**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**WASHINGTON,
      D.C. 20549**





**FORM
      10-K/A**


*Amendment
      No. 3 to 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, 2005****OR**o
            **TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934**




For
      the
      transition period from _________to_________




**Commission
      File Number**


**000-23115**





**CTI
      INDUSTRIES CORPORATION**


(Exact
      name of Registrant as specified in its charter)




Illinois
            
            36-2848943(State
                or other jurisdiction
                of
            
            (I.R.S. Employer Identification
                Number)incorporation
                or
                organization)





22160
                  N. Pepper RoadBarrington,
                  Illinois
              
              60010(Address
                  of principal executive
                  offices)
              
              (Zip
                  Code)


(847)382-1000


(Registrant’s
      telephone number, including area code)





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





Title
                of Class
            
            Name
                of each exchange
              on
                which registered:Common
                Stock, no par value
            
            NASDAQ
                Capital Market





Securities
      registered pursuant to Section 12(g) of the Act: None.





Indicate
      by check mark if the registrant is a well-known seasoned issuer, as defined
      in
      Rule 405 of the Securities Act.  Yes o No þ




Indicate
      by check mark if the registrant is not required to file reports pursuant to
      Section 13 or Section 15(d) of the
      Act.  Yes o No þ




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








Indicate
      by check mark if disclosure of delinquent filers pursuant to Item 405 of
      Regulation S-K (§229,405 of this chapter) is not contained herein, and will
      not be contained, to the best of registrant’s knowledge, in definitive proxy or
      information statements incorporated by reference in Part III of this
      Form 10-K or any amendment to this Form 10-K. þ





Indicate
      by check mark whether the Registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer. See definition of “accelerated
      filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
      (Check one):





Large
      accelerated filer o Accelerated
      filer o Non-accelerated
      filer þ




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





Based
      upon the closing price of $1.85 per share of the Registrant’s Common Stock as
      reported on NASDAQ Capital Market tier of The NASDAQ Stock Market on June 30,
      2005, the aggregate market value of the voting common stock held by
      non-affiliates of the Registrant was then approximately $1,918,931. (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 31,
      2006 was 2,036,474 (excluding treasury shares).





Documents
      Incorporated by Reference: None





**TABLE
      OF CONTENTS**





**INDEX**





EXPLANATORY
      STATEMENT





FORWARD
      LOOKING STATEMENTS





Part
      I





Item
                No. 1
            
            Business
            
            2Item
                No. 1A
            
            Risk
                Factors
            
            14Item
                No. 2
            
            Properties
            
            20Item
                No. 3
            
            Legal
                Proceedings
            
            20Item
                No. 4
            
            Submission
                of Matters to a Vote of Security Holders
            
            21Part
                IIItem
                No. 5
            
            Market
                for Registrant’s Common Equity, Related Stockholder Matters and IssuerPurchases
                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
            
            41Item
                No. 8
            
            Financial
                Statements and Supplementary Data
            
            42Item
                No. 9
            
            Changes
                in and Disagreements with Accountantson
                Accounting and Financial Disclosure
            
            42Item
                No. 9A
            
            Controls
                and Procedures
            
            42Part
                IIIItem
                No. 10
            
            Directors
                and Executive Officers of the Registrant
            
            44Item
                No. 11
            
            Executive
                Compensation
            
            48Item
                No. 12
            
            Security
                Ownership of Certain Beneficial Owners and Management and RelatedStockholder
                Matters
            
            51Item
                No. 13
            
            Certain
                Relationships and Related Transactions
            
            54Item
                No. 14
            
            Principal
                Accounting Fees and Services
            
            55Part
                IVItem
                No. 15
            
            Exhibits
                and Financial Statement Schedules
            
            57







**EXPLANATORY
      NOTE**





This
      Form 10K/A is being filed by the Company to amend and restate portions of the
      Company’s Report on Form 10-K for the fiscal year ended December 31, 2005. This
      Amendment includes the restatement of the Consolidated Statements of Operations
      for the fiscal years ended December 31, 2004 and 2003, and the restatement
      of
      the Consolidated Statements of Cash Flows for the fiscal years ended December
      31, 2005, 2004 and 2003. With respect to the Consolidated Statement of
      Operations, the restatement for the years 2004 and 2003 reflects a
      re-classification of certain items reported as Other Income to Income from
      Operations. The restatement of the Consolidated Statements of Operations for
      such periods does not result in any change in the net loss or loss per
      share for such periods. With respect to the Consolidated Statements of Cash
      Flows, the restatement for each of the years 2005, 2004 and 2003 reflects a
      change in the computation of the effect of exchange rate changes on cash. The
      restatement of the Consolidated Statements of Cash Flows for such periods does
      not result in any change in the net (decrease) increase in cash.





For
      each year with respect to which a restatement is made, the Consolidated
      Statements of Operations and the Consolidated Statements of Cash Flows set
      forth
      both (i) the amount as originally reported and (ii) the restated amounts for
      each item. Certain items in Management’s Discussion and Analysis have been
      changed to reflect the restated amounts. All of these changes are
      underlined.





Except
      as set forth above, the Company has not amended or modified any of the financial
      information or disclosures set forth in the Report on Form 10-K for the fiscal
      year ended December 31, 2005 as filed on April 14, 2006. This Form 10K/A does
      not reflect events occurring after the filing of the original Form 10-K, and
      represents the Company’s Report on Form 10-K in its entirety including changes
      to only those items identified above.




**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.”




1




**PART
      I**





**Item
      No. 1 Description of Business**





**Business
      Overview**





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





·
            **Novelty
                products**,
                principally balloons, including metalized balloons, latex balloons,
                punch
                balls and other inflatable toy items, and





·
            **Specialty
                and printed films and flexible containers**,
                for food packaging, specialized consumer uses and various commercial
                applications.





We
      focus
      our business and efforts on the printing, processing and converting of plastic
      film, and of latex, into finished products. We:





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





·
            Print
                plastic film and latex balloons. We print films, both plastic and
                latex
                with a variety of graphics for use as packaging film or for
                balloons.





·
            Convert
                printed plastic film to balloons.





·
            Convert
                plastic film to flexible containers. These finished products are
                used to
                store and package food and for storage of a variety of personal
                items.





·
            Convert
                latex to balloons and other novelty
                items.





We
      market
      and sell metalized and latex balloons in the United States and in several other
      countries. We supply coated, laminated and printed films to a number of
      companies who generally convert these films into containers for the packaging
      of
      food and other items. We supply flexible containers to companies who (i) use
      them for packaging of food or other items or (ii) market them to consumers
      who
      use them for the storage of personal items. We also market containers to and
      through retail outlets for use by consumers with sealing devices to store food
      items in their homes. In March 2006, we announced that we are completing the
      development of, and will produce, market and sell a line of pouches for use
      by
      consumers to store food items. The pouches include a resealable closure system
      and a valve permitting the evacuation of air from the pouch by a small pump
      device which we will also supply.


2





We
      were
      organized in 1976 and, initially, engaged in the business of manufacturing
      “bag-in-box” plastic packaging systems. We sold our assets related to bag-in-box
      packaging systems in 1985. In 1978, we began manufacturing metalized balloons
      (sometimes referred to as "foil" balloons), which are balloons made of a base
      material (usually nylon or polyester) having vacuum deposited aluminum and
      polyethylene coatings. These balloons remain buoyant when filled with helium
      for
      much longer periods than latex balloons and permit the printing of graphic
      designs on the surface.





In
      1985,
      we began marketing latex balloons and, in 1988 we began manufacturing latex
      balloons. In 1994, we sold our latex balloon manufacturing equipment to a
      company in Mexico and entered into an arrangement for that company to
      manufacture latex balloons for us. Since 1997, we have manufactured latex
      balloons in Mexico through a majority-owned subsidiary.





We
      market
      and sell our metalized and latex balloons and related novelty items directly
      to
      retail stores and chains and through distributors, who in turn sell to retail
      stores and chains. Our balloon and novelty products are sold to consumers
      through a wide variety of retail outlets including general merchandise and
      drugstore chains, grocery chains, card and gift shops, and party goods stores,
      as well as through florists and balloon decorators.





Most
      of
      our metalized balloons contain printed characters, designs and social expression
      messages, such as “Happy Birthday”, “Get Well Soon” and similar items. In a
      number of cases, we obtain licenses for well-known characters and print those
      characters and messages on our balloons. Currently, we maintain licenses for
      Garfield ® ,
      Face
      Offs-Tudes ® ,
      Miss
      Spider and Sunny Patch Friends® and Andrea Mistretta. In the United Kingdom, we
      maintain licenses on Postman Pat ® ,
      The
      Crazy Frog® and Dream Fairies ® .





Balloons
      and novelty items accounted for 57% of our revenues in 2005. The remainder
      of
      our revenues is generated from the sale of laminated film products, generally
      intended for use in the packaging of foods, liquids and other materials. We
      provide laminated films, often printed film, 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 2005,
      our
      revenues from these products represented approximately 40% of our net
      revenues.





We
      are an
      Illinois corporation with our principal offices and plant at 22160 N. Pepper
      Road, Barrington, Illinois.


3





**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 30 years and have developed assets, technology and expertise
                which, we believe, enable us to develop, manufacture, market and
                sell
                innovative products of high quality within our area of knowledge
                and
                expertise. We plan to focus our efforts in these areas which are
                our core
                assets and expertise - laminated films, printed films, pouches and
                film
                novelty products - to develop new products, to market and sell our
                products and to build our revenues.





·
            *Develop
                Operating Efficiencies to Enhance our Profitability*.
                Over the past two years, we have engaged in a program to reduce and
                control production expenses, as well as selling, general and
                administrative expenses, in order to increase the efficiencies of
                our
                operations and to become profitable at current levels of revenue.
                During
                2005, we reduced our domestic production overhead expenses by more
                than
                $1,460,000 compared to 2004 and we reduced our consolidated SG&A
                expenses by approximately $1,200,000 from 2004 levels. We intend
                to
                continue our efforts to control expenses, increase efficiencies and
                to
                become profitable.





·
            *Develop
                New Products, Product Improvements and Technologies*.
                We work constantly to develop new products, to improve existing products
                and to develop new technologies within our core product areas, in
                order to
                enhance our competitive position and our sales. In the novelty line,
                our
                development work includes new designs, new character licenses and
                new
                product developments. During 2005, we introduced more than 85 new
                balloon
                designs and obtained three new licensed character designs. We also
                developed and introduced a device to amplify sound through a balloon
                so
                that voice and music can be played and amplified using our Balloon
                JamzTM
                balloon. In our commercial line, over the past several years we have
                developed new pouch closure systems and valves and new film methods
                for
                liquid packaging applications. We have received 13 patents for these
                developments and have 2 patent applications
                pending.





·
            *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. During the past year, we entered into a sales and marketing
                relationship for the marketing and sale of our newly developed and
                introduced universal vacuumable sealing bags. Recently, we announced
                the
                development of a resealable bag with a valve and pump system for
                household
                storage and vacuum sealing of food items which will be marketed and
                sold
                in that same relationship. In March 2006, we entered into a four
                year
                agreement with ITW Space Bag to manufacture certain pouches for them
                and
                to provide film to them for their pouch
                production.


4





**Products**





*Metalized
      Balloons* .
      We have
      designed, produced and sold metalized balloons since 1979 and, we believe,
      are
      the second largest manufacturer of metalized balloons in the United States.
      Currently, we produce over 650 balloon designs, in different shapes and sizes,
      including the following:





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





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





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





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





·
            Shape-A-Loons®-
                shaped balloons made to be filled with helium.





·
            Minishapes
                - small shaped balloons designed to be air filled and sold on sticks
                as
                toys or inflated characters.





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





In
      addition to size and shape, a principal element of the Company's metalized
      balloon products is the printed design or message contained on the balloon.
      These designs include figures and licensed characters many of which are
      well-known. We maintain licenses for several characters, including
      Garfield ® ,
      Face
      Offs-Tudes, Miss Spider and Sunny Patch Friends® and Andrea Mistretta, and in
      the United Kingdom, Postman Pat ® ,
      The
      Crazy Frog® and Dream Fairies ® .
      For a
      period of 3 years, we also manufactured and distributed certain licensed designs
      under an arrangement with Hallmark Cards. This arrangement terminated on March
      31, 2005.





*Latex
      Balloons* .
      Through
      our majority-owned subsidiary in Guadalajara, Mexico, Flexo Universal, S.A.
      de
      C.V. (“Flexo Universal”), we manufacture latex balloons in 6 shapes and sizes
      and 40 colors. These balloons are marketed under the name Partyloons®. We also
      manufacture toy balloon products including punch balls, water bombs and "Animal
      Twisties."





*Packaging
      Films* .
      We
      produce and sell films that are utilized for the packaging of various products,
      principally food products. We laminate, extrusion coat and print films and
      sell
      them to customers who utilize the films for packaging applications. Our
      customers generally use these film products to convert them to bags or pouches
      for the packaging of food and other products.


5




*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. We
      market our food storage bags under the name Simply SmartTM. In March 2006, we
      announced that we will be offering a line of resealable, valved bags for storage
      and vacuum sealing of food items in the household. These storage bags will
      function with a small hand or powered pump to evacuate air when the bag is
      sealed.





**Markets**





*Metalized
      Balloons*





The
      metalized balloon came into existence in the late 1970s. During the 1980s,
      the
      market for metalized balloons grew rapidly. Initially, the product was sold
      principally to individual vendors, small retail outlets and at fairs, amusement
      parks, shopping centers and other outdoor facilities and functions. Metalized
      balloons remain buoyant when filled with helium for extended periods of time
      and
      they permit the printing and display of graphics and messages. As a result,
      the
      product has significant appeal as a novelty and message item. Metalized balloons
      became part of the "social expression" industry, carrying 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
      metalized balloons throughout the United States and in a number of other
      countries.





Metalized
      balloons are sold in the United States and in Europe, several countries in
      the
      Far East, Canada and to an increasing extent in Latin America. The United
      States, however, is by far the largest market for these products.





Metalized
      balloons are sold in the United States and foreign countries directly by
      producers to retail outlets and through distributors and wholesalers. Often
      the
      sale of metalized balloons by the wholesalers/distributors is accompanied by
      related products including latex balloons, floral supplies, candy containers,
      mugs, plush toys, baskets and a variety of party goods.


6





*Latex
      Balloons*





For
      a
      number of years, latex balloons and related novelty/toy latex items have been
      marketed and sold throughout the United States and in most other countries.
      Latex balloons are sold as novelty/toy items, for decorative purposes, as part
      of floral designs and as party goods and favors. In addition to standard size
      and shape balloons, inflatable latex items include punch balls, water bombs,
      balloons to be twisted into shapes, and other specialty designs. Often, latex
      balloons included printed messages or designs.





Latex
      balloons are sold principally in retail outlets, including party goods stores,
      general merchandise stores, discount chains, gift stores and drugstore chains.
      Balloons are also purchased by balloon decorators and floral outlets for use
      in
      decorative or floral designs.





Printed
      latex balloons are sold both in retail outlets and for balloon decoration
      purposes including floral designs. "Toy" balloons include novelty balloons
      sold
      in toy departments or stores, punch balls, water bombs and other specialty
      designs.





Latex
      balloons are sold both through distributors and directly to retail outlets
      by
      the producers.





*Printed
      and Specialty Films*





The
      industry and market for printed and specialty films is fragmented and includes
      many participants. There are hundreds of manufacturers of printed and specialty
      film products in the United States and in other markets. In many cases,
      companies who provide food and other products in film packages also produce
      or
      process the films used for their packages. The market for the Company's film
      products consists principally of companies who utilize the films for the
      packaging of their products, including food products and other items. In
      addition to the packaging of food products, flexible containers are used for
      medical purposes (such as colostomy bags, containers for saline solution and
      other items), "dunnage" (to cushion products being packaged), storage of
      personal and household items and other purposes.





*Flexible
      Containers/Pouches*





The
      market for flexible containers and pouches is large and diverse. Many companies
      engaged in the production of food items package their products in flexible
      containers or pouches, and, therefore, represent a market for these containers.
      Many of these companies purchase film - often printed film - and convert the
      film to pouches or packages at their own facilities while others purchase
      completed containers from suppliers.





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.


7





**Marketing,
      Sales and Distribution**





*Balloon
      Products*





We
      market
      and sell our metalized balloon, latex balloon and related novelty products
      throughout the United States and in a number of other countries. We maintain
      a
      marketing, sales staff and support staff of 10 individuals and a customer
      service department of 4 individuals. European sales are conducted by CTI
      Balloons, the Company's subsidiary located in Rugby, England. Flexo Universal
      conducts sales and marketing activities for the sale of balloon products in
      Mexico, Latin America, and certain other markets. Sales in other foreign
      countries are made generally to distributors in those countries and are managed
      at the Company's principal offices.





We
      sell
      and distribute our balloon products (i) by our employed staffs of sales and
      customer service personnel in the United States, Mexico and the UK, (ii) through
      a network of distributors and wholesalers in the United States, Mexico and
      the
      UK, (iii) through several groups of independent sales representatives and (iv)
      to selected retail chains. The distributors and wholesalers are generally
      engaged principally in the sale of balloons and related products (including
      such
      items as plush toys, mugs, containers, floral supplies and other items) and
      sell
      balloons and related products to retail outlets including grocery, general
      merchandise and drug store chains, card and gift shops, party goods stores
      as
      well as florists and balloon decorators.





Our
      largest customer for balloons during 2005 was Dollar Tree Stores. Sales to
      this
      chain in 2005 represented $3,987,000 or approximately 14% of our net
      sales.





For
      a
      period of three years, we maintained a relationship with Hallmark Cards under
      which we (i) produced balloons of Hallmark designs, and of designs licensed
      by
      Hallmark, under authority from Hallmark, (ii) sold such balloons, as well as
      latex balloons, to Hallmark for resale by Hallmark, and (iii) sold and
      distributed these balloon designs to customers in the United States. This
      arrangement and the agreements related to it expired and were terminated on
      March 31, 2005. We continue to sell balloons bearing these designs from our
      inventory during an 18 month sell-off period. Our domestic sales of balloon
      products to Hallmark during 2004 were $3,421,000 and during 2005 were $306,000.





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.


8





*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
      2005, our sales to Rapak totaled $6,860,000, representing 24% of our net
      sales **.** Under
      our
      continuing agreement with Rapak, through October 31, 2006, Rapak is committed
      to
      purchase at least 65% of its requirements for embossed film from us. We
      anticipate that Rapak will continue to purchase film from us after this date
      but
      we have no contractual commitment from Rapak for such purchases.





*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 through a sales and marketing agent to retail chains and
      outlets.





We
      produce consumer storage bags for ITW Space Bag, a division of Illinois Tool
      Works, Inc. (“ITW”) During 2005, ITW was our largest customer for pouches. Our
      sales of pouches to them in 2005 were $3,889,000, representing 13% of our net
      sales. In March 2006, we entered into a four-year agreement with ITW under
      which
      we will supply all of their requirements in North America for certain of their
      pouches which they market under the name Space Bag® and also are to supply their
      requirements of film for certain of the pouches which they produce.





During
      2005, we introduced a line of universal vacuumable bags for household storage
      of
      food products. We market these products through Heil & Lambert L.L.C, a
      marketing and sales firm, to retail stores and chains. These bags are designed
      to be used with existing vacuum and sealing devices. In March 2006, we announced
      the planned introduction of additional household food storage systems including
      (i) a re-sealable bag incorporating a valve and a hand pump to evacuate air
      from
      the bag when the bag is sealed and (ii) a produce protection bag designed to
      retard the spoiling of fresh foods. We anticipate that these new products will
      be available for sale by late spring to summer of 2006.





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





**Production
      and Operations** ***.***





We
      conduct our operations at four facilities: (i) our headquarters, offices and
      plant at Barrington, Illinois, consisting of a total of approximately 75,000
      square feet of office, production and warehouse space, (ii) a warehouse in
      Cary,
      Illinois, consisting of approximately 16,000 square feet of space, (iii) a
      plant, offices and warehouse in Guadalajara, Mexico, consisting of approximately
      43,000 square feet of office, warehouse and production space and (iv) an office
      and warehouse facility at Rugby, England, consisting of approximately 16,000
      square feet of space.


9





We
      conduct production operations at our plants in Barrington, Illinois and
      Guadalajara, Mexico. At our plants, our production operations include (i)
      lamination and extrusion coating of films, (ii) slitting of film rolls, (iii)
      printing on film and on latex balloons, (iv) converting of film to completed
      products including balloons, flexible containers and pouches and (v) production
      of latex balloon products. We perform all of the lamination, extrusion coating
      and slitting activities in our Barrington, Illinois plant and produce all of
      our
      latex balloon products at our Guadalajara, Mexico plant. We print films in
      Barrington, Illinois and we print latex balloons in Guadalajara,
      Mexico.





We
      warehouse raw materials at our plants in Barrington, Illinois and Guadalajara,
      Mexico and we warehouse finished goods at our facilities in Barrington,
      Illinois, Cary, Illinois, Guadalajara, Mexico and Rugby, England. We maintain
      customer service and fulfillment operations at each of our warehouse locations.
      We conduct sales operations for the United States and for all other markets,
      except those handled by our Mexico and England facilities, in the Barrington,
      Illinois facility. Sales for Mexico and Latin America are handled in our
      Guadalajara, Mexico facility and sales for the United Kingdom and Europe are
      handled at our Rugby, United Kingdom facility.





We
      maintain a graphic arts and development department at our Barrington, Illinois
      facility which designs our balloon products and graphics. Our creative
      department operates a networked, computerized graphic arts system for the
      production of these designs and of printed materials including catalogues,
      advertisements and other promotional materials.





We
      conduct administrative and accounting functions at our headquarters in
      Barrington, Illinois and at our facilities in Guadalajara, Mexico and Rugby,
      England.





**Raw
      Materials**





The
      principal raw materials we use in manufacturing our products are (i) petroleum
      or natural gas-based films, (ii) petroleum or natural gas-based resin, (iii)
      latex and (iv) printing inks. The cost of these raw materials represented 41%
      of
      our net revenues in 2005. Because much of the raw materials we utilize are
      based
      on petroleum or natural gas, we have experienced fluctuation in pricing, in
      relation to the fluctuation of availability and pricing of these source
      commodities. To some degree, we have been able to increase the pricing of our
      products in relation to changes in our costs of raw materials. However, during
      the past year, we have not been able to recover all raw materials price
      increases by increasing the price of our products and we are subject to the
      risk
      that our margins may be negatively affected by changes in the price of petroleum
      or natural gas-based raw materials. While we currently purchase our raw
      materials from a relatively limited number of sources, films, resin and inks
      are
      available from numerous sources and, in the past, we have generally been able
      to
      obtain a sufficient supply of raw materials. However, during August and
      September 2005, the petrochemical industry suffered facility damage, production
      disruptions and transportation shortages due to the impact of two Gulf Coast
      hurricanes. As a result, both the price and availability of petroleum and
      natural gas-based products were affected. While we were generally able to obtain
      a sufficient supply of raw materials to meet our needs during this time, prices
      of raw materials escalated rapidly and substantially; hence, the risk of
      shortages of raw materials supply existed. There can be no assurance that the
      price of such raw materials, and their availability, will not be affected
      similarly in the future and such events could have a material adverse effect
      on
      the business of the Company.


