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, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

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, 2007 was $335.6 million.

 

As of February 25, 2008, there were 200,980,403 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 20, 2008 are incorporated by reference into Part III of this Annual Report on Form 10-K.

 

 

TABLE OF CONTENTS OF FORM 10-K

 

Certain statements regarding the expectations of Graphic Packaging Corporation, including, but not limited to, statements regarding the effect of contractual price escalators and price increases for coated paperboard and cartons, inflationary pressures, cost savings from its continuous improvement programs and manufacturing rationalization, capital spending, depreciation and amortization, interest expense, debt reduction and pension plan contributions 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, the Company’s substantial amount of debt, inflation of and volatility in raw material and energy costs, continuing pressure for lower cost products, the Company’s ability to implement its business strategies, including productivity initiatives and cost reduction plans, the Company’s ability to consummate the proposed combination with Altivity Packaging, LLC and realize the anticipated benefits of such transaction, currency 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 herein under Item 1A., “Risk Factors”.

 

 

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 food, beverage 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 Kraft Foods, Inc., 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. The remaining portion is produced 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 (“U.S.”)/North America, Central/South America, Europe and Asia Pacific. For business segment and geographic area information for each of the last three fiscal years, see Note 13 in the Notes to Consolidated Financial Statements included herein under Item 8., “Financial Statements and Supplementary Data”.

 

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 (collectively referred to as the “Merger”). Riverwood Acquisition Sub LLC then merged into Riverwood Holding, which was renamed Graphic Packaging Corporation.

 

On July 9, 2007, the Company entered into a Transaction Agreement and Agreement and Plan of Merger (“Transaction Agreement”) by and among the Company, Bluegrass Container Holdings, LLC, a Delaware limited liability company (“BCH”), the owners of BCH, New Giant Corporation, a wholly-owned subsidiary of the Company (“New Graphic”), and Giant Merger Sub, Inc., a wholly-owned subsidiary of New Graphic (“Merger Sub”). The Transaction Agreement provides for the combination of the Company and Altivity Packaging, LLC, (“Altivity”) a wholly-owned subsidiary of BCH. Altivity is a provider of packaging solutions, including folding cartons and paperboard, multi-wall bags, flexible packaging and labels. On January 17, 2008, the Company’s stockholders approved the proposal to adopt the Transaction Agreement and approved the proposed combination with Altivity and approved certain related matters. The transaction remains subject to the expiration or termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended. The Company at the request of the U.S. Department of Justice has voluntarily agreed to extend the waiting period to March 3, 2008.

 

On October 16, 2007, Graphic Packaging International Holding Sweden AB (the “Seller”), an indirect wholly-owned subsidiary of the Company, entered into a Sale and Purchase Agreement with Lagrumment December nr 1031 Aktiebolg, a company organized under the laws of Sweden to sell all of the outstanding shares of Graphic Packaging International Sweden (“GP-Sweden”) for $8.6 million. The results of operations for GP-Sweden have been eliminated from the Company’s continuing operations and classified as discontinued operations for each period presented within the Company’s Consolidated Statements of Operations. See Note 15

in the Notes to Consolidated Financial Statements included herein under Item 8., “Financial Statements and Supplementary Data”.

 

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, and 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”). The Company also makes certain investor presentations and access to analyst conference calls available through its website. The information contained or incorporated into 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, cuts and glues (“converts”) the paperboard into folding 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 and provides support, service and advanced performance monitoring of the machines. The Company also sells the paperboard it produces to independent converters and, particularly in its international operations, to joint ventures which, in turn, sell converted beverage cartons to end-users for use on the Company’s proprietary packaging machines. The Company also sells limited amounts of CUK board to customers for use on third-party packaging machines.

 

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, metallization, 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 4, 6, 8, 12, 18, 20, 24, 30 and 36 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 customers, which generally require the customer to purchase a fixed portion of its carton requirements from the Company.

 

The Company’s packaging applications meet the needs of its customers for:

 

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 and film laminates tailored on a product-by-product basis. The Company’s patented Z-Flute^® carton is a key component of the Company’s strength packaging portfolio. Z-Flute offers customers the strength of corrugate with the performance characteristic of a folding carton due to the strategic location of reinforcing paperboard strips.

 

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. IntegraPak, the Company’s alternative to traditional “bag-in-box” packaging, is a prime example of our ability to create a barrier package with paperboard lamination technology.

 

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 U.S., Canada, the United Kingdom, Spain, France and Brazil, as well as through converting plants associated with its joint ventures in Japan and Denmark, contract converters and at licensees in other markets outside the U.S. 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 frequently glued and then 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 U.S. 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 coated 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. The Company’s CUK board production at its West Monroe and Macon mills was approximately 766,000 and 548,000 net tons, respectively, in 2007. The Company consumes approximately 77% of the West Monroe and Macon mills’ output in its carton converting operations.

 

CUK board is manufactured from blends of pine 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 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 392,000 net tons in 2007. 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 88% of the Kalamazoo mill’s output in its carton converting operations, and the mill is an integral part of its low-cost converting strategy.

 

Packaging Design and Proprietary Packaging Machinery

 

The Company has six research and design centers located in Golden, Colorado; Concord, New Hampshire; Marietta, Georgia; Menasha, Wisconsin; West Monroe, Louisiana; and Mississauga, Ontario, Canada. At these centers, the Company designs, tests and manufactures prototype packaging and paperboard 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. In the Concord, New Hampshire facility the focus is on consumer packaging structural design development and rapid prototyping to meet the short turn around requirements of customers. The Company also 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. The Company creates innovative graphic designs that integrate carton shape and function with customer desired identification and information while achieving point-of-sale attention.

 

At the Company’s two microwave laboratories, in Menasha, Wisconsin and Mississauga, Ontario, Canada, the Company designs, 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, enables the Company to rapidly design and test prototypes to help its customers develop, test and launch successful microwaveable food 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 multi-pack 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 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 customer locations under multi-year machinery use arrangements and (3) the development of proprietary 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. In order to meet customer requirements, the Company has developed a portfolio of packaging machines consisting of three principal machinery lines, which includes a variety of option specific models to meet the specific customer needs. 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 multi-pack ranges 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 U.S., 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, applying backer-cards to blisterpacks, automatic lidding or other automated and customized pick-and-place applications or for dividing or turning filled packages.

