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, 2008




OR




 ̈
            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  ̈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  ̈    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 o  Smaller
Reporting Company  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 $6.04
per share of the Registrant’s Common Stock as reported on NASDAQ Capital Market
tier of The NASDAQ Stock Market on June 30, 2008, the aggregate market value of
the voting common stock held by non-affiliates of the Registrant was then
approximately $11,872,000.  (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 1, 2009 was 2,808,720 (excluding treasury
shares).








DOCUMENTS
INCORPORATED BY REFERENCE





Part of Form 10-K into WhichDocument
                
                Document Is IncorporatedSections
      of the registrant’s Proxy Statement
                  To
      be filed on or before April 30, 2009 for the Annual Meeting of
      Stockholders
                
                Part
      III








TABLE
OF CONTENTS





INDEX





FORWARD
      LOOKING STATEMENTSPart
      IItem
      No. 1
                                      Description
      of Business
                                      1Item
      No. 1A
                                      Risk
      Factors
                                      13Item
      No. 1B
                                      Unresolved
      Staff Comments
                                      21Item
      No. 2
                                      Properties
                                      21Item
      No. 3
                                      Legal
      Proceedings
                                      22Item
      No. 4
                                      Submission
      of Matters to a Vote of Security Holders
                                      22Part
      IIItem
      No. 5
                                      Market
      for Registrant’s Common Equity, Related Stockholder
Mattersand
      Issuer Purchases of Equity Securities
                                      22Item
      No. 6
                                      Selected
      Financial Data
                                      25Item
      No. 7
                                      Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                                      27Item
      No. 7A
                                      Quantitative
      and Qualitative Disclosures Regarding Market Risk
                                      38Item
      No. 8
                                      Financial
      Statements and Supplementary Data
                                      38Item
      No. 9
                                      Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
                                      38Item
      No. 9A
                                      Controls
      and Procedures
                                      39Item
      No. 9B
                                      Other
      Information
                                      41Part
      IIIItem
      No. 10
                                      Directors
      and Executive Officers of the Registrant
                                      41Item
      No. 11
                                      Executive
      Compensation
                                      41Item
      No. 12
                                      Security
      Ownership of Certain Beneficial Owners and and Management and Related
      Stockholder Matters
                                      42Item
      No. 13
                                      Certain
      Relationships and Related Transactions
                                      42Item
      No. 14
                                      Principal
      Accounting Fees and Services
                                      42Part
      IVItem
      No. 15
                                      Exhibits
      and Financial Statement Schedules
                                      42





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 Description of Business





Business
Overview





We
develop, produce, market and sell three principal lines of
products:





·
            Novelty Products,
      principally balloons, including foil balloons, latex balloons, punch balls
      and other inflatable toy items,





·
            Specialty and Printed
      Films for food packaging, specialized consumer uses and various
      commercial applications, and,





·
            Flexible Containers for
      home and consumer use for the storage and preservation of food and
      personal items.





We print,
process and convert plastic film into finished products and we produce latex
balloons and novelty items.  Our principal manufacturing processes
include:





·
            Coating
      and laminating plastic film.  Generally, we adhere polyethylene
      film to another film such as nylon or
polyester.





·
            Printing
      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.


1


·
            Converting
      printed plastic film to balloons.





·
            Converting
      plastic film to flexible
containers.





·
            Producing
      latex balloons and other latex novelty
items.





We market
and sell foil 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 market them to consumers who use them for the storage of food and personal
items.  We also market containers to and through retail outlets for
use by consumers that include a resealable closure system and a valve permitting
the evacuation of air from the pouch by a small pump device, which we also
supply.





In 1978,
we began manufacturing foil 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.





In 1999,
we acquired an extrusion coating and laminating machine and began production of
coated and laminated films, which we have produced since that time.





During
the period from 1976 to 1986 and from 1996 to the present, we have produced
flexible containers for the storage of liquids, food products, household goods
and other items.





We market
and sell our foil 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, discount and drugstore chains, grocery chains, card and gift shops,
and party goods stores, as well as through florists and balloon
decorators.





Most of
our foil balloons contain printed characters, designs and social expression
messages, such as “Happy Birthday”, “Get Well” 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®,
Odie®, Face
Offs-Tudes®, Wow Wow
Wubsy®, Miss
Spider®, Sunny
Patch Friends®,
Hallmark Designs, American Greetings Designs, and in Mexico, Dreamworks
(Madagascar®,
Shrek®),
Transformers® and
Borlitas®.  In
the United Kingdom, we maintain licenses for The Crazy Frog® and
Tudes®.


2


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 2008,
our revenues from these three product lines, as a percent of total revenues
were:





·Novelty Products
              57.5%
      of revenues·Laminated Film Products
              18.3%
      of revenues·Flexible Containers
              24.2%
      of revenues





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.





·
            Maintain a Focus on Margin
      Levels and Cost Controls in Order to Establish and Maintain
      Profitability.  We engage in constant review and effort
      to control our production, and our selling, general and administrative
      expenses, in order to establish and enhance
  profitability.


3


·
            Develop New Products, Product
      Improvements and Technologies.  We work 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.  We 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 balloons.  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 nine patents for these
      developments and have three patent applications pending. During 2008, we
      introduced a line of resealable pouches with a valve and pump system for
      household storage and vacuum sealing of food items.  We work
      with customers to develop custom film products which serve the unique
      needs or requirements of the
customer.





·
            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.  On
      February 1, 2008, we entered into a Supply and License Agreement with S.C.
      Johnson & Son, Inc. to manufacture and supply to SC Johnson certain
      home food management products to be sold under the SC Johnson ZipLoc®
      brand.





Products





Foil Balloons.  We
have designed, produced and sold foil balloons since 1979 and, we believe, are
the second largest manufacturer of foil balloons in the United States.
Currently, we produce over 500 foil balloon designs, in different shapes and
sizes, including the following:





·
            Superloons® -
      18" foil balloons in round or heart shape, generally made to be filled
      with helium and remain buoyant for long periods. This is the predominant
      foil balloon size.





·
            Ultraloons® -
      31" jumbo foil balloons made to be filled with helium and remain
      buoyant.





·
            Miniloons®-
      9" foil balloons made to be air-filled and sold on holder-sticks or for
      use in decorations.





·
            Card-B-Loons®(4
      1/2") - air-filled foil balloons, often sold on a stick, used in floral
      arrangements or with a container of
candy.





·
            Shape-A-Loons® -
      “18 to 48” shaped foil balloons made to be filled with
    helium.





·
            Minishapes
      – 11” to 16”small shaped foil balloons designed to be air filled and sold
      on sticks as toys or inflated
characters.





·
            Balloon
      JamzTM –
      20” to 40” round and shaped foil balloons which emit and amplify sound
      through a speaker attached to the
balloon.


4


In
addition to size and shape, a principal element of the Company's foil 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®,
Odie®, Face
Offs-Tudes®, Wow Wow
Wubsy®, Miss
Spider®, Sunny
Patch Friends®,
Hallmark Designs, American Greetings Designs, and in Mexico, Dreamworks
(Madagascar®,
Shrek®),
Transformers® and
Borlitas®. In the
United Kingdom, we maintain licenses for The Crazy Frog® and
Tudes®.





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 42 colors.  These balloons
are marketed under the name Partyloons® and
Hitex®.  We
also manufacture toy balloon products including punch balls, water bombs and
"Animal Twisties."





Packaging Films and Custom Film
Products.  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 2008, we introduced a line of
resealable, valved bags for storage and vacuum sealing of food items in the
household.  These storage bags function with a small hand or powered
pump to evacuate air when the bag is sealed.  This product line is
marketed under the brand ZipVacTM.





Markets





Foil
Balloons





The foil
balloon came into existence in the late 1970s. During the 1980s, the market for
foil 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. Foil 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. Foil balloons became part of
the "social expression" industry, carrying graphics 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 foil balloons throughout the
United States and in a number of other countries, although “vendors” remain a
significant means of distribution in a number of areas.


5


Foil
balloons are now sold in virtually every region of the world. The United States,
however, remains the largest market for these products.





Foil
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 foil 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.





Latex
balloons are sold in virtually every region of the world.





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.


6


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.





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 foil 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 9 individuals and a customer
service department of 3 individuals in the United States. 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 2008 was Dollar Tree
Stores.  Sales to this chain in 2008 represented $9,014,000 or
approximately 20.0% of our consolidated 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.


7


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 2008, our sales to Rapak
totaled $7,608,000, representing 16.9% of our consolidated net sales.Under our
agreement with Rapak, which continues through October 31, 2011, Rapak is
committed to purchase at least 75% of its requirements for embossed film from
us.





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.





On
February 1, 2008, we entered into a License and Supply Agreement with S.C.
Johnson & Son, Inc (“SC Johnson”).  The agreement provides for the
Company to manufacture and sell to SC Johnson (or its designee, Goodwill
Commercial Services, Inc.) certain home food management products to be sold
under the SC Johnson ZipLoc® brand.  The agreement is for a term
expiring on June 30, 2011 and provides for two renewal terms of two years each
at the option of SC Johnson.  During 2008, our sales to SC Johnson
totaled $6,990,000, representing 15.5% of our consolidated net sales.





We
produce consumer storage bags for ITW Space Bag, a division of Illinois Tool
Works, Inc. (“ITW”).  In March 2006, we entered into a four-year
agreement with ITW under which we 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 market these bags through various retail
channels.  During 2007, we introduced a line of re-sealable pouches
incorporating a valve permitting the evacuation of air from the sealed pouch by
use of a hand pump supplied with the pouches.  This line of products
is marketed under the brand name ZipVacTM.  We market this line of
products to various retail outlets.


8





On April
10, 2008, we entered into an agreement with Babe Winkelman Productions, Inc.
(BWP).  The agreement provides for BWP to provide marketing and
advertising services to us in connection with our ZipVacTM brand portable food
storage system.  BWP will produce commercials featuring the ZipVacTM
product line which are to be aired under the agreement, at the time of Babe
Winkelman syndicated programs, will produce a Kris Winkelman segment of the Babe
Winkelman shows which will feature uses of the ZipVacTM product line, and will
provide other advertising and marketing services.  We received a
license to use the name, image, likeness and testimonies of Babe and Kris
Winkelman in connection with the ZipVacTM product line.  We pay a
royalty to BWP of 3% of net revenues from the sale of the ZipVacTM product and
have issued to BWP 50,000 shares of our common stock which will be earned by BWP
over a two year period.  The agreement is for a term commencing on
April 1, 2008 and expiring on March 31, 2011.





We also
produce "dunnage" bags (inflatable packaging pouches) which we sell to a
commercial customer.





Production
and Operations





We
conduct our operations at our 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 warehouse in Elgin, Illinois consisting of approximately 20,000
square feet, (iv) a plant, office and warehouse in Guadalajara, Mexico,
consisting of approximately 43,000 square feet of office, warehouse and
production space and (v) an office and warehouse facility at Rugby, England,
consisting of approximately 16,000 square feet of space.





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, Elgin, 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 are handled at our Rugby, England
facility.


9


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 raw materials represents a
significant portion of the total cost of our products, with the result that
fluctuations in the cost of raw materials has a material effect on our
profitability. The cost of our raw materials represented 43.2% of our net
revenues in 2008.  During the past several years, we have experienced
significant fluctuations in the cost of these raw materials.  We do
not have any long-term agreements for the supply of raw materials and may
experience wide fluctuations in the cost of raw materials in the
future.  Further, although we have been able to obtain adequate
supplies of raw materials in the past, there can be no assurance that we will be
able to obtain adequate supplies of one or more of our raw materials in the
future.





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
communications.  Access to the network is available to all appropriate
employees but is secured through four Microsoft servers running Active Directory
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, manufacturing costing, controls and inventory
controls, electronic data exchange and custom report writing modules of that
system.  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, load balanced and redundant T1 and cable internet connection
allowing employees to use e-mail, 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.


10


Competition





The
balloon and novelty industry is highly competitive, with numerous competitors.
We believe there are presently six principal manufacturers of foil balloons
whose products are sold in the United States including Anagram International,
Inc., Pioneer Balloon Company, Convertidora International S.A. de C.V., Barton
Enterprises Inc., and Betallic, LLC.  Several companies market and
sell foil 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.





We also
compete with other manufacturers of foil and latex balloons in Europe, Latin
America and Asia.





The
market for films, packaging, flexible containers 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.





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.





Trademarks. We own 12registered trademarks in
the United States relating to our balloon products. Many of these trademarks are
registered in foreign countries, principally in the European
Union.


11


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 foil balloons and methods of making balloons
with such valves, (ii) several foil 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, 2008 and 2007, respectively, we
estimate that the total amount spent on research and development activities was
approximately $357,000 and $350,000, respectively.





Employees





As of
December 31, 2008, the Company had 101 full-time employees in the United States,
of whom 22 are executive or supervisory, 5 are in sales, 54 are in manufacturing
or warehouse functions and 20 are clerical.  As of that same date, we
had 10 full-time employees in England, of whom 3 are executive or supervisory, 2
are in sales, 4 are in warehousing and one is clerical.  At Flexo
Universal, our Mexico subsidiary, as of December 31, 2008, we had 219 full-time
employees, of whom 5 are executive or supervisory, 3 are in sales, 201 are in
manufacturing and 10 are clerical.  The Company is not a party to any
collective bargaining agreement in the United States, 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 foil
balloons. We do not believe such legislation will have any material effect on
our operations.


12


International
Operations





We sell
balloon products in a number of countries outside of the United
States.  Our facility and personnel in Rugby, England handle the sales
of these products in the United Kingdom. Our facility and personnel in
Guadalajara, Mexico handle the sales of these products in Mexico and Latin
America.  In other countries, we sell balloon products through
distributors located in those countries. We conduct production, packaging,
warehousing and sales operations in Mexico. We conduct 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 materially adverse
effect on the business of the Company.





Our
domestic and international sales to outside customers and assets by area over
the period 2007 - 2008 have been as follows:




United
      States
                  
                  
                  United Kingdom
                  
                  
                  Mexico
                  
                  
                  ConsolidatedYear
      ended 12/31/08Sales
      to outside customers
                  
                  $
                  34,701,000
                  
                  
                  $
                  2,762,000
                  
                  
                  $
                  7,518,000
                  
                  
                  $
                  44,981,000Operating
      income
                  
                  $
                  1,612,000
                  
                  
                  $
                  412,000
                  
                  
                  $
                  359,000
                  
                  
                  $
                  2,383,000Net
      income
                  
                  $
                  795,000
                  
                  
                  $
                  215,000
                  
                  
                  $
                  144,000
                  
                  
                  $
                  1,154,000Total
      Assets
                  
                  $
                  24,709,000
                  
                  
                  $
                  740,000
                  
                  
                  $
                  4,539,000
                  
                  
                  $
                  29,988,000
 
 United
      States
                  
                  
                  United
      Kingdom
                  
                  
                  Mexico
                  
                  
                  ConsolidatedYear
      ended 12/31/07Sales
      to outside customers
                  
                  $
                  27,326,000
                  
                  
                  $
                  2,913,000
                  
                  
                  $
                  6,271,000
                  
                  
                  $
                  36,510,000Operating
      income
                  
                  $
                  810,000
                  
                  
                  $
                  215,000
                  
                  
                  $
                  220,000
                  
                  
                  $
                  1,245,000Net
      (loss) income
                  
                  $
                  (128,000
                  )
                  
                  $
                  167,000
                  
                  
                  $
                  43,000
                  
                  
                  $
                  82,000Total
      Assets
                  
                  $
                  23,128,000
                  
                  
                  $
                  1,086,000
                  
                  
                  $
                  5,110,000
                  
                  
                  $
                  29,324,000


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 operation 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.


13


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.





Our
business is dependent on the price and availability of raw
materials.





The cost
of the raw materials we purchase represents about 43.2% of our
revenues.  The principal raw materials we purchase
are:  nylon sheeting, polyester sheeting, polyethylene sheeting,
polyethylene resin and latex.  Most 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 affected, and may affect, adversely, the prices of these raw materials and
their general availability.  The price of latex has also fluctuated
significantly over the past three 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.





Changes
or limitations in the price and availability of helium to our customers may
adversely affect our sales of novelty products.





Many of
our novelty products, including many styles of foil balloons and latex balloons,
are intended to be, and are, when sold to or used by customers filled with
helium for buoyancy.  During recent months, the price of helium has
increased.  It has been reported that the supply of helium is
decreasing, that demand for helium for industrial and scientific uses has been
increasing and that exports of helium from the United States, which is the
principal producer of helium, have increased.  As a result, the
increased price of helium and possible lack of availability may adversely affect
sales of novelty balloon products, including sales by the Company.





