-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, WJxQr4hGKZATDfzbwneQn+6pbQ9PwpABS/fRhu4QpK0ZBUu/kBDaZNTMJ6qo9/9f 2JKwxDdHRYXFI2WNrN5piQ== 0001169232-04-002255.txt : 20040415 0001169232-04-002255.hdr.sgml : 20040415 20040415172234 ACCESSION NUMBER: 0001169232-04-002255 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 12 CONFORMED PERIOD OF REPORT: 20031231 FILED AS OF DATE: 20040415 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CTI INDUSTRIES CORP CENTRAL INDEX KEY: 0001042187 STANDARD INDUSTRIAL CLASSIFICATION: FABRICATED RUBBER PRODUCTS, NEC [3060] IRS NUMBER: 362848943 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: 1934 Act SEC FILE NUMBER: 000-23115 FILM NUMBER: 04736609 BUSINESS ADDRESS: STREET 1: 22160 N PEPPER RD CITY: BARRINGTON STATE: IL ZIP: 60010 MAIL ADDRESS: STREET 1: 22160 N PEPPER RD CITY: BARRINGTON STATE: IL ZIP: 60010 10-K/A 1 d59262_10k-a.txt FORM 10-K/A SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K/A Amendment No. 1 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31, 2003 Commission File Number 000-23115 CTI INDUSTRIES CORPORATION (Exact name of Registrant as specified in its charter) Illinois 36-2848943 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 22160 North Pepper Road Barrington, Illinois 60010 (Address of principal executive offices) (Zip Code) (847) 382-1000 Registrant's telephone number, including area code Securities registered pursuant to Sections 12(b) and 12(g) of the Act: Name of each exchange Title of Class on which registered: - -------------------------- ---------------------- Common Stock, no par value NASDAQ SmallCap Market 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. |X| Yes |_| No Check if disclosure of delinquent filers pursuant to Item 405 of Regulation S-B 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. The Registrant's revenues for the fiscal year ended December 31, 2003, were $36,259,638 Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2) Yes |_| No |X| Based upon the closing price of $3.00 per share of Registrant's Common Stock as reported on NASDAQ SmallCap Market at March 23, 2004, the aggregate market value of the voting stock held by non-affiliates of the Registrant was then approximately $2,860,335 (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 December 31, 2003 was 1,918,420 (excluding treasury shares). Transitional Small Business Disclosure Format (check one): Yes |_| No |X| PART I Item No. 1 Description of Business Business Overview CTI Industries Corporation is engaged in the development, manufacture, sale and distribution of two principal lines of products within a single segment: o Novelty products, principally balloons, including metalized balloons, latex balloons, punch balls and other inflatable toy items. o Specialty and printed films and flexible containers, for food packaging, specialized consumer uses and various commercial applications. 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 30 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(R), Precious Moments(R) and Hallmark. During 2002, the Company entered into agreements with Hallmark Cards to produce metalized balloons. The Party Express Division of Hallmark distributes these balloons to its customers and the Company also distributes these balloons to its distributors and customers. On an increasing basis over the past five 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 and, during 2003, represented approximately 48% of total Company revenue. 1 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 Ltd. ("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. 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 2 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, and commencing in March, 2003 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 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. 3 In 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) 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 450 balloon designs, in different shapes and sizes, including the following: o Superloons(R) - 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. o Ultraloons(R) - 34" balloons made to be filled with helium and remain buoyant. o Miniloons(R)- 9" balloons made to be air-filled and sold on holder-sticks or for use in decorations. o Card-B-Loons(R)(4 1/2") - air-filled balloons, often sold on a stick, used in floral arrangements or with a container of candy. o Shape-A-Loons(R) - shaped balloons made to be filled with helium. o Minishapes - small shaped balloons designed to be air filled and sold on sticks as toys or inflated characters. o Walk-abouts(R) - helium filled shaped balloons with attached arms and legs. 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, under an arrangement with Hallmark Cards Incorporated ("Hallmark"), manufactures and distributes balloons bearing a number of additional licensed characters. Some of these characters include Garfield(R), Precious Moments(R), Party Express(R), Kinka(R), Head First(R), Scooby Doo(R), Barbie(R), Batman(R), Spirit(R), Nascar(R), Hotwheels(R), Major League Baseball(R), Justice League(R), Star Wars(R), Butt Ugly Martians(R), Madeline(R), Mucha Lucha(R), Boohbah(R), Shrek(R) and several others. See "Patents, Trademarks and Copyrights" below. Latex Balloons. The Company sells a high end line of latex balloons under the product line name Hi-Tex(R) and a standard line of latex balloons marketed under the name Partyloons(R). The Company also manufactures toy balloon products including punch balls and water bombs and "Animal Twisties." 4 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 and drug store chains, card and gift shops, party goods stores as well as florists and balloon decorators. These outlets now represent the principal means for the sale of metalized balloons throughout the United States and in a number of other countries. Metalized balloons are sold in the United States and in Europe, several countries in the Far East, Canada and to an increasing extent in Latin America. The United States, however, is by far the largest market for these products. Metalized balloons are sold in the United States and foreign countries directly by producers to retail outlets and through distributors and wholesalers. Often the sale of metalized balloons by the wholesalers/distributors is accompanied by related products including latex balloons, floral supplies, candy containers, mugs, plush toys, baskets and a variety of party goods. 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. 5 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 9 individuals and a customer service department of 6 individuals. European sales are conducted by CTI Balloons, the Company's subsidiary located in Rugby, England. CTI Mexico and Flexo Universal conduct 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 products principally through a network of approximately 600 distributors and wholesalers situated throughout the United States and in several foreign countries. These distributors and wholesalers are engaged principally in the sale of balloons and related products (including such items as plush toys, mugs, containers, floral supplies and other items). These distributors and wholesalers, in turn, 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. Most sales are on an individual order basis. The Company also sells balloons and related products to certain retail outlets including some chain stores. The Company's largest chain store customer is Eckerd Drug Stores. 6 In March, 2002, the Company entered into an arrangement with Hallmark, under which the Company agreed to produce metalized balloons for the Party Express Division of Hallmark incorporating designs provided by Party Express as well as licensed character designs under licenses held by Hallmark. Under the arrangement, the Company is also entitled to market and sell balloons incorporating these designs to its other customers. During 2003, sales to Hallmark were $4,007,000 or 11% of the Company's total sales revenue. The Company engages in a variety of advertising and promotional activities to promote the sale of its balloon products. Each year, 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 2003 fiscal year, the Company sold such products to four principal, and a number of smaller customers. The Company's largest customer in 2003 was ITW Spacebag whose purchases from the Company of consumer storage products totaled $10,298,000 for the year, about 28% of total Company sales. The Company has an agreement with ITW Spacebag under which ITW Spacebag is obligated through July 15, 2005 to purchase all of its requirements for film for use in consumer storage bags. ITW Spacebag has no contractual commitment to the Company for the purchase of finished storage bags. Rapak L.L.C., purchased approximately $5,360,000 in laminated films from the Company in 2003; these sales represented 14.7% of total Company revenues. The Company has an agreement with Rapak under which Rapak is obligated for a term expiring on October 31, 2005, to purchase 65% of its requirements for a certain type of film for packaging applications. 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 60 million 18" balloons annually. 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. 7 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 receives and fulfills over 86,000 orders annually. The Company maintains a finished goods inventory of all balloon products at the Barrington facility and provides fulfillment for orders throughout the United States and in 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 three 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, 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. A fourth balloon production machine is being assembled and a fifth machine has been purchased. 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 (iii) 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. 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 8 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 at least 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 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. Under its agreements with Hallmark, the Company is authorized to produce for Hallmark, and to sell as a distributor for Hallmark, a number of licensed characters. 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 and (iii) patents and applications related to the design and structure of, and method of inserting and affixing, zipper-closure systems in a bag. 9 Research and Development The Company maintains a product development and research department of 8 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 the fiscal years ended December 31, 2002, and December 31, 2003, the Company estimates that the total amount spent on research and development activities was approximately $333,000 and $335,000, respectively. Employees As of December 31, 2003, the Company had 165 full-time employees in the United States, of whom 14 are executive or supervisory, 8 are in sales, 112 are in manufacturing and 31 are clerical. As of that same date, the Company had 10 full-time employees in England, of whom 2 are executive or supervisory, 1 is in sales, 4 are in warehousing and 3 are clerical. In Mexico, as of December 31, 2003, 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. 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 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 conduct the sale of metalized and latex balloons in Mexico and other markets in Latin America. Our operations in the United Kingdom conduct 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 18 of the Consolidated Financial Statements contained in Part IV hereof for financial information on revenues and assets in our domestic and international operations. 10 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 $2,912,000, having a term of 5 years, with payments amortized over 30 years and bearing interest at the rate of 6.25% per year. In August, 1998, the Company purchased a building that is adjacent to its principal plant and offices. This facility includes approximately 29,000 square feet of combined office and warehouse space. In November, 1999, the Company sold this building to a related party, and entered into a 10 year lease for the building at a monthly rental cost of $17,404. In May, 2003, the monthly rental cost of this building decreased to $15,500 per month. 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 2013. This facility is utilized for product packaging operations and to manage and service the Company's operations in England and Europe. During 2003, CTI Mexico maintained under lease in Guadalajara, Mexico four buildings having approximately 95,000 square feet, in total, of production, warehouse and office space. One plant, consisting of three buildings, was occupied at a monthly lease rate of $5,500, and the other plant, consisting of one building was occupied under a three-year lease at a monthly lease rate of $4,500. The leases on these buildings have been terminated and CTI Mexico has vacated these locations. In January, 2003, Flexo Universal entered into a 5 year lease agreement for the lease of approximately 43,000 square feet of manufacturing, warehouse and office space in Guadalajara, Mexico at the cost of $17,000 per month. We believe that our properties have been adequately maintained, are in generally good condition and are suitable for our business as presently conducted. We believe our existing facilities provide sufficient production capacity for our present needs and for our presently anticipated needs in the foreseeable future. We also believe that, with respect to leased properties, upon the 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. 11 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 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. The Company intends to vigorously defend this action and to pursue its counterclaim. 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. Item No. 4 Submission of Matters to a Vote of Security Holders Not Applicable. PART II Item No. 5 Market for Registrant's Common Equity and Related Stockholder Matters 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. 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, 2002 to March 31, 2002 ................ 1.55 1.30 April 1, 2002 to June 30, 2002 ................... 6.26 1.52 July 1, 2002 to September 30, 2002 ............... 4.47 2.05 October 1, 2002 to December 31, 2002 ............. 6.90 2.23 January 1, 2003 to March 31, 2003 ................ 6.22 4.75 April 1, 2003 to June 30, 2003 ................... 5.04 1.76 July 1, 2003 to September 30, 2003 ............... 2.45 1.70 October 1, 2003 to December 31, 2003 ............. 2.49 1.79 As of March 23, 2004, there were approximately 45 holders of record of the Company's Common Stock. It is estimated that there are in excess of 300 beneficial owners of the Company's Common Stock. 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 12 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 In June, 1999, the Company issued a note to John C. Davis, a former director and officer for $150,000 with a maturity of February 28, 2001, replacing an existing note in that amount. Mr. Davis' June, 1997, warrant to purchase up to 19,078 shares of the Company's common Stock at an exercise price of $7.86 per share was cancelled in September, 1999, and a new warrant to purchase up to 19,078 shares of the Company's Common Stock at an exercise price of $1.418 per share, with an expiration date of June 30, 2003, was issued in its place. Mr. Davis' June, 1999, Note was paid in full by the Company in February, 2001. Mr. Davis' September, 1999 warrant expired unexercised on June 30, 2003. In June, 1999, notes of the Company to Howard W. Schwan, John Schwan, and Stephen Merrick in the amounts of respectively, $50,000, $350,000 and $315,000, came due. On November 9, 1999, new notes in the same principal amounts were issued to Messrs. H. Schwan, J. Schwan and Merrick, in payment and replacement of the prior notes with maturity dates for each of November 9, 2001. In November, 1999, the June, 1997 warrants of Messrs. H. Schwan, J. Schwan and Merrick to purchase up to (respectively) 6,359, 44,515 and 40,063 shares of the Company's Common Stock at an exercise price of $7.86 per share were cancelled. At that time, new warrants to purchase up to 35,263, 246,840 and 222,157 shares of the Company's Common Stock at an exercise price of $1.418 per share were issued to Messrs. H. Schwan, J. Schwan and Merrick, respectively. Each of these warrants were exercised on June 3, 2002. The respective $50,000, $350,000 and $315,000 notes were cancelled and used as payment for the warrant shares. In July, 2001, the Company issued warrants to purchase up to 79,364 shares of the Company's Common Stock to John H Schwan and 39,683 shares of the Company's Common Stock to Stephen M. Merrick. The warrants were issued in consideration of Mr. Schwan and Mr. Merrick each personally guaranteeing and securing loans to the Company in the amount of approximately $1,600,000. The warrants are exercisable for a period of five years at a price of $1.50 per share. 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. 13 Item No. 6 Selected Financial Data The following selected financial data are derived from the consolidated financial statements of the Company. The data should be read in conjunction with the consolidated financial statements, related notes, and other financial information included herein.
Year (In thousands, except per share data) Ended Year ended December 31, October 31, -------------------------------------------------------------------- 2003 2002 2001 2000 1999(1) Statement of Income Data: Net Sales $ 36,260 $ 41,236 $ 27,446 $ 22,978 $ 18,717 Costs of Sales $ 29,627 $ 32,344 $ 19,835 $ 16,375 $ 13,781 ------------------------------------------------------------------ Gross Profit $ 6,633 $ 8,892 $ 7,611 $ 6,603 $ 4,936 SG &A $ 7,312 $ 7,447 $ 6,595 $ 6,390 $ 6,302 ------------------------------------------------------------------ (Loss) Income from Operations $ (679) $ 1,445 $ 1,016 $ 213 $ (1,366) Interest expense $ 1,103 $ 832 $ 1,030 $ 1,281 $ 942 Other (income) expense $ (433) $ 278 $ 29 $ (146) ------------------------------------------------------------------ Income (loss) before taxes and minority interest $ (1,349) $ 335 $ (14) $ (1,039) $ (2,162) Income tax expense (benefit) $ (782) $ 39 $ 276 $ 107 $ 380 Minority interest $ 0 $ 6 $ 58 $ (87) $ -- ------------------------------------------------------------------ Net Income (loss) $ (566) $ 302 $ (232) $ (1,059) $ (1,782) Earnings (loss) per common share(1) Basic $ (0.30) $ 0.18 $ (0.15) $ (0.88) $ (1.40) Diluted $ (0.30) $ 0.16 $ (0.15) $ (0.88) $ (1.40) Earnings(loss) from operations per Common Share (1) Basic $ (0.35) $ 0.86 $ 0.67 $ 0.18 $ (1.08) Diluted $ (0.35) $ 0.77 $ 0.67 $ 0.18 $ (1.08) Other Financial Data: Gross margin percentage 18.29% 21.56% 27.73% 28.74% 26.37% Capital Expenses $ 1,141 $ 2,478 $ 1,002 $ 637 $ 2,053 Depreciation & Amortization $ 1,619 $ 1,588 $ 1,666 $ 1,933 $ 1,382 Balance Sheet Data: Working capital $ (706) $ (2,907) $ (278) $ (3,862) $ (1,217) Total assets $ 30,270 $ 30,272 $ 24,664 $ 22,219 $ 24,108 Short-term obligations(3) $ 6,692 $ 7,385 $ 7,074 $ 7,787 $ 5,176 Long-term obligations $ 9,220 $ 5,726 $ 5,737 $ 2,701 $ 5,374 ------------------------------------------------------------------ Total obligations $ 15,912 $ 13,111 $ 12,811 $ 10,488 $ 10,550 Stockholders' Equity $ 5,212 $ 5,474 $ 4,325 $ 5,338 $ 5,029
- ---------- (1) Two months ended December 31, 1999 have been omitted. (3) Short-term obligations consist primarily of borrowings under bank lines of credit and the current portion of long-term debt 14 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. In 2003, our revenues as a percentage of total consolidated sales from each of our principal product categories was as follows: Commercial Films And Containers 48% Metalized Balloons 34% Latex Balloons 11% Over the past several years, revenues from commercial films and containers have increased significantly as a percentage of sales. As a percentage of total sales, revenues in this category have increased from a level of 17% of revenues in 1998 to approximately 48% of total company revenues during the past two years. The increase in sales in this product category have accounted for most of the increase in consolidated sales over the past five years. Purchases by a limited number of customers represent a significant portion of total Company revenues. In 2003, sales to our top 10 customers represented 68% of total revenues. Of those principal customers, one is a customer for storage containers and represented 28% of total 2003 revenues, one is a customer for packaging film and represented 14.7% of total 2003 revenues and one is a customer for metalized balloons and represented 11% of total 2003 revenues. For the most part, with our principal customers, we do not have long-term purchase agreements or 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. 15 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 18.3% in 2003. Most of this decline in gross margins relates to metalized balloons. Margins in that product category have declined from 27% in 2001 to 10.4% in 2003. 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 2003, of raw materials. We have experienced significant increases in factory overhead costs over the past three years, including insurance costs, health insurance costs, supervisory wages, quality control wages and depreciation. Our business plan includes: o Continued focus on our existing product categories, including efforts to generate additional revenues in these categories. o Efforts to control and reduce manufacturing costs, particularly factory overhead and direct labor costs. o Efforts to develop new products, product improvements and technologies in our existing product categories. o Development of new sales and marketing channels and relationships. We have engaged in ongoing efforts during 2003 to achieve reduction in factory overhead. In the fourth quarter of 2003, our factory overhead in the U.S. was 17% 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 2004. Results of Operations 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. 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. 16 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. Year Ended December 31, 2002 Compared to Year Ended December 31, 2001 For the fiscal year ended December 31, 2002, consolidated revenues from the sale of all products were $41,236,000, compared to consolidated revenues of $27,446,000 for the year ended December 31, 2001, an increase of 50%. This increase in revenues was the result principally of (i) a 72% increase in sales of printed and laminated films from 11,438,000 in 2001 to 19,621,000 in 2002 and (ii) a 61% increase in sales of metalized balloons from $10,155,000 in 17 2001 to $16,392,000 in 2002. These sales revenues increases are attributable principally to increases in sales to three principal customers. Sales in 2002 to these three customers were as follows: (i) $12,086,000, or 29% of total revenues to a customer for consumer storage bags, (ii) $7,000,000 representing 17% of total sales to a customer for packaging films and (iii) $5,111,000, representing 12.4% of total sales, to a customer for metalized balloons. For the fiscal year 2002, on a consolidated basis, metalized balloons represented 40% of sales, laminated and printed films 48% of sales and latex balloons 12% of sales. During fiscal 2001, metalized balloons represented 37% of sales, laminated and printed films 44% of sales and latex balloons 19% of sales. Cost of Sales. For fiscal 2002, cost of sales increased to 78.4% of net sales compared to 72.3% of net sales for fiscal 2001. In fiscal 2002, profit margins on metalized balloons, latex balloons and laminated and printed film were 24.3%, 17.5% and 27.5%, respectively, compared to margins on the same product lines for 2001 of 27.1%, 14.1% and 33%. The reduction in margins with respect to metalized balloons in 2002 is attributable principally to sales of balloons to one significant customer at prices and margins lower than other customers. Also, the Company experienced higher than normal production costs during the second half of 2002 arising from the installation of new equipment and the need to respond to large volume requirements. With respect to laminated and printed films, the reduction in margins during 2002 is attributable principally to (i) greater allocation of production overhead costs to this product line, (ii) an increase in resin costs and (iii) increased costs associated with the installation and operation of new equipment. General and Administrative. For fiscal 2002, administrative expenses were $4,225,000, or 10.2% of net sales, as compared to $3,702,000 or 13.5% of net sales for fiscal 2001. The increase in administrative expenses is attributable to increases in personnel and compensation, insurance premiums, litigation settlement costs, audit expenses, consulting fees and travel expenses. Additionally, in June, 2002, the Company entered into a settlement agreement of pending litigation, incurring an expense of $105,000. Selling. For fiscal 2002, selling expenses were $1,551,000 or 3.8% of net sales compared to $1,760,000, or 6.4% of net sales for fiscal 2001. The decline in selling expense resulted from reductions in several expense items including royalty payments and commissions. Marketing and Adverstising. For fiscal 2002, advertising and marketing expenses were $1,671,000 or 4.1% of net sales, compared to $1,133,000 or 4.1% of sales for fiscal 2001. The increase is attributable principally to the expense of additional personnel and compensation expenses. Other Expense. For fiscal 2002, interest expense and loan fees totaled $832,000. For fiscal 2001, interest expense was $1,126,000. The reduction in interest expense is attributable principally to lower applicable interest rates. The Company had currency exchange losses during 2002 of $281,000 compared to currency gains during fiscal 2001 of $89,000. 18 Net Income or Loss. For the fiscal year ended December 31, 2002, the Company had income before taxes and minority interest of $335,000 compared to a loss before taxes and minority interest for fiscal 2001 of $14,000. The net income for fiscal 2002 was $303,000 compared to a net loss for fiscal 2001 of $232,000. Income Taxes. For the fiscal year ended December 31, 2002, the Company had income tax expense of $39,000 compared to an income tax expense of $277,000 for fiscal 2001. The amount of the income tax expense recognized by the Company for both 2002 and 2001 reflects adjustments in deferred tax assets and other items arising from the operating results of the Company for each year. Contracts with foreign suppliers are stated in U.S. dollars and the Company is not subject to currency rate fluctuations on these transactions. The effect of currency rate fluctuations on intercompany transactions with the Company's England subsidiary and Mexico subsidiary has not been material. As a result, the Company has not hedged against currency rate fluctuations. Financial Condition Year Ended December 31, 2003 Compared to Year Ended December 31, 2002 Cash Flow From Operations. Cash flow provided by operations for the fiscal year ended December 31, 2003 was $2,343,000. Cash flow from operations resulted principally from increases in accounts payable of $264,000 and in depreciation and amortization of $1,619,000, and a reduction in, or disposition of, receivables, and inventory and other assets totaling $1,113,000 offset by an increase in the deferred income tax benefit of $782,000. Cash flow generated by operations for the fiscal year ended December 31, 2002, was $3,051,000. Cash Used in Investing Activities. During fiscal 2003, the Company invested $1,141,000 in machinery and equipment. During fiscal 2002, the Company invested $2,478,000 in machinery and equipment. Cash From Financing Activities. Cash used in financing activities during fiscal 2003 was $804,000. The net cash use of funds in financing activities during 2003 reflects (i) sources of cash including proceeds from a new term loan, an amended mortgage loan, subordinated loan advances and officer loans and (ii) uses of cash including payments on the term loans and mortgage loan and on vendor notes. During fiscal 2002, cash flow used in financing activities was $513,000. 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 equipment, inventory, 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, which is based upon the appraised value of the 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 receivables and up to 50% of the value of the Company's inventory. The term loan and revolving line of credit are secured by substantially all assets of the Company. In 19 connection with the Loan Agreement, two principals of the Company have executed agreements pursuant to which they have agreed, in the event appraisals of the Company's machinery and equipment to be performed during 2004 indicates 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. 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 (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. With respect to the EBITDA to fixed charges and tangible net worth covenants, the bank has issued a waiver of violations of the covenants as of December 31, 2003. For periods after December 31, 2003 the bank has agreed to modify the covenants, both the tangible net worth and ratio of EBITDA of fixed charges, to reduced levels with a measurement date commencing January 1, 2004. 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 in to 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 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 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 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 20 $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. Current assets. As of December 31, 2003, the total current assets of the Company were $15,435,000 compared to total current assets of $16,138,000 as of December 31, 2002. The change in current assets reflects, principally, a decrease in inventory of $770,000 and decrease in receivables of $765,000, partially offset by an increase in prepaid expenses and other current assets of $549,000. Inventory. The net inventory of the Company decreased from $10,034,000 as of December 31, 2002 to 9,263,000 as of December 31, 2003. The decrease reflected principally a reduction in latex balloon inventory. Property, Plant and Equipment. During fiscal 2003, the Company invested $1,141,000 in capital items. Most of this investment was in production equipment. During 2002, the Company invested $2,478,000 in capital items. Current liabilities. Total current liabilities decreased from $19,045,000 as of December 31, 2002 to $16,140,000 as of December 31, 2003. This decrease is attributable principally to a decrease in accounts payable from $9,581,000 as of December 31, 2002 to $6,799,000 as of December 31, 2003, which occurred principally by reason of the conversion of $3,534,000 of vendor obligations to term debt. Also, the amount outstanding on the line of credit was reduced from $5,643,000 on December 31, 2002 to $3,694,000 on December 31, 2003. Year Ended December 31, 2002 Compared to Year Ended December 31, 2001 Cash Flow From Operations. Cash flow provided by operations for the fiscal year ended December 31, 2002 was $3,039,000. In addition to earnings, the funds provided resulted principally from increases in accounts payable of $3,910,000 and in depreciation and amortization of $1,588,000, offset by increases in accounts receivable of $1,075,000 and in inventory of $1,965,000. Cash flow generated by operations for the fiscal year ended December 31, 2001, was $624,000. Cash Used in Investing Activities. During fiscal 2002, the Company invested $2,478,000 in machinery and equipment. During fiscal 2001, the Company invested $1,002,000 in machinery and equipment. Cash From Financing Activities. Cash used in financing activities during fiscal 2002 was $513,000. The cash used in financing activities was principally to pay down the credit facility. During fiscal 2001, cash flow provided by financing activities was $102,000. 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 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 21 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 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 in January, 2004. Also 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 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 was in the principal amount of $173,000, bears interest at 10% per annum, and has a term of three years. Current assets. As of December 31, 2002, the total current assets of the Company were $16,138,000 compared to total current assets of $14,143,000 as of December 31, 2001. The increase in current assets is attributable principally to increases during 2002 in accounts receivable and inventory. Inventory. The net inventory of the Company increased from $8,458,000 as of December 31, 2001 to $10,034,000 as of December 31, 2002. This increase was the result principally of (i) higher levels of production arising from increasing sales during 2001, (ii) a seasonal increase in balloon inventory for anticipated levels of sales in the first quarter of 2002 and (iii) production of balloons to order for a customer in the fourth quarter of 2002 for delivery in the first quarter of 2003. Property, Plant and Equipment. During fiscal 2002, the Company invested $4,709,000 in capital items, of which $2,016,000 was additional capital projects in process substantially all of which will be recorded as capital investment in plant and equipment during 2003. Most of this investment was in production equipment. During 2001, the Company invested $1,002,000 in capital items. Current liabilities. Total current liabilities increased from $14,421,000 as of December 31, 2001 to $19,045,000 as of December 31, 2002. This increase is attributable principally to an increase in accounts payable from $5,492,000 as of December 31, 2001 to $9,585,000 as of December 31, 2002. Liquidity and Financial Resources At December 31, 2003 the Company had negative working capital of $706,000 compared to negative working capital as of December 31, 2002 of $2,907,000. This improvement in working capital occurred principally as the result of the reduction in current liabilities on December 31, 2002 of $19,045,000 to $16,140,000 on December 31, 2003. This reduction occurred because (i) during 2003, approximately $3,534,000 in payables to vendors was converted to term obligations and (ii) in connection with the new senior loan completed on December 30, 2003, the entire balance due to the prior senior lender, all of which was designated 22 as short-term, was paid, consisting of $2,540,000 in term loans and $4,223,000 in revolving loan balances. The Company has maintained relatively small cash balances and reserves and relies on its credit facility for liquidity. Under the credit facility, the Company is able to borrow up to 85% of its eligible receivables and up to 50% of its eligible inventory, and utilizes the proceeds of these borrowings for its cash requirements. On December 31, 2003, the Company had available to it under the revolving loan total availability of $1,648,000. If the Company's sales were to decline significantly in any period, the Company's ability to borrow under this line would be reduced and its ability to meet its current obligations would be adversely affected. Based upon the current level of operations, we anticipate that our operating cash flow, together with available borrowings under our revolving loan, will be adequate to meet our anticipated future requirements for working capital and operating expenses for at least the next 12 months. However, the Company's ability to make scheduled payments of principal of, or to pay interest on, its current indebtedness and to satisfy its other obligations will depend upon its future performance, which, to a certain extent, will be subject to general economic, financial, competitive, business and other factors beyond the control of the Company. The contractual commitments of the Company over the next five years are as follows: Future Minimum Operating Year Principal Payments Leases Licenses Total - ------------------- ------------------ ---------- ---------- ---------- 2004 $2,998,496 $ 542,532 $ 86,664 $3,627,692 2005 $2,948,195 $ 532,905 $ 76,664 $3,557,764 2006 $ 756,065 $ 504,771 -- $1,260,836 2007 $ 759,723 $ 472,728 -- $1,232,451 2008 and thereafter $3,366,234 $ 620,400 $ -- $3,986,634 The Company does not have any current material commitments for capital expenditures. Seasonality In the metalized product line, sales have historically been seasonal with approximately 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. 