10





**Information
      Technology Systems**





Our
      corporate headquarters in Barrington, Illinois and our warehouse facility in
      Cary, Illinois are serviced by a PC-based local area network. We connect the
      facilities via a high speed T1 line that carries both voice and data. The
      PC-based network incorporates both Novell and Microsoft servers. Access to
      the
      network is available to all employees but is secured using password
      authentication. The network allows us to leverage printing resources, create
      shared file areas for cross-departmental functions and allows for a single
      source backup of critical business files. On the network we run Macola financial
      system software. Macola is a modular software system, of which we use the
      general ledger, order entry, inventory management, purchase order, electronic
      data exchange and custom report writing modules. Internal and external employee
      communications are handled by industry standard Microsoft Exchange email,
      allowing us to communicate with customers and vendors all over the world. We
      also provide a secure, firewall protected T1 connection to the Internet so
      that
      employees can research issues, support customers and securely move
      data.





At
      each
      of our Mexico and England facilities, we operate server computers and local
      area
      networks, accessible to employees at those facilities. At each of those
      facilities, we operate separate integrated financial, order entry and inventory
      management systems.





**Competition**





The
      balloon and novelty industry is highly competitive, with numerous competitors.
      We believe there are presently six principal manufacturers of metalized balloons
      whose products are sold in the United States including Anagram International,
      Inc., Pioneer Balloon, Convertidora International, Barton Enterprises and
      Betallic. Several companies market and sell metalized balloons designed by
      them
      and manufactured by others for them.





We
      believe there are approximately five manufacturers of latex balloons whose
      products are sold in the United States and numerous others whose products are
      sold in other countries.


11





The
      market for films, packaging and custom products is fragmented, and competition
      in this area is difficult to gauge. However, there are numerous participants
      in
      this market and the Company can expect to experience intense quality and price
      competition.





Many
      of
      these companies offer products and services that are the same or similar to
      those offered by us and our ability to compete depends on many factors within
      and outside our control. There are a number of well-established competitors
      in
      each of our product lines, several of which possess substantially greater
      financial, marketing and technical resources and have established, extensive,
      direct and indirect channels of distribution for their products and services.
      As
      a result, such competitors may be able to respond more quickly to new
      developments and changes in customer requirements, or devote greater resources
      to the development, promotion and sale of their products and services than
      we
      can. Competitive pressures include, among other things, price competition,
      new
      designs and product development and copyright licensing.





**Patents,
      Trademarks and Copyrights**





We
      have
      developed or acquired a number of intellectual property rights which we believe
      are significant to our business.





*Copyright
      Licenses.* We
      maintain licenses on certain popular characters and designs for our balloon
      products. We presently maintain seven licenses and produce balloon designs
      utilizing the characters or designs covered by the licenses. Licenses are
      generally maintained for a one or two year term, although the Company has
      maintained long term relationships with several of its licensors and has been
      able to obtain renewal of its license agreements with them.





*Trademarks.* We own
      12 **** registered
      trademarks in the United States relating to our balloon products. Many of these
      trademarks are registered in foreign countries, principally in the European
      Union. We have a license on the Simply SmartTM trademark for our household
      storage line of products.





*Patent
      Rights.* We own,
      or have license rights under, or have applied for, patents related to our
      balloon products, certain film products and certain flexible container products.
      These include (i) ownership of two patents, and a license under a third,
      relating to self-sealing valves for metalized balloons and methods of making
      balloons with such valves, (ii) several metalized balloon design patents, (iii)
      patents and applications related to the design and structure of, and method
      of
      inserting and affixing, zipper-closure systems in a bag, (iv) patents related
      to
      one-way valves for pouches, (v) a patent related to methods of embossing film
      and utilizing such film to produce pouches with fitments, and (vi) patent
      applications related to vacuumable storage bags with fitments.





**Research
      and Development**





We
      maintain a product development and research department of five individuals
      for
      the development or identification of new products, product components and
      sources of supply. Research and development includes (i) creative product
      development, (ii) creative marketing, and (iii) engineering development. During
      each of the fiscal years ended December 31, 2005, 2004, 2003, respectively,
      we
      estimate that the total amount spent on research and development activities
      was
      approximately $224,000, $246,000 and $335,000, respectively.


12





**Employees**





As
      of
      December 31, 2005, the Company had 85 full-time employees in the United States,
      of whom 15 are executive or supervisory, 4 are in sales, 54 are in manufacturing
      or warehouse functions and 12 are clerical. As of that same date, we had 10
      full-time employees in England, of whom 2 are executive or supervisory, 2 are
      in
      sales, 4 are in warehousing and 2 are clerical. At Flexo Universal, our Mexico
      subsidiary, as of December 31, 2005, we had 185 full-time employees, of whom
      19
      are executive or supervisory, 2 are in sales, 156 are in manufacturing and
      8 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 Environmental Protection Agency regulates the handling
      and disposal of hazardous materials. Since our printing operations have utilized
      only water-based ink, the waste generated by the Company's production process
      has not been deemed hazardous waste. We believe we are in material compliance
      with applicable environmental rules and regulations. Several states have enacted
      laws limiting or restricting the release of helium filled metalized balloons.
      We
      do not believe such legislation will have any material effect on our operations.





**International
      Operations.**





We
      sell
      balloon products in a number of countries outside the United States. Sales
      of
      these products for the United Kingdom and Europe are handled by our facility
      and
      personnel in Rugby, England, and for Mexico and Latin America are handled by
      our
      facility and personnel in Guadalajara, Mexico. In other countries, we sell
      balloon products through distributors located in those countries. We conduct
      production, packaging, warehousing and sales operations in Mexico and
      warehousing and sales operations in the United Kingdom. We rely and are
      dependent on our operations in Mexico for the supply of latex balloons in the
      United States, Mexico, Europe and other markets. Interruption of that supply
      would have a material adverse effect on the business of the Company.


13





Our
      domestic and international sales and assets by area over the period 2003 -
      2005
      have been as follows:





**United**
              **States**
            
            **United**
              **Kingdom**
            
            **Mexico**
            
            **Eliminations**
            
            **Consolidated**Year
                ended 12/31/05Revenues
            
            $
            23,564,000
            
            $
            2,573,000
            
            $
            4,536,000
            
            
            ($1,483,000
            )
            $
            29,190,000Operating
                income (loss)
            
            $
            602,000
            
            $
            290,000
            
            
            ($240,000
            )
            
            
            
            $
            652,000Net
                (loss) income
            
            
            ($342,000
            )
            $
            220,000
            
            
            ($211,000
            )
            
            
            
            
            ($333,000
            )Total
                Assets
            
            $
            21,343,000
            
            $
            2,122,000
            
            $
            4,818,000
            
            
            ($4,747,000
            )
            $
            23,536,000Year
                ended 12/31/04Revenues
            
            $
            32,855,000
            
            $
            2,664,000
            
            $
            4,890,000
            
            
            ($3,216,000
            )
            $
            37,193,000Operating
                (loss) income (restated)
            
            
            ($92,000
            )
            $
            121,000
            
            
            ($31,000
            )
            
            ($48,000
            )
            
            ($50,000
            )Net
                (loss) income
            
            
            ($2,595,000
            )
            $
            223,000
            
            
            ($59,000
            )
            
            ($48,000
            )
            
            ($2,479,000
            )Total
                Assets
            
            $
            24,072,000
            
            $
            1,989,000
            
            $
            5,319,000
            
            
            ($3,492,000
            )
            $
            27,888,000Year
                ended 12/31/03Revenues
            
            $
            32,687,000
            
            $
            2,415,000
            
            $
            4,003,000
            
            
            ($2,845,000
            )
            $
            36,260,000Operating
                (loss) income (restated)
            
            
            ($216,000
            )
            $
            191,000
            
            
            ($102,000
            )
            
            ($96,000
            )
            
            ($223,000
            )Net
                (loss) income
            
            
            ($883,000
            )
            $
            163,000
            
            $
            249,000
            
            
            ($95,000
            )
            
            ($566,000
            )Total
                Assets
            
            $
            27,603,000
            
            $
            1,412,000
            
            $
            5,476,000
            
            
            ($4,221,000
            )
            $
            30,270,000





**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.*





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.


14





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





The
      cost
      of the raw materials we purchase represents about 41% of our revenues. The
      principal raw materials we purchase are: nylon sheeting, polyester sheeting,
      polyethylene sheeting, polyethylene resin and latex. Much of these materials
      are
      derived from petroleum and natural gas. Prices for these materials fluctuate
      substantially as a result of the change in petroleum and natural gas prices,
      demand and the capacity of companies who produce these products to meet market
      needs. Instability in the world markets for petroleum and natural gas has,
      and
      may, adversely affect the prices of these raw materials and their general
      availability. The price of latex has also fluctuated significantly over the
      past
      year. Our ability to achieve and maintain profitability is partially dependent
      upon our ability to pass through to our customers the amount of increases in
      raw
      materials cost. If prices of these materials increase and we are not able to
      fully pass on the increases to our customers, our results of operations and
      our
      financial condition will be adversely affected.





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





We
      rely
      on six principal suppliers for our petroleum, natural gas and latex-based raw
      materials 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. If we were unable to obtain
      a raw material from another supplier in such event, we would be unable to
      continue to manufacture certain of our products.





***Company
      Risks***





*We
      have a history of losses and have experienced fluctuations of operating income,
      which may cause our stock to fluctuate.*





We
      have
      had a history of losses and of fluctuating income from operations over the
      past
      five years. We have reported net income in only one of the past five years.
      Our
      income (loss) from operations during that time has ranged from a profit of
      $1,445,000 to a loss of $ 223,000 and has
      been subject to significant quarterly and annual fluctuations. These
      fluctuations can be caused by:


15





·
            Economic
                conditions


·
            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, 2005, our current liabilities
      exceeded our current assets by more than $2,426,000. While we did obtain some
      additional working capital as a result of the re-financing of our bank debt
      on
      February 1, 2006 with Charter One Bank and the investment in our Company, as
      subordinated debt, of $1,000,000 by two of our principal officers, our working
      capital remains limited. As a result, we may be unable to fund capital
      investments, working capital needs, marketing and sales programs, research
      and
      development, patent or copyright licenses or other items which we would like
      to
      acquire or pursue in accordance with our business strategies. The inability
      to
      pursue any of these items may adversely affect our competitive position, our
      business, financial condition or prospects.





*A
      high percentage of our sales are to a limited number of customers and the loss
      of any one or more of those customers could adversely affect our results of
      operation, cash flow and financial condition.*





For
      the
      year ended December 31, 2005, our sales to our top 10 customers represented
      62.9% of our net sales and our sales to our top three customers represented
      50%
      of our net sales. Generally, we do not have long term contracts with our
      customers. The loss of any of our principal customers, or a significant
      reduction in the amount of our sales to any of them, would have a material
      adverse effect on our business and financial condition.





In
      March
      2006, we entered into a four-year agreement with ITW 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.





*We
      rely on intellectual property in our business and the failure to develop,
      acquire or protect our intellectual property could adversely affect our
      business.*


16





We
      consider patents, copyright licenses and to some degree trademarks, as being
      significant to our competitive position, our ability to obtain and retain
      customers and to achieve acceptable margin levels on the sale of our products.
      With respect to our film and flexible packaging/pouch business, we believe
      that
      developing, acquiring and maintaining patent rights are of significance to
      us
      for those reasons. Over the past five years, we have obtained 12 patents related
      to films, pouches, zippers for pouches, the method of inserting zippers in
      pouches and certain valves for pouches. We have 7 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.*





We
      produce all of our film products and pouches at our plant in Barrington,
      Illinois and all of our latex balloon products at our plant in Guadalajara,
      Mexico. In the event of a fire, flood, or other natural disaster, or the
      termination of our lease in Mexico, we could lose access to one or both of
      our
      plants. Loss of, significant damage to, or destruction of, one or both of these
      plants would render us unable to produce our products presently produced in
      such
      plants, possibly for an extended period of time and our business, financial
      condition and prospects would be materially adversely affected. While we
      maintain business interruption insurance, the proceeds of such insurance may
      not
      be adequate to compensate us for all of our losses in such an
      event.





*We
      are dependent on the management experience of our key
      personnel.*





We
      are
      dependent on the management experience and continued services of our executive
      officers, including Howard W. Schwan, our President, John H. Schwan, our
      Chairman and Stephen M. Merrick, our Chief Financial Officer, as well as each
      of
      these other executive officers of the Company: Brent Anderson, Sam Komar, Steve
      Frank and Timothy Patterson. We have an existing employment agreement with
      Howard Schwan, dated January 1, 1997, which is automatically renewed each July
      1
      for another year unless terminated by either party. The agreement includes
      confidentiality, inventions, non-compete and other customary provisions. The
      loss of any of these executive officers would have an adverse effect on our
      business.





In
      addition, our continued growth depends on our ability to attract and retain
      experienced key employees. Competition for qualified employees is intense,
      and
      the loss of such persons, or an inability to attract, retain and motivate such
      skilled employees, could have a material adverse effect on our results of
      operations, financial condition and prospects. There can be no assurance that
      we
      will be able to retain our existing personnel or attract and retain additional
      qualified employees.


17





*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), in combination, own approximately 43.6% of the
      outstanding shares of common stock of the Company and have options and warrants
      to purchase additional shares which, if exercised, would aggregate 57.9% 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. **





***Financial
      Risks***





*We
      have a high level of debt relative to our equity and negative working capital,
      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, 2005, we had $20,799,000 of debt outstanding and $2,726,000 in
      shareholders equity. Also, our current debt exceeded our current assets by
      $2,426,000. 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 new loan agreement with Charter One Bank
      in
      which Charter One Bank provided to us a line of credit totaling $12,800,000,
      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 $6,500,000. The proceeds of the loan were utilized to pay off
      outstanding loans from Cole Taylor Bank in the aggregate amount of $7,409,000
      and from Banco Popular in the amount of $2,944,000. Also, on the same day,
      Messrs. John Schwan and Stephen Merrick, each loaned to the Company the sum
      of
      $500,000 in exchange for five year subordinated notes and warrants to purchase
      up to 151,515 shares of common stock of the Company, each. As a result of this
      re-financing, our total debt has increased from $20,799,000 (as of December
      31,
      2005) to approximately $23,680,000 (as of February 1, 2006). However, as a
      result of these transactions, (i) there was available to the Company cash and
      loan availability (after payment of the Cole Taylor Bank loan) of about
      $1,117,000 and (ii) the Company had positive working capital at that time of
      approximately $988,000.


18





*A
      significant amount of cash will be required to service our debt 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. This,
      in
      part, is 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. In the absence
      of
      cash flow from operations sufficient to meet our debt service obligations,
      we
      could face substantial cash problems.





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





Our
      credit facility contains restrictive debt covenants that, among other things,
      restrict our ability to:





·
            Borrow
                money;


·
            Pay
                dividends and make distributions;


·
            Issue
                stock;


·
            Make
                certain investments;


·
            Use
                assets as security in other
                transactions;


·
            Create
                liens;


·
            Enter
                into affiliate transactions;


·
            Merge
                or consolidate; or


·
            Transfer
                and sell assets.





In
      addition, our credit facility also requires us to meet certain financial tests,
      including (i) achieving earnings before interest taxes and depreciation (EBITDA)
      of specified amounts for each of the months ended January 31, 2006 through
      June
      30, 2006, (ii) maintaining tangible net worth in excess of $3,500,000, (iii)
      maintaining specified ratios of senior debt to EBITDA and (iv) maintaining
      a
      ratio of EBITDA to fixed charges. These restrictive covenants may limit our
      ability to expand or pursue our business strategies.


19





Our
      ability to comply with the restrictions contained in our credit facility may
      be
      affected by changes in our business condition or results of operation, adverse
      regulatory developments, or other events beyond our control. A failure to comply
      with these restrictions could result in a default under our credit facility
      which, in turn, could cause our debt to become immediately due and payable.
      If
      our debt were to be accelerated, we cannot assure that we would be able to
      repay
      it. In addition, a default would give our lender the right to terminate any
      commitment to provide us with additional funds.





**Item
      No. 2 Properties**





We
      own
      our principal plant and offices located in Barrington, Illinois, approximately
      45 miles northwest of Chicago, Illinois. The facility includes approximately
      75,000 square feet of office, manufacturing and warehouse space. This facility
      is subject to a mortgage loan in the principal amount of $2,800,000, having
      a
      term of 5 years, with payments amortized over 25 years.





We
      lease
      a warehouse facility in Cary, Illinois under a two-year lease at the base rate
      of $6,000 per month and at a total monthly cost of approximately $8,000. The
      lease expires on September 30, 2007. The facility includes 16,306 square feet
      of
      warehouse and office space which is utilized principally for the warehousing
      of
      balloon inventory.





The
      Company also leases approximately 15,000 square feet of office and warehouse
      space in Rugby, England at an annual lease cost of $51,700, expiring in 2019.
      This facility is utilized to warehouse balloon products and to manage and
      service the Company's operations in England and Europe.





In
      January 2003, Flexo Universal entered into a 5-year lease agreement for the
      lease of approximately 43,000 square feet of manufacturing, warehouse and office
      space in Guadalajara, Mexico at the cost of $17,000 per month.





We
      believe that our properties have been adequately maintained, are in generally
      good condition and are suitable for our business as presently conducted. We
      believe our existing facilities provide sufficient production capacity for
      our
      present needs and for our presently anticipated needs in the foreseeable future.
      We also believe that, with respect to leased properties, upon the expiration
      of
      our current leases, we will be able to either secure renewal terms or to enter
      into leases for alternative locations at market terms.




**Item
      No. 3 Legal Proceedings**





On
      September 5, 2003, Airgas, Inc., Airgas-Southwest, Inc., Airgas-South, Inc.
      and
      Airgas-East, Inc. filed a joint action against CTI Industries Corporation for
      claimed breach of contract in the Circuit Court of Lake County, Illinois
      claiming as damages the aggregate amount of $162,242. The Company filed an
      answer denying the material claims of the complaint, affirmative defenses and
      a
      counterclaim. In the action, the plaintiffs claimed that CTI Industries
      Corporation owed them certain sums for (i) helium sold and delivered, (ii)
      rental charges with respect to helium tanks and (iii) replacement charges for
      tanks claimed to have been lost. On November 2, 2004, this matter was settled.
      The amount agreed to be paid by the Company in settlement totaled $100,000.
      The
      entire amount of the settlement payment has been made.


20





On
      June
      4, 2004, Spar Group, Inc. initiated an arbitration proceeding in New York City
      against the Company. In the proceeding, Spar Group claimed that there was due
      from the Company to Spar Group a sum for services rendered in the amount of
      $180,043, plus interest. Spar Group claimed to have rendered services to the
      Company in various Eckerd stores with respect to the display and ordering of
      metalized and latex balloons for sale in those stores. The Company filed an
      answer denying liability with respect to the claim and asserted a counterclaim
      for damages against Spar Group for breach of its agreement to provide such
      services. On January 13, 2005, this matter was settled. The amount agreed to
      be
      paid by the Company in settlement totaled $100,000 and such amount has been
      paid
      in full.





In
      addition, the Company is also party to certain lawsuits or claims arising in
      the
      normal course of business. The ultimate outcome of these matters is unknown,
      but
      in the opinion of management, we do not believe any of these proceedings will
      have, individually or in the aggregate, a material adverse effect upon our
      financial condition, cash
      flows or
      future results of operation.





**Item
      No. 4 Submission of Matters to a Vote of Security Holders**





At
      the
      Company’s Annual Meeting of Shareholders on December 2, 2005, the following
      actions were submitted and approved by vote of its shareholders:





1.  The
      election of seven directors; and




2.  The
      ratification of the Board’s selection of Weiser LLP as the Company’s independent
      certified public accountants.




A
      total
      of 1,750,704 shares (approximately 90%) of the issued and outstanding voting
      stock of the Company were represented by proxy or in person at the meeting.
      These shares were voted on the matters described above as
      follows:


21





1.  For
      the
      directors as follows:





**Name**
            
            **Total
                Votes For**
            
            **Total
                Votes Against**John
                H. Schwan
            
            1,748,646
            
            2,048Stephen
                M. Merrick
            
            1,748,646
            
            2,048Howard
                W. Schwan
            
            1,748,646
            
            2,048Stanley
                M. Brown
            
            1,748,646
            
            2,048Michael
                Avramovich
            
            1,748,646
            
            2,048Bret
                Tayne
            
            1,748,646
            
            2,048John
                I. Collins
            
            1,748,646
            
            2,048





2.  For
      the
      Ratification of Weiser LLP as the Company’s independent certified public
      accountants as follows:





**Total
                Votes For**
            
            **Total
                Votes Against**
            
            **Total
                Broker Non-Votes and Total Votes****Abstaining**1,748,104
            
            2000
            
            600





There
      were no other matters voted on at the Company’s 2005 Annual Meeting of
      Shareholders, nor was there a submission of any other matter to a vote of
      securities holders at any time during the Company’s fourth fiscal
      quarter.





**PART
      II**





**Item
      No. 5 Market for Registrant's Common Equity, Related Stockholder Matters and
      Issuer Purchases of Equity Securities**





Market
      Information. The Company's Common Stock was admitted to trading on the NASDAQ
      SmallCap Market (now the NASDAQ Capital Market) under the symbol CTIB on
      November 5, 1997. Prior to that time, there was no established public trading
      market for the Company's Common Stock.





The
      high
      and low sales prices for the last eight fiscal quarters (retroactively adjusted
      to reflect post-reverse split share and stock dividend values), according to
      the
      NASDAQ Stock Market's Stock Price History Report, were:




**High**
            
            **Low**January
                1, 2004 to March 31, 2004
            
            
            4.10
            
            
            2.01April
                1, 2004 to June 30, 2004
            
            
            4.38
            
            
            1.62July
                1, 2004 to September 30, 2004
            
            
            3.15
            
            
            1.32October
                1, 2004 to December 31, 2004
            
            
            2.40
            
            
            1.25January
                1, 2005 to March 31, 2005
            
            
            3.15
            
            
            1.50April
                1, 2005 to June 30, 2005
            
            
            4.74
            
            
            0.50July
                1, 2005 to September 30, 2005
            
            
            7.67
            
            
            1.48October
                1, 2005 to December 31, 2005
            
            
            5.50
            
            
            2.72January
                1, 2006 to March 31, 2006
            
            
            3.56
            
            
            2.77




22





As
      of
      March 21, 2006, there were approximately 52 holders of record of the Company’s
      Common Stock. The Company believes that its total number of actual shareholders
      is substantially greater than the number of record shareholders.





The
      Company has never paid any cash dividends on its Common Stock and does not
      currently intend to pay cash dividends on its Common Stock in the foreseeable
      future. The Company currently intends to retain all its earnings to finance
      the
      development and expansion of its business. Under the terms of its current loan
      agreement, the Company is restricted from declaring any cash dividends or other
      distributions on its shares.