The
loss of a key supplier or suppliers could lead to increased costs and lower
margins as well as other adverse results.


14


We rely
on eight principal suppliers for our petroleum, natural gas and latex-based raw
material supplies.  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 fluctuating income from operations over the past five
years.  We have reported net income from operations in four of the
past five years and a loss in one 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 $50,000 and has been subject to significant quarterly and annual
fluctuations.  These fluctuations can be caused by:





·
            Economic
      conditions


·
            Sales
      volume


·
            Competition


·
            Production
      efficiencies


·
            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, 2008, our current assets exceeded
our current liabilities by approximately $1,466,000.  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.


15


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
operation, cash flow and financial condition.





For the
year ended December 31, 2008, our sales to our top 10 customers represented
70.8% of our consolidated net sales and our sales to our top three customers
represented 52.5% of our consolidated net sales.  We do not have long
term contracts with several of our principal 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 three
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.  This agreement
expires on March 31, 2010.  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.  On May
6, 2008 we entered into an amendment to the license agreement extending the term
of the supply agreement to October 31, 2011.  On February 1, 2008, we
entered into a Supply and License Agreement with S.C. Johnson & Son, Inc. to
manufacture and sell to SC Johnson certain home food management products to be
sold under the SC Johnson ZipLoc® brand.  The agreement is for a term
expiring on June 30, 2011 and provides for two renewal terms of two years each
at the option of SC Johnson.





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 12 years,
we have obtained nine patents related to films, pouches, zippers for pouches,
the method of inserting zippers in pouches and certain valves for
pouches.  We have three 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.





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.


16


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 and its
subsidiaries:  Sam Komar, Timothy Patterson and Pablo
Gortazar.  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 44.7% of the outstanding shares of common stock of the
Company as of March 1, 2009 and then had options and warrants to purchase
additional shares which, if exercised, together with the shares owned, would
aggregate 55.3% 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.


17


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, 2008, we had $22,241,000 of debt
outstanding and $7,735,000 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 RBS Citizens, N.A.
(“RBS”), previously referred to as Charter One Bank, in which, as amended, RBS
provides to us a line of credit totaling $15,300,000, 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 $9,000,000.  In
November 2007, RBS also provided to us a capital lease line of credit in the
aggregate amount of $1,500,000 for the acquisition of production
equipment.  On January 31, 2009, we entered into an agreement with RBS
to extend the revolving line of credit for one year expiring on January 31,
2010.  Also, on February 1, 2006, 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 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.


18


In July
2006, we entered into a Standby Equity Distribution Agreement (SEDA) with
Cornell Capital Partners, LP (“Cornell Capital”) pursuant to which we could, 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 by Cornell Capital and Newbridge Securities (our placement
agent).  On January 28, 2007, the Registration Statement was declared
effective.  On July 24, 2008, we filed an amended Registration
Statement with respect to these shares that was declared effective. Through
December 31, 2008, in connection with the SEDA, we have requested and received
aggregate advances from Cornell Capital under this agreement for $1,680,000 and
Cornell Capital has purchased from us an aggregate of 341,864 shares of our
common stock.  The commitment of Cornell Capital under this agreement
expired on January 28, 2009.





We
are subject to a number of restrictive debt covenants that may restrict our
business and financing activities.





Our
credit facility, as amended January 2009, 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.





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,


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


19


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.





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 that, 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


20


Sales of
our common stock in the public market 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 2,808,720 shares of common stock outstanding as of March 1, 2009, 1,256,382
shares of common stock are, or will be, held by our “affiliates” and 1,355,242
shares of common stock, 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.




Item
No. 1B – Unresolved Staff Comments




As of the
filing of this Annual report on Form 10-K, we had no unresolved comments from
the staff of the Securities and Exchange Commission that were received not less
than 180 days before the end of our 2008 fiscal year.




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.





In
September 2005, the Company entered into a lease to rent 16,306 square feet of
space in Cary, Illinois.  This lease expires in September
2009.  The facility includes warehouse and office space, which is
utilized principally for the warehousing of balloon inventory.  In
addition, we have entered into a month-to-month agreement to rent warehouse
space as required in Elgin, Illinois.





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
February 2008, Flexo Universal entered into a 3-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 $19,200 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.


21


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 an 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.  Management is unable to
estimate a range of loss, if any, in the matter.  On February 11,
2009, Pliant Corporation filed a petition for relief under Chapter XI of the
Bankruptcy Act, and as a result of such filing, the action currently is
stayed.





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





No
matters were submitted to the shareholders of the Company during the Fourth
Quarter 2008.





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.





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
                
                
                LowJanuary
      1, 2007 to March 31, 2007
                
                $
                10.39
                
                
                $
                4.39April
      1, 2007 to June 30, 2007
                
                
                8.10
                
                
                
                3.68July
      1, 2007 to September 30, 2007
                
                
                5.59
                
                
                
                2.88October
      1, 2007 to December 31, 2007
                
                
                5.44
                
                
                
                2.76January
      1, 2008 to March 31, 2008
                
                
                6.43
                
                
                
                3.25April
      1, 2008 to June 30, 2008
                
                
                6.10
                
                
                
                4.16July
      1, 2008 to September 30, 2008
                
                
                7.30
                
                
                
                4.50October
      1, 2008 to December 31, 2008
                
                
                5.29
                
                
                
                1.60


22


As of
December 31, 2008 there were approximately 30 holders of record of the Company’s
Common Stock.  The Company believes that its total number of
beneficial owners of common stock of the Company exceeds 554.





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 during 2008.





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.  On February 8, 2008, Mr. Schwan and Mr. Merrick exercised
these warrants utilizing $793,810 in principal amount of such promissory notes
as payment of the exercise price for the shares purchased.  The
remaining amount of the notes are due on demand.





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 December 31, 2008, the Company has sold to Cornell Capital an aggregate
of 341,864 shares of common stock at an average price of $4.91 per
share.


23


On
February 1, 2007, the Company issued to Capstone Advisory Group, L.L.C. 17,000
shares of common stock for consulting services to be performed over an 18-month
period.





On April
7, 2008, the Company issued 50,000 shares of common stock to Babe Winkelman
Productions, Inc. for marketing services to be performed over a 24-month
period.





On
October 1, 2008, the Company issued warrants to purchase 20,000 shares of common
stock of the Company to both John Schwan and Stephen M. Merrick exercisable at
the price of $4.80 per share (the market price of the stock on the date of the
warrants) in consideration for the personal guarantees by each of up to $2
million in principal amount of the bank debt of the Company.





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 December, 2003 to December, 2008, the
cumulative total return (assuming reinvestment of dividends) on our common stock
with (i) NASDAQ Composite Index (U.S.), (ii) S&P 500 Specialty Stores Index
(U.S.) and (iii) a Peer Group.  The Peer Group was created based on
ten companies with similar Market-Capitalization (5 above and 5
below).  The graph assumes an investment of $100 on December 31, 2003,
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, 2003 through December 31, 2008 is based on the common stock’s
closing price as of such date.  All prices reflect any stock splits or
dividends during the period.


24








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.





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.


25


Year ended December 31,2008
                                              
                                              
                                              2007
                                              
                                              
                                              2006
                                              
                                              
                                              2005
                                              
                                              
                                              2004Statement
      of Operations Data:Net
      Sales
                                              
                                              $
                                              44,981
                                              
                                              
                                              $
                                              36,510
                                              
                                              
                                              $
                                              35,428
                                              
                                              
                                              $
                                              29,190
                                              
                                              
                                              $
                                              37,193Costs
      of Sales
                                              
                                              $
                                              34,659
                                              
                                              
                                              $
                                              27,826
                                              
                                              
                                              $
                                              26,531
                                              
                                              
                                              $
                                              22,726
                                              
                                              
                                              $
                                              30,841Gross
      Profit
                                              
                                              $
                                              10,322
                                              
                                              
                                              $
                                              8,684
                                              
                                              
                                              $
                                              8,897
                                              
                                              
                                              $
                                              6,464
                                              
                                              
                                              $
                                              6,352Operating
      expenses
                                              
                                              $
                                              7,939
                                              
                                              
                                              $
                                              7,439
                                              
                                              
                                              $
                                              6,275
                                              
                                              
                                              $
                                              5,812
                                              
                                              
                                              $
                                              6,402Income
      (loss) from operations
                                              
                                              $
                                              2,383
                                              
                                              
                                              $
                                              1,245
                                              
                                              
                                              $
                                              2,622
                                              
                                              
                                              $
                                              652
                                              
                                              
                                              $
                                              (50
                                              )Interest
      expense
                                              
                                              $
                                              1,032
                                              
                                              
                                              $
                                              1,286
                                              
                                              
                                              $
                                              1,691
                                              
                                              
                                              $
                                              1,231
                                              
                                              
                                              $
                                              1,350Other
      (income) expense
                                              
                                              $
                                              (50
                                              )
                                              
                                              $
                                              (174
                                              )
                                              
                                              $
                                              (191
                                              )
                                              
                                              $
                                              (45
                                              )
                                              
                                              $
                                              (208
                                              )Income
      (loss) before taxes and minority interest
                                              
                                              $
                                              1,401
                                              
                                              
                                              $
                                              133
                                              
                                              
                                              $
                                              1,122
                                              
                                              
                                              $
                                              (534
                                              )
                                              
                                              $
                                              (1,192
                                              )Income
      tax (benefit) expense
                                              
                                              $
                                              247
                                              
                                              
                                              $
                                              51
                                              
                                              
                                              $
                                              (774
                                              )
                                              
                                              $
                                              (200
                                              )
                                              
                                              $
                                              1,286Minority
      interest
                                              
                                              $
                                              -
                                              
                                              
                                              $
                                              -
                                              
                                              
                                              $
                                              1
                                              
                                              
                                              $
                                              -
                                              
                                              
                                              $
                                              1Net
      Income (loss)
                                              
                                              $
                                              1,154
                                              
                                              
                                              $
                                              82
                                              
                                              
                                              $
                                              1,895
                                              
                                              
                                              $
                                              (333
                                              )
                                              
                                              $
                                              (2,479
                                              )Earnings
      (loss) per common shareBasic
                                              
                                              $
                                              0.42
                                              
                                              
                                              $
                                              0.03
                                              
                                              
                                              $
                                              0.91
                                              
                                              
                                              $
                                              (0.17
                                              )
                                              
                                              $
                                              (1.28
                                              )Diluted
                                              
                                              $
                                              0.40
                                              
                                              
                                              $
                                              0.03
                                              
                                              
                                              $
                                              0.85
                                              
                                              
                                              $
                                              (0.17
                                              )
                                              
                                              $
                                              (1.28
                                              )Other
      Financial Data:Gross
      margin percentage
                                              
                                              
                                              22.95
                                              %
                                              
                                              
                                              23.79
                                              %
                                              
                                              
                                              25.11
                                              %
                                              
                                              
                                              22.14
                                              %
                                              
                                              
                                              17.08
                                              %Capital
      Expenses
                                              
                                              $
                                              2,200
                                              
                                              
                                              $
                                              2,848
                                              
                                              
                                              $
                                              553
                                              
                                              
                                              $
                                              550
                                              
                                              
                                              $
                                              306Depreciation
      & Amortization
                                              
                                              $
                                              1,593
                                              
                                              
                                              $
                                              1,299
                                              
                                              
                                              $
                                              1,205
                                              
                                              
                                              $
                                              1,463
                                              
                                              
                                              $
                                              1,651Balance
      Sheet Data:Working
      capital (Deficit)
                                              
                                              $
                                              1,466
                                              
                                              
                                              $
                                              1,318
                                              
                                              
                                              $
                                              1,848
                                              
                                              
                                              $
                                              (2,426
                                              )
                                              
                                              $
                                              (2,790
                                              )Total
      assets
                                              
                                              $
                                              29,988
                                              
                                              
                                              $
                                              29,256
                                              
                                              
                                              $
                                              26,645
                                              
                                              
                                              $
                                              23,536
                                              
                                              
                                              $
                                              27,888Short-term obligations(1)
                                              
                                              $
                                              10,416
                                              
                                              
                                              $
                                              9,767
                                              
                                              
                                              $
                                              9,422
                                              
                                              
                                              $
                                              8,618
                                              
                                              
                                              $
                                              9,962Long-term
      obligations
                                              
                                              $
                                              6,019
                                              
                                              
                                              $
                                              6,237
                                              
                                              
                                              $
                                              6,887
                                              
                                              
                                              $
                                              6,039
                                              
                                              
                                              $
                                              6,491Stockholders’
      Equity
                                              
                                              $
                                              7,735
                                              
                                              
                                              $
                                              6,523
                                              
                                              
                                              $
                                              5,102
                                              
                                              
                                              $
                                              2,726
                                              
                                              
                                              $
                                              2,951





(1)
            Short
      term obligations consist of primarily of borrowings under bank line of
      credit and current portion of long-term
debt.





The
following table sets forth selected unaudited statements of operations for each
quarter of fiscal 2008 and 2007:




For
      the Year Ended December 31, 2008 (1)1st
                      
                      2nd
                      
                      3rd
                      
                      4thQuarter
                      
                      Quarter
                      
                      Quarter
                      
                      QuarterNet
      sales
                      
                      $
                      10,735,000
                      
                      
                      $
                      12,461,000
                      
                      
                      $
                      11,953,000
                      
                      
                      $
                      9,832,000Gross
      profit
                      
                      $
                      2,332,000
                      
                      
                      $
                      2,913,000
                      
                      
                      $
                      2,742,000
                      
                      
                      $
                      2,335,000Net
      income
                      
                      $
                      279,000
                      
                      
                      $
                      485,000
                      
                      
                      $
                      269,000
                      
                      
                      $
                      121,000Earnings
      per common shareBasic
                      
                      $
                      0.10
                      
                      
                      $
                      0.17
                      
                      
                      $
                      0.10
                      
                      
                      $
                      0.04Diluted
                      
                      $
                      0.10
                      
                      
                      $
                      0.17
                      
                      
                      $
                      0.09
                      
                      
                      $
                      0.04
 
 (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


26




For
      the Year Ended December 31, 2007 (1)1st
                        
                        2nd
                        
                        3rd
                        
                        4thQuarter
                        
                        Quarter
                        
                        Quarter
                        
                        QuarterNet
      sales
                        
                        $
                        8,279,000
                        
                        
                        $
                        9,259,000
                        
                        
                        $
                        8,673,000
                        
                        
                        $
                        10,299,000Gross
      profit
                        
                        $
                        1,903,000
                        
                        
                        $
                        2,744,000
                        
                        
                        $
                        1,617,000
                        
                        
                        $
                        2,420,000Net
      (loss) income
                        
                        $
                        (52,000
                        )
                        
                        $
                        423,000
                        
                        
                        $
                        (414,000
                        )
                        
                        $
                        125,000Earnings
      per common shareBasic
                        
                        $
                        (0.02
                        )
                        
                        $
                        0.18
                        
                        
                        $
                        (0.18
                        )
                        
                        $
                        0.05Diluted
                        
                        $
                        (0.02
                        )
                        
                        $
                        0.17
                        
                        
                        $
                        (0.18
                        )
                        
                        $
                        0.05
 
 (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 foil 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 foil balloons and latex balloons - in the United States, Mexico, the
United Kingdom and a number of additional countries.





Our
revenues from each of our product categories in each of the past two years have
been as follows:





(000
      Omitted)$
                          
                          
                          %
      of
                          
                          
                          $
                          
                          
                          %
      ofProduct
      Category
                          
                          2008
                          
                          
                          Net
      Sales
                          
                          
                          2007
                          
                          
                          Net
      SalesMetalized
      Balloons
                          
                          
                          17,629
                          
                          
                          
                          39.2%
                          
                          
                          
                          15,998
                          
                          
                          
                          43.8%Films
                          
                          
                          8,212
                          
                          
                          
                          18.3%
                          
                          
                          
                          7,846
                          
                          
                          
                          21.5%Pouches
                          
                          
                          10,893
                          
                          
                          
                          24.2%
                          
                          
                          
                          4,938
                          
                          
                          
                          13.5%Latex
      Balloons
                          
                          
                          7,597
                          
                          
                          
                          16.9%
                          
                          
                          
                          6,853
                          
                          
                          
                          18.8%Helium/Other
                          
                          
                          650
                          
                          
                          
                          1.4%
                          
                          
                          
                          875
                          
                          
                          
                          2.4%Total
                          
                          
                          44,981
                          
                          
                          
                          100.0%
                          
                          
                          
                          36,510
                          
                          
                          
                          100.0%




27


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 expenses such as supervisory labor, depreciation,
utilities expense and facilities expense 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, depreciation of equipment and
facilities utilized in administration, 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
revenues. In 2008, sales to our top 10 customers represented 70.8% of net
revenues.  During 2008, there were three customers to whom our sales
represented more than 10% of net revenues.  Our principle customers
and 2008 sales to them were:





Customer
                                
                                Product
                                
                                2008
      Sales
                                
                                
                                % of 2008
                                  Revenues
                                
                                
                                2007
      Sales
                                
                                
                                % of 2007
                                  RevenuesDollar
      Tree Stores
                                
                                Balloons
                                
                                $
                                9,014,000
                                
                                
                                
                                20.0%
                                
                                
                                $
                                7,419,000
                                
                                
                                
                                20.3%Rapak
      L.L.C
                                
                                Films
                                
                                $
                                7,608,000
                                
                                
                                
                                16.9%
                                
                                
                                $
                                6,982,000
                                
                                
                                
                                19.1%S.C.
      Johnson & Son, Inc
                                
                                Pouches
                                
                                $
                                6,990,000
                                
                                
                                
                                15.5%
                                
                                
                                $
                                284,000
                                
                                
                                
                                0.8%





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, 2008 and 2007. Our
results of operations for the periods described below are not necessarily
indicative of results of operations for future periods.


