x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2007
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

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

 

 

 

 

 

 

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

Recent Developments

We announced in August 2007 that we have developed and commenced the production, marketing and sale of a new zippered vacuum storage pouch product line. The product line includes a pouch with a re-sealable zipper and valve, together with a hand pump and battery operated pump, which are used to remove the air from the pouch when it is sealed. The product is intended to be used for the storage, protection and preservation of food and other personal items. The first version of the product line - trademarked Zip-Vac(TM) - is intended for the sports-outdoors market. The product may be viewed at www.zip-vac.com.

We commenced marketing the Zip-Vac product in August 2007, and have received several orders for the product as well as indications of interest from several retail chains. We anticipate sales of this new product line in the amount of approximately $550,000 during the fourth quarter of 2007. We expect to continue to market this product line to sports and specialty retail chains.

In the second quarter 2007, we commenced a development and evaluation program for a zippered vacuum pouch product line with a significant consumer products company. No purchase commitment has been made to date but we anticipate a decision on the project by this company prior to December 31, 2007.

We now have one pouch converting machine in operation for the production of these zippered vacuum pouches. We have five additional machines on order. Two machines are scheduled to be delivered to us in November 2007 and the remaining three machines are scheduled for delivery to us in December 2007. When fully installed and operating, these six converting machines will have the capacity to produce approximately 120,000,000 to 168,000,000 pouches on an annual basis.

During the three and nine months ended September 30, 2007, we have incurred total costs related to the development of our zippered vacuum pouch line of products of approximately $627,000 and $1,312,000 respectively. Of that total, approximately $549,000 and $1,073,000 has respectively been capitalized.

 

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Results of Operations

Net Sales. For the three months ended September 30, 2007, net sales were $8,673,000 compared to net sales of $8,603,000 for the same period of 2006, an increase of 1%. For the three months ended September 30, 2007 and 2006, net sales by product category were as follows:

 

		Three Months Ended
		September 30, 2007						September 30, 2006
		$			% of			$			% of
Product Category		(000) Omitted			Net Sales			(000) Omitted			Net Sales
Metalized Balloons		$	2,899			34	%	$	4,120			48	%
Films			2,104			24	%		2,066			24	%
Pouches			1,581			18	%		698			8	%
Latex Balloons			1,900			22	%		1,641			19	%
Helium/Other			189			2	%		78			1	%
Total		$	8,673			100	%	$	8,603			100	%

 

For the nine months ended September 30, 2007, net sales were $26,210,000 compared to net sales of $25,756,000 for the nine months ended September 30, 2006, an increase of 2%. For the nine months ended September 30, 2007 and 2006, net sales by product category were as follows:

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		Nine Months Ended
		September 30, 2007						September 30, 2006
		$			% of			$			% of
Product Category		(000) Omitted			Net Sales			(000) Omitted			Net Sales
Metalized Balloons		$	11,012			42	%	$	12,378			48	%
Films			5,891			22	%		5,948			23	%
Pouches			3,548			14	%		2,582			10	%
Latex Balloons			5,023			19	%		4,295			17	%
Helium/Other			745			3	%		553			2	%
Total		$	26,219			100	%	$	25,756			100	%

 

Overall, we experienced a nominal increase in sales for the three and nine month periods ended September 30, 2007 compared to the prior periods.

Metalized Balloons. During the three months ended September 30, 2007 net sales of metalized balloons declined by 30% compared to the prior year period from $4,120,000 to $2,899,000. For the nine months, the decline in metalized balloon sales was 11% from $12,378,000 to $11,012,000. This decline is attributable to lower sales for these periods to a principal customer as well as modest declines in sales to other customers.

