UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

For the quarterly period ended June 30, 2004

OR

For the transition period from _____ to _____

Commission File Number 0-23340

Rock-Tenn Company

Registrant’s telephone number, including area code: (770) 448-2193

N/A
(Former name, former address and former fiscal year if changed since last report.)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x   No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x  No o

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

ROCK-TENN COMPANY

INDEX

PART I: FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

ROCK-TENN COMPANY

See accompanying Notes to Condensed Consolidated Financial Statements

ROCK-TENN COMPANY

See accompanying Notes to Condensed Consolidated Financial Statements

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ROCK-TENN COMPANY

See accompanying Notes to Condensed Consolidated Financial Statements

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ROCK-TENN COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Unaudited)
(In Thousands)

Supplemental schedule of non-cash investing and financing activities:

In the first nine months of fiscal 2004, we paid $1.3 million, primarily for additional consideration due to the August 2003 acquisition of PCPC, Inc., d/b/a Pacific Coast Packaging Corp. (which we refer to as “Pacific Coast Packaging”). The payment represented an adjustment based on the achievement of certain sales levels for the six-month period following the closing of the transaction. We recorded this payment as goodwill.

In the first nine months of fiscal 2003, we paid $65.3 million for the purchase of Groupe Cartem Wilco Inc. (which we refer to as “Cartem Wilco”), and made additional payments to Athena Industries, Inc. and Advertising Display Company, Inc. totaling $1.1 million. In conjunction with these acquisitions, we assumed the following liabilities:

See accompanying Notes to Condensed Consolidated Financial Statements

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ROCK-TENN COMPANY

Unless the context otherwise requires, “we,” “us,” “our” and “the Company” refer to the business of Rock-Tenn Company and its consolidated subsidiaries, including RTS Packaging, LLC, which we refer to as “RTS.” We own 65% of RTS and conduct our interior packaging products business through RTS. These terms do not include Seven Hills Paperboard, LLC, which we refer to as “Seven Hills.” We own 49% of Seven Hills, a manufacturer of gypsum plasterboard liner, which we do not consolidate for purposes of our financial statements.

Note 1. Interim Financial Statements

Our independent auditors have not audited the accompanying condensed consolidated financial statements of the Company. We derived the condensed consolidated balance sheet at September 30, 2003 from the audited consolidated financial statements. In the opinion of our management, the condensed consolidated financial statements reflect all adjustments, which are of a normal recurring nature, necessary for a fair presentation of our results of operations for the three and nine month periods ended June 30, 2004 and 2003, our financial position at June 30, 2004 and September 30, 2003, and our cash flows for the nine month periods ended June 30, 2004 and 2003.

We have condensed or omitted certain notes and other information from the interim financial statements presented in this Quarterly Report on Form 10-Q. Therefore, these financial statements should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended September 30, 2003 (the “Fiscal 2003 Form 10-K”) and each of the Quarterly Reports on Form 10-Q for the quarters ended December 31, 2003 and March 31, 2004.

The results for the three and nine months ended June 30, 2004 are not necessarily indicative of results that may be expected for the full year.

We have made certain reclassifications to prior year amounts to conform such amounts to the current year presentation.

Note 2. Summary of Significant Accounting Policies

Investment in Corporate Joint Venture

During 2000, we formed a joint venture (“Seven Hills”) with Lafarge North America, Inc. (“Lafarge”). We contributed cash and a paper machine located at our Lynchburg, Virginia paper mill. Lafarge contributed cash. Subsequent to the formation of Seven Hills, the Company and Lafarge made additional cash contributions. We have invested a total of $23.0 million in Seven Hills as of June 30, 2004. We use the equity method to account for our 49% investment in Seven Hills. Under the equity method, we initially recorded our investment at cost, then subsequently reduced the recorded amount by distributions and increased or decreased the amount by our proportionate share of Seven Hills’ net earnings or losses. The partners of the joint venture guaranteed funding of Seven Hills’ net losses in relation to their proportionate share of ownership. Under the terms of the Seven Hills joint venture arrangement, Lafarge is required to purchase all of the gypsum plasterboard liner produced by Seven Hills. A Managing Board that has equal representation by Lafarge and the Company manages Seven Hills. We provide all labor, supervision, management, executive and administrative services necessary to operate Seven Hills. We also lease the land and building occupied by Seven Hills. Our share of cumulative losses by Seven Hills as of June 30, 2004 and 2003 was $1.6 million and $1.7 million, respectively. Under the terms of the joint venture agreement, Lafarge has the option to put, at an amount determined by a formula, its interest in Seven Hills to us at any time after the expiration of six years from March 29, 2001, the date that the Seven Hills’ paper machine was converted to produce gypsum plasterboard liner. Upon the adoption of FIN 46R on March 31, 2004 (see Note 3 to the Condensed Consolidated Financial Statements under the heading “New Accounting Standards”), we determined that Seven Hills is a variable interest entity, but we are not its primary beneficiary. Accordingly, we will continue to account for Seven Hills using the equity method.

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Note 3. New Accounting Standards

In December 2003, the Financial Accounting Standards Board (which we refer to as the “FASB”) released revised FASB Statement
No. 132(R), Employers’ Disclosures about Pensions and Other Postretirement Benefits (which we refer to as “SFAS 132R”). We adopted this standard as of January 1, 2004. SFAS 132R requires additional disclosures to those required in the original SFAS 132 about the assets, obligations, cash flows and net periodic benefit costs of defined benefit pension plans and other defined benefit postretirement plans, including new disclosures in interim financial reports. We have included the new interim disclosures in Note 13 to the Condensed Consolidated Financial Statements under the heading “Retirement Plans.” Our adoption of SFAS 132R did not have a material effect on our consolidated financial statements.

