UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K

 

 

COMMISSION FILE NUMBER: 1-13182

 

Graphic Packaging Corporation

(Exact name of registrant as specified in its charter)

 

 

(770) 644-3000

Registrant’s telephone number, including area code:

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the Act).

Large accelerated filer o     Accelarated filer þ     Non-accelarated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o     No þ

 

The aggregate market value of voting and non-voting common equity held by non-affiliates at June 30, 2005 was $246.5 million.

 

As of February 24, 2006, there were 198,698,036 shares of the registrant’s Common Stock, $0.01 par value per share outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE:

 

Portions of the registrant’s definitive Proxy Statement for the Annual Meeting of Stockholders to be held on May 16, 2006 are incorporated by reference into Part III of this Annual Report on Form 10-K.

 

 

TABLE OF CONTENTS OF FORM 10-K

 

 

Certain statements of Graphic Packaging Corporation’s expectations, including, but not limited to, statements regarding inflationary pressures, cost savings from its continuous improvement programs and manufacturing rationalization, capital spending, and depreciation and amortization, in this report constitute “forward-looking statements” as defined in the Private Securities Litigation Reform Act of 1995. Such statements are based on currently available operating, financial and competitive information and are subject to various risks and uncertainties that could cause actual results to differ materially from the Company’s historical experience and its present expectations. These risks and uncertainties include, but are not limited to, inflation of and volatility in raw material and energy costs, the Company’s substantial amount of debt, continuing pressure for lower cost products, the Company’s ability to implement its business strategies, currency translation movements and other risks of conducting business internationally, and the impact of regulatory and litigation matters, including those that impact the Company’s ability to protect and use its intellectual property. Undue reliance should not be placed on such forward-looking statements, as such statements speak only as of the date on which they are made and the Company undertakes no obligation to update such statements. Additional information regarding these and other risks is contained in Item 1A. Risk Factors herein.

 

Overview

 

Graphic Packaging Corporation (“GPC” and, together with its subsidiaries, the “Company”) is a leading provider of paperboard packaging solutions for a wide variety of products to multinational and other consumer products companies. The Company strives to provide its customers with packaging solutions designed to deliver marketing and performance benefits at a competitive cost by capitalizing on its low-cost paperboard mills and converting plants, its proprietary carton designs and packaging machines, and its commitment to customer service.

 

The Company focuses on providing a range of paperboard packaging products to major companies with well-recognized brands. Its customers generally have prominent market positions in the beverage, food and household products industries. The Company offers customers its paperboard, cartons and packaging machines, either as an integrated solution or separately. The Company has long-term relationships with major companies, including Altria Group, Inc. (which includes Kraft Foods Inc. and the Philip Morris Companies), Anheuser-Busch Companies, Inc., General Mills, Inc., SABMiller plc., Molson Coors Brewing Company, and numerous Coca-Cola and Pepsi bottling companies.

 

The Company’s packaging products are made from a variety of grades of paperboard. The Company makes most of its packaging products from coated unbleached kraft paperboard (“CUK board”) and coated recycled paperboard (“CRB”) that the Company produces at its mills, and a portion from paperboard purchased from external sources.

 

The Company reports its results in two business segments: paperboard packaging and containerboard/other. The Company operates in four geographic areas: the United States, Central and South America, Europe and Asia-Pacific. For business segment and geographic area information for each of the last three fiscal years, see Note 16 in the Notes to Consolidated Financial Statements included in Item 8. Financial Statements and Supplementary Data herein.

 

GPC (formerly known as Riverwood Holding, Inc.) was incorporated on December 7, 1995 under the laws of the State of Delaware. On August 8, 2003, the corporation formerly known as Graphic Packaging International Corporation merged with and into Riverwood Acquisition Sub LLC, a wholly-owned subsidiary of Riverwood Holding, Inc. (“Riverwood Holding”), with Riverwood Acquisition Sub LLC as the surviving entity (the “Merger”). At the closing of the Merger, one share of common stock of Riverwood Holding was exchanged for each share of common stock of Graphic Packaging International Corporation. Riverwood Acquisition Sub LLC then merged into Riverwood Holding, which was renamed Graphic Packaging Corporation. After the Merger, (1) RIC Holding, Inc. merged into Graphic Packaging Holdings, Inc., which was renamed GPI Holding, Inc., and (2) the corporation formerly known as Graphic Packaging Corporation merged into Riverwood International Corporation (“RIC”), which was renamed Graphic Packaging International, Inc. (“Graphic Packaging International”). The corporation formerly known as Graphic Packaging International Corporation and its subsidiaries for periods prior to the Merger are referred to herein as “Graphic.”

 

The Company’s website is located at http://www.graphicpkg.com. The Company makes available, free of charge through its website, its Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after such materials are electronically filed or furnished to the Securities and Exchange Commission (the “SEC”), and investor presentations. The information contained or incorporated in the Company’s website is not a part of this Annual Report on Form 10-K.

Paperboard Packaging

 

The Company’s paperboard packaging products deliver marketing and performance benefits at a competitive cost. The Company supplies paperboard cartons and carriers designed to protect and contain products while providing:

 

 

The Company produces paperboard at its mills, prints and cuts (“converts”) the paperboard into cartons at its converting plants and designs and manufactures specialized, proprietary packaging machines that package bottles and cans and, to a lesser extent, non-beverage consumer products. The Company installs its packaging machines at customer plants under long-term leases and provides support, service and advanced performance monitoring of the machines. The Company also sells the paperboard it produces to independent converters.

 

The Company offers a variety of laminated, coated and printed packaging structures that are produced from its CUK board and CRB, as well as other grades of paperboard that are purchased from third party suppliers. The Company produces cartons using diverse structural designs and combinations of paperboard, films, foils, metalization, holographics, embossing and other characteristics that are tailored to the needs of individual products. The Company provides a wide range of paperboard packaging solutions for the following end-use markets:

 

 

For its beverage customers, the Company supplies beverage cartons in a variety of designs and formats, including 6, 8, 12, 18, 24 and 30 unit multi-packs. Its proprietary high speed beverage packaging machines package cans, bottles and other beverage containers into its beverage cartons. The Company believes the use of such machines creates “pull-through” demand for its cartons which in turn creates demand for its CUK board. The Company seeks to increase the customers’ use of its integrated packaging solutions in order to improve its revenue opportunities, enhance customer relationships, provide customers with greater packaging line and supply chain efficiencies and overall cash benefits, and expand opportunities for the Company to provide value-added support and service. The Company enters into annual or multi-year carton supply contracts with its beverage packaging customers, which generally require the customer to purchase a fixed portion of its carton requirements from the Company. Particularly in its international operations, the Company’s CUK board may be sold to and converted by joint ventures and licensees of its beverage carton machines which, in turn, sell converted beverage cartons to end-users for use on the Company’s proprietary packaging machines. The Company also sells CUK board that the Company produces to customers for use on third-party packaging machines.

 

The Company develops packaging applications to meet the needs of its customers. Described below are a number of characteristics of its packaging products.

 

Strength Packaging.  Through its application of materials and package designs, the Company provides sturdiness to meet a variety of packaging needs, including tear and wet strength, puncture resistance, durability and compression strength (providing stacking strength to meet store display packaging requirements). The

Company achieves such strength characteristics through combinations of paperboard, film laminates and metallized layers tailored on a product-by-product basis.

 

Promotional Packaging.  The Company offers a broad range of promotional packaging options that help differentiate its customers’ products. The Company provides products designed to enhance point-of-purchase and marketing opportunities through package shapes, portability, metallization, holographics, embossing and micro-embossing, brilliant high-tech inks, specialized coatings, hot-stamp metal foil surfaces, in-pack and on-pack customized promotions, inserts, windows and die-cuts. These promotional enhancements improve brand awareness and visibility on store shelves.

 

Convenience Packaging.  These packaging solutions improve package usage and food preparation:

 

 

Barrier Packaging.  The Company provides packages that protect against moisture, grease, oil, oxygen, sunlight, insects and other potential product-damaging factors. Its barrier technologies integrate a variety of specialized laminate and extruded film layers, metallized package layers, package sealing, applied coatings and other techniques — all customized to specific barrier requirements.

 

Converting Operations

 

The Company converts CUK board and CRB, as well as other grades of paperboard, into cartons at 24 carton converting plants that the Company operates in the United States, Canada, the United Kingdom, Spain, France and Brazil, as well as through converting plants associated with its joint ventures in Japan and Denmark and contract converters and at licensees in other markets outside the United States. The converting plants print, cut and glue paperboard into cartons designed to meet customer specifications. These plants utilize roll-fed web-printing presses with in-line cutters and sheet-fed printing presses to print and cut paperboard. Printed and cut cartons are in turn glued and shipped to the Company’s customers.

 

The Company’s U.S. converting plants are dedicated to converting paperboard produced by the Company, as well as paperboard supplied by outside producers, into cartons. The presses at the Company’s U.S. converting plants have high cutting and printing speeds, thereby reducing the labor hours per ton of cartons produced for the high-volume U.S. market. The Company’s international converting plants convert paperboard produced by the Company, as well as paperboard supplied by outside producers, into cartons. These converting plants outside of the United States are designed to meet the smaller volume orders of these markets.

 

Paperboard Production

 

CUK Board Production.  The Company is the larger of two worldwide producers of CUK board. CUK board is a specialized high-quality grade of paperboard with excellent wet and dry tear strength characteristics and printability for high resolution graphics that make it particularly suited for a variety of packaging applications. The Company produces CUK board at its West Monroe, Louisiana mill and its Macon, Georgia mill. The Company has three machines at its West Monroe mill and two machines at its Macon mill capable of making paperboard. These mills have a current total combined annual production capacity of approximately 1.2 million gross tons of CUK board. The Company’s CUK board production at its West Monroe and Macon mills was approximately 694,000 tons and 533,000 tons, respectively, in 2005.