23 Revenue Recognition. Substantially all of the Company's revenues are derived from the sale of products. With respect to the sale of products, revenue from a transaction is recognized when (i) a definitive arrangement exists for the sale of the product, (ii) delivery of the product has occurred, (iii) the price to the buyer has been fixed or is determinable and (iv) collectibility is reasonably assured. The Company generally recognizes revenue for the sale of products when the products have been shipped and invoiced. In some cases, product is provided on consignment to customers. In those cases, revenue is recognized when the customer reports a sale of the product. Allowance for Doubtful Accounts. We estimate our allowance for doubtful accounts based on an analysis of specific accounts, an analysis of historical trends, payment and write-off histories. Our credit risks are continually reviewed and management believes that adequate provisions have been made for doubtful accounts. However, unexpected changes in the financial condition of customers or changes in the state of the economy could result in write-offs which exceed estimates and negatively impact our financial results. Inventory Valuation. Inventories are stated at the lower of cost or market. Cost is determined using standard costs which approximate costing determined on a first-in, first out basis. Standard costs are reviewed and adjusted 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. As of December 31, 2003, the Company had established a reserve for obsolescence, marketability or excess quantities with respect to inventory in the aggregate amount of $492,000. As of December 31, 2002, the amount of the reserve was $354,000. In addition, on a periodic basis, the Company disposes of inventory deemed to be obsolescent or unsaleable and, at such time, records an expense for the value of such inventory. Valuation of Long-Lived Assets. We evaluate whether events or circumstances have occurred which indicate that the carrying amounts of long-lived assets (principally property and equipment and goodwill) may be impaired or not recoverable. Significant factors which may trigger an impairment review include: changes in business strategy, market conditions, the manner of use of an asset, underperformance relative to historical or expected future operating results, and negative industry or economic trends. In 2001, the FASB issued Statement No. 142, "Goodwill and Other Intangible Assets," which among other things, eliminates the amortization of goodwill and certain other intangible assets and requires that goodwill be evaluated annually for impairment by applying a fair-value based test. We retained valuation consulting firms to conduct an evaluation of our goodwill in our Mexico subsidiary in June, 2002, December, 2002 and December, 2003. In the opinion of these firms 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. Income taxes are accounted for as prescribed in SFAS No. 109-Accounting for Income Taxes. Under the asset and liability method of Statement 109, the Company recognizes the amount of income taxes currently payable and deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences 24 between the financial statement carrying amounts of existing assets and liabilities, and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years these temporary differences are expected to be recovered or settled. As of December 31, 2003, the Company had a net deferred tax asset of $1,341,000, representing the amount the Company may recover in future years from future taxable income. As of December 31, 2002, the amount of the deferred tax asset was $689,000. 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, 2003, management has determined that an appropriate allowance against the deferred tax asset, for the possibility that such amount will not be recovered, is $739,000. As of December 31, 2002, 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. 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 2003 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 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 25 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, 2003, 2002 and 2001, our interest rate expense would have increased, and income before income taxes would have decreased by $39,033, $48,745 and $47,326, 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 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. 26 We have performed a sensitivity analysis as of December 31, 2003 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 2003, 2002 and 2001 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, $173,034, $175,973 and $176,509. 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 July 22, 2003, CTI Industries Corporation (the "Registrant") engaged Eisner, LLP as the Registrant's principal accountants to audit the Registrant's financial statements for the year ending December 31, 2003. Eisner, LLP replaced McGladrey & Pullen, LLP, which had previously been engaged for the same purpose, and whose dismissal was effective July 22, 2003. The decision to change the Registrant's principal accountants was approved by the Registrant's Board of Directors on July 22, 2003. The reports of McGladrey & Pullen, LLP, on the Registrant'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. Effective July 24, 2002, the Company engaged McGladrey & Pullen, LLP as the Registrant's principal accountants to audit the Company's financial statements for the year ending December 31, 2002. McGladrey & Pullen, LLP replaced Grant Thornton, LLP, which had previously been engaged for the same purpose, and whose dismissal was effective July 24, 2002. The decision to change the Company's principal accountants was approved by the Company's Audit Committee and Board of Directors on July 24, 2002. During the Company's fiscal year ended December 31, 2002 and in the subsequent interim period through March 31, 2003, there were no disagreements with McGladrey & Pullen, LLP 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 would have caused it to make reference to the subject matter of the disagreements in connection with its reports on the financial statements for such periods. McGladrey & Pullen, LLP has not informed the Company of any reportable events during the Company's fiscal year ended December 31, 2002 or in the subsequent interim period ending March 31, 2003. The reports of Grant Thornton LLP, on the Company's financial statements for the prior two fiscal years ended December 31, 2000, and December 31, 2001 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 fiscal years ended December 31, 2000, and December 31, 2001, and in the subsequent interim periods through July 24, 2002, there were no disagreements with Grant Thornton, LLP 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 Grant Thornton, LLP, would have caused it to make reference to the subject matter of the disagreements in connection with its reports on the financial statements for such periods. 27 Grant Thornton, LLP has not informed the Company of any reportable events during the Company's two fiscal years ended December 31, 2000 and 2001 and in subsequent interim periods through July 24, 2002. 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 a date within ninety days before the filing date 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. PART III Item No. 10 Directors and Executive Officers of the Registrant Directors and Executive Officers The Company's current directors and executive officers and their ages, as of March 15, 2004, are as follows: Name Age Position With The Company - ------------------ --- ------------------------------------------------ John H. Schwan 59 Chairman and Director Howard W. Schwan 49 President and Director Stephen M. Merrick 62 Executive Vice President, Secretary and Director Mark Van Dyke 54 Senior Vice President Brent Anderson 37 Vice President of Manufacturing Samuel Komar 47 Vice President Stanley M. Brown 57 Director Bret Tayne 45 Director Michael Avramovich 52 Director Timothy Patterson 43 Vice President-Finance and Administration All directors hold office until the annual meeting next following their election and/or until their successors are elected and qualified. Officers are elected annually by the Board of 28 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 & Klimek, 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, 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. 29 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 6 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 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 five meetings during fiscal year 2003, 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 Company's Board of Directors has adopted a written charter for the Company's Audit Committee, a true and correct copy of which has been included in the exhibits to this report. 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 30 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 included in the Annual Report on Form 10-K for the year ended December 31, 2003 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 2004 annual meeting of shareholders, the selection of Eisner, LLP as the Company's independent auditors. Bret Tayne,, Audit Committee Chair Stanley M. Brown, III, Audit Committee Member Michael Avramovich, 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 2003, all Section 16(a) filing requirements applicable to the officers, directors and ten-percent 31 beneficial shareholders were complied with, except that Brent Anderson was late in filing one Form 4 for an aggregate of 8,750 shares. 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 (i) 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. A copy of the Company's Code of Ethics has been included in the Exhibits to this report. Item No. 11 Executive Compensation The following table sets forth certain information with respect to the compensation paid or accrued by the Company to its President, Chief Executive Officer and any other officer who received compensation in excess of $100,000 ("Named Executive Officers"). Summary Compensation Table
Annual Compensation Long Term Compensation ------------------- ---------------------- All Other Name and Principal Salary Other Annual Underlying Compensation Position Year $ Compensation Options ($) - -------------------------------------------------------------------------------------------------- Howard W. Schwan 2003 $162,500 $ 5,520 -- -- President 2002 $162,500 $ 8,100 14,285(1) $1,925(5) 2001 $150,000 $ 5,000 -- $1,765(5) Mark Van Dyke 2003 $125,000 -- -- -- Senior Vice President 2002 $123,100 -- -- -- 2001 $ 45,900 -- 23,809(2) -- Brent Anderson 2003 $ 95,000 -- -- -- Vice President of 2002 $ 95,000 -- 8,928(3) -- Manufacturing 2001 $ 86,700 -- 17,857(3) -- Samuel Komar 2003 $104,200 -- -- -- Vice President of Sales 2002 $104,200 -- -- -- 2001 $ 94,450 -- 11,904(4) --
- ---------- (footnotes continued on next page) 32 (1) Stock options to purchase up to 14,285 shares of the Company's Common Stock at $2.31 per share, and stock options to purchase up to 23,809 shares of the Company's Common Stock at $1.89 per share. (2) Stock options to purchase up to 23,809 shares of the Company's Common Stock at $1.47 per share. (3) Stock options to purchase up to 8,928 shares of the Company's Common Stock at $2.31 per share, and stock options to purchase up to 17,857 shares of the Company's Common Stock at $1.47 per share. (4) Stock options to purchase up to 11,904 shares of the Company's Common Stock at $1.47 per share. (5) Company contribution to the Company's 401(k) Plan as a pre-tax salary deferral. Certain Named Executive Officers have received warrants to purchase Common Stock of the Company in connection with their guarantee of certain bank loans secured by the Company and in connection with their participation in a private offering of notes and warrants conducted by the Company. See "Board of Director Affiliations and Related Transactions" below. The following stock option grants were made to certain of the Company's executive officers in the fiscal year ending December 31, 2003: Option Grants in Last Fiscal Year Individual Grants - -------------------------------------------------------------------------------- Number of Securities % of Total Underlying Options Granted Options to Employees in Exercise Price Expiration Name Granted Fiscal Year ($/share) Date - ----------------- ---------- --------------- -------------- ---------- Timothy Patterson 5,000 71.4% $2.26 2/3/2013 Aggregated Option Exercises in Last Fiscal Year and FY-End Option Values
Value of Unexercised In- the- Shares Value Number of Securities Underlying Money Options at Fiscal Year Acquired on Realized Unexercised Options at Year End End ($) Name Exercise (#) ($) (#) Exercisable/Unexercisable Exercisable/Unexercisable - ------------------ ------------ -------- ------------------------------- ----------------------------- John H. Schwan 0 0 29,762/0 $4,286/0(1) Howard W. Schwan 0 0 53,968/0 $8,810/0 (1) Stephen M. Merrick 0 0 29,762/0 $4,286/0(1) Mark Van Dyke 0 0 23,809/0 $18,809/0(1) Brent Anderson 0 0 31,546/0 $14,107/0(1) Samuel Komar 0 0 24,641/0 $12,355/0 (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, 2003. 33 Compensation Committee During 2003, the Compensation Committee was composed of John H. Schwan, Stanley M. Brown and Bret 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 2003. Compensation Committee Report on Executive Compensation The Compensation Committee of the Board of Directors of the Company is composed of three 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. 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. 34 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 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 2001, 2002 or 2003. 35 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 2001, 2002 and 2003, upon the recommendation of the Compensation Committee, the base salary of Mr. Schwan was $150,000, $162,500 and $162,500 respectively. In 2001, 2002 and 2003, annual incentive compensation was paid to Mr. Schwan in the amounts of $5,000, $8,100 and $5,520, respectively. The Compensation Committee recommended that Mr. Schwan (and other senior executives of the Company), receive incentive stock options, consistent with observed market practices, so that a significant portion of his total compensation will be based upon, and consistent with, returns to shareholders. In 2002, Mr. Schwan was granted incentive stock options to purchase up to 14,285 shares of the Company's Common Stock. Compensation Committee: John H. Schwan, Bret Tayne, Stanley M. Brown, III Compensation Committee Interlocks and Insider Participation John H. Schwan, a member of the Compensation Committee, is Chairman of the Company. Mr. Schwan is President of Packaging Systems, L.L.C. and affiliated companies. The Company made purchases of packaging materials from the entities in the amount of $118,011 and $273,910 during each of the years ended December 31, 2002 and December 31, 2003, respectively. John Schwan and Howard W. Schwan are brothers. Comparative Stock Price Performance Graph The following graph compares, for the period January 1, 1999 to December 31, 2003, 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 graph assumes an investment of $100 on January 1, 1999, in the Company's Common Stock and each of the other investment categories. 36 Total Return To Shareholders (Includes reinvestment of dividends) ANNUAL RETURN PERCENTAGE
Years Ending Company / Index Oct99 Oct00 Dec00 Dec01 Dec02 Dec03 CTI INDUSTRIES CORP -74.39 -4.76 -46.67 75.00 325.85 -63.90 NASDAQ U.S. INDEX 68.75 13.06 -27.05 -20.63 -30.86 49.51 S&P 500 SPECIALTY STORES -16.29 -4.69 -13.37 61.41 -11.11 34.66
INDEXED RETURNS
Base Years Ending Period Company / Index Oct98 Oct99 Oct00 Dec00 Dec01 Dec02 Dec03 CTI INDUSTRIES CORP 100 25.61 24.39 13.01 22.76 96.94 35.00 NASDAQ U.S. INDEX 100 168.75 190.80 139.19 110.48 76.38 114.20 S&P 500 SPECIALTY STORES 100 83.71 79.78 69.12 111.56 99.16 133.53
Employment Agreements In June, 1997, the Company entered into an Employment Agreement with Howard W. Schwan as President, which provides for an annual salary of not less than $135,000. The term of the Agreement was through June 30, 2002 and is automatically renewed thereafter for successive one year terms. The Agreement contains covenants of Mr. Schwan with respect to the use of the Company's confidential information, establishes the Company's right to inventions created by Mr. Schwan during the term of his employment, and includes a covenant of Mr. Schwan not to compete with the Company for a period of three years after the date of termination of the Agreement. Director Compensation John Schwan was compensated in the amount of $76,500 in fiscal 2003 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 April 1, 2004, 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 37 believes that the beneficial owners of the shares listed below have sole investment and voting power with respect to such shares.
Shares of Common Stock Beneficially Percent of Common Name and Address (1) Owned (2) Stock - ------------------------------------------------------------ ------------------ ----------------- John H. Schwan 642,237(3) 30.3%(4) Stephen M. Merrick 525,758(5) 25.6%(4) Howard W. Schwan 178,904(6) 9.1%(4) Brent Anderson 42,795(7) 2.2%(4) Samuel Komar 24,879(8) 1.3%(4) Mark Van Dyke 23,809(9) 1.2%(4) Timothy Patterson 5,000(10) *(4) Stanley M. Brown 1140 Larkin Wheeling, IL 60090 11,250(11) * Bret Tayne 6834 N. Kostner Avenue Lincolnwood, IL 60712 9,923(12) * Frances Ann Rohlen 1140 Larkin Wheeling, IL 60090 169,933 8.9% Michael Avramovich 70 W. Madison Street, Suite 1400 Chicago, IL 60602 0 * All Directors and Executive Officers as a group (10 persons) 1,464,555 62%(4)
- ---------- * 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. (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, options to purchase up to 23,810 shares of Common Stock at $2.08 per share granted under the Company's 1999 Stock Option Plan 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 all shares of Common Stock beneficially owned by the named person through CTI Investors, L.L.C. (footnotes continued on next page) 38 (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, options to purchase up to 23,810 shares of Common Stock at $2.08 per share granted under the Company's 1999 Stock Option Plan 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." With respect to the financial covenants, the bank has issued a waver of violations of the covenants as of December 31, 2003. For periods after December 31, 2003 the bank has agreed to modify the covenants, both the tangible net worth and ratio of EDITDA of fixed charges, to reduce levels. (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. (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 1,984 shares of Common Stock at $6.30 per share and options to purchase up to 1,984 shares of Common Stock at $10.08 per share, both 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. (footnotes continued on next page) 39 (12) Includes options to purchase up to 1,984 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 & Klimek, P.C., which serves as general counsel of the Company. In addition, Mr. Merrick is a principal stockholder of the Company. Other principals of the firm of Merrick & Klimek, P.C. own less than 1% of the Company's outstanding Common Stock. Legal fees incurred from the firm of Merrick & Klimek, P.C. for the fiscal years ended December 31, 2003, 2002 and 2001 were $106,750, $102,245 and $121,305, respectively. 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 $118,011 and $273,910 during each of the years ended December 31, 2002 and December 31, 2003, respectively. In June, 1999, notes of the Company to Howard W. Schwan, John Schwan, and Stephen Merrick in the amount of, respectively, $50,000, $350,000 and $315,000, came due. On November 9, 1999, new notes in the same principal amounts were issued to Messrs. H. Schwan, J. Schwan and Merrick, in payment and replacement of the prior notes with maturity dates for each of November 9, 2001. As of that date, each payee under the Notes had executed a consent to extend the maturity of the Notes to March 1, 2004. In November, 1999, the June, 1997 warrants of Messrs. H. Schwan, J. Schwan and Merrick to purchase up to (respectively) 6,359, 44,515 and 40,063 shares of the Company's Common Stock at an exercise price of $7.86 per share were cancelled. At that time, new warrants to purchase up to 35,263, 246,840 and 222,157 shares of the Company's Common Stock at an exercise price of $1.418 per share were issued to Messrs. H. Schwan, J. Schwan and Merrick, respectively. Each of these warrants were exercised on June 3, 2002. The respective $50,000, $350,000 and $315,000 notes were cancelled and used as payment for the warrant shares. In July, 2001, the Company issued Warrants to purchase up to 79,364 shares of the Company's Common Stock to John H. Schwan and 39,683 shares of the Company's Common Stock to Stephen M. Merrick. The warrants were issued in consideration of Mr. Schwan and Mr. Merrick guaranteeing and securing loans to the Company in the aggregate amount of approximately $1,600,000. The warrants are exercisable for a period of five years at a price of $1.50 per share. 40 On December 12, 2002, Messrs. John Schwan, Howard Schwan and Stephen Merrick exercised warrants to purchase 24,572, 30,525 and 28,780 shares of the Company's Common Stock, respectively. In each instance, the warrant holder tendered shares of the Company's Common Stock on the date of exercise. During February, 2003, John H. Schwan loaned $930,000 to the Company and Stephen M. Merrick loaned $700,000 to the Company, in exchange for (i) two year promissory notes bearing interest at 9% per annum and (ii) five year warrants to purchase up to an aggregate of 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 loan of bank loan of CTI Mexico in the amount of $880,000 and (ii) to provide financing for CTI Mexico and Flexo Universal. During 2003, John H. Schwan loaned to the Company an additional aggregate amount of $795,024 . Such amount is due on demand and bears interest at the rate of 8% per annum. During 2003, John H. Schwan loaned to Flexo Universal the aggregate amount of $225,000 and Stephen M. Merrick loaned to Flexo Universal the sum of $25,000. These advances are reflected in notes and bear interest at the rate of 8% per annum. The notes are unsecured. On November 10, 1999, the Company entered into a Lease Agreement with Pepper Road, Inc., an Illinois corporation, to lease certain warehouse and office space located at 22222 North Pepper Road, Barrington, Illinois, the building and property immediately adjacent to the Company's manufacturing facilities at 22160 North Pepper Road, Barrington, Illinois. The lease has a 10 year term and provides for monthly rent payments of $15,500 ($186,000 annually), plus all utility charges associated with the property. John Schwan, Howard Schwan and Stephen M. Merrick are officers, directors, and the sole shareholders of Pepper Road, Inc. 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. PART V Item No. 14 Principal Accountant Fees and Services Fees Billed By Independent Public Accountants The following table sets forth the aggregate amount of audit fees and all other fees billed or expected to be billed by Eisner, LLP, the Company's principal auditor, for the year ended December 31, 2003: 41 Amount -------- Audit fees (1) $ 98,500 Other audit related fees (2) $ 15,000 All other fees(3) $ 15,000 -------- Total fees $128,500 ======== - ---------- (1) Includes the annual financial statement audit and limited quarterly reviews and expenses. (2) Includes fees and expenses for other audit related activity provided by Eisner, LLP. (3) Primarily represents tax services, which include preparation of tax returns and other tax consulting services. Eisner, LLP became the Company's principal auditor in July, 2003, replacing the Company's principal auditor for the fiscal year ended December 31, 2002, McGladrey & Pullen, LLP, (See Item No. 9 - "Changes in and Disagreements with Accountants on Accounting and Financial Disclosure"). Consequently, Eisner, LLP billed no fees to the Company in 2002. The audit-related fees charged to the Company by McGladrey & Pullen, LLP and RSM McGladrey, Inc. (an affiliate of McGladrey & Pullen, LLP) for the fiscal year ended December 31, 2002 and in 2003 were as follows: 2002 Amount 2003 Amount ----------- ----------- Audit fees (1) $301,000 $ 84,200 Other audit related fees (2) $ 8,900 $ 0 All other fees (3) $ 19,100 $ 0 -------- -------- Total fees $329,000 $ 84,200 ======== ======== - ---------- (1) Includes the annual financial statement audit and limited quarterly reviews and expenses. (2) Includes fees and expenses for other audit related activity provided by McGladrey & Pullen, LLP. (3) Primarily represents tax services provided by RSM McGladrey, Inc. which include preparation of tax returns and other tax consulting services. 42 Item No. 15 Exhibits and Reports on Form 8-K Exhibits * 3.1 Third Restated Certificate of Incorporation of CTI Industries Corporation ** 3.2 By-laws of CTI Industries Corporation ** 4.1 Form of Certificate for Common Stock of CTI Industries Corporation *** 10.1 CTI Industries Corporation 1999 Stock Option Plan **** 10.2 CTI Industries Corporation 2001 Stock Option Plan ***** 10.3 CTI Industries Corporation 2002 Stock Option Plan ** 10.4 Employment Agreement dated June 30, 1997, between CTI Industries Corporation and Howard W. Schwan ****** 10.5 November, 1999 Lease Agreement between Pepper Road, Inc. and CTI Industries Corporation ****** 10.6 Warrant dated July 17, 2001 to purchase 79,364 shares of Common Stock John H. Schwan ****** 10.7 Warrant dated July 17, 2001 to purchase 39,683 shares of Common Stock Stephen M. Merrick ****** 10.8 Note dated January 28, 2003, CTI Industries Corporation to Stephen M. Merrick in the sum of $500,000 ****** 10.9 Note dated February 28, 2003, CTI Industries Corporation to Stephen M. Merrick in the sum of $200,000 ****** 10.10 Note dated February 10, 2003, CTI Industries Corporation to John H. Schwan in the sum of $150,000 ****** 10.11 Note dated February 15, 2003, CTI Industries Corporation to John Schwan in the sum of $680,000 ****** 10.12 Note dated March 3, 2003, CTI Industries Corporation to John H. Schwan in the sum of $100,000 ****** 10.13 Warrant dated March 20, 2003, to purchase 70,000 shares of Common Stock - Stephen M. Merrick ****** 10.14 Warrant dated March 20, 2003, to purchase 93,000 shares of Common Stock - John H. Schwan 10.15 Loan and Security Agreement dated December 30, 2003, between the Company and Cole Taylor Bank 10.16 Term Note in the sum of $3,500,000 dated December 30, 2003 made by CTI Industries Corporation to Cole Taylor Bank 10.17 Revolving Note in the sum of $7,500,000 dated December 30, 2003, made by CTI Industries Corporation to Cole Taylor Bank ******* 10.18 Mortgage dated January 12, 2001 for the benefit of Banco Popular, N.A. ******* 10.19 Secured Promissory Note in the sum of $2,700,000 dated December 15, 2000 made by CTI Industries Corporation to Banco Popular, N.A. ******* 10.20 Secured Promissory Note in the sum of $173,000 dated December 15, 2000 made by CTI Industries Corporation to Banco Popular, N.A. ******* 10.21 Guaranties dated January 12, 2001 by John H. Schwan, Stephen M. Merrick and Howard W. Schwan for the benefit of Banco Popular, N.A. 11.1 Computation of Earnings Per Share (Incorporated by reference to Note 17 of the Consolidated Financial Statements contained in Part IV) 21 Subsidiaries (description incorporated in Form 10-K under Item No. 1) 43 23.1 Consent of Independent Auditors, Eisner, LLP 23.2 Consent of Independent Auditors, McGladrey & Pullen, LLP 23.3 Consent of Independent Auditors, Grant Thornton, 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 99.1 Code of Ethics * 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. ** Incorporated by reference to Exhibits, contained in Registrant's Form SB-2 Registration Statement (File No. 333-31969) effective November 5, 1997. *** Incorporated by reference to Exhibit contained in Registrant's Schedule 14A Definitive Proxy Statement, as filed with the Commission on March 26, 1999. **** Incorporated by reference to Exhibit contained in Registrant's Schedule 14A Definitive Proxy Statement, as filed with the Commission on May 21, 2001 ***** Incorporated by reference to Exhibit contained in Registrant's Schedule 14A Definitive Proxy Statement, as filed with the Commission on May 15, 2002 ****** Incorporated by reference to Exhibits contained in the Registrant's 2002 10-KSB, as filed with the Commission on May 1, 2003 ******* Incorporated by reference to Exhibits contained in the Registrant's Restated 2001 10-KSB, as filed with the Commission on May 1, 2003 Reports on Form 8-K On May 28, 2003, the Company filed a report on Form 8-K to report its First Quarter Earnings. On July 28, 2003, the Company filed a report on Form 8-K to report the replacement of its then auditors, McGladrey & Pullen, LLP, with Eisner, LLP, effective July 22, 2003. On August 20, 2003, the Company filed a report on Form 8-K to report its Second Quarter Earnings. On November 20, 2003, the Company filed a report on Form 8-K to report its Third Quarter Earnings. 44 SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act the Registrant caused this report to be signed on its behalf by the undersigned thereunto duly authorized on April 15, 2004. CTI INDUSTRIES CORPORATION By: /s/ Howard W. Schwan ------------------------------------ Howard W. Schwan, President In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated. Signatures Title Date /s/ Howard W. Schwan President and Director April 15, 2004 - ------------------------ Howard W. Schwan /s/ John H. Schwan Chairman and Director April 15, 2004 - ------------------------ John H. Schwan /s/ Stephen M. Merrick Executive Vice President, April 15, 2004 - ------------------------ Secretary, Chief Financial Stephen M. Merrick Officer and Director /s/ Stanley M. Brown Director April 15, 2004 - ------------------------ Stanley M. Brown /s/ Bret Tayne Director April 15, 2004 - ------------------------ Bret Tayne /s/ Michael Avramovich Director April 15, 2004 - ------------------------ Michael Avramovich 45 INDEPENDENT AUDITOR'S REPORT To the Board of Directors CTI Industries Corporation and Subsidiaries Barrington, Illinois We have audited the accompanying consolidated balance sheets of CTI Industries Corporation and Subsidiaries as of December 31, 2002, 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 auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of CTI Industries Corporation and Subsidiaries as of December 31, 2002, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 13 to the consolidated financial statements, on January 1, 2002, the Company changed 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 INDEPENDENT AUDITORS' REPORT 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 as of December 31, 2001, and the related consolidated statement of operations, changes in 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 auditing standards generally accepted in the United States of America. 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 financial statements referred to above presently fairly, in all material respects, the consolidated financial position of CTI Industries Corporation and Subsidiaries as of December 31, 2001, and the consolidated results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. As indicated in Note 3 to these accompanying consolidated financial statements, the Company has restated its consolidated financial statements for the year ended December 31, 2001. /s/ Grant Thornton, LLP - ----------------------- Chicago, Illinois April 10, 2002, except as to Note 2, which is as of April 15, 2003 F-1 INDEPENDENT AUDITORS' REPORT Board of Directors and Stockholders CTI 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 auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated 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 accounting principles accepted 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 F-1 CTI Industries Corporation and Subsidiaries Consolidated Balance Sheets
December 31, 2003 December 31, 2002 ----------------- ----------------- ASSETS Current assets: Cash $ 329,742 $ 160,493 Accounts receivable, (less allowance for doubtful accounts of $186,215 and $223,220 respectively) 4,620,276 5,384,839 Inventories 9,263,160 10,033,593 Deferred tax assets 361,751 247,780 Prepaid expenses and other current assets 859,635 310,995 ------------ ------------ Total current assets 15,434,564 16,137,700 Property and equipment: Machinery and equipment 18,939,535 16,221,259 Building 2,678,581 2,636,595 Office furniture and equipment 1,931,831 1,746,480 Land 250,000 250,000 Leasehold improvements 582,052 388,655 Fixtures and equipment at customer locations 2,232,285 2,306,807 Projects under construction 408,961 2,331,981 ------------ ------------ 27,023,245 25,881,777 Less: accumulated depreciation (14,815,596) (14,166,764) ------------ ------------ Total property and equipment, net 12,207,649 11,715,013 Other assets: Deferred financing costs, net 222,696 51,747 Goodwill 1,113,108 1,113,108 Deferred tax assets 1,012,365 441,592 Other assets 279,800 812,698 ------------ ------------ Total other assets 2,627,969 2,419,145 ------------ ------------ TOTAL ASSETS 30,270,182 30,271,858 ============ ============
See accompanying notes F-2 CTI Industries Corporation and Subsidiaries Consolidated Balance Sheets (cont'd.) December 31, 2003 December 31, 2002 ----------------- ----------------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Checks written in excess of bank balance 341,108 113,460 Accounts payable 6,799,490 9,580,823 Line of credit 3,694,241 5,642,649 Notes payable - current portion 2,998,496 1,742,658 Accrued liabilities 2,306,745 1,965,561 ------------ ------------ Total current liabilities 16,140,080 19,045,151 Long-term liabilities: Other liabilities 1,079,041 710,257 Notes payable 5,766,091 5,016,109 Notes payable - officers 2,064,126 -- ------------ ------------ Total long-term liabilities 8,909,258 5,726,366 Minority interest 9,263 25,865 Commitments, Contingencies and Litigation (Notes 14 & 15) Stockholders' equity: Preferred Stock - no par value 2,000,000 shares authorized, 0 shares issued and outstanding 0 0 Common stock - no par value, 5,000,000 shares authorized, 2,150,216 and 2,141,882 shares issued, 1,918,420 and 1,910,086 shares outstanding, respectively 3,764,020 3,748,270 Class B Common stock - no par value, 500,000 shares authorized, 0 shares issued and outstanding 0 0 Paid-in-capital 5,554,332 5,554,332 Warrants issued in connection with subordinated debt and bank debt 595,174 135,462 Accumulated deficit (3,528,063) (2,962,016) Accumulated other comprehensive earnings (234,768) (6,002) Less: Treasury stock - 231,796 shares (939,114) (939,114) Notes receivable from stockholders 0 (56,456) ------------ ------------ Total stockholders' equity 5,211,581 5,474,476 ------------ ------------ TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $ 30,270,182 $ 30,271,858 ============ ============
See accompanying notes F-3 CTI Industries Corporation and Subsidiaries Consolidated Statements of Operations
Year Ended December 31, 2003 2002 2001 (as restated) ------------ ------------ ------------- Net Sales $ 36,259,638 $ 41,236,476 $ 27,446,494 Cost of Sales 29,626,450 32,344,115 19,835,066 ------------ ------------ ------------ Gross profit on sales 6,633,188 8,892,361 7,611,428 Operating expenses: Administrative 4,054,607 4,224,777 3,701,591 Selling 1,441,501 1,551,538 1,760,138 Advertising and marketing 1,816,301 1,671,106 1,132,977 ------------ ------------ ------------ Total operating expenses 7,312,409 7,447,421 6,594,706 ------------ ------------ ------------ (Loss) income from operations (679,221) 1,444,940 1,016,722 Other income (expense): Interest expense (1,103,395) (831,600) (1,125,606) Interest income 13,618 3,157 6,160 Gain on sale of assets 28,007 0 0 Foreign currency (loss) gain (36,132) (281,186) 89,028 Other 428,126 0 0 ------------ ------------ ------------ Total other income (expense) (669,776) (1,109,629) (1,030,418) ------------ ------------ ------------ (Loss) income before income taxes (benefit) and minority interest (1,348,998) 335,311 (13,696) Income tax (benefit) expense (782,468) 39,065 276,553 ------------ ------------ ------------ (Loss) income before minority interest (566,530) 296,246 (290,249) Minority interest in income of subsidiary (483) (6,266) (57,957) ------------ ------------ ------------ Net (loss) income $ (566,047) $ 302,512 $ (232,292) ============ ============ ============ (Loss) income applicable to common shares $ (566,047) $ 302,512 (232,292) ============ ============ ============ (Loss) income per common share - basic $ (0.30) $ 0.18 $ (0.15) ============ ============ ============ (Loss) income per common share - diluted $ (0.30) $ 0.16 $ (0.15) ============ ============ ============ Weighted average number of shares and equivalent shares of common stockoutstanding: Basic 1,918,260 1,688,384 1,511,958 ============ ============ ============ Diluted 1,918,260 1,884,405 1,511,958 ============ ============ ============
See accompanying notes F-4 CTI Industries Corporation and Subsidiaries Consolidated Statements of Cash Flows
For the Year Ended December 31, 2003 2002 2001 (as restated) ------------------------------------------------------------- Cash flows from operating activities: Net (loss) income $ (566,047) $ 302,512 $ (232,292) Adjustment to reconcile net (loss) income to cash provided by operating activities: Depreciation and amortization 1,618,563 1,588,187 1,665,758 Deferred gain on sale/leaseback (30,047) (30,046) (30,046) Amortization of Debt Discount 238,199 27,500 124,657 Minority interest in loss of subsidiary (483) (6,266) (57,957) Provision for losses on accounts receivable & inventory 355,000 300,000 240,000 Deferred income taxes (782,468) (25,700) 225,908 Change in assets and liabilities: Accounts receivable 619,113 (1,075,314) (1,859,791) Inventory 560,433 (1,964,697) (1,832,182) Other assets 66,313 (122,112) 132,809 Accounts payable and accrued expenses 263,960 4,056,872 2,246,986 ------------------------------------------------------- Net cash provided by operating activities 2,342,536 3,050,936 623,850 Cash flows from investing activity: Purchases of property, plant and equipment (1,141,468) (2,477,831) (1,002,136) ------------------------------------------------------- Net cash used in investing activities (1,141,468) (2,477,831) (1,002,136) Cash flows from financing activities: Checks written in excess of bank balance 227,648 113,460 0 Net change in revolving line of credit (1,948,408) (55,068) 2,088,176 Proceeds from issuance of long-term debt 6,768,759 0 4,299,000 Repayment of long-term debt (5,649,214) (591,182) (5,604,248) Repayment of short-term debt 0 0 (500,000) Repayment of subordinated debt 0 0 (10,000) Collection of Stockholder note 56,456 0 0 Proceeds from exercise of Stock options 15,750 0 0 Proceeds from exercise of warrants 19,750 0 Cash paid for deferred financing fees (275,044) 0 0 Purchase of Treasury Stock 0 0 (171,380) ------------------------------------------------------- Net cash (used in) provided by financing activities (803,853) (513,040) 101,548
F-5 CTI Industries Corporation and Subsidiaries Consolidated Statements of Cash Flows (cont'd.)
