Exhibit 99.4

 

Report of Independent Auditors

 

The Board of Directors

Bluegrass Container Holdings, LLC

 

We have audited the accompanying balance sheets of Bluegrass Container Holdings, LLC (the Company) as of December 31, 2006 and 2005, and the related statements of operations, statements of changes in equity, and cash flows for the period from July 1, 2006 to December 31, 2006 (Successor), the period from January 1, 2006 to June 30, 2006, and for each of the two years in the period ended December 31, 2005 (Predecessor). These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2006 and 2005, and the results of its operations and its cash flows for the period from July 1, 2006 to December 31, 2006 (Successor), the period from January 1, 2006 to June 30, 2006, and for each of the two years in the period ended December 31, 2005 (Predecessor), in conformity with accounting principles generally accepted in the United States.

 

As discussed in Note 3 to the financial statements, on December 31, 2006, the Company changed its method of accounting for defined benefit pension and other postretirement benefit plans to conform with Statement of Financial Accounting Standards (SFAS) No. 158, Employers’ Accounting for Defined-Benefit Pension and Other Postretirement Plans — An Amendment of FASB Statements No. 87, 88, 106, and 132 (R). As discussed in Note 3 to the financial statements, the Company also changed its method of accounting for maintenance costs to conform with Financial Accounting Standards Board Staff Position AUG AIR-1, Accounting for Planned Major Maintenance Activities.

 

/s/  Ernst & Young LLP

 

Chicago, Illinois

April 3, 2007

BLUEGRASS CONTAINER HOLDINGS, LLC

 

BALANCE SHEETS

 

 

The accompanying notes are an integral part of the financial statements

BLUEGRASS CONTAINER HOLDINGS, LLC

 

STATEMENTS OF OPERATIONS

 

 

The accompanying notes are an integral part of the financial statements

BLUEGRASS CONTAINER HOLDINGS, LLC

 

STATEMENTS OF CASH FLOWS

 

 

The accompanying notes are an integral part of the financial statements

BLUEGRASS CONTAINER HOLDINGS, LLC

 

STATEMENTS OF CHANGES IN EQUITY

 

 

The accompanying notes are an integral part of the financial statements

BLUEGRASS CONTAINER HOLDINGS, LLC

 

Notes to Financial Statements

 

 

Organization:  Altivity Packaging, LLC (formerly known as Bluegrass Container Company, LLC) (“Altivity,” or “Successor”), a Delaware limited liability company and a wholly-owned subsidiary of Bluegrass Container Holdings, LLC (“BCH”), purchased substantially all of the assets of the Consumer Packaging Division (“CPD” or the “Predecessor”) of Smurfit-Stone Container Enterprises, Inc. (“SSCE”), a wholly-owned subsidiary of Smurfit-Stone Container Corporation (“SSCC”) (the “CPD acquisition”). BCH is majority-owned by investment vehicles affiliated with TPG Capital, L.P. (“TPG”). Altivity completed the CPD acquisition on June 30, 2006. In October 2006, the acquisition price was reduced $5.0 million as a result of the finalization of the working capital adjustments. The net assets acquired totaled $946.2 million which, net of the working capital adjustment of $5.0 million and other transaction costs of $40.2 million, resulted in a net payment to SSCE of $911.0 million.

 

On August 16, 2006, Altivity completed the acquisition of substantially all of the operational assets of Field Holdings, Inc., a Delaware corporation, Field Container Company, L.P., a Delaware limited partnership, and Field Container Management Corporation, a Delaware corporation (the “Field Companies”). In September 2006, the acquisition price was increased as a result of the finalization of the working capital adjustments. The net assets acquired totaled $335.3 million (net of $5.0 million in retained liabilities), which included a net working capital adjustment of $2.1 million, other transaction costs of $13.2 million, and the repayment of the Field Companies’ indebtedness of $92.9 million.

 

BCH conducts no significant business and has no independent assets or operations other than its ownership of Altivity.

 

The purchase price for both the CPD acquisition and the Field acquisition exceeded the fair value of the underlying assets acquired and liabilities assumed due to the expectation by BCH of enhancing the profits of the combined entities through the realization of synergistic efficiencies, optimization of the combined assets, enhanced productivity and numerous cost reduction efforts.

 

Description of Business:  Altivity is a major manufacturer of consumer packaging products and one of the largest privately held packaging companies in the United States. Altivity is a leading producer of paperboard and manufactures folding cartons; multi-wall and consumer bag packaging; plastic packaging; label solutions; inks/coatings; contract packaging; and laminations for a variety of consumer and industrial companies.

 

 

All intercompany balances and transactions have been eliminated in consolidation.

 

Predecessor:  Prior to the CPD acquisition, the Predecessor was an operating unit of SSCE and not a separate legal entity. As such, the accompanying financial statements of the Predecessor consist solely of the combined accounts of the Consumer Packaging Division of SSCE. The accompanying statements reflect SSCE’s net investment in the Predecessor and include intercompany loans due from SSCE. Significant intercompany accounts and transactions between operations within CPD have been eliminated. The financial statements include allocation of common costs and general management services from SSCE as discussed in Note 15.

