|SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2004
Commission File Number000-23115
CTI INDUSTRIES CORPORATION(Exact name of Registrant as specified in its charter)
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|Illinois                                                                                  | 36-2848943                             
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|(State or other jurisdiction of
incorporation or organization)                            | (I.R.S. Employer Identification Number)
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|22160 North Pepper Road Barrington, Illinois
    (Address of principal executive offices) | 60010
      
(Zip Code)                

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|(847) 382-1000Registrants telephone number, including area code
Securities registered pursuant to Sections 12(b) and 12(g) of the Act:
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|Title of Class             | Name of each exchange
    on which registered:
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|                           |                                               
|Common Stock, no par value | NASDAQ SmallCap Market                        

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|Check
        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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|oYesxNo                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
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|Check
        if disclosure of delinquent filers pursuant to Item 405 of Regulation
        S-K is not contained herein, and will not be contained, to the best of
        Registrants knowledge, in definitive proxy or information statements
        incorporated in Part III of the Form 10-K or any amendment to the Form
        10-K.  o
      The
        Registrants revenues for the fiscal year ended December 31, 2004,
        were $37,193,109
      Indicate
        by check mark whether the Registrant is an accelerated filer (as defined
        in Exchange Act Rule 12b-2)oYesxNo
      Based
        upon the closing price of $2.15 per share of Registrants Common
        Stock as reported on the NASDAQ SmallCap Market at June 30, 2004, the
        aggregate market value of the voting stock held by non-affiliates of the
        Registrant was then approximately $2,049,907 (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 of the Registrants Common Stock outstanding as
        of April 15, 2005 was 1,954,100 (excluding treasury shares).
      Transitional Small
        Business Disclosure Format (check one): oYesxNo
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|PART I
Item No. 1 Description of Business
Business Overview
CTI Industries Corporation and subsidiaries (the Company) is engaged in the development, manufacture, sale and distribution of two
principal lines of products within a single segment:
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| |  | Novelty products, principally balloons, including metalized balloons, latex balloons, punch balls and
  other inflatable toy items.      
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| |  | Specialty and printed films and flexible containers, for food packaging, specialized consumer uses
  and various commercial applications.

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|The Company was organized in 1976 and initially was principally engaged in the business of manufacturing
bag-in-box plastic packaging systems. The Company sold its assets related to bag-in-box packaging
systems in 1985. In 1978, the Company began manufacturing metalized balloons (sometimes referred
to as foil balloons), balloons made of a base material (usually nylon) 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, the Company began marketing latex balloons and, in 1988, began manufacturing latex balloons.
In 1994, the Company sold its latex balloon manufacturing equipment to a company in Mexico and entered
into an arrangement for that company to manufacture latex balloons for the Company. The Company since
has acquired majority ownership of the Mexican latex manufacturing company.
The Companys metalized and latex balloons and toy products are sold throughout the United States
and in several foreign countries 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 metalized balloons contain printed characters, designs and social expression messages. The Company
maintains licenses on numerous characters and designs, including, for example, Garfield®, Precious Moments®, Elephantz®, Face Offs-Tudes®, Headfirst®, Kinka® and Successories®.  The Company also has licenses in Mexico for Shrek®, Shark Tales®, and Barbie®. In the UK, the Company maintains licenses on Postman Pat® and Dream Fairies®. For a period of three years, the Company did maintain a relationship with Hallmark Cards under which
the Company (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.
The Company has an 18 month period in which to sell off its inventory of Hallmark products.
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|On an increasing basis over the past six years, the Company also has engaged in the production, lamination,
coating and printing of films and provides custom film products for a variety of commercial applications.
These include (i) laminated and printed films for use in packaging applications and (ii) completed
products for customer storage applications and for packaging applications. Revenues from this activity
have grown rapidly since 1997. Though experiencing a decline in 2004, these revenues still represented
approximately 37.2% of total Company revenues.
Background
CTI Industries Corporation (the Company) was incorporated as Container Merger Company,
Inc. under the laws of the State of Delaware on October 14, 1983, and changed its name to CTI Industries
Corporation on August 2, 1985. A predecessor company, Creative Technology, Inc., was organized as
an Illinois corporation on December 9, 1975 and was merged into the Company in February 1984. On
November 19, 2001, the Company was reincorporated in Illinois and is now an Illinois corporation.
CTI Balloons Limited. (CTI Balloons), the Companys wholly-owned subsidiary, was organized
as a corporation under the laws of the United Kingdom on October 2, 1996. On October 24, 1996, the
Company entered into an agreement with CTI Balloons pursuant to which all of the assets and liabilities
of the Company in its branch operation in the United Kingdom were sold and transferred to CTI Balloons
and all of the capital stock of CTI Balloons was issued and delivered to the Company. Unless otherwise
specified, all references to the Company refer to the Company, its predecessor Creative Technology,
Inc., its wholly-owned subsidiaries, CTI Balloons, CTF International, S.A. de C.V., and its majority-owned
subsidiaries, CTI Mexico, S.A. de C.V. and Flexo Universal, S.A. de C.V.
In March and May of 1996, a group of investors made an equity investment of $1,000,000 in the Company
in return for 366,300 shares of Preferred Stock, $.91 par value. Each share of Preferred Stock was
entitled to an annual cumulative dividend of 13% of the purchase price, and was convertible into
one share of Common Stock. The shares of Preferred Stock, voting separately as a class, were entitled
to elect four of the Companys directors. Members of such investment group included Howard W.
Schwan, John H. Schwan and Stephen M. Merrick, current members of management.
In July 1997, the Company effected a recapitalization (the Recapitalization) without a
formal reorganization. As part of the Recapitalization, the Board of Directors approved the creation
of Class B Common Stock, approved a 1 for 2.6 reverse stock split on both the Common Stock and Preferred
Stock, and negotiated a conversion of all then outstanding shares of the Companys Convertible
Preferred Stock into an aggregate of 366,300 shares of Class B Common Stock. The conversion was effective
upon the closing of an initial public offering of 575,000 shares of the Companys Common Stock
on November 5, 1997. The shares of Class B Common Stock contained rights identical to shares of Common
Stock, except that shares of Class B Common Stock, voting separately as a class, had the right to
elect four of the Companys seven directors. Shares of Common Stock and Class B Common Stock,
voting together as a class, voted on all other matters, including the election of the remaining directors.
The recapitalization, initial public offering and related transactions were approved by written consent
of the shareholders.
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|On July 1, 2002, all outstanding shares of Class B Common Stock, by their terms, were converted to
common stock.
On October 15, 1999, the Companys Board of Directors approved a 1 for 3 reverse split of the
Companys Common Stock and Class B Common Stock. The 1 for 3 reverse stock split became effective
at the close of business on November 4, 1999, upon the approval and consent of a majority of Common
and Class B Common Stockholders voting together as a single class. As a result of the reverse stock
split, every three shares of the Companys Common Stock were reclassified and changed into one
share of the Companys Common Stock with a new par value of $.195 per share, and every three
shares of the Companys Class B Common Stock were reclassified and changed into one share of
the Companys Class B Common Stock, with a new par value of $2.73 per share. After the reincorporation
of the Company in the State of Illinois, the Companys Common and Class B Common Stock ceased
to have any par value.
On December 13, 2002, the Board of Directors of the Company declared a stock dividend of one share
of Common Stock for each 5.25 shares of Common Stock outstanding. The record date for the dividend
was December 27, 2002. Except for the elimination of par values and as otherwise indicated, share
figures in this document have been restated to reflect the stock splits and stock dividends described
above.
Mexico Operations.  Through March 2003, the Companys latex balloons were manufactured by CTI Mexico S.A.
de C.V. (CTI Mexico), formerly known as Pulidos y Terminados Finos S.A. de C.V., a Guadalajara,
Mexico company engaged principally in the manufacture of latex balloons. Commencing in March 2003,
the Companys latex balloons have been manufactured by Flexo Universal, S.A. de C.V. (Flexo
Universal). Both CTI Mexico and Flexo Universal are majority owned subsidiaries of the Company.
In 1995, the Company entered into an agreement with CTI Mexico under which (i) the Company sold to
CTI Mexico all of its latex balloon manufacturing equipment (for the manufacture of decorator balloons),
(ii) CTI Mexico agreed for a period of 10 years to supply balloons exclusively to the Company for
sale in the United States and Canada manufactured on such equipment and (iii) for such 10 year period,
CTI Mexico agreed to supply to the Company, exclusively in the United States except as to two other
companies, all balloons manufactured by CTI Mexico. Commencing in 1996, CTI Mexico began manufacturing
latex balloons for the Company.
In a series of transactions during the period 1998 through 2002, the Company acquired capital stock
of CTI Mexico and, by August 2002, had acquired 98% ownership of CTI Mexico.
Through March 2003, CTI Mexico conducted operations at four facilities in Guadalajara, Mexico having,
in total, approximately 95,000 square feet of manufacturing, office and warehouse space. At these
facilities, CTI Mexico produced, printed and packaged latex balloons, warehoused latex and foil balloons
and conducted sales, marketing and administrative activities.
On February 22, 2003, CTI Mexico effected a spin off under Mexico law under which a portion of the
assets, liabilities and capital of CTI Mexico were transferred to a newly-organized entity
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|which operates under the name Flexo Universal S.A. de C.V. Flexo Universal is also 98% owned by the
Company.
In January 2003, Flexo Universal entered into a lease for approximately 43,000 square feet of manufacturing,
office and warehouse space in Guadalajara, Mexico and all of the assets transferred to Flexo Universal
in the spin-off were moved to that facility. On March 1, 2003, Flexo Universal commenced operations
at this facility and now conducts balloon production, printing, packaging, warehousing and sales
activities there.
On or about April 2003, CTI Mexico ceased production of balloons at its leased facilities. The leases
of one facility, consisting of three buildings, and another facility, consisting of one building,
have been terminated and CTI Mexico has vacated these locations.
Products
Metalized Balloons. The metalized balloon is composed of a base material (usually nylon or polyester)
which is coated on one side with a vacuum deposited aluminum coating and on the other with polyethylene.
Typically, the balloon film is printed with graphic designs and messages.
The Company manufactures over 600 balloon designs, in different shapes and sizes, including the following:
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| |  | 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.
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| |  | Ultraloons® - 34" balloons made to be filled with helium and remain buoyant.                                                                                                      
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| |  | Miniloons®- 9" balloons made to be air-filled and sold on holder-sticks or for use in decorations.                                                                                
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| |  | Card-B-Loons®(4 1/2") - air-filled balloons, often sold on a stick, used in floral arrangements or with a container
  of candy.                                                   
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| |  | Shape-A-Loons® - shaped balloons made to be filled with helium.                                                                                                                   
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| |  | Minishapes - small shaped balloons designed to be air filled and sold on sticks as toys or inflated
  characters.                                                                 
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| | 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. The Company maintains many of its own licenses for several
  characters, and manufactures
  and distributes balloons bearing a number of
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| | additional licensed characters. Some of these characters include
Garfield®, Precious Moments®, Face
Offs-Tudes®, Headfirst®, Kinka®,
Successories®. and several others, in Mexico,
Barbie®, Shrek® and Shark Tales®
and in the UK Postman Pat® and Dream Fairies®.
See Patents, Trademarks and Copyrights below. For a period of 3
years, the Company also
  manufactured and distributed certain licensed designs under an arrangement with Hallmark Cards. This
  arrangement terminated on March 31, 2005.
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|Latex Balloons. The Company sells a high end line of latex balloons under the product line name Hi-Tex® and a standard line of latex balloons marketed under the name Partyloons®. The Company also manufactures toy balloon products including punch balls and water bombs and Animal
Twisties.
Packaging Films. The Company produces and sells films which are utilized for the packaging of various products, principally
food products. The Company laminates, extrusion coats and prints films and sells them to customers
who utilize the films for packaging applications. The Company sells these products to companies who,
generally, convert the film to bags or pouches for the packaging of food products.
Custom Film Products. The Company fabricates custom film products for various commercial and industrial purposes. These
now include dunnage bags (inflatable pouches used to cushion products in packages) and
flexible containers for the storage of clothing and personal items.
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,
the Company 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

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|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. Although the latex balloon
market overlaps the metalized balloon market, the latex balloon market has been in existence for
a longer period than metalized balloons and extends to more customers and market categories than
metalized balloons.
Latex Balloons
There are several latex balloon product lines: (i) high quality decorator balloons, (ii) standard novelty
balloons; (iii) printed balloons and (iv) toy categories. The high quality decorator balloons are
generally sold to and through balloon decorators and floral outlets and are generally of higher quality
and price than the standard line of balloons. The standard line of balloons is sold widely in retail
stores including many of the same outlets as metalized balloons.
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 through many of the same outlets as metalized balloons including grocery, general
merchandise and drug store chains, card and gift shops, party goods stores, florists and balloon
decorators. Latex balloons are sold in retail stores in packaged form as well as inflated. Also,
certain latex items are sold in retail stores, generally in packaged form, as toy items.
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,
and for its completed containers, 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, the 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.
The total volume of products manufactured and sold in this industry is estimated to be well in excess
of $3 billion.
Marketing, Sales and Distribution
The Company markets and sells its metalized balloon, latex balloon and related novelty products throughout
the United States and in a number of other countries. The Company maintains a marketing, sales staff
and support staff of 16 individuals and a customer service department of 5 individuals. European
sales are conducted by CTI Balloons, the Companys subsidiary located in
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|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.
The Company sells and distributes its balloon products (i) by its employed staffs of sales and customer
service personnel in the United States, Mexico and the UK, (ii) through a network of several hundred
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.
The Companys largest customer for balloons during 2004 was Dollar Tree Stores. Sales to this
chain in 2004 represented $4,352,000 or approximately 11.7% of net sales.
For a period of three years, the Company did maintain a relationship with Hallmark Cards under which
the Company (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.
The Company continues to sell balloons bearing these designs from its inventory during an 18 month
sell-off period. During 2004, the Companys total sales of metalized and latex balloons to Hallmark
were $3,421,000, approximately 9.2% of net sales. The Company does not anticipate significant sales revenue to Hallmark after March 31, 2005.
The Company engages in a variety of advertising and promotional activities to promote the sale of its
balloon products. Every two years, the Company produces a complete catalog of its balloon products,
and also prepares various flyers and brochures for special or seasonal products, which are disseminated
to thousands of customers, potential customers and others. The Company participates in several trade
shows for the gift, novelty, balloon and other industries and advertises in several trade and other
publications.
The Company markets and sells its printed and laminated films and converted film products directly
and through independent sales representatives. The Company sells 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. The Company markets
its custom film products, including its dunnage bags (inflatable packaging pouches) and
consumer storage bags directly to customers who use the products in their packaging systems or re-sell
the products for commercial or consumer applications. During the 2004 fiscal year, the Company sold
such products to two principal, and a number of smaller customers. The Companys largest customer
in 2004 for commercial film products was Rapak L.L.C. whose purchases from the Company of film products
totaled $7,466,000 for the year, about 20.1% of net sales.
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|During 2004, the Company had total revenues from the sale of film products and storage bags to ITW
Spacebag in the amount of $6,266,000, or 16.8% of the Companys sales. The Company has an agreement
with ITW Spacebag expiring in October 2005 under which ITW Spacebag has agreed to purchase 65% of
its requirements for film for Spacebags, provided that the Companys pricing for the film is
competitive. The Company is currently involved in discussions with ITW Spacebag to extend this agreement
through 2005 and beyond.
Manufacturing
Production and Operations.
The Barrington, Illinois headquarters incorporates the Companys principal production facilities.
The facilities include converting machines which fabricate metalized balloons and packaging bags.
These machines have the capacity to manufacture in excess of 50 million 18 balloons annually.
The Company produced 30 million balloons in 2004.
The Company owns and operates equipment for the development of films and plates utilized in the printing
of films for metalized balloons and packaging films. The Company owns and operates one state of the
art high-speed eight color press and two six color presses at its facility in Barrington, Illinois. The
Company utilizes a water-based ink process for printing.
The Company owns and operates one extrusion coating and lamination machine and one solventless laminator
to produce films for use in metalized balloons, packaging films and specialty film products. The
extrusion coating and laminating machine was acquired in 1999 and the laminator was acquired in 2002.
The Company maintains a graphic arts and development department which designs its balloon products
and graphics. The 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.
The Barrington facility also includes a computerized customer service department which received and
fulfilled over 32,000 orders in our latest fiscal year.
The Company maintains a fulfillment center in Cary, Illinois of approximately 35,000 square feet. At
this facility, the Company maintains a finished goods inventory of all balloon products and ships
orders throughout the United States and to a number of foreign countries.
Flexo Universal. Flexo Universal operates a facility in Guadalajara, Mexico which incorporates 43,000 square feet
of production, printing, warehouse and office space. At the facility, (i) Flexo Universal produces
latex balloons on four machines, (ii) prints latex balloons on two high-speed printing machines and
several manually operated machines, (iv) produces formers for latex balloon production, (v) conducts
mixing and pigment procedures and (vi) conducts sorting,
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|quality control and balloon packaging activities. At this facility, Flexo Universal also warehouses
raw materials and latex and metalized balloon products. Administrative and sales functions are also
performed at the facility.
CTI Balloons Ltd.  Through its wholly-owned subsidiary, CTI Balloons Ltd, the Company conducts a warehouse, fulfillment
and sales operation in Rugby, United Kingdom for metalized and latex balloons. Sales and fulfillment
for all of the United Kingdom, Europe and the Middle East are conducted from this facility.
Raw Materials
The principal raw materials used in manufacturing our products are (i) petroleum-based films, (ii)
petroleum-based resin, (iii) latex and (iv) printing inks. At least to some degree, we have historically
been able to change our product prices in response to changes in raw materials costs. While we currently
purchase our raw materials from a relatively limited number of sources, films, resin and inks are
available from numerous sources. Therefore, we believe our current suppliers could be replaced without
adversely affecting our manufacturing operations in any material respect.
Competition
The balloon and novelty industry is highly competitive, with numerous
competitors. Including the Company, 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. In 1998, Anagram
International, Inc. was acquired by Amscan Holdings and in 2000 M&D Balloons
was acquired by American Greetings. During 2002, Amscan acquired M&D
Balloons from American Greetings.
There are approximately seven manufacturers of latex balloons whose products are sold in the United
States.
The market for film 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 which are the same or similar to those offered
by the Company and the Companys ability to compete depends on many factors within and outside
its control. There are a number of well-established competitors in each of the Companys product
lines, several of which possess substantially greater financial, marketing and technical resources
and 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 the Company. Competitive
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|pressures include, among other things, price competition, new designs and product development and copyright
licensing.
Patents, Trademarks and Copyrights
In connection principally with its metalized balloon business, the Company has developed or acquired
a number of intellectual property rights which are significant to its business.
Copyright Licenses.  The most significant of these rights are licenses on a number of popular characters. The Company
presently maintains 8 licenses and produces balloon designs utilizing the characters 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.  The Company is the owner of 12 registered trademarks in the United States relating to its products.
Many of these trademarks are registered in foreign countries, principally in the European Community.
Patent Rights.  The Company is the owner of, or licensee under, several patents which related to both its metalized
balloon products and its 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) various 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 and (iv) patents related to one-way valves for pouches.
Research and Development
The Company maintains a product development and research department of 5 individuals for the development
or identification of new balloons and related 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, 2004, 2003, 2002,
respectively, the Company estimates that the total amount spent on research and development activities
was approximately $246,000, $335,000 and $333,000.
Employees
As of December 31, 2004, the Company had 113 full-time and 2 part-time employees in the United States, of whom 14 are
executive or supervisory, 8 are in sales, 67 are in manufacturing and 26 are clerical. As of that
same date, the Company had 16 full-time employees in England, of whom 2 are executive or supervisory,
1 is in sales, 7 are in warehousing and 6 are clerical. In Mexico, as of December 31, 2004, the Company
had 178 full-time employees, of whom 17 are executive or supervisory, 3 are in sales, 143 are in
manufacturing and 15 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.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10
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|Regulatory Matters
The Companys manufacturing operations are subject to the U.S. Occupational Safety and Health
Act (OSHA). The Company believes it is in material compliance with OSHA. The Company is subject to similar regulation in Mexico by the Labor Secretarys office. The Environmental
Protection Agency regulates the handling and disposal of hazardous materials. As the Companys
printing operations utilize only water-based ink, the waste generated by the Companys production
process is not deemed hazardous. The Company believes it is in material compliance with applicable
environmental rules and regulations. Several states have enacted laws limiting or restricting the
release of helium filled metalized balloons. The Company does not believe such legislation will have
any material effect on its operations.
International Operations.
The Company sells metalized balloons in a number of foreign countries through
distributors situated in those countries. We conduct production, packaging,
warehousing and sales operations in Mexico and warehousing and sales operations
in the United Kingdom. Our operations in Mexico include the sale of metalized
and latex balloons in Mexico and other markets in Latin America. Our operations
in the United Kingdom include warehousing and sale of metalized and latex
balloons in the United Kingdom and some countries in Europe. 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.