**Recent
      Sales of Unregistered Securities**





During
      February 2003, John H. Schwan loaned $930,000 to the Company and Stephen M.
      Merrick loaned $700,000 to the Company, each in exchange for (i) two year
      promissory notes bearing interest at 9% per annum and (ii) five year warrants
      to
      purchase up to 163,000 shares of Common Stock of the Company at $4.87 per share,
      the market price of the Common Stock on the date of the Warrants. The proceeds
      of these loans were to (i) re-finance the bank loan of CTI Mexico in the amount
      of $880,000 and (ii) to provide financing for CTI Mexico and Flexo Universal.
      Payment of the principal of the notes has been extended by agreement of Mr.
      Merrick and Mr. Schwan and is scheduled to mature on October 1, 2006.





On
      July
      1, 2004, the Company entered into a Standby Equity Distribution Agreement
      (”SEDA”) with Cornell Capital under which Cornell agreed to provide up to $5
      million to the Company in connection with the purchase of common stock of the
      Company over a two year term. Under the terms of the agreement, the Company
      has
      the option to sell shares of its common stock to Cornell at the market price
      for
      the stock at the time of the sale. The Company may request advances,
      representing purchases of its stock, of up to $100,000 in any week, up to a
      maximum amount of $400,000 in any month, subject to registration of the stock
      prior to sale. The Company has not, as yet taken action to register shares
      to be
      sold under the SEDA and the Board of Directors of the Company is reviewing
      the
      arrangement to make a determination as to whether and when to proceed under
      it.
      On August 5, 2004, the Company issued 14,162 shares of its common stock to
      Cornell and 3,500 shares of its common stock to Newbridge Securities, Cornell’s
      stock placement agent for underwriting services as partial consideration under
      the terms of SEDA.





On
      September 13, 2004, the Company issued 18,018 shares of its common stock to
      Thornhill Capital, LLC, in return for consulting services.


23


On
        September 23, 2005, the Company issued 50,229 shares of its common stock
        to
        three service providers as payment for services.


On
      February 1, 2006, John H. Schwan and Stephen M. Merrick each loaned the sum
      of
      $500,000 to the Company, each in exchange for (i) five year promissory notes
      bearing interest at 2% in excess of the prime rate and (ii) five year warrants
      to purchase up to 151,515 shares each of common stock of the Company at the
      price of $3.30 per share, an amount equal to 110% of the market price of the
      common stock on the day immediately preceding the date of the
      transaction.


24




**Item
      No. 6 Selected Financial Data**





The
      following selected financial data are derived from the consolidated financial
      statements of the Company. The data should be read in conjunction with the
      consolidated financial statements, related notes, and other financial
      information included herein.


**Year
                  ended December 31,**2005
              
              2004
              
              2003
              
              2002
              
              2001**Statement
                  of Operations Data:**Net
                  Sales
              
              $
              29,190
              
              $
              37,193
              
              $
              36,260
              
              $
              41,236
              
              $
              27,446Costs
                  of Sales
              
              $
              22,726
              
              $
              30,841
              
              $
              29,627
              
              $
              32,344
              
              $
              19,835Gross
                  Profit
              
              $
              6,464
              
              $
              6,352
              
              $
              6,633
              
              $
              8,892
              
              $
              7,611Operating
                  expenses
              
              $
              5,812
              
              $
              6,402
              
              $
              6,856
              
              $
              7,447
              
              $
              6,595(Loss)
                  income from operations
              
              $
              652
              
              $
              (50
              )
              $
              (223
              )
              $
              1,445
              
              $
              1,016Interest
                  expense
              
              $
              1,231
              
              $
              1,350
              
              $
              1,103
              
              $
              832
              
              $
              1,030Other
                  (income) expense
              
              $
              (45
              )
              $
              (208
              )
              $
              23
              
              $
              278
              
              $
              0(Loss)
                  income before taxes and minority interest
              
              $
              (534
              )
              $
              (1,192
              )
              $
              (1,349
              )
              $
              335
              
              $
              (14
              )Income
                  tax expense (benefit)
              
              $
              (200
              )
              $
              1,286
              
              $
              (782
              )
              $
              39
              
              $
              276Minority
                  interest
              
              $
              0
              
              $
              1
              
              $
              0
              
              $
              6
              
              $
              58Net
                  (loss) income
              
              $
              (333
              )
              $
              (2,479
              )
              $
              (566
              )
              $
              302
              
              $
              (232
              )(Loss)
                  earnings per common shareBasic
              
              $
              (.17
              )
              $
              (1.28)
              
              $
              (0.30
              )
              $
              0.18
              
              $
              (0.15
              )Diluted
              
              $
              (.17
              )
              $
              (1.28)
              
              $
              (0.30
              )
              $
              0.16
              
              $
              (0.15
              )**Other
                  Financial Data:**Gross
                  margin percentage
              
              
              22.14
              %
              
              17.08
              %
              
              18.29
              %
              
              21.56
              %
              
              27.73
              %Capital
                  Expenses
              
              $
              550
              
              $
              306
              
              $
              2,007
              
              $
              2,478
              
              $
              1,002Depreciation
                  & Amortization
              
              $
              1,463
              
              $
              1,651
              
              $
              1,619
              
              $
              1,588
              
              $
              1,666**Balance
                  Sheet Data:**Working
                  capital (Deficit)
              
              $
              (2,426
              )
              $
              (2,790
              )
              $
              (706
              )
              $
              (2,907
              )
              $
              (278
              )Total
                  assets
              
              $
              23,536
              
              $
              27,888
              
              $
              30,270
              
              $
              30,272
              
              $
              24,664Short-term
                  obligations(1)
              
              $
              8,618
              
              $
              9,962
              
              $
              6,692
              
              $
              7,385
              
              $
              7,074Long-term
                  obligations
              
              $
              6,039
              
              $
              6,491
              
              $
              8,909
              
              $
              5,726
              
              $
              5,737Stockholders’
                  Equity
              
              $
              2,726
              
              $
              2,951
              
              $
              5,212
              
              $
              5,474
              
              $
              4,325




(1)
        Short
        term obligations consist of primarily of borrowings under bank line of credit
        and current portion of long-term debt
  25





The
      following table sets forth selected unaudited statements of income for each
      quarter of fiscal 2005 and 2004:




For
                  the Year Ended December 31, 2005 (1)1st
              
              2nd
              
              3rd
              
              4thQuarter
              
              Quarter
              
              Quarter
              
              QuarterNet
                  sales
              
              $
              9,103,327
              
              $
              7,572,626
              
              $
              6,033,831
              
              $
              6,480,019Gross
                  profit
              
              $
              1,873,993
              
              $
              1,582,954
              
              $
              1,242,186
              
              $
              1,765,016Net
                  income (loss)
              
              $
              84,488
              
              $
              (53,616
              )
              $
              (416,267
              )
              $
              52,186Earnings
                  (loss) per common shareBasic
              
              $
              0.04
              
              $
              (0.03
              )
              $
              (0.21
              )
              $
              0.03Diluted
              
              $
              0.04
              
              $
              (0.03
              )
              $
              (0.21
              )
              $
              0.02


(1)
          Earnings per common share are computed independently for each of the quarters
          presented. Therefore, the sum of the quarterly per common share information
          may
          not equal the annual earnings per common share.
 For
                    the Year Ended December 31, 2004 (1)1st
                
                2nd
                
                3rd
                
                4thQuarter
                
                Quarter
                
                Quarter
                
                QuarterNet
                    sales
                
                $
                10,893,984
                
                $
                9,591,785
                
                $
                8,125,521
                
                $
                8,581,819Gross
                    profit
                
                $
                2,147,370
                
                $
                2,032,028
                
                $
                1,669,778
                
                $
                502,944Net
                    income (loss)
                
                $
                371,901
                
                $
                (135,681
                )
                $
                (150,370
                )
                $
                (2,565,220
                )Earnings
                    (loss) per common shareBasic
                
                $
                0.19
                
                $
                (0.07
                )
                $
                (0.08
                )
                $
                (1.31
                )Diluted
                
                $
                0.18
                
                $
                (0.07
                )
                $
                (0.08
                )
                $
                (1.31
                )
  (1)
            Earnings per common share are computed independently for each of the
            quarters
            presented. Therefore, the sum of the quarterly per common share information
            may
            not equal the annual earnings per common share.
  26


**Item
      No. 7 Management's Discussion and Analysis of Financial Condition and Results
      of
      Operations**





**Overview**





The
      Company produces film products for novelty, packaging and container
      applications. These products include metalized balloons, latex balloons and
      related latex toy products, films for packaging applications, and flexible
      containers for packaging and storage applications. We produce all of our film
      products for packaging and container applications at the facilities in
      Barrington, Illinois. We produce all of our latex balloons and latex products
      at
      our facility in Guadalajara, Mexico. Substantially all of our film products
      for
      packaging applications and flexible containers for packaging and storage are
      sold to customers in the United States. We market and sell our novelty items
      -
      principally metalized balloons and latex balloons - in the United States,
      Mexico, the United Kingdom and a number of additional countries.





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





(000
                Omitted)$
            
            %
                of
            
            $
            
            %
                of
            
            $
            
            %
                ofProduct
                Category
            
            2005
            
            Net
                Sales
            
            2004
            
            Net
                Sales
            
            2003
            
            Net
                SalesMetalized
                Balloons
            
            
            11,737
            
            
            40.2
            
            
            16,238
            
            
            43.9
            
            
            12,401
            
            
            34.2Latex
                Balloons
            
            
            4,855
            
            
            16.6
            
            
            5,244
            
            
            14.1
            
            
            4,134
            
            
            11.4Films
            
            
            7,616
            
            
            26.1
            
            
            8,808
            
            
            23.7
            
            
            6,722
            
            
            18.5Pouches
            
            
            4,079
            
            
            14.0
            
            
            5,028
            
            
            13.5
            
            
            10,718
            
            
            29.6Helium/Other
            
            
            903
            
            
            3.1
            
            
            1,875
            
            
            4.8
            
            
            2,284
            
            
            6.329,190
            
            
            
            
            
            37,193
            
            
            
            
            
            36,259





Our
      primary expenses include the cost of products sold and selling, general and
      administrative expenses.





Cost
      of
      products sold primarily consists of expenses related to raw materials, labor,
      quality control and overhead directly associated with production of our
      products, as well as shipping costs relating to the shipment of products to
      customers. Cost of products sold is impacted by the cost of the raw materials
      used in our products, the cost of shipping, along with our efficiency in
      managing the production of our products.





Selling,
      general and administrative expenses include the compensation and benefits paid
      to our employees, all other selling expenses, marketing, promotional expenses,
      travel and other corporate administrative expenses. These other corporate
      administrative expenses include professional fees, depreciation and
      amortization, occupancy costs, communication costs and other similar operating
      expenses. Selling, general and administrative expenses can be affected by a
      number of factors, including staffing levels and the cost of providing
      competitive salaries and benefits, the cost of regulatory compliance and other
      administrative costs.


27





Purchases
      by a limited number of customers represent a significant portion of our total
      revenues. In 2005, sales to our top 10 customers represented 62.9% of net
      revenues. During 2005, there were three customers to whom our sales represented
      more than 10% of net revenues:





**Customer**
            
            **Product**
            
            **2005
                Sales**
            
            **%
                of 2005****Revenues**Dollar
                Tree Stores
            
            
            Balloons
            
            $
            3,987,000
            
            
            13.6Rapak
                L.L.C
            
            
            Pouches
            
            $
            6,860,000
            
            
            23.5ITW
                Space Bag
            
            
            Film
            
            $
            3,889,000
            
            
            13.3





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.





Over
      the
      past three years, we have endeavored to reduce our operating costs and to become
      more efficient in our production activities. Our total SG&A and factory
      overhead expenses for each of the years ended December 31, 2005, 2004 and 2003
      have been as follows:


**For
                  the Year Ending 12/31****2005**
              
              **2004**
              
              **2003**Overhead(US
                  Operation Only)
              
              $
              4,575,000
              
              $
              6,042,000
              
              $
              7,124,000SG&A(Consolidated)
              
              $
              5,688,000
              
              $
              6,920,000
              
              $
              7,312,000




28





**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, 2005, 2004 and 2003.
      Our results of operations for the periods described below are not necessarily
      indicative of results of operations for future periods .




**Year
                ended December 31,****2005**
            
            **2004**
            
            **2003*****Net
                sales***
            
            
            100.0
            %
            
            100.0
            %
            
            100.0
            %Costs
                and expenses:Cost
                of products sold
            
            
            77.9
            
            
            82.9
            
            
            81.7Selling,
                general and administrative
            
            
            19.9
            
            
            17.2
            
            
            18.9Income
                from operations
            
            
            2.2
            
            
            (0.1
            )
            
            (0.6
            )Interest
                expense
            
            
            (4.2
            )
            
            (3.6
            )
            
            (3.0
            )Other
                income(expense)
            
            
            0.2
            
            
            0.5
            
            
            (0.1
            )Loss
                before income taxes
            
            
            (1.8
            )
            
            (3.2
            )
            
            (3.7
            )Provision
                for income taxes
            
            
            (0.7
            )
            
            3.4
            
            
            (2.1
            )Net
                loss
            
            
            (1.1
            )%
            
            (6.6
            )%
            
            (1.6
            )%




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





*Net
      Sales.*





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


29





*Cost
      of Sales* .





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





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





*General
      and Administrative*





For
      fiscal 2005, administrative expenses were $3,847,000, or 13% of net sales,
      compared to administrative costs in fiscal 2004 of $4,411,000, or 11.8% of
      net
      sales, a reduction of $564,000 or almost 13%. The decrease in administrative
      costs during 2005 is attributable to the following items: (i) a reduction of
      $167,000 in consulting fees, (ii) a decrease of $146,000 in legal expense,
      and
      (iii) a reduction of $102,000 in bad debt expense.





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





*Selling*





Selling
      expenses declined from $1,495,000 in fiscal 2004, or 4% of net sales, to
      $1,065,000 in fiscal 2005, or 4% of net sales. Components of the decline in
      selling expenses for 2005 were: (i) a reduction in royalties of $190,000, (ii)
      a
      reduction in salary expense of $188,000 and (iii) a reduction in commissions
      of
      $65,000.





*Marketing
      and Advertising*





Marketing
      expenses declined from $1,014,000 in fiscal 2004, or 3% of net sales, to
      $777,000 in fiscal 2005, or 3% of net sales. The components of the decline
      in
      expense for 2005 included: (i) reduced salary expense of $73,000 and (ii) a
      reduction in service fees of $160,000.





*Gain
      on Sale of Assets and Other Operating Income*





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


30




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




*Other
      Expense*





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





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





*Net
      Income or Loss*





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





*Income
      Taxes*





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


31





**Year
      Ended December 31, 2004 Compared to Year Ended December 31, 2003**





*Net
      Sales.*





For
      the
      fiscal year ended December 31, 2004, consolidated revenues from the sale of
      all
      products were $37,193,000, compared to consolidated revenues of $36,260,000
      for
      the year ended December 31, 2003, an increase of 2.6%. Revenue changes in our
      principal product categories included: (i) a 20.7% decrease in sales of printed
      and laminated films from $17,439,000 in 2003 to $13,823,000 in 2004, (ii) a
      31.6% increase in sales of metalized balloons from $12,405,000 in 2003 to
      $16,320,000 in 2004 and (iii) a 27.4% increase in the sales of latex balloons
      from $4,125,000 in 2003 to $5,255,000 in 2004. These changes in revenues
      included a decrease in sales to two principal customers. Sales in 2003 to these
      two customers were as follows: (i) $10,298,000 to ITW Spacebag for film and
      consumer storage bags and (ii) $4,006,000 to Hallmark Cards, principally for
      metalized balloons. During 2004, sales to each of those customers, respectively,
      were: (i) $6,266,000 and (ii) $3,421,000. These decreases were offset by an
      increase in sales to Rapak, LLC, a principal customer of packaging film and
      to a
      new customer of foil balloons. During 2003, sales to Rapak were $5,360,000.
      During 2004, sales to each of those customers, respectively, were $7,466,000
      and $4,352,000.





For
      the
      fiscal year 2004, on a consolidated basis, metalized balloons represented 43.9%
      of sales, laminated and printed films 37.2% of sales and latex balloons 14.1%
      of
      sales. During fiscal 2003, metalized balloons represented 34.2% of sales,
      laminated and printed films 48.1% of sales and latex balloons 11.4% of sales.
      The Company anticipates that in 2005, the mix of products will change in so far
      as the percentage of metalized ballons will decrease, laminated and printed
      films will be consistent and latex balloon sales should increase.





*Cost
      of Sales.*





For
      fiscal 2004, cost of sales increased to 82.9% of net sales compared to 81.7%
      of
      net sales for fiscal 2003. In 2004, the product mix changed from selling a
      majority of laminate and printed film to a majority of metalized balloons which
      historically have lower margins. In fiscal 2004, profit margins on metalized
      balloons, latex balloons and laminated and printed film were 13.0%, 10.1% and
      25.3%, respectively, compared to margins on the same product lines for 2003
      of
      10.4%, 9.1% and 34.9%. The decrease in the margins of the laminated and printed
      film was a result of the difference in the product mix and a reduction of
      the prices charged for consumer storage bags. Cost of sales were higher, as
      a
      percentage of net sales in the fourth quarter of 2004 than in prior quarters
      of
      2004 and the fourth quarter of 2003, resulting in lower gross profit than in
      those prior quarters by reason of the facts that: (i) sales of storage bags
      continued to decline resulting in a shift in product mix to lower margin
      products, (ii) higher costs of production in prior quarters resulted in higher
      unit costs for metalized balloons sold during the fourth quarter and (iii)
      there
      were discounted and low margin sales of balloon products in the fourth quarter.
      Management anticipates improvement in margins for balloon products during 2005
      as reduced production overhead expenses are reflected in lower unit costs.


32





*General
      and Administrative.*





For
      fiscal 2004, administrative expenses were $4,411,000 or 11.9% of net sales,
      as
      compared to $4,055,000 or 11.2% of net sales for fiscal 2003. The increase
      in
      general and administrative expenses is attributable to an increase in bad debt
      reserves and personnel costs. The Company expects that in 2005, there will
      be an
      increase in these expenses involving personnel costs.





*Selling.*





For
      fiscal 2004, selling expenses were $1,495,000 or 4.0% of net sales compared
      to
      $1,442,000, or 4.0% of net sales for fiscal 2003. There was no significant
      change in selling expenses from 2003 to 2004. The Company expects an increase
      in
      selling expenses in 2005.





*Marketing
      and Advertising.*





For
      fiscal 2004, advertising and marketing expenses were $1,014,000 or 2.7% of
      net
      sales, compared to $1,816,000 or 5% of net sales for fiscal 2003. The decrease
      is attributable principally to a reduction in personnel cost, a reduction in
      catalog expense, and decrease in artwork and films expenses. The Company
      expects a small decrease in these expenses in 2005.





*Gain
      on Sale of Assets and Other Operating Income*





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


33





The
      Company had other income during 2003 of $428,000 arising principally from the
      forgiveness of certain indebtedness





These
      items of gain from sales of assets and other income were reported as Other
      Income in the Consolidated Statements of Operations for the years ended December
      31, 2004 and have been re-classified into income (loss) from operations in
      the
      Restated Consolidated Statements of Operations for those years.




*Other
      Income (Expense).*





For
      fiscal 2004, interest expense and loan fees totaled $1,350,000 or 3.6% of sales.
      For fiscal 2003, interest expense and loan fees totaled $1,103,000 or 3.0%
      of
      sales. The increase in interest expense is attributable principally to increased
      levels of borrowing and an increased average rate of interest on outstanding
      indebtedness. The Company had currency exchange gains during 2004 of $208,000
      compared to currency exchange losses during fiscal 2003 of $36,000.





*Net
      Income or Loss.*





For
      the
      fiscal year ended December 31, 2004, the Company had a loss before taxes and
      minority interest of $1,192,000 compared to a loss before taxes and minority
      interest for fiscal 2003 of $1,349,000. The net loss for fiscal 2004 was
      $2,479,000 compared to net loss for fiscal 2003 of $566,000.





*Income
      Taxes.*





For
      the
      fiscal year ended December 31, 2004, the Company had an income tax expense
      of
      $1,286,000 compared to an income tax benefit of $782,000 for fiscal 2003. The
      amount of the income tax expense or benefit recognized by the Company for both
      2004 and 2003 reflects adjustments in deferred tax assets and other items
      arising from the operating results of the Company for each year. This increase,
      which was recorded during the fourth quarter, was made after management
      determined, based on fourth quarter activity, that the realization of the
      deferred tax asset was not likely in the foreseeable future. Fourth quarter
      activity affecting this determination included lower than anticipated sales
      in
      the storage bag product line and lower margin sales of novelty products.





**Financial
      Condition, Liquidity and Capital Resources**





*Cash
      Flow From Operations* .
      Cash
      flow from operations for the fiscal year ended December 31, 2005 was
      $ 2,658,000 ,
      compared to cash flow used in operations for the fiscal year ended December
      31,
      2004 of $ 385,000 .
      Significant changes in working capital items contributing to cash flow from
      operations during 2005 were:


34





·
            Depreciation
                and amortization of $1,480,000


·
            Other
                non-cash changes for reserves and allowances of
                $474,000


·
            A
                decrease in accounts receivable of $1,681,000


·
            A
                decrease in inventory of $1,130,000


·
            A
                decrease in other assets in the amount of $167,000


·
            A
                decrease in accounts payable in the amount of $1,976,000





Depreciation
      declined by $160,000 in 2005
      compared to 2004. We anticipate the level of depreciation to continue for 2006
      at approximately the same level as 2005. The decrease in inventory during 2005
      resulted from an effort to reduce our inventory of novelty balloon items through
      discounted and special sales and from reduced levels of production arising
      from
      reduced sales levels. We do not expect inventory to reduce during
      2006.





*Cash
      Used in Investing Activities.* During
      2005, we used net $ 400,000 in
      investing activities, consisting of purchases of equipment in the amount of $551,000 and
      sales of assets in the amount of $151,000.





*Cash
      Used in Financing Activities.* During
      fiscal 2005, cash used in financing activities amounted to $2,474,000, compared
      to cash provided by financing activities of $869,000 during fiscal 2004. We
      used
      a total of $2,604,000 to
      reduce our short and long term bank debt, and received $231,000 from the
      issuance of new long term debt.





As
      of
      December 31, 2005, we had total loans outstanding from financial institutions
      of
      $10,074,000 consisting principally of a term loan and revolving line of credit
      from Cole Taylor Bank, Chicago, Illinois in the total amount of $7,209,000
      and a
      mortgage loan from Banco Popular having a balance of $2,781,000. Under the
      terms
      of our loan agreement with Cole Taylor Bank, the credit facility with that
      bank
      expired on December 31, 2005. In December, 2005, we entered into an agreement
      with Cole Taylor Bank under which this credit facility was extended to January
      31, 2006.





On
      February 1, 2006, we entered into a Loan Agreement with Charter One Bank,
      Chicago, Illinois, under which the Bank agreed to provide a credit facility
      to
      our Company in the total amount of $12,800,000, 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 $6,500,000, secured by inventory and receivables. The amount
      we can borrow on the revolving line of credit includes 85% of eligible accounts
      receivable and 60% of eligible inventory.


