Portola Packaging 10Q 2006 Q2 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q


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

For the Quarterly Period Ended February 28, 2006


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

For the Transition Period from to

Commission File No. 33-95318

PORTOLA PACKAGING, INC.

(Exact name of Registrant as specified in its charter)


Delaware (State or other jurisdiction of incorporation or organization)		94-1582719 (I.R.S. Employer Identification No.)

951 Douglas Road
Batavia, Illinois 60510
(Address of principal executive offices, including zip code)

(630) 406-8440
(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. YESþ NOo.

Indicate by check mark whether the Registrant is large accelerated filer, and accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filero Accelerated filero Non-accelerated filerþ

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YESo NOþ.

11,931,438 shares of Registrant’s $.001 par value common stock, consisting of 2,134,992 shares of non-voting Class A Common Stock and 9,796,446 shares in the aggregate of voting Class B Common Stock, Series 1 and 2 combined, were outstanding at April 13, 2006.

PORTOLA PACKAGING, INC. AND SUBSIDIARIES

INDEX


		Page
Part I — Financial Information
Item 1.	Financial Statements
	Unaudited Condensed Consolidated Balance Sheets as of February 28, 2006 and August 31, 2005		3
	Unaudited Condensed Consolidated Statements of Operations for the Three and Six Months Ended February 28, 2006 and 2005		4
	Unaudited Condensed Consolidated Statements of Cash Flows for the Six Months Ended February 28, 2006 and 2005		5
	Notes to Unaudited Condensed Consolidated Financial Statements		6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		27
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		47
Item 4.	Controls and Procedures		49
Part II — Other Information
Item 1.	Legal Proceedings		50
Item 6.	Exhibits		51
Signatures			52
Exhibit 10.34
Exhibit 31.01
Exhibit 31.02
Exhibit 32.01

Trademark acknowledgments:

Cap Snap®, Portola Packaging®, Portola Tech International and the Portola logo are our registered trademarks used in this Quarterly Report on Form 10—Q.

PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

PORTOLA PACKAGING, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)


	February 28,			August 31,
	2006			2005
ASSETS
Current assets:
Cash and cash equivalents	$	4,421		$	1,863
Restricted cash		100			100
Accounts receivable, net of allowance for doubtful accounts of $1,786 and $1,601, respectively		29,235			33,782
Inventories, net		22,778			19,243
Other current assets		4,039			3,686
Deferred income taxes		—			2,559

Total current assets		60,573			61,233

Property, plant and equipment, net		70,587			77,133
Goodwill		20,261			20,076
Debt issuance costs, net		7,713			8,470
Trademarks		5,000			5,000
Customer relationships, net		2,282			2,347
Patents, net		1,415			1,589
Covenants not-to-compete and other intangible assets, net		558			752
Other assets, net		3,232			3,369


Total assets	$	171,621		$	179,969


LIABILITIES, MINORITY INTEREST AND SHAREHOLDERS’ EQUITY (DEFICIT)
Current liabilities:
Current portion of long-term debt	$	41		$	44
Accounts payable		16,268			18,265
Book overdraft		—			103
Accrued liabilities		8,612			7,013
Accrued compensation		3,946			3,279
Accrued interest		1,238			1,238

Total current liabilities		30,105			29,942

Long-term debt, less current portion		202,966			203,933
Deferred income taxes		1,063			3,206
Other long-term obligations		684			642

Total liabilities		234,818			237,723


Commitments and contingencies (Note 10)
Shareholders’ equity (deficit):
Class A convertible Common Stock of $.001 par value:
Authorized: 5,203 shares; Issued and outstanding: 2,135 shares		2			2
Class B, Series 1, Common Stock of $.001 par value:
Authorized: 17,715 shares; Issued and outstanding: 8,584 shares		8			8
Class B, Series 2, convertible Common Stock of $.001 par value:
Authorized: 2,571 shares; Issued and outstanding: 1,170 shares		1			1
Additional paid-in capital		6,488			6,488
Accumulated other comprehensive loss		(685	)		(931	)
Accumulated deficit		(69,011	)		(63,322	)

Total shareholders’ equity (deficit)		(63,197	)		(57,754	)


Total liabilities, minority interest and shareholders’ equity (deficit)	$	171,621		$	179,969

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

PORTOLA PACKAGING, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands)


	For the Three Months						For the Six Months
	Ended						Ended
	February 28,			February 28,			February 28,			February 28,
	2006			2005			2006			2005
Sales	$	63,402		$	63,073		$	129,324		$	125,876
Cost of sales		54,082			54,527			109,622			107,868

Gross profit		9,320			8,546			19,702			18,008


Selling, general and administrative		5,882			7,778			12,753			14,148
Research and development		1,082			845			1,958			1,931
(Gain) loss from sale of property, plant and equipment		(632	)		12			(886	)		12
Amortization of intangibles		208			237			435			502
Restructuring costs		109			222			654			366

		6,649			9,094			14,914			16,959

Income (loss) from operations		2,671			(548	)		4,788			1,049


Other (income) expense:
Interest income		(24	)		(8	)		(27	)		(23	)
Interest expense		4,269			4,045			8,496			8,135
Amortization of debt financing costs		403			399			807			806
Foreign currency transaction gain, net		(692	)		(422	)		(457	)		(2,426	)
Other expense (income), net		107			75			7			(60	)

		4,063			4,089			8,826			6,432

Loss before income taxes		(1,392	)		(4,637	)		(4,038	)		(5,383	)
Income tax expense		964			605			1,646			1,540


Net loss		(2,356	)		(5,242	)		(5,684	)		(6,923	)
Other comprehensive income (loss)		153			(555	)		246			416

Comprehensive loss	$	(2,203	)	$	(5,797	)	$	(5,438	)	$	(6,507	)

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

PORTOLA PACKAGING, INC. AND SUBSIDIARIES

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)


	For the Six Months Ended
	February 28,			February 28,
	2006			2005
Cash flows provided by (used in) operating activities:	$	3,663		$	(6,433	)


Cash flows from investing activities:
Additions to property, plant and equipment		(4,276	)		(4,999	)
Proceeds from sale of property, plant and equipment		4,286			3
Increase in other assets, net		—			30

Net cash provided by (used in) investing activities		10			(4,966	)


Cash flows from financing activities:
Borrowings under revolver		13,928			19,015
Repayments under revolver		(14,876	)		(15,600	)
Repayments under long-term debt obligations		(22	)		(8	)
Borrowings/(repayments) on other long-term obligations		10			(41	)
Other		(153	)		(161	)

Net cash (used in) provided by financing activities		(1,113	)		3,205


Effect of exchange rate changes on cash		(2	)		225


Increase (decrease) in cash and cash equivalents		2,558			(7,969	)

Cash and cash equivalents at beginning of period		1,863			12,249

Cash and cash equivalents at end of period	$	4,421		$	4,280


Supplemental disclosure of cash flow information:
Cash paid for interest	$	8,496		$	8,135

Cash paid for income taxes	$	2,446		$	1,801

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

Portola Packaging, Inc. and Subsidiaries

Notes to Unaudited Condensed Consolidated Financial Statements
(in thousands, except share and per share data and percentages)

1.Basis of presentation and accounting policies:

The accompanying unaudited condensed consolidated financial statements have been prepared by Portola Packaging, Inc. and its subsidiaries (the “Company” or “PPI”) without audit and in the opinion of management include all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair statement. The consolidated financial statements should be read in conjunction with the audited consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the year ended August 31, 2005 previously filed with the Securities and Exchange Commission on November 28, 2005 (the “Form 10-K”). The August 31, 2005 consolidated balance sheet data was derived from audited consolidated financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. Interim results are subject to seasonal variations and the results of operations for the three and six months ended February 28, 2006 are not necessarily indicative of the results to be expected for the full fiscal year ending August 31, 2006.

As of February 28, 2006, the Company had several stock-based compensation plans, which are described in Note 11 of the Notes to the Audited Consolidated Financial Statements in the Form 10-K. The Company accounts for those plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations. The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation.” Accordingly, no compensation expense has been recognized for the Company’s stock plans. Had compensation expense for the stock plans been determined based on the fair value at the grant date for all outstanding options during the three- and six-month periods ended February 28, 2006 and 2005 consistent with the provisions of SFAS No. 123, the pro forma net loss would have been reported as follows:


	For the Three						For the Six
	Months Ended						Months Ended
	February 28,			February			February 28,			February 28,
	2006			28, 2005			2006			2005
Net loss as reported	$	(2,356	)	$	(5,242	)	$	(5,684	)	$	(6,923	)
Add total compensation cost as determined under fair value based method for all awards, net of tax		(401	)		(35	)		(474	)		(64	)

Net loss pro forma	$	(2,757	)	$	(5,277	)	$	(6,158	)	$	(6,987	)

Portola Packaging, Inc. and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements
(in thousands, except share and per share data and percentages)

These results are not necessarily representative of the effects on reported net (loss) income for future years.

In February 2006 the Company’s Board of Directors approved the Incentive Stock Option Agreement (the “Incentive Agreement”) for the Company’s Chief Executive Officer, Brian Bauerbach. The Incentive Agreement grants Mr. Bauerbach an option to purchase from the Company up to a total of 400,000 shares of common stock at the estimated fair market value at the date of grant of $0.62 per share. The option shares vest as follows, 133,333 immediately; 26,667 on August 31, 2006; 106,000 on January 1, 2007; 54,000 on August 31, 2007 and 80,000 on January 1, 2008. The Board of Directors also granted stock options to certain key executives. The 2006 Stock Option Plan (the “2006 Plan”) granted a total of 1,100,000 shares of common stock at $0.62 per share to ten executives. One-third of these shares vest immediately and one-third vests on each August 31^st until 100% are vested for nine of the executives. For the remaining executive one-third vests each August 31^st until 100% are vested. The Board of Directors also granted 50,000 shares of stock options at $0.62 per share for each of the Company’s board members. One-third of the shares vested immediately and one-third vest on each August 31^st until 100% are vested. The Board of Directors also approved the immediate vesting of all stock options previously granted at $5.00 and $5.80 per share. No compensation expense was recognized related to the immediate vesting of these stock options.

2.Recent accounting pronouncements:

In November 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 151 (“SFAS 151”), Inventory Costs, an amendment of Accounting Research Bulletin No. 43 (“ARB” No. 43), Chapter 4. This Statement amends the guidance in ARB No. 43 Chapter 4, Inventory Pricing, to clarify the accounting for abnormal amounts of idle facility expense, excessive spoilage, double freight, handling costs and wasted material (spoilage). The provisions of this Statement will be effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company’s adoption of SFAS 151 had no impact on its financial position, results of operations or cash flows.

In December 2004, the FASB issued Statement No. 123(R), Shared-Based Payment.Statement No. 123(R) requires the measurement of all employee stock-based compensation awards using a fair value method as of the grant date and recording such expense in the consolidated financial statements. In addition, the adoption of Statement No. 123(R) will require additional accounting related to the income tax effects and additional disclosure regarding the cash flow effects resulting from share-based payment arrangements. Statement No. 123(R) is effective for non public companies (as defined by SEC rules) for annual periods beginning after December 15, 2005. The Company is currently evaluating the impact of the adoption of Statement No. 123(R) and anticipates adoption under the modified prospective transition method allowable under Statement No. 123(R). In November 2005, the FASB issued Staff Position No. 123(R)-3, Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards, which provides an alternative (and simplified) method to calculate the pool of excess income tax benefits upon the adoption of Statement No. 123(R). We have not yet fully evaluated this new accounting guidance and, accordingly, the Company has not determined whether it will elect the alternative method thereunder.

Portola Packaging, Inc. and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
(in thousands, except share and per share data and percentages)

based on the fair value of the assets exchanged. Statement No. 153 is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. The Company’s adoption of Statement No. 153 had no impact on its financial position, results of operations or cash flows.

In December 2004, the FASB issued FASB Staff Position No. FAS 109-2 (“FSP FAS 109-2”), Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004. The American Jobs Creation Act of 2004 introduces a special one-time dividends received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer (repatriation provision), provided certain criteria are met. FSP FAS 109-2 provides accounting and disclosure guidance for the repatriation provision. The Company does not believe the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004 nor the FASB Staff Position will have a material impact on its financial condition or results of operations.

In December 2004, the FASB issued FASB Staff Position No. FAS 109-1 (“FSP 109-1”), Application of FASB Statement No. 109, “Accounting for Income Taxes,” to the Tax Deduction on Qualified Production Activities Provided by the ‘American Jobs Creation Act of 2004.’ The American Jobs Creation Act of 2004 introduces a special 9% tax deduction on qualified production activities. FSP 109-1 clarifies that this tax deduction should be accounted for as a special tax deduction in accordance with FASB Statement No. 109. The Company’s adoption of FSP 109-1 had no impact on its financial position, results of operations or cash flows.

In February 2005, the FASB issued Emerging Issues Task Force (EITF) No. 04-10, “Determining Whether to Aggregate Segments That Do Not Meet the Quantitative Thresholds.” This statement clarifies the aggregation criteria of operating segments as defined in FASB Statement No. 131. The effective date of this statement is for fiscal years ending after September 15, 2005. The Company believes that its current segment reporting complies with EITF No. 04-10.

In March 2005, the FASB issued FASB Interpretation No. 47 (“FIN 47”), Accounting for Conditional Asset Retirement Obligations, an interpretation of FASB Statement No. 143, Accounting for Asset Retirement Obligations. FIN 47 clarifies that Statement of Accounting Standards No. 143 requires accrual of the fair value of legally required asset retirement obligations if sufficient information exists to reasonably estimate the fair value. FIN 47 is effective for the Company’s year ended August 31, 2006. The Company does not believe the adoption of FIN 47 will have a significant impact on its financial position, results of operations or cash flows.

In May 2005, the FASB issued Statement No. 154, “Accounting Changes and Error Corrections.” This statement replaces APB 20 cumulative effect accounting with retroactive restatement of comparative financial statements. It applies to all voluntary changes in accounting principle and defines “retrospective application” to differentiate it from restatements due to incorrect accounting. The provisions of this statement are effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company does not believe the adoption of Statement No. 154 will have a significant impact on its financial position, results of operations or cash flows.

