10-K 1 d10k.htm FORM 10-K Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

(Mark One)

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

For the fiscal year ended December 31, 2007

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File Number: 333-53603-03

 

 

GRAHAM PACKAGING HOLDINGS COMPANY

(Exact name of registrant as specified in its charter)

 

 

 

Pennsylvania   23-2553000

(State or other jurisdiction of

Incorporation or organization)

 

(I.R.S. Employer

Identification No.)

2401 Pleasant Valley Road

York, Pennsylvania 17402

(717) 849-8500

(Address, including zip code, and telephone number, including

area code, of the registrant’s principal executive offices)

 

 

Securities Registered pursuant to Section 12(b) of the Act: None

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 by Rule 405 of the Securities Act.    Yes  ¨    No  x.

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  ¨    No  x.

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  x    No  ¨.

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.    x

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):

 

Large accelerated filer  ¨

   Accelerated filer  ¨

Non-accelerated filer (Do not check if a smaller reporting company)  x

   Smaller reporting company  ¨

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

There is no established public trading market for any of the general or limited partnership interests in the registrant. The aggregate market value of the voting securities held by non-affiliates of the registrant as of March 15, 2008 was $-0-. As of March 15, 2008, the general partnership interests in the registrant were owned by BCP /Graham Holdings L.L.C. and Graham Packaging Corporation, and the limited partnership interests in the registrant were owned by BMP/Graham Holdings Corporation and certain members of the family of Donald C. Graham and entities controlled by them. See “Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”

DOCUMENTS INCORPORATED BY REFERENCE

None.

 

 

 


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GRAHAM PACKAGING HOLDINGS COMPANY

INDEX

 

          Page
Number

PART I

     

Item 1.

  

Business

   5

Item 1A.

  

Risk Factors

   15

Item 1B.

  

Unresolved Staff Comments

   21

Item 2.

  

Properties

   21

Item 3.

  

Legal Proceedings

   23

Item 4.

  

Submission of Matters to a Vote of Security Holders

   24

PART II

     

Item 5.

  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

   24

Item 6.

  

Selected Financial Data

   25

Item 7.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   27

Item 7A.

  

Quantitative and Qualitative Disclosures About Market Risk

   42

Item 8.

  

Financial Statements and Supplementary Data

   45

Item 9.

  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

   96

Item 9A.

  

Controls and Procedures

   96

Item 9B.

  

Other Information

   98

PART III

     

Item 10.

  

Advisory Committee Members; Executive Officers of the Registrant and Corporate Governance

   99

Item 11.

  

Executive Compensation

   101

Item 12.

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   117

Item 13.

  

Certain Relationships and Related Transactions, and Advisory Committee Member Independence

   119

Item 14.

  

Principal Accounting Fees and Services

   124

PART IV

     

Item 15.

  

Exhibits and Financial Statement Schedules

   125


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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

All statements other than statements of historical facts included in this Annual Report on Form 10-K, including statements regarding the future financial position, economic performance and results of operations of the Company (as defined below), as well as the Company’s business strategy, budgets and projected costs and plans and objectives of management for future operations, and the information referred to under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (Part II, Item 7) and “Quantitative and Qualitative Disclosures About Market Risk” (Part II, Item 7A), are forward-looking statements. In addition, forward-looking statements generally can be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “estimate,” “anticipate,” “believe” or “continue” or similar terminology. These forward-looking statements are not historical facts, and are based on current expectations, estimates and projections about the Company’s industry, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond the Company’s control. Accordingly, readers are cautioned that any such forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable as of the date made, expectations may prove to have been materially different from the results expressed or implied by such forward-looking statements. Unless otherwise required by law, the Company also disclaims any obligation to update its view of any such risks or uncertainties or to announce publicly the result of any revisions to the forward-looking statements made in this report. Important factors that could cause actual results to differ materially from the Company’s expectations include, without limitation:

 

   

the Company’s continuing net losses;

 

   

the terms of the Company’s debt instruments, which restrict the manner in which the Company conducts its business and may limit the Company’s ability to implement elements of its business strategy;

 

   

the Company’s indebtedness, which could adversely affect the Company’s cash flow;

 

   

that despite the Company’s current levels of indebtedness, the Company may incur additional debt in the future, which could increase the risks associated with the Company’s leverage;

 

   

the Company’s recovery of the carrying value of its assets;

 

   

the Company’s exposure to fluctuations in resin prices and its dependence on resin supplies;

 

   

risks associated with the Company’s international operations;

 

   

the Company’s dependence on significant customers and the risk that customers will not purchase the Company’s products in the amounts expected by the Company under their requirements contracts;

 

   

that the majority of the Company’s sales are made pursuant to requirements contracts;

 

   

a decline in prices of plastic packaging;

 

   

the Company’s ability to develop product innovations and improve the Company’s production technology and expertise;

 

   

infringement on the Company’s proprietary technology;

 

   

sales of the Company’s beverage containers may be affected by cool summer weather;

 

   

risks associated with environmental regulation and liabilities;

 

   

the possibility that the Company’s shareholders’ interests will conflict with the Company’s interests;

 

   

the Company’s dependence on key management and its labor force and the material adverse effect that could result from the loss of their services;

 

   

the Company’s ability to successfully integrate its business with those of other businesses that the Company may acquire;

 

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risks associated with a significant portion of the Company’s employees being covered by collective bargaining agreements; and

 

   

the Company’s dependence on blow molding equipment providers.

See “Item 1A. Risk Factors.” All forward-looking statements attributable to the Company, or persons acting on its behalf, are expressly qualified in their entirety by the cautionary statements set forth in this paragraph.

Unless otherwise indicated, all sources for all industry data and statistics contained herein are estimates contained in or derived from internal or industry sources believed by the Company to be reliable. Market data and certain industry forecasts used herein were obtained from internal surveys, market research, publicly available information and industry publications. Industry publications generally state that the information contained therein has been obtained from sources believed to be reliable, but that the accuracy and completeness of such information is not guaranteed. Similarly, internal surveys, industry forecasts and market research, while believed to be reliable, have not been independently verified, and the Company makes no representations as to the accuracy of such information.

 

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PART I

 

Item 1. Business

Unless the context otherwise requires, all references herein to the “Company,” “we,” “our” or “us” refer to Graham Packaging Holdings Company (“Holdings”) and its subsidiaries. Graham Packaging Company, L.P. (the “Operating Company”) is a wholly owned subsidiary of Holdings. References to the “Blackstone Investors” herein refer to Blackstone Capital Partners III Merchant Banking Fund L.P., Blackstone Offshore Capital Partners III L.P. and Blackstone Family Investment Partnership III L.P. References to the “Graham Family Investors” herein refer to Graham Capital Company, GPC Investments LLC and Graham Alternative Investment Partners I or affiliates thereof or other entities controlled by Donald C. Graham and his family. All references to “Management” herein shall mean the Management of the Operating Company at the time in question, unless the context indicates otherwise.

Plastic containers represent one of the faster growing segments in rigid packaging. The plastic container segment of the rigid packaging industry can de divided into two product types, commodity plastic containers, such as containers for soft drinks and water, and value-added, custom plastic containers, which include unique design features for specialized performance characteristics and product differentiation. Commodity plastic containers are manufactured using stock designs by both independent producers and in-house packaging operations of major beverage companies. Value-added, custom plastic containers are produced through specialized manufacturing processes using resin combinations and structures to create tailor-made solutions for customers seeking performance characteristics, including shelf stability and product differentiation, including unique shapes and high-function dispensers.

The Company focuses on the sale of value-added, custom plastic packaging products principally to large, multinational companies in the food and beverage, household, automotive lubricants and personal care/specialty product categories. The Company has manufacturing facilities in Argentina, Belgium, Brazil, Canada, Finland, France, Hungary, Mexico, the Netherlands, Poland, Spain, Turkey, the United Kingdom, the United States and Venezuela.

General

Holdings was formed under the name “Sonoco Graham Company” on April 3, 1989 as a Pennsylvania limited partnership. It changed its name to “Graham Packaging Company” on March 28, 1991 and to “Graham Packaging Holdings Company” on February 2, 1998. The Operating Company was formed under the name “Graham Packaging Holdings I, L.P.” on September 21, 1994 as a Delaware limited partnership and changed its name to “Graham Packaging Company, L.P.” on February 2, 1998. The predecessor to Holdings, controlled by the predecessors of the Graham Family Investors, was formed in the mid-1970’s as a regional domestic custom plastic container supplier. The primary business activity of Holdings is its direct and indirect ownership of 100% of the partnership interests in the Operating Company. On October 7, 2004, the Company acquired the blow molded plastic container business of Owens-Illinois, Inc. (“O-I Plastic”). With this acquisition the Company essentially doubled in size. On March 24, 2005, the Company acquired certain operations from Tetra-Pak Inc., Tetra Pak Moulded Packaging Systems Limited, Tetra Pak S.R.L., Tetra Pak MPS N.V., Tetra Pak LTDA and Tetra Pak Paketleme Sanayi Ve Ticaret A.S. The Company’s operations have included the operations of the acquired entities since their respective acquisition dates.

The principal executive offices of the Company are located at 2401 Pleasant Valley Road, York, Pennsylvania 17402, telephone (717) 849-8500. The Company maintains a website at www.grahampackaging.com. The Company makes available on its website, free of charge, its annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K as soon as practical after the Company files these reports with the U.S. Securities and Exchange Commission (“SEC”). The information contained on the Company’s website is not incorporated by reference herein.

 

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The Company is organized and managed on a geographical basis in three operating segments: North America, Europe and South America. Each operating segment includes four major categories: Food and Beverage, Household, Automotive Lubricants and Personal Care/Specialty.

The Company is a worldwide leader in the design, manufacture and sale of value-added, custom blow molded plastic containers for branded consumer products. The Company’s primary strategy is to operate in product categories where it can take advantage of the continuing conversion trend toward value-added plastic packaging in place of glass, metal and paperboard packaging. The Company pursues opportunities with selected major consumer product companies that it expects will lead the conversion to plastic in these categories. The Company utilizes its innovative design, engineering and technological capabilities to deliver customized, value-added products to its customers in these product categories.

From 1998 through 2007, net sales grew at a compounded annual growth rate of over 17% as a result of the Company’s capital investment and focus on the high growth food and beverage conversions from glass, paper and metal containers to plastic packaging, the acquisition on October 7, 2004 of O-I Plastic and an increase in resin prices (which leads to an increase in net sales as cost increases are passed along to customers) during the period. With leading positions in each of the core product categories, the Company believes it is poised to continue to benefit from the current conversion trend towards value-added plastic packaging.

The Company has an extensive blue-chip customer base that includes many of the world’s largest branded consumer products companies. Approximately one-third of the Company’s manufacturing facilities are located on-site at its customers’ plants, which the Company believes provides a competitive advantage in maintaining and growing customer relationships. The majority of the Company’s sales are made pursuant to long-term customer purchase orders and contracts. The Company’s containers are manufactured primarily from three plastic resins, including polyethylene terephthalate, or PET, high-density polyethylene, or HDPE, and polypropylene, or PP. In 2007, the Company’s top 20 customers comprised over 71% of its net sales and have been its customers for an average of over 20 years.

Food and Beverage. In the food and beverage product category, the Company produces containers for shelf-stable, refrigerated and frozen juices, non-carbonated juice drinks, teas, sports drinks/isotonics, beer, liquor, yogurt drinks, nutritional beverages, snacks, toppings, sauces, jellies and jams. Management believes, based on internal estimates, that the Company has the leading domestic position in plastic containers for hot-fill juice and juice drinks, sports drinks, drinkable yogurt and smoothies, nutritional supplements, wide-mouth food, dressings, condiments and beer, and the leading global position in plastic containers for yogurt drinks. The Company’s food and beverage sales have grown at a compound annual growth rate of 23% from fiscal 1998 through fiscal 2007. Based on the Company’s knowledge of and experience in the industry, its focus on markets which are likely to convert to plastic, its proprietary technologies and its current market position, Management believes the Company is strategically positioned to benefit from the estimated more than 60% of the domestic thermally processed food and beverage market that has yet to convert to plastic and also to take advantage of evolving domestic and international conversion opportunities like snack foods, beer, baby food, ready-to-drink teas, enhanced water and adult nutritional beverages.

The Company’s largest customers in the food and beverage product category include, in alphabetical order: Abbott Laboratories (“Abbott”), Arizona Beverages Company, LLC (“Arizona”), Clement Pappas & Co., Inc. (“Clement Pappas”), Clorox Products Manufacturing Company (“Clorox”), Coca-Cola North America (“CCNA”), Group Danone (“Danone”), H.J. Heinz Company (“Heinz”), Ocean Spray Cranberries, Inc. (“Ocean Spray”), PepsiCo, Inc. (“PepsiCo”), The Quaker Oats Company (“Quaker Oats”), Tropicana Products, Inc. (“Tropicana”), Conopco Inc. (“Unilever”) and Welch Foods, Inc. (“Welch’s”). For the years ended December 31, 2007, 2006 and 2005, the Company generated approximately 60.3%, 58.7% and 57.5%, respectively, of its net sales from food and beverage containers.

Household. In the household product category, the Company is a leading supplier of plastic containers for products such as liquid fabric care, dish care and hard-surface cleaners. The growth in prior years was fueled by

 

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conversions from powders to liquids for such products as detergents, household cleaners and automatic dishwashing detergent. Powdered products are packaged in paper based containers such as fiber wound cans and paperboard cartons. The growth of this product category now follows gross domestic product (“GDP”) growth as liquids have gained a predominant share of these products. It should be noted the fabric care industry is now offering some brands in a concentrated formula which will negatively impact sales in this product category.

The Company’s largest customers in the household product category include, in alphabetical order: Church & Dwight Co., Inc. (“Church & Dwight”), Clorox, Colgate-Palmolive Company (“Colgate-Palmolive”), Dial Corporation (“Dial,” a division of Henkel), The Procter & Gamble Company (“Procter & Gamble”) and Unilever. For the years ended December 31, 2007, 2006 and 2005, the Company generated approximately 20.4%, 20.3% and 20.6%, respectively, of its net sales from household containers.

Automotive Lubricants. Management believes, based on internal estimates, that the Company is the leading supplier of one quart/one liter plastic motor oil containers in the United States, Canada and Brazil, supplying most of the motor oil producers in these countries. The Company has been producing automotive lubricants containers since the first plastic automotive lubricants container was introduced over 20 years ago and since then has partnered with its customers to improve product quality and jointly reduce costs through design improvement, reduced container weight and manufacturing efficiencies. The Company’s joint product design and cost efficiency initiatives with its customers have also strengthened its service and customer relationships.

The Company’s largest customers in the automotive lubricants product category include, in alphabetical order: Ashland, Inc. (“Ashland,” producer of Valvoline motor oil), BP Lubricants USA, Inc. (“BP Lubricants,” an affiliated company of BP plc, producer of Castrol motor oil), Chevron Products Company (“Chevron,” a Chevron U.S.A. Inc. Division, producer of Chevron and Havoline motor oils), ExxonMobil Corporation (“ExxonMobil”) and Shell Oil Products US (“Shell,” producer of Shell, Pennzoil and Quaker State motor oils). For the years ended December 31, 2007, 2006 and 2005, the Company generated approximately 11.1%, 11.3% and 11.3%, respectively, of its net sales from automotive lubricants containers.

Personal Care/Specialty. Nearly all of the Company’s sales in the personal care/specialty product category were the result of the acquisition of O-I Plastic. In the personal care/specialty product category, the Company is a supplier of plastic containers for products such as hair care, skin care and oral care. The Company’s product design, technology development and decorating capabilities help its customers build brand awareness for their products through unique, and frequently changing, packaging design. The Company believes it has a leading domestic position in plastic containers for hair care and skin care products.

The Company’s largest customers in the personal care/specialty product category include, in alphabetical order: Intimate Brands, Inc. (“Intimate”), Procter & Gamble and Unilever. For the years ended December 31, 2007, 2006 and 2005, the Company generated approximately 8.2%, 9.7% and 10.6%, respectively, of its net sales from personal care/specialty containers.

Additional information regarding operating segments and product categories is provided in Note 21 of the Notes to Consolidated Financial Statements in this Report.

Raw Materials

PET, HDPE and PP resins constitute the primary raw materials used to make the Company’s products. These materials are available from a number of suppliers and the Company is not dependent upon any single supplier. The Company considers the supply and availability of new materials to be adequate to meet its needs. Management believes that the Company maintains an adequate inventory to meet demands, but there is no assurance this will be true in the future. Changes in the cost of resin are generally passed through to customers by means of corresponding changes in product pricing in accordance with the Company’s agreements with these customers and industry practice. The Company operates one of the largest HDPE bottles-to-bottles recycling

 

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plants in the world, and uses the recycled materials from this plant and other recycled materials in a majority of the Company’s products. The recycling plant is located near the Company’s headquarters in York, Pennsylvania.

Customers

Substantially all of the Company’s sales are made to major branded consumer products companies. The Company’s customers demand a high degree of packaging design and engineering to accommodate complex container shapes and performance and material requirements, in addition to quick and reliable delivery. As a result, many customers opt for long-term contracts, some of which have terms up to ten years. A majority of the Company’s top twenty customers are under long-term contracts. The Company’s contracts typically contain provisions allowing for price adjustments based on changes in raw materials and in some cases the cost of energy and labor, among other factors. In many cases, the Company is the sole supplier of its customers’ custom plastic container requirements nationally, regionally or for a specific brand. For the year ended December 31, 2007, the Company had sales to one customer, PepsiCo, which exceeded 10% of net sales. The Company’s sales to PepsiCo were 13.9% of net sales for the year ended December 31, 2007. For the year ended December 31, 2007, the Company’s twenty largest customers, who accounted for over 71% of net sales, were, in alphabetical order:

 

Customer (1)

  

Category

 

Company

Customer Since (1)

Abbott

   Food and Beverage   Mid 2000s

Arizona

   Food and Beverage   Late 1990s

Ashland (2)

   Automotive Lubricants   Early 1970s

BP Lubricants (3)

   Automotive Lubricants   Late 1960s

Church & Dwight

   Household   Late 1980s

Clement Pappas

   Food and Beverage   Mid 1990s

Clorox

   Food and Beverage and Household   Late 1960s

CCNA

   Food and Beverage   Late 1990s

Colgate-Palmolive

   Household   Mid 1980s

Danone

   Food and Beverage   Late 1970s

Dial

   Household and Personal Care/Specialty   Early 1990s

ExxonMobil

   Automotive Lubricants   Early 2000s

Heinz

   Food and Beverage   Early 1990s

Intimate

   Person Care/Specialty   Late 1980s

Ocean Spray

   Food and Beverage   Early 1990s

PepsiCo (4)

   Food and Beverage   Early 2000s

Frito-Lay

   Food and Beverage   Early 2000s

Quaker Oats

   Food and Beverage   Late 1990s

Tropicana

   Food and Beverage   Mid 1980s

Procter & Gamble

   Household and Personal Care/Specialty   Late 1950s

Shell (5)

   Automotive Lubricants   Early 1970s

Pennzoil-Quaker State

   Automotive Lubricants   Early 1970s

Unilever

   Household, Personal Care/Specialty and Food and Beverage   Early 1970s

Welch’s

   Food and Beverage   Early 1990s

 

(1) These companies include their predecessors, if applicable, and the dates may reflect customer relationships initiated by predecessors to the Company or entities acquired by the Company.

 

(2) Ashland is the producer of Valvoline motor oil.

 

(3) BP Lubricants is the producer of Castrol motor oil.

 

(4) PepsiCo includes Frito-Lay, Quaker Oats and Tropicana.

 

(5) Shell includes Pennzoil-Quaker State.

 

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International Operations

The Company has significant operations outside the United States in the form of wholly owned subsidiaries and other arrangements. As of the end of 2007, the Company had 28 manufacturing facilities located in countries outside of the United States. Each of the Company’s operating segments produces plastic containers for all four of the Company’s core product categories.

South America. The Company has one on-site plant in Argentina, three on-site plants in Brazil and one off-site plant in each of Argentina, Brazil and Venezuela.

Mexico. In Mexico, the Company has three off-site plants and two on-site plants.

Europe. The Company has on-site plants in each of Belgium (2), France, Hungary, the Netherlands, Poland, Spain and Turkey and seven off-site plants in Finland, France (2), the Netherlands, Poland, Turkey and the United Kingdom.

Canada. The Company has one off-site facility located near Toronto, Canada to service Canadian and northern U.S. customers.

Competition

The Company faces substantial regional and international competition across its product lines from a number of well-established businesses. The Company’s primary competitors include Alpla Werke Alwin Lehner GmbH, Amcor Limited, Ball Corporation, Consolidated Container Company LLC, Constar International Inc., Plastipak, Inc. and Silgan Holdings Inc. Several of these competitors are larger and have greater financial and other resources than the Company. Management believes that the Company competes effectively because of its superior levels of service, speed to market and product design and development capabilities.

Marketing and Distribution

The Company’s sales are made primarily through its own direct sales force, as well as selected brokers. Sales activities are conducted from the Company’s corporate headquarters in York, Pennsylvania and from field sales offices located in North America, Europe and South America. The Company’s products are typically delivered by truck, on a daily basis, in order to meet customers’ just-in-time delivery requirements, except in the case of on-site operations. In many cases, the Company’s on-site operations are integrated with its customers’ manufacturing operations so that deliveries are made, as needed, by direct conveyance to the customers’ filling lines. The Company utilizes a number of outside warehouses to store its finished goods prior to delivery to the customer.

Superior Product Design and Development Capabilities

The Company’s ability to develop new, innovative containers to meet the design and performance requirements of its customers has established the Company as a market leader. The Company has demonstrated significant success in designing innovative plastic containers that require customized features such as complex shapes, reduced weight, handles, grips, view stripes, pouring features and graphic-intensive customized labeling, and often must meet specialized performance and structural requirements such as hot-fill capability, recycled material usage, oxygen barriers, flavor protection and multi-layering. In addition to increasing demand for its customers’ products, the Company believes that its innovative packaging stimulates consumer demand and drives further conversion to plastic packaging. Consequently, the Company’s strong design capabilities have been especially important to its food and beverage customers, who generally use packaging to differentiate and add value to their brands while spending less on promotion and advertising. The Company has been awarded significant contracts based on these unique product design capabilities that it believes set it apart from its competition. Some of the Company’s design and conversion successes over the past few years include:

 

   

retortable PP container for Boost and Ensure adult nutritional beverages;

 

 

 

aseptic HDPE container for 8th Continent soy-based beverages;

 

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hot-fill PET containers with Monosorb™ oxygen scavenger for juices;

 

   

hot-fill PET and PP wide-mouth jar for Ragu pasta sauce, Seneca applesauce, Welch’s jellies and jams and Del Monte fruit slices;

 

   

a multi-layer HDPE canister for Frito-Lay’s Stax product;

 

   

a multi-layer SurShot™ PET container for ketchup, beer and juices; and

 

   

a true wide-mouth Downy Simple Pleasures PET bottle for Procter & Gamble.

The Company’s innovative designs have also been recognized, through various awards, by a number of customers and industry organizations, including its:

 

   

multi-layer PP wide-mouth jar for Del Monte (2007 Ameristar Award);

 

   

PET “Apple” container for Martinelli’s (2007 WorldStar Award, 2006 DuPont Award, 2006 Ameristar Award);

 

   

PET rectangular juice bottle for Tree Top (2007 WorldStar Award, 2006 Ameristar Award);

 

   

PET “Fridge Fit” bottle for Heinz (2006 Ameristar Award and 2006 DuPont Award);

 

   

dual-chamber bottle for Procter & Gamble Cosmetics (2005 Food & Drug Personal Care package of the year);

 

   

ATP panel-free single serve bottle and 64 oz. rectangular hot-fill bottle (2004 Ameristar Award);

 

   

Ensure reclosable bottle (2004 Ameristar Award and 2004 DuPont Award);

 

   

Flexa Tube™ (2003 DuPont Award, 2003 Ameristar Award and 2003 Food & Drug Packaging Award);

 

   

Coca-Cola Quatro bottle (2002 Mexican Packaging Association); and

 

   

Sabritas (PepsiCo) Be-Light bottle (2002 Mexican Packaging Association).

The Company has an advanced multi-layer injection technology, trade named SurShot™. The Company believes that SurShot™ is among the best multi-layer PET technologies available and billions of plastic containers are produced and sold each year using SurShot™ technology. Currently, the Company is co-developing an advanced 144 cavity SurShot™ machine, under its long-term technical arrangement with Husky Injection Molding Systems Ltd., which will offer significant production cost advantages. The Company will have exclusive rights to use this leading edge machine.