In December 2003, the FASB issued revised FASB Interpretation No. 46(R), Consolidation of Variable Interest Entities, an Interpretation of ARB 51 (which we refer to as “FIN 46R”). We adopted this interpretation on March 31, 2004 for any variable interest entities (which we refer to as “VIEs”) in which we hold a variable interest that we acquired before February 1, 2003. We have not acquired any variable interests since that date. The only VIE in which we believe we hold a variable interest is the Seven Hills joint venture with Lafarge that is discussed in Note 2 to the Condensed Consolidated Financial Statements under the heading “Investment in Corporate Joint Venture.”

Note 4. Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and the differences could be material.

The most significant accounting estimates inherent in the preparation of our financial statements include estimates associated with our evaluation of the recoverability of goodwill and property, plant and equipment as well as those that we use in the determination of taxation, insurance and restructuring. In addition, significant estimates form the basis for our reserves with respect to collectibility of accounts receivable, inventory valuations, pension benefits, and certain benefits provided to current employees. Various assumptions and other factors underlie the determination of these significant estimates. The process of determining significant estimates is fact specific and takes into account factors such as historical experience, current and expected economic conditions, product mix, and in some cases, actuarial techniques. We constantly re-evaluate these significant factors and make adjustments where facts and circumstances dictate.

Note 5. Comprehensive Income (Loss)

The following were the components of comprehensive income (loss) (in thousands):

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The change in other comprehensive income (loss) was primarily due to the fluctuation in the Canadian/U.S. dollar exchange rate and an increase in our overall investment in Canada as a result of our acquisition of Cartem Wilco in January 2003. The third quarter of fiscal 2004 was impacted as the exchange rate moved to 1.3339 at June 30, 2004 from 1.3111 at March 31, 2004. The third quarter of fiscal 2003 was impacted as the exchange rate moved to 1.3475 at June 30, 2003 from 1.4699 at March 31, 2003.

The nine months ended June 30, 2004 was impacted as the exchange rate moved to 1.3339 at June 30, 2004 from 1.3493 at September 30, 2003. The nine months ended June 30, 2003 was impacted as the exchange rate moved to 1.3475 at June 30, 2003 from 1.5870 at September 30, 2002.

Note 6. Earnings (Loss) per Share

The following table sets forth the computation of basic and diluted earnings (loss) per share (in thousands, except per share data):

We had a net loss from continuing operations for the three months ended June 30, 2004. In applying the treasury stock method for that period, we have not included the dilutive effect of stock options and awards in the denominator because the effect would be antidilutive. There were 542 shares of dilutive stock options and awards excluded from the denominator for the three months ended June 30, 2004.

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Note 7. Restructuring and Other Costs

We recorded pre-tax restructuring and other costs of $21.3 million and $27.1 million for the third quarter of fiscal 2004 and the nine months ended June 30, 2004, respectively. We recorded pre-tax charges of $0.6 million and $0.9 million for the third quarter of fiscal 2003 and the nine months ending June 30, 2003, respectively. We discuss these charges in more detail below.

Fiscal 2004

Quarter Ended June 30, 2004

During the third quarter of fiscal 2004, we announced the closure of the laminated paperboard product converting lines at our Aurora, Illinois facility and recorded a pre-tax charge of $4.3 million. The charge consisted of an asset impairment charge of $3.6 million to reduce the undepreciated cost of the equipment to its estimated fair value less cost to sell, severance and other employee costs of $0.5 million, and a pension curtailment of $0.2 million. We expect to terminate the employment of approximately 93 employees. We estimate that laminated paperboard products sales at the facility for the nine-month periods ended June 30, 2004 and June 30, 2003 were approximately $14.5 million and $12.5 million, respectively. We cannot separately identify operating losses from these products lines because the facility manufactures other items and utilizes shared services. However, we estimate pre-tax operating losses of laminated paperboard products at the facility for the same nine-month periods were approximately $3.8 million and $2.3 million, respectively. We do not anticipate consolidating the majority of the sales from these products lines into our other facilities.

We announced the closure of our Otsego, Michigan, recycled paperboard mill on July 7, 2004. We recorded a $14.6 million pre-tax charge in the third quarter of fiscal 2004 that consisted of an asset impairment charge of $13.9 million to write down the equipment and facility to fair value, $0.4 million for property, plant and equipment related parts and supplies, and a pension curtailment of $0.3 million. We expect to terminate the employment of approximately 108 employees. We did not record severance in the third quarter of fiscal 2004 because we had not yet communicated the plan to the employees. We expect to record severance of $1.0 million in the fourth quarter of fiscal 2004. A significant portion of the capacity of this facility supported the laminated paperboard product facilities we closed this fiscal year. We expect to shift approximately one third of the volume of this facility to our remaining recycled paperboard facilities. Net sales at the facility for the nine-month period ended June 30, 2004 and June 30, 2003 were approximately $5.4 million and $6.2 million, respectively. Pre-tax operating losses at the facility for the same nine-month periods were approximately $2.9 million and $0.6 million, respectively.

During the quarter, we consolidated our laminated paperboard products division and mill division under common management and reduced the size of the combined divisional staffs. We refer to the combined division as the paperboard division. We recorded a charge of $0.5 million in the quarter for severance and other employee costs.

In connection with the shutdown of the laminated paperboard product converting lines at our Aurora, Illinois facility and our decision to close our Otsego, Michigan, facility we completed step 1 of the impairment test for the paperboard division as required under Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets (“SFAS 142”),” and determined the goodwill of the paperboard division was not impaired.

In addition, we recorded a variety of charges in the quarter primarily from previously announced facility closures totaling $1.1 million. The charges consisted primarily of $0.8 million for machinery and equipment impairments, $0.2 million for equipment relocation, and $0.1 million of carrying costs.

During the third quarter of fiscal 2004, we reviewed our corporate structure and reorganized our subsidiaries, reducing the number of corporate entities and the complexity of the organizational structure. We recorded expenses of $0.8 million in connection with this project. We expect to complete the reorganization process over the next two quarters at an additional cost of approximately $0.6 million.