35




Certain
      terms of the loan agreement include:





·
            *Excess
                Availability*.
                The agreement requires us to maintain excess availability in the
                amount of
                $500,000 plus an amount equal to 36% of all payables over 90 days
                past
                due.





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


·
            Borrow
                money;


·
            Pay
                dividends and make distributions;


·
            Issue
                stock


·
            Make
                certain investments;


·
            Use
                assets as security in other
                transactions;


·
            Create
                liens;


·
            Enter
                into affiliate transactions;


·
            Merge
                or consolidate; or


·
            Transfer
                and sell assets.





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


·
            We
                are required to meet certain levels of earnings before interest taxes
                and
                depreciation (EBITDA) measured on a monthly cumulative basis during
                the
                first six months of the loan term;


·
            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.





The
      loan
      agreement provides for interest at varying rates in excess of the Bank’s prime
      rate, depending on the level of senior debt to EBITDA over time. The 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 Equity is:
            
            The
                Premium to the Prime Rate is:Greater
                or equal to 4.5 to 1.0
            
            
            1.50
            %Between
                4.5 to 1 and 4.0 to 1
            
            
            1.25
            %Between
                4.0 to 1 and 3.5 to 1
            
            
            1.00
            %Between
                3.5 to 1 and 2.75 to 1
            
            
            0.75
            %Between
                2.75 to 1 and 2.0 to 1
            
            
            0.50
            %Less
                than 2.0 to 1
            
            
            0.25
            %




36




Also,
      under the loan agreement, we are required to purchase a swap agreement with
      respect to at least 60% of the mortgage and term loan portions of our
      loan.





This
      loan
      closed on February 1, 2006. At that time, we used $10,353,000 of proceeds of
      the
      loan to pay off the loan balances of our Company for the credit facility at
      Cole
      Taylor Bank, Chicago, Illinois and the mortgage loan at Banco
      Popular.





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





*Current
      Assets.* As of
      December 31, 2005, the total current assets of the Company were $12,335,000,
      compared to total current assets of $15,645,000 as of December 31, 2004. The
      change in current assets reflects, principally, (i) a reduction in receivables
      of $1,779,000, (ii) a reduction in inventories of $1,325,000, (iii) a reduction
      in cash of $264,000 and (iv) an increase in prepaid expenses of $60,000. The
      reduction in receivables is a reflection of the reduced level of sales of the
      Company during the second half of 2005. The net inventories of the Company
      decreased from $8,348,000 as of December 31, 2004 to $7,023,000 as of December
      31, 2005, a reduction of $1,325,000 or about 15.9%. The reduction reflects
      principally a decline in the Company’s finished goods inventory of metalized
      balloons, as the result of management’s efforts to reduce inventory levels of
      that product line and also reduced production levels during the second half
      of
      2005.





*Property,
      Plant and Equipment.* During
      fiscal 2005, the Company invested $550,000 in capital items. During 2004, the
      Company invested $306,000 in capital items.





*Current
      Liabilities* .
      Total
      current liabilities decreased from $18,435,000 as of December 31, 2004 to
      $14,761,000 as of December 31, 2005, a decrease of $3,674,000 or 20%. This
      reduction reflects: (i) a decrease of $1,430,000 in trades payable, (ii) a
      decrease of $1,350,000 in the amount outstanding on our revolving line of
      credit, (iii) an increase in the amount of $6,000 in the current portion of
      long
      term debts and (v) a decrease of $886,000 in accrued liabilities.





*Liquidity
      and Capital Resources.* As of
      December 31, 2005, our current liabilities exceeded our current assets by
      $2,426,000. However, as the result of the Loan Agreement with Charter One Bank
      and the long-term subordinated debt investment of two of our principal
      shareholders on February 1, 2006, we received long-term debt funding totaling
      $7,300,000 and then had positive working capital of approximately $990,000.
      We
      believe that we have sufficient cash and financial resources to meet our
      operating requirements through December 31, 2006.





*Shareholders’
      Equity.* Shareholders’
      equity was $2,726,000 as of December 31, 2005 compared to $2,951,000 as of
      December 31, 2004.


37





The
      contractual commitments of the Company, determined as of December 31, 2005,
      over
      the next five years are as follows:


Future
                  Minimum Principal Payments
              
              Operating
                  Leases
              
              Other
                  Liabilities
              
              Licenses
              
              Total2006
              
              $
              3,567,144
              
              $
              414,876
              
              $
              -
              
              $
              76,664
              
              $
              4,058,6842007
              
              $
              811,992
              
              $
              345,643
              
              $
              850,000
              
              $
              76,664
              
              $
              2,084,2992008
              
              $
              811,992
              
              $
              51,700
              
              $
              794,339
              
              $
              76,664
              
              $
              1,734,6952009
              
              $
              896,454
              
              $
              51,700
              
              $
              -
              
              $
              -
              
              $
              948,1542010
              
              $
              811,992
              
              $
              51,700
              
              $
              -
              
              $
              -
              
              $
              863,692Thereafter
              
              $
              2,375,366
              
              $
              465,300
              
              $
              -
              
              $
              -
              
              $
              2,840,666Total
              
              $
              9,274,940
              
              $
              1,380,919
              
              $
              1,644,339
              
              $
              229,992
              
              $
              12,530,190




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





**Seasonality**





In
      the
      metalized product line, sales have historically been seasonal with approximately
      45% occurring in the period from December through March of the succeeding year
      and 21% being generated in the period July through October in recent years.
      The
      sale of latex balloons, pouches and laminated film products have not
      historically been seasonal, and as sales in these 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.


38




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




*Inventory
      Valuation.* Inventories are stated at the lower of cost or market. Cost is determined using
      standard costs which approximate costing determined on a first-in, first out
      basis. Standard costs are reviewed and adjusted periodically and at year end
      based on actual direct and indirect production costs. Labor, overhead and
      purchase price variances from standard costs are determined on a monthly basis
      and inventory is adjusted monthly reflecting these variances. 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, 2005, the Company had established a reserve
      for
      obsolescence, marketability or excess quantities with respect to inventory
      in
      the aggregate amount of $255,000. As of December 31, 2004, the amount of the
      reserve was $187,000. 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.





*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. In 2001, the FASB issued Statement No. 142, "Goodwill and
      Other
      Intangible Assets," which among other things, eliminates the amortization of
      goodwill and certain other intangible assets and requires that goodwill be
      evaluated annually for impairment by applying a fair-value based test. We
      retained valuation consulting firms to conduct an evaluation of our goodwill
      in
      our Mexico subsidiary December 2004 and 2005. As of December 31, 2005, the
      valuation consulting firm determined that the fair value of the Company’s
      interest in Flexo Universal was $988,000, and the carrying value of $1,113,000
      was impaired by $124,000. Accordingly, we have recorded the amount of this
      impairment as an expense and have reduced the carrying value of the Company’s
      interest in Flexo Universal to $989,000.





*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.


39





As
      of
      December 31, 2005, the Company had a net deferred tax asset of $2,807,000,
      representing the amount the Company may recover in future years from future
      taxable income. As of December 31, 2004, the amount of the deferred tax asset
      was $2,606,299. Each quarter and year-end management must make a judgment to
      determine the extent to which the deferred tax asset will be recovered from
      future taxable income. Management of the Company has determined that an
      appropriate allowance against the deferred tax asset, as of December 31, 2005,
      is $2,454,000. The Company recorded a deferred tax asset benefit in the amount
      of $200,000 during 2005 as management has determined that an this deferred
      tax
      asset is more likely than not to be realized.





**Recently
      Issued Accounting Standards**





In
      December 2004, the Financial Accounting Standards Board (“FASB”) issued
      Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment”
(“SFAS Statement 123R”), which replaces SFAS No. 123, “Accounting for
      Stock-Based Compensation,” and supercedes APB Opinion No. 25, “Accounting for
      Stock Issued to Employees.” This statement requires that all share-based
      payments to employees be recognized in the financial statements based on their
      fair values on the date of grant. The Company currently uses the intrinsic
      value
      method to measure compensation expense for stock-based awards. The Stock Based
      Compensation caption within Note 3 provides a pro forma net income (loss) and
      earnings per share as if the Company had used a fair-value based method provided
      by SFAS l23R to measure stock-based compensation for 2004, 2003 and 2002. SFAS
      No. 123R is effective as of the beginning of the first interim or annual
      reporting period that begins after December 31, 2005 and applies to all awards
      granted, modified, repurchased or cancelled after the effective date. The
      Company is evaluating the requirements of SFAS 123R and expects that its
      adoption will not have a material impact on the Company’s consolidated results
      of operations and earnings per share.





In
      November of 2004, the FASB issued SFAS No. 151, “Inventory Costs,” which amends
      the guidance in APB No. 43, Chapter 4, “Inventory Pricing,” to clarify the
      accounting for abnormal amounts of idle facility expense, freight, handling
      costs and wasted material (spoilage). This statement requires that those items
      be recognized as current-period charges regardless of whether they meet the
      criterion of “so abnormal” as stated in ARB No. 43. Additionally, SFAS 151
      requires that allocation of fixed production overheads to the costs of
      conversion be based on the normal capacity of the production facilities. The
      Company is required to adopt the provisions of SFAS No. 151 in the first quarter
      of 2006. The Company does not expect SFAS 151 to have a material impact on
      its
      consolidated results of operations or financial condition.





In
      December of 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets
      - An Amendment of APB Opinion No. 29” (SFAS 153). SFAS 153 eliminates the
      exception for nonmonetary exchanges of similar productive assets and replaces
      it
      with a general exception for exchanges of nonmonetary assets that do not have
      commercial substance. SFAS 153 is effective for fiscal years beginning after
      June 15, 2005 and is required to be adopted by the Company in the first quarter
      of 2006. The Company does not believe that the adoption of SFAS 153 will have
      a
      material impact on the Company’s consolidated results of operations or financial
      condition.


40





In
      May
      2005, the Financial Accounting Standards Board issued Statement of Financial
      Accounting Standards No. 154, “Accounting Changes and Error Corrections - a
      replacement of APB No. 20 and FASB Statement No. 3” (“SFAS 154”). SFAS 154
      replaces APB No. 20, “Accounting Changes” and FASB Statement No. 3, “Reporting
      Accounting Changes in Interim Financial Statements” and changes the requirement
      for accounting for and reporting of a change in accounting principles. SFAS
      154
      is effective for accounting changes and corrections of errors made in fiscal
      years beginning after December 15, 2005. The Company does not anticipate that
      adoption of SFAS 154 will have a material impact on the financial position,
      results of operations or its cash flows.





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





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





The
      Company's earnings are affected by changes in interest rates as a result of
      variable rate indebtedness. If market interest rates for our variable rate
      indebtedness averaged 1% more than the interest rate actually paid for the
      years
      ending December 31, 2005, 2004 and 2003, our interest rate expense would have
      increased, and income before income taxes would have decreased by $72,000,
      $92,000 and $64,000, for these years, respectively. These amounts are determined
      by considering the impact of the hypothetical interest rates on our borrowings.
      This analysis does not consider the effects of the reduced level of overall
      economic activity that could exist in such an environment. Further, in the
      event
      of a change of such magnitude, management would likely take actions to reduce
      our exposure to such change. However, due to the uncertainty of the specific
      actions we would take and their possible effects, the sensitivity analysis
      assumes no change in our financial structure.





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


41





We
      have
      performed a sensitivity analysis as of December 31, 2005 that measures the
      change in the results of our foreign operations arising from a hypothetical
      10%
      adverse movement in the exchange rate of all of the currencies the Company
      presently has operations in. Using the results of operations for 2005, 2004
      and
      2003 for the Company's foreign operations as a basis for comparison, an adverse
      movement of 10% would create a potential reduction in the Company's net income,
      or increase its net loss, before taxes, in the amount of, for each of those
      years, $140,000, $290,000 and $283,000, respectively.





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





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





Reference
      is made to the Consolidated Financial Statements attached hereto.





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





Effective
      February 10, 2005, the Company engaged Weiser, LLP as the Company’s principal
      accountants to audit the Company's financial statements for the year ending
      December 31, 2004. Weiser, LLP replaced Eisner, LLP, which had previously been
      engaged for the same purpose, and whose dismissal was effective February 10,
      2005. The decision to change the Company's principal accountants was approved
      by
      the Company's Audit Committee on February 10, 2005.





The
      reports of Eisner, LLP, on the Company's financial statements for the fiscal
      year ended December 31, 2003, as amended, did not contain an adverse opinion
      or
      disclaimer of opinion, nor were they qualified or modified as to uncertainty,
      audit scope, or accounting principles.





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





**Disclosure
      Controls and Procedures**





(a)
      Evaluation of disclosure controls and procedures. Our principal executive
      officer and principal financial officer, after evaluating the effectiveness
      of
      our disclosure controls and procedures (as defined in Exchange Act Rules
      13a-15(e) and 15d-15(e)) as of the end of the period covered by this report as
      of
      the date of the filing of this Amended Form 10-K, ,
      have
      concluded that, as of such date s our
      disclosure controls and procedures were adequate and effective to ensure that
      material information relating to the Company would be made known to them by
      others within the Company. The
      restatements of financial information in the Report do not include any change
      on
      the Consolidated Statements of Operations for the years ended December 31,
      2005
      or any change on the Consolidated Balance Sheets as of December 31, 2005 or
      2004. For the years ended December 31, 2004 and 2003, the restatements related
      to the Consolidated Statements of Operations do not result in any change in
      Net
      Income (Loss) or Earnings (Loss) Per share. Rather, the changes for those years
      reflect only a reclassification of items of gain or income, originally reported
      as Other Income, to Income (Loss) Form Operations. With respect to the
      Consolidated Statements of Cash Flow for the years ended December 31, 2005,
      2004
      and 2003, the restatements adjust the amounts of certain items of cash flow
      arising from the method used for calculating the effect of exchange rate changes
      on cash and other classes of assets and liabilities. The restatements did not
      result in any change in the net increase (decrease) in cash for any of these
      years. Management now utilizes the methods prescribed in SFAS 95 for the
      calculation of the effect of exchange rate changes.


42





(b)
      Changes in internal controls. There were no significant changes in our internal
      controls or in other factors that could significantly affect the Company's
      disclosure controls and procedures subsequent to the date of their evaluation,
      nor were there any significant deficiencies or material weaknesses in the
      Company's internal controls. As a result, no corrective actions were required
      or
      undertaken, except that, management has changed its method of calculating the
      effect of exchange rate changes.


43


**PART
      III**





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





**Directors
      and Executive Officers**





The
      Company's current directors and executive officers and their ages, as of March
      31, 2006, are as follows:





**Name**
            
            **Age**
            
            **Position
                With The Company**John
                H. Schwan
            
            61
            
            Chairman
                and DirectorHoward
                W. Schwan
            
            51
            
            President
                and DirectorStephen
                M. Merrick
            
            64
            
            Executive
                Vice President, Secretary and DirectorBrent
                Anderson
            
            39
            
            Vice
                President of ManufacturingSamuel
                Komar
            
            49
            
            Vice
                President of MarketingSteven
                Frank
            
            45
            
            Vice
                President of SalesTimothy
                Patterson
            
            45
            
            Vice
                President-Finance and AdministrationStanley
                M. Brown
            
            59
            
            DirectorBret
                Tayne
            
            47
            
            DirectorMichael
                Avramovich
            
            54
            
            DirectorJohn
                I. Collins
            
            46
            
            Director




All
      directors hold office until the annual meeting next following their election
      and/or until their successors are elected and qualified. Officers are elected
      annually by the Board of Directors and serve at the discretion of the Board.
      Information with respect to the business expenses and affiliation of the
      directors and the executive officers of the Company is set forth below:





John
      H.
      Schwan, Chairman. Mr. Schwan has been an officer and director of the Company
      since January 1996. Mr. Schwan has been an executive officer of Rapak L.L.C.
      or
      affiliated companies for over the last 15 years. Mr. Schwan has over 20 years
      of
      general management experience, including manufacturing, marketing and sales.
      Mr.
      Schwan served in the U.S. Army Infantry in Vietnam from 1966 to 1969, where
      he
      attained the rank of First Lieutenant.





Howard
      W.
      Schwan, President. Mr. Schwan has been associated with the Company for 21 years,
      principally in the management of the production and engineering operations
      of
      the Company. Mr. Schwan was appointed as Vice President of Manufacturing in
      November 1990, was appointed as a director in January 1996, and was appointed
      as
      President in June 1997.





Stephen
      M. Merrick, Executive Vice President and Secretary. Mr. Merrick has been a
      director of the Company for more than 20 years and has been an officer of the
      Company since 1996. Mr. Merrick is Of Counsel to the law firm of Vanasco Genelly
      & Miller, Chicago, Illinois, who have provided legal services to the
      Company, and has been engaged in the practice of law for more than 40 years.
      Mr.
      Merrick is also Senior Vice President, Director and a member of the Management
      Committee of Reliv International, Inc. (NASDAQ), a manufacturer and direct
      marketer of nutritional supplements and food products.


44





Brent
      Anderson, Vice President of Manufacturing. Mr. Anderson has been employed by
      the
      Company since January 1989, and has held a number of engineering positions
      with
      the Company including Plant Engineer and Plant Manager. In such capacities
      Mr.
      Anderson was responsible for the design and manufacture of much of the Company's
      manufacturing equipment. Mr. Anderson was appointed Vice President of
      Manufacturing in June 1997.





Samuel
      Komar, Vice President of Marketing. Mr. Komar has been employed by the Company
      since March of 1998, and was named Vice-President of Sales in September of
      2001.
      Mr. Komar has worked in sales for 16 years, and prior to his employment with
      the
      Company, Mr. Komar was with Bob Gable & Associates, a manufacturer of
      sporting goods. Mr. Komar received a Bachelor of Science Degree in Sales and
      Marketing from Indiana University.





Steven
      Frank, Vice President of Sales. Mr. Frank has been employed by the company
      since
      July 1996. Mr. Frank was hired as Sales Manager Wholesale Division and in March
      1998 was promoted to National Sales Manager and most recently to Vice President
      of Sales in May 2005. Mr. Frank is responsible for all sales functions of the
      Novelty Division.





Timothy
      Patterson, Vice President of Finance and Administration. Mr. Patterson has
      been
      employed by the Company as Vice President of Finance and Administration since
      September, 2003. Prior to his employment with the Company, Mr. Patterson was
      Manager of Controllers for the Thermoforming group at Solo Cup Company for
      two
      years. Prior to that, Mr. Patterson was Manager of Corporate Accounting for
      Transilwrap Company for three years. Mr. Patterson received a Bachelor of
      Science degree in finance from Northern Illinois University and an MBA from
      the
      University of Illinois at Chicago.





Stanley
      M. Brown, Director. Mr. Brown was appointed as a director of the Company in
      January 1996. Since March 1996, Mr. Brown has been President of Inn-Room
      Systems, Inc., a manufacturer and lessor of in-room vending systems for hotels.
      From 1968 to 1989, Mr. Brown was with the United States Navy as a naval aviator,
      achieving the rank of Captain.





Bret
      Tayne, Director. Mr. Tayne was appointed as a director of the Company in
      December 1997. Mr. Tayne has been the President of Everede Tool Company, a
      manufacturer of industrial cutting tools, since January 1992. Prior to that,
      Mr.
      Tayne was Executive Vice President of Unifin, a commercial finance company,
      since 1986. Mr. Tayne received a Bachelor of Science degree from Tufts
      University and an MBA from Northwestern University.


45





Michael
      Avramovich, Director. Mr. Avramovich is a principal of the law firm of
      Avramovich & Associates, P.C. of Chicago, Illinois, and has been engaged in
      the practice of law for over 7 years. Prior to the practice of law, Mr.
      Avramovich was an Associate Professor of Accounting and Finance at
      National-Louis University in Chicago, Illinois. Mr. Avramovich has also worked
      in various financial accounting positions at Molex International, Inc. of Lisle,
      Illinois. Mr. Avramovich received a Bachelor of Arts degree in History and
      International Relations from North Park University, a Master of Management,
      Accounting and Information Systems, and Finance from Northwestern University,
      a
      Juris Doctor from the John Marshall Law School and an LLM in International
      and
      Corporate Law from Georgetown University Law Center.





John
      I.
      Collins, Director. Mr. Collins is the Chief Administrative Officer and the
      former Chief Financial Officer of Mid-States Corporate Federal Credit Union
      (“MSCFCU”). Prior to his affiliation with MSCFCU in 2001, Mr. Collins was
      employed as both a Controller and Chief Financial Officer by Great Lakes Credit
      Union (“GLCU”), a $350 million financial institution located in North Chicago,
      Illinois. Mr. Collins is currently the Treasurer of the Illinois Credit Union
      Executives Society, and is a former member of the Chicago Federal Reserve Bank
      Advisory Group. Mr. Collins received a Bachelor of Arts degree in Economics,
      History and English from Ripon College, and a Masters in Business Administration
      from Emory University. Mr. Collins has also participated in the Kellogg
      Management Institute and the Consumer Marketing Strategy programs at
      Northwestern University on a post-graduate basis.





John
      H.
      Schwan and Howard W. Schwan are brothers.





**Audit
      Committee**





Since
      2000, the Company has had a standing Audit Committee, which is presently
      composed of Mr. Tayne, Mr. Brown and Mr. Avramovich. Mr. Avramovich has been
      designated and is the Company's "Audit Committee Financial Expert" pursuant
      to
      paragraph (h)(1)(i)(A) of Item 401 of Regulation S-K of the Exchange Act. The
      Audit Committee held four meetings during fiscal year 2005, including quarterly
      meetings with management and independent auditors to discuss the Company's
      financial statements. Mr. Avramovich and each appointed member of the Audit
      Committee satisfies the definition of "independent" as that term is used in
      Item
      7(d)(3)(iv) of Schedule 14A under the Exchange Act. The Audit Committee reviews
      and makes recommendations to the Company about its financial reporting
      requirements.





**Section
      16(a) Beneficial Ownership Reporting Compliance**





Section
      16(a) of the Securities Exchange Act of 1934 requires the Company's officers
      and
      directors, and persons who own more than ten percent of a registered class
      of
      the Company's equity securities, to file reports of ownership and changes in
      ownership with the Securities and Exchange Commission and with the NASDAQ Stock
      Market. Officers, directors and greater than ten-percent shareholders are
      required by SEC regulation to furnish the Company with copies of all Section
      16(a) forms they file.


46





Based
      solely on a review of such forms furnished to the Company, or written
      representations that no Form 5's were required, the Company believes that during
      calendar year 2005, it was in compliance with all Section 16(a) filing
      requirements applicable to the officers, directors and ten-percent beneficial
      shareholders.





**Code
      of Ethics**





The
      Company has adopted a code of ethics that applies to its senior executive and
      financial officers. The Company's Code of Ethics seeks to promote (1) honest
      and
      ethical conduct, including the ethical handling of actual or apparent conflicts
      of interest between personal and professional relationships, (2) full, fair,
      accurate, timely and understandable disclosure of information to the Commission,
      (3) compliance with applicable governmental laws, rules and regulations, (4)
      prompt internal reporting of violations of the Code to predesignated persons,
      and (5) accountability for adherence to the Code.