Portola Packaging, Inc. and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
(in thousands, except share and per share data and percentages)

3.Other comprehensive income:

Other comprehensive income consisted of cumulative foreign currency translation adjustments of $153 and $(555) for the three months ended February 28, 2006 and 2005, respectively, and $246 and $416 for the six months ended February 28, 2006 and 2005, respectively.

4.Segments:

The Company’s reportable operating businesses are organized primarily by geographic region and, in one case, by function. The Company’s United Kingdom and Mexico operations, as well as its Blow Mold Technology Division, produce both closure and bottle product lines. The Company’s United States and China operations produce closure products for plastic beverage containers and cosmetics, fragrance and toiletries (“CFT”) jars and closures. During the first and second quarter of fiscal 2006, Portola Allied Tool operations were moved from Michigan to Pennsylvania. As a result of this move Portola Allied Tool is no longer included in the Blow Mold Technologies segment, it is now a part of the Other segment data. The Blow Mold Technologies segment includes only the Canadian division. In the following tables all periods have been restated for this presentation. The Company’s China operations also manufacture plastic parts for the high-tech industry. The Company has one operating measure. Management evaluates the performance of, and allocates resources to, regions based on earnings before interest, taxes, depreciation and amortization expenses (“EBITDA”). The Company does not allocate interest expense, taxes, depreciation, amortization and amortization of debt issuance costs to its subsidiaries. Certain Company businesses and activities, including the equipment division, do not meet the definition of a reportable operating segment and have been aggregated into “Other.” Revenue generating activities within “Other” includes equipment sales and geographical regions which meet neither the quantitative nor qualitative thresholds of the Company’s reportable segments. The accounting policies of the segments are consistent with those policies used by the Company as a whole.

The table below presents information about reported segments for the three- and six-month periods ended February 28, 2006 and 2005, respectively:


	For the Three				For the Six
	Months Ended				Months Ended
	February 28,		February 28,		February 28,		February 28,
	2006		2005		2006		2005
Revenues:
United States — Closures & Corporate	$	25,023	$	23,950	$	51,637	$	48,271
United States — CFT		5,878		6,234		12,040		13,701
Blow Mold Technology		12,206		10,878		23,339		21,204
United Kingdom		9,414		11,304		20,044		22,466
Mexico		4,814		4,358		9,979		8,413
China		3,208		2,459		6,276		4,193
Other		2,859		3,890		6,009		7,628

Total consolidated	$	63,402	$	63,073	$	129,324	$	125,876

Portola Packaging, Inc. and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
(in thousands, except share and per share data and percentages)

Inter-segment revenues totaling $2,548 and $3,666 have been eliminated from the segment totals presented above for the three months ended February 28, 2006 and 2005, respectively, and $5,153 and $6,746 for the six months ended February 28, 2006 and 2005, respectively.

One Canadian customer accounted for approximately 11% and 10% of sales for the three and six months ended February 28, 2006 and 9% of accounts receivable at February 28, 2006. There were no customers that accounted for 10% or more of sales for the three or six month periods ended February 28, 2005.

The Company’s bonds are registered with the Securities and Exchange Commission and are publicly traded, but its stock is not registered or publicly traded. The Company’s primary measure of operations per past history has been focused on EBITDA, and not profit (loss) before income taxes or net income (loss) as a primary measure as the Company has had a history of significant losses both before and after tax for the past several years. Furthermore, our senior notes and senior credit facility measure compliance with restrictive covenants based upon an EBITDA measure. Therefore, bond holders, investors and analysts have focused on EBITDA as the primary measure of the Company’s financial performance.

The tables below present the detail of EBITDA by segment for the three and six months ended February 28, 2006 and 2005, respectively:


	United States		United
	- Closures &		States -		Blow Mold		United
EBITDA	Corporate		CFT		Technology		Kingdom		Mexico		China			Other			Total

For the three months ended February 28, 2006	$	2,031	$	1,064	$	1,746	$	1,683	$	428	$	564		$	(288	)	$	7,228

For the three months ended February 28, 2005	$	1,049	$	587	$	1,542	$	718	$	484	$	(225	)	$	(440	)	$	3,715


	United States		United
	- Closures &		States -		Blow Mold		United
EBITDA	Corporate		CFT		Technology		Kingdom		Mexico		China			Other			Total

For the six months ended February 28, 2006	$	4,738	$	993	$	3,420	$	2,863	$	617	$	1,056		$	(437	)	$	13,250

For the six months ended February 28, 2005	$	3,945	$	1,274	$	3,616	$	2,754	$	887	$	(149	)	$	(981	)	$	11,346

Portola Packaging, Inc. and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
(in thousands, except share and per share data and percentages)

The following table presents a reconciliation of EBITDA by segment to net loss for the three and six months ended February 28, 2006 and 2005:


	For the Three						For the Six
	Months Ended						Months Ended
	February			February			February			February
	28, 2006			28, 2005			28, 2006			28, 2005
EBITDA	$	7,228		$	3,715		$	13,250		$	11,346
Interest expense		(4,269	)		(4,045	)		(8,496	)		(8,135	)
Depreciation and amortization		(3,948	)		(3,908	)		(7,985	)		(7,788	)
Amortization of debt financing costs		(403	)		(399	)		(807	)		(806	)

Loss before income taxes	$	(1,392	)	$	(4,637	)	$	(4,038	)	$	(5,383	)

5.Restructuring:

The Company incurred restructuring costs of $109 and $654 for the three- and six-month periods ended February 28, 2006. During the first six months of fiscal 2006, the Company incurred restructuring charges of $313, including $48 during the three-month period ended February 28, 2006, due to the relocation of its Allied Tool division from Michigan to Pennsylvania. The remaining $341, including $61 during the three-month period ended February 28, 2006, is due to the Company’s Blow Mold Technology segment and restructuring charges related to the elimination of certain of its corporate selling, general and administrative areas primarily related to employee severance costs.

During the first six months of fiscal 2005, the Company incurred restructuring charges of $366 for employee severance costs relating to its United States Closures and Corporate segment.

No significant future costs are expected for this specific restructuring plan related to the Company’s United States Closures and Corporate and Blow Mold Technology segments.

At February 28, 2006 and August 31, 2005, accrued restructuring costs related to employee severance and other amounted to $359 and $1,103, respectively. As of February 28, 2006, approximately $1,398 has been paid from the restructuring reserve for the employee severance costs. Management anticipates that the accrual balance will be paid within the next twelve months.

Portola Packaging, Inc. and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
(in thousands, except share and per share data and percentages)

The following table represents the activity in the restructuring reserve by segment for the six months ended February 28, 2006:


	August 31, 2005							February 28, 2006
	Balance		Provision		Cost Paid			Balance

United States — Closures & Corporate	$	809	$	226	$	(814	)	$	221
United States — CFT		25		—		(25	)		—
Blow Mold Technology		139		115		(234	)		20
Other		130		313		(325	)		118

Total	$	1,103	$	654	$	(1,398	)	$	359

6.Inventories:

As of February 28, 2006 and August 31, 2005, inventories consisted of the following:


	February 28,			August 31,
	2006			2005
Raw materials	$	11,483		$	9,872
Work in process		992			656
Finished goods		11,712			9,943

Total inventory		24,187			20,471
Less: inventory reserve		(1,409	)		(1,228	)

Inventory — net	$	22,778		$	19,243

7.Property, plant and equipment:

On November 9, 2005 the Company sold the remaining building and land at its San Jose, California location for proceeds of $2,139 which resulted in a gain on sale of $366. During the first quarter ended November 30, 2005, the Company disposed of equipment in its closed Sumter, South Carolina facility resulting in a loss of $148. On December 28, 2005, the Company sold its facility in Sumter, South Carolina for $904 which resulted in a gain on sale of $54. On January 13, 2006, the Company sold its facility located at 84 Fairmont Avenue, Woonsocket, Rhode Island for $1,084 which resulted in a gain on sale of $560. The Company also had proceeds of $49 on the sale of other assets that resulted in a gain of $18 for the three months ended February 28, 2006 and proceeds of $159 on the sale of other assets that resulted in a gain of $54 for the six months ended February 28, 2006.

Portola Packaging, Inc. and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
(in thousands, except share and per share data and percentages)

8.Goodwill and intangible assets:

As of February 28, 2006 and August 31, 2005, goodwill and accumulated amortization by segment consisted of the following:


	February 28, 2006					August 31, 2005
	Gross					Gross
	Carrying		Accumulated			Carrying		Accumulated
	Amount		Amortization			Amount		Amortization
Goodwill:
United States — Closures & Corporate	$	12,585	$	(6,667	)	$	12,585	$	(6,667	)
United States — CFT		9,163		—			9,163		—
Blow Mold Technology		5,404		(1,510	)		5,204		(1,454	)
Mexico		3,603		(2,402	)		3,479		(2,319	)
Other		449		(364	)		449		(364	)

Total consolidated	$	31,204	$	(10,943	)	$	30,880	$	(10,804	)

Effective September 1, 2001, the Company adopted SFAS No. 142 for existing goodwill and other identifiable assets. During the fourth quarter of fiscal 2005, the Company measured goodwill by operating unit and reviewed for impairment by utilizing the EBITDA multiplier methodology for United States — Closures and Corporate, Blow Mold Technology and Mexico, and used the discounted cash flows methodology for United States — CFT. In management’s judgment, no events transpired during the first six months of fiscal 2006 that would have required management to review goodwill for impairment as of February 28, 2006.

The change in the gross carrying amounts and accumulated amortization for Blow Mold Technology and Mexico from August 31, 2005 to February 28, 2006 was due to foreign currency translation.

Portola Packaging, Inc. and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
(in thousands, except share and per share data and percentages)

In connection with the adoption of SFAS No. 142, effective September 1, 2001, the Company reassessed the useful lives and the classifications of its identifiable intangible assets and determined that they continue to be appropriate. The components of the Company’s intangible assets are as follows:


	February 28, 2006					August 31, 2005
	Gross					Gross
	Carrying		Accumulated			Carrying		Accumulated
	Amount		Amortization			Amount		Amortization
Amortizable intangible assets:
Patents	$	9,659	$	(8,244	)	$	9,659	$	(8,070	)
Debt issuance costs		11,886		(4,173	)		11,817		(3,347	)
Customer relationships		2,600		(318	)		2,600		(253	)
Covenants not-to-compete		829		(638	)		829		(571	)
Technology		400		(196	)		400		(156	)
Other		715		(552	)		714		(464	)

Total amortizable intangible assets	$	26,089	$	(14,121	)	$	26,019	$	(12,861	)


Non-amortizable intangible assets:
Trademarks		5,000		—			5,000		—


Total intangible assets	$	31,089	$	(14,121	)	$	31,019	$	(12,861	)

Gross carrying amounts and accumulated amortization may fluctuate between periods due to foreign currency translation. In addition, amortization expense for the net carrying amount of intangible assets, including debt issuance costs, for the six months ended February 28, 2006 and 2005 was $1,242 and $1,308, respectively. Amortization expense is estimated to be $1,189 for the remaining six months of fiscal 2006, $2,127 in fiscal 2007, $1,978 in fiscal 2008, $1,512 in fiscal 2009, $1,335 in fiscal 2010 and $3,827 in the remaining years thereafter.

9.Debt:

Debt:


	February 28,			August 31,
	2006			2005
Senior notes	$	180,000		$	180,000
Senior revolving credit facility		22,898			23,845
Capital lease obligations		5			10
Other		104			122
		203,007			203,977
Less: Current portion long-term debt		(41	)		(44	)
	$	202,966		$	203,933

Portola Packaging, Inc. and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
(in thousands, except share and per share data and percentages)

Senior notes:

On January 23, 2004, the Company completed an offering of $180,000 in aggregate principal amount of Senior Notes that mature on February 1, 2012 and bear interest at 8¹/4% per annum (the “Senior Notes”). Interest payments of $7,425 are due semi-annually on February 1 and August 1 of each year. Interest began accruing January 23, 2004 and the first interest payment was made on August 1, 2004. The Senior Notes indenture contains covenants and provisions that restrict, among other things, the Company’s ability to: (i) incur additional indebtedness or issue preferred stock, (ii) incur liens on its property, (iii) make investments, (iv) enter into guarantees and other contingent obligations, (v) merge or consolidate with or acquire another person or engage in other fundamental changes, (vi) engage in certain sales of assets and subsidiary stock, (vii) engage in certain transactions with affiliates, (viii) engage in sale/leaseback transactions, (ix) engage in any business other than a related business, (x) make restricted payments, and (xi) declare or pay dividends.