Reference is made to Note 17 of the Consolidated Financial Statements contained in Part IV hereof for
financial information on revenues and assets in our domestic and international operations.
Item No. 2 Properties
The Company owns its 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 $2,832,302, having a term of 5 years, due in May of 2008, with payments
amortized over 25 years and bearing interest at the rate of 6.25% per
year.
The Company leases a warehouse facility in Cary, Illinois under a one-year lease at the rate of $10,000
per month. The lease expires on September 30, 2005. The facility includes 35,000 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 2019. This facility is utilized for product packaging
operations and to manage and service the Companys operations in England and Europe.
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|11
|--



|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 $204,000 per annum.
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 and storage 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 either to 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 first payment of $50,000 was
paid on November 15, 2004. The balance of $50,000 is payable in five consecutive $10,000 monthly
installments, commencing December 30, 2004. This amount was fully accrued as of the settlement date.
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 is payable in seven consecutive $10,000 monthly installments, commencing
March 1, 2005. This amount was fully accrued as of December 31, 2004.
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, we do not believe
any of these proceedings will have, individually or in the aggregate, a material adverse effect upon
our financial condition or future results of operation.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|12
|--



|Item No. 4 Submission of Matters to a Vote of Security Holders
At
the Companys Annual Meeting of Shareholders on October 29, 2004, 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 Eisner, LLP as the Companys independent certified public accountants.
A total
of 1,722,365 shares (approximately 88%) of the issued and outstanding voting stock of the Company
were represented by proxy or in person at the meeting. These shares were voted on the matters described
above as follows:
1.            
For the directors as follows:
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

|Name               |  | Total Votes For |  | Total Votes Against | 
|------------------ |  | --------------- |  | ------------------- | 
|                   |  |                 |  |                     | 
|                   |  |                 |  |                     | 
|John H. Schwan     |  | 1,695,564       |  | 26,801              | 
|Stephen M. Merrick |  | 1,709,680       |  | 12,685              | 
|Howard W. Schwan   |  | 1,709,680       |  | 12,685              | 
|Stanley M. Brown   |  | 1,709,680       |  | 12,685              | 
|Michael Avramovich |  | 1,713,655       |  | 8,710               | 
|Bret Tayne         |  | 1,713,655       |  | 8,710               | 
|John I. Collins    |  | 1,710,680       |  | 11,685              | 

|                                                                                                                        
|------------------------------------------------------------------------------------------------------------------------
|2.
            For the Ratification of Eisner,
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 | 
| | --------------- |  | ------------------- |  | ------------------------------------------------------ | 
| |                 |  |                     |  |                                                        | 
| |                 |  |                     |  |                                                        | 
| | 1,711,119       |  | 10,246              |  | 1,000                                                  | 

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|There were no other matters voted on at the Companys October 29, 2004 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 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.

|13
|--



|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,
      2003 to March 31, 2003    |      | 6.22 |     | 
|April 1,
      2003 to June 30, 2003       |      | 5.04 |     | 
|July 1, 2003
      to September 30, 2003   |      | 2.45 |     | 
|October 1,
      2003 to December 31, 2003 |      | 2.49 |     | 
|January 1,
      2004 to March 31, 2004    |      | 4.10 |     | 
|April 1,
      2004 to June 30, 2004       |      | 4.38 |     | 
|July 1, 2004
      to September 30, 2004   |      | 3.15 |     | 
|October 1,
      2004 to December 31, 2004 |      | 2.40 |     | 
|January
      1, 2005 to March 31, 2005    |      | 3.15 |     | 

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|As of March 31, 2005, there were approximately 47 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 indefinitely by agreement of Mr. Merrick and Mr. Schwan.
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

|14
|--



|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. These shares were valued at the then current market value on the date of issue.
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.
(In thousands, except per share data)
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

|                                                                  | Year
      ended December 31, |       
|----------------------------------------------------------------- | ----------------------------- | ------
|
|Statement
      of Operations Data:                               |                               |       
|Net Sales                                                         | $                             | 37,193
|Costs of
      Sales                                              | $                             | 30,841
|                                                                  |                               |       
|Gross Profit                                                      | $                             | 6,352 
|                                                                  |                               |       
|Operating
      expenses                                          | $                             | 6,920 
|                                                                  |                               |       
|(Loss) income
      from operations                               | $                             | (568  
|                                                                  |                               |       
|Interest
      expense                                            | $                             | 1,350 
|Other (income)
      expense                                      | $                             | (726  
|                                                                  |                               |       
|(Loss)
      income before taxes and 
          minority interest | $                             | (1,192
|Income tax
      expense (benefit)                                | $                             | 1,286 
|Minority
      interest                                           | $                             | 1     
|                                                                  |                               |       
|Net
      (loss) income                                           | $                             | (2,479
|                                                                 
|(Loss) earnings
      per common share                            |                               |       
|Basic                                                             | $                             | (1.28 
|Diluted                                                           | $                             | (1.28 
|                                                                 
|Other
      Financial Data:                                       |                               |       
|Gross margin
      percentage                                     |                               | 17.08 
|Capital Expenses                                                  | $                             | 306   
|Depreciation
      & Amortization                                 | $                             | 1,651 
|Balance
      Sheet Data:                                         |                               |       
|Working capital
      (Deficit)                                   | $                             | (2,790
|Total assets                                                      | $                             | 27,888
|                                                                  |                               |       
|Short-term
      obligations (1)                                  | $                             | 9,962 
|                                                                  |                               |       
|Long-term
      obligations                                       | $                             | 6,491 
|                                                                  |                               |       
|Stockholders
      Equity                                        | $                             | 2,951 

|                                                                                                                               
|-------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                               
|(1) Short-term obligations consist primarily of borrowings under bank lines of credit and the current
portion of long-term debt

|15
|--



|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, and all of our metalized balloons at our facility 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.
      For the years 2004, 2003 and 2002 our revenues as a percentage of total consolidated sales from each of our principal product categories were as follows:
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

|                                      |  | For
      the year ending December 31, |  
|------------------------------------- |  | -------------------------------------- | -
|
|Commercial
      Films and Containers |  | 37.2                                   | %
|Metalized
      Balloons              |  | 43.9                                   | %
|Latex Balloon                         |  | 14.1                                   | %

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Over the past several years, revenues from commercial films and containers have increased significantly
as a percentage of sales. As a percentage of net sales, revenues in this category have increased
from a level of 17% of revenues in 1998 to approximately 48% during 2002 and 2003, reducing to approximately 37%
of net Company revenues during 2004. During the period from 1998 through 2003, sales in this product
category accounted for most of the increase in consolidated sales during these years. In 2004, sales to ITW
Space Bag decreased from $10,298,000 in 2003 to $6,266,000 for 2004. The decline in sales to ITW was attributable to ITW manufacturing certain space bag items for its own account and the fact that the Company did not supply certain components for the bags during 2004. Sales to
this customer for 2005 are expected to be at levels similar to, or slightly lower than, for 2004.

Purchases by a limited number of customers represent a significant portion of total Company revenues.
In 2004, sales to our top 10 customers represented 69.2% of total revenues. Of those principal customers,
one is a customer for packaging film and represented 20.1% of total 2004 revenues, one is a customer
for storage containers and represented 16.8% of total 2004 revenues and one is a customer for metalized
balloons and represented 11.7% of total 2004 revenues. For the most part, with our principal customers,
we do not have long-term purchase agreements or

|16
|--



|commitments and the risk exists that sales to one or more of these customers will decline or terminate.
With one customer for packaging film, however, we do have a contract extending through October 2005,
under which the customer is obligated to purchase at least 65% of that customers requirements
for the packaging film and with our customer for storage containers, we do have an agreement extending
through July 2005 under which that customer has agreed, subject to certain conditions, to purchase
its requirements for the film used in the storage bags. 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 the business of the Company.
We have experienced declines in our gross margins over the past several years. In general, gross margins
have declined from almost 28% in 2001 to 17% in 2004. Most of this decline in gross margins relates
to metalized balloons. Margins in that product category have declined from 27% in 2001 to 13% in
2004. The decline in margin is attributable both to price competition and to increases in the costs
principally of factory overhead and direct labor, and, to a limited degree, in 2004, of raw materials.
We experienced significant increases in factory overhead costs during 2002 and 2003; cost increases
included insurance costs, health insurance costs, supervisory wages, quality control wages and depreciation.
During 2004, we engaged in ongoing efforts to achieve reduction in factory overhead costs. In the
year, reductions in overhead costs were achieved, most significantly by a 35% decrease in indirect
labor, a 68% decrease in business insurance costs and a 51% decrease in repair and maintenance expenses.
In the fourth quarter of 2004, our factory overhead in the U.S. was 32% less than in the first quarter.
We intend to continue these efforts and believe that we will achieve additional reductions in factory
overhead and direct labor costs during 2005.
Our business plan includes:
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

| |  | Continued focus on our existing product categories, including efforts to generate additional revenues
  in these categories.
| | - | ----------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                             
| |  | Efforts to control and reduce manufacturing costs, particularly factory overhead and direct labor costs.                    
| |   |                                                                                                                             
| |  | Efforts to develop new products, product improvements and technologies in our existing product categories.                  
| |   |                                                                                                                             
| |  | Development of new sales and marketing channels and relationships.                                                          

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Results of Operations
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, a 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
|--



|$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, (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.
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.
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
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|18
|--



|exchange gains during 2004 of $208,000 compared to currency exchange losses during fiscal 2003 of $36,000.
The Company had other income during 2004 of $395,000. Items of other income included (i)
 gains related to a review and determination that various accrued items on the
books of the Mexican subsidiaries of the Company (CTI Mexico and Flexo) are not due or payable; these
items included: (a) accrued amounts for profit sharing or seniority benefits determined on the basis
of legal review not to be due, totaling $98,000, (b) accrued amounts related to an asset tax determined
not to be due or beyond the statute of limitations, in the amount approximately of $49,000, (c) accrued
amounts with respect to various accounts settled or determined not to be due or payable, in the aggregate
amount of $190,000 and (ii) gains totaling $70,000 based on the settlement of various accounts in consideration
of the payment of an amount less than the amount accrued. These items were offset by $12,000 in other expenses. Most of these gains are attributable to
the first quarter of 2004 and relate to the restructuring of CTI Mexico which commenced in February
2003 when CTI Mexico effected a spin-off under Mexican law in which a portion of the assets, liabilities
and capital of that company were transferred to Flexo Universal and Flexo Universal became the primary
subsidiary of the Company in Mexico. These other gains are not recurring.
The Company had other income during 2003 of $428,000 arising principally from the forgiveness of certain
indebtedness.
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.
Year Ended December 31, 2003 Compared to Year Ended December 31, 2002
Net Sales.  For the fiscal year ended December 31, 2003, consolidated revenues from the sale of all products
were $36,260,000, compared to consolidated revenues of $41,236,000 for the year ended December 31,
2002, a decrease of 12%. This decrease in revenues is the result principally of (i) an 11% decrease
in sales of printed and laminated films from $19,621,000 in 2002 to $17,439,000 in 2003, (ii) a 24%
decrease in sales of metalized balloons from $16,392,000 in 2002 to $12,405,000 in 2003 and (iii)
a 17% decrease in the sales of latex balloons from $4,948,000 in 2002 to $4,125,000 in 2003. These
revenue decreases are attributable principally to decreases in sales to three principal customers.
Sales in 2002 to these three customers were as follows: (i) $12,086,000 to a customer for consumer
storage bags, (ii) $7,000,000 to a customer for packaging films and (iii) $5,111,000, to a customer
for metalized balloons. During 2003, sales to each of those customers, respectively, were: (i) $10,298,000,
(ii) $5,360,000 and (iii) $4,006,000.
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|For the fiscal year 2003, on a consolidated basis, metalized balloons represented 34% of sales, laminated
and printed films 48% of sales and latex balloons 11% of sales. During fiscal 2002, metalized balloons
represented 40% of sales, laminated and printed films 48% of sales and latex balloons 12% of sales.
Cost of Sales.  For fiscal 2003, cost of sales increased to 81.7% of net sales compared to 78.4% of net sales
for fiscal 2002. In fiscal 2003, profit margins on metalized balloons, latex balloons and laminated
and printed film were 10.4%, 9.1% and 34.9%, respectively, compared to margins on the same product
lines for 2002 of 24.3%, 17.5% and 27.5%. The reduction in margins with respect to metalized balloons
in 2003 is attributable principally to pricing affected by price competition and to increases in
production overhead.
General and Administrative.  For fiscal 2003, administrative expenses were $4,055,000, or 11.2% of net sales, as compared
to $4,225,000 or 10.2% of net sales for fiscal 2002. The decrease in administrative expenses is attributable
to decreases in personnel and compensation expense, audit expenses, legal expenses and consulting
fees.
Selling.  For fiscal 2003, selling expenses were $1,442,000 or 4% of net sales compared to $1,551,000,
or 3.8% of net sales for fiscal 2002. There was no significant change in selling expenses from 2002
to 2003.
Marketing and Advertising.  For fiscal 2003, advertising and marketing expenses were $1,816,000 or 5% of net sales, compared
to $1,671,000 or 4.1% of sales for fiscal 2002. The increase is attributable principally to increases
in artwork and films and trade show expense.
Other Expense.  For fiscal 2003, interest expense and loan fees totaled $1,103,000. For fiscal 2002, interest
expense was $832,000. 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 losses during 2003 of $36,000 compared to currency exchange losses during fiscal
2002 of $281,000. The Company had other income during 2003 of $428,000 arising principally from the
forgiveness of certain indebtedness; the Company had no such income during 2002.
Net Income or Loss.  For the fiscal year ended December 31, 2003, the Company had a loss before taxes and minority
interest of $1,349,000 compared to income before taxes and minority interest for fiscal 2002 of $335,000.
The net loss for fiscal 2003 was $566,000 compared to net income for fiscal 2002 of $303,000.
Income Taxes.  For the fiscal year ended December 31, 2003, the Company had an income tax benefit of $782,000
compared to an income tax expense of $39,000 for fiscal 2002. The amount of the income tax expense
or benefit recognized by the Company for both 2003 and 2002 reflects adjustments in deferred tax
assets and other items arising from the operating results of the Company for each year.
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|Financial Condition
Year Ended December 31, 2004 Compared to Year Ended December 31, 2003
Cash Flow From Operations.  Cash flow used in operations for the fiscal year ended December 31, 2004 was $571,000. Cash
flow used in operations resulted principally from an increase in accounts receivable of $1,791,000
and a decrease in the deferred income tax asset of $1,189,000, a decrease in accounts payable and accrued expenses of $847,000, offset by depreciation and
amortization of $1,651,000, and a reduction in inventory and other assets totaling $1,281,000.
The increase in accounts receivable was
attributable principally to the existence of a receivable from one customer in the amount of $1,439,000
as of December 31, 2004, all of which has subsequently been paid. Cash flow generated by operations
for the fiscal year ended December 31, 2003 was $3,208,000.
Cash Used in Investing Activities.  During fiscal 2004, the Company invested the net amount of $273,000 in machinery and equipment. During fiscal
2003, the Company invested $2,007,000 in machinery and equipment. In the absence of additional financing
being received by the Company during 2005, the Company does not anticipate capital expenditures during
2005 in excess of $500,000. However, the Company may seek, and may receive, additional financing
intended in part for investment in capital items.
Cash From Financing Activities.  Cash provided by financing activities during fiscal 2004 was $883,000. The principal financing
activities of the Company during 2004 included (i) an increase of cash due to an increase in the
revolving line of credit of $2,707,000 and (ii) a reduction in cash resulting from the net repayment
of long-term debt of $2,513,000. During fiscal 2003, cash flow used in financing activities was $804,000.
On December 31, 2003, the Company entered into a Loan and Security Agreement with a bank under which
the lender has provided the Company with a credit facility in the amount of $11,000,000, collateralized
by machinery and equipment, inventories, trade receivables and other assets of the Company. The credit facility includes
a term loan of $3,500,000, at an interest rate of prime plus 1.5% per annum (6.75% at December 31, 2004), which is based upon
the appraised value of the machinery and equipment of the Company, and a revolving line of credit, up to a maximum
amount of $7,500,000 at an interest rate of prime plus 1.5% per annum. Advances under the revolving
line of credit include advances of up to 85% of eligible trade receivables and up to 50% of the value of
the Companys eligible inventories. The term loan and revolving line of credit are secured by substantially
all assets of the Company. In connection with the Loan Agreement, two principals of the Company executed
agreements pursuant to which they agreed, in the event appraisal (liquidation value) of the Companys machinery
and equipment to be performed during 2004 indicated values less than those specified in the Loan
Agreement, 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 (liquidation)
value of the Companys machinery and equipment. The term of this credit facility is for a period
of 2 years expiring on December 31, 2005, and is automatically extended after that date from year
to year unless (i) the bank accelerates the payment of the obligations under the Loan Agreement or
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|(ii) either party elects to terminate by giving notice of termination 90 days before the expiration
of the original or any renewal term.
Certain terms of the Loan Agreement include: (i) the requirement that the Company maintain a specified