47





**Item
      No. 11 Executive Compensation**





The
      following table sets forth certain information with respect to the compensation
      paid or accrued by the Company to its President, Chief Executive Officer and
      any
      other officer who received compensation in excess of $100,000 ("Named Executive
      Officers").




**Summary
                Compensation Table****Name
                and Principal Position**
            
            **Year**
            
            **Annual
                Compensation****Salary****$**
            
            **Long
                Term Compensation****UnderlyingOptions # of Shares**
            
            **All
                Other Compensation**
              **($)**Howard
                W. Schwan
            
            
            2005
            
            $
            138,000
            
            
            
            
            $
            20,280
            (1)President
            
            
            2004
            
            $
            153,000
            
            
            
            
            $
            12,705
            (2)2003
            
            $
            162,500
            
            
            
            
            $
            17,445
            (3)Steven
                Frank
            
            
            2005
            
            $
            97,000
            
            
            10,000Vice
                President - Sales
            
            
            2004
            
            $
            85,0002003
            
            $
            85,000Brent
                Anderson
            
            
            2005
            
            $
            105,000
            
            
            10,000Vice
                President - Manufacturing
            
            
            2004
            
            $
            99,0002003
            
            $
            95,000Samuel
                Komar
            
            
            2005
            
            $
            104,200
            
            
            7,500Vice
                President - Marketing
            
            
            2004
            
            $
            108,0002003
            
            $
            104,200Timothy
                Patterson
            
            
            2005
            
            $
            92,500
            
            
            10,000Vice
                President - Finance
            
            
            2004
            
            $
            92,5002003
            
            $
            85,000
            
            
            5,000





(1)
      Includes payment of country club dues of $5,520, employer matching contributions
      to the Company's 401(k) plan,


a
      defined
      contribution plan, of $2,760 and directors fees paid to the directors of our
      UK
      subsidiary CTI Balloons Ltd of $12,000.




(2)
      Includes Payment of country club dues of $5,520, employer matching contributions
      to the Company's 401(k) plan, a defined


contribution
      plan, of $4,685 and premiums of $2,500 on a life Insurance policy on which
      Mr.
      Schwan's estate is entitled to death benefits.




(3)
      Includes payment of country club dues of $5,520, employer matching contributions
      to the Company's 401(k) plan, a defined


contribution
      plan of $1,925 and premiums of $10,000 on a life Insurance policy on which
      Mr.
      Schwan's estate is entitled to death benefits.





Certain
      Named Executive Officers have received warrants to purchase Common Stock of
      the
      Company in connection with their guarantee of certain bank loans secured by
      the
      Company and in connection with their participation in a private offering of
      notes and warrants conducted by the Company. See "Board of Director Affiliations
      and Related Transactions" below.





48





**Option
      Grants in Last Fiscal Year**





Potential
                Realizable Value at Assumed Annual Rates of Stock Price Appreciation
                for
                Option TermGrantee
            
            #
                of Options
            
            %
                of Total Options Granted to Employees
            
            Exercise
                Price
            
            Expiration
                Date
            
            5%
                ($)
            
            10%
                (%)Schwan,
                Howard
            
            
            0Komar,
                Sam
            
            
            7,500
            
            
            9.5
            %
            
            2.88
            
            
            12/30/15
            
            $
            13,584.12
            
            
            159.4
            %Anderson,
                Brent
            
            
            10,000
            
            
            12.7
            %
            
            2.88
            
            
            12/30/15
            
            $
            18,112.17
            
            
            159.4
            %Patterson,
                Tim
            
            
            10,000
            
            
            12.7
            %
            
            2.88
            
            
            12/30/15
            
            $
            18,112.17
            
            
            159.4
            %Frank,
                Steve
            
            
            10,000
            
            
            12.7
            %
            
            2.88
            
            
            12/30/15
            
            $
            18,112.17
            
            
            159.4
            %Collins,
                John
            
            
            1,000
            
            
            1.3
            %
            
            2.88
            
            
            12/30/15
            
            $
            1,811.21
            
            
            159.4
            %Brown,
                Stanley
            
            
            1,000
            
            
            1.3
            %
            
            2.88
            
            
            12/30/15
            
            $
            1,811.21
            
            
            159.4
            %Tayne,
                Bret
            
            
            1,000
            
            
            1.3
            %
            
            2.88
            
            
            12/30/15
            
            $
            1,811.21
            
            
            159.4
            %Avromovich,
                Michael
            
            
            1,000
            
            
            1.3
            %
            
            2.88
            
            
            12/30/15
            
            $
            1,811.21
            
            
            159.4
            %




**Aggregated
      Option Exercises in Last Fiscal Year and FY-End Option
      Values**




Name
            
            Shares
                Acquired on Exercise (#)
            
            Value
                Realized ($)
            
            Number
                of Securities Underlying Unexercised Options at Year End (#)
                Exercisable/Unexercisable
            
            Value
                of Unexercised In- the-Money Options at Fiscal Year End ($)
                Exercisable/Unexercisable(1)John
                H. Schwan
            
            
            0
            
            
            0
            
            
            21,826/0
            
            $
            2,143/0Howard
                W. Schwan
            
            
            0
            
            
            0
            
            
            53,968/0
            
            $
            32,859/0Stephen
                M. Merrick
            
            
            0
            
            
            0
            
            
            21,826/0
            
            $
            2,143/0Brent
                Anderson
            
            
            0
            
            
            0
            
            
            41,549/0
            
            $
            25,715/0Samuel
                Komar
            
            
            0
            
            
            0
            
            
            32,501/0
            
            $
            25,869/0Timothy
                Patterson
            
            
            0
            
            
            0
            
            
            15,000/0
            
            $
            3,400/0Stanley
                M. Brown
            
            
            0
            
            
            0
            
            
            9,532/0
            
            $
            1,816/0Bret
                Tayne
            
            
            0
            
            
            0
            
            
            9,532/0
            
            $
            5,459/0Michael
                Avramovich
            
            
            0
            
            
            0
            
            
            1,000/0
            
            $
            30/0John
                Collins
            
            
            0
            
            
            0
            
            
            1,000/0
            
            $
            30/0





(1)
            The
                value of unexercised in-the-money options is based on the difference
                between the exercise price and the fair market value of the Company's
                Common Stock on December 31, 2005.





49




**Compensation
      Committee Interlocks and Insider Participation**





During
      2005, the Compensation Committee was composed of Stanley M. Brown, John I.
      Collins and Bret Tayne. None of the members of the Compensation Committee of
      our
      Board of Directors is an officer or employee of the Company. No executive
      officer of our Company serves as a member of the board of directors or
      compensation committee of any entity that has one or more executive officers
      serving on our Compensation Committee.





**Employment
      Agreements**





In
      June
      1997, the Company entered into an Employment Agreement with Howard W. Schwan
      as
      President, which provides for an annual salary of not less than $135,000. The
      term of the Agreement was through June 30, 2002 and is automatically renewed
      thereafter for successive one-year terms. The Agreement contains covenants
      of
      Mr. Schwan with respect to the use of the Company's confidential information,
      establishes the Company's right to inventions created by Mr. Schwan during
      the
      term of his employment, and includes a covenant of Mr. Schwan not to compete
      with the Company for a period of three years after the date of termination
      of
      the Agreement.





**Director
      Compensation**





John
      H.
      Schwan was compensated in the amount of $24,000 in fiscal year 2005 for his
      services as Chairman of the Board of Directors. John H. Schwan, Howard W. Schwan
      and Stephen M. Merrick each received $12,000 in directors fees as directors
      of
      CTI Balloons Ltd. during 2005. Directors other than members of management
      received a fee of $1,000 for each Board meeting attended.


50





**Item
      No. 12 Security Ownership of Certain Beneficial Owners and Management**





**Principal
      Stockholders**





The
      following table sets forth certain information with respect to the beneficial
      ownership of the Company's capital stock, as of March 31, 2006, by (i) each
      stockholder who is known by the Company to be the beneficial owner of more
      than
      5% of the Company's Common Stock, (ii) each director and executive officer
      of
      the Company who owns any shares of Common Stock and (iii) all executive officers
      and directors as a group. Except as otherwise indicated, the Company believes
      that the beneficial owners of the shares listed below have sole investment
      and
      voting power with respect to such shares.




**Name
                and Address****(1)**
            
            **Shares
                of Common Stock Beneficially Owned****(2)**
            
            **Percent
                of Common Stock****(4)**John
                H. Schwan
            
            
            778,142
            (3)
            
            32.6
            %Stephen
                M. Merrick
            
            
            678,663
            (5)
            
            29.2
            %Howard
                W. Schwan
            
            
            178,904
            (6)
            
            8.6
            %Brent
                Anderson
            
            
            52,795
            (7)
            
            2.5
            %Samuel
                Komar
            
            
            32,501
            (8)
            
            1.6
            %Steve
                Frank
            
            
            29,049
            (9)
            
            1.4
            %Timothy
                Patterson
            
            
            15,000
            (10)
            
            *John
                I. Collins262
                Pine StreetDeerfield
                Il 60015
            
            
            1,000
            (11)
            
            *Stanley
                M. Brown1140
                LarkinWheeling,
                IL 60090
            
            
            12,250
            (12)
            
            *Bret
                Tayne6834
                N. Kostner AvenueLincolnwood,
                IL 60712
            
            
            10,023
            (12)
            
            *Michael
                Avramovich70
                W. Madison Street, Suite 1400Chicago,
                IL 60602
            
            
            1,000
            (11)
            
            *All
                Directors and Executive Officers as a group (11 persons)
            
            
            1,789,327
            
            
            79.5
            %





*
      Less
      than one percent





(1)
            Except
                as otherwise indicated, the address of each stockholder listed above
                is
                c/o CTI Industries Corporation, 22160 North Pepper Road, Barrington,
                Illinois 60010.




51




(2)
            A
                person is deemed to be the beneficial owner of securities that can
                be
                acquired within 60 days from the date set forth above through the
                exercise
                of any option, warrant or right. Shares of Common Stock subject to
                options, warrants or rights that are currently exercisable or exercisable
                within 60 days are deemed outstanding for purposes of computing the
                percentage ownership of the person holding such options, warrants
                or
                rights, but are not deemed outstanding for purposes of computing
                the
                percentage ownership of any other person.





(3)
            Includes
                warrants to purchase up to 79,367 shares of Common Stock at $1.50
                per
                share, warrants to purchase up to 93,000 shares of Common Stock at
                $4.87
                per share, warrants to purchase up to 151,515 shares of Common Stock
                at
                $3.30 per share and options to purchase up to 5,952 shares of Common
                Stock
                at $2.55 per share granted under the Company's 2002 Stock Option
                Plan.
                Also includes indirect beneficial ownership of 130,821 shares of
                Common
                Stock through shares owned through CTI Investors, L.L.C. See "Board
                of
                Directors Affiliations and Related Transactions."





(4)
            Assumes
                the exercise of all warrants and options owned by the named person
                into
                shares of Common Stock and any shares of Common Stock beneficially
                owned
                by the named person through CTI Investors, L.L.C.





(5)
            Includes
                warrants to purchase up to 39,683 shares of Common Stock at $1.50
                per
                share, warrants to purchase up to 70,000 shares of Common Stock at
                $4.87
                per share, warrants to purchase up to 151,515 shares of Common Stock
                at
                $3.30 per share and options to purchase up to 5,952 shares of Common
                Stock
                at $2.55 per share granted under the Company's 2002 Stock Option
                Plan.
                Also includes indirect beneficial ownership of 87,214 shares of Common
                Stock through shares owned through CTI Investors, L.L.C. See "Board
                of
                Directors Affiliations and Related Transactions."





(6)
            Includes
                options to purchase up to 15,873 shares of Common Stock at $6.30
                per share
                granted under the Company's 1997 Stock Option Plan, options to purchase
                up
                to 23,810 shares of Common Stock at $1.89 per share granted under
                the
                Company's 1999 Stock Option Plan and options to purchase up to 14,285
                shares of Common Stock at $2.31 per share granted under the Company's
                2002
                Stock Option Plan. Also includes indirect beneficial ownership of
                65,410
                shares of Common Stock through shares owned through CTI Investors,
                L.L.C.
                See "Board of Directors Affiliations and Related Transactions."





(7)
            Includes
                options to purchase up to 4,762 shares of Common Stock at $6.30 per
                share
                granted under the Company's 1997 Stock Option Plan, options to purchase
                up
                to 17,858 shares of Common Stock at $1.47 per share, granted under
                the
                Company's 2001 Stock Option Plan, options to purchase up to 8,928
                shares
                of Common Stock at $2.31 per share and 10,000 shares at 2.88 granted
                under
                the Company's 2002 Stock Option Plan.




52




(8)
            Includes
                options to purchase up to 4,762 shares of Common Stock at $6.30 per
                share
                granted under the Company's 1997 Stock Option Plan, options to purchase
                up
                to 8,334 shares of Common Stock at $1.89 per share granted under
                the
                Company's 1999 Stock Option Plan, options to purchase up to 11,905
                shares
                of Common Stock at $1.47 per share granted under the Company's 2001
                Stock
                Option Plan, and options to purchase up to 7,500 shares of Common
                Stock at
                $2.88 per share granted under the Company's 2001 Stock Option
                Plan.





(9)
            Includes
                options to purchase up to 4,762 shares of Common Stock at $6.30 per
                share
                granted under the Company's 1997 Stock Option Plan, options to purchase
                up
                to 8,334 shares of Common Stock at $1.89 per share granted under
                the
                Company's 1999 Stock Option Plan, options to purchase up to 5,953
                shares
                of Common Stock at $1.47 per share granted under the Company's 2001
                Stock
                Option Plan, and options to purchase up to 10,000 shares of Common
                Stock
                at $2.88 per share granted under the Company's 2002 Stock Option
                Plan.





(10)
            Includes
                options to purchase up to 5,000 shares of Common Stock at $2.26 per
                share
                and 10,000 shares of Common Stock at $2.88 both granted under the
                Company's 2002 Stock Option Plan.





(11)
            Includes
                options to purchase up to 1,000 shares of Common Stock at $2.88 per
                share
                granted under the Company's 2002 Stock
                Option.





(12)
            Includes
                options to purchase up to 1,985 shares of Common Stock at $6.30 per
                share
                granted under the Company's 1997 Stock Option Plan, options to purchase
                up
                to 3,572 shares of Common Stock at $1.89 per share granted under
                the
                Company's 1999 Stock Option Plan options to purchase up to 2,976
                shares of
                Common Stock at $2.31 per share and options to purchase up to 1,000
                shares
                of Common Stock at $2.88 per share both granted under the Company's
                2002
                Stock Option Plan.


53




**Equity
      Compensation Plan Information**





Plan
                Category
            
            Number
                of securities
              to
                be issued upon
              exercise
                of
              outstanding
                options.
              (a)
            
            Weighted-average
              exercise
                price of
              outstanding
                options.
              (b)
            
            Number
                ofsecurities
              remainingavailable
              for
                future issuance
              under
                equity
              compensationplans
              (excludingsecurities
              reflected
                incolumn (a))(c)Equity
                compensation plans approved by security holders
            
            
            349,500
            
            $
            3.50
            
            
            907Equity
                compensation plans not approved by security holders
            
            
            0
            
            $
            0
            
            
            0Total
            
            
            349,500
            
            $
            3.50
            
            
            907




**Item
      No. 13 Certain Relationships and Related Transactions**





Stephen
      M. Merrick, Executive Vice President and Secretary of the Company, is a
      principal of the law firm of Merrick & Associates, P.C., which served as
      general counsel of the Company during portions of 2005 and is also Of Counsel
      to
      Vanasco, Genelly and Miller, a law firm who provided services to the Company
      in
      2005. In addition, Mr. Merrick is a principal stockholder of the Company. During
      2005, Mr. Merrick and such firms were paid total fees and compensation in the
      amount of $165,000.





During
      2005, John H. Schwan was an officer of an affiliate of Rapak L.L.C. For the
      year
      ended December 31, 2005, the Company had total sales to Rapak of $6,860,000.





John
      H.
      Schwan is a principal in Shamrock Packaging. The Company made purchases of
      packaging materials from this company in the amount of $165,000 during the
      year
      ended December 31, 2005.




54




Messrs.
      Schwan and Merrick made advances to the Company’s Mexican affiliate, Flexo
      Universal in the amount of $112,500 and $141,900 respectively, in 2005.
      Additionally, in 2005, Messrs. Schwan and Merrick advanced $130,000 and
      $155,000, respectively, to the Company’s UK affiliate, CTI Balloons Ltd. These
      advances are reflected in demand notes bearing interest at the rate of 7% per
      annum. Mr. Merrick also advanced $19,209 to the Company in December
      2005 **.**




On
      January 10, 2006, an officer of Flexo Universal, Pablo Gortazar, acquired all
      rights in a loan of a credit union to Flexo Universal and CTF International
      both
      Mexican subsidiaries of the Company for the book value. The principal amount
      of
      the obligation of Flexo Universal and CTF International acquired was $191,000
      and such amount bears interest at the rate of 9.5% per annum.





On
      February 1, 2006, the Company entered into a new loan agreement with Charter
      One
      Bank in which Charter One Bank provided to the Company a line of credit totaling
      $12,800,000. Also, on the same day, Messrs. John Schwan and Stephen Merrick,
      each loaned to the Company the sum of $500,000 in exchange for five year
      subordinated notes and warrants to purchase up to 151,515 shares of common
      stock
      of the Company, each.





The
      Company believes that each of the transactions set forth above were entered
      into, and any future related party transactions will be entered into, on terms
      as fair as those obtainable from independent third parties. All related party
      transactions must be approved by a majority of disinterested directors and
      subject to review in the context of the Company's Code of Ethics.





**Item
      No. 14 Principal Accountant Fees and Services**




The
      following table sets forth the aggregate amount of audit fees and all other
      fees
      billed or expected to be billed by the Company's principal auditor, for the
      years ended December 31, 2004 and December 31, 2005:





2005
                Amount
            
            2004
                AmountAudit
                fees(1)
            
            $
            310,500
            
            $
            238,000Tax
                Fees(2)
            
            $
            23,000
            
            $
            15,000Total
                fees
            
            $
            333,500
            
            $
            253,000




__________________


(1)
            Includes
                the annual financial statement audit and quarterly reviews and expenses.


(2)
            Primarily
                represents tax services





All
      audit, tax and other services to be performed by Weiser LLP for us must be
      pre-approved by our audit committee. The audit committee reviews the description
      of the services and an estimate of the anticipated costs of performing those
      services. Services not previously approved cannot commence until such approval
      has been granted. Pre-approval is granted usually at regularly scheduled
      meetings. If unanticipated items arise between meetings of the audit committee,
      our audit committee has delegated approval authority to the chairman of the
      audit committee, in which case the chairman communicates such pre-approvals
      to
      the full committee at its next meeting. During 2005, all services performed
      by
      Weiser LLP were pre-approved by the audit committee in accordance with this
      policy.




55





The
      audit
      committee of our board of directors reviews all relationships with Weiser LLP,
      including the provision of non-audit services, which may relate to the
      independent registered accounting firm’s independence. The audit committee of
      our board of directors considered the effect of Weiser LLP’s non-audit services
      in assessing the independence of the independent registered public accounting
      firm and concluded that the provision of such services by Weiser LLP was
      compatible with the maintenance of that firm’s independence in the conduct of
      its auditing functions.





56


**PART
      IV**





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





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





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





Schedule
      II  Valuation
      and qualifying accounts





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





3.
            Exhibits:





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





57





10.4
            
            Employment
                Agreement dated June 30, 1997, between CTI Industries Corporation
                and
                Howard W. Schwan (Incorporated by reference to Exhibits, contained
                in
                Registrant’s Form SB-2 Registration Statement (File No. 333-31969)
                effective November 5, 1997.)10.5
            
            Warrant
                dated July 17, 2001 to purchase 79,364 shares of Common Stock John
                H.
                Schwan (Incorporated by reference to Exhibits contained in the
                Registrant’s 2002 10-KSB, as filed with the Commission on May 1,
                2003)10.6
            
            Warrant
                dated July 17, 2001 to purchase 39,683 shares of Common Stock Stephen
                M.
                Merrick (Incorporated by reference to Exhibits contained in the
                Registrant’s 2002 10-KSB, as filed with the Commission on May 1,
                2003)10.7
            
            Note
                dated January 28, 2003, CTI Industries Corporation to Stephen M.
                Merrick
                in the sum of $500,000 (Incorporated by reference to Exhibits contained
                in
                the Registrant’s 2002 10-KSB, as filed with the Commission on May 1,
                2003)10.8
            
            Note
                dated February 28, 2003, CTI Industries Corporation to Stephen M.
                Merrick
                in the sum of $200,000 (Incorporated by reference to Exhibits contained
                in
                the Registrant’s 2002 10-KSB, as filed with the Commission on May 1,
                2003)10.9
            
            Note
                dated February 10, 2003, CTI Industries Corporation to John H. Schwan
                in
                the sum of $150,000 (Incorporated by reference to Exhibits contained
                in
                the Registrant’s 2002 10-KSB, as filed with the Commission on May 1,
                2003)10.10
            
            Note
                dated February 15, 2003, CTI Industries Corporation to John Schwan
                in the
                sum of $680,000 (Incorporated by reference to Exhibits contained
                in the
                Registrant’s 2002 10-KSB, as filed with the Commission on May 1,
                2003)10.11
            
            Note
                dated March 3, 2003, CTI Industries Corporation to John H. Schwan
                in the
                sum of $100,000 (Incorporated by reference to Exhibits contained
                in the
                Registrant’s 2002 10-KSB, as filed with the Commission on May 1,
                2003)10.12
            
            Warrant
                dated March 20, 2003, to purchase 70,000 shares of Common Stock -
                Stephen
                M. Merrick (Incorporated by reference to Exhibits contained in the
                Registrant’s 2002 10-KSB, as filed with the Commission on May 1,
                2003)10.13
            
            Warrant
                dated March 20, 2003, to purchase 93,000 shares of Common Stock -
                John H.
                Schwan (Incorporated by reference to Exhibits contained in the
                Registrant’s 2002 10-KSB, as filed with the Commission on May 1,
                2003)10.14
            
            Loan
                and Security Agreement dated December 30, 2003, between the Company
                and
                Cole Taylor Bank10.15
            
            Term
                Note in the sum of $3,500,000 dated December 30, 2003 made by CTI
                Industries Corporation to Cole Taylor
                Bank




58





10.16
            
            Revolving
                Note in the sum of $7,500,000 dated December 30, 2003, made by CTI
                Industries Corporation to Cole Taylor Bank10.17
            
            Mortgage
                dated January 12, 2001 for the benefit of Banco Popular, N.A.
                (Incorporated by reference to Exhibits contained in the Registrant’s
                Restated 2001 10-KSB, as filed with the Commission on May 1,
                2003)10.18
            
            Secured
                Promissory Note in the sum of $2,700,000 dated December 15, 2000
                made by
                CTI Industries Corporation to Banco Popular, N.A. (Incorporated by
                reference to Exhibits contained in the Registrant’s Restated 2001 10-KSB,
                as filed with the Commission on May 1, 2003)10.19
            
            Secured
                Promissory Note in the sum of $173,000 dated December 15, 2000 made
                by CTI
                Industries Corporation to Banco Popular, N.A. (Incorporated by reference
                to Exhibits contained in the Registrant’s Restated 2001 10-KSB, as filed
                with the Commission on May 1, 2003)10.20
            
            Amendment
                No. 7 to Loan and Security Agreement between Company and Cole Taylor
                Bank
                dated September 29, 2005 (Incorporated by reference to Exhibits contained
                in Registrant’s Report on Form 8-K dated September 30,
                2005)10.21
            
            Amendment
                No. 8 to Loan and Security Agreement between Company and Cole Taylor
                Bank
                dated December 28, 2005 (Incorporated by reference to Exhibits contained
                in Registrant’s Report on Form 8-K dated December 30,
                2005)10.22
            
            Loan
                and Security Agreement between Charter One Bank and the Company dated
                February 1, 2006 (Incorporated by reference to Exhibits contained
                in
                Registrant’s Report on Form 8-K dated February 3, 2006)10.23
            
            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)10.24
            
            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)10.25
            
            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)10.26
            
            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)




59





10.27
            
            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)11
            
            Computation
                of Earnings Per Share (Incorporated by reference to the Consolidated
                Financial Statements contained in Part IV)14
            
            Code
                of Ethics (Incorporated by reference to Exhibit contained in the
                Registrant’s Form 10-K/A Amendment No. 2, as filed with the Commission on
                October 8, 2004)21
            
            Subsidiaries
                (description incorporated in Form 10-K under Item No.
                1)23.1
            
            Consent
                of Independent Auditors, Weiser LLP23.2
            
            Consent
                of Independent Auditors, Eisner, 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.


