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EX-32 - CTI INDUSTRIES CORPv193220_ex32.htm
EX-31.1 - CTI INDUSTRIES CORPv193220_ex31-1.htm
EX-31.2 - CTI INDUSTRIES CORPv193220_ex31-2.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.   20549
 


FORM 10-Q

(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2010

OR

¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from _________to_________
 
Commission File Number
000-23115
CTI INDUSTRIES CORPORATION
(Exact name of Registrant as specified in its charter)

Illinois
36-2848943
(State or other jurisdiction of
(I.R.S. Employer Identification Number)
incorporation or organization)
 
   
22160 N. Pepper Road
 
    Lake Barrington, Illinois    
60010
(Address of principal executive offices)
(Zip Code)

(847) 382-1000
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ     No o
 
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o     Accelerated filer o    Non-accelerated filer o  Smaller Reporting Company  þ
 
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

The number of shares outstanding of the Registrant’s common stock as of August 1, 2010 was 3,119,068.

 
 

 

INDEX

PART I – FINANCIAL INFORMATION
 
     
Item No. 1
Financial Statements
 
 
Condensed Consolidated Interim Balance Sheet at June 30, 2010 (unaudited) and December 31, 2009
1
 
Condensed Consolidated Interim Statements of Income (unaudited) for the three and six months ended June 30, 2010 and June 30, 2009
2
 
Condensed Consolidated Interim Statements of Cash Flows (unaudited) for the three and six months ended June 30, 2010 and June 30, 2009
3
 
Condensed Consolidated Interim Earnings per Share (unaudited) for the three and six months ended June 30, 2010 and June 30, 2009
4
 
Notes to Condensed Consolidated Financial Statements (unaudited)
5
Item No. 2
Management’s Discussion and Analysis of Financial Condition and Results of Operations
16
Item No. 3
Quantitative and Qualitative Disclosures Regarding Market Risk
22
Item No. 4
Controls and Procedures
22
     
PART II – OTHER INFORMATION
 
     
Item No. 1
Legal Proceedings
23
Item No. 1A
Risk Factors
23
Item No. 2
Unregistered Sales of Equity Securities and Use of Proceeds
23
Item No. 3
Defaults Upon Senior Securities
23
Item No. 4
Submission of Matters to a Vote of Security Holders
24
Item No. 5
Other Information
24
Item No. 6
Exhibits
24
 
Signatures
 
 
Exhibit 31.1
 
 
Exhibit 31.2
 
 
Exhibit 32
 
 
 
 

 
 

Item 1.  Financial Statements

CTI Industries Corporation and Subsidiaries
Condensed Consolidated Balance Sheets

   
June 30, 2010
   
December 31, 2009
 
  
 
(unaudited)
       
ASSETS            
Current assets:
           
Cash and cash equivalents
  $ 1,329,417     $ 870,446  
Accounts receivable, (less allowance for doubtful accounts of $82,000
                
and $57,000, respectively)
   
8,032,601
     
7,320,181
 
Inventories, net
    9,419,187       9,643,914  
Net deferred income tax asset
    724,972       706,754  
Prepaid expenses and other current assets
    584,981       607,127  
                 
Total current assets
    20,091,158       19,148,422  
                 
Property, plant and equipment:
               
Machinery and equipment
    22,557,567       22,390,891  
Building
    3,260,201       3,183,795  
Office furniture and equipment
    2,704,424       2,677,476  
Intellectual property
    345,092       345,092  
Land
    250,000       250,000  
Leasehold improvements
    434,888       428,864  
Fixtures and equipment at customer locations
    2,584,159       2,541,881  
Projects under construction
    380,138       270,131  
      32,516,469       32,088,130  
Less : accumulated depreciation and amortization
    (23,524,017 )     (22,554,719 )
                 
Total property, plant and equipment, net
    8,992,452       9,533,411  
                 
Other assets:
               
Deferred financing costs, net
    106,177       11,846  
Goodwill
    1,033,077       989,108  
Net deferred income tax asset
    417,779       361,457  
Other assets (due from related party $159,000 and $79,000, respectively)
    291,114       351,065  
                 
Total other assets
    1,848,147       1,713,476  
                 
TOTAL ASSETS
    30,931,757       30,395,309  
LIABILITIES AND EQUITY
               
Current liabilities:
               
Checks written in excess of bank balance
    29,442       735,257  
Trade payables
    3,598,192       3,236,607  
Line of credit
    8,048,054       7,598,671  
Notes payable - current portion
    560,001       811,996  
Notes payable - officers, current portion, net of debt discount of $62,000 and $89,000
    1,362,803       1,368,964  
Capital lease - current portion
    21,784       299,311  
Notes Payable Affiliates - current portion
    6,142       5,793  
Accrued liabilities
    2,927,266       2,683,714  
                 
Total current liabilities
    16,553,684       16,740,313  
                 
Long-term liabilities:
               
Notes Payable - Affiliates
    151,422       774,294  
Notes payable, net of current portion
    2,224,460       2,375,435  
Capital Lease
    488,451       733,414  
Notes payable - officers, subordinated, net of debt discount of $0 and $7,000
    360,203       992,632  
Total long-term liabilities
    3,224,536       4,875,775  
                 
Equity:
               
CTI Industries Corporation stockholders' equity:
               
Preferred Stock -- no par value 2,000,000 shares  authorized
               
0 shares issued and outstanding
  $ -     $ -  
Common stock  - no par value, 5,000,000 shares authorized,
               