We expect to incur future restructuring and other costs of $3.8 million related to our previously announced initiatives, including the amounts disclosed above. These costs will primarily consist of $1.4 million for severance and other employee costs, $0.6 million for tax reorganization expenses, $0.5 million for equipment removal and relocation costs, $0.5 million for facility carrying costs, and $0.8 million for other expenses.

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Nine Months Ended June 30, 2004

During the nine months ended June 30, 2004, we recorded a pre-tax charge of $27.1 million. The charge consisted primarily of the following: $14.6 million for the closure of our Otsego facility; $4.3 million for the closure of laminated paperboard product converting lines at our Aurora facility; $7.8 million for the closure of our Wright City, Missouri, laminated paperboard products facility that consisted of an asset impairment charge of $6.7 million to record the equipment and facility at their estimated fair value less cost to sell, a goodwill impairment charge of $0.2 million, severance and other employee costs of $0.4 million, and other costs of $0.5 million.

During the period, we also recorded a $1.8 million pre-tax gain on the sale of our Mundelein, Illinois, merchandising displays facility site; reduced the size of the paperboard division staff and recorded a charge of $0.5 million for severance and other employee costs; recorded a charge of $0.8 million in connection with a project to review our corporate structure and reorganize our subsidiaries; and incurred a variety of charges totaling $0.9 million primarily from previously announced closures. These charges consisted primarily of $0.6 million for machinery and equipment impairments, $0.2 million for equipment relocation, and $0.1 million of carrying costs.

The following table represents a summary of the restructuring accrual as well as a reconciliation of the restructuring accrual to the line item “Restructuring and other costs” on our condensed consolidated statements of operations for the nine months ended June 30, 2004 (in thousands):

Fiscal 2003

Quarter Ended June 30, 2003

During the third quarter of fiscal 2003, we recorded a pre-tax charge of $0.6 million. The charge consisted primarily of $0.4 million for equipment relocation charges with $0.2 million at our Mundelein, Illinois, merchandising displays facility, $0.1 million at our Dallas, Texas, paperboard mill, and $0.1 million at our Vineland, New Jersey, laminated paperboard product converting operation; and $0.2 million for equipment impairment at our St. Paul, Minnesota, folding carton facility.

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Nine Months Ended June 30, 2003

During the nine months ended June 30, 2003, we recorded a pre-tax charge of $0.9 million, net of a gain for accrual adjustments of $1.1 million on previously announced facility closings. The $1.1 million gain resulted primarily from $0.3 million in accrual reversals for excess employee severance and other employee benefits, due primarily to voluntary employee terminations and employees who worked longer than planned in the notice period at our Vineland facility and $0.8 million in accrual reversals resulting from the earlier than planned sales of property and reduced costs associated with our Augusta, Georgia, folding carton facility ($0.2 million), our El Paso, Texas, folding carton facility ($0.1 million) and our Vineland facility ($0.5 million). Partially offsetting these accrual adjustments were $2.0 million of charges from previously announced facility closures consisting primarily of the following: a $1.6 million charge for equipment relocation expenses primarily associated with our facilities at Vineland ($0.8 million), El Paso ($0.3 million), Mundelein ($0.2 million), and Dothan ($0.2 million), and at other facilities ($0.1 million); a $0.4 million charge for the equipment impairment at our St. Paul, Minnesota, folding carton facility; a net gain of $0.5 million on the sale of property and equipment at our Vineland facility; a charge of $0.2 million for the loss on the sale of property and equipment at our Augusta facility; and other costs of $0.3 million.

The following table represents a summary of the restructuring accrual as well as a reconciliation of the restructuring accrual to the line item “Restructuring and other costs” on our condensed consolidated statements of operations for the nine months ended June 30, 2003 (in thousands):

Note 8. Discontinued Operations

In the first quarter of fiscal 2004, we completed the sale of our plastic packaging products division and the sale of certain assets and liabilities that we acquired in the January 2003 Cartem Wilco acquisition that were associated with a small folding carton and label plant in Quebec. The plastic packaging products division transaction closed effective October 27, 2003 and we received proceeds of approximately $59.0 million. As a result of the transaction, we recorded an after-tax gain of approximately $7.1 million. In the third quarter of fiscal 2004, we reached agreement with the purchaser of the plastic packaging products division on the final working capital adjustment and, as a result, we recorded an after-tax gain of approximately $0.4 million. The sale of certain Cartem Wilco assets and liabilities, effective December 1, 2003, resulted in no gain or loss and we received proceeds of approximately $2.9 million.

We expect to incur additional expenses totaling approximately $0.1 million in the fourth quarter of fiscal 2004 primarily related to severance and other related employee costs for employees required to render future service as part of the plastic packaging products division sale. We are expensing these costs ratably over the future service period, which we expect to expire in the fourth quarter of fiscal 2004.

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Note 9. Stock Option Plans

We have elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (which we refer to as “APB 25”), and related interpretations in accounting for our employee stock options. Under APB 25, because the exercise price of our employee stock options equals the market price of the underlying stock on the date of grant, we generally recognize no compensation expense.

Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (which we refer to as “SFAS 123”), requires disclosure of pro forma information regarding net income and earnings per share. SFAS 123 also requires that we determine the information as if we had accounted for our employee stock options granted subsequent to September 30, 1995 under the fair value method of that statement. We estimated, at the date of grant, the fair values for the options we granted subsequent to September 30, 1995, using a Black-Scholes option pricing model with the following weighted average assumptions:

We had a net loss from continuing operations for the three months ended June 30, 2004. In applying the treasury stock method for that period, we have not included the dilutive effect of stock options and awards in the denominator because the effect would be antidilutive.

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Note 10. Inventories

We state substantially all of our U.S. inventories at the lower of cost or market, with cost determined on the last-in, first-out (LIFO) basis. We value all other inventories at the lower of cost or market and determine cost using methods that approximate cost computed on a first-in, first-out (FIFO) basis. It is possible to make an actual valuation of inventory under the LIFO method only at the end of each fiscal year based on the inventory levels and costs at that time. Accordingly, we must base interim LIFO estimates on management’s projection of expected year-end inventory levels and costs.