60


**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 October
      4, 2006.




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
            
            October
                  4, 2006Howard
              W. Schwan/s/
                John H. Schwan
            
            Chairman
                and Director
            
            October
                  4, 2006John
              H. Schwan/s/
                Stephen M. Merrick
            
            Executive
                Vice President, Secretary, Chief Financial Officer
            
            October
                  4, 2006Stephen
              M. Merrick
            
            and Director/s/
                Stanley M. Brown
            
            Director
            
            October
                  4, 2006Stanley
              M. Brown/s/
                Bret Tayne
            
            Director
            
            October
                  4, 2006Bret
              Tayne/s/
                Michael Avramovich
            
            Director
            
            October
                  4, 2006Michael
              Avramovich/s/
                John I. Collins
            
            Director
            
            October
                  4, 2006John
              I. Collins




61





**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**





To
      the
      Board of Directors and


Stockholders
      of CTI Industries Corporation





We
      have
      audited the accompanying consolidated balance sheets of CTI Industries
      Corporation and Subsidiaries (the “Company”) as of December 31, 2005 and 2004,
      and the related consolidated statements of operations, stockholders’ equity and
      comprehensive loss, and cash flows for the years then ended. These consolidated
      financial statements are the responsibility of the Company’s management. Our
      responsibility is to express an opinion on these consolidated financial
      statements based on our audits.





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





In
      our
      opinion, the consolidated financial statements referred to above present fairly,
      in all material respects, the consolidated financial position of CTI Industries
      Corporation and Subsidiaries as of December 31, 2005 and 2004, and the results
      of their consolidated operations and their consolidated cash flows for the
      years
      then ended in conformity with U.S. generally accepted accounting principles.





We
      have
      also audited the consolidated financial statement Schedule II for the years
      ended December 31, 2005 and 2004. In our opinion, this schedule presents fairly,
      in all material respects, the information required to be set forth therein.





As
      described in Note 2 to the consolidated financial statements, the Company has
      restated its 2004 consolidated statement of operations and its 2005 and 2004
      consolidated statements of cash flows.




Weiser
      LLP


New
      York,
      New York


March
      13,
      2006, except with respect to Note 2 as


to
      which
      the date is September 28, 2006


F-1





**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**





The
      Board
      of Directors and Stockholders


CTI
      Industries Corporation





We
      have
      audited the accompanying consolidated statements of operations, stockholders’
equity and cash flows of CTI Industries Corporation and subsidiaries (the
“Company”) for the year ended December 31, 2003. These financial statements are
      the responsibility of the Company’s management. Our responsibility is to express
      an opinion on these financial statements based on our audit.





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 financial
      statements are free of material misstatement. An audit includes examining,
      on a
      test basis, evidence supporting the amounts and disclosures in the financial
      statements. An audit also includes assessing the accounting principles used
      and
      significant estimates made by management, as well as evaluating the overall
      financial statement presentation. We believe that our 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 consolidated results of operations and cash flows
      of the Company for the year ended December 31, 2003, in conformity with
      generally accepted accounting principles in the United States of America.




/s/
      Eisner LLP


New
      York,
      New York


February
      18, 2004





With
      respect to the first paragraph of Note 6


April
      14,
      2004





With
      respect to the third paragraph of Note 3


October
      1, 2004 (not presented herein)




With
        respect to Note 2
 September
        28, 2006


F-2




**CTI
      Industries Corporation and Subsidiaries**


**Consolidated
      Balance Sheets**




December
                31,2005
            
            December
                31,2004ASSETSCurrent
                assets:Cash
            
            $
            261,982
            
            $
            526,470Accounts
                receivable, (less allowance for doubtful accounts of $80,000 and
                $404,000
                respectively)
            
            
            4,343,671
            
            
            6,123,137Inventories,
                net
            
            
            7,022,569
            
            
            8,348,494Prepaid
                expenses and other current assets
            
            
            707,082
            
            
            646,805Total
                current assets
            
            
            12,335,304
            
            
            15,644,906Property,
                plant and equipment:Machinery
                and equipment
            
            
            18,869,276
            
            
            18,451,428Building
            
            
            2,602,922
            
            
            2,614,271Office
                furniture and equipment
            
            
            2,010,557
            
            
            1,926,371Land
            
            
            250,000
            
            
            250,000Leasehold
                improvements
            
            
            510,134
            
            
            640,428Fixtures
                and equipment at customer locations
            
            
            2,330,483
            
            
            2,286,814Projects
                under construction
            
            
            130,994
            
            
            55,65026,704,366
            
            
            26,224,962Less
                : accumulated depreciation and amortization
            
            
            (17,087,622
            )
            
            (15,636,451
            )Total
                property, plant and equipment, net
            
            
            9,616,744
            
            
            10,588,511Other
                assets:Net
                deferred financing costs, net
            
            
            74,396
            
            
            120,375Goodwill
            
            
            989,108
            
            
            1,113,108Net
                deferred income tax asset
            
            
            352,689
            
            
            175,288Other
                assets
            
            
            167,809
            
            
            245,376Total
                other assets
            
            
            1,584,002
            
            
            1,654,147TOTAL
                ASSETS
            
            $
            23,536,050
            
            $
            27,887,564LIABILITIES
                AND STOCKHOLDERS' EQUITYCurrent
                liabilitiesChecks
                written in excess of bank balance
            
            $
            500,039
            
            $
            513,417Trades
                payable
            
            
            4,717,733
            
            
            6,147,969Line
                of credit
            
            
            5,050,753
            
            
            6,401,225Notes
                payable - current portion
            
            
            1,329,852
            
            
            3,500,669Notes
                payable - officers current portion
            
            
            2,237,292
            
            
            60,000Accrued
                liabilities
            
            
            925,719
            
            
            1,811,775


Total
                current liabilities
            
            
            14,761,388
            
            
            18,435,055Long-term
                liabilities:Other
                liabilities (related parties of $1,056,000 and $517,000)
            
            
            1,644,339
            
            
            1,371,364Notes
                payable
            
            
            4,394,390
            
            
            2,864,129Notes
                payable - officers
            
            
            0
            
            
            2,255,616Total
                long-term liabilities
            
            
            6,038,729
            
            
            6,491,109Minority
                interest
            
            
            10,091
            
            
            10,230Stockholders'
                equity:Preferred
                stock - no par value 2,000,000 shares authorizes, 0 shares issued
                and
                outstanding
            
            
            0
            
            
            0Common
                stock - no par value, 5,000,000 shares authorized, 2,268,269 and
                2,185,896
                shares issued, 2,036,474 and 1,954,100 shares outstanding,
                respectively
            
            
            3,764,020
            
            
            3,764,020Class
                B Common stock - no par value, 500,000 shares authorized, 0 shares
                issued
                and outstanding
            
            
            0
            
            
            0Paid-in-capital
            
            
            5,869,828
            
            
            5,615,411Warrants
                issued in connection with subordinated debt and bank debt
            
            
            595,174
            
            
            595,174Accumulated
                deficit
            
            
            (6,340,646
            )
            
            (6,007,437
            )Accumulated
                other comprehensive loss
            
            
            (223,420
            )
            
            (76,884
            )Less:Treasury
                stock - 231,796 shares
            
            
            (939,114
            )
            
            (939,114
            )Total
                stockholders' equity
            
            
            2,725,842
            
            
            2,951,170TOTAL
                LIABILITIES & STOCKHOLDERS' EQUITY
            
            $
            23,536,050
            
            $
            27,887,564





See
      accompanying notes to consolidated financial statements




F-3




**CTI
        Industries Corporation and Subsidaries**
 **Consolidated
        Statement of Operations**
  Year
                  Ended December 31,2005
              
              
              2004
              
              
              2004
              
              
              2003
              
              
              2003As
                  Reported
              
              
              Restated
              
              
              As
                  Reported
              
              
              RestatedNet
                  sales
              
              $
              29,189,974
              
              $
              37,193,109
              
              $
              37,193,109
              
              $
              36,259,638
              
              $
              36,259,638Cost
                  of sales
              
              
              22,725,825
              
              
              30,840,989
              
              
              30,840,989
              
              
              29,626,450
              
              
              29,626,450Gross
                  profit
              
              
              6,464,149
              
              
              6,352,120
              
              
              6,352,120
              
              
              6,633,188
              
              
              6,633,188Operating
                  expenses:General
                  and administrative
              
              
              3,846,538
              
              
              4,410,595
              
              
              4,410,595
              
              
              4,054,607
              
              
              4,054,607Selling
              
              
              1,064,944
              
              
              1,495,257
              
              
              1,495,257
              
              
              1,441,501
              
              
              1,441,501Advertising
                  and marketing
              
              
              776,571
              
              
              1,014,463
              
              
              1,014,463
              
              
              1,816,301
              
              
              1,816,301(Gain)
                  on sale of assets
              
              
              
              
              
              
              
              
              (122,499
              )
              
              
              
              
              (28,007
              )Other
                  (income)
              
              
              
              
              
              
              
              
              (395,489
              )
              
              
              
              
              (428,125
              )Asset
                  impairment loss
              
              
              124,000Total
                  operating expenses
              
              
              5,812,053
              
              
              6,920,315
              
              
              6,402,327
              
              
              7,312,409
              
              
              6,856,277Income
                  (loss) from operations
              
              
              652,096
              
              
              (568,195
              )
              
              (50,207
              )
              
              (679,221
              )
              
              (223,089
              )Other
                  income (expense):Interest
                  expense
              
              
              (1,230,964
              )
              
              (1,350,085
              )
              
              (1,350,085
              )
              
              (1,103,395
              )
              
              (1,103,395
              )Interest
                  income
              
              
              -
              
              
              -
              
              
              -
              
              
              13,618
              
              
              13,618Gain
                  (loss) on sale of assets
              
              
              -
              
              
              122,499
              
              
              
              
              
              28,007Foreign
                  currency (loss) gain
              
              
              45,128
              
              
              208,213
              
              
              208,213
              
              
              (36,132
              )
              
              (36,132
              )Other
              
              
              
              
              
              395,489
              
              
              
              
              
              428,125Total
                  other (expense) income
              
              
              (1,185,836
              )
              
              (623,884
              )
              
              (1,141,872
              )
              
              (669,777
              )
              
              (1,125,909
              )Loss
                  before income taxes and minority interest
              
              
              (533,740
              )
              
              (1,192,079
              )
              
              (1,192,079
              )
              
              (1,348,998
              )
              
              (1,348,998
              )Income
                  tax (benefit) expense
              
              
              (200,392
              )
              
              1,286,232
              
              
              1,286,232
              
              
              (782,468
              )
              
              (782,468
              )Loss
                  before minority interest
              
              
              (333,348
              )
              
              (2,478,311
              )
              
              (2,478,311
              )
              
              (566,530
              )
              
              (566,530
              )Minority
                  interest in (loss) income of subsidiary
              
              
              (139
              )
              
              1,063
              
              
              1,063
              
              
              (483
              )
              
              (483
              )Net
                  loss
              
              $
              (333,209
              )
              $
              (2,479,374
              )
              $
              (2,479,374
              )
              $
              (566,047
              )
              $
              (566,047
              )Loss
                  applicable to common shares
              
              $
              (333,209
              )
              $
              (2,479,374
              )
              $
              (2,479,374
              )
              $
              (566,047
              )
              $
              (566,047
              )Basic
                  loss per common share
              
              $
              (0.17
              )
              $
              (1.28
              )
              $
              (1.28
              )
              $
              (0.30
              )
              $
              (0.30
              )Diluted
                  loss per common share
              
              $
              (0.17
              )
              $
              (1.28
              )
              $
              (1.28
              )
              $
              (0.30
              )
              $
              (0.30
              )






F-4




**CTI
      Industries Corporation and Subsidiaries**


**Consolidated
      Statements of Stockholders' Equity and Comprehensive
      Loss**


Warrants
                    issued
                
                
                
                
                
                
                
                LessCommon
                    Stock
                
                Class
                    B Common Stock
                
                Paid-in
                
                
                
                
                in connection
                    with  subordinated
                
                Accumulated
                
                AccumulatedOtherComprehensive
                
                Treasury
                      Stock
                
                Notes
                  RecvbleShares
                
                Amount
                
                Shares
                
                Amount
                
                Capital
                
                
                
                
                debt
                
                Deficit
                
                Loss
                
                Shares
                
                Amount
                
                Shareholders
                
                TOTALBalance,
                    December 31, 2002
                
                
                2,141,882
                
                $
                3,748,270
                
                
                -
                
                $
                -
                
                $
                5,554,332
                
                
                -
                
                $
                135,462
                
                $
                (2,962,016
                )
                $
                (6,002
                )
                
                231,796
                
                $
                (939,114
                )
                $
                (56,456
                )
                $
                5,474,476Options
                    Exercised
                
                
                8,334
                
                $
                15,750
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                $
                15,750Subordinated
                    debt contributed to exercise warrants
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                $
                459,712
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                $
                459,712Collection
                    of Notes Receivable
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                $
                56,456
                
                $
                56,456Net
                    Loss
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                ($566,047
                )
                
                
                
                
                
                
                
                
                
                
                
                
                $
                (566,047
                )Other
                    comprehensive incomeForeign
                    currency translation
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                ($228,766
                )
                
                
                
                
                
                
                
                
                
                $
                (228,766
                )Total
                    comprehensive loss
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                $
                (794,813
                )Balance,
                    December 31, 2003
                
                
                2,150,216
                
                $
                3,764,020
                
                
                -
                
                $
                -
                
                $
                5,554,332
                
                $
                -
                
                $
                595,174
                
                $
                (3,528,063
                )
                $
                (234,768
                )
                
                231,796
                
                $
                (939,114
                )
                $
                -
                
                $
                5,211,581Stock
                    issued for Services
                
                
                35,680
                
                $
                -
                
                
                
                
                
                
                
                $
                61,079
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                $
                61,079Net
                    Loss
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                ($2,479,374
                )
                
                
                
                
                
                
                
                
                
                
                
                
                $
                (2,479,374
                )Other
                    comprehensive incomeForeign
                    currency translation
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                $
                157,884
                
                
                
                
                
                
                
                
                
                
                $
                157,884Total
                    comprehensive loss
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                $
                (2,321,490
                )Balance,
                    December 31, 2004
                
                
                2,185,896
                
                $
                3,764,020
                
                
                -
                
                $
                -
                
                $
                5,615,411
                
                $
                -
                
                $
                595,174
                
                $
                (6,007,437
                )
                $
                (76,884
                )
                
                231,796
                
                $
                (939,114
                )
                $
                -
                
                $
                2,951,170Options
                    Exercised
                
                
                32,144
                
                
                
                
                
                
                
                
                
                
                $
                53,501
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                $
                53,501Stock
                    issued for Services
                
                
                50,229
                
                
                
                
                
                
                
                
                
                
                $
                200,916
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                $
                200,916Net
                    Loss
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                $
                (333,209
                )
                
                
                
                
                
                
                
                
                
                
                
                
                
                ($333,209
                )Other
                    comprehensive incomeForeign
                    currency translation
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                ($146,536
                )
                
                
                
                
                
                
                
                
                
                $
                (146,536
                )Total
                    comprehensive loss
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                $
                (479,745
                )Balance,
                    December 31, 2005
                
                
                2,268,269
                
                $
                3,764,020
                
                
                -
                
                $
                -
                
                $
                5,869,828
                
                $
                -
                
                $
                595,174
                
                $
                (6,340,646
                )
                $
                (223,420
                )
                
                231,796
                
                $
                (939,114
                )
                $
                -
                
                $
                2,725,842




See
      accompanying notes to consolidated financial statements


F-5




**CTI
      Industries Corporation and Subsidiaries**


**Consolidated
      Statements of Cash Flows**




Year
                Ended December 31,Restated
            
            
            
            Restated
            
            
            
            Restated2005
            
            2005
            
            2004
            
            2004
            
            2003
            
            2003Cash
                flows from operating activities:Net
                loss
            
            
            
            
            $
            (333,209
            )
            
            (333,209
            )
            $
            (2,479,374
            )
            
            (2,479,374
            )
            $
            (566,047
            )
            $
            (566,047
            )Adjustment
                to reconcile net loss to cash provided by (used in) operating
                activities:Depreciation
                and amortization
            
            
            
            
            
            1,463,369
            
            
            1,479,916
            
            
            1,651,322
            
            
            1,639,808
            
            
            1,618,563
            
            
            1,628,492Deferred
                gain on sale/leaseback
            
            
            
            
            
            0
            
            
            
            
            
            (175,271
            )
            
            (175,271
            )
            
            (30,047
            )
            
            (30,047
            )Amortization
                of debt discount
            
            
            
            
            
            35,967
            
            
            35,967
            
            
            251,490
            
            
            251,490
            
            
            238,199
            
            
            238,199Minority
                interest in loss of subsidiary
            
            
            
            
            
            65
            
            
            65
            
            
            1,063
            
            
            1,063
            
            
            (483
            )
            
            (483
            )Loss
                on asset impairment
            
            
            
            
            
            124,000
            
            
            124,000Provision
                for losses on accounts receivable
            
            
            
            
            
            145,000
            
            
            145,000
            
            
            288,562
            
            
            288,562
            
            
            220,000
            
            
            220,000Provision
                for losses on inventories
            
            
            
            
            
            205,000
            
            
            205,000
            
            
            60,000
            
            
            60,000
            
            
            135,000
            
            
            135,000Shares
                issued for services
            
            
            
            
            
            200,916
            
            
            200,916
            
            
            0
            
            
            
            
            
            0Deferred
                income taxes
            
            
            
            
            
            (200,392
            )
            
            (200,392
            )
            
            1,189,135
            
            
            1,189,135
            
            
            (782,468
            )
            
            (782,468
            )Change
                in operating assets and liabilities:Accounts
                receivable
            
            
            
            
            
            1,634,466
            
            
            1,680,617
            
            
            (1,791,423
            )
            
            (1,523,274
            )
            
            619,113
            
            
            430,362Inventories
            
            
            
            
            
            1,120,925
            
            
            1,129,594
            
            
            854,666
            
            
            890,945
            
            
            560,433
            
            
            475,844Other
                assets
            
            
            
            
            
            205,731
            
            
            167,332
            
            
            426,662
            
            
            397,345
            
            
            66,313
            
            
            60,091Trade
                payables, accrued and other liabilities
            
            
            
            
            
            (1,862,861
            )
            
            (1,976,307
            )
            
            (847,411
            )
            
            (925,237
            )
            
            1,129,596
            
            
            1,297,275Net
                cash provided by (used in) operating activities
            
            
            
            
            
            2,738,977
            
            
            2,658,499
            
            
            (570,579
            )
            
            (384,808
            )
            
            3,208,172
            
            
            3,106,218Cash
                flows from investing activities:Purchases
                of property, plant and equipment
            
            
            
            
            
            (549,547
            )
            
            (551,256
            )
            
            (305,546
            )
            
            (281,494
            )
            
            (2,007,104
            )
            
            (2,164,510
            )Proceeds
                from sale of property, plant and equipment
            
            
            
            
            
            151,206
            
            
            151,206
            
            
            32,094
            
            
            22,123
            
            
            0****Net
                cash used in investing activities
            
            
            
            
            
            (398,341
            )
            
            (400,050
            )
            
            (273,452
            )
            
            (259,371
            )
            
            (2,007,104
            )
            
            (2,164,510
            )Cash
                flows from financing activities:Checks
                written in excess of bank balance
            
            
            
            
            
            (13,378
            )
            
            (14,225
            )
            
            172,309
            
            
            172,291
            
            
            227,648
            
            
            228,041Net
                change in revolving line of credit
            
            
            
            
            
            (1,350,472
            )
            
            (1,350,472
            )
            
            2,706,984
            
            
            2,706,984
            
            
            (1,948,408
            )
            
            (1,948,408
            )Proceeds
                from issuance of long-term debt (Received from related parties 559,000,
                267,000 and 250,000)
            
            
            
            
            
            300,439
            
            
            231,392
            
            
            558,077
            
            
            583,298
            
            
            6,768,759
            
            
            6,725,426Repayment
                of long-term debt
            
            
            
            
            
            (811,776
            )
            
            (850,986
            )
            
            (2,513,261
            )
            
            (2,552,139
            )
            
            (5,649,014
            )
            
            (5,571,574
            )Repayment
                of short-term debt (Related parties 60,000 in 2005)
            
            
            
            
            
            (402,324
            )
            
            (402,324
            )Proceeds
                from exercise of stock options
            
            
            
            
            
            53,501
            
            
            53,501
            
            
            0
            
            
            
            
            
            15,750
            
            
            15,750Collection
                of stockholder note
            
            
            
            
            
            0
            
            
            
            
            
            0
            
            
            
            
            
            56,456
            
            
            56,456Cash
                paid for deferred financing fees
            
            
            
            
            
            (141,316
            )
            
            (141,316
            )
            
            (41,234
            )
            
            (41,234
            )
            
            (275,044
            )
            
            (275,044
            )Net
                cash (used in) provided by financing activities
            
            
            
            
            
            (2,365,326
            )
            
            (2,474,430
            )
            
            882,875
            
            
            869,200
            
            
            (803,853
            )
            
            (769,353
            )Effect
                of exchange rate changes on cash
            
            
            
            
            
            (239,797
            )
            
            (48,506
            )
            
            157,884
            
            
            (28,293
            )
            
            (227,966
            )
            
            (3,106
            )Net
                (decrease) increase in cash
            
            
            
            
            
            (264,487
            )
            
            (264,487
            )
            
            196,728
            
            
            196,728
            
            
            169,249
            
            
            169,249Cash
                at beginning of period
            
            
            
            
            
            526,469
            
            
            526,469
            
            
            329,742
            
            
            329,742
            
            
            160,493
            
            
            160,493Cash
                at end of period
            
            
            
            
            $
            261,982
            
            
            261,982
            
            $
            526,470
            
            
            526,470
            
            $
            329,742
            
            $
            329,742Supplemental
                disclosure of cash flow information:Cash
                payments for interest
            
            
            
            
            
            950,280
            
            
            950,280
            
            
            952,682
            
            
            952,682
            
            
            865,196
            
            
            865,196Cash
                payments for taxes
            
            
            
            
            
            88,151
            
            
            88,151
            
            
            47,186
            
            
            47,186
            
            
            42,295
            
            
            42,295Supplemental
                disclosure of non-cash activity:Settlement
                of liability with third party
            
            
            
            
            
            
            
            
            
            
            
            241,268
            
            
            241,268via
                ownership transfer of long-term assetStock
                issued to reduce vendor obligations at fair value
            
            
            
            
            
            
            
            
            
            
            
            61,079
            
            
            61,079Accounts
                payable converted to notes payable
            
            
            
            
            
            453,503
            
            
            453,503
            
            
            
            
            
            
            
            
            3,534,326
            
            
            3,534,326Refinance
                mortage
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            2,671,243
            
            
            2,671,243




See
      accompanying notes to consolidated financial statements




F-6







**CTI
      Industries Corporation and Subsidiaries**


**Notes
      to the Consolidated Financial Statements**




**1.**
            **Nature
                of Operations**




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


**2.**
              **Restatements**
  The
        consolidated statements of operations for the years ended December 31, 2004
        and
        2003 and the consolidated statements of cash flows for the years ended December
        31, 2005, 2004 and 2003 have been restated for correction of errors. The
        restatements do not result in any changes in net loss, net loss per share
        or net
        (decrease) increase in cash.





