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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
(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:

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ROCK-TENN COMPANY

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PART I: FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS (UNAUDITED)

ROCK-TENN COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(In Thousands, Except Per Share Data)

See Accompanying Notes to Condensed Consolidated Financial Statements

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ROCK-TENN COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In Thousands, Except Share And Per Share Data)

See Accompanying Notes to Condensed Consolidated Financial Statements

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

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)

See Accompanying Notes to Condensed Consolidated Financial Statements

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ROCK-TENN COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Three Month Period Ended December 31, 2003
(Unaudited)

     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 paperboard 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 month period ended December 31, 2003 and 2002, the Company’s financial position at December 31, 2003 and September 30, 2003, and the cash flows for the three month period ended December 31, 2003 and 2002.

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 results for the three months ended December 31, 2003 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.   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, 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 makes adjustments where facts and circumstances dictate.

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 (which we refer to as “SFAS 132R”), Employers’ Disclosures about Pensions and Other Postretirement Benefits. The requirements of the standard are effective for public entities for fiscal years ending after December 15, 2003 (for calendar year companies, this means in their 2003 year-end financial statements) and

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for quarters beginning after December 15, 2003, unless otherwise stated in the standard. The adoption of SFAS 132R is not expected to have a material effect on our consolidated financial statements.

In December 2003, the Staff of the Securities and Exchange Commission (which we refer to as the “SEC” or the “Staff”) issued Staff Accounting Bulletin No. 104 (which we refer to as “SAB 104”), Revenue Recognition, which supercedes SAB 101, Revenue Recognition in Financial Statements. Management has evaluated SAB 104 and concluded it does not have a material effect on our consolidated financial statements.

In December 2003, the FASB issued a revised version of FASB Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of ARB 51 (which we refer to as “FIN 46R”). We are required to adopt this interpretation at the end of the first interim reporting period ending after March 15, 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. The interpretation is effective immediately for any VIEs created after January 31, 2003 and for VIEs in which an enterprise obtains an interest after that date. We are currently evaluating the impact of adopting FIN 46R.

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:

•

We have a 49% ownership interest in Seven Hills, a joint venture. The partners of the joint venture guarantee funding of net losses in proportion to their share of ownership.

•

We lease certain manufacturing and warehousing facilities and equipment under various operating leases. A substantial number of these leases require us to indemnify the lessor in the event that additional taxes are assessed due to a change in the tax law. We are unable to estimate our maximum exposure under these leases because it is dependent on changes in the tax law.

•

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 $0.9 million. Accordingly, we have recorded a liability for that amount.

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Note 4.   Comprehensive Income

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

The increase in other comprehensive income for the quarter ended December 31, 2003 is primarily due to the change in the Canadian/U.S. exchange rate and an increase in our overall investment in Canada as a result of our acquisition of Groupe Cartem Wilco Inc. (which we refer to as “Cartem Wilco”), in January 2003. The exchange rate at September 30, 2003 was 1.3493 and moved to 1.2963 at December 31, 2003. Similarly, the exchange rate at September 30, 2002 was 1.5870 and moved to 1.5723 at December 31, 2002.

Note 5.   Earnings per Share

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

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Note 6.   Acquisition

In August 2003, we completed the acquisition of Pacific Coast Packaging, a folding carton manufacturer located in Kerman, California. In the first quarter of fiscal 2004 we paid additional consideration of $1.0 million, representing an adjustment based on the achievement of certain sales levels for the six-month period following the closing of the transaction. The payment was recorded as goodwill.

Note 7.   Restructuring and Other Costs

During the first quarter of fiscal 2004, we incurred approximately $0.1 million in restructuring and other costs from previously announced closures.

During the first quarter of fiscal 2003, we recognized income from restructuring and other costs of approximately $0.5 million. This income was primarily due to accrual reversals resulting from the earlier than planned sales of property associated with our Dothan, Alabama corrugated operations and our Vineland, New Jersey converting operations, both of which we closed in fiscal 2002, as well as a reduction in severance and equipment carrying costs. Partially offsetting these accrual adjustments was an impairment charge of $0.6 million that we incurred during the first quarter of fiscal 2003 as a result of our decision to remove from service certain equipment in our folding carton division.

Note 8.   Sale of Discontinued Operations

In the first quarter of fiscal 2004, we completed the sale of our plastic packaging division to Pactiv Corporation, 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 $7.2 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 $3.0 million.

We expect to incur additional expenses in future quarters related to the sale transactions discussed above. The expenses of approximately $0.4 million will be primarily related to severance and other related employee costs for employees required to render future service. We are expensing these costs ratably over the future service period. The plastic packaging sale transaction is subject to a final working capital adjustment, which we expect to complete in our second fiscal quarter of 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.

