provide up to $5
        million to the Company in connection with the purchase of common stock of
        the
        Company over a two year term. Under the terms of the agreement, and subject
        to
        various conditions, the Company had the option to sell shares of its common
        stock to Cornell at the market price for the stock at the time of the sale.
        On
        August 5, 2004, the Company issued 14,162 shares of its common stock to Cornell
        and 3,500 shares of its common stock to Newbridge Securities, Cornell’s stock
        placement agent for underwriting services as partial consideration under
        the
        terms of SEDA. On May 31, 2006, this Agreement was terminated, except as
        to the
        stock consideration paid by the Company to Cornell and Newbridge, and was
        superseded by the Standby Equity Distribution Agreement dated June 6,
        2006.
 
 On
        September 13, 2004, the Company issued 18,018 shares of its common stock
        to
        Thornhill Capital, LLC, in return for consulting services.
 
 On
        September 23, 2005, the Company issued 50,229 shares of its common stock
        to
        three service providers as payment for services.
 
 On
        February 1, 2006, John H. Schwan and Stephen M. Merrick each loaned the sum
        of
        $500,000 to the Company, each in exchange for (i) five year promissory notes
        bearing interest at 2% in excess of the prime rate and (ii) five year warrants
        to purchase up to 151,515 shares each of common stock of the Company at the
        price of $3.30 per share, an amount equal to 110% of the market price of
        the
        common stock on the day immediately preceding the date of the
        transaction.
 
 On
        June
        6, 2006, the Company entered into a Standby Equity Distribution Agreement
        with
        Cornell Capital pursuant to which Cornell Capital agreed, subject to certain
        conditions, to purchase up to $5,000,000 of the Company’s common stock for its
        own account, for investment, during a commitment period of 24 months commencing
        on the date of an effective registration statement covering the shares to
        be
        sold. Under the agreement, shares are to be purchased at the lowest volume
        weighted average price of the shares as traded during the five trading days
        after an advanced request by the Company. The number of shares to be sold
        under
        the agreement is limited to 400,000 shares unless shareholder approval shall
        have been obtained for the sale of a greater amount of shares. The sale of
        the
        shares is subject to certain conditions including the filing by the Company,
        and
        the declaration of effectiveness by the SEC, of a Registration Statement
        covering the shares to be sold under the agreement. On December 28, 2006,
        the
        Company filed a Registration Statement with respect to 403,500 shares and
        on
        January 26, 2007, the Registration Statement was declared effective. Since
        the
        effective date to March 20, 2007, the Company has sold to Cornell Capital
        an
        aggregate of 45,306 shares of common stock at an average price of $5.08 per
        share.
 
 25
 Also
        on
        July 6, 2006, the Company entered into a Placement Agent Agreement with
        Newbridge Securities Corp. under which Newbridge agreed to act as the Company’s
        exclusive placement agent in connection with the Standby Equity Distribution
        Agreement. Under this agreement, the Company agreed to issue 3,500 shares
        of its
        common stock to Newbridge.
 
 On
        June
        12, 2006, John Schwan exercised a warrant issued on July 1, 2001 to purchase
        79,367 shares of common stock of the Company at the warrant exercise price
        of
        $1.50 per share. In payment for such shares, Mr. Schwan surrendered to the
        Company 38,404 shares of common stock at the then market price per share
        of
        $3.09. On June 12, 2006, Stephen M. Merrick exercised a warrant issued on
        July
        1, 2001 to purchase 39,683 shares of common stock of the Company at the warrant
        exercise price of $1.50 per share.
 
 Each
        of
        the foregoing transactions involved the sale of securities of the Company
        to a
        limited number of sophisticated investors on a restricted basis, for investment,
        and an exemption from registration with respect to such sales is claimed
        pursuant to Section 4(2) of the Securities Act of 1933.
 
 **Stock
        Performance Graph**
 
 The
        following graph compares for the period January 2001 to December 2006, the
        cumulative total return on our common stock with (i) NASDAQ Composite Index
        (U.S.) and (ii) S&P 500 Specialty Stores Index (U.S.). The graph assumes an
        investment of $100 on January 1, 2001, in our common stock and each of the
        other
        investment categories.
 
 The
        historical stock prices of our common stock shown on the graph below are
        not
        necessarily indicative of future stock performance. Per share value as of
        December 31, 2001, 2002, 2003, 2004, 2005 and 2006 is based on the common
        stock’s closing price as of such date. All prices reflect any stock splits
        during the period.
 
 26
 **INDEXED
                    RETURNS****Base
                    Period**
                
                **Years
                    Ending****Company
                    / Index**
                
                **Jan-01**
                
                **Jan-02**
                
                **Jan-03**
                
                **Jan-04**
                
                **Jan-05**
                
                **Jan-06****CTI
                    INDUSTRIES CORP**
                
                
                100
                
                
                425.9
                
                
                153.7
                
                
                98.6
                
                
                198.0
                
                
                202.0**NASDAQ
                    U.S. INDEX**
                
                
                100
                
                
                62.6
                
                
                93.7
                
                
                102.6
                
                
                103.9
                
                
                107.5**S&P
                    500 SPECIALTY STORES**
                
                
                100
                
                
                88.8
                
                
                75.8
                
                
                103.3
                
                
                112.3
                
                
                139.0
 
 
 The
        information under this heading shall not be deemed incorporated by reference
        by
        any general statement incorporating by reference information from this Annual
        Report into any filing under the Securities Act of 1933 or under the Securities
        Exchange Act of 1934 and shall not otherwise be deemed filed under such
        Acts.
  27
  Item
        No. 6 Selected Financial Data
  The
        following selected financial data are derived from the consolidated financial
        statements of the Company. The data should be read in conjunction with the
        consolidated financial statements, related notes, and other financial
        information included herein.
 **Year
                    ended December 31,**2006
                
                2005
                
                2004
                
                2003
                
                2002**Statement
                    of Operations Data:**Net
                    sales
                
                $
                35,428
                
                $
                29,190
                
                $
                37,193
                
                $
                36,260
                
                $
                41,236Costs
                    of sales
                
                $
                26,531
                
                $
                22,726
                
                $
                30,841
                
                $
                29,627
                
                $
                32,344Gross
                    profit
                
                $
                8,897
                
                $
                6,464
                
                $
                6,352
                
                $
                6,633
                
                $
                8,892Operating
                    expenses
                
                $
                6,275
                
                $
                5,812
                
                $
                6,402
                
                $
                6,856
                
                $
                7,447Income
                    (loss) from operations
                
                $
                2,622
                
                $
                652
                
                $
                (
                    50
                )
                $
                (
                    223
                )
                $
                1,445Interest
                    expense, net
                
                $
                1,691
                
                $
                1,231
                
                $
                1,350
                
                $
                1,103
                
                $
                832Other
                    (income) expense
                
                $
                (191
                )
                $
                (45
                )
                $
                (208
                )
                $
                23
                
                $
                278Income
                    (loss) before income taxes and minority interest
                
                $
                1,122
                
                $
                (534
                )
                $
                (1,192
                )
                $
                (1,349
                )
                $
                335Income
                    tax (benefit) expense
                
                $
                (774
                )
                $
                (200
                )
                $
                1,286
                
                $
                (782
                )
                $
                39Minority
                    interest
                
                $
                1
                
                $
                0
                
                $
                1
                
                $
                0
                
                $
                6Net
                    income (loss)
                
                $
                1,895
                
                $
                (333
                )
                $
                (2,479
                )
                $
                (566
                )
                $
                302Earnings
                    (loss) per common shareBasic
                
                $
                0.91
                
                $
                (.17
                )
                $
                (1.28
                )
                $
                (0.30
                )
                $
                0.18Diluted
                
                $
                0.85
                
                $
                (.17
                )
                $
                (1.28
                )
                $
                (0.30
                )
                $
                0.16**Other
                    Financial Data:**Gross
                    margin percentage
                
                
                25.11
                %
                
                22.14
                %
                
                17.08
                %
                
                18.29
                %
                
                21.56
                %Capital
                    Expenses
                
                $
                553
                
                $
                550
                
                $
                306
                
                $
                2,007
                
                $
                2,478Depreciation
                    & Amortization
                
                $
                1,205
                
                $
                1,463
                
                $
                1,651
                
                $
                1,619
                
                $
                1,588**Balance
                    Sheet Data:**Working
                    capital (deficit)
                
                $
                1,848
                
                $
                (2,426
                )
                $
                (2,790
                )
                $
                (706
                )
                $
                (2,907
                )Total
                    assets
                
                $
                26,645
                
                $
                23,536
                
                $
                27,888
                
                $
                30,270
                
                $
                30,272Short-term
                    obligations(1)
                
                $
                9,422
                
                $
                8,618
                
                $
                9,962
                
                $
                6,692
                
                $
                7,385Long-term
                    obligations
                
                $
                6,887
                
                $
                6,039
                
                $
                6,491
                
                $
                8,909
                
                $
                5,726Stockholders’
                    Equity
                
                $
                5,102
                
                $
                2,726
                
                $
                2,951
                
                $
                5,212
                
                $
                5,474
  (1)
              Short
                  term obligations consist of primarily of borrowings under bank
                  line of
                  credit and current portion of long-term
                  debt.
 (2)
              The
                  2004 and 2003 statement of operations has been restated for
                  reclassification of other income to income from operations.
 
 28
  The
        following table sets forth selected unaudited statements of operations for
        each
        quarter of fiscal 2006 and 2005:
 For
                    the Year Ended December 31, 2006 (1)1st
                
                2nd
                
                3rd
                
                4thQuarter
                
                Quarter
                
                Quarter
                
                Quarter
                    (2)Net
                    sales
                
                $
                8,156,223
                
                $
                8,996,935
                
                $
                8,602,733
                
                $
                9,672,264Gross
                    profit
                
                $
                1,953,315
                
                $
                2,197,111
                
                $
                2,252,863
                
                $
                2,493,821Net
                    income
                
                $
                219,768
                
                $
                205,699
                
                $
                315,464
                
                $
                1,153,818Earnings
                    per common shareBasic
                
                $
                0.11
                
                $
                0.10
                
                $
                0.15
                
                $
                0.54Diluted
                
                $
                0.10
                
                $
                0.10
                
                $
                0.15
                
                $
                0.49
 (1)
                  Earnings
                      per common share are computed independently for each of the
                      quarters
                      presented. Therefore, the sum of the quarterly per common share
                      information may not equal the annual earnings per common
                      share.
 (2)
              During
                    the fourth quarter 2006, management of the Company conducted
                    an analysis
                    of the recoverability of the deferred tax asset based on results
                    of
                    operations during the fourth quarter of 2005 and for the full
                    year of
                    2006, expected continued achievement of and continuing improvement
                    in
                    operating results for the forseeable future and anticipated repatriations
                    of profits and services income to be generated from the Company’s foreign
                    subsidiaries. As a result of such analysis, management determined
                    that the
                    net recorded deferred tax asset in the amount of 1,127,000 is
                    more likely
                    than not to be realized.
 For
                    the Year Ended December 31, 2005 (1)1st
                
                2nd
                
                3rd
                
                4thQuarter
                
                Quarter
                
                Quarter
                
                QuarterNet
                    sales
                
                $
                9,103,327
                
                $
                7,572,626
                
                $
                6,033,831
                
                $
                6,480,019Gross
                    profit
                
                $
                1,873,993
                
                $
                1,582,954
                
                $
                1,242,186
                
                $
                1,765,016Net
                    income
                
                $
                84,488
                
                $
                (53,616
                )
                $
                (416,267
                )
                $
                52,186Earnings
                    per common shareBasic
                
                $
                0.04
                
                $
                (0.03
                )
                $
                (0.21
                )
                $
                0.03Diluted
                
                $
                0.04
                
                $
                (0.03
                )
                $
                (0.21
                )
                $
                0.02
 (1)
                  Earnings
                      per common share are computed independently for each of the
                      quarters
                      presented. Therefore, the sum of the quarterly per common share
                      information may not equal the annual earnings per common
                      share
  **Item
            No. 7 Management's Discussion and Analysis of Financial Condition and
            Results of
            Operations**
 
 **Overview**
 
 The
        Company produces film products for novelty, packaging and container
        applications. These products include metalized balloons; latex balloons and
        related latex toy products, films for packaging applications, and flexible
        containers for packaging and storage applications. We produce all of our
        film
        products for packaging and container applications at the facilities in
        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 applications and flexible containers for packaging and storage
        are
        sold to customers in the United States. We market and sell our novelty items
        -
        principally metalized balloons and latex balloons - in the United States,
        Mexico, the United Kingdom and a number of additional countries.
 
 29
  Our
          net
          sales from each of our product categories in each of the past three years
          have
          been as follows:
 (000
                    Omitted)$
                
                %
                    of
                
                $
                
                %
                    of
                
                $
                
                %
                    of**Product
                    Category**
                
                2006
                
                Net
                    Sales
                
                2005
                
                Net
                    Sales
                
                2004
                
                Net
                    SalesMetalized
                    Balloons
                
                
                17,050
                
                
                48.1
                %
                
                11,737
                
                
                40.2
                %
                
                16,238
                
                
                43.7
                %Films
                
                
                8,412
                
                
                23.7
                %
                
                7,616
                
                
                26.1
                %
                
                8,808
                
                
                23.7
                %Pouches
                
                
                3,081
                
                
                8.7
                %
                
                4,079
                
                
                14.0
                %
                
                5,028
                
                
                13.5
                %Latex
                    Balloons
                
                
                6,083
                
                
                17.2
                %
                
                4,855
                
                
                16.6
                %
                
                5,244
                
                
                14.1
                %Helium/Other
                
                
                802
                
                
                2.3
                %
                
                903
                
                
                3.1
                %
                
                1,875
                
                
                5.0
                %**Total**
                
                
                **35,428**
                
                
                **100.0**
                **%**
                
                **29,190**
                
                
                **100.0**
                **%**
                
                **37,193**
                
                
                **100.0**
                **%**
  Our
        primary expenses include the cost of products sold and selling, general and
        administrative expenses.
 
 Cost
        of
        products sold primarily consists of expenses related to raw materials, labor,
        quality control and overhead directly associated with production of our
        products, as well as shipping costs relating to the shipment of products
        to
        customers. Cost of products sold is impacted by the cost of the raw materials
        used in our products, the cost of shipping, along with our efficiency in
        managing the production of our products.
 
 Selling,
        general and administrative expenses include the compensation and benefits
        paid
        to our employees, all other selling expenses, marketing, promotional expenses,
        travel and other corporate administrative expenses. These other corporate
        administrative expenses include professional fees, non-production related
        depreciation and amortization, occupancy costs, communication costs and other
        similar operating expenses. Selling, general and administrative expenses
        can be
        affected by a number of factors, including staffing levels and the cost of
        providing competitive salaries and benefits, the cost of regulatory compliance
        and other administrative costs.
 
 Purchases
        by a limited number of customers represent a significant portion of our total
        net sales. In 2006, sales to our top 10 customers represented 61.2% of net
        revenues. During 2006, there were two customers to whom our sales represented
        more than 10% of net revenues and
        in
        2005 there were three customers to whom our sales represented more then 10%
        of
        net revenues.
 **Customer**
                
                **Product**
                
                **2006
                    Sales**
                
                **%
                    of 2006**
                  **Revenues**
                
                **2005
                    Sales**
                
                **%
                    of****2005**
                  **Revenues**Dollar
                    Tree Stores
                
                
                Balloons
                
                $
                8,596,000
                
                
                24.3
                
                $
                3,987,000
                
                
                13.6Rapak
                    L.L.C
                
                
                Film
                
                $
                7,110,000
                
                
                20.1
                
                $
                6,860,000
                
                
                23.5ITW
                
                
                Pouches
                
                $
                2,526,000
                
                
                7.1
                
                $
                3,889,000
                
                
                13.3
  30


The
      loss
      of one or more of these principal customers, or a significant reduction in
      purchases by one or more of them, could have a material adverse effect on our
      business.





**Results
      of Operations**





The
      following table sets forth selected results of our operations expressed as
      a
      percentage of net sales for the years ended December 31, 2006, 2005 and 2004.
      Our results of operations for the periods described below are not necessarily
      indicative of results of operations for future periods .




**Year
                ended December 31,****2006**
            
            **2005**
            
            **2004*****Net
                sales***
            
            
            100.0%
            
            
            100.0%
            
            
            100.0%Costs
                and expenses:Cost
                of products sold
            
            
            74.9
            
            
            77.9
            
            
            82.9Operating
                expenses
            
            
            17.7
            
            
            19.9
            
            
            17.2Income
                from operations
            
            
            7.4
            
            
            2.2
            
            
            (0.1
            )Interest
                expense
            
            
            (4.8
            )
            
            (4.2
            )
            
            (3.6
            )Other
                income
            
            
            0.5
            
            
            0.2
            
            
            0.6Income
                (loss) before income taxes
            
            
            3.1
            
            
            (1.8
            )
            
            (3.2
            )Provision
                for income taxes
            
            
            (2.2
            )
            
            (0.7
            )
            
            3.4Net
                profit (loss)
            
            
            5.3%
            
            
            (1.1)%
            
            
            (6.6)%




**Year
      Ended December 31, 2006 Compared to Year Ended December 31,
      2005**





*Net
      Sales*





For
      the
      fiscal year ended December 31, 2006, consolidated net sales from the sale of
      all
      products were $35,428,000 compared to consolidated net sales of $29,190,000
      for
      the year ended December 31, 2005, an increase of 23.1%. The increase in net
      sales is attributable principally to an increase in (i) metalized balloon sales
      from $11,737,000 in 2005 to $17,050,000 in 2006 and (ii) latex balloon sales
      from $4,855,000 in 2005 to $6,083,000 in 2006.





The
      increase in metalized balloon sales reflects, principally, an increase in sales
      of these products to a principal customer, Dollar Tree Stores. Sales to this
      chain increased from $3,987,000 in 2005 to $8,596,000 in 2006.





31


Sales
      of
      commercial films increased by 10% from $7,616,000 in 2005 to $8,412,000 in
      2006.
      Most of this increase is reflected in increased sales to Rapak,
      LLC.





Sales
      of
      pouches declined from $4,079,000 to $3,081,000. The decline is accounted for
      by
      reduced sales to ITW Spacebag. Sales of our vacuumable pouch line in 2006 were
      $319,000.