**Statements
      of Operations**





Certain
      items presented in other income and (expense) have been reclassified to income
      (loss) from operations in the consolidated statements of operations. The amounts
      of such reclassifications for each year are as follows:





2005
            
            2004
            
            2003Income
                (loss) from operations:As
                originally reported
            
            $
            652,096
            
            $
            (568,195
            )
            $
            (679,221
            )As
                restated
            
            
            652,096
            
            
            (50,207
            )
            
            (223,089
            )Other
                income (expense):As
                originally reported
            
            
            (1,185,836
            )
            
            (623,884
            )
            
            (669,777
            )As
                restated
            
            
            (1,185,836
            )
            
            (1,141,872
            )
            
            (1,125,909
            )





**Statements
      of Cash Flows**





The
      consolidated statements of cash flows have been restated to properly present
      the
      effect of exchange rate changes on cash within operating and financing
      activities.





2005
            
            2004
            
            2003Cash
                flows provided
                by (used in) operating activities:As
                originally reported
            
            
            2,738,977
            
            
            (570,579
            )
            
            3,208,172As
                restated
            
            
            2,658,499
            
            
            (384,808
            )
            
            3,106,218Cash
                flows used
                in investing activities:As
                originally reported
            
            
            (398,341
            )
            
            (273,452
            )
            
            (2,007,104
            )As
                restated
            
            
            (400,050
            )
            
            (259,371
            )
            
            (2,164,510
            )Cash
                flows (used
                in) provided by financing activities:As
                originally reported
            
            
            (2,365,326
            )
            
            882,875
            
            
            (803,853
            )As
                restated
            
            
            (2,474,430
            )
            
            869,200
            
            
            (769,353
            )Effect
                of exchange rate on cash:As
                originally reported
            
            
            (239,797
            )
            
            157,884
            
            
            (227,966
            )As
                restated
            
            
            (48,506
            )
            
            (28,293
            )
            
            (3,106
            )




F-7





**3.**
            **Summary
                of Significant Accounting
                Policies**





**Basis
      of Presentation**




The accompanying
      consolidated financial statements have been prepared assuming that the
      Company will continue as a going concern. The Company has incurred recurring
      operating losses, has a working capital deficit of $2,426,000 and an accumulated
      deficit of $6,341,000 as of December 31, 2005. The Company refinanced its credit
      facilities and two shareholders of the Company loaned the Company $1,000,000
      as
      more fully described in Note 22. Management believes that as a result of these
      events that it will have sufficient liquidity to meet its obligations as they
      come due. The financial statements do not include any adjustments that might
      result from the outcome of this uncertainty.




**Principles
      of Consolidation**




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




**Foreign
      Currency Translation**




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




**Use
      of Estimates**




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


F-8





**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 then
      considering the customer’s financial condition, credit history and current
      economic conditions and by using historical experience applied to an aging
      of
      accounts. A trade receivable is considered to be past due if any portion of
      the
      receivable balance is outstanding for a period over the customers’ normal terms.
      Trade receivables are written off when deemed uncollectible. Recoveries of
      trade
      receivables previously written off are recorded when received.





**Inventories**




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




Production
      costs of work in process and finished goods include material labor and overhead,
      including general and administrative expenses where applicable. Work in process
      and finished goods are not recorded in excess of net realizable
      value.




**Property,
      Plant and Equipment**




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




Building
            
            
            25
                - 30 yearsMachinery
                and equipment
            
            
            3
                - 15 yearsOffice
                furniture and equipment
            
            
            5
                - 8 yearsLeasehold
                improvements
            
            
            5
                - 8 yearsFurniture
                & equipment at customer locations
            
            
            2
                - 3 years




Projects
      in process represent those costs capitalized in connection with construction
      of
      new assets and/or improvements to existing assets. 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 not amortized but is tested at least annually
      for impairment. Goodwill on the accompanying balance sheets relates to Flexo
      Universal. It is the Company’s policy to perform impairment testing for Flexo
      Universal annually as of December 31, or as circumstances
      change.


F-9





**Valuation
      of Long Lived Assets**





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





**Deferred
      Financing Costs**





Deferred
      financing costs are amortized on a straight line basis over the term of the
      loan.





**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, in the opinion of management, it is
      more
      likely than not that some portion or all of the deferred tax assets will not
      be
      realized. The Company is subject to U.S. Federal, state and local taxes as
      well
      as foreign taxes in the United Kingdom and Mexico. The Company’s investments in
      non-U.S. subsidiaries are deemed to be invested for an indefinite period of
      time.




**Fair
      Value of Financial Instruments**




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




**Other
      Comprehensive Income (Loss)**




For
      years
      ended December 31, 2005,2004 and 2003 other comprehensive income (loss)
      consisted of foreign currency translation adjustments, which is a component
      of
      accumulated other comprehensive loss within stockholder’s equity.




**Revenue
      Recognition**




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




**Stock-Based
      Compensation**




At
      December 31, 2005, the Company has four stock-based compensation plans, which
      are described more fully in Note 17. The Company accounts for those plans under
      the recognition and measurement principles of APB Opinion No. 25, “Accounting
      for Stock Issued to Employees” and related interpretations. The Company
      recognizes compensation cost for stock-based compensation awards equal to the
      difference between the quoted market price of the stock at the date of grant
      or
      award and the price to be paid by the employee upon exercise in accordance
      with
      the provisions of APB No. 25. Based upon the terms of Company’s current stock
      option plans, the stock price on the date of grant and price paid upon exercise
      are the same. Accordingly, no stock-based employee compensation cost has been
      recognized, as all options granted under those plans had an exercise price
      equal
      to the market value of the underlying common stock on the date of grant. The
      Company has adopted the disclosure provision of Statement of Financial
      Accounting Standards (“SFAS”) No. 148 “Accounting for Stock-Based Compensation -
      Transition Disclosure,” an amendment of SFAS Statement No. 123 (“SFAS No. 148”)
      The following table illustrates the effect on net loss and earnings per share
      had compensation cost for all of the stock-based compensation plans been
      determined based on the grant date fair values of awards:


F-10




**Years
                Ended December 31,****2005**
            
            **2004**
            
            **2003**Net
                loss:Reported
            
            
            (333,000
            )
            
            (2,479,000
            )
            
            (566,000
            )Deduct
                total stock-based employee compensation expensedetermined
                under fair value based method for all awards, net ofrelated
                tax effects
            
            
            (124,000
            )
            
            -
            
            
            (9,000
            )Pro
                forma net loss
            
            
            (457,000
            )
            
            (2,479,000
            )
            
            (575,000
            )Net
                loss per share:Basic
                - As reported
            
            
            (0.17
            )
            
            (1.28
            )
            
            (0.30
            )Basic
                - Proforma
            
            
            (0.23
            )
            
            (1.28
            )
            
            (0.30
            )Diluted
                - As reported
            
            
            (0.17
            )
            
            (1.28
            )
            
            (0.30
            )Diluted
                - Proforma
            
            
            (0.23
            )
            
            (1.28
            )
            
            (0.30
            )





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





**2005**
            
            **2004**
            
            **2003**Expected
                life (years)
            
            
            5.0
            
            
            5.0
            
            
            5.0Volatility
            
            
            138.86
            %
            
            128.49
            %
            
            136.6
            %Risk-free
                interest rate
            
            
            3.89
            %
            
            1.9
            %
            
            4.4
            %Dividend
                yield
            
            
            -
            
            
            -
            
            
            -





**Research
      and Development**




The
      Company conducts product development and research activities which includes
      (i)
      creative product development, (ii) creative marketing, and (iii) engineering.
      During the years ended December 31, 2005, 2004 and 2003, research and
      development activities totaled $224,000, $246,000 and $335,000,
      respectively.


F-11





**Advertising
      Costs**





The
      Company expenses advertising costs as incurred. Advertising expenses amounted
      to
      $50,000, $152,000 and $252,000 for the years ended December 31, 2005, 2004,
      and
      2003, respectively.





**Reclassifications**





Reclassifications
      were made to the year end 2004 balance sheet to conform to the year end 2005
      presentation.





**4.**
            **Recently
                Issued Accounting
                Standards**




In
      December 2004, the Financial Accounting Standards Board (“FASB”) issued
      Statement of Financial Accounting Standards No. 123, “Share-Based Payment”
(“SFAS Statement 123R”), which replaces SFAS No. 123, “Accounting for
      Stock-Based Compensation,” and supersedes APB Opinion No. 25, “Accounting for
      Stock Issued to Employees.” This statement requires that all share-based
      payments to employees be recognized in the financial statements based on their
      fair values on the date of grant. The Company currently uses the intrinsic
      value
      method to measure compensation expense for stock-based awards. The Stock Based
      Compensation caption within Note 3 provides a pro forma net income (loss) and
      earnings per share as if the Company had used a fair-value based method provided
      by SFAS l23R to measure stock-based compensation for 2004, 2003 and 2002. SFAS
      No. 123R is effective as of the beginning of the first interim or annual
      reporting period that begins after December 31, 2005 and applies to all awards
      granted, modified, repurchased or cancelled after the effective date. The
      Company is evaluating the requirements of SFAS 123R and expects that its
      adoption will not have a material impact on the Company’s consolidated results
      of operations and earnings per share.








In
      November of 2004, the FASB issued SFAS No. 151, “Inventory Costs,” which amends
      the guidance in APB No. 43, Chapter 4, “Inventory Pricing,” to clarify the
      accounting for abnormal amounts of idle facility expense, freight, handling
      costs and wasted material (spoilage). This statement requires that those items
      be recognized as current-period charges regardless of whether they meet the
      criterion of “so abnormal” as stated in ARB No. 43. Additionally, SFAS 151
      requires that allocation of fixed production overheads to the costs of
      conversion be based on the normal capacity of the production facilities. The
      Company is required to adopt the provisions of SFAS No. 151 in the first quarter
      of 2006. The Company does not expect SFAS 151 to have a material impact on
      its
      consolidated results of operations or financial condition.





In
      December of 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets
      - An Amendment of APB Opinion No. 29” (SFAS 153). SFAS 153 eliminates the
      exception for nonmonetary exchanges of similar productive assets and replaces
      it
      with a general exception for exchanges of nonmonetary assets that do not have
      commercial substance. SFAS 153 is effective for fiscal years beginning after
      June 15, 2005 and is required to be adopted by the Company in the first quarter
      of 2006. The Company does not believe that the adoption of SFAS 153 will have
      a
      material impact on the Company’s consolidated results of operations or financial
      condition.





In
      May
      2005, the Financial Accounting Standards Board issued Statement of Financial
      Accounting Standards No. 154, “Accounting Changes and Error Corrections - a
      replacement of APB No. 20 and FASB Statement No. 3” (“SFAS 154”). SFAS 154
      replaces APB No. 20, “Accounting Changes” and FASB Statement No. 3, “Reporting
      Accounting Changes in Interim Financial Statements” and changes the requirement
      for accounting for and reporting of a change in accounting principles. SFAS
      154
      is effective for accounting changes and corrections of errors made in fiscal
      years beginning after December 15, 2005. The Company does not anticipate that
      adoption of SFAS 154 will have a material impact on the financial position,
      results of operations or its cash flows.


F-12





**5.**
            **Major
                Customers**




For
      the
      year ended December 31, 2005, the Company had three customers that accounted
      for
      approximately 23.5%, 13.6%, and 13.3%, respectively, of consolidated net sales.
      Corresponding percentages of consolidated net sales generated by these customers
      for the year ended December 31, 2004, were approximately 20.1%, 11.7%, and
      16.8%
      respectively. Corresponding percentages of consolidated net sales generated
      by
      these customers for the year ended December 31, 2003, were approximately 14.7%,
      28.4% and 0.5%, respectively and one other customer represented 11.0% of net
      sales. At December 31, 2005, the outstanding accounts receivable balances due
      from these three customers were $910,250 (related party), $1,403,861 and
      $110,908, respectively. At December 31, 2004, the outstanding accounts
      receivable balances due from these three customers were $956,739 (related
      party), $1,438,153 and $301,724, respectively.





**6.**
            **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,**
              **2005**
            
            **December
                31,**
              **2004**Raw
                materials
            
            $
            1,316,885
            
            $
            888,643Work
                in process
            
            
            730,752
            
            
            806,495Finished
                goods
            
            
            5,229,677
            
            
            6,840,068Allowance
                for excess quantities
            
            
            (254,745
            )
            
            (186,713
            )Total
                inventories
            
            $
            7,022,569
            
            $
            8,348,494




**7.**
            **Notes
                Payable**





Long-term
      debt consists of:


Dec
                  31, 2005
              
              Dec
                  31, 2004Term
                  Loan with bank, payable in monthly installments of $58,333 including
                  interest at prime (7.25% at December 31, 2005) plus 1.5%(8.75%)
                  (amortized
                  over 60 months) balance due January 31, 2006
              
              $
              2,158,341
              
              $
              2,858,337Mortgage
                  Loan with bank, payable in monthly installments of $19,209 including
                  interest at 6.25% due May 5, 2008
              
              $
              2,780,553
              
              $
              2,832,302Vendor
                  Notes, at various rates of interest (weighted average of6%) maturing
                  through December 2007
              
              $
              700,886
              
              $
              649,697Subordinated
                  Notes (Officers) due 2006, interest at 9% net of debt discount
                  of $23,441
                  and $59,408 at December 31, 2005 and 2004, respectively (See Notes
                  7,
                  10)
              
              $
              1,423,059
              
              $
              1,460,592Subordinated
                  Notes (Officers) due 2006, interest at 9%(See Notes 7,10)
              
              $
              814,233
              
              $
              795,024Loan
                  payable to a Mexican finance institution denominated in Mexican
                  Pesos
                  bearing interest at 9.81% due 2009
              
              $
              84,462
              
              $
              84,462Total
                  long-term debt
              
              $
              7,961,534
              
              $
              8,680,414Less
                  current portion
              
              $
              (3,567,144
              )
              $
              (3,560,669
              )Total
                  Long-term debt, net of current portion
              
              $
              4,394,390
              
              $
              5,119,745




F-13





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





As
      of
      December 31, 2005, the balance outstanding on the revolving line of credit
      was
      $5,050,753.


F-14





In
      January 2001, Banco Popular loaned to the Company the sum of $2,873,000 in
      a
      refinance of the Company’s principal office building and property situated in
      Barrington, Illinois. The mortgage loan is collateralized by this building
      and
      property, with a net carrying value of $2,886,595, and was made in the form
      of
      two notes. The first note was in the principal amount of $2,700,000, bearing
      interest at the rate of 9.75%, and had a term of five years with an amortization
      period of 25 years. In May of 2003, the terms of this note were renegotiated
      to
      a note in the principal amount of $2,912,000 bearing 6.25% with a term of 5
      years amortized over 30 years.




The
      second note was in the principal amount of $173,000 with an interest rate of
      10%, and has a term of three years. This obligation was paid in full January
      2004.


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:




2006
            
            $
            3,567,1442007
            
            
            922,2152008
            
            
            811,9922009
            
            
            896,4542010
            
            
            811,992Thereafter
            
            
            951,737$
            7,961,534




On
      February 1, 2006, the Company entered into a Loan Agreement with Charter One
      Bank, Chicago, Illinois. Proceeds of this loan were utilized in part to pay
      the
      entire outstanding balance of the Cole Taylor Bank loan and the Banco Popular
      mortgage loan. (See Note 22)




**8.**
            **Subordinated
                Debt**




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




In
      February 2006, the Company received $1,000,000 from two 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.




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.





**9.**
            **Income
                Taxes**





The
      income tax provisions are comprised of the following:


F-15




Dec.
                    31 2005
            
            Dec.
                    31 2004
            
            Dec.
                    31 2003Current:Federal
            
            $
            -
            
            $
            -
            
            $
            -State
            
            $
            -
            
            $
            -
            
            $
            -Foreign
            
            $
            -
            
            $
            97,097
            
            $
            -$
            -
            
            $
            97,097
            
            $
            -DeferredFederal
            
            
            (180,134
            )
            
            1,223,030
            
            
            (361,881
            )State
            
            
            (24,797
            )
            
            (63,753
            )
            
            (61,281
            )Foreign
            
            $
            4,539
            
            
            29,858
            
            
            (359,306
            )(200,392
            )
            
            1,189,135
            
            
            (782,468
            )Total
                Income Tax (Benefit) Provision
            
            $
            (200,392
            )
            $
            1,286,232
            
            $
            (782,468
            )




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




2005
            
            2004Deferred
                tax assets:Allowance
                for doubtful accounts
            
            $
            32,752
            
            $
            127,150Inventory
                allowances
            
            
            195,095
            
            
            168,006Accrued
                liabilities
            
            
            132,776
            
            
            126,372Unicap
                263A adjustment
            
            
            52,380
            
            
            52,380Net
                operating loss carryforwards
            
            
            3,302,982
            
            
            2,988,093Alternative
                minimum tax credit carryforwards
            
            
            338,612
            
            
            338,612State
                investment tax credit carryforward
            
            
            18,041
            
            
            18,041Other
                foreign tax items
            
            
            (3,179
            )
            
            109,833Foreign
                asset tax credit carryforward
            
            
            160,784
            
            
            160,784Total
                deferred tax assets
            
            
            4,230,243
            
            
            4,089,271Deferred
                tax liabilities:Book
                over tax basis of capital assets
            
            
            (1,074,863
            )
            
            (1,134,282
            )Cash
                basis of foreign inventory purchases
            
            
            (348,690
            )
            
            (348,690
            )2,806,690
            
            
            2,606,299Less:
                Valuation allowance
            
            
            (2,454,001
            )
            
            (2,454,001
            )Net
                deferred tax asset
            
            $
            352,689
            
            $
            152,298




F-16





The
      Company maintains a valuation allowance with respect to deferred tax assets
      as a
      result of the uncertainty of ultimate realization. At December 31, 2005, the
      Company has net operating loss carryforwards of approximately $5,392,538
      expiring in various years through 2025. In addition, the Company has
      approximately $338,600 of alternative minimum tax credits as of December 31,
      2005, which have no expiration date. Management has determined based upon the
      evaluation of certain transactions involving the repatriation of profits from
      its U.K. subsidiary that it is more likely than not that deferred tax assets
      will be realized in 2005. The increase in the valuation allowance, which was
      recorded in the fourth quarter of 2004, was made after management determined
      that the realization of the deferred tax asset was not likely to be realized
      in
      the foreseeable future. Income tax provisions differed from the taxes calculated
      at the statutory federal tax rate as follows:




**Years
                Ended December 31,****2005**
            
            **2004**
            
            **2003**Taxes
                at statutory rate
            
            $
            (186,809
            )
            $
            (417,228
            )
            $
            (393,154
            )State
                income taxes
            
            
            (25,716
            )
            
            (57,434
            )
            
            (55,504
            )Nondeductible
                expenses
            
            
            12,757
            
            
            15,355
            
            
            20,564Increase
                in deferred taxValuation
                allowance
            
            
            -
            
            
            1,715,401
            
            
            -Foreign
                taxes and other
            
            
            (624
            )
            
            30,138
            
            
            (354,374
            )Income
                tax provision
            
            $
            (200,392
            )
            $
            1,286,232
            
            $
            (782,468
            )




**10.**
            **Other
                Income/Expense**




Other
      income/expense set forth on the Company’s Consolidated Statement of Operations
      for the fiscal year ended December 31, 2005 included gains of $45,000 related
      to
      currency translation items





**10A.
      Operating Expenses - Other income**




Other
      income of $395,489 set forth on the Company’s Restated Consolidated Statement of
      Operations for the year ended December 31, 2004 includes (i) gains related
      to a
      review and determination that various accrued items on the books of the Mexican
      subsidiaries of the Company (CTI Mexico and Flexo) are not due or payable and
      (ii) gains based on the settlement of the various accounts in consideration
      for
      the payment of an amount less than the amount accrued. These settlements
      primarily relate to CTI Mexico an inactive subsidiary. For the year ending
      December 31, 2003, the Company had other income of $428,125. This amount
      includes income derived from the settlement of certain outstanding liabilities
      due to vendors for less than the amount recorded on the books of the Company.




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




Items
      idenfitied as Other Liabilities in the Company’s Consolidated Balance Sheet as
      of December 31, 2005 include (i) loans by officers/shareholders to Flexo
      Universal totaling $1,056,000, and (ii) obligations of CTI Mexico, Flexo, and
      CTF International totaling $587,000. Items identified as Other Liabilities
      in
      the Company’s Consolidated Balance Sheet as of December 31, 2004 include (i)
      loans by officers/shareholders to Flexo Universal totaling $517,000 due in
      2007
      and 2008, (ii) capital lease for equipment for $5,000, (iii) obligations of
      CTI
      Mexico, Flexo, and CTF International totaling $779,000 to vendors on deferred
      payment terms, and (iv) $70,000 of others.





**12.**
            **Employee
                Benefit Plan**




The
      company has a defined contribution plan for substantially all employees. Profit
      sharing contributions may be made at the discretion of the Board of Directors.
      Effective January 1, 2004, the Company amended its defined contribution plan.
      Under the amended plan, the maximum contribution for the Company is 2% of gross
      wages. Employer contributions to the plan totaled $52,147, $57,172, and $54,836
      for the years ended December 31, 2005, 2004 and 2003,
      respectively.