For the Year Ended December 31, 2003 2002 2001 (as restated) ------------------------------------------------------------- Effect of exchange rate changes on cash (227,966) (10,060) (5,308) ------------------------------------------------------- Net increase (decrease) in cash 169,249 50,005 (282,046) Cash and Equivalents at Beginning of Period 160,493 110,488 392,534 ------------------------------------------------------- Cash and Equivalents at End of Period $ 329,742 $ 160,493 $ 110,488 ================================= =========== Supplemental disclosure of cash flow information: Cash payments for interest $ 865,196 $ 776,802 $ 876,326 Cash payments for taxes 42,295 140,072 0 Supplemental non-cash investing and financing activities: Issuance of stock for subordinated debt 0 715,000 0 Long-term debt incurred for the purchase of equipment 0 2,230,719 0 Note payable incurred to purchase 21.8% of minority interest in CTI Mexico S. A. de C.V 0 148,290 0 Stock Dividend 0 1,280,758 0 Conversion of accounts payable to notes payable 3,534,326 0 0 Common stock exchanged to exercise warrants 0 192,350 0 Refinance mortgage 2,671,243 0 0
See accompanying notes F-6 CTI Industries Corporation and Subsidiaries Consolidated Statements of Stockholders' Equity
Warrants Common Stock Class B Common Stock issued in ------------------------ ------------------------- Paid-in connection with Shares Amount Shares Amount Capital subordinated debt --------------------------------------------------------------------------------------------- Balance, December 31, 2000 966,327 $ 188,434 366,300 $ 1,000,000 $ 5,554,332 $ 351,978 ============================================================================================= Expiration of stock redemption period Warrants issued in connection with subordinated debt $ 135,462 Purchase of Treasury Stock Net Loss Other comprehensive income Foreign currency translation Total comprehensive loss --------------------------------------------------------------------------------------------- Balance, December 31, 2001 966,327 $ 188,434 366,300 $ 1,000,000 $ 5,554,332 $ 487,440 ============================================================================================= Options Excersised 11,000 $ 19,750 Class B Conversion 366,300 $ 1,000,000 ($366,300) ($1,000,000) Stock Dividend 304,218 $ 1,280,758 Warrant exercise for subordinated debt 423,579 $ 1,066,978 ($351,978) Cashless exercise of warrants 70,458 $ 192,350 Net Income Less Accumulated ----------------------------- Other Treasury Stock Accumulated Comprehensive ----------------------------- Deficit Earnings Shares Amount ------------------------------------------------------------------- Balance, December 31, 2000 $ (1,751,478) $ (42,244) 124,683 $ (575,384) =================================================================== Expiration of stock redemption period Warrants issued in connection with subordinated debt Purchase of Treasury Stock 74,513 $ (171,380) Net Loss $ (232,292) Other comprehensive income Foreign currency translation $ (75,763) Total comprehensive loss ------------------------------------------------------------------- Balance, December 31, 2001 $ (1,983,770) $ (118,007) 199,196 $ (746,764) =================================================================== Options Excersised Class B Conversion Stock Dividend ($1,280,758) Warrant exercise for subordinated debt Cashless exercise of warrants $ 32,600 $ (192,350) Net Income $ 302,512 Less ------------------------------------------------------------------ Redeemable Stock Notes Recvble Common Stock Sub Recvble Shareholders TOTAL ----------------------------------------------------------------- Balance, December 31, 2000 $ -- $ 4,700 $ (56,456) $ 4,664,482 ================================================================= Expiration of stock redemption period $ -- $ (4,700) $ 4,700 Warrants issued in connection with subordinated debt $ 135,462 Purchase of Treasury Stock $ (171,380) Net Loss $ (232,292) Other comprehensive income Foreign currency translation $ (75,763) ----------- Total comprehensive loss $ (308,055) ----------------------------------------------------------------- Balance, December 31, 2001 $ -- $ -- $ (56,456) $ 4,325,209 ================================================================= Options Excersised $ 19,750 Class B Conversion $ -- Stock Dividend $ -- Warrant exercise for subordinated debt $ 715,000 Cashless exercise of warrants $ -- Net Income $ 302,512
F-7 Other comprehensive income Foreign currency translation Total comprehensive loss ------------------------------------------------------------------------------------------ Balance, December 31, 2002 2,141,882 $ 3,748,270 0 $ -- $ 5,554,332 $ 135,462 ========================================================================================== Options Excersised 8,334 $ 15,750 Warrant exercise for subordinated debt $ 459,712 Collection of Notes Receivable Net Income Other comprehensive income Foreign currency translation Total comprehensive loss ------------------------------------------------------------------------------------------ Balance, December 31, 2003 2,150,216 $ 3,764,020 -- $ -- $ 5,554,332 $ 595,174 ==========================================================================================
Other comprehensive income Foreign currency translation $ 112,005 Total comprehensive loss ------------------------------------------------------------------- Balance, December 31, 2002 $ (2,962,816) $ (6,002) 231,796 $ (939,114) =================================================================== Options Excersised Warrant exercise for subordinated debt Collection of Notes Receivable Net Loss ($566,047) Other comprehensive income Foreign currency translation ($228,776) Total comprehensive loss ------------------------------------------------------------------- Balance, December 31, 2003 $ (3,528,063) $ (234,768) 231,796 $ (939,114) =================================================================== Other comprehensive income Foreign currency translation $ 112,005 ----------- Total comprehensive loss $ 414,517 ----------------------------------------------------------------- Balance, December 31, 2002 $ -- $ -- $ (56,456) $ 5,473,676 ================================================================= Options Excersised $ 15,750 Warrants issued in connection with subordinated debt $ 459,712 Collection of Notes Receivable $ 56,456 $ 56,456 Net Income $ (566,047) Other comprehensive income Foreign currency translation $ (227,966) ----------- Total comprehensive loss $ (794,813) ----------------------------------------------------------------- Balance, December 31, 2003 $ -- $ -- $ -- $ 5,211,581 =================================================================
See accompanying notes. F-8 CTI Industries Corporation and Subsidiaries Notes to the Consolidated Financial Statements 1. Nature of Operations CTI Industries Corporation (the "Company"), 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.) (i) design, manufacture and distribute metallized and latex balloon products throughout the world and (ii) operates 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, 2003, the Company incurred a net operating loss before taxes of $1,349,000. As of December 31, 2003 and 2002, the Company had a working capital deficiency of $706,000 and $2,907,000, 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/officers for liquidity. This line of credit expires on December 31, 2005. For the year ending December 31, 2004, management anticipates improvement in its operating results and in cash generated from operating activities resulting from, among other things, restructuring certain operations. However, there is no assurance that such improvements in operating results will occur or that the funds provided from the Company's line of credit and operations will be sufficient to meet the Company's current obligations. 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 Ltd. ("CTI Balloons") and CTF International S.A. de C.V., and its majority owned subsidiaries, Flexo Universal S.A. de C.V. ("Flexo Universal") and CTI Mexico Corporation S.A. de C.V. ("CTI Mexico"). 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. Restatements The Company's December 31, 2001 financial statements have been restated as further discussed in Amendment No. 1 to the Company's 2001 Form 10-KSB. Accounting 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 good will. 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. Trade Receivables 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 F-9 CTI Industries Corporation and Subsidiaries Notes to the Consolidated Financial Statements 3. Summary of significant accounting policies, continued financial condition, credit history and current economic conditions and by using historical experience applied to an aging of accounts. A trade receivable is considered to be past due if any portion of the receivable balance is outstanding for a period over the customers normal terms. Trade receivables are written off when deemed uncollectible. Recoveries of trade receivables previously written off are recorded when received. Inventories Inventories are stated at the lower of cost or market. Cost is determined using standard costs which approximates costing determined on a first-in, first-out basis, and periodic adjustments to reflect the actual cost of production of inventories. Property and Equipment Property and equipment are stated at cost. Expenditures for maintenance and repairs are charged to operations as incurred. Depreciation is computed using the straight-line and declining-balance methods over estimated useful lives of the related assets. Leasehold improvements are amortized on a straight-line method over the lesser of the estimated useful life or the lease term. The estimated useful lives range as follows: Building ....................................... 25 - 30 years Machinery and equipment ........................ 3 - 15 years Office furniture and equipment ................. 5 - 8 years Leasehold improvements ......................... 5 - 8 years Furniture & equipment at customer locations .... 2 - 3 years Goodwill Prior to January 1, 2002, goodwill was amortized over 15 years using the straight-line method. Subsequent to that date, the Company has followed, and does now follow, the provisions of Statement of Financial Accounting Standards 142. "Goodwill and Other Intangible Assets," under which goodwill is not amortized but is tested at least annually for impairment. Goodwill on the accompanying balance sheets relates to Flexo Universal/CTI Mexico. It is the Company's policy to perform impairment testing for Flexo Universal/CTI Mexico annually as of December 31. Impairment 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 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 debt in December, 2003. These costs are being amortized on a straight-line basis over the term of the loans. F-10 CTI Industries Corporation and Subsidiaries Notes to the Consolidated Financial Statements 3. Summary of significant accounting policies, continued Income Taxes The Company accounts for income taxes using the asset and liability method. As such, deferred income taxes reflect the net tax effects of temporary differences between carrying amounts of assets and liabilities for financial reporting purposes and the amount used for income tax purposes. Deferred tax assets and liabilities are measured using enacted tax rates expected to be in effect when the anticipated reversal of these differences is scheduled to occur. The effect of a change in tax rates on deferred tax assets or liabilities is recognized in income in the period and includes the enactment date. 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. Fair Value of Financial Instruments The fair value of financial instruments are not materially different from their carrying values. Other Comprehensive Income For years ended December 31, 2003, 2002 and 2001, other comprehensive income consisted of foreign currency translation adjustments, net of related taxes. 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, (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, 2003, the Company has four stock-based compensation plans, which are described more fully in Note 15. 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 following table illustrates the effect on net income (loss) and earnings (loss) per share had compensation cost for all of the stock-based compensation plans been determined based on the grant date fair values of awards (the method described in FASB Statement No. 123, Accounting for Stock-Based Compensation): F-11 CTI Industries Corporation and Subsidiaries Notes to the Consolidated Financial Statements 3. Summary of significant accounting policies, continued
Years Ended December 31, 2003 2002 2001 -------- -------- -------- Net (Loss) Income: As reported .................................... (566,047) 302,512 (232,292) Deduct total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects ......................... (8,583) (117,375) (152,901) -------- -------- -------- Pro forma net income (loss) ................. (574,630) 185,137 (385,193) ======== ======== ======== Net income (loss) per share: Basic - As reported ......................... (0.30) 0.18 (0.15) Basic - Proforma ............................ (0.30) 0.11 (0.25) Diluted - As reported ....................... (0.30) 0.16 (0.15) Diluted - Proforma .......................... (0.30) 0.10 (0.25)
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:
2003 2002 2001 ----- ----- ----- Expected life (years) .................... 5 5 7.5 Volatility ............................... 136.6% 123.3% 117% Risk-free interest rate .................. 4.4% 2.9% 4.5% 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, 2003, 2002 and 2001, research and development activities totaled $335,000 $333,000 and $325,000, respectively. New Accounting Pronouncements In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosures Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" (FIN 45). FIN 45 requires that upon issuance of a guarantee, the guarantor must recognize a liability for the fair value of the obligation it assumes under that guarantee. FIN 45 is effective on a prospective basis to guarantees issued or modified after December 31, 2002, but has certain disclosure requirements effective for financial statements of interim or annual periods ending after December 15, 2002. The Company does not currently have any guarantees. The Company does not anticipate that the adoption of the disclosure requirements will have a material effect on its financial position or results of operations. In January, 2003 the Financial Accounting Standards Board issued FASB Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51," which addresses consolidation by business enterprises of variable interest entities ("VIE's") either: (1) that do not have sufficient equity investment at risk to permit the entity to finance its activities without additional subordinated financial support, or (2) in which the equity investors lack an essential characteristic of a controlling financial interest. In December, 2003, the FASB completed deliberations of proposed modifications to FIN 46 resulting in multiple effective dates based on the nature as well as the creation date of the VIE. Special purpose entities created prior to February 1, 2003 may be accounted for under the original or revised interpretation's provisions no later than the Company's first quarter of 2004. Non-special purpose entities created prior to February 1, 2003 are to be accounted for under the revised interpretation's provisions no later than the Company's second quarter of 2004. Management has concluded that the provisions of FIN 46 do not apply to the Company with respect to its transactions with Pepper Road, Inc. (see Note 17). F-12 CTI Industries Corporation and Subsidiaries Notes to the Consolidated Financial Statements 4. Major Customers For the year ended December 31, 2003, the Company had three customers that accounted for approximately 28.4%, 14.7% and 11%, respectively, of consolidated net sales. Corresponding percentages of consolidated net sales generated by these customers for the year ended December 31, 2002, were approximately 29%, 17% and 12% respectively, and in 2001, were approximately 23.0%, 14.0% and 2.7%, respectively. At December 31, 2003, the outstanding accounts receivable balances due from these three customers were $464,183, $566,557 and $862,407 respectively. At December 31, 2002 the outstanding accounts receivable balances due from these three customers were $1,149,856, $932,707 and $1,697,852. At December 31, 2001, the balance due from these three customers were $568,931, $579,035, and $367,677. 5. Inventory Inventory is comprised of the following: December 31, 2003 December 31, 2002 ----------------- ----------------- Raw materials .................. $ 866,111 $ 1,865,871 Work in process ................ 1,365,317 2,135,503 Finished goods ................. 7,523,889 6,386,719 Allowance, Excess Quantities ... (492,157) (354,500) ------------ ------------ Total inventory ................ $ 9,263,160 $ 10,033,593 ============ ============ 6. Notes Payable Long-term debt consists of:
Dec 31, 2003 Dec 31, 2002 ------------ ------------ Term Loan with bank, payable in monthly installments of $22,222 plus interest at prime plus 0.75% ..................................... $ -- $ 1,355,057 Term Loan with bank, payable in monthly installments of $58,333 plus interest at prime (4% at December 31, 2003) plus 1.5%; balance due February 1, 2009 .......................................... 3,500,000 -- Term Loan with bank, payable in monthly installments of $19,209 including interest at 6.25% due May 5, 2008 (loan renegotiated May 2003) ............................................................. 2,879,886 $ 2,647,586 Term Loan with bank, payable in monthly installments of $5,582 including interest at 10.00% due and paid in January 5, 2004 .......... 1,399 68,657 Term Loan with bank, payable in monthly installments of $26,139 including interest at 5.75% due January, 2004 and paid December, 2003 ........................................................ -- 1,627,720 Vendor notes, at various rates of interest, (weighted average of 6%), maturing through August, 2005 ......................................... 2,299,647 -- Subordinated Notes due to officers in 2005, Interest at 9% Net of Debt Discount of $310,898 ...................................... 1,269,102 -- Subordinated Notes due to officers, interest at 9% .................... 795,024 -- Loan payable to a Mexican finance institution denominated in Mexican Pesos bearing interest at 9.81% ............................... 83,655 90,322 Loan with bank, with interest payable monthly at prime (4.25% at December 31, 2002) ................................................. -- 969,425 -------------------------------------------------------------------------------------------------------------- Total ........................................................... $ 10,828,713 $ 6,758,767 ------------ ------------ Less current portion .................................................. (2,998,496) (1,742,658) ------------ ------------ Total long-term debt ............................................ $ 7,830,217 $ 5,016,109 ------------ ------------
F-13 CTI Industries Corporation and Subsidiaries Notes to the Consolidated Financial Statements 6. Notes Payable, continued On December 31, 2003, the Company entered into a Loan and Security 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 includes a term loan of $3,500,000, at an interest rate of prime plus 1.5% per annum (and is being amortized over a period of 60 months), which is based primarily upon the appraised value of the equipment of the Company and a revolving line of credit at an interest rate of prime plus 1.5% per annum (5.5% at December 31, 2003), the amount of which is based on advances of up to 85% of eligible receivables and up to 50% of the value of the Company's domestic inventory. 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 as of December 31, 2004, 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 Company was in violation of the EBITDA to fixed charges at December 31, 2003 for which the bank has issued a waiver. The loan agreement also prohibits new debt, loans by the Company, purchase of stock and dividends, without the consent of the Bank. As of December 31, 2003, the balance outstanding on the credit facility was $3,694,241. 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 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 31, 2004. This line of credit was paid in full at December 31, 2003 and was terminated. 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 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 2003, the terms of this note was 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 is in the principal amount of $173,000 with an interest rate of 10%, and has a term of three years. The balance on this Note of $1,399 as of December 31, 2003, was paid on January 5, 2004. Future Minimum principal payments, exclusive of debt discount, for amounts outstanding under these long-term debt agreements at December 31, 2003 are as follows: 2004 ................. 2,998,496 2005 ................. 2,948,195 2006 ................. 756,065 2007 ................. 759,723 2008 ................. 3,362,530 Thereafter ........... 3,704 ----------- Less Current Portion . (2,998,496) =========== $ 7,830,217 =========== F-14 CTI Industries Corporation and Subsidiaries Notes to the Consolidated Financial Statements 7. Subordinated Debt In November, 1999, warrants to purchase up to 35,263, 246,840 and 222,157 shares of the Company's Common Stock at an exercise price of $1.418 per share were issued to Messrs. H. Schwan, J. Schwan and Merrick, respectively in consideration of subordinated loans by such individuals to the Company in the amounts, respectively, of $50,000, $350,000 and $315,000. Each of these warrants were exercised on June 3, 2002. The respective $50,000, $350,000 and $315,000 notes were cancelled and used as payment for the warrant shares. In February, 2003, the Company received $1,630,000 from certain officers 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. As a result of valuing the warrants and allocating a portion of the proceeds to the warrants, the Company recorded additional paid in capital attributable to the warrants of $459,712 and a related discount in the subordinated debt of the same amount. The subordinated debt is recorded at December 31, 2003, net of unamortized debt discount of $310,898. The debt discount is amortized using the effective interest method over the term of the debt. At various times during 2003, a shareholder/officer loaned an aggregate of $795,024 to the Company in exchange for notes bearing interest at 8%. These notes are subordinated to the bank loan of the Company. 8. Other Income Other income of $428,126 set forth on the Comany's Consolidated Statements of Operations for the year ended December 31, 2003 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 Decmeber 31, 2003 include (i) deferred gain of the Company in the amount of $175,376 on the sale of a building to Pepper Road, Inc., (ii) loans by officers/shareholders to Flexo Universal totaling $250,000 which is subordinated to bank obligations and bearing interest at 8%, (iii) obligations of Flexo Universal to a financial institution in the amount of $83,665 and (iv) obligations of CTI Mexico, Flexo and CTF International totaling $570,000 to vendors on deferred payment terms. 10. Income Taxes The income tax provisions are comprised of the following: Year ended December 31, 2003 2002 2001 --------- -------- -------- Current: Federal ................................ $ -- $ -- $ -- State .................................. -- -- -- Foreign ................................ -- -- 22,316 --------- -------- -------- -- -- 22,316 Deferred: Federal ................................ (361,881) 25,859 199,340 State .................................. (51,281) 3,665 -- Foreign ................................ (369,306) 9,541 54,897 --------- -------- -------- (782,468) 39,065 254,237 --------- -------- -------- Total income tax (benefit) provision ...... $(782,468) $ 39,065 $276,553 ========= ======== ======== The components of the net deferred tax asset (liability) at December 31 are as follows:
2003 2002 2001 Deferred tax assets: Allowance for doubtful accounts ............... $ 139,845 $ 135,667 $ 141,915 Inventory valuation ........................... 162,248 203,032 196,092 Accrued liabilities ........................... 151,017 126,804 192,870 Sale Leaseback ................................ 68,037 79,701 (396,974) Unicap 263A Adjustment ........................ 52,380 -- -- Net operating loss carryforwards .............. 2,185,357 1,840,916 1,760,106 Alternative minimum tax credit carryforward ... 338,612 338,612 338,600 State Investment Tax Credit carryforward ...... 18,041 26,225 -- Other Foreign Tax Items ....................... 137,993 -- -- Foreign Asset Tax Credit carryforward ......... 160,784 166,790 -- ----------- ----------- ----------- Total deferred tax assets ................... 3,414,314 2,917,747 2,232,609 Deferred tax liabilities: Book over tax basis of capital assets ......... (1,069,395) (989,197) 841,626 Cash basis of foreign inventory purchases ..... (264,933) (500,578) -- ----------- ----------- ----------- (1,334,328) (1,489,775) 841,626 ------------------------------------------- Net Deferred Assets before Valuation Allowance 2,079,986 1,427,972 1,390,983 Less: Valuation allowance ........................ (738,600) (738,600) (738,600) ----------- ----------- ----------- Net deferred tax asset ........................ $ 1,341,386 $ 689,372 $ 652,383 =========== =========== ===========
F-15 CTI Industries Corporation and Subsidiaries Notes to the Consolidated Financial Statements 10. Income Taxes, continued The Company maintains a valuation allowance with respect to deferred tax assets as a result of the uncertainty of ultimate realization. At December 31, 2003 the Company has net operating loss carryforwards of approximately $5,393,000 expiring in various years through 2023. The Company has approximately $338,600 of alternative minimum tax credits as of December 31, 2003, which have no expiration date. Future use of net operating loss carryforwards and income tax credits may be limited pursuant to Section 382 of the Internal Revenue Code. In addition, as per Mexican tax regulations, Flexo Universal has net operating loss carryforwards of approximately $2,822,000, expiring in 2013. Unremitted earnings of foreign subsidiaries have been indefinitely reinvested. Income tax provisions differed from the taxes calculated at the statutory federal tax rate as follows:
Year Ended December 31, 2003 2002 2001 ------------ ------------ ------------ Taxes at statutory rate ................. $(393,154) $ 114,000 $ (4,600) State income taxes ...................... (55,504) 16,000 0 Nondeductible Expenses .................. 20,564 41,000 -- Increase in deferred tax Valuation allowance .................. 0 -- 27,300 State credit created in current year .... 0 (22,000) -- Foreign taxes and other ................. (354,374) (109,935) 253,853 --------- --------- --------- Income tax provision .................... $(782,468) $ 39,065 $ 276,553 ========= ========= =========
11. Employee Benefit Plan The company has a defined contribution plan for substantially all employees. Prior to January 1, 2004, the plan provided for the Company matching contributions on the first $300 of employee contributions with an additional bonus match of 1% of compensation for all participants who were employees on the last date of the plan year. Profit sharing contributions may also be made at the discretion of the Board of Directors. Effective January 1, 2004 the Company amended its defined contribution plan. Under the amended plan the maximum contribution for the Company is 2% of gross wages. Employer contributions to the plan totaled $54,836 for the year ended December 31, 2003, and $53,680 for the year ended December 31, 2002, and $57,160 for the year ending December 31, 2001. 12. Related Party Transactions The Company obtains legal services from a law firm in which two shareholders of the law firm are also shareholders of the Company, and in which one shareholder of the law firm is both a director and a shareholder of the Company. Legal fees incurred with this firm were $107,000 for the year ended December 31, 2003 and $102,000 for the year ended December 31, 2002, and $121,000 for the year ended December 31, 2001. 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 were reflected as a contra equity account at December 31, 2002 and 2001. During 2003, these obligations have been repaid in their entirety. A shareholder/officer 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 $118,011 and $273,910 during each of the years ended December 31, 2002 and 2003, respectively. In November, 1999, the Company sold a building to a related party. See Note 15. F-16 CTI Industries Corporation and Subsidiaries Notes to the Consolidated Financial Statements 13. 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 Company determined that no transitional impairment loss was required at January 1, 2002. The Company retained an independent consulting firm to conduct a study and make a determination whether the goodwill reflected on the Company's financial statements was impaired as of January 1, 2002, December 31, 2002 and December 31, 2003. For each of such times, the Company has received the report and opinion of such consulting firms to the effect that there was no impairment of goodwill reflected on the financial statements of the Company as of each of January 1, 2002, December 31, 2002 and December 31, 2003. The gross carrying amount of goodwill as of December 31, 2003 and 2002 is $1,113,108. The following information is provided with respect to amortization of good will during 2001: Year Ended December 31 2003 2002 2001 ------------------------------------------ Reported net income (loss) $ (566,047) $ 302,512 $ (232,292) Add back: Goodwill amortization $ -- $ $ 86,664 ----------- ----------- ----------- Adjusted net income (loss) $ (566,047) $ 302,512 $ (145,628) Basic earnings per share Reported net income (loss) $ (0.30) $ 0.18 $ (0.15) Add back: Goodwill amortization $ -- $ -- $ 0.07 ----------- ----------- ----------- Adjusted net income (loss) $ (0.30) $ 0.18 $ (0.08) =========== =========== =========== Fully diluted earnings per share: Reported net income (loss) $ (0.30) $ 0.16 $ (0.15) Add back: Goodwill amortization $ -- $ -- $ 0.07 ----------- ----------- ----------- Adjusted net income (loss) $ (0.30) $ 0.16 $ (0.08) =========== =========== =========== 14. 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., an entity which is owned by certain principal stockholders/officers of the Company. 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. The Company's United Kingdom subsidiary also maintains a lease for office and warehouse space which expires in 2019. The Company leases office equipment under operating leases which expire on various dates between April 2004 and December 2006. The net lease expense was $555,197, $348,631 and $269,643 for the years ended December 31, 2003, 2002 and 2001, which includes $193,613 in 2003 and $208,844 in 2002 and 2001 to Pepper Road, Inc. The future aggregate minimum net lease payments under existing agreements as of December 31, as follows: Pepper Road, Total Inc. Other Lease Payments ------------ ---------- -------------- 2004 .................. $ 186,000 $ 356,532 $ 542,532 2005 .................. 186,000 346,905 532,905 2006 .................. 186,000 315,771 501,771 2007 .................. 186,000 286,728 472,728 2008 .................. 186,000 51,700 237,700 Thereafter ............ 155,000 568,700 723,700 ---------- ---------- ---------- Total .............. $1,085,000 $1,926,336 $3,011,336 ---------- ---------- ---------- Licenses At December 31, 2003, Company had 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: F-17 CTI Industries Corporation and Subsidiaries Notes to the Consolidated Financial Statements 14. Commitments and Contingencies, continued 2004..................... $86,664 2005..................... $76,664 15. 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. The Company intends to vigorously defend this action and to pursue its counterclaim. 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. 16. Sale/Leaseback of Building In November, 1999, the Company sold its building located next to its headquarters in Barrington, Illinois to Pepper Road, Inc. ("Pepper Road") for a gain of $300,467, and entered into an agreement to lease back the facility. Pepper Road is an entity in which officers/shareholders of the Company have a controlling interest. The gain realized on the sale was deferred and is being recognized into income over the 10 year lease term. 17. Relationship with Pepper Road, Inc. Pepper Road, Inc. ("Pepper Road") purchased from the Company certain real estate, including a building and leases that property to the Company under a 10 year lease. The unaudited financial statements of Pepper Road for its fiscal year ended December 31, 2003 include: Gross Lease Income ............................................. $ 193,615 Net Income ..................................................... $ 3,483 Assets, primarily land and building ............................ $1,819,328 Liabilities, primarily notes payable to bank ................... $1,818,272 Equity ......................................................... $ 1,056 The Company paid a total of $193,615 in lease payments to Pepper Road during 2003, and $208,844 in lease payments during 2002 and 2001, respectively. The lease commitments of the Company to Pepper Road are included in Note 14. Each of the following persons owns a one-third equity interest in Pepper Road: Howard Schwan, President, John Schwan, Chairman of the Board and Stephen Merrick, Executive Vice President. Each of the foregoing persons is a director and a significant shareholder of the Company. Management has concluded that the provisions of FIN 46 do not apply to the Company with respect to its transactions with Pepper Road, Inc. 18. Authorized Preferred Stock The Certificate of Incorporation of the Company authorizes the issuance, by the Board of Directors fixing all rights, preferences and designations, of up to 2,000,000 shares of Preferred Stock of the Company, no par value. No shares of this Preferred Stock have been issued and there are no shares of such stock issued or outstanding. 19. Stock Options and Warrants Under the Company's 1997 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, 2003. 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, F-18 CTI Industries Corporation and Subsidiaries Notes to the Consolidated Financial Statements 19. Stock Options and Warrants, continued 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, 2003, 147,027 options had been granted under the 1999 Stock Option Plan. The options are exercisable immediately upon grant, and have a term of ten years. On April 12, 2001 the Board of Directors approved for adoption, effective December 27, 2001, the 2001 Stock Option Plan ("Plan"). The Plan authorizes the grant of options to purchase up to an aggregate of 158,733 shares of the Company's Common Stock. As of December 31, 2003, 106,550 options had been granted under the 2001 Stock Option Plan. The options are 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, 2003, 58,930 options had been granted under the 2002 Stock Option Plan. The options are exercisable immediately upon grant and have a term of ten years. The exercise price for ISOs cannot be less than the fair market value of the stock subject to the option on the grant date (110% of such fair market value in the case of ISOs granted to a stockholder who owns more than 10% of the Company's Common Stock). The exercise price of a NQO shall be fixed by the Administrator at whatever price the Administrator may determine in good faith. Unless the Administrator determines otherwise, options generally have a 10-year term (or five years in the case of ISOs granted to a participant owning more than 10% of the total voting power of the Company's capital stock). Unless the Administrator provides otherwise, options terminate upon the termination of a participant's employment, except that the participant may exercise an option to the extent it was exercisable on the date of termination for a period of time after termination. In December, 1996, certain members of company management were issued warrants to purchase 76,923 shares of the Company's Common Stock at an exercise price of $2.73 per share in consideration of their facilitating and guaranteeing a bank loan to the Company in the amount of $6.3 million. The warrants had a term of six years and were exercised in 2002. 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 management were issued warrants to purchase 119,050 shares of the Company's Common Stock at an exercise price of $1.50 per share in consideration of their facilitating and guaranteeing and securing bank loans to the Company in the amount of $1.4 million and for advancing additional monies to the company that were repaid in 2001. The warrants have a term of five years. In March, 2003, certain members of management were issued warrants to purchase an aggregate of 163,000 shares of common stock of the Company at an exercise price of $4.87, per share, the then market price, in consideration of such persons making subordinated loans to the Company in the aggregate of $1,630,000, the warrants have a term of five years. See Note 7. F-19 CTI Industries Corporation and Subsidiaries Notes to the Consolidated Financial Statements 19. Stock Options and Warrants, continued 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, 2003, 2002 and 2001:
Weighted Weighted Weighted Avg. Avg. Avg. Dec. 31, Exercise Exercise Dec. 31, Exercise 2003 Price Dec. 31, 2002 Price 2001 Price -------- -------- ------------- -------- --------- -------- Outstanding and exercisable, beginning of period ... 572,862 $2.58 1,094,739 $2.04 884,814 $2.28 Granted ............................................ 170,000 2.22 79,764 2.22 240,482 2.01 Exercised .......................................... (8,334) 1.54 (601,245) 1.54 -- -- Cancelled .......................................... (8,929) 6.51 (396) 6.51 (30,557) 5.37 ------- ----- --------- ----- --------- ----- Outstanding and exercisable at the end of period ... 725,599 $2.58 572,862 $2.58 1,094,739 $2.04
