SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
ANNUAL REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2002
Commission File Number
000-23115
CTI INDUSTRIES CORPORATION
(Exact name of Registrant as specified in its charter)
Illinois 36-2848943
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
22160 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-KSB or any amendment to the Form 10-KSB.
The Registrant's revenues for the fiscal year ended December 31, 2002,
were $41,236,000.
Based upon the closing price of $5.01 per share of Registrant's Common
Stock as reported on NASDAQ SmallCap Market at April 11, 2003, the aggregate
market value of the voting stock held by non-affiliates of the Registrant was
then approximately $4,645,523 (Determination of stock ownership by
non-affiliates was made solely for the purpose of responding to the requirements
of the Form and the Registrant is not bound by this determination for any other
purpose).
The number of shares of the Registrant's Common Stock outstanding as of
April 11, 2003, was 1,918,419 (excluding treasury shares).
Transitional Small Business Disclosure Format (check one): |_| Yes |X| No
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:
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. In 1978, the
Company began manufacturing metalized balloons (sometimes referred to as "foil"
balloons), balloons made of nylon based material with 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. They grew in popularity quickly and the Company's sales
of metalized balloons expanded rapidly during the 1980's.
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
with 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, Peanuts(R) characters, 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 2002,
represented 48% of total company revenue.
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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, 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.
On October 15, 1999, the Company's Board of Directors approved a 1 for 3
reverse split of the Company's Common Stock and Class B Common Stock. The 1 for
3 reverse stock split became effective at the close of business on November 4,
1999, upon the approval and consent of a majority of Common and Class B Common
Stockholders voting together as a single class. As a result of the reverse stock
split, every three shares of the Company's Common Stock were reclassified and
changed into one share of the Company's Common Stock with a new par value of
$.195 per share, and every three shares of the Company's Class B Common Stock
were reclassified and changed into one share of the Company's Class B Common
Stock, with a new par
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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.
During February and March, 2003, two members of management of the Company
entered into agreements with the Company pursuant to which such individuals
loaned to the Company the aggregate amount of $1,630,000 in exchange for (i) two
year 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 Company's Common Stock on the date of issuance of the
Warrants). The funds were provided to re-finance an existing loan to CTI Mexico
and Flexo Universal, the Company's Mexico subsidiaries, of $880,000 and to
provide funds for capital investment and working capital.
Mexico Operations. The Company's latex balloons are 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"), also a majority owned subsidiary. 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 January, 1998, the Company and CTI Mexico entered into an agreement
whereby (i) the Company subscribed for 45% of the outstanding capital stock of
CTI Mexico for $800,000, (ii) the Company loaned to CTI Mexico $850,000, which
loan was collateralized by certain latex balloon manufacturing equipment, and
(iii) the 1995 equipment purchase agreement between the parties was cancelled
with respect to two pieces of latex balloon manufacturing equipment; this
equipment was then owned by CTI and leased to CTI Mexico. The purchase of the
capital stock was consummated in February, 1998, and the purchase price for the
capital stock was paid by (i) applying $400,000 of advances made to CTI Mexico
prior to closing and (ii) a cash payment for the balance. The $400,000 debt
owing to the Company from the 1995 acquisition was extinguished as a result of
the cancellation of the sale of the two pieces of equipment to CTI Mexico.
In November, 1999, the Company acquired additional shares of capital stock
of CTI Mexico, resulting in the Company's ownership of approximately 72% of CTI
Mexico's total outstanding capital stock. The November, 1999 acquisition was
concluded through an agreement with a principal shareholder of CTI Mexico and
the approval of the requisite number of CTI Mexico shareholders at a
shareholders' meeting held on November 12, 1999. In the November, 1999
acquisition transaction, the Company allowed CTI Mexico to capitalize certain of
CTI
4
Mexico's outstanding indebtedness to the Company, amounting to approximately
$989,000, and contributed certain equipment with a total value of approximately
$855,000, in exchange for capital stock of CTI Mexico. In addition, in May of
2000 and August of 2002, the Company purchased additional shares of stock from
certain of CTI Mexico's shareholders, resulting in the Company's ownership of
approximately 98% of CTI Mexico's total outstanding capital stock.
During 2002, the Company, through CTI Mexico, maintained two manufacturing
facilities in Guadalajara, Mexico totaling approximately 95,000 square feet of
manufacturing, office and warehouse space and operated seven latex balloon
machines.
On February 22, 2003, the CTI Mexico effected a spin-off under Mexican law
under which a portion of the assets, liabilities and capital of CTI Mexico were
transferred to a newly-organized entity. This new entity will operate under the
name Flexo Universal, S.A. de C.V. and is owned 98% by the Company. Flexo
Universal has entered into a lease for approximately 43,000 square feet of
manufacturing, office and warehouse space in Guadalajara, Mexico and will
conduct latex balloon manufacturing, printing and packaging activities at that
location. Operations at that location commenced on March 1, 2003.
Products
Metalized Balloons. The metalized balloon is actually composed of a base
nylon material 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") and Pixiloons(TM) (2 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.
o Smackers(R)- helium filled red lip-shaped balloons.
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o You Name It(R) - balloons to which lettering can be attached for a
personalized message.
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 Peanuts(R),
Garfield(R), Precious Moments(R), Party Express(R), Betty Boop(R), Kinka(R),
Head First(R), Hallmark Shoebox(R), Scooby Doo(R), Barbie(R), Batman(R),
Spirit(R), Nascar(R), Hotwheels(R), Major League Baseball(R), Hamtaro(R),
Justice League(R), Star Wars(R), Butt Ugly Martians(R), Madeline(R), Samurai
Jack(R), Rescue Hereos(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.
Packaging Films. The Company laminates, extrusion coats and prints films
for use in packaging applications, including food packaging.
Custom Film Products. The Company fabricates custom film products for
various commercial and industrial purposes. These now include "dunnage" bags
(inflatable film products) used in the packaging of goods and flexible
containers for the storage of clothing and personal items.
The Industries
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.
6
There are presently at least six manufacturers of metalized balloons whose
products are sold in the United States. Five of these companies maintain their
own production facilities in the United States. Several companies market and
sell metalized balloons designed by them and manufactured by others for them.
Metalized balloons are marketed in the United States and foreign countries
through wholesalers or distributors and directly to retail customers. 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 are generally of higher quality and price than
the standard line of balloons. The standard line of balloons is sold widely in
retail stores including many of the same outlets as metalized balloons. Printed
latex balloons are sold both in retail outlets and for balloon decoration
purposes including floral designs. "Toy" balloons include novelty balloons sold
in toy departments or stores, punch balls, water bombs and other specialty
designs.
Latex balloons are sold through many of the same outlets as metalized
balloons including grocery, general merchandise and drug store chains, card and
gift shops, party goods stores, florists and balloon decorators. Latex balloons
are sold in retail stores in packaged form as well as inflated. Also, certain
latex items are sold in retail stores, generally in packaged form, as toy items.
There are at least seven manufacturers of latex balloons whose products
are sold in the United States.
Printed and Specialty Films
The industry and market for printed and specialty films is highly
fragmented and includes many participants. There are literally hundreds of
manufacturers of printed and specialty film products in the United States and in
other markets. In many cases, companies produce films and film packages for the
packaging of products manufactured and sold by those companies. Many of these
film products are utilized for packaging of a variety of goods, including foods.
Films are utilized for a wide variety of specialized uses - including for
medical applications, "dunnage" in packages and containers for consumer and
other uses.
The total volume of products manufactured and sold in this industry is
estimated to be well in excess of $3 billion.
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Marketing, Sales and Distribution
The Company markets and sells its metalized balloon, latex balloon and
related novelty products throughout the United States and in over 30 foreign
countries. The Company maintains a marketing, sales staff and support staff of
10 individuals and a customer service department of 7 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 a number of 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.
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 2002, sales to
Hallmark were $5,111,000 or 12.4% 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
numerous trade shows for the gift, novelty, balloon and other industries and
advertises in a number of trade and other publications. The Company also attends
licensing shows for the purpose of seeking out additional design licenses.
The Company markets and sells its printed and laminated films and
converted film products directly and through independent sales representatives.
The Company markets these products to companies which package their products in
plastic wrapping, in particular food products such as candies and coffee. The
Company markets its custom film products, including its "dunnage" bags
(inflatable film products) directly. During the 2002 fiscal year, the Company
sold such products to five principal, and a number of smaller customers. One
customer represented 29% ($12,086,000) of the Company's total sales revenue in
2002 and another represented 17% ($7,000,000) of total sales revenue.
