In fiscal 2002 the relentless efforts of our employees to satisfy our customers every time, to innovate and to attack
our total process costs had a meaningful impact on our results in the face of very difficult economic conditions.
As the recession deepened over the year and many consumer non-durable goods manufacturers such as ourselves faced
deflation in our businesses, Rock-Tenn continued to generate substantial cash. We funded $25.4 million in acquisitions
in our growing merchandising display business and reduced the principal amount of our debt by $32.4 million to $453.2
million. This is our lowest level of debt since 1996, before our 1997 acquisition of Waldorf Corporation. Our net income
per share declined to $.77 from $.91 in fiscal 2001, which fell short of our expectations at the beginning of the year.
Although many factors affected our businesses during 2002, the most challenging combination was higher recycled fiber
costs (fiber is the largest cost in our mills) and declining pricing for our mills' output – recycled paperboard. Our
average fiber costs increased sharply in the last half of the year, resulting in an average increase for the year of
$11 per ton or $12.2 million for our 1.1 million tons produced. These higher fiber costs resulted primarily from
increased Asian buying of United States-sourced recycled fiber, not domestic demand. Our actual paperboard pricing
weakened on average for the year, reflecting the challenge of the recessionary demand environment. Our average
paperboard price for fiscal 2002 declined $20 per ton or $22.1 million. These two factors alone reduced fiscal 2002
income from operations compared to 2001 by $34.3 million.
So what were the good things our employees did that made such a difference in fiscal 2002 and allowed us to meet our
expectations for cash generated to fund acquisitions and debt reduction?
We continued to increase the operating income of our largest segment, packaging products, to $50.5 million in fiscal 2002,
up $2.4 million over 2001 and $10.8 million over 2000. Our return on sales increased to 6.4% in 2002 over 6.0% in 2001 and
5.0% in 2000.
We did this through smart investments in cost-reducing technologies, allowing our employees to bring very low-cost solutions
to our customers. We excel with high service customers with specialized packaging needs, whether it's complex folding
cartons with very demanding printing or finishing requirements, or extremely short (often same day) order and fulfillment
cycles for our interior packaging products.
We believe that in our business, being able to provide the lowest full-process cost solutions to complex and demanding
requirements is the competitive advantage necessary to achieve outstanding results. That's why we lead our industry in
adopting computer-to-plate printing (CTP) technology. We are now 100% CTP in our 11 sheetfed offset folding carton
plants and are leading the introduction of CTP in our web flexographic plants. We've added high-speed printing, cutting
and finishing equipment in a number of key folding carton plants in the last three years as part of our consolidation
of our operations into larger, better equipped plants with far better cost structures. We reequipped our plastic
packaging plants adding new wide-format extrusion and thermoforming equipment creating two larger and more efficient,
low-cost plants.
We strive to be the leader in all we do. Thus, we believe we are the largest manufacturer of overnight letter envelopes for
the express mail business, with highly automated processes to make these complex overnight mailers. We are the largest
independent manufacturer of metal and plastic cutting-edged folding cartons for foils and wraps. We are the largest
manufacturer of solid fiber partitions for beer and wine, using our proprietary manufacturing equipment to make very
consistent, high-quality partitions that speed up our customers' bottle manufacturing and filling operations at plants
across North America. We are the largest manufacturer of rigid barrier polypropelene trays for case-ready meat and poultry.
Our employees have hit upon a formula for success that we are committed to follow. Be the best at what we do – and do so
at very low cost. We will continue to support our employees' efforts to lead the competition with smart investments in
the technologies they need to serve our customers better than anyone else can.
Our merchandising displays and corrugated packaging segment continued the 10% increase in sales in 2001 with another 10%
increase in 2002 to $290 million. Operating income was up 9% in 2002 over 2001 despite very weak markets for corrugated
packaging. These sales and earnings increases resulted from the continued expansion of our merchandising display platform.
Alliance Display now operates three manufacturing facilities, 12 contract packing and fulfillment centers and ten design
and sales centers across the country.