 

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^tm, 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 II^®. 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. The Company continues to innovate in new machinery development and design to drive our business and offer customers the latest packaging machinery technology to meet their changing needs.

 

Containerboard/Other

 

In the U.S., 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-capable board machines to more profitable packaging applications. The Company continues to operate two paper machines dedicated to the production of corrugating medium and kraft paper at its West Monroe mill.

 

In 2007, the Company produced approximately 128,000 tons of corrugating medium, approximately 4,000 tons of kraft paper, approximately 3,000 tons of linerboard and approximately 37,000 tons of various other linerboard products from its West Monroe mill. 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 U.S. Outside of the U.S., 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 as they are affected by economic activity and industry capacity.

 

Joint Ventures

 

To market machinery-based packaging systems, the Company is a party to joint ventures with Rengo Riverwood Packaging, Ltd. (in Japan) and Graphic Packaging International — Schur A/S (in Denmark), 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.

 

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 and integrated 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, Kirin, 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 Kraft Foods, 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 and integrated converters who convert the paperboard into cartons for consumer products. The Company has long-standing relationships with a number of major independent and integrated converters who have agreed to purchase a significant portion of their paperboard requirements from the Company and to assist the Company in customer development efforts and who use the Company’s products to grow the market for paperboard.

 

Distribution is primarily accomplished through direct sales offices in the U.S., Australia, Brazil, China, Denmark, Germany, Italy, Japan, Mexico, Spain, 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 2007, the Company did not have any one customer who represented 10% or more of its net sales.

 

Competition

 

A relatively small number of large competitors hold a significant portion of the paperboard packaging industry. The Company’s primary competitors include Altivity, Caraustar Industries, Inc., International Paper Company, MeadWestvaco Corporation, Packaging Corporation of America, R.A. Jones & Company, Inc., Cascades, Inc., and Rock-Tenn Company. There are only two major producers in the U.S. 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, CRB and solid bleached sulphate board (“SBS”) from numerous competitors and, internationally, folding boxboard, white-lined chip, and duplex/triplex paperboard. 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.

 

Energy and Raw Materials

 

Pine pulpwood, 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 largely 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 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. 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 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 U.S. The Macon mill purchases substantially all of its pine pulpwood 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 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, 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 portion of its natural gas requirements, primarily at its U.S. mills through December 2008. The Company plans to continue its hedging program for natural gas as discussed in Note 11 in the Notes to Consolidated Financial Statements included herein under Item 8., “Financial Statements and Supplementary Data”.

 

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 relationships 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 energy, chemical-based inputs and freight. 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 incurs.

 

Backlog

 

Orders from the Company’s principal customers are manufactured and shipped with minimal lead time. The Company did not have a material amount relating to backlog orders at December 31, 2007 or 2006. The Company’s entire backlog at December 31, 2007 is expected to be shipped during the first quarter 2008.

 

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 to understand long term consumer and retailer trends and create new packaging solutions. These innovative solutions across the Company growth platforms provide the business and customers with differentiated packaging solutions. 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 is convenient and with the Company’s customers because it enables them to sell more product. Another award-winning package solution is the Company’s MicroRite even heating trays that are used for frozen entrees or side dishes that benefit from directing heat towards frozen food centers and deflecting heat from vulnerable food edges to emulate in the microwave the even baking delivered by the conventional oven. Qwik Crisp, MicroFlex Q and Quilt Wave complete the microwave product line. This new product line delivers conventional oven quality at microwave preparation speed and convenience to meet the needs of today’s consumers. The Company’s new patented Z-Flute technology is a third area of innovation that

is providing a growth vehicle for the business. Z-Flute technology provides the strength of a corrugate package with the performance characteristics of a folding carton due to the strategic lamination of paperboard strips. For more information on research and development expenses see Note 2 in the Notes to Consolidated Financial Statements included herein under Item 8., “Financial Statements and Supplementary Data”.

 

Patents and Trademarks

 

As of December 31, 2007, the Company had a large patent portfolio, presently owning, controlling or holding rights to more than 1,200 U.S. and foreign patents, with more than 700 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, IntegraPak, MicroRite and Quilt Wave. The Company takes significant steps to protect its intellectual property and proprietary rights. The Company does not believe that the expiration of any of its patents at the end of their normal lives will 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, 2007, the Company had approximately 7,400 employees worldwide (excluding employees of joint ventures), of which approximately 49% were represented by labor unions and covered by collective bargaining agreements. The Company considers its employee relations to be satisfactory.

 

Certain employees in the U.S. are covered by collective bargaining agreements at 11 different sites with 11 union contracts. The Company has contracts with the United Steel, Paper and Forestry, Rubber, Manufacturing, Energy, Allied-Industrial and Service Workers International Union (“USW”), the Association of Western Pulp and Paper Workers (“AWPPW”) and the International Brotherhood of Teamsters (“IBT”).

 

 

Notes:

 

 

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

Environmental Matters

 

The Company is subject to federal, state and local environmental regulations and employs a team of professionals in order to maintain compliance at each of its facilities. For additional information on the financial effects of such regulation and compliance, see Item 7., “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Environmental Matters.”

 

 

The following risks 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 certain forward-looking statements:

 

The Company’s substantial indebtedness may adversely affect its financial health, its ability to obtain financing in the future, and its ability to react to changes in its business.

 

As of December 31, 2007, the Company had an aggregate principal amount of approximately $1.9 billion of outstanding debt. Because of the Company’s substantial debt, the Company’s ability to obtain additional financing for working capital, capital expenditures, acquisitions or general corporate purposes may be restricted in the future. The Company is also exposed to the risk of increased interest costs because approximately $0.6 billion of its debt is at variable rates of interest. As such, a significant portion of the Company’s cash flow from operations must be dedicated to the payment of principal and interest on its indebtedness, thereby reducing the funds available for other purposes. In 2008, the Company estimates it will pay between $145 million and $155 million in interest on its outstanding debt obligations.

