UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

(Mark One)
þ
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the Fiscal Year Ended January 1, 2011
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the Transition Period From           to  

Commission File Number 001-08634

Temple-Inland Inc.
(Exact Name of Registrant as Specified in its Charter)

Delaware
75-1903917
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification No.)

1300 MoPac Expressway South, 3rd Floor
Austin, Texas 78746
(Address of principal executive offices, including Zip code)

Registrant’s telephone number, including area code: (512) 434-5800

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class
Name of Each Exchange On Which Registered
Common Stock, $1.00 Par Value per  Share,
non-cumulative
New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None


Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934.  Yes o     No þ

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 has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ     Noo

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ
Accelerated filer o
Non-accelerated filer o
Smaller reporting company o
   
(Do not check if a smaller reporting company)
 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o     No þ

The aggregate market value of the Common Stock held by non-affiliates of the registrant, based on the closing sales price of the Common Stock on the New York Stock Exchange on July 3, 2010, was approximately $1,887,700,000. For purposes of this computation, all officers, directors, and five percent beneficial owners of the registrant (as indicated in Item 11) are deemed to be affiliates. Such determination should not be deemed an admission that such directors, officers, or five percent beneficial owners are, in fact, affiliates of the registrant.

As of February 16, 2011, there were 108,192,461 shares of Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Company’s definitive proxy statement to be prepared in connection with the 2011 Annual Meeting of Shareholders are incorporated by reference into Part III of this report.





 
 

 

TABLE OF CONTENTS

 
 
Page 
PART I.
Item 1.
1
Item 1A.
8
Item 1B.
12
Item 2.
12
Item 3.
15
Item 4.
17
PART II.
Item 5.
17
Item 6.
19
Item 7.
21
Item 7A.
43
Item 8.
44
Item 9.
80
Item 9A.
80
Item 9B.
80
PART III.
   
Item 10.
81
Item 11.
81
Item 12.
82
Item 13.
82
Item 14.
82
PART IV.
Item 15.
82
87

 

 


PART I

Item 1.  

Introduction
 
Temple-Inland Inc. is a Delaware corporation that was organized in 1983. We manufacture corrugated packaging and building products, which we report as separate operating segments. The following chart presents our corporate structure at year-end 2010. It does not contain all our subsidiaries, many of which are dormant or immaterial entities. A list of our subsidiaries is filed as an exhibit to this Annual Report on Form 10-K. All subsidiaries shown are 100 percent owned by their immediate parent company listed in the chart, unless indicated otherwise.

 

 
Our principal executive offices are located at 1300 MoPac Expressway South, 3rd Floor, Austin, Texas 78746. Our telephone number is (512) 434-5800.

Financial Information
 
Financial information about our principal operating segments and revenues by geographic areas are shown in our notes to financial statements contained in Item 8, and revenues and unit sales by product line are contained in Item 7 of this Annual Report on Form 10-K.

Narrative Description of the Business

Corrugated Packaging.  Our corrugated packaging segment provided 83 percent of our 2010 consolidated net revenues. Our vertically integrated corrugated packaging operation includes:
 

We manufacture containerboard (linerboard, corrugating medium, and white-top linerboard) and convert it into a complete line of corrugated packaging. We also manufacture light-weight gypsum facing paper at our mill in Newport, Indiana. We converted 92 percent of the containerboard we manufactured in 2010, in combination with containerboard we purchased from other producers, into corrugated containers at our
 
 
 
1

 
 
converting facilities. We sold the remainder of the containerboard we produced in the domestic and export markets. We routinely buy and sell various grades of containerboard depending on our product mix.

Our nationwide network of converting facilities produces a wide range of products from commodity brown boxes to intricate die cut containers that can be printed with multi-color graphics. Even though the corrugated packaging business is characterized by commodity pricing, each order for each customer is a custom order. Our corrugated packaging is sold to a variety of customers in the food, beverage, paper, glass containers, chemical, appliance, and plastics industries, among others. We also manufacture bulk containers constructed of multi-wall corrugated board for extra strength, which are used for bulk shipments of various materials.

We serve over 9,500 corrugated packaging customers with 15,000 shipping destinations. We have no single customer to which sales equal ten percent or more of consolidated revenues or the loss of which would have a material adverse effect on our corrugated packaging segment.

Sales of corrugated packaging track changing population patterns and other demographics. Historically, there has been a correlation between the demand for corrugated packaging and orders for nondurable goods.

Building Products.  Our building products segment provided 17 percent of our 2010 consolidated net revenues. We manufacture a wide range of building products, including:

 
lumber,

 
gypsum wallboard,

 
particleboard,

 
medium density fiberboard (or MDF), and

 
fiberboard.

We sell building products throughout the continental United States, with the majority of sales occurring in the southern United States. We have no single customer to which sales equal ten percent or more of consolidated revenues or the loss of which would have a material adverse effect on our building products segment. Most of our products are sold by account managers and representatives to distributors, retailers, and original equipment manufacturers. Sales of building products are heavily dependent upon the level of residential housing expenditures, including the repair and remodeling market, and commercial real estate construction.

We also own a 50 percent interest in Del-Tin Fiber LLC, a joint venture that produces MDF at a facility in El Dorado, Arkansas.

Raw Materials

Wood fiber, in various forms, is the principal raw material we use in manufacturing our products. In 2010, we purchased 42 percent of our virgin wood fiber requirements pursuant to long-term fiber supply agreements, the most significant of which were entered into in connection with our timberland sale in 2007. Purchases under these agreements are at market prices. The balance of our virgin wood fiber requirements was purchased at market prices from numerous landowners and other timber owners, as well as other producers of wood by-products.

Linerboard and corrugating medium are the principal materials used to make corrugated boxes. Our mills at Rome, Georgia and Bogalusa, Louisiana, manufacture linerboard. Our Ontario, California; Maysville, Kentucky; and Orange, Texas, mills are traditionally linerboard mills, but can also manufacture corrugating medium. Our Newport, Indiana, mill manufactures gypsum facing paper, corrugating medium, and white-top linerboard. Our New Johnsonville, Tennessee, mill manufactures corrugating medium. The principal raw material used by the Rome, Georgia; Orange, Texas; and Bogalusa, Louisiana, mills is virgin wood fiber, but each mill also uses recycled fiber for its fiber requirements. The Ontario, California and Maysville, Kentucky mills use only recycled fiber. The Newport, Indiana mill uses recycled fiber and a combination of recycled
 
 
 
2

 
 
fiber and virgin bleached pulp in manufacturing white-top linerboard. The mill at New Johnsonville, Tennessee, uses a combination of virgin wood and recycled fiber.

In 2010, recycled fiber represented 43 percent of the total fiber needs of our mill system. We purchase recycled fiber at market prices on the open market from numerous suppliers. We generally produce more linerboard and less corrugating medium than is used by our converting facilities. The deficit of corrugating medium is filled through open market purchases and/or trades, and we sell any excess linerboard in the open market.

We obtain gypsum for our wallboard operation in Fletcher, Oklahoma, from one outside source through a long-term purchase contract at market prices. At our gypsum wallboard plants in West Memphis, Arkansas, and Cumberland City, Tennessee, synthetic gypsum (also referred to as flue gas desulfurization gypsum or FGD gypsum) is used as a raw material. Synthetic gypsum is a by-product of coal-fired industrial processes. We have a long-term supply agreement for synthetic gypsum that our supplier obtains from nearby industries, including a Tennessee Valley Authority electrical plant located adjacent to our Cumberland City plant. Synthetic gypsum acquired pursuant to this agreement supplies substantially all the synthetic gypsum required by our Cumberland City and West Memphis plants. Our gypsum wallboard plant in McQueeney, Texas, uses a combination of gypsum obtained from its own quarry and synthetic gypsum.

We believe the sources outlined above will be sufficient to supply our principal raw material needs for the foreseeable future. The fiber market is difficult to predict and there can be no assurance of the future direction of prices for virgin wood or recycled fiber. It is likely that prices for fiber will continue to fluctuate in the future.

Energy

Electricity and steam requirements at our manufacturing facilities are either supplied by a local utility or generated internally through the use of a variety of fuels, including natural gas, fuel oil, coal, petroleum coke, tire derived fuel, wood bark, and other waste products resulting from the manufacturing process. By utilizing these waste products and other wood by-products as a biomass fuel to generate electricity and steam, we were able to generate 85 percent of our energy requirements in 2010 at our mills in Rome, Georgia; Bogalusa, Louisiana; and Orange, Texas. In some cases where natural gas or fuel oil is used, our facilities possess a dual capacity enabling the use of either fuel as a source of energy.

The natural gas needed to run our natural gas fueled power boilers, package boilers, and turbines is acquired pursuant to a multiple vendor solicitation process that provides for the purchase of gas, primarily on a firm basis with a few locations on an interruptible basis, at rates favorable to spot market rates. It is likely that prices of natural gas will continue to fluctuate in the future. We hedge very little of our energy costs.

Employees

We have 10,500 employees, of which 9,500 are located in the United States. Approximately 4,000 of our employees in the United States are represented by a union. The majority of the union representation is through the United Steelworkers or USW.

In 2009, we entered into a framework bargaining agreement with the USW that covers our five mills with USW represented workforces: Rome, Georgia; Bogalusa, Louisiana; New Johnsonville, Tennessee; Orange, Texas; and Newport, Indiana. The framework agreement provides for a four-year contract and will be applied to all contracts expiring through 2012.

We have 32 converting facilities where the employees are represented by a union, 26 of which are represented by the USW. In 2011, nine of these contracts will expire and need to be renegotiated.

We believe we have good working relations with our employees.

 
 
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Environmental Protection

We are committed to protecting the health and welfare of our employees, the public, and the environment and strive to maintain compliance with all state and federal environmental regulations in a manner that is also cost effective. When we construct new facilities or modernize existing facilities, we typically use best available technology for air and water emissions. This forward-looking approach is intended to minimize the effect that changing regulations have on capital expenditures for environmental compliance.

Our operations are subject to federal, state, and local provisions regulating discharges into the environment and otherwise related to the protection of the environment. Compliance with these provisions, primarily the Federal Clean Air Act, Clean Water Act, Comprehensive Environmental Response, Compensation and Liability Act of 1980 (or CERCLA), as amended by the Superfund Amendments and Reauthorization Act of 1986 (or SARA), Toxic Substances Control Act of 1976 (or TSCA), and Resource Conservation and Recovery Act (or RCRA), requires us to invest substantial funds to modify facilities to assure compliance with applicable environmental regulations. Capital expenditures directly related to environmental compliance totaled $13 million in 2010. This amount does not include capital expenditures made for another purpose that have an indirect benefit on environmental compliance.

Future expenditures for environmental control facilities will depend on new laws and regulations and other changes in legal requirements and agency interpretations thereof, as well as technological advances. We expect the prominence of environmental regulation and compliance to continue for the foreseeable future. Given these uncertainties, we currently estimate that capital expenditures for environmental purposes, excluding expenditures related to the Maximum Achievable Control Technology (or MACT) programs and landfill closures discussed below, will be $11 million in 2011, $7 million in 2012, and $8 million in 2013. The estimated expenditures could be significantly higher if more stringent laws and regulations are implemented.

In 2004, the United States Environmental Protection Agency (or EPA) published the Boiler MACT regulations affecting industrial boilers and process heaters burning all fuel types with the exception of small gas-fired units. In 2007 the U.S. Court of Appeals for the D.C. Circuit remanded and vacated the Boiler MACT regulations. EPA published new proposed Boiler MACT regulations for comment in April 2010. The Court has ordered EPA to promulgate final regulations by February 21, 2011. The EPA announced it will promulgate final regulations by this date but with standards significantly different than the April 2010 proposal. Because of the uncertainty as to the requirements of the final regulations, we are unable at this time to estimate what additional expenditures, if any, we might incur in order to comply with Boiler MACT regulations. We estimated our cost to comply with the regulations as proposed in April 2010 to be $70-$85 million based upon initial assessments and engineering performed by third parties. We anticipate compliance will not be required before 2014.