28




Year
      ended December 31,2008
                  
                  
                  2007Net
      sales
                  
                  
                  100.0%
                  
                  
                  
                  100.0%Costs
      and expenses:Cost
      of products sold
                  
                  
                  77.1
                  
                  
                  
                  76.2Operating
      Expenses
                  
                  
                  17.6
                  
                  
                  
                  20.4Income
      from operations
                  
                  
                  5.3
                  
                  
                  
                  3.4Interest
      expense
                  
                  
                  (2.3)
                  
                  
                  
                  (3.5)Other
      income
                  
                  
                  0.1
                  
                  
                  
                  0.5Income
      before income taxes
                  
                  
                  3.1
                  
                  
                  
                  0.4Provision
      for income taxes
                  
                  
                  0.5
                  
                  
                  
                  0.2Net
      profit
                  
                  
                  2.6%
                  
                  
                  
                  0.2%





Year
Ended December 31, 2008 Compared to Year Ended December 31, 2007





Net
Sales





For the
fiscal year ended December 31, 2008, consolidated net sales from the sale of all
products were $44,981,000 compared to consolidated net sales of $36,510,000 for
the year ended December 31, 2007, an increase of 23.2%.





Sales of
foil balloons increased by 10.2% from $15,998,000 in 2007 to $17,629,000 in
2008.  Most of the increase is attributable to an increase in our
sales to Dollar Tree Stores of $1,595,000 in 2008 over 2007 sales.





Sales of
film products increased by 4.7% from $7,846,000 in 2007 to $8,212,000 in
2008.  This increase is attributable to an increase in sales to Rapak,
L.L.C.





Sales of
pouch products increased by 121% from $4,938,000 in 2007 to $10,893,000 in
2008.  All of this increase is attributable to an increase in pouch
sales to Goodwill Commercial Services (for S.C. Johnson & Son, Inc.) from
$284,000 in 2007 to $6,990,000 in 2008.  Other pouch sales in 2008
included sales to ITW Spacebag and sales of our ZipVac Brand line.





Sales of
latex balloons increased by 10.9% from $6,853,000 in 2007 to $7,597,000 in
2008.  Most of the increase is attributable to increased sales of
latex balloons in Mexico by our affiliate Flexo Universal to a variety of
customers.





Cost of
Sales





Cost of
sales increased from 76.2% of sales in 2007 to 77.1% of sales in
2008.  This increase is attributable to increases in the cost of raw
materials experienced during much of 2008, including plastic sheeting, resin and
latex.  In 2008, the cost of raw materials represented 43.2% of our
revenues compared to 41.2% of our revenues in 2007.  We were able to
limit the effect of increased costs of raw materials to some degree by raising
our selling prices of certain products.


29


During
the first nine months of 2008, we determined that the cost of raw materials for
United States production increased, on average, 14.4% over that
period.  However, during the fourth quarter of 2008, the cost of most
of our raw materials declined, a change which also limited the effect of raw
materials costs on our gross margins in 2008.





During
2007, gross margins were negatively affected by certain production expenses not
incurred in 2008, including set-up, testing and initial production costs
associated with the installation and initial production of pouch product lines
which were not capitalized.  We have estimated the amount of these
costs in 2007 as being approximately $250,000.





General and Administrative
Expenses





General
and administrative expenses increased from $5,211,000 in 2007 or 14.3% of net
sales to $5,376,000 or 12.0% of net sales in 2008.  This increased is
attributable principally to (i) an increase in administrative salaries of
$229,000 due to new personnel and incentive compensation payments, (ii) an
increase in administrative travel expenses in the amount of $57,000 and (iii) an
increase in legal expenses of $85,000.





Selling





Selling
expenses increased from $754,000 or 2.1% of sales in 2007 to $886,000 or 2.0% of
sales in 2008.  This increased is attributable principally to (i) an
increase in salary expense of $113,000 associated with new personnel, (ii) an
increase in travel expenses in the amount of $43,000 and (iii) an increase in
licensing royalty payments in the amount of $41,000.





Advertising and
Marketing





Advertising
and Marketing expenses increased from $1,474,000 or 4.0% of sales in 2007 to
$1,678,000 or 3.7% of sales in 2008.  This increase is due to (i)
additional advertising and marketing expenses of $133,000 related principally to
our ZipVac product line, (ii) an increase in marketing salaries due to new
personnel in the amount of $98,000 and (iii) and increase in trade booth expense
of $52,000.





Other Income or
Expense





During
2008, we incurred net interest expense of $1,031,000 compared to net interest
expense of $1,286,000 during 2007.  The reduction in interest expense
incurred in 2008 is the result of both lower applicable interest
rates.


30


During
2008, we realized foreign currency gain in the amount of $50,000 compared to
foreign currency gain in 2007 of $174,000.





Net Income or
Loss





During
2008, we had net income of $1,154,000 compared to net income of $82,000 in
2007.  The increase in net income in 2008 over 2007 resulted
principally from an increase in gross profits in the amount of $1,638,000 over
2007 levels which was offset by an increase in operating expenses of
approximately $500,000 over 2007 levels.  Net income for 2007 was
affected by costs related to the set-up, testing and initial production of pouch
production lines.  During 2007, we incurred such costs in the total
amount of approximately $2,330,000 of which $2,082,000 was
capitalized.





Income
Taxes





In 2008,
the Company recognized income tax expense, on a consolidated basis, of
$247,000.  This income tax expense is composed of income tax expense
realized by CTI Balloons, our United Kingdom subsidiary, in the amount of
$116,000 and by Flexo Universal and CTI Mexico, our Mexico subsidiaries, in the
amounts of $119,000 and $12,000, respectively.  In 2007, the Company
recognized an income tax expense, on a consolidated basis, of
$51,000.  This income tax expense was composed of income tax expense
realized by CTI Balloons, our United Kingdom subsidiary, and Flexo Universal,
our Mexico subsidiary, in the amounts of $90,000 and $98,000, respectively,
offset by an income tax benefit of $137,000 recognized by the Company in the
United States.





Financial
Condition, Liquidity and Capital Resources





Cash
Flow Provided by Operating Activities   During fiscal
2008, cash provided by operating activities amounted to $401,000, compared to
cash flow provided by operating activities during fiscal 2007 of
$1,356,000.  Significant changes in working capital items affecting
cash flow provided by operating activities were:





·
            Depreciation
      and amortization of $1,593,000


·
            An
      increase in net inventory of
$1,380,000


·
            A
      decrease in trade payables of
$784,000


·
            An
      increase in accounts receivable of
$588,000


·
            A
      decrease in prepaid expenses and other assets of
  $122,000


·
            A
      decrease in accrued liabilities of
$455,000





The
increase in inventory during 2008 reflects increases principally in balloon film
inventory and finished balloon inventory.  We do not anticipate
significant increases in inventory during 2009.


31


Cash
Used in Investing ActivitiesDuring fiscal 2008,
cash used in investing activities amounted to $2,200,000 compared to cash used
in investing activities during fiscal 2007 of $2,848,000.  Cash used
in investing activities was principally for the purchase of production
equipment.  During 2009, we anticipate reduced levels of investment in
equipment and facilities.





Cash
Provided by Financing Activities   During fiscal 2008,
cash provided by financing activities amounted to $1,681,000, compared to cash
provided by financing activities of $1,586,000 during fiscal
2007.  During 2008, we received $1,224,000 under our capital lease
line and $17,000 from the exercise of options and warrants, and we repaid
long-term debt of $942,000.  Also, we received, net, $1,215,000
proceeds under our revolving line of credit.





On
February 1, 2006, we entered into a Loan Agreement with RBS, Chicago, Illinois,
under which, as amended, the Bank has agreed to provide a credit facility to our
Company in the total amount of $15,300,000, 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 $9,000,000, secured by inventory and
receivables.  On January 30, 2009, we entered into an amendment of the
loan agreement extending the term of the revolving line of credit to January 31,
2010 and amending certain covenants.  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:


o
            Borrow
      money;


o
            Pay
      dividends and make distributions;


o
            Issue
      stock;


o
            Make
      certain investments;


o
            Use
      assets as security in other
transactions;


o
            Create
      liens;


o
            Enter
      into affiliate transactions;


o
            Merge
      or consolidate; or


o
            Transfer
      and sell assets.





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


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


o
            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,


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


32




As of
December 31, 2008, the Company was in compliance with these financial
covenants.





The loan
agreement as amended 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 initial interest rate under the loan is prime plus 1.5% per
annum.  On a quarterly basis, this ratio will be measured and the
interest rate changed in accordance to the table below.





When
      Senior Debt to EBITDA is:
                  
                  The
      Premium
                    to
      the Prime
                    Rate
      is:Greater
      or equal to 4.00 to 1.00
                  
                  
                  1.50%Greater
      than or equal to 3.50 to 1.00; Less than 4.00 to 1.00
                  
                  
                  1.25%Greater
      than or equal to 3.25 to 1.00; Less than 3.50 to 1.00
                  
                  
                  1.00%Greater
      than or equal to 2.75 to 1.00; Less than 3.25 to 1.00
                  
                  
                  0.75%Less
      than 2.75 to 1.00
                  
                  
                  0.50%





At
December 31, 2008 the Company was paying a premium of 0.50% over
Prime.





Also,
under the loan agreement, we were required to purchase a swap agreement with
respect to part of the mortgage and term loan portions of our loan. On April 5,
2006, we entered into a swap arrangement with RBS with respect to 60% of the
principle 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.  On January 28, 2008, we entered into
another swap agreement with respect to $3,000,000 in principal amount of our
revolving loan fixing the interest rate for this portion of the revolving loan
at 6.17%.  The value of these swap agreements vary as the result of
variations in interest rates.  We record changes in the valuation of
these swap agreements as other comprehensive income (or expense).  As
of December 31, 2008, the net effect of the changes in the value of these swap
agreements is a liability of $342,000.





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 RBS up to $2,000,000.





On
November 13, 2007, RBS granted to the Company a capital lease line of credit of
up to $1,500,000 to fund equipment acquisitions by the
Company.  During the years ended December 31, 2008 and 2007, the
Company received aggregate advances under this line of $1,224,000 and $272,000,
respectively.





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).


33


On
June 6, 2006, we entered into a Standby Equity Distribution Agreement with
Cornell Capital pursuant to which we were permitted, at our discretion;
periodically sell to Cornell Capital shares of common stock for a total purchase
price of up to $5 million.  The commitment of Cornell Capital was for
a term commencing on the effective date of our registration statement covering
the shares to be sold and expiring after 24 months from that
date.  The commitment expired on January 28, 2009.  For each
share of common stock purchased under the Standby Equity Distribution Agreement,
Cornell Capital agreed to 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.  Furthermore, Cornell Capital received five percent (5%) of
each advance in cash under the Standby Equity Distribution Agreement as an
underwriting discount.




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.




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.  On July 24, 2008, we
filed an amended Registration Statement, which was declared
effective.  As of December 31, 2008, we had sold an aggregate of
341,864 shares of common stock to Cornell under the SEDA and have received net
proceeds from the sale of those shares in the amount of $1,449,000.




Current Assets.  As
of December 31, 2008, the total current assets of the Company were $17,688,000,
compared to total current assets of $17,801,000 at December 31,
2007.  The change in current assets reflects, principally, (i) an
increase in inventories of $804,000, and (ii) a decrease in cash and equivalents
of $303,000, (iii) a decrease in the net deferred income tax asset of $340,000,
and (iv) a decrease in prepaid expenses and other current assets of
$146,000.  The increase in inventory during 2008 reflects increases of
$565,000 in film raw materials and $599,000 in finished balloon
products.  We do not anticipate significant increases in inventory
during 2009.





Property, Plant and
Equipment.  During fiscal 2008, the Company invested $2,200,000
in capital items, principally in production equipment and plant
improvements.


34


Current
Liabilities.  Accrued other liabilities includes $1,147,000 in
accruals and $341,000 in mark to market liabilities.  Total current
liabilities decreased from $16,483,000 as of December 31, 2007 to $16,222,000 as
of December 31, 2008.  Changes in current liabilities included: (i) a
decrease of $1,075,000 in trade payables, (ii) an increase of the line of credit
of $1,215,000, (iii) an increase in the balance of the current portion of long
term indebtedness of $228,000 and (iv) a decrease in the balance of notes
payable to officers of $794,000.





Liquidity and Capital
Resources; Working
Capital.  As of December 31, 2008, our current assets exceeded
our current liabilities by $1,466,000.  Management believes that our
internally generated funds and the borrowing capacity under our revolving line
of credit facility will be sufficient to meet working capital requirements for
the remainder of 2009.





Shareholders’
Equity.Shareholders’ equity was $7,735,000 as of December 31,
2008 compared to $6,591,000 as of December 31, 2007.





Seasonality





In the
foil 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 products 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.


35


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, 2008, the Company had established a reserve for obsolescence,
marketability or excess quantities with respect to inventory in the aggregate
amount of $429,000.  As of December 31, 2007, the amount of the
reserve was $383,000. 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.  We record freight income as
a component of net sales and record freight costs as a component of cost of
goods sold.





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
conducted a valuation analysis of our goodwill in our Mexico subsidiary for the
years ended December 31, 2008 and 2007.  As of December 31, 2008 and
December 31, 2007, we determined that the fair value of the Company’s interest
in Flexo Universal as recorded for December 31, 2006 was not
impaired.





Foreign Currency
Translation.  All balance sheet accounts are translated using
the exchange rates in effect at the balance sheet date.  Statements of
operations amounts are translated using the average exchange rates for the
year-to-date periods.  The gains and losses resulting from the changes
in exchange rates during the period have been reported in other comprehensive
income or loss.





Stock-Based
Compensation.  On January 1, 2006, we adopted Statement of
Financial Accounting Standards No. 123(R), “Share-Based Payments” (“SFAS No.
123(R)”).  Prior to the adoption of SFAS No. 123(R), we had adopted
the disclosure-only provisions of SFAS No. 123 and accounted for employee
stock-based compensation under the intrinsic value method and no expense related
to stock options was recognized.  We adopted the provisions of SFAS
123(R) using the modified prospective transition method.  Under this
method, our consolidated financial statements as of and for the years ended
December 31, 2007 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).


36


We used
the Black-Scholes option pricing model to determine the fair value of stock
options which requires us to estimate certain key assumptions.  As a
result of adopting SFAS 123(R), we incurred employee stock-based compensation
cost of $58,000 for the year ended December 31, 2008.  At December 31,
2008, we had $185,000 of unrecognized compensation cost relating to stock
options.





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.





As of
December 31, 2008, the Company had a net deferred tax asset of $1,017,000
(deferred tax assets of $1,919,000 less a valuation allowance of $902,000)
representing the amount the Company may recover in future years from future
taxable income. As of December 31, 2007, the amount of the net deferred tax
asset was $1,080,000.  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.  Management reduced the
valuation allowance related to the deferred tax asset by $325,000 in 2008 from
$1,227,000 as of December 31, 2007 to $902,000 as of December 31,
2008.





Fair
Value Measurements





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.  In February 2008, the FASB issued FASB Staff Position
(FSP) 157-1, “Application of FASB Statement No. 157 to FASB Statement No. 13 and
Other Accounting Pronouncements that Address Fair Value Measurements for
Purposes of Lease Classification or Measurement under Statement 13” (FSP 157-1)
and FSP 157-2, “Effective Date of FASB Statement No. 157” (FSP
157-2).  FSP 157-1 amends SFAS No. 157 to remove certain leasing
transactions from its scope.  FSP 157-2 delays the effective date of
SFAS No. 157 for all non-financial assets and non-financial liabilities, except
for items that are recognized or disclosed at fair value in the financial
statements on a recurring basis (at least annually), until the beginning of the
first quarter of fiscal 2009.  The measurement and disclosure
requirements related to financial and non-financial assets and liabilities are
applied prospectively upon adoption and did not have a material impact on the
Company’s consolidated financial statements.