 

Additionally, the Company’s Credit Agreement contains covenants that 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. 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.

 

The substantial debt and the restrictions under the Credit Agreement could limit the Company’s flexibility to respond to changing market conditions and competitive pressures as well as its ability to withstand competitive pressures. The material outstanding debt obligations and the Credit Agreement restrictions may also leave the Company more vulnerable to a downturn in general economic conditions or its business or unable to carry out capital expenditures that are necessary or important to its growth strategy and productivity improvement programs.

 

Significant increases in prices for raw materials, energy, transportation and other necessary supplies and services could adversely affect the Company’s financial results.

 

Increases in the cost and availability of raw materials, including petroleum-based materials, the cost of energy, the cost of wood primarily for the West Monroe mill, transportation and other necessary services could have an adverse effect on the Company’s financial results. The Company is also limited in its ability to pass along such cost increases to customers due to contractual provisions and competitive reasons.

 

There is no guarantee that the Company’s efforts to reduce costs will be successful.

 

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. The Company’s ability to implement successfully its business strategies and to realize anticipated savings is subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond the Company’s control. These strategies include the infrastructure and reliability improvements at the Company’s West Monroe mill. If the Company cannot successfully implement the strategic cost reductions or other cost savings plans it may not be able to compete successfully against other manufacturers. In addition, any failure to generate the anticipated efficiencies and savings could adversely affect the Company’s financial results.

Work stoppages and other labor relations matters may make it substantially more difficult or expensive for the Company to manufacture and distribute its products, which could result in decreased sales or increased costs, either of which would negatively impact the Company’s financial condition and results of operations.

 

Approximately 49% of the Company’s workforce is represented by labor unions, whose goals and objectives may differ significantly from the Company’s. The Company may not be able to successfully negotiate new union contracts covering the employees at its various sites without work stoppages or labor difficulties. These events may also occur as a result of other factors. A prolonged disruption at any of the Company’s facilities due to work stoppages or labor difficulties could have a material adverse effect on its net sales, margins and cash flows. In addition, if new union contracts contain significant increases in wages or other benefits, the Company’s margins would be adversely impacted.

 

The Company may not be able to adequately protect its intellectual property and proprietary rights, which could harm its future success and competitive position.

 

The Company’s future success and competitive position depend in part upon its ability to obtain and maintain protection for certain proprietary carton and packaging machine technologies used in its value added products, particularly those incorporating the Fridge Vendor, IntegraPak, MicroFlex Q, MicroRite, Quilt Wave, Qwik Crisp and Z-Flute technologies. Failure to protect the Company’s existing intellectual property rights may result in the loss of valuable technologies or may require it to license other companies’ intellectual property rights. It is possible that any of the patents owned by the Company may be invalidated, circumvented, challenged or licensed to others or any of its pending or future patent applications may not be issued within the scope of the claims sought by the Company, if at all. Further, others may develop technologies that are similar or superior to the Company’s technologies, duplicate its technologies or design around its patents, and steps taken by the Company to protect its technologies may not prevent misappropriation of such technologies.

 

The Company is subject to environmental, health and safety laws and regulations, and costs to comply with such laws and regulations, or any liability or obligation imposed under such laws or regulations, could negatively impact its financial condition and results of operations.

 

The Company is subject to a broad range of foreign, federal, state and local environmental, health and safety laws and regulations, including those governing discharges to air, soil and water, the management, treatment and disposal of hazardous substances, the investigation and remediation of contamination resulting from releases of hazardous substances, and the health and safety of employees. Environmental liabilities and obligations may result in significant costs, which could negatively impact the Company’s financial condition and results of operations.

 

The Company’s operations outside the U.S. are subject to the risks of doing business in foreign countries.

 

The Company has several converting plants in 5 foreign countries and sells its products worldwide. For 2007, before intercompany eliminations, net sales from operations outside of the U.S. represented approximately 17% of the Company’s net sales. The Company’s revenues from export sales fluctuate with changes in foreign currency exchange rates. At December 31, 2007, approximately 7% of its total assets were denominated in currencies other than the U.S. dollar. The Company has significant operations in countries that use the British pound sterling, the Australian dollar, the Japanese yen or the euro as their functional 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.

 

The Company is also subject to the following significant risks associated with operating in foreign countries:

 

 

 

If any of the above events were to occur, the Company’s financial position, results of operations or cash flows could be adversely impacted, possibly materially.

 

The failure to complete the transaction with Altivity could cause the Company to incur significant fees and expenses and could lead to negative perceptions among investors, potential investors and customers.

 

In the event the combination with Altivity is not completed, the Company may bear certain fees and expenses associated with the transaction that would not be offset by any benefits from the transaction, in addition to the significant costs incurred prior to any termination of the Transaction Agreement. In addition, investors, potential investors and customers may consider the failure to complete the transaction to be a significantly negative development regarding the Company. The market price of the Company’s common stock may reflect positive market assumptions that the transaction will be completed and the related benefits will be realized. As a consequent of any or all of the foregoing, the Company’s stock price may be negatively impacted by the failure to complete the transaction.

 

The anticipated benefits of combining the operations of the Company and Altivity may not be realized, and the Company may face difficulties integrating Altivity’s operations.

 

The Company and BCH entered into the Transaction Agreement with the expectation that the transaction would result in various benefits, including, among other things, cost synergies and operating efficiencies. However, the achievement of the anticipated benefits of the transaction, including the cost synergies, cannot be assured or may take longer than expected. In addition, the Company may not be able to integrate Altivity’s operations with the Company’s existing operations without encountering difficulties, including:

 

 

These risks may be exacerbated by the fact that Altivity is the result of the combination of the Smurfit-Stone Container Corporation’s Consumer Packaging Division and the Field Companies in 2006, and Altivity continues to integrate these predecessor companies and receive integration support from Smurfit-Stone Container Corporation. As a result of these risks, the Company may not be able to realize the expected revenue and cash flow growth and other benefits that it expects to achieve from the transaction. In addition, the Company may be required to spend additional time or money on integration efforts that would otherwise have been spent on the development and expansion of its business and services.

 

 

None.

 

Headquarters

 

The Company leases its principal executive offices in Marietta, GA.