 

CUK board is manufactured from blends of pine and hardwood fibers and, in some cases, recycled fibers, such as double lined kraft cuttings from corrugated box plants (“DLK”) and clippings from its converting

operations. Virgin fiber is obtained in the form of wood chips or pulp wood acquired through open market purchases or the Company’s long-term purchase contract with Plum Creek Timber Company, L.P. See “— Energy and Raw Materials.” Wood chips are chemically treated to form softwood and hardwood pulp, which are then blended (together, in some cases, with recycled fibers). In the case of carrierboard (paperboard used in the beverage industry’s multi-pack cartons), chemicals are added to increase moisture resistance. The pulp is then processed through the mill’s paper machines, which consist of a paper-forming section, a press section (where water is removed by pressing the wet paperboard between rolls), a drying section and a coating section. Coating on CUK board, principally a mixture of pigments, binding agents and water, provides a white, smooth finish, and is applied in multiple steps to achieve desired levels of brightness, smoothness and shade on the print side of the paperboard. After the CUK board is coated, it is wound into rolls, which are then shipped to the Company’s converting plants or to outside converters.

 

CRB Production.  The Company’s CRB is a grade of recycled paperboard that offers superior quality graphics, strength and appearance characteristics when compared to other recycled grades. The Company has two machines at its Kalamazoo, Michigan mill capable of making paperboard. The Company’s CRB production at its Kalamazoo, Michigan mill was approximately 378,000 tons in 2005. The mill is the largest CRB facility in North America. The mill’s paperboard is specifically designed to maximize throughput on high-speed web-litho presses. The Company consumes approximately 90% of the Kalamazoo mill’s output in its carton converting operations, and the mill is an integral part of its low cost converting strategy.

 

White Lined Chip Board.  The Company produces white lined chip (“WLC”) board at its mill in Norrköping, Sweden, and produced approximately 160,000 tons of such board during 2005. WLC board which is similar to CRB, is used for a variety of folding carton applications principally throughout Europe. The Company’s WLC board incorporates recycled fibers to meet the demands of the European marketplace.

 

Packaging Design and Proprietary Packaging Machinery

 

The Company has five research and design centers located in Golden, Colorado, Marietta, Georgia, Menasha, Wisconsin, West Monroe, Louisiana and Mississauga, Ontario, Canada. At these centers, the Company designs, tests and manufactures prototype packaging for consumer products packaging applications. The Company designs and tests packaging machinery at its Marietta, Georgia product development center. The Company’s Golden, Colorado product development center contains full size pilot lines that can simulate the manufacturing environments of customers. The Company utilizes a network of computer equipment at its converting facilities to provide automated computer-to-plate graphic services designed to improve efficiencies and reduce errors associated with the pre-press preparation of printing plates.

 

At the Company’s two microwave laboratories, in Menasha, Wisconsin and Mississauga, Ontario, the Company designs, prototypes, tests and reports food performance as part of the full-service, turn-key microwave solutions for its food customers. The Company has broad technical expertise in chemistry, paper science, microwave engineering, mechanical engineering, physics, electrical engineering, and food science. This experience base, along with food technologists and investment in sample line equipment and operators, enables the Company to rapidly design and test prototypes to help its customers develop, test and launch successful microwave products into the market.

 

The Company’s engineers create and test packaging designs, processes and materials based on market and customer needs, which are generally characterized as enhanced stacking or tear strength, promotional or aesthetic appeal, consumer convenience or barrier properties. Concepts go through a gated review process through their development to ensure that resources are being focused on those projects that are most likely to succeed commercially. The Company also works to refine and build on current proprietary materials, processes and designs.

 

At the Company’s product development center in Marietta, Georgia, the Company integrates carton and packaging machinery designs from a common database balancing carton manufacturing costs and packaging line performance. The Company also manufactures and designs packaging machines for beverage multiple packaging and other consumer products packaging applications at its principal U.S. manufacturing facility in Crosby, Minnesota and at a facility near Barcelona, Spain. The Company leases substantially all of its

packaging machines to customers, typically under machinery use agreements with original terms of three to six years.

 

The Company employs a “pull-through” marketing strategy for its beverage multiple packaging customers, the key elements of which are (1) the design and manufacture of proprietary packaging machines capable of packaging plastic and glass bottles, cans and other primary containers, (2) the installation of the machines at beverage customer locations under multi-year machinery use arrangements and (3) the development of proprietary beverage cartons with high-resolution graphics for use on those machines.

 

The Company’s packaging machines are designed to package polyethylene terephthalate (“PET”) bottles, glass bottles, cans and other primary beverage containers, as well as non-beverage consumer products, using cartons designed by the Company, made from its paperboard and converted into cartons by the Company, its joint venture partners or its licensees. In order to meet customer requirements, the Company has developed an extensive portfolio of packaging machines consisting of three principal machinery lines, including over eight different models of packaging machines. Its machines package cans and PET or glass bottles in a number of formats including baskets, clips, trays, wraps and fully enclosed cartons. These machines have packaging ranges from 2 to 36 cans per package and have the ability to package cans at speeds of up to 3,000 cans per minute.

 

The Company manufactures and leases packaging machines to its non-beverage consumer products packaging customers, internationally and in the United States, but to a lesser extent than its beverage multiple packaging customers. Its non-beverage consumer products packaging machines are designed to package cans or bottles in wraps or fully enclosed cartons. The Company also manufactures ancillary equipment, such as machines for inserting coupons in cartons or for dividing or turning filled packages for conveying.

 

The Company has introduced innovative beverage packaging machines such as its Quikflex^® family of machines that package Fridge Vendor^® and Twin-Stack^® style cartons. The Quikflex TS^®, a double-layer multiple packaging design, packages Twin-Stack^® cartons providing better portability and a more visible billboard, or advertising space, compared with conventional large-volume multipacks. Double layer packaging allows for cans to be stacked vertically in a double layer in the same paperboard carton. The Company’s other lines of packaging machines include the Marksman^®, a family of machines designed to package bottles, cans, juice boxes and dairy products in a variety of wrap configurations and the Autoflex, a machine designed to package bottles in a variety of basket style carton configurations. The Company’s newest packaging machines incorporate an advanced performance monitoring system called RADAR. This system provides continuous monitoring and reporting to the Company in real time over the Internet of the performance of packaging machines installed at customers’ sites and provides technical support on-line and improved operational performance.

 

Marketing and Distribution

 

The Company markets its paperboard and paperboard-based products principally to multinational brewers, soft drink bottlers, food companies, and other well-recognized consumer products companies. It also sells paperboard in the open market to independent paperboard converters.

 

The Company’s major customers for beverage cartons include Anheuser-Busch Companies, Inc., SABMiller plc, Molson Coors Brewing Company, numerous Coca-Cola and Pepsi bottling companies, Inbev and Asahi Breweries. The Company also sells beverage paperboard in the open market to independent converters, including licensees of its proprietary carton designs, for the manufacture of beverage cartons.

 

The Company’s non-beverage consumer products packaging customers include Altria Group, Inc., General Mills, Inc., Nestle Group, Unilever, PepsiCo, Inc., Kellogg Company, The Schwan Food Company and Perseco. It also sells its paperboard to numerous independent converters who convert the paperboard into cartons for consumer products. The Company has entered into agreements with a number of major independent converters. Under the terms of these agreements, the converters agree to purchase a significant portion of their paperboard requirements from the Company and to assist the Company in customer development efforts designed to grow the market for paperboard.

Distribution is primarily accomplished through direct sales offices in the United States, Australia, Brazil, Denmark, Germany, Hong Kong, Italy, Japan, Mexico, Singapore, Spain, Sweden and the United Kingdom and, to a lesser degree, through broker arrangements with third parties. The Company’s selling activities are supported by its technical and developmental staff.

 

During 2005, the Company did not have any one customer who represented 10% or more of its net sales.

 

Joint Ventures

 

To market machinery-based packaging systems, the Company is a party to joint ventures with Rengo Company Limited (in Japan) and Graphic Packaging International Schur A/S (in Scandinavia), in which it holds a 50% and 60% ownership interest, respectively. The joint venture agreements cover CUK board supply, use of proprietary carton designs and marketing and distribution of packaging systems.

 

Competition

 

A relatively small number of large competitors hold a significant portion of the paperboard packaging industry. The Company’s primary competitors include Caraustar Industries, Inc., Field Container Company, L.P., International Paper Company, MeadWestvaco Corporation, Packaging Corporation of America, R.A. Jones & Company, Inc., Rock-Tenn Company and Smurfit-Stone Container Corporation. There are only two major producers in the United States of CUK board, MeadWestvaco Corporation and the Company. The Company faces significant competition in its CUK board business from MeadWestvaco as well as from other packaging materials manufacturers. Like the Company, MeadWestvaco produces and converts CUK board, designs and places packaging machines with customers and sells CUK board in the open market.

 

In beverage multiple packaging, cartons made from CUK board compete with plastics and corrugated packaging for packaging glass or plastic bottles, cans and other primary containers. Although plastics and corrugated packaging are typically priced lower than CUK board, the Company believes that cartons made from CUK board offer advantages over these materials, in areas such as distribution, high quality graphics, carton designs, package performance, package line speed, environmental friendliness and design flexibility.

