**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM10-Q**

 

**QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period endedJune 30, 2004**

 

**COMMISSION FILE NUMBER: 1-13182**

 

**GraphicPackaging Corporation**

(Exact name of registrantas specified in its charter)

 

| **Delaware**                                                     | ** ** | **58-2205241**                        |
|------------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |       | (I.R.S. employer  identification no.) |
|                                                             |       |                                  |
| **814  Livingston Court  Marietta, Georgia**                     | ** ** | **30067**                             |
| (Address of  principal executive offices)                        |       | (Zip Code)                            |

 

**(770)644-3000**

Registrant’stelephone number, including area code:

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.

Yes ý  No o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2 of theAct).

Yes o  No ý

 

As of July 30, 2004,there were 198,578,608 shares of the registrant’s Common Stock, par value $0.01per share, outstanding.

 

 

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**PART I.FINANCIAL INFORMATION**

 

**ITEM1.  FINANCIAL STATEMENTS**

 

2

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**GRAPHICPACKAGING CORPORATION**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(Amountsin Millions, Except Share Amounts)**

**(Unaudited)**

 
| ** **                                                                                                                                                                               | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|------------------------|------------|
| **ASSETS**                                                                                                                                                                               | ** ** | ** **         | ** ** | ** **             | ** ** |
| Current  Assets:                                                                                                                                                                         |       |               |       |                   |       |
| Cash  and Equivalents                                                                                                                                                                    |       | $                  | 5.3        |                   | $          | 17.5 |   |
| Receivables,  Less Allowance for Doubtful Accounts of $3.3 and $4.4 at June 30, 2004 and  December 31, 2003, respectively                                                                |       | 227.5              |       | 198.5                  |       |
| Inventories                                                                                                                                                                              |       | 301.7              |       | 306.9                  |       |
| Prepaid  Expenses                                                                                                                                                                        |       | 15.5               |       | 15.1                   |       |
|                                                                                                                                                                                     |       |               |       |                   |       |
| Total  Current Assets                                                                                                                                                                    |       | 550.0              |       | 538.0                  |       |
| Property,  Plant and Equipment, Net of Accumulated Depreciation of $988.6 and $908.4 at  June 30, 2004 and December 31, 2003, respectively                                               |       | 1,678.9            |       | 1,722.9                |       |
| Goodwill                                                                                                                                                                                 |       | 643.8              |       | 624.3                  |       |
| Intangible  Assets, Net of Accumulated Amortization of $55.0 and $38.0 at June 30, 2004  and December 31, 2003, respectively                                                             |       | 176.1              |       | 192.3                  |       |
| Other  Assets                                                                                                                                                                            |       | 120.6              |       | 122.8                  |       |
|                                                                                                                                                                                     |       |               |       |                   |       |
| Total  Assets                                                                                                                                                                            |       | $                  | 3,169.4    |                   | $          | 3,200.3 |   |
|                                                                                                                                                                                     |       |               |       |                   |       |
| **LIABILITIES**                                                                                                                                                                          |       |               |       |                   |       |
| Current  Liabilities:                                                                                                                                                                    |       |               |       |                   |       |
| Short-Term  Debt                                                                                                                                                                         |       | $                  | 38.8       |                   | $          | 38.4 |   |
| Accounts  Payable and Other Accrued Liabilities                                                                                                                                          |       | 321.5              |       | 346.7                  |       |
| Total  Current Liabilities                                                                                                                                                               |       | 360.3              |       | 385.1                  |       |
|                                                                                                                                                                                     |       |               |       |                   |       |
| Long  Term Debt, Less Current Portion                                                                                                                                                    |       | 2,108.5            |       | 2,116.2                |       |
| Other  Noncurrent Liabilities                                                                                                                                                            |       | 220.2              |       | 210.0                  |       |
| Total  Liabilities                                                                                                                                                                       |       | 2,689.0            |       | 2,711.3                |       |
|                                                                                                                                                                                     |       |               |       |                   |       |
| **SHAREHOLDERS’ EQUITY**                                                                                                                                                            |       |               |       |                   |       |
| Preferred  Stock par value $0.01 per share; 50,000,000 shares authorized;  no shares issued or outstanding                                                                               |       | —             |       | —                 |       |
| Common  Stock par value $0.01 per share; 500,000,000 shares authorized; 198,528,608  and 198,378,110 shares issued and outstanding at June 30, 2004 and December  31, 2003, respectively |       | 2.0                |       | 2.0                    |       |
| Capital  in Excess of Par Value                                                                                                                                                          |       | 1,169.0            |       | 1,168.5                |       |
| Accumulated  Deficit                                                                                                                                                                     |       | (610.2             | )          | (598.0                 | )          |
| Minimum  Pension Liability Adjustment                                                                                                                                                    |       | (59.1              | )          | (60.2                  | )          |
| Accumulated  Derivative Instruments Loss                                                                                                                                                 |       | (6.9               | )          | (12.7                  | )          |
| Cumulative  Currency Translation Adjustment                                                                                                                                              |       | (14.4              | )          | (10.6                  | )          |
| Total  Shareholders’ Equity                                                                                                                                                         |       | 480.4              |       | 489.0                  |       |
| Total  Liabilities and Shareholders’ Equity                                                                                                                                         |       | $                  | 3,169.4    |                   | $          | 3,200.3 |   |

 

The accompanyingnotes are an integral part of the Condensed Consolidated Financial Statements.

 

3

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**GRAPHICPACKAGING CORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**(Amountsin Millions, Except Per Share Amounts)**

**(Unaudited)**

 
| ** **                                                                  | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                                  | ** ** | **June 30,  2004**     | ** ** | **June 30,  2003**   | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** |
|                                                                        |       |                   |       |                 |       |   |   |   |   |
| Net  Sales                                                                  |       | $                      | 606.3      |                 | $          | 338.6 |   | $ | 1,182.2 |   | $ | 636.6 |   |
| Cost  of Sales                                                              |       | 508.2                  |       | 276.3                |       | 995.1 |   | 516.2 |   |
| Selling,  General and Administrative                                        |       | 49.2                   |       | 30.8                 |       | 97.4 |   | 60.7 |   |
| Research,  Development and Engineering                                      |       | 2.4                    |       | 1.9                  |       | 4.8 |   | 3.4 |   |
| Other  Expense, Net                                                         |       | 9.8                    |       | 0.4                  |       | 21.5 |   | 2.2 |   |
| Income  from Operations                                                     |       | 36.7                   |       | 29.2                 |       | 63.4 |   | 54.1 |   |
| Interest  Income                                                            |       | 0.1                    |       | 0.1                  |       | 0.2 |   | 0.2 |   |
| Interest  Expense                                                           |       | (36.1                  | )          | (33.8                | )          | (74.1 | ) | (67.8 | ) |
| Income  (Loss) before Income Taxes and Equity in Net Earnings of Affiliates |       | 0.7                    |       | (4.5                 | )          | (10.5 | ) | (13.5 | ) |
| Income  Tax Expense                                                         |       | (0.9                   | )          | (2.4                 | )          | (2.4 | ) | (3.4 | ) |
| Equity  in Net Earnings of Affiliates                                       |       | 0.4                    |       | 0.5                  |       | 0.7 |   | 0.7 |   |
| Net  Income (Loss)                                                          |       | $                      | 0.2        |                 | $          | (6.4 | ) | $ | (12.2 | ) | $ | (16.2 | ) |
|                                                                        |       |                   |       |                 |       |   |   |   |   |
| Income  (Loss) Per Share - Basic                                            |       | $                      | 0.00       |                 | $          | (0.06 | ) | $ | (0.06 | ) | $ | (0.14 | ) |
| Income  (Loss) Per Share - Diluted                                          |       | $                      | 0.00       |                 | $          | (0.06 | ) | $ | (0.06 | ) | $ | (0.14 | ) |
|                                                                        |       |                   |       |                 |       |   |   |   |   |
| Weighted  Average Number of Shares Outstanding - Basic                      |       | 198.5                  |       | 114.9                |       | 198.4 |   | 114.9 |   |
| Weighted  Average Number of Shares Outstanding - Diluted                    |       | 202.4                  |       | 114.9                |       | 198.4 |   | 114.9 |   |

 

The accompanyingnotes are an integral part of the Condensed Consolidated Financial Statements.

 

4

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**GRAPHICPACKAGING CORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)**

**(Amountsin Millions)**

**(Unaudited)**

 

 
| ** **                                                  | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                  | ** ** | **June 30,  2004**     | ** ** | **June 30,  2003**   | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** |
| Net  Income (Loss)                                          |       | $                      | 0.2        |                 | $          | (6.4 | ) | $ | (12.2 | ) | $ | (16.2 | ) |
| Other  Comprehensive Income (Loss):                         |       |                   |       |                 |       |   |   |   |   |
| Minimum  Pension Liability Adjustment, Net of Tax of $0     |       | 1.1                    |       | —               |       | 1.1 |   | — |   |
| Derivative  Instruments Gain, Net of Tax of $0              |       | 6.9                    |       | 0.7                  |       | 5.8 |   | 0.5 |   |
| Foreign  Currency Translation Adjustments, Net of Tax of $0 |       | (2.7                   | )          | 6.1                  |       | (3.8 | ) | 7.6 |   |
|                                                        |       |                   |       |                 |       |   |   |   |   |
| Comprehensive  Income (Loss)                                |       | $                      | 5.5        |                 | $          | 0.4 |   | $ | (9.1 | ) | $ | (8.1 | ) |

 

The accompanyingnotes are an integral part of the Condensed Consolidated Financial Statements.

 

5

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**GRAPHICPACKAGING CORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Amountsin Millions)**

**(Unaudited)**

 
| ** **                                                                         | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                         | ** ** | **June 30,  2004**   | ** ** | **June 30,  2003** | ** ** |
| CASH  FLOWS FROM OPERATING ACTIVITIES:                                             |       |                 |       |   |   |
| Net  Loss                                                                          |       | $                    | (12.2      | ) | $ | (16.2 | ) |
| Noncash  Items Included in Net Loss:                                               |       |                 |       |   |   |
| Depreciation  and Amortization                                                     |       | 114.2                |       | 62.0 |   |
| Deferred  Income Taxes                                                             |       | (1.0                 | )          | 0.2 |   |
| Pension,  Postemployment and Postretirement Benefits Expense, Net of Contributions |       | 12.7                 |       | 8.4 |   |
| Equity  in Net Earnings of Affiliates, Net of Dividends                            |       | 0.4                  |       | — |   |
| Amortization  of Deferred Debt Issuance Costs                                      |       | 4.4                  |       | 3.6 |   |
| Loss  on Retirement of Assets                                                      |       | 4.9                  |       | — |   |
| Other,  Net                                                                        |       | (1.8                 | )          | (0.6 | ) |
| Changes  in Operating Assets & Liabilities:                                    |       |                 |       |   |   |
| Receivables                                                                        |       | (27.8                | )          | (18.2 | ) |
| Inventories                                                                        |       | 1.6                  |       | 1.5 |   |
| Prepaid  Expenses                                                                  |       | 0.6                  |       | (3.1 | ) |
| Accounts  Payable and Other Accrued Liabilities                                    |       | (26.0                | )          | 14.7 |   |
| Other  Noncurrent Liabilities                                                      |       | (1.0                 | )          | 2.8 |   |
| Net  Cash Provided by Operating Activities                                         |       | 69.0                 |       | 55.1 |   |
| CASH  FLOWS FROM INVESTING ACTIVITIES:                                             |       |                 |       |   |   |
| Purchases  of Property, Plant and Equipment                                        |       | (75.3                | )          | (47.6 | ) |
| Proceeds  from Sales of Assets, Net of Selling Costs                               |       | 9.6                  |       | — |   |
| Increase  in Other Assets                                                          |       | (6.8                 | )          | (1.3 | ) |
| Net  Cash Used in Investing Activities                                             |       | (72.5                | )          | (48.9 | ) |
| CASH  FLOWS FROM FINANCING ACTIVITIES:                                             |       |                 |       |   |   |
| Borrowing  under Revolving Credit Facilities                                       |       | 302.1                |       | 273.3 |   |
| Payments  on Revolving Credit Facilities                                           |       | (301.2               | )          | (250.1 | ) |
| Payments  on Debt                                                                  |       | (9.8                 | )          | (38.9 | ) |
| Issuance  of Common Stock                                                          |       | 0.1                  |       | — |   |
| Repurchases  of Redeemable Common Stock                                            |       | —               |       | (0.4 | ) |
| Net  Cash Used in Financing Activities                                             |       | (8.8                 | )          | (16.1 | ) |
| EFFECT  OF EXCHANGE RATE CHANGES ON CASH                                           |       | 0.1                  |       | 0.3 |   |
| Net  Decrease in Cash and Equivalents                                              |       | (12.2                | )          | (9.6 | ) |
| Cash  and Equivalents at Beginning of Period                                       |       | 17.5                 |       | 13.8 |   |
| CASH  AND EQUIVALENTS AT END OF PERIOD                                             |       | $                    | 5.3        |   | $ | 4.2 |   |

 

The accompanyingnotes are an integral part of the Condensed Consolidated Financial Statements.

 

6

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**GRAPHICPACKAGING CORPORATION**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**NOTE 1 -ORGANIZATION AND BASIS OF PRESENTATION**

 

On August 8, 2003, thecorporation formerly known as Graphic Packaging International Corporationmerged with and into Riverwood Acquisition Sub LLC, a wholly owned subsidiaryof Riverwood Holding, Inc. (“Riverwood Holding”), with Riverwood AcquisitionSub LLC as the surviving entity (the “Merger”). At the closing of the Merger, oneshare of common stock of Riverwood Holding was exchanged for each share ofcommon stock of Graphic Packaging International Corporation. After the Merger,(1) RIC Holding, Inc. merged into Graphic Packaging Holdings, Inc. which wasrenamed GPI Holding, Inc., (2) the corporation formerly known as GraphicPackaging Corporation merged into Riverwood International Corporation (“RIC”)which was renamed Graphic Packaging International, Inc. (“Graphic PackagingInternational”), and (3) Riverwood Acquisition Sub LLC merged into RiverwoodHolding which was renamed Graphic Packaging Corporation.

 

References to the“Company” are to Riverwood Holding and its subsidiaries for periods prior tothe Merger and to Graphic Packaging Corporation and its subsidiaries for periodsafter the Merger. Graphic Packaging International Corporation and itssubsidiaries for periods prior to the Merger are referred to herein as“Graphic.”

 

For accounting purposes,the Merger was accounted for as a purchase by the Company. Under the purchasemethod of accounting, the assets and liabilities of Graphic were recorded, asof the date of the closing of the Merger, at their respective fair values andadded to those of the Company. The difference between the purchase price andthe fair market values of the assets acquired and liabilities assumed ofGraphic was recorded as goodwill. The historical financial statements ofRiverwood Holding became the historical financial statements of GraphicPackaging Corporation. Note 2 provides summary unaudited pro forma informationand information pertaining to the Merger.