3,189,725 and 2,808,720 shares issued and 3,119,068 and 2,808,720
               
 outstanding, respectively
    14,082,090       12,457,966  
Warrants issued in connection with subordinated debt and bank debt
    -       443,313  
Dividends
    (156,135 )     -  
Accumulated deficit
    (1,001,118 )     (2,206,728 )
Accumulated other comprehensive loss
    (1,686,052 )     (1,803,442 )
Less:  Treasury stock, 70,657 shares and 70,657 shares
    (128,446 )     (128,446 )
                 
Total CTI Industries Corporation stockholders' equity
    11,110,339       8,762,663  
                 
Noncontrolling interest
    43,198       16,558  
                 
Total Equity
    11,153,537       8,779,221  
                 
TOTAL LIABILITIES AND EQUITY
  $ 30,931,757     $ 30,395,309  
 
See accompanying notes to condensed consolidated unaudited financial statements
 
1

 
Condensed Consolidated Statements of Income (Unaudited)
 
   
For the Three Months Ended June 30,
   
For the Six Months Ended June 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Net Sales
  $ 12,964,203     $ 10,778,903     $ 25,374,969     $ 20,382,324  
                                 
Cost of Sales
    10,091,153       8,178,204       19,457,347       15,715,122  
                                 
Gross profit
    2,873,050       2,600,699       5,917,622       4,667,202  
                                 
Operating expenses:
                               
General and administrative
    1,307,771       1,301,032       2,568,450       2,340,669  
Selling
    218,394       203,734       558,819       380,791  
Advertising and marketing
    457,225       421,002       940,637       809,063  
                                 
Total operating expenses
    1,983,390       1,925,768       4,067,906       3,530,523  
                                 
Income from operations
    889,660       674,931       1,849,716       1,136,679  
                                 
Other income (expense):
                               
Interest expense
    (300,658 )     (280,964 )     (549,061 )     (576,628 )
Interest income
    4,263       8,398       8,593       8,511  
Foreign currency (loss) gain
    (21,463 )     2,599       (34,687 )     (18,998 )
                                 
Total other expense, net
    (317,858 )     (269,967 )     (575,155 )     (587,115 )
                                 
Net Income before taxes
    571,802       404,964       1,274,561       549,564  
                                 
Income tax (benefit) expense
    (21,036 )     (4,037 )     95,324       46,121  
                                 
Net Income
    592,838       409,001       1,179,237       503,443  
                                 
Less: Net (loss) income attributable to noncontrolling interest
    (13,929 )     263       (26,373 )     1,497  
                                 
Net income attributable to CTI Industries Corporation
  $ 606,767     $ 408,738     $ 1,205,610     $ 501,946  
                                 
Other Comprehensive Income
                               
Unrealized gain on derivative instruments; adjustment to
                               
accumulated balance on swap termination
  $ 154,418     $ 61,351     $ 188,615     $ 88,055  
Foreign currency adjustment
  $ (291,017 )   $ 332,457     $ (71,225 )   $ 183,556  
Comprehensive income
  $ 470,168     $ 802,546     $ 1,323,000     $ 773,557  
                                 
Basic income per common share
  $ 0.21     $ 0.15     $ 0.43     $ 0.18  
                                 
Diluted income per common share
  $ 0.20     $ 0.15     $ 0.42     $ 0.18  
                                 
Dividends per share
  $ 0.05     $ -     $ 0.05     $ -  
                                 
Weighted average number of shares and equivalent shares
                               
of common stock outstanding:
                               
Basic
    2,898,811       2,775,902       2,834,265       2,792,220  
                                 
Diluted
    2,959,952       2,776,797       2,877,102       2,797,256  
 
See accompanying notes to condensed consolidated unaudited financial statements

2

 
CTI Industries Corporation and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Unaudited)
 
   
For the Six Months Ended June 30,
 
   
2010
   
2009
 
             
Cash flows from operating activities:
           
Net income
  $ 1,179,237     $ 503,443  
Adjustment to reconcile net income to cash
               
provided by operating activities:
               
Depreciation and amortization
    1,052,661       945,438  
Amortization of debt discount
    44,334       44,334  
Stock based compensation
    81,251       44,698  
Provision for losses on accounts receivable
    29,651       56,102  
Provision for losses on inventories
    10,482       24,000  
Deferred income taxes
    65,324       40,121  
Change in assets and liabilities:
               
Accounts receivable
    (711,092 )     (703,853 )
Inventories
    239,113       436,308  
Prepaid expenses and other assets
    98,070       (306,180 )
Trade payables
    370,245       231,149  
Accrued liabilities
    151,241       372,023  
                 
Net cash provided by operating activities
    2,610,517       1,687,583  
                 
Cash used in investing activity - purchases of property, plant and equipment
    (418,434 )     (433,481 )
                 
Net cash used in investing activity
    (418,434 )     (433,481 )
                 
Cash flows from financing activities:
               
Change in checks written in excess of bank balance
    (705,403 )     197,714  
Net change in revolving line of credit
    449,384       (734,492 )
Repayment of long-term debt (related parties $373,000 and  $52,000)
    (1,279,473 )     (617,128 )
Proceeds from exercise of stock options and warrants
    72,561       -  
Cash received from investment in subsidiary
    42,299       -  
Dividends paid
    (156,135 )     -  
Cash paid for purchase of stock
    -       (55,036 )
Cash paid for deferred financing fees
    (189,032 )     (40,555 )
 