level of tangible net worth and a ratio of EBITDA to fixed charges, (ii) mandatory prepayment of

the term loan (A) from the proceeds of the sale or disposition of equipment and (B) 50% of excess

cash flow of the Company during 2004 and (iii) a prohibition of various acts including (A) incurring

new debt, (B) engaging in acquisitions, (C) paying dividends, (D) purchasing stock, without the
consent
of the Bank.
As of December 31, 2004, the Company was not in compliance with the financial covenant of this loan
requiring that the Company maintain a specified relationship of EBITDA to fixed charges. The Bank
has issued a waiver of this non-compliance and has agreed to an amendment modifying the covenants. Based on our financial projections, the Company will be in compliance with the
covenants for the first quarter of 2005 and, we believe, will remain in
compliance for all of 2005.

Approximately $6,763,000 in proceeds from this new loan were used to pay to a prior senior lender the
entire balance due to that lender consisting of $2,540,000 in term loans and $4,223,000 in revolving
loans.

In January
2001, the Company entered into a Loan and Security Agreement with an
institutional lender under which the lender provided the Company with a credit
facility in the amount of $9,500,000, collateralized by machinery and equipment, inventories,
trade receivables and other assets of the Company. The credit facility included a term
loan of $1,426,000, at an interest rate of prime plus 0.75% per annum, which was
based upon the appraised value of the machinery and equipment of the Company and a revolving
line of credit at an interest rate of prime plus 0.5% per annum, the amount of
which was based on advances of up to 85% of eligible trade receivables and up to 40%
of the value of the Companys inventories. In 2002, the lender advanced
additional funds on the original term loan in the amount of $490,880 and
advanced a second term loan in the amount of $1,740,000 and increased the credit
facility to $11,500,000. The term loans and revolving line of credit were
secured by substantially all assets of the Company. The term of this credit
facility was for a period of three years expiring on January 15, 2004. On
December 31, 2003, the entire balance due to the lender was paid and the credit
facility with that lender terminated.
In January 2001, another bank 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. This mortgage loan is secured by this building and property, and
has been made in the form of two notes: one note is in the principal amount of
$2,700,000, bears interest of 9.75% per annum, and has a term of five years with
a 25 year amortization, and the second note is in the principal amount of
$173,000, bears interest at 10% per annum, and has a term of three years. In May
2003, this loan was amended to increase the principal amount of the first note
to $2,912,000 and to reduce the interest rate to 6.25% per annum. The second
note was paid in full as of January 5, 2004.

During 2004, John H. Schwan and Stephen M. Merrick loaned to Flexo Universal the net amount of $86,000
and $181,000, respectively. These loans are evidenced by promissory notes and the
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|agreement of Flexo Universal to secure such notes with the receivables and equipment of Flexo Universal.
The notes bear interest at the rate of 8% per annum.

Current assets.  As of December 31, 2004, the total current assets of the Company were $15,645,000 compared to
total current assets of $15,435,000 as of December 31, 2003. The change in current assets reflects,
principally, increase in receivables of $1,503,000 partially offset by a decrease in inventory of
$915,000 and a decrease in the deferred tax asset of $362,000.

Inventories. The net inventory of the Company decrease from $9,263,000 as of December 31, 2003 to $8,348,000 as
of December 31, 2004. The decrease reflected principally a decrease in metalized balloon inventory.

Property, Plant and Equipment.During fiscal 2004, the Company invested $306,000 in capital items. Most of this investment was in
production equipment. During 2003, the Company invested $2,007,000 in capital items.

Current liabilities.  Total current liabilities increased from $16,140,000 as of December 31, 2003 to $18,435,000
as of December 31, 2004. This increase is attributable principally to an increase in the line of
credit from $3,694,000 as of December 31, 2003 to $6,401,000 as of December 31, 2004, which occurred
principally by reason of the new line of credit agreement. This was offset by (i) a decrease of accounts
payable from $6,799,000 as of December 31, 2003 to $6,148,000 as of December 31, 2004 and (ii) a decrease
in accrued liabilities from $2,307,000 as of December 31, 2003 to $1,812,000 as of December 31, 2004.

Liquidity and Capital Resources.
Managements plans to improve
profitability during 2005 include relocating certain manufacturing operations from the
United States to its foreign affiliates and continued cost reductions in the area of
direct and overhead expenses in the U.S. operations. In addition, the Company is currently
evaluating its operating strategies to expand its storage bag product line, which the Company anticipates
will improve its overall profit margin. The Company belives it has sufficient
cash and funding opportunities to meet its operating requirements through January
1, 2006.

23
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|Contractual Commitments. The contractual commitments of the Company over the next five years are as follows:
|------------------------------------------------------------------------------------------------------------
|                                                                                                            

|Year       |  | Future
      Minimum
      Principal Payments |           | Operating
      Leases |   | Licenses  |  | Total |        
|---------- |  | --------------------------------------------- | --------- | ---------------------- | - | --------- |  | ----- | -------
|           |  |                                               |           |                        |   |           |  |       |        
|2005       |  | $                                             | 3,560,669 |                        | $ | 515,846   |  | $     | 76,664 
|2006       |  | $                                             | 2,311,685 |                        | $ | 337,759   |  | $     | 66,664 
|2007       |  | $                                             | 144,189   |                        | $ | 286,728   |  | $     |       
|2008       |  | $                                             | 2,663,871 |                        | $ | 51,700    |  | $     |       
|2009       |  | $                                             |          |                        | $ | 51,700    |  | $     |       
|Thereafter |  | $                                             |          |                        | $ | 517,000   |  | $     |       
|           |  |                                               |           |                        |   |           |  |       |        
|           |  | $                                             | 8,680,414 |                        | $ | 1,760,733 |  | $     | 143,328
|           |  |                                               |           |                        |   |           |  |       |        

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

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|Seasonality
In the metalized product line, sales have historically been seasonal with approximately 20% to 30%
of annual sales of metalized balloons being generated in December and January, and 11% to 13% of
annual metalized balloon sales being generated in June and July in recent years. The sale of latex
balloons and laminated film products have not historically been seasonal, and as sales in these products
lines increase 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
recognizes revenue for the sale of products when the products have been
delivered and legal title and all risks of ownership have been transferred to
the customer. In some cases, product is provided on consignment to customers. In
those cases, revenue is recognized when the customer reports a sale of the
product.

Allowance for Doubtful Accounts.  We estimate our allowance for doubtful
accounts based on an analysis of specific accounts, an analysis of historical
trends, payment and write-off histories. Our credit risks are continually
reviewed and management believes that adequate provisions have been made for
doubtful accounts. However, unexpected changes in the financial condition of
customers or changes in the state of the economy
could result in write-offs which exceed estimates and negatively impact our
financial results. As of December 31, 2004, we had total reserves for
potential bad debts of $404,000. This reserve includes $237,000 of general
reserve against outstanding receivables and $167,000 of reserve against a
receivable from a distributor. Our general reserve is consistent with our bad
debt experience. We provided
extended payment terms to a distributor whose business is important
to our efforts in certain markets and with this distribution whom we have a long-standing relationship. We monitor the financial condition
of the distributor closely and, during 2004, received payments from the distributor
of $164,000. Total sales to this distributor in 2004 were $134,381.
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 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.
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|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 Financial Accounting Standards Board 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 in June 2002, December 2002,
December 2003 and December 2004. Based upon these evaluations, the Company believes our goodwill valuation of our Mexico
subsidiary on these dates, in the amount of $1,113,000 was not impaired.
Income Taxes and Deferred Tax Assets.  
The Company recognizes the amount of income taxes
currently payable and deferred tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of existing assets and
liabilities, and their respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years these temporary differences are
expected to be recovered or settled. Deferred tax assets are reduced by
valuation allowance when in the opinion of management it is more likely than not
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. Foreign currency translation adjustments
exclude income tax expense (benefit) given that the Companys investments in
non-U.S. subsidiaries are deemed to be reinvested for an indefinite period of
time.

As of December 31, 2004, the Company had a net deferred tax asset of $152,000, representing the
amount the Company may recover in future years from future taxable income. As of December 31, 2003,
the amount of the deferred tax asset was $1,341,000. Each year and period management must make a
judgment to determine the extent to which the deferred tax asset will be recovered from future taxable
income. As of December 31, 2004, management has determined that an appropriate allowance against
the deferred tax asset, because it is more likely than not that such amount will not be realized, is $2,454,000.
As of December 31, 2003, the amount of this reserve was $739,000. These determinations involve the
exercise of significant management judgment and are made based upon historical, current and projected
levels of revenue and profit.
Foreign Currency Translation. All
balance sheet accounts of foreign subsidiaries have been translated using the exchange rates in effect at the balance sheet
date. Statements of operations amounts have been translated using the average exchange rate for the
year. The gains and losses resulting from the changes in exchange rates
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|from year to year have been reported in other comprehensive loss.
Foreign currency transaction gains and losses are recognized in the period incurred
and are included in the Consolidated Statements of Operations.

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 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.

FASB Interpretation No. 46,
Consolidation of Variable Interest Entities (FIN No. 46) was originally issued
in January 2003 and was subsequently revised in December 2003. FIN No. 46 attempts to
clarify the application of Accounting Research Bulletin No. 51 Consolidated
Financial Statements, to certain entities in which equity investors do not have the
characteristics of a controlling financial interest or do not have sufficient equity at
risk for the entity to finance its activities without additional subordinated financial
support. The Company does not believe that it has any involvement with variable interest
entities that are required to be consolidated under FIN No. 46.



Legal proceedings
In
the ordinary course of business, we are subject to various legal proceedings, including lawsuits
and other claims related to labor, product and other matters. We are required to assess the likelihood
of adverse judgments and outcomes to these matters as well as the range of potential loss. Such assessments
are required to determine whether a loss contingency reserve is required under the provisions of
SFAS No. 5, Accounting for Contingencies, and to determine the amount of required reserves, if any.
These assessments are subjective in nature. Management makes these assessments for each individual
matter based on consultation with outside counsel and based on prior experience with similar claims.
To the extent additional information becomes available or our strategies or assessments change, our
estimates of potential liability for a given matter may change. Changes to estimates of liability
would result in a corresponding additional charge or benefit recognized in the statement of operations
in the period in which such changes become known. We recognize the costs associated with legal defense
in the periods incurred. Accordingly, the future costs of defending claims are not included in our estimated liability.
Safe Harbor Provision of the Private Securities Litigation Act of 1995 and Forward Looking Statements
The Company operates in a dynamic and rapidly changing environment that involves numerous risks and
uncertainties. The market for mylar and latex balloon products is generally characterized by intense
competition, frequent new product introductions and changes in customer tastes which can render existing
products unmarketable. The statements contained in Item 1 (Description of Business) and Item 7 (Managements
Discussion and Analysis of Financial Condition and Results of Operations) that are not historical
facts may be forward-looking statements (as such term is defined in the rules promulgated pursuant
to the Securities Exchange Act of 1934) that are subject to a variety of risks and uncertainties
more fully described in the Companys filings with the Securities and Exchange Commission including,
without limitation, those described under Risk Factors in the Companys Form SB-2
Registration Statement (File No. 333-31969) effective November 5, 1997. The forward-looking statements
are based on the beliefs of the Companys management, as well as assumptions made by, and information
currently available to the Companys management. Accordingly, these statements are subject to
significant risks, uncertainties and contingencies which could cause the Companys actual growth,
results, performance and business prospects and opportunities in 2004 and beyond to differ materially
from those expressed in, or implied by, any such forward-looking statements. Wherever possible, words
such as anticipate, plan, expect, believe, estimate,
and similar expressions have been used to identify these forward-looking statements, but are not
the exclusive means of identifying such statements. These risks, uncertainties and contingencies
include, but are not limited, to competition from, among others, national and regional balloon, packaging
and custom film product manufacturers and sellers that have greater financial, technical and marketing
resources and distribution capabilities than the Company, the availability of sufficient capital,
the maturation and success of the Companys strategy to
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|27
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|develop, market and sell its products, risks inherent in conducting international business, risks associated
with securing licenses, changes in the Companys product mix and pricing, the effectiveness
of the Companys efforts to control operating expenses, general economic and business conditions
affecting the Company and its customers in the United States and other countries in which the Company
sells and anticipates selling its products and services and the Companys ability to (i) adjust
to changes in technology, customer preferences, enhanced competition and new competitors; (ii) protect
its intellectual property rights from infringement or misappropriation; (iii) maintain or enhance
its relationships with other businesses and vendors; and (iv) attract and retain key employees. There
can be no assurance that the Company will be able to identify, develop, market, sell or support new
products successfully, that any such new products will gain market acceptance, or that the Company
will be able to respond effectively to changes in customer preferences. There can be no assurance
that the Company will not encounter technical or other difficulties that could delay introduction
of new or updated products in the future. If the Company is unable to introduce new products and
respond to industry changes or customer preferences on a timely basis, its business could be materially
adversely affected. The Company is not obligated to update or revise these forward-looking statements
to reflect new events or circumstances.
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, 2004, 2003 and 2002, our interest rate
expense would have increased, and income after income taxes would have decreased by $56,000, $39,000
and $49,000, 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 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
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|28
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|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.
We have performed a sensitivity analysis as of December 31, 2004 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
2004, 2003 and 2002 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, $177,000, $173,000 and $176,00,
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, this presents a risk that would not 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.
Previously, effective July 24, 2003, the Company dismissed McGladrey & Pullen, LLP, which had been
engaged as the Companys principal accountants to audit the Companys financial statements
for the year ended December 31, 2002. The reports of McGladrey & Pullen, LLP on the Companys
financial statements for the fiscal year ended December 31, 2002, did not contain an adverse opinion
or disclaimer of opinion, nor were they qualified or modified as to uncertainty, audit scope or accounting
principles.
During the Companys last two fiscal years ended December 31, 2002, and December 31, 2003, and
in the subsequent interim periods through April 27, 2005, there were no disagreements with McGladrey
& Pullen, LLP or Eisner, LLP, respectively, on any matter of accounting principles or practices,
financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved
to the satisfaction of McGladrey & Pullen, LLP or Eisner, LLP,
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|29
|--



|would have caused either to make reference to the subject matter of the disagreements in connection
with their respective reports on the financial statements for such periods.
Neither McGladrey & Pullen, LLP nor Eisner, LLP have informed the Company of any reportable events
during the Companys last two fiscal years ended December 31, 2002 and 2003, respectively, and
in subsequent interim periods through April 27, 2005.
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 of
this report, have concluded that, as of such date 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.
(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.