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Manufacturing
Production and Operations.
At its Barrington, Illinois headquarters, the Company owns and operates a
modern facility. The facility includes converting machines of the Company's own
design and construction which fabricate metalized balloons and packaging bags.
These production systems include a patented system for the production and
insertion of valves in balloons. 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's utilizes a water-based ink process for printing.
The Company owns and operates one extrusion coating and lamination machine
and one solventless laminator to produce films for use in metalized balloons,
packaging films and specialty film products. A new extrusion coating and
laminating machine was acquired in 1999 and the laminator was acquired in 2002.
This equipment significantly increased the Company's production capacity and
capabilities.
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 60,000 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.
CTI Mexico and Flexo Universal. Through CTI Mexico and Flexo Universal,
the Company operates several facilities in Guadalajara, Mexico, comprising, in
2002, approximately 95,000 square feet of production, warehouse and office
space. At these locations, the Company produces all of its latex balloon
products and also prints and packages latex balloons. During 2002, CTI Mexico
owned and operated, or leased, seven latex balloon manufacturing machines, two
high-speed latex printing machines and several other latex printing machines.
Balloon products are warehoused at these facilities and order fulfillment is
provided for Mexico and Latin America, as well as to the United States and
United Kingdom facilities of the Company. CTI Mexico, and now Flexo Universal,
also conduct sales and marketing activities for the sale of balloon products in
Mexico, Latin America and certain other markets.
CTI Balloons Ltd. Through its wholly-owned subsidiary, CTI Balloons Ltd,
the Company conducts a warehouse, fulfillment and sales operation in Rugby,
United Kingdom. Sales and fulfillment for all of the United Kingdom, Europe and
the Middle East are conducted from this facility.
9
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, including American Greetings,
Amscan Holdings, Inc. and Flowers, Inc., market and sell metalized balloons
designed by them and manufactured by others for them. In 1998, Anagram
International, Inc. was acquired by Amscan and in 2000 M&D Balloons was acquired
by American Greetings. During 2002, Amscan completed the purchase of 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 approximately 22
licenses and produces balloon designs utilizing the characters covered by the
licenses. Licenses are generally maintained for a one or two year term, although
the Company has maintained long term relationships with several of its licensors
and has been able to obtain renewal of its license agreements with them.
Trademarks. The Company is the owner of 21 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. 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) a patent on a combination of a greeting
card and balloon connected by a ribbon contained in single package, (iii) a
patent on a method of inserting and affixing a zipper-closure system in a bag,
and (iv) various metalized balloon design patents, including various shapes for
Valentine's Day, Halloween and birthday parties.
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Research and Development
The Company maintains a product development and research department of 7
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, 2001 and
December 31, 2002, the Company estimates that the total amount spent on research
and development activities was approximately $325,000 and $333,000,
respectively.
Employees
As of December 31, 2002, the Company had 246 full-time employees in the
United States, of whom 18 are executive or supervisory, 10 are in sales, 188 are
in manufacturing and 30 are clerical. As of that same date, the Company had 13
full-time employees in England, of whom one is executive or supervisory, 4 are
in sales, 6 are in warehousing and 2 are clerical. In Mexico, as of December 31,
2002, the Company had 213 full-time employees, of whom 6 are executive or
supervisory, 4 are in sales, 187 are in manufacturing and 16 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.
Item No. 2 Description of Property
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.
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.
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.
11
During 2002, CTI Mexico, the Company leased four buildings with
approximately 95,000 total square feet of production, warehouse and office space
in Guadalajara, Mexico. One plant, consisting of three buildings, is occupied at
a monthly lease rate of $5,500, and the other plant, consisting of one building,
has a three-year lease at a monthly lease rate of $4,500. 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 at the cost of
$17,000 per month.
Item No. 3 Legal Proceedings
On September 5, 2002, Byrne Sales Associates, Inc. filed an action against
the Company for breach of contract in the Circuit Court of Jefferson County,
Wisconsin claiming as damages the amount of $150,805. In the action, the
plaintiff alleges that certain products manufactured by the Company and sold to
the plaintiff were defective. The Company has filed a responsive pleading in
this action denying the allegations contained in the Complaint. Management of
the Company believes the claims in the action are without merit in fact or law
and intends to vigorously defend the action. Due to the preliminary stage of
this action, neither an evaluation of the outcome or a range of probable loss
can be made.
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.
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, 2001 to March 31, 2001 2.07 .87
April 1, 2001 to June 30, 2001 1.68 1.10
July 1, 2001 to September 30, 2001 1.68 1.39
October 1, 2001 to December 31, 2001 1.68 1.13
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
As of March 20, 2003, there were approximately 44 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.
12
The Company has never paid any cash dividends on its Common Stock and does
not currently intend to pay cash dividends on its Common Stock in the
foreseeable future. The Company currently intends to retain all its earnings to
finance the development and expansion of its business. Under the terms of its
current loan agreement, the Company is restricted from declaring any cash
dividends or other distributions on its shares unless certain minimum financial
performance levels are maintained. The Company expects it to be likely that it
will be required to agree to restrictions on the payment of dividends or other
distributions in connection with future financings, if any.
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.
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.
The 1999 notes and 1999 warrants issued to Messrs. Davis, H. Schwan, J.
Schwan and Merrick were issued in a private offering which was exempt from
registration under Section 4(2) of the Securities Act of 1933, as amended, as a
transaction not involving a public offering as all participants were
sophisticated investors who had access to information about the Company.
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.
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 already owned by him as full
payment for the warrant shares. The shares
13
tendered as payment were valued at the per share closing price for 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, 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.
Item No. 6 Management's Discussion and Analysis of Financial Condition and
Results of Operations
General
The Company's December 31, 2001 financial statements have been restated,
as further discussed in Amendment No. 1 to the Company's 2001 Form 10KSB.
The following table sets forth selected financial data of the Company for
the years ended December 31, 2002 and December 31, 2001 (in thousands, except
per share data):
Year ended Year ended
December 31, December 31,
2002 2001
----------------------------------
Consolidated Statement of Operations Data:
Net sales $ 41,236 $ 27,446
Cost of sales 32,344 19,835
---------------------------------
Gross profit 8,892 7,611
Operating Expenses:
General and administrative 4,225 3,702
Selling 1,551 1,760
Advertising 1,671 1,133
---------------------------------
Total operating expenses 7,447 6,595
---------------------------------
Operating income 1,445 1,016
Other expense (1,110) (1,030)
---------------------------------
Income (loss) before income taxes and minority interest 335 (14)
Income tax expense (39) (277)
---------------------------------
Income (loss) before minority interest 296 (290)
Minority interest in loss of subsidiary 6 58
---------------------------------
Net income (loss) $ 302 $ (232)
=================================
Net income (loss) applicable to common shares $ 302 $ (232)
=================================
Net income (loss) per share:
Basic $ 0.18 $ (0.19)
=================================
Diluted $ 0.16 $ (0.19)
=================================
Weighted average number of common and
common equivalent shares outstanding:
Basic 1,688,384 1,511,958
=================================
Diluted 1,884,405 1,511,958
=================================
14
Results of Operations
Net Sales. The Company generates revenue from the sale of three product
lines - metalized balloons, latex balloons and laminated and printed films. All
of the production and revenues for printed and laminated films are generated in
the Company's plant in Barrington, Illinois and virtually all of those sales are
made to domestic U.S. customers. Latex balloons are produced for the Company by
CTI Mexico at its plants in Guadalajara. CTI Balloons sells latex balloons (i)
to the Company for resale in the U.S., (ii) in the domestic Mexico market, (iii)
to CTI Balloons, Ltd (the Company's UK subsidiary) for resale in the United
Kingdom and some other markets in Europe and the Middle East and (iii) to
various other customers in Latin America and other countries. All of the
metalized balloons of the Company are manufactured by the Company in Barrington,
Illinois. The Company sells metalized balloons (i) to domestic U.S. customers,
(ii) to international customers, (iii) to CTI Mexico for resale in Mexico and
(iv) to CTI Balloons, Ltd. for resale in the United Kingdom and Europe.
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 is 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 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.