               
Net cash used in financing activities
    (1,765,799 )     (1,249,497 )
                 
Effect of exchange rate changes on cash
    (11,632 )     17,473  
                 
Net increase in cash and cash equivalents
    414,652       22,078  
                 
Cash and cash equivalents at beginning of period
    914,765       180,578  
                 
Cash and cash equivalents at end of period
  $ 1,329,417     $ 202,656  
                 
Supplemental disclosure of cash flow information:
               
    Cash payments for interest
  $ 475,508     $ 420,907  
                 
    Cash payments for taxes
  $ 30,000     $ 6,000  
                 
Supplemental Disclosure of non-cash investing and financing activity
               
Stock issued under consulting agreement
  $ -     $ 23,313  
                 
Exercise of Warrants and Payment of Subordinated Debt
  $ 1,027,000     $ -  
                 
Property, Plant & Equipment acquisitions funded by liabilities
  $ 88,940     $ 61,985  
 
See accompanying notes to condensed consolidated unaudited financial statements

3

 
CTI Industries Corporation and Subsidiaries
Condensed Consolidated Earnings per Share (unaudited)
 
   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Basic
                       
Average shares outstanding:
                       
Weighted average number of common shares
                       
outstanding
    2,898,811       2,775,902       2,834,265       2,792,220  
                                 
Net income:
                               
Net income attributable to CTI Industries Corporation
  $ 606,767     $ 408,738     $ 1,205,610     $ 501,946  
                                 
Per share amount
  $ 0.21     $ 0.15     $ 0.43     $ 0.18  
                                 
Diluted
                               
Average shares outstanding:
                               
Weighted average number of common shares
                               
outstanding
    2,898,811       2,775,902       2,834,265       2,792,220  
                                 
Effect of dilutive shares
    61,141       895       42,837       5,036  
                                 
Weighted average number of shares and
                               
equivalent shares of common stock
                               
outstanding
    2,959,952       2,776,797       2,877,102       2,797,256  
                                 
Net income:
                               
Net income attributable to CTI Industries Corporation
  $ 606,767     $ 408,738     $ 1,205,610     $ 501,946  
                                 
Per share amount
  $ 0.20     $ 0.15     $ 0.42     $ 0.18  
 
See accompanying notes to condensed consolidated unaudited financial statements

4

 
CTI Industries Corporation and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements


The accompanying condensed consolidated financial statements are unaudited but in the opinion of management contain all the adjustments (consisting of those of a normal recurring nature) considered necessary to present fairly the consolidated financial position and the consolidated results of operations and consolidated cash flows for the periods presented in conformity with generally accepted accounting principles for interim consolidated financial information and the instructions to Form 10-Q and Article 8 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.  Operating results for the three and six months ended June 30, 2010 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2010.  It is suggested that these condensed financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the Company's annual report on Form 10-K for the fiscal year ended December 31, 2009.

Principles of consolidation and nature of operations:

The condensed consolidated financial statements include the accounts of CTI-US and its wholly-owned subsidiaries, CTI Balloons Limited, CTI Helium, Inc. and CTF International S.A. de C.V., as well as its majority-owned subsidiaries CTI Mexico S.A. de C.V., Flexo Universal, S.A. de C.V. and CTI Europe gmbH (the “Company”). All significant intercompany transactions and accounts have been eliminated in consolidation. The Company (i) designs, manufactures and distributes 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.

Reclassification:

As of June 30, 2010, the Company has reclassified obligations under capital leases from notes payable to capital leases including both the long term and current portions.  This reclassification is reflected in the balance sheets for June 30, 2010 and December 31, 2009.
 
As of June 30, 2010, the Company has reclassified its equity in common stock from paid-in-capital. This reclassification is reflected in the balance sheets for June 30, 2010 and December 31, 2009.
 
Use of estimates:

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

5

 
Earnings per share:

Basic earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding during each period.

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

As of June 30, 2010, shares to be issued upon the exercise of options and warrants aggregated 160,405 and 0, respectively.  As of June 30, 2009, shares to be issued upon the exercise of options and warrants were 234,644 and 343,030, respectively.  The number of anti-dilutive shares (not included in the determination of earnings on a diluted basis) for the three and six months ended June 30, 2010 were 6,000 and 59,000, respectively, all of which were represented by options.  The number of anti-dilutive shares (not included in the determination of earnings on a diluted basis) for the three months ended June 30, 2009 were 571,121 of which 228,691 were represented by options and 343,030 were represented by warrants, and for the six months ended June 30, 2009 were 510,935 of which 167,905 were represented by options and 343,030 were represented by warrants.

Subsequent Events:

The Company has evaluated subsequent events through August 4, 2010, the date financial statements were issued for the three and six months ended June 30, 2010. 

New Accounting Pronouncements:

In June 2009, the FASB issued new accounting standards that amend the evaluation criteria to identify the primary beneficiary of a variable interest entity and require ongoing reassessments of whether an enterprise is the primary beneficiary of the variable interest entity. These accounting standards are effective for annual reporting periods that begin after November 15, 2009 and interim periods within those fiscal years. The adoption of these standards has not had a material impact on the Company’s Condensed Consolidated Financial Statements.

In June 2009, the FASB amended the accounting guidance for determining whether a transfer of a financial asset qualifies for sale accounting.  The amended guidance provided disclosure objectives designed to provide users of the financial statements with an understanding of how the transfer affects the company’s balance sheet, earnings and cash flows.  The adoption of this guidance to new transfers of financial assets beginning January 1, 2010 had no impact on our consolidated financial position or results of operation.