Item No. 9B - Other
Information


Not Applicable.

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 April 15, 2005, are
as follows:
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

|Name               |  | Age |  | Position With The Company                       
|------------------ |  | --- |  | ------------------------------------------------
|                   |  |     |  |                                                 
|John H. Schwan     |  | 60  |  | Chairman and Director                           
|Howard W. Schwan   |  | 50  |  | President and Director                          
|Stephen M. Merrick |  | 63  |  | Executive Vice President, Secretary and Director
|Mark Van Dyke      |  | 55  |  | Senior Vice President                           
|Brent Anderson     |  | 38  |  | Vice President of Manufacturing                 
|Timothy Patterson  |  | 44  |  | Vice President-Finance and Administration       
|Samuel Komar       |  | 48  |  | Vice President                                  
|Stanley M. Brown   |  | 58  |  | Director                                        
|Bret Tayne         |  | 46  |  | Director                                        
|Michael Avramovich |  | 53  |  | Director                                        
|John I. Collins    |  | 45  |  | Director                                        

|30
|--



|All directors hold office until the next annual meeting 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 the President and principal executive officer of Packaging Systems and
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 was President of the Company
from January 1996 to June 1997 when he became Chief Executive Officer of the Company. In October
1999, Mr. Merrick became Executive Vice President. Mr. Merrick is a principal of the law firm of
Merrick & Associates, P.C. of Chicago, Illinois and has been engaged in the practice of law for
more than 35 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.
Mark Van Dyke, Senior Vice President. Mr. Van Dyke rejoined the Company in August 2001. Mr. Van Dyke
has over 25 years experience in the balloon industry and was previously employed by the Company for
12 years. Prior to rejoining the Company, Mr. Van Dyke was employed by M&D Balloons, Inc. for
eight years and became Executive Director of that Company.
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 Sales. 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.
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,
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|31
|--



|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.
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 Doctorate from the John
Marshall Law School and an L.L.M. in International and Corporate Law from Georgetown University Law Center.
John I. Collins, Director. 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 is
also the Chief Administrative Officer and the former Chief Financial Officer of Mid-States Corporate
Federal Credit Union (MSCFCU), a $4.5 billion wholesale financial institution located
in Warrenville, Illinois. Mr. Collins responsibilities at MSCFCU have included all accounting,
financial reporting, strategic planning, risk management, lending and data processing matters, as
well as, more recently, working directly with MSCFCUs Chief Executive Officer in matters concerning
MSCFCUs Board of Directors and Board Committee matters and administration, corporate governance
and legal affairs. 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. During Mr. Collins tenure with GLCU from
1991 to 2001, and MSCFCU from 2001 to the present, Mr. Collins has experience working with audit
committees, public accounting firms and regulatory agencies on an ongoing basis, has supervised principal
accounting officers, and has had the responsibility of preparing audited financial statements, internal
controls and financial reporting. 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
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|32
|--



|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 4 meetings during fiscal year 2004, 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. Information
regarding the functions performed by the Committee is set forth in the Report of the Audit
Committee, as follows:
Report of the Audit Committee
The Audit Committee oversees the Companys financial reporting process on behalf of the Board
of Directors. Management has the primary responsibility for the financial statements and the reporting
process including the systems of internal controls. In fulfilling its oversight responsibilities,
the Committee reviewed the audited financial statements in the Annual Report with management including
a discussion of the quality, not just the acceptability, of the accounting principles, the reasonableness
of significant judgments, and the clarity of disclosures in the financial statements.
The Committee reviewed with the independent auditors, who are responsible for expressing an opinion
on the conformity of those audited financial statements with generally accepted accounting principles,
their judgments as to the quality, not just the acceptability, of the Companys accounting principles
and such other matters as are required to be discussed with the Committee under generally accepted
auditing standards, including but not limited to those matters required to be discussed by SAS 61
(Codification of Statements on Auditing Standards, AU ss.380). In addition, the Committee has discussed
with the independent auditors the auditors independence from management and the Company including
the matters in the written disclosures required by the Independence Standards Board.
The Committee discussed with the Companys independent auditors the overall scope and plans for
their respective audits. The Committee meets with the independent auditors, with and without management
present, to discuss the results of their examinations, their evaluations of the Companys internal
controls, and the overall quality of the Companys financial reporting.
In reliance on the reviews and discussions referred to above, the Committee recommended to the Board
of Directors (and the Board has approved) that the audited financial statements be
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|33
|--



|included in the Annual Report on Form 10-K for the year ended December 31, 2004 for filing with the
Securities and Exchange Commission. The Committee and the Board have also recommended, subject to
future shareholder approval at the Companys 2005 annual meeting of shareholders, the selection
of Weiser, LLP as the Companys independent auditors.
Michael Avramovich, Audit Committee ChairStanley M. Brown, III, Audit Committee MemberBret Tayne, Audit Committee Member
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.
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 2004, 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.
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).
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|34
|--



|                              | Summary
      Compensation Table |      |  |  
|----------------------------- | -------------------------------- | ---- |  | -
|
|
|                              |                                 
|Howard W.
      Schwan        |                                  | 2004 |  | $
|President                     |                                  | 2003 |  | $
|                              |                                  | 2002 |  | $
|                              |                                  |      |  |  
|Mark Van
      Dyke           |                                  | 2004 |  | $
|Senior Vice
      President   |                                  | 2003 |  | $
|                              |                                  | 2002 |  | $
|                              |                                  |      |  |  
|Brent
      Anderson          |                                  | 2004 |  | $
|Vice President
      of       |                                  | 2003 |  | $
|Manufacturing                 |                                  | 2002 |  | $
|                              |                                  |      |  |  
|Samuel Komar                  |                                  | 2004 |  | $
|Vice President
      of Sales |                                  | 2003 |  | $
|                              |                                  | 2002 |  | $

|           
|-----------
|
|           

|(1) | Stock options to purchase up to 14,285 shares of the Companys Common Stock at $2.31 per share.
|--- | -----------------------------------------------------------------------------------------------
|    |                                                                                                
|(2) | Stock Options to purchase up to 8,928 shares of the Companys Common Stock at $2.31 per share. 
|    |                                                                                                
|(3) | Company contribution to the Companys 401(k) Plan as a pre-tax salary deferral.                

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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. There were no stock option grants
made by the Company in the fiscal year ended December 31, 2004.
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 | 
|------------------------ | - | -------------------------------------------------- | - | ------------------------------ | -------- | ----------------------------------------------------------------------------------------------------------------------- | ------- | --------------------------------------------------------------------------------------------------------------------- | 
|John
      H. Schwan     | 0 |                                                    | 0 |                                | 29,762/0 |                                                                                                                         | $0/0(1) |                                                                                                                      
|Howard
      W. Schwan   | 0 |                                                    | 0 |                                | 53,968/0 |                                                                                                                         | $0/0(1) |                                                                                                                      
|Stephen
      M. Merrick | 0 |                                                    | 0 |                                | 29,762/0 |                                                                                                                         | $0/0(1) |                                                                                                                      
|Mark
      Van Dyke      | 0 |                                                    | 0 |                                | 23,809/0 |                                                                                                                         | $0/0(1) |                                                                                                                      
|Brent
      Anderson     | 0 |                                                    | 0 |                                | 31,546/0 |                                                                                                                         | $0/0(1) |                                                                                                                      
|Samuel
      Komar       | 0 |                                                    | 0 |                                | 24,641/0 |                                                                                                                         | $0/0(1) |                                                                                                                      
|                         |   |                                                    |   |                                |          |                                                                                                                         |         |                                                                                                                      
|Stanley
      M. Brown   | 0 |                                                    | 0 |                                | 8,532/0  |                                                                                                                         | $0/0(1) |                                                                                                                      
|Bret
      Tayne         | 0 |                                                    | 0 |                                | 8,532/0  |                                                                                                                         | $0/0(1) |                                                                                                                      
|Timothy
      Patterson  | 0 |                                                    | 0 |                                | 5,000/0  |                                                                                                                         | $0/0(1) |                                                                                                                      
|Michael
      Avramovich | 0 |                                                    | 0 |                                | 0/0      |                                                                                                                         | $0/0(1) |                                                                                                                      
|John
      Collins       | 0 |                                                    | 0 |                                | 0/0      |                                                                                                                         | $0/0(1) |                                                                                                                      

|
|
|
|

| | (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, 2004.
| | --- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|35
|--



|Equity Compensation Plan Information
The
following table provides information regarding the Companys equity compensation plans as of
December 31, 2004.
|--------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                        

|                                                                         |  | (a)     |  | (b) |         | (c) | 
|------------------------------------------------------------------------ |  | ------- |  | --- | ------- | --- | 
|
|
|                                                                         |  |         |  |     |         |     | 
|                                                                         |  |         |  |     |         |     | 
|Equity
      compensation plans approved
        by security holders     |  |         |  |     |         |     | 
|                                                                         |  |         |  |     |         |     | 
|2002
      Stock Option Plan                                             |  | 62,954  |  |     | $2.75   |     | 
|2001
      Stock Option Plan                                             |  | 88,692  |  |     | $1.47   |     | 
|1999
      Stock Option Plan                                             |  | 131,550 |  |     | $1.96   |     | 
|1997
      Stock Option Plan                                             |  | 98,415  |  |     | $6.53   |     | 
|                                                                         |  |         |  |     |         |     | 
|Equity
      compensation plans not
        approved by security holders |  | 0       |  |     | $     0 |     | 
|                                                                         |  |         |  |     |         |    
|                                                                         |  |         |  |     |         |     | 
|Total                                                                    |  | 381,611 |  |     | $3.15   |     | 
|                                                                         |  |         |  |     |         |    

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Compensation Committee Interlocks and Insider Participation
During 2004, the Compensation Committee was composed of Stanley M. Brown and Brent Tayne. The Compensation
Committee reviews and makes recommendations to the Board of Directors concerning the compensation
of officers and key employees of the Company. The Compensation Committee met one time during 2004.
Compensation Committee Report on Executive Compensation
The Compensation Committee of the Board of Directors of the Company is composed of two members of the
Board of Directors. The Compensation Committee is responsible for establishing the standards and
philosophy of the Board of Directors regarding executive compensation, for reviewing and evaluating
executive compensation and compensation programs, and for recommending levels of salary and other
forms of compensation for executives of the Company to the Board of Directors. The full Board of
Directors of the Company is responsible for setting and administering salaries, bonus payments and
other compensation awards to executives of the Company.

|36
|--



|Compensation Philosophy
The philosophy of the Compensation Committee, and of the Board of Directors of the Company, regarding
executive compensation includes the following principal components:
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                 

| | To attract and retain quality executive talent, which is regarded as critical to the long and short-term
  success of the Company, in substantial part by offering compensation programs which provide attractive
  rewards for successful effort.                                                      
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                                                                                                                         
| | To provide a reasonable level of base compensation to senior executives.                                                                                                                                                                                                                                
| |                                                                                                                                                                                                                                                                                                         
| | To create a mutuality of interest between executive officers of the Company and shareholders through
  long-term compensation structures, particularly stock option programs, so that executive officers
  share the risks and rewards of strategic decision making and its effect on shareholder value.

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|The Compensation Committee has recommended, and the Board of Directors has determined, to take appropriate
action to comply with the provisions of Section 162(m) of the Internal Revenue Code so that executive
compensation will be deductible as an expense to the fullest extent allowable.
The Companys executive compensation program consists of two key elements:(i) an annual component consisting of base salary and (ii) a long-term component, principally stock
options.
Annual Base Compensation
The Compensation Committee recommends annual salary levels for each of the Named Executives, and for
other senior executives of the Company, to the Board of Directors. The recommendations of the Compensation
Committee for base salary levels for senior executives of the Company are determined annually, in
part, by evaluating the responsibilities of the position and examining market compensation levels
and trends for similar positions in the marketplace.
Additional factors which the Compensation Committee considers in recommending annual adjustments to
base salaries include: results of operation of the Company, sales, shareholder returns, and the experience,
work-performance, leadership and team building skills of each executive. The Company receives information
from the Chief Executive Officer with regard to these matters. While each of these factors is considered
in relatively equal weight, the Compensation Committee does not utilize performance matrices or measured
weightings in its review. Each year, the Compensation Committee conducts a structured review of base
compensation of senior executives with input from the Chief Executive Officer.
Long-Term Component - Stock Options
The long-term component of compensation provided to executives of the Company has been in the form
of stock options. The Compensation Committee has recommended to the Board of

|37
|--



|Directors that a significant portion of the total compensation to executives be in the form of incentive
stock options. Stock options are granted with an exercise price equal to or greater than the fair
market value of the Companys Common Stock on the date of the grant. Stock options are exercisable
between one and ten years from the date granted. Such stock options provide incentive for the creation
of shareholder value over the long-term since the full benefit of the compensation package for an
executive cannot be realized unless an appreciation in the price of the Companys Common Stock
occurs over a specified number of years.
The magnitude of the stock option awards are determined annually by the Compensation Committee and
the Board of Directors. Generally, the number of options granted to an executive has been based on
the relative salary level of the executive.
On October 12, 2002, incentive stock options to purchase up to 14,285, 8,928, 5,952 and 5,952 shares
of the Companys Common Stock were granted to Messrs. Howard Schwan, Brent Anderson, Stephen
M. Merrick and John Schwan, respectively, under the 2002 Stock Option Plan (the 2002 Plan).
In addition, on October 12, 2002, non-qualified stock options to purchase up to 2,926 shares of the
Companys Common Stock were granted to each of Messrs. Stan Brown and Bret Tayne respectively,
under the 2002 Plan, and incentive stock options to purchase up to 5,000 shares of the Companys
Common Stock were granted to Timothy Patterson under the 2002 Stock Option Plan on December 31, 2003.
There were no other stock options granted to any of the Named Executives in 2002, 2003 or 2004.

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.