The
      increase in latex balloon sales occurred as the result of increased levels
      of
      production achieved by our Guadalajara facility and increases in sales to
      several customers in the United States and Mexico.





*Cost
      of Sales*





Cost
      of
      sales declined from 77.9% of net sales in 2005 to 74.9% of net sales in 2006.
      This improvement in gross margin has resulted from production efficiencies
      which
      include (i) the allocation of production overhead among a larger number of
      units
      produced and (ii) stabilization in the cost of raw materials.





*General
      and Administrative Expenses*





For
      2006,
      general and administrative expenses were $4,554,000 or 12.9% of net sales
      compared to $3,847,000 or 13.2% of net sales in 2005. The increases in general
      and administrative expenses consisted principally of (i) salary increases to
      existing personnel, (ii) new personnel and (iii) increases in audit expenses.
      The
      decline in general and administrative expenses as a percent of sales is
      attributable to the increase in net sales in 2006 over 2005.





We
      anticipate additional general and administrative expenses during 2007 as we
      expand our operations related to the production of vacuumable zippered pouches
      and enhance our accounting and administrative functions.





*Selling*





Selling
      expenses declined from $928,000 or 3.2% of net sales in 2005 to $847,000 or
      2.4%
      of net sales in 2006. This
      decline is attributable principally to the change in position of the executive
      from sales to marketing during 2006.


*Advertising
      and Marketing*





Advertising
      and marketing expenses increased from $913,000 or 3.1% of net sales in 2005
      to
      $1,201,000 or 3.4% of net sales in 2006. This increase is attributable
      principally to the change in position described with respect to selling
      expense.




We
      anticipate incurring additional advertising and marketing expenses during 2007
      in connection with the introduction, marketing and sale of our new product
      line
      of vacuumable zippered pouches.





32


*Other
      Operating Expense (Income)*





During
      2006, we had income from the settlement of vendor claims totaling $472,000
      and
      we incurred losses on the disposition of assets in the amount of $145,000.
      In
      2005, we did not generate income from the settlement of vendor claims and did
      not have any gain or loss from the disposition of assets.





*Other
      Expense*





During
      2006, the Company incurred $1,691,000 in net interest expense compared to net
      interest expense in 2005 of $1,231,000. The increase in interest expense is
      attributable to the fact that debt levels during 2006 were higher than 2005.





Foreign
      currency gains realized in 2006 were $191,000 compared to gains of $45,000
      in
      2005.





*Net
      Income or Loss*





The
      Company had net income for 2006 of $1,895,000 compared to a net loss of $333,000
      for 2005. The 2006 net income included an income tax benefit of $774,000 and,
      absent the tax benefit was $1,121,000 as compared to loss of $534,000 in 2005.





*Income
      Taxes*





For
      2006,
      the Company recognized an income tax benefit of $774,000. On the basis of
      results of operations over the past five quarters, anticipated repatriation
      of
      income from foreign subsidiaries, charges to foreign subsidiaries and the
      expectation of continued achievement of and improvement in operating results
      for
      the foreseeable future, the management of the Company has determined that
      it is more likely than not that the Company will realize the recorded value
      of
      its net deferred tax assets. In 2005, the Company recognized an income tax
      benefit of $200,000 arising from the deferred tax benefit of the loss incurred
      for the year. Management determined based upon the evaluation of certain
      transactions involving the repatriation of profits from its U.K. and Mexico
      subsidiaries that it was more likely than not that deferred tax assets would
      be
      realized in 2006. There
      can
      be no assurance that the Company will realize the benefit of its deferred tax
      assets.




33




Year
      Ended December 31, 2005 Compared to Year
      Ended December 31, 2004




*Net
      Sales*





For
      the
      fiscal year ended December 31, 2005, consolidated net sales from the sale of
      all
      products were $29,190,000 compared to consolidated net sales of $37,193,000
      for
      the year ended December 31, 2004, a decline of 21.5%. The decline in sales
      is
      attributable principally to a decline in metalized balloon sales of $4,501,000,
      a decline in pouch sales of $949,000 and a decline in film sales of $1,192,000.
      With respect to metalized balloons, the decline in sales reflects (i) a decline
      in sales to Hallmark Cards from $3,421,000 in 2004 to $306,000 in 2005 and
      (ii)
      a decline in sales totaling $1,624,000 to five other of our larger balloon
      customers, which was offset by an increase in sales of $428,000 to a new
      customer. The decline in sales to Hallmark Cards resulted from the expiration
      and termination of our agreements and relationship with Hallmark Cards in March
      2005. Sales of metalized balloons to a drug chain declined as the result of
      the
      sale of the chain and the termination of the balloon program in certain of
      the
      stores that were sold. The decline in pouch sales is attributable to a decline
      in sales of pouches to ITW from $4,838,000 in fiscal 2004 to $3,889,000 in
      fiscal 2005. This decline is the result of increased internal production of
      pouches by ITW at their production facility and also the fact that ITW has
      purchased and supplied to the Company certain components of the pouches produced
      by the Company. The decline in film sales is attributable principally to a
      decline in the sales of laminated film to Rapak from $7,466,000 in fiscal 2004
      to $6,860,000 in fiscal 2005. The Company continues to produce film for Rapak
      and fluctuations in the volume of film supplied are a reflection of variances
      in
      Rapak’s requirements from time to time.





*Cost
      of Sales*





Cost
      of
      sales declined in fiscal 2005 to 77.9% of net sales from a level of 82.9% in
      fiscal 2004. This decline is attributable principally to the fact that we
      reduced our factory overhead in the United States from $6,042,000 in fiscal
      2004
      to $4,575,000 in fiscal 2005, a reduction of $1,467,000 or 24%. This decrease
      in
      the factory overhead element of cost of sales was offset to some degree by
      increases we experienced in raw materials costs, particularly the cost of
      polyester and polyethylene sheeting and resin and of latex.





We
      believe that we will experience further declines in the cost of sales as a
      percentage of net sales in 2006 because (i) we expect raw materials costs to
      stabilize or decline, (ii) we expect to allocate factory overhead costs over
      a
      greater number of units in 2006 compared to 2005 and (iii) we expect to
      experience some continuing reduction in direct production costs during
      2006.





*General
      and Administrative Expenses*





For
      fiscal 2005, administrative expenses were $3,847,000, or 13.2% of net sales,
      compared to administrative costs in fiscal 2004 of $4,411,000, or 11.8% of
      net
      sales, a reduction of $564,000 or 12.7%. The decrease in administrative costs
      during 2005 is attributable to the following items: (i) a reduction of $167,000
      in consulting fees, (ii) a decrease of $146,000 in legal expense, and (iii)
      a
      reduction of $102,000 in bad debt expense.





34


We
      do not
      anticipate further decreases in administrative expenses during fiscal
      2006.





*Selling*





Selling
      expenses declined from $1,289,000 in fiscal 2004, or 3.4% of net sales, to
      $928,000 in fiscal 2005, or 3.2% of net sales. Components of the decline in
      selling expenses for 2005 were: (i) a reduction in royalties of $190,000, (ii)
      a
      reduction in salary expense of $188,000 and (iii) a reduction in commissions
      of
      $65,000.





*Advertising
      and Marketing*





Advertising
      and marketing expenses declined from $1,221,000 in fiscal 2004 or 3.3% of net
      sales, to $913,000 in fiscal 2005 or 3.1% of net sales. The components of the
      decline in expense for 2005 included: (i) reduced salary expense of $73,000
      and
      (ii) a reduction in service fees of $160,000.





*Gain
      on Sale of Assets and Other Operating Income*





Income
      from operations in fiscal 2004, as restated, was affected by (i) gain on the
      sale of assets in the amount of $122,499 and (ii) other income of $395,489.
      Such
      other income consisted of (i) gains related to a review and determination that
      various accrued items on the books of the Mexican subsidiaries of the Company
      (CTI Mexico and Flexo) are not due or payable; these items included: (a) accrued
      amounts for profit sharing or seniority benefits determined on the basis of
      legal review not to be due, totaling $98,000, (b) accrued amounts related to
      an
      asset tax determined not to be due or beyond the statute of limitations, in
      the
      amount approximately of $49,000, (c) accrued amounts with respect to various
      accounts settled or determined not to be due or payable, in the aggregate amount
      of $190,000 and (ii) gains totaling $70,000 based on the settlement of various
      accounts in consideration of the payment of an amount less than the amount
      accrued. These items were offset by $12,000 in other expenses. Most of these
      gains are attributable to the first quarter of 2004 and relate to the
      restructuring of CTI Mexico which commenced in February 2003 when CTI Mexico
      effected a spin-off under Mexican law in which a portion of the assets,
      liabilities and capital of that company were transferred to Flexo Universal
      and
      Flexo Universal became the primary subsidiary of the Company in Mexico. These
      other gains are not recurring.





These
      items of gain on the sales of assets and other income were reported as Other
      Income in the Consolidated Statements of Operations for the year ended December
      31, 2004 and have been reclassified into income (loss) from operations in the
      Restated Consolidated Statements of Operations for that year.





*Other
      Income (Expense)*





During
      2005, the Company incurred $1,231,000 in interest expense compared to $1,350,000
      in interest expense in fiscal 2004. The decline in interest expense is
      attributable to lower level of borrowings during 2005 compared to 2004. We
      anticipate that interest expense in 2006 will increase over 2005 due to (i)
      increased levels of borrowing and (ii) increased interest rates.





35


Foreign
      currency gains realized in 2005 were $45,128 compared to foreign currency gains
      in 2004 of $208,000. The decline in foreign currency gains was the result of
      reduced rates of change in currency values from 2004 to 2005.





*Net
      Income or Loss*





The
      Company incurred a net loss before income taxes and minority interest of
      $534,000 in 2005 compared to a net loss before income taxes and minority
      interest of $1,192,000 in 2004.





*Income
      Taxes*





In
      2005,
      the Company recognized an income tax benefit of $200,000 arising from the
      deferred tax benefit of the loss incurred for the year. Management had
      determined based upon the evaluation of certain transactions involving the
      repatriation of profits from its U.K. subsidiary that it is more likely than
      not
      that deferred tax assets will be realized in 2006. In 2004, the Company incurred
      an income tax expense of $1,286,000, which represented the amount of the reserve
      the Company took against the then outstanding deferred tax benefit recorded
      by
      the Company.





**Financial
      Condition, Liquidity and Capital Resources**





*Cash
      Flow From Operating Activities* Cash flow used in operations for the fiscal year ended December 31, 2006 was
      $1,353,000, compared to cash flow generated in operations for the fiscal year
      ended December 31, 2005 of $2,658,000. Significant changes in components
      of operations contributing to cash flow from operations during 2006
      were:





·
            Depreciation
                and amortization of $1,424,000


·
            A
                decrease in the valuation allowance of deferred income taxes in the
                amount
                of $744,000


·
            Other
                non-cash charges for reserves and allowances of
                $421,000


·
            An
                increase in accounts receivable of
                $2,440,000


·
            An
                increase in inventory of $1,063,000


·
            A
                decrease in trade payables in the amount of
                $1,352,000


·
            An
                increase in accrued liabilities of
                $652,000





Depreciation
      and amortization declined by $56,000 in 2006 compared to 2005. We anticipate
      the
      level of depreciation to increase in 2007 compared to 2006, reflecting
      anticipated investments in plant and equipment during 2007. We anticipate
      further increases in both accounts receivable and trade payables particularly
      during the second half of 2007, as we experience anticipated inventory build-up
      and sales of our new zippered vacuumable pouch product line.





36


*Cash
      Flows From Investing Activities* ** During
      2006, we used $553,000 in investing activities, consisting of purchases of
      equipment. During 2007, we anticipate increased levels of investing activities
      as we invest in both plant and equipment to improve and develop our production
      facilities for our new zippered vacuumable pouch line and expanded production
      of
      latex balloons.





*Cash Flows
      From Financing Activities* During fiscal 2006, cash provided by financing activities amounted to
      $2,045,000 , compared
      to cash used in financing activities of $2,474,000 during fiscal 2005. During
      2006, we received $2,647,000 in proceeds from the issuance of long-term debt
      and
      subordinated debt and warrants and we repaid long term debt of  $1,323,000.
      We received proceeds of $1,267,000 under our revolving line of
      credit.





On
      February 1, 2006, we entered into a Loan Agreement with Charter One Bank,
      Chicago, Illinois, under which, as amended, the Bank has agreed to provide
      a
      credit facility to our Company in the total amount of $13,300,000, which
      includes (i) a five year mortgage loan secured by our Barrington, Illinois
      property in the principal amount of $2,800,000, amortized over a 20 year period,
      (ii) a five year term-loan secured by our equipment at the Barrington, Illinois
      plant in the amount of $3,500,000 and (iii) a three-year revolving line of
      credit up to a maximum amount of $7,000,000, secured by inventory and
      receivables. The amount we can borrow on the revolving line of credit includes
      85% of eligible accounts receivable and 60% of eligible inventory.





Certain
      terms of the loan agreement include:





·
            *Restrictive
                Covenants*:
                The Loan Agreement includes several restrictive covenants under which
                we
                are prohibited from, or restricted in our ability
                to:


·
            Borrow
                money;


·
            Pay
                dividends and make distributions;


·
            Issue
                stock;


·
            Make
                certain investments;


·
            Use
                assets as security in other transactions;


·
            Create
                liens;


·
            Enter
                into affiliate transactions;


·
            Merge
                or consolidate; or


·
            Transfer
                and sell assets.





·
            *Financial
                Covenants*:
                The loan agreement includes a series of financial covenants we are
                required to meet including:


·
            We
                are required to maintain a tangible net worth in excess of
                $3,500,000;


·
            We
                are required to maintain specified ratios of senior debt to EBITDA
                on an
                annual basis and determined quarterly commencing as of June 30, 2006;
                and,






37




·
            We
                are required to maintain a specified level of EBITDA to fixed charges
                for
                the six months ended June 30, 2006, the nine months ending September
                30,
                2006 and twelve months thereafter.





The
      loan
      agreement provides for interest at varying rates in excess of the Bank’s prime
      rate, depending on the level of senior debt to EBITDA over time. The interest
      rate at year end is 8.50%. On a quarterly basis, this ratio will be measured
      and
      the interest rate changed in accordance to the table below.





When
                Senior Debt to Equity is:
            
            The
                Premium to the Prime Rate is:Greater
                or equal to 4.50 to 1.00
            
            
            1.00
            %Between
                4.50 to 1.00 and 4.00 to 1.00
            
            
            0.75
            %Between
                4.00 to 1.00 and 3.50 to 1.00
            
            
            0.50
            %Between
                3.50 to 1.00 and 2.75 to 1.00
            
            
            0.25
            %Less
                than 2.75 to 1.00
            
            
            0.00
            %





Also,
      under the loan agreement, we are required to purchase a swap agreement with
      respect to at least 60% of the mortgage and term loan portions of our loan.
      On
      April 5, 2006, we entered into a swap arrangement with Charter One Bank with
      respect to 60% of the principal amounts of the mortgage loan and the term loan,
      which had the effect of fixing the interest rate for such portions of the
      loans at 8.49% for the balance of the loan terms. These swap arrangements
      are subject to some market variation due to market interest rate variability.
      Management believes that these variations will not materially affect the results
      of the company. As of December 31, 2006, the net effect of these market
      adjustments was $55,000, which has been recorded in the Company’s consolidated
      financial statements.





Each
      of
      John H. Schwan and Stephen M. Merrick, officers, directors and principal
      shareholders of the Company have personally guaranteed the obligations of the
      company to Charter One Bank up to $1,400,000.





This
      loan
      closed on February 1, 2006. At that time, we used $10,353,000 of proceeds of
      the
      loan to pay off then existing bank loan balances of our Company.





Also,
      on
      February 1, 2006, two principal officers and shareholders of our Company each
      loaned to our Company the sum of $500,000 in exchange for (i) Promissory Notes
      due January 31, 2011 and bearing interest at the rate of 2% per annum in excess
      of the prime rate determined quarterly and (ii) five year Warrants to purchase
      up to 151,515 shares of common stock of the Company at the price of $3.30 per
      share (110% of the closing market price on the day preceding the date of the
      loans).





On
      June 6, 2006, we entered into a Standby Equity Distribution Agreement with
      Cornell Capital pursuant to which we may, at our discretion, periodically sell
      to Cornell Capital shares of common stock for a total purchase price of up
      to $5
      million. For each share of common stock purchased under the Standby Equity
      Distribution Agreement, Cornell Capital will pay one hundred percent (100%)
      of the lowest volume weighted average price (as quoted by Bloomberg, LP) of
      our
      common stock on the NASDAQ Capital Market or other principal market on which
      our
      common stock is traded for the five (5) days immediately following the
      notice date. The number of shares purchased by Cornell Capital for each advance
      is determined by dividing the amount of each advance by the purchase price
      for
      the shares of common stock. Furthermore, Cornell Capital will receive five
      percent (5%) of each advance in cash under the Standby Equity Distribution
      Agreement as an underwriting discount. Cornell’s obligation to purchase shares
      of our common stock under the Agreement is subject to certain conditions,
      including: (i) we shall have obtained an effective registration statement for
      the shares of common stock sold to Cornell under the Agreement and (ii) the
      amount of each advance requested by us under the Agreement shall not be more
      than $100,000.




38


Cornell
      Capital is a private limited partnership whose business operations are conducted
      through its general partner, Yorkville Advisors, LLC. In addition, we engaged
      Newbridge Securities Corporation, a registered broker-dealer, as our placement
      agent in connection with the Standby Equity Distribution Agreement. For its
      services, Newbridge received 3,500 shares of our common stock on or about June
      8, 2006, equal to approximately $11,200 based on our stock price of $3.20 when
      the shares were issued on June 26, 2006. The effectiveness of the sale of
      the shares under the Standby Equity Distribution Agreement was conditioned
      upon
      us registering the shares of common stock with the SEC and obtaining all
      necessary permits or qualifying for exemptions under applicable state law.
      Except as stated above, there are no other significant closing conditions to
      draw under the Standby Equity Distribution Agreement.