In June 2009, the FASB issued an update to ASC 810, Consolidation, which modifies the existing quantitative guidance used in determining the primary beneficiary of a variable interest entity (“VIE”) by requiring to qualitatively assess whether an enterprise is a primary beneficiary, based on whether the entity has (i) power over the significant activities of the VIE, and (ii) an obligation to absorb losses or the right to receive benefits that could be potentially significant to the VIE.  The adoption of this guidance on January 1, 2010 did not have a material effect on our consolidated financial statements.

6

 
On January 21, 2010, the Financial Accounting Standards Board (“FASB”) issued an update to Accounting Standards Codification (“ASC”) 820, Fair Value Measurements and Disclosures, adding new requirements for disclosures about transfers into and out of Levels 1 and 2 fair value measurements and additional disclosures about the activity within Level 3 fair value measurements.  The application of this guidance on January 1, 2010 did not have a material effect on our consolidated financial statements.

Note 2 - Stock-Based Compensation; Changes in Equity

We have adopted Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 718 which requires all share-based payments to employees, including grants of employee stock options, to be recognized in the condensed consolidated financial statements based on their grant-date fair values.

We have applied the Black-Scholes model to value stock-based awards.  That model incorporates various assumptions in the valuation of stock-based awards relating to the risk-free rate of interest to be applied, the estimated dividend yield and expected volatility of our common stock.  The risk-free rate of interest is the related U.S. Treasury yield curve for periods within the expected term of the option at the time of grant.  The dividend yield on our common stock is assumed to be zero as we have historically not paid dividends.  The expected volatility is based on historical volatility of the Company’s common stock.

The Company’s net income for the three months ended June 30, 2010 and 2009 includes approximately $34,000 and $24,000, respectively of compensation costs related to share based payments.  The Company’s net income for the six months ended June 30, 2010 and 2009 includes approximately $81,000 and $45,000, respectively of compensation costs related to share based payments.  As of June 30, 2010 there is $80,000 of unrecognized compensation expense related to non-vested stock option grants and stock grants.  We expect approximately $55,000 to be recognized over the remainder of 2010, and approximately $25,000 to be recognized during 2011.

As of June 30, 2010, the Company had five stock-based compensation plans pursuant to which stock options were, or may be, granted.  The Plans provide for the award of options, which may either be incentive stock options (“ISOs”) within the meaning of Section 422A of the Internal Revenue Code of 1986, as amended (the “Code”) or non-qualified options (“NQOs”) which are not subject to special tax treatment under the Code.

On April 30, 2007, the Board of Directors approved for adoption, effective October 1, 2007, the 2007 Stock Option Plan (“Plan”). The Plan authorizes the grant of options to purchase up to an aggregate of 150,000 shares of the Company’s Common Stock.  As of June 30, 2010, 165,750 options had been granted and 107,500 remain outstanding.

On April 10, 2009, the Board of Directors approved for adoption, and on June 5, 2009, the shareholders of the Corporation approved, a 2009 Incentive Stock Plan (“Incentive Stock Plan”).  The Incentive Stock Plan authorizes the issuance of up to 250,000 shares of stock or options to purchase stock of the Company.  No stock or options have been granted under this Plan to date.

7


A summary of the Company’s stock option activity and related information is as follows:

   
Shares under
Option
   
Weighted
Avgerage
Exercise Price
   
Weighted
Average
Contractual
Life
   
Aggregate
Intrinsic
Value
 
Balance at December 31, 2009
    232,644     $ 3.04              
Granted
    -       -              
Cancelled
    15,000     $ 3.48              
Exercised
    57,239     $ 2.37              
Outstanding at June 30, 2010
    160,405     $ 3.24       2.80     $ 563,721  
                                 
Exercisable at June 30, 2010
    109,280     $ 3.34       3.10     $ 373,116  

A summary of the Company’s stock warrant activity and related information is as follows:
 
   
Shares under
Warrant
   
Weighted
Avgerage
Exercise Price
   
Weighted
Average
Contractual
Life
   
Aggregate
Intrinsic Value
 
Outstanding and Exercisable at December 31, 2009
    343,030     $ 3.47              
Granted
    -       -                  
Cancelled
    -       -                  
Exercised
    343,030     $ 3.47                  
Outstanding and Exercisable at June 30, 2010
    -     $ -       -     $ -  

A summary of the Company’s stock option activity by grant date as of June 30, 2010 is as follows:
 
   
Options Outstanding
   
Options Vested
 
Options by Grant Date
 
Shares
   
Wtd Avg
   
Remain. Life
   
Intrinsic Val
   
Shares
   
Wtd Avg
   
Remain. Life
   
Intrinsic Val
 
Dec 2001
    -     $ -       -     $ -       -     $ -       -     $ -  
Apr 2002
    11,905     $ 2.10       1.8     $ 55,358       11,905     $ 2.10       1.8     $ 55,358  
Dec 2005
    41,000     $ 2.88       5.5     $ 158,670       41,000     $ 2.88       5.5     $ 158,670  
Oct 2007
    50,500     $ 4.72       1.3     $ 102,472       35,625     $ 4.70       1.3     $ 73,049  
Aug 2008
    6,000     $ 6.14       2.1     $ 3,660       3,000     $ 6.14       2.1     $ 1,830  
Oct 2008
    2,500     $ 4.97       2.3     $ 4,450       1,250     $ 4.97       2.3     $ 2,225  
Nov 2008
    48,500     $ 1.82       2.4     $ 239,111       16,500     $ 1.78       2.4     $ 81,983  
Jan 2010
    -     $ -       -     $ -       -     $ -       -     $ -  
                                                                 