 

Manufacturing Facilities

 

A listing of the principal 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 U.S. 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.

 

See also Item 7., “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Environmental Matters.”

 

 

During the fourth quarter of 2007, 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, 2007.

 

Jeffrey H. Coors, 63, was named Vice Chairman of the Company in August 2006 and served until his retirement in December 2007. Mr. Coors continues to serve as a member of the Board of Directors of the Company and served as Executive Chairman since the closing of the Merger in August 2003 until August 2007. Mr. Coors was Chairman of the former Graphic Packaging International Corporation from 2000 until the closing of the Merger, and was its Chief Executive Officer and President from its formation in 1992 until the closing of the Merger in August 2003. 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, 63, was named Vice Chairman of the Company in January 2007 and served until his retirement in December 2007. Prior to that time he had served as a Director, President and Chief Executive Officer of the Company from March 1997 until December 2006. 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, 51, was appointed as a Director, President and Chief Executive Officer of the Company in January 2007. Prior to that time he had served as the Chief Operating Officer since October 2004. Mr. Scheible served as the Company’s Executive Vice President of Commercial Operations from the closing of the Merger in August 2003 until October 2004. Mr. Scheible served as Chief Operating Officer of Graphic Packaging International Corporation from June 1999 until the closing of the Merger. He also served as President of Graphic Packaging International Corporation’s Flexible Division from January to June 1999. Previously, Mr. Scheible 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, 52, 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 the closing of the Merger in 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. From September 1999 until June 2003, Mr. Blount was Senior Vice President and Chief Financial Officer. Mr. Blount was named Vice President and Chief Financial Officer of Riverwood Holding in September 1998. Prior to joining the Company, Mr. Blount spent 13 years at Montgomery Kone, Inc., an elevator, escalator and moving ramp product manufacturer, installer and service provider, serving last as Senior Vice President, Finance.

Michael P. Doss, 41, has been the Senior Vice President, Consumer Products Packaging of the Company since September 2006. From the closing of the Merger in August 2003 through September 2006, Mr. Doss served as the Company’s Vice President of Operations, Universal Packaging Division. Since joining Graphic Packaging International Corporation in 1990, he has held positions of increasing management responsibility, including Plant Manager at the Gordonsville, TN and Wausau, WI facilities. Mr. Doss was Director of Web Systems for the Universal Packaging Division before his promotion to Vice President of Operations.

 

Stephen A. Hellrung, 60, 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, 60, has been the Company’s Senior Vice President, Human Resources since April 2001. Mr. Juby joined the Company in November 2000 and was Director, Corporate Training, until April 2001. Prior to joining the Company, Mr. Juby was Vice President, Human Resources, of National Gypsum Company, from 1994 until 1996.

 

Robert M. Simko, 48, has been the Company’s Senior Vice President, Paperboard since December 2005. From October 2002 until December 2005, Mr. Simko served as 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, 54, has been the Company’s Senior Vice President, Beverage since the closing of the Merger in August 2003 and was the Vice President and General Manager, Brewery Group of the Company from October 1996 until August 2003. Prior to that time, Mr. Schmal held various positions at the Company since 1981.

 

 

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 2007 and 2006 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 Item 7., “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 5 in the Notes to Consolidated Financial Statements included herein under Item 8., “Financial Statements and Supplementary Data”).

 

On February 25, 2008, there were approximately 2,054 stockholders of record and approximately 3,260 beneficial holders of GPC’s common stock.

 

Total Return to Stockholders

 

The following graph compares the total returns (assuming reinvestment of dividends) of the Company’s common stock, the Standard & Poor’s 500 Stock Index and the Dow Jones U.S. Container & Packaging Index. The graph assumes $100 invested on August 11, 2003 (the first day of public trading in the Company’s common stock) in the Company’s common stock and each of the indices. The stock price performance on the following graph is not necessarily indicative of future stock price performance.

 

 

 

The selected consolidated financial data set forth below should be read in conjunction with Item 7., “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements of the Company and in the Notes to Consolidated Financial Statements included herein under Item 8., “Financial Statements and Supplementary Data”.

 

 

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 2007 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 (i) to expand market share in its current markets and to identify and penetrate new markets; (ii) to capitalize on the Company’s customer relationships, business competencies, and mills and converting assets; (iii) to develop and market innovative products and applications; (iv) and to continue to reduce costs by focusing on operational improvements. The Company’s ability to fully implement its strategies and achieve its objective may be influenced by a variety of factors, many of which are beyond its control, such as inflation of raw material and other costs, which the Company cannot always pass through to its customers, and 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, 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 year over year costs by $39.3 million, $67.0 million and $93.6 million in 2007, 2006, and 2005, respectively. The 2007 costs are primarily related to fiber, outside board purchases and corrugated shipping containers ($38.7 million); chemical-based inputs ($8.3 million); and other ($2.7 million). These increases were offset by lower energy costs ($8.9 million), mainly due to the price of natural gas, and freight ($1.5 million). The Company has entered into contracts designed to manage risks associated with future variability in cash flows caused by changes in the price of natural gas. The Company has hedged approximately 45% of its expected natural gas usage for the year 2008. The Company believes that inflationary pressures, including higher costs for fiber, wood and chemical-based inputs will continue to negatively impact its results for 2008. 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 $1,878.4 million of outstanding debt obligations as of December 31, 2007. 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 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. The Company expanded the continuous improvement initiative to include the deployment of Lean principles into manufacturing and supply chain services. As the Company strengthens the systems approach to continuous improvement, Lean supports the efforts to build a high performing culture. During 2007, two converting facilities utilized Lean manufacturing techniques focused on make-ready time reduction or reducing product lead times. In 2008, the Company plans to expand deployment of Lean principles throughout the organization. During 2007, the Company achieved $46.0 million in cost savings through its continuous improvement programs and manufacturing initiatives.

 

Competition and Market Factors.  As some products can be packaged in different types of materials, the Company’s sales are affected by competition from other manufacturers’ coated unbleached kraft paperboard, or CUK board, and other substrates — solid bleached sulfate, or SBS and recycled clay coated news, or CCN. Substitute products also include shrink film and corrugated containers. 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 impact its sales. The Company’s containerboard business is subject to conditions in the cyclical worldwide commodity paperboard markets, which 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 strategic sourcing to its customers; however, pricing and other competitive pressures may occasionally result in the loss of a customer relationship.