 

Graphic PackagingCorporation and GPI Holding, Inc., its wholly-owned subsidiary, conduct nosignificant business and have no independent assets or operations other thantheir ownership of Graphic Packaging International. Graphic PackagingCorporation and GPI Holding, Inc. fully and unconditionally guaranteesubstantially all of the debt of Graphic Packaging International.

 

The CondensedConsolidated Financial Statements of the Company included herein have beenprepared by the Company without an audit, pursuant to the rules and regulationsof the Securities and Exchange Commission (the “SEC”). Certain information andfootnote disclosures normally included in the financial statements prepared inaccordance with accounting principles generally accepted in the United Statesof America have been condensed or omitted pursuant to such rules andregulations. In the opinion of management, all adjustments, consisting ofnormal recurring adjustments necessary for a fair presentation of the financialposition, results of operations and cash flows for the interim periodspresented have been made. The Condensed Consolidated Balance Sheet as ofDecember 31, 2003 was derived from audited financial statements.

 

###### **NOTE 2 — MERGER**

 

The Merger was consummated primarily to create avalue-added paperboard packaging company. Prior to the consummation of theMerger, Riverwood Holding had two classes of common stock. There were 9.0million shares of Class A common stock, par value $0.01, authorized with 7.0million shares outstanding at August 8, 2003. There were 3.0 million shares ofClass B common stock, par value $0.01, authorized with 0.5 million sharesoutstanding at August 8, 2003. In connection with the Merger, the Company’sBoard of Directors approved a 15.21-to-one stock split. At the time, the ClassA and Class B common stock were reclassified as one class of common stock, parvalue $0.01. Immediately after the stock split, there were 500.0 million sharesof common stock authorized with 114.8 million shares outstanding. The aggregatepar value of the issued common stock was increased by $1.1 million as a resultof keeping the par value price $0.01. Accordingly, Capital in Excess of ParValue was decreased $1.1 million. In connection with the Merger, theshareholders of Graphic Packaging International Corporation received one shareof the Company’s common stock and associated shareholder rights for each shareof Graphic Packaging

 

7

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International Corporation common stock and associatedshareholder rights they owned prior to the Merger. Accordingly, Capital inExcess of Par Value increased $419.5 million.

 

The Company determined that the relative outstandingshare ownership and the designation of certain senior management positionsrequire the Company to be the acquiring entity for accounting purposes,resulting in the historical financial statements of Riverwood Holding becomingthe historical financial statements of Graphic Packaging Corporation. Theassets and liabilities of the acquired business are included in the condensedconsolidated balance sheets at June 30, 2004 and December 31, 2003. Theaccompanying condensed consolidated statement of operations for the three andsix months ended June 30, 2004 includes the results of Graphic. Theaccompanying condensed consolidated statement of operations for the three andsix months ended June 30, 2003 represent the results of the Company only. Thepurchase price for the acquisition, including transaction costs, has beenallocated to the assets acquired and liabilities assumed based on the estimatedfair market values at the date of the Merger. Goodwill is allocated entirely tothe paperboard packaging segment and is not deductible for tax purposes. Thepurchase price allocation for the Merger is preliminary and further adjustmentsmay be made as valuations for property, plant, equipment, and intangible assetsare finalized. The stock-for-stock exchange resulted in the issuance ofapproximately 83.4 million shares of common stock to fund the purchase price of$469.8 million. The preliminary purchase price allocation is as follows:

 
| **(Amounts in Millions)**                                                                      | ** ** | ** ** | ** ** |
|------------------------------------------------------------------------------------------------|------------|------------|------------|
| Current assets                                                                                 |       | $          | 209.6      |   |
| Property, plant  & equipment                                                               |       | 480.3      |       |
| Goodwill                                                                                       |       | 375.8      |       |
| Intangible  assets                                                                             |       | 162.0      |       |
| Other assets                                                                                   |       | 20.0       |       |
| Total assets  aquired                                                                          |       | $          | 1,247.7    |   |
|                                                                                           |       |       |       |
| Accounts payable  and accrued expenses                                                         |       | $          | 150.9      |   |
| Total debt                                                                                     |       | 496.6      |       |
| Pension and  other post-retirement liabilities, assumed merger related liabilities, and  other |       | 130.4      |       |
| Total  Liabilities assumed                                                                     |       | $          | 777.9      |   |

 

See also Note 9 – RESTRUCTURING CHARGES AND IMPAIRMENTLOSSES.

 

**Selected Unaudited Pro FormaCombined Financial Information**

 

The following unauditedpro forma combined financial information is presented to show the estimatedeffect of the Merger and the Related Financing Transactions (as defined herein)and represents the Company’s pro forma combined financial information for thethree and six months ended June 30, 2003 as if the Merger and Related FinancingTransactions had occurred on January 1, 2003. The unaudited pro forma combinedfinancial information includes adjustments directly attributable to the Mergerand the Related Financing Transactions that are expected to have a continuingimpact on the Company. The pro forma adjustments are based upon availableinformation and certain assumptions that management believes are reasonable.

 

The following financingtransactions (the “Related Financing Transactions”) were entered into inconnection with the Merger:

 

•The entering into and borrowing under the Senior Secured Credit Agreement,dated as of August 8, 2003, among Graphic Packaging International and theseveral lender parties thereto (the “Senior Secured Credit Agreement”), whichprovides for aggregate maximum borrowings of $1.6 billion under (i) a term loanfacility (the “Term Loan Facility”) providing for term loans in an aggregateprincipal amount of $1.275 billion in two tranches, consisting of Tranche Aterm loans and Tranche B term loans, and (ii) a revolving credit facility (the“Revolving Credit Facility”) providing for up to $325 million in revolvingloans (including standby and commercial letters of credit) outstanding atanytime, to Graphic Packaging International, Inc.

 

8

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•The issuance and sale of $425 million in aggregate principal amount of 8.5%senior notes due 2011 (the “Senior Notes”) and $425 million in aggregateprincipal amount of 9.5% senior subordinated notes due 2013 (the “SeniorSubordinated Notes”).

 

•The repayment of all outstanding amounts under each of RIC’s and Graphic’sprior senior secured credit facilities and the termination of all commitmentsunder those facilities.

 

•The consummation of tender offers and consent solicitations for all of RIC’s 105/8% senior notes due 2007 (the “Senior Notes due 2007”) and 10 7/8% seniorsubordinated notes due 2008 (the “Senior Subordinated Notes due 2008” and,together with the Senior Notes due 2007, the “Prior RIC Notes”), which closedconcurrently with the Merger. The Company redeemed all Prior RIC Notes thatwere not tendered pursuant to the tender offers.

 

•The consummation of an anticipatory change of control tender offer and consentsolicitation for all of Graphic’s 8 5/8% senior subordinated notes due 2012(the “Prior Graphic Notes”) made in anticipation of the change of control offerrequired by the indenture governing the Prior Graphic Notes. Out of $300.0million in aggregate principal amount of Prior Graphic Notes outstanding,approximately $299.1 million in aggregate principal amount of Prior GraphicNotes were tendered in the anticipatory change of control tender offer. OnSeptember 15, 2003, the Company completed the change of control offer requiredpursuant to the indenture governing the Prior Graphic Notes. As of June 30,2004 and December 31, 2003, $0.8 million in principal amount of the PriorGraphic Notes was outstanding.

 

The pro forma financialinformation was prepared using the purchase method of accounting, with theCompany treated as the acquirer for accounting purposes. Under purchaseaccounting, the total cost of the Merger is allocated to the tangible andintangible assets acquired and liabilities assumed based upon their respectivefair values at the effective date of the Merger. A preliminary allocation ofthe cost of the Merger has been made based upon currently available informationand management’s estimates. The actual allocation and its effect on results ofoperations may differ significantly from the pro forma amounts included herein.

 

The pro forma financialinformation is based on the Company’s actual financial results for the periodindicated and the historical results of Graphic from the beginning of theperiod presented through June 30, 2003. The pro forma financial information hasbeen prepared in accordance with accounting principles generally accepted inthe United States of America and is provided for comparison and analysispurposes only. The unaudited pro forma combined financial information does notpurport to represent the combined company’s results of operations or financialcondition had the Merger and Related Financing Transactions actually occurredas of such dates or of the results that the combined company would haveachieved after the Merger. The unaudited pro forma combined financialinformation is as follows:

 

9

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**CombinedCompany**

**Unaudited Condensed Pro Forma Combined Statement of Operations**

**For the Three Months Ended June 30, 2003**

**(Amounts in Millions, Except Per Share Amounts)**

 
| ** **                                                                  | ** ** | **Company** | ** ** | **Graphic** | ** ** | **Pro Forma  Adjustments** | ** ** | **Condensed Pro  Forma Combined** | ** ** |
|-----------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|----------------------------|------------|-----------------------------------|------------|
| Net Sales                                                                   |       | $           | 338.6      |        | $          | 275.0                      |       | $                                 | (14.6      | )**A** | $ | 599.0 |   |
| Cost of Sales                                                               |       | 276.3       |       | 244.5       |       | (14.6                      | )**A**     | 505.7                             |       |
|                                                                        |       |        |       |        |       | (0.5                       | )**B**     |                              |       |
| Selling, General  and Administrative, Research, Development and Engineering |       | 33.1        |       | 17.9        |       | 6.9                        | **B**      | 57.9                              |       |
| Income from  Operations                                                     |       | 29.2        |       | 12.6        |       | (6.4                       | )          | 35.4                              |       |
| Interest  Expense, Net                                                      |       | (33.7       | )          | (9.7        | )          | 7.2                        | **C**      | (36.2                             | )          |
| (Loss) Income  before Income Taxes and Equity in Net Earnings of Affiliates |       | (4.5        | )          | 2.9         |       | 0.8                        |       | (0.8                              | )          |
| Income Tax  Expense                                                         |       | (2.4        | )          | (1.2        | )          | —                     |       | (3.6                              | )          |
| (Loss) Income  before Equity in Net Earnings of Affiliates                  |       | (6.9        | )          | 1.7         |       | 0.8                        |       | (4.4                              | )          |
| Equity in Net  Earnings of Affiliates                                       |       | 0.5         |       | —      |       | —                     |       | 0.5                               |       |
| Net (Loss)  Income                                                          |       | (6.4        | )          | 1.7         |       | 0.8                        |       | (3.9                              | )          |
| Preferred Stock  Dividends Declared                                         |       | —      |       | 2.5         |       | (2.5                       | )**D**     | —                            |       |
| Net (Loss)  Income Attributable to Common Stockholders                      |       | $           | (6.4       | )           | $          | (0.8                       | )          | $                                 | 3.3        |   | $ | (3.9 | ) |
|                                                                        |       |        |       |        |       |                       |       |                              |       |
| Loss Per Share -  Basic                                                     |       | $           | (0.06      | )           |       |                       |       |                              | $          | (0.02 | ) |
| Loss Per Share -  Diluted                                                   |       | $           | (0.06      | )           |       |                       |       |                              | $          | (0.02 | ) |
|                                                                        |       |        |       |        |       |                       |       |                              |       |
| Weighted Average  Number of Shares Outstanding:                             |       |        |       |        |       |                       |       |                              |       |
| Basic                                                                       |       | 114.9       |       |        |       |                       |       | 198.4                             |       |
| Diluted                                                                     |       | 114.9       |       |        |       |                       |       | 198.4                             |       |

 

10

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**Combined Company**

**Unaudited Condensed Pro Forma Combined Statement of Operations**

**For the Six Months Ended June 30, 2003**

**(Amounts in Millions, Except Per Share Amounts)**

 
| ** **                                                                  | ** ** | **Company** | ** ** | **Graphic** | ** ** | **Pro Forma  Adjustments** | ** ** | **Condensed Pro  Forma Combined** | ** ** |
|-----------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|----------------------------|------------|-----------------------------------|------------|
| Net Sales                                                                   |       | $           | 636.6      |        | $          | 535.9                      |       | $                                 | (30.4      | )**A** | $ | 1,142.1 |   |
| Cost of Sales                                                               |       | 516.2       |       | 478.7       |       | (30.4                      | )**A**     | 963.4                             |       |
|                                                                        |       |        |       |        |       | (1.1                       | )**B**     |                              |       |
| Selling, General  and Administrative, Research, Development and Engineering |       | 66.3        |       | 35.2        |       | 13.8                       | **B**      | 115.3                             |       |
| Income from  Operations                                                     |       | 54.1        |       | 22.0        |       | (12.7                      | )          | 63.4                              |       |
| Interest  Expense, Net                                                      |       | (67.6       | )          | (19.1       | )          | 14.4                       | **C**      | (72.3                             | )          |
| (Loss) Income  before Income Taxes and Equity in Net Earnings of Affiliates |       | (13.5       | )          | 2.9         |       | 1.7                        |       | (8.9                              | )          |
| Income Tax  Expense                                                         |       | (3.4        | )          | (1.2        | )          | —                     |       | (4.6                              | )          |
| (Loss) Income  before Equity in Net Earnings of Affiliates                  |       | (16.9       | )          | 1.7         |       | 1.7                        |       | (13.5                             | )          |
| Equity in Net  Earnings of Affiliates                                       |       | 0.7         |       | —      |       | —                     |       | 0.7                               |       |
| Net (Loss)  Income                                                          |       | (16.2       | )          | 1.7         |       | 1.7                        |       | (12.8                             | )          |
| Preferred Stock  Dividends Declared                                         |       | —      |       | 5.0         |       | (5.0                       | )**D**     | —                            |       |
| Net (Loss)  Income Attributable to Common Stockholders                      |       | $           | (16.2      | )           | $          | (3.3                       | )          | $                                 | 6.7        |   | $ | (12.8 | ) |
|                                                                        |       |        |       |        |       |                       |       |                              |       |
| Loss Per Share -  Basic                                                     |       | $           | (0.14      | )           |       |                       |       |                              | $          | (0.06 | ) |
| Loss Per Share -  Diluted                                                   |       | $           | (0.14      | )           |       |                       |       |                              | $          | (0.06 | ) |
|                                                                        |       |        |       |        |       |                       |       |                              |       |
| Weighted Average  Number of Shares Outstanding:                             |       |        |       |        |       |                       |       |                              |       |
| Basic                                                                       |       | 114.9       |       |        |       |                       |       | 198.4                             |       |
| Diluted                                                                     |       | 114.9       |       |        |       |                       |       | 198.4                             |       |

 

11

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Adjustments in theunaudited condensed pro forma combined financial statements are as follows:

 

----

**A** RIC soldcoated unbleached kraft paperboard (“CUK”) folding boxboard to Graphic for usein certain cartons manufactured by Graphic. This pro forma adjustmenteliminates the intercompany sales and cost of sales of $14.6 million and $30.4million for the three months and six months ended June 30, 2003, related tothis activity.