37


In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities” (SFAS No. 159).  SFAS 159
permits companies to choose to measure certain financial instruments and other
items at fair value.  The standard requires that unrealized gains and
losses are reported in earnings for items measured using the fair value
option.  SFAS No. 159 is effective for us on January 1,
2008.  We did not elect the fair value option for any assets or
liabilities that were not previously carried at fair
value.  Accordingly, the adoption of SFAS 159 had no impact on our
consolidated financial statements.





In
October 2008, the FASB issued FSP 157-3, “Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active” (FSP
157-3).  FSP 157-3 clarifies the application of SFAS No. 157 in a
market that is not active, and addresses application issues such as the use of
internal assumptions when relevant observable data does not exist, the use of
observable market information when the market is not active, and the use of
market quotes when assessing the relevance of observable and unobservable
data.  FSP 157-3 is effective for all periods presented in accordance
with SFAS No. 157.  The adoption of FSP 157-3 did not have a
significant impact on our consolidated financial statements.





Accounting
Pronouncements Not Yet Implemented





In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments
and Hedging Activities” (SFAS No. 161).  SFAS No. 161 requires
companies to disclose information that should enable financial statement users
to understand how and why a company uses derivative instruments, how derivative
instruments and related hedged items are accounted for under SFAS No. 133
“Accounting for Derivative Instruments and Hedging Activities”, and how
derivative instruments and related hedged items affect a company’s financial
position, financial performance, and cash flows.  SFAS No. 161 is
effective for financial statements issued for fiscal years beginning after
November 15, 2008.  We are currently evaluating SFAS No. 161 and have
not determined the impact on our financial statements.





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





N/A





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


38


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, 2008, 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, 2008 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.





Management’s
Report on Internal Control over Financial Reporting





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.





Our
management conducted an evaluation of the effectiveness of our internal control
over financial reporting based on the framework in Internal Control – Integrated
Framework issued by the Committee Sponsoring Organizations of the Treadway
Commission.  This evaluation included review of the documentation of
controls, evaluation of the design effectiveness of controls, testing of the
operation effectiveness of controls and a conclusion on this
evaluation.  Although there are inherent limitations in the
effectiveness of any system of internal controls over financial reporting, based
on our evaluation, management has concluded our internal controls over financial
reporting were effective as of December 31, 2008.


39


On March
5, 2009, in the course of a review by our accounting and production personnel of
various production-related expenses, we discovered that, during the years from
1997 through 2008, the Company had received and paid certain invoices for repair
and maintenance services and related parts, which had, in fact, never been
provided to the Company.  We further discovered that an officer of the
Company principally owned the company that submitted the
invoices.  This officer was also responsible for the repair and
maintenance activities in the Company and had the authority to approve and did
approve such invoices for payment, of which he was the ultimate
recipient.





We are
conducting a full investigation and review of these circumstances and of our
internal controls relating to these events.  The officer involved has
resigned and has agreed to make full restitution of the amounts wrongfully
received by him.  The aggregate amount of such payments fraudulently
received by such officer from the Company over the eleven-year period was
approximately $1,400,000.  The expense recorded in 2008 and 2007 was
$143,000 and $155,000, respectively.  To date, we have received
restitution from this former officer in the amount of $124,000.  We
believe that, under our control system in effect as of December 31, 2008, these
events would have been prevented as the current vendor selection, approval and
set up process in the accounting system is much more rigorous and independent,
requiring multiple levels of vendor review and approval prior to acceptance and
set up in the master vendor file. In addition, a control process was in place
that required that an independent review of all invoices submitted for payment
is reviewed and procedures performed to ensure the services were performed and
goods were received prior to approval for payment.  Unfortunately, a
breakdown in this control from a performance standpoint had
occurred.  While the cumulative amount of the improper payments in
total may have been substantial, the related losses were reported in cost of
sales for the respective periods and discovery of these improper payments has
not resulted in changes to any previously reported results.  Therefore
we do not consider this event to be a material weakness in our internal control
over financial reporting.





Management
of the Company, in conjunction with the Audit Committee, are conducting an
investigation and review concerning these events to gauge the adequacy of the
Company’s internal controls and to identify and implement changes and
improvements in our internal controls to remediate deficiencies in our internal
controls.  We are considering and planning at least the following
changes:





·
            Initial
      and ongoing periodic review of all vendors by individuals who are not
      involved in the purchasing process with such
  vendors;


·
            Enhanced
      documentation and review requirements of invoices prior to authorization
      for payment;


·
            Periodic
      testing of invoices by individuals not involved in purchasing or in the
      approval process of the invoices for
payment;


·
            Initiation
      of an internal audit function with respect to purchasing and treasury
      functions.


40


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.





This
annual report does not include an attestation report of the company’s registered
public accounting firm regarding internal control over financial
reporting.  Management’s report was not subject to attestation by the
company’s registered public accounting firm pursuant to temporary rules of the
Securities and Exchange Commission that permit the company to provide only
management’s report in this annual report.





Changes
in Internal Control over Financial Reporting





In light
of the events described above, we are reviewing our procedures and controls and
plan to implement certain changes and additions to our internal controls during
the second quarter of 2009.





There has
been no change during the Company’s fiscal quarter ended December 31, 2008 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
9B – Other Information





None





PART
III





Item
No. 10 – Directors and Executive Officers of the Registrant





Information
called for by Item 10 of Part III is incorporated by reference to the definitive
Proxy Statement for the 2009 Annual Meeting of Shareholders which is expected to
be filed with the Commission within 120 days after December 31,
2008.





Item
No. 11 – Executive Compensation





Information
called for by Item 11 of Part III is incorporated by reference to the definitive
Proxy Statement for the 2009 Annual Meeting of Shareholders which is expected to
be filed with the Commission within 120 days after December 31,
2008.


41


Item
No. 12 – Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters





Information
called for by Item 12 of Part III is incorporated by reference to the definitive
Proxy Statement for the 2009 Annual Meeting of Shareholders which is expected to
be filed with the Commission within 120 days after December 31,
2008.





Item
No. 13 – Certain Relationships and Related Transactions





Information
called for by Item 13 of Part III is incorporated by reference to the definitive
Proxy Statement for the 2009 Annual Meeting of Shareholders which is expected to
be filed with the Commission within 120 days after December 31,
2008.





Item
No. 14 – Principal Accountant Fees and Services





Information
called for by Item 14 of Part III is incorporated by reference to the definitive
Proxy Statement for the 2009 Annual Meeting of Shareholders which is expected to
be filed with the Commission within 120 days after December 31,
2008.





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:





ExhibitNumber
                
                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)


42




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)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
              CTI
      Industries Corporation 2007 Stock Incentive Plan (Incorporated by
      reference to Exhibit contained in Registrant’s Schedule 14A Definitive
      Proxy Statement, as filed with the Commission on April 30,
      2007)10.5
              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.)10.6
              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)10.7
              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)10.8
              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)10.9
              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)10.10
              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)


43





10.11
              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)10.12
              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)10.13
              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)10.14
              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)10.15
              Loan
      and Security Agreement between RBS Citizens, N.A. 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)10.16
              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)10.17
              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)10.18
              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)10.19
              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)10.20
              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)10.21
              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)10.22
              Standby
      Equity Distribution Agreement between Cornell Capital Partners and the
      Company dated December 28,
2006


44





10.23
              Second
      Amendment to Loan Agreement between RBS Citizens, N.A. and the Company
      dated December 18, 2006 (Incorporated by reference to Exhibit contained in
      Registrant’s Report on Form 8-K dated December 21,
  2006.)10.24
              Third
      Amendment to Loan Agreement between RBS Citizens, N.A. and the Company
      dated November 13, 2007 (Incorporated by reference to Exhibit contained in
      Registrant’s Report on Form 10-Q dated November 13,
  2007)10.25
              CTI
      Industries Corporation Incentive Compensation Plan (Incorporated by
      reference to Exhibit contained in Registrant’s Report on Form 8-K dated
      October 2, 2007)10.26
              Supply
      and License Agreement among Registrant and S.C. Johnson & Son, Inc.
      dated February 1, 2008 (Incorporated by reference to Exhibit contained in
      Registrant’s Report on Form 8-K/A dated March 19, 2008)10.27
              Agreement
      between Babe Winkelman Productions Inc and the Company dated April 10,
      2008 (Incorporated by reference to Exhibit contained in Registrant’s
      Report on Form 8-K dated April 14, 2008)10.28
              Amendment
      to the License Agreement between Rapak, LLC and the Company dated May 6,
      2008 (Incorporated by reference to Exhibit contained in Registrant’s
      Report on Form 8-K dated May 8, 2008)10.29
              Fifth
      Amendment to Loan Agreement between RBS Citizens, N.A. and the Company
      dated January 30, 2009 (Incorporated by reference to Exhibit contained in
      Registrant’s Report on Form 8-K dated February 2, 2009)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, Blackman Kallick, 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)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.


45


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 March 31, 2009.





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





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
                                
                                President
      and Director
                                March
      31, 2009Howard
      W. Schwan/s/ John H. Schwan
                                
                                Chairman
      and Director
                                March
      31, 2009John
      H. Schwan/s/ Stephen M. Merrick
                                
                                Executive
      Vice President,Stephen
      M. Merrick
                                
                                Secretary,
      Chief FinancialOfficer and Director
                                March
      31, 2009/s/ Stanley M. BrownStanley
      M. Brown
                                
                                Director
                                March
      31, 2009/s/ Bret TayneBret
      Tayne
                                
                                Director
                                March
      31, 2009/s/ John I. CollinsJohn
      I. Collins
                                
                                Director
                                March
      31, 2009/s/ Phil Roos
                                
                                Director
                                March
      31, 2009Phil
      Roos


46




CTI
Industries Corporation
 and
Subsidiaries
 
 Consolidated
Financial Statements
  Years
ended December 31, 2008 and 2007
 
 Contents
 
 Consolidated
      Financial Statements:Report
      of Independent Registered Public Accounting Firm
                            F-1Consolidated
      Balance Sheets as of December 31, 2008 and 2007
                            F-2Consolidated
      Statements of Operations for the years endedDecember
      31, 2008 and 2007
                            F-3Consolidated
      Statements of Stockholders’ Equity and Comprehensive Loss
    forthe
      years ended December 31, 2008 and 2007
                            F-4Consolidated
      Statements of Cash Flows for the years endedDecember
      31, 2008 and 2007
                            F-5Notes
      to Consolidated Financial Statements – December 31, 2008
                            F-6Financial
      Statement Schedule:Schedule
      II – Valuation and Qualifying Accounts for the years endedDecember
      31, 2008 and 2007
                            F-31
 
 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, 2008 and
December 31, 2007, and the related consolidated statements of operations,
stockholders’ equity and comprehensive loss and cash flows for the years then
ended. 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 audit 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
consolidated financial statements are free of material misstatement. The Company
has determined that it is not required to have, nor were we engaged to perform,
an audit of its internal control over financial reporting. Our audit included
consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the Company’s
internal control over financial reporting. Accordingly, we express no such
opinion. An audit also includes examining, on a test basis, evidence supporting
the amounts and disclosures in the consolidated financial statements, assessing
the accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe that
our audit provides a reasonable basis for our opinion.
  In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of CTI Industries Corporation
and Subsidiaries as of December 31, 2008 and December 31, 2007, and the
results of their operations and their cash flows for the years then ended in
conformity with accounting principles generally accepted in the United States of
America.  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.
 
 /s/
Blackman Kallick, LLP
 Chicago,
Illinois
 March
31,
2009
  F1
 
 CTI
      Industries Corporation and SubsidiariesConsolidated
      Balance Sheets
 
 December 31, 2008
                    
                    
                    December 31, 2007ASSETSCurrent
      assets:Cash
      and cash equivalents
                    
                    $
                    180,578
                    
                    
                    $
                    483,112Accounts
      receivable, (less allowance for doubtful accounts of $39,000 and $312,000,
      respectively)
                    
                    
                    5,821,593
                    
                    
                    
                    5,950,551Inventories,
      net
                    
                    
                    10,504,769
                    
                    
                    
                    9,700,618Net
      deferred income tax asset
                    
                    
                    674,872
                    
                    
                    
                    1,014,451Prepaid
      expenses and other current assets
                    
                    
                    506,225
                    
                    
                    
                    651,969Total
      current assets
                    
                    
                    17,688,037
                    
                    
                    
                    17,800,701Property,
      plant and equipment:Machinery
      and equipment
                    
                    
                    21,612,995
                    
                    
                    
                    19,520,741Building
                    
                    
                    3,179,909
                    
                    
                    
                    3,035,250Office
      furniture and equipment
                    
                    
                    1,898,642
                    
                    
                    
                    1,900,219Intellectual
      Property
                    
                    
                    345,092
                    
                    
                    
                    305,017Land
                    
                    
                    250,000
                    
                    
                    
                    250,000Leasehold
      improvements
                    
                    
                    409,797
                    
                    
                    
                    465,838Fixtures
      and equipment at customer locations
                    
                    
                    2,539,033
                    
                    
                    
                    2,381,921Projects
      under construction
                    
                    
                    1,017,737
                    
                    
                    
                    1,836,87731,253,205
                    
                    
                    
                    29,695,863Less
      : accumulated depreciation and amortization
                    
                    
                    (20,677,223
                    )
                    
                    
                    (19,599,708
                    )Total
      property,plant and equipment, net
                    
                    
                    10,575,982
                    
                    
                    
                    10,096,155Other
      assets:Deferred
      financing costs, net
                    
                    
                    123,229
                    
                    
                    
                    113,209Goodwill
                    
                    
                    989,108
                    
                    
                    
                    989,108Net
      deferred income tax asset
                    
                    
                    341,714
                    
                    
                    
                    133,756Other
      assets (due from related party $63,000 and $66,000,
      respectively)
                    
                    
                    270,121
                    
                    
                    
                    191,206Total
      other assets
                    
                    
                    1,724,172
                    
                    
                    
                    1,427,279TOTAL
      ASSETS
                    
                    
                    29,988,191
                    
                    
                    
                    29,324,135LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      liabilities:Checks
      written in excess of bank balance
                    
                    
                    680,348
                    
                    
                    
                    616,583Trade
      payables
                    
                    
                    3,153,005
                    
                    
                    
                    4,227,954Line
      of credit
                    
                    
                    7,960,765
                    
                    
                    
                    6,746,213Notes
      payable - current portion
                    
                    
                    1,091,489
                    
                    
                    
                    863,513Notes
      payable - officers, current portion, (net of debt discount of $89,000
      and $90,000)
                    
                    
                    1,363,255
                    
                    
                    
                    2,157,065Accrued/Other
      liabilities
                    
                    
                    1,973,318
                    
                    
                    
                    1,871,781Total
      current liabilities
                    
                    
                    16,222,180
                    
                    
                    
                    16,483,109Long-term
      liabilities:Notes
      payable - affiliates
                    
                    
                    894,620
                    
                    
                    
                    1,070,151Notes
      payable, net of current portion
                    
                    
                    4,220,071
                    
                    
                    
                    4,351,743Notes
      payable - officers, subordinated, (net of debt discount of $96,000 and
      $185,000)
                    
                    
                    903,964
                    
                    
                    
                    815,296Total
      long-term liabilities
                    
                    
                    6,018,655
                    
                    
                    
                    6,237,190Minority
      interest
                    
                    
                    12,756
                    
                    
                    
                    12,534Stockholders'
      equity:Preferred
      Stock — no par value 2,000,000 shares authorized 0 shares issued and
      outstanding
                    
                    
                    -
                    
                    
                    
                    -Common
      stock  - no par value, 5,000,000 shares authorized, 2,808,720
      and 2,569,124 shares issued and 2,808,720 and 2,569,124 outstanding,
      respectively
                    
                    
                    3,764,020
                    
                    
                    
                    3,764,020Paid-in-capital
                    
                    
                    8,703,265
                    
                    
                    
                    6,754,077Warrants
      issued in connection with subordinated debt and bank debt
                    
                    
                    443,313
                    
                    
                    
                    1,038,487Accumulated
      deficit
                    
                    
                    (3,209,868
                    )
                    
                    
                    (4,363,999
                    )Accumulated
      other comprehensive loss
                    
                    
                    (1,966,130
                    )
                    