CEO Compensation
The Compensation Committee utilizes the same standards and methods for recommending annual base compensation
for the Chief Executive Officer of the Company as it does for other senior executive officers of
the Company.
In 1997, the Company entered into an Employment Agreement with Howard W. Schwan, President of the Company,
providing that Mr. Schwans base annual compensation would not be less than $135,000. During
2002, 2003 and 2004, upon the recommendation of the Compensation Committee, the base salary of Mr.
Schwan was $162,500, $162,500 and $153,000, respectively. In 2002, 2003 and 2004, annual incentive
compensation was paid to Mr. Schwan in the amounts of $8,100, $5,520  and $5,520 respectively.
The Compensation Committee has evaluated the compensation of Mr. Schwan in light of the results of
operation of the Company and in comparison to compensation levels of similar companies. The Compensation
Committee determined that Mr. Schwans level of base compensation was $153,000. In light of
that review, the Compensation Committee recommended no change in the compensation of Mr. Schwan during
2004, and also did not recommend any incentive compensation for Mr. Schwan or other of the named
executives.
Compensation Committee:Brent Tayne and Stanley M. Brown
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|38
|--



|Comparative Stock Price Performance Graph/Table
The following table compares, for the period January 1, 2000 to December 31, 2004, the cumulative total
return (assuming reinvestment of dividends) on the Companys Common Stock with (i) NASDAQ Stock
Market Index (U.S.) and (ii) a peer group including the following companies: S&P 500 Specialty
Stores. The table assumes an investment of $100 on January 1, 2000, in the Companys Common
Stock and each of the other investment categories.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|Total Return To Shareholders
                 (Includes reinvestment of dividends)                                                                                                                                                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     

|ANNUAL RETURN PERCENTAGE
    Years Ending
|-----------------------------------------
|                                         
|Company / Index                          
|CTI INDUSTRIES CORP                      
|NASDAQ U.S. INDEX                        
|S&P 500 SPECIALTY STORES                 
|                                         

|                         | Base
    Period |  | INDEXED RETURNS
    Years Ending | 
|------------------------ | --------------- |  | -------------------------------- | 
|Company / Index          | Oct00           |  | Dec00                            | 
|CTI INDUSTRIES CORP      | 100             |  | 53.33                            | 
|NASDAQ U.S. INDEX        | 100             |  | 72.95                            | 
|S&P 500 SPECIALTY STORES | 100             |  | 86.63                            | 

|39
|--



|Director Compensation
John Schwan was compensated in the amount of $24,000 in fiscal 2004 for his services as Chairman of
the Board of Directors. Directors other than members of management received a fee of $1,000 for each
Board meeting attended.
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, 2005, 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                                                     |  |                                                                 | 618,428   | (3)                                    | 
|Stephen M.
      Merrick                                           |  |                                                                 | 501,949   | (5)                                    | 
|Howard W.
      Schwan                                             |  |                                                                 | 178,904   | (6)                                    | 
|Brent Anderson                                                     |  |                                                                 | 42,795    | (7)                                    | 
|Samuel Komar                                                       |  |                                                                 | 24,879    | (8)                                    | 
|Mark Van
      Dyke                                                |  |                                                                 | 23,809    | (9)                                    | 
|Timothy
      Patterson                                            |  |                                                                 | 5,000     | (10)                                   | 
|John I. Collins                                                    |  |                                                                 |           |                                        | 
|262
      Pine Street                                              |  |                                                                 |           |                                        | 
|Deerfield,
      IL 60015                                          |  |                                                                 | 0         |                                        | 
|Stanley
      M. Brown                                             |  |                                                                 |           |                                        | 
|1140
      Larkin                                                  |  |                                                                 |           |                                        | 
|Wheeling,
      IL 60090                                           |  |                                                                 | 9,267     | (11)                                   | 
|Bret Tayne                                                         |  |                                                                 |           |                                        | 
|6834
      N. Kostner Avenue                                       |  |                                                                 |           |                                        | 
|Lincolnwood,
      IL 60712                                        |  |                                                                 | 9,923     | (12)                                   | 
|Michael Avramovich                                                 |  |                                                                 |           |                                        | 
|70
      W. Madison Street, Suite 1400                             |  |                                                                 |           |                                        | 
|Chicago,
      IL 60602                                            |  |                                                                 | 0         |                                        | 
|                                                                   |  |                                                                 |           |                                        | 
|All Directors
      and Executive Officers as a group (11 persons) |  |                                                                 | 1,414,954 |                                        | 

|* 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.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                  
|----------------------------------
|(footnotes continued on next page)

|40
|--



|(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 79,364 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 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 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 4,761 shares of Common Stock at $6.30 per share granted under the
  Companys 1997 Stock Option Plan, options to purchase up to 17,857 shares of Common Stock at
  $1.47 per share, granted under the Companys 2001 Stock Option Plan and options to purchase
  up to 8,928 shares of Common Stock at $2.31 per share granted under the Companys 2002 Stock
  Option Plan.                                                                                                                                                                                                   

|                                  
|----------------------------------
|(footnotes continued on next page)

|41
|--



|(8)  | Includes options to purchase up to 4,761 shares of Common Stock at $6.30 per share granted under the
  Companys 1997 Stock Option Plan, options to purchase up to 7,976 shares of Common Stock at
  $1.89 per share granted under the Companys 1999 Stock Option Plan, options to purchase up to
  11,904 shares of Common Stock at $1.47 per share granted under the Companys 2001 Stock Option
  Plan, and 238 shares of Common Stock held by immediate family members.
|---- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|(9)  | Includes options to purchase up to 23,809 shares of Common Stock at $1.47 per share granted under the
  Companys 2001 Stock Option Plan.                                                                                                                                                                                                                                                                                                                                   
|     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|(10) | Includes options to purchase up to 5,000 shares of Common Stock at $2.26 per share granted under the
  Companys 2002 Stock Option Plan.                                                                                                                                                                                                                                                                                                                                    
|     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|(11) | 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 3,571 shares of Common Stock at $1.89 per share granted under
the Companys 1999 Stock Option Plan and options to purchase up to 2,976
shares of Common Stock at $2.31 per share granted under the Companys 2002
Stock Option Plan.                                                                       
|     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

|(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 3,571 shares of Common Stock at
  $1.89 per share granted under the Companys 1999 Stock Option Plan and options to purchase up
  to 2,976 shares of Common Stock at $2.31 per share granted under the Companys 2002 Stock Option
  Plan.
|---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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 serves as general counsel of the Company. In addition,
Mr. Merrick is a principal stockholder of the Company. No other employee or principal of the firm
of Merrick & Associates, P.C. owns any shares of the Companys outstanding Common Stock.
Legal fees incurred from the firm of Merrick & Associates, P.C. for the fiscal year ended December
31, 2004 was $97,000. In 2004, Mr. Merrick was paid $48,000 for services provided to the company.
Mr. Merrick is also an officer and director of Reliv International, Inc. (NASDAQ-RELV).
John H. Schwan is President of Packaging Systems, L.L.C. and affiliated companies. The Company made
purchases of packaging materials from these entities in the amount of $172,000 during the year ended
December 31, 2004. In 2004, Mr. Schwan was paid $24,000 for services provided to the Company.
During 2004 and 2003, John H Schwan loaned to Flexo Universal the aggregate amount of $86,000 and $225,000,
respectively. During 2004 and 2003, Stephen M. Merrick loaned to Flexo Universal the aggregate amount
of $181,000 and $25,000, respectively. These advances are reflected in notes and bear interest at
the rate of 8% per annum.





The Company entered into a 10-year
lease agreement for office and warehouse facilities in November 1999, requiring monthly
payments of $17,404 to Pepper Road, Inc., a company related through common ownership. In
2003, the rent was reduced to $15,500 per month. Approximately 50% of the facility was
subleased through March 2002, and after that, the Company assumed the remaining 50% of the
facility. In July of 2004, the company signed a lease with HP Properties LLC for
approximately 35,000 square feet of space in Cary, Illinois. In July of 2004, the Company
cancelled its lease with Pepper Road, Inc.


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 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.

At various times during 2003, John H. Schwan loaned an aggregate of $795,204 to
the Company in exchange for notes bearing interest at 8%. These notes are
subordinated to the bank loan of the Company.

|42
|--



|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 by the Companys
independent auditor, for the years ended December 31, 2003 and December 31, 2004:
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

|                         | 2003 Amount |         | 2004 Amount |  
|------------------------ | ----------- | ------- | ----------- | -
|                         |             |         |             |  
|                         |             |         |             |  
|Audit fees (1)           | $           | 256,000 |             | $
|Other audit related fees | $           | 0       |             | $
|Tax Fees                 | $           | 15,000  |             | $
|                         |             |         |             |  
|                         |             |         |             |  
|Total fees               | $           | 271,000 |             | $
|                         |             |         |             |  

|(1)                                                                                                               | Includes
      the annual financial statement audit and limited quarterly reviews and expenses.
|----------------------------------------------------------------------------------------------------------------- | -----------------------------------------------------------------------------------------------
|                                                                                                                  |                                                                                                
|(See Item No. 9 - Changes
        in and Disagreements with Accountants on Accounting and Financial Disclosure)

|43
|--



|All audit, tax, and other services to be performed by Weiser, LLP for the Company must be pre-approved
by the 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, the 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 2004, all services performed
by Eisner LLP, the Companys previous independent auditors and Weiser, LLP, were pre-approved
by the Audit Committee in accordance with this policy.
The Audit Committee of the Board of Directors reviews all relationships with its independent auditors,
including the provision of non-audit services, which may relate to the independent registered public
accounting firms independence. The Audit Committee of the Board of Directors considered the
effect of Weiser, LLPs tax 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.
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. | Exhibits:                                                                                                                                                                                                  
| |    |                                                                                                                                                                                                            

|3.1 | 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)                                                                                                 

|44
|--



|4.1   | Form of Certificate for Common Stock 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)                               
|----- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|      |                                                                                                                                                                                                                                                      
|10.1  | CTI Industries Corporation 1999 Stock Option Plan (Incorporated by reference to Exhibit contained in Registrants Schedule 14A Definitive Proxy Statement, as filed with the Commission on March 26, 1999)                                           
|      |                                                                                                                                                                                                                                                      
|10.2  | CTI Industries Corporation 2001 Stock Option Plan (Incorporated by reference to Exhibit contained in Registrants Schedule 14A Definitive Proxy Statement, as filed with the Commission on May 21, 2001)                                             
|      |                                                                                                                                                                                                                                                      
|10.3  | CTI Industries Corporation 2002 Stock Option Plan (Incorporated by reference to Exhibit contained in Registrants Schedule 14A Definitive Proxy Statement, as filed with the Commission on May 15, 2002)                                             
|      |                                                                                                                                                                                                                                                      
|10.4  | 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)                         

|45
|--



|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 Bank (Incorporated by reference to Exhibit contained in the Registrants 10-K/A Amendment No. 1, as filed with the Commission on April 15, 2004)                                  
|      |                                                                                                                                                                                                                                                                            
|10.15 | Term Note in the sum of $3,500,000 dated December 30, 2003 made by CTI Industries Corporation to Cole Taylor Bank (Incorporated by reference to Exhibit contained in the Registrants 10-K/A Amendment No. 1, as filed with the Commission on April 15, 2004)              
|      |                                                                                                                                                                                                                                                                            
|10.16 | Revolving Note in the sum of $7,500,000 dated December 30, 2003, made by CTI Industries Corporation to Cole Taylor Bank (Incorporated by reference to Exhibit contained in the Registrants 10-K/A Amendment No. 1, as filed with the Commission on April 15, 2004)        
|      |                                                                                                                                                                                                                                                                            
|10.17 | 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 | Guaranties dated January 12, 2001 by John H. Schwan, Stephen M. Merrick and Howard W. Schwan 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)
|      |                                                                                                                                                                                                                                                                            
|11.1  | Computation of Earnings Per Share (Incorporated by reference to Note 16 of 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 Registered Public Accounting Firm, Weiser, LLP                                                                                                                                                                                                                  

|46
|--



|23.2 | Consent of Independent Registered Public Accounting Firm, Eisner, LLP                                                                                                
|---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------
|     |                                                                                                                                                                      
|23.3 | Consent of Independent Registered Public Accounting Firm, McGladrey & Pullen, LLP                                                                                    
|     |                                                                                                                                                                      
|27   | Financial Data Schedule                                                                                                                                              
|     |                                                                                                                                                                      
|31.1 | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and rule 15d-14(a) of the Securities Exchange Act, as amended                                    
|     |                                                                                                                                                                      
|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                                    
|     |                                                                                                                                                                      
|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

|47
|--



|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 May 9, 2005.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                               

| | CTI INDUSTRIES CORPORATION
| | --------------------------
| | By:                       
| |                           
| |                           

|                                                                                                                                                                         
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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     |  | May 9, 2005
|                       |  |                            |  |            
|Howard W. Schwan       |  |                            |  |            
|                       |  |                            |  |            
|/s/ John H. Schwan     |  | Chairman and Director      |  | May 9, 2005
|                       |  |                            |  |            
|John H. Schwan         |  |                            |  |            
|                       |  |                            |  |            
|/s/ Stephen M. Merrick |  | Executive Vice President,  |  | May 9, 2005
|                       |  | Secretary, Chief Financial |  |            
|Stephen M. Merrick     |  | Officer and Director       |  |            
|                       |  |                            |  |            
|/s/ Stanley M. Brown   |  | Director                   |  | May 9, 2005
|                       |  |                            |  |            
|Stanley M. Brown       |  |                            |  |            
|                       |  |                            |  |            
|/s/ Bret Tayne         |  | Director                   |  | May 9, 2005
|                       |  |                            |  |            
|Bret Tayne             |  |                            |  |            
|                       |  |                            |  |            
|/s/ Michael Avramovich |  | Director                   |  | May 9, 2005
|                       |  |                            |  |            
|Michael Avramovich     |  |                            |  |            
|                       |  |                            |  |            
|/s/ John I. Collins    |  | Director                   |  | May 9, 2005
|                       |  |                            |  |            
|John I. Collins        |  |                            |  |            

|48
|--



|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 sheet of CTI Industries Corporation and Subsidiaries (the Company) as of December
31, 2004, and the related consolidated statements of operations, stockholders equity and
comprehensive income, and cash flows for year 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 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 consolidated financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes assessing
the accounting principles used and significant estimates made by management, as well as
evaluating the overall consolidated 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 financial position of CTI Industries Corporation and Subsidiaries as of December 31,
2004, and the results of their consolidated operations and their consolidated cash flows
for the year then ended in conformity with U.S. generally accepted
accounting principles.


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



/s/ Weiser LLP


New York, New York


April 15, 2005

F-1
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM


The Board of Directors
and StockholdersCTI Industries Corporation


We have audited the accompanying
consolidated balance sheet of CTI Industries Corporation and subsidiaries (the
Company) as of December 31, 2003 and the related consolidated statements of
operations, stockholders equity and cash flows for the year then ended. 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 enumerated above present fairly, in all material respects, the
consolidated financial position of CTI Industries Corporation and subsidiaries as of
December 31, 2003, and the consolidated results of their operations and their cash flows
for the year then ended, 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










F-1
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING

FIRM



To the Board of Directors

CTI Industries Corporation and Subsidiaries

Barrington, Illinois



We have audited the accompanying consolidated statements of operations,

stockholders equity, and cash flows of CTI Industries Corporation and Subsidiaries for the year ended December 31, 2002. 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, based on our audit and the report of the other auditor, the consolidated

financial statements referred to above present fairly, in all material respects, the financial position of CTI Industries Corporation and Subsidiaries for the year ended

December 31, 2002, in conformity with accounting principles generally accepted in the United States of America.



As discussed in Note 12 to the consolidated financial statements, on January 1, 2002, the

Company changes its method of accounting for goodwill to adopt Statement of Financial Accounting Standards No. 142.





/s/ McGladrey & Pullen, LLP



Schaumburg, Illinois

April 15, 2003






F-1
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|
|

|CTI Industries Corporation
      and Subsidiaries 
      Consolidated Balance Sheets                                                                                              
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
|
|
|
|Current
      assets:                                                                                                                                                             
|Cash                                                                                                                                                                              
|Accounts
      receivable, (less allowance for doubtful accounts of 
        $ 404,070 and $316,047 respectively)                                                                 
|Inventories                                                                                                                                                                       
|Deferred
      tax assets                                                                                                                                                         
|Prepaid
      expenses and other current assets                                                                                                                                   
|                                                                                                                                                                                  
|                                                                                                                                                                                  
|Total
      current assets                                                                                                                                                        
|                                                                                                                                                                                  
|Property,
      plant and equipment:                                                                                                                                              
|Machinery
      and equipment                                                                                                                                                     
|Building                                                                                                                                                                          
|Office
      furniture and equipment                                                                                                                                              
|Land                                                                                                                                                                              
|Leasehold
      improvements                                                                                                                                                      
|Fixtures
      and equipment at customer locations                                                                                                                                
|Projects
      under construction                                                                                                                                                 
|                                                                                                                                                                                  
|                                                                                                                                                                                  
|Less
      : accumulated depreciation and amortization                                                                                                                            
|                                                                                                                                                                                  
|                                                                                                                                                                                  
|Total
      property, plant and equipment, net                                                                                                                                    
|                                                                                                                                                                                  
|Other
      assets:                                                                                                                                                               
|Deferred
      financing costs, net                                                                                                                                               
|Goodwill                                                                                                                                                                          
|Deferred
      income tax asset                                                                                                                                                   
|Other
      assets                                                                                                                                                                
|                                                                                                                                                                                  
|                                                                                                                                                                                  
|Total
      other assets                                                                                                                                                          
|                                                                                                                                                                                  
|                                                                                                                                                                                  
|TOTAL ASSETS                                                                                                                                                                      
|                                                                                                                                                                                  
|See accompanying
      notes to consolidated statements                                                                                                                           
|                                                                                                                                                                                  
|LIABILITIES
      AND STOCKHOLDERS EQUITY                                                                                                                                        
|                                                                                                                                                                                  
|Checks
      written in excess of bank balance                                                                                                                                    
|Trades
      payables                                                                                                                                                             
|Line
      of credit                                                                                                                                                              
|Notes
      payable - current portion                                                                                                                                             
|Accrued
      liabilities                                                                                                                                                         
|                                                                                                                                                                                  
|                                                                                                                                                                                  
|Total
      current liabilities                                                                                                                                                   
|                                                                                                                                                                                  
|Long-term
      liabilities:                                                                                                                                                      
|Other
      liabilities (related parties of $517,000 and $250,000)                                                                                                                
|Notes
      payable                                                                                                                                                               
|Notes
      payable - officers                                                                                                                                                    
|                                                                                                                                                                                  
|                                                                                                                                                                                  
|                                                                                                                                                                                  
|Total
      long-term liabilities                                                                                                                                                 
|                                                                                                                                                                                  
|Minority
      interest                                                                                                                                                           
|                                                                                                                                                                                  
|Commitments
      and contingencies                                                                                                                                               
|                                                                                                                                                                                  
|Stockholders
      equity:                                                                                                                                                       
|Preferred
      Stock - no par value, 2,000,000
      shares authorized, 0 shares issued
      and outstanding                                                                    
|Common
      stock - no par value, 5,000,000 shares authorized, 
        2,185,896, and 2,150,216 shares issued, 1,954,100, and 1,918,420
        shares outstanding, respectively
|Class
      B Common stock - no par value, 500,000 shares authorized,
        0 shares issued and outstanding                                                                     
|Paid-in-capital                                                                                                                                                                   
|Warrants
      issued in connection with subordinated debt and bank debt                                                                                                          
|Accumulated
      deficit                                                                                                                                                         
|Accumulated
      other comprehensive loss                                                                                                                                        
|Less:                                                                                                                                                                             
|Treasury
      stock at cost - 231,796 shares                                                                                                                                     
|                                                                                                                                                                                  
|                                                                                                                                                                                  
|                                                                                                                                                                                  
|Total
      stockholders equity                                                                                                                                                  
|                                                                                                                                                                                  
|                                                                                                                                                                                  
|TOTAL LIABILITIES
      & STOCKHOLDERS EQUITY                                                                                                                                    
|                                                                                                                                                                                  

