UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

For the quarterly period ended December 31, 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 þ No o
	Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes þ 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

See accompanying Notes to Condensed Consolidated Financial Statements

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See accompanying Notes to Condensed Consolidated Financial Statements

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

Supplemental schedule of non-cash investing and financing activities (in thousands):

See accompanying Notes to Condensed Consolidated Financial Statements

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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. All references in the accompanying financial statements and Quarterly Report on Form 10-Q to data regarding sales price per ton and fiber, energy, chemical and freight costs with respect to our recycled paperboard mills excludes that data with respect to our Aurora, Illinois, recycled paperboard mill. We exclude that data because the Aurora operation is materially different. All other references herein to operating data with respect to our recycled paperboard mills, including tons data and capacity utilization rates, includes operating data from our Aurora recycled paperboard mill.

Note 1. Interim Financial Statements

Our independent auditors have not audited our accompanying condensed consolidated financial statements. We derived the condensed consolidated balance sheet at September 30, 2004 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 months ended December 31, 2004 and 2003, our financial position at December 31, 2004 and September 30, 2004, and our cash flows for the three months ended December 31, 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, 2004 (the “Fiscal 2004 Form 10-K”).

The results for three months ended December 31, 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

For a discussion of our significant accounting policies, see “Note 1: Description of Business and Summary of Significant Accounting Policies” of the Notes to Consolidated Financial Statements section of our Fiscal 2004 Form 10-K. As of the date hereof, there have been no significant developments with respect to significant accounting policies since September 30, 2004.

Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles 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 may 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 used 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

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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 regularly re-evaluate these significant factors and make adjustments where facts and circumstances dictate.

Note 3. New Accounting Standards

On December 16, 2004, the Financial Accounting Standards Board (which we refer to as the “FASB”) issued FASB Statement No. 123 (revised 2004), “Share-Based Payment” (which we refer to as “SFAS 123(R)”), which is a revision of FASB Statement No. 123, “Accounting for Stock-Based Compensation” (which we refer to as “SFAS 123”). SFAS 123(R) supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees” (which we refer to as “APB 25”), and amends FASB Statement No. 95, “Statement of Cash Flows.” Generally, the approach in SFAS 123(R) is similar to the approach described in SFAS 123. However, SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. After the effective date, pro forma disclosure will no longer be an alternative.

SFAS 123(R) must be adopted no later than July 1, 2005. Early adoption will be permitted in periods in which financial statements have not yet been issued. We expect to adopt SFAS 123(R) on July 1, 2005.

SFAS 123(R) permits public companies to adopt its requirements using one of two methods:

•	A “modified prospective” method in which the entity would recognize compensation cost beginning with the effective date: (a) based on the requirements of SFAS 123(R) for all share-based payments to be granted or modified after the effective date and (b) based on the requirements of SFAS 123 for all awards granted to employees prior to the effective date that remain unvested on the effective date.
•	A “modified retrospective” method which includes the requirements of the modified prospective method described above, but also permits entities to restate based on the amounts previously recognized under SFAS 123 for purposes of pro forma disclosures either for (a) all prior periods presented or (b) the prior interim periods of the year of adoption.

We have not made a decision as to which method we will use to adopt SFAS 123(R).

As permitted by SFAS 123, we currently account for share-based payments to employees using APB 25’s intrinsic value method and, as such, generally recognize no compensation cost for employee stock options. Accordingly, our adoption of SFAS 123(R)‘s fair value method will have a significant impact on our results of operations, although it will have no impact on our overall financial condition. We cannot predict the impact of our adoption of SFAS 123(R) at this time because it will depend on levels of share-based payments we grant in the future. However, had we adopted SFAS 123(R) in prior periods, the impact of that standard would have approximated the impact of SFAS 123 as described in the disclosure of pro forma net income and earnings per share in “Note 13 - Shareholders’ Equity” of our notes to consolidated financial statements in our Fiscal 2004 Form 10-K. The pro forma stock-based employee compensation expense was $2.7 million, $2.9 million, and $3.1 million, net of taxes, in fiscal 2004, 2003, and 2002, respectively. SFAS 123(R) will also require us to report the benefits of tax deductions in excess of recognized compensation cost as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce our net operating cash flows and increase our net financing cash flows in periods after adoption. While we cannot estimate what those amounts will be in the future (because they depend on, among other things, when employees exercise stock options), the amount of operating cash flows we recognized in prior periods for such excess tax deductions were $0.4 million, $1.0 million, and $1.3 million in fiscal 2004, 2003 and 2002, respectively.