TOTAL
    160,405     $ 3.24       2.8     $ 563,721       109,280     $ 3.34       3.1     $ 373,116  
 
The aggregate intrinsic value in the tables above represents the total pre-tax intrinsic value (the difference between the closing price of the Company’s common stock on the last trading day of the quarter ended June 30, 2010 and the exercise price, multiplied by the number of in-the-money options and warrants) that would have been received by the option and warrant holders had all the holders exercised their options on June 30, 2010.

8

 
On June 9, 2010, the Board of Directors of the Company declared a dividend of $0.05 per share to be paid to all shareholders of record as of June 18, 2010.  The dividend was paid on or about June 28, 2010.

Note 3 - Legal Proceedings


Note 4 – Other Comprehensive Loss

In the three months ended June 30, 2010 the company incurred a comprehensive loss of $136,000, principally from an unrealized gain on a derivative instrument of $155,000 and a loss of $291,000 from foreign currency translation adjustments.  In the six months ended June 30, 2010 the company incurred a comprehensive gain of $117,000, principally from an unrealized gain on a derivative instrument of $189,000 and a loss of $72,000 from foreign currency translation adjustments.  The gain on derivative instruments in the periods ended June 30, 2010 reflects the adjustment to the accumulated balance of the loss on derivatives arising from the termination of the swap agreements.

The following table sets forth the accumulated balance of other comprehensive loss and each component.
 
   
Foreign
Currency
Items
   
Unrealized Gains
(Loss) on
Derivatives
   
Accumulated Other
Comprehensive
(Loss)
 
                   
Beginning balance as of January 1, 2010
  $ (1,614,000 )   $ (189,000 )   $ (1,803,000 )
                         
Current period change, net of tax
    (72,000 )     189,000       117,000  
                         
Ending Balance as of June 30, 2010
  $ (1,686,000 )   $ -     $ (1,686,000 )
 
For the three and six months ended June 30, 2010 no tax benefit for foreign currency translation adjustments has been recorded as such amounts would result in a deferred tax asset. For the three and six months ended June 30, 2010 no income tax benefit was recorded for the unrealized losses on the derivative instruments by reason of the fact that the tax benefit was offset by a valuation allowance with respect to the related deferred tax asset.

9

 
Note 5 - Fair Value Disclosures; Derivative Instruments

Effective January 1, 2008, the Company adopted the provisions of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 820 “Fair Value Measurements and Disclosures,” which defines fair value, establishes a framework for measuring fair value, establishes a fair value hierarchy based on the quality of inputs used to measure fair value and enhances disclosure requirements for fair value measurements.  FASB ASC Topic 820 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.  FASB ASC Topic 820 also requires that a fair value measurement reflect the assumptions market participants would use in pricing an asset or liability based upon the best information available.  In February 2008, the FASB issued guidance now codified in FASB ASC Topic 820 which provides for delayed application of certain guidance related to non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually).
   
FASB ASC Topic 820 establishes a three-level valuation hierarchy for disclosure of fair value measurements.  The valuation hierarchy categorizes assets and liabilities at fair value into one of three different levels depending on the observability of the inputs employed in the measurement.  The three levels are defined as follows:

 
·
Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets are liabilities in active markets.

 
·
Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.

 
·
Level 3 – inputs to the valuation methodology are unobservable and significant to the fair value measurement.

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of the input that is significant to the fair value measurement.  The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.  The following table presents information about the Company’s liabilities measured at fair value on a recurring basis as of June 30, 2010 and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value:

   
Amount as of
           
Description
 
6/30/2010
 
Level 1
 
Level 2
 
Level 3
Interest Rate Swap 2006-1
  $ -       $ -    
Interest Rate Swap 2006-2
    -         -    
Interest Rate Swap 2008
    -         -    
    $ -       $ -    
 
10

 
   
Amount as of
           
Description
 
6/30/2009
 
Level 1
 
Level 2
 
Level 3
Interest Rate Swap 2006-1
  $ (30,000 )     $ (30,000 )  
Interest Rate Swap 2006-2
    (108,000 )       (108,000 )  
Interest Rate Swap 2008
    (115,000 )       (115,000 )  
    $ (253,000 )     $ (253,000 )  

The Company’s interest rate swap agreements have been valued using the counterparty’s mark-to-market statement, which can be validated using modeling techniques that include market inputs such as publically available interest rate yield curves, and have been designated as Level 2 within the valuation hierarchy.

FASB ASC Topic 815 requires an entity to recognize all derivatives as either assets or liabilities in the consolidated balance sheet and to measure those instruments at fair value.  Under certain conditions, a derivative may be specifically designated as a fair value hedge or a cash flow hedge.