 

OVERVIEW OF 2007 RESULTS

 

This management’s discussion and analysis contains an analysis of Net Sales, Income from Operations and other information relevant to an understanding of results of operations. To enhance the understanding of continuing operations, this discussion and analysis excludes discontinued operations for all periods presented. Information on discontinued operations can be found in Note 15 in the Notes to Consolidated Financial Statements included herein under Item 8. “Financial Statements and Supplementary Data”.

 

 

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:

 

 

2007 COMPARED WITH 2006

 

Net Sales

 

 

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

 

 

Paperboard Packaging

 

The Company’s Net Sales from paperboard packaging in 2007 increased by $98.8 million, or 4.4%, to $2,325.9 million from $2,227.1 million in 2006 due to improved pricing across all product lines as well as increased volume in North America open market and consumer packaging. The improvement in pricing reflects negotiated inflationary cost pass-throughs and other contractual increases, as well as price increases on open market rollstock. The 1.9% increase in volume primarily relates to increased carton sales in the North American food and consumer product markets, primarily for frozen and dry cartons, and sales of open market rollstock. North American beer volumes increased and included the introduction of 18 and 20 multi-packs previously packaged in containerboard. Also contributing to the increase was favorable foreign currency exchange rates, primarily in Europe and Australia.

Containerboard/Other

 

The Company’s Net Sales from containerboard/other in 2007 increased by $0.7 million, or 0.7%, to $95.3 million from $94.6 million in 2006 due primarily to improved pricing in the containerboard medium and bag markets. The pricing increase was partially offset by lower volume for liner and post print.

 

Income (Loss) from Operations

 

 

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

 

 

Note:

 

 

Paperboard Packaging

 

The Company’s Income from Operations from paperboard packaging in 2007 increased by $63.1 million, or 43.0%, to $210.0 million from $146.9 million in 2006 due primarily to the increased pricing and volume and improved performance, primarily at the Company’s West Monroe, LA mill. As previously disclosed, the Company had undertaken an initiative to upgrade the mills maintenance program. In addition, cold outage was expanded to include the overhaul of the clarifier in 2006. Continuous improvement initiatives also benefited the other product lines. These increases were partially offset by inflationary pressures, primarily for fiber, chemical-based inputs and outside board purchases.

 

Containerboard/Other

 

The Company’s Loss from Operations from containerboard/other was $13.5 million in 2007 compared to a loss of $17.9 million in 2006. This change of $4.4 million was due primarily to improved pricing in the containerboard medium and bag markets, as well as decreased volume in liner and post print which is sold at a lower margin. These increases were partially offset by inflation.

 

Corporate

 

The Company’s Loss from Operations from corporate was $45.3 million in 2007 compared to a loss of $35.2 million in 2006. This $10.1 million increase was due primarily to increased expenses for stock-based compensation, management incentives, and merger-related expenses related to the anticipated transaction with Altivity. Partially offsetting these increases was the reversal of a $3.0 million liability recorded at the time of the 2003 Merger. In addition, 2006 included a favorable legal settlement.

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

 

Interest Income

 

Interest Income was $0.4 million in 2007 and $0.6 million in 2006.

 

Interest Expense

 

Interest Expense decreased by $3.8 million to $168.2 million in 2007 from $172.0 million in 2006. Interest Expense decreased due to lower average debt balances during the year and the refinancing of the Credit Agreement in May 2007. This decrease was partially offset due to higher interest rates on the unhedged portion of the Company’s floating rate debt. As of December 31, 2007, approximately 31% of the Company’s total debt was subject to floating interest rates.

 

Income Tax Expense

 

During 2007, the Company recognized Income Tax Expense of $23.9 million on Loss before Income Taxes and Equity in Net Earnings of Affiliates of $26.1 million. During 2006, the Company recognized Income Tax Expense of $20.8 million on Loss before Income Taxes and Equity in Net Earnings of Affiliates of $77.6 million. Income Tax Expense for 2007 and 2006 primarily relates to the noncash expense associated with the amortization of goodwill for tax purposes, benefits related to losses in certain foreign countries and tax withholding in foreign jurisdictions. Income tax expense for 2007 also increased due to a liability related to a judgment received in a Swedish tax court.

 

Equity in Net Earnings of Affiliates

 

Equity in Net Earnings of Affiliates was $0.9 million in 2007 and $1.0 million in 2006 and is related to the Company’s equity investment in the joint venture Rengo Riverwood Packaging, Ltd.

 

2006 COMPARED WITH 2005

 

Net Sales

 

 

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

 

 

Paperboard Packaging

 

The Company’s Net Sales from paperboard packaging in 2006 increased by $19.0 million, or 0.9%, to $2,227.1 million from $2,208.1 million in 2005 due primarily to improved pricing and product mix in the North American food and consumer product carton markets. Also contributing to the increase was favorable product mix in the North American beverage market. These increases were partially offset by unfavorable mix

in Europe and lower volumes in the North American food and consumer product carton markets. Additionally, improved pricing in open market rollstock and Asia were completely offset by lower volumes.

 

Containerboard/Other

 

The Company’s Net Sales from containerboard/other in 2006 increased by $8.4 million, or 9.7%, to $94.6 million from $86.2 million in 2005 due primarily to improved pricing in the containerboard medium and liner markets as well as increased volumes of liner and rollstock. These increases were partially offset by unfavorable product mix for liner and medium.

 

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 2006 decreased by $14.4 million, or 8.9%, to $146.9 million from $161.3 million in 2005 due primarily to inflationary pressures primarily on energy, chemical-based inputs, freight, labor and related benefits and higher manufacturing costs, primarily at the Company’s West Monroe, LA mill. These costs include an initiative to upgrade the mill’s preventive maintenance program, the conversion of the mill’s primary boiler to allow for the burning of bark which will in turn lower energy costs, the mill’s bi-annual maintenance cold outage and an unexpected failure in a major turbine generator earlier in the year. The cold outage was expanded to include an overhaul of the clarifier, a key piece of the mill’s effluent system. These decreases were partially offset by worldwide cost reductions resulting from the Company’s cost reduction initiatives, the improved pricing in the North American food and consumer product carton markets and improved manufacturing performance at the Company’s other mills and converting operations.