There has been increasing demand by customers for the Company’s innovative packages that meet new sustainability requirements for reduced weight. Management believes the Company’s design and development capabilities has positioned the Company as the packaging design, development and technology leader in the industry. Over the past several years the Company has received and has filed for numerous patents. See “—Intellectual Property.”

In 2005, the Company enhanced its technical capability with the opening of the Global Innovation & Design Center in York, Pennsylvania. The Company also has two major Technology Centers in York, PA and Warsaw, Poland capable of producing limited quantities of new products and refurbishing equipment. The Company’s Warsaw facility also manufactures and assembles a proprietary line of extrusion blow molding machines.

The Company expenses costs to research, design and develop new packaging products and technologies as incurred. Such costs, net of any reimbursement from customers, were $11.6 million, $16.5 million and $15.8 million for the years ended December 31, 2007, 2006 and 2005, respectively.

 

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Manufacturing

A critical component of the Company’s strategy is to locate manufacturing facilities on-site, reducing expensive shipping and handling charges and increasing production and distribution efficiencies. The Company is a leader in providing on-site manufacturing arrangements. As of the end of 2007, approximately one-third of its 83 manufacturing facilities were on-site at customer and vendor facilities. The Company operates over 850 production lines. The Company sometimes dedicates particular production lines within a plant to better service customers. The plants generally operate 24 hours a day, five to seven days a week, although not every production line is run constantly. When customer demand requires, the plants run seven days a week. Historically, demand for the Company’s products has not been subject to large seasonal fluctuations.

In the blow molding process used for HDPE applications, resin pellets are blended with colorants or other necessary additives and fed into the extrusion machine, which uses heat and pressure to form the resin into a round hollow tube of molten plastic called a parison. In a wheel blow molding process, bottle molds mounted radially on a wheel capture the parison as it leaves the extruder. Once inside the mold, air pressure is used to blow the parison into the bottle shape of the mold. While certain of the Company’s competitors also use wheel technology in their production lines, the Company has developed a number of proprietary improvements which Management believes permit the Company’s wheels to operate at higher speeds and with greater efficiency in the manufacture of containers with one or more special features, such as multiple layers and in-mold labeling.

In the stretch blow molding process used for hot-fill PET applications, resin pellets are fed into an injection molding machine that uses heat and pressure to mold a test tube shaped parison or “preform.” The preform is then fed into a blow molder where it is re-heated to allow it to be formed through a stretch blow molding process into a final container. During this re-heat and blow process, special steps are taken to induce the temperature resistance needed to withstand high temperatures on customer filling lines. Management believes that the injection molders and blow molders used by the Company are widely recognized as the leading technologies for high speed production of hot-fill PET containers and have replaced less competitive technologies used initially in the manufacture of hot-fill PET containers.

Other blow molding processes include: various types of extrusion blow molding for medium- and large-sized HDPE and PP containers; stretch blow molding for medium-sized PET containers; injection blow molding for personal care containers in various materials; two-stage PET blow molding for high-volume, high-performance mono-layer, multi-layer and heat set PET containers; and proprietary blow molding for drain-back systems and other specialized applications.

The Company also operates a variety of bottle decorating platforms. Labeling and decorating is accomplished through in-mold techniques or one of many post-molding methods. Post-molding methods include pressure sensitive labelers, rotary full-wrap labelers, silk-screen decoration, heat transfer and hot stamp. These post-molding methods of decoration or labeling can be in-line or off-line with the molding machine. Typically, these decoration methods are used for bottles in the personal care/specialty product category.

The Company has implemented various process improvements to minimize labor costs, automate assembly tasks, increase throughput and improve quality. Types of automation range from case and tray packers to laser guided vehicles. Other automation equipment includes box and bulk bottle palletizers, pick and place robots, automatic in-line leak detection and vision inspection systems. Assembly automation includes bottle trimming, spout spinwelding or insertion, cap insertion and tube cutting/welding. Management believes that there are additional automation opportunities which could further minimize labor costs and improve plant efficiency.

The Company maintains a quality control program with respect to suppliers, line performance and packaging integrity for its containers. The Company’s production lines are equipped with various automatic inspection machines that electronically inspect containers. Additionally, product samples are inspected and tested by Company employees on the production line for proper dimensions and performance and are also inspected and audited after packaging. Containers that do not meet quality standards are crushed and recycled as raw

 

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materials. The Company monitors and updates its inspection programs to keep pace with modern technologies and customer demands. Quality control laboratories are maintained at each manufacturing facility to test its products.

The Company has highly modernized equipment in its plants, consisting primarily of rotational wheel systems and shuttle systems, both of which are used for HDPE and PP blow molding, and injection-stretch blow molding systems for value-added PET containers. The Company is also pursuing development initiatives in barrier technologies to strengthen its position in the food and beverage product category. In the past, the Company has achieved substantial cost savings in its manufacturing process through productivity and process enhancements, including increasing line speeds, utilizing recycled products, reducing scrap and optimizing plastic weight requirements for each product’s specifications.

Cash paid for property, plant and equipment, excluding acquisitions, for 2007, 2006 and 2005 was $153.4 million, $190.5 million and $257.6 million, respectively. Management believes that capital expenditures to maintain and upgrade property, plant and equipment are important to remain competitive. Management estimates that on average the annual maintenance capital expenditures are approximately $30 million to $40 million per year. For 2008, the Company expects to make capital expenditures, excluding acquisitions, ranging from $140 million to $160 million.

Most customer orders are manufactured with a lead time of three weeks or less. Therefore, the amount of backlog orders at December 31, 2007, was not material. The Company expects all backlog orders at December 31, 2007, to be shipped during the first quarter of 2008.

 

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Ownership

The following chart shows the Company’s ownership structure:

LOGO

Holdings is currently owned by (i) BMP/Graham Holdings Corporation, a Delaware corporation (93.7%-owned by the Blackstone Investors, 4.8%-owned by DB Investment Partners, Inc. and 1.5%-owned by Management) (“Investor LP”), who owns an 81% limited partnership interest, (ii) BCP/Graham Holdings L.L.C., a Delaware limited liability company (wholly owned by BMP/Graham Holdings Corporation) (“Investor GP” and, together with Investor LP, the “Equity Investors”), who owns a 4% general partnership interest, (iii) GPC Holdings, L.P., a Pennsylvania limited partnership (indirectly owned by the Graham Family Investors), who owns a 14.3% limited partnership interest and (iv) Graham Packaging Corporation, a Pennsylvania corporation (indirectly owned by the Graham Family Investors), who owns a 0.7% general partnership interest. Management’s 1.5% ownership interest in Investor LP constitutes a 1.3% interest in Holdings.

 

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Holdings owns a 99% limited partnership interest in the Operating Company, and GPC Opco GP LLC (“Opco GP”), a wholly owned subsidiary of Holdings, owns a 1% general partnership interest in the Operating Company. See “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” (Item 12).

GPC Capital Corp. I (“CapCo I”), a wholly owned subsidiary of the Operating Company, and GPC Capital Corp. II (“CapCo II”), a wholly owned subsidiary of Holdings, were incorporated in Delaware in January 1998. The sole purpose of CapCo I is to act as co-obligor of the Senior Notes and Senior Subordinated Notes, as defined herein, and as co-borrower under the Credit Agreement (as defined herein) (see “Item 1A. Risk Factors”). CapCo II currently has no obligations under any of the Company’s outstanding indebtedness. CapCo I and CapCo II have only nominal assets and do not conduct any operations. Accordingly, investors in the Notes, as defined herein, must rely on the cash flow and assets of the Operating Company or the cash flow and assets of Holdings, as the case may be, for payment of the Notes.

Employees

As of December 31, 2007, the Company had approximately 7,800 employees, 6,300 of which were located in North America, 1,100 of which were located in Europe and 400 of which were located in South America. Approximately 81% of the Company’s employees are hourly wage employees, 51% of whom are represented by various labor unions and are covered by various collective bargaining agreements that expire through October 2011. In North America, 82% of the Company’s employees are hourly employees, 44% of whom are represented by various labor unions. In Europe, 79% of the Company’s employees are hourly employees, 92% of whom are represented by various labor unions. In South America, 81% of the Company’s employees are hourly employees, 48% of whom are represented by various labor unions. Management believes that it enjoys good relations with the Company’s employees.

Environmental Matters

The Company’s operations, both in the United States and abroad, are subject to national, state, foreign, provincial and/or local laws and regulations that impose limitations and prohibitions on the discharge and emission of, and establish standards for the use, disposal and management of, regulated materials and waste, and that impose liability for the costs of investigating and cleaning up, and damages resulting from, present and past spills, disposals or other releases of hazardous substances or materials. These domestic and international environmental laws can be complex and may change often. Compliance expenses can be significant and violations may result in substantial fines and penalties. In addition, environmental laws such as the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, also known as “Superfund” in the United States, impose strict, and in some cases joint and several, liability on specified responsible parties for the investigation and cleanup of contaminated soil, groundwater and buildings, and liability for damages to natural resources, at a wide range of properties. As a result, the Company may be liable for contamination at properties that it currently owns or operates, as well as at its former properties or off-site properties where it may have sent hazardous substances. The Company is not aware of any material noncompliance with the environmental laws currently applicable to it and is not the subject of any material environmental claim for liability with respect to contamination at any location. Based on existing information, Management believes that it is not reasonably likely that losses related to known environmental liabilities, in aggregate, will be material to the Company’s financial position, results of operations, liquidity or cash flows. For its operations to comply with environmental laws, the Company has incurred and will continue to incur costs, which were not material in fiscal 2007 and are not expected to be material in the future.

A number of governmental authorities, both in the United States and abroad, have considered, are expected to consider or have passed legislation aimed at reducing the amount of disposed plastic wastes. Those programs have included, for example, mandating certain rates of recycling and/or the use of recycled materials, imposing deposits or taxes on plastic packaging material and/or requiring retailers or manufacturers to take back packaging used for their products. That legislation, as well as voluntary initiatives similarly aimed at reducing the level of

 

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plastic wastes, could reduce the demand for certain plastic packaging, result in greater costs for plastic packaging manufacturers or otherwise impact the Company’s business. Some consumer products companies, including some of the Company’s customers, have responded to these governmental initiatives and to perceived environmental concerns of consumers by using containers made in whole or in part of recycled plastic. To date the Company has not been materially adversely affected by these initiatives and developments. The Company operates one of the largest HDPE bottles-to-bottles recycling plants in the world.

Intellectual Property

The Company holds various patents and trademarks. While in the aggregate the patents are of material importance to its business, the Company believes that its business is not dependent upon any one patent or trademark. The Company also relies on unpatented proprietary know-how and continuing technological innovation and other trade secrets to develop and maintain its competitive position. Others could, however, obtain knowledge of this proprietary know-how through independent development or other access by legal means. In addition to its own patents and proprietary know-how, the Company is a party to licensing arrangements and other agreements authorizing it to use other proprietary processes, know-how and related technology and/or to operate within the scope of certain patents owned by other entities. The duration of the Company’s licenses generally ranges from 5 to 17 years. In some cases the licenses granted to the Company are perpetual and in other cases the term of the license is related to the life of the patent associated with the license. The Company also has licensed some of its intellectual property rights to third parties. See also “Certain Relationships and Related Transactions, and Advisory Committee Member Independance” (Item 13).

 

Item 1A. Risk Factors

The following are certain risk factors that could materially and adversely affect the Company’s business, financial condition or results of operations.

The Company may not generate profits in the future and had net losses in recent years.

For the fiscal years ended December 31, 2007, 2006 and 2005, the Company incurred net losses of $206.1 million, $120.4 million and $52.6 million, respectively. Continuing net losses may limit the Company’s ability to service its debt and fund its operations and the Company may not generate net income from operations in the future. Factors contributing to losses in recent years included, but were not limited to:

 

   

interest on the Company’s debt;

 

   

impairment of the Company’s long-lived tangible and intangible assets;

 

   

the write-off of deferred financing fees related to the Company’s debt refinancings; and

 

   

severance and other payments associated with exiting unprofitable plants.

The terms of the Company’s debt instruments restrict the manner in which the Company conducts its business and may limit the Company’s ability to implement elements of its business strategy.

The instruments and agreements governing the Company’s indebtedness contain numerous covenants including financial and operating covenants, some of which are quite restrictive. These covenants affect, and in many respects limit, among other things, the Company’s ability to:

 

   

incur additional debt;

 

   

create liens;

 

   

consolidate, merge or sell assets;

 

   

make certain capital expenditures;

 

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make certain advances, investments and loans;

 

   

enter into certain transactions with affiliates;

 

   

engage in any business other than the packaging business;

 

   

pay dividends; and

 

   

repurchase stock.

These covenants could restrict the Company in the pursuit of its business strategy.

The Company’s indebtedness could adversely affect the Company’s cash flow.

At December 31, 2007, the Company had $2,534.3 million of total consolidated indebtedness. The Company incurred much of this indebtedness as a result of the acquisition of O-I Plastic. In addition, at December 31, 2007, after taking into account letters of credit of $10.9 million, the Company had $239.1 million of revolving loans available to be borrowed under the Company’s senior secured credit facility (the “Credit Agreement”). Under the Company’s Credit Agreement, the Company also has available to it an uncommitted incremental loan facility in an amount of up to an additional $300.0 million (subject to the Company’s ability to secure lender commitments for all or any portion of the $300.0 million), and the Company may incur additional indebtedness as permitted by its Credit Agreement and other instruments governing the Company’s indebtedness.

A significant portion of the Company’s cash flow must be used to service the Company’s indebtedness and is therefore not available to be used in the Company’s business. In 2007, the Company paid $204.2 million in interest on the Company’s indebtedness. The Company’s ability to generate cash flow is subject to general economic, financial, competitive, legislative, regulatory and other factors that may be beyond the Company’s control. In addition, a substantial portion of the Company’s indebtedness bears interest at floating rates, and therefore a substantial increase in interest rates could adversely impact the Company’s results of operation. Based on the outstanding amount of the Company’s variable rate indebtedness at December 31, 2007, a one percentage point change in the interest rates for the Company’s variable rate indebtedness would impact interest expense by an aggregate of approximately $16.0 million, after taking into account the outstanding notional amount of the Company’s interest rate swap agreements at December 31, 2007.

The Company’s obligations in connection with indebtedness could have important consequences. For example, they could:

 

   

increase the Company’s vulnerability to general adverse economics and industry conditions;

 

   

require the Company to dedicate a significant portion of its cash flow from operations to payments on its indebtedness, thereby reducing the availability of the Company’s cash flow to fund working capital, acquisitions and capital expenditures, and for other general corporate purposes;

 

   

limit the Company’s flexibility in planning for, or reacting to, changes in its business and the industry in which the Company operates;

 

   

restrict the Company from making strategic acquisitions or exploiting business opportunities; and

 

   

limit the Company’s ability to borrow additional funds.

Despite the Company’s current level of indebtedness, the Company may incur additional debt in the future, which could increase the risks associated with the Company’s leverage.

The Company is continually evaluating and pursuing organic growth and acquisition opportunities in its three operating segments and may incur additional indebtedness, including indebtedness under the Company’s Credit Agreement, to finance any such growth and acquisitions and to fund any resulting increased operating needs. If new debt is added to the Company’s current debt levels, the related risks the Company now faces could

 

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increase. The Company will have to affect any new financing in compliance with the agreements governing the Company’s then existing indebtedness.

The Company may not be able to recover the carrying value of its assets.

The Company recorded asset impairment charges of $157.9 million, $25.9 million and $7.3 million for the years ended December 31, 2007, 2006 and 2005, respectively. The Company operates in a competitive industry with rapid technological innovation. In order to remain competitive, the Company develops and invests in new equipment which enhances productivity often making older equipment obsolete. In addition, changing market conditions can also impact the Company’s ability to recover the carrying value of its long-lived assets. The continuing presence of these factors, as well as other factors, could require the Company to record additional asset impairment charges in future periods.

Increases in resin prices and reductions in resin supplies could significantly slow the Company’s growth and disrupt its operations.

The Company depends on large quantities of PET, HDPE and other resins in manufacturing its products. One of its primary strategies is to grow the business by capitalizing on the conversion from glass, metal and paper containers to plastic containers. A sustained increase in resin prices, to the extent that those costs are not passed on to the end-consumer, would make plastic containers less economical for the Company’s customers and could result in a slower pace of conversions to plastic containers. Changes in the cost of resin are passed through to customers by means of corresponding changes in product pricing in accordance with the Company’s agreements with these customers and industry practice. However, if the Company is not able to do so in the future and there are sustained increases in resin prices, the Company’s operating margins could be affected adversely. Furthermore, if the Company cannot obtain sufficient amounts of resin from any of its suppliers, or if there is a substantial increase in oil or natural gas prices, and as a result an increase in resin prices, the Company may have difficulty obtaining alternate sources quickly and economically, and its operations and profitability may be impaired.

The Company’s international operations are subject to a variety of risks related to foreign currencies and local law in several countries.

The Company has significant operations outside the United States in the form of wholly owned subsidiaries and other arrangements. As a result, the Company is subject to risks associated with operating in foreign countries, including fluctuations in currency exchange and interest rates, imposition of limitations on conversion of foreign currencies into dollars or remittance of dividends and other payments by foreign subsidiaries, imposition or increase of withholding and other taxes on remittances and other payments by foreign subsidiaries, labor relations problems, hyperinflation in some foreign countries and imposition or increase of investment and other restrictions by foreign governments or the imposition of environmental or employment laws. For instance, fluctuations in the euro may materially affect the Company’s operating results. Furthermore, the Company typically prices its products in its foreign operations in local currencies. As a result, an increase in the value of the dollar relative to the local currencies of profitable foreign subsidiaries can have a negative effect on the Company’s profitability. In the Company’s consolidated financial statements, the Company translates its local currency financial results into U.S. dollars based on average exchange rates prevailing during a reporting period or the exchange rate at the end of that period. During times of a strengthening U.S. dollar, at a constant level of business, the Company’s reported international sales, earnings, assets and liabilities will be reduced because the local currency will translate into fewer U.S. dollars. Exchange rate fluctuations decreased comprehensive loss by $36.3 million and $23.2 million and increased comprehensive loss by $17.5 million for the years ended December 31, 2007, 2006 and 2005, respectively. In addition to currency translation risks, the Company incurs a currency transaction risk whenever one of its operating subsidiaries enters into either a purchase or a sales transaction using a currency different from the operating subsidiary’s functional currency. Furthermore, changes in local economic conditions can affect operations. The Company’s international operations also expose it to different local political and business risks and challenges. For example, in certain countries the Company is faced

 

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with periodic political issues which could result in currency risks or the risk that the Company is required to include local ownership or management in its businesses. The above mentioned risks in North America, Europe and South America may hurt the Company’s ability to generate revenue in those regions in the future.

The Company would lose a significant source of revenues and profits if it lost its largest customer.

PepsiCo (collectively, with its affiliates, such as Frito-Lay, Gatorade, Quaker Oats and Tropicana) is the Company’s largest customer and all product lines the Company provides to PepsiCo collectively accounted for approximately 13.9% of the Company’s net sales for the year ended December 31, 2007. The Company is not the sole supplier of plastic packaging to PepsiCo. If PepsiCo terminated its relationship with the Company, it could have a material adverse effect upon the Company’s business, financial position or results of operations. Additionally, in 2007, the Company’s top 20 customers comprised over 71% of its net sales. If any of the Company’s largest customers terminated its relationship with the Company, the Company would lose a significant source of revenues and profits. Additionally, the loss of one of the Company’s largest customers could result in the Company having excess capacity if it is unable to replace that customer. This could result in the Company having excess overhead and fixed costs and possible impairment of long-lived assets. This could also result in the Company’s selling, general and administrative expenses and capital expenditures to represent increased portions of its revenues.

Contracts with customers generally do not require them to purchase any minimum amounts of products from the Company, and customers may not purchase amounts that meet the Company’s expectations.

The majority of the Company’s sales are made pursuant to long-term customer purchase orders and contracts. Customers’ purchase orders and contracts typically vary in length with terms up to ten years. The contracts, including those with PepsiCo, generally are requirements contracts which do not obligate the customer to purchase any given amount of product from the Company. Prices under these arrangements are tied to market standards and therefore vary with market conditions. Changes in the cost of resin, the largest component of the Company’s cost of goods sold, are passed through to customers by means of corresponding changes in product pricing in accordance with the Company’s agreements with these customers and industry practice. Despite the existence of supply contracts with its customers and although in the past its customers have not purchased amounts under supply contracts that in the aggregate are materially lower than what the Company has expected, the Company faces the risk that in the future customers will not continue to purchase amounts that meet its expectations.

The Company’s industry is very competitive and increased competition could reduce prices and the Company’s profit margins.

The Company operates in a competitive environment. In the past, the Company has encountered pricing pressures in its markets and could experience further declines in prices of plastic packaging as a result of competition. Although the Company has been able over time to partially offset pricing pressures by reducing its cost structure and making the manufacturing process more efficient, the Company may not be able to continue to do so in the future. The Company’s business, results of operations and financial condition may be materially adversely affected by further declines in prices of plastic packaging and such further declines could lead to a loss of business and a decline in its margins.

If the Company is unable to develop product innovations and improve its production technology and expertise, the Company could lose customers or market share.

The Company’s success may depend on its ability to adapt to technological changes in the plastic packaging industry. If the Company is unable to timely develop and introduce new products, or enhance existing products, in response to changing market conditions or customer requirements or demands, its business and results of operations could be materially and adversely affected.

 

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The Company may be unable to protect its proprietary technology from infringement.

The Company relies on a combination of patents and trademarks, licensing agreements and unpatented proprietary know-how and trade secrets to establish and protect its intellectual property rights. The Company enters into confidentiality agreements with customers, vendors, employees, consultants and potential acquisition candidates as necessary to protect its know-how, trade secrets and other proprietary information. However, these measures and its patents and trademarks may not afford complete protection of its intellectual property, and it is possible that third parties may copy or otherwise obtain and use its proprietary information and technology without authorization or otherwise infringe on its intellectual property rights. The Company cannot assure that its competitors will not independently develop equivalent or superior know-how, trade secrets or production methods. If the Company is unable to maintain the proprietary nature of its technologies, its profit margins could be reduced as competitors imitating its products could compete aggressively against the Company in the pricing of certain products and its business, results of operations and financial condition may be materially adversely affected.

The Company is involved in litigation from time to time in the course of its business to protect and enforce its intellectual property rights, and third parties from time to time initiate litigation against the Company asserting infringement or violation of their intellectual property rights. The Company cannot assure that its intellectual property rights have the value that the Company believes them to have or that its products will not be found to infringe upon the intellectual property rights of others. Further, the Company cannot assure that it will prevail in any such litigation, or that the results or costs of any such litigation will not have a material adverse effect on its business. Any litigation concerning intellectual property could be protracted and costly and is inherently unpredictable and could have a material adverse effect on the Company’s business and results of operations regardless of its outcome.

Sales of the Company’s beverage containers may be affected by cool summer weather which may result in lower sales and profitability.

A significant portion of the Company’s revenue is attributable to the sale of beverage containers. Demand for beverages and the Company’s beverage containers tend to peak during the summer months. In the past, cool summer weather conditions have reduced the demand for beverages, which in turn has reduced the demand for beverage containers manufactured by the Company. Such unseasonably cool summer weather could reduce the Company’s sales and profitability.

The Company’s operations could expose it to substantial environmental costs and liabilities.

The Company is subject to a variety of national, state, foreign, provincial and/or local laws and regulations that impose limitations and prohibitions on the discharge and emission of, and establish standards for the use, disposal and management of, regulated materials and waste, and that impose liability for the costs of investigating and cleaning up, and damages resulting from, present and past spills, disposals or other releases of hazardous substances or materials. These domestic and international environmental laws can be complex and may change often, the compliance expenses can be significant and violations may result in substantial fines and penalties. In addition, environmental laws such as the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, also known as “Superfund” in the United States, impose strict, and in some cases joint and several, liability on specified responsible parties for the investigation and cleanup of contaminated soil, groundwater and buildings, and liability for damages to natural resources, at a wide range of properties. As a result, the Company may be liable for contamination at properties that it currently owns or operates, as well as at its former properties or off-site properties where it may have sent hazardous substances. As a manufacturer, the Company has an inherent risk of liability under environmental laws, both with respect to ongoing operations and with respect to contamination that may have occurred in the past on its properties or as a result of its operations. The Company could, in the future, incur a material liability resulting from the costs of complying with environmental laws or any claims concerning noncompliance, or liability from contamination.

 

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The Company cannot predict what environmental legislation or regulations will be enacted in the future, how existing or future laws or regulations will be administered or interpreted, or what environmental conditions may be found to exist at its facilities or at third party sites for which the Company is liable. Enactment of stricter laws or regulations, stricter interpretations of existing laws and regulations or the requirement to undertake the investigation or remediation of currently unknown environmental contamination at its own or third party sites may require the Company to make additional expenditures, some of which could be material.