Inventories were as follows (in thousands):

Note 11. Assets and Liabilities Held for Sale

The assets we recorded as held for sale at June 30, 2004 consisted of property, plant and equipment from a variety of plant closures. The assets we recorded as held for sale at September 30, 2003 were our plastic packaging products division’s assets and liabilities, and some of the assets and liabilities from the our Cartem Wilco acquisition, which we recorded at fair value less costs to sale. During the first quarter of fiscal 2004, we sold in separate transactions our plastic packaging products division and certain Cartem Wilco assets and liabilities, as discussed in Note 8 to the Condensed Consolidated Financial Statements under the heading “Discontinued Operations.”

Assets and liabilities held for sale were as follows (in thousands):

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Note 12. Debt

Debt, excluding the realized interest rate swap gains and the mark-to-market value of interest rate swaps totaling $9.6 million and $23.9 million, respectively, consisted of the following (in thousands):

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Note 13. Retirement Plans

The following table represents a summary of the components of net pension cost (in thousands):

During the nine months ended June 30, 2004, we contributed $19.6 million to our retirement plans in order to maintain 90% funded status according to Internal Revenue Service guidelines. During that period, we also reimbursed $0.1 million of expenses to our plans. During the nine months ended June 30, 2003, we contributed $22.7 million to our retirement plans.

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Note 14. Commitments and Contingencies

Environmental

We previously disclosed that we entered into an administrative consent order pursuant to which we were making improvements to the wastewater treatment system at our paperboard mill in Otsego, Michigan. On July 7, 2004, we announced that we closed the Otsego mill. We now anticipate that our total costs with respect to the wastewater treatment system will be $1.0 million less than we previously estimated would be necessary to improve the system because we will no longer be required to install a new biological treatment system. We estimate that the total cost of the wastewater treatment system project at the Otsego mill, including upgrades to date and costs to shut down the system, will total approximately $2.5 million. As of June 30, 2004, we had incurred $2.2 million to upgrade the wastewater treatment system at the Otsego mill. We have accrued the remaining $0.3 million.

Seven Hills Arbitration

We have agreed with Lafarge, our partner in the Seven Hills joint venture, to enter into arbitration with respect to the price of gypsum plasterboard liner that Seven Hills is entitled to charge Lafarge from November 2002 going forward. The arbitration will also determine certain amounts that we are entitled to recover from Seven Hills for certain services that we rendered to Seven Hills. We expect the arbitration to commence during the second quarter of fiscal 2005. While we are unable to predict with certainty the outcome of the arbitration, management believes that it is unlikely that the final determination will materially affect our financial results.

Guarantees

In November 2002, the FASB issued FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (which we refer to as “FIN 45”). We have made the following guarantees to unconsolidated third parties:

Over the past several years, we have disposed of assets and subsidiaries and have assigned liabilities pursuant to asset and stock purchase agreements. These agreements contain various representations and warranties relating to matters such as title to assets; accuracy of financial statements; legal proceedings; contracts; employee benefit plans; compliance with environmental law; patent and trademark infringement; taxes; and products, as well as various covenants. These agreements may also provide specific indemnities for breaches of representations, warranties, or covenants as well as specific indemnification provisions. These indemnification provisions address a variety of potential losses, including, among others, losses related to liabilities other than those assumed by the buyer and liabilities under environmental laws. These indemnification provisions may be affected by various conditions and external factors. Many of the indemnification provisions issued or modified before December 31, 2002 have expired either by operation of law or as a result of the terms of the agreement. We have not recorded any liability for the indemnifications issued or modified before December 31, 2002, and are not aware of any claims or other information that would give rise to material payments under such indemnities. Because of the lapse of time, or the fact that the parties have resolved certain issues, we are not aware of any outstanding indemnities issued or modified before December 31, 2002, the potential exposure for which we estimate would have a material impact on our results of operations, financial condition or cash flows. Under the terms of the agreements that were issued or modified after December 31, 2002, our specified maximum aggregate potential liability on an undiscounted basis is approximately $6.0 million, other than with respect to certain specified liabilities, including liabilities relating to environmental matters, with respect to which there is no limitation. We estimate our aggregate liability for outstanding indemnities entered into after December 31, 2002, including the indemnities described above with respect to which there are no limitations, to be approximately $0.2 million. Accordingly, we have recorded a liability for that amount.

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Note 15. Tax Provision

Our provision for income taxes for the quarter ended June 30, 2004 was a tax benefit of $7.1 million compared to income tax expense of $5.0 million for the quarter ended June 30, 2003. In the current quarter, we reviewed our corporate structure and reorganized our corporate subsidiaries, reducing the number of corporate entities and the complexity of our organizational structure. The changes we implemented as a result of this review resulted in an income tax benefit recorded in the quarter of $2.7 million. Approximately $1.5 million of the income tax benefit relates to the filing of amended tax returns for fiscal years 2001 and 2002 and comparable adjustments made to the fiscal 2003 tax returns. The amendments related to certain income apportionment factors and a correction of an allocation of intercompany charges. The amounts reflected in these amendments were not material to our results of operations for any of the past three fiscal years; therefore, we adjusted our results and are disclosing the change in the current period. The remaining $1.2 million tax benefit relates to a reduction in the deferred tax valuation allowance for net operating loss carry-forwards (“NOLs”) that we had previously concluded were not realizable. We anticipate that the restructuring will allow us to realize the benefit of these NOLs in future years.

Note 16. Subsequent Events

We announced the closure of our Otsego, Michigan, recycled paperboard mill effective July 7, 2004. We recorded a $14.6 million pre-tax charge in the third quarter of fiscal 2004 that consisted primarily of an asset impairment charge to write down the equipment and facility to fair value.

On June 13, 2004, the Steel Workers Union notified us that the union employees at our Aurora, Illinois laminated facility were going on strike. The employees returned to work on July 6, 2004. We incurred expenses and lost revenue totaling approximately $0.3 million during the third quarter of fiscal 2004 as a result of the strike.