On April 5, 2006, the Company entered into two swap agreements with RBS Citizens N.A. (“RBS”) in connection with portions (original notional amount totaling $3,780,000) of the principal amounts of a mortgage loan and term loan to the Company fixing the interest rate on such floating rate loans from prime plus 0.75% to 8.49%.  On January 28, 2008, the Company entered into an additional swap agreement with RBS with respect to a $3,000,000 notional amount of a floating rate revolving loan, fixing the interest rate on such amount from prime plus 0.75% to 6.17%.  These swap agreements are designated as cash flow hedges and hedge the Company’s exposure to interest rate fluctuations on the portions of the principal amount of loans with RBS that are covered by the swap agreements.  These swap agreements are derivative financial instruments and the Company has determined the fair market value of these agreements on a quarterly basis, based on RBS’s mark-to-market statement, recording the fair market value of these contracts on the balance sheet with the offset to other comprehensive loss.  In connection with the entry into a new credit agreement with Harris N.A. and the pay off of its loan balances with RBS, on April 30, 2010, the Company terminated these swap agreements and paid to RBS the sum of $146,000, representing the then fair value of the swap agreements, which was or will be, recorded as additional interest expense in the condensed consolidated statement of operations.

As of June 30, 2010 and December 31, 2009, the Company recorded the fair value of these swap agreements on the balance sheet as a liability of $0 and $189,000, respectively.  For the three and six months ended June 30, 2010, the Company recorded an unrealized gain of $155,000 and $189,000, compared to an unrealized gain of $61,000 and $88,000 for the same period in 2009, with respect to these swap agreements in other comprehensive income, which represents the change in value of these swap agreements for the quarters ended.
 
Since May 1, 2010, the Company has not entered into or maintained any swap agreements with respect to its outstanding indebtedness.

11

 
Note 6 – Inventories, Net

   
June 30,
   
December 31,
 
   
2010
   
2009
 
Raw materials
  $ 2,655,000     $ 1,520,000  
Work in process
    549,000       442,000  
Finished goods
    6,566,000       8,024,000  
Allowance for excess quantities
    (351,000 )     (342,000 )
Total inventories
  $ 9,419,000     $ 9,644,000  
 
Note 7 - Geographic Segment Data

The Company has determined that it operates primarily in one business segment which designs, manufactures and distributes film products for use in packaging and novelty balloon products. The Company operates in foreign and domestic regions. Information about the Company's operations by geographic areas is as follows:

   
Net Sales to Outside Customers
   
Net Sales to Outside Customers
 
   
For the Three Months Ended
   
For the Six Months Ended
 
   
June 30,
   
June 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
United States
  $ 10,212,000     $ 8,623,000     $ 19,699,000     $ 15,891,000  
Europe
    14,000       -       30,000       -  
Mexico
    2,118,000       1,559,000       4,063,000       3,241,000  
United Kingdom
    620,000       597,000       1,583,000       1,250,000  
                                 
                                 
    $ 12,964,000     $ 10,779,000     $ 25,375,000     $ 20,382,000  
                                 
                   
Total Assets at
 
                   
June 30,
   
December 31,
 
                   
2010
   
2009
 
                                 
United States
                  $ 24,027,000     $ 23,801,000  
Europe
                    128,000       -  
Mexico
                    5,656,000       5,861,000  
United Kingdom
                    1,121,000       733,000  
                                 
                                 
                     $ 30,932,000     $ 30,395,000  
 
12


Note 8 - Concentration of Credit Risk

Concentration of credit risk with respect to trade accounts receivable is generally limited due to the number of entities comprising the Company's customer base. The Company performs ongoing credit evaluations and provides an allowance for potential credit losses against the portion of accounts receivable which is estimated to be uncollectible. Such losses have historically been within management's expectations.  During the three and six months ended June 30, 2010 and 2009, there were three customers whose purchases represented more than 10% of the Company’s consolidated net sales.  The sales to each of these customers for the three and six months ended June 30, 2010 and 2009 are as follows:

   
Three Months Ended 
June 30, 2010
   
Three Months Ended 
June 30, 2009
 
Customer
 
Net Sales
   
% of Net
Sales
   
Net Sales
   
% of Net
Sales
 
                         
Customer A
  $ 4,169,000       32.2 %   $ 3,907,000       36.3 %
Customer B
  $ 1,740,000       13.4 %   $ 1,538,000       14.3 %
Customer C
  $ 1,498,000       11.6 %   $ 1,003,000       9.3 %
 
   
Six Months Ended 
June 30, 2010
   
Six Months Ended 
June 30, 2009
 
Customer
 
Net Sales
   
% of Net
Sales
   
Net Sales
   
% of Net
Sales
 
                         
Customer A
  $ 7,323,000       28.9 %   $ 6,407,000       31.4 %
Customer B
  $ 3,854,000       15.2 %   $ 1,441,000       7.1 %
Customer C
  $ 2,958,000       11.7 %   $ 3,250,000       15.9 %
 
As of June 30, 2010, the total amount owed to the Company by these customers was $2,408,000 or 30.0%, $839,000 or 10.4%, and $1,167,000 or 14.5% of the Company’s consolidated accounts receivables.  The amounts owed at June 30, 2009 were $1,969,000, or 29.8%, $515,000, or 7.8%, and $902,000 or 13.6% of the Company’s consolidated net accounts receivables, respectively.
 
Note 9 – Related Party Transactions

Stephen M. Merrick, Executive Vice President, Secretary and a Director of the Company, is of counsel to the law firm of Vanasco Genelly and Miller PC which provides legal services to the Company. Legal fees incurred by the Company with this firm for the three months ended June 30, 2010 and 2009, respectively, were $43,000 and $35,000.  Legal fees incurred by the Company with this firm for the six months ended June 30, 2010 and 2009, respectively, were $85,000 and $47,000.