In addition, a number of governmental authorities, both in the United States and abroad, have considered, or are expected to consider, legislation aimed at reducing the amount of plastic wastes disposed. Programs have included, for example, mandating certain rates of recycling and/or the use of recycled materials, imposing deposits or taxes on plastic packaging material and requiring retailers or manufacturers to take back packaging used for their products. Legislation, as well as voluntary initiatives similarly aimed at reducing the level of plastic wastes, could reduce the demand for certain plastic packaging, result in greater costs for plastic packaging manufacturers or otherwise impact the Company’s business. Some consumer products companies, including some of the Company’s customers, have responded to these governmental initiatives and to perceived environmental concerns of consumers by using containers made in whole or in part of recycled plastic. Future legislation and initiatives could adversely affect the Company in a manner that would be material.

Blackstone Investors control the Company and may have conflicts of interest with the Company in the future.

The Blackstone Investors indirectly control approximately 80% of the partnership interests in Holdings. Pursuant to the Fifth Amended and Restated Limited Partnership Agreement (the “Holdings Partnership Agreement”) by and among the Graham Family Investors, Graham Packaging Corporation, BCP/Graham Holdings L.L.C. and BMP/Graham Holdings Corporation, holders of a majority of the partnership interests generally have the sole power, subject to certain exceptions, to take actions on behalf of Holdings, including the appointment of management and the entering into of mergers, sales of substantially all assets and other extraordinary transactions. For example, the Blackstone Investors could cause the Company to make acquisitions that increase the amount of its indebtedness or to sell revenue generating assets, impairing the Company’s ability to make payments under its debt agreements. Additionally, the Blackstone Investors are in the business of making investments in companies and may from time to time acquire and hold interests in businesses that compete directly or indirectly with the Company. The Blackstone Investors may also pursue acquisition opportunities that may be complementary to the Company’s business, and as a result, those acquisition opportunities may not be available to the Company. The Graham Family Investors have substantial expertise and knowledge in the Company’s industry and may also from time to time seek to compete, directly or indirectly, with the Company.

The Company’s ability to operate effectively could be impaired if it lost key personnel.

The success of the Company depends to a large extent on a number of key employees, and the loss of the services provided by them could have a material adverse effect on the Company’s ability to operate its business and implement its strategies effectively. The loss of members of the Company’s senior management team could have a material adverse effect on its operations. The Company does not maintain “key” person insurance on any of its executive officers.

If the Company makes acquisitions in the future, it may experience assimilation problems and dissipation of management resources and it may need to incur additional indebtedness.

The Company’s future growth may be a function, in part, of acquisitions of other consumer goods packaging businesses. To the extent that it grows through acquisitions, the Company will face the operational and financial risks commonly encountered with that type of a strategy. The Company would also face operational risks, such as failing to assimilate the operations and personnel of the acquired businesses, disrupting the Company’s ongoing business, dissipating the Company’s limited management resources and impairing relationships with employees and customers of the acquired business as a result of changes in ownership and

 

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management. Additionally, the Company has incurred indebtedness to finance past acquisitions, and would likely incur additional indebtedness to finance future acquisitions, as permitted under the Credit Agreement and the Notes, in which case it would also face certain financial risks associated with the incurrence of additional indebtedness to make an acquisition, such as a reduction in its liquidity, access to capital markets and financial stability.

Additionally, the types of acquisitions the Company will be able to make are limited by the Company’s Credit Agreement, which limits the amount that the Company may pay for an acquisition to $120 million plus additional amounts based on an unused available capital expenditure limit, certain proceeds from new equity issuances and other amounts.

The Company’s operations and profitability could suffer if it experiences labor relation problems.

As of the end of 2007, approximately 3,200 of the Company’s approximately 7,800 employees were covered by collective bargaining agreements with various international and local labor unions. In addition, as of the end of 2007, the Company operated 83 facilities, of which 40 were union facilities operated primarily by union employees. The Company’s union agreements typically have a term of three or four years and thus regularly expire and require negotiation in the course of the Company’s business. In 2008, collective bargaining agreements covering approximately 140 employees will expire. Management believes that the Company enjoys good relations with its employees, and there have been no significant work stoppages in the past three years. Upon the expiration of any of the Company’s collective bargaining agreements, however, the Company may be unable to negotiate new collective bargaining agreements on terms favorable to the Company, and the Company’s business operations at one or more of its facilities may be interrupted as a result of labor disputes or difficulties and delays in the process of renegotiating the Company’s collective bargaining agreements. A work stoppage at one or more of the Company’s facilities could have a material adverse effect on its business, results of operations and financial condition.

The Company’s ability to expand its operations could be adversely affected if it lost access to additional blow molding equipment.

Access to blow molding technology is important to the Company’s ability to expand its operations. The Company has access to a broad array of blow molding equipment and suppliers. However, if the Company fails to continue to access this new blow molding equipment or these suppliers, the Company’s ability to expand its operations may be materially and adversely affected until alternative sources of technology could be arranged. The Equipment Sales, Services and License Agreement (the “Equipment Sales Agreement”) with Graham Engineering Corporation (“Graham Engineering”), as described in “Item 13. Certain Relationships and Related Transactions, and Advisory Committee Member Independance” herein, expired on December 31, 2007. The Company has obtained alternative sources for the equipment supplied by Graham Engineering globally.

 

Item 1B. Unresolved Staff Comments

None.

 

Item 2. Properties

At the end of 2007, the Company owned or leased 83 plants located in Argentina, Belgium, Brazil, Canada, Finland, France, Hungary, Mexico, the Netherlands, Poland, Spain, Turkey, the United Kingdom, the United States and Venezuela. Twenty-seven of the plants are located on-site at customer and vendor facilities. The Company believes that its plants, which are of varying ages and types of construction, are in good condition, are suitable for its operations and generally are expected to provide sufficient capacity to meet its requirements for the foreseeable future.

 

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The following table sets forth the location of the Company’s manufacturing and administrative facilities, their approximate current square footage, whether on-site or off-site and whether leased or owned. In addition to the facilities listed, the Company leases other warehousing space.

 

    

Location

   Size
(Square Feet)
   On-Site
or Off-Site
   Leased/
Owned
   U.S. Packaging Facilities (1)         
1.    Findlay, Ohio    406,800    Off-Site    Owned
2.    York (Household), Pennsylvania    395,554    Off-Site    Owned
3.    Maryland Heights, Missouri    308,961    Off-Site    Owned
4.    Henderson, Nevada    298,407    Off-Site    Owned
5.    Vandalia, Illinois    277,500    Off-Site    Owned
6.    Rockwall, Texas    241,000    Off-Site    Owned
7.    Modesto, California    238,000    Off-Site    Owned
8.    Hazleton (Household), Pennsylvania    218,384    On-Site    Leased
9.    Holland, Michigan    218,168    Off-Site    Leased
10.    Fremont, Ohio    210,883    Off-Site    Owned
11.    Bedford, New Hampshire    210,510    Off-Site    Owned
12.    York (Food & Beverage), Pennsylvania    210,370    Off-Site    Leased
13.    Tolleson, Arizona    209,468    Off-Site    Owned
14.    Cartersville, Georgia    208,000    Off-Site    Owned
15.    Florence (Food and Beverage), Kentucky    203,000    Off-Site    Owned
16.    Woodridge, Illinois    197,462    Off-Site    Leased
17.    Edison, New Jersey (2)    194,000    Off-Site    Owned
18.    Hazleton (Food and Beverage), Pennsylvania    185,080    Off-Site    Owned
19.    Harrisonburg, Virginia    180,000    Off-Site    Owned
20.    Selah, Washington    170,553    Off-Site    Owned
21.    Atlanta, Georgia    165,000    On-Site    Leased
22.    Jefferson, Louisiana    162,047    Off-Site    Leased
23.    Kansas City, Missouri    162,000    Off-Site    Leased
24.    Belvidere, New Jersey    160,000    Off-Site    Owned
25.    Florence (Personal Care/Specialty), Kentucky    153,600    Off-Site    Owned
26.    Montgomery, Alabama    150,143    Off-Site    Leased
27.    Emigsville, Pennsylvania    148,300    Off-Site    Leased
28.    Levittown, Pennsylvania    148,000    Off-Site    Leased
29.    Evansville, Indiana    146,720    Off-Site    Leased
30.    Iowa City, Iowa    140,896    Off-Site    Owned
31.    Baltimore, Maryland    128,500    Off-Site    Owned
32.    Santa Ana, California    127,680    Off-Site    Owned
33.    Chicago, Illinois    125,500    Off-Site    Owned
34.    Muskogee, Oklahoma    125,000    Off-Site    Leased
35.    Kansas City, Kansas    111,000    On-Site    Leased
36.    Casa Grande, Arizona    100,000    Off-Site    Leased
37.    Bradford, Pennsylvania    90,350    Off-Site    Leased
38.    Atlanta, Georgia    81,600    Off-Site    Leased
39.    Lakeland, Florida    80,000    Off-Site    Leased
40.    Berkeley, Missouri    75,000    Off-Site    Owned
41.    Alta Vista, Virginia    62,900    Off-Site    Owned
42.    Lakeland, Florida    59,500    Off-Site    Leased
43.    Cambridge, Ohio    57,000    On-Site    Leased
44.    Port Allen, Louisiana    56,721    On-Site    Leased
45.    Richmond, California    55,256    Off-Site    Leased
46.    Houston, Texas    52,500    Off-Site    Owned
47.    Newell, West Virginia    50,000    On-Site    Leased
48.    Darlington, South Carolina    43,200    On-Site    Leased
49.    Vicksburg, Mississippi    31,200    On-Site    Leased
50.    Bordentown, New Jersey    30,000    On-Site    Leased
51.    Joplin, Missouri    29,200    On-Site    Leased
52.    Minster, Ohio    27,674    On-Site    Leased
53.    West Jordan, Utah    25,760    On-Site    Leased
54.    Bradenton, Florida    21,500    On-Site    Leased

 

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Location

   Size
(Square Feet)
    On-Site
or Off-Site
   Leased/Owned
   Canadian Packaging Facilities        
55.    Mississauga, Ontario    78,416     Off-Site    Owned
   Mexican Packaging Facilities        
56.    Tlalnepantla    214,349     Off-Site    Owned
57.    Pachuca    152,286     Off-Site    Owned
58.    Mexicali    59,700     Off-Site    Leased
59.    Irapuato    54,000     On-Site    Leased
60.    Tlaxcala    9,792     On-Site    Leased
   European Packaging Facilities        
61.    Zoetermeer, Netherlands    254,900     On-Site    Leased
62.    Assevent, France    186,000     Off-Site    Owned
63.    Ryttyla, Finland    182,233     Off-Site    Owned
64.    Rotselaar, Belgium    162,212     On-Site    Leased
65.    Chalgrove, the United Kingdom    132,000     Off-Site    Leased
66.    Etten-Leur, Netherlands    124,450     Off-Site    Leased
67.    Bierun, Poland    114,657     On-Site    Leased
68.    Sulejowek, Poland    83,700     Off-Site    Owned
69.    Meaux, France    80,000     Off-Site    Owned
70.    Aldaia, Spain    75,350     On-Site    Leased
71.    Istanbul, Turkey    50,000     Off-Site    Owned
72.    Lummen, Belgium    42,840     On-Site    Leased
73.    Villecomtal, France    31,300     On-Site    Leased
74.    Eskisehir, Turkey    9,461     On-Site    Leased
75.    Nyirbator, Hungary    5,000     On-Site    Leased
   South American Packaging Facilities        
76.    Valencia, Venezuela    78,871     Off-Site    Leased
77.    Sao Paulo, Brazil    71,300     Off-Site    Leased
78.    Buenos Aires, Argentina (San Martin)    33,524 **   Off-Site    Owned/Leased
79.    Caxias, Brazil    29,493 **   On-Site    Owned/Leased
80.    Longchamps, Argentina    27,976 **   On-Site    Owned/Leased
81.    Inhauma, Brazil    14,208     On-Site    *
82.    Carambei, Brazil    9,310     On-Site    *
   Graham Recycling        
83.    York, Pennsylvania    44,416     Off-Site    Owned
   Administrative Facilities        
  

•     York, Pennsylvania – Technology Center

   159,000     N/A    Leased
  

•     York, Pennsylvania – Corporate Office

   116,400     N/A    Leased
  

•     Sulejowek, Poland

   9,950     N/A    Leased
  

•     Blyes, France

   9,741     N/A    Leased
  

•     Rueil, Paris, France

   4,300     N/A    Leased
  

•     Mexico City, Mexico

   360     N/A    Leased

 

(1) Substantially all of the Company’s domestic tangible and intangible assets are pledged as collateral pursuant to the terms of the Credit Agreement.

 

(2) The Company has announced the closing of this facility.

 

 * The Company operates these on-site facilities without leasing the space it occupies.

 

 ** The building is owned and the land is leased.

 

Item 3. Legal Proceedings

On November 3, 2006, the Company filed a complaint with the Supreme Court of the State of New York against Owens-Illinois, Inc. and OI Plastic Products FTS, Inc. (collectively, “OI”). The complaint alleges certain misrepresentations by OI in connection with the Company’s 2004 purchase of O-I Plastic and seeks damages in excess of $30 million. In December 2006, OI filed an Answer and Counterclaim, seeking to rescind a Settlement Agreement entered into between OI and the Company in April 2005, and disgorgement of more than $39 million

 

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paid by OI to the Company in compliance with that Settlement Agreement. The Company filed a Motion to Dismiss the Counterclaim in July 2007, which was granted by the Court in October 2007. On August 1, 2007, the Company filed an Amended Complaint to add additional claims seeking indemnification from OI for claims made against the Company by former OI employees pertaining to their pension benefits. These claims arise from an arbitration between the Company and Glass, Molders, Pottery, Plastic & Allied Workers, Local #171 (“the Union”) that resulted in an award on April 23, 2007, in favor of the Union. The Arbitrator ruled that the Company had failed to honor certain pension obligations for past years of service to former employees of OI, whose seven Union-represented plants were acquired by the Company in October 2004. In the Amended Complaint, the Company maintains that under Section 8.2 of the Stock Purchase Agreement between the Company and OI, OI is obligated to indemnify the Company for any losses associated with differences in the two companies’ pension plans including any losses incurred in connection with the Arbitration award. The litigation is proceeding.

The Company is party to various other litigation matters arising in the ordinary course of business. The ultimate legal and financial liability of the Company with respect to such litigation cannot be estimated with certainty, but Management believes, based on its examination of these matters, experience to date and discussions with counsel, that ultimate liability from the Company’s various litigation matters will not be material to the business, financial condition, results of operations or cash flows of the Company.

 

Item 4. Submission of Matters to a Vote of Security Holders

No matters were submitted to a vote of security holders during the fourth quarter of 2007.

PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Because Holdings is a limited partnership, equity interests in Holdings take the form of general and limited partnership interests. There is no established public trading market for any of the general or limited partnership interests in Holdings.

There are two owners of general partnership interests in Holdings: Investor GP and Graham Packaging Corporation. The limited partnership interests in Holdings are owned by Investor LP and GPC Holdings, L.P. See “Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”

Opco GP is the sole owner of a general partnership interest in the Operating Company, and Holdings is the sole owner of a limited partnership interest in the Operating Company.

The Operating Company owns all of the outstanding capital stock of CapCo I. Holdings owns all of the outstanding capital stock of CapCo II.

Under the Credit Agreement, the Operating Company is subject to restrictions on the payment of dividends and other distributions to Holdings; provided that, subject to certain limitations, the Operating Company may pay dividends or other distributions to Holdings:

 

   

in respect of overhead, tax liabilities, legal, accounting and other professional fees and expenses; and

 

   

to fund purchases and redemptions of equity interests of Holdings or Investor LP held by then present or former officers or employees of Holdings, the Operating Company or their Subsidiaries (as defined therein) or by any employee stock ownership plan upon that person’s death, disability, retirement or termination of employment or other circumstances with annual dollar limitations.

Holdings has made no cash dividends to its owners.

 

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Item 6. Selected Financial Data

The following tables set forth the selected historical consolidated financial data and other operating data of the Company for and at the end of each of the years in the five-year period ended December 31, 2007, which are derived from the Company’s audited consolidated financial statements. The following tables should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (Item 7) and the Financial Statements included under Item 8.

 

     Year Ended December 31,  
     2007     2006     2005     2004 (1)     2003  
     (In millions)  

STATEMENT OF OPERATIONS DATA:

          

Net sales (2)

   $ 2,493.5     $ 2,520.9     $ 2,473.4     $ 1,353.0     $ 978.7  

Cost of goods sold (2)

     2,154.3       2,233.4       2,177.9       1,159.4       798.4  
                                        

Gross profit (2)

     339.2       287.5       295.5       193.6       180.3  

Selling, general and administrative expenses

     136.4       131.4       127.5       86.3       66.8  

Asset impairment charges (3)

     157.9       25.9       7.3       7.0       2.5  

Net loss (gain) on disposal of fixed assets

     19.5       13.8       13.6       2.2       (2.6 )
                                        

Operating income

     25.4       116.4       147.1       98.1       113.6  

Interest expense (4)

     210.6       207.5       185.0       140.8       97.1  

Interest income

     (0.9 )     (0.5 )     (0.6 )     (0.3 )     (0.5 )

Other expense (income), net

     2.0       2.2       0.2       (1.1 )     (0.3 )

Income tax provision (benefit) (5)

     19.8       27.6       14.4       (2.1 )     6.8  

Minority interest

     —         —         0.7       1.4       0.8  
                                        

Net (loss) income

   $ (206.1 )   $ (120.4 )   $ (52.6 )   $ (40.6 )   $ 9.7  
                                        

OTHER DATA:

          

Cash flow provided by (used in):

          

Operating activities

   $ 174.2     $ 263.0     $ 120.0     $ 107.5     $ 85.7  

Investing activities

     (149.1 )     (172.4 )     (261.4 )     (1,382.5 )     (95.9 )

Financing activities

     (23.2 )     (104.6 )     147.9       1,288.4       8.2  

Depreciation and amortization (6)

     203.0       205.5       201.1       112.1       74.3  

Ratio of earnings to fixed charges (7)

     —         —         —         —         1.2 x

BALANCE SHEET DATA (at period end):

          

Cash and cash equivalents

   $ 18.3     $ 13.3     $ 26.7     $ 22.1     $ 7.1  

Working capital (8)

     158.8       139.4       248.0       184.9       6.4  

Total assets

     2,233.8       2,441.9       2,562.4       2,505.0       876.1  

Total debt (9)

     2,534.3       2,546.9       2,638.3       2,465.2       1,097.4  

Partners’ capital (deficit)

     (787.4 )     (597.8 )     (493.7 )     (434.1 )     (421.5 )

 

(1) On October 7, 2004, the Company acquired O-I Plastic for $1,191.8 million, including direct costs of the acquisition. Amounts shown under the caption “Investing Activities” include cash paid, net of cash acquired, in the acquisition. This transaction was accounted for under the purchase method of accounting. Results of operations are included since the date of the acquisition.

 

(2) Net sales increase or decrease based on fluctuations in resin prices. Changes in the cost of resin are passed through to customers by means of corresponding changes in product pricing in accordance with the Company’s agreements with these customers and industry practice. As resin prices can fluctuate significantly, the Company believes that its gross profit, as well as certain expense items, should not be analyzed solely on a percentage of net sales basis.

 

(3)

The Company evaluated the recoverability of its long-lived tangible and intangible assets in selected locations, due to indicators of impairment, and recorded impairment charges of $156.8 million, $14.2 million, $6.9 million, $7.0 million and $2.5 million for the years ended December 31, 2007, 2006, 2005,

 

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2004 and 2003, respectively. Goodwill is reviewed for impairment on an annual basis. The resulting impairment charges recognized, based on a comparison of the related net book value of the location to projected discounted future cash flows of the location, were $1.1 million, $11.7 million and $0.4 million for the years ended December 31, 2007, 2006 and 2005, respectively. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations” (Item 7) for a further discussion.

 

(4) The years ended December 31, 2007, 2006, 2004 and 2003 included the effects of the refinancing of the Company’s prior senior credit agreements, which resulted in the write-offs of debt issuance fees of $4.5 million, $2.1 million, $20.9 million and $6.6 million, respectively, and the write-off of tender and call premiums of $15.2 million for the year ended December 31, 2004 associated with the redemption of the Company’s prior senior subordinated notes and senior discount notes.

 

(5) As limited partnerships, Holdings and the Operating Company are not subject to U.S. federal income taxes or most state income taxes. Instead, taxes are assessed to Holdings’ partners based on their distributive share of the income of Holdings. Certain U.S. subsidiaries acquired as part of O-I Plastic are corporations subject to U.S. federal and state income taxes. The Company’s foreign operations are subject to tax in their local jurisdictions. Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and are measured using enacted tax rates expected to apply to taxable income in the years in which the temporary differences are expected to reverse.

 

(6) Depreciation and amortization excludes amortization of debt issuance fees, which is included in interest expense, and impairment charges.

 

(7) For purposes of determining the ratio of earnings to fixed charges, earnings are defined as pre-tax earnings from continuing operations before minority interest and income from equity investees, plus fixed charges and amortization of capitalized interest, less interest capitalized. Fixed charges include interest expense on all indebtedness, interest capitalized, amortization of debt issuance fees and one-third of rental expense on operating leases representing that portion of rental expense deemed to be attributable to interest. Earnings were insufficient to cover fixed charges by $189.2 million, $100.0 million, $42.1 million and $41.7 million for the years ended December 31, 2007, 2006, 2005 and 2004, respectively.

 

(8) Working capital is defined as current assets less current liabilities.

 

(9) Total debt includes capital lease obligations.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

Management believes the Company is a worldwide leader in the design, manufacture and sale of customized blow molded plastic containers for the branded food and beverage, household, automotive lubricants and personal care/specialty product categories. As of the end of 2007, the Company operated 83 manufacturing facilities throughout North America, Europe and South America. The Company’s primary strategy is to operate in select markets that will position it to benefit from the growing conversion to value-added plastic packaging from more commodity packaging.

Management believes that critical success factors to the Company’s business are its ability to:

 

   

develop its own proprietary technologies that provide meaningful competitive advantage in the marketplace;

 

   

maintain relationships with and serve the complex packaging demands of its customers which include some of the world’s largest branded consumer products companies;

 

   

participate in growth opportunities associated with the conversion of packaging products from glass, metal and paper to plastic; and

 

   

make investments in plant and technology necessary to satisfy the three factors mentioned above.

On October 7, 2004, the Company acquired O-I Plastic for approximately $1.2 billion (the “Acquisition”). Since October 7, 2004, the Company’s operations have included the operations of O-I Plastic. With this acquisition the Company essentially doubled in size.

Management believes that the area with the greatest opportunity for growth continues to be in producing containers for the food and beverage product category because of the continued conversion to plastic packaging, including the demand for containers for juices, juice drinks, nutritional beverages, sports drinks, teas, yogurt drinks, snacks, beer and other food products. Since much of the growth in this area has been in the sale of smaller sized containers, over the past few years the Company has experienced an overall mix shift toward smaller containers. Based on internal estimates, Management believes the Company is a leader in the value-added segment for hot-fill PET juice containers. Management also believes the Company is a leading participant in the rapidly growing market of yogurt drinks and nutritional beverages where the Company manufactures containers using polyolefin resins. From the beginning of 2005 through December 31, 2007, the Company has invested over $380.0 million in capital expenditures in the food and beverage product category. For the year ended December 31, 2007, the Company’s sales of containers for the food and beverage product category grew to $1,502.4 million from $1,422.5 million in 2005.

The Company’s household container product category is a product category whose growth in prior years was fueled by conversions from powders to liquids for such products as detergents, household cleaners and automatic dishwashing detergent. Powdered products are typically packaged in paper based containers such as fiber wound cans and paperboard cartons. The Company’s strongest position is in fabric care, where Management believes the Company is a leader in plastic container design and manufacture. It should be noted the fabric care industry is now offering some brands in a concentrated formula which management believes will negatively impact sales in this product category by $50 million to $70 million per year. The Company has continually upgraded its machinery, principally in the United States, to new, larger, more productive blow molders in order to standardize production lines, improve flexibility and reduce manufacturing costs.

The Company’s North American one quart motor oil container product category is in a mature industry. Unit volume in the one quart motor oil industry decreased approximately 10% per year from 2005 through 2007 as the product category migrated towards the quick-lube market and larger multi-quart packages.