 

**B**The amortizationof the identifiable intangible assets (customer relationships, patents andproprietary technology) is reflected as a pro forma adjustment to the unauditedcondensed pro forma combined statement of operations. The Company is amortizingthe estimated fair value of the identifiable intangibles of approximately$162.0 million on a straight-line basis over an average estimated useful lifeof eighteen years except for non-compete agreements which have an estimateduseful life of approximately one year. Depreciation expense would havedecreased by $0.5 million and $1.1 million for the three months and six monthsended June 30, 2003, respectively, as a result of the Company revising thedepreciable asset lives and the fair value of the property purchased in theMerger. The net effect of this increased amortization and decreaseddepreciation of $6.4 million and $12.7 million for the three months and sixmonths ended June 30, 2003, respectively, is reflected in the unauditedcondensed pro forma combined statement of operations as follows:

 
| ** **                                                                                                  | ** ** | **Three Months Ended  June 30, 2003** | ** ** | **Six Months Ended  June 30, 2003** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| Cost of Sales                                                                                               |       | $                                     | (0.5       | )                                   | $          | (1.1 | ) |
| Selling, General  and Administrative, Research, Development and Engineering                                 |       | 6.9                                   |       | 13.8                                |       |
|                                                                                                        |       |                                  |       |                                |       |
| Total Net  Additional Amortization and Depreciation of Intangible Assets and Property,  Plant and Equipment |       | $                                     | 6.4        |                                | $          | 12.7 |   |

 

**C** In connectionwith the Merger, substantially all of RIC’s and Graphic’s then outstandingindebtedness was redeemed, repurchased or otherwise repaid and replaced withborrowings under the Senior Secured Credit Agreement and indebtedness under theSenior Notes and Senior Subordinated Notes. Excluding hedges and amortizationof financing costs, the pro forma interest expense adjustments reflect anaverage variable interest rate of 3.9% for the combined company’s new bank debtand a blended fixed rate of 9.0% on the combined company’s Senior Notes andSenior Subordinated Notes.

 

**D** To reflectthe new equity structure of the Company, including conversion of $100 millionof Graphic’s convertible preferred stock into common stock (accordingly thereare no preferred stock dividends declared).

 

**NOTE 3 — SUMMARY OF SIGNIFICANTACCOUNTING POLICIES**

 

For a summary of the Company’s significant accountingpolicies, please refer to the Company’s Annual Report on Form 10-K for the yearended December 31, 2003.

 

The preparation of the Condensed ConsolidatedFinancial Statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the CondensedConsolidated Financial Statements and the reported amounts of revenues andexpenses during the reporting period. Actual amounts could differ from thoseestimates.

 

The Company’s Condensed Consolidated FinancialStatements include all subsidiaries in which the Company has the ability toexercise direct or indirect control over operating and financial policies.Intercompany transactions and balances are eliminated in consolidation.

 

The Company has reclassified the presentation ofcertain prior period information to conform to the current presentation format.

 

12

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As permitted by Statementof Financial Accounting Standards (“SFAS”) No. 123 “Accounting for Stock-BasedCompensation,” the Company continues to apply intrinsic value accounting forits stock option plans under Accounting Principles Board Opinion No. 25 (“APB25”), “Accounting for Stock Issued to Employees.” Compensation cost for stockoptions, if any, is measured as the excess of the market price of the Company’scommon stock at the date of grant over the exercise price to be paid by thegrantee to acquire the stock. The Company has adopted disclosure-onlyprovisions of SFAS No. 123 and SFAS No. 148, “Accounting for Stock-BasedCompensation—Transition and Disclosure—an Amendment of FASB Statement No. 123.”If the Company had elected to recognize compensation expense based upon thefair value at the grant dates for awards under these plans, the Company’s NetIncome (Loss) would have been as follows:

 
| ** **                                                                                                                                                   | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                                                                                                                   | ** ** | **June 30,  2004**     | ** ** | **June 30,  2003**   | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** |
| Net Income  (Loss), As Reported                                                                                                                              |       | $                      | 0.2        |                 | $          | (6.4 | ) | $ | (12.2 | ) | $ | (16.2 | ) |
| Add: Stock-based  employee compensation expense included in reported net loss, net of related  tax effects                                                   |       | 1.0                    |       | 0.3                  |       | 2.4 |   | 0.6 |   |
|                                                                                                                                                         |       |                   |       |                 |       |   |   |   |   |
| (Deduct) Add:  Total stock-based employee compensation (expense) income determined under  fair value based method for all awards, net of related tax effects |       | (3.2                   | )          | 0.3                  |       | (6.8 | ) | 0.6 |   |
|                                                                                                                                                         |       |                   |       |                 |       |   |   |   |   |
| Adjusted Net  Loss                                                                                                                                           |       | $                      | (2.0       | )                    | $          | (5.8 | ) | $ | (16.6 | ) | $ | (15.0 | ) |
|                                                                                                                                                         |       |                   |       |                 |       |   |   |   |   |
| Income (Loss)  Per Basic Share-As Reported                                                                                                                   |       | $                      | 0.00       |                 | $          | (0.06 | ) | $ | (0.06 | ) | $ | (0.14 | ) |
| Income (Loss)  Per Basic Share-As Adjusted                                                                                                                   |       | $                      | (0.01      | )                    | $          | (0.05 | ) | $ | (0.08 | ) | $ | (0.13 | ) |
|                                                                                                                                                         |       |                   |       |                 |       |   |   |   |   |
| Income (Loss)  Per Diluted Share-As Reported                                                                                                                 |       | $                      | 0.00       |                 | $          | (0.06 | ) | $ | (0.06 | ) | $ | (0.14 | ) |
| Income (Loss)  Per Diluted Share-As Adjusted                                                                                                                 |       | $                      | (0.01      | )                    | $          | (0.05 | ) | $ | (0.08 | ) | $ | (0.13 | ) |

 

The following table displays the intangible assetsthat continue to be subject to amortization and aggregate amortization expenseas well as intangible assets not subject to amortization as of June 30, 2004and December 31, 2003:

 

13

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| ** **                        | ** ** | **As of June 30, 2004**    | ** ** |
|-----------------------------------|------------|----------------------------|------------|
| **(In millions of dollars)**      | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net Carrying  Amount** | ** ** |
| Amortizable  Intangible Assets:   |       |                       |       |   |   |   |   |
| Customer  Relationships           |       | $                          | 109.9      |   | $ | 4.6 |   | $ | 105.3 |   |
| Non-Compete  Agreements           |       | 23.3                       |       | 18.5 |   | 4.8 |   |
| Patents,  Trademarks and Licenses |       | 97.9                       |       | 31.9 |   | 66.0 |   |
|                              |       | $                          | 231.1      |   | $ | 55.0 |   | $ | 176.1 |   |
|                              |       |                       |       |   |   |   |   |
| Unamortizable  Intangible Assets: |       |                       |       |   |   |   |   |
| Goodwill                          |       | $                          | 643.8      |   | — |   | $ | 643.8 |   |

 

| ** **                        | ** ** | **As of December 31, 2003** | ** ** |
|-----------------------------------|------------|-----------------------------|------------|
| ** **                        | ** ** | **Gross Carrying  Amount**  | ** ** | **Accumulated  Amortization** | ** ** | **Net Carrying  Amount** | ** ** |
| Amortizable  Intangible Assets:   |       |                        |       |   |   |   |   |
| Customer  Relationships           |       | $                           | 109.9      |   | $ | 2.0 |   | $ | 107.9 |   |
| Non-Compete  Agreements           |       | 23.3                        |       | 7.3 |   | 16.0 |   |
| Patents,  Trademarks and Licenses |       | 97.1                        |       | 28.7 |   | 68.4 |   |
|                              |       | $                           | 230.3      |   | $ | 38.0 |   | $ | 192.3 |   |
|                              |       |                        |       |   |   |   |   |
| Unamortizable  Intangible Assets: |       |                        |       |   |   |   |   |
| Goodwill                          |       | $                           | 624.3      |   | — |   | $ | 624.3 |   |

 

The Company recorded amortization expense of $8.6million and $1.0 million for the three months ended June 30, 2004 and 2003,respectively, and $16.9 million and $1.9 million for the six months ended June30, 2004 and 2003, respectively, relating to intangible assets subject toamortization. The Company expects amortization expense to be approximately $26million for 2004 and approximately $12 million for each of the following fourfiscal years.

 

**NOTE 4— INVENTORIES**

 

The major classes ofinventories were as follows:

 
| **(In millions  of dollars)** | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|-------------------------------|------------|--------------------|------------|------------------------|------------|
| Finished goods                |       | $                  | 168.9      |                   | $          | 172.8 |   |
| Work-in progress              |       | 19.2               |       | 22.6                   |       |
| Raw materials                 |       | 69.2               |       | 66.0                   |       |
| Supplies                      |       | 44.4               |       | 45.5                   |       |
|                          |       | $                  | 301.7      |                   | $          | 306.9 |   |

 

Raw materials and consumables used in the productionprocess such as wood chips and chemicals are valued at purchase cost on afirst-in, first-out (“FIFO”) basis upon receipt. Work in process and finishedgoods inventories are valued at the cost of raw material consumed plus directmanufacturing costs (such as labor, utilities and supplies) as incurred and aproportion of manufacturing overhead.

 

**NOTE 5 — CONTINGENCIES ANDCOMMITMENTS**

 

TheCompany is subject to a broad range of foreign, federal, state and localenvironmental, health and safety laws and regulations, including those governingdischarges to air, soil and water, the management, treatment and disposal ofhazardous substances, the management, treatment and disposal of solid andhazardous wastes, the investigation and remediation of contamination resultingfrom historical site operations and releases of hazardous substances, and thehealth and safety of employees. The Company’s environmental potentialliabilities and obligations may result in significant costs, which couldnegatively impact its financial condition and results of operations. Inaddition, capital expenditures may be necessary for

 

14

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theCompany to comply with such laws and regulations, including the U.S.Environmental Protection Agency’s regulations mandating stringent controls onair and water discharges from pulp and paper mills (referred to herein as the“cluster rules”). Any failure to comply with environmental, health and safetylaws or any permits and authorizations required thereunder could subject the Companyto fines, corrective action or other sanctions. In addition, some of theCompany’s current and former facilities are the subject of environmentalinvestigations and remediations resulting from historical operations and therelease of hazardous substances or other constituents. Some current and formerfacilities have a history of industrial usage for which investigation andremediation obligations may be imposed in the future or for whichindemnification claims may be asserted against the Company. The Company cannotpredict with certainty future investigation or remediation costs or futurecosts relating to historical usage or indemnification claims. Also, potentialfuture closures or sales of facilities may necessitate further investigationand which may result in future remediation at those facilities. The Companywill continue to review and revise its estimate of potential, contingentenvironmental liabilities related to past, present and future operations asadditional information related to its environmental liabilities is obtained.

 

Thefederal Clean Air Act imposes stringent limits on air emissions, establishes afederal permit program (Title V) and provides for enforcement sanctions. Wherenecessary, the Company’s plants have received or submitted an application tothe appropriate permitting authority for a Title V permit. The Company fromtime to time upgrades and replaces equipment in order to comply with airquality standards.

 

Thefederal Clean Water Act establishes a system of minimum national effluentstandards for each industry, water quality standards for the nation’s waterwaysand a permit program that provides discharge limitations and provides forenforcement sanctions. It also regulates releases of pollutants and spills ofpollutants, including oil and hazardous materials. Many of the Company’sfacilities have discharges of pollutants which are permitted by appropriateregulatory agencies permitting the discharge to publicly owned treatment worksor to surface water.

 

Thefederal Comprehensive Environmental Response, Compensation and Liability Act(“CERCLA”) establishes liability for waste generators, current and former siteowners and operators and others in connection with release of hazardoussubstances. In several instances, the Company has been identified as aPotentially Responsible Party (“PRP”) under CERCLA and similar state laws withrespect to remediation of sites at which hazardous substances have beenreleased. At many of these sites, the liability of the Company has been resolvedthrough settlement with other PRPs and/or appropriate regulatory agencies. Theremaining sites which are currently known and at which Graphic’s liability isnot resolved are believed by the Company not to be material.

 

TheCompany is involved in investigation and remediation projects for certainproperties that it currently owns or formerly owned or operated. The Companyhas also received demands arising out of alleged contamination of variousproperties currently for formerly operated by it, and at certain waste disposalsites. The Company believes that these potential liabilities are either notmaterial or that in many instances the potential for liability cannot bereasonably estimated until investigations have been completed and the need forand scope of remediation have been determined.

 

Toaddress contingent losses at those sites where available information indicatesthat liability is probable or at which liability has been incurred and a rangeof amounts of the liability can be reasonably estimated and the estimation ofthe amount of the liability is material, an environmental reserve has beenestablished. To the extent that additional costs may be incurred that exceedthe accrued reserves, such amounts are not expected to have a material impact onthe financial condition of the Company, although no assurances can be giventhat significant costs will not be incurred in connection with contingentenvironmental site liabilities, including the sites specifically identifiedbelow:

 

NorthPortland, Oregon Facility.  The presenceof contamination in soils on and groundwater beneath the North Portlandfacility has been identified at levels exceeding Oregon state screening limits.Current information indicates that the contamination is naturally attenuating, isconfined and/or is the result of off-site contamination which has migrated togroundwater beneath the facility. The facility is listed on the OregonConfirmed Release List; however, the facility is under no current order oragreement to conduct additional investigation and/or remediation at this time.The EPA has determined that it will require no further action at the site. TheCompany believes it is probable that additional investigation will be requiredat the facility by Oregon although it is not possible to predict a time-tablefor additional action. Based on current information, the Company believes thatno active remediation will be required as a result of any additionalinvestigation at the facility.

 

15

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KalamazooPaperboard Mill and Carton Plant.  TheKalamazoo facilities and adjacent properties have long histories of industrialand commercial usages. Portions of the property on which the mill is locatedhave been found to contain contamination exceeding Michigan state screeninglevels. Restrictive covenants restricting land usage in portions of the millproperty where contamination has been identified have been recorded to addresscontamination in those areas. The Company believes that there is a reasonablepossibility that some or all of the contamination which has been identified atthe facility will be determined to be the result of past activities unrelatedto the Company’s operations; however, further investigation will be necessaryto make a final determination. Although the Company is not under any currentorder or agreement to conduct additional site investigation, the Company plansto submit an Interim Remedial Action Plan (“IRAP”) to investigate and addressthe presence of contamination at the mill during the third or fourth quarter of2004. The IRAP will be conducted over a five (5) year period. There is notsufficient information available to determine whether any additionalinvestigation or remediation will be required after completion of the IRAP noris there sufficient information to reasonably estimate the cost of anyadditional investigation or remediation beyond the requirements of the IRAP.