In November 2004, the FASB released FASB Statement No, 151, “Inventory Costs — an amendment of ARB No. 43, Chapter 4” (which we refer to as “SFAS 151”). SFAS 151 is the result of the FASB’s efforts to converge U.S. accounting standards for inventories with international accounting standards. SFAS 151 requires us to recognize abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage) as current-period charges. It also requires us to base our allocation of fixed production overheads to the costs of conversion on the normal capacity of the production facilities. SFAS 151 is effective for inventory costs incurred

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during fiscal years beginning after June 15, 2005. We do not expect our adoption of SFAS 151 to have a material effect on our consolidated financial statements.

On December 15, 2004 the FASB issued Statement No. 153, “Exchanges of Nonmonetary Assets an amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions” (which we refer to as “SFAS 153”). SFAS 153 is based on the principle that nonmonetary asset exchanges should be recorded and measured at the fair value of the assets exchanged, with certain exceptions. This standard will require us to account for exchanges of productive assets at fair value, rather than at carryover basis, unless (1) neither the asset received nor the asset surrendered has a fair value that is determinable within reasonable limits or (2) the transactions lack commercial substance (as defined). In addition, the Board decided to retain the guidance in Accounting Principles Board Opinion No. 29, “Accounting for Nonmonetary Transactions” (which we refer to as “APB 29”), for purposes of assessing whether the fair value of a nonmonetary asset is determinable within reasonable limits. The new standard is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. We cannot predict the impact of our adoption of SFAS 153 at this time because it will depend on whether we enter into nonmonetary transactions in the future.

Note 4. Comprehensive Income

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

The change in other comprehensive income was primarily due to the fluctuation in the Canadian/U.S. dollar exchange rate. The first quarter of fiscal 2005 was impacted as the exchange rate moved to 1.1995 at December 31, 2004 from 1.2614 at September 30, 2004. The first quarter of fiscal 2004 was impacted as the exchange rate moved to 1.2963 at December 31, 2003 from 1.3493 at September 30, 2003.

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Note 5. Earnings per Share

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

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Note 6. Restructuring and Other Costs

We recorded pre-tax restructuring and other costs of $0.5 million and $0.1 million for the first quarter of fiscal 2005 and 2004, respectively, as outlined below:

Fiscal 2005

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 three months ended December 31, 2004 (in thousands):

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Fiscal 2004

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 three months ended December 31, 2003 (in thousands):

Summary of Restructuring Initiatives

During the fourth quarter of fiscal 2003, we announced the closure of our Dallas, Texas, laminated paperboard facility. We consolidated the operations of this plant into other existing facilities. Except for equipment we are able to utilize elsewhere in our operations, we recognized an impairment charge to reduce the carrying value of the equipment from this facility to its estimated fair value less cost to sell. We have disposed of substantially all of the equipment from this facility and we have classified the facility as held for sale.

During the second quarter of fiscal 2004, we announced the closure of our Wright City, Missouri, laminated paperboard products facility effective March 31, 2004. We did not consolidate the majority of the sales of this operation into our remaining laminated facilities. Except for equipment we are able to utilize elsewhere in our operations, we recognized an impairment charge to reduce the carrying value of the equipment and the facility to its estimated fair value less cost to sell. We have classified the property, plant and equipment of this facility as held for sale. We have disposed of substantially all of the equipment from this facility, and we sold the facility in the first quarter of fiscal 2005.

During the third quarter of fiscal 2004, we announced the closure of the laminated paperboard products converting lines at our Aurora, Illinois, facility. We did not consolidate the majority of the sales from these products lines into our other facilities. We recognized an impairment charge to reduce the carrying value of the equipment, consisting primarily of a laminator, to its estimated fair value less cost to sell. We have classified the equipment as held for sale.

During the fourth quarter of fiscal 2004, we announced the closure of our Otsego, Michigan, specialty recycled paperboard mill. A significant portion of the capacity of this facility supported the laminated paperboard products facilities that we closed during fiscal 2004. We shifted approximately one third of the volume of this facility to our remaining recycled paperboard facilities. Except for equipment we are able to utilize elsewhere in our operations, we recognized an impairment charge to reduce the carrying value of the equipment and facility to its estimated fair value.