 

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The Company’s personal care/specialty product category is driven by new product launch and re-launch cycles. Based on the volume of its sales to many major suppliers of personal care/specialty products, Management believes the Company is among the leading suppliers in this product category which includes products for the hair care, skin care, oral care and specialty markets. Management believes that the Company’s leading supply position results from its commitment to and reputation in new product development and flexible manufacturing processes and operations.

As of the end of 2007, the Company operated 28 manufacturing facilities outside of the United States in Argentina, Belgium, Brazil, Canada, Finland, France, Hungary, Mexico, the Netherlands, Poland, Spain, Turkey, the United Kingdom and Venezuela. Over the past few years, the Company has expanded its international operations with the addition of a new plant in the Netherlands, as well as the acquisition of O-I Plastic which included the addition of plants in Finland, Mexico, the Netherlands, the United Kingdom and Venezuela, and the acquisition of certain plants in Brazil, Belgium and Turkey from Tetra-Pak Inc. on March 24, 2005.

For the year ended December 31, 2007, 71.6% of the Company’s net sales were generated by its top twenty customers. The majority of the top twenty customers were under long-term contracts with terms up to ten years, while the balance represents customers with whom the Company has been doing business for over 20 years on average. Prices under these arrangements are typically tied to market standards and, therefore, vary with market conditions. In general, the contracts are requirements contracts that do not obligate the customer to purchase any given amount of product from the Company. The Company had sales to one customer, PepsiCo, which exceeded 10% of total sales in each of the years ended December 31, 2007, 2006 and 2005. The Company’s sales to PepsiCo were 13.9%, 17.0% and 17.9% of total sales for the years ended December 31, 2007, 2006 and 2005, respectively. For the years ended December 31, 2007, 2006 and 2005, approximately 100%, 100% and 98%, respectively, of the sales to PepsiCo were made in North America.

The largest component of the Company’s cost of goods sold is resin costs. Based on industry data, the following table summarizes average market prices per pound of polyethylene terephthalate, or PET, and high-density polyethylene, or HDPE, resins in the United States during 2007, 2006 and 2005:

 

     Year
     2007    2006    2005

PET

   $ 0.82    $ 0.80    $ 0.79

HDPE

     0.73      0.71      0.67

Changes in the cost of resin are passed through to customers by means of corresponding changes in product pricing in accordance with the Company’s agreements with these customers and industry practice. A sustained increase in resin prices, to the extent that those costs are not passed on to the end-consumer, would make plastic containers less economical for the Company’s customers and could result in a slower pace of conversions to plastic containers.

Holdings and the Operating Company, as limited partnerships, do not pay U.S. federal income taxes under the provisions of the Internal Revenue Code, as the applicable income or loss is included in the tax returns of the partners. However, certain U.S. subsidiaries acquired as part of O-I Plastic are corporations and are subject to U.S. federal and state income taxes. The Company’s foreign operations are subject to tax in their local jurisdictions.

 

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Results of Operations

The following tables set forth the major components of the Company’s net sales and such net sales expressed as a percentage of total net sales:

 

     Year Ended December 31,  
     2007     2006     2005  
     (Dollars in millions)  

North America

   $ 2,140.1    85.8 %   $ 2,220.5    88.1 %   $ 2,168.2    87.7 %

Europe

     277.9    11.2       235.9    9.3       240.1    9.7  

South America

     75.5    3.0       64.5    2.6       65.1    2.6  
                                       

Total Net Sales

   $ 2,493.5    100.0 %   $ 2,520.9    100.0 %   $ 2,473.4    100.0 %
                                       
     Year Ended December 31,  
     2007     2006     2005  
     (Dollars in millions)  

Food and Beverage

   $ 1,502.4    60.3 %   $ 1,478.8    58.7 %   $ 1,422.5    57.5 %

Household

     508.0    20.4       512.3    20.3       508.7    20.6  

Automotive Lubricants

     277.9    11.1       284.7    11.3       278.7    11.3  

Personal Care/Specialty

     205.2    8.2       245.1    9.7       263.5    10.6  
                                       

Total Net Sales

   $ 2,493.5    100.0 %   $ 2,520.9    100.0 %   $ 2,473.4    100.0 %
                                       

2007 Compared to 2006

The following table sets forth the condensed consolidated statements of income and related percentage change for the periods indicated:

 

     Year ended
December 31,
    %Increase/
(Decrease)
 
     2007     2006    
     (Dollars in millions)  

Net sales

   $ 2,493.5     $ 2,520.9     (1.1 )%

Cost of goods sold

     2,154.3       2,233.4     (3.5 )
                      

Gross profit

     339.2       287.5     18.0  

% of net sales (1)

     13.6 %     11.4 %  

Selling, general and administrative expenses

     136.4       131.4     3.8  

% of net sales (1)

     5.5 %     5.2 %  

Asset impairment charges

     157.9       25.9     >100.0  

Net loss on disposal of fixed assets

     19.5       13.8     41.3  
                      

Operating income

     25.4       116.4     (78.2 )

% of net sales (1)

     1.0 %     4.6 %  

Interest expense

     210.6       207.5     1.5  

Interest income

     (0.9 )     (0.5 )   80.0  

Other expense, net

     2.0       2.2     (9.1 )

Income tax provision

     19.8       27.6     (28.3 )
                      

Net loss

   $ (206.1 )   $ (120.4 )   (71.2 )%
                      

 

(1) As resin prices can fluctuate significantly, the Company believes that its gross profit, as well as certain expense items, should not be analyzed solely on a percentage of net sales basis.

 

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Net Sales. Net sales for the year ended December 31, 2007 decreased $27.4 million, or 1.1%, to $2,493.5 million from $2,520.9 million for the year ended December 31, 2006. The decrease in sales was primarily due to higher sales of lower priced products and price reductions in response to competitive pressure, offset by an increase in resin costs which are passed through to customers and the positive impact of changes in exchange rates. Container units sold increased 0.4%. On a geographic basis, sales for the year ended December 31, 2007 in North America decreased $80.4 million, or 3.6%, from the year ended December 31, 2006, primarily due to higher sales of lower priced products, price reductions in response to competitive pressure and lower container units sold of 2.8%, offset by an increase in resin costs which are passed through to customers. North American sales in the food and beverage, household, automotive lubricants and personal care/specialty product categories contributed $14.7 million, $15.8 million, $9.0 million and $40.9 million, respectively, to the decrease. Container units sold in North America increased in the household product category by 0.5% and decreased in the food and beverage, automotive lubricants and personal care/specialty product categories by 0.6%, 6.8% and 14.8%, respectively. Sales for the year ended December 31, 2007 in Europe increased $42.0 million, or 17.8%, from the year ended December 31, 2006. The increase in sales was primarily due to currency conversion of $24.8 million and higher container units sold of 7.2% compared to the same period last year. Sales for the year ended December 31, 2007 in South America increased $11.0 million, or 17.1%, from the year ended December 31, 2006. The increase in sales was primarily due to increased volume and currency conversion of $5.9 million.

Gross Profit. Gross profit for the year ended December 31, 2007 increased $51.7 million to $339.2 million from $287.5 million for the year ended December 31, 2006. Gross profit for the year ended December 31, 2007 increased in North America, Europe and South America by $39.7 million, $10.9 million and $1.1 million, respectively, when compared to the year ended December 31, 2006. The increase in gross profit was driven by several factors including ongoing expense reduction initiatives, the absence in 2007 of expenses related to the hurricanes in the United States in the second half of 2005 of $13.6 million, lower project startup costs (primarily costs associated with the startup of equipment and new plants) of $9.4 million, lower integration expenses for the O-I Plastic acquisition of $5.2 million and a weakening of the dollar against the euro and other currencies of $5.3 million.

Selling, General & Administrative Expenses. Selling, general and administrative expenses for the year ended December 31, 2007 increased $5.0 million to $136.4 million from $131.4 million for the year ended December 31, 2006. The increase was primarily due to increases in consulting expenses associated with restructuring of the business and compensation-related expenses, partially offset by a decrease in costs associated with aborted acquisitions, costs related to employee severance and development costs. Selling, general and administrative expenses as a percent of sales increased to 5.5% for the year ended December 31, 2007 from 5.2% for the year ended December 31, 2006.

Asset Impairment Charges. Impairment charges were $157.9 million for the year ended December 31, 2007 as compared to $25.9 million for the year ended December 31, 2006. The Company operates in a competitive industry with rapid technological innovation. In order to remain competitive, the Company develops and invests in new equipment which enhances productivity often making older equipment obsolete. In addition, changing market conditions can also impact the Company’s ability to recover the carrying value of its long-lived assets. During 2007, the Company noted several factors indicating that there may be impairment in some of its asset groups. These included:

 

   

a steady conversion to concentrate containers in the liquid laundry detergent market which will result in decreased sales;

 

   

an ongoing reduction in the automotive quart container business as the Company’s customers convert to multi-quart containers;

 

   

introduction by the Company, and its competitors, of newer production technology in the food and beverage sector which is improving productivity, causing certain of the Company’s older machinery and equipment to become obsolete; and

 

   

the loss of the European portion of a customer’s business.

 

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The Company conducted an impairment test in accordance with Statement of Financial Accounting Standards (“SFAS”) 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” and recorded an impairment charge of $135.7 million for property plant and equipment for the year ended December 31, 2007, compared to $14.2 million for the year ended December 31, 2006. The impairment of property, plant and equipment in 2006 was primarily due to a significant decrease in revenue in several European plants, the discontinuation of preform manufacturing in Europe and the loss of a major customer in South America. Of the 2007 impairment charge, $116.8 million was recorded in North America, $18.3 million was recorded in Europe and $0.6 million was recorded in South America.

The Company also evaluated the recoverability of its intangible assets, and consequently recorded impairment charges related to intangible assets other than goodwill in the United States of $21.1 million for the year ended December 31, 2007. The Company impaired its licensing agreements, customer relationships and patented technologies by $19.1 million, $1.7 million and $0.3 million, respectively, all in its North American Operating Segment. These intangible assets were recorded in conjunction with the acquisition of O-I Plastic in 2004. The licensing agreements were impaired due to lower projected royalty revenues associated with licensing agreements acquired in the acquisition of O-I Plastic as compared to royalty revenues projected at the time of the acquisition. The customer relationships were impaired due primarily to reduced revenues with a major customer as a result of that customer’s policy regarding allocation of its business among several vendors. The impairment in technology is primarily a result of the conversion of a significant portion of the Company’s continuous extrusion manufacturing to Graham Wheel technology.

The Company conducted its annual test for goodwill impairment as of December 31, 2007 and recorded an impairment charge of $1.1 million, as compared to $11.7 million for the year ended December 31, 2006. The 2007 impairment was all due to the Company’s Venezuelan plant while the 2006 impairment was due to the Company’s operations in Ecuador, Finland, the United Kingdom and Venezuela. In 2006 the Company was notified that it would lose the business of a major customer of the Ecuador plant. The Company closed its Ecuador plant in 2007. The Finland and the United Kingdom reporting units have not performed at the levels expected and the Company’s projected cash flows are not sufficient to cover the goodwill recorded at the time of the O-I Plastic acquisition. The Venezuela reporting unit has suffered several years of losses and the Company’s projected cash flows are not sufficient to cover the goodwill recorded at the time of the O-I Plastic acquisition.

Interest Expense. Interest expense increased $3.1 million to $210.6 million for the year ended December 31, 2007 from $207.5 million for the year ended December 31, 2006. The increase was primarily related to the write-off in 2007 of $4.5 million of deferred financing fees in connection with the March 30, 2007 amendment to the Company’s Credit Agreement (as compared to the write-off in 2006 of $2.1 million of deferred financing fees in connection with a 2006 amendment to the Company’s Credit Agreement) and an increase in interest rates (average 90-day LIBOR increased from 5.19% for the year ended December 31, 2006 to 5.30% for the year ended December 31, 2007), partially offset by lower debt levels in the year ended December 31, 2007.

Other Expense, Net. Other expense, net predominantly included net foreign exchange losses for the years ended December 31, 2007 and 2006. Other expense, net decreased $0.2 million to $2.0 million for the year ended December 31, 2007 from $2.2 million for the year ended December 31, 2006.

Income Tax Provision Income tax provision decreased $7.8 million to $19.8 million for the year ended December 31, 2007 from $27.6 million for the year ended December 31, 2006. Improved profitability in jurisdictions where the company has income tax liabilities, principally Europe and Mexico, and valuation allowances placed on domestic and international deferred tax assets were more than offset by decreases in tax expense in the United States. These decreases in the U.S. were attributable to several factors. Both a restructuring of the ownership of the Company’s Poland operations and a new protocol to the U.S. – Belgium Income Tax Treaty resulted in lower tax on repatriation of unremitted earnings to the U.S. In addition, income tax expense decreased due to reductions in deemed investments in U.S. property of the Company’s foreign subsidiaries.

 

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Net Loss. Primarily as a result of factors discussed above, net loss was $206.1 million for the year ended December 31, 2007 compared to net loss of $120.4 million for the year ended December 31, 2006.

2006 Compared to 2005

The following table sets forth the condensed consolidated statements of income and related percentage change for the periods indicated:

 

     Year ended
December 31,
    % Increase/
(Decrease)
 
   2006     2005    
     (Dollars in millions)  

Net sales

   $ 2,520.9     $ 2,473.4     1.9 %

Cost of goods sold

     2,233.4       2,177.9     2.5  
                      

Gross profit

     287.5       295.5     (2.7 )

% of net sales (1)

     11.4 %     11.9 %  

Selling, general and administrative expenses

     131.4       127.5     3.1  

% of net sales (1)

     5.2 %     5.2 %  

Asset impairment charges

     25.9       7.3     >100.0  

Net loss on disposal of fixed assets

     13.8       13.6     1.5  
                      

Operating income

     116.4       147.1     (20.9 )

% of net sales (1)

     4.6 %     5.9 %  

Interest expense

     207.5       185.0     12.2  

Interest income

     (0.5 )     (0.6 )   (16.7 )

Other expense, net

     2.2       0.2     >100.0  

Income tax provision

     27.6       14.4     91.7  

Minority interest

     —         0.7     (100.0 )
                      

Net loss

   $ (120.4 )   $ (52.6 )   (128.9 )%
                      

 

(1) As resin prices can fluctuate significantly, the Company believes that its gross profit, as well as certain expense items, should not be analyzed solely on a percentage of net sales basis.

Net Sales. Net sales for the year ended December 31, 2006 increased $47.5 million, or 1.9%, to $2,520.9 million from $2,473.4 million for the year ended December 31, 2005. The increase in sales was primarily due to an increase in resin costs which are passed through to customers and volume, offset by higher sales of lower priced products and price reductions in response to competitive pressure. Container units sold increased 3.7%, principally due to additional food and beverage container business where container units sold increased 7.6%. On a geographic basis, sales for the year ended December 31, 2006 in North America increased $52.3 million, or 2.4%, from the year ended December 31, 2005, primarily due to an increase in resin costs which are passed through to customers and higher container units sold of 2.7%, offset by higher sales of lower priced products and price reductions in response to competitive pressure. North American sales in the food and beverage, household and automotive lubricants product categories contributed $56.2 million, $18.1 million and $7.3 million, respectively, to the increase, while North American sales in the personal care/specialty product category decreased $29.3 million. Container units sold in North America increased in the food and beverage and household product categories by 7.1% and 5.0%, respectively, and decreased in the automotive lubricants and personal care/specialty product categories by 7.1% and 12.6%, respectively. Sales for the year ended December 31, 2006 in Europe decreased $4.2 million, or 1.7%, from the year ended December 31, 2005. The decrease in sales was primarily due to container weight reduction programs and an overall mix shift to smaller containers, partially offset by an increase in volume and exchange rate changes of approximately $3.0 million. Sales for the year ended December 31, 2006 in South America decreased $0.6 million, or 0.9%, from the year ended December 31, 2005. The decrease in sales was primarily due to an overall mix shift to smaller containers and price reductions in response to competitive pressure, partially offset by exchange rate changes of $3.6 million and volume.

 

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Gross Profit. Gross profit for the year ended December 31, 2006 decreased $8.0 million to $287.5 million from $295.5 million for the year ended December 31, 2005. Gross profit for the year ended December 31, 2006 increased $1.9 million in North America and decreased $4.4 million and $5.5 million in Europe and South America, respectively, when compared to the year ended December 31, 2005. The positive impact on gross profit of added volume was offset by a negative impact of approximately $8.4 million due to the inability to recover all raw material costs related to extraordinary efforts during the Rita/Katrina hurricane events during the latter half of 2005 to procure PET raw materials and build unusually high inventory levels to make certain the Company met its customers’ requirements in the short term and build for the peak isotonic beverage demand in the long term. Gross profit was also negatively impacted by price reductions in response to competitive pressure, increased inflationary pressures on labor, utilities and other operating costs and an increase in other expenses of $5.7 million related to the hurricanes in the United States in the second half of 2005, partially offset by operational improvements, volume, lower integration expenses for the O-I Plastic acquisition of $6.6 million, a decrease in costs related to employee severance of $3.7 million, lower project startup costs of $1.7 million and a weakening of the dollar against the euro and other currencies of $0.7 million.

Selling, General & Administrative Expenses. Selling, general and administrative expenses for the year ended December 31, 2006 increased $3.9 million to $131.4 million from $127.5 million for the year ended December 31, 2005. The increase was primarily due to increases in costs related to employee severance, costs associated with aborted acquisitions, consulting expenses associated with restructuring of the business, professional fees, recruitment expenses and depreciation expenses, partially offset by lower integration expenses for the O-I Plastic acquisition and a decrease in bad debt expense. Selling, general and administrative expenses as a percent of sales remained at 5.2% of sales for each of the years ended December 31, 2006 and 2005.

Asset Impairment Charges. Asset impairment charges were $25.9 million for the year ended December 31, 2006 as compared to $7.3 million for the year ended December 31, 2005. Due to changes in the ability to utilize certain assets in Brazil, Ecuador, Finland, France, the Netherlands, Poland, Spain, the United Kingdom and the United States in 2006 and in Brazil, Ecuador, France and the United States in 2005, the Company evaluated the recoverability of these assets. For these assets to be held and used, the Company determined that the undiscounted cash flows were below the carrying value of these long-lived assets. Accordingly, the Company adjusted the carrying value of these long-lived assets to their estimated fair value in accordance with SFAS 144, resulting in impairment charges of $14.1 million and $6.8 million for the years ended December 31, 2006 and 2005, respectively. Similarly, the Company evaluated the recoverability of its goodwill, and consequently recorded impairment charges of $11.8 million and $0.5 million for the years ended December 31, 2006 and 2005, respectively, related to Ecuador, Finland, the United Kingdom and Venezuela in 2006 and Turkey in 2005. Goodwill was evaluated for impairment and the resulting impairment charges recognized were based on a comparison of the related net book value of the goodwill of the reporting unit to its implied fair value.

Interest Expense. Interest expense increased $22.5 million to $207.5 million for the year ended December 31, 2006 from $185.0 million for the year ended December 31, 2005. The increase was primarily related to higher LIBOR rates in 2006 compared to 2005.

Other Expense, Net. Other expense, net predominantly included net foreign exchange losses for the years ended December 31, 2006 and 2005. Other expense, net increased $2.0 million to $2.2 million for the year ended December 31, 2006 from $0.2 million for the year ended December 31, 2005.

Income Tax Provision. Income tax provision increased $13.2 million to $27.6 million for the year ended December 31, 2006 from $14.4 million for the year ended December 31, 2005. The increase was attributable to several factors. A reduced tax benefit was attributable to lower taxable income in the Company’s U.S. subsidiaries acquired as part of the acquisition of O-I Plastic and for operations in Europe and Mexico for the year ended December 31, 2006. In addition, valuation allowances were placed on certain deferred tax assets originally treated as purchased in the acquisition of O-I Plastic.

 

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Net Loss. Primarily as a result of factors discussed above, net loss was $120.4 million for the year ended December 31, 2006 compared to net loss of $52.6 million for the year ended December 31, 2005.

Effect of Changes in Exchange Rates

In general, the Company’s results of operations are affected by changes in foreign exchange rates. Subject to market conditions, the Company prices its products in its foreign operations in local currencies. Income and expense accounts and cash flow items are translated at average monthly exchange rates during the period. As a result, a decline in the value of the U.S. dollar relative to the local currencies of profitable foreign subsidiaries can have a favorable effect on the profitability of the Company, and an increase in the value of the U.S. dollar relative to the local currencies of profitable foreign subsidiaries can have a negative effect on the profitability of the Company. Included in other expense were foreign exchange losses of $1.9 million, $1.9 million and $0.3 million for the years ended December 31, 2007, 2006 and 2005, respectively.

Assets and liabilities are translated at exchange rates in effect at the balance sheet date. Net exchange gains or losses resulting from the translation of foreign financial statements are recorded directly as a separate component of Partners’ Capital (Deficit) under the caption “accumulated other comprehensive income.” Exchange rate fluctuations decreased comprehensive loss by $36.3 million and $23.2 million and increased comprehensive loss by $17.5 million for the years ended December 31, 2007, 2006 and 2005, respectively.

Liquidity and Capital Resources

In 2007, 2006 and 2005, the Company generated $174.2 million, $263.0 million and $120.0 million of cash from operations, respectively, and in 2005, generated $150.1 million from increased indebtedness. These funds were primarily used to fund $149.1 million, $170.9 million and $242.6 million of net cash paid for property, plant and equipment for 2007, 2006 and 2005, respectively, $1.4 million and $18.8 million of acquisitions for 2006 and 2005, respectively, and $4.5 million, $1.0 million and $2.1 million of debt issuance fee payments for 2007, 2006 and 2005, respectively.

The Company’s Credit Agreement currently consists of a senior secured B Loan to the Operating Company totaling $1,860.9 million and a revolving credit facility (the “Revolving Credit Facility”) to the Operating Company totaling $250.0 million. Pursuant to its terms, on March 30, 2007, the Credit Agreement was amended in order to, among other things, increase the Term Loan B facility provided under the Credit Agreement by approximately $305.0 million. Proceeds of the amendment were used to pay off a second-lien credit agreement ($250.0 million), with $50.0 million being used to reduce outstanding borrowings on the existing Revolving Credit Facility provided for under the Credit Agreement and approximately $5.0 million being used to pay fees and expenses. The amendment also eliminated one of the Company’s financial ratio covenants, increased the maximum allowable leverage under another financial ratio covenant and waived any potential excess cash flow payment required for the year ended December 31, 2006. The obligations of the Operating Company under the Credit Agreement are guaranteed by Holdings and certain other subsidiaries of Holdings. The B Loan is payable in quarterly installments and requires payments of $18.7 million in each of 2008, 2009 and 2010 and $1,804.8 million in 2011. The Company expects to fund scheduled debt repayments from cash from operations and unused lines of credit. The Credit Agreement requires that up to 50% of excess cash flow (as defined in the Credit Agreement) be applied on an annual basis to pay down the B Loan. No excess cash flow payment is due for the year ended December 31, 2007. The Revolving Credit Facility expires on October 7, 2010.

The Acquisition and refinancing of substantially all of the Company’s prior debt (the “Transactions”) included the issuance of $250.0 million of Senior Notes due 2012 and the issuance of $375.0 million of Senior Subordinated Notes due 2014. The Senior Notes, together with the Senior Subordinated Notes, are herein collectively referred to as the “Notes.” The Senior Notes mature on October 7, 2012, with interest payable semi-annually at 8.50%. The Senior Subordinated Notes mature on October 7, 2014, with interest payable semi-annually at 9.875%. On August 23, 2005 the Operating Company and CapCo I completed an Exchange Offer

 

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whereby the Senior Notes and Senior Subordinated Notes were exchanged for Notes registered under the Securities Act of 1933, as amended. The Notes are fully and unconditionally guaranteed by Holdings.

At December 31, 2007, the Company’s total indebtedness was $2,534.3 million.

Unused lines of credit at December 31, 2007 and 2006 were $249.7 million and $196.2 million, respectively. Substantially all unused lines of credit have no major restrictions and are provided under notes between the Company and the respective lending institutions.

The Credit Agreement and the Notes contain a number of significant covenants. The Company believes that these covenants are material terms of these agreements and that information about the covenants is material to an investor’s understanding of the Company’s financial condition and liquidity. Covenant compliance EBITDA (as defined below) is used to determine the Company’s compliance with many of these covenants. Any breach of covenants in the Credit Agreement that are tied to financial ratios based on covenant compliance EBITDA could result in a default under the Credit Agreement and the lenders could elect to declare all amounts borrowed to be immediately due and payable. Any such acceleration would also result in a default under the Notes. Additionally, these covenants restrict the Company’s ability to dispose of assets, repay other indebtedness, incur additional indebtedness, pay dividends, prepay subordinated indebtedness, incur liens, make capital expenditures, investments or acquisitions, engage in mergers or consolidations, engage in transactions with affiliates and otherwise restrict the Company’s activities. Under the Credit Agreement, the Company is required to satisfy specified financial ratios and tests. The Company may also be required to make annual excess cash flow payments as defined in the Credit Agreement. The March 30, 2007 amendment to the Credit Agreement eliminated the interest coverage ratio, increased the maximum allowable leverage under another financial ratio covenant and waived any potential excess cash flow payment required for the year ended December 31, 2006. As of December 31, 2007, the Company was in compliance with the financial ratios and tests specified in the Credit Agreement and the Company currently anticipates being able to comply with such financial ratios and tests for the next fiscal year, however, the Company can not give any assurance this will occur.