We own landfills used for disposal of non-hazardous waste at four containerboard mills and two building products facilities. Based on third-party cost estimates, we expect to spend, on an undiscounted basis, $42 million through 2083 to ensure proper closure of these landfills. The estimated annual average closure cost through 2020 for these landfills is $1 million per year. We also have one additional site that we are remediating. We expect to spend, on an undiscounted basis, $2 million for the remediation of that site. Appropriate reserves have been established for these closure and remediation costs.

In addition to the expenditures discussed above, we incur significant expenditures for maintenance costs to continue compliance with environmental regulations. We do not believe, however, that these costs will have a material adverse effect on our earnings. Expenditures for environmental compliance should not have a material effect on our competitive position because our competitors are also subject to these regulations.

Our facilities are periodically inspected by environmental authorities. We are required to file with these authorities periodic reports on the discharge of pollutants. Occasionally, one or more of our facilities may operate in violation of applicable pollution control standards, which could subject us to fines or penalties. We believe that any fines or penalties that may be imposed as a result of these violations will not have a material adverse effect on our earnings or competitive position. No assurance can be given, however, that any fines levied in the future for any such violations will not be material.
 

 
 
4

 
 
Under CERCLA, liability for the cleanup of a Superfund site may be imposed on waste generators, site owners and operators, and others regardless of fault or the legality of the original waste disposal activity. While joint and several liability is authorized under CERCLA, as a practical matter, the cost of cleanup is generally allocated among the many waste generators. We are named as a potentially responsible party in proceedings relating to the cleanup of seven hazardous waste sites under CERCLA and similar state laws, excluding sites for which our records disclose no involvement or for which our potential liability has been finally determined. In all but two of these sites, we are either designated as a de minimus potentially responsible party or believe our financial exposure is insignificant. We have conducted investigations or document review for all seven sites and currently estimate that the remediation costs to be allocated to us are about $2 million and should not have a material effect on our earnings, cash flows, or competitive position. There can be no assurance that we will not be named as a potentially responsible party at additional Superfund sites in the future or that the costs associated with the remediation of those sites would not be material.

Climate Change

There is an increasing likelihood that our manufacturing sites could be affected in some way in the future by regulation or taxation of greenhouse gas, or GHG, emissions. Although climate change legislation is pending in Congress, it is difficult at this time to estimate the likelihood of passage of legislation, or alternatively, the potential impact of direct regulation of GHG emissions by the EPA. Several states, including California, have implemented their own GHG regulatory programs. Our sites that are subject to state-imposed GHG regulations, have not experienced significant cost increases as a result, although future application of these restrictions or additional GHG emission restrictions could result in significant compliance costs. In addition to direct regulation of GHG emissions, certain state and pending federal legislation proposes to reduce GHG emissions by providing incentives to use biomass fuels for the production of electricity. A broad definition of qualified biomass could result in the diversion of wood fiber from paper and forest products manufacturing to energy production, which could result in substantially higher prices for wood fiber. Potential consequences of such federal and state regulations include increased capital requirements at the time of permitting for new emission sources or major modification of existing sources and at the time of renewal of existing permits. Also, such regulations could cause energy and wood fiber costs to rise faster than the level of general inflation, as well as increase direct compliance costs. Currently, however, it is not possible to estimate the likely financial impact of potential future GHG regulation or taxation on any of our manufacturing sites.

Coal Combustion By-products

EPA has published two alternative proposals regulating Coal Combustion By-products (CCBs). One proposal (Option 1) would designate all CCBs destined for disposal as hazardous waste and regulate their disposal accordingly. The second proposal (Option 2) maintains the current regulatory status for CCBs as non-hazardous waste, but imposes new performance standards for disposal activities. In the preamble to the rule proposal, EPA repeatedly states that neither proposal is intended to regulate CCBs destined for beneficial use, including flue gas desulfurization gypsum (FGD gypsum), also referred to as synthetic gypsum, used in the manufacture of wallboard. Contingent upon the actual language of the final regulation, designating FGD gypsum as a hazardous waste, even with the beneficial use exception, could have a potential direct impact on our continued use of FGD gypsum, which makes up approximately 60 percent of the raw material requirements for our gypsum wallboard manufacturing. Alternate sources of natural gypsum are available but at a higher delivered cost. Such designation of FGD gypsum as hazardous waste would reverse the EPA’s affirmative determination in 1993 and in 2000 that FGD gypsum was non-hazardous and negate the EPA’s express encouragement of the use of CCBs in the manufacture of building products. The designation of CCBs as hazardous waste could also have the indirect impact of potentially raising the cost of electricity as coal-fired utilities would incur increased waste disposal costs that would likely be passed through to customers. Until any such regulation is actually proposed for final adoption, it is not possible to estimate the financial impact of this potential regulation.
 

 
 
5

 
 
Competition

We operate in highly competitive industries. The commodity nature of our manufactured products gives us little control over market pricing or market demand for our products. The level of competition in a given product or market may be affected by economic factors, including production of nondurable goods, interest rates, housing starts, home repair and remodeling activities, and the strength of the dollar, as well as other market factors including supply and demand for these products, geographic location, and the operating efficiencies of competitors. Our competitive position is influenced by varying factors depending on the characteristics of the products involved. The primary factors are product quality and performance, price, service, and product innovation.

The corrugated packaging industry is highly competitive with 1,250 box plants in the United States and 300 in Mexico. Our box plants accounted for 13 percent of total industry shipments in 2010, making us the third largest producer of corrugated packaging in the United States. Although corrugated packaging is dominant in the national distribution process, our products also compete with various other packaging materials, including products made of paper, plastics, wood, and metals.

In building products markets, we compete with many companies that are substantially larger and have greater resources in the manufacturing of building products.

Executive Officers of the Registrant

The names, ages, and titles of our executive officers are:

Name
Age
Office
Doyle R. Simons 
47
Chairman of the Board and Chief Executive Officer
J. Patrick Maley III
49
President and Chief Operating Officer
Larry C. Norton
51
Group Vice President
Dennis J. Vesci 
63
Group Vice President
Randall D. Levy
59
Chief Financial Officer and Treasurer
J. Bradley Johnston 
55
Chief Administrative Officer
C. Morris Davis
68
General Counsel
Scott Smith 
56
Chief Information Officer
Grant F. Adamson
52
Chief Governance Officer
Leslie K. O’Neal 
55
Senior Vice President, Assistant General Counsel and Secretary
Carolyn C. Ferguson 
50
Vice President, Internal Audit
Troy L. Hester 
54
Principal Accounting Officer and Corporate Controller


Doyle R. Simons became Chairman of the Board and Chief Executive Officer on December 29, 2007. He was previously named Executive Vice President in February 2005 following his service as Chief Administrative Officer since November 2003. Since joining the Company in 1992, Mr. Simons has served as Vice President, Administration from November 2000 to November 2003 and Director of Investor Relations from 1994 through 2000.

J. Patrick Maley III became President and Chief Operating Officer on December 29, 2007. He was previously named Executive Vice President — Paper in November 2004 following his appointment as Group Vice President in May 2003. Prior to joining the Company, Mr. Maley served in various capacities from 1992 to 2003 at International Paper.

Larry C. Norton joined the Company as Vice President in May 2007 and became Group Vice President in May 2008. Prior to joining the Company, Mr. Norton was at International Paper, which he joined in 1981, serving most recently as Vice President, Manufacturing, Printing & Communications Paper.
 
 
 
6

 
 
Dennis J. Vesci became Group Vice President in August 2005. Mr. Vesci joined the Company in 1975 and has served as an officer of our corrugated packaging segment since 1998.

Randall D. Levy was named Chief Financial Officer in May 1999 and Treasurer in November 2008. Mr. Levy joined the Company in 1989 serving in various capacities in our former financial services segment before being named Chief Financial Officer.

J. Bradley Johnston became Chief Administrative Officer in February 2005. Prior to that, Mr. Johnston served as General Counsel from August 2002 through May 2006 and in various capacities in our former financial services segment since 1993.

C. Morris Davis became General Counsel in May 2006. Mr. Davis joined Temple-Inland after 39 years with the law firm of McGinnis, Lochridge & Kilgore in Austin, where he served seven years as the firm’s managing partner.

Scott Smith became Chief Information Officer in February 2000. Prior to that, Mr. Smith served in various capacities within our former financial services segment since 1988.

Grant F. Adamson became Chief Governance Officer in May 2006. Mr. Adamson joined the Company in 1991 and has served in various capacities including Assistant General Counsel.

Leslie K. O’Neal was named Senior Vice President in May 2010. Ms. O’Neal served as Vice President since August 2002 and has served as Secretary since February 2000 after serving as Assistant Secretary since 1995. Ms. O’Neal, who joined the Company in 1980, also serves as Assistant General Counsel, a position she has held since 1985.

Carolyn C. Ferguson was named Vice President, Internal Audit, in August 2005. Ms. Ferguson joined the Company in 2001 as Director, Internal Audit.

Troy L. Hester was named Principal Accounting Officer in August 2006. Mr. Hester has been with Temple-Inland since 1999 and has served in various capacities including Controller of our former financial services segment, Vice President Accounting Center, and was named Corporate Controller in May 2006.

The Board of Directors annually elects officers to serve until their successors have been elected and have qualified or as otherwise provided in our Bylaws.

Available Information

From our Internet website, http://www.templeinland.com, you may obtain, free of charge, additional information about us including:

 
our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, including amendments to these reports, and other documents as soon as reasonably practicable after we file them with the Securities and Exchange Commission (or SEC);

 
beneficial ownership reports filed by officers, directors, and principal security holders under Section 16(a) of the Securities Exchange Act of 1934, as amended (or the Exchange Act); and

 
corporate governance information that includes our

 
corporate governance principles,

 
audit committee charter,

 
management development and executive compensation committee charter,

 
nominating and governance committee charter,

 
standards of business conduct and ethics,

 
code of ethics for senior financial officers, and

 
information on how to communicate directly with our Board of Directors.

 
 
7

 
 
In addition, the materials we file with the SEC may be read and copied at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. Information about the operation of the Public Reference Room is available by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site (http://www.sec.gov) that contains reports, proxy and information statements, and other information that is filed electronically with the SEC.

Item 1A.  
Risk Factors

The business segments in which we operate are highly competitive.

The business segments in which we operate are highly competitive and are affected to varying degrees by supply and demand factors and economic conditions, including changes in production of nondurable goods, interest rates, new housing starts, home repair and remodeling activities, and the strength of the U.S. dollar. Given the commodity nature of the markets for our manufactured products, we have little control over market pricing or market demand. No single company is dominant in any of our industries.

Our corrugated packaging competitors include large, vertically-integrated paperboard and packaging products companies and numerous smaller companies. The industries in which we compete are particularly sensitive to price fluctuations as well as other factors, including innovation, design, quality, and service, with varying emphasis on these factors depending on the product line. To the extent that one or more of our competitors become more successful with respect to any key competitive factor, our business could be materially adversely affected. Although corrugated packaging is dominant in the national distribution process, our products also compete with various other packaging materials, including products made of paper, plastics, wood, and various types of metal.

In the building products markets, we compete with many companies that are substantially larger and have greater resources in the manufacturing of building products.

The profitability of our business is affected by changes in raw material and other costs.

Virgin wood fiber and recycled fiber are the principal raw materials we use to manufacture corrugated packaging and certain of our building products. We purchase virgin wood fiber in highly competitive, price sensitive markets. The price for wood fiber has historically fluctuated on a cyclical basis and has often depended on a variety of factors over which we have no control, including environmental and conservation regulations, natural disasters, the price and level of imported timber and the continuation of any applicable tariffs, and weather. In addition, an increase in demand for old corrugated containers, especially from China, may cause a significant increase over time in the cost of recycled fiber used in the manufacture of recycled containerboard and related products. Such costs are likely to continue to fluctuate.

In addition, we rely on suppliers under long-term fiber supply contracts for a significant portion of our virgin fiber requirements. While we have not experienced any significant difficulty in obtaining virgin wood fiber and recycled fiber in economic proximity to our facilities, if the parties under our long-term fiber supply agreements were unable to perform, this may not continue to be the case for any or all of our facilities. Any such supply disruption could negatively affect our cost of virgin fiber.