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During the fourth quarter of fiscal 2004, we announced the closure of our St. Paul, Minnesota, folding carton facility. We closed the facility in January 2005. We expect to shift a majority of the production to our other folding carton facilities. Except for equipment we are able to utilize elsewhere in our operations, we recognized an impairment charge to reduce the carrying value of the equipment to its estimated fair value less cost to sell. We have classified the assets as held and used at December 31, 2004.

During 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 expect to complete the reorganization process in fiscal 2005.

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The following table represents a summary of restructuring and other charges related to our active restructuring initiatives that we incurred during the current quarter, the fiscal year, and cumulatively since we announced the initiative, and that we expect to incur in the future (in thousands):

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Note 7. Discontinued Operations

In the first quarter of fiscal 2004, we completed the sale of our plastic packaging division and the sale of certain assets and liabilities associated with a small folding carton and label plant in Quebec that we acquired in January 2003 when we purchased Groupe Cartem Wilco (which we refer to as “Cartem Wilco”). We received cash proceeds of $59.0 million from the plastic packaging division transaction. Income from discontinued operations, net of tax, was $7.7 million in the first quarter of fiscal 2004, primarily as a result of the gain recorded on the sale of the plastic packaging division. The sale of certain Cartem Wilco assets and liabilities resulted in no gain or loss and we received cash proceeds of approximately $2.9 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.

Note 8. Tax Provision

The tax provision is in excess of our normal provision primarily due to adjustment of $0.6 million related to our acquisition of the Athens, Alabama, corrugated sheet stock manufacturing facility (which we refer to as our “Athens corrugator”). We originally recorded this adjustment as a reduction of tax expense in the year ended September 30, 2004.

Note 9. Stock Option Plans

We have elected to follow 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.

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:

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

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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. Debt

The following were individual components of debt (in thousands):

The following were the aggregate components of debt (in thousands):

(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 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. We issued the 2011 Notes at a discount of $0.7 million, which we are amortizing over the term of the 2011 Notes. We are also amortizing debt issuance costs of approximately $2.1 million 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%.

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(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. We are amortizing debt issuance costs of approximately $0.9 million 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. We are also amortizing the costs associated with the interest rate adjustment transaction of $1.5 million 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%. During the first quarter of fiscal 2005, we purchased $6.0 million of our 2005 Notes at an average price of 103.1% of par value, or $0.18 million over par value, excluding the favorable impact of unamortized realized interest rate swap gains. The average price including the favorable impact of unamortized realized interest rate swap gains was 101.6% of par value, or $0.1 million over par value.

(d)

We maintain a $75.0 million receivables-backed financing transaction (which we refer to as the “Asset Securitization Facility”). A bank provides a back-up liquidity facility. The borrowing rate, which consists of a daily commercial paper rate plus a fee for the used portion of the facility, was 2.69% as of December 31, 2004. The borrowing rate at September 30, 2004 was 2.17%. Both the Asset Securitization Facility and the back-up liquidity facility are 364-day vehicles. Our Asset Securitization Facility is scheduled to expire on March 28, 2005. Borrowing availability under this facility, which is based on the eligible underlying secured assets as of December 31, 2004, was approximately $66 million.

(e)

Payments of principal and interest on these industrial development 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. These bonds are remarketed periodically based on the interest rate period selected by us. In the event these bonds cannot be remarketed, the bank has agreed to extend long-term financing to us in an amount sufficient to retire the bonds. These bonds are secured by the underlying assets.

(f)	We maintain a revolving credit facility, which is provided by a syndicate of banks, in the amount of $75.0 million. The facility is scheduled to expire on June 30, 2006. At December 31, 2004 due to the restrictive covenants on the revolving credit facility, maximum available borrowings under this facility were approximately $36 million assuming no outstanding balance under our Asset Securitization Facility. Combined borrowing availability under the Asset Securitization Facility and the revolving credit facility was approximately $36 million as of December 31, 2004, unless the entire borrowing was under the Asset Securitization Facility, in which event it was approximately $66 million as of that date. 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 that is referred to as EBITDA in the documentation for our revolving credit facility and is calculated based on earnings before interest, taxes, depreciation and amortization less special items. The overnight borrowing rate plus credit spread, and facility fee at December 31, 2004, were 3.435% and 0.25%, respectively. The overnight borrowing rate plus credit spread, and facility fee at September 30, 2004, were 3.065% 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 these restrictions.
	Three of our Canadian subsidiaries have revolving credit facilities with Canadian banks. The facilities provide borrowing availability of up to $10.0 million Canadian, and can be renewed on an annual basis. As of December 31, 2004 and September 30, 2004, there were no amounts outstanding under these facilities.