At December 31, 2003, available options to grant were 76,930. Significant option and warrant groups outstanding at December 31, 2003 and related weighted average price and remaining life information are as follows: Exercise Remaining Grant Date Outstanding Exercisable Price Life (Years) - --------------------- ----------- ----------- -------- ------------ September 1997 ...... 5,953 5,953 $6.28 3 September 1998 ...... 92,463 92,463 $6.51 4 September 1998 ...... 11,905 11,905 $2.10 4 September 1999 ...... 19,079 19,079 $1.42 0 March 2000 .......... 138,693 138,693 $1.95 6 July 2001 ........... 119,050 119,050 $1.50 2 December 2001 ....... 100,597 100,597 $1.46 7 April 2002 .......... 11,905 11,905 $2.10 8 December 2002 ....... 55,954 55,954 $2.36 8 February 2003 ....... 163,000 163,000 $4.87 4 December 2003 ....... 7,000 7,000 $2.26 10 ------- ------- ----- Total Options and Warrants Outstanding .. 725,599 725,799 ======= ======= The weighted average fair value of options granted during the year ending December 31, 2003, 2002 and 2001 were $2.26, $1.92 and $1.48 per share, respectively. 20. 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. All references in the accompanying financial statements to the number of common shares and pre-share amounts for 2001 have been restated to reflect the stock dividend. 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 F-20 CTI Industries Corporation and Subsidiaries Notes to the Consolidated Financial Statements 20. Stock Dividend and Class B Common Stock Conversion, continued 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. 21. Earnings Per Share Basic earnings per share is computed by dividing the income available to common shareholders, net earnings, 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. Earnings per share for the years ended December 31, 2003, December 31, 2002 and December 31, 2001 was computed as follows:
Year Ended Year Ended Year Ended December 31, December 31, December 31, 2003 2002 2001 ------------ ------------ ------------ BASIC Average shares outstanding: Weighted average shares Outstanding during period .................... 1,918,260 1,688,384 1,511,958 ============ =========== =========== Earnings: Net (loss) income ................................. $ (566,047) $ 302,512 $ (232,292) ============ =========== =========== Amount for per share Computation .................................... $ (566,047) $ 302,512 $ (232,292) ============ =========== =========== Net (loss) earnings applicable to Common shares ................................ $ (0.30) $ 0.18 $ (0.15) ============ =========== =========== DILUTED Average shares outstanding: Weighted average shares Outstanding .................................. 1,918,260 1,688,384 1,511,958 Common stock equivalents (options/warrants) .... 196,021 -- ------------ ----------- ----------- Weighted average shares Outstanding during period ...................... 1,918,260 1,884,405 1,511,958 ============ =========== =========== Earnings: Net (loss) income .............................. $ (566,047) $ 302,512 $ (232,292) ============ =========== =========== Amount for per share Computation .................................... $ (566,047) $ 302,512 $ (232,292) ============ =========== =========== Net (loss) earnings applicable to Common shares ................................ $ (0.30) $ 0.16 $ (0.15) ============ =========== ===========
F-21 CTI Industries Corporation and Subsidiaries Notes to the Consolidated Financial Statements 22. 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, and December 31, 2003 are as follows:
United States United Kingdom Mexico Eliminations Consolidated ------------ ------------ ------------ ------------ ------------ Year ended 12/31/03 Revenues ............... $ 32,686,979 $ 2,415,028 $ 4,003,217 $ (2,845,586) $ 36,259,638 Operating income ....... (246,299) 190,521 (527,767) (95,676) (679,221) Net income (loss) ...... (883,369) 163,218 249,297 (95,193) (566,047) Total Assets ........... $ 27,602,666 $ 1,412,352 $ 5,475,850 $ (4,220,686) $ 30,270,182 Year ended 12/31/02 Revenues ............... $ 37,418,425 $ 1,965,736 $ 5,235,119 $ (3,382,804) $ 41,236,476 Operating income ....... 1,259,905 68,535 212,174 (95,674) 1,444,940 Net income (loss) ...... 451,582 40,065 (99,724) (89,411) 302,512 Total Assets ........... $ 26,311,194 $ 979,959 $ 4,982,751 $ (2,002,046) $ 30,271,858 Year ended 12/31/01 Revenues ............... $ 24,706,305 $ 1,672,672 $ 5,940,039 $ (4,872,522) $ 27,446,494 Operating income ....... 1,089,865 66,594 128,002 (267,739) 1,016,722 Net income (loss) ...... (104,384) 49,697 46,451 (224,056) (232,292) Total Assets ........... $ 20,354,875 $ 620,228 $ 5,785,584 $ (2,096,462) $ 24,664,225
23. Fourth Quarter Adjustments, 2002 During the fourth quarter of 2002, the Company determined that adjustments to inventory, intercompany accounts, and other accounts were necessary. The net effect of these fourth quarter adjustments did not materially effect the operating results of the first three quarters of 2002. During the fourth quarter of 2003, the Company determined that adjustments to inventory and projects in process accounts were necessary. The net effect of these fourth quarter adjustments did not materially affect the operating results of the first three quarters of 2003. F-22 EX-10.15 3 d59262_ex10-15.txt LOAN AND SECURITY AGREEMENT EXHIBIT 10.15 LOAN AND SECURITY AGREEMENT DATED AS OF DECEMBER 31, 2003 AMONG COLE TAYLOR BANK, AS LENDER, AND CTI INDUSTRIES CORPORATION, AND CTI HELIUM, INC., AS BORROWERS TABLE OF CONTENTS Page 1. DEFINITIONS; RULES OF INTERPRETATION.......................................1 (a) Defined Terms.....................................................1 (b) Accounting Terms..................................................1 (c) Terms Defined in UCC..............................................2 (d) Other Definitional Provisions; Construction.......................2 (e) References to Agreements, Enactments, Etc.........................2 2. LOANS......................................................................2 (a) Revolving Loans...................................................2 (b) Term Loan.........................................................4 (c) Repayments........................................................4 (d) Notes.............................................................5 3. LETTERS OF CREDIT..........................................................6 (a) General Terms.....................................................6 (b) Requests for Letters of Credit....................................6 (c) Obligations Absolute..............................................6 (d) Expiration Dates of Letters of Credit.............................7 4. INTEREST, FEES AND CHARGES.................................................7 (a) Interest Rate.....................................................7 (b) Fees and Charges..................................................7 (c) Maximum Interest..................................................8 5. COLLATERAL.................................................................8 (a) Grant of Security Interest to Lender..............................8 (b) Other Security....................................................9 (c) Possessory Collateral.............................................9 (d) Electronic Chattel Paper..........................................9 (e) Letter-of-Credit Rights...........................................9 (f) Third-Party Collateral...........................................10 (g) Deposit Account..................................................10 6. PRESERVATION OF COLLATERAL AND PERFECTION OF SECURITY INTERESTS THEREIN...10 7. POSSESSION OF COLLATERAL AND RELATED MATTERS..............................10 8. COLLECTIONS...............................................................11 9. COLLATERAL, AVAILABILITY AND FINANCIAL REPORTS AND SCHEDULES..............12 (a) Weekly Reports...................................................12 (b) Monthly Reports..................................................12 (c) Financial Statements.............................................13 (d) Annual Projections...............................................13 i TABLE OF CONTENTS (continued) Page (e) Explanation of Budgets and Projections...........................13 (f) Public Reporting.................................................14 (h) Other Information................................................14 10. TERMINATION; AUTOMATIC RENEWAL............................................14 11. REPRESENTATIONS AND WARRANTIES............................................15 (a) Financial Statements and Other Information.......................15 (b) Locations; Certain Collateral....................................15 (c) Loans by Borrower................................................15 (d) Accounts and Inventory...........................................15 (e) Liens............................................................16 (f) Organization, Authority and No Conflict..........................16 (g) Litigation.......................................................16 (h) Compliance with Laws and Maintenance of Permits..................16 (i) Affiliate Transactions...........................................16 (j) Names and Trade Names............................................17 (k) Equipment........................................................17 (l) Enforceability...................................................17 (m) Solvency.........................................................17 (n) Indebtedness.....................................................17 (o) Margin Security and Use of Proceeds..............................17 (p) Parent, Subsidiaries and Affiliates..............................17 (q) No Defaults......................................................17 (r) Employee Matters.................................................18 (s) Intellectual Property............................................18 (t) Environmental Matters............................................18 (u) ERISA Matters....................................................18 (v) Collective Enterprise............................................18 12. AFFIRMATIVE COVENANTS.....................................................19 (a) Maintenance of Records...........................................19 (b) Notices..........................................................19 (c) Compliance with Laws and Maintenance of Permits..................20 (d) Inspection and Audits............................................21 (e) Insurance........................................................21 (f) Collateral.......................................................22 (g) Use of Proceeds..................................................23 (h) Taxes............................................................23 (i) Intellectual Property............................................23 (j) Financial Services Accounts......................................23 13. NEGATIVE COVENANTS........................................................24 (a) Indebtedness.....................................................24 (b) Liens............................................................24 ii TABLE OF CONTENTS (continued) Page (c) Mergers, Sales, Acquisitions, Subsidiaries and Other Transactions Outside the Ordinary Course of Business.............24 (d) Dividends and Distributions......................................25 (e) Investments; Loans...............................................25 (f) Fundamental Changes, Line of Business............................25 (g) Equipment........................................................25 (h) Affiliate Transactions...........................................25 (i) Settling of Accounts.............................................25 (j) Management Fees; Compensation....................................26 14. FINANCIAL COVENANTS.......................................................26 (a) Tangible Net Worth...............................................26 (b) Fixed Charge Coverage............................................27 (c) Capital Expenditure Limitations..................................27 (d) Operating Lease Obligations......................................27 15. DEFAULT...................................................................27 (a) Payment..........................................................27 (b) Breach of this Agreement and the Other Agreements................27 (c) Breaches of Other Obligations....................................27 (d) Breach of Representations and Warranties.........................28 (e) Loss of Collateral...............................................28 (f) Levy, Seizure or Attachment......................................28 (g) Bankruptcy or Similar Proceedings................................28 (h) Appointment of Receiver..........................................28 (i) Judgment.........................................................28 (j) Death or Dissolution of Obligor..................................28 (k) Default or Revocation of Guaranty; Subordination Agreement.......29 (l) Criminal Proceedings.............................................29 (m) Change of Control................................................29 (n) Change of Management.............................................29 (o) Material Adverse Change..........................................29 16. REMEDIES UPON AN EVENT OF DEFAULT.........................................29 17. CONDITIONS PRECEDENT......................................................30 18. JOINT AND SEVERAL LIABILITY...............................................31 19. INDEMNIFICATION...........................................................33 20. NOTICE....................................................................33 21. CHOICE OF GOVERNING LAW; CONSTRUCTION; FORUM SELECTION....................33 22. MODIFICATION AND BENEFIT OF AGREEMENT.....................................34 23. HEADINGS OF SUBDIVISIONS..................................................35 24. POWER OF ATTORNEY.........................................................35 25. CONFIDENTIALITY...........................................................35 26. COUNTERPARTS..............................................................35 iii TABLE OF CONTENTS (continued) Page 27. ELECTRONIC SUBMISSIONS....................................................35 28. WAIVER OF JURY TRIAL; OTHER WAIVERS.......................................36 iv ANNEX 1 - DEFINITIONS EXHIBIT A - BORROWING BASE CERTIFICATE EXHIBIT B - COMPLIANCE CERTIFICATE SCHEDULE 1 - PERMITTED LIENS SCHEDULE 11(b) - BUSINESS AND COLLATERAL LOCATIONS; CERTAIN COLLATERAL SCHEDULE 11(g) - LITIGATION SCHEDULE 11(i) - AFFILIATE TRANSACTIONS SCHEDULE 11(j) - NAMES & TRADE NAMES SCHEDULE 11(n) - INDEBTEDNESS SCHEDULE 11(p) - PARENT, SUBSIDIARIES AND AFFILIATES SCHEDULE 11(s) - INTELLECTUAL PROPERTY LOAN AND SECURITY AGREEMENT THIS LOAN AND SECURITY AGREEMENT (as amended, modified or supplemented from time to time, this "Agreement"), made this 31st day of December, 2003, by and among COLE TAYLOR BANK, an Illinois corporation ("Lender"), 111 West Washington Street, Suite 400, Chicago, Illinois 60602, and CTI INDUSTRIES CORPORATION, an Illinois corporation, having its principal place of business at 22160 N. Pepper Road, Barrington, Illinois 60010 ("CTI Industries"), and CTI HELIUM, INC., an Illinois corporation, having its principal place of business at 22160 N. Pepper Road, Barrington, Illinois 60010 ("CTI Helium") (CTI Industries and CTI Helium are collectively referred to herein as "Borrowers"). W I T N E S S E T H: WHEREAS, Borrowers may, from time to time, request Loans from Lender, and the parties wish to provide for the terms and conditions upon which such Loans or other financial accommodations, if made by Lender, shall be made; NOW, THEREFORE, in consideration of any Loan (including any Loan by renewal or extension) hereafter made to a Borrower by Lender, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged by Borrowers, the parties agree as follows: 1. DEFINITIONS; RULES OF INTERPRETATION. (a) Defined Terms. For the purposes of this Agreement, the following capitalized words and phrases shall have the meanings set forth in Annex I attached hereto and made a part hereof. (b) Accounting Terms. Any accounting terms used in this Agreement which are not specifically defined herein shall have the meanings customarily given them in accordance with GAAP. Calculations and determinations of financial and accounting terms used and not otherwise specifically defined hereunder and the preparation of financial statements to be furnished to the Lender pursuant hereto shall be made and prepared, both as to classification of items and as to amount, in accordance with GAAP as used in the preparation of the financial statements of the Borrowers on the date of this Agreement. If any changes in accounting principles or practices from those used in the preparation of the financial statements are hereafter occasioned by the promulgation of rules, regulations, pronouncements and opinions by or required by the Financial Accounting Standards Board or the American Institute of Certified Public Accountants (or any successor thereto or agencies with similar functions), which results in a material change in the method of accounting in the financial statements required to be furnished to the Lender hereunder or in the calculation of financial covenants, standards or terms contained in this Agreement, the parties hereto agree to enter into good-faith negotiations to amend such provisions so as equitably to reflect such changes to the end that the criteria for evaluating the financial condition and performance of the Borrowers will be the same after such changes as they were before such changes; and, if the parties fail to agree on the amendment of such provisions, the Borrowers will furnish financial statements in accordance with such changes but shall provide calculations for all financial covenants, perform all financial covenants and otherwise observe all financial standards and terms in accordance with applicable accounting principles and practices in effect immediately prior to such changes. (c) Terms Defined in UCC. The terms "Account," "Account Debtor," "Certificated Security," "Chattel Paper," "Commercial Tort Claim," "Deposit Account," "Document," "Electronic Chattel Paper," "Equipment," "Financial Asset," "Fixture," "General Intangible," "Goods," "Health-Care-Insurance Receivables," "Instrument," "Inventory," "Investment Property," "Letter-of-Credit Right," "Payment Intangible," "Proceeds," "Security," "Securities Account," "Security Entitlement," "Software," "Supporting Obligation," "Tangible Chattel Paper" and "Uncertificated Security" shall have the respective meanings assigned to such terms in the UCC. All other capitalized words and phrases used herein and not otherwise specifically defined shall have the respective meanings assigned to such terms in the UCC, to the extent the same are used or defined therein. (d) Other Definitional Provisions; Construction. Whenever the context so requires, the neuter gender includes the masculine and feminine, the single number includes the plural, and vice versa, and in particular the word "Borrower" shall be so construed. The words "hereof", "herein" and "hereunder" and words of similar import when used in this Agreement shall refer to this Agreement as a whole and not to any particular provision of this Agreement, and references to Article, Section, Subsection, Annex, Schedule, Exhibit and like references are references to this Agreement unless otherwise specified. The word "including" shall mean "including, without limitation". An Event of Default shall "continue" or be "continuing" until such Event of Default has been waived in accordance with Section 28(e) hereof. References in this Agreement to any party shall include such party's successors and permitted assigns. References to any "Section" shall be a reference to such Section of this Agreement unless otherwise stated. To the extent any of the provisions of the Other Agreements are inconsistent with the terms of this Loan Agreement, the provisions of this Loan Agreement shall govern. This Agreement and the Other Agreements are the result of negotiations among and have been reviewed by counsel to the Lender, Borrowers and any other parties thereto, are the product of all parties and, accordingly, shall not be construed against the Lender. (e) References to Agreements, Enactments, Etc. Unless otherwise expressly provided herein, (i) references to agreements (including this Agreement) and other contractual instruments shall be deemed to include all subsequent amendments, restatements, supplements and other modifications thereto, but only to the extent such amendments and other modifications are not prohibited by the terms of this Agreement or any Other Agreement, and (ii) references to any statute or regulation shall be construed as including all statutory and regulatory provisions amending, replacing, supplementing or interpreting such statute or regulation. 2. LOANS. (a) Revolving Loans. Subject to the terms and conditions of this Agreement and the Other Agreements, during the Original Term and any Renewal Term, Lender shall, absent the occurrence of an Event of Default, make revolving loans and advances to Borrowers (the "Revolving Loans") in an amount up to the sum of the following sublimits (the "Revolving Borrowing Base Amount"): 2 (i) Up to eighty-five percent (85%), or such lesser percentage as determined by Lender in its sole discretion exercised in good faith, of the face amount (less maximum discounts, credits and allowances which may be taken by or granted to Account Debtors in connection therewith in the ordinary course of such Borrower's business) of Borrowers' Eligible Accounts; provided that such advance rate shall be reduced by one (1) percentage point for each whole or partial percentage point by which Dilution (as determined by Lender in good faith based on the results of the most recent twelve (12) month period for which Lender has conducted a field audit of Borrowers) exceeds five percent (5%); plus (ii) Up to the lesser of (A) fifty percent (50%), or such lesser percentage as determined by Lender in its sole discretion exercised in good faith, of the lower of cost or market value of Borrowers' Eligible Inventory (which shall include work-in-process Inventory) or (B) an amount not to exceed ninety percent (90%) of the Net Orderly Liquidation Value of Borrowers' Inventory or (C) Three Million Seven Hundred Fifty Thousand and No/100 Dollars ($3,750,000), whichever is less; minus (iii) such reserves as Lender elects, in its sole discretion, to establish from time to time; provided, that (w) the Revolving Borrowing Base Amount shall in no event exceed Seven Million Five Hundred Thousand and No/100 Dollars ($7,500,000) (the "Maximum Revolving Loan Limit") except as such amount may be increased or decreased by Lender, in its sole discretion, (x) the sum of the advances to all Borrowers with respect to clause (ii) above relative to Inventory consisting of packaging and related materials shall at no time exceed Four Hundred Thousand Dollars ($400,000), (y) the sum of all advances with respect to Third-Party Inventory (to the extent any such advances are otherwise permitted hereunder) shall at no time exceed Two Hundred Thousand Dollars ($200,000), and (z) the amount of Eligible Inventory advances with respect to clause "(ii)" above shall include a "costing revaluation" of up to the lesser of $750,000 or the actual amount of the "costing revaluation" line item on the most recent inventory report delivered to Lender. The aggregate unpaid principal balance of the Revolving Loans shall not at any time exceed the lesser of the (i) Revolving Borrowing Base Amount minus the Letter of Credit Obligations and (ii) the Maximum Revolving Loan Limit minus the Letter of Credit Obligations. If at any time the amount of outstanding Revolving Loans exceeds either the Revolving Borrowing Base Amount or the Maximum Revolving Loan Limit, in each case minus the Letter of Credit Obligations, or any portion of the Revolving Loans and Letter of Credit Obligations exceeds any applicable sublimit within the Revolving Borrowing Base Amount, Borrowers shall immediately, and without the necessity of demand by Lender, pay to Lender such amount as may be necessary to eliminate such excess and Lender shall apply such payment to the Revolving Loans in such order as Lender shall determine in its sole discretion. Each Borrower hereby authorizes Lender, in its sole discretion, to charge any of such Borrower's accounts or advance Revolving Loans to make any payments of 3 principal, interest, fees, costs or expenses required to be made under this Agreement or the Other Agreements. A request for a Revolving Loan shall be made or shall be deemed to be made, each in the following manner: The Borrower requesting such Revolving Loan shall give Lender same-day notice, no later than 1:00 p.m. (determined based on the local time of each Borrower at its principal place of business) on such day, of its request for a Revolving Loan. In the event that a Borrower maintains a controlled disbursement account with Lender, each check presented for payment against such controlled disbursement account and any other charge or request for payment against such controlled disbursement account shall constitute a request for a Revolving Loan as a Prime Rate Revolving Loan. As an accommodation to Borrowers, Lender may permit telephone requests for Revolving Loans and electronic transmittal of instructions, authorizations, agreements or reports to Lender by Borrowers. Unless a Borrower specifically directs Lender in writing not to accept or act upon telephonic or electronic communications from such Borrower, Lender shall have no liability to Borrowers for any loss or damage suffered by a Borrower as a result of Lender's honoring of any requests, execution of any instructions, authorizations or agreements or reliance on any reports communicated to it telephonically or electronically and purporting to have been sent to Lender by a Borrower, and Lender shall have no duty to verify the origin of any such communication or the authority of the Person sending it. Each Borrower hereby irrevocably authorizes Lender to disburse the proceeds of each Revolving Loan requested by such Borrower, or deemed to be requested by such Borrower, as follows: the proceeds of each Revolving Loan requested under Section 2(a) shall be disbursed by Lender in lawful money of the United States of America in immediately available funds, in the case of the initial borrowing, in accordance with the terms of the written disbursement letter from such Borrower and, in the case of each subsequent borrowing, by wire transfer or Automated Clearing House (ACH) transfer to such bank account as may be agreed upon by such Borrower and Lender from time to time, or elsewhere if pursuant to a written direction from such Borrower. (b) Term Loan. Subject to the terms and conditions of this Agreement and the Other Agreements, on the date that the conditions to the initial Loans are satisfied, Lender shall make a term loan to Borrowers in an amount equal to the lesser of (i) Three Million Five Hundred Thousand and No/100 Dollars ($3,500,000) and (ii) eighty-five percent (85%) of the net orderly liquidation value of Borrowers' Equipment (as determined by an appraiser acceptable to Lender) (the "Term Loan"). Such Equipment shall be subject to the first-priority perfected security interest in favor of Lender and to no other Lien whatsoever, other than Permitted Liens. Amounts repaid with respect to the Term Loan may not be reborrowed. (c) Repayments. The Obligations shall be repaid as follows: (i) Repayment of Revolving Loans. The Revolving Loans and all other Obligations (other than the Term Loan) shall be repaid on the last day of the 4 Original Term or any Renewal Term if this Agreement is renewed pursuant to Section 10 hereof. (ii) Repayment of Term Loan. The Term Loan shall be repaid in sixty (60) equal monthly installments of Fifty-Eight Thousand Three Hundred Thirty-Three Dollars ($58,333.00) each, payable beginning on February 1, 2004 and on the first day of each month thereafter; provided, that any remaining outstanding principal balance of the Term Loan shall be repaid at the end of the Original Term or any Renewal Term if this Agreement is renewed pursuant to Section 10 hereof or at any time this Agreement is terminated pursuant to the terms hereof. If any such payment due date is not a Business Day, then such payment may be made on the next succeeding Business Day and such extension of time shall be included in the computation of the amount of interest and fees due hereunder. (iii) Mandatory Prepayments of the Term Loan. (A) Sales of Assets. Upon receipt of the proceeds of the sale or other disposition of any Equipment or real property of a Borrower which is subject to any mortgage lien in favor of Lender, or if any of the Equipment or real property subject to such mortgage is damaged, destroyed or taken by condemnation in whole or in part, the proceeds thereof shall be paid by such Borrower to Lender as a mandatory prepayment of the Term Loan, such payment to be applied against the remaining installments of principal in the inverse order of their maturities until repaid in full, and then against the other Obligations, as determined by Lender, in its sole discretion. (B) Excess Cash Flow. Ten (10) days after receipt of Borrowers' Fiscal Year end audited financial statements for each Fiscal Year of Borrowers commencing with Borrowers' Fiscal Year ended December 31, 2004, Borrowers shall make a mandatory prepayment of the Term Loan in an amount equal to fifty percent (50%) of Borrowers' "Excess Cash Flow" (as described below) for the Fiscal Year just ended, such prepayment to be applied against the remaining installments of principal in the inverse order of their maturities, such mandatory prepayments to continue for each Fiscal Year until the ratio of (i) all Term Loans hereunder to (ii) the net orderly liquidation value of the Equipment of Borrowers (based on appraisals in form and substance acceptable to Lender in its sole discretion) is greater than eighty percent (80%) for such Fiscal Year. For purposes hereof, "Excess Cash Flow" shall mean, for each of Borrowers' Fiscal Years, Borrowers' EBITDA for such period, minus Borrowers' taxes actually paid during such period and any distributions to their shareholders in respect of taxes actually paid for such period, minus cash interest actually paid during such period, minus actual principal payments made with respect to long-term debt during such period, minus all unfinanced Capital Expenditures by Borrowers during such period. (d) Notes. The Loans shall, in Lender's sole discretion, be evidenced by one or more promissory notes in form and substance satisfactory to Lender. However, if such Loans are not so evidenced, such Loans 5 may be evidenced solely by entries upon the books and records maintained by Lender. 3. LETTERS OF CREDIT. (a) General Terms. As of the Closing Date, no Letter of Credit Obligations are outstanding. Subject to the terms and conditions of this Agreement and the Other Agreements, during the Original Term or any Renewal Term, Lender shall, in its sole discretion, absent an Event of Default, from time to time cause to be issued and co-sign for or otherwise guarantee, upon a Borrower's request, commercial and/or standby Letters of Credit; provided, that the aggregate undrawn face amount of all such Letters of Credit shall at no time exceed an amount determined by Lender in its sole discretion. Payments made by Lender to any Person on account of any Letter of Credit shall constitute Loans hereunder, and each Borrower agrees that each payment made by the issuer of a Letter of Credit in respect of a Letter of Credit issued on behalf of such Borrower shall constitute a request by such Borrower for a Loan to reimburse such issuer. Borrowers shall remit to Lender a Letter of Credit fee in an amount agreed between Lender and Borrowers per month on the aggregate undrawn face amount of all Letters of Credit outstanding, which fee shall be payable monthly in arrears on the last Business Day of each month. Borrowers shall also pay on demand the normal and customary administrative charges of the issuer of the Letter of Credit for issuance, amendment, negotiation, renewal or extension of any Letter of Credit. (b) Requests for Letters of Credit. Each Borrower shall make requests for Letters of Credit in writing at least two (2) Business Days prior to the date such Letter of Credit is to be issued. Each such request shall specify the date such Letter of Credit is to be issued, the amount thereof, the name and address of the beneficiary thereof and a description of the transaction to be supported thereby. Any such notice shall be accompanied by the form of Letter of Credit requested and any application or reimbursement agreement required by the issuer of such Letter of Credit. If any term of such application or reimbursement agreement is inconsistent with this Agreement, then the provisions of this Agreement shall control to the extent of such inconsistency. (c) Obligations Absolute. Each Borrower shall be obligated to reimburse the issuer of any Letter of Credit, or Lender if Lender has reimbursed such issuer on a Borrower's behalf, for any payments made in respect of any Letter of Credit, which obligation shall be unconditional and irrevocable and shall be paid regardless of: (i) any lack of validity or enforceability of any Letter of Credit, (ii) any amendment or waiver of or consent or departure from all or any provisions of any Letter of Credit, this Agreement or any Other Agreement, (iii) the existence of any claim, setoff, defense or other right which a Borrower or any other Person may have against any beneficiary of any Letter of Credit, Lender or the issuer of the Letter of Credit, (iv) any draft or other document presented under any Letter of Credit proving to be forged, fraudulent, invalid or insufficient in any respect or any statement therein being untrue or inaccurate in any respect, (v) any payment under any Letter of Credit against presentation of a draft or other document that does not comply with the terms of such Letter of Credit, and (vi) any other act or omission to act or delay of any kind of the issuer of such Letter of Credit, the Lender or any other Person or any other event or circumstance that might otherwise constitute a legal or equitable discharge of a Borrower's obligations hereunder. It is understood 6 and agreed by each Borrower that the issuer of any Letter of Credit may accept documents that appear on their face to be in order without further investigation or inquiry, regardless of any notice or information to the contrary. (d) Expiration Dates of Letters of Credit. The expiration date of each Letter of Credit shall be no later than the earlier of (i) one (1) year from the date of issuance and (ii) the thirtieth (30th) day prior to the end of the Original Term or any Renewal Term. Notwithstanding the foregoing, a Letter of Credit may provide for automatic extensions of its expiration date for one or more one (1) year periods, so long as the issuer thereof has the right to terminate the Letter of Credit at the end of each one (1) year period and no extension period extends past the thirtieth (30th) day prior to the end of the Original Term or any Renewal Term. 4. INTEREST, FEES AND CHARGES. (a) Interest Rate. Each Revolving Loan and the Term Loan shall bear interest at the rate of one and one-half percent (1 1/2%) per annum in excess of the Prime Rate in effect from time to time, all such interest to be payable on the first Business Day of each month in arrears. Said rate of interest shall increase or decrease by an amount equal to each increase or decrease in the Prime Rate effective on the effective date of each such change in the Prime Rate. Upon the occurrence of an Event of Default and during the continuance thereof, each Loan shall bear interest at the rate of two percent (2%) per annum in excess of the interest rate otherwise payable thereon, which interest shall be payable on demand. All interest shall be calculated on the basis of a 360-day year. (b) Fees and Charges. (i) Closing Fee: Borrowers shall jointly and severally pay to Lender a closing fee of One Hundred Ten Thousand Dollars ($110,000), which fee shall be fully earned and payable on the date of disbursement of the initial Loans hereunder. (ii) Costs and Expenses: Borrowers shall reimburse Lender for all costs and expenses, including, without limitation, legal expenses and reasonable attorneys' fees (whether for internal or outside counsel), incurred by Lender in connection with the (i) documentation and consummation of this transaction and any other transactions between Borrowers and Lender, including, without limitation, Uniform Commercial Code and other public record searches and filings, overnight courier or other express or messenger delivery, appraisal costs, surveys, title insurance and environmental audit or review costs; (ii) collection, protection or enforcement of any rights in or to the Collateral; (iii) collection of any Obligations; and (iv) administration and enforcement of any of Lender's rights under this Agreement or any Other Agreement. Borrowers shall also pay all normal service charges with respect to all accounts maintained by each Borrower with Lender and any additional services requested by a Borrower from Lender. All such costs, expenses and charges shall, if owed to Lender, be reimbursed by Lender and in such event or in the event such costs and expenses are owed to Lender, shall constitute Obligations hereunder, shall be payable by Borrowers to Lender on demand and, until paid, shall bear interest at the highest rate then applicable to Loans hereunder. 7 (iii) Capital Adequacy Charge. If Lender shall have determined that the adoption of any law, rule or regulation regarding capital adequacy, or any change therein or in the interpretation or application thereof, or compliance by Lender with any request or directive regarding capital adequacy (whether or not having the force of law) from any central bank or governmental authority enacted after the date hereof, does or shall have the effect of reducing the rate of return on such party's capital as a consequence of its obligations hereunder to a level below that which Lender could have achieved but for such adoption, change or compliance (taking into consideration Lender's policies with respect to capital adequacy) by a material amount, then from time to time, after submission by Lender to Borrowers of a written demand therefor ("Capital Adequacy Demand") together with the certificate described below, Borrowers shall pay to Lender such additional amount or amounts ("Capital Adequacy Charge") as will compensate Lender for such reduction, such Capital Adequacy Demand to be made with reasonable promptness following such determination. A certificate of Lender claiming entitlement to payment as set forth above shall be conclusive in the absence of manifest error. Such certificate shall set forth the nature of the occurrence giving rise to such reduction, the amount of the Capital Adequacy Charge to be paid to Lender, and the method by which such amount was determined. In determining such amount, Lender may use any reasonable averaging and attribution method, applied on a nondiscriminatory basis. (c) Maximum Interest. It is the intent of the parties that the rate of interest and other charges to each Borrower under this Agreement and the Other Agreements shall be lawful; therefore, if for any reason the interest or other charges payable under this Agreement are found by a court of competent jurisdiction, in a final determination, to exceed the limit which Lender may lawfully charge such Borrower, then the obligation to pay interest and other charges shall automatically be reduced to such limit and, if any amount in excess of such limit shall have been paid, then such amount shall be refunded to such Borrower. 