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:

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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 December 31, 2003 and September 30, 2003 were as follows (in thousands):

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Note 11.   Debt

Debt, excluding the fair value of hedging instruments of $18.1 million and $23.9 million at December 31, 2003 and September 30, 2003, respectively, consists of the following (in thousands):

(a)		In March 2003, we sold $100.0 million in aggregate principal amount of our 5.625% notes due March 15, 2013 (which we refer to as the “2013 Notes”). The 2013 Notes are not redeemable prior to maturity and are not subject to any sinking fund requirements. The 2013 Notes are unsubordinated, unsecured obligations. The indenture related to the 2013 Notes restricts us and our subsidiaries from incurring certain liens and entering into certain sale and leaseback transactions, subject to a number of exceptions. Debt issuance costs of approximately $0.8 million are being amortized over the term of the 2013 Notes. Giving effect to the amortization of the original issue discount, and the debt issuance costs, the effective interest rate on the 2013 Notes is approximately 5.744%.
(b)		In August 2001, we sold $250.0 million in aggregate principal amount of our 8.20% notes due August 15, 2011 (which we refer to as the “2011 Notes”), the proceeds of which we used to repay borrowings outstanding under our revolving credit agreement. The 2011 Notes are not redeemable prior to maturity and are not subject to any sinking fund requirements. The 2011 Notes are unsubordinated, unsecured obligations. The indenture related to the 2011 Notes restricts us and our subsidiaries from incurring certain liens and entering into certain sale and leaseback transactions, subject to a number of exceptions. The 2011 Notes were issued at a discount of $0.7 million, which is being amortized over the term of the 2011 Notes. Debt issuance costs of approximately $2.1 million are being amortized over the term of the 2011 Notes. Giving effect to the amortization of the original issue discount and the debt issuance costs, the effective interest rate of the 2011 Notes is approximately 8.31%.
(c)		In August 1995, we sold $100.0 million in aggregate principal amount of our 7.25% notes due August 1, 2005 (which we refer to as the “2005 Notes”). The 2005 Notes are not redeemable prior to maturity and are not subject to any sinking fund requirements. The 2005 Notes are unsubordinated, unsecured obligations. The indenture related to the 2005 Notes restricts us and our subsidiaries from incurring certain liens and entering into certain sale and leaseback transactions, subject to a number of exceptions. Debt issuance costs of approximately $0.9 million are being amortized over the term of the 2005 Notes. In May 1995, we entered into an interest rate adjustment transaction in order to effectively fix the interest rate on the 2005 Notes subsequently issued in August 1995. The costs associated with the interest rate adjustment transaction of $1.5 million are being amortized over the term of the 2005 Notes. Giving effect to the amortization of the original issue discount, the debt issuance costs and the costs associated with the interest rate adjustment transaction, the effective interest rate on the 2005 Notes is approximately 7.51%.

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(d)		In November 2000, we entered into a $125.0 million receivables-backed financing transaction (the “Receivables Financing Facility”), the proceeds of which we used to repay borrowings outstanding under our revolving credit agreement. A bank provides a back-up liquidity facility. We had no outstanding borrowing under this facility as of December 31, 2003. The effective interest rate was 2.10% as of September 30, 2003. Both the Receivables Financing Facility and the back-up liquidity facility are 364-day vehicles.
(e)		Payments of principal and interest on these industrial revenue bonds are guaranteed by a letter of credit issued by a bank. Restrictive covenants similar to those described in note (f) below exist under the terms of the letter of credit agreements. The bonds are remarketed periodically based on the interest rate period selected by us. In the event the bonds cannot be remarketed, the bank has agreed to extend long-term financing to us in an amount sufficient to retire the bonds. The bonds are secured by the underlying assets.
(f)		In March 2003, we amended our revolving credit facility, provided by a syndicate of banks, to reduce the size of the facility from $300.0 million to $125.0 million through June 2005. Combined credit availability under the Receivables Financing Facility and the revolving credit facility exceeds $100.0 million as of December 31, 2003. Borrowings outstanding under the revolving credit facility bear interest based upon LIBOR plus an applicable margin. Annual facility fees range from 0.125% to 0.50% of the aggregate borrowing availability, based on the ratio of our consolidated funded debt to a financial measure referred to as EBITDA in the documentation for our revolving credit facility (which we refer to as “Credit Facility Earnings Before Interest, Taxes, Depreciation, Amortization, and Other Cash and Non-Cash Items”). Credit Facility Earnings Before Interest, Taxes, Depreciation, Amortization, and Other Cash and Non-Cash Items is not a defined term under accounting principles generally accepted in the United States and should not be considered as an alternative financial measure to cash flows from operations as a measure of liquidity or to net income as a measure of operating results. This liquidity measure, which is referred to as EBITDA in our revolving credit facility, differs from the term EBITDA as the SEC defines the term for disclosure purposes, which is earnings (net income) before interest expense, taxes (income tax expense), depreciation, and amortization). The borrowing rate, and facility fee, at December 31, 2003 was 2.1875% and 0.25% respectively. The borrowing rate and facility fees at September 30, 2003 were 2.25% and 0.25%, respectively. The agreements covering this facility include restrictive covenants regarding the maintenance of financial ratios, creation of additional long-term and short-term debt, certain leasing arrangements, mergers, acquisitions, disposals and other matters. We are in compliance with such restrictions.

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Note 12.   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, plant closing and related expenses and certain corporate expenses.