 

Containerboard/Other

 

The Company’s Loss from Operations from containerboard/other was $17.9 million in 2006 compared to a loss of $16.1 million in 2005. This change of $1.8 million was due primarily to inflationary pressures partially offset by the improved pricing in the containerboard medium markets.

Corporate

 

The Company’s Loss from Operations from corporate was $35.2 million in 2006 compared to a loss of $58.7 million in 2005. This $23.5 million improvement was due primarily to lower Merger related expenses, primarily related to the conversion to the SAP system in 2005, lower consulting fees and expenses related to Sarbanes-Oxley compliance efforts and gains on foreign currency transactions. Offsetting these improvements was the 2005 benefit recorded of $4.5 million relating to the settlement of a lawsuit.

 

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

 

Interest Income

 

Interest Income was $0.6 million in both 2006 and 2005.

 

Interest Expense

 

Interest Expense increased by $15.6 million to $172.0 million in 2006 from $156.4 million in 2005, due to higher interest rates on the unhedged portion of the Company’s floating rate debt.

 

Income Tax Expense

 

During 2006, the Company recognized Income Tax Expense of $20.8 million on Loss before Income Taxes and Equity in Net Earnings of Affiliates of $77.6 million. During 2005, the Company recognized Income Tax Expense of $22.0 million on Loss before Income Taxes and Equity in Net Earnings of Affiliates of $69.3 million. Income Tax Expense for 2006 and 2005 primarily relates to the noncash expense associated with the amortization of goodwill for tax purposes, benefits related to losses in certain foreign countries and tax withholding in foreign jurisdictions.

 

Equity in Net Earnings of Affiliates

 

Equity in Net Earnings of Affiliates was $1.0 million in 2006 and $1.2 million in 2005 and is related to the Company’s equity investment in the joint venture Rengo Riverwood Packaging, Ltd.

 

DISCONTINUED OPERATIONS

 

On October 16, 2007, Graphic Packaging International Holding Sweden AB (the “Seller”), an indirect wholly-owned subsidiary of the Company, entered into a Sale and Purchase Agreement with Lagrumment December nr 1031 Aktiebolg, a company organized under the laws of Sweden that will be renamed Fiskeby International Holding AB (the “Purchaser”), and simultaneously completed the transactions contemplated by such agreement. Pursuant to such Purchase and Sales Agreement, the Purchaser will acquire all of the outstanding shares of Graphic Packaging International Sweden (“GP-Sweden”). GP-Sweden and its subsidiaries are in the business of developing, manufacturing and selling paper and packaging boards made from recycled fiber. The Sale and Purchase Agreement specifies that the purchase price is $8.6 million and contains customary representations and warranties of the Seller.

 

The Purchaser is affiliated with Jeffrey H. Coors, the Vice Chairman and a member of the Board of Directors of the Company. The Seller undertook the sale of GP-Sweden to the Purchaser after a thorough exploration of strategic alternatives with respect to GP-Sweden. The transactions contemplated by the Sale and Purchase Agreement were approved by the Audit Committee of the Board of Directors of the Company pursuant to its Policy Regarding Related Party Transactions and by the full Board of Directors other than Mr. Coors.

 

In accordance with the FASB SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”), the Company reviews long-lived assets for impairment when events or changes in circumstances indicate the carrying value of these assets may exceed their current fair values. During the third quarter of 2007, the Company recognized an impairment charge of $25.2 million relating to GP-Sweden. The

Company’s plan to sell the operations led to the testing for impairment of long-lived assets. The fair value of the impaired assets was determined based on selling price less cost to sell. During the fourth quarter of 2007, the Company recognized a reduction to the impairment charge of $6.6 million for the non-cash currency translation adjustment component of accumulated other comprehensive income related to the sale of the Swedish paperboard mill. This reduction, which should have been recorded in the third quarter, related to the impairment recorded in the third quarter. The Company has determined that the impact of this item was not material to the third quarter or fourth quarter. The impairment charge is reflected as a component of Loss from Discontinued Operations on the Condensed Consolidated Statements of Operations.

 

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 $2.0 million in 2007. Net Cash Provided by Operating Activities in 2007 totaled $141.7 million, compared to $141.3 million in 2006. This increase was principally due to lower Net Loss and the non-cash add backs for the Impairment Charge, the Loss on Early Extinguishment of Debt and the Loss (Gain) on Disposal of Assets. The Impairment Charge and Loss on Disposal of Assets relate to the impairment and subsequent sale of the Swedish operations. The Loss on Early Extinguishment of Debt represents a portion of the unamortized deferred financial cost associated with the previous revolving credit and term loan facilities. The increase was offset by an increase of Operating Assets and Liabilities and higher employer contributions to the pension plan. Changes in Operating Assets and Liabilities used $35.9 million primarily from an increase in Inventories which was due primarily to timing of year-end shipments and a decrease in Interest Payable resulting from lower interest rates and debt balances. These increases were partially offset by an increase in Accounts Payable due to the Company’s implementation of credit cards to process vendor payments which resulted in extended payment periods. Depreciation and Amortization during 2007 totaled $194.8 million.

 

Net Cash Used in Investing Activities in 2007 totaled $90.8 million, compared to $90.4 million in 2006. This year over year change was principally due to proceeds received from the sales of assets primarily related to the sale of the Swedish operations.

 

Net Cash Used in Financing Activities in 2007 totaled $50.0 million, compared to $56.6 million in 2006. This change was principally due to lower net debt repayments in 2007, partially offset by $7.0 million in debt issuance costs related to the refinancing in May 2007.

 

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. The Company believes that cash generated from operations, together with the amounts available under the revolving credit facility will be adequate to meet its debt service, capital expenditures, ongoing operating costs and working capital needs.