5. COLLATERAL. (a) Grant of Security Interest to Lender. As security for the payment of all Loans now or in the future made by Lender to Borrowers hereunder and for the payment or other satisfaction of all other Obligations, each Borrower hereby assigns to Lender and grants to Lender a continuing security interest in the following property of such Borrower, whether now or hereafter owned, existing, acquired or arising and wherever now or hereafter located: (a) all Accounts (whether or not Eligible Accounts) and all Goods whose sale, lease or other disposition by such Borrower has given rise to Accounts and have been returned to, or repossessed or stopped in transit by, such Borrower; (b) all Chattel Paper, Instruments, Documents and General Intangibles (including, without limitation, all Intellectual Property, licenses, software, franchises, tax refund claims, claims against carriers and shippers, guarantee claims, contract rights, Payment Intangibles, security interests, security deposits and rights to indemnification); (c) all Inventory (whether or not Eligible Inventory); (d) all Goods (other than Inventory), including, without limitation, Equipment, vehicles and Fixtures; (e) all Investment Property; (f) all Deposit Accounts, bank accounts, deposits and cash; (g) all Letter-of-Credit Rights; (h) Commercial Tort Claims listed on Schedule 11(b) hereto from time to time; (i) any other property of such Borrower now or hereafter in the possession, custody or control of Lender or any agent or any 8 parent, affiliate or subsidiary of Lender or any participant with Lender in the Loans, for any purpose (whether for safekeeping, deposit, collection, custody, pledge, transmission or otherwise) and (j) all additions and accessions to, substitutions for, and replacements, products and Proceeds of the foregoing property, including, without limitation, proceeds of all insurance policies insuring the foregoing property, and all of such Borrower's books and records relating to any of the foregoing and to such Borrower's business. (b) Other Security. Lender, in its sole discretion, without waiving or releasing any obligation, liability or duty of a Borrower under this Agreement or the Other Agreements or any Event of Default, may at any time or times hereafter, but shall not be obligated to, pay, acquire or accept an assignment of any Lien asserted by any Person in, upon or against the Collateral, provided, that Lender may take such actions with respect to Permitted Liens only after the occurrence and during the continuance of an Event of Default. All sums paid by Lender in respect thereof and all costs, fees and expenses, including, without limitation, reasonable attorney fees, all court costs and all other charges relating thereto incurred by Lender shall constitute Obligations payable by Borrowers to Lender on demand and, until paid, shall bear interest at the highest rate then applicable to Loans hereunder. (c) Possessory Collateral. Immediately upon a Borrower's receipt of any portion of the Collateral evidenced by an agreement, Instrument or Document, including, without limitation, any Tangible Chattel Paper and any Investment Property consisting of Certificated Securities, such Borrower shall deliver the original thereof to Lender together with an appropriate endorsement or other specific evidence of assignment thereof to Lender (in form and substance acceptable to Lender). If an endorsement or assignment of any such items shall not be made for any reason, Lender is hereby irrevocably authorized, as each Borrower's attorney and agent-in-fact, to endorse or assign the same on such Borrower's behalf. (d) Electronic Chattel Paper. To the extent that a Borrower obtains or maintains any Electronic Chattel Paper, such Borrower shall create, store and assign the record or records comprising the Electronic Chattel Paper in such a manner that (i) a single authoritative copy of the record or records exists which is unique, identifiable and, except as otherwise provided in clauses (iv), (v) and (vi) below, unalterable, (ii) the authoritative copy identifies Lender as the assignee of the record or records, (iii) the authoritative copy is communicated to and maintained by the Lender or its designated custodian, (iv) copies or revisions that add or change an identified assignee of the authoritative copy can only be made with the participation of Lender, (v) each copy of the authoritative copy and any copy of a copy is readily identifiable as a copy that is not the authoritative copy and (vi) any revision of the authoritative copy is readily identifiable as an authorized or unauthorized revision. (e) Letter-of-Credit Rights. If Borrower at any time is a beneficiary under a letter of credit now or hereafter issued in favor of Borrower, at the request and option of Lender, Borrower shall, pursuant to an agreement in form and substance satisfactory to Lender, either (i) arrange for the issuer and any confirmer of such letter of credit to consent to an assignment to Lender of the proceeds of any drawing under the letter of credit, or (ii) arrange for Lender to become the transferee beneficiary of the letter of credit, with Lender agreeing, in each case, that the proceeds of any drawing under the letter to credit are to be applied as provided in this Agreement. 9 (f) Third-Party Collateral. If Borrower shall at any time hold or acquire an interest in Collateral in the possession of a third party (other than Certificated Securities and Goods covered by a Document), Borrower shall immediately obtain an acknowledgment from the third party that it is holding such Collateral for the benefit of the Lender and a collateral access agreement in favor of Lender in form and substance satisfactory to Lender. (g) Deposit Account. Borrower shall deliver to Lender with respect to each Deposit Account maintained by Borrower now or hereafter (other than with Lender) and that is permitted hereby, upon obtaining an interest in such Deposit Account, a deposit account control agreement in form and substance satisfactory to Lender, executed by the financial institution at which such account is maintained, and shall take such other actions as Lender may request to ensure that Lender's security interest in such account is perfected by control as such term is used in UCC Section 9-104. 6. PRESERVATION OF COLLATERAL AND PERFECTION OF SECURITY INTERESTS THEREIN. Each Borrower shall, at Lender's request, at any time and from time to time, authenticate, execute and deliver to Lender such financing statements, documents and other agreements and instruments (and pay the costs of filing or recording the same in all public offices deemed necessary or desirable by Lender) and do such other acts and things or cause third parties to do such other acts and things as Lender may deem necessary or desirable in its sole discretion in order to establish and maintain a valid, attached and perfected security interest in the Collateral in favor of Lender (free and clear of all other Liens, except Permitted Liens) to secure payment of the Obligations, and in order to facilitate the collection of the Collateral. Each Borrower irrevocably hereby makes, constitutes and appoints Lender (and all Persons designated by Lender for that purpose) as such Borrower's true and lawful attorney and agent-in-fact to execute and file such financing statements, documents and other agreements and instruments and do such other acts and things as may be necessary to preserve and perfect Lender's security interest in the Collateral. Each Borrower further agrees that a carbon, photographic, photostatic or other reproduction of this Agreement or of a financing statement shall be sufficient as a financing statement; each Borrower further ratifies and confirms the prior filing by Lender of any and all financing statements which identify such Borrower as debtor, Lender as secured party and any or all Collateral as collateral. 7. POSSESSION OF COLLATERAL AND RELATED MATTERS. Until otherwise notified by Lender following the occurrence of an Event of Default, each Borrower shall have the right, except as otherwise provided in this Agreement, in the ordinary course of such Borrower's business, to (a) sell, lease or furnish under contracts of service any of such Borrower's Inventory normally held by such Borrower for any such purpose; and (b) use and consume any raw materials, work in process or other materials normally held by such Borrower for such purpose; and (c) dispose of obsolete or unuseful Equipment so long as all of the proceeds thereof are paid to Lender for application to the Obligations (except for such proceeds as are required to be delivered to the holder of a Permitted Lien which is prior in right of payment); provided, however, that a sale in the ordinary course of business shall not include any transfer or sale in satisfaction, partial or complete, of a debt owed by such Borrower. 10 8. COLLECTIONS. (a) Each Borrower shall direct all of its Account Debtors to make all payments on the Accounts directly to a post office box (the "Lock Box") designated by, and under the exclusive control of, Lender. Each Borrower shall establish an account (the "Lock Box Account") in Lender's name with Lender, into which all payments received in the Lock Box shall be deposited, and into which such Borrower will immediately deposit all payments received by such Borrower on Accounts in the identical form in which such payments were received, whether by cash or check. If a Borrower, any Affiliate or Subsidiary, any shareholder, officer, director, employee or agent of a Borrower or any Affiliate or Subsidiary, or any other Person acting for or in concert with a Borrower shall receive any monies, checks, notes, drafts or other payments relating to or as Proceeds of Accounts or other Collateral, such Borrower and each such Person shall receive all such items in trust for, and as the sole and exclusive property of, Lender and, immediately upon receipt thereof, shall remit the same (or cause the same to be remitted) in kind to the Lock Box Account. Each Borrower agrees that all payments made to such Lock Box Account or otherwise received by Lender, whether in respect of the Accounts or as Proceeds of other Collateral or otherwise (except for proceeds of Collateral which are required to be delivered to the holder of a Permitted Lien which is prior in right of payment), will be applied on account of the Obligations in accordance with the terms of this Agreement. Each Borrower agrees to pay all fees, costs and expenses in connection with opening and maintaining the Lock Box and Lock Box Account. All of such fees, costs and expenses shall constitute Obligations hereunder, shall be payable to Lender by Borrowers upon demand and, until paid, shall bear interest at the highest rate then applicable to Loans hereunder. All checks, drafts, instruments and other items of payment or Proceeds of Collateral shall be endorsed by the applicable Borrower to Lender, and, if that endorsement of any such item shall not be made for any reason, Lender is hereby irrevocably authorized to endorse the same on such Borrower's behalf. For the purpose of this section, each Borrower irrevocably hereby makes, constitutes and appoints Lender (and all Persons designated by Lender for that purpose) as such Borrower's true and lawful attorney and agent-in-fact (i) to endorse such Borrower's name upon said items of payment and/or Proceeds of Collateral and upon any Chattel Paper, Document, Instrument, invoice or similar document or agreement relating to any Account of such Borrower or Goods pertaining thereto; (ii) to take control in any manner of any item of payment or Proceeds thereof and (iii) to have access to any lock box or postal box into which any of such Borrower's mail is deposited, and open and process all mail addressed to such Borrower and deposited therein. (b) Lender may, at any time and from time to time after the occurrence and during the continuance of an Event of Default, whether before or after notification to any Account Debtor and whether before or after the maturity of any of the Obligations, (i) enforce collection of any of Borrowers' Accounts or other amounts owed to a Borrower by suit or otherwise; (ii) exercise all of such Borrower's rights and remedies with respect to proceedings brought to collect any Accounts or other amounts owed to such Borrower; (iii) surrender, release or exchange all or any part of any Accounts or other amounts owed to such Borrower, or compromise or extend or renew for any period (whether or not longer than the original period) any indebtedness thereunder; (iv) sell or assign any Account of such Borrower or other amount owed to such Borrower upon such terms, for such amount and at such time or times as Lender deems advisable; (v) prepare, file and sign such Borrower's name on any proof of claim in bankruptcy or other similar document against any Account Debtor or other Person obligated to 11 such Borrower; and (vi) do all other acts and things which are necessary, in Lender's sole discretion, to fulfill such Borrower's obligations under this Agreement and the Other Agreements and to allow Lender to collect the Accounts or other amounts owed to such Borrower. In addition to any other provision hereof, Lender may at any time, whether before or after the occurrence and during the continuance of an Event of Default, at Borrowers' expense, notify any parties obligated on any of the Accounts to make payment directly to Lender of any amounts due or to become due thereunder. (c) For purposes of calculating interest and fees, Lender shall, within two (2) Business Days after receipt by Lender at its office in Chicago, Illinois of (i) checks and (ii) cash or other immediately available funds from collections of items of payment and Proceeds of any Collateral, apply the whole or any part of such collections or Proceeds against the Obligations in such order as Lender shall determine in its sole discretion. For purposes of determining the amount of Loans available for borrowing purposes, checks and cash or other immediately available funds from collections of items of payment and Proceeds of any Collateral shall be applied in whole or in part against the Obligations, in such order as Lender shall determine in its sole discretion, on the day of receipt, subject to actual collection. (d) On a monthly basis, Lender shall deliver to Borrowers an account statement showing all Loans, charges and payments, which shall be deemed final, binding and conclusive upon Borrowers unless a Borrower notifies Lender in writing, specifying any error therein, within thirty (30) days of the date such account statement is sent to Borrowers, and any such notice shall only constitute an objection to the items specifically identified. 9. COLLATERAL, AVAILABILITY AND FINANCIAL REPORTS AND SCHEDULES. (a) Weekly Reports. Each Borrower shall deliver to Lender an executed borrowing base certificate in the form of Exhibit B on a weekly basis (via facsimile with original to follow via U.S. Mail), and otherwise, from time to time, to the extent requested by Lender in connection with any Revolving Loan requested of Borrowers which shall be accompanied by copies of such Borrower's sales journal, cash receipts journal and credit memo journal for the relevant period. Such borrowing base certificate shall reflect the activity of such Borrower with respect to Accounts for the immediately preceding period, and shall be in a form and with such specificity as is satisfactory to Lender and shall contain such additional information concerning Accounts and Inventory as may be requested by Lender, including, without limitation, but only if specifically requested by Lender, copies of all invoices prepared in connection with such Accounts. (b) Monthly Reports. Borrowers shall deliver to Lender, in addition to any other reports, as soon as practicable and in any event: (i) within ten (10) days after the end of each month, (A) a detailed trial balance of each Borrower's Accounts aged per invoice date, in form and substance reasonably satisfactory to Lender, including, without limitation, the names and addresses of all Account Debtors of each Borrower, and (B) a summary and detail of accounts payable (such Accounts and accounts payable divided into such time intervals as Lender may require in its sole discretion), including a listing of any held checks; (ii) within ten (10) days after the end of each month, the general ledger inventory account balance, a perpetual 12 inventory report and Lender's standard form of Inventory report then in effect or the form most recently requested from Borrowers by Lender, for each Borrower by each category of Inventory, together with a description of the monthly change in each category of Inventory; and (iii) within ten (10) days after the end of each month, a month-end Borrowing Base Certificate that reconciles to all month-end reports, in form and substance acceptable to Lender. (c) Financial Statements. Borrowers shall deliver to Lender the following financial information, all of which shall be prepared in accordance with GAAP consistently applied, and shall be accompanied by a certificate in the form of Exhibit B hereto, which compliance certificate ("Compliance Certificate") signed by the Chief Financial Officer or President of Borrowers, which shall (x) set forth in reasonable detail the calculations for the financial covenants contained in Section 14 hereof and (y) state that, based upon an examination sufficient to permit him to make an informed statement, no Default or Event of Default exists, or if such is not the case, specifying such Default or Event of Default, its nature, when it occurred, whether it is continuing the steps begin taken by Borrowers with respect thereto: (i) no later than thirty (30) days after each calendar month, copies of internally prepared financial statements, including, without limitation, balance sheets and statements of income, of such Borrowers from and after the month ending April 30, 2004 on a consolidated and consolidating (separately for each Borrower) basis, certified by the chief financial officer of each Borrower; (ii) no later than thirty (30) days after the end of each of the first three quarters of each Borrower's Fiscal Year, copies of internally prepared financial statements, including, without limitation, balance sheets, statements of income, retained earnings, cash flows and reconciliation of surplus of Borrowers on a consolidated and consolidating (separately for each Borrower) basis, certified by the chief financial officer of Borrowers; and (iii) no later than ninety (90) days after the end of each of Borrowers' Fiscal Years, audited annual consolidated and consolidating (separately for each Borrower) financial statements with an unqualified opinion by independent certified public accountants selected by Borrowers and reasonably satisfactory to Lender, which financial statements shall be accompanied by (A) a letter from such accountants acknowledging that they are aware that a primary intent of Borrowers in obtaining such financial statements is to influence Lender and that Lender is relying upon such financial statements in connection with the exercise of its rights hereunder, provided, that Borrower shall only be required to use its reasonable efforts exercised in good faith to obtain such letter; and (B) copies of any management letters sent to a Borrower by such accountants. (d) Annual Projections. As soon as practicable and in any event no less than thirty (30) days prior to the beginning of each Fiscal Year, Borrowers shall deliver to Lender projected balance sheets, statements of income and cash flow for Borrowers on a consolidated and consolidating basis, for each of the twelve (12) months during such Fiscal Year, which shall include the assumptions used therein, together with appropriate supporting details as reasonably requested by Lender. (e) Explanation of Budgets and Projections. In conjunction with the delivery of the annual presentation of projections or budgets referred to in Subsection 9(d) above, Borrowers shall deliver a letter, signed by the president or a vice president of each Borrower and by the treasurer or chief financial officer of each Borrower, describing, comparing and analyzing, in detail, all changes and developments between the anticipated financial results included in such projections or budgets and the historical financial statements of Borrowers. 13 (f) Public Reporting. Promptly upon the filing thereof, each Borrower shall deliver to Lender copies of all registration statements and annual, quarterly, monthly or other regular reports which such Borrower or any of its Subsidiaries files with the Securities and Exchange Commission, as well as promptly providing to Lender copies of any reports and proxy statements delivered to its shareholders. (g) Appraisals. Borrowers shall deliver (i) an updated Equipment appraisal in form and substance acceptable to Lender, no later than March 31, 2004 (the "Initial 2004 M & E Appraisal") and (ii) an Inventory appraisal, in form and substance acceptable to Lender, on or before March 31, 2004 and thereafter not less frequently than once every 180 days. (h) Other Information. Promptly following request therefor by Lender, such other business or financial data, reports, appraisals and projections as Lender may reasonably request. 10. TERMINATION; AUTOMATIC RENEWAL. THIS AGREEMENT SHALL BE IN EFFECT FOR A PERIOD OF TWO (2) YEARS FROM THE DATE HEREOF UNTIL DECEMBER 31, 2005 (THE "ORIGINAL TERM") AND SHALL AUTOMATICALLY RENEW ITSELF FROM YEAR TO YEAR THEREAFTER (EACH SUCH ONE-YEAR RENEWAL BEING REFERRED TO HEREIN AS A "RENEWAL TERM") UNLESS (A) THE DUE DATE OF THE OBLIGATIONS IS ACCELERATED PURSUANT TO SECTION 16 HEREOF; OR (B) A BORROWER OR LENDER ELECTS TO TERMINATE THIS AGREEMENT AT THE END OF THE ORIGINAL TERM OR AT THE END OF ANY RENEWAL TERM BY GIVING THE OTHER PARTY WRITTEN NOTICE OF SUCH ELECTION AT LEAST NINETY (90) DAYS PRIOR TO THE END OF THE ORIGINAL TERM OR THE THEN-CURRENT RENEWAL TERM AND IN WHICH CASE BORROWERS SHALL PAY ALL OF THE OBLIGATIONS IN FULL ON THE LAST DAY OF SUCH TERM. If one or more of the events specified in clauses (A) or (B) occurs or this Agreement otherwise expires, then (i) Lender shall not make any additional Loans on or after the date identified as the date on which the Obligations are to be repaid; and (ii) this Agreement shall terminate on the date thereafter that the Obligations are paid in full. At such time as Borrowers have repaid all of the Obligations and this Agreement has terminated, each Borrower shall deliver to Lender a release, in form and substance satisfactory to Lender, of all obligations and liabilities of Lender and its officers, directors, employees, agents, parents, subsidiaries and affiliates to such Borrower, and, if such Borrower is obtaining new financing from another lender, such Borrower shall deliver such lender's indemnification of Lender, in form and substance satisfactory to Lender, for checks which Lender has credited to such Borrower's account but which subsequently are dishonored for any reason or for automatic clearinghouse or wire transfers not yet posted to such Borrower's account. If, during the term of this Agreement, Borrowers prepay all of the Obligations from any source other than income from the ordinary-course operations of Borrowers' business and this Agreement is terminated, Borrowers jointly and severally agree to pay to Lender as a prepayment fee, in addition to the payment of all other Obligations, an amount equal to (i) three percent (3%) of the Maximum Loan Limit if such prepayment occurs at least one (1) year prior to the end of the Original Term, or (ii) two percent (2%) of the Maximum Loan Limit if such prepayment occurs less than one (1) year prior to the end of the Original Term or any then-current Renewal Term; provided, 14 however, such prepayment fee shall be waived if repayment is made within ninety (90) days prior to the end of the Original Term or any then current Renewal Term. 11. REPRESENTATIONS AND WARRANTIES. Each Borrower hereby represents and warrants to Lender, which representations and warranties (whether appearing in this Section 11 or elsewhere) shall be true at the time of Borrowers' execution hereof and the closing of the transactions described herein or related hereto, shall remain true until the repayment in full and satisfaction of all the Obligations and termination of this Agreement, and shall be remade by each Borrower at the time each Loan is made pursuant to this Agreement. (a) Financial Statements and Other Information. The financial statements and other information delivered or to be delivered by Borrowers to Lender at or prior to the date of this Agreement fairly present, in all material respects, the financial condition of Borrowers, and there has been no adverse change in the financial condition, the operations or any other status of a Borrower since the date of the financial statements delivered to Lender most recently prior to the date of this Agreement. All written information now or heretofore furnished by each Borrower to Lender is true and correct as of the date with respect to which such information was furnished. (b) Locations; Certain Collateral. The office where each Borrower keeps its books, records and accounts (or copies thereof) concerning the Collateral, each Borrower's principal place of business and all of each Borrower's other places of business, locations of Collateral and post office boxes and locations of bank accounts are as set forth in Schedule 11(b) and at other locations within the continental United States of which Lender has been advised by a Borrower in accordance with Subsection 12(b)(i). The Collateral, including, without limitation, the Equipment (except any part thereof which a Borrower shall have advised Lender in writing consists of Collateral normally used in more than one state) is kept, or, in the case of vehicles, based, only at the addresses set forth on Schedule 11(b), and at other locations within the continental United States of which Lender has been advised by a Borrower in writing in accordance with Subsection 12(b)(i) hereof. Schedule 11(b) hereto contains a complete listing of all of Borrower's (a) Intellectual Property which is subject to registration statutes and licenses of Intellectual Property to which Borrower is a party (whether as licensor or licensee), (b) Instruments (other than Instruments deposited for collection in the ordinary course of business), (c) Deposit Accounts, (d) Investment Property, (e) Letter-of-Credit Rights, (f) Chattel Paper, (g) Documents, (h) Commercial Tort Claims, (i) Collateral which is subject to certificate of title statutes and (j) tangible Collateral located with any bailee, warehousemen or other third parties. (c) Loans by Borrower. No Borrower has made any loans or advances to any Affiliate or other Person except for advances authorized hereunder to employees, officers and directors of such Borrower for travel and other expenses arising in the ordinary course of such Borrower's business and loans permitted pursuant to Subsection 13(e) hereof. (d) Accounts and Inventory. Each Account or item of Inventory which a Borrower shall, expressly or by implication, request Lender to classify as an Eligible Account or as Eligible Inventory, respectively, shall, as of the time when such request is made, conform in all respects to the requirements of such classification as set forth in the respective definitions of 15 "Eligible Account" and "Eligible Inventory" as set forth herein and as otherwise established by Lender from time to time. (e) Liens. Each Borrower is the lawful owner of all Collateral now purportedly owned or hereafter purportedly acquired by such Borrower, free from all Liens, other than the Permitted Liens. (f) Organization, Authority and No Conflict. Each Borrower is a corporation, duly organized, validly existing and in good standing in the State of Illinois, and such Borrower is duly qualified and in good standing in all states where the nature and extent of the business transacted by it or the ownership of its assets makes such qualification necessary or, if such Borrower is not so qualified, such Borrower may cure any such failure without losing any of its rights, incurring any Liens or material penalties or otherwise affecting Lender's rights. CTI Industries' State Organization Identification Number is 6178-634-1 and CTI Helium's State Organizational Identification Number is 6201-017-7. Each Borrower has the right and power and is duly authorized and empowered to enter into, execute and deliver this Agreement and the Other Agreements and perform its obligations hereunder and thereunder. Each Borrower's execution, delivery and performance of this Agreement and the Other Agreements do not conflict with the provisions of the organizational documents of such Borrower, any statute, regulation, ordinance or rule of law, or any agreement, contract or other document which may now or hereafter be binding on such Borrower, except for conflicts with agreements, contracts or other documents which would not have a Material Adverse Effect on such Borrower, and each Borrower's execution, delivery and performance of this Agreement and the Other Agreements shall not result in the imposition of any Lien upon any of such Borrower's property (other than Permitted Liens) under any existing indenture, mortgage, deed of trust, loan or credit agreement or other agreement or instrument by which such Borrower or any of its property may be bound or affected. (g) Litigation. Except as disclosed to Lender on Schedule 11(g) hereto, there are no actions or proceedings which are pending or, to the best of Borrower's knowledge, threatened against a Borrower which are, in the determination of Lender, reasonably likely to have a Material Adverse Effect on such Borrower, and each Borrower shall, promptly upon becoming aware of any such pending or threatened action or proceeding, give written notice thereof to Lender. (h) Compliance with Laws and Maintenance of Permits. Each Borrower has obtained all governmental consents, franchises, certificates, licenses, authorizations, approvals and permits, the lack of which would have a Material Adverse Effect on such Borrower. Each Borrower is in compliance in all material respects with all applicable federal, state, local and foreign statutes, orders, regulations, rules and ordinances (including, without limitation, Environmental Laws and statutes, orders, regulations, rules and ordinances relating to taxes, employer and employee contributions and similar items, securities, ERISA or employee health and safety) the failure to comply with which would have a Material Adverse Effect on such Borrower. (i) Affiliate Transactions. Except as set forth on Schedule 11(i) hereto or as permitted pursuant to Subsection 11(c) hereof, no Borrower is conducting, permitting or 16 suffering to be conducted, transactions with any Affiliate other than transactions with Affiliates for the purchase or sale of Inventory or services in the ordinary course of business pursuant to terms that are no less favorable to such Borrower than the terms upon which such transactions would have been made had they been made to or with a Person that is not an Affiliate. (j) Names and Trade Names. Each Borrower's name has always been as set forth on the first page of this Agreement and no Borrower uses trade names, assumed names, fictitious names or division names in the operation of its business, except as set forth on Schedule 11(j) hereto. (k) Equipment. Except for Permitted Liens, each Borrower has good and indefeasible and merchantable title to and ownership of all Equipment. No Equipment is a Fixture to real estate unless such real estate is owned by such Borrower and is subject to a mortgage or mortgagee agreement in favor of Lender or, if such real estate is leased, is subject to a landlord's agreement in favor of Lender on terms acceptable to Lender, or an accession to other personal property unless such personal property is subject to a first-priority Lien in favor of Lender. (l) Enforceability. This Agreement and the Other Agreements to which a Borrower is a party are the legal, valid and binding obligations of such Borrower and are enforceable against such Borrower in accordance with their respective terms. (m) Solvency. Each Borrower, after giving effect to the transactions contemplated hereby, is solvent, is able to pay its debts as they become due, has capital sufficient to carry on its business, now owns property having a value both at fair valuation and at present fair saleable value greater than the amount required to pay its debts, and will not be rendered insolvent by the execution and delivery of this Agreement or any of the Other Agreements or by completion of the transactions contemplated hereunder or thereunder. (n) Indebtedness. Except as set forth on Schedule 11(n) hereto, no Borrower is obligated (directly or indirectly) for any Indebtedness other than the Loans. (o) Margin Security and Use of Proceeds. No Borrower owns any margin securities, and none of the proceeds of the Loans hereunder shall be used for the purpose of purchasing or carrying any margin securities or for the purpose of reducing or retiring any indebtedness which was originally incurred to purchase any margin securities or for any other purpose not permitted by Regulation U of the Board of Governors of the Federal Reserve System as in effect from time to time. (p) Parent, Subsidiaries and Affiliates. Except as set forth on Schedule 11(p) hereto, no Borrower has any Parents, Subsidiaries or other Affiliates or divisions, nor is any Borrower engaged in any joint venture or partnership with any other Person. (q) No Defaults. No Borrower is in default under any material contract, lease or commitment to which it is a party or by which it is bound, nor does any Borrower know of any dispute regarding any contract, lease or commitment which would have a Material Adverse Effect on such Borrower. 17 (r) Employee Matters. There are no controversies pending or threatened between a Borrower and any of its employees, agents or independent contractors, other than employee grievances arising in the ordinary course of business which would not, in the aggregate, have a Material Adverse Effect on such Borrower, and each Borrower is in compliance with all federal and state laws respecting employment and employment terms, conditions and practices except for such noncompliance as would not have a Material Adverse Effect on such Borrower. (s) Intellectual Property. All patents, patent applications, copyrights, service marks, trademarks, trademark applications, trade styles and trade names of each Borrower are listed on Schedule 11(s) hereto, and each Borrower possesses adequate licenses with respect thereto or necessary to continue to conduct its business as heretofore conducted by it except to the extent that the failure to possess such items would not have a Material Adverse Effect on Borrower and each such license is described on Schedule 11(s) hereto. (t) Environmental Matters. No Borrower has generated, used, stored, treated, transported, manufactured, handled, produced or disposed of any Hazardous Materials, on or off its premises (whether or not owned by it) in any manner which at any time violates any Environmental Law or any license, permit, certificate, approval or similar authorization thereunder, and the operations of each Borrower comply in all material respects with all Environmental Laws and all licenses, permits, certificates, approvals and similar authorizations thereunder. There has been no investigation, proceeding, complaint, order, directive, claim, citation or notice by any governmental authority or any other Person, nor is any pending or to the best of each Borrower's knowledge threatened with respect to any noncompliance with or violation of the requirements of any Environmental Law by a Borrower or the release, spill or discharge, threatened or actual, of any Hazardous Materials or the generation, use, storage, treatment, transportation, manufacture, handling, production or disposal of any Hazardous Materials or any other environmental, health or safety matter which affects a Borrower or its business, operations or assets or any properties at which a Borrower has transported, stored or disposed of any Hazardous Materials. No Borrower has any material liability (contingent or otherwise) in connection with a release, spill or discharge, threatened or actual, of any Hazardous Materials or the generation, use, storage, treatment, transportation, manufacture, handling, production or disposal of any Hazardous Materials. (u) ERISA Matters. Each Borrower has paid and discharged all obligations and liabilities arising under ERISA of a character which, if unpaid or unperformed, might result in the imposition of a Lien against any of its properties or assets. (v) Collective Enterprise. Borrowers are engaged in the businesses of purchasing, selling, distributing, developing and/or manufacturing helium gas and/or balloons, punch balls and other inflatable toy products, films and flexible containers as of the date hereof, as well as in certain other businesses. These operations require financing on a basis such that the credit supplied can be made available from time to time to Borrowers, as required for the continued successful operation of Borrowers taken as a whole. Borrowers have requested the Lender make credit available hereunder primarily for the purposes of Subsection 12(g) and generally for the purposes of financing the operations of Borrowers. Each Borrower expects to derive benefit (and the Board of Directors of each Borrower has determined that such Borrower 18 may reasonably be expected to derive benefit), directly or indirectly, from a portion of the credit extended by Lender hereunder, both in its separate capacity and as a member of the group of companies, since the successful operation and condition of each Borrower is dependent on the continued successful performance of the functions of the group as a whole. Each Borrower acknowledges that, but for the agreement of each of the other Borrowers to execute and deliver this Agreement, Lender would not have made available the credit facilities established hereby on the terms set forth herein. 