Films. During the first nine months of 2007 compared to the same period last year, sales of laminated films decreased by 1%. On April 28, 2006, we entered into a License Agreement with Rapak under which we granted a worldwide, irrevocable license to Rapak under a patent relating to textured film and pouches utilizing such film which was issued during 2006 and will expire in January 2027. The term of the license is for the entire term of the patent. The License Agreement also amends our existing Supply Agreement with Rapak, entered into on December 20, 2002, under which we supply textured film to Rapak for use by them in the production of pouches. The License Agreement extends the term of the Supply Agreement until October 31, 2008; the Supply Agreement is automatically renewed thereafter for successive one-year terms unless terminated by either party. We have supplied textured film to Rapak for several years and will continue to supply textured film to Rapak under the License Agreement and the Supply Agreement as amended. For the nine months ended September 30, 2007 and 2006 our net sales of film to Rapak were $5,300,000, or 20% of total net sales and $5,294,000, or 21% of total net sales, respectively. For the three months ended September 30, 2007 and 2006, our net sales of film to Rapak were $1,960,000, or 23%, and $1,939,000, or 23%, respectively.

 

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Pouches. Sales of pouches increased by 127% from $698,000 to $1,581,000 for the three months ended September 30, 2007 compared to the same prior year period. Sales of pouches increased from $2,582,000 in the first nine months of 2006 to $3,548,000 or 37% in the first nine months of 2007. This increase reflects an increase for those periods in sales to our current principal customer for pouches, ITW Spacebag, a division of Illinois Tool Works, Inc. (“ITW”). In March 2006, we entered into a four-year agreement with ITW under which we will supply all of its requirements in North America for certain of the pouches which they market under the name Space Bag(R) and also are to supply their requirements of film for certain of the pouches which they produce, if pricing for the film is competitive. We have supplied ITW with certain pouches for several years. For the nine months ended September 30, 2007 and 2006, our net sales to ITW Spacebag were $2,887,000, or 11%, and $2,158,000, or 8% of net sales, respectively. For the three months ended September 30, 2007 and 2006, our net sales to ITW Spacebag were $1,124,000, or 13%, and $591,000, or 7% of net sales, respectively. Pouch revenues in the third quarter included approximately $284,000 from sales of our new zippered vacuum pouches.

Latex Balloons. Sales of latex balloons increased by 16% from $1,641,000 to $1,900,000 for the three months ended September 30, 2007 compared to the same prior year period. For the nine months, net sales increased by 17% from $4,295,000 in the nine months ended September 30, 2006 to $5,023,000 for the same period of 2007. This increase is principally related to an increase in sales by our Mexican affiliate Flexo Universal to customers in Mexico and, to a lesser extent, increased sales in the United States.

 

Sales to a limited number of customers continue to represent a significant percentage of our net sales. The table below illustrates the impact on sales of our top three and ten customers for the three and nine months ended September 30, 2007 and 2006.

 

		Three Months Ended						Nine Months Ended
		% of Net Sales						% of Net Sales
		September 30, 2007			September 30, 2006			September 30, 2007			September 30, 2006
Top 3 customers			47.3	%		53.4	%		47.1	%		51.3	%
Top 10 Customers			67.8	%		63.4	%		64.4	%		60.3	%

 

During the nine months ending September 30, 2007, there were three customers whose purchases represented more than 10% of the Company’s sales. The sales to each of these customers for the nine months ended September 30, 2007 were, respectively, $5,300,000 or 20%, $4,165,000 or 16% and $2,887,000 or 11% of consolidated net sales respectively. Sales to these customers in the same period of 2006 were $5,294,000 or 21%, $5,755,000 or 22% and $2,158,000 or 8% of consolidated net sales, respectively. During the three months ending September 30, 2007, there were three customers whose purchases represented more than 10% of the Company’s sales. The sales to each of these customers for the three months ended September 30, 2007 were $1,960,000 or 23%, $1,124,000 or 13% and $1,018,000 or 11% of consolidated net sales, respectively. Sales to these customers for the same period of 2006 were $1,939,000 or 23%, $591,000 or 7% and $2,064,000 or 24%, respectively.

 

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Cost of Sales. During the three months ended September 30, 2007, the cost of sales represented 81% of net sales compared to 74% for the third quarter of 2006. The reduction in gross margin for the quarter compared to 2006 resulted primarily from a change in product mix of sales for the period. For the nine months ended September 30, 2007, the cost of sales represented 76% of net sales compared to 75% for the same period of 2006.