 

ManvilleForest Products Wood Treatment Facility. On July 6, 2000, the Company entered into a settlement agreement withthe Louisiana Department of Environmental Quality (“LDEQ”) to resolve claimsagainst the Company for liability related to the historical operations at adecommissioned, wood treatment facility in Shreveport, Louisiana located onLine Avenue. Subsequently, the Company and the LDEQ reached an agreement withOlin Corporation, a former site owner/operator, to contribute 50% of allremedial activities. The Company has completed and the LDEQ has approved theremedial action required by the settlement agreement. Under the settlementagreement, the Company and Olin are obligated to conduct long-term monitoringand maintenance of the site.

 

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

 

**NOTE 6 — BUSINESS SEGMENTINFORMATION**

 

The Company reports itsresults in two business segments: paperboard packaging andcontainerboard/other. These segments are evaluated by the chief operatingdecision maker based primarily on income from operations. The Company’sreportable segments are based upon strategic business units that offerdifferent products. The paperboard packaging business segment includes theproduction and sale of paperboard for its beverage multiple packaging andconsumer products packaging businesses from its West Monroe, Louisiana, Macon,Georgia, Kalamazoo, Michigan and Norrköping, Sweden mills; carton convertingfacilities in the United States, Europe, Brazil and Canada; and the design,manufacture and installation of packaging machinery related to the assembly ofcartons. The containerboard/other business segment primarily includes theproduction and sale of linerboard, corrugating medium and kraft paper frompaperboard mills in the United States.

 

16

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Business segmentinformation is as follows:

 
| ** **                      | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------|------------|------------------------|------------|----------------------|------------|
| **(In millions of dollars)**    | ** ** | **June 30,  2004**     | ** ** | **June 30,  2003**   | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** |
| NET SALES:                      |       |                   |       |                 |       |   |   |   |   |
| Paperboard  Packaging           |       | $                      | 583.9      |                 | $          | 319.1 |   | $ | 1,141.2 |   | $ | 595.0 |   |
| Containerboard/Other            |       | 22.4                   |       | 19.5                 |       | 41.0 |   | 41.6 |   |
|                            |       | $                      | 606.3      |                 | $          | 338.6 |   | $ | 1,182.2 |   | $ | 636.6 |   |
|                            |       |                   |       |                 |       |   |   |   |   |
| INCOME (LOSS)  FROM OPERATIONS: |       |                   |       |                 |       |   |   |   |   |
| Paperboard  Packaging           |       | $                      | 65.4       |                 | $          | 43.1 |   | $ | 118.3 |   | $ | 82.0 |   |
| Containerboard/Other            |       | (7.0                   | )          | (6.4                 | )          | (15.5 | ) | (13.1 | ) |
| Corporate                       |       | (21.7                  | )          | (7.5                 | )          | (39.4 | ) | (14.8 | ) |
|                            |       | $                      | 36.7       |                 | $          | 29.2 |   | $ | 63.4 |   | $ | 54.1 |   |

 

**NOTE 7 — FINANCIAL INSTRUMENTS,DERIVATIVES AND HEDGING ACTIVITIES**

 

The Company is exposed tofluctuations in interest rates on its variable debt, fluctuations in foreigncurrency transaction cash flows and variability in cash flows attributable tocertain commodity purchases. The Company actively monitors these fluctuationsand periodically uses derivatives and other financial instruments to hedgeexposures to interest, commodity and currency risks. The Company’s use ofderivative instruments may result in short-term gains or losses and mayincrease volatility in its earnings. In addition, these instruments involve, tovarying degrees, elements of market and credit risk in excess of the amountsrecognized in the Condensed Consolidated Balance Sheets. The Company does nottrade or use derivative instruments with the objective of earning financialgains on interest or currency rates, nor does it use leveraged instruments orinstruments where there are no underlying exposures identified.

 

*Interest Rate Risk*

 

The Company uses interestrate swaps to manage interest rate risks on future income caused by interestrate changes on its variable rate Term Loan facility. The differential to bepaid or received under these agreements is recognized as an adjustment tointerest expense related to the debt. At June 30, 2004 the Company had interestrate swap agreements with a notional amount of $770 million, which expire onvarious dates from 2004 to 2007 under which the Company will pay fixed rates of1.89% to 3.27% and receive three-month LIBOR.

 

During the six monthsended June 30, 2004, there was approximately $1.9 million determined to be theineffective portion related to changes in the fair value of the interest rateswap agreements. Additionally, there were no amounts excluded from the measureof effectiveness.

 

*Commodity Risk*

 

To manage risksassociated with future variability in cash flows and price risk attributable tocertain commodity purchases, the Company entered into fixed price natural gascontracts designed to effectively hedge prices for a portion of its natural gasrequirements at its U.S. mills through January 2005. These contracts are notaccounted for as derivative instruments under SFAS No. 133*, Accountingfor Derivative Instruments and Hedging Activities, as amended by SFAS No. 137,Accounting for Derivative Instruments and Hedging Activities—Deferral of theEffective Date of FASB Statement No. 133, and SFAS No. 138, Accounting forCertain Derivative Instruments and Certain Hedging Activities*(‘‘SFAS No. 133’’), as they qualify for the normal purchase exemption.

 

*Foreign Currency Risk*

 

The Company enters intoforward exchange contracts to manage risks associated with future variabilityin cash flows resulting from anticipated foreign currency transactionsadversely affected by changes in exchange rates. Gains/losses, if any, relatedto these contracts are recognized in income when the anticipated transactionaffects income.

 

17

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At June 30, 2004 andDecember 31, 2003, multiple forward exchange contracts existed that expire onvarious dates through the year 2004. When measured in U.S. dollars at June 30,2004 exchange rates, the notional amount of the purchased forward exchangecontracts totaled approximately $68.0 million. When measured in U.S. dollars atDecember 31, 2003 exchange rates, the notional amount of the purchased forwardexchange contracts totaled approximately $141.7 million.

 

No amounts werereclassified to earnings during the six months ended June 30, 2004 inconnection with forecasted transactions that were no longer considered probableof occurring and there was no material ineffective portion related to changesin the fair value of foreign currency forward contracts. Additionally, therewere no amounts excluded from the measure of effectiveness.

 

*Derivatives not Designated asHedges*

 

The Company enters intoforward exchange contracts to effectively hedge substantially all accountsreceivable and certain accounts payable resulting from transactions denominatedin foreign currencies in order to manage risks associated with foreign currencytransactions adversely affected by changes in exchange rates. At June 30, 2004and December 31, 2003, the Company had various foreign currency forwardexchange contracts, with maturities ranging up to six months. When aggregatedand measured in U.S. dollars at period-end exchange rates, the net notionalamount of these forward currency exchange contracts totaled approximately $27.2million and $29.3 million at June 30, 2004 and December 31, 2003, respectively.Generally, unrealized gains and losses resulting from these contracts are recognizedin operations and approximately offset corresponding unrealized gains andlosses recognized on the hedged accounts receivable or payable. These contractsare presently being and will continue to be marked to market through the incomestatement.

 

*Accumulated DerivativeInstruments Loss*

 

The following is areconciliation of changes in the fair value of the interest rate swapagreements and foreign currency forward and option contracts which have beenrecorded as Accumulated Derivative Instruments Loss in the accompanyingCondensed Consolidated Balance Sheet at June 30, 2004 and at June 30, 2003 andas Derivative Instruments Loss in the accompanying Condensed ConsolidatedStatements of Comprehensive Income (Loss) for the six months ended June 30, 2004and 2003.

 
| **(In millions of dollars)**         | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|
| Balance at  January 1                |       | $        | (12.7      | )        | $          | (6.1 | ) |
| Reclassification  to earnings        |       | (6.2     | )          | (2.7     | )          |
| Current period  change in fair value |       | 12.0     |       | 3.2      |       |
| Balance at June  30                  |       | $        | (6.9       | )        | $          | (5.6 | ) |

 

The balance recorded inAccumulated Derivative Instruments Loss at June 30, 2004 is expected to bereclassified into future earnings, contemporaneously with and offsettingchanges in the related hedged exposure. The actual amount that will bereclassified to future earnings over the next twelve months may vary from thisamount as a result of changes in market conditions.

 

18

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**Note 8 — PENSIONS AND OTHERPOSTRETIREMENT BENEFITS**

 

The Company maintainsdefined benefit pension plans for its U.S. employees. Benefits are based onyears of service and average base compensation levels over a period of years.The Company’s funding policies with respect to its U.S. pension plans are tocontribute funds to trusts as necessary to at least meet the minimum fundingrequirements of the U.S. Internal Revenue Code. Plan assets are investedprimarily in equities and fixed income securities.

 

The pension expenserelated to the U.S. plans consisted of the following:

 
| ** **                      | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------|------------|------------------------|------------|----------------------|------------|
| **(In millions of dollars)**    | ** ** | **June 30,  2004**     | ** ** | **June 30,  2003**   | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** |
| Service Cost                    |       | $                      | 3.7        |                 | $          | 1.9 |   | $ | 6.9 |   | $ | 3.3 |   |
| Interest Cost                   |       | 7.5                    |       | 4.3                  |       | 14.3 |   | 8.5 |   |
| Expected Return  on Plan Assets |       | (6.9                   | )          | (4.1                 | )          | (13.8 | ) | (8.3 | ) |
| Amortizations:                  |       |                   |       |                 |       |   |   |   |   |
| Prior Service  Cost             |       | 0.4                    |       | 0.6                  |       | 0.9 |   | 0.7 |   |
| Actuarial Loss                  |       | 0.9                    |       | 1.7                  |       | 1.8 |   | 2.1 |   |
|                            |       |                   |       |                 |       |   |   |   |   |
| Net Periodic  Pension Cost      |       | $                      | 5.6        |                 | $          | 4.4 |   | $ | 10.1 |   | $ | 6.3 |   |

 

The Company disclosed inits financial statements for the year ended December 31, 2003, that due tocertain minimum regulatory requirements, the Company may be required to makecontributions to its U.S. pension plans. The contributions were contingent uponfinal pension funding proposals separately approved by both houses of the U.S.Congress as well as the completion of the Company’s 2004 valuation by itsactuaries. The legislative actions have now been passed and the 2004 valuationhas been completed. The Company estimates that no contributions to its U.S.pension plans will be required to be paid in 2004.

 

The Company maintains international defined benefit pension plans thatare both noncontributory and contributory and are funded in accordance withapplicable local laws. The pension or termination benefits are based primarilyon years of service and the employees’ compensation. Plan Assets are investedprimarily in equities and fixed income securities.

 

The pension expense related to the international plans consisted of thefollowing:

 
| ** **                      | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------|------------|------------------------|------------|----------------------|------------|
| **(In millions of dollars)**    | ** ** | **June 30,  2004**     | ** ** | **June 30,  2003**   | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** |
| Service Cost                    |       | $                      | 0.1        |                 | $          | 0.1 |   | $ | 0.1 |   | $ | 0.1 |   |
| Interest Cost                   |       | 1.5                    |       | 1.3                  |       | 3.1 |   | 2.6 |   |
| Expected Return  on Plan Assets |       | (1.5                   | )          | (1.2                 | )          | (3.0 | ) | (2.3 | ) |
| Amortizations:                  |       |                   |       |                 |       |   |   |   |   |
| Actuarial Loss                  |       | 0.2                    |       | 0.1                  |       | 0.4 |   | 0.2 |   |
|                            |       |                   |       |                 |       |   |   |   |   |
| Net Periodic  Pension Cost      |       | $                      | 0.3        |                 | $          | 0.3 |   | $ | 0.6 |   | $ | 0.6 |   |

 

For its international pension plans, the Company contributed $3.0million in the second quarter of 2004 for a total of $3.0 million for the sixmonths ended June 30, 2004 and expects to contribute a total of $3.6 million in2004.

 

The Company sponsorspostretirement health care plans that provide medical and life insurancecoverage to eligible salaried and hourly retired U.S. employees and theirdependents. No postretirement medical benefits are offered to salariedemployees who began employment after December 31, 1993.

 

The other postretirementbenefits expense consisted of the following:

 
| ** **                                 | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------|------------|------------------------|------------|----------------------|------------|
| **(In millions of dollars)**               | ** ** | **June 30,  2004**     | ** ** | **June 30,  2003**   | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** |
| Service Cost                               |       | $                      | 0.2        |                 | $          | 0.1 |   | $ | 0.4 |   | $ | 0.2 |   |
| Interest Cost                              |       | 0.7                    |       | 0.4                  |       | 1.5 |   | 0.9 |   |
| Amortizations:                             |       |                   |       |                 |       |   |   |   |   |
| Prior Service  Cost                        |       | —                 |       | —               |       | (0.1 | ) | (0.1 | ) |
| Actuarial Loss                             |       | 0.1                    |       | 0.1                  |       | 0.2 |   | 0.2 |   |
|                                       |       |                   |       |                 |       |   |   |   |   |
| Net Periodic  Postretirement Benefits Cost |       | $                      | 1.0        |                 | $          | 0.6 |   | $ | 2.0 |   | $ | 1.2 |   |

 

In December 2003, President Bush signed into law the MedicarePrescription Drug, Improvement and Modernization Act of 2003 (“the Act”). TheAct expands Medicare primarily by adding a prescription drug benefit forMedicare-eligible individuals beginning in 2006. Pursuant to guidance providedin FASB Staff Position SFAS No. 106-1 (“*Accountingfor Disclosure Requirements Related to the Medicare Prescription Drug,Improvement and Modernization Act of 2003*”), the Company has chosento defer recognition of the Act, and, accordingly, postretirement benefitobligations and net periodic postretirement benefit cost do not reflect anypotential impact of the legislation. The authoritative guidance on theaccounting for the federal subsidy is pending and that guidance, when issued,could require the Company to change previously reported information.