Sales and selected financial information on a geographic basis for 2001
and 2002 are set forth below:
United States United Kingdom Mexico Eliminations Consolidated
Year ended 12/31/01
Revenues $ 24,707,000 $1,672,000 $ 5,940,000 $(4,873,000) $ 27,446,000
Operating income 1,089,000 67,000 128,000 (268,000) 1,016,000
Net income (loss) (105,000) 50,000 47,000 (224,000) (232,000)
Total Assets $ 20,355,000 $ 620,000 $ 5,785,000 $(2,096,000) $ 24,664,000
Year ended 12/31/02
Revenues $ 37,418,000 $1,966,000 $ 5,235,000 $(3,383,000) $ 41,236,000
Operating income 1,260,000 69,000 212,000 (96,000) 1,445,000
Net income (loss) 452,000 40,000 (99,000) (91,000) 302,000
Total Assets $ 26,311,000 $ 980,000 $ 4,983,000 $(2,002,000) $ 30,272,000
(1) All intercompany transactions are eliminated for consolidated information.
(2) The United Kingdom facility is a warehouse and sales operation marketing
and selling products manufactured in the United States and Mexico.
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
15
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. 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.
Advertising. 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.
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.
16
Financial Condition
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 has provided the Company
with a credit facility in the amount of $9,500,000, collateralized by equipment,
inventory, receivables and other assets of the Company. The credit facility
includes a term loan of $1,426,000, at an interest rate of prime plus 0.75% per
annum, which is 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 is 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 are
secured by substantially all assets of the Company. The term of this credit
facility is for a period of three years expiring on January 31, 2004, which may
be extended by either party for an additional year.
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 is in the
principal amount of $173,000, bears interest at 10% per annum, and has a term of
three years.
Cash and cash equivalents. The Company's cash management strategy includes
maintaining limited cash balances and utilizing the revolving line of credit for
liquidity. As of December 31, 2002, the Company had total cash and cash
equivalents of $160,000 compared to cash and equivalents of $110,000 as of
December 31, 2001.
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.
17
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 $1,002,00 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, 2002 the Company had negative working capital of
$2,907,000 compared to positive working capital as of December 31, 2001 of
$278,000. This decline in working capital arose principally as the result of the
Company's use of funds for investing activities, principally the purchase of
production equipment, and the corresponding increase in accounts payable.
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 40% of
its eligible inventory, and utilizes the proceeds of these borrowings for its
cash requirements. 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.
The Company believes that existing capital resources and cash generated
from operations, and from borrowings on the credit facility, will be sufficient
to meet the Company's requirements for at least 12 months. The contractual
commitments of the Company over the next five years are as follows:
Future Minimum
Principal
Year Payments Operating Leases Licenses Total
2003 $1,742,658 $514,523 $271,700 $2,528,881
2004 $2,528,824 $511,883 $126,700 $3,167,401
2005 $ 39,225 $507,974 $126,700 $ 673,899
2006 $2,537,447 $499,775 -- $3,037,222
2007 $ -- $499,775 -- $ 489,775
18
Seasonality
In the metalized product line, sales have historically been seasonal with
approximately 20% to 30% of annual sales of metalized balloons being generated
in December and January, and 11% to 13% of annual metalized balloon sales being
generated in June and July in recent years. The sale of latex balloons and
laminated film products have not historically been seasonal, and as sales in
these products lines increase as a percentage of total sales, the seasonality of
the Company's total net sales has decreased.
Critical Accounting Policies
The financial statements of the Company are based on the selection and
application of significant accounting policies which require management to make
various estimates and assumptions. The following are some of the more critical
judgment areas in the application of our accounting policies that currently
affect our financial condition and results of operation.
Revenue Recognition. Substantially all of the Company's revenues are
derived from the sale of products. With respect to the sale of products, revenue
from a transaction is recognized when (i) a definitive arrangement exists for
the sale of the product, (ii) delivery of the product has occurred, (iii) the
price to the buyer has been fixed or is determinable and (iv) collectibility is
reasonably assured. The Company 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, 2002, the Company had
established a reserve for obsolescence, marketability or excess quantities with
respect to inventory in the aggregate amount of $335,000. As of December 31,
2001, the amount of the reserve was $303,000. 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
19
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 a valuation
consulting firm to conduct an evaluation of our goodwill in our Mexico
subsidiary in June, 2002 and December, 2002. In the opinion of the consultant
the our goodwill valuation of our Mexico subsidiary, 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 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, 2002, the Company had a net deferred tax asset of
$689,000, representing the amount the Company may recover in future years from
future taxable income. As of December 31, 2001, the amount of the deferred tax
asset was $652,000. 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, 2002, 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, 2001,
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 6 (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 2002 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
20
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 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. 7 Financial Statements
Reference is made to the Consolidated Financial Statements attached
hereto.
Item No. 8 Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
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.
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 last two 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.
21
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.
PART III
Item No. 9 Directors and Executive Officers of the Registrant
Directors and Executive Officers
The Company's current directors and executive officers and their ages, as
of April 1, 2003, are as follows:
Name Age Position With The Company
John H. Schwan 58 Chairman and Director
Howard W. Schwan 48 President and Director
Stephen M. Merrick 61 Executive Vice President,
Secretary and Director
Mark Van Dyke 53 Senior Vice President
Brent Anderson 36 Vice President of Manufacturing
Samuel Komar 46 Vice President
Stanley M. Brown 56 Director
Bret Tayne 44 Director
Alfred J. Lescher 38 Controller
All directors hold office until the annual meeting next following their
election and/or until their successors are elected and qualified. Officers are
elected annually by the Board of Directors and serve at the discretion of the
Board. Information with respect to the business expenses and affiliation of the
directors and the executive officers of the Company is set forth below:
John H. Schwan, Chairman. Mr. Schwan has been an officer and director of
the Company since January, 1996. Mr. Schwan has been 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
22
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.
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.
Alfred J. Lescher, Controller. Mr. Lescher has been employed by the
Company as Controller since February, 2002. He has been engaged in accounting
since 1994 and has held accounting positions with several companies. He received
a Bachelor of Science Degree in Finance from Arizona State University in 1988
and a Bachelor of Science in Accounting equivalency at DePaul University in
1993.
John H. Schwan and Howard W. Schwan are brothers.
23
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 2001, all Section 16(a) filing requirements applicable
to the officers, directors and ten-percent beneficial shareholders were complied
with, except that Brent Anderson filed a late report on Form 4 to report 4
purchases and 4 sale transactions during 2002.
Item No. 10 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 2002 $162,500 $ 8,100 14,285(2) $1,925(6)
President 2001 $150,000 $ 5,000 -- $1,765(6)
2000 $135,000 $ 9,719(1) 23,809(2) $1,650(6)
Mark Van Dyke 2002 $123,100 -- -- --
Senior Vice President 2001 $ 45,900 -- 23,809(3) --
2000 -- -- -- --
Brent Anderson 2002 $ 95,000 -- 8,928(4) --
Vice President of 2001 $ 86,700 -- 17,857(4) --
Manufacturing 2000 $ 82,300 -- -- --
Samuel Komar 2002 $104,200 -- -- --
Vice President of Sales 2001 $ 94,450 -- 11,904(5) --
2000 $ 89,500 -- -- --
----------
(1) Perquisites include country club membership of $3,950 in 2000.
(2) 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.
(3) Stock options to purchase up to 23,809 shares of the Company's Common
Stock at $1.47 per share.
(footnotes continued on next page)
24
(4) 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. Stock options to purchase
up to 8,928 shares of the Company's Common Stock at $2.31 per share.
(5) Stock options to purchase up to 11,904 shares of the Company's Common
Stock at $1.47 per share.
(6) Company contribution to the Company's 401(k) Plan as a pre-tax salary
deferral.
Certain Named Executive Officers have received warrants to purchase Common
Stock of the Company in connection with their guarantee of certain bank loans
secured by the Company and in connection with their participation in a private
offering of notes and warrants conducted by the Company. See "Board of Director
Affiliations and Related Transactions" below. The following stock option grants
were made to certain of the Company's executive officers in the fiscal year
ending December 31, 2002.
Option Grants in Last Fiscal Year
Individual Grants
Number of
Securities % of Total Options
Underlying Granted to Employees in Exercise Price Expiration
Name Options Granted Fiscal Year ($/share) Date
---- --------------- ----------- --------- ----
Howard W. Schwan 14,285 24.2% $2.31 10/12/2007
Brent Anderson 8,928 15.2% $2.31 10/12/2007
Stephen M. Merrick 5,952 10.1% $2.55 10/12/2007
John H. Schwan 5,952 10.1% $2.55 10/12/2007
Aggregated Option Exercises in Last Fiscal Year and FY-End Option Values
Number of Securities Underlying Value of Unexercised In-
Shares Value Unexercised Options at the-Money Options
Acquired on Realized Year End (#) at Fiscal Year End ($)
Name Exercise (#) ($) Exercisable/Unexercisable Exercisable/Unexercisable
---- ------------ --- ------------------------- -------------------------
John H. Schwan 0 0 45,633/0 $121,603/0(1)
Howard W. Schwan 0 0 53,966/0 $160,471/0(1)
Stephen M. Merrick 0 0 45,633/0 $121,603/0(1)
Mark Van Dyke 0 0 23,809/0 $114,045/0(1)
Brent Anderson 0 0 39,879/0 $157,216/0(1)
Samuel Komar 0 0 24,641/0 $ 91,875/0(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, 2002.