General and Administrative. For the three months ended September 30, 2007, general and administrative expenses were $1,413,000 or 16% of net sales, compared to $1,216,000 or 14% of net sales for the same period in 2006. For the nine months ended September 30, 2007, general and administrative expenses were $3,923,000 or 15% of net sales, compared to $3,326,000 or 13% for the same period of 2006. The increase resulted primarily from additions to administrative staff, compensation rate adjustments for existing staff, increases in travel expenses related to pouch project and consulting fees relating to financial reporting and general management.

Selling. For the three months ended September 30, 2007, selling expenses were $162,000 or 2% of net sales for the quarter, compared to $213,000 or 2% of net sales for the same three months of 2006. For the nine months ended September 30, 2007, selling expenses were $592,000 or 2% of net sales for that period, compared to $624,000 or 2% of net sales for the same period of 2006.

Advertising and Marketing. For the three months ended September 30, 2007, advertising and marketing expenses were $326,000 or 4% of net sales for the period, compared to $361,000 or 4% of net sales for the same period of 2006. For the nine months ended September 30, 2007, advertising and marketing expenses were $1,013,000 or 4% of net sales for that period, compared to $846,000 or 3% for the same period of 2006. The change in advertising and marketing was principally due to an increase in the amortization of artwork and printing plate costs that were expensed in the period as compared to the prior period.

Other Income (Expense). During the nine months ended September 30, 2007, the Company has incurred interest expense of $985,000 compared to $1,297,000 incurred during the same period of 2006. During the three months ended September 30, 2007, the company had incurred interest expense of $351,000, compared to interest expense incurred during the same period of 2006 in the amount of $521,000. The decrease in interest expense in both periods is a result of both a lower rate of interest payable on outstanding loan balances and decreased levels of borrowing.

During the nine months ended September 30, 2007, the Company had currency transaction gains of $165,000 compared to currency transaction gains during the same period of 2006 in the amount of $154,000.

Income Taxes. For the nine months ended September 30, 2007, there was an income tax benefit of $31,000. This was net of a provision for income taxes for CTI Balloons, Ltd, the Company’s subsidiary in the United Kingdom and Flexo Universal the Company’s subsidiary in Mexico. For the same period of 2006, the Company recorded an income tax expense of $59,000, relating to income taxes in the United Kingdom.

 

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Net (Loss) Income. For the three months ended September 30, 2007, the Company had a net loss of $414,000 or $0.18 per share (basic and diluted) compared to net income for the same period in 2006 of $315,000 or $0.15 per share (basic and diluted). For the nine months ended September 30, 2007, the Company had a net loss of $43,000 or $0.02 per share (basic and diluted) per share, compared to net income of $741,000 or $0.36 per share (basic) and $0.34 (diluted) for the same period of 2006. The difference in net income for the third quarter of 2007 compared to the same period of 2006 is attributable principally to (i) a lower level of gross margin during the third quarter of 2007 resulting from a change in product mix in the period and (ii) an item of other income realized in the third quarter of 2006 in the amount of $460,000 arising from the settlement of a vendor claim for less than the amount reserved for the claim.

Financial Condition, Liquidity and Capital Resources 

Cash Flow Items

Operating Activities. During the nine months ended September 30, 2007, net cash provided by operations was $924,000, compared to net cash used in operations during the same period in 2006 of $1,434,000.

Significant changes in working capital items during the nine months ended September 30, 2007 consisted of (i) a decrease in accounts receivable of $610,000, (ii) an increase in inventories of $1,624,000, (iii) an increase in trade payables of $1,126,000, and (iv) a decrease in accrued expenses of $411,000.

Investing Activity. During the nine months ended September 30, 2007, net cash used in investing activities was $1,775,000 compared to $330,000 in the same period of 2006. We do anticipate incurring additional capital expenditures during the balance of 2007 and the first quarter of 2008 for improvements to our facilities and for the acquisition of production equipment related principally to our new pouch products. Our additional current commitment for capital expenditures is $775,000.