Changes in the prices of energy and transportation can have a significant effect on our profitability. While we have attempted to contain energy costs through internal generation and in some instances the use of by-products from our manufacturing processes as fuel, these efforts only relate to a portion of our energy usage. No assurance can be given that such efforts will be successful in the future or that energy prices will not rise to levels that would have a material adverse effect on our results of operations despite these efforts. We hedge very little of our energy needs.

The corrugated packaging and building products industries are cyclical in nature and experience periods of overcapacity.

The operating results of our corrugated packaging and building products segments reflect each such industry’s general cyclical pattern. While the cycles of each industry do not historically coincide, demand and
 
 
 
8

 
 
prices in each historically tend to drop in an economic downturn. The building products industry is further influenced by the residential construction and remodeling markets. Further, each industry periodically experiences substantial overcapacity. Both industries are capital intensive, which leads to high fixed costs and historically results in continued production as long as prices are sufficient to cover marginal costs. These conditions have contributed to substantial price competition and volatility in these industries, even when demand is strong. From time to time, we have closed certain of our facilities or have taken downtime in order to match our production with the demand for our products and we may continue to do so, thereby reducing our total production levels. Certain of our competitors have also temporarily closed or reduced production at their facilities, but can reopen and/or increase production capacity at any time, which could exacerbate overcapacity in these industries and depress prices.

We are subject to environmental regulations and liabilities that could have a negative effect on our operating results.

We are subject to federal, state, and local provisions regulating the discharge of materials into the environment and otherwise related to the protection of the environment. Compliance with these provisions has required us to invest substantial funds to modify facilities to ensure compliance with applicable environmental regulations. In other sections of this Annual Report on Form 10-K, we provide certain estimates of expenditures we expect to make for environmental compliance in the next few years. However, we could incur additional significant expenditures due to changes in law or the discovery of new information, and such expenditures could have a material adverse effect on our financial condition, cash flows, and results of operations. In addition, we are subject to litigation filed by private parties alleging injury due to environmental exposures in or near our facilities.

One example of a potential regulatory change involves the EPA considering regulations that would classify materials produced primarily from the combustion of coal in coal-fired industrial processes (sometimes referred to as coal combustion by-products) as hazardous materials. Such regulation could impact our use of synthetic gypsum in the manufacture of gypsum wallboard. If synthetic gypsum, along with other coal combustion by-products, is classified as a hazardous material, our use of it as a raw material may be adversely affected, and we could need to find alternative sources of gypsum. These alternative sources would likely be materially more expensive than the synthetic gypsum we currently use. For a more detailed description, please see “Environmental Protection — Coal Combustion By-products” on page 5.

Another example is pending legislative and regulatory actions concerning greenhouse gas (GHG) emissions. Potential consequences of such federal and state regulations include increased capital requirements at the time of permitting for new emission sources or major modification of existing sources, and at the time of renewal of existing permits. Also, such regulations will potentially increase energy and wood fiber costs above the level of general inflation, as well as increase direct compliance costs. For a more detailed description, please see “Environmental Protection — Climate Change” on page 5.

Profitability in our building products segment will continue to be negatively affected as long as the United States continues to experience historically low levels of residential construction.

The residential homebuilding industry is sensitive to changes in economic conditions, including employment, interest rates, foreclosure rates, and availability of financing. These conditions have resulted in residential construction in the United States reaching the lowest levels in decades. Profitability in our building products segment will continue to be negatively affected as long as the United States continues to experience historically low levels of residential construction. Any further adverse changes in market conditions generally, or particularly in the market regions where we operate, could result in lower pricing and demand for many of our building products, particularly lumber and gypsum wallboard, which could have increased negative effects on our revenues and earnings.
 
 
 
9

 

 
Recent conditions in financial markets could have adverse consequences on our ability to finance our operations.

Recent conditions in financial markets, which include the bankruptcy and restructuring of certain financial institutions, could affect financial institutions with which we have relationships and result in adverse effects on our ability to finance our operations. The possible effects of these conditions would include the possibility that a lender under our existing credit facilities may be unwilling or unable to fund a borrowing request, and we may not be able to replace any such lender. In addition, financial market conditions could have a negative effect on the ability of customers, suppliers, and others to conduct business with us on a normal basis.

We may incur additional costs in connection with our box plant transformation initiative and there is no guarantee that this initiative will be successful.

Over the past few years, we have been focused on changing the culture in our box plant system to run converting equipment near design capacity, thereby lowering costs through improved asset utilization. We refer to our current initiative as Box Plant Transformation II. While we expect our cost saving initiatives will result in significant savings throughout our company, our estimated savings are based on several assumptions that may prove to be inaccurate. Accordingly, we cannot provide assurance that we will realize these cost savings or that, if realized, these cost savings will be sustained. If we cannot successfully implement and sustain these strategic initiatives, our financial condition and results of operations could be negatively affected. For more information on our box plant transformation initiative, please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” on page 24.

Our performance depends on the uninterrupted operation of our facilities, which are becoming increasingly dependent on our information technology systems.

Our performance depends on the efficient and uninterrupted operation of the manufacturing equipment in our production facilities. The inability to operate one or more of our facilities due to a natural disaster; power outage; labor dispute; or failure of one or more of our information technology, telecommunications, or other systems could significantly impair our ability to manufacture our products. Our manufacturing equipment is becoming increasingly dependent on our information technology systems. A disruption in our information technology systems due to a catastrophic event or security breach could interrupt or damage our operations. In addition, we could be subject to reputational harm or liability if confidential customer information is misappropriated from our information technology systems. Despite our security measures and business continuity plans, these systems could be vulnerable to disruption, and any such disruption could negatively affect our financial condition and results of operations.

The level of returns on pension and postretirement plan assets and the actuarial assumptions used for valuation purposes could affect our earnings and cash flows in future periods.

Assumptions used in determining projected benefit obligations and the expected return on plan assets for our pension plan and other postretirement benefit plans are evaluated by us in consultation with outside actuaries. If we determine that changes are warranted in the assumptions used, such as the discount rate, expected long-term rate of return, or health care cost trend rate, our future pension and postretirement benefit expenses and funding requirements could increase. In addition, several factors could result in actual results differing significantly from the actuarial assumptions that we use. Funding obligations are determined based on the value of assets and liabilities on a specific date as required under relevant regulations. Future pension funding requirements, and the timing of funding payments, could be affected by legislation enacted by governmental authorities.
 
 
 
10

 

 
If certain internal restructuring transactions and the distributions of Forestar and Guaranty are determined to be taxable for U.S. federal income tax purposes, we and our stockholders that are subject to U.S. federal income tax could incur significant U.S. federal income tax liabilities.

At the end of 2007, we spun off two subsidiaries, Forestar Group Inc. and Guaranty Financial Group Inc., and entered into certain internal restructuring transactions in preparation for the spin-offs. We received a private letter ruling from the IRS and opinions of tax counsel regarding the tax-free nature of these transactions and the distributions. The ruling and opinions rely on certain facts, assumptions, representations, and undertakings from us regarding the past and future conduct of our businesses and other matters. If any of these are incorrect or not otherwise satisfied, then we and our stockholders may not be able to rely on the ruling or opinions and could be subject to significant tax liabilities. Notwithstanding the ruling and opinions, the IRS could determine on audit that the distributions or the internal restructuring transactions should be treated as taxable transactions if it determines that any of these facts, assumptions, representations, or undertakings are not correct or have been violated, or if the distributions should become taxable for other reasons, including as a result of significant changes in stock ownership after the distribution. If the IRS were to make any such determination, we could incur significant tax liabilities.

If the sale of our strategic timberland did not qualify for installment method reporting for U.S. federal income tax purposes, we could be required to fund significant U.S. federal income tax liabilities the payment of which we believe to be deferred.

In 2007, we sold our strategic timberland in a manner intended for U.S. federal income tax purposes to defer recognition of a substantial portion of the gain on the sale. Under the installment method, we will not be required to pay U.S. federal income taxes on the deferred gain until we are required to recognize the gain for income tax purposes. We received opinions of tax counsel regarding the timberland sale and the deferred gain. The opinions rely on certain facts, assumptions, representations, and undertakings from us regarding the past and future conduct of our businesses and other matters. If any of these are incorrect or not otherwise satisfied, then we may not be able to rely on the opinions. Notwithstanding the opinions, the IRS could determine on audit that the gain does not qualify for deferral if it determines that any of these facts, assumptions, representations, or undertakings are not correct or have been violated or that the transaction otherwise does not qualify for the installment method. In any such event, some or all of the deferred taxes recorded from the gain on the sale of our timberlands and payable in 2027 could become currently payable.

If the credit ratings of a bank issuing letters of credit in our timberland financing transaction are lowered below designated levels and we failed to secure substitute letter of credit issuers, we could be required to fund significant U.S. federal income tax liabilities the payment of which we believe to be deferred.

The financial assets of special purpose entities relate to the sale of our strategic timberlands in 2007 and are secured by letters of credit issued by four banks. The letters of credit are secured by the purchaser’s long-term cash deposits with the banks. The letter of credit issuers are required to maintain a credit rating on their long-term unsecured debt of at least A+ by Standard & Poor’s Financial Services LLC, a subsidiary of McGraw-Hill Companies, Inc., and A1 by Moody’s Investors Service, Inc. If a credit rating of any of these banks were downgraded below this level, the bank must be replaced with another qualifying financial institution. To date two letter of credit banks have been replaced. The credit ratings of all the participating banks are currently at or above the designated level, and we have agreements with two additional banks pursuant to which each bank agrees to issue up to $1.4 billion in irrevocable letters of credit in substitution for letters of credit issued by a bank whose credit ratings get reduced below the required minimums. If a credit rating of one of the participating banks were downgraded below the designated level and following the downgrade a qualifying financial institution could not be substituted (which would be referred to as a failed substitution), it is possible that a portion of the deferred taxes recorded from the gain on the sale of our timberlands and payable in 2027 would become currently payable. If there were a second failed substitution, it is possible that the remaining deferred taxes from the gain on the sale of our timberlands would become currently payable. For a more detailed description, please see “Capital Resources and Liquidity-Financial Assets and Nonrecourse Financial Liabilities of Special Purpose Entities” on page 37.
 
 
 
11

 

 
We have interest rate risk in connection with our financial assets and nonrecourse financial liabilities of special purpose entities.

In October 2007, we received $2.38 billion in notes due in 2027 from the sale of our strategic timberland, which we later contributed to two wholly-owned, bankruptcy-remote special purpose entities. In December 2007, the special purpose entities pledged the notes as collateral for $2.14 billion nonrecourse loans payable in 2027. Both the notes and the borrowings require quarterly interest payments based on variable interest rates. Interest rates on the notes are based on LIBOR and reset quarterly. Interest rates on the borrowings reflect the lenders’ pooled commercial paper issuances and reset daily. Because of the differences in reference rates, margins, and reset dates, there could be periods in which the interest paid on the nonrecourse financial liabilities is significantly more than the interest received on the financial assets. For a more detailed description, please see “Capital Resources and Liquidity-Financial Assets and Nonrecourse Financial Liabilities of Special Purpose Entities” on page 37.

Item 1B.  
Unresolved Staff Comments

None.

Item 2.  