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PART I.   FINANCIAL INFORMATION

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

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 Annual Report on Form 10-K which we filed with the SEC on December 19, 2003. The table in Note 12 to the condensed consolidated financial statements shows certain operating data for our three industry segments.

Overview

Demand for our businesses was stable over the course of the first quarter of fiscal 2004. The trends in sales volume for most of our major businesses were positive. At the end of the quarter, however, we experienced some weakness, particularly in our northeast folding carton operations and our coated paperboard operations. This weakness late in the quarter adversely affected our earnings. Net sales for our merchandising display business were down very slightly compared to the first quarter of fiscal 2003. Compared to the prior year quarter, net sales were up 11% in part due to net sales in the folding carton division that increased 24.8%, due to growth arising from our acquisitions during fiscal 2003 and growth in our business that was not attributable to acquisitions during the period (which we refer to as “base business”), as well as net sales in the paperboard segment that were up 5.2%. These increases were generally in line with our expectations, with the exception of the weakness noted above at the end of the quarter. Net sales in our interior packaging division were relatively unchanged on slightly lower volume. Our corrugated packaging division net sales were relatively flat on slightly higher volume and lower prices compared to the first quarter of fiscal 2003. Over the same period, net sales of recycled fiber decreased on higher volume and lower prices, while net sales of laminated paperboard products decreased on lower volume and prices.

Energy costs were much higher in the first quarter of fiscal 2004 than in the year ago quarter. While we experienced higher volume and slightly increased prices for our recycled paperboard, these gains were more than offset by increases in fiber and energy costs compared to the first quarter of fiscal 2003. The pricing environment for our products remained highly competitive in all our businesses. We believe there was some growth in the manufacturing sector during the first quarter of fiscal 2004, but it was insufficient to change the current market environment to permit the recovery of cost increases. Pricing pressure has also been aggravated by continued consolidation by consumer products companies that are our customers.

We anticipate that pricing pressures will continue until such time as demand in the industry increases either due to continued reduction of capacity in the industry or increased demand resulting from economic growth. Our mills operated at 92% of capacity during the first quarter of fiscal 2004, which provides us with some room for improvement if demand improves or if we continue to gain market share as we did in the last quarter of fiscal 2003. A number of major containerboard producers have announced price increases that will be effective generally in February and March of 2004. We do not expect these price increases to have a material effect on our results of operations in our second fiscal quarter because of the timing of the increases. The market for merchandising displays is becoming more price competitive, which is reflected in trends toward more frequent bidding for business and customer turnover, as well as increased demand for lower cost displays with more economical designs. We expect that these factors will continue to affect our sales of merchandising displays. The corrugated packaging division also experienced continued pricing pressure for its products, while raw material costs increased compared to the prior year quarter.

Margins in our folding carton and interior packaging operations improved compared to the first quarter of fiscal 2003. The improvement came primarily from growth due to acquisitions, growth in our base business and cost reductions, which more than offset cost increases and price erosion. In the folding carton division, we incurred a $1.1 million receivables and inventory write-off that resulted from a customer’s bankruptcy that occurred after the first quarter of fiscal 2004 ended. Before accounting for this write-off, the margin results in our folding carton operations improved but were somewhat below our seasonally adjusted expectations, primarily due to pricing pressures as well as certain higher than budgeted costs. In our merchandising display business, margins were down somewhat compared to the prior year quarter, primarily due to the pricing pressures and competitive bidding

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discussed above as well as changes in customer and product mix. Margins in the paperboard segment were down compared to the prior year quarter primarily due to higher fiber and energy costs.

During the first quarter of fiscal 2004, we sold our plastic packaging operations in a transaction valued at approximately $60.0 million. We invested in this business and repositioned it during fiscal 2000 and 2001, creating what we believed to be a competitive cost platform. We considered opportunities to expand the plastic packaging business; however, in the end, we concluded that the business would be more valuable to a strategic acquirer with a greater presence in the market. This sale will allow us to redeploy the sales proceeds into our core businesses. During the quarter, we also sold a small folding carton and label plant in Quebec that we acquired in the Cartem Wilco acquisition. The very short run business operations of this plant did not fit with our business profile, so we sold the operations to a former owner for no gain or loss. Primarily as a result of these transactions, our net income for the quarter included income of $7.7 million from discontinued operations.

Results of Operations (Consolidated)

Net Sales (Unaffiliated Customers)

The increase in net sales for the quarter ended December 31, 2003 compared to the prior year quarter was primarily due to growth arising from the acquisition of Cartem Wilco and Pacific Coast Packaging by our folding carton division, which were completed in January and August 2003, respectively, growth in the base business of our folding carton operations, and market share gained in our paperboard mills where tons shipped were up 6.4%. 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 December 31, 2003 compared to the prior year quarter resulted primarily from increases in raw material and energy costs as well as a $0.6 million inventory write-off due to a customer’s bankruptcy that occurred after the quarter ended. Natural gas costs averaged $10 per ton more in the first quarter of fiscal 2004 compared to the same quarter last year. Last year, we hedged most of our natural gas purchases for the quarter ended December 31, 2002 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 energy purchases for the quarter ended December 31, 2003 at a NYMEX equivalent price of approximately $5.20 per MMBtu. 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.

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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