 

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**Note 9 —RESTRUCTURING CHARGES AND IMPAIRMENT LOSSES**

 

The Company adopted aplan in the first quarter of 2004 to restructure its operations by closingfacilities, relocating equipment and severing employees in an effort to betterposition the Company to operate in the current business environment. Componentsof the restructuring charges for the six months ended June 30, 2004 are asfollows:

 
| **(In millions of dollars)**                                           | ** ** | **Six Months Ended  June 30, 2004** | ** ** |
|------------------------------------------------------------------------|------------|-------------------------------------|------------|
| Restructuring  Charges:                                                |       |                                |       |
| Equipment  Removal Costs                                               |       | $                                   | 1.4        |   |
| Facility  Restoration and Carrying Costs                               |       | 0.7                                 |       |
| Severance of  Employees and Other Employee Termination-Related Charges |       | 4.2                                 |       |
|                                                                   |       |                                |       |
| Total  Restructuring Charges                                           |       | $                                   | 6.3        |   |

 

The initial purchase price allocation of $7.2 million recorded at March31, 2004 was reduced by $0.9 million in the second quarter of 2004 primarilyfor lower facility restoration and carrying costs as the building was soldsooner than anticipated. Through June 30, 2004, the Company has made paymentsfor severance and other employee termination-related charges in the amount of$1.1 million and for equipment removal and facilities restoration in the amountof $0.7 million, both of which reduced the initial reserve detailed above. Therestructuring activities described herein are expected to be completed by theend of 2005 and affect only the paperboard packaging segment. As of June 30,2004, the Company had approximately $4.5 million accrued for restructuring, asfollows:

 
| **(In millions of dollars)**                                           | ** ** | **Balance at  January 1,  2004** | ** ** | **Adjustments  (Statement of  Operations Impact)** | ** ** | **Cash  Payments** | ** ** | **Purchase  Price  Allocation** | ** ** | **Reclassification** | ** ** | **Balance at  June 30,  2004** | ** ** |
|------------------------------------------------------------------------|------------|----------------------------------|------------|----------------------------------------------------|------------|--------------------|------------|---------------------------------|------------|----------------------|------------|--------------------------------|------------|
| ** **                                                             | ** ** | ** **                       | ** ** | ** **                                         | ** ** | ** **         |
| ** **                                                             | ** ** | ** **                       | ** ** | ** **                                         | ** ** | ** **         |
| ** **                                                             | ** ** | **Expense**                      | ** ** | **Reversal**                                       | ** ** | ** **         | ** ** | ** **                      | ** ** |
| Equipment  Removal Costs                                               |       | $                                | —     |                                               | $          | —             |       | $                               | —     |                 | $          | (0.6                           | )          | $ | 1.4 |   | $ | — |   | $ | 0.8 |   |
| Facility  Restoration and Carrying Costs                               |       | —                           |       | —                                             |       | —             |       | (0.1                            | )          | 0.7                  |       | —                         |       | 0.6 |   |
|                                                                   |       |                             |       |                                               |       |               |       |                            |       |                 |       |                           |       |   |   |
| Severance of  Employees and Other Employee Termination-Related Charges |       | —                           |       | —                                             |       | —             |       | (1.1                            | )          | 4.2                  |       | —                         |       | 3.1 |   |
| Total                                                                  |       | $                                | —     |                                               | $          | —             |       | $                               | —     |                 | $          | (1.8                           | )          | $ | 6.3 |   | $ | — |   | $ | 4.5 |   |

 

20

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**ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**OVERVIEW**

 

The Company is a leadingprovider of paperboard packaging solutions to multinational consumer productscompanies. The Company has vertically integrated operations enabling it tooffer customers paperboard, cartons and packaging machines, either as anintegrated solution or separately.

 

The Company’s objectiveis to expand its position as a leading provider of paperboard packagingsolutions. To achieve this objective, the Company is implementing strategies toexpand market share in its current markets and to identify and penetrate newmarkets; to capitalize on the Company’s and Graphic’s complementary customerrelationships, business competencies, and mills and converting assets; todevelop and market innovative products and applications; to continue to reducecosts by focusing on operational improvements and identified operatingsynergies from the Merger; and to use anticipated future cash flows to reducedebt.

 

**The Merger**

 

The Merger was accounted for as a purchase by theCompany. Under the purchase method of accounting, the assets and liabilities ofGraphic were recorded, as of the date of the closing of the Merger, at theirrespective fair values and added to those of the Company.

 

The Company is ahead of schedule in merger integrationand in realizing the initial estimate of approximately $52 million of annualsynergies by the third year after the closing of the Merger, primarily due tointegration of the Company’s paperboard production into its carton convertingsystem, more effective leveraging of the Company’s purchasing power,disciplined reduction of excess overhead and rationalization of the Company’smanufacturing capacity. As of June 30, 2004, the Company has achieved synergiesat an annualized rate of approximately $70 million. In January 2004, theCompany announced plans to close its Garden Grove, CA converting plant, and inMay 2004 announced plans to close its Bow, NH and Clinton, MS convertingplants. By the end of 2006, the Company estimates that it will realize anadditional $19 million in annual synergies, improved cost structures andincreased productivity as a result of these facilities closures. The Companycannot make assurances as to the amount or timing of future synergies, if any,that may be realized. Potential difficulties in realizing such projectedsynergies include, among other things, the integration of personnel, thecombination of different corporate cultures and the integration of facilities.

 

For additional discussion of the Merger and the impactof the Merger on the Company’s financial condition and results of operations,see Note 1, Note 2 and Note 9 in Notes to Condensed Consolidated FinancialStatements.

 

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**Segment Information**

 

The Company reports itsresults in two business segments: paperboard packaging andcontainerboard/other. Business segment information is as follows:

 
| ** **                     | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------|------------|------------------------|------------|----------------------|------------|
| **(In millions of dollars)**   | ** ** | **June 30,  2004**     | ** ** | **June 30,  2003**   | ** ** | **June 30,  2004** | ** ** | **June 30,  2003** | ** ** |
| NET SALES:                     |       |                   |       |                 |       |   |   |   |   |
| Paperboard Packaging           |       | $                      | 583.9      |                 | $          | 319.1 |   | $ | 1,141.2 |   | $ | 595.0 |   |
| Containerboard/Other           |       | 22.4                   |       | 19.5                 |       | 41.0 |   | 41.6 |   |
|                           |       | $                      | 606.3      |                 | $          | 338.6 |   | $ | 1,182.2 |   | $ | 636.6 |   |
|                           |       |                   |       |                 |       |   |   |   |   |
| INCOME (LOSS) FROM OPERATIONS: |       |                   |       |                 |       |   |   |   |   |
| Paperboard Packaging           |       | $                      | 65.4       |                 | $          | 43.1 |   | $ | 118.3 |   | $ | 82.0 |   |
| Containerboard/Other           |       | (7.0                   | )          | (6.4                 | )          | (15.5 | ) | (13.1 | ) |
| Corporate                      |       | (21.7                  | )          | (7.5                 | )          | (39.4 | ) | (14.8 | ) |
|                           |       | $                      | 36.7       |                 | $          | 29.2 |   | $ | 63.4 |   | $ | 54.1 |   |

 

**Significant Factors That ImpactThe Company’s Business**

 

The Company’s net sales,income from operations, cash flows from operations and financial condition areinfluenced by a variety of factors, many of which are beyond its control.

 

*Sales.* TheCompany sells its packaging products primarily to major consumer productcompanies in traditionally non-cyclical industries, such as beverage, food andother consumer products, and has long-term relationships with major companies,including Altria Group, Anheuser-Busch, General Mills, Miller Brewing Company,Coors Brewing Company, and numerous Coca-Cola and Pepsi bottling companies. TheCompany’s products are used primarily in the following end-use markets:

 

• beverage,including beer, soft drinks, water and juices;

 

•food, including cereal, desserts, frozen and microwavable foods, and pet foods;

 

•prepared foods, including snacks, quick serve foods in restaurants and foodservice products;

 

•household products, including dishwasher and laundry detergent, sporting goods,health care and beauty aids, and tissues and papers; and

 

•tobacco, including flip top boxes and long cartons.

 

The Company historicallyexperienced stable pricing for its integrated beverage multiple packagingproducts and moderate cyclical pricing for its other product offerings. Becausesome products can be packaged in different types of materials, the Company’ssales are affected by competition from other manufacturers’ coated unbleached kraftpaperboard, or CUK board, and other substrates — solid bleached sulfate, orSBS, recycled clay coated news, or CCN, and, internationally, white linedchipboard, or WLC — as well as by general market conditions. Graphic’s saleshistorically were driven primarily by consumer buying habits in the markets itscustomers serve. New product introductions and promotional activity byGraphic’s customers and Graphic’s introduction of new packaging products alsoimpacted its sales. The Company’s containerboard business is subject toconditions in the cyclical worldwide commodity paperboard markets which have asignificant impact on containerboard sales.

 

The Company works to maintain market share throughefficiency, product innovation and strategic sourcing to its customers;however, pricing and other competitive pressures may occasionally result in theloss of a customer relationship.

 

Packaging machineryplacements during the first six months of 2004 increased approximately 100%compared to the first six months of 2003 partially due to the timing ofshipments. The Company expects

 

22

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packaging machineryplacements for 2004 to be approximately 60% higher when compared to 2003. TheCompany has been and will continue to be selective in future packagingmachinery placements to ensure appropriate return on the Company’s investment.

 

*Cost of Sales*. The Company’s costof sales consist primarily of energy, pine pulpwood, hardwood, chemicals,recycled fibers, purchased paperboard, paper, aluminum foil, ink, plastic filmsand resins, depreciation expense and labor. Energy, including natural gas, fueloil and electricity, represents a significant portion of the Company’smanufacturing costs. During the first six months of 2004, the Companyexperienced a significant increase in its energy costs compared to the prioryear period, principally at its mills, in excess of $5 million on a pro formabasis representing an approximate 11% increase. The Company has entered intocontracts designed to mitigate the impact of future cost increases for aportion of its natural gas requirement, at its U.S. mills through January 2005.The Company will continue to evaluate its position regarding natural gaspurchase commitments. The Company believes that higher energy costs willcontinue to negatively impact its results for 2004.

 

*Commitment to Cost Reduction*.In light of increasing margin pressure throughout the paperboard packagingindustry, the Company has programs in place that are designed to reduce costs,improve productivity and increase profitability. The Company is continuing toimplement a global continuous improvement initiative that uses statisticalprocess control to help design and manage many types of activities, includingproduction and maintenance. This includes a Six Sigma process focused onreducing variable and fixed manufacturing and administrative costs. During thefirst six months of 2004, the Company achieved approximately $15 million inannualized cost savings through its continuous improvement initiative.

 

The Company is alsoimplementing an initiative designed to enhance the competitiveness of itsbeverage multiple packaging converting operations. This initiative is expectedto add new manufacturing technology, add press capacity and consolidate certainbeverage carton converting operations. The Company expects to make capitalinvestments of approximately $75 million through 2005 and to realize costsavings relative to 2002 from this initiative of approximately $39 million annuallyby 2005. The Company has spent approximately $56 million of the projectedcapital investment through June 30, 2004.

 

The Company continues toevaluate its current operations and assets with a view to rationalizing itsoperations and improving profitability. The Company is continuing to focus onreducing working capital and increasing liquidity.

 

**Critical Accounting Policies**

 

The preparation ofCondensed Consolidated Financial Statements in conformity with generallyaccepted accounting principles in the United States requires the Company tomake estimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting period. These estimates and assumptions are based onhistorical experience and various other factors that are believed to bereasonable under the circumstances. Actual results could differ from theseestimates under different assumptions or conditions.

 

The Company believes thefollowing accounting policies are the most critical because these policiesrequire significant judgment or involve complex estimations that are importantto the portrayal of the Company’s financial conditions and operating results:

 

•Revenue Recognition — The Company receives revenue from the sales ofmanufactured products, the leasing of packaging machinery, and the servicing ofpackaging machinery. The Company recognizes sales revenue when the followingcriteria are met: persuasive evidence of an agreement exists, delivery hasoccurred or services have been rendered, the Company’s price to the buyer isfixed and determinable, and collectibility is reasonably assured. Delivery isnot considered to have occurred until the customer takes title and assumes therisks and rewards of ownership. The timing of revenue recognition is largelydependent on shipping terms. Revenue is recorded at the time of shipment forterms designated as free on board, or f.o.b., shipping point. For salestransactions designated f.o.b. destination, revenue is recorded when theproduct is delivered to the customer’s delivery site. The Company recognizesrevenues on its annual and multi-year carton supply contracts as the shipmentoccurs in accordance with the shipping terms discussed above.

 

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Payments from packagingmachinery use agreements are recognized on a straight-line basis over the termof the agreements. Service revenue on packaging machinery is recorded at thetime of service.

 

Discounts and allowancesare comprised of trade allowances, cash discounts, and sales returns. Cashdiscounts and sales returns are estimated using historical experience. Tradeallowances are based on the estimated obligations and historical experience.Rebates are determined based on the quantity purchased and are recorded at thetime of sale.

 

•Collectibility of Accounts Receivable — The Company estimateslosses for uncollectible accounts based on the aging of accounts receivable andthe evaluation of the likelihood of success in collecting the receivables.Typically, allowances are needed for disputed accounts, customers that arehaving financial problems or bankruptcies.

 

•Inventory Costing — The Company’s inventories are stated at the lower of costor market with cost determined principally by the first-in, first-out(‘‘FIFO’’) basis (see Note 4 in Notes to the Condensed Consolidated FinancialStatements). Average cost basis is used to determine the cost of suppliesinventories. Raw materials and consumables used in the production process suchas wood chips and chemicals are valued at purchase cost on a FIFO basis uponreceipt. Work in progress and finished goods inventories are valued at the costof raw material consumed plus direct manufacturing costs (such as labor,utilities and supplies) as incurred and a proportion of manufacturing overhead.Inventories are stated net of an allowance for slow-moving and obsoleteinventory, which is based on estimates. If the condition of the inventories orthe state of the Company’s business were to deteriorate, additional allowancesmay be required which would reduce income.

 

•Self-Insurance Reserves — The Company is self-insured for certain losses relatingto workers’ compensation claims and employee medical and dental benefits.Provisions for expected losses are recorded based on the Company’s estimates,on an undiscounted basis, of the aggregate liabilities for known claims andestimated claims incurred but not reported. The Company has purchased stop-losscoverage or insurance with deductibles in order to limit its exposure tosignificant claims. The Company also has an extensive safety program in placeto minimize its exposure to workers’ compensation claims. Self-insured lossesare accrued based upon estimates of the aggregate uninsured claims incurredusing certain actuarial assumptions followed in the insurance industry andhistorical experience.

 

•Retirement-Related Benefits — The Company sponsors defined benefit plans, orthe plans, for eligible employees and retirees. The effect of the plans on theCondensed Consolidated Financial Statements is subject to many assumptions. TheCompany believes that the most critical assumptions are (1) the discount rate,(2) the rate of increase in future compensation levels and (3) the expectedlong-term rate of return on plan assets. The projected unit credit cost methodis used for valuation purposes.

 

•Goodwill Valuation — The Company estimates the value of its goodwill using thediscounted cash flow method of valuation on an annual basis. The Company’s cashflows are generated by its operations and are used to fund working capitalneeds, debt service and capital spending. The Company discounts these cash flowsusing its weighted average cost of capital. Changes in borrowing rates, whichare impacted by market rate fluctuations, would impact discounted cash flowcalculations. Other factors, such as significant operating losses oracquisitions of new operations, would also impact discounted cash flowcalculations.