12. AFFIRMATIVE COVENANTS. Until payment and satisfaction in full of all Obligations and termination of this Agreement, unless Borrowers obtain Lender's prior written consent waiving or modifying any of Borrowers' covenants hereunder in any specific instance, each Borrower covenants and agrees as follows: (a) Maintenance of Records. Each Borrower shall at all times keep accurate and complete books, records and accounts with respect to all of such Borrower's business activities, in accordance with sound accounting practices and GAAP consistently applied, and shall keep such books, records and accounts, and any copies thereof, only at the addresses indicated for such purpose on Schedule 11(b). (b) Notices. Each Borrower shall: (i) Locations. Promptly (but in no event less than ten (10) days prior to the occurrence thereof) notify Lender of the proposed opening of any new place of business or new location of Collateral, the closing of any existing place of business or location of Collateral, any change of in the location of such Borrower's books, records and accounts (or copies thereof), the opening or closing of any post office box, the opening or closing of any bank account or, if any of the Collateral consists of Goods of a type normally used in more than one state, the use of any such Goods in any state other than a state in which such Borrower has previously advised Lender that such Goods will be used. (ii) Eligible Accounts and Inventory. Promptly upon becoming aware thereof, notify Lender if any Account or Inventory identified by such Borrower to Lender as an Eligible Account or Eligible Inventory becomes ineligible for any reason. (iii) Litigation and Proceedings. Promptly upon becoming aware thereof, notify Lender of any actions or proceedings which are pending or threatened against such Borrower which might have a Material Adverse Effect on such Borrower and of any Commercial Tort Claims of such Borrower which may arise, which notice shall constitute such Borrower's authorization to amend Schedule 11(b) to add such Commercial Tort Claim. (iv) Names and Trade Names. Notify Lender within ten (10) days of the change of its name or the use of any trade name, assumed name, fictitious name or division name not previously disclosed to Lender in writing. (v) ERISA Matters. Promptly notify Lender of (x) the occurrence of any "reportable event" (as defined in ERISA) which might result in the termination by 19 the Pension Benefit Guaranty Corporation (the "PBGC") of any employee benefit plan ("Plan") covering any officers or employees of such Borrower, any benefits of which are, or are required to be, guaranteed by the PBGC, (y) receipt of any notice from the PBGC of its intention to seek termination of any Plan or appointment of a trustee therefor or (z) its intention to terminate or withdraw from any Plan. (vi) Environmental Matters. Immediately notify Lender upon becoming aware of any investigation, proceeding, complaint, order, directive, claim, citation or notice with respect to any noncompliance with or violation of the requirements of any Environmental Law by such Borrower or the generation, use, storage, treatment, transportation, manufacture handling, production or disposal of any Hazardous Materials or any other environmental, health or safety matter which affects such Borrower or its business operations or assets or any properties at which such Borrower has transported, stored or disposed of any Hazardous Materials unless the foregoing could not reasonably be expected to have a Material Adverse Effect on Borrower. (vii) Default; Material Adverse Change. Promptly advise Lender of any material adverse change in the business, property, assets, prospects, operations or condition, financial or otherwise, of such Borrower, the occurrence of any Event of Default hereunder or the occurrence of any event which, if uncured, will become an Event of Default after notice or lapse of time, or both. (viii) Subordinated Debt. Promptly advise Lender of any default or any event which, with the giving of notice or lapse of time, or both, would constitute a default, under any subordination agreement relative to Subordinated Debt, or any agreement, instrument or document evidencing or relating to any Subordinated Debt, and a certificate of a authorized officer of Borrower specifying the nature thereof and Borrower's proposed response thereto, in reasonable detail. All of the foregoing notices shall be provided by Borrowers to Lender in writing. (c) Compliance with Laws and Maintenance of Permits. Each Borrower shall maintain all governmental consents, franchises, certificates, licenses, authorizations, approvals and permits the lack of which would have a Material Adverse Effect on such Borrower, and each Borrower shall remain in compliance with all applicable federal, state, local and foreign statutes, orders, regulations, rules and ordinances (including, without limitation, Environmental Laws and statutes, orders, regulations, rules and ordinances relating to taxes, employer and employee contributions and similar items, securities, ERISA or employee health and safety) the failure to comply with which would have a Material Adverse Effect on such Borrower. Following any determination by Lender that there is noncompliance, or any condition which requires any action by or on behalf of a Borrower in order to avoid noncompliance, with any Environmental Law, such Borrower shall at such Borrower's expense cause an independent environmental engineer acceptable to Lender to conduct such tests of the relevant site(s) as are appropriate and prepare and deliver a report setting forth the results of such tests, a proposed plan for remediation and an estimate of the costs thereof. 20 (d) Inspection and Audits. Each Borrower shall permit Lender, or any Persons designated by it, to call at such Borrower's places of business at any reasonable times and, without hindrance or delay, to inspect the Collateral and to inspect, audit, check and make extracts from such Borrower's books, records, journals, orders, receipts and any correspondence and other data relating to such Borrower's business, the Collateral or any transactions between the parties hereto, and Lender shall have the right to make such verification concerning such Borrower's business as Lender may consider reasonable under the circumstances. Each Borrower shall furnish to Lender such information relevant to Lender's rights under this Agreement and the Other Agreements as Lender shall at any time and from time to time request. Lender, through its officers, employees or agents shall have the right, at any time and from time to time, in Lender's name, to verify the validity, amount or any other matter relating to any of such Borrower's Accounts, by mail, telephone, telecopy, electronic mail or otherwise. Each Borrower authorizes Lender to discuss the affairs, finances and business of such Borrower with any officers, employees or directors of such Borrower, or with its Parent or any Affiliate or the officers, employees or directors of its Parent or any Affiliate, and to discuss the financial condition of such Borrower with such Borrower's independent public accountants. Any such discussions shall be without liability to Lender or to Borrowers' independent public accountants. Borrowers shall pay to Lender all customary fees (currently $750 per person per day) and all costs and out-of-pocket expenses incurred by Lender in the exercise of its rights hereunder, and all of such fees, costs and expenses shall constitute Obligations hereunder, shall be payable on demand and, until paid, shall bear interest at the highest rate then applicable to Loans hereunder. So long as no Event of Default exists, Lender intends to conduct audits based upon a 90 day audit schedule and so long as no Event of Default exists, Lender shall use reasonable efforts to notify Borrowers of any change in such audit schedule. (e) Insurance. Each Borrower shall: (i) Keep the Collateral properly housed and insured for the full insurable value thereof against loss or damage by fire, theft, explosion, sprinklers, collision (in the case of motor vehicles) and such other risks as are customarily insured against by Persons engaged in businesses similar to that of such Borrower, with such companies, in such amounts, with such deductibles, and under policies in such form, as shall be satisfactory to Lender. Original (or certified) copies of such policies of insurance have been or shall be, within ninety (90) days of the date hereof, delivered to Lender, together with evidence of payment of all premiums therefor, and shall contain an endorsement, in form and substance acceptable to Lender, showing loss under such insurance policies payable to Lender. Such endorsement, or an independent instrument furnished to Lender, shall provide that the insurance company shall give Lender at least thirty (30) days' written notice before any such policy of insurance is altered or cancelled and that no act, whether willful or negligent, or default of such Borrower or any other Person shall affect the right of Lender to recover under such policy of insurance in case of loss or damage. In addition, each Borrower shall cause to be executed and delivered to Lender an assignment of proceeds of its business interruption insurance policies. Each Borrower hereby directs all insurers under all policies of insurance to pay all proceeds payable thereunder directly to Lender. Each Borrower irrevocably makes, constitutes and appoints Lender (and all officers, employees or agents designated by Lender) as such Borrower's true and lawful attorney (and agent-in-fact) for the purpose of making, 21 settling and adjusting claims under such policies of insurance, endorsing the name of such Borrower on any check, draft, instrument or other item of payment for the proceeds of such policies of insurance and making all determinations and decisions with respect to such policies of insurance, provided however, that if no Event of Default shall have occurred and is continuing, Borrower may make, settle and adjust claims involving less than $25,000 in the aggregate without Lenders' consent. (ii) Maintain, at its expense, such public liability and third-party property damage insurance as is customary for Persons engaged in businesses similar to that of such Borrower with such companies and in such amounts, with such deductibles and under policies in such form as shall be satisfactory to Lender and original (or certified) copies of such policies have been or shall be, within ninety (90) days after the date hereof, delivered to Lender, together with evidence of payment of all premiums therefor; each such policy shall contain an endorsement showing Lender as additional insured thereunder and providing that the insurance company shall give Lender at least thirty (30) days' written notice before any such policy shall be altered or cancelled. If a Borrower at any time or times hereafter shall fail to obtain or maintain any of the policies of insurance required above or to pay any premium relating thereto, then Lender, without waiving or releasing any obligation or default by Borrowers hereunder, may (but shall be under no obligation to) obtain and maintain such policies of insurance and pay such premiums and take such other actions with respect thereto as Lender deems advisable. Such insurance, if obtained by Lender, may, but need not, protect such Borrower's interests or pay any claim made by or against such Borrower with respect to the Collateral. Such insurance may be more expensive than the cost of insurance such Borrower may be able to obtain on its own and may be cancelled only upon such Borrower providing evidence that it has obtained the insurance as required above. All sums disbursed by Lender in connection with any such actions, including, without limitation, court costs, expenses, other charges relating thereto and reasonable attorneys' fees, shall constitute Loans hereunder, shall be payable on demand by Borrowers to Lender and, until paid, shall bear interest at the highest rate then applicable to Loans hereunder. (f) Collateral. Each Borrower shall keep the Collateral in good condition, repair and order and shall make all necessary repairs to the Equipment and replacements thereof so that the operating efficiency and the value thereof shall at all times be preserved and maintained in all material respects. Each Borrower shall permit Lender to examine any of the Collateral at any time and wherever the Collateral may be located, and each Borrower shall, immediately upon request therefor by Lender, deliver to Lender any and all evidence of ownership of any of the Equipment, including, without limitation, certificates of title and applications of title. Each Borrower shall, at the request of Lender, indicate on its records concerning the Collateral a notation, in form satisfactory to Lender, of the security interest of Lender hereunder. If, prior to the termination of this Agreement, Borrower shall obtain rights to any new Collateral of the type described in the last sentence of Subsection 11(b), Borrower shall notify Lender in writing (with reasonable detail) of such changes at least once every thirty (30) days. Borrower hereby authorizes Lender to unilaterally modify this Agreement by amending Schedule 11(b) to include any such Collateral. Notwithstanding the foregoing, Borrower hereby agrees that Lender's security interest shall extend to all such Collateral, regardless of whether Lender actually amends Schedule 11(b). 22 (g) Use of Proceeds. All monies and other property obtained by a Borrower from Lender pursuant to this Agreement shall be used solely for the refinancing of certain indebtedness of each Borrower and for business purposes of such Borrower. (h) Taxes. Each Borrower shall file all required tax returns and pay all of its taxes when due, subject to any extensions granted by the applicable taxing authority, including, without limitation, taxes imposed by federal, state or municipal agencies, and shall cause any Liens for taxes to be promptly released; provided, that such Borrower shall have the right to contest the payment of such taxes in good faith by appropriate proceedings so long as (i) the amount so contested is shown on such Borrower's financial statements; (ii) the contesting of any such payment does not give rise to a Lien for taxes; (iii) such Borrower keeps on deposit with Lender (such deposit to be held without interest) or a reserve is maintained against such Borrower's availability to borrow money under Subsection 2(a), in either case in an amount of money which, in the sole judgment of Lender, is sufficient to pay such taxes and any interest or penalties that may accrue thereon; and (iv) if such Borrower fails to prosecute such contest with reasonable diligence, Lender may apply the money so deposited in payment of such taxes. If a Borrower fails to pay any such taxes and in the absence of any such contest by such Borrower, Lender may (but shall be under no obligation to) advance and pay any sums required to pay any such taxes and/or to secure the release of any Lien therefor, and any sums so advanced by Lender shall constitute Loans hereunder, shall be payable by such Borrower to Lender on demand and, until paid, shall bear interest at the highest rate then applicable to Loans hereunder. (i) Intellectual Property. Each Borrower shall maintain adequate licenses, patents, patent applications, copyrights, service marks, trademarks, trademark applications, tradestyles and trade names to continue its business as heretofore conducted by it or as hereafter conducted by it unless the failure to maintain any of the foregoing could not reasonably be expected to have a Material Adverse Effect on such Borrower. (j) Financial Services Accounts. Each Borrower covenants and agrees, at all times during the term of this Agreement, to utilize the Lender as its primary bank of account and depository for all financial services, including all receipts, disbursements, cash management and related services. In the event that the average collected balances of each Borrower are not sufficient to cover the costs of related activity, the account of such Borrower will be subject to the standard charges of the Lender, which shall be debited against such account on a monthly basis. (k) Key Man Insurance. The Borrowers shall at all times (i) maintain key man life insurance on the life of Mr. Howard Schwan in a face amount equal to at least Two Million and No/100 Dollars ($2,000,000), in form and substance, and issued by an insurance company, acceptable to Lender in its sole discretion (collectively, the "Key Man Insurance"), and (ii) cause the Key Man Insurance and all proceeds thereof to be validly assigned to Lender, and subject to the first priority perfected security interest of Lender, and subject to no other Lien other than Permitted Liens. Borrowers shall obtain such policy and deliver an assignment executed on behalf of the insurer and reasonably acceptable to Lender on the Closing Date. (l) Keepwell Obligations. Borrowers shall deliver to Lender a Keepwell Agreement in favor of Lender of certain principal shareholders of Borrowers (which are 23 acceptable to Lender), pursuant to which such principals shall agree to, at the option of Lender in its sole discretion, either (i) a Subordinated Debt investment into CTI Industries, or (ii) execute and deliver to Lender an individual guaranty of the Obligations of the Borrowers, in each case (collectively, the "Principal Investment Amount") in an amount not less than the following: (A) If the orderly liquidation value of the Equipment of the Borrowers set forth in the Initial 2004 M & E Appraisal is less than $4,120,000, then such Principal Investment Amount shall be an amount equal to the positive difference between (x) $4,120,000 and (y) the amount set forth in the Initial 2002 M & E Appraisal for the orderly liquidation value of the Equipment of Borrowers; and (B) If the forced liquidation value of the Equipment of Borrowers as set forth in the Initial 2002 M & E Appraisal is less than the then outstanding principal amount of the Term Loan, then the Principal Investment Amount shall be an amount equal to the positive difference between (x) the amount of the forced liquidation value of the Equipment of Borrowers as set forth in the Initial 2004 M & E Appraisal, and (y) the then outstanding principal amount of the Term Loan, as of the date of such Initial 2004 M & E Appraisal. 13. NEGATIVE COVENANTS. Until payment and satisfaction in full of all Obligations and termination of this Agreement, unless Borrowers obtain Lender's prior written consent waiving or modifying any of Borrowers' covenants hereunder in any specific instance, each Borrower agrees as follows: (a) Indebtedness. No Borrower shall create, incur, assume or become obligated (directly or indirectly), for any Indebtedness other than the Loans, except that a Borrower may (i) incur Subordinated Debt; (ii) maintain its present Indebtedness listed on Schedule 11(n) hereto; and (iii) incur purchase money Indebtedness or Capital Lease Obligations in connection with Capital Expenditures permitted pursuant to Subsection 14(c) hereof. Borrower shall not make any payment of any part or all of any Subordinated Debt or take any other action or omit to take any other action in respect of any Subordinated Debt, except in accordance with the Subordination Agreement relative thereto or the subordination provisions thereof; or amend or modify any agreement, instrument or document evidencing or relating to any Subordinated Debt. Borrowers may make regularly scheduled payments in respect of Subordinated Debt existing as of the Closing Date (and not prepayments) of (i) interest only, not to exceed an aggregate amount of $210,000 in any Fiscal Year of Borrowers, and (ii) principal not to exceed an aggregate amount of $60,000 in any Fiscal Year of Borrowers, in each case if and only to the extent that, after giving effect to such payment: (x) no Default or Event of Default exists or would result from such payment, and (y) Borrowers will have Excess Availability of not less than $150,000. (b) Liens. No Borrower shall grant or permit to exist (voluntarily or involuntarily) any Lien on any of its assets, other than Permitted Liens. (c) Mergers, Sales, Acquisitions, Subsidiaries and Other Transactions Outside the Ordinary Course of Business. No Borrower shall (i) enter into any merger or consolidation; (ii) change its state of organization or enter into any transaction which has the effect of changing its state of organization; (iii) sell, lease or otherwise dispose of any of its 24 assets other than in the ordinary course of business; (iv) purchase the stock, other equity interests or all or a material portion of the assets of any Person or division of such Person; or (v) enter into any other transaction outside the ordinary course of such Borrower's business, including, without limitation, any purchase, redemption or retirement of any shares of any class of its stock or any other equity interest, and any issuance of any shares of, or warrants or other rights to receive or purchase any shares of, any class of its stock or any other equity interest. No Borrower shall form any Subsidiaries or enter into any joint ventures or partnerships with any other Person. (d) Dividends and Distributions. No Borrower shall declare or pay any dividend or other distribution (whether in cash or in kind) on any class of its stock (if such Borrower is a corporation) or on account of any equity interest in such Borrower (if such Borrower is a partnership, limited liability company or other type of entity). (e) Investments; Loans. No Borrower shall purchase or otherwise acquire, or contract to purchase or otherwise acquire, the obligations or stock of any Person, other than direct obligations of the United States, obligations insured by the Federal Deposit Insurance Corporation and obligations unconditionally guaranteed by the United States; nor shall a Borrower lend or otherwise advance funds to any Person except for advances made to employees, officers and directors for travel and other expenses arising in the ordinary course of business. (f) Fundamental Changes, Line of Business. No Borrower shall amend its organizational documents or change its Fiscal Year or enter into a new line of business materially different from such Borrower's current business unless (i) such actions would not have a Material Adverse Effect on any Borrower; (ii) such actions would not affect the obligations of any Borrower to Lender; (iii) such actions would not affect the interpretation of any of the terms of this Agreement or the Other Agreements and (iv) Lender has received ten (10) days' prior written notice of such amendment or change. (g) Equipment. No Borrower shall (i) permit any Equipment to become a Fixture to real property unless such real property is owned by such Borrower and is subject to a mortgage in favor of Lender or, if such real property is leased, is subject to a landlord's agreement in favor of Lender on terms acceptable to Lender or (ii) permit any Equipment to become an accession to any other personal property unless such personal property is subject to a first-priority Lien in favor of Lender. (h) Affiliate Transactions. Except as set forth on Schedule 11(i) hereto or as permitted pursuant to Subsection 11(c) hereof, no Borrower shall conduct, permit or suffer to be conducted, transactions with Affiliates other than transactions for the purchase or sale of Inventory or services in the ordinary course of business pursuant to terms that are no less favorable to such Borrower than the terms upon which such transactions would have been made had they been made to or with a Person that is not an Affiliate. (i) Settling of Accounts. Each Borrower shall not settle or adjust any Account identified by such Borrower as an Eligible Account or with respect to which the Account Debtor is an Affiliate without the consent of Lender, provided, that following the 25 occurrence and during the continuance of an Event of Default, such Borrower shall not settle or adjust any Account without the consent of Lender. (j) Management Fees; Compensation. No Borrower shall pay any management or consulting fees to any shareholders of CTI Industries, or any management employees of CTI Industries (except to the extent described on Schedule 11(i) and existing as of the Closing Date), or pay annual aggregate compensation, whether as salary, bonus or otherwise, to all directors or officers of such Borrower in excess of one hundred ten percent (110%) of the aggregate compensation, whether as salary, bonus or otherwise, to all directors, and officers of such Borrower in effect on the date of this Agreement for the first year and one hundred ten percent (110%) of the prior year's aggregate compensation amount for each subsequent year. The aggregate annual compensation amount(s) shall be adjusted each year for the net addition or loss of directors or officers. 14. FINANCIAL COVENANTS. Each Borrower shall maintain and keep (or cause to be maintained and kept, as the case may be) in full force and effect each of the financial covenants set forth below: (a) Tangible Net Worth. Borrowers' Tangible Net Worth shall not at any time be less than the Minimum Tangible Net Worth; "Minimum Tangible Net Worth" being defined for purposes of this Subsection as follows: (i) $2,200,000 for the period ending December 31, 2003; (ii) thereafter, from the first day of each Fiscal Year of Borrowers through the last day of such Fiscal Year of Borrowers, and at the last day of each fiscal quarter of Borrowers (on a year-to-date 12 month basis), the Minimum Tangible Net Worth during the immediately preceding Fiscal Year or fiscal quarter period, as applicable, plus eighty percent (80%) of Borrowers' net income (but without reduction for any net loss) for such year-to-date period, ending on the last day of the immediately preceding period as reflected on Borrowers' most recent financial statements delivered to Lender pursuant to Section 9 hereof; and (iii) For each Fiscal Year of Borrower following the Fiscal Year ended December 31, 2003, the Minimum Tangible Net Worth amount calculated pursuant to clause "(ii)" above shall be based upon the Tangible Net Worth of Borrowers as of December 31 of the immediately preceding Fiscal Year; and "Tangible Net Worth" being defined for purposes of this Subsection as Borrowers' shareholders' equity (including retained earnings) less the book value of all intangible assets as determined solely by Lender on a consistent basis plus the amount of any amount of any Subordinated Debt, all as determined under GAAP applied on a consistent basis. 26 (b) Fixed Charge Coverage. Borrowers shall not permit the ratio of their EBITDA to Fixed Charges for each period set forth below to be less than the ratio set forth below for the corresponding period set forth below. Period Ending Ratio ------------- ----- (i) For the 3 months ending December 31, 2003 .95 to 1.0 (ii) For the 6 months ending March 31, 2004 1.0 to 1.0 (iii) For the 9 months ending June 30, 2004 .95 to 1.0 (iv) For the 12 months ending September 30, 2004 .90 to 1.0 (v) For the 12 months ending December 31, 2004 .90 to 1.0 (vi) As of the last day of the month ending each 1.0 to 1.0 fiscal quarter thereafter, for the four (4) fiscal quarters then ending (c) Capital Expenditure Limitations. Borrowers shall not make any Capital Expenditures if, after giving effect to such Capital Expenditure, the aggregate cost of all such fixed assets purchased or otherwise acquired would exceed Five Hundred Thousand and 00/100 Dollars ($500,000) during any Fiscal Year. (d) Operating Lease Obligations. Borrower shall not incur operating lease obligations requiring payments in excess of $100,000 in the aggregate during any Fiscal Year of Borrower. 15. DEFAULT. The occurrence of any one or more of the following events shall constitute an "Event of Default" by Borrowers hereunder: (a) Payment. The failure of any Obligor to pay when due, declared due or demanded by Lender any of the Obligations. (b) Breach of this Agreement and the Other Agreements. The failure of any Obligor to perform, keep or observe any of the covenants, conditions, promises, agreements or obligations of such Obligor under this Agreement or any of the Other Agreements; provided that any such failure by any Borrower under Subsections 12(b)(i), (iv), (v), (vi), 12(c) and 12(i) of this Agreement shall not constitute an Event of Default hereunder until the fifteenth (15th) day following the occurrence thereof. (c) Breaches of Other Obligations. The failure of any Obligor to perform, keep or observe any of the covenants, conditions, promises, agreements or obligations of such Obligor under any other agreement with any Person if such failure might have a Material Adverse Effect on such Obligor, including under any subordination agreement relative to Subordinated Debt of such Obligor, or any agreement, instrument or document evidencing or relating to such Subordinated Debt. 27 (d) Breach of Representations and Warranties. The making or furnishing by any Obligor to Lender of any representation, warranty, certificate, schedule, report or other communication within or in connection with this Agreement or the Other Agreements, or in connection with any other agreement between such Obligor and Lender, which is untrue or misleading in any respect. (e) Loss of Collateral. The loss, theft, damage or destruction of any of the Collateral in an amount in excess of $25,000 in the aggregate for all such events during any year of the Original Term or any Renewal Term as determined by Lender in its sole discretion determined in good faith, or (except as permitted hereby) the sale, lease or furnishing under a contract of service of any of the Collateral. (f) Levy, Seizure or Attachment. The making or any attempt by any Person to make any levy, seizure or attachment upon any of the Collateral. (g) Bankruptcy or Similar Proceedings. The commencement of any proceedings in bankruptcy by or against any Obligor or for the liquidation or reorganization of any Obligor, or alleging that such Obligor is insolvent or unable to pay its debts as they mature, or for the readjustment or arrangement of any Obligor's debts, whether under the United States Bankruptcy Code or under any other law, whether state or federal, now or hereafter existing, for the relief of debtors, or the commencement of any analogous statutory or nonstatutory proceedings involving any Obligor; provided, however, that if such commencement of proceedings against such Obligor is involuntary, such action shall not constitute an Event of Default unless such proceedings are not dismissed within forty-five (45) days after the commencement of such proceedings, though Lender shall have no obligation to make Loans or issue Letters of Credit to any Borrowers during such forty-five (45) day period or, if earlier, until such proceedings are dismissed. (h) Appointment of Receiver. The appointment of a receiver or trustee for any Obligor, for any of the Collateral or for any substantial part of any Obligor's assets or the institution of any proceedings for the dissolution, or the full or partial liquidation, or the merger or consolidation, of any Obligor which is a corporation, limited liability company or a partnership; provided, however, that if such appointment or commencement of proceedings against such Obligor is involuntary, such action shall not constitute an Event of Default unless such appointment is not revoked or such proceedings are not dismissed within forty-five (45) days after the commencement of such proceedings, though Lender shall have no obligation to make Loans or issue Letters of Credit to Borrowers during such forty-five (45) day period or, if earlier, until such appointment is revoked or such proceedings are dismissed. (i) Judgment. The entry of any judgments or orders aggregating in excess of $25,000 against any Obligor which remain unsatisfied or undischarged and in effect for thirty (30) days after such entry without a stay of enforcement or execution. (j) Death or Dissolution of Obligor. The death of any Obligor who is a natural Person, or of any general partner who is a natural Person of any Obligor which is a partnership, or any member who is a natural Person of any Obligor which is a limited liability 28 company or the dissolution of any Obligor which is a partnership, limited liability company, corporation or other entity. (k) Default or Revocation of Guaranty; Subordination Agreement. The occurrence of an event of default under, or the revocation or termination of, any agreement, instrument or document executed and delivered by any Person to Lender pursuant to which such Person has guaranteed to Lender the payment of all or any of the Obligations or has granted Lender a Lien upon some or all of such Person's real and/or personal property to secure the payment of all or any of the Obligations or has subordinated indebtedness in whole or in part to the Obligations. (l) Criminal Proceedings. The institution in any court of a criminal proceeding against any Obligor which would have a Material Adverse Effect on such Obligor, or the indictment of any Obligor for any crime other than traffic and boating tickets and misdemeanors not punishable by jail terms. (m) Change of Control. The occurrence of any Change of Control. (n) Change of Management. Howard W. Schwan shall cease to be the President of each Borrower at any time. (o) Material Adverse Change. Any material adverse change in the Collateral, business, property, assets, prospects, operations or condition, financial or otherwise of any Obligor, as determined by Lender in its sole judgment or the occurrence of any event which, in Lender's sole judgment, could have a Material Adverse Effect. 16. REMEDIES UPON AN EVENT OF DEFAULT. (a) Upon the occurrence and during the continuance of an Event of Default described in Subsection 15(g) hereof, all of the Obligations shall immediately and automatically become due and payable, without notice of any kind. Upon the occurrence of any other Event of Default, all Obligations may, at the option of Lender, and without demand, notice or legal process of any kind, be declared, and immediately shall become, due and payable. (b) Upon the occurrence and during the continuance of an Event of Default, Lender may exercise from time to time any rights and remedies available to it under the Uniform Commercial Code and any other applicable law in addition to, and not in lieu of, any rights and remedies expressly granted in this Agreement or in any of the Other Agreements and all of Lender's rights and remedies shall be cumulative and non-exclusive to the extent permitted by law. In particular, but not by way of limitation of the foregoing, Lender may, without notice, demand or legal process of any kind, take possession of any or all of the Collateral (in addition to Collateral of which it already has possession), wherever it may be found and, for that purpose, may pursue the same wherever it may be found, and may enter onto any of Borrowers' premises where any of the Collateral may be, and search for, take possession of, remove, keep and store any of the Collateral until the same shall be sold or otherwise disposed of, and Lender shall have the right to store the same at any of Borrowers' premises without cost to Lender. At Lender's request, each Borrower shall, at Borrowers' expense, assemble the Collateral and make it available to Lender at one or more places to be designated by Lender and reasonably convenient 29 to Lender and such Borrower. Each Borrower recognizes that if a Borrower fails to perform, observe or discharge any of its Obligations under this Agreement or the Other Agreements, no remedy at law will provide adequate relief to Lender, and agrees that Lender shall be entitled to temporary and permanent injunctive relief in any such case without the necessity of proving actual damages. Any notification of intended disposition of any of the Collateral required by law will be deemed to be a reasonable authenticated notification of disposition if given at least ten (10) days prior to such disposition and such notice shall (i) describe Lender and the applicable Borrower(s), (ii) describe the Collateral that is the subject to the intended disposition, (iii) state the method of the intended disposition, (iv) state that the applicable Borrower(s) is entitled to an accounting of the Obligations and state the charge, if any, for an accounting and (v) state the time and place of any public disposition or the time after which any private sale is to be made. Lender may disclaim any warranties that might arise in connection with the sale, lease or other disposition of the Collateral and has no obligation to provide any warranties at such time. Any Proceeds of any disposition by Lender of any of the Collateral may be applied by Lender to the payment of expenses in connection with the Collateral, including, without limitation, legal expenses and reasonable attorneys' fees, and any balance of such Proceeds may be applied by Lender toward the payment of such of the Obligations, and in such order of application as Lender may from time to time elect. 17. CONDITIONS PRECEDENT. The obligation of Lender to fund the Term Loan, to fund the initial Revolving Loan, and to issue or cause to be issued the initial Letter of Credit is subject to the satisfaction or waiver, on or before the date hereof, of the following conditions precedent: (a) Lender shall have received each of the agreements, opinions, reports, approvals, consents, certificates and other documents set forth on the closing document list pertaining to this Agreement (the "Closing Document List") in each case in form and substance satisfactory to Lender; (b) Since December 31, 2002, no event shall have occurred which has had or could reasonably be expected to have a Material Adverse Effect on any Obligor, as determined by Lender in its sole discretion, determined in good faith; (c) Lender shall have received payment in full of all fees and expenses payable to it by Borrowers or any other Person in connection herewith, on or before disbursement of the initial Loans hereunder; (d) Lender shall have determined that immediately after giving effect to (A) the making of the initial Loans, including without limitation the Term Loan and the Revolving Loans, if any, requested to be made on the date hereof, (B) the issuance of the initial Letter of Credit, if any, requested to be made on such date, (C) the payment of all fees due upon such date, and (D) the payment or reimbursement by Borrowers of Lender for all closing costs and expenses incurred in connection with the transactions contemplated hereby, Borrowers have Excess Availability of not less than Seven Hundred Fifty Thousand and no/100 Dollars ($750,000); 30 (e) The Obligors shall have executed and delivered to Lender all such other documents, instruments and agreements which Lender determines are reasonably necessary to consummate the transactions contemplated hereby; (f) The indebtedness of Borrowers to Congress Financial shall have been paid in full and Lender shall have been provided a payoff letter and all applicable termination statements and other releases evidencing the payment in full thereof, in form and substance acceptable to Lender; (g) Lender shall be satisfied with its review of each of the following: (i) Borrowers' licensing agreements, (ii) Borrowers' buy/sell agreements, (iii) Borrowers' vendor payout agreements and (iv) CTI Helium's interim year-to-date financial statements; (h) Subordinated Agreements with respect to all Subordinated Debt existing as of the Closing Date shall have been executed and delivered to Lender; (i) Validity and Support Agreement executed by Mr. Howard Schwan and Stephen M. Merrick, in form and substance acceptable to Lender, shall have been delivered to Lender; (j) The Key Man Insurance shall be effective and Borrowers shall have delivered an assignment in favor of Lender with respect to the Key Man Insurance pursuant to Section 12(k); and (k) Keepwell Agreement of certain principal shareholders of CTI Industries (which are acceptable to Lender) as provided in Section 12(l) hereof. 