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Note 12. Retirement Plans

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

During the three months ended December 31, 2004 and December 31, 2003, we made no contributions to our five defined benefit pension plans. We anticipate contributing approximately $12 to $16 million to these plans in fiscal 2005.

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, 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. 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. See “Business - Forward-Looking Information and Risk Factors.”

We estimate that we will spend less than $0.7 million for capital expenditures during fiscal year 2005 in connection with matters relating to environmental compliance. It may also be necessary to upgrade wastewater treatment equipment at one of our facilities during the next two years at a cost of approximately $0.1 million. Additionally, to comply with emissions regulations under the Clean Air Act, we expect to modify or replace a coal-fired boiler at one of our facilities, the cost of which we estimate will be approximately $2.0 to $3.0 million. We anticipate that we will incur those costs within the next three years.

We have been identified as a potentially responsible party (which we refer to as a “PRP”) at nine active “superfund” sites pursuant to 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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•	With respect to each of two sites, while we have been identified as a PRP, our records reflect no evidence that we are associated with the site. Accordingly, if we are considered to be a PRP, we believe that we should be categorized as an unproven PRP.

•	With respect to each of seven sites, we preliminarily determined that, while we may be associated with the site and while it is probable that we have incurred a liability with respect to the site, one of the following conclusions was applicable:

	•	With respect to each of five sites, we determined that it was appropriate to conclude that, while it was not estimable, the potential liability was reasonably likely to be a de minimus amount and immaterial.
	•	With respect to each of two sites, while we have preliminarily determined that it was appropriate to conclude that the potential liability was best reflected by a range of reasonably possible liabilities all of which we expect to be de minimus and immaterial.

We can make no assessment of any potential for our liability with respect to any of these sites. Further, there can be no assurance that we will not be required to conduct some remediation in the future at any of these sites and that the remediation will not have a material adverse effect on our results of operations, financial condition or cash flows. We believe that we can assert claims for indemnification pursuant to existing rights we have under settlement and purchase agreements in connection with certain of these sites. If any party brings an environmental claim or action against us involving any such site, we intend to assert claims for indemnification in connection with that site. There can be no assurance that we will be successful with respect to any claim regarding such indemnification rights or that, if we are successful, that any amounts paid pursuant to the indemnification rights will be sufficient to cover all costs and expenses.

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 as of September 30, 2004:

•	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

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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.

Seven Hills Arbitration

We have agreed with Lafarge North America, Inc. (which we refer to as “Lafarge”), our partner in our Seven Hills joint venture (which we refer to as “Seven Hills”), 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. The arbitration commenced 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 adversely affect our financial results.

Insurance Placed with Kemper

During fiscal years 1985 through 2002, Kemper Insurance Companies/Lumbermens Mutual provided us with workers’ compensation insurance, auto liability insurance and general liability insurance. Kemper has made public statements that they are uncertain that they will be able to pay all of their claims liabilities in the future. At present, based on public comments made by Kemper, we believe it is reasonably possible they will not be able to pay some or all of the future liabilities associated with our open and reopened claims. However, we cannot reasonably estimate the amount that Kemper may be unable to pay. Additionally, we cannot reasonably estimate the impact of state guarantee funds and any facultative and treaty reinsurance that may be available to pay such liabilities. We believe the range of our liability is between approximately $0 and $4 million and we are unable to estimate the liability because of the factors described above. If Kemper is ultimately unable to pay such liabilities, there can be no assurance that any associated liabilities we may ultimately incur will not be material to our results of operations, financial condition or cash flows.

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Note 14. 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.

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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 audited consolidated financial statements and notes thereto for the fiscal year ended September 30, 2004, 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 2004 Form 10-K which we filed with the SEC on December 14, 2004. The table in Note 14 to the condensed consolidated financial statements shows certain operating data for our three industry segments.

Overview

During the first quarter of fiscal 2005, net sales increased in each of our segments. Overall, net sales increased 5.4% compared to the first quarter of fiscal 2004 primarily due to increased volume in our Packaging Products segment, corrugated packaging division, and recycled fiber division, and higher average paperboard prices in our paperboard division. Increased Paperboard segment income was offset by lower segment income in the Packaging Products segment and Merchandising Displays and Corrugated Packaging segment.