 

In non-beverage consumer products packaging, the Company’s paperboard competes principally with MeadWestvaco’s CUK board, recycled clay-coated news (“CCN”) and solid bleached sulphate board (“SBS”) from numerous competitors and, internationally, WLC board and folding boxboard. Paperboard grades compete based on price, strength and printability. CUK board and CRB have generally been priced in a range that is lower than SBS board. There are a large number of producers in the paperboard markets, which are subject to significant competitive and other business pressures. Suppliers of paperboard compete primarily on the basis of price, strength and printability of their paperboard, quality and service.

 

Containerboard/Other

 

In the United States, the Company manufactures containerboard — linerboard, corrugating medium and kraft paper — for sale in the open market. Corrugating medium is combined with linerboard to make corrugated containers. Kraft paper is used primarily to make grocery bags and sacks. Although the Company’s principal paper machines have the capacity to produce both linerboard and CUK board, the Company has shifted significant mill capacity away from linerboard production on its CUK board machines to more profitable packaging applications and intends to stop producing linerboard. The Company continues to operate two paper machines dedicated to the production of corrugating medium and kraft paper at its West Monroe mill.

 

In 2005, the Company shipped approximately 127,000 tons of corrugating medium, approximately 36,000 tons of kraft paper and approximately 13,000 tons of linerboard from its West Monroe mill. In 2005, the Company also shipped approximately 36,000 tons of various other linerboard products.

 

The primary customers for the Company’s U.S. containerboard production are independent and integrated corrugated converters. The Company sells corrugating medium and linerboard through direct sales offices and agents in the United States. Outside of the United States, linerboard is primarily distributed through independent sales representatives.

The Company’s containerboard business operates within a highly fragmented industry. Most products within this industry are viewed as commodities, consequently, selling prices tend to be cyclical, being affected by economic activity and industry capacity.

 

Energy and Raw Materials

 

Pine pulpwood, hardwood, paper and recycled fibers, (including DLK and old corrugated containers (“OCC”)) and energy used in the manufacture of paperboard, as well as various chemicals used in the coating of paperboard represent the largest components of the Company’s variable costs of paperboard production. The cost of these materials is subject to market fluctuations caused by factors beyond the Company’s control.

 

Since the October 1996 sale of the Company’s timberlands in Louisiana and Arkansas, the Company relies on private landowners and the open market for all of its pine pulpwood, hardwood and recycled fiber requirements, supplemented by CUK board clippings that are obtained from its converting operations. Under the terms of the sale of those timberlands, the Company entered into a 20-year supply agreement with the buyer, Plum Creek Timber Company, L.P., with a 10-year renewal option, for the purchase by the Company, at market-based prices, of a majority of the West Monroe mill’s requirements for pine pulpwood and residual chips, as well as a portion of its needs for hardwood at the West Monroe mill. An assignee of Plum Creek supplies residual chips to the Company pursuant to this supply agreement. The Company purchases the remainder of the wood fiber used in CUK board production at the West Monroe mill from other private landowners in this region. The Company believes that adequate supplies of open market timber currently are available to meet its fiber needs at the West Monroe mill.

 

The Macon mill purchases most of its fiber requirements on the open market, and is a significant consumer of recycled fiber, primarily in the form of clippings from the Company’s domestic converting plants as well as DLK and other recycled fibers. The Company has not experienced any significant difficulties obtaining sufficient DLK or other recycled fibers for its Macon mill operations, which the Company purchases in part from brokers located in the eastern United States. The Macon mill purchases substantially all of its pine pulpwood and hardwood requirements from private landowners in central and southern Georgia. Because of the adequate supply and large concentration of private landowners in this area, the Company believes that adequate supplies of pine pulpwood and hardwood timber currently are available to meet its fiber needs at the Macon mill.

 

The Kalamazoo mill produces paperboard made primarily from OCC, old newsprint (“ONP”), and boxboard clippings. ONP and OCC recycled fibers are purchased through brokers at market prices and, less frequently, purchased directly from sources under contract. Boxboard clippings are provided by the Company’s folding carton converting plants and, to a lesser degree, purchased through brokers. The market price of each of the various recycled fiber grades fluctuates with supply and demand. The Company has many sources for its fiber requirements and believes that the supply is adequate to satisfy its needs.

 

In addition to paperboard that is supplied to its converting operations from its own mills, to a lessor extent, the Company converts a variety of other paperboard grades such as SBS and uncoated recycled board. The Company purchases such paperboard requirements, including additional CRB, from outside vendors, in some cases through multi-year supply agreements.

 

Energy, including natural gas, fuel oil and electricity, represents a significant portion of the Company’s manufacturing costs. The Company has entered into contracts designed to manage risks associated with future variability in cash flows and price risk related to future energy cost increases for a significant portion of its natural gas requirements, primarily at its U.S. mills through December 2006. The Company plans to continue its hedging program for natural gas. Refer to Note 15 in Notes to Consolidated Financial Statements.

 

The Company purchases a variety of other raw materials for the manufacture of its paperboard and cartons, such as inks, aluminum foil, plastic filling, plastic resins, adhesives, process chemicals and coating chemicals such as kaolin and titanium dioxide. While such raw materials are generally readily available from many sources, and the Company is not dependent upon any one source of such raw materials, the Company has developed strategic long-standing alliances with some of its vendors, including the use of multi-year

supply agreements, in order to provide a guaranteed source of raw materials that satisfies customer requirements.

 

The Company continues to be negatively impacted by inflationary pressures, including higher costs for chemical-based inputs, energy and fiber and believes these higher costs will negatively impact its results for 2006. Since negotiated contracts and the market largely determine the pricing for its products, the Company is at times limited in its ability to pass through to its customers any inflationary or other cost increases that the Company may incur in the future.

 

Seasonality

 

The Company’s net sales, income from operations and cash flows from operations are subject to moderate seasonality, with demand usually increasing in the spring and summer due to the seasonality of the worldwide beverage multiple packaging markets.

 

Working Capital

 

The Company continues to focus on reducing working capital needs and increasing liquidity. The Company’s working capital needs arise primarily from maintaining a sufficient amount of inventories to meet the delivery requirements of the Company’s customers and its policy to extend short-term credit to customers.

 

Research, Development and Engineering

 

The Company’s research and development staff works directly with its sales and marketing personnel in meeting with customers and pursuing new business. The Company’s development efforts include, but are not limited to, extending the shelf life of customers’ products, reducing production costs, enhancing the heat-managing characteristics of food packaging and refining packaging appearance through new printing techniques and materials. The Company’s revolutionary Fridge Vendor^® carton, a horizontal beverage 12-pack that delivers cold beverages while conserving refrigerator space, is but one example of the Company’s successful projects involving both carton and machine design to introduce a new consumer friendly package. This patented package has proven popular with consumers because it’s convenient and with the Company’s customers because it sells more product. Another recent award-winning package solution is the Company’s Micro-Rite^® even heating trays that are used for frozen entrees or side dishes that do not need browning and crisping. This new product line delivers conventional oven quality at microwave preparation speed and convenience to meet the needs of today’s consumers.

 

Patents and Trademarks

 

As of December 31, 2005, the Company had a large patent portfolio, presently owning, controlling or holding rights to more than 1,700 U.S. and foreign patents, with more than 475 U.S. and foreign patent applications currently pending. The Company’s patent portfolio consists primarily of patents relating to packaging machinery, manufacturing methods, structural carton designs and microwave and barrier protection packaging. These patents and processes are significant to the Company’s operations and are supported by trademarks such as Z-flute^®, Fridge Vendor^®, Composipac^® and Micro-Rite^® Quiltwave^tm and Tower Pack^tm. The Company takes significant steps to protect its intellectual property and proprietary rights, but may not be completely successful in all instances. The Company does not believe that the expiration of any of its patents at the end of their normal lives would have a material adverse effect on its financial condition or results of operations, and the Company’s operations are not dependent upon any single patent or trademark.

 

Employees and Labor Relations

 

As of December 31, 2005, the Company had approximately 7,800 employees worldwide (excluding employees of joint ventures), of which approximately 51% were represented by labor unions and covered by collective bargaining agreements. The Company considers its employee relations to be satisfactory.

Employees covered by collective bargaining agreements are located at 11 different sites with 11 union contracts. The contracts with employees represented by the United Steel, Paper and Forestry, Rubber, Manufacturing, Energy, Allied-Industrial and Service Workers International Union (“USW”), formerly PACE, at the Company’s Charlotte, NC and West Monroe, LA converting operations were scheduled to expire on August 12, 2005 and August 31, 2005, respectively. The Company and the USW negotiated a new four (4) year agreement in Charlotte, NC that runs from August 13, 2005 through August 12, 2009. Negotiations with USW for the West Monroe, LA converting facility continue to date with the old contract in force.

 

In addition to employees at the Charlotte, NC and West Monroe, LA, USW represents employees at the Gordonsville, TN, and Cincinnati, OH converting plants; the Macon, GA Paper mill; the West Monroe, LA Paper mill and the Kalamazoo, MI converting plant and mill. Both USW and International Brotherhood of Teamsters (“IBT”) formerly GCIU, represent employees at the Wausau, WI and Menasha, WI converting plants and the International Association of Machinists and Aerospace Workers and the International Brotherhood of Electrical Workers also represent certain maintenance employees at the Macon, GA Paper mill who are covered by the same agreement as the Company has with USW.

 

The Company’s contracts with USW and the IBT that cover employees at the Menasha and Wausau, WI plants extend through October 31, 2008 and June 30, 2009 respectively. The contract with the IBT covering certain employees at the Kalamazoo, MI transportation center extends through July 31, 2010.

 

The contract with USW at the Gordonsville, TN facility runs through October 14, 2007 and at the Macon, GA mill, a seven-year agreement with USW extends from January 1, 2004 through December 31, 2010. At the West Monroe Paper mill, a six-year contract with USW covers the period from March 1, 2003 to February 28, 2009. A contract was also reached in 2003 with USW for the Kalamazoo facility, which will expire in January 2008. The Company’s labor agreement with USW for its Cincinnati, OH converting plant covers the five-year period from February 1, 2001 through January 31, 2006. Negotiations with USW for the Cincinnati, OH converting facility continue to date with the old contract in force.