                    
                    (601,283
                    )Total
      stockholders' equity
                    
                    
                    7,734,600
                    
                    
                    
                    6,591,302TOTAL
      LIABILITIES AND STOCKHOLDERS' EQUITY
                    
                    $
                    29,988,191
                    
                    
                    $
                    29,324,135
 
 See
accompanying notes to consolidated financial statements
  F2
 
 CTI
      Industries Corporation and SubsidiariesConsolidated
      Statements of Operations
 
 For the Year Ended December
    31,2008
                        
                        
                        2007Net
      Sales
                        
                        $
                        44,980,674
                        
                        
                        $
                        36,509,710Cost
      of Sales
                        
                        
                        34,658,271
                        
                        
                        
                        27,825,493Gross
      profit
                        
                        
                        10,322,403
                        
                        
                        
                        8,684,217Operating
      expenses:General
      and administrative
                        
                        
                        5,375,526
                        
                        
                        
                        5,211,470Selling
                        
                        
                        886,391
                        
                        
                        
                        753,571Advertising
      and marketing
                        
                        
                        1,677,900
                        
                        
                        
                        1,474,289Total
      operating expenses
                        
                        
                        7,939,817
                        
                        
                        
                        7,439,330Income
      from operations
                        
                        
                        2,382,586
                        
                        
                        
                        1,244,887Other
      income (expense):Interest
      expense
                        
                        
                        (1,037,136
                        )
                        
                        
                        (1,294,726
                        )Interest
      income
                        
                        
                        5,679
                        
                        
                        
                        8,762Foreign
      currency gain
                        
                        
                        50,003
                        
                        
                        
                        173,510Total
      other expense
                        
                        
                        (981,454
                        )
                        
                        
                        (1,112,454
                        )Income
      before income taxes and minority interest
                        
                        
                        1,401,132
                        
                        
                        
                        132,433Income
      tax expense
                        
                        
                        246,779
                        
                        
                        
                        50,673Income
      before minority interest
                        
                        
                        1,154,353
                        
                        
                        
                        81,760Minority
      interest in loss (income) of subsidiary
                        
                        
                        222
                        
                        
                        
                        (138
                        )Net
      income
                        
                        $
                        1,154,131
                        
                        
                        $
                        81,898Other
      Comprehensive Loss, net of taxesUnrealized
      loss on derivative instruments
                        
                        $
                        (241,809
                        )
                        
                        $
                        (99,636
                        )Foreign
      currency adjustment
                        
                        $
                        (1,123,038
                        )
                        
                        $
                        (204,157
                        )Comprehensive
      loss
                        
                        $
                        (210,716
                        )
                        
                        $
                        (221,895
                        )Basic
      income per common share
                        
                        $
                        0.42
                        
                        
                        $
                        0.03Diluted
      income per common share
                        
                        $
                        0.40
                        
                        
                        $
                        0.03Weighted
      average number of shares and equivalent shares of common stock
      outstanding:Basic
                        
                        
                        2,763,017
                        
                        
                        
                        2,346,126Diluted
                        
                        
                        2,898,681
                        
                        
                        
                        2,589,960
 
 See
accompanying notes to consolidated financial statements
  F3
  CTI
Industries Corporation and Subsidiaries
 Consolidated
Statements of Stockholders' Equity and Comprehensive Loss
 
 Value
      of warrants
                                  
                                  
                                  
                                  
                                  
                                  Accumulatedissued
      in
                                  
                                  
                                  
                                  
                                  
                                  Other
                                  
                                  
                                  LessCommon
      Stock
                                  
                                  
                                  Paid-in
                                  
                                  
                                  connection
      with
                                  
                                  
                                  Accumulated
                                  
                                  
                                  Comprehensive
                                  
                                  
                                  Treasury
      StockShares
                                  
                                  
                                  Amount
                                  
                                  
                                  Capital
                                  
                                  
                                  subordinated
      debt
                                  
                                  
                                  Deficit
                                  
                                  
                                  Loss
                                  
                                  
                                  Shares
                                  
                                  
                                  Amount
                                  
                                  
                                  TOTALBalance,
      December 31, 2006
                                  
                                  
                                  2,412,297
                                  
                                  
                                  $
                                  3,764,020
                                  
                                  
                                  $
                                  6,100,587
                                  
                                  
                                  $
                                  1,038,487.0
                                  
                                  
                                  $
                                  (4,445,897
                                  )
                                  
                                  $
                                  (297,490
                                  )
                                  
                                  
                                  270,200
                                  
                                  
                                  $
                                  (1,057,782
                                  )
                                  
                                  $
                                  5,101,925Options
      Exercised
                                  
                                  
                                  93,576
                                  
                                  
                                  $
                                  -
                                  
                                  
                                  $
                                  228,467
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  195,466Shares
      issued under SEDA agreement (net of issuance costs)
                                  
                                  
                                  323,625
                                  
                                  
                                  $
                                  -
                                  
                                  
                                  $
                                  1,354,824
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  1,354,824Shares
      issued under consulting agreement
                                  
                                  
                                  17,000
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  79,050
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  79,050Cancellation
      of Treasury Shares
                                  
                                  
                                  (270,200
                                  )
                                  
                                  
                                  
                                  
                                  
                                  $
                                  (1,057,782
                                  )
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  (270,200
                                  )
                                  
                                  $
                                  1,057,782
                                  
                                  
                                  $
                                  -Compensation
      relating to Option Issuance
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  14,000
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  14,000Excess
      tax benefit - Options
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  67,932
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  67,932Shares
      Surrendered to Exercise Options
                                  
                                  
                                  (7,174
                                  )
                                  
                                  
                                  
                                  
                                  
                                  $
                                  (33,001
                                  )
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  -Net
      Income
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  81,898
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  81,898Other
      comprehensive income, net of taxesUnrealized
      loss on derivative instruments
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  (99,636
                                  )
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  (99,636
                                  )Foreign
      currency translation
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  (204,157
                                  )
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  (204,157
                                  )Total
      comprehensive income
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  (303,793
                                  )
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  (221,895
                                  )Balance,
      December 31, 2007
                                  
                                  
                                  2,569,124
                                  
                                  
                                  $
                                  3,764,020
                                  
                                  
                                  $
                                  6,754,077
                                  
                                  
                                  $
                                  1,038,487
                                  
                                  
                                  $
                                  (4,363,999
                                  )
                                  
                                  $
                                  (601,283
                                  )
                                  
                                  $
                                  -
                                  
                                  
                                  $
                                  -
                                  
                                  
                                  $
                                  6,591,302Warrants
      Exercised
                                  
                                  
                                  163,000
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  793,810
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  793,810Options
      Exercised
                                  
                                  
                                  8,357
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  16,775
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  16,775Issue
      of warrants
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  126,371
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  126,371related
      to loan guaranteeShares
      issued under SEDA agreement (net of issuance costs)
                                  
                                  
                                  18,239
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  94,500
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  94,500Reclass  exercised
      warrants issued with debt
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  595,174
                                  
                                  
                                  $
                                  (595,174
                                  )
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  -Stock
      issued for services
                                  
                                  
                                  50,000
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  235,188
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  235,188Compensation
      relating to Option Issuance
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  58,061
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  58,061Excess
      tax benefit - Options
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  29,309
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  29,309Net
      Income
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  1,154,131
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  1,154,131Other
      comprehensive income,  net of taxesUnrealized
      loss on derivative instruments
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  (241,809
                                  )
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  (241,809
                                  )Foreign
      currency translation
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  (1,123,038
                                  )
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  (1,123,038
                                  )Total
      comprehensive income
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  (1,364,847
                                  )
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  (210,716
                                  )Balance,
      December 31, 2008
                                  
                                  
                                  2,808,720
                                  
                                  
                                  
                                  3,764,020
                                  
                                  
                                  $
                                  8,703,265
                                  
                                  
                                  $
                                  443,313
                                  
                                  
                                  $
                                  (3,209,868
                                  )
                                  
                                  $
                                  (1,966,130
                                  )
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  $
                                  7,734,600
 
 See
accompanying notes to consolidated financial statements
  F4
 
 CTI
      Industries Corporation and SubsidiariesConsolidated
      Statements of Cash Flows
 
 For
      the Year Ended December 31,2008
                                              
                                              
                                              2007Cash
      flows from operating activities:Net
      income
                                              
                                              $
                                              1,154,131
                                              
                                              
                                              $
                                              81,898Adjustment
      to reconcile net income (loss) to cash provided by (used in) operating
      activities:Depreciation
      and amortization
                                              
                                              
                                              1,592,891
                                              
                                              
                                              
                                              1,466,419Amortization
      of debt discount
                                              
                                              
                                              88,668
                                              
                                              
                                              
                                              90,389Stock
      based compensation
                                              
                                              
                                              58,061
                                              
                                              
                                              
                                              14,000Excess
      tax benefits from stock-based compensation
                                              
                                              
                                              (12,801
                                              )
                                              
                                              
                                              (35,373
                                              )Minority
      interest in loss of subsidiary
                                              
                                              
                                              222
                                              
                                              
                                              
                                              138Provision
      for losses on accounts receivable
                                              
                                              
                                              138,657
                                              
                                              
                                              
                                              105,153Provision
      for losses on inventories
                                              
                                              
                                              178,288
                                              
                                              
                                              
                                              141,305Stock
      issued under consulting agreement
                                              
                                              
                                              69,437
                                              
                                              
                                              
                                              43,917Deferred
      income taxes
                                              
                                              
                                              218,080
                                              
                                              
                                              
                                              (21,323
                                              )Change
      in assets and liabilities:Accounts
      receivable
                                              
                                              
                                              (587,572
                                              )
                                              
                                              
                                              338,142Inventories
                                              
                                              
                                              (1,380,459
                                              )
                                              
                                              
                                              (1,872,903
                                              )Prepaid
      expenses and other assets
                                              
                                              
                                              122,169
                                              
                                              
                                              
                                              270,117Trade
      payables
                                              
                                              
                                              (783,752
                                              )
                                              
                                              
                                              823,185Accrued
      liabilities
                                              
                                              
                                              (455,409
                                              )
                                              
                                              
                                              (88,874
                                              )Net
      cash provided by operating activities
                                              
                                              
                                              400,611
                                              
                                              
                                              
                                              1,356,190Cash
      used in investing activity - purchases of property, plant and
      equipment
                                              
                                              
                                              (2,200,454
                                              )
                                              
                                              
                                              (2,848,003
                                              )Net
      cash used in investing activities
                                              
                                              
                                              (2,200,454
                                              )
                                              
                                              
                                              (2,848,003
                                              )Cash
      flows from financing activities:Change
      in checks written in excess of bank balance
                                              
                                              
                                              79,838
                                              
                                              
                                              
                                              507,932Net
      change in revolving line of credit
                                              
                                              
                                              1,214,552
                                              
                                              
                                              
                                              428,353Proceeds
      from issuance of long-term debt and warrants
                                              
                                              
                                              1,224,267
                                              
                                              
                                              
                                              325,913Repayment
      of long-term debt (related parties $176,000 and $224,000)
                                              
                                              
                                              (942,436
                                              )
                                              
                                              
                                              (1,241,757
                                              )Excess
      tax benefits from stock-based compensation
                                              
                                              
                                              12,801
                                              
                                              
                                              
                                              35,373Proceeds
      from exercise of stock options and warrants
                                              
                                              
                                              16,775
                                              
                                              
                                              
                                              195,467Proceeds
      from issuance of stock, net
                                              
                                              
                                              94,500
                                              
                                              
                                              
                                              1,354,821Cash
      paid for deferred financing fees
                                              
                                              
                                              (19,425
                                              )
                                              
                                              
                                              (20,213
                                              )Net
      cash provided by financing activities
                                              
                                              
                                              1,680,872
                                              
                                              
                                              
                                              1,585,889Effect
      of exchange rate changes on cash
                                              
                                              
                                              (183,564
                                              )
                                              
                                              
                                              4,472Net
      (decrease) increase in cash and cash equivalents
                                              
                                              
                                              (302,535
                                              )
                                              
                                              
                                              98,548Cash
      and cash equivalents at beginning of period
                                              
                                              
                                              483,113
                                              
                                              
                                              
                                              384,565Cash
      and cash equivalents at end of period
                                              
                                              $
                                              180,578
                                              
                                              
                                              $
                                              483,113Supplemental
      disclosure of cash flow information:Cash
      payments for interest
                                              
                                              $
                                              1,039,433
                                              
                                              
                                              $
                                              1,201,228Cash
      payments for taxes
                                              
                                              $
                                              90,206
                                              
                                              
                                              $
                                              81,900Supplemental
      Disclosure of non-cash investing and financing activityStock
      issued under consulting agreement
                                              
                                              $
                                              69,437
                                              
                                              
                                              $
                                              43,917Exercise
      of Warrants and payment of Subordinated Debt
                                              
                                              $
                                              793,810
                                              
                                              
                                              $
                                              -Issuance
      of warrants for guarantee of debt
                                              
                                              $
                                              126,371
                                              
                                              
                                              $
                                              -Property,
      Plant and Equipment acquisitions funded by liabilities
                                              
                                              $
                                              122,757
                                              
                                              
                                              $
                                              133,390
 
 See
accompanying notes to consolidated financial statements
 F5
  December
31, 2008
 
 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 metalized 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
valuation allowances for doubtful accounts, lower of cost or market of
inventory, deferred tax assets, and recovery value of goodwill.
  F6
 
 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.
  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 through
consideration of the customer’s financial condition, credit history and current
economic conditions and use of 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 customer’s 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 method 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 yearsProjects
      that prolong the life and increase efficiency of machinery
                  3 -
      5 yearsLight
      Machinery
                  5 -
      10 yearsHeavy
      Machinery
                  10
      - 15 yearsOffice
      furniture and equipment
                  5 -
      8 yearsLeasehold
      improvements
                  5 -
      8 yearsFurniture
      and equipment at customer locations
                  1 -
      3 years
  F7
  Light
machinery consists of forklifts, scissor lifts, and other warehouse
machinery.  Heavy machinery consists of production equipment including
laminating, printing and converting equipment.  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 of $79,000.  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 the Company’s acquisition
of Flexo Universal in a prior year. It is the Company’s policy to perform
impairment testing for Flexo Universal annually as of December 31, or as
circumstances change.  An annual impairment review was completed and
no impairment was noted for the years ended December 31, 2008 and
2007.  (See note 16)  While the Company believes that its
estimates of future cash flows are reasonable, different assumptions regarding
such cash flows could materially affect these evaluations.
  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.
  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 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 that
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.
  F8
  In July
2006, the FASB issued Interpretation (“FIN”) No. 48, Accounting for
Uncertainty in Income Taxes — An Interpretation of FASB Statement
No. 109 (“FIN 48”). FIN 48 provides detailed guidance for the
financial statement recognition, measurement and disclosure of uncertain tax
positions recognized in an enterprise’s financial statements in accordance with
SFAS 109.  Income tax positions must meet a more-likely-than-not
recognition threshold at the effective date to be recognized upon the adoption
of FIN 48 and in subsequent periods.  We adopted FIN 48
effective January 1, 2007, and the provisions of FIN 48 have been
applied to all income tax positions commencing from that date.  There
was no material impact from this adoption.
  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.
 
 Research
and Development
  The
Company conducts product development and research activities which includes (i)
creative product development and (ii) engineering. During the years ended
December 31, 2008 and 2007, research and development activities totaled $357,000
and $350,000, respectively.
  Advertising
Costs
  The
Company expenses advertising costs as incurred. Advertising expenses amounted to
$346,000 and $194,000 for the years ended December 31, 2008 and 2007,
respectively.
 
 
 3.New Accounting
Pronouncements
 
 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.  In February 2008, the FASB issued FASB Staff Position
(FSP) 157-1, “Application of FASB Statement No. 157 to FASB Statement No. 13 and
Other Accounting Pronouncements that Address Fair Value Measurements for
Purposes of Lease Classification or Measurement under Statement 13” (FSP 157-1)
and FSP 157-2, “Effective Date of FASB Statement No. 157” (FSP
157-2).  FSP 157-1 amends SFAS No. 157 to remove certain leasing
transactions from its scope.  FSP 157-2 delays the effective date of
SFAS No. 157 for all non-financial assets and non-financial liabilities, except
for items that are recognized or disclosed at fair value in the financial
statements on a recurring basis (at least annually), until the beginning of the
first quarter of fiscal 2009.  The measurement and disclosure
requirements related to financial and non-financial assets and liabilities are
applied prospectively upon adoption and did not have a material impact on the
Company’s consolidated financial statements.
  F9
  In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities” (SFAS No. 159).  SFAS 159
permits companies to choose to measure certain financial instruments and other
items at fair value.  The standard requires that unrealized gains and
losses are reported in earnings for items measured using the fair value
option.  SFAS No. 159 is effective for us on January 1,
2008.  We did not elect the fair value option for any assets or
liabilities that were not previously carried at fair
value.  Accordingly, the adoption of SFAS 159 had no impact on our
consolidated financial statements.
 