 

•Recovery of Long-Lived Assets — The Company reviews long-lived assets(including property, plant and equipment and intangible assets) for impairmentwhenever events or changes in business circumstances, such as the closure of aplant, indicate that the carrying value of an asset may not be fullyrecoverable by undiscounted cash flows. Measurement of the impairment loss, ifany, is based on the fair value of the asset, which is generally determined by thediscounting of future estimated cash flows, or in the case of real estate,determining market value. The Company evaluates the recovery of its long-livedassets by analyzing operating results and considering significant events orchanges in the business environment that may have triggered impairment.

 

•Deferred Tax Asset Valuation Allowance — The Company estimates therealizability of deferred tax assets, by estimating the projected reversal ofoffsetting deferred tax liability amounts and future taxable income. Asdiscussed above in “Goodwill Valuation,” significant operating losses oracquisitions of operations would impact projected taxable income used toestimate the reversal of deferred tax balances.

 

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•Legal Accruals — The Company estimates the amount of potential exposure it mayhave with respect to litigation, claims and assessments, based upon analysesprepared by in-house and outside counsel, and records reserves when managementbelieves it is probable that a loss will occur and the amount of loss isreasonably estimable. While there can be no assurance as to the ultimateoutcome of any current lawsuits, claims or investigations relating to suchuncertainties, the Company does not believe that such uncertainties will have amaterial adverse impact on its results of operations, cash flows or financialcondition. However, future uncertainties may have a material adverse impact onresults of operations, cash flows or financial condition.

 

•Environmental Expenditures and Remediation Liabilities — Environmentalexpenditures that relate to current operations are expensed or capitalized asappropriate. Expenditures that relate to an existing condition caused by pastoperations, and which do not contribute to current or future revenuegeneration, are expensed. Liabilities are recorded when remedial efforts areprobable and the costs can be reasonably estimated. Typically, environmentalexpenditures relate to the maintenance and upgrading of equipment as well asthe installation of new equipment that is necessary in order to comply withenvironmental laws.

 

• BusinessCombinations—The Company, in assessing the fair market value of assets acquiredand liabilities assumed in the Merger, has used certain estimates andassumptions that were based, in part, upon independent third-party appraisalsand valuations.

 

**RESULTS OFOPERATIONS**

 

The Merger was accounted for as a purchase by theCompany thus, the results of operations for the three and six months ended June30, 2003 represent the results of the Company only. The Company’s results ofoperations for the three months and six months ended June 30, 2004 include theresults of Graphic. Accordingly, amounts for the three months and six monthsended June 30, 2004 are not comparable to those for the three months and sixmonths ended June 30, 2003. See Note 2 in Notes to Condensed ConsolidatedFinancial Statements.

 
| ** **                             | ** ** | **Three Months Ended** | ** ** | **Six Months Ended**                          | ** ** |
|----------------------------------------|------------|------------------------|------------|-----------------------------------------------|------------|
| **(Amounts in Millions)**              | ** ** | **June 30,  2004**     | ** ** | **Increase  (Decrease)  From  Prior  Period** | ** ** | **June 30,  2003** | ** ** | **June 30,  2004** | ** ** | **Increase  (Decrease)  From  Prior  Period** | ** ** | **June 30,  2003** | ** ** |
|                                   |       |                   |       |                                          |       |   |   |   |   |   |   |   |   |
| Net Sales                              |       | $                      | 606.3      |                                          | 79.1       | % | $ | 338.6 |   | 1182.2 |   | 85.7 | % | 636.6 |   |
| Cost of Sales                          |       | 508.2                  |       | 83.9                                          |       | 276.3 |   | 995.1 |   | 92.8 |   | 516.2 |   |
| Gross Profit                           |       | 98.1                   |       | 57.5                                          |       | 62.3 |   | 187.1 |   | 55.4 |   | 120.4 |   |
| Selling, General  and Administrative   |       | 49.2                   |       | 59.7                                          |       | 30.8 |   | 97.4 |   | 60.5 |   | 60.7 |   |
| Research,  Development and Engineering |       | 2.4                    |       | 26.3                                          |       | 1.9 |   | 4.8 |   | 41.2 |   | 3.4 |   |
| Other Expense,  Net                    |       | 9.8                    |       | 2,350.0                                       |       | 0.4 |   | 21.5 |   | 877.3 |   | 2.2 |   |
| Income from  Operations                |       | $                      | 36.7       |                                          | 25.7       | % | $ | 29.2 |   | $ | 63.4 |   | 17.2 | % | $ | 54.1 |   |
|                                        |            |                        |            |                                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**SECOND QUARTER 2004 COMPARED WITHSECOND QUARTER 2003**

 

**Net Sales**

 

The Company’s Net Salesin the second quarter of 2004 increased by $267.7 million, or 79.1%, to $606.3million from $338.6 million in the second quarter of 2003, due primarily to theaddition of Graphic’s paperboard packaging business which increased Net Salesby $272.7 million. Foreign currency exchange rates positively impacted NetSales by $7.6 million. These increases were somewhat offset by lower pricing inthe Company’s North American markets primarily as a result of increased marketcompetitiveness.

 

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**Gross Profit**

 

The Company’s GrossProfit in the second quarter of 2004 increased by $35.8 million, or 57.5%, to$98.1 million from $62.3 million in the second quarter of 2003. The Company’sgross profit margin decreased to 16.2% in the second quarter of 2004 from 18.4%in the second quarter of 2003. The decrease in gross profit margin was dueprimarily to lower pricing in North American markets as a result of increasedmarket competitiveness, lower margin product mix in North American marketsincluding the addition of Graphic’s paperboard packaging business, higherenergy and fiber costs, and inflation. In addition, unfavorable manufacturingvariances contributed to the decline in gross profit margin as the marketmovement to adopt the Fridge Vendor® beverage carton is occurring faster than anticipated. TheCompany expects that its production costs will be lower once it completes thebeverage multiple packaging converting operations initiative. The decrease ingross profit margin was somewhat offset by worldwide cost reductions resultingfrom the Company’s cost reduction initiatives.

 

**Selling, General andAdministrative**

 

Selling, General andAdministrative expenses increased by $18.4 million, or 59.7%, to $49.2 millionin the second quarter of 2004 from $30.8 million in the second quarter of 2003,due primarily to the addition of Graphic’s Selling, General and Administrativeexpenses of $11.5 million, higher incentive expenses, inflation and higherconsulting fees primarily associated with Sarbanes-Oxley compliance efforts. Asa percentage of Net Sales, Selling, General and Administrative expenses were8.1% in the second quarter of 2004 versus 9.1% in the second quarter of 2003.

** **

**Research, Developmentand Engineering**

 

Research, Development andEngineering expenses increased by $0.5 million, or 26.3%, to $2.4 million inthe second quarter of 2004 from $1.9 million in the second quarter of 2003, dueto the addition of Graphic’s Research, Development and Engineering expenses of$1.0 million, somewhat offset by lower investment related to the Company’sproducts and packaging machinery.

 

**Other Expense, Net**

 

Other Expense, Net was$9.8 million in the second quarter of 2004 as compared to $0.4 million in thesecond quarter of 2003. This change was principally due to higher amortizationexpense of $7.6 million due to the effects of purchase accounting in connectionwith the Merger and non-cash charges of approximately $1.9 million recorded inthe second quarter of 2004 associated with the retirement of certain equipment.

 

**Income from Operations**

 

Primarily as a result ofthe factors discussed above, the Company’s Income from Operations in the secondquarter of 2004 increased by $7.5 million, or 25.7%, to $36.7 million from$29.2 million in the second quarter of 2003, while its operating margindecreased to 6.1% in the second quarter of 2004 from 8.6% in the second quarterof 2003.

 

**Fluctuations in U.S.Currency Exchange Rates**

 

The weakening of the U.S.dollar currency exchange rates as compared to certain currencies including theeuro, other European currencies and the Japanese yen had a $7.6 million impacton Net Sales, while there was a modest impact on Gross Profit, Income fromOperations, and operating expenses during the second quarter of 2004.

 

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

 

**Interest Income**

 

Interest Income remainedconstant at $0.1 million in the second quarter of 2004 and 2003.

 

**Interest Expense**

 

Interest Expenseincreased by $2.3 million to $36.1 million in the second quarter of 2004 from$33.8 million in the second quarter of 2003, due primarily to higher debtbalances following the Merger. The increase was somewhat offset by lowerinterest rates on the new Senior and Senior Subordinated notes.

 

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**Income Tax Expense**

 

During the second quarterof 2004, the Company recognized an Income Tax Expense of $0.9 million on Incomebefore Income Taxes and Equity in Net Earnings of Affiliates of $0.7 million.During the second quarter of 2003, the Company recognized an Income Tax Expenseof $2.4 million on Loss before Income Taxes and Equity in Net Earnings ofAffiliates of $4.5 million.  Income TaxExpense for the second quarter of 2004 and 2003 was due primarily to incomeearned in certain foreign countries where no valuation allowance is recorded.

 

**Equity in Net Earnings ofAffiliates**

 

Equity in Net Earnings ofAffiliates decreased by $0.1 million to $0.4 million in the second quarter of2004 from $0.5 million in the second quarter of 2003 as a result of slightlylower operating results of the Company’s non-consolidated joint venture, RengoRiverwood Packaging, Ltd. (“Rengo”).

 

**FIRST SIX MONTHS 2004 COMPAREDWITH FIRST SIX MONTHS 2003**

 

**Net Sales**

 

The Company’s Net Salesin the first six months of 2004 increased by $545.6 million, or 85.7%, to$1,182.2 million from $636.6 million in the first six months of 2003, dueprimarily to the addition of Graphic’s paperboard packaging business whichincreased Net Sales by $551.6 million. Foreign currency exchange rates positivelyimpacted Net Sales by $22.9 million. These increases were somewhat offset bylower pricing in the Company’s North American markets primarily as a result ofincreased market competitiveness.

 

**Gross Profit**

 

The Company’s GrossProfit in the first six months of 2004 increased by $66.7 million, or 55.4%, to$187.1 million from $120.4 million in the first six months of 2003. TheCompany’s gross profit margin decreased to 15.8% in the first six months of2004 from 18.9% in the first six months of 2003. The decrease in gross profitmargin was due primarily to lower pricing in North American markets as a resultof increased market competitiveness, lower margin product mix in North Americanmarkets including the addition of Graphic’s paperboard packaging business,higher energy and fiber costs, and inflation. In addition, unfavorablemanufacturing variances contributed to the decline in gross profit margin asthe market movement to adopt the Fridge Vendor® beverage carton is occurring fasterthan anticipated. The Company expects that its production costs will be loweronce it completes the beverage multiple packaging converting operationsinitiative. The decrease in gross profit margin was somewhat offset byworldwide cost reductions resulting from the Company’s cost reductioninitiatives.

 

**Selling, General andAdministrative**

 

Selling, General andAdministrative expenses increased by $36.7 million, or 60.5%, to $97.4 millionin the first six months of 2004 from $60.7 million in the first six months of2003, due primarily to the addition of Graphic’s Selling, General andAdministrative expenses of $23.0 million, increased expenses related to theMerger of $1.0 million, higher incentive expenses, inflation and higherconsulting fees primarily associated with Sarbanes-Oxley compliance efforts. Asa percentage of Net Sales, Selling, General and Administrative expenses were8.2% in the first six months of 2004 versus 9.5% in the first six months of2003.

 

**Research, Developmentand Engineering**

 

Research, Development andEngineering expenses increased by $1.4 million, or 41.2%, to $4.8 million inthe first six months of 2004 from $3.4 million in the first six months of 2003,due to the addition of Graphic’s Research, Development and Engineering expensesof $1.9 million somewhat offset by lower investment related to the Company’sproducts and packaging machinery.

 

**Other Expense, Net**

 

Other Expense, Net was$21.5 million in the first six months of 2004 as compared to $2.2 million inthe first six months of 2003. This change was principally due to higheramortization expense of $15.0 million due to

 

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the effects of purchase accounting in connection with the Merger andnon-cash charges of approximately $4.9 million recorded in the first six monthsof 2004 associated with the retirement of certain equipment, somewhat offset bythe charge of approximately $1.9 million recorded in the first six months of2003 to write off deferred costs associated with the withdrawal of the proposedinitial public offering of the Company’s common stock.

 

**Income from Operations**

 

Primarily as a result ofthe factors discussed above, the Company’s Income from Operations in the firstsix months of 2004 increased by $9.3 million, or 17.2%, to $63.4 million from$54.1 million in the first six months of 2003, while its operating margindecreased to 5.4% in the first six months of 2004 from 8.5% in the first sixmonths of 2003.

 

**Fluctuations in U.S.Currency Exchange Rates**

 

The weakening of the U.S.dollar currency exchange rates as compared to certain currencies including theeuro, other European currencies and the Japanese yen had a $22.9 million impacton Net Sales, while there was a modest impact on Gross Profit, Income fromOperations, and operating expenses during the first six months of 2004.

 

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

 

**Interest Income**

 

Interest Income remainedconstant at $0.2 million in the first six months of 2004 and 2003.

 

**Interest Expense**

 

Interest Expenseincreased by $6.3 million to $74.1 million in the first six months of 2004 from$67.8 million in the first six months of 2003, due primarily to higher debtbalances following the Merger. The increase was somewhat offset by lowerinterest rates on the new Senior and Senior Subordinated notes.

 

**Income Tax Expense**

 

During the first sixmonths of 2004, the Company recognized an Income Tax Expense of $2.4 million onLoss before Income Taxes and Equity in Net Earnings of Affiliates of $10.5million. During the first six months of 2003, the Company recognized an IncomeTax Expense of $3.4 million on Loss before Income Taxes and Equity in NetEarnings of Affiliates of $13.5 million. Income Tax Expense for the first sixmonths of 2004 and 2003 was due primarily to income earned in certain foreigncountries where no valuation allowance is recorded.

 

**Equity in Net Earnings ofAffiliates**

 

Equity in Net Earnings ofAffiliates remained constant at $0.7 million in the first six months of 2004 and2003 and relates principally to the Company’s non-consolidated joint venture,Rengo.

 

**FINANCIAL CONDITION,LIQUIDITY AND CAPITAL RESOURCES**

 

The Company broadlydefines liquidity as its ability to generate sufficient funds from bothinternal and external sources to meet its obligations and commitments. Inaddition, liquidity includes the ability to obtain appropriate debt and equityfinancing and to convert into cash those assets that are no longer required tomeet existing strategic and financial objectives. Therefore, liquidity cannotbe considered separately from capital resources that consist of current orpotentially available funds for use in achieving long-range business objectivesand meeting debt service commitments.