25
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 $78,000 in fiscal 2002 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. 11 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 2, 2003, by (i)
each stockholder who is known by the Company to be the beneficial owner of more
than 5% of the Company's Common Stock, (ii) each director and executive officer
of the Company who owns any shares of Common Stock and (iii) all executive
officers and directors as a group. Except as otherwise indicated, the Company
believes that the beneficial owners of the shares listed below have sole
investment and voting power with respect to such shares.
Shares of Common Stock
Name and Address (1) Beneficially Owned (2) Percent of Common Stock
-------------------- ---------------------- -----------------------
John H. Schwan 658,109(3) 30.8%(4)
Stephen M. Merrick 541,630(5) 26.1%(4)
Howard W. Schwan 178,901(6) 9.1%(4)
Brent Anderson 51,128(7) 2.6%(4)
Samuel Komar 24,879(8) 1.3%(4)
Mark Van Dyke 23,809(9) 1.2%(4)
Stanley M. Brown 11,250(10) *
747 Glenn Avenue
Wheeling, IL 60090
Bret Tayne 9,923(11) *
6834 N. Kostner Avenue
Lincolnwood, IL 60712
Frances Ann Rohlen 169,933(12) 8.9%(4)
747 Glenn Avenue
Wheeling, IL 60090
All Directors and Executive Officers as a 1,499,629 61%(4)
group (8 persons)
----------
*Less than one percent
(footnotes continued on next page)
26
(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 15,872 shares of Common Stock
at $6.93 per share granted under the Company's 1997 Stock Option Plan,
options to purchase up to 23,809 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.
(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 15,872 shares of Common Stock
at $6.93 per share granted under the Company's 1997 Stock Option Plan,
options to purchase up to 23,809 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 15,872 shares of Common Stock at $6.30
per share granted under the Company's 1997 Stock Option Plan, options to
purchase up to 23,809 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."
(footnotes continued on next page)
27
(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 8,333 shares of Common Stock at $1.89 per share granted
under the Company's 1999 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 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.
(11) 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.
(12) Also includes indirect beneficial ownership of 109,017 shares of Common
Stock through shares owned through CTI Investors, L.L.C.
Item No. 12 Certain Relationships and Related Transactions
Board of Directors Affiliations and Related Transactions
Stephen M. Merrick, Executive Vice President 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 &
28
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, 2001 and December 31, 2002 were $121,305 and $107,245,
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 $143,000 and $118,011 during each of the years ended December
31, 2001 and December 31, 2002, 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
on 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.
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 already owned by him as full
payment for the warrant shares. The shares tendered as payment were valued at
the per share closing price for 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 March and April, 2003, an officer of the Company loaned to the
Company an additional aggregate amount of $690,000. Such amount is due on demand
and bears interest at the rate of 8% per annum.
In or about May, 1998, the Company advanced on behalf of each of Howard W.
Schwan (President and Director), John H. Schwan (Chairman of the Board) and
Stephen M. Merrick (Executive Vice President and Director), the sum of $18,818
for the purchase of Company common stock from the estate of a deceased
shareholder. The loans bear interest at the rate of 6% per annum and are payable
in full on or before December 31, 2003. The loans are unsecured. Each of the
named persons is personally liable and responsible for the full amount of the
principal and all interest accrued on the loan to such person.
In or about September, 1998, the Company advanced to Howard Schwan,
President, the sum of $24,896. This loan bears interest at the rate of 6% per
annum and is payable in full on or
29
before December 31, 2003. The loan is unsecured. Mr. Schwan is personally liable
and responsible for the full amount of the principal and all interest accrued on
the loan.
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 calls for monthly rent payments of $17,400 ($208,800 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.
Item No. 13 Exhibits and Reports on Form 8-K
Exhibits
Exhibit
Number Description
------- -----------
* 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
30
Exhibit
Number Description
------- -----------
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 January 12, 2001, between
the Company and Congress Financial Corporation (Central)
******10.16 Term Note in the sum of $1,426,000 dated January 12, 2001 made
by CTI Industries Corporation to Congress Financial
Corporation (Central)
******10.17 Mortgage dated January 12, 2001 for the benefit of Banco
Popular, N.A.
******10.18 Secured Promissory Note in the sum of $2,700,000 dated
December 15, 2000 made by CTI Industries Corporation to Banco
Popular, N.A.
******10.19 Secured Promissory Note in the sum of $173,000 dated December
15, 2000, made by CTI Industries Corporation to Banco Popular,
N.A.
******10.20 Guaranties dated January 12, 2001, by Stephen M. Merrick and
John H. Schwan for benefit of Congress Financial Corporation
(Central)
******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.
10.23 Consent of Independent Auditors
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-KSB under
Item No. 1)
27 Financial Data Schedule
* 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
2001 10-KSB, as filed with the Commission on April 16, 2002
Reports on Form 8-K
On July 30, 2002, the Company filed a report on Form 8-K to report the
replacement of its then auditors, Grant Thornton, LLP with McGladrey & Pullen,
LLP, effective July 24, 2002.
Item No. 14 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-14(c) and 15d-14(c)) as of
December 31, 2002, have determined subsequent to December 31, 2002,
in connection with our independent audit, that there were
deficiencies in the design or operation of internal controls during
the fourth quarter of 2002. These deficiencies occurred because
intercompany account reconciliations were not completed or reviewed
on a timely basis, inventory cost standards have not been updated on
a timely basis, corporate accounting office is understaffed, has
experienced turnover and has been subject to a lack of supervision
and review. As a result, there were material adjustments in the
fourth quarter financial statements in order to correct intercompany
account balances, accrued expenses and inventory balances.
(b) Changes in internal controls. The individual who was responsible for
the reconciliation of intercompany account balances and inventory
reconciliations has been terminated and management is in the process
of hiring a replacement. Additional resources are being acquired,
and management is conducting a review regarding changes which are
appropriate to strengthen controls in these areas.
31
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 29, 2003.