|                                                 
|-------------------------------------------------
|See accompanying notes to consolidated statements
|                                                 
|F-2                                              
|                                                 

|
|



|                                                                                                   
|---------------------------------------------------------------------------------------------------
|
|
|
|
|
|Net
      Sales                                                                                    
|                                                                                                   
|Cost of Sales                                                                                      
|                                                                                                   
|                                                                                                   
|Gross
      profit                                                                                 
|                                                                                                   
|Operating
      expenses:                                                                          
|General
      and administrative                                                                   
|Selling                                                                                            
|Advertising
      and marketing                                                                    
|                                                                                                   
|                                                                                                   
|Total
      operating expenses                                                                     
|                                                                                                   
|                                                                                                   
|(Loss)
      income from operations                                                                
|                                                                                                   
|Other income
      (expense):                                                                      
|Interest
      expense                                                                             
|Interest
      income                                                                              
|Gain
      on sale of assets                                                                       
|Foreign
      currency (loss) gain                                                                 
|Other                                                                                              
|                                                                                                   
|                                                                                                   
|Total
      other income (expense)                                                                 
|                                                                                                   
|                                                                                                   
|(Loss)
      income before income taxes and minority interest                                      
|                                                                                                   
|Income tax
      expense (benefit)                                                                 
|                                                                                                   
|                                                                                                   
|(Loss)
      income before minority interest                                                       
|                                                                                                   
|Minority
      interest in income (loss) of subsidiary                                             
|                                                                                                   
|                                                                                                   
|Net
      (loss) income                                                                            
|                                                                                                   
|                                                                                                   
|Basic
      (loss) income per common share                                                         
|                                                                                                   
|                                                                                                   
|Diluted
      (loss) income per common share                                                       
|                                                                                                   
|                                                                                                   
|Weighted
      average number of shares and equivalent 
        shares of common stock outstanding:
|Basic                                                                                              
|                                                                                                   
|                                                                                                   
|Diluted                                                                                            
|                                                                                                   
|                                                                                                   
|                                                                                                   

|See accompanying notes to consolidated statements
|-------------------------------------------------
|                                                 
|F-3                                              
|                                                 
|                                                 



|
|

|                                                                            |  | Common
      Stock                                    |        | Class
      B Common Stock |           | Paid-in
      Capital |          |        |   | Warrants
      issued in
      connection 
      with
      subordinated 
      debt |   | Accumulated
      Deficit |           | Accumulated
      Other
      Compre-
      hensive
      Income
      (loss) |  | Less |  | TOTAL |          
|--------------------------------------------------------------------------- |  | ----------------------------------------------------- | ------ | -------------------------- | --------- | --------------------- | -------- | ------ | - | ------------------------------------------------------------------------------------ | - | ------------------------- | --------- | ----------------------------------------------------------------------------- |  | ---- |  | ----- | ---------
|                                                                           
|Treasury
      Stock                                                        |  | Notes
      
      Recvble
      Share-
      holders
|                                                                            |  |                                                      
|Shares                                                                      |  | Amount                                                | Shares |                            | Amount    | Shares                |          | Amount
|                                                                           
|                                                                            |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|Balance,
         December 31, 2001                                         |  | 966,327                                               |        | $                          | 188,434   |                       | 366,300  |        | $ | 1,000,000                                                                            |   | $                         | 5,554,332 |                                                                               |  |      |  | $     | 487,440  
|                                                                            |  |                                                       |       
|                                                                            |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|Options Exercised                                                           |  | 11,000                                                |        | $                          | 19,750    |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|                                                                            |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|Class B Conversion                                                          |  | 366,300                                               |        | $                          | 1,000,000 |                       | (366,300 | )      |   | ($1,000,000                                                                          | ) |                           |           |                                                                               |  |      |  |       |          
|                                                                            |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|Stock Dividend                                                              |  | 304,218                                               |        | $                          | 1,280,758 |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|                                                                            |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|Subordinated
      
         debt contributed
         to exercise warrants |  | 423,579                                               |        | $                          | 1,066,978 |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       | ($351,978
|                                                                            |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|Cashless exercise
      
         of warrants                               |  | 70,458                                                |        | $                          | 192,350   |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|                                                                            |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|Net Income                                                                  |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|                                                                            |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|Other comprehensive
         income Foreign 
         currency translation  |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|                                                                            |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|Total 
         comprehensive loss                                          |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|                                                                            |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|                                                                            |  |                                                       |       
|Balance, 
         December 31, 2002                                        |  | 2,141,882                                             |        | $                          | 3,748,270 |                       |         |        | $ |                                                                                     |   | $                         | 5,554,332 |                                                                               |  |      |  | $     | 135,462  
|                                                                            |  |                                                       |       
|                                                                            |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|Options Exercised                                                           |  | 8,334                                                 |        | $                          | 15,750    |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|                                                                            |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|Subordinated
      
         debt contributed
         to exercise warrants |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  | $     | 459,712  
|                                                                            |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|Collection of
      
         Notes Receivable                              |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|                                                                            |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|Net loss                                                                    |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|                                                                            |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|Other comprehensive
         income Foreign
         currency translation   |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|                                                                            |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|Total comprehensive
      
         loss                                    |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|                                                                            |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|                                                                            |  |                                                       |       
|Balance, 
         December 31, 2003                                        |  | 2,150,216                                             |        | $                          | 3,764,020 |                       |         |        | $ |                                                                                     |   | $                         | 5,554,332 |                                                                               |  |      |  | $     | 595,174  
|                                                                            |  |                                                       |       
|                                                                            |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|Stock issued
        for services                                           |  | 35,680                                                |        | $                          |          |                       |          |        |   |                                                                                      |   | $                         | 61,079    |                                                                               |  |      |  |       |          
|                                                                            |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|Net loss                                                                    |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|                                                                            |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|Other comprehensive
         income Foreign 
         currency translation  |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|                                                                            |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|Total comprehensive
      
         loss                                    |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|                                                                            |  |                                                       |        |                            |           |                       |          |        |   |                                                                                      |   |                           |           |                                                                               |  |      |  |       |          
|                                                                            |  |                                                       |       
|Balance, 
         December 31, 2004                                        |  | 2,185,896                                             |        | $                          | 3,764,020 |                       |         |        | $ |                                                                                     |   | $                         | 5,615,411 |                                                                               |  |      |  | $     | 595,174  
|                                                                            |  |                                                       |       

|                                                                        
|------------------------------------------------------------------------
|The accompanying notes are an integral part of the financial statements.
|                                                                        
|F-4                                                                     
|                                                                        
|                                                                        



|
|

|                                                                                                           | Year Ended December 31, |           
|---------------------------------------------------------------------------------------------------------- | ----------------------- | ----------
|                                                                                                           |                         |           
|                                                                                                           | 2004                    |           
|                                                                                                           |                         |           
|Cash
      flows from operating activities:                                                                |                         |           
|Net (loss) income                                                                                          | $                       | (2,479,374
|Adjustments to reconcile net (loss) income to cash
            (used in) provided by operating activities: |                         |           
|Depreciation and amortization                                                                              |                         | 1,651,322 
|Deferred gain on sale/leaseback                                                                            |                         | (175,271  
|Amortization of debt discount                                                                              |                         | 251,490   
|Minority interest in income (loss) of subsidiary                                                           |                         | 1,063     
|Provision for losses on accounts receivable                                                                |                         | 288,562   
|Provision for losses on inventory                                                                          |                         | 60,000    
|Deferred income taxes                                                                                      |                         | 1,189,135 
|Change in operating assets and liabilities:                                                                |                         |           
|Accounts receivable                                                                                        |                         | (1,791,423
|Inventories                                                                                                |                         | 854,666   
|Other assets                                                                                               |                         | 426,662   
|Trade
      payables, accrued and other liabilities                                                        |                         | (847,411  
|                                                                                                           |                         |           
|                                                                                                           |                         |           
|Net
      cash (used in) provided by operating activities                                                  |                         | (570,579  
|                                                                                                           |                         |           
|Cash
      flows from investing activities:                                                                |                         |           
|                                                                                                           |                         |           
|Purchases of property, plant and equipment                                                                 |                         | (305,546  
|Proceeds from sale of property, plant and equipment                                                        |                         | 32,094    
|                                                                                                           |                         |           
|                                                                                                           |                         |           
|Net cash used in investing activities                                                                      |                         | (273,452  
|                                                                                                           |                         |           
|Cash
      flows from financing activities:                                                                |                         |           
|Checks written in excess of bank balance                                                                   |                         | 172,309   
|Net change in revolving line of credit                                                                     |                         | 2,706,984 
|Proceeds
      from issuance of long-term debt                                                             |                         | 558,077   
|Repayment
      of long-term debt                                                                          |                         | (2,513,261
|Proceeds from exercise of stock options                                                                    |                         | 0         
|Proceeds from exercise of warrants                                                                         |                         | 0         
|Collection of stockholder note                                                                             |                         | 0         
|Cash paid for deferred financing fees                                                                      |                         | (41,234   
|                                                                                                           |                         |           
|                                                                                                           |                         |           
|Net
      cash provided by (used in) financing activities                                                  |                         | 882,875   
|                                                                                                           |                         |           
|Effect
      of exchange rate changes on cash                                                              |                         | 157,884   
|                                                                                                           |                         |           
|                                                                                                           |                         |           
|Net
      increase in cash                                                                                 |                         | 196,728   
|                                                                                                           |                         |           
|Cash
      at beginning of period                                                                          |                         | 329,742   
|                                                                                                           |                         |           
|                                                                                                           |                         |           
|Cash
      at end of period                                                                                | $                       | 526,470   
|                                                                                                           |                         |           

|                                                 
|-------------------------------------------------
|See accompanying notes to consolidated statements
|                                                 
|                                                 



|Supplemental
      disclosure of cash flow information:                                                           |         |  |           |  |           | 
|----------------------------------------------------------------------------------------------------------------- | ------- |  | --------- |  | --------- | 
|Cash payments for interest                                                                                        | 952,682 |  | 865,196   |  | 776,802   | 
|Cash payments for taxes                                                                                           | 47,186  |  | 42,295    |  | 140,072   | 
|                                                                                                                  |         |  |           |  |           | 
|Supplemental
      non-cash investing and financing activities:                                                   |         |  |           |  |           | 
|Settlement
      of liability with third party via ownership transfer
              of long-term asset            | 241,268 |  | 0         |  | 0         | 
|Accounts payable converted to notes payable                                                                       | 0       |  | 3,534,326 |  | 0         | 
|Issuance of stock for subordinated debt                                                                           | 0       |  | 0         |  | 715,000   | 
|Long-term
      debt incurred for the purchase of equipment                                                       | 0       |  | 0         |  | 2,230,719 | 
|Note
      payable incurred to purchase 21.8% of minority
              interest in CTI Mexico S. A.
      de C.V | 0       |  | 0         |  | 148,290   | 
|Stock dividend                                                                                                    | 0       |  | 0         |  | 1,280,758 | 
|Issuance of stock for equity issue expenses                                                                       | 61,079  |  | 0         |  | 0         | 
|Common stock exchanged to exercise warrants                                                                       | 0       |  | 0         |  | 192,350   | 
|Refinance mortgage                                                                                                | 0       |  | 2,671,243 |  | 0         | 

|                                                 
|-------------------------------------------------
|See accompanying notes to consolidated statements
|                                                 
|F-5                                              
|                                                 
|                                                 



|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.) (the Company) (i) design, manufacture and distribute metalized and latex balloon
products throughout the world and (ii) operate systems for the production, lamination, coating and
printing of films used for food packaging and other commercial uses and for conversion of films to
flexible packaging containers and other products.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              

| | 2. | Basis of Presentation
| | -- | ---------------------

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|During the year ended December 31, 2004, the Company
incurred a net operating loss before taxes of $1,192,000.
As of December 31, 2004 and December 31, 2003, the Company had a working capital deficiency of $2,790,000
and $706,000, respectively. The Company depends on its line of credit, including a term loan and
revolving line of credit with its principal lenders, and continued financial support from its principal
stockholders /officer for liquidity. This line of credit expires on December 31, 2005. 
Managements plans to improve
profitability during 2005 include relocating certain manufacturing operations from the
United States to its foreign affiliates and continued cost reductions in the area of
direct and overhead expenses in the U.S. operations. In addition, the Company is currently
evaluating its operating strategies to expand its storage bag product line, which the Company anticipates
will improve its overall profit margin. The Company belives it has sufficient
cash and funding opportunities to meet its operating requirements through January
1, 2006.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

| | 3. | Summary of Significant Accounting Policies
| | -- | ------------------------------------------

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Principles of Consolidation
The consolidated financial statements include the accounts of CTI Industries Corporation, its wholly
owned subsidiaries CTI Balloons Limited and CTF International S.A. de C.V., 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.
Cash and Cash Equivalents
Cash and cash equivalents includes 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

|F-6
|---



|CTI Industries Corporation and Subsidiaries
  Notes to the Consolidated Financial Statements
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 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, plant 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 years | 
| | Machinery and equipment                       | 3 - 15 years  | 
| | Office furniture and equipment                | 5 - 8 years   | 
| | Leasehold improvements                        | 5 - 8 years   | 
| | Furniture and 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 re-classed to the appropriate asset class.
Goodwill
Prior to January 1, 2002, goodwill was being amortized over 15 years using the straight-line method.
Subsequent to that date, the Company has followed, and does now follow, 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 CTI Mexico. It is the Companys
policy to perform impairment testing for Flexo Universal annually as of December 31, or as circumstances change.
Valuation of long lived assets
The Company evaluates whether events or circumstances have occurred which indicate that the carrying
amounts of long-lived assets (principally property, plant and equipment) may be impaired or not recoverable.
The significant factors that are considered that could trigger an impairment review include: changes
in business strategy, market conditions, or the manner of use of an asset; underperformance relative
to historical or expected future operating results; and negative industry or economic trends. In
evaluating an asset for possible impairment, management estimates that assets future undiscounted
cash flows and appraised values to measure whether the asset is recoverable, the Company measures
the impairment based on the projected discounted cash flows of the asset over its remaining life.
While the Company believes that 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 relates to the refinancing of long-term debt in December 2003. These costs
are being amortized on a straight-line basis over the term of the loans.
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 reinvested
for an indefinite period of time.

|F-7
|---



|CTI Industries Corporation and Subsidiaries
  Notes to the Consolidated Financial Statements
Fair Value of Financial Instruments

The fair value of the Companys financial instruments relating to accounts
receivable, accounts 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, 2004 and 2003, other comprehensive income (loss) consisted of foreign currency
translation adjustments, which is a component of other comprehensive income (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, 2004, the Company has four stock-based compensation plans, which are described more
fully in Note 14. 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 provisions of Statement
of Financial Accounting Standards (SFAS) No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure, an amendment of SFAS Statement No. 123 (SFAS No. 148).
The following table illustrates the effect on net (loss) income 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.
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   

|                                                                                                                                                                           |                                |           
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------ | ----------
|                                                                                                                                                                           | Years
      Ended December 31, |           
|                                                                                                                                                                           |                                |           
|                                                                                                                                                                           | 2004                           |           
|                                                                                                                                                                           |                                |           
|Net (loss):                                                                                                                                                                |                                |           
|Reported                                                                                                                                                                   | $                              | (2,479,000
|                                                                                                                                                                           |                                |           
|Deduct total
      stock-based employee compensation expense 
         determined under fair value based method for all awards,
      net of 
         related tax effects |                                | 0         
|                                                                                                                                                                           |                                |           
|Pro
      forma net (loss)                                                                                                                                                 | $                              | (2,479,000
|                                                                                                                                                                           |                                |           
|                                                                                                                                                                           |                                |           
|Net (loss)
      per share:                                                                                                                                                |                                |           
|                                                                                                                                                                           |                                |           
|Basic
      - As reported                                                                                                                                                  |                                | (1.28     
|                                                                                                                                                                           |                                |           
|Basic
       Proforma                                                                                                                                                     |                                | (1.28     
|                                                                                                                                                                           |                                |           
|Diluted
      - As reported                                                                                                                                                |                                | (1.28     
|                                                                                                                                                                           |                                |           
|Diluted
       Proforma                                                                                                                                                   |                                | (1.28     

|F-8
|---



|CTI Industries Corporation and Subsidiaries
  Notes to the Consolidated Financial Statements
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:
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                     

| |                         | 2004 |         | 2003 |  | 2002   | 
| | ----------------------- | ---- | ------- | ---- |  | ------ | 
| | Expected life (years)   |      | 5.0     |      |  | 5.0    | 
| |                         |      |         |      |  |        | 
| | Volatility              |      | 128.49% |      |  | 136.6% | 
| | Risk-free interest rate |      | 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,
2004, 2003 and 2002, research and development activities
totaled $246,000, $335,000 and $333,000, respectively.
|                                                                                                                                                                                                                                                                                                                                              

|Advertising Costs

The Company expenses advertising
costs as incurred.  Advertising expense amounted to $151,506, $252,204 and $308,197 for
the years ended December 31, 2004, 2003 and 2002, respectively.