We own and operate manufacturing facilities throughout the United States, four converting plants in Mexico, and one in Puerto Rico. We believe our manufacturing facilities are suitable for their purposes and adequate for our business. Additional information about selected facilities by business segment follows:

Paperboard Mills

 
Location
 
Product
Number of
Machines
Annual
Capacity
2010
Production
   
  (In tons)
Ontario, California
Linerboard and corrugating medium
1
360,190
354,939
Rome, Georgia
Linerboard
2
877,100
811,006
Orange, Texas
Linerboard and corrugating medium
2
778,650
788,755
Bogalusa, Louisiana
Linerboard
2
895,000
859,883
Maysville, Kentucky
Linerboard and corrugating medium
1
524,900
495,993
New Johnsonville, Tennessee
Corrugating medium
1
372,860
367,484
Newport, Indiana
 
Corrugating medium, white-top linerboard,  and gypsum facing paper
1
356,570
357,437
     
4,165,270
4,035,497

Converting Facilities*

 
Location
Corrugator
Size
Fort Smith, Arkansas
87”
Fort Smith, Arkansas(1)***
None
Bell, California
98”
Buena Park, California(1)
85”
El Centro, California(1)
87”
Gilroy, California(1)
87”
Gilroy, California(1)***
98”
Ontario, California
87”
Santa Fe Springs, California
98”
 
 
 
12

 
 
 
Location
 Corrugator
Size
Santa Fe Springs, California(1)**
87” and 85”
Tracy, California
110”
Union City, California(1)***
None
Wheat Ridge, Colorado
87”
Orlando, Florida
98”
Tampa, Florida(1)
78”
Carol Stream, Illinois (closure announced for second quarter 2011)
87”
Chicago, Illinois
87”
Chicago, Illinois(1)***
None
Elgin, Illinois
78”
Elgin, Illinois***
None
Crawfordsville, Indiana
98”
Indianapolis, Indiana
87”
Indianapolis, Indiana***
None
St. Anthony, Indiana***
None
Tipton, Indiana***
110”
Garden City, Kansas
98”
Kansas City, Kansas
87”
Bogalusa, Louisiana
98”
Minden, Louisiana
98”
Minneapolis, Minnesota
87”
St. Louis, Missouri
87”
St. Louis, Missouri***
98”
Milltown, New Jersey(1)***
None
Spotswood, New Jersey
98”
Binghamton, New York
87”
Buffalo, New York***
None
Scotia, New York***
None
Utica, New York***
None
Warren County, North Carolina
98”
Madison, Ohio***
None
Marion, Ohio
87”
Middletown, Ohio
98”
Streetsboro, Ohio
98”
Biglerville, Pennsylvania
98”
Hazleton, Pennsylvania
98”
Littlestown, Pennsylvania***
None
Vega Alta, Puerto Rico
87”
Lexington, South Carolina
98”
Ashland City, Tennessee(1)***
None
Elizabethton, Tennessee(1)***
None
Dallas, Texas
98”
Edinburg, Texas
87”
San Antonio, Texas
98”
San Antonio, Texas***
98”
Petersburg, Virginia
98”
San Jose Iturbide, Mexico
98”
 
 
 
13

 
 
 
Location
 Corrugator
Size
Monterrey, Mexico
87”
Los Mochis, Sinaloa, Mexico
98”
Guadalajara, Mexico(1)***
None
____________

*
The annual capacity of the converting facilities is a function of the product mix, customer requirements and the type of converting equipment installed and operating at each plant, each of which varies from time to time.
   
**
This plant has two corrugators.
   
***
Sheet or sheet feeder plants.
   
(1)
Leased facilities.

Additionally, we own a graphics resource center in Indianapolis, Indiana, that has a 100” preprint press. We lease 37 warehouses located throughout much of the United States.

Building Products

 
Description
 
Location
Rated Annual
Capacity
   
(In millions of
   
board feet)
Lumber 
Diboll, Texas
   270
Lumber 
Pineland, Texas
   360
 **
Lumber 
Buna, Texas
   198
 ***
Lumber 
Rome, Georgia
   180
 
Lumber
DeQuincy, Louisiana
   198
 
 Total lumber
 
1,206
 
____________

*
Includes separate finger jointing capacity of 20 million board feet.
   
**
Includes separate stud mill capacity of 110 million board feet.
   
***
In 2009, production at this facility was ceased for an indefinite period.

 
Description
 
Location
Rated Annual
Capacity
   
(In millions of
   
square feet)
Gypsum Wallboard
West Memphis, Arkansas
440
Gypsum Wallboard
Fletcher, Oklahoma
460
Gypsum Wallboard
McQueeney, Texas
400
Gypsum Wallboard
Cumberland City, Tennessee
800
Total gypsum wallboard
 
2,100
Particleboard
Monroeville, Alabama
150
Particleboard
Thomson, Georgia
150
Particleboard
Diboll, Texas
150
Particleboard
Hope, Arkansas
200
Total particleboard
 
650
MDF*
El Dorado, Arkansas
150
MDF(1)
Mt. Jewett, Pennsylvania
140
Total MDF
 
290
Fiberboard
Diboll, Texas
272
 
 
 
14

 
____________

*
The table shows the full capacity of this facility that is owned by a joint venture in which we own a 50 percent interest.
   
(1)
Leased facilities.

Other

We occupy 176,000 square feet of leased office space in Austin, Texas. We own and occupy a 150,000 square feet office building in Diboll, Texas.


Item 3.  
Legal Proceedings

We are involved in various legal proceedings that arise from time to time in the ordinary course of doing business. We believe that adequate reserves have been established for any probable losses and that the outcome of any of these proceedings should not have a material adverse effect on our financial position or long-term results of operations or cash flows. It is possible, however, that charges related to these matters could be significant to results of operations or cash flows in any single accounting period. A summary of our more significant legal matters is set forth below.

Antitrust

On September 9, 2010, we were one of eight containerboard producers named as a defendant in a class action complaint that alleged a civil violation of Section 1 of the Sherman Act. The suit is captioned Kleen Products LLC v. Packaging Corp. of America (N.D. Ill.). The complaint alleges that the defendants, beginning in August 2005, conspired to limit the supply and thereby increase prices of containerboard products. The alleged class is all persons who purchased containerboard products directly from any defendant for use or delivery in the United States during the period August 2005 to the present. The complaint seeks to recover an unspecified amount of treble actual damages and attorney’s fees on behalf of the purported class. Four similar complaints were filed and have been consolidated in the Northern District of Illinois. We strongly dispute the allegations made against us and intend to defend vigorously against this litigation. However, because this action is in its preliminary stages, we are unable to predict an outcome or to estimate a range of reasonably possible loss.

Bogalusa Litigation

On October 15, 2003, a release of nitrogen dioxide and nitrogen oxide took place at our linerboard mill in Bogalusa, Louisiana. The mill followed appropriate protocols for handling this type of event, notifying the Louisiana Department of Environmental Quality, the EPA, and local law enforcement officials. The federal and state environmental agencies have analyzed the reports we prepared and have not indicated that they will take any action against us.

To date, we have been served with 11 lawsuits seeking damages for various personal injuries allegedly caused by either exposure to the released gas or fears of exposure. These 11 lawsuits have been consolidated under Louisiana state rules for purpose of discovery. We are vigorously defending against these allegations.

Asbestos

We are a defendant in various lawsuits involving alleged workplace exposure to asbestos. These cases involve exposure to asbestos in premises owned or operated by us. We do not manufacture any products that contain asbestos, and all our cases in this area are limited to workplace exposure claims. Historically, our aggregate annual settlements related to asbestos claims have been approximately $1 million. The number of claims has remained relatively constant in the past few years.

Guaranty Bank

In February 2007, we announced a transformation plan that included spinning off our financial services segment, Guaranty Financial Group (including its subsidiary Guaranty Bank), and our real estate segment,
 
 
 
15

 
 
Forestar Group, and selling our timberlands. In October 2007, we closed the sale of the timberlands, and in December 2007 we distributed 100 percent of the stock of Guaranty Financial Group and Forestar Group to our shareholders consistent with this transformation plan. Since their spin-off in December 2007, we have had no ownership in or affiliation with Guaranty Financial Group, Guaranty Bank, or Forestar Group. In connection with the spin-off, we received an opinion from a qualified advisor that Guaranty Financial Group and Guaranty Bank would be solvent and adequately capitalized after the spin-off. In addition, Guaranty Bank satisfied Office of Thrift Supervision criteria to be considered well capitalized both before and after the spin off.

In August 2009, the Office of Thrift Supervision closed Guaranty Bank and appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. Shortly thereafter, Guaranty Financial Group, filed for bankruptcy. In second quarter 2010, we received a document request from the FDIC pursuant to an Order of Investigation of the acts of the former officers and directors of Guaranty Bank in connection with its failure. We voluntarily produced documents in our possession responsive to the request. We are not aware of any claims being filed in connection with Guaranty Bank’s failure. As a result of the process we followed in connection with the spin-off, we do not believe that if the receiver made any claim against us that we would have any liability related to the spin-off of Guaranty Financial Group.

Often in its capacity as receiver for a failed financial institution, the FDIC will bring professional liability claims against the directors and officers of the failed institution in an effort to recoup losses suffered by the deposit insurance fund. We are not currently aware of any such claims being filed in connection with the failure of Guaranty Bank. If any such claims are filed, certain of our employees and directors who served as officers or directors of Guaranty Bank or Guaranty Financial Group prior to the spin-off may have a right to seek indemnification from us for any losses suffered as a result of such claims. The indemnification would generally not be available to an individual who had not acted in good faith or had reason to believe their actions were opposed to our best interests. We believe that any such claims for indemnification would be limited to the time during which we owned Guaranty Bank and would be covered by our director and officer liability insurance. Accordingly, we do not anticipate that we would incur any significant liability if any such indemnification claims actually arise.

Hearing Loss

We have been named as a defendant in several cases in Louisiana state court claiming hearing loss as a result of continuous long-term hazardous noise exposure at one of our facilities. We have observed an increase in this type of litigation against operators of industrial facilities in states that exclude claims from long-term exposures from workers’ compensation coverage. While it is too early for us to form an opinion as to risk of loss in these matters, we believe that we substantially complied with workplace health and safety regulations and good industry practices relating to potential hearing loss over the various periods of employment. We will continue to defend vigorously against these allegations.
 
 
 
16

 

 
Item 4.  
(Removed and Reserved)

PART II

Item 5.  
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information

Our Common Stock is traded on the New York Stock Exchange. The high and low sales prices for our Common Stock and dividends paid in each fiscal quarter in the two most recent fiscal years were:

 
 
2010
   
2009
 
 
 
Price Range
         
Price Range
       
 
 
High
   
Low
   
Dividends
   
High
   
Low
   
Dividends
 
First Quarter
  $ 23.32     $ 15.95     $ 0.11     $ 6.47     $ 2.37     $ 0.10  
Second Quarter
  $ 25.03     $ 17.78     $ 0.11     $ 15.64     $ 4.95     $ 0.10  
Third Quarter
  $ 22.98     $ 15.48     $ 0.11     $ 18.90     $ 10.90     $ 0.10  
Fourth Quarter
  $ 22.94     $ 18.02     $ 0.11     $ 22.68     $ 14.85     $ 0.10  
For the Year
  $ 25.03     $ 15.48     $ 0.44     $ 22.68     $ 2.37     $ 0.40  

Shareholders

Our stock transfer records indicated that as of February 16, 2011, there were approximately 4,175 holders of record of our Common Stock.

Dividend Policy

As indicated above, we paid quarterly dividends during each of the two most recent years in the amounts shown. On February 4, 2011, the Board of Directors declared a quarterly dividend on our Common Stock of $0.13 per share payable on March 15, 2011, to shareholders of record on March 1, 2011. The Board periodically reviews the dividend policy, and the declaration of dividends will necessarily depend upon our earnings and financial requirements and other factors within the discretion of the Board.

 
Issuer Purchases of Equity Securities(1)

 
 
 
 
 
 
 
Period
 
 
 
 
Total
Number of
Shares
Purchased(2)
   
 
 
 
Average
Price
Paid per
Share
   
Total Number
of Shares
Purchased as
Part of Publicly
Announced
Plans or
Programs
   
Maximum
Number of
Shares That
May Yet be
Purchased
Under the
Plans
or Programs
 
Month 1 (10/1/2010 — 10/31/2010)
    308     $ 18.63             6,650,000  
Month 2 (11/1/2010 — 11/30/2010) 
    5,790     $ 20.90             6,650,000  
Month 3 (12/1/2010 — 12/31/2010)
    266     $ 20.98             6,650,000  
 Total                                                                                                  
    6,364     $ 20.79                
____________

(1)
On August 4, 2006, our Board of Directors authorized the repurchase of up to 6,000,000 shares of our common stock. We have purchased 4,350,000 shares under this authorization, which has no expiration date. On February 2, 2007, our Board of Directors authorized the purchase of up to an additional 5,000,000 shares of our common stock, increasing the maximum number of shares yet to be purchased under our repurchase plans to 6,650,000 shares. We have no plans or programs that expired during the period covered by the table above and no plans or programs that we intend to terminate prior to expiration or under which we no longer intend to make further purchases.
   
(2)
Represents shares purchased from employees to pay taxes related to the exercise of stock options.
 