Pursuant
      to the Standby Equity Distribution Agreement, we may periodically sell shares
      of
      common stock to Cornell Capital to raise capital to fund our working capital
      needs. The periodic sale of shares is known as an advance. We may request an
      advance every five (5) trading days. A closing will be held the first trading
      day after the pricing period at which time we will deliver shares of common
      stock and Cornell Capital will pay the advance amount. There are no closing
      conditions imposed on CTI for any of the draws other than that CTI has filed
      its
      periodic and other reports with the SEC, has delivered the stock for an advance,
      and the trading of CTI’s common stock has not been suspended. We may request
      advances under the Standby Equity Distribution Agreement until Cornell Capital
      has advanced $5 million or twenty-four (24) months after the effective date
      of
      this Registration Statement, whichever occurs first. It is unlikely that we
      will
      be able to draw the entire amount of $5 million before twenty-four (24) months
      after the effective date of this Registration Statement, given the limitations
      on the size and frequency with which we may request advances from Cornell
      Capital, unless our stock price increases significantly.




The
      amount of each advance is subject to a maximum amount of $100,000, and we may
      not submit an advance within five (5) trading days of a prior advance. The
      amount available under the Standby Equity Distribution Agreement is not
      dependent on the price or volume of our common stock. Our ability to request
      advances is conditioned upon us registering the shares of common stock with
      the
      SEC. In addition, we may not request advances if the shares to be issued in
      connection with such advances would result in Cornell Capital owning more than
      9.9% of our outstanding common stock. Cornell Capital’s beneficial ownership of
      CTI common stock was 0% before the initial advance. We would be permitted to
      make draws on the Standby Equity Distribution Agreement only so long as Cornell
      Capital’s beneficial ownership of our common stock remains lower than 9.9% and,
      therefore, a possibility exists that Cornell Capital may own more than 9.9%
      of
      CTI’s outstanding common stock at a time when we would otherwise plan to make an
      advance under the Standby Equity Distribution Agreement.




39


We
      do not
      have any agreements with Cornell Capital regarding the distribution of such
      stock, although Cornell Capital has indicated that it intends to promptly sell
      any stock received under the Standby Equity Distribution Agreement.




We
      cannot
      predict the actual number of shares of common stock that will be issued pursuant
      to the Standby Equity Distribution Agreement, in part, because the purchase
      price of the shares will fluctuate based on prevailing market conditions, and
      we
      have not determined the total amount of advances we intend to draw. Nonetheless,
      we can estimate the number of shares of our common stock that will be issued
      using certain assumptions. We have registered 400,000 shares of common stock
      for
      the sale under the Standby Equity Distribution Agreement. The Company and
      Cornell have agreed that the Company will not sell to Cornell Capital in excess
      of 400,000 shares unless and until the Company shall have obtained shareholder
      approval for such sales. In order to access all funds available to us under
      the
      Standby Equity Distribution Agreement with the 400,000 shares being registered
      in this offering, the average price of shares issued under the Standby Equity
      Distribution Agreement would need to be $12.50.




On
      December 28, 2006, we filed a Registration Statement for the registration of
      403,500 shares of our common stock. On January 26, 2007, the Registration
      Statement was declared effective. Since that time, to March 20, 2007, we have
      sold an aggregate of 45,306 shares of common stock to Cornell under the SEDA
      and
      have received net proceeds from the sale of those shares in the amount of
      $217,000. We intend to continue to sell shares to Cornell under the
      SEDA.




*Current
      Assets.* As of
      December 31, 2006, the total current assets of the Company were $16,491,000,
      compared to total current assets of $12,335,000 as of December 31, 2005. The
      change in current assets reflects, principally, (i) an increase in receivables
      of $2,099,000, (ii) an increase in inventories of $952,000, (iii) an increase
      in
      cash and equivalents of $123,000, (iv) a decrease in prepaid expenses of $43,000
      and (v) an increase in the current portion of the Company’s net deferred
      tax
      asset of $1,026,000. The increase in receivables is a reflection of the
      increased level of sales of the Company during the second half of 2006.
      Similarly, the increase in net inventories of the Company from December 31,
      2005
      to December 31, 2006, is a reflection of substantially increased levels of
      sales
      in both metalized and latex balloons. We anticipate that both receivables and
      inventories will increase further during the second half of 2007 as we commence
      our production and sales of zippered vacuumable pouches.





40


*Property,
      Plant and Equipment.* During
      fiscal 2006, the Company invested $553,000 in capital items. Although we do
      not
      have specific commitments for capital expenses in 2007, we anticipate that
      investment in plant and equipment will exceed 2006 levels.





*Current
      Liabilities* .
      Total
      current liabilities decreased from $14,761,000 as of December 31, 2005 to
      $14,643,000 as of December 31, 2006. Changes in current liabilities included:
      (i) a decrease of $1,307,000 in trades payable, (ii) an increase of $1,267,000
      in the amount outstanding on our revolving line of credit, (iii) a decrease
      of
      $381,000 in the current portion of long term debts and (v) an increase of
      $776,000 in accrued liabilities.





*Liquidity
      and Capital Resources.* As of
      December 31, 2006, our current assets exceeded our current liabilities by
      $1,848,000. In addition, during 2007 through March 20, 2007, we have received
      $217,000 in net proceeds from the sale of our stock to Cornell under the SEDA
      and we anticipate receiving additional net proceeds from the sale of stock
      to
      Cornell under the SEDA. We believe that we have sufficient cash and financial
      resources to meet our operating requirements through December 31, 2007.





*Shareholders’
      Equity.* Shareholders’
      equity was $5,102,000 as of December 31, 2006 compared to $2,726,000 as of
      December 31, 2005.





The
      contractual commitments of the Company, determined as of December 31, 2006,
      over
      the next five years are as follows:


**Payments
                  due by Period****2012****Total**
              
              **2007**
              
              **2008-2009**
              
              **2010-2011**
              
              **And
                  Thereafter**Revolving
                  line of credit
              
              $
              6,318
              
              $
              6,318
              
              $
              -
              
              $
              -
              
              $
              -Current
                  maturities of long-term debt
              
              $
              3,104
              
              $
              3,104
              
              $
              -
              
              $
              -
              
              $
              -Long-Term
                  debt, net of current maturities
              
              $
              5,593
              
              $
              -
              
              $
              1,447
              
              $
              4,146
              
              $
              -Estimated
                  interest payments
              
              $
              1,962
              
              $
              721
              
              $
              871
              
              $
              370
              
              $
              -Lease
                  Obligations (includes real estate taxes)
              
              $
              1,426
              
              $
              428
              
              $
              409
              
              $
              175
              
              $
              414Licenses
              
              $
              183
              
              $
              92
              
              $
              91
              
              $
              -Total
                  contractual obligations
              
              $
              18,586
              
              $
              10,663
              
              $
              2,818
              
              $
              4,691
              
              $
              414





The
      Company does not have any current material commitments for capital expenditures.





41


**Seasonality**





In
      the
      metalized product line, sales have historically been seasonal with approximately
      45% occurring in the period from December through March of the succeeding year
      and 21% being generated in the period July through October in recent years.
      The
      sale of latex balloons, pouches and laminated film products have not
      historically been seasonal, and as sales in these product lines have increased
      as a percentage of total sales, the seasonality of the Company's total net
      sales
      has decreased.





**Critical
      Accounting Policies**





The
      financial statements of the Company are based on the selection and application
      of significant accounting policies which require management to make various
      estimates and assumptions. The following are some of the more critical judgment
      areas in the application of our accounting policies that currently affect our
      financial condition and results of operation.





*Revenue
      Recognition.* Substantially all of the Company's revenues are derived from the sale of
      products. With respect to the sale of products, revenue from a transaction
      is
      recognized when (i) a definitive arrangement exists for the sale of the product,
      (ii) delivery of the product has occurred, (iii) the price to the buyer has
      been
      fixed or is determinable and (iv) collectibility is reasonably assured. The
      Company generally recognizes revenue for the sale of products when the products
      have been shipped and invoiced. In some cases, product is provided on
      consignment to customers. In those cases, revenue is recognized when the
      customer reports a sale of the product.





*Allowance
      for Doubtful Accounts.* We
      estimate our allowance for doubtful accounts based on an analysis of specific
      accounts, an analysis of historical trends, payment and write-off histories.
      Our
      credit risks are continually reviewed and management believes that adequate
      provisions have been made for doubtful accounts. However, unexpected changes
      in
      the financial condition of customers or changes in the state of the economy
      could result in write-offs, which exceed estimates and negatively impact our
      financial results.





*Inventory
      Valuation.* Inventories
      are stated at the lower of cost or market. Cost is determined using standard
      costs which approximate costing determined on a first-in, first out basis.
      Standard costs are reviewed and adjusted at the time of introduction of a new
      product or design, periodically and at year end based on actual direct and
      indirect production costs. On a periodic basis, the Company reviews its
      inventory levels for estimated obsolescence or unmarketable items, in reference
      to future demand requirements and shelf life of the products. As of December
      31,
      2006, the Company had established a reserve for obsolescence, marketability
      or
      excess quantities with respect to inventory in the aggregate amount of $276,000.
      As of December 31, 2005, the amount of the reserve was $255,000. In addition,
      on
      a periodic basis, the Company disposes of inventory deemed to be obsolete or
      unsaleable and, at such time, records an expense for the value of such
      inventory.





42


*Valuation
      of Long-Lived Assets.* We
      evaluate whether events or circumstances have occurred which indicate that
      the
      carrying amounts of long-lived assets (principally property and equipment and
      goodwill) may be impaired or not recoverable. Significant factors which may
      trigger an impairment review include: changes in business strategy, market
      conditions, the manner of use of an asset, underperformance relative to
      historical or expected future operating results, and negative industry or
      economic trends. FASB issued Statement No. 142, "Goodwill and Other Intangible
      Assets," which requires that goodwill be evaluated annually for impairment
      by
      applying a fair-value based test. We have conducted a valuation analysis in
      consultation with valuation consulting firms of our goodwill in our Mexico
      subsidiary as of December 2004, 2005 and 2006. As of December 31, 2005, we
      determined in consultation with a valuation consulting firm, that the fair
      value
      of the Company’s interest in Flexo Universal was $989,000, and the carrying
      value of $1,113,000 was impaired by $124,000. Accordingly, we recorded the
      amount of this impairment as an expense and reduced the carrying value of the
      Company’s interest in Flexo Universal to $989,000. As of December 31, 2006, we
      determined that the recorded value of the Company’s goodwill associated with
      Flexo Universal was not impaired.





*Income
      Taxes and Deferred Tax Assets.* Income
      taxes are accounted for as prescribed in SFAS No. 109-Accounting for Income
      Taxes. Under the asset and liability method of Statement 109, the Company
      recognizes the amount of income taxes currently payable. Deferred tax assets
      and
      liabilities are recognized for the future tax consequences attributable to
      differences between the financial statement carrying amounts of existing assets
      and liabilities, and their respective tax bases. Deferred tax assets and
      liabilities are measured using enacted tax rates expected to apply to taxable
      income in the years these temporary differences are expected to be recovered
      or
      settled. Deferred
      tax assets are reduced by a valuation allowance when management cannot, in
      its
      opinion, determine that it is more likely than not that the Company will recover
      the recorded value of the deferred tax asset.





As
      of
      December 31, 2006, the Company had a net deferred tax asset of $1,127,000,
      representing the amount the Company may recover in future years from future
      taxable income. As of December 31, 2005, the amount of the deferred tax asset
      was $2,807,000. Each quarter and year-end management makes a judgment to
      determine the extent to which the deferred tax asset will be recovered from
      future taxable income. The Company recorded a deferred tax asset benefit in
      the
      amount of $774,000 during 2006 as management has determined that this deferred
      tax asset is more likely than not to be realized.





**Recently
      Issued Accounting Standards**





***Accounting
      Pronouncements Not Yet Implemented***




In
      September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” which
      defines fair value, establishes a framework for measuring fair value, and
      expands disclosures about fair value measurements. This statement clarifies
      how
      to measure fair value as permitted under other accounting pronouncements but
      does not require any new fair value measurements. The Company will be required
      to adopt SFAS No. 157 as of January 1, 2008. The
      Company is currently evaluating the impact of SFAS 157 and does not believe
      it
      will have a material impact on its financial statements.





43


In
      September 2006, the SEC issued Staff Accounting Bulletin No.108, “Considering
      the Effects of Prior Year Misstatements when Quantifying Misstatements in
      Current Year Financial Statements” (“SAB 108”). SAB 108 provides guidance on how
      prior year misstatements should be taken into consideration when quantifying
      misstatements in the current year financial statements. SAB 108 is effective
      for
      fiscal years ended on or after November 15, 2006. The
      Company has evaluated the impact of adopting SAB 108 on the Company’s financial
      statements and does not believe such adoption will have a material
      effect.




In
      June
      2006, the FASB issued FASB Interpretation No. 48, *Accounting
      for Uncertainty in*  *Income
      Taxes-an interpretation of FASB No. 109* (“FIN
      48”), which prescribes accounting for and disclosure of uncertainty in tax
      positions. This interpretation defines the criteria that must be met for the
      benefits of a tax position to be recognized in the financial statements and
      the
      measurement of tax benefits recognized. The provisions of FIN 48 are effective
      as of the beginning of the Company’s 2007 fiscal year, with the cumulative
      effect of the change in accounting principle recorded as an adjustment to
      opening retained earnings. The Company has evaluated the impact of adopting
      FIN
      48 on the Company’s financial
      statements and does not believe such adoption will have a material
      effect.





**Item
      No. 7A - Qualitative And Quantitative Disclosures About Market Risk**





The
      Company is exposed to various market risks, primarily foreign currency risks
      and
      interest rate risks.





The
      Company's earnings are affected by changes in interest rates as a result of
      variable rate indebtedness. If market interest rates for our variable rate
      indebtedness averaged 1% more than the interest rate actually paid for the
      years
      ending December 31, 2006, 2005 and 2004, our interest rate expense would have
      increased, and income (loss) before income taxes would have decreased
      (increased) by $96,000, $72,000 and $92,000, for these years, respectively.
      These amounts are determined by considering the impact of the hypothetical
      interest rates on our borrowings. This analysis does not consider the effects
      of
      the reduced level of overall economic activity that could exist in such an
      environment. Further, in the event of a change of such magnitude, management
      would likely take actions to reduce our exposure to such change. However, due
      to
      the uncertainty of the specific actions we would take and their possible
      effects, the sensitivity analysis assumes no change in our financial structure.





The
      Company's earnings and cash flows are subject to fluctuations due to changes
      in
      foreign currency rates, particularly the Mexican peso, the British pound and
      the
      euro, as the Company produces and sells products in Mexico for sale in the
      United States and other countries and the Company's U.K. subsidiary purchases
      balloon products from the Company in U.S. Dollars and sells throughout Europe.
      Also, the Mexican subsidiary purchases goods from external sources in U.S.
      Dollars and is affected by currency fluctuations in those transactions.
      Substantially all of the Company's purchases and sales of goods for its
      operations in the United States are done in U.S. Dollars. However, the Company's
      level of sales in other countries may be affected by currency fluctuations.
      As a
      result, exchange rate fluctuations may have an effect on sales and gross
      margins. Accounting practices require that the Company's results from operations
      be converted to U.S. dollars for reporting purposes. Consequently, the reported
      earnings of the Company in future periods may be affected by fluctuations in
      currency exchange rates, generally increasing with a weaker U.S. dollar and
      decreasing with a strengthening U.S. dollar. To date, we have not entered into
      any transactions to hedge against currency fluctuation effects.





44


We
      have
      performed a sensitivity analysis as of December 31, 2006 that measures the
      change in the results of our foreign operations arising from a hypothetical
      10%
      adverse movement in the exchange rate of all of the currencies the Company
      presently has operations in. Using the results of operations for 2006, 2005
      and
      2004 for the Company's foreign operations as a basis for comparison, an adverse
      movement of 10% would create a potential reduction in the Company's net income,
      or increase its net loss, before taxes, in the amount of, for each of those
      years, $248,000, $140,000 and $290,000, respectively.





The
      Company is also exposed to market risk in changes in commodity prices in some
      of
      the raw materials it purchases for its manufacturing needs. However, in the
      past, we have been able to adjust the sales price of our products so as to
      minimize the effect of changes in raw materials pricing and, as a result, we
      do
      not believe this market risk presents a risk that would have a material effect
      on the Company’s results of operations or financial condition.





**Item
      No. 8 Financial Statements and Supplementary Data**





Reference
      is made to the Consolidated Financial Statements contained in Part IV hereof.





**Item
      No. 9 Changes in and Disagreements with Accountants on Accounting and Financial
      Disclosure**





None




**Item
      No. 9A - Controls and Procedures**




**Disclosure
      Controls and Procedures**





As
      required by Rule 13a-15(b) under the Exchange Act, we conducted an evaluation,
      under the supervision and with the participation of our management, including
      our Chief Executive Officer and Chief Financial Officer (together the
“Certifying Officers”), of the effectiveness of the design and operation of our
      disclosure controls and procedures as of December 31, 2006, the end of the
      period covered by this report. Based upon that evaluation, the Certifying
      Officers concluded that our disclosure controls and procedures were effective
      as
      of December 31, 2006 to provide reasonable assurance that the information
      required to be disclosed in our Exchange Act reports is recorded, processed,
      summarized and reported within the time periods specified in the SEC’s rules and
      forms and that such information is accumulated and communicated to our
      management, including our Certifying Officers, as appropriate, to allow for
      timely decisions regarding required disclosure.





45
 
  **Inherent
        Limitations of Effectiveness of Controls**





Management
      is responsible for establishing and maintaining adequate internal control over
      financial reporting to provide reasonable assurance regarding the reliability
      of
      financial reporting and the preparation of financial statements for external
      purposes in accordance with U.S. generally accepted accounting principles.
      Internal control over financial reporting includes those policies and procedures
      that (i) pertain to the maintenance of records that, in reasonable detail,
      accurately and fairly reflect the transactions and dispositions of assets;
      (ii)
      provide reasonable assurance that transactions are recorded as necessary to
      permit preparation of financial statements in accordance with U.S. generally
      accepted accounting principles, and that receipts and expenditures are being
      made only in accordance with authorizations of the management and the Board;
      and
      (iii) provide reasonable assurance regarding prevention or timely detection
      of
      unauthorized acquisition, use or disposition of Company assets that could have
      a
      material effect on the financial statements.