Sales at Alliance Display alone increased 20.7% to $219 million in 2002. Operating income at Alliance Display increased
23.7% over 2001. We think the promotional display business is a very good place for us to continue to focus our efforts.
It is a growing business, fueled by the trend toward large retailers such as Wal-Mart and The Home Depot and their strong
use of in-store marketing and promotions. It is a very demanding business, requiring innovative new display designs,
and rapid and flawless project execution, including display manufacturing and assembly, packing displays with our
customers' products and shipping large numbers of packed displays to their distribution centers and to retail outlets
on very demanding time schedules. Our excellence in design and our broad and dedicated fulfillment capabilities continue
to attract new customers and increased business from existing customers.
We are committed to continuing to be the service leader in this business as well. In 2001 we introduced with several of
our leading customers our BlueCuda® project management software. BlueCuda® makes possible web-based collaborative
display project management involving both the customer's team and our team – from concept to completion. In 2003 we
will adopt enterprise-wide application integration technology that we are developing with Sapient Corporation that
will integrate our major display business systems, allowing us to streamline our processes and greatly enhance the
financial and operating systems and data we use in this complex business. This project also will include developing
web-based access that will allow our customers to track their projects online at each stage of execution. Since most
of the costs of this project must be expensed as incurred (only the time spent on actual software coding can be
capitalized), we will take a short-term earnings hit in the first two quarters of 2403 for the costs of this project.
We estimate that our total outside development fees will be approximately $5.0 million.
The effects of recycled fiber costs and competitive conditions in our mill business have significantly reduced the
contribution of the paperboard segment to our operating income. Over the course of the economic decline of the last
two years, paperboard segment operating income declined from $51.4 million in fiscal 2000, when it represented 43%
of total segment operating income to $24.1 million in fiscal 2002, when it represented 22% of total segment operating
income.
I have already quantified the specific impact on paperboard operating income of the increase in recycled fiber costs
and reduction in average selling prices over the course of fiscal 2002. Recycled fiber costs declined in the fall and
are significantly lower than the fourth quarter 2002 peak costs. In early December 2002 delivered costs to our mills
were in the range of $55–$60 for old corrugated containers, $70–$75 for old newsprint and $45–$50 for box cuttings,
our three most important fiber sources. Another risk going forward is the possibility of steeply increasing natural
gas costs, a risk that came home in 2000 with wellhead natural gas costs reaching $7 and $8 per mcf (natural gas is
currently around $4 per mcf). The possibility of a normally cold winter this year and low reserve replacement
performance in 2002 by natural gas producers are major concerns for us in fiscal 2003.
Mitigating these risks are a number of actions we have taken in the last few years. Our mills are in excellent shape
after three years of heavy capital expenditures. They are more efficient, as we used that capital at several of our
mills to upgrade fiber cleaning systems to give us the flexibility to change our fiber mix in response to changes in
market pricing and to add latest-generation computer control systems that lead to markedly improved quality and
reduced waste. These actions, together with the rebuilding and conversion to gypsum linerboard production of our
Lynchburg No. 2 machine, the introduction of our Millennium Board® SUS replacement product and MillMask® grease
masking paperboard technology, and many other targeted actions, allowed us to increase our total tons produced in
fiscal 2002, to 1.105 million tons compared to 1.066 million tons in fiscal 2001. Since we shut down our Lynchburg
No. 1 specialty machine in December 2001 and our Dallas specialty machine in September 2002, removing 165 thousand
tons of specialty paperboard capacity, we expect to operate at much higher production rates in fiscal 2003, as we
need to do given the current paperboard margin environment.