 

IBT represented employees in the Clinton, MS converting plant were operating under a six-year contract covering the six-year period from February 1, 2003 through January 31, 2009, until the facility was permanently closed during the fourth quarter of 2005.

 

The Association of Western Pulp & Paper Union (“AWP & PU”) represents employees at the North Portland, OR converting plant. In 2002, a four-year agreement was reached at the North Portland converting plant which expired February 28, 2006. Negotiations with AWP & PU for the North Portland, OR converting facility are scheduled to begin in March 2006.

 

The Company’s international employees are represented by unions in Brazil, France, Spain, Sweden and the United Kingdom.

 

Environmental Matters

 

Certain environmental matters in which the Company is involved are discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Environmental Matters.”

 

The following important factors, and those important factors described elsewhere in this report, could affect (and in some cases have affected) the Company’s actual results and could cause such results to differ materially from estimates or expectations reflected in the forward-looking statements:

 

 

 

None.

 

Headquarters

 

The Company’s principal executive offices are located in Marietta, GA, where it currently leases approximately 52,000 square feet of office space.

 

Manufacturing Facilities

 

A listing of the principal plants and properties owned or leased and operated by the Company is set forth below. The Company’s buildings are adequate and suitable for the business of the Company. The Company also leases certain smaller facilities, warehouses and office space throughout the United States and in foreign countries from time to time.

 

Notes:

 

 

The Company is a party to a number of lawsuits arising in the ordinary conduct of its business. Although the timing and outcome of these lawsuits cannot be predicted with certainty, the Company does not believe that disposition of these lawsuits will have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.

 

During the fourth quarter of 2005, there were no matters submitted to a vote of security holders.

 

EXECUTIVE OFFICERS OF THE REGISTRANT

 

Pursuant to General Instruction G(3) of Form 10-K, the following list is included as an unnumbered item in Part I of this Report in lieu of being included in the definitive proxy statement that will be filed within 120 days after December 31, 2005.

 

Jeffrey H. Coors, 61, has been the Executive Chairman and a director of GPC since the closing of the Merger. Mr. Coors was Chairman of Graphic from 2000 and until the closing of the Merger, and was its Chief Executive Officer and President from Graphic’s formation in 1992 and until the closing of the Merger. Mr. Coors served as Executive Vice President of the Adolph Coors Company from 1991 to 1992 and as its President from 1985 to 1989, as well as at Coors Technology Companies as its President from 1989 to 1992.

 

Stephen M. Humphrey, 61, has been the President and Chief Executive Officer and a director of GPC since the closing of the Merger. From March 1997 until the closing of the Merger, Mr. Humphrey was the President and Chief Executive Officer and a director of Riverwood, RIC Holding, Inc. and RIC. From 1994 through 1996, Mr. Humphrey was Chairman, President and Chief Executive Officer of National Gypsum Company, a manufacturer and supplier of building products and services. From 1981 until 1994, Mr. Humphrey was employed by Rockwell International Corporation, a manufacturer of electronic industrial, automotive products, telecommunications systems and defense electronics products and systems, where he held a number of key executive positions.

 

David W. Scheible, 49, has been the Company’s Chief Operating Officer since October 2004. Previously, Mr. Scheible served as the Company’s Executive Vice President of Commercial Operations since the closing of the Merger. Mr. Scheible served as Graphic’s Chief Operating Officer from June 1999 until the closing of the Merger. He was President of Graphic’s Flexible Division from January to June 1999. Before joining Graphic, he was affiliated with the Avery Denison Corporation, working most recently as its Vice President and General Manager of the Specialty Tape Division from 1995 through January 1999 and Vice President and General Manager of the Automotive Division from 1993 to 1995.

 

Daniel J. Blount, 50, has been the Company’s Senior Vice President and Chief Financial Officer since September 2005. From October 2003 until September 2005, he was the Senior Vice President, Integration. From August 2003 until October 2003, he was the Senior Vice President, Integration, Chief Financial Officer and Treasurer. From June 2003 until August 2003, he was Senior Vice President, Chief Financial Officer and Treasurer of Riverwood, RIC Holding, Inc. and RIC. From September 1999 until June 2003, Mr. Blount was Senior Vice President and Chief Financial Officer of Riverwood, RIC Holding, Inc. and RIC. Mr. Blount was named Vice President and Chief Financial Officer of Riverwood, RIC Holding, Inc. and RIC in September 1998. Prior to joining Riverwood, Mr. Blount spent 13 years at Montgomery Kone, Inc., an elevator, escalator

and moving ramp product manufacturer, installer and service provider, lastly as Senior Vice President, Finance.

 

Stephen A. Hellrung, 58, has been the Company’s Senior Vice President, General Counsel and Secretary since October 2003. He was Senior Vice President, General Counsel and Secretary of Lowe’s Companies, Inc., a home improvement specialty retailer, from April 1999 until June 2003. Prior to joining Lowe’s Companies, Mr. Hellrung held similar positions with The Pillsbury Company and Bausch & Lomb, Incorporated.

 

Wayne E. Juby, 58, has been the Company’s Senior Vice President, Human Resources since the closing of the Merger. Mr. Juby was the Senior Vice President, Human Resources of Riverwood, RIC Holding, Inc. and RIC, from April 2001 until the closing of the Merger. Mr. Juby joined Riverwood in November 2000. From November 2000 until April 2001, Mr. Juby was Director, Corporate Training, of Riverwood. Prior to joining Riverwood, Mr. Juby was Vice President, Human Resources, of National Gypsum Company, from 1994 until 1996.

 

Robert M. Simko, 46, has been the Company’s Senior Vice President — Paperboard Division since December 19, 2005. From October 2002 to December 2005, Mr. Simko served as the Company’s Vice President, Supply Chain Operations. Mr. Simko joined the Company in February 1999 as the Vice President and Resident Manager, Georgia Paperboard Operations after serving as the Director of Operations for Sealright Co., Inc. for approximately three years and holding several key manufacturing positions with the Films Division at Mobil Chemical Co.

 

Michael R. Schmal, 53, has been the Company’s Senior Vice President, Beverage Division since the closing of the Merger and was the Vice President and General Manager, Brewery Group of Riverwood from October 1, 1996 until the closing of the Merger. Prior to that time, Mr. Schmal held various positions at Riverwood since joining the Company in 1981.

 

Donald W. Sturdivant, 45, has been the Company’s Senior Vice President, Consumer Packaging Division since December 2005. From the closing of the merger through December 2005, he served as the Company’s Senior Vice President, Universal Packaging Division. Mr. Sturdivant joined Graphic in August 1999 as President of the Performance Packaging Division. Mr. Sturdivant joined James River Corporation in 1991, serving first as a General Manager, and then, beginning in June 1995, as Vice President and General Manager. He continued in this capacity after James River and Fort Howard merged to become Fort James Corporation in 1997. In February 1999, he was promoted to President of the Packaging Business and served in that position until Graphic’s acquisition of the folding carton business of Fort James Corporation in August 1999.

 

GPC’s common stock (together with the associated stock purchase rights) is traded on the New York Stock Exchange under the symbol “GPK.” The historical range of the high and low sales price per share for each quarter of 2005 and 2004 are as follows:

 

 

No cash dividends have been paid during the last three years to the Company’s common stockholders. The Company’s intent is not to pay dividends at this time. Additionally, the Company’s credit facilities and the indentures governing its debt securities place substantial limitations on the Company’s ability to pay cash

dividends on its common stock (see “Covenant Restrictions” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 7 in Notes to Consolidated Financial Statements).

 

On February 24, 2006, there were approximately 1,980 stockholders of record and 3,570 beneficial holders of GPC’s common stock.

 

The selected consolidated financial data set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements of the Company and Notes thereto included elsewhere in this report.

 

 

Notes:

 

 

INTRODUCTION

 

This management’s discussion and analysis of financial conditions and results of operation is intended to provide investors with an understanding of the Company’s past performance, its financial condition and its prospects. The following will be discussed and analyzed:

 

Overview of Business

 

Overview of 2005 Results

 

Results of Operations

 

Financial Condition, Liquidity and Capital Resources

 

Critical Accounting Policies

 

New Accounting Standards

 

Business Outlook

 

OVERVIEW OF BUSINESS

 

The Company’s objective is to strengthen its position as a leading provider of paperboard packaging solutions. To achieve this objective, the Company offers customers its paperboard, cartons and packaging machines, either as an integrated solution or separately. The Company is also implementing strategies to expand market share in its current markets and to identify and penetrate new markets; to capitalize on the Company’s customer relationships, business competencies, and mills and converting assets; to develop and market innovative products and applications; and to continue to reduce costs by focusing on operational improvements. The Company’s ability to fully implement its strategies and achieve its objectives maybe influenced by a variety of factors, many of which are beyond its control including (i) inflation of raw material and other costs, which the Company cannot always pass through to its customers, and (ii) the effect of overcapacity in the worldwide paperboard packaging industry.