 

 
 
17

 
 
Performance Graph

The following graph compares the cumulative total shareholder return on our common stock to the Standard & Poor’s 500 Stock Index and an index we composed of our peers assuming an investment of $100 and the reinvestment of all dividends over the five-year period ended December 31, 2010. At the end of 2007, we paid a special dividend of $10.25 per share and spun-off Forestar Group Inc. and Guaranty Financial Group Inc. In accordance with SEC rules our stock price has been adjusted in preparing the graph to reflect the special dividend and these spin-offs as special dividends that were reinvested in our stock. Due to the fundamental change to our company from these transactions, comparisons to periods before 2008 may not be meaningful.

The performance graph is based on a peer index composed of AbitibiBowater Inc.; Boise, Inc.; Canfor Corporation; Cascades Inc.; Catalyst Paper; Domtar Corporation; Glatfelter; Graphic Packaging Holding Co.; International Paper Company; MeadWestvaco Corporation; Mercer International Inc.; Neenah Paper Inc.; NewPage Corp.; Packaging Corporation of America; Rock-Tenn Co.; Smurfit-Stone Container Corporation; Verso Paper Corp.; Wausau Paper Corp.; and West Fraser Timber Co. Ltd. Some companies in our peer index do not have publicly traded common stock and are not included in the performance graph. The Standard & Poor’s 500 Stock Index is a broad equity market index published by Standard & Poor’s.


Assumes $100 invested on the last trading day in fiscal year 2005
Total return assumes reinvestment of dividends

Pursuant to SEC rules, the returns of each of the companies in the peer index are weighted according to the respective company’s stock market capitalization at the beginning of each period for which a return is indicated. Historic stock price is not indicative of future stock price performance.

Other

See Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters for disclosure regarding securities authorized for issuance under equity compensation plans.
 
 
18

 

Item 6.  
Selected Financial Data

 
 
For the Year
 
 
 
2010
   
2009(a)
   
2008(b)
   
2007(c)
   
2006(d)
 
   
(In millions, except per share)
 
Revenues:
                             
Corrugated packaging
  $ 3,153     $ 3,001     $ 3,190     $ 3,044     $ 2,977  
Building products
    646       576       694       806       1,119  
Timber and timberland(e)
                      76       89  
Total revenues
  $ 3,799     $ 3,577     $ 3,884     $ 3,926     $ 4,185  
Segment operating income:
                                       
Corrugated packaging
  $ 333     $ 347     $ 225     $ 287     $ 255  
Building products
    (19 )     (27 )     (40 )     8       221  
Timber and timberland(e)
                      65       63  
Segment operating income
    314       320       185       360       539  
Items not included in segments:
                                       
General and administrative expense
    (70 )     (70 )     (76 )     (100 )     (107 )
Share-based and long-term incentive compensation
    (33 )     (58 )     2       (34 )     (38 )
Gain on sale of timberland(e)
                      2,053        
Other operating income (expense)(f)
    (16 )     206       (29 )     (188 )     26  
Other non-operating income (expense)(f)
    (1 )     (1 )           (35 )     93  
Net interest income (expense) on financial assets and nonrecourse financial liabilities of special purpose entities(e)
    (15 )     (2 )     (2 )     10        
Interest expense on debt
    (51 )     (63 )     (81 )     (111 )     (123 )
Income (loss) before taxes
    128       332       (1 )     1,955       390  
Income tax (expense) benefit(g)
    40       (125 )     (7 )     (753 )     (103 )
Income (loss) from continuing operations
    168       207       (8 )     1,202       287  
Discontinued operations(h)
                      103       181  
Net income (loss)
    168       207       (8 )     1,305       468  
Less: Net (income) loss attributable to noncontrolling interest of special purpose entities(e)
          (1 )                  
Net income (loss) attributable to Temple-Inland Inc. 
  $ 168     $ 206     $ (8 )   $ 1,305     $ 468  
Diluted earnings (loss) per share:
                                       
Income (loss) from continuing operations(i)
  $ 1.52     $ 1.89     $ (0.08 )   $ 10.89     $ 2.53  
Discontinued operations(h)
                      0.96       1.63  
Net income (loss)
  $ 1.52     $ 1.89     $ (0.08 )   $ 11.85     $ 4.16  
Dividends per common share(j)
  $ 0.44     $ 0.40     $ 0.40     $ 11.37     $ 1.00  
Average basic shares outstanding
    107.9       106.9       106.7       106.0       108.8  
Average diluted shares outstanding
    109.5       108.0       107.4       108.1       110.8  
Common shares outstanding at year-end
    108.0       107.4       106.5       106.1       104.9  
Depreciation and amortization
  $ 193     $ 200     $ 206     $ 214     $ 225  
Capital expenditures
  $ 233     $ 130     $ 164     $ 237     $ 204  
At Year-End:
                                       
Assets:
                                       
Manufacturing assets
  $ 3,434     $ 3,234     $ 3,395     $ 3,559     $ 3,627  
Financial assets of special purpose entities(e)
    2,475       2,475       2,474       2,383        
Assets of discontinued operations(h)
                            16,847  
Total assets
  $ 5,909     $ 5,709     $ 5,869     $ 5,942     $ 20,474  
Debt (long-term excluding current maturities and nonrecourse financial liabilities of special purpose entities)
  $ 718     $ 710     $ 1,191     $ 852     $ 1,584  
Nonrecourse financial liabilities of special purpose entities(e)
  $ 2,140     $ 2,140     $ 2,140     $ 2,140     $  
Liability for pension and postretirement benefits
  $ 434     $ 407     $ 290     $ 256     $ 366  
Noncontrolling interest of special purpose entities(e)
  $ 92     $ 92     $ 91     $     $  
Temple-Inland Inc. shareholders’ equity
  $ 929     $ 794     $ 686     $ 780     $ 2,189  
Ratio of debt to total capitalization
    44 %     47 %     63 %     52 %     42 %
____________

(a)
In 2009, we adopted the following new accounting guidance: (i) Consolidation — adoption required the reclassification of $91 million of noncontrolling interest of special purpose entities to shareholders’ equity; and (ii) Earning Per Share — adoption reduced our earnings per share by $0.02 in 2009, $0.23 in 2007, and $0.06 in 2006; there was no impact in 2008.
 
 
 
19

 
 
   
(b)
The 2008 fiscal year, which ended on January 3, 2009, had 53 weeks. The extra week did not have a significant effect on earnings or financial position. In July 2008, we purchased our partner’s 50 percent interest in Premier Boxboard Limited LLC (PBL). Unaudited pro forma information assuming this acquisition and related financing had occurred at the beginning of 2008, is not presented because the results would not have been materially different from those reported.
   
(c)
In 2007, we adopted the following new accounting guidance: (i) Accounting for Uncertainty in Income Taxes — adoption increased our assets by $2 million, reduced our liabilities by $3 million and increased our beginning retained earnings by $5 million (we also reclassified $11 million from deferred income taxes to other long-term liabilities); and (ii) measurement date provisions of Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans — adoption reduced our beginning retained earnings by $5 million.
   
(d)
In 2006, we adopted the following new accounting guidance: (i) Share-Based Payment — adoption decreased our 2006 income before taxes by $6 million; (ii) Accounting for Purchases and Sales of Inventory with the Same Counterparty — adoption decreased our income before taxes by $7 million in 2006 and $2 million in 2007; and (iii) Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — adoption increased our liability for pension and postretirement benefits by $76 million, decreased prepaid expenses and other assets by $16 million, decreased deferred income taxes by $35 million, and decreased shareholders’ equity by $57 million. In January 2006, we purchased our partner’s 50 percent interest in Standard Gypsum LP.
   
(e)
Timber and timberland is no longer an active segment as a result of the sale of our timberlands. In October 2007, we sold 1.55 million acres of timberland for $2.38 billion to an investment entity affiliated with The Campbell Group, LLC and recognized a pre-tax gain of $2.053 billion. The total consideration consisted almost entirely of $2.38 billion in notes due in 2027 that are secured by irrevocable letters of credit issued by independent financial institutions. We later contributed the $2.38 billion in notes to two wholly-owned, bankruptcy-remote special purpose entities. In December 2007, the special purpose entities pledged the notes as collateral for $2.14 billion nonrecourse loans payable in 2027. We include our special purpose entities in our consolidated financial statements. In 2008, the buyer of our timberland transferred the timberland out of special purpose entities that it had formed to complete the purchase. Upon this transfer, these special purpose entities became variable interest entities, and we determined that we were the primary beneficiary. As a result, we began consolidating the timberland buyer’s special purpose entities in 2008.
 
 
 
20

 
 
   
(f)
Other operating and non-operating income (expense) consists of:

   
For the Year
 
 
 
2010
   
2009
   
2008
   
2007
   
2006
 
   
(In millions)
 
Other operating income (expense):
                             
Alternative fuel mixture tax credits, net of costs
  $ 10     $ 213     $     $     $  
Costs and asset impairments, primarily related to box plant transformation and in 2007 the impairment of a long-term lease on a building products particleboard facility
    (26 )     (5 )     (9 )     (55 )     (4 )
Transformation costs (advisory and legal fees, change of control and employee related)
                (20 )     (69 )      
Litigation
                5       (56 )     (6 )
Environmental remediation
                      (9 )     (8 )
Softwood Lumber Agreement
                            42  
Other charges
          (2 )     (5 )     1       2  
    $ (16 )   $ 206     $ (29 )   $ (188 )   $ 26  
Other non-operating income (expense):
                                       
Substitution costs
  $     $ (17 )   $     $     $  
Gain (loss) on purchase and retirement of debt
    (1 )     15                    
Charges related to early repayment of debt
                (4 )     (40 )      
Tax litigation settlement
                            89  
Interest and other income
          1       4       5       4  
    $ (1 )   $ (1 )   $     $ (35 )   $ 93  
____________

(g)
Income taxes include the following tax benefits and tax charges: in 2010 a benefit of $83 million related to cellulosic biofuel producer credits and a one-time charge of $3 million due to the elimination of the tax deduction for drug expenses reimbursed under the Medicare Part D subsidy program; in 2007 a benefit of $7 million, of which $3 million is related to changes to the State of Texas margin tax and $4 million is related to the resolution of state income tax matters; and in 2006 a benefit of $36 million, of which $6 million is related to the State of Texas margin tax and $30 million is related to the non-taxable tax litigation settlement.
   
(h)
Discontinued operations include our financial services and real estate segments, which were spun off to our shareholders on December 28, 2007, and the chemical business obtained in the Gaylord acquisition, which was sold in August 2007.
   
(i)
In 2008, earnings per share was based on average basic shares outstanding due to our loss from continuing operations.
   
(j)
Includes special dividends of $10.25 per share in 2007.

Item 7.  
Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

Management’s Discussion and Analysis of Financial Condition and Results of Operations contains “forward-looking statements” within the meaning of the federal securities laws. These forward-looking statements are identified by their use of terms and phrases such as “believe,” “anticipate,” “could,” “estimate,” “likely,” “intend,” “may,” “plan,” “expect,” and similar expressions, including references to assumptions. These statements reflect management’s current views with respect to future events and are subject to risk and uncertainties. A variety of factors and uncertainties could cause our actual results to differ significantly from
 
 
 
21

 
 
the results discussed in the forward-looking statements. Factors and uncertainties that might cause such differences include, but are not limited to:

 
general economic, market, or business conditions

 
the opportunities (or lack thereof) that may be presented to us and that we may pursue

 
fluctuations in costs and expenses including the costs of raw materials, purchased energy, and freight

 
changes in interest rates

 
demand for new housing

 
accuracy of accounting assumptions related to impaired assets, pension and postretirement costs, contingency reserves, and income taxes

 
competitive actions by other companies

 
changes in laws or regulations

 
our ability to execute certain strategic and business improvement initiatives

 
the accuracy of certain judgments and estimates concerning the integration of acquired operations

 
other factors, many of which are beyond our control


Our actual results, performance, or achievement probably will differ from those expressed in, or implied by, these forward-looking statements, and accordingly, we can give no assurances that any of the events anticipated by the forward-looking statements will transpire or occur, or if any of them do so, what impact they will have on our results of operations or financial condition. In view of these uncertainties, you are cautioned not to place undue reliance on these forward-looking statements. Except as required by law, we expressly disclaim any obligation to publicly revise any forward-looking statements contained in this report to reflect the occurrence of events after the date of this report.