 

On May 16, 2007, the Company entered into a new $1,355 million Credit Agreement (“Credit Agreement”). The Credit Agreement provides for a $300 million revolving credit facility due on May 16, 2013 and a $1,055 million term loan facility due on May 16, 2014. The revolving credit facility bears interest at a rate of LIBOR plus 225 basis points and the term loan facility bears interest at a rate of LIBOR plus 200 basis points. The facilities under the Credit Agreement replace the revolving credit facility due on August 8, 2009 and the term loan due on August 8, 2010 under the Company’s previous senior secured credit agreement. The

Company’s obligations under the new Credit Agreement are collateralized by substantially all of the Company’s domestic assets.

 

In connection with the replacement of the Company’s previous revolving credit and term loan facilities and in accordance with Emerging Issues Task Force (“EITF”) 96-19, “Debtor’s Accounting for a Modification or Exchange of Debt Instruments” and EIFT 98-14, “Debtor’s Accounting for Changes in Line-of-Credit or Revolving-Debt Arrangements”, the Company recorded a charge of $9.5 million, which represented a portion of the unamortized deferred financial costs associated with the previous revolving credit and term loan facilities. This charge is reflected as Loss on Early Extinguishment of Debt in the Company’s Consolidated Statement of Operations. In connection with the new Credit Agreement, the Company recorded approximately $7 million of deferred financing costs. These costs, combined with the remainder of the deferred financing costs relating to the previous senior secured credit agreement, will be amortized over the term of the new facilities.

 

Long-Term Debt consisted of the following:

 

 

At December 31, 2007, the Company and its U.S. and international subsidiaries 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 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, 2007, the Company had interest rate swap agreements with a notional amount of $440.0 million, which expire on various dates from 2008 to 2009 under which the Company will pay fixed rates of 4.53% to 5.46% and receive three-month LIBOR rates.

 

Effective as of December 31, 2007, the Company had approximately $1.4 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.

 

Covenant Restrictions

 

The Credit Agreement and the indentures governing the Senior Notes and Senior Subordinated Notes (the “Notes”) limit the Company’s ability to incur additional indebtedness. Additional covenants contained in the Credit Agreement, among other things, restrict the ability of the Company to dispose of assets, incur guarantee obligations, prepay other indebtedness, make dividends 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 (not including the proposed combination of the Company’s business with that of Altivity), change the business conducted by the Company and its subsidiaries, and engage in certain transactions with affiliates. Such restrictions, together with the highly leveraged nature of the Company, could limit the Company’s ability to respond to changing market conditions, fund its capital spending program, provide for unexpected capital investments or take advantage of business opportunities.

 

Under the terms of the Credit Agreement, as long as any commitment remains outstanding under the revolving credit facility, the Company must comply with a maximum consolidated leverage ratio covenant and a minimum consolidated interest expense ratio covenant. The financial covenants contained in the Credit Agreement, among other things, specify the following requirements for each of period of four consecutive fiscal quarters ending March, June, September and December of:

 

 

Note:

 

 

At December 31, 2007, the Company was in compliance with the financial covenants in the Credit Agreement and the ratios were as follows:

 

Consolidated Debt to Credit Agreement EBITDA Leverage Ratio — 5.02 to 1.00

Credit Agreement EBITDA to Consolidated Interest Expense Ratio — 2.32 to 1.00

 

The Company’s management believes that presentation of Credit Agreement EBITDA and the related ratios herein provides useful information to investors because borrowings under the Credit Agreement are a

key source of the Company’s liquidity, and the Company’s ability to borrow under the Credit Agreement is dependent on, among other things, its compliance with the financial ratio covenants. Any failure by the Company to comply with these financial ratio covenants could result in an event of default, absent a waiver or amendment from the lenders under such agreement, in which case the lenders may be entitled to declare all amounts owed to be due and payable immediately.

 

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

 

 

 

 

The Senior Notes are rated B– by Standard & Poor’s and B2 by Moody’s Investor Services. The Senior Subordinated Notes are rated B– by Standard & Poor’s and B3 by Moody’s Investor Services. The Company’s indebtedness under the Credit Agreement is rated BB- by Standard & Poor’s and Ba2 by Moody’s Investor Services. As of December 31, 2007, both Standard & Poor’s and Moody’s Investor Services’ ratings on the Company remain on negative outlook. During 2007, cash paid for interest was approximately $168 million.

 

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 Credit Agreement. The Company’s ability to comply in future periods with the financial covenants in the 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 Credit Agreement and the indentures governing the Notes

have 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 Credit Agreement is collateralized by substantially all of the Company’s domestic assets.

 

Capital Investment

 

The Company’s capital investment in 2007 was $95.9 million, compared to $94.5 million in 2006. During 2007, the Company had capital spending of $58.3 million for improving process capabilities, $23.4 million for capital spares, $14.0 million for manufacturing packaging machinery and $0.2 million for compliance with environmental laws and regulations.

 

Environmental Matters

 

The Company is subject to a broad range of foreign, federal, state and local environmental, health and safety laws and regulations, 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.

 

During the first quarter of 2006, the Company self-reported certain violations of its Title V permit under the federal Clean Air Act for its West Monroe, Louisiana mill to the Louisiana Department of Environmental Quality (the “LADEQ”). The violations relate to the collection, treatment and reporting of hazardous air pollutants. The Company recorded $0.6 million of expense in the first quarter of 2006 for compliance costs to correct the technical issues causing the Title V permit violations. The Company received a consolidated Compliance Order and notice of potential penalty dated July 5, 2006 from the LADEQ indicating that the Company may be required to pay civil penalties for violations that occurred from 2001 through 2005. The Company believes that the LADEQ will assess a penalty of approximately $0.3 million to be paid partially in cash and partially through the completion of beneficial environmental projects.

 

At the request of the County Administrative Board of Östergötland, Sweden, the Company conducted a risk classification of its mill property located in Norrköping, Sweden. Based on the information collected through this activity, the Company determined that some remediation of the site is reasonably probable and recorded a $3.0 million reserve in the third quarter of 2007. Pursuant to the Sale and Purchase Agreement dated October 16, 2007 between Graphic Packaging International Holding Sweden AB (the “Seller”) and Lagrumment December nr 1031 Aktiebolg under which the Company’s Swedish operations were sold, the Seller retains liability for certain environmental claims after the sale. See Note 15 — Discontinued Operations regarding the sale of the Swedish operations.