 

Significant Factors That Impact The Company’s Business

 

Impact of Inflation.  The Company’s cost of sales consists primarily of energy (including natural gas, fuel oil and electricity), pine pulpwood, hardwood, chemicals, recycled fibers, purchased paperboard, paper, aluminum foil, ink, plastic films and resins, depreciation expense and labor. The Company continues to be negatively impacted by inflationary pressures which increased costs $96.3 million compared to the prior year and are primarily related to chemical-based inputs ($25.9 million); fiber, outside board purchases and corrugated shipping containers ($21.7 million); energy ($17.4 million); labor and related benefits ($15.8 million); freight ($12.2 million); and other ($3.3 million). The Company has entered into contracts designed to manage risks associated with future variability in cash flows and price risk related to future energy cost increases for a significant portion of its natural gas requirements, primarily at its U.S. mills through December 2006. The Company plans to continue its hedging program for natural gas. The Company believes that inflationary pressures will negatively impact its results for 2006. Since negotiated sales contracts and the market largely determine the pricing for its products, the Company is at times limited in its ability to raise prices and pass through to its customers any inflationary or other cost increases that the Company may incur thereby further exacerbating the inflationary problems.

 

Substantial Debt Obligations.  The Company has approximately $1,978 million of outstanding debt obligations as of December 31, 2005. This debt can have significant consequences for the Company, as it requires a significant portion of cash flow from operations to be used for the payment of principal and interest, exposes the Company to the risk of increased interest rates and restricts the Company’s ability to obtain additional financing. Covenants in the Company’s Senior Secured Credit Agreement also prohibit or restrict, among other things, the disposal of assets, the incurrence of additional indebtedness (including guarantees) and

payment of dividends, loans or advances and certain other types of transactions. These restrictions could limit the Company’s flexibility to respond to changing market conditions and competitive pressures. The covenants also require compliance with certain financial ratios. The Company’s ability to comply in future periods with the financial covenants will depend on its ongoing financial and operating performance, which in turn will be subject to many other factors, many of which are beyond the Company’s control. See “Financial Condition, Liquidity and Capital Resources — Liquidity and Capital Resources” and “— Covenant Restrictions” for additional information regarding the Company’s debt obligations.

 

Commitment to Cost Reduction.  In light of increasing margin pressure throughout the paperboard packaging industry, the Company has programs in place that are designed to reduce costs, improve productivity and increase profitability. The Company utilizes a global continuous improvement initiative that uses statistical process control to help design and manage many types of activities, including production and maintenance. This includes a Six Sigma process focused on reducing variable and fixed manufacturing and administrative costs. In addition, the Company finalized its initiative designed to enhance the competitiveness of its beverage multiple packaging converting operations and has begun to recognize improved converting performance. The Company has made expenditures of approximately $73 million on this initiative through December 31, 2005 and added new manufacturing technology, new presses and optimized current press capacity, and also consolidated certain beverage carton converting operations. As part of the Company’s manufacturing rationalization initiatives, the Company announced in January 2004 plans to close its Garden Grove, CA converting plant, and in May 2004 announced plans to close its Bow, NH and Clinton, MS converting plants. In addition, the Company announced it is expanding certain of its existing sites, including Fort Smith, AR and Lumberton, NC, and as a result expects to make expenditures of approximately $28 million over the 2004 to 2006 period. The Company has spent approximately $26 million of the projected expenditures through December 31, 2005. During 2005, the Company achieved approximately $50 million in cost savings through its continuous improvement programs and manufacturing initiatives.

 

In December 2005, the Company completed a reduction in work force affecting 62 corporate and divisional support staff. The Company recorded a one-time charge of approximately $5 million for severance and related costs in the fourth quarter of 2005. The Company took this action to reduce on-going operating expenses in future periods.

 

Market Factors.  Because some products can be packaged in different types of materials, the Company’s sales are affected by competition from other manufacturers’ CUK board and other substrates such as SBS, CCN and WLC, substitute products including shrink film and corrugated containers, as well as by general market conditions. In addition, the Company’s sales historically are driven by consumer buying habits in the markets its customers serve. New product introductions and promotional activity by the Company’s customers and the Company’s introduction of new packaging products also impacted its sales. The Company’s containerboard business is subject to conditions in the cyclical worldwide commodity paperboard markets that have a significant impact on containerboard sales. In addition, the Company’s net sales, income from operations and cash flows from operations are subject to moderate seasonality, with demand usually increasing in the spring and summer due to the seasonality of the worldwide beverage multiple packaging markets.

 

The Company works to maintain market share through efficiency, product innovation and long-term board and machinery and supply contracts to its customers; however, pricing and other competitive pressures may occasionally result in the loss of a customer relationship.

 

Packaging machinery placements during 2005 decreased approximately 27% compared to 2004 due primarily to timing differences and to the additional placements in 2004 as a result of the success of the new Fridge Vendor^® Package. The Company expects packaging machinery placements for 2006 to be higher when compared to 2005.

 

OVERVIEW OF 2005 RESULTS

 

 

 

RESULTS OF OPERATIONS

 

Segment Information

 

The Company reports its results in two business segments: paperboard packaging and containerboard/other. Business segment information is as follows:

 

 

2005 COMPARED WITH 2004

 

Net Sales

 

The components of the change in Net Sales are as follows:

 

 

Paperboard Packaging

 

The Company’s Net Sales from paperboard packaging in 2005 increased by $6.6 million, or 0.3%, to $2,297.8 million from $2,291.2 million in 2004 due primarily to a 5.9% increase in North American food and consumer product carton sales as a result of higher unit volumes and increased pricing. These increases were somewhat offset by lower volumes in North American open market rollstock sales and lower volumes in international food and consumer product markets as well as lower pricing in North American beverage carton markets as a result of increased market competitiveness.

 

Containerboard/Other

 

The Company’s Net Sales from containerboard/other in 2005 decreased by $9.1 million, or 9.5%, to $86.2 million from $95.3 million in 2004 due primarily to lower linerboard sales as a result of producing coated board in place of containerboard tons. This additional coated board was utilized in the production of food and consumer product cartons. This decrease was somewhat offset by improved pricing in the containerboard medium and linerboard markets.

Income (Loss) from Operations

 

The components of the change in Income (Loss) from Operations are as follows:

 

Note:

 

 

Paperboard Packaging

 

The Company’s Income from Operations from paperboard packaging in 2005 decreased by $49.6 million, or 23.5%, to $161.7 million from $211.3 million in 2004 due primarily to inflationary pressures primarily on chemical-based inputs, fiber, outside board purchases and corrugated shipping containers, energy, labor and related benefits and freight; and the lower pricing in North American beverage carton markets as a result of increased market competitiveness. These decreases were somewhat offset by worldwide cost reductions resulting from the Company’s cost reduction initiatives, improved volume and pricing in the North American food and consumer product carton markets, and lower depreciation expense.

 

Containerboard/Other

 

The Company’s Loss from Operations from containerboard/other was $16.1 million in 2005 compared to a loss of $21.6 million in 2004. This $5.5 million improvement was due primarily to improved pricing in the containerboard medium and linerboard markets.

 

Corporate

 

The Company’s Loss from Operations from corporate was $58.7 million in 2005 compared to a loss of $74.1 million in 2004. This $15.4 million improvement was due primarily to lower amortization expense of Merger related intangibles of $15.3 million and a $4.5 million benefit relating to the settlement of a lawsuit, somewhat offset by higher consulting fees in 2005.

 

INTEREST INCOME, INTEREST EXPENSE, INCOME TAX EXPENSE, AND EQUITY IN NET EARNINGS OF AFFILIATES

 

Interest Income

 

Interest Income was $0.6 million in 2005 and 2004.

 

Interest Expense

 

Interest Expense increased by $6.9 million to $156.5 million in 2005 from $149.6 million in 2004, due to higher interest rates on the unhedged portion of the Company’s floating rate debt. The increase was somewhat offset by lower average debt balances in 2005 and a 25 basis points reduction in interest charged during 2005 on the Term Loan Facility as a result of the first amendment to the Company’s Senior Secured Credit Agreement (as defined herein).

 

Income Tax Expense

 

During 2005, the Company recognized an Income Tax Expense of $23.3 million on Loss before Income Taxes and Equity in Net Earnings of Affiliates of $69.0 million. During 2004, the Company recognized an Income Tax Expense of $28.9 million on Loss before Income Taxes and Equity in Net Earnings of Affiliates of $33.4 million. Income Tax Expense for 2005 and 2004 was primarily due to the noncash expense associated

with the amortization of goodwill for tax purposes, valuation allowance adjustments and tax withholding in foreign jurisdictions.

 

Equity in Net Earnings of Affiliates

 

Equity in Net Earnings of Affiliates was $1.2 million in 2005 and $1.4 million in 2004 and related to the Company’s equity investment in the joint venture Rengo Riverwood Packaging, Ltd. (“Rengo”).

 

2004 COMPARED WITH 2003

 

Net Sales

 

The components of the change in Net Sales are as follows:

 

 

Paperboard Packaging Segment

 

The Company’s Net Sales from paperboard packaging in 2004 increased by $690.6 million, or 43.1%, to $2,291.2 million from $1,600.6 million in 2003 due primarily to the inclusion of an additional 221 days in 2004 of Graphic’s paperboard packaging business, which resulted in increased Net Sales of $690.2 million. Net sales were positively impacted by foreign currency exchange rates of $39.8 million. These increases were somewhat offset by lower pricing in the Company’s North American markets, primarily as a result of increased market competitiveness.

 

Containerboard/Other

 

The Company’s Net Sales from containerboard/other in 2004 increased by $12.6 million, or 15.2%, to $95.3 million from $82.7 million in 2003 due primarily to improved pricing in the containerboard medium and linerboard markets.

 

Income (Loss) from Operations

 

The components of the change in Income (Loss) from Operations are as follows:

 

Note:

 

 

Paperboard Packaging Segment

 

The Company’s Income from Operations from paperboard packaging in 2004 increased by $41.5 million, or 24.4%, to $211.3 million from $169.8 million in 2003 due primarily to the addition of Graphic’s paperboard packaging business and worldwide cost reductions resulting from the Company’s cost reduction initiatives. The increase was somewhat offset by inflationary pressures primarily on fiber, outside board purchases and corrugated shipping containers, energy, labor and related benefits, freight and chemical-based inputs as well as lower pricing in North American markets as a result of increased market competitiveness.