Management
      personnel, including the Certifying Officers, recognize that our internal
      control over financial reporting cannot prevent or detect all error and all
      fraud. A control system, no matter how well designed and operated, can provide
      only reasonable, not absolute, assurance that the control system’s objectives
      will be met. The design of a control system must reflect the fact that there
      are
      resource constraints, and the benefits of controls must be considered relative
      to their costs. Further, because of the inherent limitations in all control
      systems, no evaluation of controls can provide absolute assurance that
      misstatements due to error or fraud will not occur or that all control issues
      and instances of fraud, if any, have been detected. The design of any system
      of
      controls is based in part on certain assumptions about the likelihood of future
      events, and there can be no assurance that any design will succeed in achieving
      its stated goals under all potential future conditions.





**Changes
      in Internal Control over Financial Reporting**





There
      has
      been no change during the Company’s fiscal quarter ended December 31, 2006 in
      the Company’s internal control over financial reporting (as such term is defined
      in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that has materially
      affected, or is reasonably likely to materially affect, the company’s internal
      control over financial reporting.




**Item
        No. 9B - Other Information**
 
 None


46


**PART
      III**





**The
      information to be provided under Part III is incorporated by reference to the
      definitive proxy materials of the Company if filed on or before April 30, 2007
      or, if not filed on or before such date, shall be provided by amendment to
      this
      Annual Report on Form 10-K filed on or before April 30,
      2007.**









PART
      IV





**Item
      No. 15 Exhibits and Financial Statement Schedules**





1.
            The
                Consolidated Financial Statements filed as part of this report on
                Form
                10-K are listed on the accompanying Index to Consolidated Financial
                Statements and Consolidated Financial Statement
                Schedules.




2.
            Financial
                schedules required to be filed by Item 8 of this form, and by Item
                15(d)
                below:





Schedule
      II  Valuation
      and qualifying accounts





All
      other
      financial schedules are not required under the related instructions or are
      inapplicable and therefore have been omitted.





3.
            Exhibits:


Exhibit
                Number
              
              Document3.1
              
              Third
                  Restated Certificate of Incorporation of CTI Industries Corporation
                  (Incorporated by reference to Exhibit A contained in Registrant’s Schedule
                  14A Definitive Proxy Statement for solicitation of written consent
                  of
                  shareholders, as filed with the Commission on October 25,
                  1999)3.2
              
              By-Laws
                  of CTI Industries Corporation (Incorporated by reference to Exhibits,
                  contained in Registrant’s Form SB-2 Registration Statement (File No.
                  333-31969) effective November 5, 1997)4.1
              
              Form
                  of CTI Industries Corporation’s common stock certificate (Incorporated by
                  reference to Exhibits, contained in Registrant’s Form SB-2 Registration
                  Statement (File No. 333-31969) effective November 5,
                  1997)10.1
              
              CTI
                  Industries Corporation 1999 Stock Option Plan (Incorporated by
                  reference
                  to Exhibit contained in Registrant’s Schedule 14A Definitive Proxy
                  Statement, as filed with the Commission on March 26,
                  1999)10.2
              
              CTI
                  Industries Corporation 2001 Stock Option Plan (Incorporated by
                  reference
                  to Exhibit contained in Registrant’s Schedule 14A Definitive Proxy
                  Statement, as filed with the Commission on May 21,
                  2001)
  47
  10.3
              
              CTI
                  Industries Corporation 2002 Stock Option Plan (Incorporated by
                  reference
                  to Exhibit contained in Registrant’s Schedule 14A Definitive Proxy
                  Statement, as filed with the Commission on May 15,
                  2002)


10.4
            
            Employment
                Agreement dated June 30, 1997, between CTI Industries Corporation
                and
                Howard W. Schwan (Incorporated by reference to Exhibits, contained
                in
                Registrant’s Form SB-2 Registration Statement (File No. 333-31969)
                effective November 5, 1997.)10.5
            
            Warrant
                dated July 17, 2001 to purchase 79,364 shares of Common Stock John
                H.
                Schwan (Incorporated by reference to Exhibits contained in the
                Registrant’s 2002 10-KSB, as filed with the Commission on May 1,
                2003)10.6
            
            Warrant
                dated July 17, 2001 to purchase 39,683 shares of Common Stock Stephen
                M.
                Merrick (Incorporated by reference to Exhibits contained in the
                Registrant’s 2002 10-KSB, as filed with the Commission on May 1,
                2003)10.7
            
            Note
                dated January 28, 2003, CTI Industries Corporation to Stephen M.
                Merrick
                in the sum of $500,000 (Incorporated by reference to Exhibits contained
                in
                the Registrant’s 2002 10-KSB, as filed with the Commission on May 1,
                2003)10.8
            
            Note
                dated February 28, 2003, CTI Industries Corporation to Stephen M.
                Merrick
                in the sum of $200,000 (Incorporated by reference to Exhibits contained
                in
                the Registrant’s 2002 10-KSB, as filed with the Commission on May 1,
                2003)10.9
            
            Note
                dated February 10, 2003, CTI Industries Corporation to John H. Schwan
                in
                the sum of $150,000 (Incorporated by reference to Exhibits contained
                in
                the Registrant’s 2002 10-KSB, as filed with the Commission on May 1,
                2003)10.10
            
            Note
                dated February 15, 2003, CTI Industries Corporation to John Schwan
                in the
                sum of $680,000 (Incorporated by reference to Exhibits contained
                in the
                Registrant’s 2002 10-KSB, as filed with the Commission on May 1,
                2003)10.11
            
            Note
                dated March 3, 2003, CTI Industries Corporation to John H. Schwan
                in the
                sum of $100,000 (Incorporated by reference to Exhibits contained
                in the
                Registrant’s 2002 10-KSB, as filed with the Commission on May 1,
                2003)10.12
            
            Warrant
                dated March 20, 2003, to purchase 70,000 shares of Common Stock -
                Stephen
                M. Merrick (Incorporated by reference to Exhibits contained in the
                Registrant’s 2002 10-KSB, as filed with the Commission on May 1,
                2003)10.13
            
            Warrant
                dated March 20, 2003, to purchase 93,000 shares of Common Stock -
                John H.
                Schwan (Incorporated by reference to Exhibits contained in the
                Registrant’s 2002 10-KSB, as filed with the Commission on May 1,
                2003)




48




10.14
            
            Loan
                and Security Agreement between Charter One Bank and the Company dated
                February 1, 2006 (Incorporated by reference to Exhibits contained
                in
                Registrant’s Report on Form 8-K dated February 3, 2006)10.15
            
            Warrant
                dated February 1, 2006, to purchase 151,515 shares of Common Stock
                - John
                H. Schwan (Incorporated by reference to Exhibits contained in Registrant’s
                Report on Form 8-K dated February 3, 2006)10.16
            
            Warrant
                dated February 1, 2006, to purchase 151,515 shares of Common Stock
                -
                Stephen M. Merrick (Incorporated by reference to Exhibits contained
                in
                Registrant’s Report on Form 8-K dated February 3, 2006)10.17
            
            Note
                dated February 1, 2006, CTI Industries Corporation to John Schwan
                in the
                sum of $500,000 (Incorporated by reference to Exhibits contained
                in
                Registrant’s Report on Form 8-K dated February 3, 2006)10.18
            
            Note
                dated February 1, 2006, CTI Industries Corporation to Stephen M.
                Merrick
                in the sum of $500,000 (Incorporated by reference to Exhibits contained
                in
                Registrant’s Report on Form 8-K dated February 3, 2006)10.19
            
            Production
                and Supply Agreement between ITW Spacebag and the Company dated March
                17,
                2006 (Incorporated by reference to Exhibits contained in Registrant’s
                Report on Form 8-K dated March 17, 2006)10.20
            
            License
                Agreement between Rapak, LLC and the Company dated April 28, 2006
                (Incorporated by reference to Exhibit contained in Registrant’s Report on
                Form 8-K dated May 3, 2006)10.21
            
            Standby
                Equity Distribution Agreement between Cornell Capital Partners and
                the
                Company dated December 28, 2006)10.22
            
            Second
                Amendment to Loan Agreement between Charter One Bank and the Company
                dated
                December 18, 2006 (Incorporated by reference to Exhibit contained
                in
                Registrant’s Report on from 8-K dated December 21,
                2006.)14
            
            Code
                of Ethics (Incorporated by reference to Exhibit contained in the
                Registrant’s Form 10-K/A Amendment No. 2, as filed with the Commission on
                October 8, 2004)21
            
            Subsidiaries
                (description incorporated in Form 10-K under Item No.
                1)23.1
            
            Consent
                of Independent Auditors, Weiser LLP31.1
            
            Certification
                of Chief Executive Officer pursuant to Rule 13a-14(a) and rule 15d-14(a)
                of the Securities Exchange Act, as amended (filed
                herewith)31.2
            
            Certification
                of Chief Financial Officer pursuant to Rule 13a-14(a) and rule 15d-14(a)
                of the Securities Exchange Act, as amended (filed
                herewith)




49




32
            
            Certification
                of Chief Executive Officer and Chief Financial Officer Pursuant to
                18
                U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
                Act
                of 2002 (filed herewith)





(a)
            The
                Exhibits listed in subparagraph (a)(3) of this Item 15 are attached
                hereto
                unless incorporated by reference to a previous
                filing.


(b)
            The
                Schedule listed in subparagraph (a)(2) of this Item 15 is attached
                hereto.




50




**SIGNATURES**





In
      accordance with Section 13 or 15(d) of the Exchange Act, the Registrant caused
      this report to be signed on its behalf by the undersigned thereunto duly
      authorized on April 9, 2007.


CTI
                INDUSTRIES CORPORATIONBy:
            /s/ Howard W. SchwanHoward
              W. Schwan, President


By:
            /s/ Stephen
              M. MerrickStephen
              M. Merrick, Executive
              Vice President, Secretary, Chief Financial Officer and
              Director


In
      accordance with the Exchange Act, this report has been signed below by the
      following persons on behalf of the Registrant in the capacities and on the
      dates
      indicated.





**Signatures**
            
            **Title**
            
            **Date**/s/
                Howard W. Schwan
              Howard
                W. Schwan
            
            President
                and Director
            
            April
                9, 2007/s/
                John H. Schwan
              John
                H. Schwan
            
            Chairman
                and Director
            
            April
                9, 2007/s/
                Stephen M. Merrick
              Stephen
                M. Merrick
            
            Executive
                Vice President, Secretary, Chief Financial Officer and
                Director
            
            April
                9, 2007/s/
                Stanley M. Brown
              Stanley
                M. Brown
            
            Director
            
            April
                9, 2007/s/
                Bret Tayne
              Bret
                Tayne
            
            Director
            
            April
                9, 2007/s/
                Michael Avramovich
              Michael
                Avramovich
            
            Director
            
            April
                9, 2007/s/
                John I. Collins
              John
                I. Collins
            
            Director
            
            April
                9, 2007





51




CTI
      Industries Corporation


and
      Subsidiaries





Consolidated
      Financial Statements




Years
      ended December 31, 2006, 2005 and 2004





**Contents**




Report
                of Independent Registered Public Accounting Firm
            
            
            F-1Consolidated
                Financial Statements:Consolidated
                Balance Sheets as of December 31, 2006 and 2005
            
            
            F-2Consolidated
                Statements of Operations for the years endedDecember
                31, 2006, 2005 and 2004
            
            
            F-3Consolidated
                Statements of Stockholders’ Equity  and Comprehensive Loss for the
                years endedDecember
                31, 2006, 2005 and 2004
            
            
            F-4Consolidated
                Statements of Cash Flows for the years endedDecember
                31, 2006, 2005 and 2004
            
            
            F-5Notes
                to Consolidated Financial Statements - December 31, 2006
            
            
            F-6Financial
                Statement Schedule:Schedule
                II - Valuation and Qualifying Accounts for the years ended
            
            
            F-28December
                31, 2006, 2005 and 2004




All
      other
      schedules for which provision is made in the applicable accounting regulation
      of
      the Securities and Exchange Commission are not required under the related
      instructions or are inapplicable and, therefore, have been
      omitted.










Report
      of
      Independent Registered Public Accounting Firm





The
      Board
      of Directors and Stockholders


CTI
      Industries Corporation





We
      have
      audited the accompanying consolidated balance sheets of CTI Industries
      Corporation and Subsidiaries (the “Company”) as of December 31, 2006 and 2005,
      and the related consolidated statements of operations, stockholders’ equity and
      comprehensive loss, and cash flows for each of the three years in the
      period ended December 31, 2006, 2005 and 2004. Our audits also included the
      financial statement schedule listed in the Index at Item 15(a). These
      consolidated financial statements and consolidated schedule are the
      responsibility of the Company’s management. Our responsibility is to express an
      opinion on these consolidated financial statements and consolidated schedule
      based on our audits.





We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the financial
      statements are free of material misstatement. An audit includes examining,
      on a
      test basis, evidence supporting the amounts and disclosures in the financial
      statements. An audit also includes assessing the accounting principles used
      and
      significant estimates made by management, as well as evaluating the overall
      financial statement presentation. We believe that our audits provide a
      reasonable basis for our opinion.





In
      our
      opinion, the consolidated financial statements referred to above present fairly,
      in all material respects, the consolidated financial position of CTI Industries
      Corporation and Subsidiaries as of December 31, 2006 and 2005, and the
      consolidated results of their operations and their cash flows for each of the
      three years in the period ended December 31, 2006, 2005 and 2004, in
      conformity with U.S. generally accepted accounting principles. Also, in our
      opinion, the related consolidated financial statement schedule, when considered
      in relation to the basic consolidated financial statements taken as a whole,
      presents fairly, in all respects, the information set forth
      therein.





As
      discussed in Note 2 to the consolidated financial statements, the Company
      adopted the provisions of Statement of Finanacial Accounting Standards No.
      123
      (Revised 2004), “Share-Based Payment”, applying the modified prospective method
      at the beginning of the year ended December 31, 2006.





/s/
      Weiser LLP


New
      York,
      New York


April 9,
      2007




F-1


**CTI
                    Industries Corporation and Subsidiaries****Consolidated
                    Balance Sheets**
  **December
                    31, 2006**
                
                **December
                    31, 2005**ASSETSCurrent
                    assets:Cash
                    and cash equivalents
                
                $
                384,565
                
                $
                261,982Accounts
                    receivable, (less allowance for doubtful accounts of
                    $210,000
                
                
                6,442,765
                
                
                4,343,671and
                    $80,000 respectively)Inventories,
                    net
                
                
                7,974,113
                
                
                7,022,569Net
                    deferred income tax asset
                
                
                1,025,782
                
                
                0Prepaid
                    expenses and other current assets
                
                
                664,020
                
                
                707,082Total
                    current assets
                
                
                16,491,245
                
                
                12,335,304Property,
                    plant and equipment:Machinery
                    and equipment
                
                
                18,763,007
                
                
                18,869,276Building
                
                
                2,689,956
                
                
                2,602,922Office
                    furniture and equipment
                
                
                2,087,708
                
                
                2,010,557Land
                
                
                250,000
                
                
                250,000Leasehold
                    improvements
                
                
                459,502
                
                
                510,134Fixtures
                    and equipment at customer locations
                
                
                2,330,483
                
                
                2,330,483Projects
                    under construction
                
                
                289,229
                
                
                130,99426,869,885
                
                
                26,704,366Less
                    : accumulated depreciation and amortization
                
                
                (18,277,611
                )
                
                (17,087,622
                )Total
                    property,plant and equipment, net
                
                
                8,592,274
                
                
                9,616,744Other
                    assets:Deferred
                    financing costs, net
                
                
                207,049
                
                
                74,396Goodwill
                
                
                989,108
                
                
                989,108Net
                    deferred income tax asset
                
                
                101,102
                
                
                352,689Other
                    assets (due from related party $30,000 and $19,000,
                    respectively)
                
                
                264,161
                
                
                167,809Total
                    other assets
                
                
                1,561,420
                
                
                1,584,002TOTAL
                    ASSETS
                
                $
                26,644,939
                
                $
                23,536,050LIABILITIES
                    AND STOCKHOLDERS' EQUITYCurrent
                    liabilities:Checks
                    written in excess of bank balance
                
                $
                108,704
                
                $
                500,039Trade
                    payables
                
                
                3,410,869
                
                
                4,717,733Line
                    of credit
                
                
                6,317,860
                
                
                5,050,753Notes
                    payable - current portion
                
                
                948,724
                
                
                1,329,852Notes
                    payable - officers, current portion, net of debt discount
                
                
                2,155,284
                
                
                2,237,292Accrued
                    liabilities
                
                
                1,701,933
                
                
                925,719Total
                    current liabilities
                
                
                14,643,374
                
                
                14,761,388Long-term
                    liabilities:Other
                    liabilities (related parties $1,274,000 and $1,056,000)
                
                
                1,294,272
                
                
                1,644,339Notes
                    payable
                
                
                4,866,008
                
                
                4,394,390Notes
                    payable - officers, subordinated, net of debt discount
                
                
                726,688
                
                
                0Total
                    long-term liabilities
                
                
                6,886,968
                
                
                6,038,729Minority
                    interest
                
                
                12,672
                
                
                10,091Stockholders'
                    equity:Preferred
                    Stock —
                    no par value 2,000,000 shares authorized0
                    shares issued and outstanding
                
                
                0
                
                
                0Common
                    stock - no par value, 5,000,000 shares authorized,2,412,297
                    and 2,268,270 shares issued, 2,142,097 and2,036,474
                    shares outstanding, respectively
                
                
                3,764,020
                
                
                3,764,020Paid-in-capital
                
                
                6,100,587
                
                
                5,869,828Warrants
                    issued in connection with subordinated debt and bank debt
                
                
                1,038,487
                
                
                595,174Accumulated
                    deficit
                
                
                (4,445,897
                )
                
                (6,340,646
                )Accumulated
                    other comprehensive loss
                
                
                (297,490
                )
                
                (223,420
                )Less:Treasury
                    stock - 270,200 and 231,796 shares, respectively
                
                
                (1,057,782
                )
                
                (939,114
                )Total
                    stockholders' equity
                
                
                5,101,925
                
                
                2,725,842TOTAL
                    LIABILITIES AND STOCKHOLDERS' EQUITY
                
                $
                26,644,939
                
                $
                23,536,050
  See
                    accompanying notes to consolidated financial
                    statements
  F-2
 