 

On October 8, 2007, the Company received a notice from the United States Environmental Protection Agency (the “EPA”) indicating that it is a potentially responsible party for the remedial investigation and feasibility study to be conducted at the Devil’s Swamp Lake site in East Baton Rouge Parish, Louisiana. The Company expects to enter into negotiations with the EPA regarding its potential responsibility and liability, but it is too early in the investigation process to quantify possible costs with respect to such site.

The Company has established reserves for those facilities or issues where liability is probable and the costs are reasonably estimable. Except for the Title V permit issue and the Devil’s Swamp issue (for which it is too early in the investigation and regulatory process to make a determination), 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 other future corrective 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.

 

Contractual Obligations and Commitments

 

A summary of our contractual obligations and commitments as of December 31, 2007 is as follows:

 

 

Notes:

 

 

International Operations

 

For 2007, before intercompany eliminations, net sales from operations outside of the U.S. represented approximately 17% of the Company’s net sales. The Company’s revenues from export sales fluctuate with changes in foreign currency exchange rates. At December 31, 2007, approximately 7% of its total assets were denominated in currencies other than the U.S. dollar. The Company has significant operations in countries that use the British pound sterling, the Australian dollar, the Japanese yen or the euro as their functional currencies. The effect of a generally weaker U.S. dollar against these currencies produced a net currency translation adjustment gain of $11.2 million, which was recorded as an adjustment to Shareholders’ Equity for the year ended December 31, 2007. 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 portion of its natural gas requirements through December 2008. 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 Item 7A, “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 $17.8 million in 2007 compared with $26.0 million in 2006. 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 2007 and 2006. The expected long-term rate of return on pension assets was determined based on several factors, including historical rates of return, input from our pension investment consultants and projected long-term returns of broad equity and bond 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, 2007, the net actuarial loss was $52.5 million. These 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 Statement of Financial Accounting Standards (“SFAS”) No. 87, “Employers’ Accounting for Pensions.”

 

The discount rate used to determine the present value of future pension obligations at December 31, 2007 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 increased from a plan specific rate ranging from 5.95% to 6.05% in 2006 to a plan specific rate ranging from 6.15% to 6.35% in 2007. 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 $16 million in 2008. The estimate is based on an expected long-term rate of return of 8.25%, a discount rate ranging from 6.15% to 6.35% and other assumptions. Pension expense beyond 2008 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 .25 percent, pension expense would increase by approximately $1 million and the December 31, 2007 pension funding obligation would increase by about $19 million.

 

The fair value of assets in the U.S. plans was $468.0 million at December 31, 2007 and $441.9 million at December 31, 2006. Lower discount rates have caused the projected benefit obligations to exceed the fair value of plan assets by $128.4 million and $152.7 million as of December 31, 2007 and 2006, respectively. Primarily due to the lower discount rates, the accumulated benefit obligation (“ABO”) exceeded plan assets by $108.8 million at the end of 2007. At the end of 2006, the ABO exceeded the fair value of plan assets by $134.0 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 8 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. See Note 14 in the Notes to Consolidated Financial Statements included herein under Item 8., “Financial Statements and Supplementary Data”.

 

• Deferred Income Taxes and Potential Assessments

 

As of December 31, 2007, the Company, in accordance with Accounting Principles Board (“APB”) Opinion 23, “Accounting for Income Taxes, Special Areas” has determined that $61.0 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 $28.3 million. As of December 31, 2006, the Company had determined that $67.2 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 $30.2 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 most likely outcome 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 2 in the Notes to Consolidated Financial Statements included herein under Item 8., “Financial Statements and Supplementary Data”.

 

BUSINESS OUTLOOK

 

The Company expects inflationary pressures for production inputs, including higher costs for fiber, wood and chemical-based inputs, to continue to impact results in 2008. To help offset inflation in 2008, the Company expects to realize approximately $40 million in year over year operating cost savings from its continuous improvement programs, including Lean manufacturing projects. In addition, contractual price escalators and price increases in 2007 for coated board and cartons should favorably impact 2008.

 

Total capital investment for 2008 is expected to be between approximately $100 million and $120 million and is expected to relate principally to the Company’s process capabilities improvements and for maintaining compliance with environmental laws and regulations (approximately $72 million), capital spares (approximately $25 million), and the production of packaging machinery (approximately $13 million),

 

The Company also expects the following in 2008:

 

 

 

The Company does not trade or use derivative instruments with the objective of earning financial gains on interest or currency rates, nor does it use leveraged instruments or instruments where there are no underlying exposures identified.

 

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 $440.0 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 effectively 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 these accounts receivable will be adversely affected by changes in exchange rates. At December 31, 2007, multiple foreign currency forward exchange contracts existed, with maturities ranging up to three months. Those forward currency exchange contracts outstanding at December 31, 2007, when aggregated and measured in U.S. dollars at December 31, 2007 exchange rates, had net notional amounts totaling $14.5 million. The Company continuously monitors these forward exchange contracts and adjusts accordingly to minimize the exposure.

 

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.

 

Minimal amounts were reclassified to earnings during 2007 in connection with forecasted transactions that were no longer considered probable of occurring due to the sale of the Swedish operations and there was no amount of ineffective portion related to changes in the fair value of foreign currency forward contracts. No amounts were reclassified to earnings during 2006 in connection with forecasted transactions that were no longer considered probable of occurring and there was no amount of ineffective portion related to changes in

the fair value of foreign currency forward contracts. Additionally, there were no amounts excluded from the measure of effectiveness.

 

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 approximately 45% of its expected natural gas usage through December 2008 with a weighted average contractual rate of $8.14 per MMBTU. The carrying amount and fair value of the natural gas swap contracts is a liability of $1.1 million as of December 31, 2007, and is recorded as 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 Shareholders’ Equity. 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.

 

 

INDEX TO FINANCIAL STATEMENTS

 

GRAPHIC PACKAGING CORPORATION

 

 

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

GRAPHIC PACKAGING CORPORATION