18. JOINT AND SEVERAL LIABILITY. (a) Notwithstanding anything to the contrary contained herein, all Obligations of each Borrower hereunder shall be joint and several obligations of Borrowers. (b) Notwithstanding any provisions of this Agreement to the contrary, it is intended that the joint and several nature of the Obligations of Borrowers, and the liens and security interests granted by Borrowers to secure the Obligations, not constitute a "Fraudulent Conveyance" (as defined below). Consequently, Lender and Borrowers agree that if the Obligations of a Borrower, or any liens or security interests granted by such Borrower securing the Obligations, would, but for the application of this sentence, constitute a Fraudulent Conveyance, the Obligations of such Borrower and the liens and security interests securing such Obligations shall be valid and enforceable only to the maximum extent that would not cause such Obligations or such lien or security interest to constitute a Fraudulent Conveyance, and the Obligations of such Borrower and this Agreement shall automatically be deemed to have been amended accordingly. For purposes hereof, "Fraudulent Conveyance" means a fraudulent conveyance under Section 548 of Chapter 11 of Title II of the United States Code (11 U.S.C. ss. 101, et seq.), as amended (the "Bankruptcy Code"), or a fraudulent conveyance or fraudulent transfer under the applicable provisions of any fraudulent conveyance or fraudulent transfer law or similar law of any state, nation or other governmental unit, as in effect from time to time. 31 (c) Each Borrower assumes responsibility for keeping itself informed of the financial condition of the each other Borrower, and any and all endorsers and/or guarantors of any instrument or document evidencing all or any part of such other Borrower's Obligations, and of all other circumstances bearing upon the risk of nonpayment by such other Borrowers of their Obligations and each Borrower agrees that Lender shall not have any duty to advise such Borrower of information known to Lender regarding such condition or any such circumstances or to undertake any investigation not a part of its regular business routine. If Lender, in its sole discretion, undertakes at any time or from time to time to provide any such information to a Borrower, Lender shall not be under any obligation to update any such information or to provide any such information to such Borrower on any subsequent occasion. (d) Lender is hereby authorized, without notice or demand and without affecting the liability of a Borrower hereunder, to, at any time and from time to time, (i) renew, extend, accelerate or otherwise change the time for payment of, or other terms relating to, a Borrower's Obligations or otherwise modify, amend or change the terms of any promissory note or other agreement, document or instrument now or hereafter executed by a Borrower and delivered to Lender; (ii) accept partial payments on a Borrower's Obligations; (iii) take and hold security or collateral for the payment of a Borrower's Obligations hereunder or for the payment of any guaranties of a Borrower's Obligations or other liabilities of a Borrower and exchange, enforce, waive and release any such security or collateral; (iv) apply such security or collateral and direct the order or manner of sale thereof as Lender, in its sole discretion, may determine; and (v) settle, release, compromise, collect or otherwise liquidate a Borrower's Obligations and any security or collateral therefor in any manner, without affecting or impairing the obligations of the other Borrowers. Lender shall have the exclusive right to determine the time and manner of application of any payments or credits, whether received from a Borrower or any other source, and such determination shall be binding on such Borrower. All such payments and credits may be applied, reversed and reapplied, in whole or in part, to any of a Borrower's Obligations as Lender shall determine in its sole discretion without affecting the validity or enforceability of the Obligations of the other Borrowers. (e) Each Borrower hereby agrees that, except as hereinafter provided, its obligations hereunder shall be unconditional, irrespective of (i) the absence of any attempt to collect a Borrower's Obligations from any Borrower or any guarantor or other action to enforce the same; (ii) the waiver or consent by Lender with respect to any provision of any instrument evidencing Borrowers' Obligations, or any part thereof, or any other agreement heretofore, now or hereafter executed by a Borrower and delivered to Lender; (iii) failure by Lender to take any steps to perfect and maintain its security interest in, or to preserve its rights to, any security or collateral for Borrowers' Obligations; (iv) the institution of any proceeding under the Bankruptcy Code, or any similar proceeding, by or against a Borrower or Lender's election in any such proceeding of the application of Section 1111(b)(2) of the Bankruptcy Code; (v) any borrowing or grant of a security interest by any Borrower as debtor-in-possession under Section 364 of the Bankruptcy Code; (vi) the disallowance, under Section 502 of the Bankruptcy Code, of all or any portion of Lender's claim(s) for repayment of any of Borrowers' Obligations; or (vii) any other circumstance which might otherwise constitute a legal or equitable discharge or defense of a guarantor. 32 (f) No payment made by or for the account of a Borrower, including, without limitations, (i) a payment made by such Borrower on behalf of another Borrower's Obligations or (ii) a payment made by any other person under any guaranty, shall entitle such Borrower, by subrogation or otherwise, to any payment from such other Borrower or from or out of such other Borrower's property and such Borrower shall not exercise any right or remedy against such other Borrower or any property of such other Borrower by reason of any performance of such Borrower of its joint and several obligations hereunder. 19. INDEMNIFICATION. Each Borrower agrees to defend (with counsel satisfactory to Lender), protect, indemnify and hold harmless Lender, each affiliate or subsidiary of Lender, and each of their respective officers, directors, employees, attorneys and agents (each an "Indemnified Party") from and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, claims, costs, expenses and disbursements of any kind or nature (including, without limitation, the disbursements and the reasonable fees of counsel for each Indemnified Party in connection with any investigative, administrative or judicial proceeding, whether or not the Indemnified Party shall be designated a party thereto), which may be imposed on, incurred by, or asserted against, any Indemnified Party (whether direct, indirect or consequential and whether based on any federal, state or local laws or regulations, including, without limitation, securities laws and regulations, Environmental Laws and commercial laws and regulations, under common law or in equity, or based on contract or otherwise) in any manner relating to or arising out of this Agreement or any Other Agreement, or any act, event or transaction related or attendant thereto, the making or issuance and the management of the Loans or any Letters of Credit or the use or intended use of the proceeds of the Loans or any Letters of Credit; provided, however, that no Borrower shall have any obligation hereunder to any Indemnified Party with respect to matters caused by or resulting from the willful misconduct or gross negligence of such Indemnified Party. To the extent that the undertaking to indemnify set forth in the preceding sentence may be unenforceable because it is violative of any law or public policy, each Borrower shall satisfy such undertaking to the maximum extent permitted by applicable law. Any liability, obligation, loss, damage, penalty, cost or expense covered by this indemnity shall be paid to each Indemnified Party on demand, and, failing prompt payment, shall, together with interest thereon at the highest rate then applicable to Loans hereunder from the date incurred by each Indemnified Party until paid by Borrowers, be added to the Obligations of Borrowers and be secured by the Collateral. The provisions of this Section 19 shall survive the satisfaction and payment of the other Obligations and the termination of this Agreement. 20. NOTICE. All written notices and other written communications with respect to this Agreement shall be sent by ordinary, certified or overnight mail, by telecopy or delivered in person, and in the case of Lender shall be sent to it at 111 West Washington Street, Suite 400, Chicago, Illinois 60602, attention: Mr. Jeffrey J. Podwika, facsimile number: (312) 442-5100, jpodwika@coletaylor.com, and in the case of Borrowers shall be sent to them at their respective principal places of business set forth on Schedule 11(b) or as otherwise directed by Borrowers in writing. All notices shall be deemed received upon actual receipt thereof or refusal of delivery. 21. CHOICE OF GOVERNING LAW; CONSTRUCTION; FORUM SELECTION. This Agreement and the Other Agreements are submitted by Borrowers to Lender for Lender's acceptance or rejection at Lender's principal place of business as an offer by Borrowers to borrow monies from Lender now and from time to time hereafter, and shall not be 33 binding upon Lender or become effective until accepted by Lender, in writing, at said place of business. If so accepted by Lender, this Agreement and the Other Agreements shall be deemed to have been made at said place of business. THIS AGREEMENT AND THE OTHER AGREEMENTS SHALL BE GOVERNED AND CONTROLLED BY THE INTERNAL LAWS OF THE STATE OF ILLINOIS AS TO INTERPRETATION, ENFORCEMENT, VALIDITY, CONSTRUCTION, EFFECT, AND IN ALL OTHER RESPECTS, INCLUDING, WITHOUT LIMITATION, THE LEGALITY OF THE INTEREST RATE AND OTHER CHARGES, BUT EXCLUDING PERFECTION OF THE SECURITY INTERESTS IN COLLATERAL LOCATED OUTSIDE OF THE STATE OF ILLINOIS, WHICH SHALL BE GOVERNED AND CONTROLLED BY THE LAWS OF THE RELEVANT JURISDICTION IN WHICH SUCH COLLATERAL IS LOCATED. If any provision of this Agreement shall be held to be prohibited by or invalid under applicable law, such provision shall be ineffective only to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or remaining provisions of this Agreement. To induce Lender to accept this Agreement, each Borrower irrevocably agrees that, subject to Lender's sole and absolute election, ALL ACTIONS OR PROCEEDINGS IN ANY WAY, MANNER OR RESPECT, ARISING OUT OF OR FROM OR RELATED TO THIS AGREEMENT, THE OTHER AGREEMENTS OR THE COLLATERAL SHALL BE LITIGATED IN COURTS HAVING SITUS WITHIN THE CITY OF CHICAGO, STATE OF ILLINOIS. EACH BORROWER HEREBY CONSENTS AND SUBMITS TO THE JURISDICTION OF ANY LOCAL, STATE OR FEDERAL COURTS LOCATED WITHIN SAID CITY AND STATE. EACH BORROWER HEREBY WAIVES PERSONAL SERVICE OF ANY AND ALL PROCESS AND AGREES THAT ALL SUCH SERVICE OF PROCESS MAY BE MADE UPON SUCH BORROWER BY CERTIFIED OR REGISTERED MAIL, RETURN RECEIPT REQUESTED, ADDRESSED TO SUCH BORROWER AT THE ADDRESS SET FORTH FOR NOTICE IN THIS AGREEMENT AND SERVICE SO MADE SHALL BE COMPLETE TEN (10) DAYS AFTER THE SAME HAS BEEN POSTED. LENDER AGREES TO ENDEAVOR TO PROVIDE A COPY OF SUCH PROCESS TO THE LAW FIRM OF MERRICK & KLIMEK, P.C. BY MAIL AT THE ADDRESS OF 33 N. LASALLE STREET, SUITE 2200, CHICAGO, ILLINOIS 60602 OR BY FACSIMILE TRANSMISSION AT FACSIMILE NUMBER (312) 284-1521. FAILURE OF LENDER TO PROVIDE A COPY OF SUCH PROCESS SHALL NOT IMPAIR LENDER'S RIGHTS HEREUNDER, CREATE A CAUSE OF ACTION AGAINST LENDER OR CREATE ANY CLAIM OR RIGHT ON BEHALF OF ANY BORROWER OR ANY THIRD PARTY. EACH BORROWER HEREBY WAIVES ANY RIGHT IT MAY HAVE TO TRANSFER OR CHANGE THE VENUE OF ANY LITIGATION BROUGHT AGAINST SUCH BORROWER BY LENDER IN ACCORDANCE WITH THIS SECTION. 22. MODIFICATION AND BENEFIT OF AGREEMENT. This Agreement and the Other Agreements may not be modified, altered or amended except by an agreement in writing signed by each Borrower or such other Person who is a party to such Other Agreement and Lender. No Borrower may sell, assign or transfer this Agreement, or the Other Agreements or any portion thereof, including, without limitation, such Borrower's rights, titles, interest, remedies, powers or duties hereunder and thereunder. Each Borrower hereby consents to Lender's sale, assignment, transfer or other disposition, at any time and from time to time 34 hereafter, of this Agreement, or the Other Agreements, or of any portion thereof, or participations therein, including, without limitation, Lender's rights, titles, interest, remedies, powers and/or duties and agrees that it shall execute and deliver such documents as Lender may request in connection with any such sale, assignment, transfer or other disposition. 23. HEADINGS OF SUBDIVISIONS. The headings of subdivisions in this Agreement are for convenience of reference only, and shall not govern the interpretation of any of the provisions of this Agreement. 24. POWER OF ATTORNEY. Each Borrower acknowledges and agrees that its appointment of Lender as its attorney and agent-in-fact for the purposes specified in this Agreement is an appointment coupled with an interest and shall be irrevocable until all of the Obligations are satisfied and paid in full and this Agreement is terminated. 25. CONFIDENTIALITY. Lender hereby agrees to use commercially reasonable efforts to assure that any and all information relating to such Borrower which is (i) furnished by such Borrower to Lender (or to any affiliate of Lender); and (ii) non-public, confidential or proprietary in nature shall be kept confidential by Lender or such affiliate in accordance with applicable law; provided, however, that such information and other credit information relating to such Borrower may be distributed by Lender or such affiliate to Lender's or such affiliate's directors, officers, employees, attorneys, affiliates, assignees, participants, auditors, agents and regulators, and upon the order of a court or other governmental agency having jurisdiction over Lender or such affiliate, to any other party. Each Borrower and Lender further agree that this provision shall survive the termination of this Agreement. Notwithstanding the foregoing, each Borrower hereby consents to Lender publishing a tombstone or similar advertising material relating to the financing transaction contemplated by this Agreement. 26. COUNTERPARTS. This Agreement, any of the Other Agreements and any amendments, waivers, consents or supplements may be executed in any number of counterparts and by different parties hereto in separate counterparts, each of which, when so executed and delivered, shall be deemed an original, but all of which counterparts together shall constitute but one agreement. 27. ELECTRONIC SUBMISSIONS. Upon not less than thirty (30) days' prior written notice (the "Approved Electronic Form Notice"), Lender may permit or require that any of the documents, certificates, forms, deliveries or other communications, authorized, required or contemplated by this Agreement or the Other Agreements, be submitted to Lender in "Approved Electronic Form" (as hereafter defined), subject to any reasonable terms, conditions and requirements in the applicable Approved Electronic Forms Notice. For purposes hereof "Electronic Form" means e-mail, e-mail attachments, data submitted on web-based forms or any other communication method that delivers machine readable data or information to Lender and "Approved Electronic Form" means an Electronic Form that has been approved in writing by Lender (which approval has not been revoked or modified by Lender) and sent to Borrowers in an Approved Electronic Form Notice. Except as otherwise specifically provided in the applicable Approved Electronic Form Notice, any submissions made in an applicable Approved Electronic Form shall have the same force and effect that the same submissions would have had 35 if they had been submitted in any other applicable form authorized, required or contemplated by this Agreement or the Other Agreements. 28. WAIVER OF JURY TRIAL; OTHER WAIVERS. (a) EACH BORROWER AND LENDER EACH HEREBY WAIVES ALL RIGHTS TO TRIAL BY JURY IN ANY ACTION OR PROCEEDING WHICH PERTAINS DIRECTLY OR INDIRECTLY TO THIS AGREEMENT, ANY OF THE OTHER AGREEMENTS, THE OBLIGATIONS, THE COLLATERAL, ANY ALLEGED TORTUOUS CONDUCT BY A BORROWER OR LENDER OR WHICH, IN ANY WAY, DIRECTLY OR INDIRECTLY, ARISES OUT OF OR RELATES TO THE RELATIONSHIP BETWEEN A BORROWER AND LENDER. IN NO EVENT SHALL LENDER BE LIABLE FOR LOST PROFITS OR OTHER SPECIAL, EXEMPLARY, PUNITIVE OR CONSEQUENTIAL DAMAGES. (b) Each Borrower hereby waives demand, presentment, protest and notice of nonpayment, and further waives the benefit of all valuation, appraisal and exemption laws. (c) Each Borrower hereby waives the benefit of any law that would otherwise restrict or limit Lender or any affiliate of Lender in the exercise of its right, which is hereby acknowledged and agreed to, to set-off against the Obligations, without notice at any time hereafter, any indebtedness, matured or unmatured, owing by Lender or such affiliate of Lender to such Borrower, including, without limitation any deposit account at Lender or such affiliate. (d) EACH BORROWER HEREBY WAIVES ALL RIGHTS TO NOTICE AND HEARING OF ANY KIND PRIOR TO THE EXERCISE BY LENDER OF ITS RIGHTS TO REPOSSESS THE COLLATERAL OF SUCH BORROWER WITHOUT JUDICIAL PROCESS OR TO REPLEVY, ATTACH OR LEVY UPON SUCH COLLATERAL, PROVIDED THAT IN THE EVENT THAT LENDER SEEKS TO ENFORCE ITS RIGHTS HEREUNDER BY JUDICIAL PROCESS OR SELF HELP, LENDER SHALL PROVIDE BORROWER WITH SUCH NOTICES AS ARE REQUIRED BY LAW. (e) Lender's failure, at any time or times hereafter, to require strict performance by a Borrower of any provision of this Agreement or any of the Other Agreements shall not waive, affect or diminish any right of Lender thereafter to demand strict compliance and performance therewith. Any suspension or waiver by Lender of an Event of Default under this Agreement or any default under any of the Other Agreements shall not suspend, waive or affect any other Event of Default under this Agreement or any other default under any of the Other Agreements, whether the same is prior or subsequent thereto and whether of the same or of a different kind or character. No delay on the part of Lender in the exercise of any right or remedy under this Agreement or any Other Agreement shall preclude other or further exercise thereof or the exercise of any right or remedy. None of the undertakings, agreements, warranties, covenants and representations of Borrowers contained in this Agreement or any of the Other Agreements and no Event of Default under this Agreement or default under any of the Other Agreements shall be deemed to have been suspended or waived by Lender unless such 36 suspension or waiver is in writing, signed by a duly authorized officer of Lender and directed to Borrowers specifying such suspension or waiver. SIGNATURE PAGES FOLLOW 37 Signature Page to Loan and Security Agreement IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement as of the date first written above. CTI INDUSTRIES CORPORATION By /s/ Howard W. Schwan ----------------------- Howard W. Schwan President CTI HELIUM, INC. By /s/ Howard W. Schwan ----------------------- Howard W. Schwan President Signature Page to Loan and Security Agreement COLE TAYLOR BANK By /s/ Jeffrey J. Podwika ------------------------- Vice President ANNEX I - DEFINED TERMS "Affiliate" shall mean any Person (i) which, directly or indirectly through one or more intermediaries, controls, is controlled by, or is under common control with, a Borrower, (ii) which beneficially owns or holds five percent (5%) or more of the voting control or equity interests of a Borrower, or (iii) five percent (5%) or more of the voting control or equity interests of which is beneficially owned or held by a Borrower. "Business Day" shall mean any day other than a Saturday, a Sunday or any day that banks in Chicago, Illinois are required or permitted to close. "Capital Expenditures" shall mean with respect to any period, the aggregate of all expenditures (whether paid in cash or accrued as liabilities and including expenditures for Capital Lease Obligations) by Borrowers during such period that are required by GAAP, consistently applied, to be included in or reflected by the property, plant and equipment or similar fixed asset accounts (or intangible accounts subject to amortization) on the balance sheet of Borrowers. "Capital Lease" shall mean, as to any Person, a lease of any interest in any kind of property or asset, whether real, personal or mixed, or tangible or intangible, by such Person as lessee that is, or should be, recorded as a "capital lease" on the balance sheet of such Person prepared in accordance with GAAP. "Capital Lease Obligations" shall mean, as to any Person, indebtedness represented by obligations under a Capital Lease that is required to be capitalized for financial reporting purposes in accordance with GAAP. "Change of Control" shall mean any merger or consolidation of or with any Borrower or sale of all or substantially all of the property or assets of any Borrower. For purposes of this definition, "control of Borrower" shall mean the power, direct or indirect (x) to vote 50% or more of the securities having ordinary voting power for the election of directors of any Borrower or (y) to direct or cause the direction of the management and policies of any Borrower by contract or otherwise. "Closing Date" shall mean December 31, 2003. "Collateral" shall mean all of the property of each Borrower described in Section 5 hereof, together with all other real or personal property of any Obligor or any other Person now or hereafter pledged to Lender to secure, either directly or indirectly, repayment of any of the Obligations. "Compliance Certificate" shall have the meaning set forth in Section 9(c) hereof. "Contingent Liability" shall mean any agreement, undertaking or arrangement by which any Person guarantees, endorses or otherwise becomes or is contingently liable upon (by direct or indirect agreement, contingent or otherwise, to provide funds for payment, to supply funds to or otherwise to invest in a debtor, or otherwise to assure a creditor against loss) any indebtedness, obligation or other liability of any other Person (other than by endorsements of 1 instruments in the course of collection), or guarantees the payment of dividends or other distributions upon the shares of any other Person. The amount of any Contingent Liability shall (subject to any limitation set forth herein) be deemed to be the outstanding principal amount (or maximum permitted principal amount, if larger) of the indebtedness, obligation or other liability guaranteed or supported thereby. "Derivative Obligations" shall mean every obligation of a Person under any forward contract, futures contract, exchange contract, swap, option or other financing agreement or arrangement (including, without limitation, caps, floors, collars and similar agreement), the value of which is dependent upon interest rates, currency exchange rates, commodities or other indices. "Dilution" shall mean, with respect to any period, the percentage obtained by dividing (i) the sum of non-cash credits against Accounts (including, but not limited to returns, adjustments and rebates) of Borrowers for such period, plus pending or probable, but not yet applied, non-cash credits against Accounts of Borrowers for such period, as determined by Lender in its sole discretion, by (ii) gross invoiced sales of Borrowers for such period. "EBITDA" shall mean, with respect to any period, Borrowers' net income after taxes for such period (excluding any after-tax gains on the sale of assets (other than the sale of Inventory in the ordinary course of business) and excluding other after-tax extraordinary gains) plus interest expense, income tax expense, depreciation and amortization for such period, plus or minus any other non-cash charges or gains which have been subtracted or added in calculating net income after taxes for such period. "Eligible Account" shall mean an Account owing to a Borrower which is acceptable to Lender in its sole discretion for lending purposes. Without limiting Lender's discretion, Lender shall, in general, consider an Account to be an Eligible Account if it meets, and so long as it continues to meet, the following requirements: (i) it is genuine and in all respects what it purports to be; (ii) it is owned by such Borrower, such Borrower has the right to subject it to a security interest in favor of Lender or assign it to Lender and it is subject to a first priority perfected security interest in favor of Lender and to no other Lien whatsoever, other than Permitted Liens; (iii) it arises from (A) the performance of services by such Borrower in the ordinary course of such Borrower's business, and such services have been fully performed and acknowledged and accepted by the Account Debtor thereunder; or (B) the sale or lease of Goods by such Borrower in the ordinary course of such Borrower's business, and (x) such Goods have been completed in accordance with the Account Debtor's specifications (if any) and delivered to the Account Debtor, (y) such Account Debtor has not refused to accept, returned or offered to return any of the Goods which are the subject of such Account, and (z) such Borrower has possession of, or such Borrower has delivered to Lender (at Lender's request), shipping and delivery receipts evidencing delivery of such Goods; 2 (iv) it is evidenced by an invoice rendered to the Account Debtor thereunder, is due and payable within ninety (90) days after the date of the invoice and does not remain unpaid ninety (90) days past the invoice date thereof; provided, however, that if more than twenty-five percent (25%) of the aggregate dollar amount of invoices owing by a particular Account Debtor remain unpaid ninety (90) days after the respective invoice dates thereof, then all Accounts owing by that Account Debtor shall be deemed ineligible; (v) it is a valid, legally enforceable and unconditional obligation of the Account Debtor thereunder, and is not subject to setoff, counterclaim, credit, allowance or adjustment by such Account Debtor, or to any claim by such Account Debtor denying liability thereunder in whole or in part; (vi) it does not arise out of a contract or order which fails in any material respect to comply with the requirements of applicable law; (vii) the Account Debtor thereunder is not a director, officer, employee or agent of a Borrower, or a Subsidiary, Parent or Affiliate; (viii) it is not an Account with respect to which the Account Debtor is the United States of America or any state or local government, or any department, agency or instrumentality thereof, unless such Borrower assigns its right to payment of such Account to Lender pursuant to, and in full compliance with, the Assignment of Claims Act of 1940, as amended, or any comparable state or local law, as applicable; (ix) it is not an Account with respect to which the Account Debtor is located in a state which requires such Borrower, as a precondition to commencing or maintaining an action in the courts of that state, either to (A) receive a certificate of authority to do business and be in good standing in such state; or (B) file a notice of business activities report or similar report with such state's taxing authority, unless (x) such Borrower has taken one of the actions described in clauses (A) or (B); (y) the failure to take one of the actions described in either clause (A) or (B) may be cured retroactively by such Borrower at its election; or (z) such Borrower has proven, to Lender's satisfaction, that it is exempt from any such requirements under any such state's laws; (x) the Account Debtor is located within the United States of America; (xi) it is not an Account with respect to which the Account Debtor's obligation to pay is subject to any repurchase obligation or return right, as with sales made on a bill-and-hold, guaranteed sale, sale on approval, sale or return or consignment basis; (xii) it is not an Account (A) with respect to which any representation or warranty contained in this Agreement is untrue; or (B) which violates any of the covenants of such Borrower contained in this Agreement; 3 (xiii) it is not an Account which, when added to a particular Account Debtor's other indebtedness to such Borrower, exceeds twenty percent (20%) of all Accounts of such Borrower or a credit limit determined by Lender in its sole discretion determined in good faith for that Account Debtor (except that Accounts excluded from Eligible Accounts solely by reason of this clause (xiii) shall be Eligible Accounts to the extent of such credit limit), provided that Lender shall give such Borrower written notice of any such credit limit; and (xiv) it is not an Account with respect to which the prospect of payment or performance by the Account Debtor is or will be impaired, as determined by Lender in its sole discretion determined in good faith. "Eligible Inventory" shall mean Inventory and work-in-process Inventory of a Borrower, each to the extent acceptable to Lender in its sole discretion determined in good faith for lending purposes. Without limiting Lender's discretion, Lender shall, in general, consider Inventory to be Eligible Inventory if it meets, and so long as it continues to meet, the following requirements: (i) it is owned by such Borrower, such Borrower has the right to subject it to a security interest in favor of Lender and it is subject to a first priority perfected security interest in favor of Lender and to no other Lien whatsoever, other than Permitted Liens; (ii) it is located on one of the premises listed on Schedule 11(b) (or other locations of which Lender has been advised in writing pursuant to Subsection 12(b)(i) hereof) and is not in transit; (iii) if held for sale or lease or furnishing under contracts of service, it is (except as Lender may otherwise consent in writing) new and unused and free from defects which would, in Lender's sole determination, determined in good faith, affect its market value; (iv) it is not stored with a bailee, consignee, warehouseman, processor or similar party unless Lender has given its prior written approval and such Borrower has caused any such bailee, consignee, warehouseman, processor or similar party to issue and deliver to Lender, in form and substance acceptable to Lender, such Uniform Commercial Code financing statements, warehouse receipts, waivers, collateral access agreements and other documents as Lender shall require (such Inventory being referred to herein as "Third-Party Inventory"); (v) Lender has determined, in good faith, in accordance with Lender's customary business practices, that it is not unacceptable due to age, type, category or quantity; and (vi) it is not Inventory (A) with respect to which any of the representations and warranties contained in this Agreement are untrue; or (B) which violates any of the covenants of such Borrower contained in this Agreement. 4 "Environmental Laws" shall mean all federal, state, district, local and foreign laws, rules, regulations, ordinances, and consent decrees relating to health, safety, hazardous substances, pollution and environmental matters, as now or at any time hereafter in effect, applicable to a Borrower's business or facilities owned or operated by a Borrower, including laws relating to emissions, discharges, releases or threatened releases of pollutants, contamination, chemicals, or hazardous, toxic or dangerous substances, materials or wastes into the environment (including, without limitation, ambient air, surface water, ground water, land surface or subsurface strata) or otherwise relating to the generation, manufacture, processing, distribution, use, treatment, storage, disposal, transport or handling of Hazardous Materials. "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as amended, modified or restated from time to time. "Event of Default" shall have the meaning specified in Section 15 hereof. "Excess Availability" shall mean, as of any date of determination by Lender, the excess, if any, of the lesser of (i) the Maximum Revolving Loan Limit less the sum of the outstanding Revolving Loans and Letter of Credit Obligations and (ii) the Revolving Borrowing Base Amount less the sum of the outstanding Revolving Loans and Letter of Credit Obligations, in each case as of the close of business on such date and assuming, for purposes of calculation, that all accounts payable which remain unpaid more than sixty (60) days after the due dates thereof as the close of business on such date are treated as additional Revolving Loans outstanding on such date. "Excess Cash Flow" shall have the meaning set forth in Section 2(c)(iii)(B) hereof. "Fiscal Year" shall mean each twelve (12) month accounting period of Borrowers, which ends on December 31 of each year. "Fixed Charges" shall mean for any period, without duplication, scheduled payments of principal during the applicable period with respect to all Indebtedness of Borrowers and their Subsidiaries, on a consolidated basis, for borrowed money, plus scheduled payments of principal during the applicable period with respect to all Capital Lease Obligations of Borrowers and their Subsidiaries, on a consolidated basis, plus scheduled payments of interest during the applicable period with respect to all Indebtedness of Borrowers and their Subsidiaries, on a consolidated basis, for borrowed money including Capital Lease Obligations, plus unfinanced Capital Expenditures of Borrowers and their Subsidiaries, on a consolidated basis, during the applicable period, plus payments during the applicable period in respect of income or franchise taxes of Borrowers and their Subsidiaries, on a consolidated basis, plus any cash dividends or payments of Subordinated Debt permitted by Lender paid by Borrowers during such period. "GAAP" shall mean generally accepted accounting principles, using the accrual basis of accounting and consistently applied with prior periods; provided, however, that GAAP with respect to any interim financial statements or reports shall be deemed subject to fiscal year-end adjustments and footnotes made in accordance with GAAP. 5 "Hazardous Materials" shall mean any hazardous, toxic or dangerous substance, materials and wastes, including, without limitation, hydrocarbons (including naturally occurring or man-made petroleum and hydrocarbons), flammable explosives, asbestos, urea formaldehyde insulation, radioactive materials, biological substances, polychlorinated biphenyls, pesticides, herbicides and any other kind and/or type of pollutants or contaminants (including, without limitation, materials which include hazardous constituents), sewage, sludge, industrial slag, solvents and/or any other similar substances, materials, or wastes and including any other substances, materials or wastes that are, or become, regulated under any Environmental Law (including, without limitation, any that are, or become, classified as hazardous or toxic under any Environmental Law). "Indebtedness" of any Person shall mean, without duplication, (a) all indebtedness of such Person for borrowed money, whether or not evidenced by bonds, debentures, notes or similar instruments, (b) all Capital Lease Obligations of such Person, (c) all obligations of such Person to pay the deferred purchase price of property or services (excluding trade accounts payable in the ordinary course of business), (d) all indebtedness secured by a Lien on the property of such Person, whether or not such indebtedness shall have been assumed by such Person, (e) all obligations, contingent or otherwise, with respect to the face amount of all letters of credit (whether or not drawn) and banker's acceptances issued for the account of such Person, (f) all Derivative Obligations of such Person, (g) all Contingent Obligations, and (h) all liabilities of any partnership or joint venture of which such Person is a general partner or joint venturer. "Indemnified Party" shall have the meaning specified in Section 19 hereof. "Initial 2004 M & E Appraisal" shall have the meaning set forth in Section 9(g) hereof. "Intellectual Property" shall mean all past, present and future: trade secrets (including, without limitation, customer lists), know-how and other proprietary information; trademarks, Internet domain names, service marks, trade dress, trade names, business names, designs, logos, slogans (and all translations, adaptations, derivations and combinations of the foregoing), indicia and other source and/or business identifiers, and the goodwill of the business relating thereto and all registrations or applications for registrations which have heretofore been or may hereafter be issued thereon throughout the world; copyrights (including copyrights for computer programs) and copyright registrations or applications for registrations which have heretofore been or may hereafter be issued throughout the world and all tangible property embodying the copyrights; unpatented inventions (whether or not patentable); patent applications and patents; industrial designs, industrial design applications and registered industrial designs; license agreements related to any of the foregoing and income therefrom; books, records, writings, computer tapes or disks, flow diagrams, specification sheets, computer software, source codes, object codes, executable code, data, databases and other physical manifestations, embodiments or incorporations of any of the foregoing; the right to sue for all past, present and future infringements of any of the foregoing; all other intellectual property; and all common law and other rights throughout the world in and to all of the foregoing. "Key-Man Insurance" shall have the meaning set forth in Section 17(j) hereto. 