Non-GAAP Financial Measure

Return on investment (ROI) is an important internal measure for us because it is a key component of our evaluation of overall performance and the performance of our business segments. Studies have shown that there is a direct correlation between shareholder value and ROI and that shareholder value is created when ROI exceeds the cost of capital. ROI allows us to evaluate our performance on a consistent basis as the amount we earn relative to the amount invested in our business segments. A significant portion of senior management’s compensation is based on achieving ROI targets.

In evaluating overall performance, we define ROI as total segment operating income, less general and administrative expenses and share-based and long-term incentive compensation not included in segments, divided by total assets, less certain assets and certain current liabilities. We do not believe there is a comparable GAAP financial measure to our definition of ROI. The reconciliation of our ROI calculation to amounts reported under GAAP is included in a later section of Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Despite its importance to us, ROI is a non-GAAP financial measure that has no standardized definition and as a result may not be comparable with other companies’ measures using the same or similar terms. Also there may be limits in the usefulness of ROI to investors. As a result, we encourage you to read our consolidated financial statements in their entirety and not to rely on any single financial measure.

Accounting Policies

Critical Accounting Estimates

In preparing our financial statements, we follow U.S. generally accepted accounting principles, which in many cases require us to make assumptions, estimates, and judgments that affect the amounts reported. Our
 
 
 
22

 
 
significant accounting policies are included in Note 1 to the Consolidated Financial Statements. Many of these policies are relatively straightforward. There are, however, a few accounting policies that are critical because they are important in determining our financial condition and results, and they are difficult for us to apply. They include asset impairments, contingency reserves, pension accounting and income taxes. The difficulty in applying these policies arises from the assumptions, estimates, and judgments that we have to make currently about matters that are inherently uncertain, such as future economic conditions, operating results and valuations, as well as our intentions. As the difficulty increases, the level of precision decreases, meaning actual results can, and probably will, differ from those currently estimated. We base our assumptions, estimates, and judgments on a combination of historical experiences and other factors that we believe are reasonable. We have reviewed the selection and disclosure of these critical accounting estimates with our Audit Committee.

 
Measuring assets for impairment requires estimating intentions as to holding periods, future operating cash flows and residual values of the assets under review. Changes in our intentions, market conditions, or operating performance could require us to revise the impairment charges we previously provided.

 
Contingency reserves are established for potential losses related to litigation, environmental remediation and other items. Estimating these reserves requires us to make certain judgments and assumptions regarding actual or potential claims, interpretations to be made by courts or regulatory bodies, and other factors and events that are outside our control. Changes and inaccuracies in our interpretations and actions of others could require us to revise the reserves we previously provided.

 
The expected long-term rate of return on pension plan assets is an important assumption in determining pension expense. In selecting that rate, particular consideration is given to our asset allocation because about 80 percent of our plan assets are debt related with a duration that closely matches that of our benefit obligation. Another important consideration is the discount rate used to determine the present value of our benefit obligation. We determined the discount rate by referencing the Citigroup Pension Discount Curve. Differences between actual and expected rates of return and changes in the discount rate will affect future pension expense and funded status. For example, a 25 basis point change in the discount rate would affect the projected benefit obligation by about $49 million and the net periodic pension cost by about $5 million. A 25 basis point change in the expected long-term rate of return would affect the net periodic pension cost by about $3 million.
 
 
Tax provisions are based on the respective tax laws and regulations of the jurisdictions in which we operate. When we believe a tax position is supportable but the outcome uncertain, we include the item in our tax return but do not recognize the related benefit in our provision for income taxes. Instead, we record a reserve for unrecognized tax benefits, which represents our expectation of the most likely outcome considering the technical merits and specific facts of the position. Changes to this reserve are only made when an event occurs that changes the most likely outcome, such as settlement with the relevant tax authority, expiration of statutes of limitations, changes in tax law, or recent court rulings.

New Accounting Pronouncements

In the last several years, we adopted a number of new accounting pronouncements. Please read Note 1 to the Consolidated Financial Statements and footnotes (a), (c), and (d) to the Selected Financial Data table.

Transformation

On December 28, 2007, we completed our transformation plan, which included sale of our timberlands and spin-offs of our real estate and financial services segments. The transformation plan significantly changed our capital structure and operations. Since completion of the transformation plan, we are a manufacturing company focused on corrugated packaging and building products.
 
 
 
23

 

 
Box Plant Transformation II

Over the past few years, we have been focused on changing the culture in our box plant system to run converting equipment near design capacity, thereby lowering costs through improved asset utilization. The first phase of this effort, which we called “Box Plant Transformation,” resulted in the closure of four box plants and the elimination of about 1,100 employee positions significantly lowering costs and improving margins.

In February 2010, we announced the second phase of this effort, “Box Plant Transformation II,” which is designed to further reduce our box plant system cost. We anticipate Box Plant Transformation II to take three years and result in the closure of up to 12 box plants and the elimination of as many as 900 employee positions. The capital investment for Box Plant Transformation II is estimated to be about $250 million over the three years, which we will likely fund from operations or borrowings under our committed credit agreements.

The initial steps in effecting Box Plant Transformation II began in 2010 when we closed our Santa Fe Springs, California sheet plant and our Phoenix, Arizona; Evansville, Indiana; and Scranton, Pennsylvania box plants. In addition, we have announced the closure of our Carol Stream, Illinois box plant, which is expected to close in second quarter 2011. In 2010 we recognized non-cash asset impairment charges of $14 million, severance and other employee costs of $2 million for about 370 employees, and other transformation costs of $9 million related to box plant transformation activities. As we continue to refine and implement Box Plant Transformation II, it is likely we will incur additional asset impairments, severance and other costs, which could be significant.

Results of Operations for the Years 2010, 2009 and 2008

Summary

Our two key objectives are:

 
Maximizing ROI and

 
Profitably growing our business

We strive to accomplish these key objectives through execution of our strategic initiatives:

 
Maintaining a high integration level in corrugated packaging

 
Driving for low cost through asset utilization and manufacturing excellence

 
Improving mix and margins through sales excellence

 
Profitably growing our business

In 2010, consistent with our key strategic initiatives:

 
We improved our ROI to 8.2 percent.

 
Corrugated Packaging ROI was 16.5 percent.

 
We initiated Box Plant Transformation II, which will further drive down the cost structure of our box plant system and allow us to better serve our customers and target a higher value segment of the corrugated packaging market.

 
We used available cash flow to reinvest in the business through capital expenditures of $233 million, primarily related to Box Plant Transformation II.

 
We grew our higher-margin, local account corrugated packaging business.

 
We grew our market share in all of our building products.
 
 
 
24

 

 
A summary of our consolidated results follows:

 
 
For the Year
 
 
 
2010
   
2009
   
2008
 
   
(In millions, except per share)
 
Consolidated revenues
  $ 3,799     $ 3,577     $ 3,884  
Income (loss) attributable to Temple-Inland Inc. 
    168       206       (8 )
Income (loss) per share, attributable to Temple-Inland Inc. 
    1.52       1.89       (0.08 )
ROI
    8.2 %     7.0 %     4.5 %

In 2010, significant items affecting income included:

 
We experienced higher prices and flat volumes for our corrugated packaging products, higher volumes for all of our building products and higher prices for lumber and MDF.

 
Input costs, principally recycled fiber, wood fiber and freight costs, increased significantly, but we continue to benefit from our initiatives to lower costs, improve asset utilization, and increase operating efficiencies.

 
Pension costs increased $19 million primarily due to higher amortization of actuarial losses and $4 million of expense related to the payment of lump-sum benefits from our supplemental defined benefit plan.

 
Share-based and long-term incentive compensation expense decreased $25 million primarily due to a higher than normal expense in 2009 caused by our increasing share price in 2009. Excluding the impact of the increase in our share price in 2009, share-based and long-term incentive compensation expense was flat.

 
Other operating income (expense) includes a $26 million charge associated with asset impairments, severance and other costs primarily related to Box Plant Transformation II and a $10 million benefit related to alternative fuel mixture tax credits.

 
Net interest expense of special purpose entities increased $13 million due to lower interest rate spreads and costs related to agreements with potential replacement issuers of letters of credit securing the financial assets.

 
Interest expense decreased primarily due to the 2009 purchase and retirement of long-term debt, lower levels of average variable rate debt and, to a lesser degree, lower interest rates on our variable-rate debt.

 
We recognized a tax benefit of $83 million related to cellulosic biofuel producer credits and one-time income tax expense of $3 million related to the impact of the Patient Protection and Affordable Care Act on the Medicare Part D retiree drug subsidy program.

In 2009, significant items affecting income included:

 
We experienced lower prices and volumes for our corrugated packaging products, and lower prices and volumes for most of our building products, except for gypsum wallboard volumes.

 
We realized benefits from the production of white-top linerboard at the Newport mill and its integration into our corrugated packaging operations.

 
We continued to see the benefits in our manufacturing operations from our initiatives to lower costs, improve asset utilization, and increase operating efficiencies, and realized benefits from lower costs for energy, freight and fiber in our corrugated packaging operations.

 
Share-based and long-term incentive compensation increased $60 million primarily due to the impact on our cash-settled awards of the increase in the market price of our common stock.

 
We recognized other operating income of $213 million related to alternative fuel mixture tax credits, net of related costs.
 
 
 
25

 
 

 
 
We incurred $7 million of other operating expense primarily associated with 2008 facility closures and severance.

 
We recognized a net gain of $15 million in connection with the purchase and retirement of $245 million of our long-term debt.

 
We recognized $17 million of non-operating expense associated with the substitution of an issuer of irrevocable letters of credit securing the notes we received in connection with the 2007 sale of our strategic timberland.

 
Interest expense decreased primarily due to our purchase and retirement of long-term debt, lower levels of variable rate debt and, to a lesser degree, lower interest rates on our variable-rate debt.

In 2008, significant items affecting income included:

 
We experienced higher pricing and lower volumes for our corrugated packaging products, lower volumes for most of our building products, and lower pricing for gypsum wallboard.

 
While we continued to see the benefits in our manufacturing operations from our initiatives to lower costs, improve asset utilization, and increase operating efficiencies, the increased costs of energy, freight and fiber in our corrugated packaging operations more than offset these benefits.

 
Share-based compensation decreased $36 million primarily due to the impact on our cash-settled awards of the decrease in the market price of our common stock.

 
We incurred $20 million of costs primarily related to our transformation plan, of which $15 million was related to payments of lump-sum benefits from our supplemental defined pension plan. We also decreased litigation reserves by $5 million due to the final settlement of antitrust litigation.
 
 
Charges related to the closure of our Rome, Georgia converting facility totaled $2 million and charges related to our exit of the hardboard siding business in building products totaled $7 million.

 
Interest expense decreased primarily due to the December 2007 early retirement of $286 million of 6.75% Notes and $213 million of 7.875% Senior Notes.

 
In July 2008, we purchased for $62 million the remaining 50 percent interest we did not previously own in PBL. Subsequent to the purchase we prepaid $50 million in joint venture debt and incurred a $4 million prepayment penalty.

Business Segments

We manage our operations through two business segments: corrugated packaging and building products.

Our operations are affected to varying degrees by supply and demand factors and economic conditions including changes in energy costs, interest rates, new housing starts, home repair and remodeling activities, and the strength of the U.S. dollar. Given the commodity nature of our manufactured products, we have little control over market pricing or market demand.

Corrugated Packaging

We manufacture linerboard, corrugating medium, and white-top linerboard (collectively referred to as containerboard) that we convert into corrugated packaging. In July 2008, we purchased our partner’s 50 percent interest in PBL, a joint venture that manufactures containerboard and light-weight gypsum facing paper at a mill in Newport, Indiana. We have integrated the PBL operations into our corrugated packaging system. Late in 2008, we began producing white-top linerboard at the Newport mill. Our corrugated packaging segment revenues are principally derived from the sale of corrugated packaging products and, to a lesser degree, from the sale of containerboard and light-weight gypsum facing paper (collectively referred to as paperboard).
 