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 29, 2003
-------------------------
Howard W. Schwan
/s/ John H. Schwan Chairman and Director April 29, 2003
-------------------------
John H. Schwan
/s/ Stephen M. Merrick Executive Vice President, April 29, 2003
------------------------- Secretary, Chief Financial
Stephen M. Merrick Officer and Director
/s/ Stanley M. Brown Director April 29, 2003
-------------------------
Stanley M. Brown
/s/ Bret Tayne Director April 29, 2003
-------------------------
Bret Tayne
32
CERTIFICATIONS
I, Howard W. Schwan, Chief Executive Officer of CTI Industries
Corporation, certify that:
1. I have reviewed this annual report on Form 10-KSB 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 29, 2003
CTI INDUSTRIES CORPORATION
By: /s/ Howard W. Schwan
------------------------------------
Howard W. Schwan Chief Executive
Officer
33
CERTIFICATIONS
I, Stephen M. Merrick, Chief Financial Officer of CTI Industries
Corporation, certify that:
1. I have reviewed this annual report on Form 10-KSB 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 29, 2003
CTI INDUSTRIES CORPORATION
By: /s/ Stephen M. Merrick
------------------------------------
Stephen M. Merrick, Chief Financial
Officer
34
SARBANES-OXLEY ACT
SECTION 906 CERTIFICATION
I certify that the periodic report on Form 10-KSB 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-KSB 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
35
SARBANES-OXLEY ACT
SECTION 906 CERTIFICATION
I certify that the periodic report on Form 10-KSB 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-KSB 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
36
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors
CTI Industries Corporation and Subsidiaries
Barrington, Illinois
We have audited the accompanying consolidated balance sheet 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 10 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 present 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 2 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
CTI Industries Corporation and Subsidiaries
Consolidated Balance Sheets
December 31, 2002 December 31, 2001
------------ ------------
ASSETS
Current assets:
Cash $ 160,493 $ 110,488
Accounts receivable, less allowance for doubtful accounts
2002 $223,220; 2001 $375,755 5,384,839 4,385,050
Inventories 10,033,593 8,458,421
Deferred tax assets 247,780 290,816
Prepaid expenses and other current assets 310,995 898,130
------------ ------------
Total current assets 16,137,700 14,142,905
Property and equipment:
Machinery and equipment 16,221,259 14,635,962
Building 2,636,595 2,398,039
Office furniture and equipment 1,746,480 1,731,848
Land 250,000 250,000
Leasehold improvements 388,655 161,885
Fixtures and equipment at customer locations 2,306,807 2,206,096
Projects under construction 2,331,981 316,230
------------ ------------
25,881,777 21,700,060
Less: accumulated depreciation (14,166,764) (13,000,561)
------------ ------------
Total property and equipment, net 11,715,013 8,699,499
Other assets:
Deferred financing costs, less accumulated amortization
2002 $85,602; 2001 $58,324 51,747 82,653
Goodwill 1,113,108 1,113,108
Deferred tax assets 441,592 361,567
Other assets 812,698 264,493
------------ ------------
Total other assets 2,419,145 1,821,821
------------ ------------
TOTAL ASSETS $ 30,271,858 $ 24,664,225
============ ============
See accompanying notes to consolidated statements
F-2
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Excess of outstanding checks over bank balance $ 113,460 $ --
Accounts payable 9,580,823 5,492,488
Line of credit 5,642,649 5,697,717
Notes payable - current portion 1,742,658 1,376,291
Accrued liabilities 1,965,561 1,854,710
------------ ------------
Total current liabilities 19,045,151 14,421,206
Long-term liabilities:
Other liabilities 710,257 1,477,978
Notes payable 5,016,109 3,544,002
Subordinated Debt -- 715,000
------------ ------------
Total long-term liabilities 5,726,366 5,736,980
Minority interest 25,865 180,830
Stockholders' equity:
Common stock - no par value, 5,000,000 shares authorized,
2,141,882 and 966,327 shares issued, 1,910,086 and 767,131 shares
outstanding at December 31, 2002 and 2001, respectively 3,748,270 188,434
Class B Common stock - no par value, 500,000 shares authorized,
0 and 366,300 shares issued and outstanding at December 31, 2002
and 2001, respectively -- 1,000,000
Paid-in-capital 5,554,332 5,554,332
Warrants issued in connection with senior and subordinated debt 135,462 487,440
Accumulated deficit (2,962,816) (1,983,770)
Accumulated other comprehensive earnings (6,002) (118,007)
Less:
Treasury stock - 231,796 and 199,196 shares at December 31,
2002 and 2001, respectively (939,114) (746,764)
Notes receivable from stockholders (56,456) (56,456)
------------ ------------
Total stockholders' equity 5,474,476 4,325,209
------------ ------------
TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $ 30,271,858 $ 24,664,225
============ ============
See accompanying notes to consolidated statements
F-3
CTI Industries Corporation and Subsidiaries
Consolidated Statements of Operations
Year ended December 31,
2002 2001
------------ -------------
Net Sales $ 41,236,476 $ 27,446,494
Cost of Sales 32,344,115 19,835,066
------------ ------------
Gross profit 8,892,361 7,611,428
Operating expenses:
General and Administrative 4,224,777 3,701,591
Selling 1,551,538 1,760,138
Advertising 1,671,106 1,132,977
------------ ------------
Total operating expenses 7,447,421 6,594,706
------------ ------------
Income from operations 1,444,940 1,016,722
Other income (expense):
Interest expense (831,600) (1,125,606)
Interest income 3,157 6,160
Foreign currency (loss) gain (281,186) 89,028
------------ ------------
Total other (expense) (1,109,629) (1,030,418)
------------ ------------
Income (loss) before income taxes and minority interest 335,311 (13,696)
Income tax expense 39,065 276,553
------------ ------------
Income (loss) before minority interest 296,246 (290,249)
Minority interest in (loss) of subsidiary (6,266) (57,957)
------------ ------------
Net income (loss) $ 302,512 $ (232,292)
============ ============
Basic income (loss) per common share $ 0.18 $ (0.15)
============ ============
Diluted income (loss) per common share $ 0.16 $ (0.15)
============ ============
Weighted average number of shares and equivalent shares
of common stock outstanding:
Basic 1,688,384 1,511,958
============ ============
Diluted 1,884,405 1,511,958
============ ============
See accompanying notes to consolidated statements
F-4
CTI Industries Corporation and Subsidiaries
Consolidated Statements of Cash Flows
Year Ended
December 31, 2002 December 31, 2001
-------------------------------------
Cash flows from operating activities:
Net income (loss) $ 302,512 $ (232,292)
Adjustment to reconcile net income (loss) to cash
provided by operating activities:
Depreciation and amortization 1,588,187 1,665,758
Deferred gain on sale/leaseback (30,046) (30,046)
Amortization of Debt Discount 27,500 124,657
Minority interest in loss of subsidiary (6,266) (57,957)
Provision for losses on accounts receivable & inventory 300,000 240,000
Deferred income taxes (25,700) 225,908
Change in assets and liabilities:
Accounts receivable (1,075,314) (1,859,791)
Inventory (1,964,697) (1,832,182)
Other assets (122,112) 132,809
Accounts payable and accrued expenses 4,056,872 2,246,986
-----------------------------
Net cash provided by operating activities 3,050,936 623,850
Cash flows from investing activities:
Purchases of property and equipment (2,477,831) (1,002,136)
-----------------------------
Net cash (used in) investing activities (2,477,831) (1,002,136)
Cash flows from financing activities:
Excess of outstanding checks written over bank balance 113,460 --
Net change in revolving line of credit (55,068) 2,088,176
Proceeds from issuance of long-term debt -- 4,299,000
Repayment of long-term debt (591,182) (5,604,248)
Repayment of short-term debt -- (500,000)
Repayment of subordinated debt -- (10,000)
Proceeds from exercise of warrants 19,750 --
Purchase of treasury stock -- (171,380)
-----------------------------
Net cash provided by (used in) financing activities (513,040) 101,548
Effect of exchange rate changes on cash (10,060) (5,308)
-----------------------------
Net increase (decrease) in cash 50,005 (282,046)
Cash and Equivalents at Beginning of Period 110,488 392,534
-----------------------------
Cash and Equivalents at End of Period $ 160,493 $ 110,488
=============================
Supplemental disclosure of cash flow information:
Cash payments for interest $ 776,802 $ 876,326
Cash payments for taxes $ 140,072 $ --
Schedule of non-cash investing and financing activities:
Issuance of stock for subordinated debt $ 715,000 $ --
Purchase of additional minority interest $ 148,290 $ --
Stock Dividend $ 1,280,758 $ --
Notes payable incurred to purchase equipment $ 2,230,719 $ --
Common stock exchanged to exercise warrants $ 192,350 $ --
See accompanying notes to consolidated statements
F-5
CTI Industries Corporation and Subsidiaries
Consolidated Statements of Stockholders' Equity
Warrants
issued in
Common Stock Class B Common Stock connection with
------------ -------------------- Paid-in senior and Accumulated
Shares Amount Shares Amount Capital subordinated debt Deficit
----------------------------------------------------------------------------------------------
Balance, December 31, 2000 966,327 $ 188,434 366,300 $1,000,000 $ 5,554,332 $ 351,978 $(1,751,478)
==============================================================================================
Expiration of stock
redemption period
Warrants issued in connection
with senior and subordinated debt $ 135,462
Purchase of treasury stock
Net (loss) $ (232,292)
Other comprehensive (loss)
Foreign currency translation
Total comprehensive (loss)
----------------------------------------------------------------------------------------------
Balance, December 31, 2001 966,327 $ 188,434 366,300 $1,000,000 $ 5,554,332 $ 487,440 $(1,983,770)
==============================================================================================
Options exercised 11,000 $ 19,750
Class B conversion 366,300 $ 1,000,000 (366,300) ($1,000,000)
Stock dividend 304,218 $ 1,280,758 $(1,280,758)
Subordinated debt contributed
to exercise warrants 423,579 $ 1,066,978 $(351,978)
Cashless exercise of warrants 70,458 $ 192,350
Net income $ 302,512
Other comprehensive income
Foreign currency translation
Total comprehensive loss
----------------------------------------------------------------------------------------------
Balance, December 31, 2002 2,141,882 $ 3,748,270 -- $ -- $ 5,554,332 $ 135,462 $(2,962,016)
==============================================================================================
Less
Accumulated -----------------------------------------------------
Other Treasury Stock
Comprehensive -------------- Stock Notes Recvble
Income (loss) Shares Amount Sub Recvble Shareholders TOTAL
---------------------------------------------------------------------------------
Balance, December 31, 2000 $ (42,244) 124,683 $ (575,384) $ 4,700 $ (56,456) $4,664,482
=================================================================================
Expiration of stock
redemption period $ (4,700) $ 4,700
Warrants issued in connection
with senior and subordinated
debt $ 135,462
Purchase of treasury stock 74,513 $ (171,380) $ (171,380)
Net (loss) $ (232,292)
Other comprehensive (loss)
Foreign currency translation $ (75,763) $ (75,763)
----------
Total comprehensive (loss) $ (308,055)
---------------------------------------------------------------------------------
Balance, December 31, 2001 $ (118,007) 199,196 $ (746,764) $ -- $ (56,456) $4,325,209
=================================================================================
Options exercised 19,750
Class B conversion --
Stock dividend --
Subordinated debt contributed to
exercise warrants 715,000
Cashless exercise of warrants 32,600 $ (192,350) --
Net income 302,512
Other comprehensive income
Foreign currency translation $ 112,005 112,005
----------
Total comprehensive income 414,517
---------------------------------------------------------------------------------
Balance, December 31, 2002 $ (6,002) 231,796 $ (939,114) $ -- $ (56,456) $5,474,476
=================================================================================
F-6
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 (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. Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of CTI Industries
Corporation, its wholly owned subsidiaries CTI Balloons Limited and CTF
International S.A. de C.V., and its majority owned subsidiary CTI Mexico
Corporation, S.A. de C.V. 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 10KSB.