 **CTI
                              Industries Corporation and Subsidiaries****Consolidated
                              Statements of Operations**
  Year
                              Ended December 31,2006
                          
                          2005
                          
                          2004Net
                              sales
                          
                          $
                          35,428,155
                          
                          $
                          29,189,974
                          
                          $
                          37,193,109Cost
                              of sales
                          
                          
                          26,531,045
                          
                          
                          22,725,825
                          
                          
                          30,840,989Gross
                              profit
                          
                          
                          8,897,110
                          
                          
                          6,464,149
                          
                          
                          6,352,120Operating
                              expenses:General
                              and administrative
                          
                          
                          4,554,324
                          
                          
                          3,846,538
                          
                          
                          4,410,595Selling
                          
                          
                          847,244
                          
                          
                          928,444
                          
                          
                          1,288,598Advertising
                              and marketing
                          
                          
                          1,200,782
                          
                          
                          913,071
                          
                          
                          1,221,122Loss
                              (gain) on sale of asset
                          
                          
                          144,936
                          
                          
                          -
                          
                          
                          (122,499
                          )Other
                              operating income
                          
                          
                          (471,802
                          )
                          
                          -
                          
                          
                          (395,489
                          )Asset
                              impairment loss
                          
                          
                          -
                          
                          
                          124,000
                          
                          
                          -Total
                              operating expenses
                          
                          
                          6,275,484
                          
                          
                          5,812,053
                          
                          
                          6,402,327Income
                              (loss) from operations
                          
                          
                          2,621,626
                          
                          
                          652,096
                          
                          
                          (50,207
                          )Other
                              income (expense):Interest
                              expense
                          
                          
                          (1,713,801
                          )
                          
                          (1,230,964
                          )
                          
                          (1,350,085
                          )Interest
                              income
                          
                          
                          22,976
                          
                          
                          
                          
                          
                          -Foreign
                              currency gain
                          
                          
                          191,270
                          
                          
                          45,128
                          
                          
                          208,213Total
                              other (expense)
                          
                          
                          (1,499,555
                          )
                          
                          (1,185,836
                          )
                          
                          (1,141,872
                          )Income
                              (loss) before income taxes and minority interest
                          
                          
                          1,122,071
                          
                          
                          (533,740
                          )
                          
                          (1,192,079
                          )Income
                              tax (benefit) expense
                          
                          
                          (774,195
                          )
                          
                          (200,392
                          )
                          
                          1,286,232Income
                              (loss) before minority interest
                          
                          
                          1,896,266
                          
                          
                          (333,348
                          )
                          
                          (2,478,311
                          )Minority
                              interest in income (loss) of subsidiary
                          
                          
                          1,517
                          
                          
                          (139
                          )
                          
                          1,063Net
                              income (loss)
                          
                          $
                          1,894,749
                          
                          $
                          (333,209
                          )
                          $
                          (2,479,374
                          )Income
                              (loss) applicable to common shares
                          
                          $
                          1,894,749
                          
                          $
                          (333,209
                          )
                          $
                          (2,479,374
                          )Basic
                              income (loss) per common share
                          
                          $
                          0.91
                          
                          $
                          (0.17
                          )
                          $
                          (1.28
                          )Diluted
                              income (loss) per common share
                          
                          $
                          0.85
                          
                          $
                          (0.17
                          )
                          $
                          (1.28
                          )Weighted
                              average number of shares and equivalent sharesof
                              common stock outstanding:Basic
                          
                          
                          2,087,145
                          
                          
                          1,977,235
                          
                          
                          1,930,976Diluted
                          
                          
                          2,234,901
                          
                          
                          1,977,235
                          
                          
                          1,930,976See
                              accompanying notes to consolidated financial
                              statements
   F-3
  **CTI
                          Industries Corporation and Subsidiaries****Consolidated
                          Statements of Stockholders' Equity and Comprehensive
                          Loss**
  Value
                          of warrants
                        issued
                          in
                        connection
                        with
                      
                      
                      
                      AccumulatedOther
                      
                      LessCommon
                          Stock
                      
                      Paid-in
                      
                      subordinated
                      
                      Accumulated
                      
                      Comprehensive
                      
                      Treasury
                          StockShares
                      
                      Amount
                      
                      Capital
                      
                      debt
                      
                      Deficit
                      
                      Loss
                      
                      Shares
                      
                      Amount
                      
                      TOTALBalance,
                          December 31, 2003
                      
                      
                      2,150,216
                      
                      $
                      3,764,020
                      
                      $
                      5,554,332
                      
                      $
                      595,174
                      
                      $
                      (3,528,063
                      )
                      $
                      (234,778
                      )
                      
                      231,796
                      
                      $
                      (939,114
                      )
                      $
                      5,211,581Stock
                          issued in settlement of vendorobligations
                      
                      
                      35,681
                      
                      $
                      -
                      
                      $
                      61,079
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      61,079Net
                          Loss
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      (2,479,374
                      )
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      (2,479,374
                      )Other
                          comprehensive incomeForeign
                          currency translation
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      157,884
                      
                      
                      
                      
                      
                      
                      
                      $
                      157,884Total
                          comprehensive loss
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      (2,321,490
                      )Balance,
                          December 31, 2004
                      
                      
                      2,185,897
                      
                      $
                      3,764,020
                      
                      $
                      5,615,411
                      
                      $
                      595,174
                      
                      $
                      (6,007,437
                      )
                      $
                      (76,884
                      )
                      
                      231,796
                      
                      $
                      (939,114
                      )
                      $
                      2,951,170Options
                          Exercised
                      
                      
                      32,144
                      
                      
                      
                      
                      $
                      53,501
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      53,501Stock
                          issued in settlement of vendorobligations
                      
                      
                      50,229
                      
                      
                      
                      
                      $
                      200,916
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      200,916Net
                          Loss
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      ($333,209
                      )
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      (333,209
                      )Other
                          comprehensive lossForeign
                          currency translation
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      ($146,536
                      )
                      
                      
                      
                      
                      
                      
                      $
                      (146,536
                      )Total
                          comprehensive loss
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      (479,745
                      )Balance,
                          December 31, 2005
                      
                      
                      2,268,270
                      
                      $
                      3,764,020
                      
                      $
                      5,869,828
                      
                      $
                      595,174
                      
                      $
                      (6,340,646
                      )
                      $
                      (223,420
                      )
                      
                      231,796
                      
                      $
                      (939,114
                      )
                      $
                      2,725,842Options
                          Exercised
                      
                      
                      21,477
                      
                      
                      
                      
                      $
                      41,577
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      41,577Warrants
                          Exercised
                      
                      
                      119,050
                      
                      
                      
                      
                      $
                      178,192
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      178,192Shares
                          Surrendered to Exercise Warrants
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      38,404
                      
                      $
                      (118,668
                      )
                      $
                      (118,668
                      )Issue
                          of warrantsrelated
                          to subordinated debt
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      443,313
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      443,313Stock
                          issued in advance for servicesrelating
                          to the SEDA agreement
                      
                      
                      3,500
                      
                      
                      
                      
                      $
                      10,990
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      10,990Net
                          Income
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      1,894,749
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      1,894,749Other
                          comprehensive lossForeign
                          currency translation
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      (74,070
                      )
                      
                      
                      
                      
                      
                      
                      $
                      (74,070
                      )Total
                          comprehensive income
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      $
                      1,820,679Balance,
                          December 31, 2006
                      
                      
                      2,412,297
                      
                      $
                      3,764,020
                      
                      $
                      6,100,587
                      
                      $
                      1,038,487
                      
                      $
                      (4,445,897
                      )
                      $
                      (297,490
                      )
                      
                      270,200
                      
                      $
                      (1,057,782
                      )
                      $
                      5,101,925
  See
                          accompanying notes to consolidated financial
                          statements
  F-4
  **CTI
                          Industries Corporation and Subsidiaries****Consolidated
                          Statements of Cash Flows**
  For
                              the Year Ended December 31,2006
                          
                          2005
                          
                          2004Cash
                              flows from operating activities:Net
                              income (loss)
                          
                          $
                          1,894,749
                          
                          $
                          (333,209
                          )
                          $
                          (2,479,374
                          )Adjustment
                              to reconcile net income (loss) to cash(used
                              in) provided by operating activities:Depreciation
                              and amortization
                          
                          
                          1,424,385
                          
                          
                          1,479,916
                          
                          
                          1,639,808Deferred
                              gain on sale/leaseback
                          
                          
                          0
                          
                          
                          0
                          
                          
                          (175,271
                          )Amortization
                              of debt discount
                          
                          
                          102,939
                          
                          
                          35,967
                          
                          
                          251,490Minority
                              interest in loss of subsidiary
                          
                          
                          1,517
                          
                          
                          65
                          
                          
                          1,063Loss
                              on sale of asset
                          
                          
                          144,936
                          
                          
                          0
                          
                          
                          0Loss
                              on impairment of goodwill
                          
                          
                          0
                          
                          
                          124,000
                          
                          
                          0Gain
                              on cancellation of vendor claim
                          
                          
                          (471,802
                          )
                          
                          0
                          
                          
                          0Provision
                              for losses on accounts receivable
                          
                          
                          202,571
                          
                          
                          145,000
                          
                          
                          288,562Provision
                              for losses on inventories
                          
                          
                          218,730
                          
                          
                          205,000
                          
                          
                          60,000Shares
                              issued for services
                          
                          
                          0
                          
                          
                          200,916
                          
                          
                          0Deferred
                              income taxes
                          
                          
                          (774,195
                          )
                          
                          (200,392
                          )
                          
                          1,189,135Change
                              in operating assets and liabilities:Accounts
                              receivable
                          
                          
                          (2,440,174
                          )
                          
                          1,680,617
                          
                          
                          (1,523,274
                          )Inventories
                          
                          
                          (1,063,203
                          )
                          
                          1,129,594
                          
                          
                          890,945Prepaid
                              expenses and other assets
                          
                          
                          106,112
                          
                          
                          167,332
                          
                          
                          397,345Trade
                              payables
                          
                          
                          (1,351,823
                          )
                          
                          (825,275
                          )
                          
                          (925,237
                          )Accrued
                              liabilities
                          
                          
                          651,861
                          
                          
                          (1,151,032
                          )
                          
                          0Net
                              cash (used in) provided by operating activities
                          
                          
                          (1,353,397
                          )
                          
                          2,658,499
                          
                          
                          (384,808
                          )Cash
                              flows from investing activities:Proceeds
                              from sale of property, plant and equipment
                          
                          
                          0
                          
                          
                          151,206
                          
                          
                          22,123Purchases
                              of property, plant and equipment
                          
                          
                          (552,798
                          )
                          
                          (551,256
                          )
                          
                          (281,494
                          )****Net
                              cash used in investing activities
                          
                          
                          (552,798
                          )
                          
                          (400,050
                          )
                          
                          (259,371
                          )Cash
                              flows from financing activities:Checks
                              written in excess of bank balance
                          
                          
                          (390,748
                          )
                          
                          (14,225
                          )
                          
                          172,291Net
                              change in revolving line of credit
                          
                          
                          1,267,107
                          
                          
                          (1,350,472
                          )
                          
                          2,706,984Proceeds
                              from issuance of long-term debt and warrants(received
                              from related party $1,000,000,0 and 0)
                          
                          
                          2,647,879
                          
                          
                          231,392
                          
                          
                          583,298Repayment
                              of long-term debt (related parties $15,000, $45,000
                              and
                              $60,000)
                          
                          
                          (959,647
                          )
                          
                          (850,986
                          )
                          
                          (2,552,139
                          )Repayment
                              of short-term debt
                          
                          
                          (363,358
                          )
                          
                          (402,324
                          )
                          
                          0Proceeds
                              from exercise of warrants and options, net of cashless
                              exercise
                          
                          
                          101,101
                          
                          
                          53,501
                          
                          
                          0Cash
                              paid for deferred financing fees
                          
                          
                          (256,884
                          )
                          
                          (141,316
                          )
                          
                          (41,234
                          )Net
                              cash provided by (used in) financing activities
                          
                          
                          2,045,450
                          
                          
                          (2,474,430
                          )
                          
                          869,200Effect
                              of exchange rate changes on cash
                          
                          
                          (16,672
                          )
                          
                          (48,506
                          )
                          
                          (28,293
                          )Net
                              increase (decrease) in cash
                          
                          
                          122,583
                          
                          
                          (264,487
                          )
                          
                          196,728Cash
                              at beginning of period
                          
                          
                          261,982
                          
                          
                          526,469
                          
                          
                          329,742Cash
                              and cash equivalents at end of period
                          
                          $
                          384,565
                          
                          $
                          261,982
                          
                          $
                          526,470Supplemental
                              disclosure of cash flow information:Cash
                              payments for interest
                          
                          $
                          1,215,596
                          
                          $
                          950,280
                          
                          $
                          952,682Cash
                              payments for taxes
                          
                          $
                          80,508
                          
                          $
                          88,151
                          
                          $
                          47,186Supplemental
                              Disclosure of non-cash activitySettlement
                              of liability with third party
                          
                          $
                          -
                          
                          $
                          -
                          
                          $
                          241,268Stock
                              issued to reduce vendor obligations at fair value
                          
                          $
                          
                          
                          $
                          -
                          
                          $
                          61,079Accounts
                              payable converted to notes payable
                          
                          $
                          -
                          
                          $
                          453,503
                          
                          $
                          -Issue
                              of Warants related to Subordinated Debt
                          
                          $
                          443,313
                          
                          $
                          -
                          
                          $
                          -Stock
                              Issued to Placement Agent
                          
                          $
                          10,990
                          
                          $
                          -
                          
                          $
                          -
  See
                accompanying notes to consolidated financial statements
  F-5


Notes
      to
      Consolidated Financial Statements




December
      31, 2006





**1.
      Nature of Business**





***Nature
      of Operations***





CTI
      Industries Corporation, its United Kingdom subsidiary (CTI Balloons Limited),
      its Mexican subsidiaries (Flexo Universal, S.A. de C.V., CTI Mexico Corporation,
      S.A. de C.V. and CTF International S.A. de C.V.), and CTI Helium, Inc. (the
      “Company”) (i) design, manufacture and distribute metallized and latex balloon
      products throughout the world and (ii) operate systems for the production,
      lamination, coating and printing of films used for food packaging and other
      commercial uses and for conversion of films to flexible packaging containers
      and
      other products.





**2.
      Summary of Significant Accounting Policies**





***Principles
      of Consolidation***




The
      consolidated financial statements include the accounts of CTI Industries
      Corporation, its wholly owned subsidiaries CTI Balloons Limited, CTF
      International S.A. de C.V., and CTI Helium, Inc. and its majority owned
      subsidiaries, Flexo Universal and CTI Mexico Corporation. All significant
      intercompany accounts and transactions have been eliminated upon
      consolidation.




***Foreign
      Currency Translation***




The
      financial statements of foreign subsidiaries are translated into U.S. dollars
      using the exchange rate at each balance sheet date for assets and liabilities,
      the historical exchange rate for stockholders’ equity, and a weighted average
      exchange rate for each period for revenues and expenses. Translation adjustments
      are recorded in accumulated other comprehensive income (loss) as the local
      currencies of the subsidiaries are the functional currencies. Foreign currency
      transaction gains and losses are recognized in the period incurred and are
      included in the Consolidated Statements of Operations.




***Use
      of Estimates***




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




F-6




***Cash
      and Cash Equivalents***




Cash
      and
      cash equivalents include cash on hand, demand deposits and short term
      investments with original maturities of three months or less. At
      December 31, 2006, cash balances exceeded FDIC insured amounts by approximately
      $141,000.




***Accounts
      Receivable***




Trade
      receivables are carried at original invoice amount less an estimate for doubtful
      receivables based on a review of all outstanding amounts on a monthly basis.
      Management determines the allowance for doubtful accounts by identifying
      troubled accounts, evaluating the individual customer receivables then
      considering the customer’s financial condition, credit history and current
      economic conditions and by using historical experience applied to an aging
      of
      accounts. A trade receivable is considered to be past due if any portion of
      the
      receivable balance is outstanding for a period over the customers’ normal terms.
      Trade receivables are written off when deemed uncollectible. Recoveries of
      trade
      receivables previously written off are recorded when received.





***Inventories***




Inventories
      are stated at the lower of cost or market. Cost is determined using standard
      costs which approximates costing determined on a first-in, first-out basis,
      to
      reflect the actual cost of production of inventories.




Production
      costs of work in process and finished goods include material labor and overhead.
      Work in process and finished goods are not recorded in excess of net realizable
      value.





***Property,
      Plant and Equipment***




Property
      and equipment are stated at cost. Expenditures for maintenance and repairs
      are
      charged to operations as incurred. Depreciation is computed using the
      straight-line and declining-balance methods over estimated useful lives of
      the
      related assets. Leasehold improvements are amortized on a straight-line method
      over the lesser of the estimated useful life or the lease term. The estimated
      useful lives range as follows:




Building
            
            25
                - 30 yearsMachinery
                and equipment
            
            3
                -
                15 yearsOffice
                furniture and equipment
            
            5
                -
                8 yearsLeasehold
                improvements
            
            5
                -
                8 yearsFurniture
                and equipment at customer locations
            
            1
                -
                3 years




F-7




Projects
      in process represent those costs capitalized in connection with construction
      of
      new assets and/or improvements to existing assets including a factor for
      interest on funds committed to projects in process. Upon completion, these
      costs
      are reclassified to the appropriate asset class.




***Goodwill***




The
      Company applies the provisions of SFAS 142, “Goodwill and Other Intangible
      Assets”, under which goodwill is tested at least annually for impairment.
      Goodwill on the accompanying balance sheets relates to Flexo Universal. It
      is
      the Company’s policy to perform impairment testing for Flexo Universal annually
      as of December 31, or as circumstances change.




***Valuation
      of Long Lived Assets***




The
      Company evaluates whether events or circumstances have occurred which indicate
      that the carrying amounts of long-lived assets (principally property, plant
      and
      equipment) may be impaired or not recoverable. The significant factors that
      are
      considered that could trigger an impairment review include: changes in business
      strategy, market conditions, or the manner of use of an asset; underperformance
      relative to historical or expected future operating results; and negative
      industry or economic trends. In evaluating an asset for possible impairment,
      management estimates that asset’s future undiscounted cash flows and appraised
      values to measure whether the asset is recoverable, the Company measures the
      impairment based on the projected discounted cash flows of the asset over its
      remaining life. While the Company believes that its estimates of future cash
      flows are reasonable, different assumptions regarding such cash flows could
      materially affect these evaluations.