Covenant compliance EBITDA is defined as EBITDA (i.e., earnings before interest, taxes, depreciation and amortization) further adjusted to exclude non-recurring items, non-cash items and other adjustments required in calculating covenant compliance under the Credit Agreement and the Notes, as shown in the table below. Covenant compliance EBITDA is not intended to represent cash flow from operations as defined by generally accepted accounting principles and should not be used as an alternative to net income as an indicator of operating performance or to cash flow as a measure of liquidity. The Company believes that the inclusion of covenant compliance EBITDA in this annual report on Form 10-K is appropriate to provide additional information to investors about the calculation of certain financial covenants in the Credit Agreement and the Notes. Because not all companies use identical calculations, these presentations of covenant compliance EBITDA may not be comparable to other similarly titled measures of other companies. A reconciliation of net loss to covenant compliance EBITDA is as follows:

Reconciliation of net loss to EBITDA

 

     Year Ended
December 31, 2007
 
     (In millions)  

Net loss

   $ (206.1 )

Interest income

     (0.9 )

Interest expense

     210.6  

Income tax provision

     19.8  

Depreciation and amortization

     203.0  
        

EBITDA

   $ 226.4  
        

 

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Reconciliation of EBITDA to covenant compliance EBITDA

 

     Year Ended
December 31, 2007
     (In millions)

EBITDA

   $ 226.4

Asset impairment charges

     157.9

Other non-cash charges (a)

     19.5

Fees related to monitoring agreements (b)

     5.0

Non-recurring items (c)

     32.0
      

Covenant compliance EBITDA

   $ 440.8
      

 

(a) Represents the net loss on disposal of fixed assets.

 

(b) Represents annual fees paid to Blackstone Management Partners III L.L.C. and a limited partner of Holdings under monitoring agreements.

 

(c) The Company is required to adjust EBITDA, as defined above, for the following non-recurring items as defined in the Credit Agreement:

 

     Year Ended
December 31, 2007
     (In millions)

Reorganization and other costs (i)

   $ 22.3

Project startup costs (ii)

     9.7
      
   $ 32.0
      

 

(i) Represents non-recurring costs related to consulting expenses associated with restructuring of the business, employee severance, the integration of O-I Plastic, aborted acquisitions and other costs defined in the Credit Agreement.

 

(ii) Represents non-recurring costs associated with project startups.

Under the debt agreements, the Company’s ability to engage in activities such as incurring additional indebtedness, making investments and paying dividends is also tied to ratios based on covenant compliance EBITDA. The Credit Agreement requires that the Company maintain a senior secured debt to covenant compliance EBITDA ratio at a maximum of 5.50x for the most recent four quarter period. For the four quarters ended December 31, 2007, the Operating Company’s covenant compliance EBITDA was $440.8 million. The senior secured debt to covenant compliance EBITDA ratio was 4.29x for the four quarters ended December 31, 2007. The ability of the Operating Company to incur additional debt and make certain restricted payments under its Notes is tied to a covenant compliance EBITDA to fixed charges (primarily cash interest expense) ratio of 2.0x, except that the Operating Company may incur certain debt and make certain restricted payments without regard to the ratio, such as up to $2.2 billion under the Credit Agreement and investments equal to 7.5% of the Operating Company’s total assets. The covenant compliance EBITDA to fixed charges ratio was 2.2x for the four quarters ended December 31, 2007.

Substantially all of the Company’s domestic tangible and intangible assets are pledged as collateral pursuant to the terms of the Credit Agreement.

Under the Credit Agreement, the Operating Company is subject to restrictions on the payment of dividends or other distributions to Holdings; provided that, subject to certain limitations, the Operating Company may pay dividends or other distributions to Holdings:

 

   

in respect of overhead, tax liabilities, legal, accounting and other professional fees and expenses; and

 

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to fund purchases and redemptions of equity interests of Holdings or Investor LP held by then present or former officers or employees of Holdings, the Operating Company or their Subsidiaries (as defined therein) or by any employee stock ownership plan upon that person’s death, disability, retirement or termination of employment or other circumstances with annual dollar limitations.

The Company and its subsidiaries, affiliates or significant shareholders (including The Blackstone Group L.P. and its affiliates) may from time to time , in their sole discretion, purchase, repay, redeem or retire any of the Company’s outstanding debt or equity securities (including any publicly issued debt or equity securities), in privately negotiated or open market transactions, by tender offer or otherwise.

Cash paid for property, plant and equipment, excluding acquisitions, for 2007, 2006 and 2005 was $153.4 million, $190.5 million and $257.6 million, respectively. Management believes that capital expenditures to maintain and upgrade property, plant and equipment are important to remain competitive. Management estimates that on average the annual maintenance capital expenditures are approximately $30 million to $40 million per year. Additional capital expenditures beyond this amount will be required to expand capacity or improve the Company’s cost structure.

For the fiscal year 2008, the Company expects to incur capital investments ranging from $140 million to $160 million. However, total capital investments for 2008 will depend on the size and timing of growth related opportunities. The Company’s principal sources of cash to fund ongoing operations and capital requirements have been and are expected to continue to be net cash provided by operating activities and borrowings under the Credit Agreement. Management believes that these sources will be sufficient to fund the Company’s ongoing operations and its foreseeable capital requirements. In connection with plant expansion and improvement programs, the Company had commitments for capital expenditures of $41.0 million at December 31, 2007.

The Company has entered into agreements with an unrelated third-party for the financing of specific accounts receivable of certain foreign subsidiaries. For a further description of these agreements see “—Off-Balance Sheet Arrangements.”

Contractual Obligations and Commitments

The following table sets forth the Company’s significant contractual obligations and commitments as of December 31, 2007:

 

     Payments Due by Period

Contractual Obligations

   Total    2008    2009 and
2010
   2011 and
2012
   2013 and
beyond
     (In millions)

Long-term debt

   $ 2,501,152    $ 33,560    $ 37,744    $ 2,054,841    $ 375,007

Capital lease obligations

     33,180      12,135      15,575      5,468      2

Interest payments

     839,565      191,119      372,284      209,506      66,656

Operating leases

     136,893      31,091      45,132      24,846      35,824

Capital expenditures

     40,991      40,991      —        —        —  

Fees related to monitoring agreements (a)

     25,000      5,000      10,000      10,000      —  
                                  

Total contractual cash obligations

   $ 3,576,781    $ 313,896    $ 480,735    $ 2,304,661    $ 477,489
                                  

 

(a) Represents annual fees paid to Blackstone Management Partners III L.L.C. and a limited partner of Holdings under monitoring agreements. Such agreements have no contractual term and for purposes of this schedule are presumed to be outstanding for a period of five years.

Interest payments are calculated based upon the Company’s 2007 year-end actual interest rates.

 

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In addition to the amounts included above, in 2008 the Company expects to make cash contributions to its pension plans of approximately $5.9 million. Cash contributions in subsequent years will depend on a number of factors including the performance of plan assets.

Uncertain tax contingencies are positions taken or expected to be taken on an income tax return that may result in additional payments to tax authorities. However, due to the uncertainty of the timing of future cash flows associated with the Company’s unrecognized tax benefits, the Company is unable to make reasonably reliable estimates of the period of cash settlement, if any, with the respective taxing authorities. Accordingly, unrecognized tax benefits of $16.6 million as of December 31, 2007 have been excluded from the contractual obligations table above. For further information related to unrecognized tax benefits, see Note 18, “Income Taxes,” of the Notes to Consolidated Financial Statements included in this Report.

Off-Balance Sheet Arrangements

Other than letter of credit agreements and operating leases, as of December 31, 2007, the Company did not have any off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of SEC Regulation S-K. The Company had letter of credit agreements outstanding in the amount of $11.0 million as of December 31, 2007.

The Company has entered into agreements with an unrelated third-party for the financing of specific accounts receivable of certain foreign subsidiaries. The financing of accounts receivable under these agreements is accounted for as sales in accordance with SFAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities.” Under the terms of the financing agreements, the Company transfers ownership of eligible accounts receivable without recourse to the third-party purchaser in exchange for cash. Proceeds on the transfer reflect the face value of the accounts receivable less a discount. The discount is recorded against net sales on the Consolidated Statement of Operations in the period of the sale. The eligible receivables financed pursuant to this factoring agreement are excluded from accounts receivable on the Consolidated Balance Sheet and are reflected as cash provided by operating activities on the Consolidated Statement of Cash Flows, while non-eligible receivables remain on the balance sheet with a corresponding liability established when those receivables are financed. The Company does not continue to service, administer and collect the eligible receivables under this program. The third-party purchaser has no recourse to the Company for failure of debtors constituting eligible receivables to pay when due. The Company maintains insurance on behalf of the third-party purchaser to cover any losses due to the failure of debtors constituting eligible receivables to pay when due. At December 31, 2007 and 2006, the Company had sold $32.4 million and $20.7 million of eligible accounts receivable, respectively, which represent the face amounts of total outstanding receivables at those dates.

Transactions with Affiliates

The Company was a party to an Equipment Sales, Services and License Agreement dated February 2, 1998, (“Equipment Sales Agreement”) with Graham Engineering, a company controlled by the Graham Family Investors, who have a 15% ownership interest in the company. Under the Equipment Sales Agreement, Graham Engineering provided the Company with certain sizes of wheels used in extrusion blow molding, on an exclusive basis within the countries and regions in which the Company had material sales of plastic containers. The Company received equipment and related services of $11.0 million, $10.3 million and $13.1 million for the years ended December 31, 2007, 2006 and 2005, respectively.

On July 9, 2002, the Company and Graham Engineering executed a First Amendment to the Equipment Sales Agreement to, among other things, obligate the Company, retroactive to January 1, 2002, and subject to certain credits and carry-forwards, to make payments for products and services to Graham Engineering in the amount of at least $12.0 million per calendar year, or else pay to Graham Engineering a shortfall payment. The minimum purchase commitment for 2007 was not met, resulting in a shortfall penalty of $0.2 million.

The Equipment Sales Agreement terminated on December 31, 2007. The Company now manufactures equipment for its own use in Sulejowek, Poland.

 

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The Graham Family Investors have supplied management services to the Company since 1998. The Company has recorded $2.0 million, $2.0 million and $2.1 million of expense for the years ended December 31, 2007, 2006 and 2005, respectively, including the annual fee paid pursuant to the Holdings Partnership Agreement and the Monitoring Agreement (as defined herein).

Blackstone Management Partners III L.L.C. has supplied management services to the Company since 1998. The Company has recorded $3.3 million, $3.1 million and $3.1 million of expense for the years ended December 31, 2007, 2006 and 2005, respectively, including the annual fee paid pursuant to the Monitoring Agreement.

Critical Accounting Policies and Estimates

Long-Lived Assets

The plastic container business is capital intensive and highly competitive. Technology and market conditions can change rapidly, possibly impacting the fair value of the Company’s long-lived assets. Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable in accordance with SFAS 144. The Company generally uses a probability-weighted estimate of the future undiscounted net cash flows of the related asset or asset grouping over the remaining life in measuring whether the assets are recoverable. Any impairment loss, if indicated, is measured on the amount by which the carrying amount of the asset exceeds the estimated fair value of the asset. When fair values are not available, the Company generally estimates fair value using the probability-weighted expected future cash flows discounted at a risk-adjusted rate. Management believes that this policy is critical to the financial statements, particularly when evaluating long-lived assets for impairment. Varying results of this analysis are possible due to the significant estimates involved in the Company’s evaluations.

Impairment of Goodwill

Goodwill is not amortized, but instead is subject to impairment testing. The Company performs an evaluation to determine whether goodwill is impaired annually, or when events occur or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Events or circumstances that might indicate an interim evaluation is warranted include unexpected adverse business conditions, economic factors, unanticipated technological changes or competitive activities, loss of key personnel and acts by governments and courts. The identification and measurement of goodwill impairment involves the estimation of the fair value of reporting units. The Company considers a number of factors, including the input of an independent appraisal firm, in conducting the impairment testing of its reporting units. The Company performs its impairment testing by comparing the estimated fair value of the reporting unit to the carrying value of the reported net assets, with such testing occurring as of the end of each year. Fair value is generally based on the income approach using a calculation of discounted cash flows, based on the most recent financial projections for the reporting units. The financial projections are Management’s best estimates based on current and forecasted market conditions. The calculation of fair value for the Company’s reporting units incorporates many assumptions including future growth rates, profit margins and discount factors. Changes in economic and operating conditions impacting these assumptions could result in additional impairment charges in future periods.

Derivatives

The Company accounts for derivatives under SFAS 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended by SFAS 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities – An Amendment of FASB Statement No. 133.” These standards establish accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. All derivatives, whether designated in hedging relationships or not, are required to be recorded on the balance sheet at fair value. The fair value of the derivatives is determined from sources independent of the Company, including the financial institutions which are party to the derivative instruments. If

 

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the derivative is designated as a fair value hedge, the changes in the fair value of the derivative and the hedged item will be recognized in earnings. If the derivative is designated as a cash flow hedge, the effective portion of the change in the fair value of the derivative will be recorded in other comprehensive income (loss) and will be recognized in the income statement when the hedged item affects earnings.

In the past, the Company has entered into forward exchange contracts to hedge the exchange rate exposure on transactions that are denominated in a foreign currency. These forward contracts are accounted for as cash flow hedges. At December 31, 2007 and 2006, the Company had no foreign currency forward exchange contracts outstanding.

SFAS 133 defines requirements for designation and documentation of hedging relationships as well as ongoing effectiveness assessments in order to use hedge accounting. For a derivative that does not qualify as a hedge, changes in fair value will be recognized in earnings. Continued use of hedge accounting is dependent on management’s adherence to this accounting policy. Failure to properly document the Company’s interest rate swaps and collars as cash flow hedges would result in income statement recognition of all or part of any future unrealized gain or loss recorded in other comprehensive income (loss). The potential income statement impact resulting from a failure to adhere to this policy makes this policy critical to the financial statements.

Benefit Plans

The Company has several defined benefit plans, under which participants earn a retirement benefit based upon a formula set forth in the plan. Key assumptions used in the actuarial valuations include the discount rate and the anticipated rate of return on plan assets, as determined by Management. These rates are based on market interest rates, and therefore, fluctuations in market interest rates could impact the amount of pension expense recorded for these plans. The Company’s primary U.S. defined benefit plan for hourly and salaried employees was frozen to future salary and service accruals in the fourth quarter of 2006.

Income Taxes

The Company accounts for income taxes in accordance with SFAS 109, “Accounting for Income Taxes,” which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the financial reporting and tax bases of recorded assets and liabilities. SFAS 109 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax asset will not be realized. The Company has recorded a valuation allowance to reduce its deferred tax assets to the amount that it believes is more likely than not to be realized. The Company’s assumptions regarding future realization may change due to future operating performance and other factors.

Inherent in determining the Company’s effective tax rate are judgments regarding business plans and expectations about future operations. These judgments include the amount and geographic mix of future taxable income, limitations on usage of net operating loss carry-forwards, potential tax law changes, the impact of ongoing or potential tax audits, earnings repatriation plans and other future tax consequences.

In 2007, the Company implemented Financial Accounting Standards Board (“FASB”) Interpretation No. (“FIN”) 48, which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on accounting for derecognition, interest, penalties, accounting in interim periods, disclosure and classification of matters related to uncertainty in income taxes and transitional requirements upon adoption of FIN 48. Due to the significant amounts involved and judgment required, the Company deems this policy to be critical to its financial statements.

For disclosure of all of the Company’s significant accounting policies see Note 1 of the Notes to Consolidated Financial Statements.

 

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Subsequent Events

On February 1, 2008, the Company extended the term for certain options granted on February 2, 1998, for which any unexercised options would have expired on February 2, 2008. No change was made to the number of options, nor the exercise price, and the options remained fully vested. This extension of the term is considered a modification under SFAS 123(R), “Share-Based Payment,” which will require a charge to expense in the first quarter of 2008, of approximately $2.4 million, for the difference between the fair value of the options after the modification and the fair value of the options before the modification.

In March 2008, the Company offered employees who hold options under an option plan that the Company adopted in 2004 a twenty-business day election period for replacing those options with a new grant of options. The new grant of options will have an exercise price based upon the current value of the Company determined at the date of the new grant and will only begin to vest as of the date of the new grant, and the original grant of options will be canceled. The new grant of options is considered a modification under SFAS 123(R), which will require the incremental fair value of the options after the modification over the fair value of the options before the modification to be recorded as compensation cost over the new service (vesting) period.

Recently Issued Accounting Pronouncements

In June 2006, the FASB issued FIN 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109.” FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on accounting for derecognition, interest, penalties, accounting in interim periods, disclosure and classification of matters related to uncertainty in income taxes and transitional requirements upon adoption of FIN 48. The Company adopted FIN 48 effective January 1, 2007 which resulted in an increase in the Company’s other non-current liabilities for unrecognized tax benefits of $10.0 million (including interest of $2.2 million and penalties of $4.8 million), an increase in the Company’s non-current deferred tax assets of $5.2 million and a corresponding decrease in partners’ capital of $4.8 million. See Note 18 of the Notes to Consolidated Financial Statements in this Report for additional discussion regarding the impact of the Company’s adoption of FIN 48.

In June 2006, the Emerging Issues Task Force (“EITF”) reached a consensus on EITF 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation).” EITF 06-3 provides that the presentation of taxes assessed by a governmental authority that is directly imposed on a revenue producing transaction between a seller and a customer on either a gross basis (included in revenues and costs) or on a net basis (excluded from revenues) is an accounting policy decision that should be disclosed. EITF 06-3 was effective January 1, 2007. The Company presents these taxes on a net basis for all periods presented.

In September 2006, the FASB issued SFAS 158. Under SFAS 158, companies are required to (1) recognize in its statement of financial position an asset for a plan’s over funded status or a liability for a plan’s under funded status, (2) measure a plan’s assets and its obligations that determine its funded status as of the end of the Company’s fiscal year and (3) recognize changes in the funded status of a defined benefit post-retirement plan in the year in which the changes occur. Those changes will be reported in accumulated other comprehensive income. The Company adopted SFAS 158 as of December 31, 2006. The adoption of SFAS 158 resulted in a decrease in total partners’ capital (deficit) of $2.6 million as of December 31, 2006. For further information regarding the impact of the adoption of SFAS 158, refer to Note 13 of the Notes to Consolidated Financial Statements in this Report.

In September 2006, the FASB issued SFAS 157, “Fair Value Measurements.” This statement establishes a single authoritative definition of fair value, sets out a framework to classify the source of information used in fair value measurements, identifies additional factors that must be disclosed about assets and liabilities measured at fair value based on their placement in the new framework and modifies the long-standing accounting

 

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presumption that the transaction price of an asset or liability equals its initial fair value. In February 2008, the FASB delayed the effective date for certain nonfinancial assets and liabilities until January 1, 2009. The Company does not expect the adoption to have a significant impact on its financial statements.

In February 2007, the FASB issued SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of FASB Statement No. 115.” Under SFAS 159, companies may elect to measure specified financial instruments and warranty and insurance contracts at fair value on a contract–by–contract basis, with changes in fair value recognized in earnings each reporting period. The Company does not expect the adoption to have a significant impact on its financial statements.

In December 2007, the FASB issued SFAS 141(R), “Business Combinations.” SFAS 141(R) establishes principles and requirements for the reporting entity in a business combination, including recognition and measurement in the financial statements of the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree. This statement also establishes disclosure requirements to enable financial statement users to evaluate the nature and financial effects of the business combination. SFAS 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first fiscal year beginning after December 15, 2008. The guidance in SFAS 141(R) will be applied prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning after December 15, 2008.

In December 2007, the FASB issued SFAS 160, “Noncontrolling Interests in Consolidated Financial Statements—Amendment of ARB No. 51.” SFAS 160 establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, changes in a parent’s ownership of a noncontrolling interest, calculation and disclosure of the consolidated net income attributable to the parent and the noncontrolling interest, changes in a parent’s ownership interest while the parent retains its controlling financial interest and fair value measurement of any retained noncontrolling equity investment. SFAS 160 is effective for financial statements issued for fiscal years beginning after December 15, 2008. Early adoption is prohibited. The Company does not expect the adoption to have a significant impact on its financial statements.

In March 2008, the FASB issued SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities.” The new standard is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance and cash flows. It requires disclosure of the fair values of derivative instruments and their gains and losses in a tabular format. It also provides more information about an entity’s liquidity by requiring disclosure of derivative features that are credit risk–related, and requires cross-referencing within footnotes to enable financial statement users to locate important information about derivative instruments. It is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company is currently in the process of assessing the impact of the adoption of SFAS 161 on its financial statement disclosures.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

In the normal course of business the Company is subject to risk from adverse fluctuations in interest and foreign exchange rates and commodity prices. The Company manages these risks through a program that includes the use of derivative financial instruments, primarily swaps, collars and forwards. Counterparties to these contracts are major financial institutions. These instruments are not used for trading or speculative purposes. The extent to which the Company uses such instruments is dependent upon its access to them in the financial markets and its use of other methods, such as netting exposures for foreign exchange risk and establishing sales arrangements that permit the pass-through to customers of changes in commodity prices and foreign exchange rates, to affectively achieve its goal of risk reduction. The Company’s objective in managing its exposure to market risk is to limit the impact on earnings and cash flow.

 

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Interest Rate Risk

The Company had significant long- and short-term debt commitments outstanding as of December 31, 2007. These on-balance sheet financial instruments, to the extent they provide for variable rates of interest, expose the Company to interest rate risk. Based on the outstanding amount of the Company’s variable rate indebtedness at December 31, 2007, a one percentage point change in the interest rates for the Company’s variable rate indebtedness would impact interest expense by an aggregate of approximately $16.0 million, after taking into account the outstanding notional amount of the Company’s interest rate swap agreements at December 31, 2007. The Company manages its interest rate risk by entering into interest rate swap and collar agreements. All of the Company’s derivative financial instrument transactions are entered into for non-trading purposes.

The Company’s financial instruments, including derivative instruments that expose the Company to interest rate risk and market risk are presented in the table below. For variable rate debt obligations, the table presents principal cash flows and related actual weighted average interest rates as of December 31, 2007. For fixed rate debt obligations, the table presents principal cash flows and related weighted average interest rates by maturity dates. For interest rate swap agreements, the following table presents notional amounts and the interest rates by expected (contractual) maturity dates for the pay rate and the actual interest rates at December 31, 2007 for the receive rate. Note 11 of the Notes to Consolidated Financial Statements should be read in conjunction with the table below. Also refer to the interest rate sensitivity analysis in “Risk Factors” (Item 1A).

 

     Expected Maturity Date of Long-Term Debt (Including Current Portion) and Interest
Rate Swap Agreements at December 31, 2007
    Fair Value
December

31, 2007
 
     2008     2009     2010     2011     2012     Thereafter     Total    
     (Dollars in thousands)  

Interest rate sensitive liabilities:

                

Variable rate borrowings, including short-term amounts

   $ 33,385     $ 18,850     $ 18,750     $ 1,804,689     $ —       $ —       $ 1,875,674     $ 1,875,674  

Average interest rate

     10.32 %     7.50 %     7.50 %     7.50 %       %       %     7.55 %  

Fixed rate borrowings

   $ 12,310     $ 5,925     $ 9,794     $ 5,457     $ 250,163     $ 375,009     $ 658,658     $ 588,808  

Average interest rate

     7.53 %     7.52 %     7.54 %     7.51 %     8.50 %     9.87 %     9.23 %  

Total interest rate sensitive liabilities

   $ 45,695     $ 24,775     $ 28,544     $ 1,810,146     $ 250,163     $ 375,009     $ 2,534,332     $ 2,464,482  
                                                                

Derivatives matched against liabilities:

                

Pay fixed swaps

   $ 275,000               $ 275,000     $ 78  

Pay rate

     4.11 %               4.11 %  

Receive rate

     5.28 %               5.28 %  

Interest rate collars

       $ 385,000           $ 385,000     $ (785 )

Cap rate

         4.70 %           4.70 %  

Floor rate

         2.88 %           2.88 %  

Foreign Currency Exchange Rate Risk

The Company manages foreign currency exposures (primarily to the Euro, Canadian dollar, Polish Zloty and pound Sterling) at the operating unit level. Exposures that cannot be naturally offset within an operating unit are hedged with derivative financial instruments where possible and cost effective in the Company’s judgment. Foreign exchange contracts which hedge defined exposures generally mature within twelve months. The Company does not generally hedge its exposure to translation gains or losses on its non-U.S. net assets. There were no forward exchange contracts outstanding as of December 31, 2007 and 2006.