Senior revolving credit facility:

Concurrently with the offering of the Senior Notes on January 23, 2004, the Company entered into an amended and restated five-year senior revolving credit facility of up to $50,000, maturing on January 23, 2009. The Company entered into an amendment to this senior secured credit facility on May 21, 2004, a limited waiver and second amendment to this senior secured credit facility on November 24, 2004 (the “November 24 Amendment”), a fifth amendment to the senior secured credit facility on April 4, 2005 (the “April 4 Amendment”), a sixth amendment to the senior secured credit facility on May 2, 2005 (the “May 2 Amendment”) and a seventh amendment to the senior secured credit facility on June 21, 2005 (the “June 21 Amendment”). The amended and restated credit facility contains covenants and provisions that restrict, among other things, the Company’s ability to: (i) redeem warrants and repurchase stock, except during the first year, (ii) incur additional indebtedness, (iii) incur liens on its property, (iv) make investments, (v) enter into guarantees and other contingent obligations, (vi) merge or consolidate with or acquire another person or engage in other fundamental changes, or in certain sales of assets, (vii) engage in certain transactions with affiliates, (viii) make restricted junior payments, and (ix) declare or pay dividends. The June 21 Amendment, which superseded the April 4 Amendment and the May 2 Amendment and their covenants, revised the credit agreement as follows: (a) the borrowing base calculation is based on the product of trailing 12 month restricted EBITDA and a leverage multiple of 2.5 less any outstanding senior indebtedness, which excludes senior indebtedness evidenced by the Senior Notes and any guaranties thereof and excluding any fees, liabilities or other obligations payable with respect to such senior indebtedness; (b) the Company is required to maintain EBITDA for any 12-month period ending on the last day of each fiscal month, commencing with the fiscal month ending May 31, 2005, of at least $17,500; (c) the Company no longer is required to maintain a borrowing availability amount; and (d) the amount the Company can invest in certain specified subsidiaries was increased from $6,700 to $8,500. The June 21 Amendment also eliminated the fixed charge coverage and senior leverage ratios. The Company’s future compliance with the amended covenants is dependent upon the Company achieving its projected operating results in fiscal 2006 and beyond. The Company believes that it will attain its projected results and that it will be in compliance with the covenants throughout fiscal 2006 and beyond. An unused fee is payable on the facility based on the total commitment amount less the average daily aggregate amount of outstanding liability, at the rate of 0.50% per annum. In addition, interest payable is based on, at the Company’s election

Portola Packaging, Inc. and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
(in thousands, except share and per share data and percentages)

either the Bank Prime Loan rate plus 1.50% or the LIBOR Loan rate plus 3.00% determined by a pricing table based on the outstanding credit facility balance. At February 28, 2006, the Bank Prime Loan rate and the LIBOR Loan rate were 7.50% and 5.15%, respectively. At February 28, 2005, the Company had approximately $26,100 available for borrowing under the credit facility under the borrowing base formula described above.

Capital lease obligations:

The Company acquired certain machinery and office equipment under noncancelable capital leases. Property, plant and equipment include the following items held under capital lease obligations:


	February 28,			August 31,
	2006			2005

Equipment	$	1,152		$	1,152
Less accumulated depreciation		(605	)		(545	)

	$	547		$	607

Aggregate maturities of long-term debt:

The aggregate maturities of long-term debt for the remaining six months of fiscal 2006 and the next four years and thereafter based on amounts outstanding at February 28, 2006 were as follows:


Six months ended August 31, 2006	$	22
Year ended August 31, 2007		33
Year ended August 31, 2008		27
Year ended August 31, 2009		22,922
Year ended August 31, 2010		3
Thereafter		180,000

	$	203,007

10.Commitments and contingencies:

Legal:

The Company is currently a defendant in a suit filed by Blackhawk Molding Co., Inc. on August 28, 2003 in the U.S. District Court for the Northern District of Illinois, Eastern Division. Blackhawk Molding alleges that a “single-stick” label attached to the Company’s five—gallon caps causes the Company’s caps to infringe a patent held by it and is seeking damages. The Company has answered the complaint denying all allegations and asserting that its product does not infringe the Blackhawk patent and that the patent is invalid. The Court has completed the first phase of claim construction. Fact and expert witness discovery has substantially been completed. The Court denied the parties various motions for summary judgment, except it granted Blackhawk’s motion for summary judgment on infringement and inequitable conduct, but ruled that the issue of whether Blackhawk’s patent is valid must be tried. Pre-trial proceedings and the trial are not scheduled at this time. The ultimate outcome of this action is uncertain and cannot be reasonably estimated because the standard for damages has not been determined yet and will depend on facts and circumstances to be introduced at trial. An unfavorable outcome in this action could result in the Company sustaining material damages to its financial position, results of operations and liquidity. In addition, any litigation concerning intellectual property could be

Portola Packaging, Inc. and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
(in thousands, except share and per share data and percentages)

protacted and costly and could have a material adverse effect on the Company’s business and results of operations regardless of its outcome.

In the normal course of business, except for the Blackhawk litigation mentioned above, the Company is subject to various legal proceedings and claims. Based on the facts currently available the amount of liability, if any, cannot be estimated. Management believes that the ultimate amount of liability beyond reserves provided, if any, for any such pending actions will not have a material adverse effect on the Company’s financial position, results of operations or liquidity.

Commitments and Contingencies:

The Company leases certain office, production and warehouse facilities under operating lease agreements expiring on various dates through 2021 and with various terms. Most of these agreements require the Company to pay an initial base rent for a certain period of time, with escalation based on a fixed amount or a percentage tied to an economic index. The Company calculates its lease obligation, including the escalation, and recognizes the rent expense on a straight-line basis over the lease term. Under the terms of the facilities’ leases, the Company is responsible for common area maintenance expenses, which include taxes, insurance, repairs and other operating costs. Rent expense for the three-month periods ended February 28, 2006 and 2005 was $1,432 and $1,360, respectively. Rent expense for the six-month periods ended February 28, 2006 and 2005 was $2,698 and $2,643, respectively.

The future minimum rental commitments under agreements with terms in excess of twelve months were as follows:


Six months ending August 31, 2006	$	1,842
Fiscal year ending August 31, 2007		3,106
Fiscal year ending August 31, 2008		2,956
Fiscal year ending August 31, 2009		2,940
Fiscal year ending August 31, 2010		2,911
Thereafter		15,984

	$	29,739

11.Supplemental condensed consolidated financial statements:

On January 23, 2004, the Company completed the offering of $180,000 in aggregate principal amount of 8¹/4% Senior Notes due 2012. The majority of the net proceeds of such offering were used to redeem all of the previously outstanding $110,000 in aggregate principal amount of 10³/4% Senior Notes. In the fourth quarter of fiscal 2004, the Company exchanged the outstanding Senior Notes for registered exchange notes having substantially the same terms. The exchange notes have the following guarantors, all of which are 100% owned subsidiaries of the Company and have provided guarantees that are full and unconditional and for which they are jointly and severally liable: Allied Tool; Portola Limited; Portola Packaging, Inc. Mexico, S.A. de C.V.; Portola Packaging Canada Ltd.; Portola Packaging Limited; and Portola Tech International (“PTI”). The tables below set forth financial information of the guarantors and non-guarantors at February 28, 2006 and August 31, 2005 and for the three-and six-month periods ended February 28, 2006 and 2005.

Portola Packaging, Inc. and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
(in thousands, except share and per share data and percentages)

Supplemental Condensed Consolidated Balance Sheet
February 28, 2006


							Combined
				Combined			Non-
	Parent			Guarantor			Guarantor
	Company			Subsidiaries			Subsidiaries			Eliminations			Consolidated

ASSETS
Current assets:
Cash and cash equivalents	$	894		$	2,557		$	1,070		$	—		$	4,521
Accounts receivable, net		10,451			17,069			4,088			(2,373	)		29,235
Inventories, net		6,127			14,506			2,145			—			22,778
Other current assets		1,258			1,443			1,338			—			4,039

Total current assets		18,730			35,575			8,641			(2,373	)		60,573
Property, plant and equipment, net		33,751			32,568			4,284			(16	)		70,587
Goodwill		5,917			14,344			—			—			20,261
Debt issuance costs		7,713			—			—			—			7,713
Trademarks		—			5,000			—			—			5,000
Customer relationships, net		—			2,282			—			—			2,282
Investment in subsidiaries		10,627			13,518			896			788			25,829
Common stock of subsidiaries		(1,267	)		(18,988	)		(4,357	)		—			(24,612	)
Other assets		3,276			641			71			—			3,988

Total assets	$	78,747		$	84,940		$	9,535		$	(1,601	)	$	171,621

LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
Current liabilities:
Accounts payable	$	6,455		$	10,916		$	1,270		$	(2,373	)	$	16,268
Intercompany (receivable) payable		(77,300	)		65,909			11,436			(45	)		—
Other current liabilities		7,171			5,076			1,098			492			13,837

Total current liabilities		(63,674	)		81,901			13,804			(1,926	)		30,105
Long-term debt, less current portion		202,899			—			67			—			202,966
Other long-term obligations		2,719			(123	)		(849	)		—			1,747

Total liabilities		141,944			81,778			13,022			(1,926	)		234,818

Other equity (deficit)		5,814			(131	)		(742	)		873			5,814
Accumulated equity (deficit)		(69,011	)		3,293			(2,745	)		(548	)		(69,011	)

Total shareholders’ equity (deficit)		(63,197	)		3,162			(3,487	)		325			(63,197	)

Total liabilities and shareholders’ equity (deficit)	$	78,747		$	84,940		$	9,535		$	(1,601	)	$	171,621

Portola Packaging, Inc. and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
(in thousands, except share and per share data and percentages)

Supplemental Condensed Consolidated Balance Sheet
August 31, 2005


				Combined			Combined
				Guarantor			Non-Guarantor
	Parent Company			Subsidiaries			Subsidiaries			Eliminations			Consolidated

ASSETS
Current assets:
Cash and cash equivalents	$	388		$	857		$	718		$	—		$	1,963
Accounts receivable, net		12,221			19,342			3,794			(1,575	)		33,782
Inventories, net		5,330			12,011			1,902			—			19,243
Other current assets		3,603			1,666			976			—			6,245

Total current assets		21,542			33,876			7,390			(1,575	)		61,233
Property, plant and equipment, net		38,122			34,407			4,620			(16	)		77,133
Goodwill		5,917			14,159			—			—			20,076
Debt issuance costs		8,470			—			—			—			8,470
Trademarks		—			5,000			—			—			5,000
Customer relationships, net		—			2,347			—			—			2,347
Investment in subsidiaries		9,816			13,523			896			1,700			25,935
Common stock of subsidiaries		(1,267	)		(18,988	)		(4,457	)		—			(24,712	)
Other assets		3,718			715			55			(1	)		4,487

Total assets	$	86,318		$	85,039		$	8,504		$	108		$	179,969


LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)
Current liabilities:
Accounts payable	$	6,915		$	11,422		$	1,503		$	(1,575	)	$	18,265
Intercompany (receivable) payable		(77,805	)		67,108			10,697			—			—
Other current liabilities		6,324			3,964			899			490			11,677

Total current liabilities		(64,566	)		82,494			13,099			(1,085	)		29,942
Long-term debt, less current portion		203,848			—			85			—			203,933
Other long-term obligations		4,790			(98	)		(844	)		—			3,848

Total liabilities		144,072			82,396			12,340			(1,085	)		237,723

Other equity (deficit)		5,568			(308	)		(822	)		1,130			5,568
Accumulated equity (deficit)		(63,322	)		2,951			(3,014	)		63			(63,322	)

Total shareholders’ equity (deficit)		(57,754	)		2,643			(3,836	)		1,193			(57,754	)

Total liabilities and shareholders’ equity (deficit)	$	86,318		$	85,039		$	8,504		$	108		$	179,969

Portola Packaging, Inc. and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
(in thousands, except share and per share data and percentages)

Supplemental Condensed Consolidated Statements of Operations
For the Three-Month Period Ended
February 28, 2006


				Combined			Combined
	Parent			Guarantor			Non-Guarantor
	Company			Subsidiaries			Subsidiaries			Eliminations			Consolidated

Sales	$	28,568		$	32,589		$	4,793		$	(2,548	)	$	63,402
Cost of sales		23,461			29,281			3,784			(2,444	)		54,082

Gross profit		5,107			3,308			1,009			(104	)		9,320

Selling, general and administrative		3,674			1,582			730			(104	)		5,882
Research and development		762			320			—			—			1,082
Gain on sale of property, plant and equipment		(53	)		(579	)		—			—			(632	)
Amortization of intangibles		136			72			—			—			208
Restructuring costs		51			58			—			—			109

Income from operations		537			1,855			279			—			2,671

Interest income		—			(22	)		(2	)		—			(24	)
Interest expense		4,247			22			—			—			4,269
Amortization of debt financing costs		403			—			—			—			403
Foreign currency transaction gain, net		(372	)		(320	)		—			—			(692	)
Intercompany interest (income) expense		(1,245	)		1,121			124			—			—
Other (income) expense, including (income) expense from equity investments, net		(1,413	)		180			—			1,340			107


(Loss) income before income taxes		(1,083	)		874			157			(1,340	)		(1,392	)

Income tax expense (benefit)		1,273			(309	)		—			—			964


Net (loss) income	$	(2,356	)	$	1,183		$	157		$	(1,340	)	$	(2,356	)

Portola Packaging, Inc. and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
(in thousands, except share and per share data and percentages)

Supplemental Condensed Consolidated Statements of Operations
For the Three-Month Period Ended
February 28, 2005


							Combined
				Combined			Non-
	Parent			Guarantor			Guarantor
	Company			Subsidiaries			Subsidiaries			Eliminations			Consolidated

Sales	$	27,996		$	33,771		$	4,972		$	(3,666	)	$	63,073
Cost of sales		23,463			29,541			4,828			(3,305	)		54,527

Gross profit		4,533			4,230			144			(361	)		8,546

Selling, general and administrative		5,369			1,880			890			(361	)		7,778
Research and development		497			347			1			—			845
Loss on sale of property, plant and equipment		—			12			—			—			12
Amortization of intangibles		180			57			—			—			237
Restructuring costs		17			205			—			—			222

(Loss) income from operations		(1,530	)		1,729			(747	)		—			(548	)

Interest income		(3	)		(5	)		—			—			(8	)
Interest expense		4,000			18			27			—			4,045
Amortization of debt financing costs		394			5			—			—			399
Foreign currency transaction (gain) loss		(237	)		(194	)		9			—			(422	)
Intercompany interest (income) expense		(999	)		902			70			27			—
Other (income) expense, including (income) expense from equity investments, net		575			286			47			(833	)		75


Loss before income taxes		(5,260	)		717			(900	)		806			(4,637	)

Income tax (benefit) expense		(18	)		623			—			—			605


Net (loss) income	$	(5,242	)	$	94		$	(900	)	$	806		$	(5,242	)

Portola Packaging, Inc. and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
(in thousands, except share and per share data and percentages)

Supplemental Condensed Consolidated Statements of Operations
For the Six-Month Period Ended
February 28, 2006


				Combined			Combined
	Parent			Guarantor			Non-Guarantor
	Company			Subsidiaries			Subsidiaries			Eliminations			Consolidated

Sales	$	57,830		$	66,867		$	9,780		$	(5,153	)	$	129,324
Cost of sales		46,590			59,976			7,741			(4,685	)		109,622

Gross profit		11,240			6,891			2,039			(468	)		19,702

Selling, general and administrative		8,137			3,502			1,582			(468	)		12,753
Research and development		1,300			658			—			—			1,958
Gain on sale of property, plant and equipment		(271	)		(615	)		—			—			(886	)
Amortization of intangibles		291			144			—			—			435
Restructuring costs		226			428			—			—			654

Income from operations		1,557			2,774			457			—			4,788

Interest income		—			(25	)		(2	)		—			(27	)
Interest expense		8,451			44			1			—			8,496
Amortization of debt financing costs		807			—			—			—			807
Foreign currency transaction (gain) loss		(1	)		(475	)		19			—			(457	)
Intercompany interest (income) expense		(2,457	)		2,211			246			—			—
Other (income) expense, including (income) expense from equity investments, net		(673	)		158			—			522			7


(Loss) income before income taxes		(4,570	)		861			193			(522	)		(4,038	)

Income tax expense		1,114			532			—			—			1,646


Net (loss) income	$	(5,684	)	$	329		$	193		$	(522	)	$	(5,684	)

Portola Packaging, Inc. and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
(in thousands, except share and per share data and percentages)

Supplemental Condensed Consolidated Statements of Operations
For the Six-Month Period Ended
February 28, 2005


							Combined
				Combined			Non-
	Parent			Guarantor			Guarantor
	Company			Subsidiaries			Subsidiaries			Eliminations			Consolidated

Sales	$	55,551		$	67,896		$	9,175		$	(6,746	)	$	125,876
Cost of sales		46,362			58,970			8,545			(6,009	)		107,868

Gross profit		9,189			8,926			630			(737	)		18,008

Selling, general and administrative		9,214			3,818			1,853			(737	)		14,148
Research and development		1,180			733			18			—			1,931
Loss on sale of property, plant and equipment		—			12			—			—			12
Amortization of intangibles		359			143			—			—			502
Restructuring costs		138			218			10			—			366

(Loss) income from operations		(1,702	)		4,002			(1,251	)		—			1,049

Interest income		(15	)		(7	)		(1	)		—			(23	)
Interest expense		8,056			31			48			—			8,135
Amortization of debt financing costs		795			11			—			—			806
Foreign currency transaction (gain) loss		(1,165	)		(1,271	)		10			—			(2,426	)
Intercompany interest (income) expense		(1.989	)		1,840			129			20			—
Other (income) expense, including (income) expense from equity investments, net		(661	)		137			49			415			(60	)


(Loss) income before income taxes		(6,723	)		3,261			(1,486	)		(435	)		(5,383	)

Income tax expense		200			1,340			—			—			1,540


Net (loss) income	$	(6,923	)	$	1,921		$	(1,486	)	$	(435	)	$	(6,923	)

Portola Packaging, Inc. and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
(in thousands, except share and per share data and percentages)

Supplemental Condensed Consolidated Statements of Cash Flows
For the Six-Month Period Ended
February 28, 2006


							Combined
				Combined			Non-
	Parent			Guarantor			Guarantor
	Company			Subsidiaries			Subsidiaries			Eliminations			Consolidated

Cash flow provided by operations	$	89		$	3,148		$	426		$	—		$	3,663


Additions to property, plant and equipment		(1,636	)		(2,762	)		(248	)		370			(4,276	)
Proceeds from the sale of property, plant and equipment		3,147			1,139			—			—			4,286
Other		12			167			191			(370	)		—

Net cash provide by (used in) investing activities		1,523			(1,456	)		(57	)		—			10


Borrowings under revolver		13,928			—			—			—			13,928
Repayments under revolver		(14,876	)		—			—			—			(14,876	)
Other		(158	)		10			(17	)		—			(165	)

Net cash (used in) provided by financing activities		(1,106	)		10			(17	)		—			(1,113	)


Effect of exchange rate changes on cash		—			(2	)		—			—			(2	)


Increase in cash		506			1,700			352			—			2,558

Cash and cash equivalents at beginning of period		288			857			718			—			1,863

Cash and cash equivalents at end of period	$	794		$	2,557		$	1,070		$	—		$	4,421

Portola Packaging, Inc. and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
(in thousands, except share and per share data and percentages)

Supplemental Condensed Consolidated Statements of Cash Flows
For the Six-Month Period Ended
February 28, 2005


							Combined
				Combined			Non-
	Parent			Guarantor			Guarantor
	Company			Subsidiaries			Subsidiaries			Eliminations			Consolidated

Cash flow (used in) provided by operations	$	(7,675	)	$	1,499		$	(257	)	$	—		$	(6,433	)


Additions to property, plant and equipment		(2,722	)		(1,590	)		(750	)		63			(4,999	)
Other		137			(37	)		(4	)		(63	)		33

Net cash used in investing activities		(2,585	)		(1,627	)		(754	)		—			(4,966	)


Borrowings under revolver		19,015			—			—			—			19,015
Repayments under revolver		(15,600	)		—			—			—			(15,600	)
Other		(236	)		—			26			—			(210	)

Net cash provided by financing activities		3,179			—			26			—			3,205


Effect of exchange rate changes on cash		—			177			48			—			225

(Decrease) increase in cash		(7,081	)		49			(937	)		—			(7,969	)

Cash and cash equivalents at beginning of period		7,955			2,708			1,586			—			12,249

Cash and cash equivalents at end of period	$	874		$	2,757		$	649		$	—		$	4,280

12.Income taxes:

Income tax expense for the three and six months ended February 28, 2006 and 2005 consisted of the following:


	For the Three				For the Six
	Months Ended				Months Ended
	February 28,		February 28,		February 28,		February 28,
	2006		2005		2006		2005

Current:
Federal	$	—	$	—	$	—	$	—
State		—		—		—		—
Foreign		556		405		1,231		1,340

		556		405		1,231		1,340

Deferred		408		200		415		200

	$	964	$	605	$	1,646	$	1,540

Income tax expense reported in the accompanying Condensed Consolidated Statements of Operations is primarily the result of taxable earnings generated in the Company’s Canada and United Kingdom operations. The effective tax rate differs from the statutory tax rate primarily as a result of a valuation allowance. The Company has provided valuation allowances of $27,795 and $19,606 against deferred tax assets as of February 28, 2006 and 2005, respectively to reduce deferred tax assets to the amounts expected to be realized. The increase in the valuation allowances is primarily related to increases in net operating losses in certain of the Company’s taxable jurisdictions.

Portola Packaging, Inc. and Subsidiaries
Notes to Unaudited Condensed Consolidated Financial Statements (Continued)
(in thousands, except share and per share data and percentages)

13.Related party transactions:

The Company engages in certain related party transactions throughout the course of its business. Related party sales of $1,294 and $1,742 for the three months ended February 28, 2006 and 2005, respectively, and $2,945 and $3,544 for the six months ended February 28, 2006 and 2005, respectively, consisted primarily of closures produced by the Company’s U.K. operations that were sold to the Company’s joint venture, CSE. For the three months ended February 28, 2005 the Company paid $3 base salary and incurred $42 for legal services rendered and for the six months ended February 28, 2005 the Company paid $6 base salary and incurred $104 for legal services rendered by Themistocles G. Michos, the Company’s former Vice President and General Counsel. There have been no other significant additional related party transactions from those disclosed in “Item 13. — Certain Relationships and Related Transactions” and Note 15 of Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended August 31, 2005.

14.Management’s deferred compensation plan :

On December 5, 2005, the Company approved the termination of the Portola Packaging, Inc. Management Deferred Compensation Plan (the “MDC Plan”).

In connection with the preparation of its financial statements for the quarter ended November 30, 2005, the Company determined that its MDC Plan, which it terminated in December 2005 in accordance with the December 31, 2005 transition period under Internal Revenue Code section 409A, had not been accounted for by the Company. In connection with terminating the MDC Plan, it was determined that the liability for plan benefits of $917 exceeded plan assets of $648 by $269. The amount of plan liability in excess of $269 has been charged to expense in the three-month period ended November 30, 2005. Had the Company been properly recording the MDC Plan since inception, $244 of this amount would have been charged in years prior to fiscal 2006. However, the Company believes that the impact of not previously recording the MDC Plan was not material to the Company’s consolidated financial statements for any prior year or quarter. Further, the Company does not believe that the $244 relating to periods prior to fiscal 2006 is material to the consolidated financial statements for the first six months of fiscal 2006, or to the projected full year results for fiscal 2006.

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

In addition to historical information, this report includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements other than statements of historical fact included in this Form 10-Q, including, without limitation, statements related to the impact of the final disposition of legal matters in the “Commitments and Contingencies” footnote to the unaudited condensed consolidated financial statements, anticipated cash flow sources and uses under “Liquidity and Capital Resources” and other statements contained in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section regarding our critical accounting policies and estimates, financial position, business strategy, plans and objectives of our management for future operations, and industry conditions, are forward-looking statements. In addition, certain statements, including, without limitation, statements containing the words “believes,” “anticipates,” “estimates,” “expects,” “plans,” and words of similar import, constitute forward-looking statements. Readers are referred to sections of this Report entitled “Risk Factors,” “Critical Accounting Policies and Estimates,” and “Quantitative and Qualitative Disclosures About Market Risk.” Although we believe that the expectations reflected in any such forward-looking statements are reasonable, we cannot assure you that such expectations will prove to be correct. Any forward-looking statements herein are subject to certain risks and uncertainties in our business, including, but not limited to, competition in our markets and reliance on key customers, all of which may be beyond our control. Any one or more of these factors could cause actual results to differ materially from those expressed in any forward-looking statement. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements. Readers should carefully review the risk factors described in this paragraph, elsewhere in this Report and in other documents we file from time to time with the Securities and Exchange Commission.

Overview

We are a leading designer, manufacturer and marketer of plastic closures and bottles and related equipment used for packaging applications in the non-carbonated beverage and institutional foods market. We also design, manufacture and sell closures and containers for the cosmetics, fragrance and toiletries (“CFT”) market. Our products provide our customers with a number of value-added benefits, such as the ability to increase the security and safety of their products by making them tamper evident and substantially leak-proof.

Critical accounting policies and estimates

General.The unaudited condensed consolidated financial statements and notes to the unaudited condensed consolidated financial statements contain information that is pertinent to “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions about future events 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. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment based on various assumptions and other factors such as historical experience, current and expected economic conditions and, in some cases, actuarial techniques. We constantly re—evaluate these factors and make adjustments where facts and circumstances dictate. We believe that the following accounting policies are critical due to the degree of estimation required.

Allowance for doubtful accounts.We provide credit to our customers in the normal course of business, perform ongoing credit evaluations of our customers and maintain reserves for potential credit losses. The allowance for doubtful accounts related to trade receivables is determined based on two methods. The amounts calculated from each of these methods are combined to determine the total amount reserved. First, an evaluation of specific accounts is conducted when information is available indicating that a customer may not be able to meet its financial obligations. Judgments are made in these specific cases based on available facts and circumstances, and a specific reserve for that customer may be recorded to reduce the receivable to the amount that is expected to be collected. These specific reserves are re—evaluated and adjusted as additional information is received that impacts the amount reserved. Second, a general reserve is established for all customers based on historical collection and write—off experience. The collectibility of trade receivables could be significantly reduced if default rates are greater than expected or if an unexpected material adverse change occurs in a major customer’s ability to meet its financial obligations. The allowance for doubtful accounts totaled approximately $1.8 million and $1.6 million as of February 28, 2006 and August 31, 2005, respectively.

Revenue recognition.The Company recognizes revenue upon shipment of our products when persuasive evidence of an arrangement exists with fixed pricing and collectibility is reasonably assured. Our general conditions of sale explicitly state that the delivery of our products is F.O.B. shipping point and that title and all risks of loss and damages pass to the buyer upon delivery of the sold products to the common carrier. The Company has one CFT customer who receives shipments under a consignment arrangement. Revenue for this customer is recognized upon consumption by the customer. All shipping and handling fees billed to customers are classified as revenue and the corresponding costs are recognized in cost of goods sold.

Inventory valuation.Cap and bottle related inventories are stated at the lower of cost (first—in, first—out method) or market and equipment related inventories are stated at the lower of cost (average cost method) or market. We record reserves against the value of inventory based upon ongoing changes in technology and customer needs. These reserves are estimates, which could vary significantly, either favorably or unfavorably, from actual requirements if future economic conditions, customer inventory levels or competitive conditions differ from our expectations. The inventory reserve accounts totaled approximately $1.4 million and $1.2 million as of February 28, 2006 and August 31, 2005, respectively.

Depreciation lives.We periodically evaluate the depreciable lives of our fixed assets. Management performed detailed analysis and also researched industry averages concerning the average life of our molds. We concluded that the lives for our molds should be five years based on our findings. As of September 1, 2003, we changed the depreciable lives of our molds from three years to five years.

Impairment of assets.We periodically evaluate our property, plant and equipment, and other intangible assets for potential impairment. Management’s judgment regarding the existence of impairment indicators are based on market conditions and operational performance of the business. Future events could cause management to conclude that impairment indicators exist and that property, plant and equipment and other intangible assets may be impaired. Any resulting impairment loss could have a material adverse impact on our results of operations and financial condition. No significant impairment loss was recognized during the three and six months ended February 28, 2006 and 2005, respectively.

Impairment of goodwill and non amortizing assets. At August 31, 2005, we measured goodwill by operating unit and reviewed for impairment by utilizing the EBITDA multiplier methodology for United States — Closures and Corporate, Blow Mold Technology, Mexico, and the

United Kingdom, and used the discounted cash flows methodology for United States — CFT. Based on our reviews, we did not record an impairment loss during fiscal 2005. The impairment test for the non-amortizable intangible assets other than goodwill consisted of a comparison of the estimated fair value with carrying amounts. The value of the trademark and tradename was measured using the relief-from-royalty method. The Company tests these assets annually as of August 31 or more frequently if events or changes in circumstances indicate that the assets might be impaired.

Income taxes.We estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating our current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the unaudited condensed consolidated balance sheet. We then assess the likelihood that the deferred tax assets will be recovered from future taxable income, and, to the extent recovery is not likely, a valuation allowance is established. When an increase in this allowance within a period is recorded, we include an expense in the tax provision in the unaudited condensed consolidated statement of operations. Management’s judgment is required in determining the provision (benefit) for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against the net deferred tax assets. Although realization is not assured, management believes that the deferred tax assets will be realized before expiration through the recognition of future taxable income, except where a valuation allowance has been provided. While the deferred tax assets for which valuation allowances have not been provided are considered realizable, actual amounts could be reduced if future taxable income is not achieved. We have provided valuation allowances of $27.8 million and $23.8 million against net deferred tax assets as of February 28, 2006 and August 31, 2005, respectively.

Foreign currency translation.Our foreign subsidiaries use the local currency as their functional currency. Assets and liabilities are translated at quarter-end exchange rates. Income and expense items are translated at average exchange rates for the relevant period. Translation gains and losses are not included in determining net income (loss) but are accumulated as a separate component of shareholders’ equity (deficit). Gains (losses) arising from foreign currency transactions and the revaluation of certain intercompany debt are included in determining net income (loss).

Results of operations

Three months ended February 28, 2006 compared to the three months ended February 28, 2005

Sales.Sales increased $0.3 million to $63.4 million for the second quarter of fiscal 2006 compared to $63.1 million for the second quarter of fiscal 2005. Increased selling prices resulting from the higher cost of resin across all divisions that we were able to pass through to customers was a contributing factor to our increased sales compared to the same period of the prior year. Sales at our Blow Mold Technology operations increased $1.3 million primarily due to increased average selling prices and also a favorable foreign exchange rate. Sales at our China operations increased $0.7 million primarily due to increased cutlery and push-pull closure sales and the addition of cosmetic product sales. Sales at our Mexico operations increased $0.5 million due to increased bottle volume. We also realized increased sales in our U.S. Closures operations by $0.1 million primarily due to increased selling prices, as we were able to pass through to customers increased resin costs. Offsetting these increases were decreased PTI sales of $0.4 million due to decreased orders from our customers. United Kingdom sales decreased $1.9 million due to an unfavorable foreign exchange rate, a decrease in closure volume and a decrease in equipment sales. U.S. Equipment sales, which include Allied Tool, decreased $0.3 million due to the interruption of business caused by the move of operations to Pennsylvania.

Gross profit.Gross profit increased $0.7 million to $9.3 million for the second quarter of fiscal 2006 compared to $8.6 million for the second quarter of fiscal 2005. The increase in gross profit was primarily due to lower employee and overhead costs resulting from cost reduction activities in the U.S. Closures division and the closing of one plant in the Blow Mold Technology division as well as other productivity enhancements from our continuous improvement programs. Gross profit in the United States Closures and Corporate division increased by $0.7 million due primarily to employee cost reductions, productivity enhancements and cost reduction activities. China increased gross profit by $0.8 million due to increased sales in cutlery, push-pull closures and cosmetic products. These improvements were offset partially by decreased sales volume in the UK, lower sales volume at PTI and lower pricing and an unfavorable product mix in our Mexico operations. As a percentage of sales, gross profit increased to 14.7% for the second quarter of fiscal 2006 from 13.6% for the same quarter of fiscal 2005.

For the three months ended February 28, 2006, direct materials, labor and overhead costs represented 48.3%, 15.9% and 21.0% of sales, respectively, compared to 45.1%, 17.4% and 23.9%, respectively, for the three months ended February 28, 2005. Direct material costs increased by $2.2 million for the three months ended February 28, 2006 compared to the three months ended February 28, 2005 due primarily to an increase in resin costs.

Selling, general and administrative expenses.Selling, general and administrative expenses decreased $1.9 million to $5.9 million for the second quarter of fiscal 2006 compared to $7.8 million for the second quarter of fiscal 2005. United States Closures and Corporate decreased by $1.8 million due primarily to decreases in legal, consulting fees and employee costs. The decrease in these expenses has been primarily a result of various cost improvement programs that have been implemented by the Company. Selling, general and administrative expenses decreased as a percentage of sales to 9.3% for the second quarter of fiscal 2006 from 12.4% for the same quarter of fiscal 2005.

Research and development expenses.Research and development expenses increased $0.3 million to $1.1 million for the second quarter of fiscal 2006 compared to $0.8 million for the second quarter of fiscal 2005. The increase in expenses was primarily due to higher prototypes expense on increased activity.

Loss (gain) from sale of property, plant and equipment.We recognized a net gain of $0.6 million on the sale of property, plant and equipment during the second quarter of fiscal 2006 due principally to the sale of a warehouse building in Woonsocket, Rhode Island ($0.5 million gain) and the sale of our facility in Sumter, South Carolina ($0.1 million gain).

Amortization of intangibles.Amortization of intangibles (consisting primarily of amortization of patents, technology licenses, tradenames, covenants not-to-compete and customer relationships) remained constant at approximately $0.2 million for the second quarter of fiscal 2006 compared to $0.2 million for the second quarter of fiscal 2005.

Restructuring costs.Restructuring charges decreased $0.1 million to $0.1 million for the second quarter of fiscal 2006 compared to $0.2 million for the second quarter of fiscal 2005. Fiscal 2006 restructuring charges related primarily to the Company’s relocation of its Allied Tool division from Michigan to Pennsylvania. The Company also incurred restructuring charges related to our Blow Mold Technology segment and the elimination of certain personnel in corporate selling, general and administrative, the cost relate primarily to employee severance costs. Fiscal 2005 restructuring charges were for severance costs relating to the Company’s United States Closures and Corporate divisions.

Income from operations.Reflecting the effect of the factors summarized above, income from operations increased $3.2 million to $2.7 million for the second quarter of fiscal 2006 compared to a loss from operations of $(0.5) million for the second quarter of fiscal 2005. Income (loss) from operations increased as a percentage of sales to 4.2% in the second quarter of fiscal 2006 compared to (0.8)% in the same period of fiscal 2005.

Other (income) expense.Other (income) expense includes interest income, interest expense, amortization of debt financing costs, foreign currency transactions, minority interest expense, equity (income) loss of unconsolidated affiliates and other expense, net.

Interest expense increased $0.2 million to $4.2 million for the second quarter of fiscal 2006 compared to $4.0 million for the second quarter of fiscal 2005. The increase is due to a slight increase in the amount outstanding on the senior secured credit facility as compared to February 28, 2005 and an increase in both the Prime and LIBOR interest rates of approximately 2.0%.

Amortization of debt issuance costs remained constant at $0.4 million for the three months ended February 28, 2006 and 2005. The amortization of debt issuance cost is consistent between periods due to the Company not incurring any additional cost related to issuance cost.

We recognized a gain of $0.7 million on foreign exchange transactions for the second quarter of fiscal 2006 compared to a gain of $0.4 million for the second quarter of fiscal 2005. The gain on foreign exchange transactions for the three months ended February 28, 2006 was due primarily to the United Kingdom pound sterling and the Canadian dollar performing stronger against the U.S. dollar. The gain in foreign exchange transactions for the three months ended February 28, 2005 is due primarily to the United Kingdom pound sterling performing stronger against the U.S. dollar.

Income tax expense.The income tax expense for the second quarter of fiscal 2006 was $0.9 million on loss before income taxes of $1.4 million, compared to $0.6 million on loss before income taxes of $4.6 million for the second quarter of fiscal 2005. Tax expense for the second quarter of fiscal 2006 is due primarily to our Blow Mold Technology and China operations, which had net income for the second quarter of fiscal 2006. Our effective tax rate differs from the U.S. statutory rate principally due to providing a valuation allowance against net deferred tax assets in our domestic jurisdictions as well as our China, Mexico and Czech operations.

Net loss.Net loss was $2.4 million for the second quarter of fiscal 2006 compared to a net loss of $5.2 million for the second quarter of fiscal 2005. The improvement in net loss was due primarily to a decrease in selling, general and administrative expense, a favorable foreign exchange effect and decreased labor and overhead expenses, partially offset by an increase in material costs and research and development expenses for the second quarter of 2006 compared to the same quarter of 2005.

Six months ended February 28, 2006 compared to the six months ended February 28, 2005

Sales.Sales increased $3.4 million to $129.3 million for the six months ended February 28, 2006 compared to $125.9 million for the six months ended February 28, 2005. Increased selling prices resulting from the higher cost of resin across all divisions that we were able to pass through to customers was a contributing factor to our increased sales compared to the same period of the prior year. Sales at our Blow Mold Technology operations increased $2.1 million primarily due to increased bottle volume through the sale of new products and customers and also a favorable foreign exchange rate. Sales at our China operations increased $2.1 million primarily due to increased cutlery and push-pull closures sales and the addition of cosmetic product sales. Sales at our Mexico operations increased $1.6 million due to increased bottle

volume and also a favorable foreign exchange rate. We also realized increased sales in our U.S. Closures operations by $2.0 million primarily due to increased selling prices, as we were able to pass through to customers increased resin costs. Offsetting these increases were decreased PTI sales of $1.7 million due to decreased orders from our customers. United Kingdom sales decreased $2.4 million due to an unfavorable foreign exchange rate, a decrease in volume due to the timing of customer orders and decreased equipment sales. U.S. Equipment sales, which include Allied Tool, decreased $0.3 million.

Gross profit.Gross profit increased $1.7 million to $19.7 million for the six months ended February 28, 2006 compared to $18.0 million for the six months ended February 28, 2005. The increase in gross profit was primarily due to lower overhead costs resulting from cost reduction activities in the U.S. Closures division and the closing of one plant in the Blow Mold Technology division as well as other productivity enhancements from our continuous improvement programs. Gross profit in the United States Closures and Corporate division increased by $2.1 million due primarily to a favorable product mix, employee cost reductions, productivity enhancements and cost reduction activities. China increased gross profit by $1.2 million due to increased sales in cutlery, push-pull closures and cosmetic products. These improvements were offset partially by decreased sales volume in the UK, lower sales volume at PTI and lower pricing and an unfavorable product mix in our Mexico operations. As a percentage of sales, gross profit increased to 15.2% for the six months ended February 28, 2006 from 14.3% for the same period of fiscal 2005.

For the six months ended February 28, 2006, direct materials, labor and overhead costs represented 46.7%, 16.1% and 22.0% of sales, respectively, compared to 44.0%, 17.9% and 23.8%, respectively, for the six months ended February 28, 2005. Direct material costs increased by $5.0 million for the six months ended February 28, 2006 compared to the six months ended February 28, 2005 due primarily to an increase in resin costs.

Selling, general and administrative expenses.Selling, general and administrative expenses decreased $1.3 million to $12.8 million for the six months ended February 28, 2006 compared to $14.1 million for the six months ended February 28, 2005. United States Closures and Corporate decreased by $1.3 million due primarily to reduced employee and overhead expenses at the Corporate division, partially offset by the dissolution of our MDC Plan and increased trade show expense and commission expense due to increased sales incentives. The reduction in these expenses has been primarily a result of various cost improvement programs that have been implemented by the Company. Selling, general and administrative expenses decreased as a percentage of sales to 9.9% for the six months ended February 28, 2006 from 11.2% for the same period of fiscal 2005.

In connection with the preparation of its financial statements for the quarter ended November 30, 2005, the Company determined that its MDC Plan, which it terminated in December 2005 in accordance with the December 31, 2005 transition period under Internal Revenue Code section 409A, had not been accounted for by the Company. In connection with terminating the MDC Plan, it was determined that the liability for plan benefits of $0.9 million exceeded plan assets of $0.6 million by $0.3 million. The amount of plan liability in excess of $0.3 million was charged to expense in the three-month period ended November 30, 2005. Had the Company been properly recording the MDC Plan since inception, $0.2 million of this amount would have been charged in years prior to fiscal 2006. However, the Company believes that the impact of not previously recording the MDC Plan was not material to the Company’s consolidated financial statements for any prior year or quarter. Further, the Company does not believe that the $0.2 relating to periods prior to fiscal 2006 is material to the consolidated financial statements for the first six months of fiscal 2006, or to the projected full year results for fiscal 2006.

Research and development expenses.Research and development expenses increased $0.1 million to $2.0 million for the six months ended February 28, 2006 compared to $1.9 million for the six months ended February 28, 2005. The increase in expenses was primarily due to higher prototypes expense on increased activity.

Loss (gain) from sale of property, plant and equipment.We recognized a net gain of $0.9 million on the sale of property, plant and equipment during the six months ended February 28, 2006 due to the sale of an office building in San Jose, California, a warehouse in Woonsocket, Rhode Island and our facility in Sumter, South Carolina. We sold the buildings and facilities for proceeds of $4.3 million resulting in a net gain of $1.0 million. Partially offsetting this gain was a loss on disposal of equipment located in our Sumter, South Carolina facility of $0.1 million.

Amortization of intangibles.Amortization of intangibles (consisting primarily of amortization of patents, technology licenses, tradenames, covenants not-to-compete and customer relationships) remained relatively constant at approximately $0.4 million for the six months ended February 28, 2006 compared to $0.5 million for the six months ended February 28, 2005.

Restructuring costs.Restructuring charges increased $0.3 million to $0.7 million for the six months ended February 28, 2006 compared to $0.4 million for the six months ended February 28, 2005. Fiscal 2006 restructuring charges related primarily to the Company’s relocation of its Allied Tool division from Michigan to Pennsylvania. The Company also incurred restructuring charges related to the Company’s corporate selling, general and administrative activities. Fiscal 2005 restructuring charges were for severance costs relating to the Company’s United States Closures and Corporate divisions.

Income from operations.Reflecting the effect of the factors summarized above, income from operations increased $3.7 million to $4.8 million for the six months ended February 28, 2006 compared to $1.1 million for the six months ended February 28, 2005. Income from operations increased as a percentage of sales to 3.7% in the six months ended February 28, 2006 compared to 0.8% in the same period of fiscal 2005.

Interest expense increased $0.4 million to $8.5 million for the six months ended February 28, 2006 compared to $8.1 million for the six months ended February 28, 2005. The increase is due to a slight increase in the amount outstanding on the senior secured credit facility as compared to February 28, 2005 and an increase in both the Prime and LIBOR interest rates of approximately 2.0%.

Amortization of debt issuance costs remained constant at $0.8 million for the six months ended February 28, 2006 and 2005. The amortization of debt issuance cost remained constant due to the Company not incurring any additional cost related to issuance cost and the current cost being amortized on the straight line method over the life of the loan.

We recognized a gain of $0.5 million on foreign exchange transactions for the six months ended February 28, 2006 compared to a gain of $2.4 million for the six months ended February 28, 2005. The gain on foreign exchange transactions for the six months ended February 28, 2006 was due primarily to the Canadian dollar performing stronger against the U.S. dollar. The gain in foreign exchange transactions for the six months ended February 28, 2005 is due primarily to

the United Kingdom pound sterling and the Canadian dollar performing stronger against the U.S. dollar.

Income tax expense.The income tax expense for the six months ended February 28, 2006 was $1.6 million on loss before income taxes of $4.0 million, compared to $1.5 million on loss before income taxes of $5.4 million for the six months ended February 28, 2005. Tax expense for the six months ended February 28, 2006 is due primarily to our UK, Blow Mold Technology and China operations, which had net income for the six months ended February 28, 2006. Our effective tax rate differs from the U.S. statutory rate principally due to providing a valuation allowance against net deferred tax assets in our domestic jurisdictions as well as our China, Mexico and Czech operations.

Net loss.Net loss was $5.7 million for the six months ended February 28, 2006 compared to a net loss of $6.9 million for the six months ended February 28, 2005. The improvement in net loss was due primarily to a reduction of labor and overhead expenses and decreased selling general and administrative expenses, partially offset by an unfavorable foreign exchange effect, increased resin costs not fully passed through to customers and restructuring charges for the six months ended February 28, 2006 compared to the same period of 2005.

Liquidity and capital resources

In recent years, we have relied primarily upon cash from operations and borrowings to finance our operations and fund capital expenditures and acquisitions. At February 28, 2006, we had cash and cash equivalents of $4.5 million, an increase of $2.5 million from August 31, 2005.

Operating activities.Cash provided by operations totaled $3.7 million for the six months ended February 28, 2006, which represented a $10.1 million increase from the $6.4 million used in operations for the six months ended February 28, 2005. The change in cash from operations is due to improved financial performance related to employee cost reductions programs, productivity enhancements and cost reduction activities; a decrease in overall accounts receivables from improved collections and a decrease in sales; increases in accruals for bonuses, due to improved financial performance; increases in legal and general accruals, due to timing of invoices; and a decrease in restructuring accrual as compared to 2005. Working capital (current assets less current liabilities) decreased by $0.8 million to $30.5 million as of February 28, 2006, compared to $31.3 million as of August 31, 2005.

Investing activities.Cash from investing activities netted close to zero for the six months ended February 28, 2006 compared to cash used in investing activities of $5.0 million for the six months ended February 28, 2005. For the six months ended February 28, 2006, cash provided by investing activities was primarily due to the proceeds from the sale of our office building in San Jose, California, the warehouse in Woonsocket, Rhode Island and our facility in Sumter, South Carolina, this was offset partially by additions to property, plant and equipment. For the six months ended February 28, 2005, net cash used in investing activities consisted of $5.0 million primarily related to additions to and sale of property, plant and equipment. We have budgeted approximately $13.5 million for additions to property, plant and equipment for the fiscal year ended August 31, 2006.

Financing activities.At February 28, 2006, we had total indebtedness of $203.0 million, $180.0 million of which was attributable to the Senior Notes. Of the remaining indebtedness, $22.9 million was attributable to our senior secured credit facility and $0.1 million was principally comprised of capital lease and other obligations.

On January 23, 2004, we completed an offering of $180.0 million in aggregate principal amount of Senior Notes. Interest payments of approximately $7.4 million are due semi-annually on February 1 and August 1 of each year. Interest began accruing January 23, 2004, and the first interest payment was made on August 1, 2004. The indenture under which the senior notes were issued contains covenants and provisions that restrict, among other things, our ability to: (i) incur additional indebtedness or issue preferred stock, (ii) incur liens on our property, (iii) make investments, (iv) enter into guarantees and other contingent obligations, (v) merge or consolidate with or acquire another person or engage in other fundamental changes, (vi) engage in certain sales of assets and subsidiary stock, (vii) engage in certain transactions with affiliates, (viii) engage in sale/leaseback transactions, (ix) engage in any business other than a related business, (x) make restricted payments, and (xi) declare or pay dividends.

Concurrently with the offering of the Senior Notes, we amended our credit agreement by entering into an amended and restated five-year senior revolving credit agreement that provided a secured credit facility of up to $50.0 million, maturing on January 23, 2009. We entered into an amendment to this agreement on May 21, 2004, a limited waiver and second amendment to this credit agreement on November 24, 2004 (the “November 24 Amendment”), a fifth amendment to the senior secured credit facility on April 4, 2005 (the “April 4 Amendment”), a sixth amendment to the senior secured credit facility on May 2, 2005 (the “May 2 Amendment”) and a seventh amendment to the senior secured credit facility on June 21, 2005 (the “June 21 Amendment”). The amended and restated credit agreement contains covenants and provisions that restrict, among other things, our ability to: (i) redeem warrants and repurchase stock, except during the first year, (ii) incur additional indebtedness, (iii) incur liens on our property, (iv) make investments, (v) enter into guarantees and other contingent obligations, (vi) merge or consolidate with or acquire another person or engage in other fundamental changes, or in certain sales of assets, (vii) engage in certain transactions with affiliates, (viii) make restricted junior payments, and (ix) declare or pay dividends. The June 21 Amendment, which superseded the April 4 Amendment and the May 2 Amendment and their covenants, revised the credit agreement as follows: (a) the borrowing base calculation is based on the product of trailing 12 month restricted EBITDA and a leverage multiple of 2.5 less any outstanding senior indebtedness, which excludes senior indebtedness evidenced by the Senior Notes and any guaranties thereof and excluding any fees, liabilities or other obligations payable with respect to such senior indebtedness; (b) we are required to maintain EBITDA for any 12-month period ending on the last day of each fiscal month, commencing with the fiscal month ending May 31, 2005, of at least $17.5 million; (c) we no longer are required to maintain a borrowing availability amount; and (d) the amount we can invest in certain specified subsidiaries was increased from $6.7 million to $8.5 million. The June 21 Amendment also eliminated the fixed charge coverage and senior leverage ratios. An unused fee is payable under the facility based on the total commitment amount less the average daily aggregate amount of outstanding liability, at the rate of 0.50% per annum. In addition, interest payable is based on, at our election, the Bank Prime Loan rate plus 1.50% or the LIBOR Loan rate plus 3.00% determined by a pricing table based on the outstanding credit facility balance.

Our senior secured credit agreement, as amended, and the indenture governing our Senior Notes contain a number of significant restrictions and covenants as discussed above. We were in compliance with these covenants at February 28, 2006, and believe that we will attain the projected results to ensure compliance with the covenants throughout fiscal 2006 and beyond. However, adverse changes in our operating results or other negative developments, such as significant increases in interest rates or in resin prices, severe shortages of resin supply or decreases in sales of our products could result in non-compliance with financial covenants in our senior secured credit agreement. If we violate these covenants and are unable to obtain waivers from our lender, we would be in default under the indenture and our secured credit agreement, and our lenders could accelerate our obligations thereunder. If our indebtedness is accelerated, we may not be able to repay these debts or borrow sufficient funds to refinance them. Even if we are able to obtain new

financing, it may not be on commercially reasonable terms, or terms that are acceptable to us. If our expectations of future operating results are not achieved, or our debt is in default for any reason, our business, liquidity, financial condition and results of operations would be materially and adversely affected. In addition, complying with these covenants may make it more difficult for us to successfully execute our business strategy and compete against companies who are not subject to such restrictions.

Cash and cash equivalents.In May 2004, appraisals of our property, plant and equipment assets in the U.S., Canada and the U.K. were completed. At that time, the value of these assets was included in the borrowing base of our revolving credit line, and that had the effect of increasing our borrowing capacity by approximately $15.0 million. As of February 28, 2006, we had $4.5 million in cash and cash equivalents, and our unused borrowing capacity under the senior secured credit facility was approximately $26.1 million.

We believe that our existing financial resources, together with our current and anticipated results of operations, will be adequate for the foreseeable future to service our secured and long-term debt, to meet our applicable debt covenants and to fund our other liquidity needs, but, for the reasons stated above, we cannot assure you that this will be the case. We have budgeted approximately $13.5 million for additions to property, plant and equipment for the fiscal year ended August 31, 2006. In addition, as the cost of resin increases substantially it results in increased inventory costs. Our cash flows from operations have varied over the years and along with our availability from our senior secured credit facility, we have been able to fund our operations and capital requirements, but this is not guaranteed in the future. Based on our current plan we should continue to have sufficient resources to meet our needs unless we experience some significant additional cash requirements. In this respect, we note that competitive pressures and costs of raw materials have not been favorable. Further, while we believe that these trends have stabilized, and we are beginning to achieve favorable results from our continuing efforts at reducing costs and implementing manufacturing and organizational efficiencies, we cannot assure you that substantial improvements will occur through the remainder of fiscal 2006 or beyond.

Contractual obligations

The following sets forth our contractual obligations as of February 28, 2006:


	Payments Due by Period
			Less than				3 - 5		More than
	Total		1 Year		1 - 3 Years		Years		5 Years
Contractual obligations:	(dollars in thousands)

Long-term debt, including current portion:
Senior Notes (1)	$	269,100	$	14,850	$	29,700	$	29,700	$	194,850
Revolver (2)	$	28,340	$	1,866	$	26,474	$	—	$	—
Capital lease obligations (3)	$	109	$	22	$	60	$	27	$	—
Operating lease obligations (4)	$	29,739	$	3,395	$	5,979	$	5,836	$	14,529


(1)		On January 23, 2004, we completed an offering of $180.0 million in aggregate principal amount of Senior Notes that mature on February 1, 2012 and bear interest at 8¹/4% per annum. Interest payments of approximately $7.4 million are due semi-annually on February 1 and August 1 of each year. Interest began accruing January 23, 2004 and the first interest payment was made August 1, 2004. The indenture governing the Senior Notes contains certain restrictive covenants and provisions. The table above includes an estimate of interest to be paid over the life of the loan.

(2)		Concurrently with the offering of $180.0 million in aggregate principal amount of our 8¹/4% Senior Notes due 2012 on January 23, 2004, we entered into an amended and restated five-year senior revolving credit facility of up to $50.0 million. The Company’s future compliance with the amended covenants is dependent upon the Company achieving its projected operating results in fiscal 2006 and beyond. If the Company does not achieve these projected results and all outstanding borrowings become immediately due and payable, the Company’s liquidity would be negatively affected. The table above includes an estimate of interest to be paid over the life of the loan.

(3)		We acquired certain machinery and office equipment under non-cancelable capital leases.

(4)		We lease certain office, production and warehouse facilities under operating lease agreements expiring on various dates through 2021. Under the terms of the facilities’ leases, we are responsible for common area maintenance expenses, which include taxes, insurance, repairs and other operating costs. Base rent expense for fiscal 2006 is estimated to be $4.7 million.

Related party transactions

We engage in certain related party transactions throughout the course of our business. Related party sales of $1.3 million and $1.7 million for the three months ended February 28, 2006 and 2005, respectively and $2.9 million and $3.5 million for the six months ended February 28, 2006 and 2005, respectively, consisted primarily of closures produced by our U.K. operations that were sold to our joint venture, CSE. For the three months ended February 28, 2005, the Company paid the base salary and legal expenses of $0.1 and for the six months ended February 28, 2005, the Company paid base salary and legal expenses of $0.1 million for services rendered by Themistocles G. Michos, the Company’s former Vice President and General Counsel. There have been no other significant additional related party transactions from those disclosed in “Item 13. – Certain Relationships and Related Transactions” and Note 15 of Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended August 31, 2005.

Recent accounting pronouncements

consolidated financial statements. In addition, the adoption of Statement No. 123(R) will require additional accounting related to the income tax effects and additional disclosure regarding the cash flow effects resulting from share-based payment arrangements. Statement No. 123(R) is effective for non public companies (as defined by SEC rules) for annual periods beginning after December 15, 2005. The Company is currently evaluating the impact of the adoption of Statement No. 123(R) and anticipates adoption under the modified prospective transition method allowable under Statement No. 123(R). In November 2005, the FASB issued Staff Position No. 123(R)-3, Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards, which provides an alternative (and simplified) method to calculate the pool of excess income tax benefits upon the adoption of Statement No. 123(R). We have not yet fully evaluated this new accounting guidance and, accordingly, the Company has not determined whether it will elect the alternative method thereunder.

In December 2004, the FASB issued Statement No. 153, Exchange of Nonmonetary Assets, an amendment of APB Opinion No. 29. Statement No. 153 addresses the measurement of exchanges of nonmonetary assets and redefines the scope of transactions that should be measured based on the fair value of the assets exchanged. Statement No. 153 is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. The Company’s adoption of Statement No. 153 had no impact on its financial position, results of operations or cash flows.

In February 2005, the FASB issued Emerging Issues Task Force (EITF) No. 04-10, “Determining Whether to Aggregate Segments That Do Not Meet the Quantitative Thresholds.” This statement clarifies the aggregation criteria of operating segments as defined in SFAS No. 131. The effective date of this statement is for fiscal years ending after September 15, 2005. The Company believes that its current segment reporting complies with EITF No. 04-10.

In May 2005, the FASB issued Statement No. 154, “Accounting Changes and Error Corrections.” This statement replaces APB 20 cumulative effect accounting with retroactive

restatement of comparative financial statements. It applies to all voluntary changes in accounting principle and defines “retrospective application” to differentiate it from restatements due to incorrect accounting. The provisions of this statement are effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company does not believe the adoption of Statement No. 154 will have a significant impact on its financial position, results of operations or cash flows.