F-17





**13.**
            **Related
                Party Transactions, See Note
                16.**




Stephen
      M. Merrick is a shareholder of 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 were $117,000 for the year ended
      December 31, 2005, $97,000 for the year ended December 31, 2004 and $107,000
      for
      the year ended December 31, 2003. In 2005, Mr. Merrick received $48,000 for
      services performed from CTI Industries and an additional $12,000 in directors
      fees from CTI Balloons Limited located in the United Kingdom.




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




John
      H.
      Schwan is principal of Shamrock Packaging and affiliated companies. The Company
      made purchases of packaging materials from them of approximately $165,000,
      $172,000 and $274,000 during the years ended December 31, 2005, 2004 and 2003,
      respectively.




John
      H.
      Schwan is an officer of an affiliate of Rapak L.L.C. Rapak purchased an
      aggregate of $6,860,000, $7,837,000 and $5,360,000 of film from the Company
      during the fiscal years 2005, 2004 and 2003, respectively.




For
      each
      of the years ended December 31, 2005, 2004 and 2003, respectively, Mr. Schwan
      received $24,000 for services performed from CTI Industries. Further, he
      received an additional $12,000 in directors fees in 2005 from CTI Balloons
      Limited located in the United Kingdom.




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. The warrants have a term of
      five
      years.




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.




Messrs.
      Schwan and Merrick made advances to the Company’s Mexican affiliate, Flexo
      Universal in the amount of $112,500 and $141,900, respectively in 2005, $86,000
      and $181,000, respectively in 2004, and $225,000 and $25,000 in 2003,
      respectively. Additionally, Messrs. Schwan and Merrick advanced $130,000 and
      $155,000, in 2005 respectively to the Company’s UK affiliate, CTI Balloons Ltd.
      These advances are reflected in demand notes bearing interest at the rate of
      8%
      per annum in 2004 and 2003, and 7% in 2005.




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


F-18





Interest
      paid to related parties during 2005, 2004 and 2003 was $146,898, $119,230 and
      $150,674, respectively.





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




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




The
      Company retained a valuation consulting firm to conduct an evaluation of our
      goodwill in our Mexico subsidiary December 2004 and December 2005. As of
      December 31, 2005, the valuation consulting firm determined that the fair value
      of the Company’s interest in Flexo Universal was $988,000, and the carrying
      value of $1,113,000 was impaired by $124,000. Accordingly, we have recorded
      the
      amount of this impairment as an expense and have reduced the carrying value
      of
      the Company’s interest in Flexo Universal to $989,108.




The
      carrying amount of goodwill as of December 31, 2005 was $989,108 and as of
      December 31, 2004 was $1,113,108. When acquired prior to 2003, goodwill was
      recorded at $1,299,954. When goodwill ceased to be amortized with the adoption
      of SFAS 142, amortization was $186,846, resulting in the $1,113,108 carrying
      value through December 31, 2004. The primary indicator attributable to the
      impairment loss was the inability of the subsidiary to meet its financial
      projections.




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




**Operating
      Leases**




In
      July
      of 2004, the Company signed a month to month lease with HP Properties LLC for
      approximately 35,000 square feet of space in Cary, Illinois. In September of
      2005, the Company signed a lease to rent 16,306 square feet of space from
      Trinity Assets replacing the previous lease with HP Properties. This lease
      has a
      2 year term. The Company’s United Kingdom subsidiary also maintains a lease for
      office and warehouse space which expires in 2019. The Company’s Mexico
      subsidiary signed a five year lease in January of 2003 to rent 43,000 square
      feet of space at a cost of approximately $17,000 per month. The Company leases
      office equipment under operating leases which expire on various dates through
      December 2006.  See Note 16 relating to cancellation of Pepper Road
      lease.




The
      net
      lease expense was $598,440, $401,848 and $555,197 for the years ended December
      31, 2005, 2004, and 2003, respectively, which includes $76,500 and $193,615
      paid
      to Pepper Road (a related party) in 2004 and 2003, respectively.




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




**Trinity
                Assets**
            
            **Other**
            
            **Total**
              **Lease**
              **Payments**2006
            
            $
            77,117
            
            
            337,759
            
            $
            414,8762007
            
            
            58,916
            
            
            286,727
            
            
            345,6432008
            
            
            
            
            
            51,700
            
            
            51,7002009
            
            
            
            
            
            51,700
            
            
            51,7002010
            
            
            
            
            
            51,700
            
            
            51,700Thereafter
            
            
            
            
            
            465,300
            
            
            465,300Total
            
            $
            136,033
            
            $
            1,244,886
            
            $
            1,380,919




F-19





**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:




2006
            
            $
            76,6642007
            
            $
            76,6642008
            
            $
            76,664




**16.**
            **Sale/Leaseback
                of Building - Related
                Party**





In
      November 1999, the Company sold its building located next to its headquarters
      in
      Barrington, Illinois for a gain of $300,467, and entered into an agreement
      to
      lease back the facility. The building was owned by an entity in which
      officers/shareholders of the Company have a controlling interest. The gain
      realized on the sale was deferred and was being recognized into income over
      the
      10 year lease term. In July of 2004, this building was sold and the remaining
      deferred gain of $160,000 was fully recognized.




**17.**
            **Stock
                Options and Warrants**





Under
      the
      Company’s 1997 Stock Option Plan (effective July 1, 1997), a total of 119,050
      shares of Common Stock are reserved for issuance under the Stock Option Plan.
      Options to purchase 98,416 shares of Common Stock have been granted as of
      October 31, 1998, and remain outstanding at December 31, 2005. The options
      are
      exercisable immediately upon grant and have a term of ten years. The Plan
      provides 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. The Plan is administered by
      the
      Board or a committee appointed by the Board (the “Administrator”). Officers,
      directors, and employees of, and consultants to, the Company or any parent
      or
      subsidiary corporation selected by the Administrator are eligible to receive
      options under the Plan. Subject to certain restrictions, the Administrator
      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 and other terms.




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, 2005, 148,219 options had been granted under the 1999 Stock
      Option Plan. The options are exercisable immediately upon grant, and have a
      term
      of ten years.




On
      April
      12, 2001, the Board of Directors approved for adoption, effective December
      27,
      2001, the 2001 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, 2005, 112,503 options had been granted under the
      2001
      Stock Option Plan. The options are exercisable immediately upon grant and have
      a
      term of ten years.


F-20





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, 2005, 141,954 options had been granted under the 2002 Stock Option
      Plan. The options are exercisable immediately upon grant and have a term of
      ten
      years.




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 Administrator
      (Board of Directors or other designated person) at whatever price the
      Administrator may determine in good faith. Unless the Administrator 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 Administrator 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.




In
      September 1998, the Company issued an option to purchase 11,905 shares of the
      Company’s Common Stock at an exercise price of $2.10 per share to Thornhill
      Capital LLC in consideration for services. The option has a term of 10 years.
      In
      September 1999, warrants to purchase 19,079 shares of the Company’s Common Stock
      at an exercise price of $9.36 per share were cancelled and reissued at an
      exercise price of $1.42 per share. In April 2002, the Company issued an option
      to purchase 11,905 shares of the Company’s Common Stock at an exercise price of
      $2.10 per share to Thornhill Capital in consideration of services.




In
      November 1999, warrants issued in 1997 to purchase up to 76,389 shares of the
      Company’s Common Stock for $9.36 were cancelled. New warrants to purchase up to
      423,579 shares of the Company’s Common Stock at $1.688 were issued. The new
      warrants had a term of 3 years and were exercised in 2002.




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. The warrants have a term of
      five
      years.





In
      March
      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.




In
      December 2003, certain members of company management were issued incentive-based
      options to purchase 7,000 shares of the Company’s Common Stock at an exercise
      price of $2.29 per share. These options have a term of 10 years.




In
      December 2005, certain members of company management were issued incentive-based
      options to purchase 79,000 shares of the Company’s Common Stock at an exercise
      price of $2.88 per share. These options have a term of 10 years.




In
      February 2006, certain members of company management were issued warrants 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.


F-21




The
      following is a summary of the activity in the Company’s stock option plans and
      other options and warrants issued, for the years ended December 31, 2005, 2004
      and 2003, respectively.





**Dec.
                31,**
              **2005**
            
            **Weighted**
              **Avg.**
              **Exercise**
              **Price**
            
            **Dec.
                31,**
              **2004**
            
            **Weighted**
              **Avg.**
              **Exercise**
              **Price**
            
            **Dec.
                31,**
              **2003**
            
            **Weighted**
              **Avg.**
              **Exercise**
              **Price**Outstanding
                and exercisable, beginning of period
            
            
            687,472
            
            $
            3.16
            
            
            725,597
            
            $
            2.58
            
            
            572,862
            
            $
            2.58Granted
            
            
            79,000
            
            
            2.88
            
            
            0
            
            
            
            
            
            170,000
            
            
            2.22Exercised
            
            
            (32,144
            )
            
            1.70
            
            
            0
            
            
            
            
            
            (8,336
            )
            
            1.54Cancelled
            
            
            (90,876
            )
            
            1.77
            
            
            (38,125
            )
            
            1.81
            
            
            (8,929
            )
            
            6.51Outstanding
                and exercisable at the end of period
            
            
            643,452
            
            $
            3.40
            
            
            687,472
            
            $
            3.33
            
            
            725,597
            
            $
            2.58




At
      December 31, 2005, available options to grant were 907.




Significant
      option and warrant groups outstanding at December 31, 2005 and related weighted
      average price and remaining life information are as follows:





**Grant
                Date**
            
            **Outstanding**
            
            **Exercisable**
            
            **Exercise**
              **Price**
            
            **Remaining**
              **Life
                (Years)**September
                1997
            
            
            5,953
            
            
            5,953
            
            $
            6.28
            
            
            1September
                1998
            
            
            88,494
            
            
            88,494
            
            $
            6.51
            
            
            2September
                1998
            
            
            11,905
            
            
            11,905
            
            $
            2.10
            
            
            2March
                2000
            
            
            57,143
            
            
            57,143
            
            $
            1.95
            
            
            4July
                2001
            
            
            119,050
            
            
            119,050
            
            $
            1.50
            
            
            0.5December
                2001
            
            
            44,048
            
            
            44,048
            
            $
            1.47
            
            
            5April
                2002
            
            
            11,905
            
            
            11,905
            
            $
            2.10
            
            
            6December
                2002
            
            
            55,954
            
            
            55,954
            
            $
            2.36
            
            
            6February
                2003
            
            
            163,000
            
            
            163,000
            
            $
            4.87
            
            
            2December
                2003
            
            
            7,000
            
            
            7,000
            
            $
            2.29
            
            
            8December
                2005
            
            
            79,000
            
            
            79,000
            
            $
            2.88
            
            
            9643,452
            
            
            643,452





There
      were 79,000 options issued in 2005, no options issued in 2004, the weighted
      average fair value of options granted during the years ending December 31,
      2005
      and December 31, 2003 was $2.88 and $2.29 per share, respectively.




**18.**
            **Earnings
                Per Share**





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


F-22





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




**CTI
      Industries Corporation and Subsidiaries**


**Consolidated
      Earnings per Share**





Year
                Ended December 31,2005
            
            2004
            
            2003**Basic**Average
                shares outstanding:Weighted
                average number of shares outstanding during the period
            
            
            1,977,235
            
            
            1,930,976
            
            
            1,918,260**Earnings:**Net
                loss:
            
            $
            (333,210
            )
            $
            (2,479,374
            )
            $
            (566,047
            )Amount
                for per share Computation
            
            $
            (333,210
            )
            $
            (2,479,374
            )
            $
            (566,047
            )Net
                (loss) earnings applicable to Common Shares
            
            $
            (0.17
            )
            $
            (1.28
            )
            $
            (0.30
            )**Diluted**Average
                shares outstanding:
            
            
            1,977,235
            
            
            1,930,976
            
            
            1,918,260Weighted
                averages shares Outstanding Common stock equivalents (options,
                warrants)Weighted
                average number of shares outstanding during the period
            
            
            1,977,235
            
            
            1,930,976
            
            
            1,918,260Earnings:Net
                (loss) income
            
            $
            (333,210
            )
            $
            (2,479,374
            )
            $
            (566,047
            )Amount
                for per share computation
            
            $
            (333,210
            )
            $
            (2,479,374
            )
            $
            (566,047
            )Net
                loss applicable to Common Shares
            
            $
            (0.17
            )
            $
            (1.28
            )
            $
            (0.30
            )




**19.**
            **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 periods ended December 31,
      2003, December 31, 2004 and December 31, 2005 are as follows:


F-23




**United**
                **States**
              
              **United**
                **Kingdom**
              
              **Mexico**
              
              **Eliminations**
              
              **Consolidated**Year
                  ended 12/31/05Revenues
              
              $
              23,564,000
              
              $
              2,573,000
              
              $
              4,536,000
              
              
              ($1,483,000
              )
              $
              29,190,000Operating
                  income (loss)
              
              $
              602,000
              
              $
              290,000
              
              
              ($240,000
              )
              
              
              
              $
              652,000Net
                  (loss) income
              
              
              ($342,000
              )
              $
              220,000
              
              
              ($211,000
              )
              
              
              
              
              ($333,000
              )Total
                  Assets
              
              $
              21,343,000
              
              $
              2,122,000
              
              $
              4,818,000
              
              
              ($4,747,000
              )
              $
              23,536,000Year
                  ended 12/31/04Revenues
              
              $
              32,855,000
              
              $
              2,664,000
              
              $
              4,890,000
              
              
              ($3,216,000
              )
              $
              37,193,000Operating
                  (loss) income (restated)
              
              
              ($92,000
              )
              $
              121,000
              
              
              ($31,000
              )
              
              ($48,000
              )
              
              ($50,000
              )Net
                  (loss) income
              
              
              ($2,595,000
              )
              $
              223,000
              
              
              ($59,000
              )
              
              ($48,000
              )
              
              ($2,479,000
              )Total
                  Assets
              
              $
              24,072,000
              
              $
              1,989,000
              
              $
              5,319,000
              
              
              ($3,492,000
              )
              $
              27,888,000Year
                  ended 12/31/03Revenues
              
              $
              32,687,000
              
              $
              2,415,000
              
              $
              4,003,000
              
              
              ($2,845,000
              )
              $
              36,260,000Operating
                  (loss) income (restated)
              
              
              ($216,000
              )
              $
              191,000
              
              
              ($102,000
              )
              
              ($96,000
              )
              
              ($223,000
              )Net
                  (loss) income
              
              
              ($883,000
              )
              $
              163,000
              
              $
              249,000
              
              
              ($95,000
              )
              
              ($566,000
              )Total
                  Assets
              
              $
              27,603,000
              
              $
              1,412,000
              
              $
              5,476,000
              
              
              ($4,221,000
              )
              $
              30,270,000




**20.**
            **Litigation**





On
      September 5, 2003, Airgas Inc., Airgas-Southwest, Inc., Airgas-South, Inc.
      and
      Airgas-East, Inc. filed a joint action against CTI Industries Corporation for
      claimed breach of contract in the Circuit Court of Lake County, Illinois
      claiming as damages the aggregate amount of $162,242. The Company has filed
      an
      answer denying the material claims of the complaint, affirmative defenses and
      a
      counterclaim. In the action, the plaintiffs claim that CTI Industries
      Corporation owes them certain sums for (i) helium sold and delivered, (ii)
      rental charges with respect to helium tanks and (iii) replacement charges for
      tanks claimed to have been lost. On November 2, 2004, this matter was settled.
      The amount agreed to be paid by the Company in settlement totaled $100,000.
      The
      first payment of $50,000 was paid on November 15, 2004. The balance of $50,000
      was payable in five consecutive $10,000 monthly installments, commencing
      December 30, 2004 and has been paid. The Company had fully accrued the amount
      of
      the settlement as of December 31, 2004.





On
      June
      4, 2004, Spar Group, Inc. initiated an arbitration proceeding in New York City
      against the Company. In the proceeding, Spar Group claimed that there was due
      from the Company to Spar Group a sum for services rendered in the amount of
      $180,043, plus interest. Spar Group claimed to have rendered services to the
      Company in various Eckerd stores with respect to the display and ordering of
      metalized and latex balloons for sale in those stores. The Company filed an
      answer denying liability with respect to the claim and asserted a counterclaim
      for damages against Spar Group for breach of its agreement to provide such
      services. On January 13, 2005, this matter was settled. The amount agreed to
      be
      paid by the Company in settlement totaled $100,000. The first payment of $30,000
      was paid on February 1, 2005. The balance of $70,000 was payable in seven
      consecutive $10,000 monthly installments, commencing March 1, 2005 and has
      been
      paid in full. The Company had fully accrued the amount of the settlement as
      of
      December 31, 2004.


F-24





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.





**21. 
      Quarterly Financial Data (Unaudited):**




The
      following table sets forth selected unaudited statements of income for each
      quarter of fiscal 2005 and 2004:





Quarter
                Ended(1)March
                31,
            
            June
                30,
            
            Sept.
                30,
            
            Dec.
                31,2005
            
            2005
            
            2005
            
            2005Net
                sales
            
            $
            9,103,327
            
            $
            7,572,626
            
            $
            6,033,831
            
            $
            6,480,189Gross
                profit
            
            $
            1,873,993
            
            $
            1,582,954
            
            $
            1,242,186
            
            $
            1,765,016Net
                income (loss)
            
            $
            84,488
            
            
            ($53,616
            )
            
            ($416,267
            )
            $
            52,186Earnings
                (loss) per common shareBasic
            
            $
            0.04
            
            
            ($0.03
            )
            
            ($0.21
            )
            $
            0.03Diluted
            
            $
            0.04
            
            
            ($0.03
            )
            
            ($0.21
            )
            $
            0.02


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




Quarter
                Ended(1)March
                31,
            
            June
                30,
            
            Sept.
                30,
            
            Dec.
                31,2004
            
            2004
            
            2004
            
            2004(2)(3)Net
                sales
            
            $
            10,893,964
            
            $
            9,591,785
            
            $
            8,125,521
            
            $
            8,581,819Gross
                profit
            
            $
            2,147,370
            
            $
            2,032,028
            
            $
            1,669,778
            
            $
            502,944Net
                income (loss)
            
            $
            371,901
            
            
            ($135,681
            )
            
            ($150,370
            )
            
            ($2,565,224
            )Earnings
                (loss) per common shareBasic
            
            $
            0.19
            
            
            ($0.07
            )
            
            ($0.08
            )
            
            ($1.31
            )Diluted
            
            $
            0.18
            
            
            ($0.07
            )
            
            ($0.08
            )
            
            ($1.31
            )


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





(2)
      Cost
      of sales were higher, as a percentage of net sales in the fourth quarter of
      2004
      than in prior quarters of 2004, resulting in lower gross profit than in those
      prior quarters by reason of the facts that: (i) sales of storage bags continued
      to decline resulting in a shift in product mix to lower margin products, (ii)
      higher costs of production in prior quarters resulted in higher unit costs
      for
      metalized balloons sold during the fourth quarter and (iii) there were
      discounted and low margin sales of balloon products in the fourth quarter.





(3)
      The
      amount of the income tax expense recognized by the Company in 2004 reflects
      adjustments in deferred tax assets and other items arising from the operating
      results of the Company for the year. This increase, which was recorded during
      the fourth quarter, was made after management determined, based on fourth
      quarter activity, that the realization of the deferred tax asset was not likely
      in the foreseeable future. Fourth quarter activity affecting this determination
      included lower than anticipated sales in the storage bag product line and lower
      margin sales of novelty products, as described above.


F-25





**22.**
            **Subsequent
                Events**




On
      February 1, 2006, the Company entered into a Loan Agreement with Charter One
      Bank, Chicago, Illinois, under which the Bank agreed to provide a credit
      facility to the Company in the total amount of $12,800,000, 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 20 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 $6,500,000, 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. Proceeds of this loan totaling
      $10,349,653 were utilized to pay the entire outstanding principal amount of
      the
      Company’s outstanding debt obligations to Cole Taylor Bank and Banco Popular.
      Under the terms of the Loan Agreement, the Company is restricted from declaring
      any cash dividends or other distributions on its shares.




On
      January 10, 2006, an officer of Flexo Universal, Pablo Gortazar, acquired all
      rights in a loan of a credit union to Flexo Universal and CTF International
      both
      Mexican subsidiaries of the Company for the book value. The principal
      amount of the obligation of Flexo Universal and CTF International acquired
      was
      $191,000, and such amount bears interest at the rate of 9.5% per
      annum.




On
      February 1, 2006, two principal shareholders and officers of the Company each
      loaned to the 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 the common stock of the Company, each, at the price
      of
      $3.30 per share.




On
      March
      9, 2006, the Company entered into a four-year term Production and Supply
      Agreement with ITW Spacebag, a division of Illinois Tool Works, Inc., under
      which ITW is to purchase from the Company (i) all of its requirements for a
      certain kind of pouch for the storage of personal and household items and (ii)
      all of its requirements, subject to being price competitive, for film to be
      utilized by ITW to produce certain other storage pouches.




**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:




2005
            
            2004
            
            2003Balance
                at beginning of year
            
            $
            404,070
            
            $
            316,047
            
            $
            391,406Charged
                to expenses
            
            $
            145,000
            
            $
            288,562
            
            $
            145,000Uncollectible
                accounts written off
            
            $
            (468,865
            )
            $
            (200,539
            )
            $
            (220,359
            )Balance
                at end of year
            
            $
            80,205
            
            $
            404,070
            
            $
            316,047




F-26




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





2005
            
            2004
            
            2003Balance
                at beginning of year
            
            $
            186,713
            
            $
            492,157
            
            $
            392,142Charged
                to expenses
            
            $
            205,000
            
            $
            60,000
            
            $
            210,000Obsolete
                inventory written off
            
            $
            (136,968
            )
            $
            (365,444
            )
            $
            (109,985
            )Balance
                at end of year
            
            $
            254,745
            
            $
            186,713
            
            $
            492,157





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





2005
            
            2004
            
            2003**Cost
                Basis**Balance
                at beginning of year
            
            $
            26,224,962
            
            $
            27,023,245
            
            $
            25,881,777Additions
            
            $
            549,547
            
            $
            305,547
            
            $
            2,007,104Disposals
            
            $
            (70,143
            )
            $
            (1,103,830
            )
            $
            (865,636
            )Balance
                at end of year
            
            $
            26,704,366
            
            $
            26,224,962
            
            $
            27,023,245**Accumulated
                depreciation**Balance
                at beginning of year
            
            $
            15,636,451
            
            $
            14,815,596
            
            $
            14,166,764Depreciation
            
            $
            1,463,369
            
            $
            1,651,322
            
            $
            1,514,468Disposals
            
            $
            (12,198
            )
            $
            (830,467
            )
            $
            (865,636
            )Balance
                at end of year
            
            $
            17,087,622
            
            $
            15,636,451
            
            $
            14,815,596Property
                and equipment, net
            
            $
            9,616,744
            
            $
            10,588,511
            
            $
            12,207,649


F-27