 

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Commodity Pricing Risk

The Company purchases commodities for its products such as HDPE and PET resins. These commodities are generally purchased pursuant to contracts or at market prices established with the vendor. In general, the Company does not engage in hedging activities for these commodities due to its ability to pass on price changes to its customers.

The Company also purchases other commodities, such as natural gas and electricity, and is subject to risks on the pricing of these commodities. In general, the Company purchases these commodities pursuant to contracts or at market prices. The Company manages a portion of its exposure to natural gas price fluctuations through natural gas swap agreements. During 2007 and 2006, the Company entered into natural gas swap agreements to hedge approximately 50 percent and 19 percent, respectively, of its domestic exposure to fluctuations in natural gas prices. At December 31, 2007, the Company did not have any natural gas swap agreements outstanding.

 

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Item 8. Financial Statements and Supplementary Data

INDEX TO FINANCIAL STATEMENTS

 

     Page
Number

Report of Independent Registered Public Accounting Firm

   46

Consolidated Financial Statements

   47

Consolidated Balance Sheets at December 31, 2007 and 2006

   47

Consolidated Statements of Operations for the years ended December 31, 2007, 2006 and 2005

   48

Consolidated Statements of Partners’ Capital (Deficit) for the years ended December 31, 2007, 2006 and 2005

   49

Consolidated Statements of Cash Flows for the years ended December 31, 2007, 2006 and 2005

   50

Notes to Consolidated Financial Statements

   51

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Partners

Graham Packaging Holdings Company

We have audited the accompanying consolidated balance sheets of Graham Packaging Holdings Company and subsidiaries (the “Company”) as of December 31, 2007 and 2006, and the related consolidated statements of operations, partners’ capital (deficit), and cash flows for each of the three years in the period ended December 31, 2007. Our audits also included financial statement schedules I and II listed in the index at Item 15(a). These financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2007 and 2006, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2007 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.

DELOITTE & TOUCHE LLP

Philadelphia, Pennsylvania

March 31, 2008

 

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GRAHAM PACKAGING HOLDINGS COMPANY

CONSOLIDATED BALANCE SHEETS

(In thousands)

 

     December 31,  
     2007     2006  

ASSETS

    

Current assets:

    

Cash and cash equivalents

   $ 18,314     $ 13,327  

Accounts receivable, net

     247,953       240,692  

Inventories

     266,184       238,941  

Deferred income taxes

     7,520       15,409  

Prepaid expenses and other current assets

     40,698       64,870  
                

Total current assets

     580,669       573,239  

Property, plant and equipment

     2,181,384       2,386,764  

Less accumulated depreciation and amortization

     938,966       960,752  
                

Property, plant and equipment, net

     1,242,418       1,426,012  

Intangible assets, net

     52,852       78,511  

Goodwill

     306,719       303,394  

Other non-current assets

     51,175       60,781  
                

Total assets

   $ 2,233,833     $ 2,441,937  
                

LIABILITIES AND PARTNERS’ CAPITAL (DEFICIT)

    

Current liabilities:

    

Current portion of long-term debt

   $ 45,695     $ 32,308  

Accounts payable

     166,573       206,672  

Accrued expenses and other current liabilities

     184,559       180,177  

Deferred revenue

     25,024       14,660  
                

Total current liabilities

     421,851       433,817  

Long-term debt

     2,488,637       2,514,579  

Deferred income taxes

     25,778       28,538  

Other non-current liabilities

     84,964       62,759  

Commitments and contingent liabilities (see Notes 19 and 20) Partners’ capital (deficit):

    

General partners

     (41,508 )     (30,965 )

Limited partners

     (796,694 )     (595,148 )

Notes and interest receivable for ownership interests

     (1,939 )     (3,295 )

Accumulated other comprehensive income

     52,744       31,652  
                

Total partners’ capital (deficit)

     (787,397 )     (597,756 )
                

Total liabilities and partners’ capital (deficit)

   $ 2,233,833     $ 2,441,937  
                

 

See accompanying notes to consolidated financial statements.

 

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GRAHAM PACKAGING HOLDINGS COMPANY

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands)

 

     Year Ended December 31,  
     2007     2006     2005  

Net sales

   $ 2,493,471     $ 2,520,936     $ 2,473,449  

Cost of goods sold

     2,154,282       2,233,439       2,177,918  
                        

Gross profit

     339,189       287,497       295,531  

Selling, general and administrative expenses

     136,487       131,414       127,534  

Asset impairment charges

     157,853       25,875       7,263  

Net loss on disposal of fixed assets

     19,461       13,851       13,591  
                        

Operating income

     25,388       116,357       147,143  

Interest expense

     210,546       207,503       184,995  

Interest income

     (859 )     (552 )     (633 )

Other expense, net

     2,005       2,192       244  
                        

Loss before income taxes and minority interest

     (186,304 )     (92,786 )     (37,463 )

Income tax provision

     19,748       27,590       14,450  

Minority interest (net of tax of $297)

     —         —         728  
                        

Net loss

   $ (206,052 )   $ (120,376 )   $ (52,641 )
                        

Net loss allocated to general partners

   $ (10,303 )   $ (6,019 )   $ (2,632 )

Net loss allocated to limited partners

   $ (195,749 )   $ (114,357 )   $ (50,009 )

 

See accompanying notes to consolidated financial statements.

 

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GRAHAM PACKAGING HOLDINGS COMPANY

CONSOLIDATED STATEMENTS OF PARTNERS’ CAPITAL (DEFICIT)

(In thousands)

 

    General
Partners
    Limited
Partners
    Notes and
Interest
Receivable for
Ownership
Interests
    Accumulated
Other
Comprehensive
Income (Loss)
    Total  

Consolidated balance at January 1, 2005

  $ (22,314 )   $ (428,774 )   $ (2,920 )   $ 19,908     $ (434,100 )

Net loss for the year

    (2,632 )     (50,009 )     —         —         (52,641 )

Changes in fair value of derivatives
(net of tax of $0)

    —         —         —         11,129       11,129  

Minimum pension liability adjustment
(net of tax of $387)

    —         —         —         (673 )     (673 )

Cumulative translation adjustment
(net of tax of $0)

    —         —         —         (17,513 )     (17,513 )
               

Comprehensive loss

            (59,698 )

Stock compensation expense

    —         270       —         —         270  

Interest on notes receivable for ownership interests

    —         —         (182 )     —         (182 )
                                       

Consolidated balance at December 31, 2005

    (24,946 )     (478,513 )     (3,102 )     12,851       (493,710 )

Net loss for the year

    (6,019 )     (114,357 )     —         —         (120,376 )

Changes in fair value of derivatives
(net of tax of $0)

    —         —         —         (3,648 )     (3,648 )

Minimum pension liability adjustment prior to adoption of SFAS 158 (as defined in Note 1) (net of tax of $(273)), pension and post-retirement benefit plans

    —         —         —         1,837       1,837  

Cumulative translation adjustment
(net of tax of $0)

    —         —         —         23,197       23,197  
               

Comprehensive loss

            (98,990 )

Adjustment to initially apply SFAS158 (net of tax of $239), pension and post-retirement plans

    —         —         —         (2,585 )     (2,585 )

Stock compensation expense

    —         187       —         —         187  

Interest on notes receivable for ownership interests

    —         —         (193 )     —         (193 )

Purchase of partnership units

    —         (2,762 )     —         —         (2,762 )

Exercise of options

    —         297       —         —         297  
                                       

Consolidated balance at December 31, 2006

    (30,965 )   $ (595,148 )   $ (3,295 )   $ 31,652     $ (597,756 )

Net loss for the year

    (10,303 )     (195,749 )     —         —         (206,052 )

Changes in fair value of derivatives
(net of tax of $0)

    —         —         —         (11,572 )     (11,572 )

Pension and post-retirement benefit plans
(net of tax of $(363))

    —         —         —         (3,670 )     (3,670 )

Cumulative translation adjustment
(net of tax of $1,212)

    —         —         —         36,334       36,334  
               

Comprehensive loss

            (184,960 )

Stock compensation expense

    —         608       —         —         608  

Interest on notes receivable for ownership interests

    —         —         (114 )     —         (114 )

Purchase of partnership units

    —         (1,470 )     —         —         (1,470 )

Repayment of notes and interest

    —         —         1,470       —         1,470  

Amounts recognized upon implementation of FIN 48 (as defined in Note 1)

    (240 )     (4,557 )     —         —         (4,797 )

Purchase of partnership units

    —         (378 )     —         —         (378 )
                                       

Consolidated balance at December 31, 2007

  $ (41,508 )   $ (796,694 )   $ (1,939 )   $ 52,744     $ (787,397 )
                                       

See accompanying notes to consolidated financial statements.

 

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GRAHAM PACKAGING HOLDINGS COMPANY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

     Year Ended December 31,  
     2007     2006     2005  

Operating activities:

      

Net loss

   $ (206,052 )   $ (120,376 )   $ (52,641 )

Adjustments to reconcile net loss to net cash provided by operating activities:

      

Depreciation and amortization

     203,047       205,518       201,056  

Amortization of debt issuance fees

     14,916       12,490       10,302  

Net loss on disposal of fixed assets

     19,461       13,851       13,591  

Pension expense

     3,014       9,408       11,381  

Asset impairment charges

     157,853       25,875       7,263  

Stock compensation expense

     608       187       270  

Minority interest

     —         —         728  

Foreign currency transaction loss

     569       411       535  

Interest receivable for ownership interests

     (114 )     (193 )     (182 )

Changes in operating assets and liabilities, net of acquisitions of businesses:

      

Accounts receivable

     626       14,819       (3,521 )

Inventories

     (22,793 )     50,931       (52,287 )

Prepaid expenses and other current assets

     23,324       (12,535 )     (4,900 )

Other non-current assets

     (5,179 )     4,441       (2,070 )

Pension contributions

     (7,891 )     (10,684 )     (7,319 )

Other non-current liabilities

     6,299       20,511       1,698  

Accounts payable and accrued expenses

     (13,458 )     48,297       (3,907 )
                        

Net cash provided by operating activities

     174,230       262,951       119,997  
                        

Investing activities:

      

Cash paid for property, plant and equipment

     (153,385 )     (190,539 )     (257,605 )

Proceeds from sale of property, plant and equipment

     4,278       19,605       14,994  

Acquisitions of/investments in businesses, net of cash acquired

     —         (1,426 )     (18,773 )
                        

Net cash used in investing activities

     (149,107 )     (172,360 )     (261,384 )
                        

Financing activities:

      

Proceeds from issuance of long-term debt

     667,461       809,828       1,115,762  

Payment of long-term debt

     (683,040 )     (913,722 )     (965,672 )

Proceeds from issuance of partnership units

     —         297       —    

Purchase of partnership units

     (3,140 )     —         —    

Debt issuance fees

     (4,500 )     (1,000 )     (2,145 )
                        

Net cash (used in) provided by financing activities

     (23,219 )     (104,597 )     147,945  
                        

Effect of exchange rate changes on cash and cash equivalents

     3,083       649       (2,005 )
                        

Increase (decrease) in cash and cash equivalents

     4,987       (13,357 )     4,553  

Cash and cash equivalents at beginning of year

     13,327       26,684       22,131  
                        

Cash and cash equivalents at end of year

   $ 18,314     $ 13,327     $ 26,684  
                        

Supplemental disclosures

      

Cash paid for interest, net of amounts capitalized

   $ 198,447     $ 179,673     $ 172,003  

Cash paid for income taxes

   $ 18,299     $ 18,646     $ 10,128  

Non-cash investing and financing activities:

      

Capital leases

   $ 2,324     $ 11,939     $ 22,784  

Accruals for purchases of property, plant and equipment

   $ 19,595     $ 35,032     $ 33,768  

Accruals for purchases of partnership units from severed executives

   $ —       $ 2,762     $ —    

Accruals related to acquisitions

   $ —       $ —       $ 1,408  

See accompanying notes to consolidated financial statements.

 

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GRAHAM PACKAGING HOLDINGS COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2007

1.    Significant Accounting Policies

Description of Business

The Company focuses on the manufacture and sale of value-added plastic packaging products principally to large, multinational companies in the food and beverage, household, automotive lubricants and personal care/specialty product categories. The Company has manufacturing facilities in Argentina, Belgium, Brazil, Canada, Finland, France, Hungary, Mexico, the Netherlands, Poland, Spain, Turkey, the United Kingdom, the United States and Venezuela.

Principles of Consolidation

The consolidated financial statements include the operations of Graham Packaging Holdings Company (“Holdings”), a Pennsylvania limited partnership formerly known as Graham Packaging Company; Graham Packaging Company, L.P., a Delaware limited partnership formerly known as Graham Packaging Holdings I, L.P. (the “Operating Company”); and subsidiaries thereof. In addition, the consolidated financial statements of the Company include GPC Capital Corp. I (“CapCo I”), a wholly owned subsidiary of the Operating Company, and GPC Capital Corp. II (“CapCo II”), a wholly owned subsidiary of Holdings. The purpose of CapCo I is solely to act as co-obligor with the Operating Company under the Senior Notes and Senior Subordinated Notes (as defined herein) and as co-borrower with the Operating Company under the Credit Agreements (as defined herein). CapCo II currently has no obligations under any of the Company’s outstanding indebtedness. CapCo I and CapCo II have only nominal assets and do not conduct any independent operations. These entities and assets are referred to collectively as Graham Packaging Holdings Company (the “Company”). All significant intercompany accounts and transactions have been eliminated in the consolidated financial statements.

Holdings has no assets, liabilities or operations other than its direct and indirect investments in the Operating Company and its ownership of CapCo II. Holdings has fully and unconditionally guaranteed the Senior Notes and Senior Subordinated Notes of the Operating Company and CapCo I.

Revenue Recognition

The Company recognizes revenue on product sales in the period when the sales process is complete. This generally occurs when products are shipped to the customer in accordance with terms of an agreement of sale, under which title and risk of loss have been transferred, collectability is reasonably assured and pricing is fixed or determinable. For a small percentage of sales where title and risk of loss passes at point of delivery, the Company recognizes revenue upon delivery to the customer, assuming all other criteria for revenue recognition are met. Sales are recorded net of discounts, allowances and returns. Sales allowances are recorded as a reduction to sales in accordance with Emerging Issues Task Force (“EITF”) 01-9, “Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products).” The Company maintains a sales return allowance to reduce sales for estimated future product returns.

Shipping and Handling Costs

Shipping and handling costs are included as a component of cost of goods sold in the consolidated statements of operations.

Research and Development Costs

The Company expenses costs to research, design and develop new packaging products and technologies as incurred. Such costs, net of any reimbursement from customers, were $11.6 million, $16.5 million and $15.8 million for the years ended December 31, 2007, 2006 and 2005, respectively.

 

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GRAHAM PACKAGING HOLDINGS COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)

DECEMBER 31, 2007

 

Cash and Cash Equivalents

The Company considers cash and investments with an initial maturity of three months or less when purchased to be cash and cash equivalents.

Accounts Receivable

The Company maintains allowances for estimated losses resulting from the inability of specific customers to meet their financial obligations to the Company. A specific reserve for doubtful receivables is recorded against the amount due from these customers. For all other customers, the Company recognizes reserves for doubtful receivables based on the length of time specific receivables are past due based on past experience.

Inventories

Inventories include material, labor and overhead and are stated at the lower of cost or market with cost determined by the first-in, first-out (“FIFO”) method. Provisions for potentially obsolete or slow-moving inventory are made based on management’s analysis of inventory levels, historical usage and market conditions. See Note 4.

Property, Plant and Equipment

Property, plant and equipment are stated at cost. The Company capitalizes significant improvements, and charges repairs and maintenance costs that do not extend the lives of the assets to expense as incurred. The Company accounts for its molds in accordance with EITF 99-5, “Accounting for Pre-Production Costs Related to Long-Term Supply Arrangements.” All molds, whether owned by the Company or its customers, are included in property, plant and equipment in the consolidated balance sheet. Interest costs are capitalized during the period of construction of capital assets as a component of the cost of acquiring these assets. Depreciation and amortization are computed by the straight-line method over the estimated useful lives of the various assets ranging from 3 to 31.5 years. Depreciation and amortization are included in cost of goods sold and selling, general and administrative expenses on the Consolidated Statements of Operations. The Company removes the cost and accumulated depreciation of assets sold or otherwise disposed of from the accounts and recognizes any resulting gain or loss upon the disposition of the assets.

Conditional Asset Retirement Obligations

The Company accounts for obligations associated with the retirement of its tangible long-lived assets in accordance with Statement of Financial Accounting Standards (“SFAS”) 143, “Accounting for Asset Retirement Obligations,” and Financial Accounting Standards Board (“FASB”) Interpretation No. (“FIN”) 47, “Accounting for Conditional Asset Retirement Obligations.” The Company recognizes a liability for a conditional asset retirement obligation when incurred if the liability can be reasonably estimated. A conditional asset retirement obligation is a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the Company. In addition, the Company would record a corresponding amount by increasing the carrying amount of the related long-lived asset, which is depreciated over the useful life of such long-lived asset. The net present value of these obligations was $9.9 million and $4.4 million as of December 31, 2007 and 2006, respectively. The increase during 2007 was primarily due to a change in the estimated cash flows required to retire assets associated with certain leased facilities.

 

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GRAHAM PACKAGING HOLDINGS COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)

DECEMBER 31, 2007

 

Goodwill and Intangible Assets

The Company accounts for purchased goodwill in accordance with SFAS 142, “Goodwill and Other Intangible Assets.” Under SFAS 142, goodwill is not amortized, but rather is tested for impairment at least annually.

Intangible assets, other than goodwill, with definite lives are amortized over their estimated useful lives. Intangible assets consist of patented technology, customer relationships, licensing agreements and non-compete agreements. The Company amortizes these intangibles using the straight-line method over the estimated useful lives of the assets ranging from 3 to 20 years. The Company periodically evaluates the reasonableness of the estimated useful lives of these intangible assets. See Note 6.

In order to test goodwill for impairment under SFAS 142, a determination of the fair value of the Company’s reporting units is required and is based upon, among other things, estimates of future operating performance. Changes in market conditions, among other factors, may have an impact on these estimates. The Company performs its required annual impairment tests in the fourth quarter of each fiscal year. See Notes 7, 8 and 21.

Other Non-Current Assets

Other non-current assets primarily include debt issuance fees and deferred income tax assets. Debt issuance fees totaled $44.3 million and $54.7 million as of December 31, 2007 and 2006, respectively. Debt issuance fees are net of accumulated amortization of $31.2 million and $23.3 million as of December 31, 2007 and 2006, respectively. Amortization is computed by the effective interest method over the term of the related debt.

Impairment of Long-Lived Assets and Intangible Assets

Long-lived assets and amortizable intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable in accordance with SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” The Company generally uses a probability-weighted estimate of the future undiscounted cash flows of the related asset or asset grouping over the remaining life in measuring whether the assets are recoverable. Any impairment loss, if indicated, is measured on the amount by which the carrying amount of the asset exceeds the estimated fair value of the asset. When fair values are not available, the Company generally estimates fair value using probability-weighted expected future cash flows discounted at a risk-adjusted rate. See Note 8.

Derivatives

The Company accounts for derivatives under SFAS 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended by SFAS 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities – An Amendment of FASB Statement No. 133.” These standards establish accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. SFAS 133 defines requirements for designation and documentation of hedging relationships as well as ongoing effectiveness assessments in order to use hedge accounting. All derivatives, whether designated in hedging relationships or not, are required to be recorded on the balance sheet at fair value. The fair value of the derivatives is determined from sources independent of the Company, including the financial institutions which are party to the derivative instruments. If the derivative is designated as a fair value hedge, the

 

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GRAHAM PACKAGING HOLDINGS COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)

DECEMBER 31, 2007

 

changes in the fair value of the derivative and the hedged item will be recognized in earnings. If the derivative is designated as a cash flow hedge, the effective portion of the change in the fair value of the derivative will be recorded in other comprehensive income (loss) and will be recognized in the income statement when the hedged item affects earnings.

In the past, the Company has entered into forward exchange contracts to hedge the exchange rate exposure on transactions that are denominated in a foreign currency. These forward contracts are accounted for as cash flow hedges.

Benefit Plans

The Company has several defined benefit plans, under which participants earn a retirement benefit based upon a formula set forth in the plan. Accounting for defined benefit pension plans, and any curtailments thereof, requires various assumptions, including, but not limited to, discount rates, expected rates of return on plan assets and future compensation growth rates. The Company evaluates these assumptions at least once each year or as facts and circumstances dictate and makes changes as conditions warrant. Changes to these assumptions will increase or decrease the Company’s reported income, which will result in changes to the recorded benefit plan assets and liabilities.

Foreign Currency Translation

The Company uses the local currency as the functional currency for all foreign operations, except as noted below. All assets and liabilities of such foreign operations are translated into U.S. dollars at year-end exchange rates. Income statement items are translated at average exchange rates prevailing during the year. The resulting translation adjustments are included in accumulated other comprehensive income as a component of partners’ capital (deficit). Exchange gains and losses arising from transactions denominated in foreign currencies other than the functional currency of the entity entering into the transactions are included in current operations. For operations in highly inflationary economies, the Company remeasures such entities’ financial statements as if the functional currency was the U.S. dollar.

Comprehensive Income (Loss)

The Company follows SFAS 130, “Reporting Comprehensive Income,” which requires the classification of items of other comprehensive income (loss) by their nature, and the disclosure of the accumulated balance of other comprehensive income (loss) separately within the equity section of the consolidated balance sheet. Comprehensive income (loss) is comprised of net loss and other comprehensive income (loss), which includes certain changes in equity that are excluded from net loss. Changes in fair value of derivatives designated and accounted for as cash flow hedges, amortization of prior service costs and unrealized actuarial losses included in net periodic benefit costs for pension and post-retirement plans and foreign currency translation adjustments are included in other comprehensive income (loss) and added to net loss to determine total comprehensive income (loss), which is displayed in the Consolidated Statements of Partners’ Capital (Deficit). Prior to the adoption of SFAS 158, “Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans – An Amendment of FASB Statements No. 87, 88, 106, and 132(R),” as of December 31, 2006, a minimum pension liability adjustment was required when the actuarial present value of accumulated pension plan benefits exceeded plan assets and accrued pension liabilities, less allowable intangible assets. A minimum pension liability adjustment, net of income taxes, was recorded as a component of other comprehensive income (loss). Subsequent to the adoption of SFAS 158, changes to the balances of the unrecognized prior service cost and the unrecognized net actuarial loss, net of income taxes, are recorded as a component of other comprehensive income (loss).

 

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GRAHAM PACKAGING HOLDINGS COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)

DECEMBER 31, 2007

 

Income Taxes

Holdings and the Operating Company, as limited partnerships, do not pay U.S. federal income taxes under the provisions of the Internal Revenue Code, as the applicable income or loss is included in the tax returns of its partners. However, certain U.S. subsidiaries acquired as part of the acquisition of the blow molded plastic container business of Owens-Illinois, Inc. (“O-I Plastic”) are corporations and are subject to U.S. federal and state income taxes. The Company’s foreign operations are subject to tax in their local jurisdictions. Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and are measured using enacted tax rates expected to apply to taxable income in the years in which the temporary differences are expected to reverse. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized.

Option Plans

The Company adopted SFAS 123(R), “Share-Based Payment,” on January 1, 2006 using the prospective method. In accordance with SFAS 123(R), the Company applied this statement prospectively to awards issued, modified, repurchased or cancelled after January 1, 2006. Under SFAS 123(R), actual tax benefits, if any, recognized in excess of tax benefits previously established upon grant are reported as a financing cash inflow. Prior to adoption, such excess tax benefits, if any, were reported as an operating cash inflow.