Containerboard/Other

 

The Company’s Loss from Operations from containerboard/other was $21.6 million in 2004 compared to a loss of $27.3 million in 2003. This $5.7 million improvement was due primarily to improved pricing in the containerboard medium and linerboard markets.

 

Corporate

 

The Company’s Loss from Operations from corporate was $74.1 million in 2004 compared to a loss of $36.4 million in 2003, due primarily to the inclusion of an additional 221 days in 2004 of Graphic’s corporate operations as well as higher amortization expense of $17.7 million due to the effects of purchase accounting in connection with the Merger, and inflation including higher medical and health benefits and higher expenses associated with Sarbanes-Oxley compliance efforts.

 

LOSS ON EARLY EXTINGUISHMENT OF DEBT, INTEREST INCOME, INTEREST EXPENSE, INCOME TAX EXPENSE, AND EQUITY IN NET EARNINGS OF AFFILIATES

 

Loss on Early Extinguishment of Debt

 

In 2003 and in connection with the Merger and the related financing transactions, the Company recorded a non-cash charge to earnings of approximately $16.7 million, related to the write-off of remaining debt issuance costs on its prior senior secured credit facilities, RIC’s 105/8% senior notes due 2007 (“Senior Notes due 2007”) and RIC’s 107/8% senior subordinated notes due 2008 (“Senior Subordinated Notes due 2008” and, together with the Senior Notes due 2007, the “Prior RIC Notes”), and also recorded a charge of approximately $28.6 million, related to the call premium paid upon redemption of the Prior RIC Notes.

 

Interest Income

 

Interest Income decreased by $0.4 million to $0.6 million in 2004 from $1.0 million in 2003 due primarily to interest received in 2003 on monies held in tax escrow.

 

Interest Expense

 

Interest Expense increased by $5.1 million to $149.6 million in 2004 from $144.5 million in 2003, due primarily to higher debt balances following the Merger. Interest Expense was also affected by higher interest rates on the unhedged portion of the Company’s floating rate debt. The increase was somewhat offset by lower interest rates on the new Senior and Senior Subordinated notes and by lower interest rates resulting from the first amendment of the Senior Secured Credit Agreement (as defined herein).

 

Income Tax Expense

 

During 2004, the Company recognized an Income Tax Expense of $28.9 million on Loss before Income Taxes and Equity in Net Earnings of Affiliates of $33.4 million. During 2003, the Company recognized an Income Tax Expense of $14.3 million on Loss before Income Taxes and Equity in Net Earnings of Affiliates of $82.7 million. Income Tax Expense for 2004 resulted from the noncash expense associated with the amortization of goodwill for tax purposes, income earned in foreign countries, valuation allowance adjustments and tax contingencies. Income Tax Expense for 2003 resulted from the noncash expense associated with the amortization of goodwill for tax purposes and income earned in foreign countries somewhat offset by the benefit from valuation allowance adjustments.

 

Equity in Net Earnings of Affiliates

 

Equity in Net Earnings of Affiliates was $1.4 million in 2004 and $1.3 million in 2003 and related to the Company’s non-consolidated joint venture, Rengo.

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES

 

The Company broadly defines liquidity as its ability to generate sufficient funds from both internal and external sources to meet its obligations and commitments. In addition, liquidity includes the ability to obtain appropriate debt and equity financing and to convert into cash those assets that are no longer required to meet existing strategic and financial objectives. Therefore, liquidity cannot be considered separately from capital resources that consist of current or potentially available funds for use in achieving long-range business objectives and meeting debt service commitments.

 

Cash Flows

 

Cash and Equivalents increased by $5.4 million in 2005. Cash provided by operating activities in 2005 totaled $169.5 million, compared to $263.8 million in 2004. This decrease was principally due to lower operating income as well as $19.6 million of cash contributions made to fund the Company’s pension plans and unfavorable changes in operating assets and liabilities. Cash used in investing activities in 2005 totaled $114.6 million, compared to $141.5 million in 2004. This decrease was principally due to lower capital investment of $42.2 million (see “— Capital Investment”) which was somewhat offset by lower proceeds from the sale of assets. Cash used in financing activities in 2005 totaled $49.1 million, compared to $133.0 million in 2004. This decrease was principally due to lower debt payments and higher net borrowings under the Company’s revolving credit facilities. Depreciation and amortization during 2005 totaled $205.3 million.

 

Liquidity and Capital Resources

 

The Company’s liquidity needs arise primarily from debt service on its substantial indebtedness and from the funding of its capital expenditures, ongoing operating costs and working capital.

 

At December 31, 2005 and 2004, Long-Term Debt consisted of the following:

 

 

The Senior Notes are rated B- by Standard & Poor’s and B2 by Moody’s Investor Services. During 2005, cash paid for interest was approximately $152 million.

At December 31, 2005, the Company had the following commitments, amounts outstanding and amounts available under revolving credit facilities:

 

Note:

 

 

 

Principal and interest payments under the Term Loan Facility and the Revolving Credit Facility, together with principal and interest payments on the Senior Notes and the Senior Subordinated Notes, represent significant liquidity requirements for the Company. Based upon current levels of operations, anticipated cost-savings and expectations as to future growth, the Company believes that cash generated from operations, together with amounts available under its Revolving Credit Facility and other available financing sources, will be adequate to permit the Company to meet its debt service obligations, necessary capital expenditure program requirements, ongoing operating costs and working capital needs, although no assurance can be given in this regard. The Company’s future financial and operating performance, ability to service or refinance its debt and ability to comply with the covenants and restrictions contained in its debt agreements (see “— Covenant Restrictions”) will be subject to future economic conditions and to financial, business and other factors, many of which are beyond the Company’s control and will be substantially dependent on the selling prices and demand for the Company’s products, raw material and energy costs, and the Company’s ability to successfully implement its overall business and profitability strategies.

 

The Company expects that its working capital and business needs will require it to continue to have access to the Revolving Credit Facility or a similar revolving credit facility after the maturity date in 2009, and that the Company accordingly will have to extend, renew, replace or otherwise refinance such facility at or prior to such date. No assurance can be given that it will be able to do so. The Company has in the past refinanced and in the future may seek to refinance its debt prior to the respective maturities of such debt.

 

The Company uses interest rate swaps to manage interest rate risks caused by interest rate changes on its variable rate Term Loan Facility. The differential to be paid or received under these agreements is recognized as an adjustment to interest expense related to the debt. At December 31, 2005, the Company had interest rate swap agreements with a notional amount of $660 million, which expire on various dates from 2006 to 2008 under which the Company will pay fixed rates of 2.69% to 4.53% and receive three-month LIBOR.

 

Effective as of December 31, 2005, the Company had approximately $1.2 billion of net operating loss carryforwards (“NOLs”) for U.S. federal income tax purposes. These NOLs generally may be used by the Company to offset taxable income earned in subsequent taxable years. However, the Company’s ability to use these NOLs to offset its future taxable income may be subject to significant limitation as a result of certain shifts in ownership due to direct or indirect transfers of the Company’s common stock by one or more 5 percent stockholders, or issuances or redemptions of the Company’s common stock, which, when taken together with previous changes in ownership of the Company’s common stock, constitute an ownership change under the Internal Revenue Code. Imposition of any such limitation on the use of NOLs could have an adverse effect on the Company’s future after tax free cash flow.

Covenant Restrictions

 

The Senior Secured Credit Agreement, which governs the Term Loan Facility and the Revolving Credit Facility, imposes restrictions on the Company’s ability to make capital expenditures and both the Senior Secured Credit Agreement and the indentures governing the Senior Notes and Senior Subordinated Notes (the “Notes”) limit the Company’s ability to incur additional indebtedness. Such restrictions, together with the highly leveraged nature of the Company, could limit the Company’s ability to respond to market conditions, meet its capital spending program, provide for unexpected capital investments or take advantage of business opportunities. The covenants contained in the Senior Secured Credit Agreement, among other things, restrict the ability of the Company to dispose of assets, incur additional indebtedness, incur guarantee obligations, prepay other indebtedness, make dividend and other restricted payments, create liens, make equity or debt investments, make acquisitions, modify terms of indentures under which the Notes are issued, engage in mergers or consolidations, change the business conducted by the Company and its subsidiaries, make capital expenditures and engage in certain transactions with affiliates.

 

On October 17, 2005, the Company, entered into the Second Amendment (the “Second Amendment”) to the Senior Secured Credit Agreement. As a result, the Company incurred fees and transaction costs of approximately $4 million.

 

The Second Amendment relaxed the maximum Consolidated Debt to Credit Agreement EBITDA Leverage Ratio covenant and the minimum Credit Agreement EBITDA to Consolidated Interest Expense Ratio covenant as shown below beginning with the covenant requirements for September 30, 2005.

 

 

At December 31, 2005, the Company was in compliance with the financial covenants in the Secured Credit Agreement, as amended, and the ratios were as follows:

 

Consolidated Debt to Credit Agreement EBITDA Leverage Ratio — 6.15 to 1.00

 

Credit Agreement EBITDA to Consolidated Interest Expense Ratio — 2.18 to 1.00

Credit Agreement EBITDA as used herein is a financial measure that is used in the Senior Secured Credit Agreement. Credit Agreement EBITDA is not a defined term under accounting principles generally accepted in the United States and should not be considered as an alternative to income from operations or net income as a measure of operating results or cash flows as a measure of liquidity. Credit Agreement EBITDA differs from the term “EBITDA” (earnings before interest expense, income tax expense, and depreciation and amortization) as it is commonly used. In addition to adjusting net income to exclude interest expense, income tax expense, and depreciation and amortization, Credit Agreement EBITDA also adjusts net income by excluding certain other items and expenses, as specified below. The Company’s definition of Credit Agreement EBITDA may differ from that of other similarly titled measures at other companies.