 In
October 2008, the FASB issued FSP 157-3, “Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active” (FSP
157-3).  FSP 157-3 clarifies the application of SFAS No. 157 in a
market that is not active, and addresses application issues such as the use of
internal assumptions when relevant observable data does not exist, the use of
observable market information when the market is not active, and the use of
market quotes when assessing the relevance of observable and unobservable
data.  FSP 157-3 is effective for all periods presented in accordance
with SFAS No. 157.  The adoption of FSP 157-3 did not have a
significant impact on our consolidated financial statements.
 
 In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments
and Hedging Activities” (SFAS No. 161).  SFAS No. 161 requires
companies to disclose information that should enable financial statement users
to understand how and why a company uses derivative instruments, how derivative
instruments and related hedged items are accounted for under SFAS No. 133
“Accounting for Derivative Instruments and Hedging Activities”, and how
derivative instruments and related hedged items affect a company’s financial
position, financial performance, and cash flows.  SFAS No. 161 is
effective for financial statements issued for fiscal years beginning after
November 15, 2008.  We are currently evaluating SFAS No. 161 and have
not determined the impact on our financial statements.
 
 4.  Fair
Value Disclosures; Derivative Instruments
 
 Financial
Accounting Standards Board (“FASB”) Statement No. 157, Fair Value Measurements
(“SFAS 157”) defines fair value, establishes a framework for measuring fair
value, establishes a fair value hierarchy based on the quality of inputs used to
measure fair value and enhances disclosure requirements for fair value
measurements.  The implementation of SFAS 157 did not cause a change
in the method of calculating fair value assets or liabilities. F10
  SFAS 157
establishes a three-level valuation hierarchy for disclosure of fair value
measurements.  The valuation hierarchy categorizes assets and
liabilities at fair value into one of three different levels depending on the
observability of the inputs employed in the measurement.  The three
levels are defined as follows:
 
 ·
                Level 1 –
      inputs to the valuation methodology are quoted prices (unadjusted) for
      identical assets are liabilities in active
  markets.
 
 ·
                Level 2 –
      inputs to the valuation methodology include quoted prices for similar
      assets and liabilities in active markets, and inputs are observable for
      the asset or liability, or
      unobservable but corroborated by market data, for substantially the
      full term of the financial
instrument.
 
 ·
                Level 3 –
      inputs to the valuation methodology are unobservable and significant to
      the fair value measurement.
 
 A
financial instrument’s categorization within the valuation hierarchy is based
upon the lowest level of the input that is significant to the fair value
measurement.  The Company’s assessment of the significance of a
particular input to the fair value measurement in its entirety requires judgment
and considers factors specific to the asset or liability.  The
following table presents information about the Company’s liabilities measured at
fair value on a recurring basis as of December 31, 2008 and indicates the fair
value hierarchy of the valuation techniques utilized by the Company to determine
such fair value:
  Description
                                                  
                                                  12/31/2008
                                                  
                                                  
                                                  Level
      1
                                                  
                                                  
                                                  Level
      2
                                                  
                                                  
                                                  Level
      3Interest
      Rate Swap 2006-1
                                                  
                                                  $
                                                  (49,929
                                                  )
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  $
                                                  (49,929
                                                  )Interest
      Rate Swap 2006-2
                                                  
                                                  
                                                  (142,351
                                                  )
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  (142,351
                                                  )Interest
      Rate Swap 2008
                                                  
                                                  
                                                  (149,165
                                                  )
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  (149,165
                                                  )$
                                                  (341,445
                                                  )
                                                  
                                                  
                                                  
                                                  
                                                  
                                                  $
                                                  (341,445
                                                  )
 
 The
Company’s interest rate swap agreements are valued using the counterparty’s
mark-to-market statement, which can be validated using modeling techniques that
include market inputs such as publically available interest rate yield curves,
and are designated as Level 2 within the valuation hierarchy.
 
 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.
  F11
  On April
5, 2006, the Company entered into two swap agreements with RBS Citizens N.A.
(“RBS”) in connection with portions (totaling $3,780,000) of the principal
amounts of a mortgage loan and term loan to the Company fixing the interest rate
on such floating rate loans at 8.49%.  On January 28, 2008, the
Company entered into a swap agreements with the Bank with respect to $3,000,000
in principal amount of a floating rate revolving loan fixing the interest rate
on such amount at 6.17%.  These swap agreements are designated as cash
flow hedges and hedge the Company’s exposure to interest rate fluctuations on
the portions of the principal amount of loans with the Bank that are covered by
the swap agreements.  These swap agreements are derivative financial
instruments and the Company determines the fair market value of these agreements
on a quarterly basis, based on the Bank’s mark-to-market statement, recording
the fair market value of these contracts on the balance sheet with the offset to
other comprehensive loss.  As of December 31, 2008, the Company has
recorded the fair value of these swap agreements on the balance sheet as a
liability of $341,000.  For the quarter and year ended December 31,
2008, the Company recorded an unrealized loss of $162,000 and $218,000, and for
the quarter and year ended December 31, 2007, the Company recorded an unrealized
loss of $44,000 and $68,000, respectively with respect to these swap agreements
in other comprehensive income, which represents the change in value of these
swap agreements for the quarter and year then ended.
 
 The
Company has not had any realized loss from financial instruments during 2007 and
2008.
  F12
  5.  Other
Comprehensive Loss
 
 The
following table sets forth the tax effects of components of other comprehensive
loss and the accumulated balance of other comprehensive loss and each
component.
 
 Tax
      Effects Allocated to Each Component of Other Comprehensive
      Lossfor
      the years ended December 31, 2008 and 2007TaxBefore-Tax
                                                      
                                                      
                                                      (Expense)
                                                      
                                                      
                                                      Net-of-TaxAmount
                                                      
                                                      
                                                      or
      Benefit
                                                      
                                                      
                                                      Amount2008Foreign
      currency translation adjustments
                                                      
                                                      $
                                                      (1,123,038
                                                      )
                                                      
                                                      $
                                                      -
                                                      
                                                      
                                                      $
                                                      (1,123,038
                                                      )Unrealized
      loss on derivative instruments
                                                      
                                                      
                                                      (241,809
                                                      )
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      (241,809
                                                      )Other
      Comprehensive loss
                                                      
                                                      $
                                                      (1,364,847
                                                      )
                                                      
                                                      $
                                                      -
                                                      
                                                      
                                                      $
                                                      (1,364,847
                                                      )TaxBefore-Tax
                                                      
                                                      
                                                      (Expense)
                                                      
                                                      
                                                      Net-of-TaxAmount
                                                      
                                                      
                                                      or
      Benefit
                                                      
                                                      
                                                      Amount2007Foreign
      currency translation adjustments
                                                      
                                                      $
                                                      (204,157
                                                      )
                                                      
                                                      $
                                                      -
                                                      
                                                      
                                                      $
                                                      (204,157
                                                      )Unrealized
      loss on derivative instruments
                                                      
                                                      
                                                      (99,636
                                                      )
                                                      
                                                      
                                                      -
                                                      
                                                      
                                                      
                                                      (99,636
                                                      )Other
      Comprehensive loss
                                                      
                                                      $
                                                      (303,793
                                                      )
                                                      
                                                      $
                                                      -
                                                      
                                                      
                                                      $
                                                      (303,793
                                                      )Accumulated
      Other Comprehensive Loss Balances as December 31, 2008AccumulatedForeign
                                                      
                                                      
                                                      Unrealized
                                                      
                                                      
                                                      OtherCurrency
                                                      
                                                      
                                                      Loss
      on
                                                      
                                                      
                                                      ComprehensiveItems
                                                      
                                                      
                                                      Derivatives
                                                      
                                                      
                                                      IncomeBeginning
      balance
                                                      
                                                      $
                                                      (501,647
                                                      )
                                                      
                                                      $
                                                      (99,636
                                                      )
                                                      
                                                      $
                                                      (601,283
                                                      )Current
      period change, net of tax
                                                      
                                                      
                                                      (1,123,038
                                                      )
                                                      
                                                      
                                                      (241,809
                                                      )
                                                      
                                                      
                                                      (1,364,847
                                                      )Ending
      balance
                                                      
                                                      $
                                                      (1,624,685
                                                      )
                                                      
                                                      $
                                                      (341,445
                                                      )
                                                      
                                                      $
                                                      (1,966,130
                                                      )Accumulated
      Other Comprehensive Loss Balances as December 31, 2007AccumulatedForeign
                                                      
                                                      
                                                      Unrealized
                                                      
                                                      
                                                      OtherCurrency
                                                      
                                                      
                                                      Loss
      on
                                                      
                                                      
                                                      ComprehensiveItems
                                                      
                                                      
                                                      Derivatives
                                                      
                                                      
                                                      IncomeBeginning
      balance
                                                      
                                                      $
                                                      (297,490
                                                      )
                                                      
                                                      $
                                                      -
                                                      
                                                      
                                                      $
                                                      (297,490
                                                      )Current
      period Change, net of tax
                                                      
                                                      
                                                      (204,157
                                                      )
                                                      
                                                      
                                                      (99,636
                                                      )
                                                      
                                                      
                                                      (303,793
                                                      )Ending
      balance
                                                      
                                                      $
                                                      (501,647
                                                      )
                                                      
                                                      $
                                                      (99,636
                                                      )
                                                      
                                                      $
                                                      (601,283
                                                      )
 
 For the
years ended December 31, 2008 and 2007 no tax benefit for foreign currency
translation adjustments has been recorded as such amounts would result in a
deferred tax asset. For the years ended December 31, 2008 and 2007 no income tax
benefit was recorded for the unrealized losses on the derivative instruments by
reason of the fact that the tax benefit was offset by the valuation allowance
with respect to the related deferred tax asset.
  F13
  6.Major
Customers
 
 For the
year ended December 31, 2008, the Company had three customers that accounted for
approximately 20.0%, 16.9% and 15.5%, respectively, of consolidated net sales.
In 2007, the first two customers accounted for approximately 20.3%, and 19.1%
respectively.  See note 15 for disclosure of related parties major
customer in 2008 and 2007.  At December 31, 2008, the outstanding
accounts receivable balances due from these three customers were $2,155,000,
$311,000 and $144,000, respectively. At December 31, 2007, the outstanding
accounts receivable balances due from these customers were $2,905,000, $519,000,
and $0 respectively.
 
 7.  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,
                      2008
                    
                    
                    December
      31,
                      2007Raw
      materials
                    
                    $
                    1,676,000
                    
                    
                    $
                    1,452,000Work
      in process
                    
                    
                    1,075,000
                    
                    
                    
                    1,423,000Finished
      goods
                    
                    
                    8,183,000
                    
                    
                    
                    7,208,000Allowance
      for excess quantities
                    
                    
                    (429,000
                    )
                    
                    
                    (382,000
                    )Total
      inventories
                    
                    $
                    10,505,000
                    
                    
                    $
                    9,701,000
  F14
  
 8.
                Notes
      Payable
 
 Long term
debt consists of:
 
 Dec.
      31, 2008
                                                    
                                                    
                                                    Dec.
      31, 2007Term
      Loan with RBS, payable in monthly installments of $58,333 plus interest at
      prime 3.25% and 7.25% at December 31, 2008 and 2007, respectively) plus
      .50% (3.75%) and 0.75% (8.00%) at December 31, 2008 and 2007, respectively
      (amortized over 60 months) balance due January 31, 2011
                                                    
                                                    $
                                                    1,517,000
                                                    
                                                    
                                                    $
                                                    2,257,000Mortgage
      Loan with RBS, payable in monthly installments of $9,333 plus interest at
      prime (3.25% and 7.25% at December 31, 2008 and 2007, respectively) plus
      .50% (3.75%) and 0.75% (8.00%) at December 31, 2008 and 2007, respectively
      (amortized over 25 years) balance of $2,300,000 due January 31,
      2011
                                                    
                                                    $
                                                    2,481,000
                                                    
                                                    
                                                    $
                                                    2,677,000Subordinated
      Notes (Officers) due 2009, interest at 9%  (See
      Notes  10,15)
                                                    
                                                    $
                                                    638,000
                                                    
                                                    
                                                    $
                                                    1,432,000Subordinated
      Notes (Officers) due 2008, interest at 8% (See Notes
10,15)
                                                    
                                                    $
                                                    814,000
                                                    
                                                    
                                                    $
                                                    814,000Subordinated
      Notes (Officers) due 2011, interest at prime (3.25% and 7.25% at December
      31, 2008 and 2007, respectively) + 2%, 5.25% and 9.25% as of December 31,
      2008 and 2007, respectively, net of debt discount of $185,000
      and  $273,000 at December 31, 2008 and 2007,
      respectively
                                                    
                                                    $
                                                    815,000
                                                    
                                                    
                                                    $
                                                    727,000(2008)
      Asset Financing Loans (Forklift financed with Yale Financial Services;
      Pouch Machines financed with RBS): Forklift payable in monthly
      installments of $426 (amortized over 5 years); Pouch Machine #6; payable
      in monthly installments of $5,626 (amortized over 5 years); Pouch Machine
      #7, 8; payable in monthly installments of $9,891 (amortized over 5 years);
      Pousch Machine #9, 10,11; payable in monthly installments of $14,111
      (amortize over 5 years); (2007) Asset Financing Loans: Forklift payable in
      monthly installments of $426 (amoritized over 5 years); Pouch Machine #6;
      payable in monthly installments of $5,626 (amortized over 5
      years);
                                                    
                                                    $
                                                    1,314,000
                                                    
                                                    
                                                    $
                                                    281,000Total
      long-term debt
                                                    
                                                    $
                                                    7,579,000
                                                    
                                                    
                                                    $
                                                    8,188,000Less
      current portion
                                                    
                                                    $
                                                    (2,455,000
                                                    )
                                                    
                                                    $
                                                    (3,021,000
                                                    )Total
      Long-term debt, net of current portion
                                                    
                                                    $
                                                    5,124,000
                                                    
                                                    
                                                    $
                                                    5,167,000
  F15
  On
February 1, 2006, the Company entered into a Loan Agreement with RBS Citizens
N.A. (“RBS”), Chicago, Illinois, previously referred to as Charter One Bank,
under which, as amended, RBS has agreed to provide a credit facility to the
Company in the total amount of $15,300,000, 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 $9,000,000, 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.  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:
 o
                Borrow
      money;
 o
                Pay
      dividends and make distributions;
 o
                Issue
      stock;
 o
                Make
      certain investments;
 o
                Use
      assets as security in other
transactions;
 o
                Create
      liens;
 o
                Enter
      into affiliate transactions;
 o
                Merge
      or consolidate; or
 o
                Transfer
      and sell assets.
 
 ·
                Financial
      Covenants:  The loan agreement includes a series of
      financial covenants we are required to meet
  including:
 o
                We
      are required to maintain a tangible net worth in excess of
      $3,500,000;
 o
                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,
 o
                We
      are required to maintain a specified level of EBITDA to fixed charges for
      the six months ending June 30, 2006, the nine months ending September 30,
      2006 and twelve months thereafter.
 
 As of
December 31, 2008, the Company was in
compliance with these covenants.  On January 31, 2009, the
Company entered into an amendment to the Loan Agreement extending the revolving
loan term to January 31, 2010.
 
 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.  (See Note 4)
 
 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 RBS up to $2,000,000.  (See Note 15)
 
 As of
December 31, 2008 the balance outstanding on the revolving line of credit with
RBS was $7,961,000 with an interest rate of 3.50%.
  F16
  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:
  2009
                              
                              $
                              2,455,0002010
                              
                              
                              1,023,0002011
                              
                              
                              3,688,0002012
                              
                              
                              318,0002013
                              
                              
                              95,000Thereafter
                              
                              
                              -$
                              7,579,000
 
 9.
                Current
      Liabilities
 
 As of
December 31, 2008, Accrued/Other Liabilities includes $1,147,000 in accruals and
$341,000 in mark to market liabilities.  As of December 31, 2007, this
account includes $1,872,000 in accrued liabilities.
 