The Company continued to account for equity based compensation to employees for awards outstanding as of January 1, 2006 using the intrinsic value method prescribed in Accounting Principles Board Opinion (“APB”) 25, “Accounting for Stock Issued to Employees.” SFAS 123, “Accounting for Stock-Based Compensation,” established accounting and disclosure requirements using a fair value based method of accounting for equity based employee compensation plans. The exercise prices of all unit options were equal to or greater than the fair value of the units on the dates of the grants and, accordingly, no compensation cost has been recognized under the provisions of APB 25. However, as part of the North American reductions in force that occurred in 2005, certain individuals were terminated and were allowed to keep their unit options, resulting in compensation cost for the years ended December 31, 2006 and 2005 under SFAS 123 of $0.2 million and $0.3 million, respectively. Under SFAS 123, compensation cost is measured at the grant date based on the value of the award and is recognized over the service (or vesting) period. Had compensation cost for all option plans been determined under SFAS 123, based on the fair market value at the grant dates, the Company’s pro forma net loss for 2007, 2006 and 2005 would have been reflected as follows:

 

     Year Ended December 31,  
     2007     2006     2005  
     (In thousands)  

Net loss, as reported

   $ (206,052 )   $ (120,376 )   $ (52,641 )

Add: stock-based compensation expense included in reported net loss, net of income taxes

     608       187       270  

Deduct: total stock-based compensation expense under the fair value method for all awards, net of income taxes

     (1,126 )     (1,122 )     (1,441 )
                        

Pro forma net loss

   $ (206,570 )   $ (121,311 )   $ (53,812 )
                        

 

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GRAHAM PACKAGING HOLDINGS COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)

DECEMBER 31, 2007

 

Postemployment Benefits

The Company maintains deferred compensation plans for the Company’s current and former Chief Executive Officers, which provide them with postemployment benefits. Accrued postemployment benefits of $3.0 million and $1.8 million as of December 31, 2007 and 2006, respectively, were included in other non-current liabilities.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

Recently Issued Accounting Pronouncements

In June 2006, the FASB issued FIN 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109.” FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on accounting for derecognition, interest, penalties, accounting in interim periods, disclosure and classification of matters related to uncertainty in income taxes and transitional requirements upon adoption of FIN 48. The Company adopted FIN 48 effective January 1, 2007 which resulted in an increase in the Company’s other non-current liabilities for unrecognized tax benefits of $10.0 million (including interest of $2.2 million and penalties of $4.8 million), an increase in the Company’s non-current deferred tax assets of $5.2 million and a corresponding decrease in partners’ capital of $4.8 million. See Note 18 for additional discussion regarding the impact of the Company’s adoption of FIN 48.

In June 2006, the EITF reached a consensus on EITF 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation).” EITF 06-3 provides that the presentation of taxes assessed by a governmental authority that is directly imposed on a revenue producing transaction between a seller and a customer on either a gross basis (included in revenues and costs) or on a net basis (excluded from revenues) is an accounting policy decision that should be disclosed. EITF 06-3 was effective January 1, 2007. The Company presents these taxes on a net basis for all periods presented.

In September 2006, the FASB issued SFAS 158. Under SFAS 158, companies are required to (1) recognize in its statement of financial position an asset for a plan’s over funded status or a liability for a plan’s under funded status, (2) measure a plan’s assets and its obligations that determine its funded status as of the end of the Company’s fiscal year and (3) recognize changes in the funded status of a defined benefit post-retirement plan in the year in which the changes occur. Those changes will be reported in accumulated other comprehensive income. The Company adopted SFAS 158 as of December 31, 2006. The adoption of SFAS 158 resulted in a decrease in total partners’ capital (deficit) of $2.6 million as of December 31, 2006. For further information regarding the impact of the adoption of SFAS 158, refer to Note 13.

In September 2006, the FASB issued SFAS 157, “Fair Value Measurements.” This statement establishes a single authoritative definition of fair value, sets out a framework to classify the source of information used in fair value measurements, identifies additional factors that must be disclosed about assets and liabilities measured at fair value based on their placement in the new framework and modifies the long-standing accounting

 

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GRAHAM PACKAGING HOLDINGS COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)

DECEMBER 31, 2007

 

presumption that the transaction price of an asset or liability equals its initial fair value. In February 2008, the FASB delayed the effective date for certain nonfinancial assets and liabilities until January 1, 2009. The Company does not expect the adoption to have a significant impact on its financial statements.

In February 2007, the FASB issued SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of FASB Statement No. 115.” Under SFAS 159, companies may elect to measure specified financial instruments and warranty and insurance contracts at fair value on a contract-by-contract basis, with changes in fair value recognized in earnings each reporting period. The Company does not expect the adoption to have a significant impact on its financial statements.

In December 2007, the FASB issued SFAS 141(R), “Business Combinations.” SFAS 141(R) establishes principles and requirements for the reporting entity in a business combination, including recognition and measurement in the financial statements of the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree. This statement also establishes disclosure requirements to enable financial statement users to evaluate the nature and financial effects of the business combination. SFAS 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first fiscal year beginning after December 15, 2008. The guidance in SFAS 141(R) will be applied prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning after December 15, 2008.

In December 2007, the FASB issued SFAS 160, “Noncontrolling Interests in Consolidated Financial Statements – Amendment of ARB No. 51.” SFAS 160 establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, changes in a parent’s ownership of a noncontrolling interest, calculation and disclosure of the consolidated net income attributable to the parent and the noncontrolling interest, changes in a parent’s ownership interest while the parent retains its controlling financial interest and fair value measurement of any retained noncontrolling equity investment. SFAS 160 is effective for financial statements issued for fiscal years beginning after December 15, 2008. Early adoption is prohibited. The Company does not expect the adoption to have a significant impact on its financial statements.

In March 2008, the FASB issued SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities.” The new standard is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance and cash flows. It requires disclosure of the fair values of derivative instruments and their gains and losses in a tabular format. It also provides more information about an entity’s liquidity by requiring disclosure of derivative features that are credit risk-related, and requires cross-referencing within footnotes to enable financial statement users to locate important information about derivative instruments. It is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company is currently in the process of assessing the impact of the adoption of SFAS 161 on its financial statement disclosures.

Reclassifications

Certain reclassifications have been made to the 2006 and 2005 financial statements to conform to the 2007 presentation, including the following:

 

   

a reclassification to reflect deferred revenue as a separate line on the Consolidated Balance Sheets. The amount for this line item was previously included in accrued expenses and other current liabilities.

 

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GRAHAM PACKAGING HOLDINGS COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)

DECEMBER 31, 2007

 

   

a reclassification to reflect as separate components of cash provided by operating activities in the Consolidated Statements of Cash Flows, pension expense and pension contributions. Amounts for these line items were previously included in changes in other non-current assets, changes in other non-current liabilities and changes in accounts payable and accrued expenses.

2.    Accounts Receivable

Accounts receivable are presented net of an allowance for doubtful accounts of $5.7 million and $6.3 million at December 31, 2007 and 2006, respectively. Management performs ongoing credit evaluations of its customers and generally does not require collateral.

3.    Concentration of Credit Risk

For the year ended December 31, 2007, 71.6% of the Company’s net sales were generated by its top twenty customers. The Company had sales to one customer, PepsiCo, which exceeded 10% of total sales in each of the years ended December 31, 2007, 2006 and 2005. The Company’s sales to PepsiCo were 13.9%, 17.0% and 17.9% of total sales for the years ended December 31, 2007, 2006 and 2005, respectively. For the years ended December 31, 2007, 2006 and 2005, approximately 100%, 100% and 98%, respectively, of the sales to PepsiCo were made in North America.

As of December 31, 2007, the Company had $148.5 million of accounts receivable from its top twenty customers. As of December 31, 2007, the Company had $24.3 million of accounts receivable from PepsiCo.

4.    Inventories

Inventories, at lower of cost or market, consisted of the following:

 

     December 31,
     2007    2006
     (In thousands)

Finished goods

   $ 188,236    $ 175,362

Raw materials and parts

     77,948      63,579
             
   $ 266,184    $ 238,941
             

 

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GRAHAM PACKAGING HOLDINGS COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)

DECEMBER 31, 2007

 

5.    Property, Plant and Equipment

A summary of gross property, plant and equipment at December 31 is presented in the following table:

 

     Expected
Useful
Lives
(in years)
   2007    2006
          (In thousands)

Land

      $ 45,560    $ 44,167

Buildings and improvements

   7-31.5      239,914      236,952

Machinery and equipment

   3-15      1,804,497      1,962,386

Construction in progress

        91,413      143,259
                
      $ 2,181,384    $ 2,386,764
                

Depreciation expense, including depreciation expense on assets recorded under capital leases, for the years ended December 31, 2007, 2006 and 2005 was $193.2 million, $194.1 million and $184.5 million, respectively.

Capital leases included in buildings and improvements were $2.3 million and $5.4 million at December 31, 2007 and 2006, respectively. Capital leases included in machinery and equipment were $52.1 million and $50.2 million at December 31, 2007 and 2006, respectively. Accumulated depreciation on all property, plant and equipment accounted for as capital leases is included with accumulated depreciation on owned assets on the Consolidated Balance Sheets.

The Company capitalizes interest on borrowings during the active construction period of major capital projects. Capitalized interest is added to the cost of the underlying assets and is amortized over the useful lives of assets. Interest capitalized for the years ended December 31, 2007, 2006 and 2005 was $5.7 million, $9.5 million and $6.1 million, respectively.

6.    Intangible Assets

The gross carrying amount and accumulated amortization of the Company’s intangible assets subject to amortization as of December 31, 2007 were as follows:

 

     Gross
Carrying
Amount
   Accumulated
Amortization
    Net    Weighted Average
Amortization
Period
     (In thousands)     

Patented technology

   $ 24,421    $ (5,646 )   $ 18,775    11 years

Customer relationships

     36,288      (3,342 )     32,946    18 years

Licensing agreements

     601      —         601    1 year

Non-compete agreements

     1,543      (1,013 )     530    5 years
                        

Total

   $ 62,853    $ (10,001 )   $ 52,852   
                        

 

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GRAHAM PACKAGING HOLDINGS COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)

DECEMBER 31, 2007

 

The gross carrying amount and accumulated amortization of the Company’s intangible assets subject to amortization as of December 31, 2006 were as follows:

 

     Gross
Carrying
Amount
   Accumulated
Amortization
    Net    Weighted Average
Amortization
Period
     (In thousands)     

Patented technology

   $ 23,982    $ (5,011 )   $ 18,971    11 years

Customer relationships

     41,982      (5,559 )     36,423    18 years

Licensing agreements

     28,000      (5,727 )     22,273    11 years

Non-compete agreements

     1,544      (700 )     844    5 years
                        

Total

   $ 95,508    $ (16,997 )   $ 78,511   
                        

Amortization expense for the years ended December 31, 2007, 2006 and 2005 was $7.6 million, $7.7 million and $7.1 million, respectively. Estimated aggregate amortization expense for each of the next five years ending December 31 is as follows (in thousands):

 

2008

   $ 5,500

2009

     5,200

2010

     5,100

2011

     5,200

2012

     5,300

7.    Goodwill

The changes in the carrying amount of goodwill were as follows:

 

     North
America
Segment
    Europe
Segment
    South
America
Segment
    Total  
     (In thousands)  

Balance at January 1, 2006

   $ 288,158     $ 17,278     $ 11,735     $ 317,171  

Foreign currency translation adjustments

     (642 )     2,124       79       1,561  

Impairment

     —         (2,661 )     (9,068 )     (11,729 )

Other adjustments*

     (2,676 )     (914 )     (19 )     (3,609 )
                                

Balance at December 31, 2006

     284,840       15,827       2,727       303,394  

Foreign currency translation adjustments

     (110 )     2,780       188       2,858  

Impairment

     —         —         (1,100 )     (1,100 )

Other adjustments**

     1,565       —         2       1,567  
                                

Balance at December 31, 2007

   $ 286,295     $ 18,607     $ 1,817     $ 306,719  
                                

 

* Settlement of tax contingencies related to the acquisition of O-I Plastic.
** Settlement of tax audit of purchase price allocation and tax adjustment related to opening balance of pension liability.

 

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GRAHAM PACKAGING HOLDINGS COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)

DECEMBER 31, 2007

 

8.    Asset Impairment Charges

The components of asset impairment charges in the Consolidated Statements of Operations for the years ended December 31 are reflected in the table below and are described in the paragraphs following the table:

 

     Year ended December 31,
     2007    2006    2005
     (In thousands)

Property, plant and equipment

   $ 135,660    $ 14,136    $ 6,826

Intangible assets

     21,093      —        —  

Goodwill

     1,100      11,739      437
                    
   $ 157,853    $ 25,875    $ 7,263
                    

Property, Plant and Equipment

During 2007, the Company evaluated the recoverability of its long-lived tangible assets in light of several trends in some of the markets it serves. Among other factors, the Company considered the following in its evaluation:

 

   

a steady conversion to concentrate containers in the liquid laundry detergent market which will result in decreased sales;

 

   

an ongoing reduction in the automotive quart container business as the Company’s customers convert to multi-quart containers;

 

   

introduction by the Company, and its competitors, of newer production technology in the food and beverage sector which is improving productivity, causing certain of the Company’s older machinery and equipment to become obsolete; and

 

   

the loss of the European portion of a customer’s business.

The impaired assets consisted of machinery and equipment for the production lines and support assets for the production lines, as well as land and buildings. The Company determined the fair value of the production lines and support assets using probability-weighted discounted cash flows and determined the fair value of land and buildings using current market information.

Impairment of property, plant and equipment in 2006 was primarily due to a significant decrease in revenue in several European plants, the discontinuation of preform manufacturing in Europe and the loss of a major customer in South America.

The impairment of property, plant and equipment was recorded in the following operating segments:

 

     Year ended December 31,
     2007    2006    2005
     (In thousands)

North America

   $ 116,807    $ 2,942    $ 5,177

Europe

     18,310      9,281      250

South America

     543      1,913      1,399
                    
   $ 135,660    $ 14,136    $ 6,826
                    

 

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GRAHAM PACKAGING HOLDINGS COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)

DECEMBER 31, 2007

 

Intangible Assets

During 2007, the Company impaired its licensing agreements, customer relationships and patented technologies by $19.1 million, $1.7 million and $0.3 million, respectively, all in its North American operating segment. These intangible assets were recorded in conjunction with the acquisition of O-I Plastic in 2004. The licensing agreements were impaired due to lower projected royalty revenues associated with licensing agreements acquired in the acquisition of O-I Plastic as compared to royalty revenues projected at the time of the acquisition. The customer relationships were impaired due primarily to reduced revenues with a major customer as a result of that customer’s policy regarding allocation of its business among several vendors. The impairment of patented technology is primarily a result of the conversion of a significant portion of the Company’s continuous extrusion manufacturing to Graham Wheel technology.

Goodwill

The Company performs its annual test of impairment of goodwill as of December 31. As a result of this test the Company recorded impairment charges of $1.1 million, $11.7 million and $0.4 million for the years ended December 31, 2007, 2006 and 2005, respectively, related to the following locations (with the operating segment under which it reports in parentheses):

 

   

Venezuela in 2006 and 2007 (South America)

   

Ecuador in 2006 (South America)

   

the United Kingdom in 2006 (Europe)

   

Finland in 2006 (Europe)

   

Turkey in 2005 (Europe)

The Venezuela reporting unit has suffered several years of losses and the Company’s projected cash flows are not sufficient to cover the goodwill recorded at the time of the O-I Plastic acquisition. In 2006, the Company was notified that it would lose the business of a major customer of the Ecuador plant. The Company closed its Ecuador plant in 2007. The Finland and the United Kingdom reporting units have not performed at the levels expected and the Company’s projected cash flows are not sufficient to cover the goodwill recorded at the time of the O-I Plastic acquisition. In 2005, the Company’s projected cash flows for Turkey were not sufficient to cover the goodwill recorded at the time of the Turkey acquisition.

9.    Accrued Expenses and Other Current Liabilities

Accrued expenses and other current liabilities consisted of the following:

 

     December 31,
     2007    2006
     (In thousands)

Accrued employee compensation and benefits

   $ 68,409    $ 58,491

Accrued interest

     32,069      34,885

Accrued sales allowance

     29,622      20,254

Other

     54,459      66,547
             
   $ 184,559    $ 180,177
             

In recent years, the Company has initiated a series of restructuring activities to reduce costs, achieve synergies and streamline operations.

 

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GRAHAM PACKAGING HOLDINGS COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)

DECEMBER 31, 2007

 

For the year ended December 31, 2007, the Company recognized severance expense in the United States of $2.1 million (which is reflected predominantly in selling, general and administrative expenses) related to the severing of 59 employees, all of which were terminated by December 31, 2007. Substantially all of the cash payments for these termination benefits are expected to be made by September 30, 2008. The Company also recognized severance expense in France of $1.9 million (which is reflected in selling, general and administrative expenses) related to the severing of 14 employees, none of which were terminated as of December 31, 2007. Substantially all of the cash payments for these termination benefits are expected to be made by December 31, 2008.

For the year ended December 31, 2006, the Company recognized severance expense in the United States of $1.6 million related to the severing of 46 employees, all of which were terminated by December 31, 2007. Substantially all of the cash payments for these termination benefits are expected to be made by March 31, 2008. The Company also recognized severance expense of $5.3 million related to the separation of its former Chief Executive Officer and Chief Financial Officer on December 3, 2006. Substantially all of the cash payments for these termination benefits are expected to be made by December 31, 2009.

For the year ended December 31, 2005, the Company recognized severance expense in the United States of $2.3 million related to the severing of 16 employees. Substantially all of the cash payments for these termination benefits are expected to be made by March 31, 2008. The Company also recognized severance expense in France of $3.8 million related to the severing of 37 employees. Substantially all of the cash payments for these termination benefits are expected to be made by December 31, 2008.

The following table summarizes these severance accruals, and related expenses and payments, by operating segment for the last three years. At December 31, 2007, $1.6 million of the consolidated balance was included in other non-current liabilities and the remainder was included in accrued employee compensation and benefits:

 

     North
America
    Europe     Total  
     (In thousands)  

Balance at January 1, 2005

   $ 4,148     $ 631     $ 4,779  

Charged to expense during the year

     2,288       3,849       6,137  

Payments during the year

     (2,945 )     (157 )     (3,102 )

Other adjustments

     (1,448 )*     (79 )     (1,527 )
                        

Balance at December 31, 2005

     2,043       4,244       6,287  

Charged to expense during the year

     6,965       (140 )     6,825  

Payments during the year

     (2,246 )     (3,412 )     (5,658 )

Other adjustments

     —         380       380  
                        

Balance at December 31, 2006

     6,762       1,072       7,834  

Charged to expense during the year

     2,025       1,681       3,706  

Payments during the year

     (4,125 )     (711 )     (4,836 )

Other adjustments

     —         84       84  
                        

Balance at December 31, 2007

   $ 4,662     $ 2,126     $ 6,788  
                        

 

* represents the reduction of an accrual established in 2004 in accordance with EITF 95-3, “Recognition of Liabilities in Connection with a Purchase Business Combination.” This accrual was treated as having been assumed in the acquisition of O-I Plastic and included in the allocation of the acquisition cost.

 

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GRAHAM PACKAGING HOLDINGS COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)

DECEMBER 31, 2007

 

In addition to the above costs, as of December 31, 2006, the Company had accrued (within current liabilities) payments made on January 5, 2007 to the Company’s former Chief Executive Officer and Chief Financial Officer for the repurchase of all of their outstanding partnership units and options, pursuant to separation agreements dated as of December 3, 2006. The gross amount accrued as of December 31, 2006 and paid in 2007 was $3.4 million.

10.    Debt Arrangements

Long-term debt consisted of the following:

 

     December 31,
     2007    2006
     (In thousands)

Term loan

   $ 1,860,938    $ 1,819,861

Revolving Credit Facility

     —        56,000

Foreign and other revolving credit facilities

     14,501      7,174

Senior Notes

     250,000      250,000

Senior Subordinated Notes

     375,000      375,000

Capital leases

     33,180      37,607

Other

     713      1,245
             
     2,534,332      2,546,887

Less amounts classified as current

     45,695      32,308
             
   $ 2,488,637    $ 2,514,579
             

The Company’s credit agreement consists of a term loan B to the Operating Company totaling $1,860.9 million (the “Term Loan” or “Term Loan Facility”) and a $250.0 million revolving credit facility (the “Revolving Credit Facility”) (the “Credit Agreement”). The obligations of the Operating Company under the Credit Agreement are guaranteed by Holdings and certain other subsidiaries of Holdings. Term Loan B is payable in quarterly installments and requires payments of $18.7 million in each of 2008, 2009 and 2010 and $1,804.8 million in 2011. The Revolving Credit Facility expires on October 7, 2010. Availability under the Company’s Revolving Credit Facility as of December 31, 2007 was $239.1 million (as reduced by $10.9 million of outstanding letters of credit). Interest under the Credit Agreement is payable at (a) the “Alternate Base Rate” (“ABR”) (the higher of the Prime Rate or the Federal Funds Rate plus 0.50%) plus a margin ranging from 1.00% to 1.75%; or (b) the “Eurodollar Rate” (the applicable interest rate offered to banks in the London interbank eurocurrency market) plus a margin ranging from 2.00% to 2.75%. A commitment fee of 0.50% is due on the unused portion of the revolving loan commitment.

Substantially all domestic tangible and intangible assets of the Company are pledged as collateral pursuant to the terms of the Credit Agreement.

The majority of the Company’s prior credit facilities were refinanced on October 7, 2004 in connection with the acquisition of O-I Plastic (the “Transactions”). The Operating Company, Holdings, CapCo I and a syndicate of lenders entered into a new credit agreement and second-lien credit agreement (the “Second-Lien Credit Agreement” and, together with the Credit Agreement, the “Credit Agreements”). Pursuant to its terms, on April 18, 2006, the Credit Agreement was amended in order to, among other things, increase the Term Loan B facility provided under the Credit Agreement by $150.0 million (the “2006 Amendment”). Proceeds of the 2006

 

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GRAHAM PACKAGING HOLDINGS COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)

DECEMBER 31, 2007

 

Amendment were used to pay down $100.0 million of the Second-Lien Credit Agreement, with the remaining $50.0 million being used to reduce outstanding borrowings on the existing revolving credit facility provided for under the Credit Agreement. Pursuant to its terms, on March 30, 2007, the Credit Agreement was further amended in order to, among other things, increase the Term Loan B facility provided under the Credit Agreement by approximately $305.0 million (the “2007 Amendment”). Proceeds of the 2007 Amendment were used to pay off the Second-Lien Credit Agreement ($250.0 million), with $50.0 million being used to reduce outstanding borrowings on the existing revolving credit facility provided for under the Credit Agreement and approximately $5.0 million being used to pay fees and expenses. The 2007 Amendment also eliminated one of the Company’s financial ratio covenants, increased the maximum allowable leverage under another financial ratio covenant and waived any potential excess cash flow payment required for the year ended December 31, 2006.

The Transactions also included the issuance of $250.0 million in Senior Notes of the Operating Company and $375.0 million in Senior Subordinated Notes of the Operating Company (collectively “the Notes”). The Notes are unconditionally guaranteed, jointly and severally, by Holdings and mature on October 7, 2012 (Senior Notes) and October 7, 2014 (Senior Subordinated Notes). Interest on the Senior Notes is payable semi-annually at 8.50% and interest on the Senior Subordinated Notes is payable semi-annually at 9.875%.

During 2004 and 2005, the Operating Company entered into forward starting interest rate swap agreements that effectively fixed the interest rate on $925.0 million of the Term Loans at a weighted average rate of 4.02%. These swaps went into effect at various points in 2006 and expired in December 2007 ($650.0 million) and January 2008 ($275.0 million).

During 2007, the Operating Company entered into two forward starting collar agreements that effectively fix the interest rate within a fixed cap and floor rate on $385.0 million of the Term Loans at a weighted average cap rate of 4.70% and a weighted average floor rate of 2.88%. These forward starting collar agreements went into effect January 2008 and expire in 2010.

The Credit Agreement and Notes contain a number of significant covenants that, among other things, restrict the Company’s ability to dispose of assets, repay other indebtedness, incur additional indebtedness, pay dividends, prepay subordinated indebtedness, incur liens, make capital expenditures, investments or acquisitions, engage in mergers or consolidations, engage in transactions with affiliates and otherwise restrict the Company’s activities. In addition, under the Credit Agreement, the Company is required to satisfy specified financial ratios and tests. The Credit Agreement requires that up to 50% of excess cash flow (as defined in the Credit Agreement) be applied on an annual basis to pay down the B Loan. No excess cash flow payment is due for the year ended December 31, 2007. As of December 31, 2007, the Company was in compliance with all covenants.

Under the Credit Agreement, the Operating Company is subject to restrictions on the payment of dividends or other distributions to Holdings; provided that, subject to certain limitations, the Operating Company may pay dividends or other distributions to Holdings:

 

   

in respect of overhead, tax liabilities, legal, accounting and other professional fees and expenses; and

 

   

to fund purchases and redemptions of equity interests of Holdings or Investor LP held by then present or former officers or employees of Holdings, the Operating Company or their Subsidiaries (as defined therein) or by any employee stock ownership plan upon that person’s death, disability, retirement or termination of employment or other circumstances with annual dollar limitations.