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 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.


FASB Interpretation No. 46,
Consolidation of Variable Interest Entities (FIN No. 46) was originally issued
in January 2003 and was subsequently revised in December 2003. FIN No. 46 attempts to
clarify the application of Accounting Research Bulletin No. 51 Consolidated
Financial Statements, to certain entities in which equity investors do not have the
characteristics of a controlling financial interest or do not have sufficient equity at
risk for the entity to finance its activities without additional subordinated financial
support. The Company does not believe that it has any involvement with variable interest
entities that are required to be consolidated under FIN No. 46.
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4. | Major Customers
| | -- | ---------------

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|For the year ended December 31, 2004, the Company had four customers that accounted for approximately
20.1%, 16.8%, 11.7% and 9.2%, respectively, of consolidated net sales. Corresponding percentages
of consolidated net sales generated by these customers for the year ended December 31, 2003, were
approximately 14.7%, 28.4%, 0.5% and 11.0%, respectively.
For the year ended 2002, the corresponding percentages of consolidated net sales for these customers were 17.0%, 29.0%, 0.0% and 12.7%, respectively.
At December 31, 2004, the outstanding accounts
receivable balances due from these four customers were $956,739, $301,724, $1,438,153 and $215,096,
respectively. At December 31, 2003, the outstanding accounts receivable balances due from these three
customers were $566,557, $464,183, $176,316 and $862,407.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

| | 5. | Inventories
| | -- | -----------

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

| |                                    | December
      31, 2004 |           | December
      31, 2003 |   |          
| | ---------------------------------- | ----------------------- | --------- | ----------------------- | - | ---------
| | Raw materials                      | $                       | 888,644   |                         | $ | 866,111  
| | Work in process                    |                         | 806,495   |                         |   | 1,365,317
| | Finished
      goods               |                         | 6,840,068 |                         |   | 7,523,889
| | Allowance,
      excess quantities |                         | (186,713  | )                       |   | (492,157 
| |                                    |                         |           |                         |   |          
| | Total inventories                  | $                       | 8,348,494 |                         | $ | 9,263,160

|F-9
|---



|CTI Industries Corporation and Subsidiaries
  Notes to the Consolidated Financial Statements
|--------------------------------------------------------------------------------------------
|                                                                                            

| | 6. | Notes Payable
| | -- | -------------

|                           
|---------------------------
|Long-term debt consists of:
|                           

|                                                                                                                                                                                                                      | Dec 31, 2004 |            | Dec 31, 2003 |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------ | ---------- | ------------ | -
|                                                                                                                                                                                                                     
|Term Loan
      with bank, payable in monthly installments of $58,333
      including interest at prime (5.25% at December 31, 2004) plus 1.5%
      (6.75%) (amortized over 60 months) balance due December 31, 2005 | $            | 2,858,337  |              | $
|                                                                                                                                                                                                                     
|Mortgage
      Loan with bank, payable in monthly installments of $19,209
      including interest at 6.25% due May 5, 2008                                                                                           |              | 2,832,302  |              |  
|                                                                                                                                                                                                                     
|Term Loan
      with bank, payable in monthly installments of $5,582
      including interest at 10.00% due January 5, 2004                                                                                           |              |           |              |  
|                                                                                                                                                                                                                     
|Vendor Notes,
      at various rates of interest (weighted average of
      6%) maturing through August 2005                                                                                                          |              | 649,697    |              |  
|                                                                                                                                                                                                                     
|Subordinated
      Notes (Related Parties) due 2006, interest at 9% net of debt
      discount of $59,408 and $310,898 at December 31, 2004 and 2003, respectively
      
      (See Note 11)                         |              | 1,460,592  |              |  
|                                                                                                                                                                                                                     
|Subordinated
      Notes (Related Parties) due 2006, interest at 9%
      (See Note 11)                                                                                                                               |              | 795,024    |              |  
|                                                                                                                                                                                                                     
|Loan payable
      to a Mexican finance institution denominated in
      Mexican Pesos bearing interest at 9.81% Due 2007                                                                                             |              | 84,462     |              |  
|                                                                                                                                                                                                                      |              |            |              |  
|Total long-term
      debt                                                                                                                                                                                            | $            | 8,680,414  |              | $
|                                                                                                                                                                                                                      |              |            |              |  
|Less current
      portion                                                                                                                                                                                            |              | (3,560,669 | )            |  
|                                                                                                                                                                                                                      |              |            |              |  
|Total
      long-term debt                                                                                                                                                                                            | $            | 5,119,745  |              | $
|                                                                                                                                                                                                                      |              |            |              |  

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|On December 31, 2003, the Company entered into a Loan and Security Agreement (Loan Agreement) with a 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 expires on December 31, 2005; it is automatically renewed for
successive one year terms unless terminated by either of the parties. The credit
facility of $7,500,000 includes a term loan of $3,500,000, at an interest rate
of prime plus 1.5% per annum (6.75% at December 31, 2004), 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 (6.75%
at December 31, 2004), the amount of which is based on advances of up to 85% of
eligible trade receivables and up to 50% of the value of the Companys
eligible inventories. 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. Upon the receipt of any proceeds
of sale or other disposition of equipment, or any proceeds from damage,
destruction or condemnation, such proceeds must be paid as a mandatory
prepayment of the term loan. In addition, 50% of excess cash flow is required to
be paid as a prepayment of the term loan. The Loan Agreement includes financial
covenants requiring a minimal level of tangible net worth and ratio of EBITDA to
fixed charges. The Bank has issued a waiver of this covenant for December 31,
2004 and has agreed to an amendment modifying the covenants. The Company
believes that it will be within the covenants for the first quarter of 2005 and
going forward.
As of December 31, 2004, the balance outstanding on the credit facility was $6,401,000.
The following credit facility was repaid in December 2003. In January 2001, the Company entered into a Loan and Security Agreement with an institutional lender

under which the lender has provided the Company with a credit facility in the amount of $9,500,000,

collateralized by equipment, inventory, receivables and other assets of the Company. The credit
facility
included a term loan of $1,426,000, at an interest rate of prime plus 0.75% per annum,
which was
based upon the appraised value of the equipment of the Company and a revolving line of
credit at
an interest rate of prime plus 0.5% per annum, the amount of which was based on advances
of up to
85% of eligible receivables and up to 40% of the value of the Companys inventory.
In 2002,
the lender advanced additional funds on the original term loan in the amount of $490,880,
advanced
a second term loan in the amount of $1,740,000 and increased the credit facility to $11,500,000.

The term loans and revolving line of credit were secured by substantially all assets of the Company.

The term of this credit facility was for a period of three years expiring in January 15, 2004.

|F-10
|----



|CTI Industries Corporation and Subsidiaries
  Notes to the Consolidated Financial Statements
Also in January 2001, another lender 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 has
been made in the form of two notes. The first note is in the principal amount of $2,700,000, bears
interest at the rate of 9.75%, and has 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 had 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 are as follows for the year ended December 31, 2004:
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

| |      | 2004 |           | 
| | ---- | ---- | --------- | 
| |      |      |           | 
| |      |      |           | 
| | 2005 | $    | 3,560,669 | 
| | 2006 |      | 2,311,685 | 
| | 2007 |      | 144,189   | 
| | 2008 |      | 2,663,871 | 
| | 2009 |      | 0         | 
| |      |      |           | 
| |      |      |           | 
| |      | $    | 8,680,414 | 
| |      |      |           | 

|F-11
|----



|CTI Industries Corporation and Subsidiaries
  Notes to the Consolidated Financial Statements
|--------------------------------------------------------------------------------------------

| |  | 
| |  | 

| | 7. | Income Taxes
| | -- | ------------

|                                                         
|---------------------------------------------------------
|The income tax provisions are comprised of the following:
|                                                         

|                                           | Year Ended
      December 31: |          
|------------------------------------------ | ----------------------------- | ---------
|
|                                           |                               |          
|Current:                                   |                               |          
|Federal                                    | $                             |         
|State                                      |                               |         
|Foreign                                    |                               | 97,097   
|                                           |                               |          
|                                           | $                             | 97,097   
|                                           |                               |          
|Deferred:                                  |                               |          
|Federal                                    |                               | 1,223,030
|State                                      |                               | (63,753  
|Foreign                                    |                               | 29,858   
|                                           |                               |          
|                                           |                               | 1,189,135
|                                           |                               |          
|Total income
      tax provision (benefit) | $                             | 1,286,232
|                                           |                               |          

|F-12
|----



|CTI Industries Corporation and Subsidiaries
Notes to the Consolidated Financial Statements
The components of the net deferred tax asset (liability) at December 31 are as follows:
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                  

|                                                   | 2004 |            | 2003 |  
|-------------------------------------------------- | ---- | ---------- | ---- | -
|                                                   |      |            |      |  
|Deferred
      tax assets:                         |      |            |      |  
|Allowance
      for doubtful accounts              | $    | 127,150    |      | $
|Inventory
      allowances                         |      | 168,006    |      |  
|Accrued
      liabilities                          |      | 126,372    |      |  
|Sale
      leaseback                               |      | 0          |      |  
|Unicap
      263A adjustment                       |      | 52,380     |      |  
|Net
      operating loss carryforwards             |      | 2,988,093  |      |  
|Alternative
      minimum tax credit carryforwards |      | 338,612    |      |  
|State
      Investment tax credit carryforward     |      | 18,041     |      |  
|Other
      foreign tax items                      |      | 109,833    |      |  
|Foreign
      asset tax credit carryforward        |      | 160,784    |      |  
|                                                   |      |            |      |  
|                                                   |      |            |      |  
|Total
      deferred tax assets                    |      | 4,089,271  |      |  
|                                                  
|Deferred
      tax liabilities:                    |      |            |      |  
|Book
      over tax basis of capital assets        |      | (1,134,282 | )    |  
|Cash
      basis of foreign inventory purchases    |      | (348,690   | )    |  
|                                                   |      |            |      |  
|                                                   |      | 2,606,299  |      |  
|Less: Valuation
      allowance                    |      | (2,454,001 | )    |  
|                                                   |      |            |      |  
|Net
      deferred tax asset                       | $    | 152,298    |      | $
|                                                   |      |            |      |  

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|The Company maintains a valuation
        allowance with respect to deferred tax assets as a result of the uncertainty
        of ultimate realization. At December 31, 2004, the Company has net operating
        loss carryforwards of approximately $7,341,000 expiring in various years
        through 2024. In addition, the Company has approximately $338,600 of alternative
        minimum tax credits as of December 31, 2004, which have no expiration
        date. The Companys investments in non-U.S. subsidiaries are deemed
to be reinvested for an indefinite period of time. The increase in the valuation allowance, which was
recorded in the fourth quarter, 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:
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         

|                                                                 | Year Ended December 31: |          
|---------------------------------------------------------------- | ----------------------- | ---------
|
|                                                                 |                         |          
|Taxes at
      statutory rate                                    | $                       | (417,228 
|State income
      taxes                                         |                         | (57,434  
|Nondeductible
      expenses                                     |                         | 15,355   
|Increase
      in deferred tax 
             Valuation allowance |                         | 1,715,401
|                                                                 |                         |          
|State credit created
      in current year                       |                         | 0        
|Foreign taxes
      and other                                    |                         | 30,138   
|                                                                 |                         |          
|Income tax
      provision                                       | $                       | 1,286,232
|                                                                 |                         |          

| |  | 
| |  | 

| | 8. | Other Income
| | -- | ------------

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Other income of $395,489 set forth on
the Companys 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 various accounts in consideration of
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 $428,126.
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.

| |  | 
| |  | 

| | 9. | Other Liabilities
| | -- | -----------------

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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, (ii) capital lease for
equipment for $5,000 and (iii) obligations of CTI Mexico, Flexo, and CTF International
totaling $779,000 to vendors on deferred payment terms.
For the year ending December 31, 2003, items identified as Other Liabilities in
the Companys Consolidated Balance Sheet include (i) deferred gain of the
Company in the amount of $175,376 on the sale of a building to Pepper Road, Inc.
(a related party, see notes 11 and 13), (ii) loans by officers/shareholders to
Flexo Universal totaling $250,000 and bearing interest at 8% (see note 11),
(iii) obligation of Flexo Universal to a financial institution in the amount of
$83,665 and (iv) obligation of CTI Mexico, Flexo and CTF International totaling
$570,000 to vendors on deferred payment plans.

| |  | 
| |  | 

| | 10. | 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.

|F-13
|----



|CTI Industries Corporation and Subsidiaries
Notes to the Consolidated Financial Statements
Employer contributions to the plan totaled $57,172 for the year ending December 31, 2004, $54,836 for
the year ended December 31, 2003, and $53,680 for the year ended December 31, 2002.
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                    

| | 11. | Related Party Transactions
| | --- | --------------------------

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|The Company obtains legal
services from a law firm in which one shareholder of the law firm is also a
director and a shareholder of the Company. Legal fees incurred with this
firm were $97,000 for the year ended December 31, 2004 and $107,000 for the year
ended 2003 and $102,000 for the year ended 2002. Mr. Merrick also received $48,000 for services performed in 2004.

In 1998, the Company advanced funds totaling $81,352 to officers of the Company. $56,456 of these funds
were used to purchase common stock of the Company and is reflected as a contra equity account at
December 31, 2002 and 2001. This obligation has been repaid in its entirety.
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
, an officer and director of the Company,
is President of Packaging Systems, L.L.C. and affiliated companies. The Company made
purchases of packaging materials from these entities in the amount of approximately $172,000, $274,000 and $118,000 during the
years ended December 31, 2004, 2003 and 2002, respectively. Mr. Schwan also received $24,000 for services performed in 2004.

During 2004
and 2003, John H. Schwan loaned to Flexo Universal the aggregate amount of $86,000 and $225,000
respectively. During 2004 and 2003, Stephen M. Merrick loaned to Flexo Universal the aggregate amount
of $181,000 and $25,000, respectively. These advances are reflected in notes and bear interest at
the rate of 8% per annum. Payment of these loans have been deferred for more than one year.

At various times during 2003, John H. Schwan loaned an aggregate of $795,204 to
the Company in exchange for notes bearing interest at 8% per annum. These notes
are subordinated to the bank loan of the Company. Payment of these loans have
been deferred for more than one year.
The Company entered into a 10-year lease agreement for office and warehouse facilities in November
1999, requiring monthly payments of $17,404, to Pepper Road, Inc., a company related through common
ownership. In 2003, the rent was reduced to $15,500 per month. Approximately 50% of the facility was
subleased through March 2002, and after that, the Company assumed the remaining 50% of the facility.
In July of 2004, the Company signed a lease with HP Properties LLC for approximately
35,000 square feet of space in Cary, Illinois. In July of 2004, the Company cancelled its
lease with Pepper Road, Inc. (See notes 13 and 14)
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.

|F-14
|----



|CTI Industries Corporation and Subsidiaries
Notes to the Consolidated Financial Statements
|------------------------------------------------------------------------------------------
|                                                                                          

| | 12. | Goodwill and Intangible Assets
| | --- | ------------------------------