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 in the financial statements and
accompanying notes. Actual results could differ from those estimates.
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 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.
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:
F-7
CTI Industries Corporation and Subsidiaries
Notes to the Consolidated Financial Statements
2. Summary of significant accounting policies, continued
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 being amortized over 15 years using the
straight-line method. Subsequent to that date, the Company follows the
provisions of SFAS 142, Goodwill and Other Intangibles, under which goodwill is
not amortized but is tested at least annually for impairment. Goodwill on the
accompanying balance sheets relates to CTI Mexico. It is the Companies' policy
to perform impairment testing for CTI Mexico annually on December 31.
Valuation of long lived assets
The Company evaluates whether events or circumstances have occurred which
indicate that the carrying amounts of long-lived assets (principally property
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 to
measure whether the asset is recoverable, the Company measures the impairment
based on the projected discounted cash flows of the asset over its remaining
life. While the Company believes that our estimates of future cash flows are
reasonable, different assumptions regarding such cash flows could materially
affect these evaluations.
Deferred Financing Costs
Deferred financing costs relates to the refinancing of long-term debt in January
2001. These costs are being amortized on a straight-line basis over the term
of the loans.
Income Taxes
The Company accounts for income taxes using the liability method. As such,
deferred income taxes reflect the net tax effects of temporary differences
between carrying amounts of assets and liabilities for financial reporting
purposes and the amount used for income tax purposes. Deferred tax assets and
liabilities are measured using enacted tax rates expected to be in effect when
the anticipated reversal of these differences is scheduled to occur. Deferred
tax assets are reduced by a valuation allowance when, in the opinion of
F-8
CTI Industries Corporation and Subsidiaries
Notes to the Consolidated Financial Statements
2. Summary of significant accounting policies, continued
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, 2002 and 2001, other comprehensive income consisted
of foreign currency translation adjustments.
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.
The Company generally recognizes revenues for the sale of product when the
products have been shipped and invoiced. 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, 2002, 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 and earnings per share had
compensation cost for all of the stock-based compensation plans been determined
based on the grant date fair values of awards (the method described in FASB
Statement No. 123, Accounting for Stock-Based Compensation):
Years Ended December 31,
------------------------
2002 2001
---------- ----------
Net Income (Loss):
As reported 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 (117,375) (152,901)
---------- ----------
Pro forma net income (loss) 185,137 (385,193)
========== ==========
Net income (loss) per share:
Basic - As reported 0.18 (0.15)
Basic - Proforma 0.11 (0.25)
Diluted - As reported 0.16 (0.15)
Diluted - Proforma 0.10 (0.25)
F-9
CTI Industries Corporation and Subsidiaries
Notes to the Consolidated Financial Statements
2. Summary of significant accounting policies, continued
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:
2002 2001
---- ----
Expected life (years) 5.0 7.5
Volatility 123.3% 117%
Risk-free interest rate 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 year ended December 31, 2002, and the year ended
December 31, 2001, Research and development activities totaled $333,000 and
$325,000, respectively.
Reclassifications
Certain items in the 2001 financial statements have been reclassified to conform
to the 2002 presentation with no effect on operations for the year then ended.
New Accounting Pronouncements
Statement of Financial Accounting Standards (SFAS) No. 143, "Accounting for
Asset Retirement Obligations," was issued in 2001. SFAS No. 143 requires the
recognition of a liability and offsetting asset for any legal obligation
associated with the retirement of long-lived assets. The asset retirement cost
is depreciated over the life of the related asset. This statement is effective
for financial statements issued for fiscal years beginning after June 15, 2002.
Management does not believe SFAS No. 143 will have a significant effect on our
company.
Effective January 1, 2002 the Company adopted Statement No. 144 ("Statement
144"),"Accounting for the Impairment or Disposal of Long-Lived Assets".
Statement 144 provides a consistent method to value long-lived assets to be
disposed of and broadens the presentation of discontinued operations to include
more disposal transactions. The adoption of Statement 144 did not have a
material effect on our financial position, cash flows or results of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," which addresses accounting for restructuring
and similar costs. SFAS No. 146 supersedes previous accounting guidance,
principally Emerging Issues Task Force Issue No. 94-3. SFAS No. 146 requires
that the liability for costs associated with an exit or disposal activity be
recognized when the liability is incurred. SFAS No. 146 also establishes that
the liability should initially be measured and recorded at fair value.
Accordingly SFAS No. 146 may affect the timing of recognizing future
restructuring costs as well as the
F-10
CTI Industries Corporation and Subsidiaries
Notes to the Consolidated Financial Statements
2. Summary of significant accounting policies, continued
amount recognized. The provisions of SFAS 146 are effective for exit or disposal
activities that are initiated after December 31, 2002. The Company believes that
the adoption of SFAS No. 146 will not have a material impact on its reported
financial position or results of operations.
3. Major Customers
For the year ended December 31, 2002, the Company had three customers that
accounted for approximately 29%, 17% and 12%, respectively, of consolidated net
sales. Corresponding percentages of consolidated net sales generated by these
customers for the year ended December 31, 2001, were approximately 23.0%, 14.0%
and 2.7% respectively. At December 31, 2002, the outstanding accounts receivable
balances due from these two customers were $1,149,856, $932,707 and 1,697,852
respectively. At December 31, 2001 the outstanding accounts receivable balances
due from these three customers were $568,931, $579,035 and 367,677.
4. Inventory
Inventory is comprised of the following:
December 31, 2002 December 31, 2001
Raw materials $ 1,865,871 $ 728,344
Work in process 2,135,503 2,302,440
Finished goods 6,386,719 5,730,737
Allowance, Excess Quantities (354,500) (303,100)
----------- -----------
Total inventory $10,033,593 $ 8,458,421
=========== ===========
F-11
CTI Industries Corporation and Subsidiaries
Notes to the Consolidated Financial Statements
5. Notes Payable
Long-term debt at December 31, 2002 consists of:
Dec 31,2002 Dec 31, 2001
Term Loan with bank, payable in monthly installments
of $22,222 plus interest at prime(4.25% at December
31, 2002) plus 0.75% due February 1, 2004, net of debt
discount of $89,387 and $138,135 at December 31, 2002
and 2001, respectively. $ 1,355,057 $ 1,070,010
Term Loan with bank, payable in monthly installments
of $24,060 including interest at 9.75% due January 5,
2006 2,647,586 $ 2,671,546
Term Loan with bank, payable in monthly installments
of $5,582 including interest at 10.00% due January 5, 2004 68,657 $ 120,889
Term Loan with bank, payable in monthly installments
of $26,139 including interest at 5.75% due January 5, 2006 1,627,720 --
Loan payable to a Mexican finance institution
denominated in Mexican Pesos bearing interest at
9.81% 90,322 90,322
Loan with bank, with interest payable monthly at prime
(4.25% at December 31, 2002) due December 31, 2003 969,425 967,526
--------------------------------
Total $ 6,758,767 $ 4,920,293
Less current portion (1,742,658) (1,376,291)
--------------------------------
Total long-term debt $ 5,016,109 $ 3,544,002
--------------------------------
In January, 2001, the Company entered into a Loan and Security Agreement with an
institutional lender under which the lender has provided the Company with a
credit facility in the amount of $9,500,000, collateralized by equipment,
inventory, receivables and other assets of the Company. The credit facility
includes a term loan of $1,426,000, at an interest rate of prime plus 0.75% per
annum, which is 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 is 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 are
secured by substantially all assets of the Company. The term of this credit
facility is for a period of three years expiring on January 31, 2004, which may
be extended by either party for an additional year.