 

The Company’s management believes that presentation of Credit Agreement EBITDA provides useful information to investors because borrowings under the Senior Secured Credit Agreement are a key source of the Company’s liquidity, and the Company’s ability to borrow under the Senior Secured Credit Agreement is dependent on, among other things, its compliance with the financial ratio covenants. Failure to comply with these financial ratio covenants would result in a violation of the Senior Secured Credit Agreement and, absent a waiver or amendment from the lenders under such agreement, permit the acceleration of all outstanding borrowings under the Senior Secured Credit Agreement.

 

The calculations of the components of the Company’s financial covenant ratios are listed below:

 

 

 

Notes:

 

 

In addition to the changes to the financial covenants described above, the Second Amendment modifies the pricing for the Senior Secured Term Loan Facility by increasing the applicable margin by 0.25% if, and for so long as, the Company’s indebtedness under the Senior Secured Credit Agreement is rated less than B+ by Standard & Poor’s Ratings Group (a division of The McGraw Hill Companies Inc.) or less than B1 by Moody’s Investors Service, Inc.

 

If the negative impact of inflationary pressures on key inputs continues, or depressed selling prices, lower sales volumes, increased operating costs or other factors have a negative impact on the Company’s ability to increase its profitability, the Company may not be able to maintain its compliance with the financial covenants in its Senior Secured Credit Agreement, as amended. The Company’s ability to comply in future periods with the financial covenants in the Senior Secured Credit Agreement will depend on its ongoing financial and operating performance, which in turn will be subject to economic conditions and to financial, business and other factors, many of which are beyond the Company’s control and will be substantially dependent on the selling prices for the Company’s products, raw material and energy costs, and the Company’s ability to successfully implement its overall business strategies, and meet its profitability objective. If a violation of any of the covenants occurred, the Company would attempt to obtain a waiver or an amendment from its lenders, although no assurance can be given that the Company would be successful in this regard. The Senior Secured Credit Agreement and the indentures governing the Senior Subordinated Notes and the Senior Notes have covenants as well as certain cross-default or cross-acceleration provisions; failure to comply with these covenants in any agreement could result in a violation of such agreement which could, in turn, lead to violations of other agreements pursuant to such cross-default or cross-acceleration provisions. If an event of default occurs, the lenders are entitled to declare all amounts owed to be due and payable immediately. The Senior Secured Credit Agreement is collateralized by substantially all of the Company’s domestic assets.

 

Capital Investment

 

The Company’s capital investment in 2005 was $95.6 million, compared to $137.8 million in 2004. During 2005, the Company invested $46.9 million for improving process capabilities, $15.8 million for the expansion of its Fort Smith, AR and Lumberton, NC converting plants, $19.0 million for manufacturing packaging machinery, $8.2 million for compliance with environmental laws and regulations and $5.7 million for its beverage multiple packaging converting operations initiative.

 

Environmental Matters

 

The Company is subject to a broad range of foreign, federal, state and local environmental, health and safety laws and regulations that change from time to time, including those governing discharges to air, soil and water, the management, treatment and disposal of hazardous substances, solid waste and hazardous wastes, the investigation and remediation of contamination resulting from historical site operations and releases of hazardous substances, and the health and safety of employees. Compliance initiatives could result in significant costs, which could negatively impact the Company’s financial position, results of operations or cash flows. Any failure to comply with such laws and regulations or any permits and authorizations required thereunder could subject the Company to fines, corrective action or other sanctions.

 

In addition, some of the Company’s current and former facilities are the subject of environmental investigations and remediations resulting from historical operations and the release of hazardous substances or

other constituents. Some current and former facilities have a history of industrial usage for which investigation and remediation obligations may be imposed in the future or for which indemnification claims may be asserted against the Company. Also, potential future closures or sales of facilities may necessitate further investigation and may result in future remediation at those facilities.

 

The Company has established reserves for those facilities or issues where liability is probable and the costs are reasonably estimable. The Company believes that the amounts accrued for all of its loss contingencies, and the reasonably possible loss beyond the amounts accrued, are not material to the Company’s financial position, results of operations or cash flows. The Company cannot estimate with certainty future compliance, investigation or remediation costs, all of which the Company currently considers to be remote. Costs relating to historical usage or indemnification claims that the Company considers to be reasonably possible are not quantifiable at this time. The Company will continue to monitor environmental issues at each of its facilities and will revise its accruals, estimates and disclosures relating to past, present and future operations as additional information is obtained.

 

Commitments

 

At December 31, 2005, total commitments of the Company under long-term, non-cancelable contracts were as follows:

 

 

Notes:

 

 

International Operations

 

For 2005, before intercompany eliminations, net sales from operations outside of the United States represented approximately 21% of the Company’s net sales. The Company’s revenues from export sales fluctuate with changes in foreign currency exchange rates. At December 31, 2005, approximately 6% of its total assets were denominated in currencies other than the U.S. dollar. The Company has significant operations in countries that use the Swedish krona, the British pound sterling, the Japanese yen, the Brazilian real or the euro as their functional currencies. The effect of a generally stronger U.S. dollar against the euro and other European currencies, and the Japanese yen, produced a net currency translation adjustment loss of $17.2 million, which was recorded as an adjustment to shareholders’ equity for the year ended December 31, 2005. The magnitude and direction of this adjustment in the future depends on the relationship of the U.S. dollar to other currencies. The Company cannot predict major currency fluctuations. The Company pursues a currency hedging program in order to limit the impact of foreign currency exchange fluctuations on financial results. See “Financial Instruments” below.

Financial Instruments

 

The functional currency of the Company’s international subsidiaries is the local currency for the country in which the subsidiaries own their primary assets. The translation of the applicable currencies into U.S. dollars is performed for balance sheet accounts using current exchange rates in effect at the balance sheet date and for revenue and expense accounts using a weighted average exchange rate during the period. Any related translation adjustments are recorded directly to shareholders’ equity. Gains and losses on foreign currency transactions are included in Other Expense, Net for the period in which the exchange rate changes.

 

The Company pursues a currency hedging program which utilizes derivatives to limit the impact of foreign currency exchange fluctuations on its consolidated financial results. Under this program, the Company has entered into forward exchange contracts in the normal course of business to hedge certain foreign currency denominated transactions. Realized and unrealized gains and losses on these forward contracts are included in the measurement of the basis of the related foreign currency transaction when recorded. The Company also pursues a hedging program which utilizes derivatives designed to manage risks associated with future variability in cash flows and price risk related to future energy cost increases. Under this program the Company has entered into natural gas swap contracts to hedge a significant portion of its natural gas requirements through December 2006. Realized gains and losses on these contracts are included in the financial results concurrently with the recognition of the commodity purchased. The Company uses interest rate swaps to manage interest rate risks on future income caused by interest rate changes on its variable rate Term Loan facility. These instruments involve, to varying degrees, elements of market and credit risk in excess of the amounts recognized in the Consolidated Balance Sheets. The Company does not hold or issue financial instruments for trading purposes. See “Quantitative and Qualitative Disclosure About Market Risk.”

 

CRITICAL ACCOUNTING POLICIES

 

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net sales and expenses during the reporting period. Actual results could differ from these estimates, and changes in these estimates are recorded when known. The critical accounting policies used by management in the preparation of the Company’s consolidated financial statements are those that are important both to the presentation of the Company’s financial condition and results of operations and require significant judgments by management with regard to estimates used. The critical judgments by management relate to pension benefits, retained insurable risks, future cash flows associated with impairment testing for goodwill and long-lived assets, and deferred taxes.

 

• Pension Benefits

 

The Company sponsors defined benefit pension plans (the “Plans”) for eligible employees in North America and certain international locations. The funding policy for the qualified defined benefit plans in North America is to, at a minimum, contribute assets as required by the Internal Revenue Code Section 412. Nonqualified U.S. plans providing benefits in excess of limitations imposed by the U.S. income tax code are not funded.

 

U.S. pension expense for defined benefits pension plans was $22.0 million in 2005 compared with $18.7 million in 2004. Pension expense is calculated based upon a number of actuarial assumptions applied to each of the defined benefit plans. The expected long-term rate of return on pension fund assets used to calculate pension expense was 8.25% in both 2005 and 2004. The expected long-term rate of return on pension assets was determined based on several factors, including input from our pension investment consultants and projected long-term returns of broad equity and bond indices. The Company also considered the plan’s historical 10-year compounded annual return of 8.80%, which has been in excess of these broad equity and bond benchmark indices. The Company will continue to evaluate its long-term rate of return assumptions at least annually and will adjust them as necessary.

 

The Company determined pension expense using both the fair value of assets and a calculated value that averages gains and losses over a period of years. Investment gains or losses represent the difference between

the expected and actual return on assets. As of December 31, 2005, the cumulative unrecognized investment loss was $96.6 million. These unrecognized net losses may increase future pension expense if not offset by (i) actual investment returns that exceed the assumed investment returns, or (ii) other factors, including reduced pension liabilities arising from higher discount rates used to calculate pension obligations, or (iii) other actuarial gains, including whether such accumulated actuarial losses at each measurement date exceed the “corridor” determined under SFAS 87, Employers’ Accounting for Pensions.