Risk factors

The following risk factors may cause actual results to differ materially from those in any forward–looking statements contained in such business description or elsewhere in this report or made in the future by us or our representatives:

Risks related to our outstanding indebtedness

Our level of indebtedness could limit cash flow available for our operations and could adversely affect our ability to obtain additional financing.

As of February 28, 2006, our total indebtedness was approximately $203.0 million. $180.0 million of this amount represented the Senior Notes due 2012, $22.9 million represented funds drawn down under our senior secured credit facility and $0.1 million was principally composed of capital leases. Moreover, as of February 28, 2006 we have a total shareholders’ deficit of $63.2 million. Our level of indebtedness and limits on our ability to incur additional indebtedness under existing credit agreements could restrict our operations and make it more difficult for us to fulfill our obligations thereunder. Among other things, our level of indebtedness and restrictions on our indebtedness may:

	•		limit our ability to obtain additional financing for working capital, capital expenditures, strategic acquisitions and general corporate purposes;

	•		require us to dedicate all or a substantial portion of our cash flow to service our debt, which will reduce funds available for other business purposes, such as capital expenditures or acquisitions;

	•		limit our flexibility in planning for or reacting to changes in the markets in which we compete;

	•		place us at a competitive disadvantage relative to our competitors with less indebtedness;

	•		render us more vulnerable to general adverse economic and industry conditions; and

	•		make it more difficult for us to satisfy our financial obligations.

Nonetheless, at present, we and our subsidiaries may still be able to incur substantially more debt. The terms of our senior secured credit facility and the indenture governing our Senior Notes permit additional borrowings and such borrowings may be secured debt.

Our ability to service our debt and meet our cash requirements depends on many factors, some of which are beyond our control.

Our ability to satisfy our obligations will depend on our future operating performance and financial results, which will be subject, in part, to factors beyond our control, such as interest rates

and general economic, financial and business conditions. If we are unable to generate sufficient cash flow to service our debt, we may be required to:

	•		refinance all or a portion of our debt;

	•		obtain additional financing;

	•		sell certain of our assets or operations;

	•		reduce or delay capital expenditures; or

	•		revise or delay our strategic plans.

If we are required to take any of these actions, it could have a material adverse effect on our business, financial condition and results of operations. In addition, we cannot assure you that we would be able to take any of these actions, that these actions would enable us to continue to satisfy our capital requirements or that these actions would be permitted under the terms of our various credit agreements, including the indenture governing our Senior Notes.

The covenants in our senior secured credit facility and the indenture governing our Senior Notes impose restrictions that may limit our operating and financial flexibility.

Our senior secured credit facility and the indenture governing our Senior Notes contain a number of significant restrictions and covenants that limit our ability and our subsidiaries’ ability to:

	•		incur liens and debt or provide guarantees in respect of obligations of any other person;

	•		issue redeemable preferred stock and subsidiary preferred stock;

	•		make redemptions and repurchases of capital stock;

	•		make loans, investments and capital expenditures;

	•		prepay, redeem or repurchase debt;

	•		engage in mergers, consolidations and asset dispositions;

	•		engage in sale/leaseback transactions and affiliate transactions;

	•		change our business, amend certain debt and other material agreements, and issue and sell capital stock of subsidiaries; and

	•		make distributions to shareholders.

Future adverse changes in our operating results or other negative developments, such as increases in interest rates or in resin prices, shortages of resin supply or decreases in sales of our products, could result in our being unable to comply with the financial covenants in our senior secured credit facility. If we fail to comply with any of our loan covenants in the future and are unable to obtain waivers from our lenders, we could be declared in default under these agreements, and our lenders could accelerate our obligations thereunder. If our indebtedness is accelerated, we may not be able to repay our debt or borrow sufficient funds to refinance it. Even if we are able to obtain new financing, it may not be on commercially reasonable terms, or terms that are acceptable to us. In addition, complying with these covenants may make it more difficult for us to successfully

execute our business strategy and compete against companies who are not subject to such restrictions.

Our Senior Notes are effectively subordinated to all of our secured debt, and if a default occurs, we may not have sufficient funds to fulfill our obligations under the Senior Notes.

Our Senior Notes are not secured by any of our assets. The indenture governing the Senior Notes permits us to incur certain secured indebtedness, including indebtedness under our senior secured credit facility. If we become insolvent or are liquidated, or if payment under the credit facility or other secured indebtedness is accelerated, the lenders under the credit facility and the holders of any other secured indebtedness would be entitled to exercise the remedies available to them as secured creditors under applicable laws and pursuant to instruments governing such indebtedness. Accordingly, such secured indebtedness would have a prior claim on the collateral and would effectively be senior to the Senior Notes to the extent that the value of such collateral is sufficient to satisfy the indebtedness secured thereby. To the extent that the value of such collateral is not sufficient to satisfy the secured indebtedness, amounts remaining outstanding on such indebtedness would be entitled to share with holders of Senior Notes and other claims on us with respect to any of our other assets. In either event, because the Senior Notes are not secured by any of our assets, it is possible that there will be insufficient assets remaining from which claims of the holders of the Senior Notes could be satisfied. In addition, we cannot assure you that the guarantees from our subsidiary guarantors, or any guarantee delivered by a restricted subsidiary formed in the future, would not be subject to avoidance by another creditor as a fraudulent transfer or for other reasons. Our unrestricted subsidiaries do not guarantee our obligations under the Senior Notes. Upon liquidation of any unrestricted subsidiary, such obligations would be effectively subordinated to claims of such subsidiary’s creditors upon its assets. It is likely that this will also be the case for other unrestricted subsidiaries that we may form in the future. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations —Overview” of our Annual Report Form 10-K for the fiscal year ended August 31, 2005 for additional information regarding our restricted and unrestricted subsidiaries.

We may be unable to purchase our Senior Notes upon a change of control.

Upon a change of control of Portola (as defined in the indenture governing our Senior Notes), each holder of Senior Notes will have certain rights to require us to repurchase all or a portion of such holder’s Senior Notes. If a change of control were to occur, we cannot assure you that we would have sufficient funds to pay the repurchase price for all Senior Notes tendered by the holders thereof. In addition, a change of control would constitute a default under our senior secured credit facility and, since indebtedness under the credit facility effectively ranks senior in priority to indebtedness under the Senior Notes, we would be obligated to repay indebtedness under the credit facility in advance of indebtedness under our Senior Notes. Our repurchase of Senior Notes as a result of the occurrence of a change of control may be prohibited or limited by, or create an event of default under, the terms of other agreements relating to borrowings that we may enter into from time to time, including agreements relating to secured indebtedness. Failure by us to make or consummate a change of control offer would constitute an immediate event of default under the indenture governing the Senior Notes, thereby entitling the trustee or holders of at least 25% in principal amount of the then outstanding Senior Notes to declare all of the Senior Notes to be due and payable immediately; provided that so long as any indebtedness permitted to be incurred pursuant to the senior secured credit facility is outstanding, such acceleration shall not be effective until the earlier of (i) an acceleration of any such indebtedness under the credit facility or (ii) five business days after receipt by us of written notice of such acceleration. In the event all of the Senior Notes are declared due and payable, our ability to repay the Senior Notes would be subject to the limitations referred to above.

Risks related to our business

We have completed the integration of PTI with the beverage product elements of our Company, and we may not realize the anticipated benefits of this acquisition on a timely basis or at all.

The integration of PTI with our other operations has been completed. Nonetheless, we may not realize the expected operating efficiencies, growth opportunities and other benefits of the transaction that we anticipated at the time of the acquisition or may realize them later than planned. Our management was not initially experienced in the sales and marketing of CFT products, and we depend significantly on the sales and marketing capabilities of inherited PTI management. Although most of PTI’s management has continued in the roles they performed prior to the acquisition, we cannot assure you that they will continue to do so in the future.

The integration of PTI’s accounting records and systems into our own information and reporting systems has resulted in adjustments to PTI’s historical financial statements. We filed a form 8-K/A with the SEC on February 9, 2004 amending historical financial statements of PTI to adjust the amount of revenue and cost of sales previously reported on a Form 8-K/A filed with the SEC on December 4, 2003.

We may be subject to pricing pressures and credit risks due to consolidation in our customers’ industries, and we do not have long–term contracts with most of our customers.

The dairy, bottled water and fruit juice industries, which constitute our largest customer base from a revenue perspective, have experienced consolidations through mergers and acquisitions in recent years, and this trend may continue. We could experience additional customer concentration, and our results of operations would be increasingly sensitive to changes in the business of customers that represent an increasingly large portion of our sales or any deterioration of their financial condition. During fiscal 2005 our top ten customers accounted for approximately 39% of our sales. Consolidation has resulted in pricing pressures, as larger customers often have been able to make greater pricing and other demands over us.

We do not have firm long–term contracts covering a majority of our sales. Although customers that are not under firm contracts provide indications of their product needs and purchases on a periodic basis, they generally purchase our products on an order–by–order basis, and the relationship, as well as particular orders, can be terminated at any time. The loss or significant decrease in business or a change in the procurement practices of any of our major customers may produce pricing pressures that could have a material adverse effect on our business, results of operations and financial condition.

We are subject to competition in our markets.

We face direct competition in each of our product lines from a number of companies, many of which have financial and other resources that are substantially greater than ours. We are experiencing significant competition from existing competitors with entrenched positions, and we may encounter new competitors with respect to our existing product lines as well as with respect to new products we might introduce. We have experienced a negative impact due to competitor pricing, and this impact has accelerated during the past and current fiscal years. Further, numerous well–capitalized competitors might expand their product offerings, either through internal product development or acquisitions of our direct competitors. Such competitors could introduce products or establish prices for their products in a manner that could adversely affect our ability to compete. Additionally, from time to time, we also face direct competition from bottling companies, carton manufacturers and other food and beverage providers that elect to produce their own closures rather than purchase them from outside sources.

We are subject to the risk of changes in resin prices.

Our products are molded from various plastic materials, primarily low density polyethylene (“LDPE”) resin. LDPE resin, which is a broadly traded commodity, accounts for a significant portion of our cost of sales for closures. Plastic resins, including LDPE, are subject to substantial price fluctuations resulting from increasingly chronic shortages in supply and frequent increases in the prices of natural gas, crude oil and other petrochemical products from which resins are produced, as well as other factors. These factors will likely continue to materially adversely affect the price and timely availability of these raw materials. We have contracts with our three principal resin suppliers that provide for the adjustment of prices payable by us depending on periodic increases or decreases in published indices of national resin bulk pricing. The effects of resin price increases on us to a certain extent lag the market. Unprecedented significant resin price increases experienced during fiscal 2004, 2005 and for the first six months of fiscal 2006, have materially and adversely affected our gross margins and operating results. In the event that significant increases in resin prices continue in the future, we may not be able to pass such increases on to customers promptly in whole or in part. Such inability to pass on such increases, or delays in passing them on, would continue to have a material adverse effect on our sales and margins on a current or delayed basis. Most of our sales are either made to customers on a purchase order basis, which provide us with no assurance that we can pass on price increases to these customers, or pursuant to contracts that generally allow only quarterly price adjustments, which could delay our ability to pass on price increases to these customers, if at all. Moreover, even if the full amount of such price increases were passed on to customers, the increases would have the effect of reducing our gross margins. On the other hand, if resin prices decrease, customers typically would expect rapid pass–through of the decrease, and we cannot assure you that we would be able to maintain our gross margins.

We may not be able to arrange for sources of resin from our regular vendors or alternative sources in the event of an industry–wide general shortage of resins used by us, or a shortage or discontinuation of certain types of grades of resin purchased from one or more of our suppliers.

We are capital constrained, which has reduced our ability to make capital expenditures and has limited our flexibility in operating our business.

At February 28, 2006, we had cash and cash equivalents of $4.4 million. A significant portion of our cash and cash equivalents and cash from operations must be used to service our significant debt obligations, which includes $7.4 million in semi-annual interest payments with respect to our Senior Notes. In addition, our senior secured credit facility and the indenture governing our Senior Notes contain a number of significant restrictions and covenants that limit our ability and our subsidiaries’ ability to incur further indebtedness or make capital expenditures. We would also likely encounter difficulties in raising capital through an equity offering, particularly as a company whose stock is not publicly traded. As a result of our current financial position, we may be limited in our ability to allocate equipment and other resources to meet emerging market and customer needs and from time to time are unable to take advantage of sales opportunities for new products. Similarly, we are sometimes unable to implement cost-reduction measures that might be possible if we were able to bring on line more efficient plant and equipment. These limitations in operating our business could adversely affect our operating results and growth prospects.

We depend on new business development and international expansion.

We believe that growth has slowed in the domestic markets for our traditional beverage products. In order to increase our sales, we have intensified and streamlined domestic sales channels but we cannot assure you that these changes will cause improvements in sales. We believe we must also continue to develop new products in the markets we currently serve and new products in different markets and to expand in our international markets. Developing new products and expanding into new markets will require a substantial investment and involve additional risks. We cannot assure you that our efforts to achieve such development and expansion will be successful.

Expansion poses risks and potential adverse effects on our operating results, such as the diversion of management’s attention, the loss of key personnel and the risks of unanticipated problems and liabilities. We do not anticipate making acquisitions in the near future because of capital constraints and because, our senior credit facility imposes significant restrictions on our ability to make investments in or to acquire other companies.

Difficulties presented by non–U.S. economic, political, legal, accounting and business factors could negatively affect our interests and business efforts.