In our Packaging Products segment, folding carton division net sales increased 6.5% compared to the first quarter of last year due to volume growth with existing customers. In the current margin environment for our folding carton division, competitive pricing pressure continues to offset the contribution from increased volume. We expect competitive pricing pressures to continue during fiscal 2005. The strong growth in folding carton sales and the high capacity at which some of our folding carton facilities operated has created inefficiencies at some of our operations. We expect to address these inefficiencies during fiscal 2005, in part by adding printing capacity and in part by reducing sales to our lower margin accounts. Based on our current expectations, which are affected by the announced closure of our St. Paul, Minnesota, facility, we may see a modest decline in folding carton sales in fiscal 2005. Further, the closure will have an impact on our results while we wind down the operations of the St. Paul facility. First quarter operating income in fiscal 2005 was reduced by increased material costs and $1.3 million of pre-tax operating loss at the St. Paul facility. We closed the facility in January 2005 and expect a small loss for these activities in the second quarter of fiscal 2005. Net sales in our interior packaging division increased 4.5% during the first quarter of fiscal 2005 compared to the same period last year due to a combination of higher prices and increased volume.

In our Merchandising Displays and Corrugated Packaging segment, our corrugated packaging division net sales increased 50.1% compared to the first quarter of last year primarily due to a combination of higher selling prices and increased volume primarily from our acquisition of the Athens corrugator in August 2004. Net sales of merchandising displays decreased by 5.3% during these same periods due to weaker than expected sales throughout the quarter. The display business can be very weak in the December quarter, although this has not always been the case. Sales in the current quarter decreased, in part, due to an absence of significant new product launches scheduled during the quarter. The market for merchandising displays also continues to reflect price competitiveness through more frequent bidding for business and increased demand for lower cost displays with more economical designs. Operating income at the merchandising displays division decreased due to decreased sales levels that resulted in poor coverage of our fixed costs, a change in product mix, and increased material costs, primarily for permanent displays.

Our Paperboard segment net sales were relatively flat during the first quarter of fiscal 2005 compared to the first quarter of fiscal 2004. In our paperboard division, average paperboard prices were up $45 a ton compared to the same period last year, which more than offset the $34 a ton cost increase for recycled fiber, energy, chemicals and freight during the same period. The price increases we announced last year are allowing us to begin recovering the cost increases we have been absorbing. The effect of the price increases during the quarter was partially offset by a decrease in tons shipped by our clay-coated and specialty paperboard mills, due to seasonal weakness and the closure of our Otsego, Michigan, specialty recycled paperboard mill. Despite that decrease, the overall operating rate for our recycled paperboard mills remained relatively constant at 92% compared to the first quarter of fiscal 2004. Laminated paperboard operation net sales declined primarily due to the actions we took in fiscal 2003 and 2004 to exit operations that were no longer cash flow positive. Our laminated paperboard operations continued to

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experience competitive pricing and a decrease in demand for our products by customers in the ready-to-assemble furniture and book and binder industries, which to date have been our primary laminated paperboard products markets. Net sales in our recycled fiber division increased 44.9% due to a combination of increased fiber prices and higher volumes.

We are preparing to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and related regulations of the SEC and the PCAOB (which we refer to collectively as the “Section 404 Rules”). So that management will be prepared to deliver the report required by the Section 404 Rules in our annual report on Form 10-K for the fiscal year ended September 30, 2005, management is engaged in an ongoing process of evaluating and improving our internal control over financial reporting. These efforts continue to require that we commit significant financial and managerial resources. We currently estimate we will spend approximately $1 million dollars during fiscal 2005 on external resources with respect to these efforts.

Results of Operations (Consolidated)

Net Sales (Unaffiliated Customers)

Net sales increased in each of our segments for the quarter ended December 31, 2004 compared to the comparable prior year quarter. The increased net sales were due primarily to increased volume in our folding carton division, increased volume in our corrugated packaging division primarily due to our acquisition of the Athens corrugator, and paperboard price increases.

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

We experienced cost increases across our businesses for the quarter ended December 31, 2004, compared to the comparable prior year quarter. Increased costs for fiber, energy, chemicals and freight at our recycled paperboard mills aggregated to $8.4 million. The shift in product mix to more permanent displays in our merchandising displays division also increased our cost of goods sold as a percentage of sales. Energy costs continued to be driven by higher natural gas prices. The increase in freight is primarily due to increased volumes associated with our increased net sales, increased fuel surcharges, tight freight capacity and longer shipping routes.