6 "Letter of Credit" shall mean any Letter of Credit issued on behalf of a Borrower in accordance with this Agreement. "Letter of Credit Obligations" shall mean, as of any date of determination, the sum of (i) the aggregate undrawn face amount of all Letters of Credit, and (ii) the aggregate unreimbursed amount of all drawn Letters of Credit not already converted to Loans hereunder. "Lien" shall mean any mortgage, pledge, claim, hypothecation, judgment lien or similar legal process, title retention lien, or other lien or security interest, including, without limitation, the interest of a vendor under any conditional sale or other title retention agreement and the interest of a lessor under a lease of any interest in any kind of property or asset, whether real, personal or mixed, or tangible or intangible, that is, or should be, accounted for as a Capital Lease. "Loan Documents" shall mean this Agreement and the Other Agreements. "Loans" shall mean all loans and advances made by Lender to or on behalf of Borrowers hereunder. "Lock Box" and "Lock Box Account" shall have the meanings specified in Subsection 8(a) hereof. "Material Adverse Effect" shall mean a material adverse effect on the business, property, assets, prospects, operations or condition, financial or otherwise, of a Person. "Maximum Loan Limit" shall mean Eleven Million and No/100 Dollars ($11,000,000). "Maximum Revolving Loan Limit" shall have the meaning specified in Subsection 2(a) hereof. "Net Orderly Liquidation Value" shall mean the aggregate net realizable value of Borrowers' Inventory, by category, recoverable in an orderly liquidation thereof (net of all liquidation expenses), as determined by a certified appraiser satisfactory to Lender. "Obligations" shall mean any and all obligations, liabilities and indebtedness of Borrowers to Lender, or to any parent, affiliate or subsidiary of Lender, of any and every kind and nature, howsoever created, arising or evidenced and howsoever owned, held or acquired, whether now or hereafter existing, whether now due or to become due, whether primary, secondary, direct, indirect, absolute, contingent or otherwise (including, without limitation, obligations of performance), whether several, joint or joint and several, and whether arising or existing under written or oral agreement or by operation of law. "Obligor" shall mean Borrowers and each other Person who is or shall become primarily or secondarily liable for any of the Obligations. "Original Term" shall have the meaning specified in Section 10 hereof. 7 "Other Agreements" shall mean all agreements, instruments and documents, other than this Agreement, including, without limitation, guaranties, mortgages, trust deeds, pledges, powers of attorney, consents, assignments, contracts, notices, security agreements, leases, financing statements, subordination agreements, and all other writings heretofore, now or from time to time hereafter executed by or on behalf of a Borrower or any other Person and delivered to Lender or to any parent, affiliate or subsidiary of Lender in connection with the Obligations or the transactions contemplated hereby, as each of the same may be amended, modified or supplemented from time to time. "Parent" shall mean any Person now or at any time or times hereafter owning or controlling (alone or with any other Person) at least a majority of the issued and outstanding equity of a Borrower and, if a Borrower is a partnership, the general partner of such Borrower. "PBGC" shall have the meaning specified in Subsection 12(b)(v) hereof. "Permitted Liens" shall mean (i) statutory Liens of landlords, carriers, warehousemen, processors, mechanics, materialmen or suppliers incurred in the ordinary course of business and securing amounts not yet due or declared to be due by the claimant thereunder or amounts which are being contested in good faith and by appropriate proceedings and for which Borrower has maintained adequate reserves; (ii) Liens in favor of Lender; (iii) zoning restrictions and easements, licenses, covenants and other restrictions affecting the use of real property that do not individually or in the aggregate have a material adverse effect on a Borrower's ability to use such real property for its intended purpose in connection with such Borrower's business; (iv) Liens in connection with purchase money indebtedness and Capital Leases otherwise permitted pursuant to this Agreement, provided, that such liens attach only to the assets the purchase of which was financed by such purchase money indebtedness or which is the subject of such Capital Leases; (v) Liens set forth on Schedule 1; (vi) Liens specifically permitted by Lender in writing; and (vii) involuntary Liens securing amounts less than $100,000 and which are released or for which a bond acceptable to Lender in its sole discretion, determined in good faith, has been posted within ten (10) days of its creation. "Person" shall mean any individual, sole proprietorship, partnership, joint venture, trust, unincorporated organization, association, corporation, limited liability company, institution, entity, party or foreign or United States government (whether federal, state, county, city, municipal or otherwise), including, without limitation, any instrumentality, division, agency, body or department thereof. "Plan" shall have the meaning specified in Subsection 12(b)(v) hereof. "Prime Rate" shall mean Lender's publicly announced prime rate (which is not intended to be Lender's lowest or most favorable rate in effect at any time) in effect from time to time. "Principal Investment Amount" shall have the meaning set forth in Section 12(l) hereof. "Renewal Term" shall have the meaning specified in Section 10 hereof. 8 "Revolving Borrowing Base Amount" shall have the meaning specified in Subsection 2(a) hereof. "Revolving Loans" shall have the meaning specified in Subsection 2(a) hereof. "Subordination Agreements" shall mean, individually and collectively, all subordination agreements, intercreditor agreements, consent and similar agreements among either Borrower, Lender and any holder of Indebtedness, whether entered into on or prior to the date hereof or from time to time hereafter, together with all modifications, amendments and restatements of any of the foregoing. "Subordinated Debt" shall mean Indebtedness of any Borrower or any Subsidiary of any Borrower that is subordinated to the Obligations in a manner satisfactory to Agent, and contains terms, including, without limitation, payment terms, satisfactory to Agent. "Subsidiary" shall mean any corporation of which more than fifty percent (50%) of the outstanding capital stock having ordinary voting power to elect a majority of the board of directors of such corporation (irrespective of whether, at the time, stock of any other class of such corporation shall have or might have voting power by reason of the happening of any contingency) is at the time, directly or indirectly, owned by a Borrower, or any partnership, joint venture or limited liability company of which more than fifty percent (50%) of the outstanding equity interests are at the time, directly or indirectly, owned by a Borrower or any partnership of which a Borrower is a general partner. "Tangible Net Worth" shall have the meaning specified in Subsection 14(a) hereof. "Term Loan" shall have the meaning specified in Subsection 2(b) hereof. "Third Party Inventory" shall have the meaning set forth in the definition "Eligible Inventory". "UCC" shall mean the Uniform Commercial Code as in effect from time to time in the State of Illinois. 9 EX-10.16 4 d59262_ex10-16.txt TERM NOTE IN THE SUM OF $3,500,000 EXHIBIT 10.16 TERM NOTE $3,500,000 Chicago, Illinois December 31, 2003 FOR VALUE RECEIVED, the undersigned, CTI INDUSTRIES CORPORATION, an Illinois corporation, and CTI HELIUM, INC., an Illinois corporation (collectively, the "Borrowers" and, individually, each a "Borrower"), jointly and severally, each promise to pay to the order of COLE TAYLOR BANK (hereinafter, together with any holder hereof, called "Lender"), at the principal office of the Lender, the principal sum of THREE MILLION FIVE HUNDRED THOUSAND DOLLARS ($3,500,000). Each Borrower, jointly and severally, further promise to pay interest on the outstanding principal amount hereof on the dates and at the rates provided in the Loan Agreement (as hereinafter defined) from the date hereof until payment in full hereof. This Note was delivered pursuant to that certain Loan and Security Agreement dated as of the date hereof, as it may be amended from time to time, together with all exhibits thereto, between Lender and the Borrowers (the "Loan Agreement"). All terms which are capitalized and used herein (which are not otherwise defined herein) shall have the meaning ascribed to such term in the Loan Agreement. This Note is secured by the personal property described in and pursuant to the Loan Agreement and various Loan Documents referred to therein, and reference is made thereto for a statement of terms and provisions of such Collateral security, a description of Collateral and the rights of Lender in respect thereof. Principal hereunder shall be payable pursuant to the terms of the Loan Agreement. Upon the occurrence of an Event of Default, the unpaid balance of the principal amount of this Note, together with all accrued and unpaid interest thereon, may become, or may be declared to be, due and payable in the manner, upon the conditions and with the effect provided in the Loan Agreement. Each Borrower hereby authorizes the Lender to charge any account of such Borrower for all sums due hereunder. If payment hereunder becomes due and payable on a day that is not a Business Day, the due date thereof shall be extended to the next succeeding Business Day, and interest shall be payable thereon at the rate specified during such extension. Credit shall be given for payments made in the manner and at the times provided in the Loan Agreement. It is the intent of the parties that the rate of interest and other charges to the Borrowers under this Note shall be lawful; therefore, if for any reason the interest or other charges payable hereunder are found by a court of competent jurisdiction, in a final determination, to exceed the limit which Lender may lawfully charge the Borrowers, then the obligation to pay interest or other charges shall automatically be reduced to such limit and, if any amount in excess of such limit shall have been paid, then such amount shall be refunded to the Borrowers. The principal and all accrued interest hereunder may be prepaid by the Borrowers, in whole, but not in part, at any time (subject to any applicable prepayment fee). Each Borrower waives the benefit of any law that would otherwise restrict or limit Lender in the exercise of its right, which is hereby acknowledged, to set-off against the Obligations, without notice and at any time hereafter, any indebtedness matured or unmatured owing from Lender to the Borrowers. Each Borrower waives every defense, counterclaim or setoff which such Borrower may now have or hereafter may have to any action by Lender in enforcing this Note and/or any of the other Obligations, or in enforcing Lender's rights in the Collateral and ratifies and confirms whatever Lender may do pursuant to the terms hereof and of the Loan Agreement and with respect to the Collateral and agrees that Lender shall not be liable for any error in judgment or mistakes of fact or law. Each Borrower, any other party liable with respect to the Obligations and any and all endorsers and accommodation parties, and each one of them, if more than one, waive any and all presentment, demand, notice of dishonor, protest, and all other notices and demands in connection with the enforcement of Lender's rights hereunder. The loan evidenced hereby has been made and this Note has been delivered at Chicago, Illinois. THIS NOTE SHALL BE GOVERNED AND CONTROLLED BY THE INTERNAL LAWS OF THE STATE OF ILLINOIS AS TO INTERPRETATION, ENFORCEMENT, VALIDITY, CONSTRUCTION, EFFECT, AND IN ALL OTHER RESPECTS, INCLUDING WITHOUT LIMITATION, THE LEGALITY OF THE INTEREST RATE AND OTHER CHARGES, and shall be binding upon the Borrowers and their respective successors and assigns. If this Note contains any blanks when executed by the Borrowers, the Lender is hereby authorized, without notice to the Borrowers to complete any such blanks according to the terms upon which the loan or loans were granted. Wherever possible, each provision of this Note shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Note shall be prohibited by or be invalid under such law, such provision shall be severable, and be ineffective to the extent of such prohibition or invalidity, without invalidating the remaining provisions of this Note. To induce the Lender to make the loan evidenced by this Note, each Borrower (i) irrevocably agrees that, subject to Lender's sole and absolute election, all actions arising directly or indirectly as a result or in consequence of this Note or any other agreement with the Lender, or the Collateral, shall be instituted and litigated only in courts having situs in the City of Chicago, Illinois; (ii) hereby consents to the exclusive jurisdiction and venue of any State or Federal Court located and having its situs in said city; and (iii) waives any objection based on forum non-conveniens. IN ADDITION, LENDER AND EACH BORROWER HEREBY WAIVE TRIAL BY JURY IN ANY ACTION OR PROCEEDING WHICH PERTAINS DIRECTLY OR INDIRECTLY TO THIS NOTE, THE OBLIGATIONS, THE COLLATERAL, ANY ALLEGED TORTIOUS CONDUCT BY BORROWER OR LENDER OR WHICH IN ANY WAY, DIRECTLY OR INDIRECTLY, ARISES OUT OF OR RELATES TO THE RELATIONSHIP BETWEEN BORROWER AND LENDER. In addition, each Borrower agrees that all service of process shall be made as provided in the Loan Agreement. [Signature Page Follows] 2 Signature Page to Term Note IN WITNESS WHEREOF, each Borrower has executed this Note on the date above set forth. CTI INDUSTRIES CORPORATION, an Illinois corporation By: /s/ Howard W. Schwan ------------------------------ Howard W. Schwan President CTI HELIUM, INC., an Illinois corporation By: /s Howard W. Schwan ------------------------------ Howard W. Schwan President EX-10.17 5 d59262_ex10-17.txt REVOLVING NOTE IN THE SUM OF $7,500,000 EXHIBIT 10.17 REVOLVING NOTE $7,500,000 Chicago, Illinois December 31, 2003 FOR VALUE RECEIVED, on or before the end of the Original Term or any applicable Renewal Term (or, if such day is not a Business Day, on the next following Business Day), the undersigned, CTI INDUSTRIES CORPORATION, an Illinois corporation, and CTI HELIUM, INC., an Illinois corporation (collectively, the "Borrowers" and, individually, each a "Borrower"), jointly and severally, each promise to pay to the order of COLE TAYLOR BANK (herein, together with its successors and assigns, called the "Lender"), the maximum principal sum of SEVEN MILLION FIVE HUNDRED THOUSAND DOLLARS ($7,500,000) or, if less, the aggregate unpaid principal amount of all Revolving Loans made by Lender to any one or more of the Borrowers pursuant to that certain Loan and Security Agreement of even date herewith among the Borrowers and Lender (herein, as the same may be amended, modified, restated or supplemented from time to time, called the "Loan Agreement"). Each Borrower, jointly and severally, further promises to pay to the order of Lender interest on the aggregate unpaid principal amount hereof from time to time outstanding from the date hereof until paid in full at such rates and at such times as shall be determined in accordance with the provisions of the Loan Agreement. Accrued interest shall be payable on the dates specified in the Loan Agreement. Payments of both principal and interest are to be made in the lawful money of the United States of America in immediately available funds at Lender's principal office at 111 West Washington Street, Suite 400, Chicago, Illinois 60602, or at such other place as may be designated by Lender to the Borrowers in writing. This Note is the promissory note referred to in, evidences indebtedness incurred under, and is subject to the terms and provisions of, the Loan Agreement. The Loan Agreement, to which reference is hereby made, sets forth said terms and provisions, including those under which this Note may or must be paid prior to its due date or may have its due date accelerated. Terms used but not otherwise defined herein are used herein as defined in the Loan Agreement. This Note is secured by the personal property described in and pursuant to the Loan Agreement and various Loan Documents referred to therein, and reference is made thereto for a statement of terms and provisions of such Collateral security, a description of Collateral and the rights of Lender in respect thereof. In addition to, and not in limitation of, the foregoing and the provisions of the Loan Agreement hereinabove referred to, each Borrower, jointly and severally, further agrees, subject only to any limitation imposed by applicable law, to pay all expenses, including reasonable attorneys' fees and expenses, incurred by the holder of this Note in seeking to collect any amounts payable hereunder which are not paid when due, whether by acceleration or otherwise. All parties hereto, whether as makers, endorsers or otherwise, severally waive presentment, demand, protest and notice of dishonor in connection with this Note. This Note is binding upon the Borrowers and their successors and assigns, and shall inure to the benefit of Lender and its successors and assigns. The Borrowers and their successors and assigns shall be jointly and severally obligated hereunder. This Note is made under and governed by the laws of the State of Illinois without regard to conflict of laws principles. [SIGNATURES FOLLOW] 2 Signature Page to Revolving Note IN WITNESS WHEREOF, each Borrower has executed this Revolving Note as of the day and year first above written. CTI INDUSTRIES CORPORATION, an Illinois corporation By: /s/ Howard W. Schwan --------------------------- Howard W. Schwan President CTI HELIUM, INC., an Illinois corporation By: /s/ Howard W. Schwan --------------------------- Howard W. Schwan President EX-23.1 6 d59262_ex23-1.txt CONSENT OF INDEPENDENT AUDITORS, EISNER, LLP EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in the Registration Statements on Form S-8 (Nos. 333-76006 and 333-76008) and the Registration Statement on Form SB-2 (No. 333-31969), of our report dated February 18, 2004 (with respect to Note 6, April 14, 2004), relating to our audit of the consolidated financial statements of CTI Industries Corporation and subsidiaries included in the 2003 annual report on Form 10-K/A Amendment No. 1. /s/ Eisner LLP New York, New York April 15, 2004 EX-23.2 7 d59262_ex23-2.txt CONSENT OF INDEPENDENT AUDITORS EXHIBIT 23.2 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statement (Form S-8 No. 333-76006) pertaining to the CTI Industries Corporation 2001 Stock Option Plan, in the Registration Statement (Form S-8 No. 333-76008) pertaining to the CTI Industries Corporation 1999 Stock Option Plan and Registration Statement (Form SB-2 No. 333-31969), of our report dated April 15, 2003, with respect to the consolidated financial statements included in the Annual Report of CTI Industries Corporation and Subsidiaries on Form 10-K for the year ended December 31, 2003. /s/ McGladrey & Pullen, LLP - --------------------------- Schaumburg, Illinois April 14, 2004 EX-23.3 8 d59262_ex23-3.txt CONSENT OF GRANT THORNTON, LLP EXHIBIT 23.3 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS We have issued our report dated April 10, 2002, except for Note 3, which is dated April 15, 2003, accompanying the consolidated financial statements included in the Annual Report of CTI Industries Corporation and Subsidiaries on Form 10-K for the year ended December 31, 2001. We hereby consent to the incorporation by reference of said report in the Registration Statements of CTI Industries Corporation and Subsidiaries on Form S-8 (Nos. 333-76006 and 333-76008) and SB-2 (No. 333-31969). /s/ Grant Thornton LLP - ---------------------- Chicago, Illinois April 14, 2004 EX-31.1 9 d59262_ex31-1.txt CERTIFICATION OF CHIEF EXECUTIVE OFFICER CERTIFICATIONS I, Howard W. Schwan, Chief Executive Officer of CTI Industries Corporation, certify that: 1. I have reviewed this annual report on Form 10-K/A Amendment No. 1 of CTI Industries Corporation; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) Presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: April 15, 2004 CTI INDUSTRIES CORPORATION By: /s/ Howard W. Schwan ------------------------------------ Howard W. Schwan Chief Executive Officer EX-31.2 10 d59262_ex31-2.txt CERTIFICATION OF CHIEF FINANCIAL OFFICER CERTIFICATIONS I, Stephen M. Merrick, Chief Financial Officer of CTI Industries Corporation, certify that: 1. I have reviewed this annual report on Form 10-K/A Amendment No. 1 of CTI Industries Corporation; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) Presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: April 15, 2004 CTI INDUSTRIES CORPORATION By: /s/ Stephen M. Merrick ------------------------------------ Stephen M. Merrick, Chief Financial Officer EX-32 11 d59262_ex32.txt SEXTION 906 CERTIFICATION OF CEO AND CFO SARBANES-OXLEY ACT SECTION 906 CERTIFICATION I certify that the periodic report on Form 10-K/A Amendment No. 1 containing the financial statements fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o (d)) and that information contained in the periodic report on Form 10-K/A Amendment No. 1 fairly presents, in all material respects, the financial condition and results of operations of the issuer. CTI INDUSTRIES CORPORATION By: /s/ Howard W. Schwan ------------------------------------ Howard W. Schwan Chief Executive Officer SARBANES-OXLEY ACT SECTION 906 CERTIFICATION I certify that the periodic report on Form 10-K/A Amendment No. 1 containing the financial statements fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o (d)) and that information contained in the periodic report on Form 10-K/A Amendment No. 1 fairly presents, in all material respects, the financial condition and results of operations of the issuer. CTI INDUSTRIES CORPORATION By: /s/ Stephen M. Merrick ------------------------------------ Stephen M. Merrick, Chief Financial Officer EX-99.1 12 d59262_ex99-1.txt CODE OF ETHICS EXHIBIT 99.1 CTI INDUSTRIES CORPORATION Code of Ethics for Senior Executive and Financial Officers I. General The policy of CTI Industries Corporation (the "Company") is to comply strictly with all laws governing its operations and to conduct its affairs in keeping with the highest moral, legal and ethical standards. Senior executive and financial officers hold an important and elevated role in maintaining a commitment to (i) honest and ethical conduct, (ii) full, fair, accurate, timely and understandable disclosure in the Company's public communications, and (iii) compliance with applicable governmental rules and regulations. Accordingly, the Company has adopted this Code of Ethics for its Chief Executive Officer, Chief Financial Officer, Controller and any other senior executive or financial officers performing similar functions and so designated from time to time by the Chief Executive Officer (the "Senior Executive and Financial Officers"). This Code of Ethics shall be approved annually by the Audit Committee of the Board of Directors (the "Committee") and disbursed to the public by means of one of the methods described in Item 406 of Regulation S-K promulgated by the Securities and Exchange Commission (the "SEC"). II. Honest and Ethical Conduct Senior Executive and Financial Officers are expected to exhibit and promote the highest standards of honest and ethical conduct, by, among other things, their adherence to the following policies and procedures: o Senior Executive and Financial Officers shall engage in only honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships. o Senior Executive and Financial Officers shall inform the Company's Corporate Counsel or, in his absence, the Chairman of the Committee of (a) deviations in practice from policies and procedures governing honest and ethical behavior or (b) any material transaction or relationship that could reasonably be expected to create a conflict of interest. o Senior Executive and Financial Officers shall demonstrate personal support for the policies and procedures set forth in this Code of Ethics through periodic communications reinforcing these principles and standards throughout the Company. o Senior Executive and Financial Officers shall respect the confidentiality of information acquired in performance of one's responsibilities and shall not use confidential information for personal advantage. III. Financial Records and Periodic Reports The Company is committed to full, fair, accurate, timely and understandable disclosures in reports and documents that it files with, or submits to, the SEC and in other public communications made by the Company. In support of this commitment, the Company has, among other measures, (a) designed and implemented disclosure controls and procedures (within the meaning of applicable SEC rules) and (b) required the maintenance of accurate and complete records, the prohibition of false, misleading or artificial entries on its books and records, and the full and complete documentation and recording of transactions in the Company's accounting records. In addition to performing their duties and responsibilities under these requirements, each of the Senior Executive and Financial Officers will establish and manage the Company's reporting systems and procedures with due care and diligence to ensure that: o Reports filed with or submitted to the SEC and other public communications contain information that is full, fair, accurate, timely and understandable and do not misrepresent or omit material facts. o Business transactions are properly authorized and completely and accurately recorded in all material respects on the Company's books and records in accordance with generally accepted accounting principles and the Company's established financial policies. o Retention or disposal of Company records is in accordance with established Company policies and applicable legal and regulatory requirements. IV. Compliance with Applicable Laws, Rules and Regulations The policy of the Company is to comply strictly with all laws governing its operations and to conduct its affairs in keeping with the highest moral, legal and ethical standards. Accordingly, the Senior Executive and Financial Officers will comply with all applicable governmental laws, rules and regulations, and will establish and maintain mechanisms to: o Monitor compliance of the Company's finance organization and other key employees with all applicable federal, state and local statutes, rules, regulations and administrative procedures. o Identify, report and correct any detected deviations from applicable federal, state and local statutes, rules, regulations and administrative procedures. 2 V. Compliance with Code of Ethics The Senior Executive and Financial Officers shall acknowledge and certify their ongoing compliance with this Code of Ethics annually and provide a copy of such certification to the Committee. This Code of Ethics will be published and made available to all employees, and any employee should promptly report any violation of this Code of Ethics to the General Counsel or, in his or her absence, the Chairman of the Committee. The Board of Directors shall take appropriate action with respect tot he failure of any Senior Executive or Financial Officer to comply with this Code of Ethics, which may include reprimand, demotion or dismissal, depending on the seriousness of the offense. Adopted: April, 2004 3 EX-99.2 13 d59262_ex99-2.txt AUDIT COMMITTEE CHARTER EXHIBIT 99.2 AUDIT COMMITTEE CHARTER OF CTI INDUSTRIES CORPORATION 1. Organization There shall be a committee of the Board of Directors of CTI Industries Corporation (the "Corporation") to be known as the Audit Committee. This charter (the "Charter") shall govern the operations of the Audit Committee. The Committee shall review and reassess the adequacy of this Charter at least annually, and shall submit any revisions to this Charter to the Board of Directors for their approval. The Audit Committee shall be composed of at least three directors who are independent of the management of the Corporation. A director shall be deemed independent if he is free of any relationship that, in the opinion of the Board of Directors, would interfere with exercise of independent judgment as a Committee member. To ensure that an audit committee member satisfies the definition of "independent" according to both Item 7(d) (3) (iv) of Schedule 14A under the Securities Exchange Act and NASDAQ's SmallCap Marketplace Rules, an Audit Committee member may not: o have been employed by the Corporation or its affiliates in the current or past three years; o have accepted any compensation from the Corporation or its affiliates in excess of $60,000 during the previous fiscal year (except for board service, retirement plan benefits, or non-discretionary compensation); o have an immediate family member who is, or has been in the past three years, employed by the Corporation or its affiliates as an executive officer; o have been a partner, controlling shareholder or an executive officer of any for-profit business to which the Corporation made, or from which it received, payments (other than those which arise solely from investments in the Corporation's securities) that exceed five percent of the organization's consolidated gross revenues for that year, or $200,000, whichever is more, in any of the past three years; or o have been employed as an executive of another entity where any of the Corporation's executives serve on that entity's compensation committee. In addition, the Corporation shall have one member who is designated and meets the requirements of an "audit committee financial expert" as that term is defined in Item 401(h) of Regulation S-K of the Exchange Act. An "audit committee financial expert" shall possess all of the following five attributes: o An understanding of generally accepted accounting principles ("GAAP") and financial statements; o The ability to assess the general application of such principles in connection with the accounting for estimates, accruals and reserves; o Experience preparing, auditing, analyzing or evaluating financial statements that present a breadth and level of complexity of accounting issues that are generally comparable to the breadth and complexity of issues that can reasonably be expected to be raised by the Corporation's financial statements, or experience actively supervising one or more persons engaged in such activities; o An understanding of internal controls and procedures for financial reporting; and o An understanding of audit committee functions. The foregoing attributes must have been acquired by the audit committee financial expert through one or more of the following means: (1) Education and experience as a public accountant or a principal financial officer, controller or principal accounting office of a company, or experience in one or more positions involving the performance of similar functions; (2) Experience actively supervising any of the persons referred to in (1) above; (3) Experience in overseeing or assessing the performance of companies or public accountants with respect to the preparation, auditing or evaluation of financial statements; or (4) other relevant experience. All Audit Committee members shall be able to read and understand fundamental financial statements, including but not limited to balance sheets, income statements and cash flow statements. 2. Statement of Policy The Audit Committee shall provide assistance to the Corporation's directors in fulfilling their responsibility to the shareholders, potential shareholders, and investment community relating to corporate accounting and financial reporting practices of the Corporation, and the quality and integrity of the financial reports of the Corporation. In so doing, it is the responsibility of the Audit Committee to maintain free and open means of communication between the directors, the independent auditors, the internal auditors, and the financial management of the Corporation. In discharging its oversight role, the Committee is empowered to investigate any matter brought to its attention with full access to all books, records, facilities, and counsel or other experts for this purpose. 3. Responsibilities and Processes The primary responsibility of the Audit Committee is to oversee the Corporation's financial reporting process on behalf of the Board and report the results of their activities to the Board. Management is responsible for preparing the Corporation's financial statements, and the independent auditors are responsible for auditing those financial statements. In carrying out its responsibilities, the Audit Committee believes its policies and procedures should remain flexible, 2 in order to best react to changing conditions and to ensure to the directors and shareholders that the corporate accounting and reporting practices of the Corporation are in accordance with all applicable requirements and are of the highest quality. In carrying out these responsibilities, the Audit Committee will: 3.1 Provide an open avenue of communication between the independent auditor, the internal auditor, management and the Board of Directors. The Committee shall have a clear understanding with management and the independent auditors that the independent auditors are ultimately accountable to the Board and the Audit Committee. 3.2 Meet at least one time per year or more frequently as circumstances require. The Audit Committee may ask members of management or others to attend meetings and provide pertinent information as necessary. 3.3 Review and recommend to the Directors the independent auditors to be selected to audit the financial statements of the corporation, and approve the compensation of the independent auditors. The Committee shall have the ultimate authority and responsibility to evaluate and, where appropriate, replace the independent auditors (or to nominate the independent auditor to be proposed for shareholder approval in any proxy statement). 3.4 Review and concur in the appointment, replacement, reassignment or dismissal of the internal auditor. 3.5 Confirm and assure the independence of the independent auditors. The Audit Committee has the responsibility for ensuring its receipt from the independent auditors of a formal written statement delineating all relationships between the auditors and the Corporation. The Audit Committee also has the responsibility for actively engaging in a dialogue with the independent auditors with respect to any disclosed relationships or services that may impact the objectively and independence of the independent auditor and for taking, or recommending that the full Board take appropriate action to oversee the independence of the independent auditors. 3.6 Meet with the independent auditors and internal auditors to review the scope of the proposed audit for the current year and the audit procedures to be utilized, and at the conclusion thereof review such audit, including any comments or recommendations of the independent or internal auditors. 3.7 Review with the independent auditors and the internal auditor(s) the adequacy and effectiveness of the accounting and financial controls of the Corporation, and elicit any recommendations for the improvement of such internal control procedures or particular areas where new or more detailed controls or procedures are desirable. The Audit Committee should also review with the independent and internal auditors the coordination of audit efforts to assure 3 completeness of coverage, reduction of redundant efforts, and the effective use of audit resources. 3.8 Inquire of management, the internal auditor(s), and the independent auditors about significant business risks or exposures and assess the steps management has taken to minimize such risk to the Corporation. 3.9 Review with management, the independent auditors and the internal auditor(s) the interim financial report prior to the filing of the quarterly report on Form 10-Q. The Audit Committee shall discuss the results of the quarterly review and any other matters required to be communicated to the Audit Committee by the independent auditors under generally accepted auditing standards. 3.10 The Audit Committee shall review with management, the independent auditors and the internal auditor(s) the financial statements to be included in the Annual Report on Form 10-K, including their judgment about the quality, not just acceptability, of accounting principles, the reasonableness of significant judgments, and the clarity of the disclosures in the financial statements. Also, the Audit Committee shall discuss the results of the annual audit and any other matters required to be communicated to the Audit Committee by the independent auditors under generally accepted auditing standards. 3.11 Review with the Board of Directors and the independent auditors at the completion of the annual examination: (a) The Corporation's annual financial statements and related footnotes; (b) The independent auditor's audit of the financial statements and his report thereon; (c) Any significant changes required in the independent auditor's audit plan; (d) Any serious difficulties or disputes with management encountered during the course of the audit; and (e) Other matters relating to the conduct of the audit which are to be communicated to the Audit Committee under generally accepted auditor standards. 3.12 Consider and review with management and the internal auditor(s): (a) Significant findings during the year and management's responses thereto; (b) Any difficulties encountered in the course of their audits, including any restrictions on the scope of their work or access to required information; 4 (c) Any changes required in the planned scope of their audit plan; (d) The internal auditing department budget and staffing; and (e) Internal auditing's compliance with appropriate accounting standards. 3.13 Provide sufficient opportunity for the internal and independent auditors to meet with the members of the Audit Committee with and without members of management present to discuss results of examinations. Among the items to be discussed in these meetings are the independent auditors' evaluation of the corporation's financial, accounting, and auditor personnel, and the cooperation that the independent auditors received during the course of the audit. 3.14 Review legal and regulatory matters that may have a material impact on the financial statements, related company compliance policies, and programs and reports received from regulators. 3.15 Submit the minutes of all meetings of the Audit Committee to, or discuss the matters discussed at each committee meeting with, the Board of Directors. 3.16 Investigate any matter brought to its attention within the scope of its duties. 3.17 Report Committee actions to the Board of Directors with such recommendations as the Audit Committee may deem appropriate. 3.18 The duties and responsibilities of a member of the Audit Committee are in addition to those duties set out for a member of the Board of Directors. Effective this 8th day of April, 2004, by order of this Corporation's Board of Directors. /s/ Stephen M. Merrick ----------------------------- Stephen M. Merrick, Secretary 5 -----END PRIVACY-ENHANCED MESSAGE-----