Financing Activities. For the nine months ended September 30, 2007, net cash provided by financing activities was $784,000 compared to cash provided by financing activities for the same period of 2006 in the amount of $1,763,000. In the first nine months of 2007 financing activities included the receipt of $882,000 from the sale of common stock under the SEDA agreement to Cornell Capital, receipt of $146,000 in proceeds from the exercise of stock options and payments of $935,000 on long-term debt and reductions of the revolving loan balance in the amount of $859,000.

Liquidity and Capital Resources. At September 30, 2007, the Company had a cash and cash equivalents balance of $331,000. At September 30, 2007, the Company had a working capital balance of $1,834,000 compared to a working capital balance of $1,848,000 at December 31, 2006.

 

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The Company's current cash management strategy includes utilizing the Company's revolving line of credit for liquidity. Under our line of credit with RBS Citizens, N.A., successor by merger to Charter One Bank, we are entitled to borrow an amount equal to 85% of eligible receivables and 60% of eligible inventory, up to a maximum of $7,000,000. Foreign receivables and inventory held by our foreign subsidiaries are not eligible. In addition, in order to be permitted to make advances under the line of credit, we are required to meet various financial covenants. As of September 30, 2007, the Company was not in compliance with two of the covenants. The Company has received a waiver of such covenant violations for the period ended September 30.

On November 13, 2007, we entered into Amendment Number 3 to the Loan Agreement with RBS Citizens, N.A.. The Amendment (i) increased the maximum amount available to the Company under the revolving line of credit from $7 million to $9 million, (ii) increased the maximum advance amount on inventory from $3.5 million to $4.5 million, (iii) amended a financial covenant concerning the ratio of EBITDA to fixed payment obligations so that all proceeds from the sale of stock and the leasing line provided by the Bank which are used in capital investment will not affect the covenant determination, (iv) amended a financial covenant concerning the ratio of EBITDA to senior debt and (v) authorized a capital lease line of credit to the Company in the amount of $1.5 million.

 

In connection with the amendment, John H. Schwan and Stephen M. Merrick, officers, directors and principal shareholders of the Company have executed personal guarantees of the company obligations to RBS Citizens, N.A. each in the amount of $2 million.

 

We believe that with our present cash and working capital and the amounts available to us under our line of credit and through sales of common stock, we will have sufficient funds to enable us to meet our obligations through the next twelve months, and further that we will be able to comply with the financial covenants, as amended, of our Loan Agreement with RBS Citizens, N.A.

The loan agreement provides for interest at varying rates in excess of the Bank’s prime rate, depending upon the level of senior debt to EBITDA over time. As of September 30, 2007, the applicable premium being applied was 0.75%.

Also, under the loan agreement, we were required to purchase a swap agreement with respect to at least 60% of the mortgage and term loan portions of our loan. On April 5, 2006, we entered into a swap arrangement with RBS Citizens, N.A. with respect to 60% of the principal amounts of the mortgage loan and the term loan, which had the effect of fixing the interest rate for such portions of the loans for the balance of the loan terms. These swap arrangements are subject to some market variation due to market interest rate variability. Management believes that these variations will not materially affect the results of the Company.

On September 6, 2006, we entered into a Standby Equity Distribution Agreement with Cornell Capital pursuant to which we may, at our discretion, periodically sell to Cornell Capital shares of common stock for a total purchase price of up to $5 million. For each share of common stock purchased under the Standby Equity Distribution Agreement, Cornell will pay 100% of the lowest volume weighted average price (as quoted by Bloomberg, LP) of our common stock on the Nasdaq Capital Market or other principal market on which our stock is traded for the five days immediately following the notice date. The number of shares purchased by Cornell Capital for each advance is determined by dividing the amount of each advance by the purchase price for the shares of common stock. Furthermore, Cornell Capital will receive 5% of each advance in cash under the Standby Equity Distribution Agreement as an underwriting discount. Cornell’s obligation to purchase shares of our common stock under the Agreement is subject to certain conditions, including: (i) we have obtained an effective registration statement for the shares of common stock sold to Cornell under the Agreement and (ii) the amount of each advance requested by us under the Agreement shall not be more than $100,000.