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Note 17. Segment Information

The following table shows certain operating data for our three industry segments (in thousands). We do not allocate certain of our income and expenses to our segments and, thus, the information that management uses to make operating decisions and assess performance does not reflect such amounts. We report these items as non-allocated expenses. These items include elimination of intercompany profit, restructuring and other costs and certain corporate expenses.

In April 2004, we consolidated our laminated paperboard products division and mill division under common management. We refer to the combined division as the paperboard division. The paperboard division now consists of the previously consolidated specialty paperboard division, the former coated paperboard division and the former laminated paperboard products division. As part of this reorganization, we moved our Macon, Georgia, drum manufacturing facility into the corrugated packaging division. We have restated our segment data as a result of these actions.

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PART I. FINANCIAL INFORMATION

The following discussion should be read in conjunction with the condensed consolidated financial statements and notes thereto, included herein and in each of the Quarterly Reports on Form 10-Q for the quarters ended December 31, 2003, and March 31, 2004, and our audited consolidated financial statements and notes thereto for the fiscal year ended September 30, 2003, as well as the information under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” that are part of our Fiscal 2003 Form 10-K and in each such Quarterly Report on Form 10-Q. The table in Note 17 to the condensed consolidated financial statements shows certain operating data for our three industry segments.

Overview

The trends in sales volume for most of our major businesses were positive in the third quarter of fiscal 2004 compared to the same period last year. Net sales increased in each of our segments for the three and nine months ended June 30, 2004 despite a pricing environment for our products that remains highly competitive. In our Packaging Products segment, folding carton division sales increased due to growth in our business that was not attributable to acquisitions during the period (which we refer to as our “base business”) and growth arising from our acquisitions that we completed during fiscal 2003. In the current margin environment for our folding carton division, pricing pressure significantly offset the contribution from increased net sales. We expect this trend to continue during our next fiscal year. Net sales in our Packaging Products segment from our interior packaging division increased due to increased volume net of decreased pricing. We expect net sales for this division to show a modest gain in the fourth fiscal quarter. Net sales of merchandising displays increased primarily due to strong demand and sales to new customers as we expanded our presence in the North American display business. The market for merchandising displays continues to reflect price competitiveness through more frequent bidding for business and increased demand for lower cost displays with more economical designs. We continue to expand that business platform by broadening our permanent and multi-material display capabilities as well as developing theft deterrent solutions for high theft products that are sold in various classes of retailers. These theft deterrent solutions are in various stages of development. Our corrugated packaging division net sales increased in the third quarter of fiscal 2004 due to increased volume. Our Paperboard segment net sales increased during the third quarter of fiscal 2004 primarily as a result of higher selling prices and increased volumes. We announced board price increases that seek to recover higher costs we have experienced in areas such as fiber, energy, chemicals, and pension expense. These increases began to take effect in April 2004. Our average selling price increased $15 per ton compared to the second quarter of fiscal 2004. We expect to see continued modest price improvement over the course of the fourth quarter of fiscal 2004.

The increase in cost of goods sold as a percentage of sales we have experienced during fiscal 2004 resulted primarily from increases in fiber, energy, and freight costs at our recycled paperboard mills. The higher energy costs continue to be driven by higher natural gas prices.

During the third quarter of fiscal 2004, we announced the closure of the laminated paperboard product converting lines at our Aurora, Illinois, facility. We do not anticipate consolidating the majority of the sales from these products into our remaining facilities. We will continue to manufacture specialty recycled paperboard and solid fiber book and binder products at the facility. We announced the closure of our Otsego, Michigan, recycled paperboard mill effective July 7, 2004. We expect to shift approximately 35,000 tons, approximately one third of the volume of this facility, to our remaining recycled paperboard facilities. Our strategy in operating these facilities had been to recover as much cash as possible from the operations. We closed these facilities primarily when we concluded that the operations were no longer cash positive. Operating losses at our Aurora facility, with respect to its laminated paperboard products operations, and at our Otsego mill for the nine month period ended June 30, 2004 were $3.8 million and $2.9 million, respectively. As a result of these closures we expect greater capacity utilization, reduced costs and more efficient production operations that will be accretive to earnings.

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We expect our annual pension cost will increase from approximately $11 million in fiscal 2003 to approximately $17 million in fiscal 2004, primarily due to two factors. Costs increased $3.4 million because we reduced our assumed discount rate from 7.25% to 6.50% on September 30, 2003. Our net pension cost also increased $2.9 million due to negative market returns in recent years.

Results of Operations (Consolidated)

Net Sales (Unaffiliated Customers)

The increase in net sales for the quarter ended June 30, 2004 compared to the comparable prior year quarter occurred primarily due to a net sales increase of 11.6% in our folding carton business. We also experienced increased net sales in our Paperboard segment (7.5%) and Merchandising Displays and Corrugated Packaging segment (5.7%).

The increase in net sales for the nine months ended June 30, 2004 compared to the prior year period occurred primarily due to strong net sales increases in our folding carton division (19.1%), Merchandising Displays and Corrugated Packaging segment (6.5%), and Paperboard segment (6.2%).

We have provided further information regarding factors that impacted net sales in the segment discussions included below under the heading “Results of Operations (Segment Data).”

Cost of Goods Sold

The increase in cost of goods sold as a percentage of sales for the quarter ended June 30, 2004 compared to the comparable prior year quarter resulted primarily from increased fiber and energy costs at our recycled paperboard mills amounting to $5.6 million (1.4% of net sales), and $1.5 million (0.4% of net sales), respectively. Energy costs continued to be driven by higher natural gas prices. Across our businesses we also experienced increased pension, group insurance, and freight expenses of $0.6 million (0.2% of net sales), $1.2 million (0.3% of net sales), and $2.1 million (0.5% of net sales), respectively, compared to the prior year quarter. The increase in freight is primarily due to increased volumes associated with our increased net sales, and to a lesser degree increased fuel surcharges. We have foreign currency transaction risk primarily due to our operations in Canada. The impact in the third quarter of fiscal 2004 compared to the prior year quarter reduced costs of goods sold by $0.9 million (0.2% of net sales).