A second term loan was established in July of 2002 in the initial amount of
$1,229,000, at an interest rate of prime(4.25% at December 31, 2002) plus 1%.
The credit facility is collateralized by substantially all assets of the
Company. The term of this credit facility is for a period of three years, which
may be extended by either party for an additional year.
As of December 31, 2002 and 2001, the balance outstanding on the credit facility
was $5,642,649 and $5,697,717, respectively.
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
F-12
CTI Industries Corporation and Subsidiaries
Notes to the Consolidated Financial Statements
5. Notes payable, continued
interest at the rate of 9.75%, and has a term of five years with an amortization
period of 25 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.
Future Minimum principal payments, exclusive of debt discount, for amounts
outstanding under these long-term debt agreements are as follows for the year
ended December 31, 2002:
2002
----
2003 1,742,658
2004 2,528,824
2005 39,225
2006 2,537,447
----------
$6,848,154
==========
The agreements impose limitations on the Company with respect to dividends,
maintaining minimum net worth of no less than $5,000,000 and allowing for the
subjective acceleration of amounts due under the loan agreements in the event of
material adverse changes.
6. Subordinated Debt
In November, 1999, the Company received $865,000 from certain shareholders in
exchange for (a) two year 10% subordinated notes, and (b) three year warrants to
purchase 423,579 common shares at $1.69 per share. The cash proceeds were
allocated to the note and warrants based upon the relative fair value of the
securities issued. The value of the warrants was $593,467 calculated using
Black-Scholes option pricing formula. The $865,000 proceeds were allocated to
subordinated notes in the amount of $513,022 and warrants issued in connection
with subordinated debt, within stockholders' equity, of $351,978 based upon the
relative fair values. The Company applied the debt discount of $351,978 against
the subordinated debt. The debt discount was amortized using the effective
interest method over the term of the debt which matured in December 2001. During
2002, the stockholders contributed the remaining subordinated debt totaling
$715,000 to equity.
In December, 2002 the warrants were exercised.
F-13
CTI Industries Corporation and Subsidiaries
Notes to the Consolidated Financial Statements
7. Income Taxes
The income tax provisions are comprised of the following:
Dec. 31 Dec. 31,
2002 2001
Current:
Federal $ -- $ --
State -- --
Foreign -- 22,316
-------------------------
-- 22,316
Deferred:
Federal 25,859 199,340
State 3,665 --
Foreign 9,541 54,897
-------------------------
39,065 254,237
-------------------------
Total income tax provision (benefit) $ 39,065 $276,553
=========================
The components of the net deferred tax asset(liability)at December 31 are as
follows:
2002 2001
Deferred tax assets:
Allowance for doubtful accounts $ 135,667 $ 141,915
Inventory valuation 203,032 196,092
Accrued liabilities 126,804 192,870
Sale Leaseback 79,701 (396,974)
Net operating loss carryforwards 1,840,916 1,760,106
Alternative minimum tax credit carryforwards 338,612 338,600
State Investment Tax Credit carryforward 26,225 --
Foreign Asset Tax Credit carryforward 166,790 --
----------- -----------
Total deferred tax assets 2,917,747 2,232,609
Deferred tax liabilities:
Book over tax basis of capital assets (989,197) 841,626
Cash basis of foreign inventory purchases (500,578) --
----------- -----------
1,427,972 1,390,983
Less: Valuation allowance (738,600) (738,600)
----------- -----------
Net deferred tax asset $ 689,372 $ 652,383
=========== ===========
The Company maintains a valuation allowance with respect to deferred tax assets
as a result of the uncertainty of ultimate realization. At December 31, 2002 the
Company has net operating loss carryforwards of approximately $4,600,000
expiring in various years through 2022. In addition, the Company has
approximately $338,600 of alternative minimum tax credits as of
F-14
CTI Industries Corporation and Subsidiaries
Notes to the Consolidated Financial Statements
7. Income Taxes, continued
December 31, 2002, which have no expiration date. 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:
December 31, December 31,
2002 2001
Taxes at statutory rate $ 114,000 $ (4,600)
State income taxes 16,000 0
Nondeductible Expenses 41,000 --
Increase in deferred tax
Valuation allowance -- 27,300
State credit created in current year (22,000) --
Foreign taxes and other (109,935) 253,853
--------------------------
Income tax provision $ 39,065 $276,553
==========================
8. Employee Benefit Plan
The Company has a defined contribution plan for substantially all employees. The
plan provides 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 are employees on the last date of the plan year. Profit
sharing contributions may also be made at the discretion of the Board of
Directors. Employer contributions to the plan totaled $53,680 for the year ended
December 31, 2002, and $57,160 for the year ended December 31, 2001.
9. 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 $102,000 for the year ended December 31, 2002 and
$121,305 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 is
reflected as a contra equity account at December 31, 2002 and 2001.
In November 1999, the Company sold one of its buildings to a related party. See
Note 12.
10. 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
F-15
CTI Industries Corporation and Subsidiaries
Notes to the Consolidated Financial Statements
10. Goodwill and Intangible Assets, continued
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 and December 31, 2002. On March
24, 2003, the Company received the report and opinion of the outside firm to the
effect there was no impairment of the goodwill reflected on the financial
statements of the Company as of December 31, 2002.
The gross carrying amount of goodwill as of December 31, 2002 and 2001 is
$1,113,108.
Year to Date December 31
2002 2001
----------- -------------
Reported net income (loss) $ 302,512 $ (232,292)
Add back: Goodwill amortization $ -- $ 86,664
----------- -----------
Adjusted net income (loss) $ 302,512 $ (145,628)
=========== ===========
Basic earnings per share
Reported net income (loss) $ 0.18 $ (0.15)
Add back: Goodwill amortization $ -- 0.07
----------- -----------
Adjusted net income (loss) $ 0.18 $ (0.08)
=========== ===========
Fully diluted earnings per share:
Reported net income (loss) $ 0.16 $ (0.15)
Add back: Goodwill amortization $ -- 0.07
----------- -----------
Adjusted net income (loss) $ 0.16 $ (0.08)
=========== ===========
11. Commitments and Contingencies
Operating Leases
The Company entered into a 10-year lease agreement for office and warehouse
facilities in November 1999, requiring monthly payments of $17,404, to Pepper
Road, Inc., a company related through common ownership. 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 May 2003 and December 2006.
F-16
CTI Industries Corporation and Subsidiaries
Notes to the Consolidated Financial Statements
11. Commitments and Contingencies, continued
The net lease expense was $348,631 and 269,643 for the years ended December 31,
2002 and 2001, which includes $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:
Total
Pepper Road, Inc. Other Lease Payments
----------------- ----- --------------
2003 $ 208,844 305,679 $ 514,523
2004 208,844 303,039 511,883
2005 208,844 299,130 507,974
2006 208,844 290,931 499,775
2007 208,844 290,931 499,775
Thereafter 382,881 602,886 985,767
---------- --------- ----------
Total 1,427,101 2,092,596 $3,519,697
---------- --------- ----------
12. Commitments and contingencies
Licenses
The Company has certain merchandising license agreements which are of a one to
two year duration that require royalty payments based upon the Company's net
sales of the respective products. The agreements call for guaranteed minimum
commitments that are determined on a calendar year basis. Future guaranteed
commitments due, as computed on a pro rata basis, as of December 31, are as
follows:
2003 $271,700
2004 $126,700
2005 $126,700
13. Sale/Leaseback of Building
In November, 1999, the Company sold its building located next to its
headquarters in Barrington, Illinois for a gain of $300,467, and entered into an
agreement to lease back the facility. The building is owned by 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.
14. Relationship with Pepper Road Company
In January, 2003, the Financial Accounting Standards Board issued interpretation
No. 46, Consolidation of Variable Interest Entities. This Interpretation
establishes standards for identifying a variable interest entity and for
determining under what circumstances a variable interest entity should be
consolidated with its primary beneficiary. The requirements of Interpretation 46
apply to the Company for its year ending December 31, 2004.