 

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GRAHAM PACKAGING HOLDINGS COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)

DECEMBER 31, 2007

 

The Company’s weighted average effective interest rate on the outstanding borrowings under the Term Loan and Revolving Credit Facility was 7.50% and 7.99% at December 31, 2007 and 2006, respectively, excluding the effect of interest rate swaps.

The Company had several variable-rate revolving credit facilities denominated in U.S. Dollars, Brazilian Real, Argentine Pesos, Polish Zloty and Venezuela Bolivar with aggregate available borrowings at December 31, 2007 equivalent to $25.1 million. The Company’s average effective interest rate on borrowings of $14.5 million on these credit facilities at December 31, 2007 was 13.99%. The Company’s average effective interest rate on borrowings of $7.2 million on these credit facilities at December 31, 2006 was 11.58%.

Cash paid for interest during 2007, 2006 and 2005, net of amounts capitalized of $5.7 million, $9.5 million and $6.1 million, respectively, totaled $198.4 million, $179.7 million and $172.0 million, respectively.

The annual debt service requirements of the Company for the succeeding five years are as follows (in thousands):

 

2008

   $ 45,700

2009

     24,800

2010

     28,500

2011

     1,810,100

2012

     250,200

11.    Fair Value of Financial Instruments and Derivatives

The following methods and assumptions were used to estimate the fair values of each class of financial instruments:

Cash and Cash Equivalents, Accounts Receivable and Accounts Payable

The fair values of these financial instruments approximate their carrying amounts.

Long-Term Debt

The fair values of the variable-rate, long-term debt instruments approximate their carrying amounts. The fair value of other long-term debt was based on market price information. Other long-term debt includes $250.0 million of Senior Notes and $375.0 million of Senior Subordinated Notes and totaled $658.7 million and $663.5 million at December 31, 2007 and 2006, respectively. The fair value of this long-term debt, including the current portion, was approximately $588.8 million and $671.3 million at December 31, 2007 and 2006, respectively.

Derivatives

The Company is exposed to market risk from changes in interest rates and currency exchange rates. The Company manages these exposures on a consolidated basis and enters into various derivative transactions for selected exposure areas. The financial impacts of these hedging instruments are offset by corresponding changes in the underlying exposures being hedged. The Company does not hold or issue derivative financial instruments for trading purposes.

Interest rate swap, collar and forward rate agreements are used to hedge exposure to interest rates associated with the Company’s Credit Agreement. Under these agreements, the Company agrees to exchange with a third

 

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GRAHAM PACKAGING HOLDINGS COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)

DECEMBER 31, 2007

 

party at specified intervals the difference between fixed and variable interest amounts calculated by reference to an agreed-upon notional principal amount. In 2007 and 2006, the assets or liabilities associated with interest rate swaps and collars were recorded on the balance sheet in prepaid expenses and other current assets and other non-current assets, or in other current liabilities and other non-current liabilities, at fair value. The hedges are highly effective as defined in SFAS 133, with the effective portion of the cash flow hedges recorded in other comprehensive income (loss). The effective portion of the cash flow hedges recorded in other comprehensive income (loss) was an unrealized loss of $0.7 million and an unrealized gain of $10.9 million as of December 31, 2007 and 2006, respectively. Failure to properly document the Company’s interest rate swaps and collars as effective hedges would result in income statement recognition of all or part of the cumulative $0.7 million unrealized loss recorded in accumulated other comprehensive income (loss) as of December 31, 2007. Approximately 44% of the amount recorded within other comprehensive income (loss) is expected to be recognized as interest expense in the next twelve months.

The following table presents information for all interest rate swaps, forward rate agreements and interest rate collars. The interest rate swaps, forward rate agreements and interest rate collars are accounted for as cash flow hedges. The notional amount does not necessarily represent amounts exchanged by the parties, and therefore is not a direct measure of the Company’s exposure to credit risk. The fair value approximates the cost to settle the outstanding contracts.

 

     December 31,
     2007     2006
     (In thousands)

Swaps:

    

Notional amount

   $ 275,000     $ 925,000

Fair value—asset

     78       10,725

Forward rate agreements:

    

Notional amount

     —         1,145,241

Fair value—asset

     —         206

Collars:

    

Notional amount

     385,000       —  

Fair value—(liability)

     (785 )     —  

Derivatives are an important component of the Company’s interest rate management program, leading to acceptable levels of variable interest rate risk. Had the Company not hedged its interest rates in 2007, 2006 and 2005, interest expense would have been higher by $12.3 million, $11.5 million and $2.8 million, respectively, compared to an entirely unhedged variable rate debt portfolio.

The Company manufactures and sells its products in a number of countries throughout the world and, as a result, is exposed to movements in foreign currency exchange rates. The Company, where possible and cost effective in the Company’s judgment, utilizes foreign currency hedging activities to protect against volatility associated with purchase commitments that are denominated in foreign currencies for machinery, equipment and other items created in the normal course of business. The terms of these contracts are generally less than one year. Gains and losses related to qualifying hedges of foreign currency firm commitments or anticipated transactions are accounted for as cash flow hedges in accordance with SFAS 133. There were no currency forward contracts outstanding at December 31, 2007 and 2006.

Credit risk arising from the inability of a counterparty to meet the terms of the Company’s financial instrument contracts is generally limited to the amounts, if any, by which the counterparty’s obligations exceed

 

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GRAHAM PACKAGING HOLDINGS COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)

DECEMBER 31, 2007

 

the obligations of the Company. It is the Company’s policy to enter into financial instruments with a diverse group of creditworthy counterparties in order to spread the risk among multiple counterparties.

12.    Transactions with Related Parties

The Company had transactions with entities affiliated through common ownership. The Company was a party to an Equipment Sales, Services and License Agreement dated February 2, 1998 (“Equipment Sales Agreement”) with Graham Engineering Corporation (“Graham Engineering”), under which Graham Engineering provided the Company with certain sizes of the Graham Wheel, which is an extrusion blow molding machine, on an exclusive basis within the countries and regions in which the Company had material sales of plastic containers. Innopack, S.A., former minority shareholder of Graham Innopack de Mexico S. de R.L. de C.V., has supplied goods and related services to the Company. The Company purchased the remaining interest in Graham Innopack de Mexico S. de R.L. de C.V. on May 9, 2005. Certain entities controlled by Donald C. Graham and his family (the “Graham Family Investors”) own Graham Engineering and have a 15% ownership interest in the Company. In addition, they have supplied management services to the Company since 1998. An entity affiliated with Blackstone Capital Partners III Merchant Banking Fund L.P., Blackstone Offshore Capital Partners III L.P. and Blackstone Family Investment Partnership III L.P., who together have an 80% ownership interest in the Company, has supplied management services to the Company since 1998.

Transactions with entities affiliated through common ownership included the following:

 

     Year Ended December 31,
     2007    2006    2005
     (In thousands)

Equipment and related services purchased from affiliates

   $ 11,011    $ 10,311    $ 13,147

Goods and related services purchased from affiliates

   $ —      $ 35    $ 41

Management services provided by affiliates

   $ 5,293    $ 5,140    $ 5,156

Sales to affiliates, including raw materials

   $ —      $ —      $ 20

Interest income on notes receivable from owners

   $ 114    $ 193    $ 182

Account balances with affiliates included the following:

 

     As of December 31,
     2007    2006
     (In thousands)

Accounts payable

   $ 1,745    $ 907

Notes and interest receivable for ownership interests

   $ 1,939    $ 3,295

Receivable from partner

   $ 4,232    $ —  

At December 31, 2007, the Company had loans outstanding to certain management employees. These loans were made in connection with the capital call payments made on September 29, 2000 and March 29, 2001 pursuant to the capital call agreement dated as of August 13, 1998. The proceeds from the loans were used to fund management’s share of the capital call payments. The loans mature on March 30, 2008 and September 28, 2012, respectively, and accrue interest at a rate of 6.22%. The loans are secured by a pledge of the stock purchased by the loans and by a security interest in any bonus due and payable to the respective borrowers on or after the maturity date of the loans. The loans and related interest are reflected in Partners’ Capital (Deficit) on the Consolidated Balance Sheets.

 

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GRAHAM PACKAGING HOLDINGS COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)

DECEMBER 31, 2007

 

Gary G. Michael, a member of the committee that advises the partnership and the general partners (the “Advisory Committee”), also serves on the Board of Directors of The Clorox Company, which is a large customer of the Company. Included in current assets at December 31, 2007 and 2006 were receivables from The Clorox Company of $2.1 million and $1.7 million, respectively. Included in net sales for the year ended December 31, 2007, 2006 and 2005 were net sales to The Clorox Company of $30.0 million, $30.6 million and $32.0 million, respectively.

13.    Pension Plans

Substantially all employees of the Company participate in noncontributory defined benefit or defined contribution pension plans.

The U.S. defined benefit plan covering salaried employees provides retirement benefits based on the final five years average compensation, while plans covering hourly employees provide benefits based on years of service. The Company’s hourly and salaried pension plan covering non-union employees was frozen to future salary and service accruals in the fourth quarter of 2006. The Company recorded a $3.1 million curtailment gain in the fourth quarter of 2006 as a result of the plan freeze.

On September 29, 2006, the FASB issued SFAS 158. The Company adopted SFAS 158 effective December 31, 2006. The adoption of SFAS 158 resulted in a decrease in total partners’ capital (deficit) of $2.6 million as of December 31, 2006.

 

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GRAHAM PACKAGING HOLDINGS COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)

DECEMBER 31, 2007

 

The Company uses a December 31 measurement date for all of its plans. The components of pension expense and other changes in plan assets and benefit obligations recognized in other comprehensive income (loss) were as follows:

 

     Pension Plan  
     U.S.     Non-U.S.  
     2007     2006     2005     2007     2006     2005  
     (In thousands)  

Net periodic benefit cost and amounts recognized in other comprehensive income (loss):

            

Service cost

   $ 2,192     $ 10,387     $ 10,107     $ 798     $ 718     $ 655  

Interest cost

     4,339       4,245       3,563       891       774       827  

Expected return on assets

     (5,114 )     (3,977 )     (3,409 )     (953 )     (771 )     (687 )

Amortization of prior service cost

     673       388       315       53       31       29  

Amortization of net loss

     85       738       662       50       78       45  

Special benefits

     —         14       —         —         —         —    

Curtailment (gain) loss

     —         (3,085 )     8       —         (132 )     (734 )
                                                

Net periodic pension costs

     2,175     $ 8,710     $ 11,246       839     $ 698     $ 135  
                                    

Other changes in plan assets and benefit obligations recognized in other comprehensive income (loss):

            

Prior service cost for period

     5,050           303      

Net loss (gain) for period

     27           (504 )    

Amortization of prior service cost

     (673 )         (53 )    

Amortization of net loss

     (85 )         (50 )    

Foreign currency exchange rate change

     —             369      
                        

Total

     4,319           65      
                        

Total recognized in net periodic benefit cost and

            

other comprehensive income (loss)

   $ 6,494         $ 904      
                        

The estimated prior service cost and net actuarial loss for the defined benefit pension plans that will be amortized from accumulated other comprehensive loss into net periodic benefits cost in 2008 are $0.6 million and $0.1 million, respectively, for the U.S. plans, and $0.1 million and $0.1 million, respectively, for the non-U.S. plans.

 

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GRAHAM PACKAGING HOLDINGS COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)

DECEMBER 31, 2007

 

All of the Company’s plans have a benefit obligation in excess of plan assets. Using the most recent actuarial valuations, the following table sets forth the change in the Company’s benefit obligation and pension plan assets at market value for the years ended December 31, 2007 and 2006. The Company uses the fair value of its pension assets in the calculation of pension expense for all of its pension plans.

 

    U.S.     Non-U.S.  
    2007     2006     2007     2006  
    (In thousands)  

Change in benefit obligation:

       

Benefit obligation at beginning of year

  $ (68,018 )   $ (74,339 )   $ (16,539 )   $ (14,867 )

Service cost

    (2,192 )     (10,387 )     (798 )     (718 )

Interest cost

    (4,339 )     (4,245 )     (891 )     (773 )

Benefits paid

    1,360       1,339       355       392  

Change in benefit payments due to experience

    —           (3 )     29  

Settlements/curtailments

    —         15,496       —         131  

Participant contributions

    —         —         (106 )     (88 )

Effect of exchange rate changes

    —         —         (1,273 )     (1,163 )

Decrease in benefit obligation due to change in discount rate

    1,699       3,932       —         —    

Special termination benefits

    —         (14 )     —         —    

Actuarial gain

    491       319       1,302       518  

Increase in benefit obligation due to plan change

    (5,050 )     (119 )     (303 )     —    
                               

Benefit obligation at end of year

  $ (76,049 )   $ (68,018 )   $ (18,256 )   $ (16,539 )
                               

Change in plan assets:

       

Plan assets at market value at beginning of year

  $ 55,908     $ 43,029     $ 12,761     $ 10,411  

Actual return on plan assets

    2,897       4,272       160       1,024  

Foreign currency exchange rate changes

    —         —         1,092       875  

Employer contributions

    6,888       9,946       1,003       738  

Participant contributions

    —         —         106       88  

Benefits paid

    (1,360 )     (1,339 )     (355 )     (375 )
                               

Plan assets at market value at end of year

  $ 64,333     $ 55,908     $ 14,767     $ 12,761  
                               

Funded status

  $ (11,716 )   $ (12,110 )   $ (3,489 )   $ (3,778 )
                               

Amounts recognized in the statement of financial position consist of:

       

Current liabilities

  $ —       $ —       $ (18 )   $ (24 )

Non-current liabilities

    (11,716 )     (12,110 )     (3,471 )     (3,754 )
                               

Total

  $ (11,716 )   $ (12,110 )   $ (3,489 )   $ (3,778 )
                               

Amounts recognized in accumulated other comprehensive income (loss):

 

     

Unrecognized prior service cost

  $ 6,467     $ 2,089     $ 550     $ 300  

Unrecognized net actuarial loss

    1,753       1,812       924       1,109  
                               

Total

  $ 8,220     $ 3,901     $ 1,474     $ 1,409  
                               

Accrued benefit cost:

       

Accrued benefit cost at beginning of year

  $ (8,209 )   $ (9,445 )   $ (2,368 )   $ (2,172 )

Net periodic benefit cost

    (2,175 )     (8,710 )     (839 )     (698 )

Change in assumptions

    —         —         —         78  

Employer contributions

    6,888       9,946       1,003       738  

Effect of exchange rate changes

    —         —         189       (315 )
                               

Accrued benefit cost at end of year

  $ (3,496 )   $ (8,209 )   $ (2,015 )   $ (2,369 )
                               

 

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GRAHAM PACKAGING HOLDINGS COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)

DECEMBER 31, 2007

 

The following table presents significant assumptions used to determine benefit obligations at December 31:

 

     2007      2006  

Discount rate:

     

- U.S.

   6.00 %    5.75 %

- Canada

   5.25 %    5.00 %

- UK

   5.37 %    5.00 %

- Mexico

   7.64 %    5.59 %

Rate of compensation increase:

     

- U.S.

   N/A      4.50 %

- Canada

   4.00 %    4.00 %

- UK

   3.60 %    3.60 %

- Mexico

   4.54 %    4.91 %

The following table presents significant assumptions used to determine benefit costs for the years ended December 31:

 

     Actuarial Assumptions  
     U.S.     Canada     UK     Mexico  

Discount rate:

        

2007

   5.75 %   5.00 %   5.00 %   5.59 %

2006

   5.75 %   5.00 %   4.90 %   7.46 %

2005

   6.00 %   6.00 %   5.40 %   8.68 %

Long-term rate of return on plan assets:

        

2007

   8.75 %   8.00 %   6.92 %   N/A  

2006

   8.75 %   8.00 %   6.20 %   N/A  

2005

   8.75 %   8.00 %   6.60 %   N/A  

Weighted average rate of increase for future compensation levels:

        

2007

   4.50 %   4.00 %   3.60 %   4.91 %

2006

   4.50 %   4.00 %   3.50 %   4.88 %

2005

   4.50 %   4.00 %   3.50 %   5.55 %

Pension expense is calculated based upon a number of actuarial assumptions established on January 1 of the applicable year, detailed in the table above, including a weighted-average discount rate, rate of increase in future compensation levels and an expected long-term rate of return on plan assets. The discount rate used by the Company for valuing pension liabilities is based on a review of high quality corporate bond yields with maturities approximating the remaining life of the projected benefit obligations. The U.S. expected long-term rate of return assumption on plan assets (which consist mainly of U.S. equity and debt securities) was developed by evaluating input from the Company’s actuaries and investment consultants as well as long-term inflation assumptions. Projected returns by such consultants are based on broad equity and bond indices. The expected long-term rate of return on plan assets is based on an asset allocation assumption of 65% with equity managers and 35% with fixed income managers. At December 31, 2007, the Company’s asset allocation was 60% with equity managers, 34% with fixed income managers and 6% other. At December 31, 2006, the Company’s asset allocation was 65% with equity managers, 34% with fixed income managers and 1% other. The Company believes that its long-term asset allocation on average will approximate 65% with equity managers and 35% with fixed income managers. The Company regularly reviews its actual asset allocation and periodically rebalances its investments to targeted allocations when considered appropriate. Based on this methodology, the Company’s expected long-term rate of return assumption is 8.75% in 2007 and 2006.

 

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GRAHAM PACKAGING HOLDINGS COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)

DECEMBER 31, 2007

 

Asset allocation for the Company’s Canadian plan is substantially similar to the U.S. plan. Asset allocation for the Company’s UK plan is 49% with equity managers, 34% with fixed income managers and 17% in real estate.

The Company made cash contributions to its pension plans in 2007 of $7.9 million and paid benefit payments of $1.7 million. The Company estimates that based on current actuarial calculations it will make cash contributions to its pension plans in 2008 of $5.9 million. Cash contributions in subsequent years will depend on a number of factors including performance of plan assets.

The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid:

 

     Benefit Payments
     (In thousands)

2008

   $ 2,222

2009

     2,529

2010

     2,743

2011

     3,088

2012

     3,598

Years 2013 – 2017

     24,662

The Company also participated in a defined contribution plan under Internal Revenue Code Section 401(k), which covered all U.S. employees of the Company except those represented by a collective bargaining unit. The Company’s contributions were determined as a specified percentage of employee contributions, subject to certain maximum limitations. The Company’s costs for the defined contribution plan for 2007, 2006 and 2005 were $8.5 million, $3.2 million and $3.2 million, respectively.

14.    Partners’ Capital

Holdings was formed under the name “Sonoco Graham Company” on April 3, 1989 as a limited partnership in accordance with the provisions of the Pennsylvania Uniform Limited Partnership Act, and on March 28, 1991, Holdings changed its name to “Graham Packaging Company.” Pursuant to an Agreement and Plan of Recapitalization, Redemption and Purchase, dated as of December 18, 1997 (the “Recapitalization Agreement”), (i) Holdings, (ii) the then owners of the Company (the “Graham Entities”) and (iii) BMP/Graham Holdings Corporation, a Delaware corporation ("Investor LP") formed by Blackstone Capital Partners III Merchant Banking Fund L.P., and BCP/Graham Holdings L.L.C., a Delaware limited liability company and a wholly owned subsidiary of Investor LP (“Investor GP” and together with Investor LP, the “Equity Investors”) agreed to a recapitalization of Holdings (the “Recapitalization”). Closing under the Recapitalization Agreement occurred on February 2, 1998. Upon the closing of the Recapitalization, the name of Holdings was changed to “Graham Packaging Holdings Company.” Holdings will continue until its dissolution and winding up in accordance with the terms of the Holdings Partnership Agreement (as defined below).

As a result of the consummation of the Recapitalization, Investor LP owns an 81% limited partnership interest in Holdings and Investor GP owns a 4% general partnership interest in Holdings. The Graham Family Investors have retained a 0.7% general partnership interest and a 14.3% limited partnership interest in Holdings. Additionally, Holdings owns a 99% limited partnership interest in the Operating Company, and GPC Opco GP L.L.C., a wholly owned subsidiary of Holdings, owns a 1% general partnership interest in the Operating Company.

 

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GRAHAM PACKAGING HOLDINGS COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)

DECEMBER 31, 2007

 

As contemplated by the Recapitalization Agreement, Graham Family Investors (as successors and assigns of Graham Capital Corporation and Graham Family Growth Partnership), Graham Packaging Corporation (“Graham GP Corp”), Investor LP and Investor GP entered into a Fifth Amended and Restated Agreement of Limited Partnership (the “Holdings Partnership Agreement”). The general partners of the partnership are Investor GP and Graham GP Corp. The limited partners of the partnership are GPC Holdings, L.P. and Investor LP.

Capital Accounts. A capital account is maintained for each partner on the books of the Company. The Holdings Partnership Agreement provides that at no time during the term of the partnership or upon dissolution and liquidation thereof shall a limited partner with a negative balance in its capital account have any obligation to Holdings or the other partners to restore such negative balance. Items of partnership income or loss are allocated to the partners’ capital accounts in accordance with their percentage interests except as provided in Section 704(c) of the Internal Revenue Code with respect to contributed property where the allocations are made in accordance with the U.S. Treasury regulations thereunder.

Distributions. The Holdings Partnership Agreement requires certain tax distributions to be made if and when Holdings has taxable income. Other distributions shall be made in proportion to the partners’ respective percentage interests.

Transfers of Partnership Interests. The Holdings Partnership Agreement provides that, subject to certain exceptions including, without limitation, an IPO Reorganization (as defined below) and the transfer rights described below, general partners shall not withdraw from Holdings, resign as a general partner nor transfer their general partnership interests without the consent of all general partners, and limited partners shall not transfer their limited partnership interests.

If either Graham GP Corp. and/or GPC Holdings, L.P. (individually “Continuing Graham Partner” and collectively the “Continuing Graham Partners”) wishes to sell or otherwise transfer its partnership interests pursuant to a bona fide offer from a third party, Holdings and the Equity Investors must be given a prior opportunity to purchase such interests at the same purchase price set forth in such offer. If Holdings and the Equity Investors do not elect to make such purchase, then such Continuing Graham Partner may sell or transfer such partnership interests to such third party upon the terms set forth in such offer. If the Equity Investors wish to sell or otherwise transfer their partnership interests pursuant to a bona fide offer from a third party, the Continuing Graham Partners shall have a right to include in such sale or transfer a proportionate percentage of their partnership interests. If the Equity Investors (so long as they hold 51% or more of the partnership interests) wish to sell or otherwise transfer their partnership interests pursuant to a bona fide offer from a third party, the Equity Investors shall have the right to compel the Continuing Graham Partners to include in such sale or transfer a proportionate percentage of their partnership interests.

Dissolution. The Holdings Partnership Agreement provides that Holdings shall be dissolved upon the earliest of (i) the sale, exchange or other disposition of all or substantially all of Holdings’ assets (including pursuant to an IPO Reorganization), (ii) the withdrawal, resignation, filing of a certificate of dissolution or revocation of the charter or bankruptcy of a general partner, or the occurrence of any other event which causes a general partner to cease to be a general partner unless (a) the remaining general partner elects to continue the business or (b) if there is no remaining general partner, a majority-in-interest of the limited partners elect to continue the partnership, or (iii) such date as the partners shall unanimously elect.

IPO Reorganization. “IPO Reorganization” means the transfer of all or substantially all of Holdings’ assets and liabilities to CapCo II in contemplation of an initial public offering of the shares of common stock of CapCo

 

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GRAHAM PACKAGING HOLDINGS COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(continued)

DECEMBER 31, 2007

 

II. The Holdings Partnership Agreement provides that, without the approval of each general partner, the IPO Reorganization may not be effected through any entity other than CapCo II.

15.    Comprehensive Income (Loss)

The components of accumulated other comprehensive income (loss), net of income taxes, consisted of:

 

     Cash
Flow
Hedges
    Pension
Liability
    Cumulative
Translation
Adjustments
    Total  
     (In thousands)  

Balance at January 1, 2005

   $ 3,385     $ (3,868 )   $ 20,391     $ 19,908  

Change

     11,129       (673 )     (17,513 )     (7,057 )
                                

Balance at December 31, 2005

     14,514       (4,541 )     2,878       12,851  

Change

     (3,648 )     —         23,197       19,549  

Minimum pension liability adjustment prior to adoption of
SFAS 158

     —         1,837       —         1,837  

Adjustment to initially apply SFAS 158

     —         (2,585 )     —         (2,585 )
                                

Balance at December 31, 2006

     10,866       (5,289 )     26,075       31,652