The increase in cost of goods sold as a percentage of sales for the nine months ended June 30, 2004 compared to the same period last year resulted primarily from increased fiber and energy costs at our recycled paperboard mills amounting to $11.3 million (1.0% of net sales), and $7.9 million (0.7% of net sales), respectively. Energy costs continue to be driven by higher natural gas prices. In fiscal 2003, we hedged most of our winter requirements for natural gas purchases at a NYMEX equivalent price of less than $3.50 per MMBtu (million British thermal units). In fiscal 2004, we hedged approximately two-thirds of our winter energy purchases at a NYMEX equivalent price of approximately $5.20 per MMBtu that resulted in a small benefit compared to the winter spot prices. Across our businesses we also experienced increased pension, group insurance, and freight expenses of $2.9 million (0.2% of net sales), $2.6 million (0.2% of net sales), and $4.5 million (0.4% of net sales), respectively, during the nine-month

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period compared to the prior year period. The increase in freight is primarily due to increased volumes associated with our increased net sales, and to a lesser degree increased fuel surcharges. We have foreign currency transaction risk primarily due to our operations in Canada. The impact for the nine months ended June 30, 2004 compared to the same period last year reduced costs of goods sold by $1.0 million (0.1% of net sales). We have provided further information regarding factors that impacted cost of goods sold in the segment discussions included below under the heading “Results of Operations (Segment Data).”

We value substantially all of our U.S. inventories at the lower of cost or market. For such purposes, we determine cost on the last-in, first-out (LIFO) inventory valuation method, which we believe generally results in a better matching of current costs and revenues than under the first-in, first-out (FIFO) inventory valuation method. In periods of decreasing costs, the LIFO method generally results in lower cost of goods sold than under the FIFO method. In periods of increasing costs, the results are generally the opposite. Our quarterly results of operations reflect LIFO estimates based on management’s projection of expected year-end inventory levels and costs.

The following table illustrates the comparative effect of LIFO and FIFO accounting on our results of operations. These supplemental FIFO earnings reflect the after-tax effect of eliminating the LIFO adjustment each year.

Gross Profit

For a discussion of factors that impacted our gross profit, see the discussion included above and below under the headings “Results of Operations (Consolidated) - Net Sales (Unaffiliated Customers),” “Results of Operations (Consolidated) - Cost of Goods Sold” and “Results of Operations (Segment Data).”

Selling, General and Administrative Expenses

Selling, general and administrative (“SG&A”) expenses decreased as a percentage of net sales in the quarter ended June 30, 2004 compared to the same quarter last year primarily due to our focus on reducing our costs, which did not increase proportionately with our sales during the 2004 quarter. Pension and group insurance expenses were $1.4 million and $1.1 million higher, respectively, in the current quarter as compared to the same quarter of the prior year. Somewhat offsetting these increases was employee bonus expense that was $1.9 million lower than the same quarter of the prior year. We accrue bonuses based on progress achieved with respect to certain predefined targets.

SG&A expenses decreased as a percentage of net sales in the nine months ended June 30, 2004 compared to the same period last year. SG&A expenses were $11.1 million higher than the prior year as a result of increases in bad debt expense, pension expense, sales commissions and the amortization of certain identifiable intangible assets which

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were $2.9 million, $2.2 million, $1.9 million and $1.3 million, respectively, higher than during the same period last year. Offsetting these items during the current period were travel and entertainment expenses and consulting expenses that were $1.5 million and $1.1 million, respectively, lower than the prior year. Bad debt expense increased due to the declining credit quality of certain customers, the size of our credit exposure to individual customers, and customer bankruptcies. Commissions expense increased because of increased sales, primarily in our folding carton business, which was due, in part, to acquisitions. Amortization of identifiable intangible assets increased primarily due to the fiscal 2003 acquisitions. Travel and entertainment expenses decreased as a result of our continued focus on controlling costs. Consulting expenditures were higher in fiscal 2003 due to our merchandising displays division’s enterprise application integration system project.

Restructuring and Other Costs

We recorded pre-tax restructuring and other costs of $21.3 million and $27.1 million for the third quarter of fiscal 2004 and the nine months ended June 30, 2004, respectively. We recorded pre-tax charges of $0.6 million and $0.9 million for the third quarter of fiscal 2003 and the nine months ending June 30, 2003, respectively. We discuss these charges in more detail below.

Fiscal 2004

Quarter Ended June 30, 2004

During the third quarter of fiscal 2004, we announced the closure of the laminated paperboard product converting lines at our Aurora, Illinois facility and recorded a pre-tax charge of $4.3 million. The charge consisted of an asset impairment charge of $3.6 million to reduce the undepreciated cost of the equipment to its estimated fair value less cost to sell, severance and other employee costs of $0.5 million, and a pension curtailment of $0.2 million. We expect to terminate the employment of approximately 93 employees. We estimate that laminated paperboard products sales at the facility for the nine-month period ended June 30, 2004 and June 30, 2003 were approximately $14.5 million and $12.5 million, respectively. We cannot separately identify operating losses from these products lines because the facility manufactures other items and utilizes shared services. However, we estimate pre-tax operating losses of laminated paperboard products at the facility for the same nine-month periods were approximately $3.8 million and $2.3 million, respectively. We do not anticipate consolidating the majority of the sales from these products lines into our other facilities.

We announced the closure of our Otsego, Michigan, recycled paperboard mill on July 7, 2004. We recorded a $14.6 million pre-tax charge in the third quarter of fiscal 2004 that consisted of an asset impairment charge of $13.9 million to write down the equipment and facility to fair value, $0.4 million for property, plant and equipment related parts and supplies, and a pension curtailment of $0.3 million. We expect to terminate the employment approximately 108 employees. We did not record severance in the third quarter of fiscal 2004 because we had not yet communicated the plan to the employees. We expect to record severance of $1.0 million in the fourth quarter of fiscal 2004. A significant portion of the capacity of this facility supported the laminated paperboard product facilities we closed this fiscal year. We expect to shift approximately one third of the volume of this facility to our remaining recycled paperboard facilities. Net sales at the facility for the nine-month period ended June 30, 2004 and June 30, 2003 were approximately $5.4 million and $6.2 million, respectively. Pre-tax operating losses at the facility for the same nine-month periods were approximately $2.9 million and $0.6 million, respectively.

During the quarter, we consolidated our laminated paperboard products division and mill division under common management and reduced the size of the combined divisional staffs. We refer to the combined division as the paperboard division. We recorded a charge of $0.5 million in the quarter for severance and other employee costs.

In connection with the shutdown of the laminated paperboard product converting lines at our Aurora, Illinois facility and our decision to close our Otsego, Michigan, facility we completed step 1 of the impairment test for the paperboard division as required under SFAS 142 and determined the goodwill of the paperboard division was not impaired.

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In addition, we recorded a variety of charges in the quarter primarily from previously announced facility closures totaling $1.1 million. The charges consisted primarily of $0.8 million for machinery and equipment impairments, $0.2 million for equipment relocation, and $0.1 million of carrying costs.

During the third quarter of fiscal 2004, we reviewed our corporate structure and reorganized our subsidiaries, reducing the number of corporate entities and the complexity of the organizational structure. We recorded expenses of $0.8 million in connection with this project. We expect to complete the reorganization process over the next two quarters at an additional cost of approximately $0.6 million.

We expect to incur future restructuring and other costs of $3.8 million related to our previously announced initiatives, including the amounts disclosed above. These costs will primarily consist of $1.4 million for severance and other employee costs, $0.6 million for tax reorganization expenses, $0.5 million for equipment removal and relocation costs, $0.5 million for facility carrying costs, and $0.8 million for other expenses.

Nine Months Ended June 30, 2004

During the nine months ended June 30, 2004, we recorded a pre-tax charge of $27.1 million. The charge consisted primarily of the following: $14.6 million for the closure of our Otsego facility; $4.3 million for the closure of laminated paperboard product converting lines at our Aurora facility; $7.8 million for the closure of our Wright City, Missouri, laminated paperboard products facility that consisted of an asset impairment charge of $6.7 million to record the equipment and facility at their estimated fair value less cost to sell, a goodwill impairment charge of $0.2 million, severance and other employee costs of $0.4 million, and other costs of $0.5 million.

During the period, we also recorded a $1.8 million pre-tax gain on the sale of our Mundelein, Illinois, merchandising displays facility site; reduced the size of the paperboard division staff and recorded a charge of $0.5 million for severance and other employee costs; recorded a charge of $0.8 million in connection with a project to review our corporate structure and reorganize our subsidiaries; and incurred a variety of charges totaling $0.9 million primarily from previously announced closures. These charges consisted primarily of $0.6 million for machinery and equipment impairments, $0.2 million for equipment relocation, and $0.1 million of carrying costs.

Fiscal 2003

Quarter Ended June 30, 2003

During the third quarter of fiscal 2003, we recorded a pre-tax charge of $0.6 million. The charge consisted primarily of $0.4 million for equipment relocation charges with $0.2 million at our Mundelein, Illinois, merchandising displays facility, $0.1 million at our Dallas, Texas, paperboard mill, and $0.1 million at our Vineland, New Jersey, laminated paperboard product converting operation; and $0.2 million for equipment impairment at our St. Paul, Minnesota, folding carton facility.

Nine Months Ended June 30, 2003

During the nine months ended June 30, 2003, we recorded a pre-tax charge of $0.9 million, net of a gain for accrual adjustments of $1.1 million on previously announced facility closings. The $1.1 million gain resulted primarily from $0.3 million in accrual reversals for excess employee severance and other employee benefits, due primarily to voluntary employee terminations and employees who worked longer than planned in the notice period at our Vineland facility and $0.8 million in accrual reversals resulting from the earlier than planned sales of property and reduced costs associated with our Augusta, Georgia, folding carton facility ($0.2 million), our El Paso, Texas, folding carton facility ($0.1 million) and our Vineland facility ($0.5 million). Partially offsetting these accrual adjustments were $2.0 million of charges from previously announced facility closures consisting primarily of the following: a $1.6 million charge for equipment relocation expenses primarily associated with our facilities at Vineland ($0.8 million), El Paso ($0.3 million), Mundelein ($0.2 million), and Dothan ($0.2 million), and at other facilities ($0.1 million); a $0.4 million charge for the equipment impairment at our St. Paul, Minnesota folding carton facility; a net gain of $0.5 million on the sale of property and equipment at our Vineland facility; a charge of $0.2 million for the loss on the sale of property and equipment at our Augusta facility; and other costs of $0.3 million.

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Unconsolidated Joint Venture

During the quarter ended June 30, 2004, our Seven Hills joint venture reported income of $0.3 million compared to a $0.1 million loss for the same quarter last year. Seven Hills is structured so that we earn our primary income in fees paid by Seven Hills to our paperboard division, which we recorded in our Paperboard segment income. We calculate the gains and losses that we recognize from Seven Hills based upon how it performs versus benchmark performance standards that are set forth in the joint venture agreement. The favorable increase compared to the prior year quarter was due to increased production levels and operational efficiencies in the current year quarter.

During the nine months ended June 30, 2004, Seven Hills reported income of $0.2 million compared to a $0.4 million loss for the same period last year.

We have agreed with Lafarge to enter into arbitration with respect to the price of gypsum plasterboard liner that Seven Hills is entitled to charge Lafarge from November 2002 going forward. The arbitration will also determine certain amounts that we are entitled to recover from Seven Hills for certain services that we render to Seven Hills. We expect the arbitration to commence during the second quarter of fiscal 2005. While we are unable to predict with certainty the outcome of the arbitration, management believes that it is unlikely that the final determination will materially affect our financial results.

Interest Expense

Interest expense for the quarter ended June 30, 2004 decreased 19.8% to $5.9 million from $7.4 million for the quarter ended June 30, 2003. The decrease was primarily attributable to both lower interest rates, which we believe lowered interest expense by $1.2 million, and a decrease in our average outstanding borrowings, which we believe lowered interest expense by $0.3 million. The decrease in rates was primarily due to our utilization of favorable interest rate swaps.

Interest expense for the nine months ended June 30, 2004 decreased 13.3% to $17.7 million from $20.4 million for the nine months ended June 30, 2003. The decrease was primarily attributable to lower interest rates, which we believe lowered interest expense by $2.9 million, partially offset by an increase in our average outstanding borrowings, which we believe increased interest expense by $0.2 million. The decrease in rates was primarily due to our utilization of favorable interest rate swaps.

Provision for Income Taxes

We recorded an income tax benefit of $7.1 million for the quarter ended June 30, 2004 compared to income tax expense of $5.0 million for the quarter ended June 30, 2003. In the current quarter, we reviewed our corporate structure and reorganized our corporate subsidiaries, reducing the number of corporate entities and the complexity of our organizational structure. The changes we implemented as a result of this review resulted in a one-time income tax benefit of $2.7 million. Approximately $1.5 million of the benefit relates to the filing of amended tax returns for fiscal years 2001 and 2002 and comparable adjustments made to the fiscal 2003 tax returns. The amendments related to certain income apportionment factors and a correction of an allocation of intercompany charges. The impact of these changes was not material to our net income for any of the fiscal years in question; therefore, we recorded the cumulative impact in the current period. The remaining $1.2 million tax benefit relates to a reduction in the deferred tax valuation allowance for net operating loss carry-forwards that we had previously concluded were not realizable. We anticipate that the restructuring will allow us to realize the benefit of these NOLs in future years. Due to this one-time tax benefit, our effective income tax rate is not comparable to our 39.1% effective income tax rate for the third quarter of fiscal 2003. We estimate that the marginal effective income tax rate for the quarter ended June 30, 2004 was approximately 38%.

For the nine months ended June 30, 2004 we recorded a tax benefit of $2.5 million compared to income tax expense of $12.9 million for the same period last year. Our effective income tax rate is not comparable to the rate for the same period last year due to the one-time tax benefit discussed above. The effective income tax rate for the nine

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months ended June 30, 2003 was 39.3%. We estimate that the marginal effective income tax rate for the nine months ended June 30, 2004 was approximately 38%.

Discontinued Operations

In the first quarter of fiscal 2004, we completed the sale of our plastic packaging products division and the sale of certain assets and liabilities that we acquired in the January 2003 Cartem Wilco acquisition that were associated with a small folding carton and label plant in Quebec. The plastic packaging products division transaction closed effective October 27, 2003 and we received proceeds of approximately $59.0 million. As a result of the transaction, we recorded an after-tax gain of approximately $7.1 million. The sale of certain Cartem Wilco assets and liabilities, effective December 1, 2003, resulted in no gain or loss and we received proceeds of approximately $2.9 million. We expect to incur additional expenses totaling approximately $0.1 million in the fourth quarter of fiscal 2004 primarily related to severance and other related employee costs for employees required to render future service as part of the plastic packaging products division sale. We are expensing these costs ratably over the future service period, which we expect to expire in the fourth quarter of fiscal 2004. In the third quarter of fiscal 2004, we reached agreement with the purchaser of the plastic packaging products division on the final working capital adjustment and, as a result, we recorded an after-tax gain of $0.4 million. We have reclassified the results of operations for these components as income from discontinued operations, net of tax, on the consolidated statements of operations for all periods presented.

We reported income from discontinued operations for the quarter ended June 30, 2004 of $0.4 million compared to a loss of $0.6 million for the quarter ended June 30, 2003. The income in the third quarter of fiscal 2004 was primarily due to the final working capital adjustment and the severance and other related employee costs related to the sale of our plastic packaging products division described above. The loss from discontinued operations in the quarter ended June 30, 2003 was primarily due to high resin prices for our plastic packaging products division during most of fiscal 2003.

Income from discontinued operations for the nine months ended June 30, 2004 was $8.0 million compared to a loss of $0.3 million for the nine months ended June 30, 2003. Income from discontinued operations for the first nine months of fiscal 2004 includes an after-tax gain of approximately $7.4 million from the sale of our plastic packaging products division.

Net Income (Loss)

Net income (loss) in the third quarter of fiscal 2004 and 2003 included income of $0.4 million and a loss of $0.6 million from discontinued operations, respectively, and pre-tax expense of $21.3 million and $0.6 million, respectively, for restructuring and other costs. Additionally, we recorded a one-time income tax benefit of $2.7 million in the third quarter of fiscal 2004. For a discussion of factors that impacted our restructuring and other costs, see the disclosure included under the headings “Results of Operations (Consolidated) – Restructuring and Other Costs.” For a discussion of factors that impacted our provision for income taxes, see the disclosure included above under the headings “Results of Operations (Consolidated) – Provision for Income Taxes.”

Net income for the nine months ended June 30, 2004 included income of $8.0 million from discontinued operations and pre-tax expense of $27.1 million for restructuring and other costs. Approximately $7.4 million of the income from discontinued operations was due to the gain we recognized on the sale of our plastic packaging products division. Net income for the nine months ended June 30, 2003 included a loss of $0.3 million from discontinued operations and pre-tax expense of $0.9 million for restructuring and other costs. We also recorded a one-time

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income tax benefit of $2.7 million during the third quarter of fiscal 2004. For a discussion of factors that impacted our restructuring and other costs, see the disclosure included under the headings “Results of Operations (Consolidated) – Restructuring and Other Costs.” For a discussion of factors that impacted our provision for income taxes, see the disclosure included above under the headings “Results of Operations (Consolidated) – Provision for Income Taxes.”

Earnings Per Common and Common Equivalent Share