 

**Cash Flows**

 

Cash and Equivalents decreased by approximately $12.2million in the first six months of 2004. Cash provided by operating activitiesin the first six months of 2004 totaled $69.0 million, compared to cash

 

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provided by operating activities of $55.1 million inthe first six months of 2003. This improvement was principally due to anincrease in operating cash flow before changes in operating assets andliabilities, somewhat offset by unfavorable changes in receivables and accountspayable and other accrued liabilities, as a result of the additional workingcapital needs following the Merger and timing differences. Cash used ininvesting activities in the first six months of 2004 totaled $72.5 million,compared to $48.9 million in the first six months of 2003. This change wasprincipally due to an increase in purchases of property, plant and equipment ofapproximately $27.7 million (see “—Capital Expenditures”) somewhat offset bythe net proceeds of $9.6 million from the sale of assets, principally theCompany’s Garden Grove, California plant ($9.2 million). Cash used in financingactivities in the first six months of 2004 totaled $8.8 million, compared to$16.1 million in the first six months of 2003. This change was principally dueto lower net borrowings under the Company’s revolving credit facilities andlower payments on debt. Depreciation and amortization during the first sixmonths of 2004 totaled approximately $114.2 million and is expected to beapproximately $220 million to $230 million in 2004.

 

**Liquidity and CapitalResources**

 

The Company’s liquidityneeds arise primarily from debt service on its substantial indebtedness andfrom the funding of its capital expenditures, ongoing operating costs andworking capital.

 

The following financingtransactions (the “Related Financing Transactions”) were entered into inconnection with the Merger:

 

•The entering into and borrowing under the Senior Secured Credit Agreement,dated as of August 8, 2003, among Graphic Packaging International, Inc. and theseveral lender parties thereto (the “Senior Secured Credit Agreement”), whichprovides for aggregate maximum borrowings of $1.6 billion under (i) a term loanfacility (the “Term Loan Facility”) providing for term loans in an aggregateprincipal amount of $1.275 billion in two tranches, consisting of Tranche Aterm loans and Tranche B term loans, and (ii) a revolving credit facility (the“Revolving Credit Facility”) providing for up to $325 million in revolvingloans (including standby and commercial letters of credit) outstanding atanytime, to Graphic Packaging International, Inc.

 

•The issuance and sale of $425 million in aggregate principal amount of 8.5%senior notes due 2011 (the “Senior Notes”) and $425 million in aggregate principalamount of 9.5% senior subordinated notes due 2013 (the “Senior SubordinatedNotes”).

 

•The repayment of all outstanding amounts under each of RIC’s and Graphic’sprior senior secured credit facilities and the termination of all commitmentsunder those facilities.

 

•The consummation of tender offers and consent solicitations for all of RIC’s 105/8% senior notes due 2007 (the “Senior Notes due 2007”) and 10 7/8% seniorsubordinated notes due 2008 (the “Senior Subordinated Notes due 2008” and,together with the Senior Notes due 2007, the “Prior RIC Notes”), which closedconcurrently with the Merger. The Company redeemed all Prior RIC Notes thatwere not tendered pursuant to the tender offers.

 

•The consummation of an anticipatory change of control tender offer and consentsolicitation for all of Graphic’s 8 5/8% senior subordinated notes due 2012(the “Prior Graphic Notes”) made in anticipation of the change of control offerrequired by the indenture governing the Prior Graphic Notes. Out of $300.0 millionin aggregate principal amount of Prior Graphic Notes outstanding, approximately$299.1 million in aggregate principal amount of Prior Graphic Notes weretendered in the anticipatory change of control tender offer. On September 15,2003, the Company completed the change of control offer required pursuant tothe indenture governing the Prior Graphic Notes. As of June 30, 2004 andDecember 31, 2003, $0.8 million in principal amount of the Prior Graphic Noteswas outstanding.

 

As of June 30, 2004, theCompany had outstanding $2.1 billion of long-term debt, consisting primarily of$850 million aggregate principal amount of Senior Notes and Senior SubordinatedNotes, $1,256 million of term loans under the Term Loan Facility, $21 millionof revolving credit borrowings under the Revolving Credit Facility, and otherdebt issues and facilities.

 

Principal and interestpayments under the Term Loan Facility and the Revolving Credit Facility,together with principal and interest payments on the Senior Notes and theSenior Subordinated Notes, represent significant liquidity requirements for theCompany. The Tranche A term loans mature in 2009 and amortize in

 

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semi-annual installmentsover their term on the following amortization schedule: $7.5 million onDecember 31, 2004 and June 30, 2005, $11.25 million on December 31, 2005 andJune 30, 2006, $15.0 million on December 31, 2006 and June 30, 2007, and $18.75million on December 31, 2007, June 30, 2008, December 31, 2008 and at maturity.The Tranche B term loans mature in 2010 and amortize in semi-annualinstallments of $5.625 million payable on December 31 and June 30 of each yearthrough December 31, 2009, with a final payment of approximately $1.05 billionat maturity. The Revolving Credit Facility matures in 2009.

 

The loans under theSenior Secured Credit Agreement bear interest at fluctuating rates based uponthe interest rate option elected by the Company. The loans under the Term LoanFacility bore interest as of June 30, 2004 at an average rate per annum of3.9%. The Senior Notes and the Senior Subordinated Notes bear interest at ratesof 8.5% and 9.5%, respectively. The loans under the Revolving Credit Facilitybore interest as of June 30, 2004 at an average rate per annum of 5.04%.

 

Interest expense in 2004is expected to be approximately $145 million, including approximately $9million of non-cash amortization of deferred debt issuance costs. During thefirst six months of 2004, cash paid for interest was approximately $61 million.

 

At June 30, 2004, theCompany and its U.S. and international subsidiaries had the followingcommitments, amounts outstanding and amounts available under revolving creditfacilities:

 
| **(In millions of dollars)** | ** ** | **Total Amount of  Commitments** | ** ** | **Total Amount  Outstanding** | ** ** | **Total Amount  Available (A)** | ** ** |
|------------------------------|------------|----------------------------------|------------|-------------------------------|------------|---------------------------------|------------|
| Revolving Credit  Facility   |       | $                                | 325.0      |                          | $          | 21.4                            |       | $ | 292.7 |   |
| International  Facilities    |       | 15.6                             |       | 8.4                           |       | 7.2                             |       |
|                         |       | $                                | 340.6      |                          | $          | 29.8                            |       | $ | 299.9 |   |

 

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**Note:**

(A)      Inaccordance with its debt agreements, the Company’s availability under itsRevolving Credit Facility has been reduced by the amount of standby letters ofcredit issued of approximately $10.9 million as of June 30, 2004. These lettersof credit are used as security against its self-insurance obligations, workers’compensation obligations and an outstanding note payable. These letters ofcredit expire at various dates through 2005 unless extended.

 

Based upon current levelsof operations, anticipated cost-savings and expectations as to future growth,the Company believes that cash generated from operations, together with amountsavailable under its Revolving Credit Facility and other available financingsources, will be adequate to permit the Company to meet its debt serviceobligations, capital expenditure program requirements, ongoing operating costsand working capital needs, although no assurance can be given in this regard.The Company’s future financial and operating performance, ability to service orrefinance its debt and ability to comply with the covenants and restrictionscontained in its debt agreements (see “—Covenant Restrictions”), will besubject to future economic conditions and to financial, business and otherfactors, many of which are beyond the Company’s control and will besubstantially dependent on the selling prices and demand for the Company’sproducts, raw material and energy costs, and the Company’s ability tosuccessfully implement its overall business and profitability strategies.

 

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

 

The Company uses interestrate swaps to manage interest rate risks on future income caused by interestrate changes on its variable rate Term Loan Facility. The differential to bepaid or received under these agreements is recognized as an adjustment tointerest expense related to the debt. At June 30, 2004 the Company had interestrate swap agreements with a notional amount of $770 million, which expire onvarious dates from 2004 to 2007 under which the Company will pay fixed rates of1.89% to 3.27% and receive three-month LIBOR.

 

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Effective as of December31, 2003, the Company had approximately $1.3 billion of net operating losscarryforwards (“NOLs”). These NOLs generally may be used by the Company tooffset taxable income earned in subsequent taxable years. However, theCompany’s ability to use these NOLs to offset its future taxable income may besubject to significant limitation as a result of certain shifts in ownershipdue to direct or indirect transfers of the Company’s common stock by one ormore 5-percent stockholders, or issuances or redemptions of the Company’scommon stock, which, when taken together with previous changes in ownership ofthe Company’s common stock, constitute an ownership change under the InternalRevenue Code. Imposition of any such limitation on the use of NOLs could havean adverse effect on the Company’s future after tax free cash flow.

 

**Covenant Restrictions**

 

The Senior Secured CreditAgreement, which governs the Term Loan Facility and the Revolving CreditFacility, imposes restrictions on the Company’s ability to make capitalexpenditures and both the Senior Secured Credit Agreement and the indenturesgoverning the Senior Notes and Senior Subordinated Notes (the “Notes”) limitthe Company’s ability to incur additional indebtedness. Such restrictions,together with the highly leveraged nature of the Company, could limit theCompany’s ability to respond to market conditions, meet its capital spendingprogram, provide for unanticipated capital investments or take advantage ofbusiness opportunities. The covenants contained in the Senior Secured CreditAgreement, among other things, restrict the ability of the Company to disposeof assets, incur additional indebtedness, incur guarantee obligations, prepayother indebtedness, make dividend and other restricted payments, create liens,make equity or debt investments, make acquisitions, modify terms of indenturesunder which the Notes are issued, engage in mergers or consolidations, changethe business conducted by the Company and its subsidiaries, make capitalexpenditures and engage in certain transactions with affiliates.

 

The financial covenantsin the Senior Secured Credit Agreement specify, among other things, thefollowing requirements for each four quarter period ending during the followingtest periods:

 
| **Test Period**                        | ** ** | **Consolidated Debt to  Credit Agreement EBITDA  Leverage Ratio(A)** | ** ** | **Credit Agreement  EBITDA to Consolidated  Interest Expense Ratio(A)** | ** ** |
|----------------------------------------|------------|----------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|
| October 1, 2003  - December 30, 2004   |       | 6.40 to 1.00                                                         |       | 2.00 to 1.00                                                            |       |
| December 31,  2004 - December 30, 2005 |       | 6.15 to 1.00                                                         |       | 2.25 to 1.00                                                            |       |
| December 31,  2005 - December 30, 2006 |       | 5.75 to 1.00                                                         |       | 2.35 to 1.00                                                            |       |
| December 31,  2006 - December 30, 2007 |       | 5.25 to 1.00                                                         |       | 2.50 to 1.00                                                            |       |
| December 31,  2007 - December 30, 2008 |       | 4.75 to 1.00                                                         |       | 2.75 to 1.00                                                            |       |
| December 31,  2008 - June 30, 2010     |       | 4.50 to 1.00                                                         |       | 2.90 to 1.00                                                            |       |

 

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Note:

(A) See “—Credit Agreement EBITDA” below.

 

At June 30, 2004, theCompany was in compliance with the financial covenants in the Senior SecuredCredit Agreement. The Company’s ability to comply in future periods with thefinancial covenants in the Senior Secured Credit Agreement will depend on itsongoing financial and operating performance, which in turn will be subject toeconomic conditions and to financial, business and other factors, many of whichare beyond the Company’s control and will be substantially dependent on theselling prices for the Company’s products, raw material and energy costs, andthe Company’s ability to successfully implement its overall business andprofitability strategies. If a violation of any of the covenants occurred, theCompany would attempt to get a waiver or an amendment from its lenders,although no assurance can be given that the Company would be successful in thisregard. The Senior Secured Credit Agreement and the indentures governing theSenior Subordinated Notes and the Senior Notes have covenants as well ascertain cross-default or cross-acceleration provisions; failure to comply withthese covenants in any agreement could result in a violation of such agreementwhich could, in turn, lead to violations of other agreements pursuant to suchcross-default or cross-acceleration provisions.

 

The Senior Secured CreditAgreement is collateralized by substantially all of the Company’s domesticassets.

 

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**CreditAgreement EBITDA**

 

The table below sets forthEBITDA as defined in the Company’s Senior Secured Credit Agreement, which isreferred to in this report as “Credit Agreement EBITDA.” CreditAgreement EBITDA as presented below is a financial measure that is used in theSenior Secured Credit Agreement. Credit Agreement EBITDA is not a defined termunder accounting principles generally accepted in the United States and shouldnot be considered as an alternative to income from operations or net income asa measure of operating results or cash flows as a measure of liquidity. CreditAgreement EBITDA differs from the term “EBITDA” (earnings before interestexpense, income tax expense, and depreciation and amortization) as it iscommonly used. In addition to adjusting net income to exclude interest expense,income tax expense, and depreciation and amortization, Credit Agreement EBITDAalso adjusts net income by excluding certain other items and expenses, asspecified below. The Company’s definition of Credit Agreement EBITDA may differfrom that of other similarly titled measures at other companies. The SeniorSecured Credit Agreement requires the Company to comply with a specifiedconsolidated debt to Credit Agreement EBITDA leverage ratio and a specifiedCredit Agreement EBITDA to consolidated interest expense ratio for specifiedperiods, as described in the preceding section, “Covenant Restrictions.”

 

Borrowings under theSenior Secured Credit Agreement are a key source of the Company’s liquidity.The Company’s ability to borrow under the Senior Secured Credit Agreement isdependent on, among other things, its compliance with the financial ratiocovenants referred to in the preceding section. Failure to comply with thesefinancial ratio covenants would result in a violation of the Senior SecuredCredit Agreement and, absent a waiver or amendment from the lenders under suchagreement, permit the acceleration of all outstanding borrowings under the SeniorSecured Credit Agreement.