Across our businesses we had cost increases for many of our inventory items. Compared to the prior year quarter, we also experienced increased group insurance of $1.2 million and increased freight expenses of $1.1 million, excluding the amount included in the recycled paperboard freight costs referred to above. We have foreign currency transaction risk primarily due to our operations in Canada. The impact in the first quarter of fiscal 2005 compared to the prior year quarter increased costs of goods sold by $0.3 million. Partially offsetting the cost increases for the quarter ended December 31, 2004, were decreased pension expense of approximately $0.7 million, decreased direct labor costs of $0.4 million due to net efficiency gains in our operations, and decreased maintenance and repair expenses of $0.4 million.

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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 December 31, 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 first quarter of fiscal 2005. Commission expense decreased $0.6 million due to both decreased sales of merchandising displays and the mix of commissionable sales in our businesses. Employee bonus expense decreased approximately $0.6 million, primarily in our merchandising displays division where operating income was less than applicable bonus targets. Bad debt expense decreased $0.5 million compared to the prior year quarter resulting from lower total exposure to and improvements in the credit quality of several customers. Pension expense decreased $0.3 million.

Restructuring and Other Costs

We recorded pre-tax restructuring and other costs of $0.5 million and $0.1 million for the first quarter of fiscal 2005 and 2004, respectively.

During the first quarter of fiscal 2005, we incurred approximately $0.5 million in restructuring and other costs from previously announced closures. We received proceeds of $1.5 million from the sale of our previously closed Wright City, Missouri, laminated paperboard converting facility and reduced the previously recorded impairment charge by $0.7 million to record the property at fair value less cost to sell. We incurred expenses of $0.9 million

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for our previously announced St. Paul, Minnesota, folding carton facility that was closed January 2005. The expenses were primarily for severance and other employee costs. At our previously closed Otsego, Michigan, recycled paperboard mill we incurred expenses of $0.4 million, consisting primarily of equipment removal and relocation expense of $0.2 million and carrying costs of $0.1 million. We also incurred a variety of other miscellaneous charges and accrual adjustments that aggregated to income of $0.1 million.

We expect to incur future restructuring and other costs of $2.1 million related to our previously announced restructuring initiatives. We identify these expected costs and historical costs related to these initiatives in “Note 6. Restructuring and Other Costs” of the Notes to Condensed Consolidated Financial Statements section of the Financial Statements included herein.

Unconsolidated Joint Venture

During the quarter ended December 31, 2004, our Seven Hills joint venture reported income of $0.1 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 record 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.

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. 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. The arbitration commenced 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 adversely affect our financial results.

Interest Expense

Interest expense for the quarter ended December 31, 2004 increased 9.2% to $6.4 million from $5.9 million for the same quarter last year. The increase was primarily attributable to increased interest rates, net of swaps, which we believe increased interest expense by $1.0 million. This increase in rates was partially offset by a decrease in our average outstanding borrowings, which we believe lowered interest expense by approximately $0.5 million.

Provision for Income Taxes

We recorded income tax expense of $1.4 million for the quarter ended December 31, 2004, compared to income tax expense of $2.7 million for the quarter ended December 31, 2003. The tax provision is in excess of our normal provision primarily due to adjustment of $0.6 million related to Athens corrugator acquisition. Due to this adjustment, our effective income tax rate is not comparable to our 39.4% effective income tax rate for the first quarter of fiscal 2004. We estimate that the annual marginal effective income tax rate as of the quarter ended December 31, 2004, was approximately 38%.

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Discontinued Operations

In the first quarter of fiscal 2004, we completed the sale of our plastic packaging division and the sale of certain assets and liabilities associated with a small folding carton and label plant in Quebec that we acquired in the acquisition of Cartem Wilco in January 2003. We received cash proceeds of $59.0 million from the plastic packaging division transaction. Income from discontinued operations, net of tax, was $7.7 million in the first quarter of fiscal 2004, primarily as a result of the gain recorded on the sale of the plastic packaging division. The sale of certain Cartem Wilco assets and liabilities resulted in no gain or loss and we received cash proceeds of approximately $2.9 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.

Net Income (Loss)

Net income in the first quarter of fiscal 2005 and 2004 included pre-tax restructuring and other costs of $0.5 million and $0.1 million, respectively. The first quarter of fiscal 2004 included income from discontinued operations of $7.7 million from the sale of our plastic packaging division. 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