***Deferred
      Financing Costs***




Deferred
      financing costs are amortized on a straight line basis over the term of the
      loan. Upon a refinancing, existing unamortized deferred financing costs are
      expensed.





***Income
      Taxes***




The
      Company accounts for income taxes using the asset and liability method. As
      such,
      deferred income taxes reflect the net tax effects of temporary differences
      between carrying amounts of assets and liabilities for financial reporting
      purposes and the amount used for income tax purposes. Deferred tax assets and
      liabilities are measured using enacted tax rates expected to be in effect when
      the anticipated reversal of these differences is scheduled to occur. Deferred
      tax assets are reduced by a valuation allowance when, management cannot
      determine, in its opinion, that it is more likely than not that the Company
      will
      recover the recorded value of the deferred tax asset. The Company is
      subject to U.S. Federal, state and local taxes as well as foreign taxes in
      the
      United Kingdom and Mexico.




F-8




***Fair
      Value of Financial Instruments***




The recorded
      value of the Company’s financial instruments relating to accounts receivable,
      trades payable and accrued expenses approximates fair value due to their
      short-term nature. The fair value of debt approximates its carrying value as
      the
      interest rates applicable to these debt instruments are comparable to current
      market rates for similar maturities.




***Other
      Comprehensive Income (Loss)***




For
      years
      ended December 31, 2006, 2005 and 2004 other comprehensive income (loss)
      consisted of foreign currency translation adjustments, which is a component
      of
      accumulated other comprehensive loss within stockholder’s equity.




***Revenue
      Recognition***




The
      Company recognizes revenue when title transfers upon shipment. Revenue from
      a
      transaction is not recognized until (i) a definitive arrangement exists, (ii)
      delivery of the product has occurred or the services have been performed and
      legal title and risk are transferred to the customer, (iii) the price to the
      buyer has been fixed or is determinable and (iv) collectibility is reasonably
      assured. In some cases, product is provided on consignment to customers. For
      these cases, revenue is recognized when the customer reports a sale of the
      product.


***Shipping
        and Handling Costs***
  Shipping
        and handling costs are included in cost of sales.




***Stock-Based
      Compensation***


On
        January 1, 2006, the Company adopted Statement of Financial Accounting Standards
        No. 123, “Share-Based Payments” (“SFAS No. 123(R)”) using the modified
        prospective transition method. Under this method, the Company’s consolidated
        financial statements for prior periods have not been restated and do not
        include
        the impact of SFAS No. 123(R). Accordingly, no compensation expense related
        to
        stock option awards was recognized in the years ended December 31, 2005 and
        2004
        because all stock options granted had an exercise price equal to the fair
        market
        value of the underlying common stock on the date of grant. The following
        table
        shows the effect on net income and earnings per share as if the fair-value-based
        method of accounting had been applied to all outstanding and unvested stock
        options prior to adoption of SFAS No. 123(R). For purposes of this pro forma
        disclosure, the estimated fair value of the stock option award is assumed
        to be
        expensed over the award’s vesting periods (immediately) using the Black-Scholes
        model.


At
      December 31, 2005, the Company had 4 stock-based compensation plans, which
      are
      described more fully in Note 16. The Company accounted for those plans under
      the
      recognition and measurement principles of APB Opinion No. 25, “Accounting for
      Stock Issued to Employees” and related interpretations. The Company recognized
      compensation cost for stock-based compensation awards equal to the difference
      between the quoted market price of the stock at the date of grant or award
      and
      the price to be paid by the employee upon exercise in accordance with the
      provisions of APB No. 25. Based upon the terms of Company’s current stock option
      plans, the stock price on the date of grant and price paid upon exercise are
      the
      same. Accordingly, no stock-based employee compensation cost has been
      recognized, as all options granted under those plans had an exercise price
      equal
      to the market value of the underlying common stock on the date of grant.





F-9




**Years
                  Ended December 31,****2005**
              
              **2004**Net
                  (loss):Reported
              
              $
              (333,000
              )
              $
              (2,479,000
              )Deduct
                  total stock-based employee compensation expense determined under
                  fair
                  value method for all awards, net of related tax effects
              
              
              (124,000
              )Pro
                  forma net loss
              
              $
              (457,000
              )
              $
              (2,479,000
              )Net
                  loss per share:Basic
                  - As reported
              
              $
              (0.17
              )
              $
              (1.28
              )Basic
                  - Proforma
              
              $
              (0.23
              )
              $
              (1.28
              )Diluted
                  - As reported
              
              $
              (0.17
              )
              $
              (1.28
              )Diluted
                  - Proforma
              
              $
              (0.23
              )
              $
              (1.28
              )





The
      fair
      value of each option was estimated as of the date of the grant using the
      Black-Scholes option pricing model based on the following
      assumptions:





**2005**
            
            
            **2004**Expected
                life (years)
            
            
            5
            
            
            
            5Volatility
            
            
            138.86
            %
            
            
            128.49
            %Risk-free
                interest rate
            
            
            3.89
            %
            
            
            1.90
            %Dividend
                yield
            
            
            -
            
            
            
            -




F-10




The
      Company accounts for options granted to non-employees under the fair value
      approach required by EITF 96-18, “Accounting for Equity Instruments that are
      Issued to Other Than Employees for Acquiring, or in Conjunction with Selling,
      Goods, or Services.”





***Research
      and Development***




The
      Company conducts product development and research activities which includes
      (i)
      creative product development, (ii) creative marketing, and (iii) engineering.
      During the years ended December 31, 2006, 2005 and 2004, research and
      development activities totaled $230,000, $224,000 and $246,000,
      respectively.




***Advertising
      Costs***




The
      Company expenses advertising costs as incurred. Advertising expenses amounted
      to
      $116,000, $50,000 and $152,000 for the years ended December 31, 2006, 2005
      and
      2004, respectively.




***Reclassifications***




Reclassifications
      were made to the year end 2005 and
      2004 statements of operations to confirm the year end 2006
      presentation.




***Derivative
        Instruments and Hedging Activities***
 
 SFAS
        No.
        133 “Accounting for Derivative Instruments and Hedging Activities,” SFAS No.
        137, “Accounting for Derivative Instruments and Hedging Activities — Deferral of
        the Effective Date of SFAS No. 133,” SFAS No. 138, “Accounting for Certain
        Derivative Instruments and Certain Hedging Activities” and SFAS No. 149,
“Amendment of Statement 133 on Derivative Instruments and Hedging Activities,
        (Collectively “SFAS 133”) require an entity to recognize all derivatives as
        either assets or liabilities in the consolidated balance sheet and to measure
        those instruments at fair value. Under certain conditions, a derivative may
        be
        specifically designated as a fair value hedge or a cash flow hedge. The
        accounting for changes in the fair value of a derivative are recorded each
        period in current earnings.




F-11




**3.**
            **New
                Accounting Pronouncements**





*Uncertain
      Tax Positions*





In
      July
      2006, the Financial Accounting Standards Board (“FASB”) issued FASB
      Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN No.
      48”). FIN No. 48 prescribes a more likely than not threshold for financial
      statement presentation and measurement of a tax position taken or expected
      to be
      taken in a tax return. FIN No. 48 also provides guidance on de-recognition
      of
      income tax assets and liabilities, accounting for interest and penalties
      associated with tax positions, accounting for income taxes in interim periods,
      and income tax disclosures. For the Company, FIN No. 48 is effective as of
      January 1, 2007. The Company does not expect the impact of FIN No. 48 to have
      a
      material impact on its consolidated financial statements.





*Staff
      Accounting Bulletin, No. 108*





In
      September 2006, the SEC issued Staff Accounting Bulletin No.108, “Considering
      the Effects of Prior Year Misstatements when Quantifying Misstatements in
      Current Year Financial Statements” (“SAB 108”). SAB 108 provides guidance on how
      prior year misstatements should be taken into consideration when quantifying
      misstatements in current year financial statements. SAB 108 is effective for
      fiscal years ended on or after November 15, 2006. The adoption by the Company
      of
      SAB 108 did not have a material impact on the Company’s consolidated financial
      statements.





*Fair
      Value Positions*





In
      September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” which
      defines fair value, establishes a framework for measuring fair value, and
      expands disclosures about fair value measurements. This statement clarifies
      how
      to measure fair value as permitted under other accounting pronouncements but
      does not require any new fair value measurements. The Company will be required
      to adopt SFAS No. 157 as of January 1, 2008. The Company is currently evaluating
      the impact of SFAS 157 and does not believe it will have a material impact
      on
      its financial statements.





**4.**
            **Major
                Customers**




For
      the
      year ended December 31, 2006, the Company had 2 customers that accounted for
      approximately 24.3% and 20.1%, respectively, of consolidated net sales. In
      2005,
      the company had 3 customers that accounted for approximately 13.6%, 23.5% and
      13.3% respectively. Corresponding percentages of consolidated net sales
      generated by these customers for the year ended December 31, 2004, were
      approximately 11.7% and 20.1%, and 16.8% respectively. At December 31, 2006,
      the
      outstanding accounts receivable balances due from these two customers were
      $2,641,000 and $598,000, respectively. At December 31, 2005, the outstanding
      accounts receivable balances due from these three customers were $910,250
      (related party), $1,404,000 and $111,000, respectively. At December 31, 2004,
      the outstanding account receivable balances due from these three customers
      were
      $957,000 (related party), $1,438,000 and $302,000.





F-12




**5.**
            **Inventories**





Inventories
      are stated at the lower of cost or market. Cost is determined using standard
      costs which approximate costing determined on a first-in, first out basis.
      Standard costs are reviewed and adjusted periodically and at year end based
      on
      actual direct and indirect production costs. On a periodic basis, the Company
      reviews its inventory levels for estimated obsolescence or unmarketable items,
      in reference to future demand requirements and shelf life of the
      product.




Inventories
      are comprised of the following:


**December
                  31,**
                **2006**
              
              **December
                  31,**
                **2005**Raw
                  materials
              
              $
              1,449,000
              
              $
              1,317,000Work
                  in process
              
              
              945,000
              
              
              731,000Finished
                  goods
              
              
              5,855,000
              
              
              5,230,000Allowance
                  for excess quantities
              
              
              (275,000
              )
              
              (255,000
              )Total
                  inventories
              
              $
              7,974,000
              
              $
              7,023,000




**6.**
            **Notes
                Payable**




Long
      term
      debt consists of:


Dec.
                    31, 2006
                
                Dec.
                    31, 2005(2006)
                    Term Loan with bank, payable in monthly installments of $58,333
                    plus
                    interest at prime (8.25% at December 31, 2006) plus .25% (8.50%)
                    (amortized over 60 months) balance due January 31, 2011; (2005)
                    Term Loan
                    with bank, paid February 1, 2006.
                
                $
                2,936,242
                
                $
                2,158,341(2006)
                    Mortgage Loan with bank, payable in monthly installments of $9,333
                    plus
                    interest at prime (8.25% at December 31, 2006) plus .25% (8.50%)
                    (amortized over 25 years) balance due January 31, 2011; (2005)
                    Mortgage
                    Loan with bank, paid February 1, 2006.
                
                $
                2,741,763
                
                $
                2,780,553Vendor
                    Notes, at various rates of interest (weighted average of 6%)
                    maturing
                    through December 2007
                
                $
                136,725
                
                $
                700,886Subordinated
                    Notes (Officers) due 2008, interest at 9% net of debt discount
                    of $1,781
                    and $23,441 at December 31, 2006 and 2005, respectively (See
                    Notes
                    9,15)
                
                $
                1,429,781
                
                $
                1,423,059Subordinated
                    Notes (Officers) due 2007, interest at 8% (See Notes 9,15)
                
                $
                814,233
                
                $
                814,233Subordinated
                    Notes (Officers) due 2011, interest at prime (8.25% at December
                    31, 2006)
                    + 2%, 10.25%, net of debt discount of $362,040 at December 31,
                    2006
                
                $
                637,960
                
                $
                0Loan
                    payable to a Mexican finance institution denominated in Mexican
                    Pesos
                    bearing interest at 9.81% due 2009. In 2006 debt transferred
                    to an
                    affiliated party.
                
                $
                0
                
                $
                84,462Total
                    long-term debt
                
                $
                8,696,704
                
                $
                7,961,534Less
                    current portion
                
                $
                (3,104,008
                )
                $
                (3,567,144
                )Total
                    Long-term debt, net of current portion
                
                $
                5,592,696
                
                $
                4,394,390





On
      February 1, 2006, the Company entered into a Loan Agreement with Charter One
      Bank, Chicago, Illinois, under which, as amended, the Bank has agreed to provide
      a credit facility to the Company in the total amount of $13,300,000, which
      includes (i) a five year mortgage loan secured by the Barrington, Illinois
      property in the principal amount of $2,800,000, amortized over a 25 year period,
      (ii) a five year term loan secured by the equipment at the Barrington, Illinois
      plant in the amount of $3,500,000 and (iii) a three-year revolving line of
      credit up to a maximum amount of $7,000,000, secured by inventory and
      receivables. The amount the Company can borrow on the revolving line of credit
      includes 85% of eligible receivables and 60% of eligible inventory. The Loan
      Agreement includes a number of covenants including financial covenants relating
      to Tangible Net Worth, Senior Debt to EBITDA, and Fixed Charge coverage. As
      of
      December 31, 2006, the Company was in compliance with these covenants. On
      February 1, 2006, proceeds of these loans totaling $10,349,653 were utilized
      to
      pay the entire outstanding principal amount of the Company’s then outstanding
      debt obligations to Cole Taylor Bank and Banco Popular.





F-13




On
      December 31, 2003, the Company entered into a Loan and Security Agreement (“Loan
      Agreement”) with Cole Taylor Bank under which the Bank provided to the Company a
      credit facility in the aggregate amount of $11,000,000, collateralized by
      substantially all assets of the Company. The credit facility expired on December
      31, 2005 and was renewed to January 31, 2006. The credit facility included
      a
      term loan of $3,500,000, at an interest rate of prime plus 1.5% per annum (8.75%
      at December 31, 2005), which is based upon the appraised (liquidation basis)
      value of the machinery and equipment of the Company and a revolving line of
      credit at an interest rate of prime plus 1.5% per annum (8.75% at December
      31,
      2005), the amount of which was based on advances of up to 85% of eligible trade
      receivables and up to 50% of the value of the Company’s eligible inventory. In
      connection with the Loan Agreement, two principals of the Company executed
      agreements pursuant to which they agreed, in the event appraisals of the
      Company’s machinery and equipment to be performed during 2004 indicated values
      less than those specified in the Loan Agreement (liquidation value), to provide
      guarantees of a portion of the term loan or loan subordinated funds to the
      Company. During 2004, these two principals pledged certain of their individual
      assets as security for the amount by which the principal balance of the term
      loan exceeded the most recent appraised value of the Company’s machinery and
      equipment. The Loan Agreement also provided that, upon the receipt of any
      proceeds of sale or other disposition of equipment, or any proceeds from damage,
      destruction or condemnation, such proceeds were to be paid as a mandatory
      prepayment of the term loan. In addition, 50% of excess cash flow was required
      to be paid as a prepayment of the term loan. The Loan Agreement also included
      financial covenants requiring a minimal level of tangible net worth and ratio
      of
      EBITDA to fixed charges. The Bank had issued a waiver of these covenants for
      December 31, 2004 and had agreed to an amendment modifying the covenants. The
      entire balance outstanding under the Loan Agreement was paid in full on February
      1, 2006. The
      impact of this hedge is included in notes payable. The change in value recorded
      in 2006 was $55,000 and is included in interest expense.




The
        Company used interest rate swaps as a cash flow hedge to manage interest
        costs
        and the risk associated with changing interest rates of long-term debt. During
        the
        second quarter ended June 30, 2006, the Company entered into two separate
        forward-starting interest rate swap agreements as a means of managing its
        interest rate exposure on its variable rate $2.8 million mortgage and $3.5
        million term loan. These agreements were effective beginning on May 1, 2006
        and
        were designed to swap a variable rate of prime plus varying rates for a fixed
        rate ranging of 8.49%. The aggregate notional amount of the swaps was $6.2
        million. The swap agreements expire on January 1, 2011. The
        impact of this hedge is included in Notes Payable. The change in value recorded
        in 2006 was $55,000 and is included in interest expense.
  Each
      of John H. Schwan and Stephen M. Merrick, officers, directors and
      principal shareholders of the Company have personally guaranteed the obligations
      of the Company to Charter One Bank up to $1,400,000.





As
      of
      December 31, 2006, the balance outstanding on the revolving line of credit
      with
      Charter One Bank was $6,318,000 and the interest rate was 8.5%.




Future
      minimum principal payments, exclusive of debt discount, for amounts outstanding
      under these long-term debt agreements for each of the years ended December
      31:


2007
              
              $
              3,104,0002008
              
              
              723,0002009
              
              
              723,0002010
              
              
              723,0002011
              
              
              3,424,000Thereafter
              
              
              0$
              8,697,000




F-14




**7.**
            **Subordinated
                Debt**




In
      February 2003, the Company received $1,630,000 from certain shareholders in
      exchange for (a) two year 9% subordinated notes, and (b) five year warrants
      to
      purchase 163,000 common shares at $4.87 per share. The proceeds were to (i)
      re-finance the bank loan of CTI Mexico in the amount of $880,000 and (ii) to
      provide financing for CTI Mexico and Flexo Universal. The value of the warrants
      was $640,427 calculated using Black-Scholes option pricing formula. The Company
      applied the debt discount of $459,780 against the subordinated debt. The debt
      discount is amortized using the effective interest method over the term of
      the
      debt. These loans are subordinated to the Bank debt of the Company.




In
      February 2006, the Company received $1,000,000 from certain shareholders in
      exchange for (a) five year subordinated notes bearing interest at 2% over the
      prime rate determined on a quarterly basis, and (b) five year warrants to
      purchase an aggregate of 303,030 shares of common stock of the Company at the
      price of $3.30 per share. The proceeds were to fund capital improvements and
      give additional liquidity to the Company. The value of the warrants was $443,313
      using the Black-Scholes option pricing formula (See Note 16). The Company
      applied the debt discount of the $443,313 against the subordinated debt. 
The debt discount is amortized using the effective interest method over the
      term
      of the debt. These loans are subordinated to the Bank debt of the
      Company.