Until now, a company has generally included another entity in its consolidated
financial statements only if it controlled the entity through voting interests.
Interpretation 46 changes that by requiring a variable interest entity to be
consolidated by a company if that company is subject to a majority of the risk
F-17
CTI Industries Corporation and Subsidiaries
Notes to the Consolidated Financial Statements
14. Relationship with Pepper Road Company, continued
of loss from the variable interest entity's activities or is entitled to receive
a majority of the entity's residual returns or both.
In is possible that the Company will consolidate Pepper Road Company ("Pepper
Road") when this interpretation becomes effective. 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, 2002 include:
--------------------------------------------------------------------------------
Gross Lease Income $ 208,844
--------------------------------------------------------------------------------
Net Income $ 19,215
--------------------------------------------------------------------------------
Assets, primarily land and building $1,756,800
--------------------------------------------------------------------------------
Liabilities, primarily notes payable to bank $1,712,727
--------------------------------------------------------------------------------
Equity $ 44,073
--------------------------------------------------------------------------------
The Company paid a total of $208,844 in lease payments to Pepper Road during
2002 and 2001, respectively. The lease commitments of the Company to Pepper Road
are included in Note 11. 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.
When Interpretation 46 becomes effective, if a determination is made that the
Company will consolidate with Pepper Road, the net amount added to the Company's
balance sheet must be recognized as the cumulative effect of an accounting
change. Interpretation 46 may be applied by restating previously issued
financial statements with a cumulative-effect adjustment as of the beginning of
the first year restated. The Company is not required to restate its financial
statements and does not intend to do so. The impact that adoption of
Interpretation 46 is expected to have on the Company's financial statements is
not currently known.
15. Stock Options and Warrants
Under the Company's 1997 Stock Option Plan (effective July 1, 1997), a total of
119,050 shares of Common Stock are reserved for issuance under the Stock Option
Plan. Options to purchase 98,416 shares of Common Stock have been granted as of
October 31, 1998, and remain outstanding at December 31, 2002. The options are
exercisable immediately upon grant and have a term of ten years. The Plan
provides for the award of options, which may either be incentive stock options
("ISOs") within the meaning of Section 422A of the Internal Revenue Code of
1986, as amended (the "Code") or non-qualified options ("NQOs") which are not
subject to special tax treatment under the Code. The Plan is administered by the
Board or a committee appointed by the Board (the "Administrator"). Officers,
directors, and employees of, and consultants to, the Company or any parent or
subsidiary corporation selected by the Administrator are eligible to receive
options under the Plan. Subject to certain restrictions, the Administrator is
authorized to designate the number of shares to be covered by each award, the
terms of the award, the date on which and the rates at which options or other
awards may be exercised, the method of payment and other terms.
F-18
CTI Industries Corporation and Subsidiaries
Notes to the Consolidated Financial Statements
15. Stock Options and Warrants, continued
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, 2002, 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, 2002, 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, 2002, 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.
F-19
CTI Industries Corporation and Subsidiaries
Notes to the Consolidated Financial Statements
15. Stock Options and Warrants, continued
In November 1999, warrants issued in 1997 to purchase up to 76,389 shares of the
Company's Common Stock for $9.36 were cancelled. New warrants to purchase up to
423,579 shares of the Company's Common Stock at $1.688 were issued. The new
warrants had a term of 3 years and were exercised in 2002.
In July, 2001, certain members of company management were issued warrants to
purchase 119,050 shares of the Company's Common Stock at an exercise price of
$1.50 per share in consideration of their facilitating and guaranteeing and
securing bank loans to the Company in the amount of $1.4 million and for
advancing additional monies to the company that were repaid in 2001. The
warrants have a term of five years.
The following is a summary of the activity in the Company's stock option plans
and other options and warrants issued, as restated for the stock dividend, for
the years ended December 31, 2002 and December 31, 2001.
Dec. 31, 2002 Weighted Avg. Dec. 31, 2001 Weighted Avg.
Exercise Exercise
Price Price
Outstanding and exercisable,
beginning of period 1,094,739 $2.04 884,814 $2.28
Granted 79,764 2.22 240,482 2.01
Exercised (601,245) 1.54 -- --
Cancelled (396) 6.51 (30,557) 5.37
---------------------------------------------------------------
Outstanding and exercisable at the end of period 572,862 $2.58 1,094,739 $2.04
At December 31, 2002, available options to grant were 84,000.
Significant option and warrant groups outstanding at December 31, 2002 and
related weighted average price and remaining life information are as follows:
Remaining
Grant Date Outstanding Exercisable Exercise Price Life (Years)
September 1997 5,953 5,953 $6.28 6
September 1998 92,463 92,463 $6.51 7
September 1998 11,905 11,905 $2.10 6
September 1999 19,079 19,079 $1.42 3
March 2000 147,027 147,027 $1.95 8
July 2001 119,050 119,050 $1.50 3
December 2001 106,550 106,550 $1.46 9
April 2002 11,905 11,905 $2.10 3
December 2002 58,930 58,930 $2.36 5
The weighted average fair value of options granted during the years ending
December 31, 2002 and December 31, 2001 was $1.92 and $1.48 per share,
respectively.
16. 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 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.
17. Earnings Per Share
Basic earnings per share is computed by dividing the income available to common
shareholders, net earnings, less redeemable preferred stock dividends and
redeemable common stock accretion, by the weighted average number of shares of
common stock outstanding during each period.
F-20
CTI Industries Corporation and Subsidiaries
Notes to the Consolidated Financial Statements
17. Earnings Per Share, continued
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, 2002, and December 31, 2001
was computed as follows:
Year Ended Year ended
December 31, December 31,
2002 2001
BASIC
Average shares outstanding:
Weighted average shares
Outstanding during period 1,688,384 1,511,958
========== ==========
Earnings:
Net income (loss) $ 302,512 $ (232,292)
========== ==========
Amount for per share
Computation $ 302,512 $ (232,292)
========== ==========
Net earnings applicable to
Common shares $ 0.18 $ (0.15)
========== ==========
DILUTED
Average shares outstanding:
Weighted average shares
Outstanding 1,688,384 1,511,958
Common stock equivalents
(options/warrants) 196,021 --
---------- ----------
Weighted average shares
Outstanding during period 1,884,405 1,511,958
========== ==========
Earnings:
Net income $ 302,512 $ (232,292)
========== ==========
Amount for per share
Computation $ 302,512 $ (232,292)
========== ==========
Net earnings applicable to
Common shares $ 0.16 $ (0.15)
========== ==========
18. 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, 2001, and December 31, 2002 are as follows:
F-21
CTI Industries Corporation and Subsidiaries
Notes to the Consolidated Financial Statements
18. Geographic Segment Data, continued
United States United Kingdom Mexico Eliminations Consolidated
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
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
19. Litigation
On September 5, 2002, Byrne Sales Associates, Inc. filed an action against the
Company in the Circuit Court of Jefferson County, Wisconsin for alleged breach
of contract, claiming damages in the amount of $151,000. In the action, the
plaintiff alleges that certain products manufactured by the Company and sold to
plaintiff were defective. The Company has filed an answer to the complaint
denying the substantive claims. Management of the Company believes the claims
are without merit in fact or law and intends vigorously to defend the action.
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.
20. Fourth Quarter Adjustments
During the fourth quarter, 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.
21. Subsequent Events
On February 22, 2003, CTI Mexico S.A. de C.V., 97% owned subsidiary of the
Company, effected a spin-off under Mexican law under which a portion of the
assets, liabilities and capital of CTI Mexico were transferred to a newly
organized entity. This entity will operate under the name Flexo Universal S.A.
de C.V. The capital ownership of Flexo Universal is identical to that of CTI
Mexico. Flexo Universal commenced operations on March 1, 2003.
During February and March, 2003, two officers of the Company entered into
agreements with the Company pursuant to which such individuals loaned the
Company an aggregate of $1,630,000 in exchange for(i)two year 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 Company's common stock on the date of issuance of the Warrants). The funds
were provided to re-finance an existing loan to CTI Mexico and Flexo Universal
of $880,000 and to provide funds to Flexo Universal for capital investment and
working capital.
During March and April, 2003, an officer of the Company loaned to the
Company an additional aggregate amount of $690,000. Such amount is due on demand
and bears interest at the rate of 8% per annum.
F-22