 10.
                Subordinated
      Debt
  In
February 2003, the Company received $1,630,000 from certain shareholders in
exchange for (a) 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
$460,000 calculated using Black-Scholes option pricing formula. The Company
applied the discount against the subordinated debt. The discount is being
amortized using the effective interest method to interest expense over the term
of the debt. These loans are subordinated to the Bank debt of the
Company.  On February 8, 2008 those shareholders exercised these
warrants in exchange for a reduction on these notes of $794,000.  The
remaining balance of $836,000 is due on demand.
  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 $443,000 using the Black-Scholes option pricing formula. The Company applied
the discount against the subordinated debt. The discount is amortized using the
effective interest method to interest expense 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.  The remaining balance of
$836,000 is due on demand.
  F17
 
 11.
                Income
      Taxes
 
 The
income tax provisions are comprised of the following:
 Dec.
      31 2008
                                            
                                            
                                            Dec.
      31 2007Current:Federal
                                            
                                            $
                                            -
                                            
                                            
                                            $
                                            -State
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -Foreign
                                            
                                            
                                            205,089
                                            
                                            
                                            
                                            162,218$
                                            205,089
                                            
                                            
                                            $
                                            162,218DeferredFederal
                                            
                                            $
                                            41,690
                                            
                                            
                                            $
                                            (94,934
                                            )State
                                            
                                            
                                            -
                                            
                                            
                                            
                                            (16,611
                                            )Foreign
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -41,690
                                            
                                            
                                            
                                            (111,545
                                            )Total
      Income Tax Provision
                                            
                                            $
                                            246,779
                                            
                                            
                                            $
                                            50,673
 
 The
components of the net deferred tax asset at December 31 are as
follows:
 2008
                              
                              
                              2007Deferred
      tax assets:Allowance
      for doubtful accounts
                              
                              $
                              8,389
                              
                              
                              $
                              113,265Inventory
      allowances
                              
                              
                              126,109
                              
                              
                              
                              110,156Accrued
      liabilities
                              
                              
                              60,868
                              
                              
                              
                              71,576Unicap
      263A adjustment
                              
                              
                              121,144
                              
                              
                              
                              114,774Net
      operating loss carryforwards
                              
                              
                              2,451,446
                              
                              
                              
                              2,972,715Alternative
      minimum tax credit carryforwards
                              
                              
                              342,673
                              
                              
                              
                              342,673State
      investment tax credit carryforward
                              
                              
                              30,512
                              
                              
                              
                              30,512Foreign
      tax credit carryforward
                              
                              
                              298,635
                              
                              
                              
                              -Other
      foreign tax items
                              
                              
                              43,582
                              
                              
                              
                              55,556Foreign
      asset tax credit carryforward
                              
                              
                              -
                              
                              
                              
                              38,872Total
      deferred tax assets
                              
                              
                              3,483,358
                              
                              
                              
                              3,850,099Deferred
      tax liabilities:Book
      over tax basis of capital assets
                              
                              
                              (1,276,174
                              )
                              
                              
                              (1,193,457
                              )Other
      foreign tax items
                              
                              
                              (288,146
                              )
                              
                              
                              (281,434
                              )1,919,038
                              
                              
                              
                              2,375,208Less:
      Valuation allowance
                              
                              
                              (902,452
                              )
                              
                              
                              (1,227,001
                              )Net
      deferred tax assets
                              
                              $
                              1,016,586
                              
                              
                              $
                              1,148,207
 
 The
Company maintains a valuation allowance with respect to deferred tax assets as a
result of the uncertainty of ultimate realization. At December 31, 2008, the
Company has net operating loss carryforwards of approximately $6,040,000
expiring in various years through 2025. In addition, the Company has
approximately $343,000 of alternative minimum tax credits as of December 31,
2008, which have no expiration date.
  F18
  Income
tax provisions differed from the taxes calculated at the statutory federal tax
rate as follows:
  Years
      Ended December 31,2008
                                
                                
                                2007Taxes
      at statutory rate
                                
                                $
                                490,397
                                
                                
                                $
                                46,352State
      income taxes
                                
                                
                                67,507
                                
                                
                                
                                6,381Nondeductible
      expenses
                                
                                
                                24,277
                                
                                
                                
                                18,317Decrease
      in deferred tax valuation allowance
                                
                                
                                (324,549
                                )
                                
                                
                                -Foreign
      taxes and other
                                
                                
                                (10,853
                                )
                                
                                
                                (20,377
                                )Income
      tax provision
                                
                                $
                                246,779
                                
                                
                                $
                                50,673
 
 The
Company files tax returns in the U.S. federal and U.K and Mexico foreign tax
jurisdictions and various state jurisdictions. The tax years 2004 through 2006
remain open to examination. Our policy is to recognize interest and penalties
related to uncertain tax positions in income tax expense. During the twelve
months ended December 31, 2008, the Company did not recognize expense for
interest or penalties, and do not have any amounts accrued at December 31, 2008,
as the Company does not believe it has taken any uncertain tax
positions.
 
 12.
                Other
      Income/Expense
  Other
income/expense set forth on the Company’s Consolidated Statement of Income for
the fiscal year ended December 31, 2008 included gains of $50,000 from currency
variability. In 2007, the Company had a gain of $174,000 related to currency
variability items.
 
 13.
                Notes
      Payable - Affiliates
  Items
identified as Notes Payable Affiliates in the Company’s Consolidated Balance
Sheet as of December 31, 2008 include loans by officers/shareholders to Flexo
Universal totaling $894,000.  The note has a 15-year term maturing in
2021.  Items identified as Notes Payable Affiliates in the Company’s
Consolidated Balance Sheet as of December 31, 2007 include (i) loans by
officers/shareholders to Flexo Universal totaling $1,056,000, and (ii) $14,000
owed to others.  (See Note 15)
 
 14.
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 $118,000 and $105,000 for the
years ended December 31, 2008 and 2007, respectively.
  F19
  15.
                Related
      Party Transactions
  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 $174,000 and
$106,000 for the years ended December 31, 2008 and 2007,
respectively.
  John H.
Schwan, Chairman of the Company, is a principal of Shamrock Packaging and
affiliated companies. The Company made purchases of packaging materials from
Shamrock of approximately $824,000 and $622,000 during the years ended December
31, 2008 and 2007, respectively.
 
 John H.
Schwan, Chairman of the Company, is one of the owners of White Horse Production,
Inc.  The Company made purchases from White Horse of approximately
$46,000 and $16,500 during the years ended December 31, 2008 and 2007,
respectively.
 
 John H.
Schwan, Chairman of the Company, is the brother of Gary Schwan, one of the
owners of Schwan Incorporated which provides building maintenance and remodeling
services to the Company.  The Company made purchases from Schwan
Incorporated of approximately $142,000 and $111,000 during the years ended
December 31, 2008 and 2007, respectively.
 
 During
the period from January 2003 to the present, John H. Schwan, Chairman of the
Company, and Stephen M. Merrick, Executive Vice President and Chief Financial
Officer have made loans to the Company and to Flexo which have outstanding
balances, for the
Company of $2,267,000 and $2,973,000 (net of discount of $185,000) and for Flexo
of $858,000 and $858,000 as of December 31, 2008 and 2007,
respectively.
  During
2008 and 2007 interest paid to these individuals on these outstanding loans was
$414,000 and $299,000, respectively.  (See Notes 10 and
13)
 
 16.
                Goodwill
  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, 2008 and 2007 we determined that the fair value of the Company’s
interest in goodwill related to Flexo Universal as recorded was not
impaired.  The carrying amount of goodwill as of December 31, 2008 and
2007 was $989,000.
  F20
 
 17.
                Commitments
  Operating
Leases
 
 In
September of 2005, the Company signed a lease to rent 16,306 square feet of
space in Cary, Illinois from Trinity Assets.  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.  In February 2008, Flexo Universal entered into a new 3-year
lease to rent 43,000 square feet of warehouse and office space in Guadalajara,
Mexico at the cost of $19,200 per month.  The Company leases office
and warehouse equipment under operating leases, which expire on various dates
through December 2011.  All of the Company’s lease payments are
recognized on a straight-line basis as none
of the leases have escalation clauses.
 
 The net
lease expense was $445,000 and $430,000 for the years ended December 31, 2008
and 2007, respectively.
  The
future aggregate minimum net lease payments under existing agreements as of
December 31, are as follows:
 
 TotalLeaseTrinity
      Assets
                                
                                
                                Other
                                
                                
                                Payments2009
                                
                                $
                                79,000
                                
                                
                                $
                                614,000
                                
                                
                                $
                                693,0002010
                                
                                
                                -
                                
                                
                                
                                633,000
                                
                                
                                
                                633,0002011
                                
                                
                                -
                                
                                
                                
                                412,000
                                
                                
                                
                                412,0002012
                                
                                
                                -
                                
                                
                                
                                370,000
                                
                                
                                
                                370,0002013
                                
                                
                                -
                                
                                
                                
                                146,000
                                
                                
                                
                                146,0002014
      and thereafter
                                
                                
                                -
                                
                                
                                
                                310,000
                                
                                
                                
                                310,000Total
                                
                                $
                                79,000
                                
                                
                                $
                                2,485,000
                                
                                
                                $
                                2,564,000
 
 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:
  F21
 
 2009
                      
                      $
                      103,0002010
                      
                      $
                      97,0002011
                      
                      $
                      103,000
 
 18.
                Stockholders’
      Equity
 
 Stock
Options
 
 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, stock based compensation expense for 2008 and 2007
includes the requisite service period portion of the grant date fair value of:
(a) all awards of equity instruments granted prior to, but not yet vested as of,
January 1, 2006; and (b) all awards of equity instruments granted subsequent to
January 1, 2006.
 
 The
Compensation Committee administers the Plans. 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.
 
 The
valuation assumptions were determined as follows:
 
 Historical
stock price volatility:  The Company used the monthly 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.
  F22
  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.
 
 As of
December 31, 2008, the Company had five stock-based compensation plans pursuant
to which stock options were 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.  When a new stock option plan is adopted no
further options will be issued under any previous stock option
plan.
 
 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, 2008, 98,415 shares of Common Stock have been granted and
were fully vested at the time of grant, no shares remain
outstanding.  No options were exercised during 2008.  The
1997 Stock Option Plan expired in September 2008.
 
 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, 2008, 148,217 shares have been granted under the 1999 Stock
Option Plan and were fully vested at the time of grant, 25,786 remain
outstanding.  During 2008, 3,976 options were exercised and proceeds
of $7,515 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 119,050 shares of the Company’s Common
Stock. As of December 31, 2008, 137,955 shares have been granted and were fully
vested at the time of grant, 37,311 remain outstanding.  During 2008,
4,381 options were exercised and $9,260 in proceeds 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 (“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, 2008, 123,430 shares have been granted and were fully vested at the
time of grant, 48,500 remain outstanding.  No options were exercised
during 2008.
 
 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. Of these shares, 59,500 shares were issued under the
2001 Stock Option Plan and the remaining 19,500 shares were issued under the
2002 Stock Option Plan. These options have a term of 10 years.  During
2008, 2,000 options were exercised and $6,000 in proceeds were
received.
  F23
  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 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.  The
fair value of these options was $202,000, which were fully vested at the time of
grant.
 
 On June
22, 2007, the Board of Directors approved for adoption, effective October 1,
2007, the 2007 Incentive Stock Plan (“Plan”). The Plan authorizes the grant of
options to purchase up to an aggregate of 150,000 shares of the Company’s Common
Stock.On
October 1, 2007, the company issued 74,000 shares under the 2007
Plan.  During 2008, the company issued an additional 77,500 shares
under the 2007 Plan.  The fair value of these options was estimated at
the date of grant using a Black-Scholes option pricing model with the following
weighted average assumptions:  risk-free interest rate of 3.89%;
dividend yield of 0%; volatility factor of the expected price of the Company’s
stock was 60.67%; and a weighted average expected life of 2.8
years.  The weighted average fair value of the options granted during
2008 was $1.21 per share.  The Company has recorded $58,000 and
$14,000 in share based compensation expense relating to this option program for
the years ended December 31, 2008 and 2007, respectively.  The Company
has $185,000 of unrecognized compensation cost as of December 31, 2008, which
relates to non vested shares.  This expense will be recognized over
the next 12 quarters.  Under this plan, 149,000 shares remain
outstanding, 35,750 shares are vested and 113,250 are not vested.
  2008
                        
                        
                        2007Options
      granted
                        
                        
                        77,500
                        
                        
                        
                        74,000Options
      vested
                        
                        
                        -
                        
                        
                        
                        35,750
 
 The
following is a summary of options exercised during the years ended December
31:
 
 2008
                                    
                                    
                                    2007Intrinsic
                                    
                                    
                                    
                                    
                                    
                                    IntrinsicShares
                                    
                                    
                                    Value
                                    
                                    
                                    Shares
                                    
                                    
                                    Value1997
      Plan
                                    
                                    
                                    -
                                    
                                    
                                    $
                                    -
                                    
                                    
                                    
                                    4,762
                                    
                                    
                                    $
                                    17,0001999
      Plan
                                    
                                    
                                    3,976
                                    
                                    
                                    $
                                    13,000
                                    
                                    
                                    
                                    23,812
                                    
                                    
                                    $
                                    166,0002001
      Plan
                                    
                                    
                                    4,381
                                    
                                    
                                    $
                                    18,000
                                    
                                    
                                    
                                    5,953
                                    
                                    
                                    $
                                    34,0002002
      Plan
                                    
                                    
                                    -
                                    
                                    
                                    $
                                    -
                                    
                                    
                                    
                                    59,049
                                    
                                    
                                    $
                                    119,000
  F24
  Vesting of 2007 & 2008 Options%
                      
                      Years After Grant
                        Date25
                      
                      
                      0.550
                      
                      
                      175
                      
                      
                      2100
                      
                      
                      3
 
 The
following is a summary of the activity in the Company’s stock option plans and
other options for the years ended December 31, 2008 and 2007,
respectively.
  Weighted
                              
                              
                              
                              
                              
                              WeightedAvg.
                              
                              
                              
                              
                              
                              Avg.Dec. 31,
                              
                              
                              Exercise
                              
                              
                              Dec. 31,
                              
                              
                              Exercise2008
                              
                              
                              Price
                              
                              
                              2007
                              
                              
                              PriceExercisable,
      beginning of period
                              
                              
                              194,365
                              
                              
                              $
                              3.42
                              
                              
                              
                              337,941
                              
                              
                              $
                              3.42Granted
                              
                              
                              -
                              
                              
                              
                              4.75
                              
                              
                              
                              -
                              
                              
                              
                              3.30Vested
                              
                              
                              35,750
                              
                              
                              
                              4.76Exercised
                              
                              
                              (8,357
                              )
                              
                              
                              2.44
                              
                              
                              
                              (93,576
                              )
                              
                              
                              1.88Cancelled
                              
                              
                              (62,511
                              )
                              
                              
                              5.75
                              
                              
                              
                              (50,000
                              )
                              
                              
                              6.30Exercisable
      at the end of period
                              
                              
                              159,247
                              
                              
                              $
                              2.87
                              
                              
                              
                              194,365
                              
                              
                              $
                              3.42
 Weighted
                          
                          
                          
                          
                          
                          WeightedAvg.
                          
                          
                          
                          
                          
                          Avg.Dec. 31,
                          
                          
                          Exercise
                          
                          
                          Dec. 31,
                          
                          
                          Exercise2008
                          
                          
                          Price
                          
                          
                          2007
                          
                          
                          PriceOutstanding, beginning of period
                          
                          
                          268,365
                          
                          
                          $
                          3.71
                          
                          
                          
                          337,941
                          
                          
                          $
                          3.42Granted
                          
                          
                          77,500
                          
                          
                          
                          4.75
                          
                          
                          
                          74,000
                          
                          
                          
                          4.75Exercised
                          
                          
                          (8,357
                          )
                          
                          
                          2.44
                          
                          
                          
                          (93,576
                          )
                          
                          
                          2.44Cancelled
                          
                          
                          (65,011
                          )
                          
                          
                          5.75
                          
                          
                          
                          (50,000
                          )
                          
                          
                          5.75Outstanding
      at the end of period
                          
                          
                          272,497
                          
                          
                          $
                          2.95
                          
                          
                          
                          268,365
                          
                          
                          $
                          3.71
  At
December 31, 2008, available options to grant were 1,000, under the 2007 Stock
Option Plan.
  Significant
option groups outstanding at December 31, 2008 and related weighted average
price and remaining life information are as follows:
 
 AverageExercise
                                                  
                                                  
                                                  RemainingGrantDate
                                                  
                                                  Outstanding
                                                  
                                                  
                                                  Exercisable
                                                  
                                                  
                                                  Price
                                                  
                                                  
                                                  Life(Years)March
      2000
                                                  
                                                  
                                                  25,781
                                                  
                                                  
                                                  
                                                  25,786
                                                  
                                                  
                                                  $
                                                  1.89
                                                  
                                                  
                                                  
                                                  1.3December
      2001
                                                  
                                                  
                                                  23,811
                                                  
                                                  
                                                  
                                                  23,811
                                                  
                                                  
                                                  $
                                                  1.47
                                                  
                                                  
                                                  
                                                  3.0April
      2002
                                                  
                                                  
                                                  11,905
                                                  
                                                  
                                                  
                                                  11,905
                                                  
                                                  
                                                  $
                                                  2.10
                                                  
                                                  
                                                  
                                                  3.4December
      2005
                                                  
                                                  
                                                  62,000
                                                  
                                                  
                                                  
                                                  62,000
                                                  
                                                  
                                                  $
                                                  2.88
                                                  
                                                  
                                                  
                                                  7.0October
      2007
                                                  
                                                  
                                                  71,500
                                                  
                                                  
                                                  
                                                  35,750
                                                  
                                                  
                                                  $
                                                  4.75
                                                  
                                                  
                                                  
                                                  2.9August
      2008
                                                  
                                                  
                                                  6,000
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  $
                                                  6.14
                                                  
                                                  
                                                  
                                                  3.8October
      2008
                                                  
                                                  
                                                  2,500
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  $
                                                  4.97
                                                  
                                                  
                                                  
                                                  3.9November
      2008
                                                  
                                                  
                                                  69,000
                                                  
                                                  
                                                  
                                                  0
                                                  
                                                  
                                                  $
                                                  1.84
                                                  
                                                  
                                                  
                                                  3.9272,497
                                                  
                                                  
                                                  
                                                  159,252
 
 F25
  The
aggregate intrinsic value of options were $20,000 as of December 31, 2008 for
all options in the money, outstanding and exercisable.
 