 

The calculation of Credit Agreement EBITDA for theperiods indicated is set forth below. Credit Agreement EBITDA for the sixmonths ended June 30, 2004 is calculated in accordance with the Senior SecuredCredit Agreement. Credit Agreement EBITDA for the twelve months ended June 30,2004 and December 31, 2003 is calculated on a pro forma basis giving effect tothe Merger in accordance with the Senior Secured Credit Agreement. CreditAgreement EBITDA for the six months ended June 30, 2003 is also calculated on apro forma basis giving effect to the Merger as if the Senior Secured CreditAgreement was in effect with respect to such period. See Note 2 in Notes toCondensed Consolidated Financial Statements for selected unaudited pro formacombined financial information giving effect to the Merger.

 
| ** **                                                            | ** ** | **Six Months Ended**      | ** ** | **Twelve Months Ended**      | ** ** |
|-----------------------------------------------------------------------|------------|---------------------------|------------|------------------------------|------------|
| **(Amounts in Millions)**                                             | ** ** | **Jun. 30, 2004  Actual** | ** ** | **Jun. 30, 2003  Pro Forma** | ** ** | **Jun. 30, 2004  Pro Forma** | ** ** | **Dec. 31, 2003  Pro Forma** | ** ** |
| Unaudited  Combined Income (Loss) Attributable to Common Stockholders |       | $                         | (12.2      | )                            | $          | (12.8 | ) | $ | (73.8 | ) | $ | (74.4 | ) |
| Income Tax  Expense                                                   |       | 2.4                       |       | 4.6                          |       | 0.3 |   | 2.5 |   |
| Interest  Expense, Net                                                |       | 73.9                      |       | 72.3                         |       | 149.7 |   | 148.1 |   |
| Depreciation and  Amortization                                        |       | 114.2                     |       | 105.9                        |       | 223.2 |   | 214.9 |   |
| Equity in Net  Earnings of Affiliates                                 |       | (0.7                      | )          | (0.7                         | )          | (1.3 | ) | (1.3 | ) |
| Other Non-Cash  Charges (A)                                           |       | 19.6                      |       | 11.4                         |       | 40.0 |   | 31.8 |   |
| Merger Related  Expenses                                              |       | 2.2                       |       | 3.5                          |       | 11.8 |   | 13.1 |   |
| Dividends from  Equity Investments                                    |       | 1.1                       |       | 0.7                          |       | 1.1 |   | 0.7 |   |
| Loss on Early  Extinguishment of Debt                                 |       | —                    |       | —                       |       | 46.6 |   | 46.6 |   |
| Credit Agreement  EBITDA (B)                                          |       | $                         | 200.5      |                         | $          | 184.9 |   | $ | 397.6 |   | $ | 382.0 |   |

 

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**Notes:**

(A) Other non-cashcharges include non-cash charges for pension, postretirement and postemploymentbenefits, and amortization of premiums on hedging contracts deducted indetermining net income.

 

(B) Credit AgreementEBITDA is calculated in accordance with the definitions contained in theCompany’s Senior Secured Credit Agreement. Credit Agreement EBITDA is definedas consolidated net income before consolidated interest expense, non-cashexpenses and charges, total income tax expense, depreciation expense, expenseassociated with amortization of intangibles and other assets, non-cashprovisions for reserves for discontinued operations, extraordinary, unusual ornon-recurring gains or losses or charges or credits, gain or loss associatedwith sale or write-down of assets not in the ordinary course of business, andany income or loss accounted for by the equity method of accounting.

 

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**Capital Expenditures**

 

The Company’s capitalspending for the first six months of 2004 was approximately $75.3 million, up58.2% from $47.6 million for the first six months of 2003. During the first sixmonths of 2004, the Company had capital spending of approximately $32.4 millionfor improving process capabilities, approximately $27.5 million for itsbeverage multiple packaging converting operations initiative, approximately$12.9 million for manufacturing packaging machinery and approximately $2.5million for compliance with cluster rules. Total capital spending for 2004 isexpected to be approximately $150 million and is expected to relate principallyto improving the Company’s process capabilities including the Company’sbeverage multiple packaging converting operations initiative (approximately$125 million), the production of packaging machinery (approximately $20million) and environmental cluster rules compliance (approximately $6 million).Through 2005, the Company anticipates that it will spend approximately $20million at its U.S. mills to comply with the cluster rules. The Company isaccelerating certain capital driven cost reduction projects that it anticipateswill deliver benefits in 2004 and 2005.

 

**Seasonality**

 

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

 

**Environmental Matters**

 

TheCompany is subject to a broad range of foreign, federal, state and localenvironmental, health and safety laws and regulations, including thosegoverning discharges to air, soil and water, the management, treatment anddisposal of hazardous substances, the management, treatment and disposal ofsolid and hazardous wastes, the investigation and remediation of contaminationresulting from historical site operations and releases of hazardous substances,and the health and safety of employees. The Company’s environmental potentialliabilities and obligations may result in significant costs, which couldnegatively impact its financial condition and results of operations. Inaddition, capital expenditures may be necessary for the Company to comply withsuch laws and regulations, including the U.S. Environmental Protection Agency’sregulations mandating stringent controls on air and water discharges from pulpand paper mills, or the cluster rules. Any failure to comply with environmental,health and safety laws or any permits and authorizations required thereundercould subject the Company to fines, corrective action or other sanctions. Inaddition, some of the Company’s current and former facilities are the subjectof environmental investigations and remediations resulting from historicaloperations and the release of hazardous substances or other constituents. Somecurrent and former facilities have a history of industrial usage for whichinvestigation and remediation obligations may be imposed in the future or forwhich indemnification claims may be asserted against the Company. The Companycannot predict with certainty future investigation or remediation costs orfuture costs relating to historical usage or indemnification claims. Also, potentialfuture closures or sales of facilities may necessitate further investigationand which may result in future remediation at those facilities. The Companywill continue to review and revise its estimate of potential, contingentenvironmental liabilities related to past, present and future operations asadditional information related to its environmental liabilities is obtained.

 

Thefederal Clean Air Act imposes stringent limits on air emissions, establishes afederal permit program (Title V) and provides for enforcement sanctions. Wherenecessary, the Company’s plants have received or submitted an application tothe appropriate permitting authority for a Title V permit. The Company fromtime to time upgrades and replaces equipment in order to comply with airquality standards.

 

Thefederal Clean Water Act establishes a system of minimum national effluentstandards for each industry, water quality standards for the nation’s waterwaysand a permit program that provides discharge limitations

 

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andprovides for enforcement sanctions. It also regulates releases of pollutantsand spills of pollutants, including oil and hazardous materials. Many of theCompany’s facilities have discharges of pollutants which are permitted byappropriate regulatory agencies permitting the discharge to publicly ownedtreatment works or to surface water.

 

Thefederal Comprehensive Environmental Response, Compensation and Liability Act(“CERCLA”) establishes liability for waste generators, current and former siteowners and operators and others in connection with release of hazardoussubstances. In several instances, the Company has been identified as aPotentially Responsible Party (“PRP”) under CERCLA and similar state laws withrespect to remediation of sites at which hazardous substances have beenreleased. At many of these sites, the liability of the Company has beenresolved through settlement with other PRPs and/or appropriate regulatoryagencies. The remaining sites which are currently known and at which Graphic’sliability is not resolved are believed by the Company not to be material.

 

TheCompany is involved in investigation and remediation projects for certainproperties that it currently owns or formerly owned or operated. The Companyhas also received demands arising out of alleged contamination of variousproperties currently for formerly operated by it, and at certain waste disposalsites. The Company believes that these potential liabilities are either notmaterial or that in many instances the potential for liability cannot bereasonably estimated until investigations have been completed and the need forand scope of remediation have been determined.

 

Toaddress contingent losses at those sites where available information indicatesthat liability is probable or at which liability has been incurred and a rangeof amounts of the liability can be reasonably estimated and the estimation ofthe amount of the liability is material, an environmental reserve has beenestablished. To the extent that additional costs may be incurred that exceedthe accrued reserves, such amounts are not expected to have a material impacton the financial condition of the Company, although no assurances can be giventhat significant costs will not be incurred in connection with contingentenvironmental site liabilities, including the sites specifically identifiedbelow:

 

NorthPortland, Oregon Facility.  The presenceof contamination in soils on and groundwater beneath the North Portlandfacility has been identified at levels exceeding Oregon state screening limits.Current information indicates that the contamination is naturally attenuating,is confined and/or is the result of off-site contamination which has migratedto groundwater beneath the facility. The facility is listed on the OregonConfirmed Release List; however, the facility is under no current order oragreement to conduct additional investigation and/or remediation at this time.The EPA has determined that it will require no further action at the site. TheCompany believes it is probable that additional investigation will be requiredat the facility by Oregon although it is not possible to predict a time-tablefor additional action. Based on current information, the Company believes thatno active remediation will be required as a result of any additionalinvestigation at the facility.

 

KalamazooPaperboard Mill and Carton Plant.  TheKalamazoo facilities and adjacent properties have long histories of industrialand commercial usages. Portions of the property on which the mill is locatedhave been found to contain contamination exceeding Michigan state screeninglevels. Restrictive covenants restricting land usage in portions of the millproperty where contamination has been identified have been recorded to addresscontamination in those areas. The Company believes that there is a reasonablepossibility that some or all of the contamination which has been identified atthe facility will be determined to be the result of past activities unrelatedto the Company’s operations; however, further investigation will be necessaryto make a final determination. Although the Company is not under any currentorder or agreement to conduct additional site investigation, the Company plansto submit an Interim Remedial Action Plan (“IRAP”) to investigate and addressthe presence of contamination at the mill during the third or fourth quarter of2004. The IRAP will be conducted over a five (5) year period. There is notsufficient information available to determine whether any additionalinvestigation or remediation will be required after completion of the IRAP noris there sufficient information to reasonably estimate the cost of anyadditional investigation or remediation beyond the requirements of the IRAP.

 

ManvilleForest Products Wood Treatment Facility. On July 6, 2000, the Company entered into a settlement agreement withthe Louisiana Department of Environmental Quality (“LDEQ”) to resolve claimsagainst the Company for liability related to the historical operations at adecommissioned, wood treatment facility in Shreveport, Louisiana located onLine Avenue. Subsequently, the Company and the LDEQ reached an agreement withOlin Corporation, a former site owner/operator, to contribute 50% of all remedialactivities.

 

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TheCompany has completed and the LDEQ has approved the remedial action required bythe settlement agreement. Under the settlement agreement, the Company and Olinare obligated to conduct long-term monitoring and maintenance of the site.

 

**InformationConcerning Forward-Looking Statements**

 

Certainstatements of the Company’s expectations including, but not limted to,statements regarding the reduction of debt, production efficiency improvements,synergies from the Merger, energy and fiber costs, depreciation andamortization, interest expense, capital expenditures and the outcome oflitigation and environmental proceedings in this report constitute“forward-looking statements” as defined in the Private Securities LitigationReform Act of 1995. Such statements are based on currently available operating,financial and competitive information and are subject to various risks anduncertainties that could cause actual results to differ materially from theCompany’s historical experience and its present expectations. These risks anduncertainties include, but are not limited to, the Company’s ability toimplement its business strategies and achieve forecast synergies from theMerger, the Company’s substantial amount of debt, continuing pressure for lowercost products, increases and volatility in raw materials and energy costs,rising labor costs, unfavorable currency translation movements and other risksof conducting business internationally, and the impact of regulatory andlitigation matters, including those that impact the Company’s ability toprotect and use its intellectual property. Undue reliance should not be placedon such forward-looking statements, as such statements speak only as of the dateon which they are made. Additional information regarding these and other risksis contained in the Company’s other periodic filings with the SEC.

 

**ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUTMARKET RISK**

 

For a discussion ofcertain market risks related to the Company, see Part II, Item 7A,“Quantitative and Qualitative Disclosure about Market Risk”, in the Company’sAnnual Report on Form 10-K for the fiscal period ended December 31, 2003. Therehave been no significant developments with respect to derivatives or exposureto market risk during the first six months of 2004; see Note 7 in Notes toCondensed Consolidated Financial Statements and Management’s Discussion andAnalysis of Financial Condition and Results of Operations “-Liquidity and CapitalResources”.

 

**ITEM 4.  CONTROLS AND PROCEDURES**

 

The Company’s managementhas carried out an evaluation, with the participation of its chief executiveofficer and chief financial officer, of the effectiveness of the Company’sdisclosure controls and procedures pursuant to Rule 13a-15 of the SecuritiesExchange Act of 1934. Based upon management’s evaluation, the Company’s chiefexecutive officer and chief financial officer have concluded that the Company’sdisclosure controls and procedures were effective as of June 30, 2004. Therewas no change in the Company’s internal control over financial reporting thatoccurred during the Company’s last fiscal quarter that has materially affected,or is reasonably likely to materially affect, the Company’s internal controlover financial reporting.

 

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**PART II - OTHER INFORMATION**

 

**ITEM 1. LEGAL PROCEEDINGS**

 

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

 

**ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS**

 

At the Company’s AnnualMeeting of Stockholders held on May 18, 2004, the stockholders elected thefollowing nominees to the Board of Directors to serve a three-year term. Thevotes cast were as follows:

 

Jeffrey H. Coors

 
| For:      |   | 170,507,672 |   |
|-----------|--------|-------------|--------|
| Withheld: |   | 2,047,629   |   |

 

Kevin J. Conway

 
| For:      |   | 170,951,594 |   |
|-----------|--------|-------------|--------|
| Withheld: |   | 1,603,707   |   |

 

Robert W. Tieken 

 
| For:      |   | 172,267,017 |   |
|-----------|--------|-------------|--------|
| Withheld: |   | 288,284     |   |

 

The terms of Stephen M.Humphrey, John D. Beckett, John R. Miller, G. Andrea Botta, Harold R. Logan,Jr. and Martin D. Walker continue after the Annual Meeting of Stockholders.

 

The stockholders approvedthe Graphic Packaging Corporation 2004 Stock and Incentive Compensation Plan.Votes cast were as follows:

 
| For:             |   | 163,152,483 |   |
|------------------|--------|-------------|--------|
| Against:         |   | 2,138,721   |   |
| Abstain:         |   | 2,497,626   |   |
| Broker Non-Votes |   | 4,516,471   |   |

 

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**ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K**

 

a)  Exhibit Index

 
| **Exhibit Number** | ** ** | **Description**                                                                              |
|--------------------|------------|----------------------------------------------------------------------------------------------|
|               |       |                                                                                         |
| 31.1               |       | Certification required  by Rule 13a-14(a).                                                   |
|               |       |                                                                                         |
| 31.2               |       | Certification required  by Rule 13a-14(a).                                                   |
|               |       |                                                                                         |
| 32.1               |       | Certification required  by Section 1350 of Chapter 63 of Title 18 of the United States Code. |
|               |       |                                                                                         |
| 32.2               |       | Certification required  by Section 1350 of Chapter 63 of Title 18 of the United States Code. |

 

b. Reports on Form 8-K.

 
|   |   | Reports on Form 8-K  filed with the SEC:                                 |
|--------|--------|--------------------------------------------------------------------------|
|   |   |                                                                     |
|   |   | None.                                                                    |
|   |   |                                                                     |
|   |   | Reports on Form 8-K furnished to the SEC on:                             |
|   |   |                                                                     |
|   |   | May 6, 2004 reporting  the Registrant’s first quarter 2004 results. |

 

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**SIGNATURES**

 

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, theRegistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
| GRAPHIC PACKAGING  CORPORATION |                                                                   |           |
|--------------------------------|------------------------------------------------------------------------|----------------|
| (Registrant)                   |                                                                   |           |
|                           |                                                                   |           |
| /s/  STEPHEN A. HELLRUNG       | Senior Vice President,  General                                        |           |
| Stephen A. Hellrung            | Counsel and Secretary                                                  | August 5, 2004 |
|                           |                                                                   |           |
| /s/  JOHN T. BALDWIN           | Senior Vice President  and                                             |           |
| John T. Baldwin                | Chief Financial Officer  (Principal  Financial and Accounting Officer) | August 5, 2004 |

 

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