 

The discount rate used to determine the present value of future pension obligations at December 31, 2005 was based on a yield curve constructed from a portfolio of high quality corporate debt securities with maturities ranging from 1 year to 30 years. Each year’s expected future benefit payments were discounted to their present value at the appropriate yield curve rate thereby generating the overall discount rate for U.S. pension obligations. The discount rate for U.S. plans decreased from 6.00% in 2004 to 5.75% in 2005. For non-U.S. plans, the discount rate is determined using long-term local corporate bonds.

 

U.S. pension expense is estimated to be approximately $24 million in 2006. The estimate is based on an expected long-term rate of return of 8.25%, a discount rate of 5.75% and other assumptions. Pension expense beyond 2006 will depend on future investment performance, the Company’s contribution to the plans, changes in discount rates and other factors related to covered employees in the plans.

 

If the discount rate assumptions for these plans were reduced by 0.25 percent, pension expense would increase by approximately $2 million and the December 31, 2005 minimum pension liability would increase by about $18 million.

 

The fair value of assets in the U.S. plans was $391.8 million at December 31, 2005 and $376.6 million at December 31, 2004. Lower discount rates have caused the projected benefit obligations to exceed that fair value of plan assets by approximately $183.2 million and $138.1 million as of December 31, 2005 and 2004, respectively. Primarily due to the lower discount rates, the accumulated benefit obligation (“ABO”) exceeded plan assets by $159.2 million at the end of 2005. At the end of 2004, the ABO exceeded the fair value of plan assets by $111.2 million.

 

• Retained Insurable Risks

 

The Company is self-insured for certain losses relating to workers’ compensation claims and employee medical and dental benefits. Provisions for expected losses are recorded based on the Company’s estimates, on an undiscounted basis, of the aggregate liabilities for known claims and estimated claims incurred but not reported. The Company has purchased stop-loss coverage or insurance with deductibles in order to limit its exposure to significant claims. The Company also has an extensive safety program in place to minimize its exposure to workers’ compensation claims. Self-insured losses are accrued based upon estimates of the aggregate uninsured claims incurred using certain actuarial assumptions and loss development factors followed in the insurance industry and historical experience.

 

• Goodwill

 

The Company tests the carrying amount of its goodwill using the discounted cash flow method of valuation on an annual basis and whenever events or circumstances indicate that impairment may have occurred. The review for impairment is based on a discounted cash flow approach, which requires the Company to estimate future net cash flows, the timing of these cash flows and a discount rate (based upon a weighted average cost of capital). The Company’s cash flows are generated by its operations and are used to fund working capital needs, debt service and capital spending. The Company discounted these cash flows using a weighted average cost of capital of 9 percent. Changes in borrowing rates, which are impacted by market rate fluctuations, would impact discounted cash flow calculations. Other factors, such as significant operating losses or acquisitions of new operations, would also impact discounted cash flow calculations. If the discount rate used in the discounted cash flow calculations were to be increased 100 basis points, the fair value would continue to exceed the carrying amount in the Company’s goodwill valuation analysis. The Company has completed its annual goodwill impairment testing and has determined that none of its goodwill is impaired.

• Recovery of Long-Lived Assets

 

The Company reviews long-lived assets (including property, plant and equipment and intangible assets) for impairment whenever events or changes in circumstances indicate that the carrying amount of such long-lived assets may not be fully recoverable by undiscounted cash flows. Measurement of the impairment loss, if any, is based on the fair value of the asset, which is generally determined by the discounting of future estimated cash flows, or in the case of real estate, determining market value. The Company evaluates the recovery of its long-lived assets by analyzing operating results and considering significant events or changes in the business environment that may have triggered impairment.

 

• Deferred Income Taxes and Potential Assessments

 

As of December 31, 2005, the Company has recorded deferred tax assets totaling $616.0 million primarily related to income tax loss carryforwards and income tax credit carryforwards and has established valuation allowances against these deferred tax assets of $252.1 million, thereby resulting in net deferred tax assets of $363.9 million. The remaining deferred tax assets may be utilized against future deferred tax liabilities excluding those liabilities resulting from indefinite lived intangible assets. As of December 31, 2004, the net deferred tax assets were $364.8 million. The Company’s income tax losses are in U.S. and non-U.S. taxing jurisdictions. In determining the valuation allowances to establish against these deferred tax assets, the Company considers many factors, including the specific taxing jurisdiction, the carryforward period, forecasted earnings for the entities in each jurisdiction and tax strategies. A valuation allowance is recognized if, based on the weight of available evidence, the Company concludes that it is more likely than not that some portion or all of the deferred tax asset will not be realized.

 

As of December 31, 2005, the Company, in accordance with Accounting Principles Board (“APB”) Opinion 23, Accounting for Income Taxes, Special Areas has determined that $71.5 million of undistributed foreign earnings are not intended to be reinvested indefinitely by its non-U.S. subsidiaries. Deferred income tax was recorded as a reduction to the Company’s net operating losses on these undistributed earnings as well as the financial statement carrying value in excess of tax basis in the amount of $35.8 million. As of December 31, 2004 the Company had determined that $71.8 million of undistributed foreign earnings were not intended to be reinvested indefinitely. Deferred income tax was recorded as a reduction to the Company’s net operating losses on these undistributed earnings as well as the financial statement carrying value in excess of tax basis in the amount of $48.8 million. Prior to 2004, the Company’s intent was to permanently reinvest its foreign earnings and it was not practical to determine the amount of unrecognized deferred U.S. income tax liability on these unremitted earnings. The Company periodically determines whether the non-U.S. subsidiaries will invest their undistributed earnings indefinitely and reassesses this determination as appropriate.

 

The Company records current liabilities for potential assessments. The accruals relate to uncertain tax positions in a variety of taxing jurisdictions and are based on what management believes will be the ultimate resolution of these positions. These liabilities may be affected by changing interpretations of laws, rulings by tax authorities, or the expiration of the statute of limitations.

 

NEW ACCOUNTING STANDARDS

 

For a discussion of recent accounting pronouncements impacting the Company, see Note 3 in Notes to Consolidated Financial Statements.

 

BUSINESS OUTLOOK

 

The Company expects inflationary pressures for production inputs to continue to impact results in 2006. Specifically, the higher cost of natural gas is expected to negatively influence results, particularly in the first quarter 2006. Because higher priced inputs first began to impact the Company at the end of 2004, the Company expects prior period comparisons to be more favorable than in 2005.

 

To help offset inflation in 2006, the Company expects to realize approximately $50 million in year over year operating cost savings from its continuous improvement programs and manufacturing rationalization. In

addition, price increases announced in October 2005 for coated board and containerboard will carry through to 2006. Finally, the Company expects to gain further price increases on cartons.

 

Total capital investment for 2006 is expected to be between approximately $80 million and $90 million and is expected to relate principally to improving the Company’s process capabilities (approximately $62 million), the production of packaging machinery (approximately $17 million) and environmental laws and regulations (approximately $6 million).

 

Depreciation and amortization is expected to be between approximately $190 million and $200 million for the full year 2006.

 

Interest Rates

 

The Company is exposed to changes in interest rates, primarily as a result of its short-term and long-term debt, which bear both fixed and floating interest rates. The Company uses interest rate swap agreements effectively to fix the LIBOR rate on $660.0 million of variable rate borrowings. The table below sets forth interest rate sensitivity information related to the Company’s debt.

 

Long-Term Debt Principal Amount by Maturity-Average Interest Rate

 

 

Total Interest Rate Swaps-Notional Amount by Expiration-Average Swap Rate

 

 

Foreign Exchange Rates

 

The Company enters into forward exchange contracts to hedge substantially all accounts receivable resulting from transactions denominated in foreign currencies. The purpose of these forward exchange contracts is to protect the Company from the risk that the eventual functional currency cash flows resulting from the collection of the hedged accounts receivable will be adversely affected by changes in exchange rates.

Foreign Exchange Rates Sensitivity-Contractual Amount by Expected
Maturity-Average Contractual Exchange Rate

 

 

The Company also enters into forward exchange contracts to hedge certain other anticipated foreign currency transactions. The purpose of these contracts is to protect the Company from the risk that the eventual functional currency cash flows resulting from anticipated foreign currency transactions will be adversely affected by changes in exchange rates.

 

Foreign Exchange Rates Sensitivity-Contractual Amount by Expected
Maturity-Average Contractual Exchange Rate

 

Natural Gas Contracts

 

The Company entered into natural gas swap contracts to hedge prices for a significant portion of its natural gas requirements through December 2006 with a weighted average contractual rate of $11.24 per MMBTU. The carrying amount and fair value of the natural gas swap contracts was a liability of $1.2 million as of December 31, 2005 and was recorded in Other Accrued Liabilities in the Consolidated Balance Sheet. Such contracts are designated as cash flow hedges and are accounted for by deferring the quarterly change in fair value of the outstanding contracts in Accumulated Derivative Instruments Gain (Loss). On the date a contract matures, the resulting gain or loss is reclassified into Cost of Sales concurrently with the recognition of the commodity purchased. The ineffective portion of the swap contracts change in fair value, if any, would be recognized immediately in earnings. During 2005, there was a minimal amount of ineffective portion related to changes in fair value of natural gas swap contracts. Additionally, there were no amounts excluded from the measure of effectiveness. During 2004, there was no material ineffective portion related to changes in fair value of natural gas swap contracts. Additionally, there were no amounts excluded from the measure of effectiveness.

 

INDEX TO FINANCIAL STATEMENTS

 

GRAPHIC PACKAGING CORPORATION

 

CONSOLIDATED BALANCE SHEETS

 

 

The accompanying notes are an integral part of the consolidated financial statements.

GRAPHIC PACKAGING CORPORATION

 

CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

The accompanying notes are an integral part of the consolidated financial statements.

GRAPHIC PACKAGING CORPORATION

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS