UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

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

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 six months of fiscal 2004, we paid $1,094, 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 and was recorded as goodwill. In the first six months of fiscal 2003, the Company paid $65,220 for the purchase of Groupe Cartem Wilco Inc. (which we refer to as “Cartem Wilco”). In conjunction with the acquisitions, liabilities were assumed as follows:

See Accompanying Notes to Condensed Consolidated Financial Statements

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ROCK-TENN COMPANY

Unless the context otherwise requires, “we,” “us,” “our” or “the Company” refers to the business of Rock-Tenn Company and its subsidiaries, including RTS Packaging, LLC, which we refer to as “RTS,” and Seven Hills Paperboard, LLC, which we refer to as “Seven Hills.” We own 65% of RTS and conduct our interior packaging products business through RTS. 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

The accompanying condensed consolidated financial statements of the Company have not been audited by independent auditors. The condensed consolidated balance sheet at September 30, 2003 has been derived 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 the results of operations for the three and six month periods ended March 31, 2004 and 2003, the Company’s financial position at March 31, 2004 and September 30, 2003, and the cash flows for the six month periods ended March 31, 2004 and 2003.

Certain notes and other information have been condensed or omitted from the interim financial statements presented in this Quarterly Report on Form 10-Q. Therefore, these financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2003 (the “Fiscal 2003 Form 10-K”).

The results for the three and six months ended March 31, 2004 are not necessarily indicative of results that may be expected for the full year.

Certain reclassifications have been made to prior year amounts to conform with the current year presentation.

Note 2.    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 12 to the Condensed Consolidated Financial Statements. The 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 in is discussed in Note 3 to the Condensed Consolidated Financial Statements under the heading “Investment in Corporate Joint Venture.”

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Note 3.    Summary of Significant Accounting Policies

The following significant accounting policies have been revised since we filed our Fiscal 2003 Form 10-K to more clearly reflect our accounting for these items. Except for our adoption of FIN 46R, none of these changes represent a change in accounting principle or policy.

     Investment in Corporate Joint Venture

During 2000, the Company formed a joint venture (“Seven Hills” or the “Joint Venture”) with Lafarge North America, Inc. (“Lafarge”). The Company contributed cash and a paper machine located at its Lynchburg, Virginia paper mill. Lafarge contributed cash. Subsequent to inception the Company and Lafarge have made additional cash contributions. The Company has invested a total of $22.9 million in Seven Hills as of March 31, 2004. The Company uses the equity method to account for its 49% investment in Seven Hills. Under the equity method, the Company’s investment was initially recorded at cost, then subsequently reduced by distributions and increased or decreased by the Company’s proportionate share of the Joint Venture’s net earnings or loss. Funding of net losses is guaranteed by the partners of the joint venture 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. Seven Hills is managed by a Managing Board that has equal representation by Lafarge and the Company. The Company provides all labor, supervision, management, executive and administrative services necessary to operate Seven Hills and leases the land and building occupied by Seven Hills. Our share of cumulative losses as of March 31, 2004 and 2003 are $1.8 million and $1.6 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 the Joint Venture to the Company at any time after the expiration of six years from March 29, 2001, the date that the Joint Venture’s paper machine was converted to produce gypsum plasterboard liner. Upon the adoption of FIN 46R on March 31, 2004 (see Note 2 above), the Company determined the Joint Venture is a VIE, but the Company is not its primary beneficiary. Accordingly, we will continue to account for Seven Hills using the equity method.

     Revenue Recognition

We recognize revenue when all of the following criteria, which are detailed in Codification of Staff Accounting Bulletins, Topic 13:A.1, Revenue Recognition-General, are met:

Items that we net against our gross revenue include provisions for discounts, returns, allowances, customer rebates, outbound freight billed to customers and other adjustments. We account for such provisions during the same period in which we record the related revenues, except for changes in the fair value of derivatives, which we recognize as described below, and expense for cash discounts are recorded as earned when payments are received from our customers.

     Derivatives

The Company enters into a variety of derivative transactions. The Company uses swap agreements to manage the interest rate characteristics of a portion of its outstanding debt. The Company uses forward contracts to limit exposure to fluctuations in Canadian foreign currency rates with respect to its receivables denominated in Canadian dollars. The Company also uses commodity swap agreements to limit exposure to falling sales prices and rising raw material costs. The Company is exposed to counterparty credit risk for nonperformance and, in the event of nonperformance, to market risk for changes in interest rates. The Company manages exposure to counterparty credit risk through minimum credit standards, diversification of counterparties and procedures to monitor concentrations of credit risk.

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For each derivative instrument that is designated and qualifies as a fair value hedge, the gain or loss on the derivative instrument as well as the offsetting loss or gain on the hedged item attributable to the hedged risk are recognized in current earnings during the period of the changes in fair values. For each derivative instrument that is designated and qualifies as a cash flow hedge, the effective portion of the gain or loss on the derivative instrument is reported as a component of accumulated other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. The ineffective portion of the hedge is recognized in current earnings during the period of change. Gains or losses on the termination of interest rate swap agreements are deferred and amortized as an adjustment to interest expense of the related debt instrument over the remaining term of the original contract life of the terminated swap agreements. For derivative instruments not designated as hedging instruments, the gain or loss is recognized in current earnings during the period of change. The fair value of the Company’s derivative instruments are based on market quotes and represents the net amount required to terminate the position, taking into consideration market rates and counterparty credit risk. Derivative contracts that are an asset from the Company’s perspective are reported as other assets. Contracts that are liabilities from the Company’s perspective are recorded as other liabilities.

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 the Company’s financial statements include estimates associated with its evaluation of the recoverability of goodwill and property, plant and equipment as well as those used in the determination of taxation, insurance and restructuring. In addition, significant estimates form the basis for the Company’s 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

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

The change in other comprehensive income is primarily due to the fluctuation in the Canadian/U.S. exchange rate and an increase in our overall investment in Canada as a result of our acquisition of Cartem Wilco in January 2003. The second quarter of fiscal 2004 was impacted as the exchange rate moved to 1.3111 at March 31, 2004 from 1.2963 at December 31, 2003. The second quarter of fiscal 2003 was impacted as the exchange rate moved to 1.4699 at March 31, 2003 from 1.5723 at December 31, 2003.

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The six months ended March 31, 2004 was impacted as the exchange rate moved to 1.3111 at March 31, 2004 from 1.3493 at September 30, 2003. The six months ended March 31, 2003 was impacted as the exchange rate moved to 1.4699 at March 31, 2003 from 1.5870 at September 30, 2002.

Note 6.    Earnings per Share

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

Note 7.    Restructuring and Other Costs

We recorded pre-tax restructuring and other costs of $6.0 million and $6.2 million for the second quarter of fiscal 2004 and the six months ending March 31, 2004, respectively. We recorded pre-tax charges of $0.9 million and $0.4 million for the second quarter of fiscal 2003 and the six months ending March 31, 2003, respectively. These charges are discussed below.

During the second quarter of fiscal 2004, we announced the closure of our Wright City, Missouri laminated paperboard facility effective March 31, 2004 and recorded a pre-tax charge of $7.7 million. The charge consisted of an asset impairment charge of $6.5 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, inventory write-off of $0.4 million, and other costs of $0.2 million. The closure resulted in the termination of approximately 68 employees. Net sales at the facility for the six-month period ended March 31, 2004 and March 31, 2003 were $5.1 million and $6.7 million, respectively. Operating losses at the facility for the same six-month periods were $1.6 million and $1.9 million, respectively. We do not anticipate consolidating the majority of the sales of this operation into our remaining laminated facilities. We also sold our previously closed Mundelein, Illinois merchandising display facility site for a pre-tax gain of $1.8 million. In addition, we recorded a variety of charges from previously announced closures totaling $0.1 million in the period.

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During the six months ended March 31, 2004, we recorded a pre-tax charge of $7.7 million for the closure of our Wright City facility, recorded a $1.8 million pre-tax gain on the sale of our Mundelein facility, and incurred a variety of charges from previously announced closures totaling $0.3 million. The charges from the previously announced closings consisted primarily of $0.1 million for equipment relocation, $0.1 million for inventory write-off, 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 the condensed consolidated statements of income for the six months ended March 31, 2004 (in thousands):

During the second quarter of fiscal 2003, we recorded a pre-tax charge of $0.9 million. In that quarter, we announced the closure of our Hunt Valley, Maryland and Mundelein merchandising displays facilities. The closures resulted in the termination of approximately 49 employees. In connection with these closings, we accrued $0.1 million for severance and other employee costs. These facilities were consolidated into the operations of other existing facilities. The other $0.8 million consisted primarily of the following: $0.7 million for equipment relocation charges primarily consisting of $0.3 million at our El Paso, Texas folding carton facility and $0.3 million at our Vineland, New Jersey converting operation; $0.2 million of inventory write-offs at our Dothan, Alabama corrugated facility; $0.1 million for an accrual adjustment related to severance at our El Paso facility; a net gain of $0.3 million for equipment sales primarily of folding carton equipment at our St. Paul, Minnesota folding carton facility; and miscellaneous other items at a variety of locations totaling $0.1 million.

During the six months ended March 31, 2003, we recorded a pre-tax charge of $0.4 million. The charge of $0.4 million was net of a gain for accrual adjustments of $1.0 million on previously announced facility closings. The $1.0 million gain resulted from $0.6 million in excess employee severance and other employee benefits due to employee voluntary terminations and employees who worked longer than planned in the notice period; and $0.4 million in accrual reversals resulting from the earlier than planned sales of property associated with our facilities in Augusta, Georgia ($0.1 million), Dothan, Alabama ($0.1 million) and Vineland, New Jersey ($0.2 million). Partially offsetting these accrual adjustments were $1.2 million of equipment relocation expenses consisting primarily of $0.7 million for Vineland, $0.3 million for El Paso, and $0.1 million for Dothan; $0.2 million for an accrual adjustment for severance at our El Paso facility; $0.1 million in severance adjustments for our Hunt Valley and Mundelein facilities; $0.2 million of inventory write-offs at Dothan; a $0.2 million net charge for the removal and ultimate sale of certain equipment in our St. Paul facility, a net gain on the sale of our Vineland property and equipment of $0.5 million, and a charge of $0.2 million for the loss on the sale of our Augusta property and equipment.

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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 the condensed consolidated statements of income for the six months ended March 31, 2003 (in thousands):

Note 8.    Discontinued Operations

In the first quarter of fiscal 2004, we completed the sale of our plastic packaging division, and the sale of some of the 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 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 some of the 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 $0.2 million in the third and 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 division sale. We are expensing these costs ratably over the future service period, which is anticipated to expire in the fourth quarter of fiscal 2004. The plastic packaging sale transaction is subject to a final working capital adjustment, which we expect to complete in the third quarter of fiscal 2004. The adjustment is not expected to be material.

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, generally no compensation expense is recognized.

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Pro forma information regarding net income and earnings per share is required by Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, which also requires that the information be determined as if we had accounted for our employee stock options granted subsequent to September 30, 1995 under the fair value method of that statement. The fair values for the options granted subsequent to September 30, 1995 were estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions:

Note 10.    Inventories

Substantially all of our U.S. inventories are stated at the lower of cost or market, with cost determined on the last-in, first-out (LIFO) basis. All other inventories are valued at the lower of cost or market, with cost determined using methods that approximate cost computed on a first-in, first-out (FIFO) basis. An actual valuation of inventory under the LIFO method can only be made at the end of each year based on the inventory levels and costs at that time. Accordingly, interim LIFO estimates must necessarily be based on management’s projection of expected year-end inventory levels and costs.

Inventories at March 31, 2004 and September 30, 2003 were as follows (in thousands):

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Note 11.    Debt

Debt, excluding the realized interest rate swap gains and the mark-to-market value of interest rate swaps totaling $25.1 million and $23.9 million at March 31, 2004 and September 30, 2003, respectively, consists of the following (in thousands):

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Note 12.    Retirement Plans

The following table represents a summary of the components of net pension cost for the three and six months ended March 31, 2004 and March 31, 2003 (in thousands):

We expect to contribute $19.5 million to our pension plans in fiscal 2004 in order to maintain a 90% funded level. The current year net pension cost reflected in the table above assumes the payment will be made. As of March 31, 2004 we have contributed approximately $0.1 million.

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Note 13.    Commitments and Contingencies

     Environmental and Other Matters

We are subject to various federal, state, local and foreign environmental laws and regulations, including those regulating the discharge, storage, handling and disposal of a variety of substances. These laws and regulations include, among others, the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”), the Clean Air Act (as amended in 1990), the Clean Water Act, the Resource Conservation and Recovery Act (including amendments relating to underground tanks) and the Toxic Substances Control Act. These environmental regulatory programs are primarily administered by the U.S. Environmental Protection Agency (“US EPA”). In addition, some states in which we operate have adopted equivalent or more stringent environmental laws and regulations or have enacted their own parallel environmental programs, which are enforced through various state administrative agencies.

We do not believe that future compliance with these environmental laws and regulations will have a material adverse effect on our results of operations, financial condition or cash flows. However, environmental laws and regulations are becoming increasingly stringent. Consequently, our compliance and remediation costs could increase materially. In addition, we cannot currently assess with certainty the impact that the future emissions standards and enforcement practices associated with changes to regulations promulgated under the Clean Air Act will have on our operations or capital expenditure requirements. However, we believe that any such impact or capital expenditures will not have a material adverse effect on our results of operations, financial condition or cash flows.

We account for environmental related costs as follows:

We have been identified as a potentially responsible party (“PRP‘) at nine active “superfund” sites pursuant to CERCLA or comparable state statutes (“Superfund legislation”). Based upon currently available information and the opinions of our environmental compliance managers and general counsel, although there can be no assurance, we have reached the following conclusions with respect to these nine sites:

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     Seven Hills Arbitration

The Company and Lafarge have agreed 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 the Company is entitled to recover from Seven Hills for certain services rendered to Seven Hills by the Company. The arbitration is expected to commence during the third fiscal quarter. 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 the financial results of the Company.

Note 14.    Subsequent Events

In April 2004, we purchased $11.0 million of our 2005 Notes at a price of 106.1% of par value. Concurrently, we terminated $11.0 million of our interest rate swap on our 2005 Notes. The premium paid over par for the debt less the favorable impact of unamortized realized interest rate swap gains resulted in an overall net loss of $0.3 million to the Company. This loss will be reflected in our results of operations for the third quarter of fiscal 2004.

Our Receivables Financing Facility was scheduled to expire on March 29, 2004. We extended the facility until April 29, 2004. On April 29, 2004, we renewed the facility through March 28, 2005, and reduced the size of the facility from $125.0 million to $75.0 million. On May 3, 2004, we reduced the size of our revolving credit facility from $125.0 million to $75.0 million.

Our combined credit availability under the Receivables Financing Facility and the revolving credit facility exceeded $100.0 million as of March 31, 2004.

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Note 15.    Segment Information

The following table shows certain operating data for our three industry segments (in thousands). Certain of our income and expenses are not allocated to our segments and are thus not reflected in the information used by management to make operating decisions and assess performance. These items are reported as non-allocated expenses. These items include elimination of intercompany profit, restructuring and other costs and certain corporate expenses.

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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 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 which we filed with the SEC on December 19, 2003. The table in Note 15 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 second quarter of fiscal 2004 compared to the same period last year. Net sales increased in each of our segments for the three and six months ended March 31, 2004 despite a pricing environment for our products that remains highly competitive. 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 completed during fiscal 2003. 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. We expect display sales to be weaker in the coming quarter as we begin to experience the complete impact of transitioning out the business of the customers whose business we previously reported we had lost due to competitive bidding. While we began to experience the transitioning in of new business we were awarded during fiscal 2003, we did not experience as much of the transitioning out of lost business during the second quarter of fiscal 2004 as we had previously anticipated. 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. Our corrugated packaging division net sales increased in the second quarter of fiscal 2004, but continued to experience pricing pressure for its products. Net sales in our interior packaging division decreased slightly on lower volume and pricing. We expect net sales to show a modest gain in the fourth fiscal quarter as we transition in a new customer. Our Paperboard Segment net sales have increased as a result of higher selling prices and increased volumes. We announced board price increases that seek to recover higher costs such as fiber, energy, chemicals, and pension expense. The price increases will begin to take effect in April 2004. We expect these price increases will begin to contribute to revenue in the third quarter of fiscal 2004 and have a greater impact in the fourth quarter of fiscal 2004. The price increase will be delayed, in part, because we sell a portion of our production on the basis of published index prices that do not immediately reflect such price increases. In March 2004, we announced the closure of our Wright City, Missouri laminated paperboard products facility. Sales by this facility in the first six months of fiscal 2004 and 2003 resulted in operating losses. We do not anticipate consolidating the majority of the sales of this operation into our remaining laminated facilities.

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

In fiscal 2004, we have experienced increased pension expense compared to the prior year. We expect our annual pension cost will increase from approximately $11 million in fiscal 2003 to approximately $17 million in fiscal 2004. Assuming we continue to fund our pensions at the 90% level, and, assuming our assumptions for the discount rate, increase in compensation levels, and long term rate of return on plan assets remain as disclosed in our Fiscal 2003 Form 10-K, we expect pension expense to decrease to approximately $15 million in fiscal 2005.

Critical Accounting Policies

Our accompanying condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States, which require management to make estimates and assumptions that affect the amounts of revenues, expenses, assets and liabilities reported. The disclosure under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies” in our Fiscal 2003 Form 10-K is a discussion of certain critical accounting matters that are

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important to the portrayal of our financial condition and results of operations and that require some of management’s most subjective and complex judgments. The accounting for these matters involves the making of estimates and assumptions based on current facts and circumstances that, in management’s judgment, are material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change. In management’s judgment, the impact of these estimates and assumptions on our reported financial condition and results of operations is also material and may cause our actual financial condition and results of operations to differ materially. Set forth below, is disclosure that supplements and updates certain aspects of the critical accounting policies disclosure in the Fiscal 2003 Form 10-K:

Impairment of Long-Lived Assets and Goodwill

We account for our goodwill under Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets (“SFAS 142”).” We review the recorded value of our goodwill annually at the beginning of the fourth quarter of each fiscal year, or sooner if events or changes in circumstances indicate that the carrying amount may exceed fair value. We determine recoverability by comparing the estimated fair value of the reporting unit to which the goodwill applies to the carrying value, including goodwill, of that reporting unit.

The SFAS 142 goodwill impairment model is a two-step process. In step 1, we utilize the present value of expected net cash flows to determine the estimated fair value of our reporting units. This present value model requires management to estimate future net cash flows, the timing of these cash flows, and a discount rate (based on our weighted average cost of capital), which represents the time value of money and the inherent risk and uncertainty of the future cash flows. The assumptions we use to estimate future cash flows are consistent with the assumptions that the reporting units use for internal planning purposes. If we determine that the estimated fair value of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is not impaired. If we determine that the carrying amount of the reporting unit exceeds its estimated fair value, we must complete step 2 of the impairment analysis. Step 2 involves determining the implied fair value of the reporting unit’s goodwill and comparing it to the carrying amount of that goodwill. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, we recognize an impairment loss in an amount equal to that excess.

Our judgments regarding the existence of impairment indicators are based on legal factors, market conditions and operational performance. Future events could cause us to conclude that impairment indicators exist and that assets associated with a particular operation are impaired. Evaluating the impairment also requires us to estimate future operating results and cash flows, which also require judgment by management. Any resulting impairment loss could have a material adverse impact on our financial condition and results of operations.

In connection with the shutdown of our facility in Wright City, Missouri, we recorded a goodwill impairment charge of $0.2 million for the Wright City facility. Subsequently, we performed step 1 of the SFAS 142 impairment test for the Laminated Paperboard Products division. The results of our testing indicated the goodwill of the Laminated Paperboard Products division was not further impaired.

We follow SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS 144"), in determining whether the carrying value of any of our long-lived assets is impaired. The SFAS 144 test is a 3-step test for assets that are “held and used” as that term is defined by SFAS 144. First, we determine whether indicators of impairment are present. SFAS 144 requires us to review long-lived assets for impairment only when events or changes in circumstances indicate that the carrying amount of the long-lived asset might not be recoverable. Accordingly, while we do routinely assess whether impairment indicators are present, we do not routinely perform tests of recoverability. Second, we determine whether the estimated undiscounted cash flows for the potentially impaired assets are less than the carrying value. This model requires management to estimate future net cash flows. The assumptions we use to estimate future cash flows are consistent with the assumptions we use for internal planning purposes, updated to reflect current expectations. Third, we estimate the fair value of the asset and record an impairment charge if the carrying value is less than the fair value of the asset. The test is similar for assets classified as “held for sale,” except that the assets are recorded at the lower of their carrying value or fair value less anticipated cost to sell.

Our judgments regarding the existence of impairment indicators are based on legal factors, market conditions and operational performance. Future events could cause us to conclude that impairment indicators exist and that assets associated with a particular operation are impaired. Evaluating the impairment also requires us to estimate future operating results and cash flows, which also require judgment by management. Any resulting impairment loss could have a material adverse impact on our financial condition and results of operations.

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Self-Insurance

We are self-insured for the majority of our group health insurance costs, subject to specific retention levels. We calculate our group insurance reserve based on a combination of claims lag data provided by our claims administrators and, if claims lag data is not available, we use estimated rates provided by our insurance consultants. At the end of each month during a fiscal year, we calculate our average monthly claims paid utilizing the actual monthly payments during the trailing 12-month period. At that time, we also calculate our required reserve utilizing payment lag information during that 12-month period. For example, during the last 12-month period, the average monthly claims paid fluctuated between $2.4 million and $2.5 million and our average claims lag fluctuated between 1.43 and 1.52 times the average monthly claims paid. Our accrual at March 31, 2004 represents approximately 1.52 times the average monthly claims paid. A 5% change in the average claims lag would change our reserve by approximately $0.2 million. While we believe that our assumptions are appropriate, significant differences in our actual experience or significant changes in our assumptions may materially affect our group health insurance costs.

Accounting for Income Taxes

As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. We estimate our actual current tax exposure and assess 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 within our consolidated balance sheet. A 1% increase in our effective tax rate would increase tax expense by approximately $0.1 million for the six months ended March 31, 2004. While we believe that our assumptions are appropriate, significant differences in our actual experience or significant changes in our assumptions may materially affect our income tax exposure.

Pension and Other Post-Retirement Benefits

The determination of our obligation and expense for pension and other post-retirement benefits is dependent on our selection of certain assumptions used by actuaries in calculating such amounts. Those assumptions are described in Note 11 to the consolidated financial statements in our Fiscal 2003 Form 10-K and include, among others, the discount rate, expected long-term rate of return on plan assets and rates of increase in compensation levels. During fiscal 2003, the effect of a 0.25% change in the discount rate would have impacted income before income taxes by approximately $1.0 million. During fiscal 2003, the effect of a 0.25% change in the expected long-term rate of return on plan assets would have impacted income before income taxes by approximately $0.5 million.

In accordance with accounting principles generally accepted in the United States, actual results that differ from our assumptions are accumulated and amortized over future periods and, therefore, generally affect our recognized expense, recorded obligation and funding requirements in future periods. While we believe that our assumptions are appropriate, significant differences in our actual experience or significant changes in our assumptions may materially affect our pension and other post-retirement benefit obligations and our future expense.

Results of Operations (Consolidated)

Net Sales (Unaffiliated Customers)

The increase in net sales for the quarter ended March 31, 2004 compared to the prior year quarter was primarily due to strong net sales increases in our folding carton and merchandising display businesses. Our paperboard segment also experienced increased net sales.

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The increase in net sales for the six months ended March 31, 2004 compared to the prior year period was primarily due to strong net sales increases in our folding carton, merchandising display, and paperboard businesses.

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 March 31, 2004 compared to the prior year quarter resulted primarily from increased fiber and energy costs at our recycled paperboard mills amounting to $4.6 million (1.1% of net sales) and $3.8 million (0.9% of net sales), respectively. The energy costs continue to be driven by higher natural gas prices. We also experienced increased pension expense of $1.3 million (0.3% of net sales) compared to the prior year quarter.

The increase in cost of goods sold as a percentage of sales for the six months ended March 31, 2004 compared to the same period last year resulted primarily from increased fiber and energy costs at our recycled paperboard mills amounting to $5.7 million (0.7% of net sales) and $6.4 million (0.8% of net sales), respectively. The 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. We also experienced increased pension expense of $2.3 million (0.3% of net sales) during the six-month period compared to the prior year period. 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).”

Substantially all of our U.S. inventories are valued at the lower of cost or market with cost determined 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.

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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 increased as a percentage of net sales in the quarter ended March 31, 2004 compared to the same quarter last year, primarily due to increased bad debt expense and increased commissions. Bad debt expense increased $3.7 million (0.9% of net sales). We perform on-going evaluations of our customers’ credit information, such as financial condition and payment history, and our bad debt expense can fluctuate based on customer credit quality and the size of our credit exposure to individual customers. In the second quarter of fiscal 2003, we lowered our allowance for bad debt by $2.0 million, while in the same period this year we incurred expense of $1.7 million. Commissions expense increased $1.0 million (0.3% of net sales) in the second quarter of fiscal 2004 compared to the same quarter last year. The increase in commissions was driven by increased sales, primarily in our folding carton business.

SG&A expenses decreased as a percentage of net sales in the six months ended March 31, 2004 compared to the same period last year primarily due to the increase in net sales, which were up 12.6%. The reduction as a percentage of net sales was partially offset by increased bad debt expense and increased commissions. Bad debt expense increased $3.4 million (0.4% of net sales) and commission expense increased $1.6 million (0.2% of net sales) in the six months of fiscal 2004 compared to the same period last year. The increase in commissions was driven by increased sales, primarily in our folding carton business.

Restructuring and Other Costs

We recorded pre-tax restructuring and other costs of $6.0 million and $6.2 million for the second quarter of fiscal 2004 and the six months ended March 31, 2004, respectively. We recorded pre-tax charges of $0.9 million and $0.4 million for the second quarter of fiscal 2003 and the six months ended March 31, 2003, respectively. These charges are discussed below.

During the second quarter of fiscal 2004, we announced the closure of our Wright City, Missouri laminated paperboard facility effective March 31, 2004 and recorded a pre-tax charge of $7.7 million. The charge consisted of an asset impairment charge of $6.5 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, inventory write-off of $0.4 million, and other costs of $0.2 million. The closure resulted in the termination of approximately 68 employees. Net sales at the facility for the six-month period ended March 31, 2004 and March 31, 2003 were $5.1 million and $6.7 million, respectively. Operating losses at the facility for the same six-month periods were $1.6 million and $1.9 million, respectively. We do not anticipate consolidating the majority of the sales of this operation into our other laminated facilities. Since the Wright City closure, we have streamlined the management of the operating facilities in the laminated paperboard products division. This new structure has reduced the costs associated with managing these facilities. Our Aurora, Illinois and Columbus, Indiana manufacturing facilities now

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operate as part of our mill division, and our Macon, Georgia manufacturing facility was transferred to our corrugated division. We expect to incur a charge of approximately $0.6 million in severance and other employee costs related to these activities, most of which will be incurred in the third fiscal quarter of 2004. We also sold our previously closed Mundelein, Illinois merchandising display facility site for a pre-tax gain of $1.8 million. In addition, we recorded a variety of charges from previously announced closures totaling $0.1 million in the period.

During the six months ended March 31, 2004, we recorded a pre-tax charge of $7.7 million for the closure of our Wright City facility, recorded a $1.8 million pre-tax gain on the sale of our Mundelein facility, and incurred a variety of charges from previously announced closures totaling $0.3 million. The charges from the previously announced closings consisted primarily of $0.1 million for equipment relocation, $0.1 million for inventory write-off, and $0.1 million of carrying costs.

During the second quarter of fiscal 2003, we recorded a pre-tax charge of $0.9 million. In that quarter, we announced the closure of our Hunt Valley, Maryland and Mundelein merchandising display facilities. The closures resulted in the termination of approximately 49 employees. In connection with these closings, we accrued $0.1 million for severance and other employee costs. These facilities were consolidated into the operations of other existing facilities. The other $0.8 million consisted primarily of the following: $0.7 million for equipment relocation charges primarily consisting of $0.3 million at our El Paso, Texas folding carton facility and $0.3 million at our Vineland, New Jersey converting operation; $0.2 million of inventory write-offs at our Dothan, Alabama corrugated facility; $0.1 million for an accrual adjustment related to severance at our El Paso facility; a net gain of $0.3 million for equipment sales primarily of folding carton equipment at our St. Paul, Minnesota folding carton facility; and miscellaneous other items at a variety of locations totaling $0.1 million.

During the six months ended March 31, 2003, we recorded a pre-tax charge of $0.4 million. The charge of $0.4 million was net of a gain for accrual adjustments of $1.0 million on previously announced facility closings. The $1.0 million gain resulted from $0.6 million in excess employee severance and other employee benefits due to employee voluntary terminations and working longer than planned in the notice period; and $0.4 million in accrual reversals resulting from the earlier than planned sales of property associated with our facilities in Augusta, Georgia ($0.1 million), Dothan, Alabama ($0.1 million) and Vineland, New Jersey ($0.2 million). Partially offsetting these accrual adjustments were $1.2 million of equipment relocation expenses consisting primarily of $0.7 million for Vineland, $0.3 million for El Paso, and $0.1 million for Dothan; $0.2 million for an accrual adjustment for severance at our El Paso facility; $0.1 million in severance adjustments for our Hunt Valley and Mundelein facilities; $0.2 million of inventory write-offs at Dothan; a $0.2 million net charge for the removal and ultimate sale of certain equipment in our St. Paul facility, a net gain on the sale of our Vineland property and equipment of $0.5 million, and a charge of $0.2 million for the loss on the sale of our Augusta property and equipment.

Unconsolidated Joint Venture

During the quarter ended March 31, 2004, our Seven Hills joint venture reported a loss of less than $0.1 million compared to a $0.3 million loss for the same quarter last year. The joint venture is structured so that our primary income is earned in fees paid by the joint venture to our mill division. The gains and losses that we recognize from the joint venture are calculated based upon how it performs versus benchmark performance standards that are set forth in the joint venture agreement.

During the six months ended March 31, 2004, our Seven Hills joint venture reported a loss of $0.1 million compared to $0.3 million loss for the same period last year.

The Company and Lafarge have agreed 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 the Company is entitled to recover from Seven Hills for certain services rendered to Seven Hills by the Company. The arbitration is expected to commence during the third fiscal quarter. 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 the financial results of the Company.

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Interest Expense

Interest expense for the quarter ended March 31, 2004 decreased 10.6% to $5.9 million from $6.6 million for the quarter ended March 31, 2003. The decrease was primarily attributable to lower interest rates, resulting in decreased interest expense of $0.6 million, and decreased expense of $0.1 million due to a decrease in our average outstanding borrowings in the second quarter of fiscal 2004 compared to the same quarter last year. The decrease in rates was primarily due to our utilization of favorable interest rate swaps.

Interest expense for the six months ended March 31, 2004 decreased 9.6% to $11.8 million from $13.0 million for the six months ended March 31, 2003. The decrease was primarily attributable to lower interest rates, resulting in decreased interest expense of $1.7 million, which was partially offset by increased expense of $0.5 million due to an increase in our average outstanding borrowings in the first six months of fiscal 2004 compared to the same prior year period. The decrease in rates was primarily due to our utilization of favorable interest rate swaps.

Provision for Income Taxes

Income tax expense for the quarter ended March 31, 2004 was $1.8 million compared to income tax expense of $4.5 million for the quarter ended March 31, 2003. The Company’s effective income tax rate decreased to 38.1% for the three months ended March 31, 2004 compared to 38.8% for the second quarter of fiscal 2003. The small change in rate was primarily the result of a shift in the proportion of total income taxable from the United States to foreign tax jurisdictions with lower rates. We estimate that the marginal effective income tax rate for our domestic operations for the quarter ended March 31, 2004 was approximately 38.25%.

Income tax expense for the six months ended March 31, 2004 was $4.6 million compared to income tax expense of $7.9 million for the same period last year. The Company’s effective income tax rate decreased to 38.9% for the six months ended March 31, 2004 compared to 39.4% for the six months ended March 31, 2003. The small change in rate was primarily the result of a shift in the proportion of total income taxable from the United States to foreign tax jurisdictions with lower rates. We estimate that the marginal effective income tax rate for our domestic operations for the six months ended March 31, 2004 was approximately 38.25%.

Discontinued Operations

In the first quarter of fiscal 2004, we completed the sale of our plastic packaging division and the sale of some of the 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 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 some of the 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 $0.2 million in the third and 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 division sale. We are expensing these costs ratably over the future service period, which is anticipated to expire in the fourth quarter of fiscal 2004. The plastic packaging sale transaction is subject to a final working capital adjustment, which we expect to complete in the third quarter of fiscal 2004. The adjustment is not expected to be material. We have reclassified the results of operations for these components as income from discontinued operations on the consolidated statements of operations for all periods presented.

We reported a loss from discontinued operations for the quarter ended March 31, 2004 of $0.1 million compared to income of $0.2 million for the quarter ended March 31, 2003. The charge in the second quarter of fiscal 2004 was primarily due to severance and other related employee costs, as noted above.

Income from discontinued operations for the six months ended March 31, 2004 was $7.6 million compared to $0.3 million for the six months ended March 31, 2003. Income from discontinued operations for the first six months of fiscal 2004 includes an after-tax gain of approximately $7.1 million on the sale of our plastic packaging division.

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Net Income

Net income in the second quarter of fiscal 2004 and 2003, respectively, included a loss of $0.1 million and income of $0.2 million from discontinued operations and pre-tax expense of $6.0 million and $0.9 million for restructuring and other costs. 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.”

Net income for the six months ended March 31, 2004 included income of $7.6 million from discontinued operations and pre-tax expense of $6.2 million for restructuring and other costs. Approximately $7.1 million of the $7.6 million of income from discontinued operations was due to the gain on the sale of the plastic packaging division. Net income for the six months ended March 31, 2003 included income of $0.3 million from discontinued operations and pre-tax expense of $0.4 million for restructuring and other costs. 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.”

Earnings Per Common and Common Equivalent Share

For a discussion of factors that impacted our earnings per common and common equivalent dollars per share, see the disclosure included under the headings “Results of Operations (Consolidated) – Net Income.”

Results of Operations (Segment Data)

Packaging Products Segment (Aggregate before Intersegment Eliminations)