Fiscal 2002 marked a number of important milestones for our Company affecting our outlook and our future. In May 2002,
directors and executive officers, holding enough Class B super voting stock to effect the elimination of our two
classes of common stock structure, converted their super voting shares to one vote per share Class A common stock,
resulting in the conversion of all Class B common stock to Class A common stock. Those shareholders took this action
without seeking any compensation because they believed it would be good for all shareholders to make our common
stock a more attractive investment for institutional owners (our reported institutional ownership did increase
during the year, from 23% at September 30, 2001 to 35% at September 30, 2002). In October 2002, we increased our
dividend to $.32 per share (our first increase since we went public in 1994), reflecting our confidence in the
cash flow generating ability of our Company and our expectation that the relatively high capital expenditure levels
of the last five years will not be necessary in the coming years, unless directed toward growth initiatives. We
made Six Sigma process improvement a part of our culture and expect the crossover date to cumulative profitability
to occur in January 2003, 16 months after we started the program. We made headway in consolidating our purchasing
at the corporate level to reduce our costs by using the leverage our business size and scope provides. We committed
to a corporate-wide diversity program to broaden opportunities at our Company to our extremely diverse workforce...
and the list of actions goes on.
Our employees want to work at a great company and feel a natural discomfort with the status quo that motivates us to
continue to work and innovate to improve our businesses, our processes, our quality, our cost structure, and our
customer service.
Fiscal 2002 marks another milestone for all of us at Rock-Tenn. Since 1976, Brad Currey has been synonymous with
Rock-Tenn Company as was his predecessor as Chairman, Worley Brown, whose widow Lou Brown Jewell succeeded Worley
on our Board of Directors in 1994. In January 2003, Lou and Brad will retire as Directors under a mandatory
retirement policy that Brad sponsored and, when it came his time, honored. We would not be the Company we are
without the team of Currey and Brown. It is with great affection and admiration that we mark the upcoming
retirement from our Board of Brad Currey and Lou Jewell.
Our economy is in recession, we fight deflation and our competitors, and yet you will observe nothing but optimism
from my comments in this letter. My optimism is grounded in the confidence that the actions we are taking are
making Rock-Tenn Company a much tougher competitor than it has ever been. But more than that, it is because I get
to work every day with the 8,500 people who are Rock-Tenn Company. I hope this report does a good job of pointing
out some of their successes in 2002 and the actions they've taken to make 2003 more successful.
Sincerely,
James A. Rubright
Chairman and Chief Executive Officer
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We've spent the last three years attacking our cost structure and improving our quality in our packaging and paperboard businesses.
We believed then that our growth in profitability was more important than sales growth. We achieved income growth in packaging,
up 27% in fiscal 2002 over fiscal 2000, and in our paperboard business we've performed very well compared to our peers in a
very difficult cycle. We've shown we can grow where we've got our business model right. Alliance Display's five-year compound
annual growth rate in sales through 2002 was 32%. I believe we can grow our largest segment, packaging, capitalizing on our
cost structure in folding cartons and product innovation in plastics. We will also target acquisitions to increase our sales
of pharmaceutical and health and beauty care packaging, the fastest-growing folding carton segment. We also expect continued
growth in merchandising displays, where our record speaks for itself. We likely will not see significant growth in our
paperboard business, where our current operating rates are quite high and excess industry capacity presently precludes
capacity additions at Rock-Tenn.
The kind of people who are attracted to work at Rock-Tenn are terrifically competitive people who can't stand not being the best,
and better yet, who will work to be the best. They expect to be challenged, to be given responsibility and to be accountable.
They want to see their results measured – how else to compare results and to recognize success or failure. If we keep these
people working in a decentralized environment in businesses where we can be the best at what we do, we'll have a great Company
and produce outstanding results.
We manage to return over capital costs (ROCC) – down to each individual plant. In businesses like ours, where capital is
important, we believe focusing on ROCC gets the best decisions made at the plant level, where our people are closest to our
customers and are best able to make the major decisions that chart our future. We track productivity measures by employee
and by major piece of equipment for the many products we manufacture. We also measure the performance of our employees
through our performance management program. We meet their needs for recognition and reward, and we plot together a course
for each employee's career development. There's nothing more important than that.
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