At
      various times during 2003, John H. Schwan loaned an aggregate of $795,204 to
      the
      Company in exchange for notes bearing interest at various annual rates (5%-8%).
      These notes are subordinated to the bank loan of the Company. Mr. Merrick also
      advanced $19,209 to the Company in December 2005.





**8.**
            **Income
                Taxes**




The
      income tax provisions are comprised of the following:


Dec.
                  31
              
              Dec.
                  31
              
              Dec.
                  312006
              
              2005
              
              2004Current:Federal
              
              $
              -
              
              $
              -
              
              $
              -State
              
              
              -
              
              
              -
              
              
              -Foreign
              
              
              -
              
              
              -
              
              
              97,097$
              -
              
              $
              -
              
              $
              97,097DeferredFederal
              
              $
              (806,683
              )
              $
              (180,134
              )
              $
              1,223,030State
              
              
              32,488
              
              
              (24,797
              )
              
              (63,753
              )Foreign
              
              
              -
              
              
              4,539
              
              
              29,858(774,195
              )
              
              (200,392
              )
              
              1,189,135Total
                  Income Tax (Benefit) Provision
              
              $
              (774,195
              )
              $
              (200,392
              )
              $
              1,286,232




F-15




The
      components of the net deferred tax asset at December 31 are as
      follows:


2006
              
              2005Deferred
                  tax assets:Allowance
                  for doubtful accounts
              
              $
              73,047
              
              $
              32,752Inventory
                  allowances
              
              
              47,166
              
              
              195,095Accrued
                  liabilities
              
              
              64,859
              
              
              132,776Unicap
                  263A adjustment
              
              
              109,111
              
              
              52,380Net
                  operating loss carryforwards
              
              
              3,036,424
              
              
              3,302,982Alternative
                  minimum tax credit carryforwards
              
              
              338,612
              
              
              338,612State
                  investment tax credit carryforward
              
              
              30,512
              
              
              18,041Other
                  foreign tax items
              
              
              55,556
              
              
              (3,179
              )Foreign
                  asset tax credit carryforward
              
              
              136,744
              
              
              160,784Total
                  deferred tax assets
              
              
              3,892,031
              
              
              4,230,243Deferred
                  tax liabilities:Book
                  over tax basis of capital assets
              
              
              (1,346,794
              )
              
              (1,074,863
              )Cash
                  basis of foreign inventory purchases
              
              
              0
              
              
              (348,690
              )Other
                foregn tax items
              
              
              (191,352
              )
              
              02,353,885
              
              
              2,806,690Less:
                  Valuation allowance
              
              
              (1,227,001
              )
              
              (2,454,001
              )Net
                  deferred tax asset
              
              $
              1,126,884
              
              $
              352,689





The
      Company maintains a valuation allowance with respect to deferred tax assets
      as a
      result of the uncertainty of ultimate realization. At December 31, 2006, the
      Company has net operating loss carryforwards of approximately $7,648,000
      expiring in various years through 2025. In addition, the Company has
      approximately $339,000 of alternative minimum tax credits as of December 31,
      2006, which have no expiration date.





As
      of
      December 31, 2006 management of the Company conducted an analysis of the recoverability
      of the deferred tax asset based on results of operationsduring
      the fourth quarter of 2005 and for the full year of 2006, expected
      continued achievement of and continuing improvement in operating results for
      the
      foreseeable futureand anticipated repatriation of profits and
      service income to be generated from the Company’s foreign subsidiaries. As
      a
      result of such analysis, management determined that the net recorded deferred
      tax asset in the amount of $1,127,000 is more likely than not to be
      realized. As of December 31, 2005, management determined based upon the
      evaluation of certain transactions involving the repatriation of profits from
      its U.K. subsidiary that it was more likely than not that the recorded deferred
      tax assets would be realized in 2006.




F-16




The
        following reconciles the income tax provision with the expected provision
        obtained by applying statutory rates to pre-tax income:


**Years
                  Ended December 31,****2006**
              
              **2005**
              
              **2004**Taxes
                  at statutory rate
              
              $
              392,725
              
              $
              (186,809
              )
              $
              (417,228
              )State
                  income taxes
              
              
              54,061
              
              
              (25,716
              )
              
              (57,434
              )Nondeductible
                  expenses
              
              
              20,530
              
              
              12,757
              
              
              15,355(Decrease)
                  increase in deferred tax valuation allowance
              
              
              (1,227,001
              )
              
              0
              
              
              1,715,401Foreign
                  taxes and other
              
              
              (14,510
              )
              
              (624
              )
              
              30,138Income
                  tax provision
              
              $
              (774,195
              )
              $
              (200,392
              )
              $
              1,286,232


The
        Company did not record a provision for current income taxes in 2006 since
        current taxable income was reduced through the application of net operating
        losses.




**9.**
            **Other
                Income/Expense**




Other
      income/expense set forth on the Company’s Consolidated Statement of Operations
      for the fiscal year ended December 31, 2006 included gains of $191,000 from
      currency variability. In 2005 and 2004, the Company had a gain of $45,000 and
      $208,000, respectively, related to currency variability items.





**10.**
            **Other
                Operating Expense (Income)**





Other
      operating expense (income) set forth on the Company’s Consolidated Statement of
      Operations for the fiscal year ended December 31, 2006 included gains of
      $472,000 related to the settlement of certain vendor claims in consideration
      for
      the payment of an amount less than the amount accrued.





**11.**
            **Other
                Liabilities**




Items
      identified as Other Liabilities in the Company’s Consolidated Balance Sheet as
      of December 31, 2006 include (i) loans by officers/shareholders to Flexo
      Universal totaling $1,090,000, and (ii) loans by officers/shareholders to CTI
      Balloons Limited of $184,000 and (iii) $20,000 owed to others. Items identified
      as Other Liabilities in the Company’s Consolidated Balance Sheet as of December
      31, 2005 include (i) loans by officers/shareholders totaling $1,056,000, and
      (ii) obligations of CTI Mexico, Flexo, and CTF International totaling
      $587,000.





**12.
      Employee Benefit Plan**





The
      Company has a defined contribution plan for substantially all employees. Profit
      sharing contributions may be made at the discretion of the Board of Directors.
      Effective January 1, 2006, the Company amended its defined contribution plan.
      Under the amended plan, the maximum contribution for the Company is 5% of gross
      wages. Employer contributions to the plan totaled $91,341, $52,147 and $57,172
      for the years ended December 31, 2006, 2005 and 2004, respectively.




F-17




**13.**
            **Related
                Party Transactions. (See Notes 6 and
                7)**




Stephen
      M. Merrick is of counsel to a law firm from which we received legal services
      during the year. Mr. Merrick is both a director and a shareholder of the
      Company. Legal fees incurred with this firm or predecessor, were $120,000,
      $117,000 and $97,000 for the years ended December 31, 2006, 2005 and 2004,
      respectively.




In
      February 2003, the Company received $1,630,000 from certain shareholders in
      exchange for (a) two year 9% subordinated notes, and (b) five year warrants
      to
      purchase 163,000 common shares at $4.87 per share. The proceeds were to (i)
      re-finance the bank loan of CTI Mexico in the amount of $880,000 and (ii) to
      provide financing for CTI Mexico and Flexo Universal. The value of the warrants
      was $640,427 calculated using Black-Scholes option pricing formula. The Company
      applied the debt discount of $459,780 against the subordinated debt. The debt
      discount is amortized using the effective interest method over the term of
      the
      debt. The notes and warrants are currently outstanding.




John
      H.
      Schwan is principal of Shamrock Packaging and affiliated companies. The Company
      made purchases of packaging materials from them of approximately $368,000,
      $165,000 and $172,000 during the years ended December 31, 2006, 2005 and 2004,
      respectively.





John
      H.
      Schwan was an officer of an affiliate of Rapak, LLC. Mr. Schwan ended his
      affiliation with Rapak in 2006. Rapak’s purchases of products from the Company
      totaled $7,110,000, $6,860,000, and $7,837,000 in each of the years ended
      December 31, 2006, 2005 and 2004, respectively.





Mr.
      Schwan received compensation from the Company as Chairman of the Board in the
      amount of $24,000 in each of the years ended December 31, 2006, 2005 and 2004,
      respectively.





In
      July
      2001, John Schwan and Stephen M. Merrick were issued warrants to purchase
      119,050 shares of the Company’s Common Stock at an exercise price of $1.50 per
      share in consideration of their facilitating and guaranteeing and securing
      bank
      loans to the Company in the amount of $1.4 million and for advancing additional
      monies to the Company that were repaid in 2001. On June 12, 2006, Mr. Schwan
      and
      Mr. Merrick exercised these warrants.




At
      various times during 2003, John H. Schwan loaned an aggregate of $795,204 to
      the
      Company in exchange for notes bearing interest at various annual rates (5%-8%).
      These notes are subordinated to the bank loan of the Company. Mr. Merrick also
      advanced $19,209 to the Company in December 2005. These obligations are
      currently outstanding.




In
        January 2006, an officer of Flexo Universal acquired the loan of Flexo Universal
        payable to a Mexican financial institution. During 2006, Flexo Universal
        made
        payments of $8,400 in principal and interest on this loan to the
        officer.




F-18




Messrs.
      Schwan and Merrick made advances to the Company’s Mexican affiliate, Flexo
      Universal in the amount of $112,500 and $141,900, respectively, in 2005 and
      $86,000 and $181,000, respectively, in 2004, respectively. Additionally, Messrs.
      Schwan and Merrick advanced $130,000 and $155,000, in 2005 respectively, to
      the
      Company’s UK affiliate, CTI Balloons Ltd. These advances are reflected in demand
      notes bearing interest at the rate of 8% per annum in 2004 and 2003, and 7%
      in
      2005 and 2006.




On
      February 1, 2006, Mr. Schwan and Mr. Merrick advanced $500,000 each to the
      Company in exchange for (a) five year promissory notes bearing interest at
      2%
      over the prime rate determined quarterly and (b) five year warrants to purchase
      an aggregate of 303,030 shares of common stock of the Company at the price
      of
      $3.30 per share (110% of the market price on the day proceeding the day of
      the
      loans) **.**




Interest
      paid to related parties during 2006, 2005 and 2004 was $277,000, $147,000 and
      $119,000, respectively.





**14.**
            **Goodwill
                and Intangible Assets**




Under
      the
      provisions of SFAS 142, goodwill is subject to at least annual assessments
      for
      impairment by applying a fair-value based test. SFAS 142 also requires that
      an
      acquired intangible asset should be separately recognized if the benefit of
      the
      intangible asset is obtained through contractual or other legal rights, or
      if
      the asset can be sold, licensed, rented or exchanged, regardless of the
      acquirer’s intent to do so. The Company has no acquired intangible assets other
      than goodwill.




As
      of
      December 31, 2005, we determined in consultation with a valuation consultant
      that the fair value of the Company’s interest in Flexo Universal was $989,000,
      and the carrying value of $1,113,000 was impaired by $124,000. Accordingly,
      in
      fiscal 2005, we recorded the amount of this impairment as an expense and have
      reduced the carrying value of the Company’s interest in Flexo Universal to
      $989,000. As of December 31, 2006, we determined, in consultation with a
      valuation consultant, that the fair value of the Company’s interest in goodwill
      related to Flexo Universal was not impaired.




The
      carrying amount of goodwill as of December 31, 2006 and 2005 was $989,000.





**15.**
            **Commitments
                and Contingencies**




Operating
      Leases





In
      September of 2005, the Company signed a lease to rent 16,306 square feet of
      space from Trinity Assets replacing the previous lease with HP Properties.
      This
      lease has a 2-year term. In September of 2006, the Company signed an extension
      to this lease to run through September of 2009. The Company’s United Kingdom
      subsidiary also maintains a lease for office and warehouse space, which expires
      in 2019. The Company’s Mexico subsidiary signed a five-year lease in January of
      2003 to rent 43,000 square feet of space at a cost of approximately $18,000
      per
      month. The Company leases office equipment under operating leases, which expire
      on various dates through December 2011.




The
      net
      lease expense was $312,000, $598,000 and $402,000 for the years ended December
      31, 2006, 2005, and 2004 respectively, which includes $77,000 paid to Pepper
      Road (a related party) in 2004.




F-19




The
      future aggregate minimum net lease payments under existing agreements as of
      December 31, are as follows:


**Trinity
                  Assets**
              
              **Other**
              
              **Total**
                **Lease**
                **Payments**2007
              
              $
              102,000
              
              $
              326,000
              
              $
              428,0002008
                  - 2009
              
              
              183,000
              
              
              226,000
              
              
              409,0002010-2011
              
              
              
              
              
              175,000
              
              
              175,0002012
                  and thereafter
              
              
              
              
              
              414,000
              
              
              414,000Total
              
              $
              285,000
              
              $
              1,141,000
              
              $
              1,426,000




**Licenses**




The
      Company has certain merchandising license agreements which are of a one to
      two
      year duration that require royalty payments based upon the Company’s net sales
      of the respective products. The agreements call for guaranteed minimum
      commitments that are determined on a calendar year basis. Future guaranteed
      commitments due, as computed on a pro rata basis, as of December 31, are as
      follows:




2007
            
            $
            92,0002008
                -2009
            
            $
            91,0002010
                - 2011
            
            $
            0




**16.**
            **Stockholders’
                Equity**





**Stock
      Options**





As
      of
      December 31, 2006, the Company had four stock-based compensation plans pursuant
      to which stock options may be granted. The
      Plans
      provide for the award of options, which may either be incentive stock options
      (“ISOs”) within the meaning of Section 422A of the Internal Revenue Code of
      1986, as amended (the “Code”) or non-qualified options (“NQOs”) which are not
      subject to special tax treatment under the Code.




Under
      the
      Company’s 1997 Stock Option Plan (effective July 1, 1997), a total of 119,050
      shares of Common Stock were reserved for issuance under the Stock Option Plan.
      As of December 31, 2006, 92,463 shares of Common Stock have been granted and
      remain outstanding.




F-20




On
      March
      19, 1999, the Board of Directors approved for adoption, effective May 6, 1999,
      the 1999 Stock Option Plan (“Plan”). The Plan authorizes the grant of options to
      purchase up to an aggregate of 158,733 shares of the Company’s Common Stock. As
      of December 31, 2006, 53,574 options had been granted under the 1999 Stock
      Option Plan and remain outstanding. In 2006, 3,572 options were exercised
      and proceeds of $6,751 were received from this plan. In
      2005,
      17,263 options were exercised and proceeds of $32,627 were received from this
      plan.




On
      April
      12, 2001, the Board of Directors approved for adoption, effective December
      27,
      2001, the 2001 Stock Option Plan (the“Plan”). The Plan authorizes the grant of
      options to purchase up to an aggregate of 158,733 shares of the Company’s Common
      Stock. As of December 31, 2006, 47,645 options had been granted and remain
      outstanding. In 2006, 17,905 options were exercised and $33,600 in proceeds
      were received from this plan. In
      2005
      14,881 options were exercised and proceeds of $21,875 were received from this
      plan.




On
      April
      24, 2002, the Board of Directors approved for adoption, effective October 12,
      2002, the 2002 Stock Option Plan (the “Plan”). The Plan authorizes the grant of
      options to purchase up to an aggregate of 142,860 shares of the Company’s Common
      Stock **.** As
      of
      December 31, 2006, 120,454 options had been granted and remain
      outstanding.





On
      January 1, 2006, the Company adopted SFAS 123(R). Prior to the adoption of
      SFAS
      123(R), the Company had adopted the disclosure-only provisions of SFAS 123
      and
      accounted for employee stock-based compensation under the intrinsic value
      method, and no expense related to stock options was recognized. The Company
      adopted the provisions of SFAS 123(R) using the modified prospective transition
      method. Under this method, the Company's consolidated financial statements
      as of
      and for the year ended December 31, 2006 reflect the impact of SFAS 123(R),
      while the consolidated financial statements for prior periods have not been
      restated to reflect, and do not include, the impact of SFAS 123(R). SFAS 123(R)
      amends SFAS No. 95, “Statement of Cash Flows,” to require that excess tax
      benefits be reported as a financing cash flow rather than as an operating cash
      flow.





The
      Compensation Committee administers the Plan. The exercise price for ISOs cannot
      be less than the fair market value of the stock subject to the option on the
      grant date (110% of such fair market value in the case of ISOs granted to a
      stockholder who owns more than 10% of the Company’s Common Stock). The exercise
      price of a NQO shall be fixed by the Compensation Committee at whatever price
      the Committee may determine in good faith. Unless the Committee determines
      otherwise, options generally have a 10-year term (or five years in the case
      of
      ISOs granted to a participant owning more than 10% of the total voting power
      of
      the Company’s capital stock). Unless the Committee provides otherwise, options
      terminate upon the termination of a participant’s employment, except that the
      participant may exercise an option to the extent it was exercisable on the
      date
      of termination for a period of time after termination. Officers, directors,
      and
      employees of, and consultants to, the Company or any parent or subsidiary
      corporation selected by the Committee are eligible to receive options under
      the
      Plan. Subject to certain restrictions, the Committee is authorized to designate
      the number of shares to be covered by each award, the terms of the award, the
      date on which and the rates at which options or other awards may be exercised,
      the method of payment, vesting and other terms.




F-21




In
      December 2005, certain members of company management were issued incentive-based
      options to purchase 79,000 shares of the Company’s Common Stock at an exercise
      price of $2.88 per share. These options have a term of 10 years. No stock
      options were issued under any of the Plans during 2006.





The
      fair
      value of the options granted in 2005 were estimated at the date of grant using
      a
      Black-Scholes option pricing model with the following weighted average
      assumptions: risk-free interest rate of 3.9; dividend yield of 0%; volatility
      factor of the expected price of the Company’s stock was138.9%; and a weighted
      average expected life of 5 years. The weighted average fair value of the options
      granted during 2005 was $2.56 per share.


The
        valuation assumptions were determined as follows:
 
 Historical
        stock price volatility: The Company used the weekly closing price to calculate
        historical annual volatility.
 