 
 
26

 

 
A summary of our corrugated packaging results follows:

 
 
For the Year
 
 
 
2010
   
2009
   
2008
 
   
(In millions)
 
Revenues 
  $ 3,153     $ 3,001     $ 3,190  
Costs and expenses 
    (2,820 )     (2,654 )     (2,965 )
Segment operating income 
  $ 333     $ 347     $ 225  
Segment ROI 
    16.5 %     16.5 %     11.3 %

Corrugated packaging results for 2008 would not have been materially different from those reported assuming the purchase of PBL had occurred at the beginning of 2008.

Fluctuations in product pricing (which includes freight and is net of discounts) and shipments follow:

 
 
Year over Year
Increase (Decrease) 
 
2010 
2009 
2008 
Corrugated packaging
     
Average prices
3%
(3)%
4%
Shipments, average week
—%
1%
(2)%
Industry shipments, average week(a)
3%
(7)%
(4)%
Paperboard
     
Average prices
26%
(12)%
1%
Shipments, in thousand tons(b)
41
(116)
166

____________

(a)
Source: Fibre Box Association
   
(b)
The decrease in 2009 paperboard shipments to third parties was primarily due to a decrease of 150,000 tons of containerboard shipments offset by an increase of 40,000 tons of light-weight gypsum facing paper shipments. The increase in 2008 includes 43,000 tons of light-weight gypsum facing paper and 25,000 tons of containerboard shipped by PBL since its purchase in July 2008.

We benefited in 2010 compared with 2009 from higher box prices, lower mill maintenance, and box plant transformation. In 2009, corrugated packaging prices were down due to economic conditions. In 2008, corrugated packaging prices were up as a result of price increases implemented in 2007 and mid-2008; however economic conditions in 2008 had a negative impact on our shipments.

Costs and expenses were up six percent in 2010 compared with 2009, down ten percent in 2009 compared with 2008, and up eight percent in 2008 compared with 2007. The higher costs in 2010 were primarily the result of higher input costs for wood fiber, recycled fiber, energy, and freight. In addition, pension and postretirement cost increased in 2010. The lower costs in 2009 were primarily the result of lower prices for wood fiber, recycled fiber, energy, and freight; lower converting costs; and reduced outside purchases of white-top linerboard and medium due to the integration of the Newport mill, somewhat offset by an increase in employee benefit costs. The higher costs in 2008 were primarily the result of higher prices for recycled fiber, energy, and freight, and the inclusion of PBL since its purchase in July 2008.
 
 
 
27

 

 
Fluctuations in our significant cost and expense components included:

 
 
 
Year over Year
Increase (Decrease)
 
 
 
2010
   
2009
   
2008
 
   
(In millions)
 
Wood fiber
  $ 23     $ (27 )   $ 5  
Recycled and purchased pulp fiber 
    157       (30 )     15  
Energy, principally natural gas
    10       (62 )     61  
Freight 
    33       (27 )     29  
Depreciation 
    (2 )     (1 )     4  
Health care 
    (2 )     6       (1 )
Pension and postretirement 
    13       5        

The costs of our wood and recycled fiber, energy, and freight fluctuate based on the market prices we pay for these commodities. It is likely that these costs will continue to fluctuate in 2011.

Information about our converting facilities and mills follows:

 
For the Year 
 
2010 
2009 
2008 
Number of converting facilities (at year-end)
59
63
63
Corrugated packaging shipments, in million tons
3.3
3.3
3.3
Paperboard production, in million tons
4.0
3.9
3.7
Percent containerboard production used internally
92%
93%
88%
Percent of total fiber requirements sourced from recycled fiber
43%
44%
42%

Paperboard production in 2009 includes production from our Newport mill that we acquired in July 2008. In 2009 and 2008, we reduced our production of containerboard to match our demand. In 2008, we lost production of 38,000 tons of containerboard due to hurricanes Gustav and Ike.

Please read Box Plant Transformation II for further information about our 2010 facilities closures and $25 million of transformation related costs that are not included in segment results. We also incurred impairment charges and employee related costs totaling $3 million for 2009 and $2 million for 2008 related to our continuing efforts to lower costs and improve operating efficiencies, which are not included in segment results.

 
Building Products

We manufacture lumber, gypsum wallboard, particleboard, medium density fiberboard (MDF), and fiberboard. Our building products segment revenues are principally derived from sales of these products. We also own a 50 percent interest in Del-Tin Fiber LLC (Del-Tin), a joint venture that produces MDF at a facility in El Dorado, Arkansas.

A summary of our building products results follows:

   
For the Year
 
 
 
2010
   
2009
   
2008
 
   
(Dollars in millions)
 
Revenues
  $ 646     $ 576     $ 694  
Costs and expenses
    (665 )     (603 )     (734 )
Segment operating income (loss)
  $ (19 )   $ (27 )   $ (40 )
Segment ROI
    (3.8 )%     (5.0 )%     (7.1 )%
 
 
 
28

 

 
Fluctuations in product pricing (which includes freight and is net of discounts) and shipments follow:

 
 
Year over Year
Increase (Decrease) 
 
2010 
2009 
2008 
Lumber:
     
 Average prices                                                                                                                                  
17%
(14)%
1%
 Shipments                                                                                                                                  
4%
(7)%
(8)%
Gypsum wallboard:
     
 Average prices                                                                                                                                  
(4)%
(4)%
(18)%
 Shipments                                                                                                                                  
11%
10%
(28)%
Particleboard:
     
 Average prices                                                                                                                                  
(2)%
(7)%
4%
 Shipments                                                                                                                                  
2%
(17)%
(7)%
MDF:
     
 Average prices                                                                                                                                  
9%
—%
12%
 Shipments                                                                                                                                  
3%
(11)%
4%

Pricing and demand for most of our building products for 2010, 2009, and 2008 were impacted by the deteriorating conditions in the housing industry, which began in late 2007. The increase in lumber prices in 2010 was primarily the result of increased demand in the second quarter. Both demand and prices declined sharply in the third quarter of 2010. While our volumes for gypsum wallboard, particleboard and MDF increased in 2010 compared with 2009, absolute demand levels remain low. We expect markets to continue to be challenging in 2011.

Segment results also include our share of income from Del-Tin of $3 million in 2010, $2 million in 2009, and $1 million in 2008. The operating results from the joint venture generally fluctuate in relation to the price and shipment changes noted above for MDF.

Costs and expenses were up 10 percent in 2010 compared with 2009, down 18 percent in 2009 compared with 2008, and down eight percent in 2008 compared with 2007. The increase in costs for 2010 was primarily attributable to an increase in input costs and slightly higher operating rates. In addition, 2010 costs included $3 million of pension expense associated with payments of lump-sum benefits from our supplemental defined benefit plan for employees who retired in 2010. The lower costs in 2009 and 2008 are primarily attributable to curtailment of production to match demand for our products and reductions in employment. In 2009, we recognized a $3 million gain from a sale in lieu of condemnation of land near our lumber mill in Rome, Georgia, and we incurred costs of about $1 million related to an indefinite shutdown of our lumber mill in Buna, Texas. We incurred severance charges of $3 million in 2008 related to reductions in employment.
 
Fluctuations in our significant cost and expense components included:

 
 
 
Year over Year
Increase (Decrease)
 
 
 
2010
   
2009
   
2008
 
   
(In millions)
 
Wood fiber
  $ 20     $ (33 )   $ (43 )
Energy, principally natural gas
    3       (26 )      
Freight
    14       (15 )     (6 )
Chemicals
    6       (25 )     12  
Depreciation
    (3 )     (4 )     3  
Health care
    (1 )           (2 )
Pension and postretirement
    6       (2 )     1  

The costs of our fiber, energy, freight, and chemicals fluctuate based on usage and the market prices we pay for these commodities. It is likely that these costs will continue to fluctuate in 2011.
 
 
 
29

 

 
Information about our converting and manufacturing facilities follows:

 
At Year-End 
 
2010 
2009 
2008 
Number of converting and manufacturing facilities
16
16
16

The number of converting and manufacturing facilities includes our lumber mill in Buna, Texas, which was indefinitely shutdown in second quarter 2009. In recent years we have curtailed our production to match demand for our products. In December 2008, we permanently ceased production of hardboard siding at our fiberboard operations, incurring impairment charges and employee related costs totaling $7 million, which are not included in segment results.

Items Not Included in Segments

Items not included in segments are income and expenses that are managed on a company-wide basis and include corporate general and administrative expense, share-based and long-term incentive compensation, other operating and non-operating income (expense), and interest income and expense.

Our general and administrative expense in 2010 was flat compared with 2009. The $6 million and $24 million decrease in general and administrative expense in 2009 and 2008 was principally due to our cost reduction efforts, which included a 27 percent reduction in business support employees in 2008. The decrease in 2009 general and administrative expense was somewhat offset by an increase in incentive compensation due to a higher ROI in 2009 compared with 2008.

Our share-based and long-term incentive compensation fluctuates because a significant portion of our share-based awards are cash settled and are affected by changes in the market price of our common stock. The volatility in the stock markets since the end of 2008 contributed to dramatic changes in the market price of our common stock, which resulted in fluctuations in our share-based compensation expense during this period. Share-based and long-term incentive compensation expense decreased $25 million in 2010 primarily due to a higher than normal expense in 2009 caused by our increasing share price in 2009. Excluding the impact of the increase in our share price in 2009, share-based and long-term incentive compensation expense was flat in 2010 compared with 2009. The $60 million increase in 2009 was principally due to the increase in the market price of our common stock in 2009. The $36 million decrease in 2008 was principally due to the decrease in the market price of our common stock in 2008. Assuming no change to our year-end 2010 share price, it is likely that our 2011 share-based and long-term incentive compensation expense will be about $36 million. For each $1 change in the market price of our common stock, our share-based compensation changes about $2 million to $3 million.
 
Other operating income (expense) not included in business segments consists of:

 
 
For the Year
 
 
 
2010
   
2009
   
2008
 
   
(In millions)
 
Alternative fuel mixture tax credits, net of costs
  $ 10     $ 213     $  
Costs and asset impairments, primarily related to box plant transformation
    (26 )     (5 )     (9 )
Transformation costs
                (20 )
Litigation
                5  
Other charges
          (2 )     (5 )
    $ (16 )   $ 206     $ (29 )

The Internal Revenue Code allows an excise tax credit for alternative fuel mixtures produced for sale or for use in a trade or business. The credit expired on December 31, 2009. In 2009, we generated and claimed alternative fuel mixture tax credits of $228 million of which we recognized $218 million and provided a $10 million reserve due to an uncertainty in the tax law regarding whether a portion of the alternative fuel we used would qualify for the tax credit. In first quarter 2010, the Internal Revenue Service (IRS) clarified this uncertainty allowing us to release the $10 million reserve established in 2009.
 
 
 
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We continue our efforts to enhance return on investment by lowering costs, improving operating efficiencies, and increasing asset utilization. As a result, we continue to review operations that are unable to meet return objectives and determine appropriate courses of action, including possibly consolidating and closing facilities. In connection with the second phase of our box plant transformation, in 2010, we closed our Santa Fe Springs, California sheet plant and our Phoenix, Arizona; Evansville, Indiana; and Scranton, Pennsylvania box plants. In addition, we announced the closure of our Carol Stream, Illinois box plant, which is expected to close in second quarter 2011. In connection with our box plant transformation activities, we recognized asset impairment charges of $14 million, severance and other employee costs of $2 million, and other transformation related costs of $9 million. In December 2008, we closed our Rome, Georgia box plant and permanently ceased production of hardboard siding at our fiberboard plant in Diboll, Texas. These actions resulted in impairment charges and employee related costs totaling $5 million in 2009 and $9 million in 2008.

In 2008, we settled and paid one remaining state court claim regarding alleged civil violations of Section 1 of the Sherman Act and released our remaining reserve of $5 million.