13

 
John H. Schwan, Chairman of the Company, is a principal of Shamrock Packaging and affiliated companies. The Company made purchases of approximately $478,000 from Shamrock Packaging during the three months ended June 30, 2010 and $557,000 during the three months ended June 30, 2009.  The Company made purchases of approximately $987,000 from Shamrock Packaging during the six months ended June 30, 2010 and $965,000 during the six months ended June 30, 2009.  At June 30, 2010 and 2009, outstanding accounts payable balances were $381,000 and $269,000, respectively.

John H. Schwan, Chairman of the Company, and Howard W. Schwan, President of the Company, are the brothers of Gary Schwan, one of the owners of Schwan Incorporated, which provides building maintenance and remodeling services to the Company.  The Company received services from Schwan Incorporated of approximately $10,000 during the three months ended June 30, 2010 and $8,000 during the three months ended June 30, 2009.  The Company received services from Schwan Incorporated of approximately $24,000 during the six months ended June 30, 2010 and $17,000 during the six months ended June 30, 2009.

On February 1, 2006, John H. Schwan and Stephen M. Merrick advanced $500,000 each to the Company in exchange for (a) five year promissory notes bearing interest at 2% over the prime rate determined quarterly and (b) five year warrants to purchase an aggregate of 303,030 shares of common stock of the Company at the price of $3.30 per share.  On May 28, 2010, John H. Schwan (with respect to 101,515 shares of common stock of the Company at the price of $3.30 per share and 20,000 shares of common stock of the Company at the price of $4.80 per share) and Stephen M. Merrick (with respect to 151,515 shares of common stock of the Company at the price of $3.30 per share) exercised such warrants in consideration of the cancellation of indebtedness to them of the Company in the amount of such exercise price.

On April 3, 2007, John H. Schwan assigned and transferred warrants to purchase up to 50,000 shares of common stock to Howard W. Schwan, an officer and director of the Company.  On June 25, 2010, Howard W. Schwan exercised warrants to purchase 50,000 shares of common stock of the Company at the price of $3.30 per share in consideration of the transfer to the Company and cancellation of 22,971 shares of common stock of the Company having a market value in the amount of such purchase price.

On October 1, 2008, the Company issued warrants to purchase 20,000 shares of common stock of the Company to both John H. Schwan and Stephen M. Merrick exercisable at the price of $4.80 per share (the market price of the stock on the date of the warrants) in consideration for the personal guarantees by each of up to $2 million in principal amount of the bank debt of the Company.  On May 28, 2010, John H. Schwan and Stephen M. Merrick exercised these warrants in consideration of the cancellation of indebtedness of the Company to them in the amount of the exercise price.

Interest payments have been made to John H. Schwan and Stephen M. Merrick for loans made to the Company.  During the three months ended June 30, 2010 these interest payments totaled  $40,000 and $16,000, respectively.  For the three months ended June 30, 2009 these interest payments totaled $42,000 and $19,000, respectively.  During the six months ended June 30, 2010 these interest payments totaled $80,000 and $32,000, respectively.  For the six months ended June 30, 2009 these interest payments totaled $75,000 and $30,000, respectively.

14

 
Note 10 – Changes in Contracts; Indebtedness

On April 29, 2010, the Company entered into a Credit Agreement with Harris N.A. (“Harris”) replacing and paying off the Company’s credit line with RBS Citizens N.A. (formerly Charter One Bank).  Under the Credit Agreement, Harris agreed to provide loans and credits to the Company in the aggregate maximum amount of $14,417,000.  The arrangement includes:

 
i.
A revolving credit up to a maximum amount of $9,000,000 based upon a borrowing base of 85% of eligible receivables and 60% of eligible inventory (up to a maximum of $5,000,000);
 
ii.
A mortgage loan in the principal amount of $2,333,350, amortized over 25 years, the principal balance due on April 29, 2013;
 
iii.
A term loan in the principal amount of $583,333 maturing in monthly principal installments of $58,333; and
 
iv.
An equipment loan commitment in the amount of up to $2,500,000 providing for loan advances from time to time until April 29, 2011 based upon 100% of the purchase price of equipment purchased, the loans to be amortized on a five year basis commencing April 29, 2011, the balance due on April 29, 2013.

The Credit Agreement includes various representations, warranties and covenants of the Company.

In connection with the Credit Agreement, the Company executed and delivered to Harris, a Term Loan Note, a Mortgage Loan Note, an Equipment Note and a Revolving Note, as well as a form of Mortgage, Security Agreement, Pledge Agreement (pursuant to which shares of capital stock of the Registrant’s Mexico subsidiary were pledged as security for the loans), Patent Security Agreement and Trademark Security Agreement.  Two officers and principal shareholders of the Company, John H. Schwan and Stephen M. Merrick each executed Limited Guaranties of the loans and also executed Subordination Agreements with respect to obligations of the Company to them.

On April 29, 2010, Harris advanced a total of $11,963,518 under these loans on behalf of the Company for the pay-off of all outstanding loan and lease financing balances of the Company to RBS Citizens N.A. and RBS Asset Finance.

Under the terms of the Credit Agreement, in order to obtain advances under the revolving line of credit and the equipment loan, the Company is required to meet various financial covenants including a senior leverage ratio, fixed charge coverage ratio and tangible net worth.  As of June 30, 2010, we were in compliance with these covenants.