 Risk-free
        interest rate: The Company bases the risk-free interest rate on the rate
        payable
        on US treasury securities in effect at the time of the grant.
  Expected
        life: The expected life of the option represents the period of time options
        are expected to be outstanding. The Company uses one half of the life of
        the
        option.
  Dividend
        yield: The estimate for dividend yield is 0.0%, because the Company has not
        historically paid, and does not intend for the foreseeable future to pay,
        a
        dividend.


The
      following is a summary of the activity in the Company’s stock option plans for
      the years ended December 31, 2006, 2005 and 2004, respectively.


**Dec.
                  31,****2006**
              
              **Weighted****Avg.****Exercise****Price**
              
              **Dec.
                  31,****2005**
              
              **Weighted****Avg.****Exercise****Price**
              
              **Dec.
                  31,****2004**
              
              **Weighted****Avg.****Exercise****Price**Outstanding
                  and exercisable, beginning of period
              
              
              361,402
              
              $
              3.36
              
              
              405,422
              
              $
              3.25
              
              
              443,547
              
              $
              2.58Granted
              
              
              
              
              
              3.30
              
              
              79,000
              
              
              2.88
              
              
              0Exercised
              
              
              (21,477
              )
              
              1.88
              
              
              (32,144
              )
              
              1.70
              
              
              0Cancelled
              
              
              (1,984
              )
              
              6.30
              
              
              (90,876
              )
              
              1.77
              
              
              (38,125
              )
              
              1.81Outstanding
                  and exercisable at the end of period
              
              
              337,941
              
              $
              3.42
              
              
              361,402
              
              $
              3.36
              
              
              405,422
              
              $
              3.25




At
      December 31, 2006, available options to grant were 25,382.





Significant
      option groups outstanding at December 31, 2006 and related weighted average
      price and remaining life information are as follows:


**Outstanding**
              
              **Exercisable**
              
              **Exercise
                  Price**
              
              **Remaining
                  Contractural Term**September
                  1997
              
              
              30,160
              
              
              30,160
              
              $
              6.30
              
              
              0.9September
                  1998
              
              
              62,302
              
              
              62,302
              
              $
              6.62
              
              
              1.9September
                  1998
              
              
              11,905
              
              
              11,905
              
              $
              2.10
              
              
              1.9March
                  2000
              
              
              53,570
              
              
              53,570
              
              $
              1.89
              
              
              3.2December
                  2001
              
              
              32,145
              
              
              32,145
              
              $
              1.47
              
              
              5.0April
                  2002
              
              
              11,905
              
              
              11,905
              
              $
              2.10
              
              
              1.4October
                  2002
              
              
              55,954
              
              
              55,954
              
              $
              2.36
              
              
              5.1December
                  2003
              
              
              5,000
              
              
              5,000
              
              $
              2.29
              
              
              7.0December
                  2005
              
              
              75,000
              
              
              75,000
              
              $
              2.88
              
              
              9.0Total
              
              
              337,941
              
              
              337,941
 F-22




There
      were no options issued in 2006, 79,000 options issued in 2005 and no options
      issued in 2004, the weighted average fair value of options granted during the
      years ending December 31, 2005 were $2.88 per share. No options have been
      granted at below fair market value at date of grant, as a result there is no
      aggregate intrinsic value as of December 31, 2006.





**Warrants**





In
      July
      2001, certain members of Company management were issued warrants to purchase
      119,050 shares of the Company’s Common Stock at an exercise price of $1.50 per
      share in consideration of their facilitating and guaranteeing and securing
      bank
      loans to the Company in the amount of $1.4 million and for advancing additional
      monies to the company that were repaid in 2001. On June 12, 2006 one
      member
      of company mangement paid $59,524 to exercise 39,683 shares and another
      member of the company management turned in 38,404 shares with a market
      value of $3.09 per share on the day of the transaction, or
      $118,666.




In
      March
      2003, certain members of company management were issued warrants,
      which
      are fully vested immediately,to purchase 163,000 shares of the Company’s
      Common Stock at an exercise price of $4.87 per share in consideration of their
      loaning the company $1,630,000.





In
      February 2006, certain members of company management were issued warrants,
      which
      are fully vested immediately, to purchase 303,030 shares of the
      Company’s Common Stock at an exercise price of $3.30 per share in consideration
      of their loaning the company $1,000,000. The
      fair
      value of the warrants granted on February 1, 2006, were estimated at the date
      of
      grant using a Black-Scholes pricing model with the following weighted average
      assumptions: risk-free interest rate of 3.9%; dividend yield of 0%; volatility
      factor of the expected price of the Company’s stock was 138.9%; and a weighted
      average expected life of 5 years. The weighted average fair value of the options
      granted during 2005 was $2.56 per share.


**Weighted**
              
              
              
              **Weighted**
              
              
              
              **Weighted****Avg.**
              
              
              
              **Avg.**
              
              
              
              **Avg.****Dec.
                    31,**
              
              **Exercise**
              
              **Dec.
                    31,**
              
              **Exercise**
              
              **Dec.
                    31,**
              
              **Exercise****2006**
              
              **Price**
              
              **2005**
              
              **Price**
              
              **2004**
              
              **Price**Outstanding
                  and exercisable, beginning of period
              
              
              282,050
              
              $
              3.45
              
              
              282,050
              
              $
              3.45
              
              
              282,050
              
              $
              3.45Granted
              
              
              303,030
              
              
              3.30
              
              
              -
              
              
              -
              
              
              0Exercised
              
              
              (119,050
              )
              
              1.50
              
              
              -
              
              
              -
              
              
              0Cancelled
              
              
              -
              
              
              6.30
              
              
              -
              
              
              -
              
              
              -
              
              
              0Outstanding
                  and exercisable at the end of period
              
              
              466,030
              
              $
              3.85
              
              
              282,050
              
              $
              3.45
              
              
              282,050
              
              $
              3.45
 Aggregate
          intrinsic value of options and warrants were $635,000 and $473,000 respectively,
          as of December 31, 2006 for all options and warrants in the money, outstanding
          and exercisable.
  F-23


**17.**
            **Earnings
                Per Share**





Basic
      earnings per share is computed by dividing the income available to common
      shareholders, net earnings, less redeemable preferred stock dividends and
      redeemable common
      stock accretion, by the weighted average number of shares of common stock
      outstanding during each period.




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




**CTI
      Industries Corporation and Subsidiaries**


**Consolidated
      Earnings per Share**


Year
                  Ended December 31,2006
              
              2005
              
              2004**Basic**Average
                  shares outstanding:Weighted
                  average number of shares outstanding during the period
              
              
              2,087,145
              
              
              1,977,235
              
              
              1,930,976**Earnings:**Net
                  income (loss):
              
              $
              1,894,749
              
              $
              (333,209
              )
              $
              (2,479,374
              )Amount
                  for per share Computation
              
              $
              1,894,749
              
              $
              (333,209
              )
              $
              (2,479,374
              )Net
                  income (loss) earnings applicable to Common Shares
              
              $
              0.91
              
              $
              (0.17
              )
              $
              (1.28
              )**Diluted**Average
                  shares outstanding:
              
              
              2,087,145
              
              
              1,977,235
              
              
              1,930,976Weighted
                  averages shares Outstanding Common stock equivalents (options,
                  warrants)
              
              
              147,756
              
              
              0
              
              
              0Weighted
                  average number of shares outstanding during the period
              
              
              2,234,901
              
              
              1,977,235
              
              
              1,930,976**Earnings:**Net income
                  (loss)
              
              $
              1,894,749
              
              $
              (333,209
              )
              $
              (2,479,374
              )Amount
                  for per share computation
              
              $
              1,894,749
              
              $
              (333,209
              )
              $
              (2,479,374
              )Net
                  income (loss) applicable to Common Shares
              
              $
              0.85
              
              $
              (0.17
              )
              $
              (1.28
              )




F-24




**18.**
            **Geographic
                Segment Data**





The
      Company’s operations consist of a business segment which designs, manufactures,
      and distributes film products. Transfers between geographic areas were primarily
      at cost. The Company’s subsidiaries have assets consisting primarily of trade
      accounts receivable, inventory and machinery and equipment. Sales and selected
      financial information by geographic area for the years ended December 31, 2006,
      2005 and 2004, respectively are as follows:


**United
                  States**
              
              **United
                  Kingdom**
              
              **Mexico**
              
              **Eliminations**
              
              **Consolidated**Year
                  ended 12/31/06Revenues
              
              $
              28,808,000
              
              $
              2,925,000
              
              $
              6,564,000
              
              
              ($2,869,000
              )
              $
              35,428,000Operating
                  income (loss)
              
              $
              2,116,000
              
              $
              64,000
              
              $
              578,000
              
              
              ($25,000
              )
              $
              2,733,000Net
                  income (loss)
              
              $
              1,544,000
              
              $
              93,000
              
              $
              284,000
              
              
              ($26,000
              )
              $
              1,895,000Total
                  Assets
              
              $
              25,245,000
              
              $
              2,627,000
              
              $
              5,050,000
              
              
              ($6,288,000
              )
              $
              26,634,000Year
                  ended 12/31/05Revenues
              
              $
              23,564,000
              
              $
              2,573,000
              
              $
              4,536,000
              
              
              ($1,483,000
              )
              $
              29,190,000Operating
                  income (loss)
              
              $
              602,000
              
              $
              290,000
              
              
              ($240,000
              )
              
              
              
              $
              652,000Net
                  (loss) income
              
              
              ($342,000
              )
              $
              220,000
              
              
              ($211,000
              )
              
              
              
              
              ($333,000
              )Total
                  Assets
              
              $
              21,343,000
              
              $
              2,122,000
              
              $
              4,818,000
              
              
              ($4,747,000
              )
              $
              23,536,000Year
                  ended 12/31/04Revenues
              
              $
              32,855,000
              
              $
              2,664,000
              
              $
              4,890,000
              
              
              ($3,216,000
              )
              $
              37,193,000Operating
                  (loss) income
              
              
              ($92,000
              )
              $
              121,000
              
              
              ($31,000
              )
              
              ($48,000
              )
              
              ($50,000
              )Net
                  (loss) income
              
              
              ($2,595,000
              )
              $
              223,000
              
              
              ($59,000
              )
              
              ($48,000
              )
              
              ($2,479,000
              )Total
                  Assets
              
              $
              24,072,000
              
              $
              1,989,000
              
              $
              5,319,000
              
              
              ($3,492,000
              )
              $
              27,888,000





**19.**
            **Litigation**





On
      December 20, 2006, Pliant Corporation filed an action against the Company in
      the
      Circuit Court of Cook County, Illinois. In the action, Pliant claims that there
      is due from the Company to Pliant the sum of $245,000 for goods sold and
      delivered by Pliant to the Company as well as interest on such amount. On
      February 21, 2007, the Company filed and answer to the complaint and
      counterclaim denying liability and asserting certain claims against Pliant
      for
      damages for the sale by Pliant to the Company of defective products. Management
      intends to defend the claims of Pliant in this action and to pursue its
      counterclaims and believes that the Company has established adequate reserves
      regarding the claim.





F-25




In
      addition, the Company is also party to certain lawsuits arising in the normal
      course of business. The ultimate outcome of these matters is unknown, but in
      the
      opinion of management, the settlement of these matters is not expected to have
      a
      significant effect on the future financial position, cash flows or results
      of
      operations of the Company.





**20. 
      Quarterly Financial Data (Unaudited):**




The
      following table sets forth selected unaudited statements of income for each
      quarter of fiscal 2006 and 2005:


Quarter
                  Ended (1)March
                  31,
              
              June
                  30,
              
              Sept.
                  30,
              
              Dec.
                  31,2006
              
              2006
              
              2006
              
              2006(2)Net
                  sales
              
              $
              8,156,000
              
              $
              8,997,000
              
              $
              8,603,000
              
              $
              9,672,000Gross
                  profit
              
              $
              1,953,000
              
              $
              2,197,000
              
              $
              2,253,000
              
              $
              2,494,000Net
                  income
              
              $
              220,000
              
              $
              206,000
              
              
              315,000
              
              $
              1,154,000Earnings
                  per common shareBasic
              
              $
              0.11
              
              $
              0.10
              
              $
              0.15
              
              $
              0.54Diluted
              
              $
              0.10
              
              $
              0.10
              
              $
              0.15
              
              $
              0.49





(1)
            Earnings
                per common share are computed independently for each of the quarters
                presented. Therefore, the sum of the quarterly per common share
                information may not equal the annual earnings per common
                share.





(2)
            During
                  the fourth quarter 2006, management of the Company conducted an
                  analysis
                  of the recoverability of the deferred tax asset based on results
                  of
                  operations during the fourth quarter of 2005 and for the full year
                  of
                  2006, expected continued achievement of and continuing improvement
                  in
                  operating results for the for seeable future and anticipated repatriations
                  of profits and services income to be generated from the Company’s foreign
                  subsidiaries. As a result of such analysis, management determined
                  that the
                  net recorded deferred tax asset in the amount of 1,127,000 is more
                  likely
                  than not to be
                  realized.





F-26
 
  Quarter
                    Ended(1)March
                    31,
                
                June
                    30,
                
                Sept.
                    30,
                
                Dec.
                    31,2005
                
                2005
                
                2005
                
                2005Net
                    sales
                
                $
                9,103,000
                
                $
                7,573,000
                
                $
                6,034,000
                
                $
                6,480,000Gross
                    profit
                
                $
                1,874,000
                
                $
                1,583,000
                
                $
                1,242,000
                
                $
                1,765,000Net
                    income (loss)
                
                $
                84,000
                
                
                ($54,000
                )
                
                ($416,000
                )
                
                52,000Earnings
                    (loss) per common shareBasic
                
                $
                0.04
                
                
                ($0.03
                )
                
                ($0.21
                )
                $
                0.03Diluted
                
                $
                0.
                    04
                
                
                ($0.03
                )
                
                ($0.21
                )
                $
                0.02


(1)
            Earnings
                per common share are computed independently for each of the quarters
                presented. Therefore, the sum of the quarterly per common share
                information may not equal the annual earnings per common share.


For
                  the Year Ended December 31, 2004
                  (1)1st
              
              2nd
              
              3rd
              
              4thQuarter
              
              Quarter
              
              Quarter
              
              QuarterNet
                  sales
              
              $
              10,893,984
              
              
              9,591,785
              
              $
              8,125,521
              
              $
              8,581,819Gross
                  profit
              
              $
              2,147,370
              
              
              2,032,028
              
              $
              1,669,778
              
              $
              502,944Net
                  income (loss)
              
              $
              371,901
              
              
              (135,681
              )
              $
              (150,370
              )
              $
              (2,565,220
              )Earnings
                  (loss) per common shareBasic
              
              $
              0.19
              
              
              (0.07
              )
              $
              (0.08
              )
              $
              (1.31
              )Diluted
              
              $
              0.18
              
              
              (0.07
              )
              $
              (0.08
              )
              $
              (1.31
              )
 (1)
                Earnings
                    per common share are computed independently for each of the quarters
                    presented. Therefore, the sum of the quarterly per common share
                    information may not equal the annual earnings per common
                    share.





**21.
      Subsequent Events**





In
        July
        2006, we entered into a Standby Equity Distribution Agreement (SEDA) with
        Cornell Capital Partners, LP (“Cornell Capital”) pursuant to which we may, at
        our discretion, periodically sell to Cornell Capital shares of common stock
        at a
        price equal to the volume weighted average price of our common stock on the
        NASDAQ Capital Market for the five days immediately following the date we
        notify
        Cornell Capital of our request. On December 28, 2006, we filed a Registration
        Statement with the SEC for the registration of 403,500 shares to be sold to
        Cornell Capital and Newbridge Securities (our placement agent). On January
        28,
        2007, the Registration Statement was declared effective. Through March 20,
        2009, in connection with the SEDA, we have received $217,000 in net
        proceedsfrom
        Cornell Capital and Cornell Capital has purchased from us an aggregate of
        45,306 shares of our common stock.





In
      December 2006 the Board approved the retirement of all treasury shares to
      be effected in 2007.


F-27




**Schedule
      II - Valuation and Qualifying Accounts:**





The
      following is a summary of the allowance for doubtful accounts related to
      accounts receivable for the years ended December 31:


2006
                
                2005
                
                2004Balance
                    at beginning of year
                
                $
                80,205
                
                $
                404,070
                
                $
                316,047Charged
                    to expenses
                
                $
                202,571
                
                $
                145,000
                
                $
                288,562Uncollectible
                    accounts written off
                
                $
                (72,328
                )
                $
                (468,865
                )
                $
                (200,539
                )Balance
                    at end of year
                
                $
                210,448
                
                $
                80,205
                
                $
                404,070





The
      following is a summary of the allowance for obsolete inventory for the years
      ended December 31:


2006
              
              
              2005
              
              
              2004Balance
                  at beginning of year
              
              $
              254,745
              
              $
              186,713
              
              $
              492,157Charged
                  to expenses
              
              $
              218,730
              
              $
              205,000
              
              $
              60,000Obsolete
                  inventory written off
              
              $
              (197,690
              )
              $
              (136,968
              )
              $
              (365,444
              )Balance
                  at end of year
              
              $
              275,785
              
              $
              254,745
              
              $
              186,713





The
      following is a summary of property and equipment and the related accounts of
      accumulated depreciation for the years ended December 31:


2006
              
              2005
              
              2004**Cost
                  Basis**Balance
                  at beginning of year
              
              $
              26,704,366
              
              $
              26,224,962
              
              $
              27,023,245Additions
              
              $
              604,028
              
              $
              549,547
              
              $
              305,547Disposals
              
              $
              (438,509
              )
              $
              (70,143
              )
              $
              (1,103,830
              )Balance
                  at end of year
              
              $
              26,869,885
              
              $
              26,704,366
              
              $
              26,224,962**Accumulated
                  depreciation**Balance
                  at beginning of year
              
              $
              17,087,622
              
              $
              15,636,451
              
              $
              14,815,596Depreciation
              
              $
              1,189,989
              
              $
              1,463,369
              
              $
              1,651,322Disposals
              
              $
              -
              
              $
              (12,198
              )
              $
              (830,467
              )Balance
                  at end of year
              
              $
              18,277,611
              
              $
              17,087,622
              
              $
              15,636,451Property
                  and equipment, net
              
              $
              8,592,274
              
              $
              9,616,744
              
              $
              10,588,511





F-28