 

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We are permitted to make draws on the Standby Equity Distribution Agreement only so long as Cornell Capital’s beneficial ownership of our common stock remains lower than 9.9%. A possibility exists that Cornell Capital may own more than 9.9% of CTI’s outstanding common stock at a time when we would otherwise plan to make an advance under the Standby Equity Distribution Agreement. We do not have any agreements with Cornell Capital regarding the distribution of such stock, although Cornell Capital has indicated that it intends promptly to sell any stock received under the Standby Equity Distribution Agreement.

We cannot predict the actual number of shares of common stock that will be issued pursuant to the Standby Equity Distribution Agreement, in part, because the purchase price of the shares will fluctuate based on prevailing market conditions, and we have not determined the total amount of advances we intend to draw. We have registered 400,000 shares of common stock for the sale under the Standby Equity Distribution Agreement. The Company and Cornell have agreed that the Company will not sell to Cornell Capital in excess of 400,000 shares unless and until the Company shall have obtained shareholder approval for such sales.

 

On December 28, 2006, we filed a Registration Statement for the registration of 403,500 shares of our common stock. On January 26, 2007, the Registration Statement was declared effective. Since that time, to October 29, 2007 we have sold an aggregate of 323,625 shares of common stock to Cornell under the SEDA and have received net proceeds from the sale of those shares in the amount of $1,355,000.

Seasonality

Sales in the metalized balloon product line have historically been seasonal with approximately 45% occurring in the period from December through March and 21% being generated in the period July through October. The sale of latex balloons and laminated film products have not historically been seasonal.

Critical Accounting Policies

A summary of our critical accounting policies and estimates is presented on pages 42 and 43 of our 2006 Annual Report on Form 10-K, as filed with the Securities and Exchange Commission. There have been no changes to these policies during the nine months ended September 30, 2007.

 

Item 3. Quantitative and Qualitative Disclosures Regarding Market Risk 

 

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

The Company’s earnings are affected by changes in interest rates as a result of variable rate indebtedness. If market interest rates for our variable rate indebtedness average 1% more than the interest rate actually paid for the quarter ended September 30, 2007 and 2006, our interest rate expense would have increased, and income before income taxes would have decreased by $21,000 and $23,000 for these periods, respectively. If market interest rates for our variable rate indebtedness average 1% more than the interest rate actually paid for the nine months ended September 30, 2007 and 2006, our interest rate expense would have increased, and income before income taxes would have decreased by $63,000 and $68,000 for these quarters, respectively. These amounts are determined by considering the impact of the hypothetical interest rates on our borrowings. This analysis does not consider the effects of the reduced level of overall economic activity that could exist in such an environment. Further, in the event of a change of such magnitude, management would likely take actions to reduce our exposure to such change. However, due to the uncertainty of the specific actions we would take and their possible effects, the sensitivity analysis assumes no change in our financial structure.

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

We have performed a sensitivity analysis as of September 30, 2007 that measures the change in the results of our foreign operations arising from a hypothetical 10% adverse movement in the exchange rate of all of the currencies the Company presently has operations in. Using the results of operations for the three months ended September 30, 2007 and 2006, for the Company’s foreign operations as a basis for comparison, an adverse movement of 10% would create a potential reduction in the Company’s net income, or increase its net loss before taxes, in the amount of $48,000 and $54,000 for each of those periods, respectively. Using the results of operations for the nine months ended September 30, 2007 and 2006 for the Company’s foreign operations as a basis for comparison, an adverse movement of 10% would create a potential reduction in the Company’s net income, or increase its net loss before taxes, in the amount of $144,000 and $48,000 for each of those periods, respectively.

 

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The Company is also exposed to market risk in changes in commodity prices in some of the raw materials it purchases for its manufacturing needs. However, this presents a risk that would not have a material effect on the Company’s results of operations or financial condition.