The Credit Agreement provides that the outstanding balance of all loans under the agreement will bear interest with reference to a base rate or, at the option of the Company, with reference to an adjusted LIBOR.  At June 30, 2010, the effective rate on the outstanding loan balances was 4.0%.
 
 
15

 
 
FORWARD-LOOKING STATEMENTS
 
This quarterly report includes both historical and “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended.  We have based these forward-looking statements on our current expectations and projections about future results.  Words such as “may,” “should,” “could,” “would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “continue,” or similar words are intended to identify forward-looking statements, although not all forward-looking statements contain these words.  Although we believe that our opinions and expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements, and our actual results may differ substantially from the views and expectations set forth in this quarterly report on Form 10-Q.  We disclaim any intent or obligation to update any forward-looking statements after the date of this quarterly report to conform such statements to actual results or to changes in our opinions or expectations.

Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview.  We produce film products for novelty, packaging and container applications. These products include metalized balloons, latex balloons and related latex toy products, films for packaging and custom product applications, and flexible containers for packaging and consumer storage applications. We produce all of our film products for packaging and container applications at our plant in Lake Barrington, Illinois. We produce all of our latex balloons and latex products at our facility in Guadalajara, Mexico. Substantially all of our film products for packaging and custom product applications are sold to customers in the United States. We market and sell our novelty items and flexible containers for consumer use in the United States, Mexico, Latin America, the United Kingdom and Europe.

Results of Operations

Net Sales.   For the three months ended June 30, 2010, net sales were $12,964,000 compared to net sales of $10,779,000 for the same period of 2009, an increase of 20.3%.  For the quarters ended June 30, 2010 and 2009, net sales by product category were as follows:

   
Three Months Ended
 
   
June 30, 2010
   
June 30, 2009
 
   
$
   
% of
   
$
   
% of
 
Product Category
 
(000) Omitted
   
Net Sales
   
(000) Omitted
   
Net Sales
 
                         
Metalized Balloons
    6,262               48%          5,747              53%      
                                 
Film Products
    1,905               15%          1,644              15%      
                                 
Pouches
    2,225               17%          1,577              15%      
                                  
Latex Balloons
    2,318               18%          1,653              15%      
                                 
Helium/Other
    254               2%          158              2%      
                                 
Total
    12,964               100%          10,779              100%      
 
 
16

 

Net Sales.   For the six months ended June 30, 2010, net sales were $25,375,000 compared to net sales of $20,382,000 for the same period of 2009, an increase of 24.5%.  For the six months ended June 30, 2010 and 2009, net sales by product category were as follows:

   
Six Months Ended
 
   
June 30, 2010
   
June 30, 2009
 
   
$
   
% of
   
$
   
% of
 
Product Category
 
(000) Omitted
   
Net Sales
   
(000) Omitted
   
Net Sales
 
                         
Metalized Balloons
    12,167              48%          10,786              53%      
                                 
Film Products
    3,272              13%          3,519              17%      
                                 
Pouches
    5,266              21%          2,562              13%      
                                 
Latex Balloons
    4,145              16%          3,196              16%      
                                 
Helium/Other
    525              2%          319              1%      
                                 
Total
    25,375              100%          20,382              100%      

Metalized Balloons. During the three months ended June 30, 2010 revenues from the sale of metalized balloons increased by 9.0% compared to the prior year period from $5,747,000 to $6,262,000.  During the six months ended June 30, 2010 revenues from the sale of metalized balloons increased by 12.8% compared to the prior year period from $10,786,000 to $12,167,000.  These increases are attributable to increased sales to a principal balloon customer, as well as other customers in the United States.

Films. During the three months ended June 30, 2010 revenues from the sale of laminated film products increased by 15.9% compared to the prior year period from $1,644,000 to $1,905,000.  During the second quarter, we began deliveries of a new film product to a medical device supplier.  During the six months ended June 30, 2010 revenues from the sale of laminated film products decreased by 7.0% compared to the prior year period from $3,519,000 to $3,272,000.  The decrease was the result of reduced sales to a principal film customer.

Pouches. During the three months ended June 30, 2010 revenues from the sale of pouches increased by 41.1% compared to the prior year period from $1,577,000 to $2,225,000.  During the six months ended June 30, 2010 revenues from the sale of pouches increased by 105.5% compared to the prior year period from $2,562,000 to $5,266,000.  Most of this increase was a result of an increase in sales to a principal pouch customer.  Also, sales of the ZipVac line of product accounted for a portion of the increase.

Latex Balloons.  During the three months ended June 30, 2010 revenues from the sale of latex balloons increased by 40.2% compared to the prior year period from $1,653,000 to $2,318,000.  During the six months ended June 30, 2010 revenues from the sale of latex balloons increased by 29.7% compared to the prior year period from $3,196,000 to $4,145,000.  The increase is attributable to increased sales in Mexico by Flexo Universal, our subsidiary there, as well as increased sales to various customers in the United States.

Sales to a limited number of customers continue to represent a large percentage of our net sales.  The table below illustrates the impact on sales of our top three and ten customers for the three and six months ended June 30, 2010 and 2009.

 
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Three Months Ended
   
Six Months Ended
 
   
% of Net Sales
   
% of Net Sales
 
   
June 30, 2010
   
June 30, 2009
   
June 30, 2010
   
June 30, 2009
 
                         
Top 3 Customers
   
57.1%
     
59.8%
     
55.7%
     
54.4%
 
                                 
Top 10 Customers
   
71.8%
     
75.7%
     
71.9%
     
70.2%