 

Successor:  The accompanying consolidated financial statements of the Successor as of December 31, 2006 and for the six months then ended include the accounts of the Predecessor and, subsequent to the Field acquisition, the Field Companies.

 

BLUEGRASS CONTAINER HOLDINGS, LLC

 

Notes to Financial Statements — (Continued)

 

BCH has allocated the purchase price of the CPD acquisition on the basis of the fair value of the underlying assets acquired and liabilities assumed as follows:

 

 

BLUEGRASS CONTAINER HOLDINGS, LLC

 

Notes to Financial Statements — (Continued)

 

BCH has allocated the purchase price of the Field acquisition on the basis of the fair value of the underlying assets acquired and liabilities assumed as follows:

 

 

Management represents that book values approximate fair value for cash and cash equivalents, trade accounts receivable, prepaid expenses and other current assets, accounts payable, accrued liabilities and other current liabilities, given the short-term nature of these assets and liabilities. Other non-current assets, long-term debt and other non-current liabilities outstanding as of the effective date of the acquisitions have been allocated based on management’s judgments and estimates.

 

Deferred income taxes have been provided in the consolidated balance sheet based on the tax versus book basis of the assets acquired and liabilities assumed, as adjusted to estimated fair values. Valuation allowances were established for deferred tax assets related to all of the net operating loss carry-forwards for which utilization is uncertain.

 

BCH’s projected pension and other postretirement benefit obligations and assets have been reflected in the allocation of purchase price at the projected benefit obligation less plan assets at fair value.

 

BCH expects to recognize additional restructuring reserves in 2007 which will be charged to goodwill.

 

BCH determined and reflected in the allocation of the purchase price the fair values of inventories, property, plant and equipment and intangible assets acquired, including patents, trademarks, customer relationships, leases and supply contracts.

 

The allocation of the purchase price is based on preliminary estimates and assumptions and is subject to revision when valuation and integration plans are finalized. Accordingly, revisions of the allocation of purchase

 

BLUEGRASS CONTAINER HOLDINGS, LLC

 

Notes to Financial Statements — (Continued)

 

price, which may be significant, will be reported in a future period as an increase or decrease to the amounts previously reported.

 

 

Use of Estimates:  The preparation of financial statements in conformity with accounting principles generally accepted in the United States (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Revenue Recognition:  Revenue from sales is recognized at the time: (1) ownership and all risks of loss have been transferred to the buyer, which is generally upon shipment, (2) the price is fixed and determinable and (3) collectability is reasonably assured.

 

Shipping and Handling:  Shipping and handling costs, including delivery cost to the customer, is included in cost of sales. Freight billed to customers is included in net revenues.

 

Major Maintenance Activities:  Altivity employs the direct expense method for all maintenance activities.

 

Cash Equivalents:  BCH considers cash and all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. The carrying value of cash and cash equivalents approximates fair value because of the short maturities of these instruments.

 

Accounts Receivable:  Credit is extended to customers based on an evaluation of their financial condition. BCH evaluates the collectability of accounts receivable on a case-by-case basis and makes adjustments to the bad debt reserve for expected losses, considering such things as ability to pay, bankruptcy, credit ratings and payment history. BCH also estimates reserves for bad debts based on historical experience and past due status of the accounts. Receivables are stated net of an allowance for doubtful accounts. Aging for delinquency purposes is based on the due date terms extended to the customer. Accounts receivable are charged to the allowance when BCH determines that the receivable will not be collected after all collection efforts have been exhausted.

 

Inventories:  The Successor’s inventories are valued at the lower of cost or market. Inventories of the Predecessor were valued at the lower of cost or market under the last in, first out (“LIFO”) method, except for $29.2 million, which was valued at the lower of average cost or market at December 31, 2005.

 

The Predecessor’s LIFO and profit-in-inventory reserves have been allocated to its reporting units, which are its business segments, based on the reporting unit’s proportionate share of the total SSCE inventory value. The profit-in-inventory reserve represents the elimination of intercompany profit on sales between the coated recycled box board mills and the folding carton converting facilities. Historically, SSCE’s inventory reserves have not been allocated as described to the various reporting units. The impact of the allocation on the Predecessor’s statements of operations was an expense of $5.3 million, $5.1 million and $1.7 million for the six months ended June 30, 2006 and the years ended December 31, 2005 and 2004, respectively.

 

Net Property, Plant and Equipment:  Property, plant and equipment are carried at cost. The costs of additions, improvements and major replacements are capitalized, while maintenance and repairs are charged to expense as incurred. Provisions for depreciation and amortization, which are combined in the consolidated

 

BLUEGRASS CONTAINER HOLDINGS, LLC

 

Notes to Financial Statements — (Continued)

 

statement of operations, are made using straight-line rates over the estimated useful lives of the related assets which range in years as follows:

 

 

Leasehold improvements are capitalized and amortized over their estimated useful lives or the terms of the applicable leases, if shorter.

 

Goodwill:  Goodwill represents the excess of purchase price and related costs over the value assigned to the tangible and identifiable intangible assets of businesses acquired. Goodwill is not amortized, but is tested for impairment annually, or more frequently if circumstances indicated a possible impairment may exist. No circumstances have occurred to indicate the possibility of impairment and management believes that goodwill is not impaired.

 

BCH evaluates the recoverability of goodwill by comparing the fair value for the reporting unit to its book value including goodwill. In the case that the fair value is less than the book value, the implied fair value for the goodwill is determined based on the difference between the fair value of the reporting entity and the net fair value of the identifiable assets and liabilities. If the implied fair value of the goodwill is less than the book value, the difference is recognized as an impairment loss.

 

Other Intangible Assets:  Other intangible assets represent the fair value of other intangible assets acquired in purchase business combinations. Other intangible assets are amortized over their expected useful life.

 

Deferred Debt Issuance Costs:  Deferred debt issuance costs were incurred to obtain long-term financing and are amortized using the effective interest method over the term of the related debt. The amortization of deferred debt issuance costs is classified in interest expense in the statement of operations.

 

Income Taxes:  BCH accounts for income taxes in accordance with the liability method of accounting for income taxes. Under the liability method, deferred assets and liabilities are recognized based upon anticipated future tax consequences attributable to differences between financial statement carrying amounts of assets and liabilities and their respective tax bases. The Predecessor’s operating results were included in SSCE’s taxable income in its consolidated federal and state income tax returns. The Predecessor’s income tax provisions are computed on a separate return basis and any liability was settled through intercompany accounts included in SSCE’s net investment.

 

Foreign Currency Translation:  BCH’s Mexican operations’ functional currency is the local currency. Assets and liabilities of this operation are translated at the exchange rate in effect at the balance sheet date, and income and expenses are translated at average exchange rates prevailing during the period. Translation gains or losses are included within equity as part of accumulated other comprehensive income (loss) (“OCI”).

 

BCH’s Canadian operations’ functional currency is the U.S. dollar. Assets and liabilities of this operation are translated at the exchange rate in effect at the balance sheet date, and income and expenses are translated at average exchange rates prevailing during the period. Transaction gains or losses are included within the statements of operations.

 

Derivatives and Hedging Activities:  All derivative financial instruments are recorded at fair value as either assets or liabilities. For derivative instruments that are designated and qualify as a cash flow hedge of a variable rate instrument, the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income (loss) and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. The remaining gain or loss on the derivative instrument

 

BLUEGRASS CONTAINER HOLDINGS, LLC

 

Notes to Financial Statements — (Continued)

 

in excess of the cumulative change in the present value of the future cash flows of the hedged item, if any, is recognized in current earnings during the period of change. For derivative instruments not designated at inception as a hedging instrument, the gain or loss is recognized in current earnings during the period of change.

 

Environmental Matters:  BCH expenses environmental expenditures related to existing conditions resulting from past or current operations from which no current or future benefit is discernible. Expenditures that extend the life of the related property or mitigate or prevent future environmental contamination are capitalized. BCH records a liability at the time when it is probable and can be reasonably estimated.

 

Restructuring:  Costs associated with plans to exit an activity of an acquired company are recognized as liabilities assumed in the acquisition and included in the allocation of acquisition cost. Costs associated with exit or disposal activities not in connection with a plan to exit an activity of an acquired company are generally recognized when they are incurred rather than at the date of a commitment to an exit or disposal plan.

 

Recently Issued Accounting Pronouncements:  In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (“SFAS No. 158”). SFAS No. 158 requires an employer to recognize the over-funded or under-funded status of a defined benefit postretirement plan (other than a multi-employer plan) as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. SFAS No. 158 also requires an employer to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions. BCH adopted the provisions of SFAS No. 158 at December 31, 2006, which necessitated an increase to accrued pension liabilities and a charge to accumulated comprehensive income of $4.9 million.

 

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principle and expands disclosure about fair value measurements. The statement is effective for fiscal years beginning after November 15, 2007. BCH will adopt this statement on January 1, 2008 and has not yet evaluated the impact that its adoption may have on BCH’s financial statements.

 

The FASB issued, in March 2007, SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” which allows companies the option to recognize most financial assets and liabilities and certain other items at fair value. The statement is effective for fiscal years beginning after November 15, 2007. The impact that its adoption may have on BCH’s financial statements has not yet been evaluated.

 

Effective January 1, 2007, BCH adopted the provisions of FIN 48, which clarifies the accounting for uncertainty in income taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation prescribes the minimum recognition threshold that a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods and disclosure. The impact of the reassessment of tax positions in accordance with FIN 48 did not have a material impact on our results of operations, financial condition or liquidity.

 

In September 2006, the FASB issued FASB Staff Position AUG AIR-1 “Accounting for Planned Major Maintenance Activities” (“FSP AUG AIR-1”), which is effective for fiscal years beginning after December 15, 2006. This position statement eliminates the accrue-in-advance method of accounting for planned major maintenance activities. The Company adopted FSP AUG AIR-1 on January 1, 2007 and changed to direct expensing method allowed by FSP AUG AIR-1, and has retrospectively adjusted its year-end 2006 financial statements to be in compliance. The effects of adoption on the 2006 periods were not significant.

 

BLUEGRASS CONTAINER HOLDINGS, LLC

 

Notes to Financial Statements — (Continued)

 

 

BCH has recorded various restructuring charges related to the rationalization of its boxboard mills and converting operations, including the termination of employees and liabilities for lease commitments at the closed facilities.

 

In conjunction with the CPD acquisition and the Field acquisition, BCH formulated plans to exit or restructure certain activities. Restructuring reserves, initially totaling $8.5 million, were established for employee severance and benefit payments and the cost of three plant closures, two of which were announced and completed in 2006. BCH expects to announce three to five additional plant closures in the first six months of 2007, the cost of which will be charged to goodwill. The severance payments and the activities associated with the plant closures are expected to be substantially completed by December 31, 2007. The table below summarizes the transactions within the restructuring reserve during the period January 1, 2003 through December 31, 2006.

 

During 2005, Predecessor recorded restructuring charges of $5.0 million, including non-cash charges of $2.5 million related to the write-down of assets, primarily property, plant and equipment, as a result of the decline in estimated net realizable values. The remaining charges were primarily for severance, benefits and lease commitments. The restructuring charges incurred during 2005 related to facilities closed in the prior year.

 

During 2004, Predecessor recorded restructuring charges of $1.9 million related to the closure of a carton facility and additional costs incurred for prior year closures. These charges are net of a $1.1 million gain from the sale of a multi-wall bag facility closed in the prior year. This shutdown resulted in approximately 75 employees being terminated. The net sales and operating loss of this shutdown operation in 2004 prior to closure were $21.6 million and $2.4 million, respectively. The net sales and operating profits of this facility in 2003 were $39.5 million and $2.6 million, respectively. A significant portion of the business at the closed facility was transferred to other BCH facilities.

 

During 2003, Predecessor permanently closed one of two paper machines at its Philadelphia, Pennsylvania, coated recycled boxboard mill and closed two carton operations and one multi-wall bag operation. As a result BCH recorded restructuring charges of $10.8 million, including non-cash charges of $6.9 million related to the write-down of assets, primarily property, plant and equipment, to estimated net realizable values. The remaining charges were primarily for severance, benefits and lease commitments. These shutdowns resulted in approximately 400 people being terminated. The sales and operating losses of these shutdown operations in 2003 prior to closure were $65.2 million and $8.8 million, respectively.

 

 

BLUEGRASS CONTAINER HOLDINGS, LLC

 

Notes to Financial Statements — (Continued)

 

 

 

Inventories consist of the following:

 

 

Inventories at December 31, 2005 were valued under the last-in, first-out method, except for $29.2 million, which was valued at the lower of average cost or market. First-in, first-out costs (which approximate replacement costs) exceeded the last-in, first out value by $36.6 million at December 31, 2005. Inventories of the Successor at December 31, 2006 were valued at the lower of cost or market under the first-in, first-out method.

 

 

Net property, plant and equipment at December 31 consist of:

 

 

BLUEGRASS CONTAINER HOLDINGS, LLC

 

Notes to Financial Statements — (Continued)

 

The Successor’s property, plant and equipment includes capitalized leases of $3.6 million and related accumulated amortization of $0.4 million at December 31, 2006. The Predecessor’s property, plant and equipment includes capitalized leases of $4.8 million and related accumulated amortization of $2.9 million at December 31, 2005.

 

 

Goodwill of the Successor represents the excess of cost over the fair value of net assets acquired in connection with both the CPD acquisition and the Field acquisition. At June 30, 2006, goodwill of $245.0 million was acquired in connection with the CPD acquisition. Goodwill acquired in connection with the Field acquisition totaled $113.9 million, resulting in a consolidated goodwill balance of $358.9 million at December 31, 2006.

 

Goodwill of the Predecessor represented the excess of cost over the fair value of net assets acquired in connection with various acquisitions made by SSCE. The Predecessor goodwill balance of $279.0 million at December 31, 2005 was eliminated at June 30, 2006 in conjunction with the accounting for the CPD acquisition.

 

 

Intangible assets are amortized over their estimated useful lives, ranging from three to fourteen years. The customer relationship intangible of the Predecessor was $2.8 million at December 31, 2005 which, net of accumulated amortization of $0.9 million, totaled $1.9 million.

 

As a result of the CPD acquisition and the Field acquisition, other intangible assets were restated at their fair value, as of the respective acquisition dates. The Successor’s other intangible assets include the following at December 31, 2006:

 

 

The Successor’s amortization expense totaled $4.8 million for the period July 1, 2006 through December 31, 2006. The Predecessor’s gross carrying value of definite life intangible assets, primarily customer relationships is $2.8 million with accumulated amortization of $0.9 million at December 31, 2005. The weighted-average amortization period is eight years. The Predecessor’s amortization expense totaled $0.2 million, $0.4 million and $0.4 million for the period January 1, 2006 through June 30, 2006 and the years ended December 31, 2005 and 2004, respectively. The estimated amortization expense for the years ending December 31, 2007 through December 31, 2011 is $10.5 million, $10.5 million, $11.5 million, $12.5 million and $10.5 million, respectively.

 

BLUEGRASS CONTAINER HOLDINGS, LLC

 

Notes to Financial Statements — (Continued)

 

 

Long-term debt consists of the following:

 

 

The amount of total debt outstanding at December 31, 2006 maturing over the next five years is as follows:

 

 

Bank Credit Facilities

 

In connection with the CPD acquisition, Altivity and its subsidiaries, Bluegrass Mills Holdings Company, LLC and Altivity Packaging Canada Corp. entered into First-Lien and Second-Lien Credit Agreements on June 30, 2006 (collectively, the “Credit Agreements”). The First-Lien Credit Agreement provides for First-Lien Term Loans and revolving credit facilities. The Second-Lien Credit Agreement provides for Second-Lien Term Loans. The First-Lien Term Loans are payable in quarterly installments of $2.1 million beginning September 30, 2006 and mature June 28, 2013. The Second-Lien Term Loans mature December 31, 2013.

 

The U.S. revolving credit facility allows for maximum borrowings of $150.0 million and includes sub-limits on the issuance of letters of credit and swing line loans. A commitment fee of 0.5% is payable on the unused portion of the facilities. At December 31, 2006, the unused portion, after giving consideration to outstanding letters of credit, was $139.0 million. The Canadian revolving credit facility allows for maximum borrowings of $10.0 million, which was the outstanding balance as of December 31, 2006. The revolving credit facilities mature June 28, 2013.

 

Initial borrowings of First-Lien and Second-Lien Term Loans and the revolving credit facilities made in connection with the CPD acquisition were $635.0 million, $250.0 million and $10.0 million, respectively. Borrowings of First-Lien and Second-Lien Term Loans made in connection with the Field acquisition were $190.0 million and $80.0 million, respectively.

 

BLUEGRASS CONTAINER HOLDINGS, LLC

 

Notes to Financial Statements — (Continued)

 

Borrowings bear interest at rates based on the prime rate or LIBOR plus or minus a floating margin based on BCH’s financial performance. The weighted average variable rates of the borrowings under the First-Lien Term Loans, Second-Lien Term Loans and the revolving credit facility as of December 31, 2006 were 7.4%, 10.3% and 7.6%, respectively.

 

The obligations of Altivity under the Credit Agreements are unconditionally guaranteed by Altivity, its U.S. subsidiaries and BCH. The obligations are secured by substantially all assets of Altivity and its U.S. subsidiaries, a pledge of the capital stock of Altivity and its U.S. subsidiaries and a pledge of 65% of the capital stock of Altivity Packaging Canada Corp. that is directly owned by Altivity.

 

The Credit Agreements contain various covenants and restrictions including the maintenance of certain financial covenants and limitations on: (i) the incurrence of indebtedness, liens, leases and sale-leaseback transactions; (ii) fundamental changes in corporate structure; (iii) dividends, redemptions and repurchases of capital stock; (iv) the sale of assets; (v) investments; (vi) debt repayments and (vii) capital expenditures. The Credit Agreements also require prepayments if Altivity exceeds certain cash flow targets, receives proceeds from certain asset sales, receives certain insurance proceeds or incurs certain indebtedness. At December 31, 2006, Altivity was in compliance with the financial covenants required by the Credit Agreements.

 

Altivity has entered into interest rate swap contracts effectively fixing the interest rate at 5.1% for $570.0 million of the First-Lien Term Loans (see Note 10).

 

Capitalized interest costs totaled $0.5 million, $0.6 million, $0.7 million and $0.7 million for the six months ended December 31, 2006, the six months ended June 30, 2006 and the years ended December 31, 2005 and December 31, 2004, respectively.

 

Interest payments made by the Successor totaled $42.6 million during the six months ended December 31, 2006. Interest payments made by SSCE on behalf of the Predecessor totaled $0.5 million, $1.0 million and $1.0 million during the six months ended June 30, 2006 and the years ended December 31, 2006 and 2005, respectively.

 

 

BCH’s derivative instruments and hedging activities are designated as cash flow hedges and are utilized to minimize exposure to fluctuations in the price of commodities used in its operations and the fluctuation in the interest rate on its variable rate debt.

 

Commodity Derivative Instruments:  Altivity uses derivative instruments to manage fluctuations in cash flows resulting from commodity price risk in the procurement of natural gas. The objective is to fix the price of a portion of Altivity’s purchases of natural gas used in the manufacturing process. These instruments have been designated cash-flow hedges under SFAS No. 133, and as such, as long as the hedge is effective and the underlying transaction is probable, the effective portion of the changes in fair value of these contracts is recorded in OCI until earnings are affected by the cash flows being hedged. The fair value of the commodity derivative agreements is the estimated amount that Altivity would pay or receive to terminate the agreements. As of December 31, 2006, the maximum length of time over which Altivity is hedging its exposure to the variability in future cash flows associated with natural gas transactions is through June 30, 2007.

 

The fair value of Altivity’s commodity derivative instruments at December 31, 2006 was $1.2 million and is included in current accrued liabilities.

 

Interest Rate Derivative Instruments:  Altivity is subject to interest rate risk on its long-term variable rate debt. To manage a portion of this exposure to interest rate fluctuations on outstanding debt, Altivity has entered into interest rate swap agreements. These instruments have been designated as cash-flow hedges under SFAS No. 133, and as such, as long as the hedge is effective and the underlying transaction is probable, the effective portion of the changes in fair value of these contracts is recorded in OCI until earnings are affected

 

BLUEGRASS CONTAINER HOLDINGS, LLC

 

Notes to Financial Statements — (Continued)

 

by the cash flows being hedged. The fair value of the interest rate derivative agreements is the estimated amount that Altivity would pay or receive to terminate the agreements.

 

During the third quarter of 2006, Altivity entered into an interest rate swap agreement at a fixed rate of 5.1% and maturing on December 31, 2009 in order to hedge interest risk on its long-term variable debt. The fair value of Altivity’s interest rate derivative instrument at December 31, 2006 was $0.9 million and is included in other long-term liabilities.

 

 

Altivity leases certain facilities and equipment for production, selling and administrative purposes under operating leases expiring at various dates. Certain leases contain renewal options for varying periods, and others include options to purchase the leased property during or at the end of the lease term. Future minimum rental commitments (exclusive of real estate taxes and other expenses) under operating leases having initial or remaining non-cancelable terms in excess of one year, excluding lease commitments on closed facilities, are reflected below:

 

 

The Successor incurred net rental expense for operating leases, including leases having durations of less than one year, of $16.2 million for the period July 1, 2006 through December 31, 2006. The Predecessor incurred net rental expense for operating leases, including leases having durations of less than one year, of $16.0 million for the period from January 1, 2006 through June 30, 2006, $29.5 million and $29.7 million for the years ended December 31, 2005 and 2004, respectively.

 

BLUEGRASS CONTAINER HOLDINGS, LLC

 

Notes to Financial Statements — (Continued)

 

 

Significant components of BCH’s deferred tax assets and liabilities at December 31 are as follows:

 

 

The Successor is taxed as a partnership for federal income tax purposes. Its two foreign wholly-owned subsidiaries are taxable corporations in the countries in which they operate. Federal income tax laws provide that partnership income is includable in the taxable income of its partners. Accordingly, no provision for U.S. federal income taxes of the Successor has been included in the financial statements for the period July 1, 2006 through December 31, 2006.

 

BCH has municipality-apportioned net operating loss carryforwards of $4.8 million which may be offset against future taxable income in certain municipalities in which BCH operates, which expire in 2011. Further, BCH has a net operating loss carryforward for Canadian tax purposes of approximately $2.2 million. A valuation allowance of $1.1 million has been established against the Canadian net operating loss carryforward and the other net Canadian deferred tax assets based upon management’s determination that the criteria has not been met which would allow recognition of this tax benefit.

 

BLUEGRASS CONTAINER HOLDINGS, LLC

 

Notes to Financial Statements — (Continued)

 

The components of BCH’s income tax expense for the periods are as follows:

 

 

The Successor made income tax payments of $0.4 million during the period July 1, 2006 through December 31, 2006. During the period January 1, 2006 through June 30, 2006 and the years ended December 31, 2005 and 2004, the Predecessor made income tax payments of $17.1 million, $32.1 million and $20.1 million, respectively, which are included in intercompany settlements in the SSCE investment.

 

The Successor is taxed as a partnership for federal income tax purposes and therefore its effective income tax rate is based on state, local and other taxes. The effective income tax rate of 40% for 2005 and 39.7% for 2004 for the Predecessor includes the U.S. federal statutory rate of 35% in addition to state, local and other taxes of 5.0% and 4.7%, respectively.

 

 

Defined Benefit Plans

 

BCH sponsors noncontributory defined benefit pension plans covering substantially all U.S. employees. BCH also sponsors noncontributory and contributory defined benefit pension plans for its Canadian operations. Certain salaried and hourly employees also participate in health care and postretirement defined benefit plans.

 

Substantially all employees of the Predecessor participated in noncontributory defined benefit pension plans offered by SSCE. Salaried and certain hourly employees also participated in certain health care and postretirement benefits offered by SSCE. The expense allocated by SSCE to the Predecessor for these pension and postretirement medical plans was $12.3 million, $21.6 million and $22.3 million for the six months ended June 30, 2006 and the years ended December 31, 2005 and 2004, respectively. The net benefit obligation, plan assets and funded status for the Predecessor under these plans have not been separately determined by SSCE, and therefore, the accompanying December 31, 2005 balance sheet does not include an account balance related to these plans.

 

Salaried and hourly employees of the Predecessor also participated in voluntary savings plans offered by SSCE. BCH match for salaried employees of the Predecessor was paid in SSCC common stock, up to an annual maximum.

 

BLUEGRASS CONTAINER HOLDINGS, LLC

 

Notes to Financial Statements — (Continued)

 

The Successor’s pension plans’ weighted-average asset allocations at December 31, 2006 by asset category are as follows:

 

 

The primary objective of BCH’s investment policy is to provide eligible employees with scheduled pension benefits. The basic strategy of this investment policy is to earn the highest risk adjusted rate of return on assets consistent with prudent investor standards identified in the Employee Retirement Income Security Act of 1974 for the U.S. plans and the Quebec Supplemental Pension Plans Act and other applicable legislation in Canada for the Canadian plans. In identifying the target asset allocation that would best meet the above policy, consideration is given to a number of factors including the various pension plans’ demographic characteristics, the long-term nature of the liabilities, the sensitivity of the liabilities to interest rates and inflation, the long-term return expectations and risks associated with key asset classes as well as their return correlation with each other, diversification among asset classes and other practical considerations for investing in certain asset classes. The target asset allocation for the pension plans during a complete market cycle is as follows:

 

 

BLUEGRASS CONTAINER HOLDINGS, LLC

 

Notes to Financial Statements — (Continued)

 

The following provides a reconciliation of the aggregate benefit obligations, plan assets and funded status of the Successor’s defined benefit pension and post-retirement plans as of December 31, 2006:

 

 

The Successor’s increase in the minimum pension liability, included in other comprehensive (income) loss, was $4.9 million for the period July 1, 2006 through December 31, 2006. The Successor’s accumulated benefit obligation for all defined benefit pension plans was $41.8 million at December 31, 2006.

 

The components of net periodic benefit cost for the defined benefit and postretirement benefit plans for the period July 1, 2006 through December 31, 2006 are as follows:

 

 

BLUEGRASS CONTAINER HOLDINGS, LLC

 

Notes to Financial Statements — (Continued)

 

The weighted average assumptions used to determine the benefit obligations are as follows:

 

 

The weighted average assumptions used to determine net periodic benefit cost are as follows:

 

 

The Successor’s health care cost trend rate assumption is 12% and 9.5% for its foreign and domestic plans, respectively, grading down by 1% annually to an ultimate rate of 5%.

 

The fundamental assumptions which support the expected rate of return on plan assets are the cumulative effect of several estimates, including the anticipated yield on debt securities, the long term return on equity securities and active investment management.

 

BCH expects to make contributions as necessary to meet minimum funding requirements to its various benefit plans in 2007 totaling $4.4 million.

 

Expected Future Benefit Plan Payments

 

Expected future benefit plan payments to participants, which reflect expected future service, are as follows:

 

 

Savings Plans:  BCH sponsors voluntary savings plans (primarily 401k plans) covering substantially all salaried and certain hourly employees. The Successor’s expense for the savings plans totaled $2.0 million for the period of July 1, 2006 through December 31, 2006. The Predecessor’s expense for the savings plans

 

BLUEGRASS CONTAINER HOLDINGS, LLC

 

Notes to Financial Statements — (Continued)

 

totaled $2.7 million, $4.4 million and $4.3 million for the six months ended June 30, 2006 and the years ended December 31, 2005 and 2004, respectively.

 

Supplemental defined contribution plan:  In connection with the CPD acquisition, BCH intends to establish a supplemental defined contribution plan for the salaried employees of CPD, to replace benefits previously provided by a similar plan provided by SSCE. Although the documents to establish the plan have not been finalized, BCH has accrued $3.0 million as of December 31, 2006 as the estimated cost of the plan benefits.

 

Multi-employer benefit plans:  The Predecessor’s contributions to multi-employer benefit plans totaled $0.9 million, $1.8 million and $1.7 million for the six months ended June 30, 2006 and the years ended December 31, 2005 and 2004, respectively. The Successor’s contributions to such plans totaled $0.8 million for the six months ended December 31, 2006.

 

 

The components of accumulated other comprehensive (loss) is as follows:

 

 

 

Coincident with the CPD acquisition, the Successor entered into a Transitional Services Agreement (TSA) with SSCE in which SSCE agreed to provide certain administrative services through March 31, 2007. Altivity may terminate any of the services at any time upon thirty days notice or elect to extend the agreement on a monthly basis for up to nine additional months. The TSA expense incurred during 2006 totaled $6.4 million.

 

BCH paid TPG one-time transaction fees in connection with the CPD and Field acquisitions of $12.0 million and $3.0 million, respectively. BCH has also contracted with TPG to provide management and consulting services for $3.0 million per year, payable quarterly. Fees for services provided in 2006 totaled $1.5 million.

 

The Successor purchases packaging material from a vendor which is owned by a family member of a member of Altivity’s Board of Directors. Purchases in 2006 totaled $0.8 million. The balance due the vendor at December 31, 2006 was $0.3 million. The Successor also leases certain facilities from two entities owned by a member of Altivity’s Board of Directors. Lease expense in 2006 totaled $0.5 million.

 

BLUEGRASS CONTAINER HOLDINGS, LLC

 

Notes to Financial Statements — (Continued)

 

Predecessor transactions with SSCE and Affiliates:  Transactions with SSCE and affiliates for the six months ended June 30, 2006 and the year ended December 31, 2005 and 2004 were as follows:

 

 

Product sales to SSCE relate primarily to the sales of colored films and specialty laminations to SSCE corrugated facilities. Purchases from SSCE relate primarily to kraft paper, bleached linerboard, corrugated boxes and recycled fiber. The Predecessor purchased product from other divisions or segments within SSCE at agreed-upon transfer prices. Management believes the transfer prices approximate market value; however, the Predecessor did not routinely bid these purchases to external parties to obtain the lowest possible price due to the integrated nature of SSCE’s operations.

 

SSCE allocated certain common costs for insurance and other employee benefit costs to the Predecessor based on direct salaries and headcount. These benefits primarily included participation in a noncontributory defined benefit pension plan and health care and life insurance benefit plans sponsored by SSCE. Since the employees of the Predecessor represented only a portion of the SSCE benefit plan participants, the net benefit obligation, plan assets and funded status of these plans are the obligation of SSCE and as such are not reflected in these financial statements.

 

SSCE also allocated the realized gains or losses from SSCE’s natural gas hedging program. SSCE used derivative instruments, including fixed price swaps and options, to manage fluctuations in cash flows resulting from commodity price risk in the procurement of natural gas. The objective was to fix the price of a portion of the Predecessor’s purchases of natural gas used in the manufacturing process. The changes in the market value of such derivative instruments had historically been highly effective at offsetting changes in price of the hedged item. Changes in the fair value of derivatives which qualify as hedges were deferred until the hedged item was recognized in earnings. The Predecessor was allocated $0.4 million in realized losses for the six months ended June 30, 2006 and $3.9 million and $0.5 million in realized gains for the years ended December 31, 2005 and 2004, respectively, for derivative contracts related to hedged items recognized in earnings during the respective periods, based on the Predecessor’s proportionate share of natural gas consumption.

 

Stock compensation expense related to stock options and restricted stock units granted to certain officers and key managers of the Predecessor under the various stock-based compensation plans sponsored by SSCC were allocated to the Predecessor directly based on those employees.

 

BLUEGRASS CONTAINER HOLDINGS, LLC

 

Notes to Financial Statements — (Continued)

 

SSCE provided general management services to the Predecessor through corporate departments, which included information systems, treasury, accounting, human resources, tax, risk management, certain legal services, internal audit and other indirect administrative functions. The cost of matching contributions for a voluntary savings plan offered by SSCE, which is paid in SSCC common stock, is included in these corporate costs. In addition, the SSCE Consumer Packaging Division provided certain additional management services related to the operations of the Predecessor. In consideration for these management services, the Predecessor was allocated a portion of SSCE’s actual corporate and division costs using an established formula. The formula was based upon the Predecessor’s utilization of the employees, property, plant and equipment and contribution to total sales.

 

In the opinion of management, the Predecessor has been allocated its proportionate share of SSCE’s shared costs utilizing these methods. However, the common costs allocated to the Predecessor are not necessarily indicative of the costs that would have been incurred if the Predecessor were operated as a stand-alone business.

 

Centralized Finance Organization:  SSCE utilized a centralized cash management system whereby the Predecessor’s cash requirements are provided directly by SSCE. Similarly, cash generated by the Predecessor was remitted directly to SSCE. All charges and allocations of costs for functions and services provided by SSCE were deemed paid by the Predecessor, in cash, in the period in which the cost is recorded in these financial statements. Intercompany balances with SSCE, net of any settlements, are included in the SSCE investment.

 

The Predecessor participated in an accounts receivable discounting program sponsored by SSCE, which provided for the sale of certain trade receivables of the Predecessor. The qualifying trade receivables of the Predecessor were transferred to SSCE at face value and then sold without recourse to qualifying special purpose entities. As a result, the accompanying Predecessor balance sheet does not include these trade receivables.

 

SSCE does not have indebtedness directly attributable to the assets of the Predecessor, except for an industrial revenue bond of $10.0 million and other debt of $4.9 million discussed in Note 9. As such, the related indebtedness and interest expense have been allocated to the Predecessor. No other indebtedness or related interest expense has been allocated to the Predecessor. The Predecessor’s assets were included in the general assets of SSCE and its subsidiaries and were pledged as collateral for the SSCE bank credit facility which included approximately $1,266.0 million in term loans outstanding and $245.0 million in outstanding revolving credit facilities at December 31, 2005.

 

 

Altivity is engaged in various litigation, environmental contingencies and other legal matters in the normal course of its business none of which, in the opinion of management, are expected to result in an outcome materially adverse to the financial condition of Altivity.

 

Approximately 59% of Altivity’s hourly labor (47% of its total employees) have employment agreements obtained through collective bargaining.

 

 

Altivity has three reportable segments:  (1) Folding Carton and Paperboard, (2) Multi-wall Bag and (3) Flexible Packaging/Label. Each segment is a strategic business unit, separately managed and manufacturing distinct products. The Folding Carton and Paperboard segment is highly integrated and includes a system of mills and plants that produces a broad range of coated recycled boxboard convertible into folding cartons. Folding cartons are used primarily to protect products, such as food, detergents, paper products, beverages, and health and beauty aids, while providing point of purchase advertising. The Multi-wall Bag segment converts

 

BLUEGRASS CONTAINER HOLDINGS, LLC

 

Notes to Financial Statements — (Continued)

 

kraft and specialty paper into multi-wall bags, consumer bags and specialty retail bags. The bags are designed to ship and protect a wide range of industrial and consumer products including fertilizers, chemicals, concrete and pet and food products. The Flexible Packaging/Label segment converts a wide variety of technologically advanced films for use in the food, pharmaceutical and industrial end-markets. Flexible packaging paper and metallicized paper labels and heat transfer labels are used in a wide range of consumer applications.

 

The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies. Intersegment sales and transfers are recorded at agreed upon transfer prices. Management believes the transfer prices approximate market value.