Approximately 54% of our sales for fiscal 2005 were derived from shipments to destinations outside of the United States or from our operations outside the United States. We intend to expand such exports and our international operations and customer base. Our sales outside of the United States generally involve longer payment cycles from customers than our sales inside the United States. Our operations outside the United States require us to comply with the legal requirements of foreign jurisdictions and expose us to the political consequences of operating in foreign jurisdictions. Our operations outside the United States are also subject to the following potential risks:

	•		difficulty in managing and operating such operations because of distance, and, in some cases, language and cultural differences;

	•		fluctuations in the value of the U.S. dollar that could increase or decrease the effective price of our products sold in U.S. dollars and might have a material adverse effect on sales or costs, require us to raise or lower our prices or affect our reported sales or margins in respect of sales conducted in foreign currencies;

	•		difficulty entering new international markets due to greater regulatory barriers than those of the United States and differing political systems;

	•		increased costs due to domestic and foreign customs and tariffs, adverse tax legislation, imposition or increases of withholding and other taxes on remittances and other payments by subsidiaries;

	•		credit risk or financial condition of local customers and distributors;

	•		potential difficulties in staffing and labor disputes;

	•		risk of nationalization of private enterprises;

	•		government embargoes or foreign trade restrictions such as anti–dumping duties;

	•		increased costs of transportation or shipping;

	•		ability to obtain supplies from foreign vendors and ship products internationally during times of crisis or otherwise;

	•		difficulties in protecting intellectual property;

	•		increased worldwide hostilities;

	•		potential imposition of restrictions on investments; and

•

local political, economic and social conditions such as hyper–inflationary conditions and political instability.

Any further expansion of our international operations would increase these and other risks. As we enter new geographic markets, we may encounter competition from the primary participants in those markets that may have significantly greater market knowledge and that may have substantially greater resources than we do. In addition, we conduct some of our international operations through joint venture arrangements in which our operational and financial control of the business are limited.

Adverse weather conditions could adversely impact our financial results.

Weather conditions around the world can have a significant impact on our sales. Unusually cool temperatures during a hot weather season in one or more of our markets have adversely affected, and could again adversely affect, sales of our products in those markets.

We are subject to risks that our intellectual property may not be adequately protected, and we may be adversely affected by the intellectual property rights of others.

We rely on a combination of patents and trademarks, licensing agreements and unpatented proprietary know–how and trade secrets to establish and protect our intellectual property rights. We enter into confidentiality agreements with customers, vendors, employees, consultants and potential acquisition candidates to protect our know–how, trade secrets and other proprietary information. However, these measures and our patents and trademarks may not afford complete protection of our intellectual property and it is possible that third parties may copy or otherwise obtain and use our proprietary information and technology without authorization or otherwise infringe on our intellectual property rights. We cannot assure you that our competitors will not independently develop equivalent or superior know–how, trade secrets or production methods.

We are involved in litigation from time to time in the course of our business to protect and enforce our intellectual property rights, and third parties from time to time initiate litigation against us asserting that our business infringes or violates their intellectual property rights. We cannot assure you that our intellectual property rights have the value that we believe them to have or that our products will not be found to infringe upon the intellectual rights of others. Further, we cannot assure you that we will prevail in any such litigation, or that the results or costs of any such litigation will not have a material adverse effect on our business. Any litigation concerning intellectual property could be protracted and costly and is inherently unpredictable and could have a material adverse effect on our business and results of operations regardless of its outcome.

A number of our patents relating to one of our closure product lines have expired in recent years. We believe that such expirations have, to varying effect, adversely affected our margins as competitors who have become free to imitate our designs have begun to compete aggressively

against us in the pricing of certain products. These adverse effects will only be partially ameliorated to the extent that we continue to obtain new patents.

The laws of certain countries in which our products or technology are or may be licensed may not protect our intellectual property rights to the same extent as the laws of the United States. The protection offered by the patent laws of foreign countries may be less protective than the United States patent laws.

Defects in our products could result in litigation and harm our reputation.

Many of our products are used to cap beverage and food products. From time to time in the past, we and other producers of similar products have received complaints from customers and end–consumers claiming that such products might cause or have almost caused injury to the end–consumer. In some instances, such claims have alleged defects in manufacture or faulty design of our closures. In the event an end–consumer suffers a harmful accident, we could incur substantial costs in responding to complaints or litigation. Further, if any of our products were found to be defective, we could incur damages and significant costs in correcting any defects, lose sales and suffer damage to our reputation.

Our customers’ products could be contaminated through tampering, which could harm our reputation and business.

Terrorist activities could result in contamination or adulteration of our customers’ products, as our products are tamper resistant but not tamper proof. We cannot assure you that a disgruntled employee or third party could not introduce an infectious substance into packages of our finished products, either at our manufacturing plants or during shipment of our products. Were our products or our customers’ products to be tampered with in a manner not readily capable of detection, we could experience a material adverse effect to our reputation, business, operations and financial condition.

Changes to government regulations affecting our products could harm our business.

Our products are subject to governmental regulation, including regulation by the Federal Food and Drug Administration and other agencies in the United States and elsewhere. A change in government regulation could adversely affect our business. We cannot assure you that federal, state or foreign authorities will not issue regulations in the future that could materially increase our costs of manufacturing certain of our products. Our failure to comply with applicable laws and regulations could subject us to civil remedies, including fines, injunctions, recalls, or seizures as well as potential criminal sanctions, which could have a material adverse effect on us.

Our business may be adversely affected by compliance obligations or liabilities under environmental, health and safety laws and regulations.

We are subject to federal, state, local and foreign environmental and health and safety laws and regulations that could result in liability, affect ongoing operations and increase capital costs and operating expenses in order to maintain compliance with such requirements. Some of these laws and regulations provide for strict and joint and several liability regarding contaminated sites. Such sites may include properties currently or formerly owned or operated by us and properties to which we disposed of, or arranged to dispose of, wastes or hazardous substances. Based on the information presently known to us, we do not expect environmental costs or contingencies to have a material adverse effect on us. We may, however, be affected by hazards or other conditions presently unknown to us. In addition, we may become subject to new requirements pursuant to

evolving environmental, and health and safety, laws and regulations. Accordingly, we cannot assure you that we will not incur material environmental costs or liabilities in the future.

We depend upon key personnel.

We believe that our future success depends upon the knowledge, ability and experience of our personnel. The loss of key personnel responsible for managing Portola or for advancing our product development could adversely affect our business and financial condition.

We are controlled by Jack L. Watts, a member of our Board of Directors, and J.P. Morgan Partners 23A SBIC, LLC, an affiliate of J.P. Morgan Securities Inc., and their interests may conflict with those of our other security holders.

Jack L. Watts (a member of our Board of Directors), and J.P. Morgan Partners 23A SBIC, LLC (an affiliate of J.P. Morgan Securities Inc., one of the initial purchasers of our Senior Notes) own a majority of our common stock. Robert Egan, a member of our Board of Directors, is a Senior Advisor to J.P. Morgan Partners, LLC and a Partner of J.P. Morgan Entertainment Partners, LLC, each of which is an affiliate of J.P. Morgan Partners 23A SBIC, LLC. The interests of Mr. Watts, Mr. Egan and J.P. Morgan Partners 23A SBIC, LLC may not in all cases be aligned with the interests of our security holders. We currently have two independent directors on our Board of Directors. Our Board of Directors and Compensation Committee have not met the standard “independence” requirements that would be applicable if our equity securities were traded on NASDAQ or the New York Stock Exchange, but the Audit Committee does. We have engaged in a number of related party transactions. For example, from 1999 through 2002, we engaged in several transactions with Sand Hill Systems, Inc., an entity in which Mr. Watts and other of our officers and directors had a financial interest. See “Item 13—Certain Relationships and Related Transactions” and Note 15 of the Notes to Consolidated Financial Statements of our Annual Report on Form 10-K for the fiscal year ended August 31, 2005.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risk related to changes in interest rates, foreign currency exchange rate, credit risk and resin prices. We do not use derivative financial instruments for speculative or trading purposes. There have been no material changes in market risk related to changes in interest rates from that which was those disclosed in our Annual Report on Form 10-K for the fiscal year ended August 31, 2005.

Interest rate sensitivity

We are exposed to market risk from changes in interest rates on long–term debt obligations and we manage such risk through the use of a combination of fixed and variable rate debt. Currently, we do not use derivative financial instruments to manage our interest rate risk.

Exchange rate sensitivity

Our foreign subsidiaries use the local currency as their functional currency. Assets and liabilities are translated at month–end exchange rates. Income and expense items are translated at average exchange rates for the relevant periods. Translation gains and losses are not included in determining net income (loss) but are accumulated as a separate component of shareholders’ equity (deficit). Gains (losses) arising from foreign currency transactions are included in determining net income (loss). During the three and six months ended February 28, 2006, we incurred a gain of $0.7 million and $0.5 million arising from foreign currency transactions. To date, we have not entered

into any foreign currency forward exchange contracts or other derivative financial instruments relative to foreign currency exchange rates.

Credit risk sensitivity

Financial instruments which potentially subject us to concentrations of credit risk consist principally of cash and cash equivalents and trade receivables. Our cash and cash equivalents are concentrated primarily in several United States banks. At times, such deposits may be in excess of insured limits. Management believes that the financial institutions which hold our financial instruments are financially sound and, accordingly, minimal credit risk exists with respect to these financial instruments.

Our products are principally sold to entities in the beverage, food and CFT industries in the United States, Canada, the United Kingdom, Mexico, China, Australia, New Zealand and throughout Europe. Ongoing credit evaluations of customers’ financial condition are performed and collateral is generally not required. We maintain reserves for potential credit losses which, on a historical basis, have not been significant. One Canadian customer accounted for 11% and 10% of sales for the three and six months ended February 28, 2006 and 9% of accounts receivable at February 28, 2006. There were no customers that accounted for 10% or more of sales for the three and six months ended February 28, 2005.

Resin price sensitivity

The majority of our products are molded from various plastic resins that comprise a significant portion of our cost of sales. These resins are subject to substantial price fluctuations, resulting from shortages in supply, changes in prices in petrochemical products and other factors. During fiscal 2005 and the first six months of fiscal 2006, we experienced unprecedented significant increases in resin prices. In the past, we generally have been able to pass on increases in resin prices directly to our customers after delays required in many cases because of governing contractual provisions. Significant increases in resin prices coupled with an inability to promptly pass such increases on to customers could have a material adverse impact on us. The significant resin price increases we experienced during fiscal 2004, 2005 and for the three and six months ended February 28, 2006, have materially and adversely affected our gross margins and operating results for those periods. See “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations.”

ITEM 4. CONTROLS AND PROCEDURES.

Evaluation of disclosure controls and procedures

We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a–15e of the Securities Exchange Act of 1934 (the “Exchange Act”). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of February 28, 2006, the end of the period covered by this report, our disclosure controls and procedures were effective in timely alerting them to material information relating to Portola (including its consolidated subsidiaries) required to be included in our Exchange Act filings and to ensure that information required to be disclosed by us in the reports we file under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC’s rules and forms.

Changes in internal control over financial reporting

During the quarter ended February 28, 2006, there were no changes in our internal control over financial reporting that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Limitations on effectiveness of controls and procedures

Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Portola have been detected. These inherent limitations include, but are not limited to, the realities that judgments in decision–making can be faulty and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost–effective control system, misstatements due to error or fraud may occur and not be detected.

PART II — OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

In the normal course of business, we are subject to various legal proceedings and claims. Based on the facts currently available the liability, if any, for such proceedings cannot be estimated. Management believes that, subject to the qualifications expressed in the following paragraph, the ultimate amount of liability beyond reserves provided, if any, for any such pending actions in the ordinary course of business will not have a material adverse effect on our financial position, results of operations or liquidity.

We are currently a defendant in a suit filed by Blackhawk Molding Co., Inc. on August 28, 2003 in the U.S. District Court for the Northern District of Illinois, Eastern Division. Blackhawk Molding alleges that a “single-stick” label attached to our five–gallon caps causes our caps to infringe a patent held by it and is seeking damages. We have answered the complaint denying all allegations and asserting that Portola’s products do not infringe the Blackhawk patent and that the patent is invalid. The Court has completed the first phase of claim construction. Fact and expert witness discovery has substantially been completed. The Court denied the parties’ various motions for summary judgment, except it granted Blackhawk’s motion for summary judgment on infringement and inequitable conduct, but ruled that the issue of whether Blackhawk’s patent is valid must be tried. Pre-trial proceedings and the trial are not scheduled at this time. The ultimate outcome of this action is uncertain and cannot be reasonably estimated because the standard for damages has not been determined yet and will depend on facts and circumstances to be introduced at trial. An unfavorable outcome in this action could result in our sustaining material damages to our financial position, results of operations and liquidity. In addition, any litigation concerning intellectual property could be protracted and costly and could have a material adverse effect on our business and results of operations regardless of its outcome.

ITEM 6. EXHIBITS

Exhibits

	10.34		Employment and Options Agreement with Brian J. Bauerbach

	31.01		Certification of Brian J. Bauerbach, Chief Executive Officer of Portola Packaging, Inc., pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

	31.02		Certification of Michael T. Morefield, Chief Financial Officer of Portola Packaging, Inc., pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

	32.01		Certification of Brian J. Bauerbach, Chief Executive Officer of Portola Packaging, Inc., and Michael T. Morefield, Chief Financial Officer of Portola Packaging, Inc., pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes – Oxley Act of 2002

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


		PORTOLA PACKAGING, INC.
		(Registrant)

Date: April 13, 2006		/s/ Michael T. Morefield
		Michael T. Morefield
		Senior Executive Vice President and
		Chief Financial Officer
		(Principal Financial and Accounting Officer
		and Duly Authorized Officer)

EXHIBIT INDEX


Exhibit
Number		Exhibit Title

10.34		Employment and Option Agreement with Brian J. Bauerbach

31.01		Certification of Brian J. Bauerbach, Chief Executive Officer of Portola Packaging, Inc., pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.02		Certification of Michael T. Morefield, Chief Financial Officer of Portola Packaging, Inc., pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.01		Certification of Brian J. Bauerbach, Chief Executive Officer of Portola Packaging, Inc., and Michael T. Morefield, Chief Financial Officer of Portola Packaging, Inc., pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes – Oxley Act of 2002

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	8th grade Avg

Portola Packaging Inactive 10-Q2006 Q2 Quarterly report

Content analysis