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|On January 1, 2002, the Company implemented Statement of Financial Accounting Standards No. 142, Goodwill
and Other Intangible Assets. Under the provisions of SFAS 142, goodwill is no longer subject to amortization
over its estimated useful life, but instead will be 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 gross carrying amount of goodwill as of December 31, 2004 and 2003 is $1,113,108.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               

| | 13. | Commitments and Contingencies
| | --- | -----------------------------

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Operating Leases
The Company entered into a 10-year lease agreement for office and warehouse facilities in November
1999, requiring monthly payments of $17,404, to Pepper Road, Inc., a company related through common
ownership. In 2003, the rent was reduced to $15,500 per month. Approximately 50% of the facility was
subleased through March 2002, and after that, the Company assumed the remaining 50% of the facility.
In August of 2004, the company signed a one year lease with HP Properties LLC for approximately
35,000 square feet of space in Cary, Illinois. In July of 2004, the Company cancelled its lease
with Pepper Road, Inc. 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.
The net lease expense was $401,848, $555,197 and $348,631 for the years ended December 31, 2004, 2003 and 2002, which
includes $76,500, $193,615 and $208,844 paid to Pepper Road (a related party) in 2004, 2003 and 2002, respectively.
The future aggregate minimum net lease payments under existing agreements as of December 31, as follows:
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              

| | HP Properties,
      LLC |  | Other |         | Total
      Lease Payments |   |          
| | ------------------------ |  | ----- | ------- | -------------------------- | - | ---------
| |                          |  |       |         |                            |   |          
| | 2005                     |  | $     | 118,660 |                            | $ | 397,186  
| | 2006                     |  |       |         |                            |   | 337,759  
| | 2007                     |  |       |         |                            |   | 286,728  
| | 2008                     |  |       |         |                            |   | 51,700   
| | 2009                     |  |       |         |                            |   | 51,700   
| | Thereafter               |  |       |         |                            |   | 517,000  
| |                          |  |       |         |                            |   |          
| | Total                    |  | $     | 118,660 |                            | $ | 1,642,073
| |                          |  |       |         |                            |   |          

|F-15
|----



|CTI Industries Corporation and Subsidiaries
Notes to the Consolidated Financial Statements
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:
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

| | 2005 | $ | 76,664 |  | 
| | ---- | - | ------ |  | 
| | 2006 | $ | 66,664 |  | 
| |      |   |        |  | 

| | 14. | 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.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

| | 15. | 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, 2004. 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, 2004, 148,219 options had
been granted under the 1999 Stock Option Plan. The options were 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, 2004, 112,503
options had been granted under the 2001 Stock Option Plan. The options were exercisable immediately
upon grant and have a term of ten years.
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, 2004, 65,930
options had been granted under the 2002 Stock Option Plan. The options were 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

|F-16
|----



|CTI Industries Corporation and Subsidiaries
Notes to the Consolidated Financial Statements
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.
The following is a summary of the activity in the Companys stock option plans and other options
and warrants issued, as restated for the stock dividend, for the years ended December 31, 2004,
December 31, 2003 and December 31, 2002.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

|                                                       |                     |         |                                                   |   |                     | 
|------------------------------------------------------ | ------------------- | ------- | ------------------------------------------------- | - | ------------------- | 
|                                                       | Dec. 31,
      2004 |         | Weighted 
      Avg. 
      Exercise 
      Price |   | Dec. 31,
      2003 | 
|                                                       |                     |         |                                                   |   |                     | 
|                                                       |                     |         |                                                   |   |                     | 
|Outstanding and exercisable, 
     beginning of period |                     | 725,597 |                                                   | $ | 2.58                | 
|Granted                                                |                     | 0       |                                                   |   |                     | 
|Exercised                                              |                     | 0       |                                                   |   |                     | 
|Cancelled                                              |                     | (38,125 | )                                                 |   | 1.81                | 
|                                                       |                     |         |                                                   |   |                     | 
|Outstanding and exercisable at the 
     end of period |                     | 687,472 |                                                   | $ | 3.33                | 

|                                                                                                                                                                                                                      
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|At December 31, 2004, available options to grant were 79,707.
Significant option and warrant groups outstanding at December 31, 2004 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   |                      |  |                              | $
|September 1998 |  | 92,463      |  |             | 92,463  |                      |  |                              | $
|September 1998 |  | 11,905      |  |             | 11,905  |                      |  |                              | $
|March 2000     |  | 83,930      |  |             | 83,930  |                      |  |                              | $
|March 2000     |  | 47,620      |  |             | 47,620  |                      |  |                              | $
|July 2001      |  | 119,050     |  |             | 119,050 |                      |  |                              | $
|December 2001  |  | 88,692      |  |             | 88,692  |                      |  |                              | $
|April 2002     |  | 11,905      |  |             | 11,905  |                      |  |                              | $
|December 2002  |  | 55,954      |  |             | 55,954  |                      |  |                              | $
|February 2003  |  | 163,000     |  |             | 163,000 |                      |  |                              | $
|December 2003  |  | 7,000       |  |             | 7,000   |                      |  |                              | $
|               |  |             |  |             |         |                      |  |                              |  
|               |  | 687,472     |  |             | 687,472 |                      |  |                              |  
|               |  |             |  |             |         |                      |  |                              |  

|The aggregate number of warrants
outstanding at December 31, 2004 was 282,050.



F-17
|--------------------------------------------------------------------------------------



|CTI Industries Corporation and Subsidiaries
Notes to the Consolidated Financial Statements
There were no options issued in 2004. The weighted average fair value of options granted during the
years ending December 31, 2003 and December 31, 2002 was $2.26 and $1.92 per share, respectively.


Stock Dividend and Class B Common Stock Conversion
On December 27, 2002, the Company distributed 304,218 shares of common stock in connection with a 19.05%
dividend. As a result of the stock dividend, common stock was increased by $1,280,758 and accumulated
deficit was increased by $1,280,758.
In July 1997, the Company effected a recapitalization (the Recapitalization) without a
formal reorganization. As part of the Recapitalization, the Board of Directors approved the creation
of Class B Common Stock, approved a 1 for 2.6 reverse stock split on both the Common Stock and Preferred
Stock, and negotiated a conversion of all then outstanding shares of the Companys Convertible
Preferred Stock into an aggregate of 366,300 shares of Class B Common Stock. The conversion was effective
upon the closing of an initial public offering of 575,000 shares of the Companys Common Stock
on November 5, 1997. The shares of Class B Common Stock contained rights identical to shares of Common
Stock, except that shares of Class B Common Stock, voting separately as a class, had the right to
elect four of the Companys seven directors. Shares of Common Stock and Class B Common Stock,
voting together as a class, vote on all other matters, including the election of the remaining directors.
The recapitalization, initial public offering and related transactions were approved by written consent
of the shareholders. On July 1, 2002, all outstanding shares of Class B Common Stock, by their terms,
were converted to common stock.
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

| | 16. | Earnings Per Share
| | --- | ------------------

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Basic earnings per share is computed by dividing the income available to common shareholders, net earnings,
less redeemable preferred stock dividends and redeemable common stock accretion, by the weighted
average number of shares of common stock outstanding during each period.
Diluted earnings per share is computed by dividing the net earnings by the weighted average number
of shares of common stock and common stock equivalents (redeemable common stock, stock options and
warrants), unless anti-dilutive, during each period.

|F-18
|----



|CTI Industries Corporation and Subsidiaries
Notes to the Consolidated Financial Statements
Earnings per share for the years ended December 31, 2004, December 31, 2003 and December 31, 2002:
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                             

|                                                  | Year Ended
      December 31,
      2004 |            | Year Ended
      December 31,
      2003 |   | Year Ended
      December 31,
      2002 |  
|------------------------------------------------- | ---------------------------------------- | ---------- | ---------------------------------------- | - | ---------------------------------------- | -
|                                                  |                                          |            |                                          |   |                                          |  
|BASIC                                             |                                          |            |                                          |   |                                          |  
|Average shares outstanding:                       |                                          |            |                                          |   |                                          |  
|Weighted average shares Outstanding during period |                                          | 1,930,976  |                                          |   | 1,918,260                                |  
|                                                  |                                          |            |                                          |   |                                          |  
|Earnings:                                         |                                          |            |                                          |   |                                          |  
|Net (loss) income                                 | $                                        | (2,479,374 | )                                        | $ | (566,047                                 | )
|                                                  |                                          |            |                                          |   |                                          |  
|Amount for per share Computation                  | $                                        | (2,479,374 | )                                        | $ | (566,047                                 | )
|                                                  |                                          |            |                                          |   |                                          |  
|Net (loss) earnings applicable to Common shares   | $                                        | (1.28      | )                                        | $ | (0.30                                    | )
|                                                  |                                          |            |                                          |   |                                          |  
|DILUTED                                           |                                          |            |                                          |   |                                          |  
|Average shares outstanding:                       |                                          |            |                                          |   |                                          |  
|Weighted average shares Outstanding               |                                          | 1,930,976  |                                          |   | 1,918,260                                |  
|Common stock equivalents (options/warrants)       |                                          | 0          |                                          |   | 0                                        |  
|                                                  |                                          |            |                                          |   |                                          |  
|Weighted average shares Outstanding during period |                                          | 1,930,976  |                                          |   | 1,918,260                                |  
|                                                  |                                          |            |                                          |   |                                          |  
|Earnings:                                         |                                          |            |                                          |   |                                          |  
|Net (loss) income                                 | $                                        | (2,479,374 | )                                        | $ | (566,047                                 | )
|                                                  |                                          |            |                                          |   |                                          |  
|Amount for per share Computation                  | $                                        | (2,479,374 | )                                        | $ | (566,047                                 | )
|                                                  |                                          |            |                                          |   |                                          |  
|Net (loss) earnings applicable to Common shares   | $                                        | (1.28      | )                                        | $ | (0.30                                    | )
|                                                  |                                          |            |                                          |   |                                          |  

| |     |                        
| | --- | -----------------------
| | 17. | Geographic Segment Data

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|The Companys operations consist of a business segment which designs, manufactures, and distributes
balloon 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, 2002,
December 31, 2003 and December 31,2004 are as follows:
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

|                        | United States |            | United Kingdom |   | Mexico    |  | Eliminations |           | Consolidated |  
|----------------------- | ------------- | ---------- | -------------- | - | --------- |  | ------------ | --------- | ------------ | -
|                        |               |            |                |   |           |  |              |           |              |  
|Year ended 12/31/04     |               |            |                |   |           |  |              |           |              |  
|Net sales               | $             | 32,854,580 |                | $ | 2,664,465 |  | $            | 4,889,577 |              | $
|Operating (loss) income |               | (214,427   | )              |   | 121,016   |  |              | (426,946  | )            |  
|Net (loss) income       |               | (2,594,627 | )              |   | 223,018   |  |              | (58,864   | )            |  
|Total Assets            | $             | 24,071,875 |                | $ | 1,989,006 |  | $            | 5,318,625 |              | $
|                        |               |            |                |   |           |  |              |           |              |  
|Year ended 12/31/03     |               |            |                |   |           |  |              |           |              |  
|Net sales               | $             | 32,686,979 |                | $ | 2,415,028 |  | $            | 4,003,217 |              | $
|Operating (loss) income |               | (246,299   | )              |   | 190,521   |  |              | (527,767  | )            |  
|Net income              |               | (883,369   | )              |   | 163,218   |  |              | 249,297   |              |  
|Total Assets            | $             | 27,602,666 |                | $ | 1,412,352 |  | $            | 5,475,850 |              | $
|                        |               |            |                |   |           |  |              |           |              |  
|Year ended 12/31/02     |               |            |                |   |           |  |              |           |              |  
|Net sales               | $             | 37,418,425 |                | $ | 1,965,736 |  | $            | 5,235,119 |              | $
|Operating income (loss) |               | 1,259,905  |                |   | 68,535    |  |              | 212,174   |              |  
|Net income (loss)       |               | 451,582    |                |   | 40,065    |  |              | (99,724   | )            |  
|Total Assets            | $             | 26,311,194 |                | $ | 979,959   |  | $            | 4,982,751 |              | $

|F-19
|----



|CTI Industries Corporation and Subsidiaries
Notes to the Consolidated Financial Statements
|------------------------------------------------------------------------------------------

| |     |           
| | --- | ----------
| | 18. | 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 is payable in five consecutive $10,000 monthly
installments, commencing December 30, 2004. The amount was fully accrued for by the Company 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 is payable in seven consecutive $10,000 monthly
installments, commencing March 1, 2005. The amount was fully accrued for by the
Company as of December 31, 2004.
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 or
results of operations of the Company.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                

| | 19. | Quarterly Financial Data (Unaudited):
| | --- | -------------------------------------
| |     |                                      

|                                       | Quarter
      Ended, |            | Year
      Ending 
      December 31,
      2004 |  
|-------------------------------------- | -------------------- | ---------- | ------------------------------------------------ | -
|                                       | 3/31/04              |            | 6/30/04                                          |  
|                                       |                      |            |                                                  |  
|Net sales                              | $                    | 10,893,984 |                                                  | $
|                                       |                      |            |                                                  |  
|Gross profit                           | $                    | 2,147,370  |                                                  | $
|                                       |                      |            |                                                  |  
|Net
      income (loss)                | $                    | 371,901    |                                                  | $
|                                       |                      |            |                                                  |  
|Earnings
      (loss) per common share |                      |            |                                                  |  
|Basic                                  | $                    | 0.19       |                                                  | $
|Diluted                                | $                    | 0.18       |                                                  | $

|F-20
|----



|                                 | Quarter Ended, |            | Year Ending 
      December 31,
      2003 |  
|-------------------------------- | -------------- | ---------- | ------------------------------------------ | -
|                                 | 3/31/03        |            | 6/30/03                                    |  
|                                 |                |            |                                            |  
|Net sales                        | $              | 10,162,495 |                                            | $
|                                 |                |            |                                            |  
|Gross profit                     | $              | 1,937,053  |                                            | $
|                                 |                |            |                                            |  
|Net income (loss)                | $              | (689,788   | )                                          | $
|                                 |                |            |                                            |  
|Earnings (loss) per common share |                |            |                                            |  
|Basic                            | $              | (0.36      | )                                          | $
|Diluted                          | $              | (0.36      | )                                          | $

|                                 | Quarter Ended, |           | Year Ending 
      December 31,
      2002 |  
|-------------------------------- | -------------- | --------- | ------------------------------------------ | -
|
|
|Net sales                        | $              | 9,738,097 |                                            | $
|                                 |                |           |                                            |  
|Gross profit                     | $              | 2,554,252 |                                            | $
|                                 |                |           |                                            |  
|Net income (loss)                | $              | 370,431   |                                            | $
|                                 |                |           |                                            |  
|Earnings (loss) per common share |                |           |                                            |  
|Basic                            | $              | 0.33      |                                            | $
|Diluted                          | $              | 0.30      |                                            | $

|(1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         | 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.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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-21
|----



|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:
| | ---------------------------------------------------------------------------------------------------------------------------------

| |  | 2004                               |  | 2003      |   | 2002      |   | 2001      |  
| |  | ---------------------------------- |  | --------- | - | --------- | - | --------- | -
| |  |                                    | 
| |  |                                    |  |           |   |           |   |           |  
| |  | Balance at beginning of year       |  | $316,047  |   | $391,406  |   | $375,755  |  
| |  | Charged to expenses                |  | $288,562  |   | $145,000  |   | $120,000  |  
| |  | Uncollectible accounts written off |  | ($200,539 | ) | ($220,359 | ) | ($104,349 | )
| |  |                                    | 
| |  | Balance at end of year             |  | $404,070  |   | $316,047  |   | $391,406  |  
| |  |                                    | 

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

| |  | 2004                           |  | 2003      |   | 2002      |   | 2001     |  
| |  | ------------------------------ |  | --------- | - | --------- | - | -------- | -
| |  |                                | 
| |  |                                |  |           |   |           |   |          |  
| |  | Balance at beginning of year   |  | $492,157  |   | $392,142  |   | $303,100 |  
| |  | Charged to expenses            |  | $60,000   |   | $210,000  |   | $180,000 |  
| |  | Obsolete inventory written off |  | ($365,444 | ) | ($109,985 | ) | ($90,958 | )
| |  |                                | 
| |  | Balance at end of year         |  | $186,713  |   | $492,157  |   | $392,142 |  
| |  |                                | 

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

| |  | 2004                         |  | 2003        |   | 2002        |   | 2001        |  
| |  | ---------------------------- |  | ----------- | - | ----------- | - | ----------- | -
| |  |                              | 
| |  |                              |  |             |   |             |   |             |  
| |  | Cost Basis                   |  |             |   |             |   |             |  
| |  | Balance at beginning of year |  | $27,023,245 |   | $25,881,777 |   | $21,700,060 |  
| |  | Additions                    |  | $305,547    |   | $2,007,104  |   | $4,708,550  |  
| |  | Disposals                    |  | ($1,103,830 | ) | ($865,636   | ) | ($526,833   | )
| |  |                              | 
| |  | Balance at end of year       |  | $26,224,962 |   | $27,023,245 |   | $25,881,777 |  
| |  |                              | 
| |  |                              |  |             |   |             |   |             |  
| |  | Accumulated depreciation     | 
| |  | Balance at beginning of year |  | $14,815,596 |   | $14,166,764 |   | $13,000,561 |  
| |  | Depreciation                 |  | $1,651,322  |   | $1,514,468  |   | $1,498,967  |  
| |  | Disposals                    |  | ($830,467   | ) | ($865,636   | ) | ($332,764   | )
| |  |                              | 
| |  | Balance at end of year       |  | $15,636,451 |   | $14,815,596 |   | $14,166,764 |  
| |  |                              | 
| |  |                              |  |             |   |             |   |             |  
| |  |                              | 
| |  | Property and equipment, net  |  | $10,588,511 |   | $12,207,649 |   | $11,715,013 |  
| |  |                              | 

| | The following is
a summary of costs in excess of fair value of net assets acquired and the
related accumulated amortization for the years ended December 31:
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | 2004                                                |  | 2003       |  | 2002       |  | 2001       | 
| |  | --------------------------------------------------- |  | ---------- |  | ---------- |  | ---------- | 
| |  |                                                     | 
| |  |                                                     |  |            |  |            |  |            | 
| |  | Cost Basis                                          |  |            |  |            |  |            | 
| |  | Balance at beginning and end of year                |  | $1,299,954 |  | $1,299,954 |  | $1,299,954 | 
| |  |                                                     | 
| |  |                                                     |  |            |  |            |  |            | 
| |  | Accumulated amortization                            |  |            |  |            |  |            | 
| |  | Balance at beginning of year                        |  | $186,846   |  | $186,846   |  | $186,846   | 
| |  | Amortization                                        |  | $0         |  | $0         |  | $0         | 
| |  |                                                     | 
| |  | Balance at end of year                              |  | $186,846   |  | $186,846   |  | $186,846   | 
| |  |                                                     | 
| |  |                                                     |  |            |  |            |  |            | 
| |  |                                                     | 
| |  | Cost in excess of fair value of net assets acquired |  | $1,113,108 |  | $1,113,108 |  | $1,113,108 | 
| |  |                                                     | 

|F-22
|----