 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
the company management paid $59,524 to exercise warrants for 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, to pay for
the shares issued under the warrant.
 
 In
February 2003, certain members of company management were issued warrants 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.  On February 8, 2008 those shareholders exercised these
options in exchange for a reduction on these notes of $794,000.
 
 In
February 2006, certain members of company management were issued warrants, which
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, was $443,000 which was estimated at the date of grant using
the 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 warrants granted during 2006 was $2.56 per share.
 
 On
October 1, 2008, the Company issued warrants to purchase 20,000 shares of common
stock of the Company to both John Schwan and Stephen M. Merrick exercisable at
the price of $4.80 per share (the market price of the stock on the date of the
warrants) in consideration for the personal guarantees by each of up to $2
million in principal amount of the bank debt of the Company.
 
 The
following is a summary of the activity in the Company’s warrants for the years
ended December 2008 and 2007:
  F26
  Weighted
                        
                        
                        
                        
                        
                        WeightedAvg.
                        
                        
                        
                        
                        
                        Avg.Dec. 31,
                        
                        
                        Exercise
                        
                        
                        Dec. 31,
                        
                        
                        Exercise2008
                        
                        
                        Price
                        
                        
                        2007
                        
                        
                        PriceOutstanding and Exercisable, beginning of period
                        
                        
                        466,030
                        
                        
                        $
                        3.85
                        
                        
                        
                        466,030
                        
                        
                        $
                        3.85Granted
                        
                        
                        40,000
                        
                        
                        
                        4.80
                        
                        
                        
                        -
                        
                        
                        
                        -Exercised
                        
                        
                        (163,000
                        )
                        
                        
                        4.87
                        
                        
                        
                        -
                        
                        
                        
                        -Cancelled
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -Outstanding
      and Exercisable at the end of period
                        
                        
                        343,030
                        
                        
                        $
                        3.47
                        
                        
                        
                        466,030
                        
                        
                        $
                        3.85
 
 The
warrants, outstanding and exercisable as of December 31, 2008 had zero intrinsic
value since they were out of the money.
 Intrinsic Value of Warrants Exercised2008
                                                                                      
                                                                                      
                                                                                      2007Intrinsic
                                                                                      
                                                                                      
                                                                                      
                                                                                      
                                                                                      
                                                                                      IntrinsicShares
                                                                                      
                                                                                      
                                                                                      Value
                                                                                      
                                                                                      
                                                                                      Shares
                                                                                      
                                                                                      
                                                                                      Value2003
      Warrants
                                                                                      
                                                                                      
                                                                                      163,000
                                                                                      
                                                                                      
                                                                                      $
                                                                                      -
                                                                                      
                                                                                      
                                                                                      
                                                                                      -
                                                                                      
                                                                                      
                                                                                      $
                                                                                      -
 
 SEDA
 
 On
June 6, 2006, we entered into a Standby Equity Distribution Agreement with
Cornell Capital pursuant to which we were permitted, at our discretion;
periodically sell to Cornell Capital shares of common stock for a total purchase
price of up to $5 million.  The commitment of Cornell Capital was for
a term commencing on the effective date of our registration statement covering
the shares to be sold and expiring after 24 months from that
date.  The commitment expired on January 28, 2009.  For each
share of common stock purchased under the Standby Equity Distribution Agreement,
Cornell Capital agreed to 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.  Furthermore, Cornell Capital received five percent (5%) of
each advance in cash under the Standby Equity Distribution Agreement as an
underwriting discount.
 
 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.  On July 24, 2008, we
filed an amended Registration Statement, which was declared
effective.  As of December 31, 2008, we had sold an aggregate of
341,864 shares of common stock to Cornell under the SEDA and have received net
proceeds from the sale of those shares in the amount of $1,449,000.
 
 19.
                Earnings
      Per Share
 
 Basic
earnings per share is computed by dividing net income by the weighted average
number of shares of common stock outstanding during each period.
 
 F27
  Diluted
earnings per share is computed by dividing the net income by the weighted
average number of shares of common stock and equivalents (stock options and
warrants), unless anti-dilutive, during each period.
 
 The
number of anti-dilutive shares (not included in the determination of earnings on
a diluted basis) for the three months ended December 31, 2008, were 423,030 of
which 343,030 were represented by warrants and 80,000 were represented by
options.  For the twelve months ended December 31, 2008, 120,000
shares were anti-dilutive 40,000 were represented by warrants, 80,000 were
represented by options.  The number of anti-dilutive shares (not
included in the determination of earnings on a diluted basis) for the three
months ended December 31, 2007 were 286,606 of which 163,000 were represented by
warrants and 123,606 were represented by options, and for the twelve months
ended December 31, 2007 were 212,606 of which 163,000 were represented by
warrants and 49,606 were represented by options.
 
 Consolidated
Earnings per Share
  YearEndedDecember31,2008
                                      
                                      
                                      2007BasicAverage
      shares outstanding:Weighted
      average number of shares outstanding during the period
                                      
                                      
                                      2,763,017
                                      
                                      
                                      
                                      2,346,126Earnings:Net
      income:
                                      
                                      $
                                      1,154,133
                                      
                                      
                                      $
                                      81,898Amount
      for per share Computation
                                      
                                      $
                                      1,154,133
                                      
                                      
                                      $
                                      81,898Net
      earnings applicable to Common Shares
                                      
                                      $
                                      0.42
                                      
                                      
                                      $
                                      0.03DilutedAverage
      shares outstanding:
                                      
                                      
                                      2,763,017
                                      
                                      
                                      
                                      2,346,126Weighted
      averages shares Outstanding Common stock equivalents (options,
      warrants)
                                      
                                      
                                      135,664
                                      
                                      
                                      
                                      243,834Weighted
      average number of shares outstanding during the period
                                      
                                      
                                      2,898,681
                                      
                                      
                                      
                                      2,589,960Earnings:Net
      income
                                      
                                      $
                                      1,154,133
                                      
                                      
                                      $
                                      81,898Amount
      for per share computation
                                      
                                      $
                                      1,154,133
                                      
                                      
                                      $
                                      81,898Net
      income applicable to Common Shares
                                      
                                      $
                                      0.40
                                      
                                      
                                      $
                                      0.03
  F28
 
 20.
                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, 2008
and 2007, respectively:
 
 United States
                            
                            
                            United Kingdom
                            
                            
                            Mexico
                            
                            
                            ConsolidatedYear ended 12/31/08Sales
      to outside customers
                            
                            $
                            34,701,000
                            
                            
                            $
                            2,762,000
                            
                            
                            $
                            7,518,000
                            
                            
                            $
                            44,981,000Operating
      income
                            
                            $
                            1,612,000
                            
                            
                            $
                            412,000
                            
                            
                            $
                            359,000
                            
                            
                            $
                            2,383,000Net
      income
                            
                            $
                            795,000
                            
                            
                            $
                            215,000
                            
                            
                            $
                            144,000
                            
                            
                            $
                            1,154,000Total
      Assets
                            
                            $
                            24,709,000
                            
                            
                            $
                            740,000
                            
                            
                            $
                            4,539,000
                            
                            
                            $
                            29,988,000United States
                            
                            
                            United Kingdom
                            
                            
                            Mexico
                            
                            
                            ConsolidatedYear
      ended 12/31/07Sales
      to outside customers
                            
                            $
                            27,326,000
                            
                            
                            $
                            2,913,000
                            
                            
                            $
                            6,271,000
                            
                            
                            $
                            36,510,000Operating
      income
                            
                            $
                            810,000
                            
                            
                            $
                            215,000
                            
                            
                            $
                            220,000
                            
                            
                            $
                            1,245,000Net
      (loss) income
                            
                            $
                            (128,000
                            )
                            
                            $
                            167,000
                            
                            
                            $
                            43,000
                            
                            
                            $
                            82,000Total
      Assets
                            
                            $
                            23,128,000
                            
                            
                            $
                            1,086,000
                            
                            
                            $
                            5,110,000
                            
                            
                            $
                            29,324,000
 
 21.
                Contingencies
 
 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 an 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.  Management is unable to
estimate a range of loss, if any, in the matter.  On February 11,
2009, Pliant Corporation filed a petition for relief under Chapter XI of the
Bankruptcy Act, and as a result of such filing, the action currently is
stayed.
 
 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.
 
 F29
  22.
                Subsequent
      Events
 
 On
January 31, 2009, the Company entered into the Fifth Amendment to Loan Agreement
with RBS under which the term of the revolving loan facility of the Company with
the Bank was extended to January 31, 2010 and certain covenants of the Loan
Agreement were amended. (See Note 8)
 
 On March
5, 2009, the Company became aware that an employee of the Company had submitted
to the Company certain invoices by a corporation in which the employee is a
principal owner purporting to provide certain repair and maintenance services
and parts, approved such invoices and received payment on them, and that such
corporation had not in fact provided the services or materials indicated in the
invoices.  This information was discovered by reason of a review of
various production expenses being conducted by the accounting and production
personnel of the Company in which inquiry was made as to the receipt of services
or materials claimed to have been provided.  Invoices received from
this corporation for purported services or materials during 2008 and 2007,
totaled $168,000 and $155,000, respectively.  Amounts paid by the
Company to this corporation during 2008 and 2007 were $143,000 and $155,000,
respectively. The Company has determined that none of the services or materials
represented by these invoices was received.
 
 The
Company is conducting a review and investigation regarding transactions with
this corporation and this executive.  The Company has determined that,
for years prior to 2007, the Company has received invoices for parts and
services from, and paid to, this corporation the aggregate amount of
$1,098,000.  The Company does not believe that the Company received
any services or materials with respect to such invoiced amounts.
 
 The
employee involved (i) has acknowledged that there is due from such employee to
the Company the sum of at least $1,396,000 and has signed a promissory note to
the Company for the payment of such amount, (ii) has agreed to make restitution
to the Company of such amount, (iii) has resigned his employment with the
Company, (iv) has agreed to make various specific periodic payments to the
Company.  To date, the Company has received restitution from this
former executive in the amount of $124,000. The Company will only record any
such recoveries upon their receipt.
 
 F30
  23.
                Quarterly
      Financial Data (Unaudited):
  The
following table sets forth selected unaudited statements of income for each
quarter of fiscal 2008 and 2007:
  For the Year Ended December 31, 2008
      (1)1st
                                
                                
                                2nd
                                
                                
                                3rd
                                
                                
                                4thQuarter
                                
                                
                                Quarter
                                
                                
                                Quarter
                                
                                
                                QuarterNet
      sales
                                
                                $
                                10,735,000
                                
                                
                                $
                                12,461,000
                                
                                
                                $
                                11,953,000
                                
                                
                                $
                                9,832,000Gross
      profit
                                
                                $
                                2,332,000
                                
                                
                                $
                                2,913,000
                                
                                
                                $
                                2,742,000
                                
                                
                                $
                                2,335,000Net
      income
                                
                                $
                                279,000
                                
                                
                                $
                                485,000
                                
                                
                                $
                                269,000
                                
                                
                                $
                                121,000Earnings
      per common shareBasic
                                
                                $
                                0.10
                                
                                
                                $
                                0.17
                                
                                
                                $
                                0.10
                                
                                
                                $
                                0.04Diluted
                                
                                $
                                0.10
                                
                                
                                $
                                0.17
                                
                                
                                $
                                0.09
                                
                                
                                $
                                0.04
 (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, 2007 (1)1st
                                                      
                                                      
                                                      2nd
                                                      
                                                      
                                                      3rd
                                                      
                                                      
                                                      4thQuarter
                                                      
                                                      
                                                      Quarter
                                                      
                                                      
                                                      Quarter
                                                      
                                                      
                                                      QuarterNet
      sales
                                                      
                                                      $
                                                      8,279,000
                                                      
                                                      
                                                      $
                                                      9,259,000
                                                      
                                                      
                                                      $
                                                      8,673,000
                                                      
                                                      
                                                      $
                                                      10,299,000Gross
      profit
                                                      
                                                      $
                                                      1,903,000
                                                      
                                                      
                                                      $
                                                      2,744,000
                                                      
                                                      
                                                      $
                                                      1,617,000
                                                      
                                                      
                                                      $
                                                      2,420,000Net
      income
                                                      
                                                      $
                                                      (52,000
                                                      )
                                                      
                                                      $
                                                      423,000
                                                      
                                                      
                                                      $
                                                      (414,000
                                                      )
                                                      
                                                      $
                                                      125,000Earnings
      per common shareBasic
                                                      
                                                      $
                                                      (0.02
                                                      )
                                                      
                                                      $
                                                      0.18
                                                      
                                                      
                                                      $
                                                      (0.18
                                                      )
                                                      
                                                      $
                                                      0.05Diluted
                                                      
                                                      $
                                                      (0.02
                                                      )
                                                      
                                                      $
                                                      0.17
                                                      
                                                      
                                                      $
                                                      (0.18
                                                      )
                                                      
                                                      $
                                                      0.05
  (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
  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:
  2008
                            
                            
                            2007Balance at beginning of
year
                            
                            $
                            312,000
                            
                            
                            $
                            210,000Charged to expenses
                            
                            $
                            75,000
                            
                            
                            $
                            105,000Uncollectible
      accounts written off
                            
                            $
                            (348,000
                            )
                            
                            $
                            (3,000
                            )Balance
      at end of year
                            
                            $
                            39,000
                            
                            
                            $
                            312,000
 
 F31
  The
following is a summary of the allowance for excess inventory for the years ended
December 31:
  2008
                            
                            
                            2007Balance at beginning of
year
                            
                            $
                            383,000
                            
                            
                            $
                            276,000Charged to expenses
                            
                            $
                            150,000
                            
                            
                            $
                            231,000Obsolete
      inventory written off
                            
                            $
                            (104,000
                            )
                            
                            $
                            (124,000
                            )Balance
      at end of year
                            
                            $
                            429,000
                            
                            
                            $
                            383,000
 
 The
following is a summary of property and equipment and the related accounts of
accumulated depreciation for the years ended December 31:
 
 2008
                                  
                                  
                                  2007Cost BasisBalance at beginning of
year
                                  
                                  $
                                  29,696,000
                                  
                                  
                                  $
                                  26,870,000Additions
                                  
                                  $
                                  1,557,000
                                  
                                  
                                  $
                                  2,826,000Disposals
                                  
                                  $
                                  -
                                  
                                  
                                  $
                                  -Balance
      at end of year
                                  
                                  $
                                  31,253,000
                                  
                                  
                                  $
                                  29,696,000Accumulated depreciationBalance at beginning of
year
                                  
                                  $
                                  19,600,000
                                  
                                  
                                  $
                                  18,278,000Depreciation
                                  
                                  $
                                  1,077,000
                                  
                                  
                                  $
                                  1,322,000Disposals
                                  
                                  $
                                  -
                                  
                                  
                                  $
                                  -Balance
      at end of year
                                  
                                  $
                                  20,677,000
                                  
                                  
                                  $
                                  19,600,000Property
      and equipment, net
                                  
                                  $
                                  10,576,000
                                  
                                  
                                  $
                                  10,096,000
 
 F32