Other non-operating income (expense) not included in business segments consists of:

 
 
For the Year
 
 
 
2010
   
2009
   
2008
 
   
(In millions)
 
Gain (loss) on purchase and retirement of debt
  $ (1 )   $ 15     $  
Substitution costs
          (17 )      
Charges related to early repayment of debt
                (4 )
Interest and other income
          1       4  
    $ (1 )   $ (1 )   $  

The loss of $1 million recognized in 2010 is associated with the purchase and retirement of $16 million of our 7.875% Senior Notes due in 2012. The gain of $15 million recognized in 2009 is associated with the purchase and retirement of $90 million of our 7.875% Senior Notes due in 2012, $136 million of our 6.375% Senior Notes due in 2016, and $19 million of our 6.625% Senior Notes due in 2018. The $17 million in substitution costs recognized as other non-operating expense in 2009 are fees associated with the replacement of issuers of irrevocable letters of credit securing the notes we received in connection with the sale of our strategic timberland in 2007. Other non-operating income (expense) in 2008 includes a $4 million charge related to early repayment of $50 million in debt of PBL upon our acquisition of our partner’s interest.

Net interest income (expense) on financial assets and nonrecourse financial liabilities of special purpose entities relates to interest income on the $2.38 billion of notes received from the sale of our timberland in 2007; interest expense on the $2.14 billion of borrowings secured by a pledge of the notes received; and in 2010, costs related to agreements with potential replacement issuers of letters of credit securing these assets. The notes receivable were contributed to and the borrowings were made by two wholly-owned, bankruptcy-remote, special purpose entities, which we consolidate. The borrowings are nonrecourse beyond these two entities. In 2010 and 2009, the average interest rate on our financial assets was 0.38 percent and 1.00 percent and the average interest rate on our nonrecourse financial liabilities was 0.91 percent and 1.30 percent. The 2010 increase in net interest income (expense) on financial assets and nonrecourse financial liabilities of special purpose entities was primarily due to lower interest rate spreads and costs related to 2010 agreements with potential replacement issuers of letters of credit securing the financial assets.

The change in interest expense in 2010 compared with 2009 was primarily due to the 2009 purchase and retirement of long-term debt; lower levels of average variable rate debt; and to a lesser degree, lower interest rates on our borrowings under committed credit agreements. The change in interest expense in 2009 compared with 2008 was due to our purchase and retirement of $245 million of long-term debt with an average interest rate in excess of 7 percent; lower levels of variable rate debt; and, to a lesser degree, lower interest rates on our variable-rate debt. The decrease in interest expense in 2008 was primarily related to the December 2007 early retirement of $286 million of 6.75% Notes and $213 million of 7.875% Senior Notes. At year-end 2010, we had $540 million of debt with fixed interest rates that averaged 7.15 percent and $178 million of debt with
 
 
 
31

 
 
variable interest rates that averaged 1.60 percent. This compares with $555 million of debt with fixed interest rates that averaged 7.17 percent and $155 million of debt with variable interest rates that averaged 1.73 percent at year-end 2009.

Goodwill

Our goodwill totals $394 million of which $265 million is allocated to our corrugated packaging segment and $129 million to the gypsum wallboard reporting unit of our building products segment. Substantially all our goodwill is deductible for income tax purposes.

Goodwill was tested for impairment at the beginning of fourth quarter 2010 in conjunction with our annual test. Our test indicated that our goodwill was not impaired and that the estimated fair value of the reporting units substantially exceeded their carrying value. In performing this impairment analysis, we estimated fair value based on discounted cash flow models, which included estimates of amounts and timing of future cash flows, discount rates between 9 percent and 12 percent based on a weighted average cost of capital analysis adjusted for market risk premiums, product pricing and shipments, and input costs.

Since the annual impairment testing for 2010, there were no changes in the composition of our reporting units or in our operations to indicate that it was likely that there had been any significant deterioration in the estimated fair value of our reporting units. Therefore, we did not test goodwill for impairment at year-end 2010. If economic and market conditions are depressed for a prolonged time, it is possible that in future periods our goodwill could become impaired, and we would be required to recognize impairment charges, which could possibly be significant.

Income Taxes

In 2010, the IRS provided clarification to the effect that black liquor, a by-product of the paper making process, produced and used as a fuel by a registered producer qualifies for the $1.01 per gallon taxable, non-refundable cellulosic biofuel producer credit. This credit may be used to offset federal income taxes payable, subject to certain limitations. Our registration as a producer of cellulosic biofuel was approved on August 16, 2010. The IRS also clarified that cellulosic biofuel produced before registration may be claimed and that a producer may not claim both the cellulosic biofuel producer credit and the alternative fuel mixture tax credit for the same volume of black liquor. However, both alternative fuel mixture tax credits and cellulosic biofuel producer credits can be claimed in the same taxable year for different volumes of black liquor. As a result, in 2010 we recognized an income tax benefit of $83 million related to cellulosic biofuel producer credits that we earned on black liquor produced and used in 2009 prior to implementation of our process to produce an alternative fuel mixture.

As we previously disclosed, we claimed and recognized $228 million of alternative fuel mixture tax credits related to black liquor produced and used from late March 2009, when we began mixing black liquor as an alternative fuel, through year-end 2009.

Both the alternative fuel mixture credit and the cellulosic biofuel producer credit apply only to black liquor produced and used in 2009.

Excluding the tax benefit of $83 million related to cellulosic biofuel producer credits and the one-time income tax charge of $3 million due to the elimination of the tax deduction for drug expenses reimbursed under the Medicare Part D subsidy program, our effective tax rate, which is income tax expense as a percentage of income before taxes, was 31 percent in 2010. Our effective tax rate was 37 percent in 2009. Differences between the effective tax rate and the statutory rate are due to state income taxes, nondeductible items, the domestic production activities deduction, and deferred taxes on unremitted foreign income. The lower effective tax rate in 2010 when compared with 2009 was primarily due to the expected utilization of state net operating loss carry-forwards previously reserved and a higher domestic production activities deduction. We did not have a meaningful effective tax rate in 2008 because of a loss before taxes and the impact of state income taxes, nondeductible items, and taxes on unremitted foreign income.

We anticipate returning to a more normal effective tax rate in 2011 of about 40 percent.
 
 
 
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Average Shares Outstanding

The increase in average shares outstanding in 2010 was due to shares issued to employees exercising stock options and vesting of share-settled units. Average diluted shares outstanding increased in 2010 and 2009 due to the increase in the dilutive effect of stock options as a result of the higher average market price of our common stock. Average diluted shares outstanding decreased in 2008 due a to decrease in the dilutive effect of stock options as a result of the lower average market price of our common stock in 2008.

Capital Resources and Liquidity

Sources and Uses of Cash

We operate in cyclical industries and our operating cash flows vary accordingly. Our principal operating cash requirements are for compensation, wood and recycled fiber, energy, interest, and taxes. Working capital is subject to cyclical operating needs, the timing of collection of receivables and the payment of payables and expenses and, to a lesser extent, to seasonal fluctuations in our operations.

 
 
For the Year
 
 
 
2010
   
2009
   
2008
 
   
(In millions)
 
Cash received from:
                 
Operations (including payments related to our 2007 transformation plan of $50 million in 2008)(a)(b)
  $ 334     $ 549     $ 222  
Working capital (including payments related to our 2007 transformation plan of $297 million in 2008)(c)
    (74 )     91       (404 )
Cash received from (used for) operations
    260       640       (182 )
Borrowings, net
    6             286  
Exercise of options and related tax benefits
    8       8        
Other
    3       5       4  
Total sources
    277       653       108  
Cash used to:
                       
Reduce borrowings, net
          (467 )      
Return to shareholders through dividends
    (47 )     (43 )     (43 )
Reinvest in the business through:
                       
Capital expenditures
    (233 )     (130 )     (164 )
Acquisition of PBL, net of cash acquired
                (57 )
Joint ventures and other
    (5 )     (18 )     (30 )
Total uses
    (285 )     (658 )     (294 )
Change in cash and cash equivalents
  $ (8 )   $ (5 )   $ (186 )
____________

(a)
Includes voluntary, discretionary contributions to our defined benefit plan of $30 million in 2010, 2009, and 2008.
   
(b)
Includes alternative fuel mixture tax credits, net of related costs and tax payments, of $175 million in 2009.
   
(c)
Includes $14 million of alternative fuel mixture tax credits in 2010 that were accrued at year-end 2009.


Our operating cash flows for 2010, 2009, and 2008 have been adversely affected by worsening conditions in the housing markets and by the weakness in the national economy. Our cash from operations in 2010 decreased compared with 2009, primarily due to the impact of alternative fuel mixture tax credits received in 2009, lower earnings, and increased working capital needs. Our 2009 operating cash flows improved significantly when compared with 2008, primarily due to our cost reduction efforts in our operations, increased
 
 
 
33

 
 
earnings, and receipt of $175 million of alternative fuel mixture tax credits, net of related costs and tax payments. Payments related to our 2007 transformation plan totaled $347 million in 2008.

We issued 555,587 net shares of common stock in 2010; 864,755 net shares of common stock in 2009; and 77,736 net shares of common stock in 2008 to employees exercising options and for vesting of share-settled units.

We paid cash dividends to shareholders of $0.44 per share in 2010, and $0.40 per share in 2009 and 2008. On February 4, 2011, our Board of Directors declared a regular quarterly dividend of $0.13 per share payable on March 15, 2011, which represents an 18 percent increase over the previous dividend.

In 2006 and 2007, our Board of Directors approved repurchase programs aggregating 11.0 million shares. As of year-end 2010 we had purchased 4.4 million shares under these programs resulting in 6.6 million shares remaining to be purchased. In 2010, 2009, and 2008, we did not purchase any shares under these programs.

In 2010, capital expenditures were $233 million, or 121 percent of depreciation and amortization, a significant portion of which is related to Box Plant Transformation II. Capital expenditures were $130 million, or 65 percent of depreciation and amortization in 2009, and $164 million, or 80 percent of depreciation and amortization in 2008. Capital expenditures in 2011 are expected to be about $225 million to $235 million, which includes a significant portion related to the continuation of Box Plant Transformation II.

In 2010, our borrowings increased $8 million as we used available cash to reinvest in the business through capital expenditures related to Box Plant Transformation II. In 2009, we used available cash of $467 million to reduce our borrowings, including our purchase and retirement of $245 million of long-term debt. In 2008, our net borrowings increased principally as the result of payments made related to the completion of our 2007 transformation plan and the purchase of our partner’s 50 percent interest in PBL for $62 million. The joint venture had $50 million in debt, of which $25 million was related to the purchased interest. We had previously guaranteed the entire $50 million in joint venture debt.

Liquidity and Contractual Obligations

Credit Agreements

Our sources of short-term funding are our operating cash flows and borrowings under our credit agreements and accounts receivable securitization facility. At year-end 2010, we had $766 million in unused borrowing capacity under our committed credit agreements and accounts receivable securitization facility.

 
 
 
 
 
 
Committed
Credit
Agreements
   
Accounts
Receivable
Securitization
Facility
   
 
 
 
Total
 
   
(In millions)
 
Committed    
  $ 710     $ 250     $ 960  
Less: borrowings and commitments
    (41 )     (153 )     (194 )
Unused borrowing capacity at year-end 2010
  $ 669     $ 97     $ 766  

In June 2010 we replaced our existing $750 million revolving credit facility, which would have matured in July 2011, with a new credit facility that matures in June 2014. The new credit facility provides for a $600 million unsecured revolving line of credit, which includes a $100 million sublimit for the issuance of letters of credit. The remaining $110 million of our committed credit agreements are bilateral agreements, of which $25 million mature in 2011 and $85 million mature in 2013. At year-end 2010, we had $16 million of letters of credit issued under our new credit facility and $25 million of borrowings outstanding under our bilateral agreements.

Our accounts receivable securitization facility expires in 2013. Under this facility, a wholly-owned, bankruptcy-remote subsidiary purchases, on an on-going basis, substantially all of our trade receivables. As we need funds, the subsidiary draws under its revolving credit agreement, pledges the trade receivables as collateral, and remits the proceeds to us. In the event of liquidation of the subsidiary, its creditors would be
 
 
 
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entitled to satisfy their claims from the subsidiary’s pledged receivables prior to distributions back to us. We include this subsidiary in our consolidated financial statements. At year-end 2010, the subsidiary owned $365 million in net trade receivables. The borrowing base, which is determined by the level of our trade receivables, may be below the maximum committed amount of the facility in periods when the balance of our trade receivables is low. At year-end 2010, the borrowing base was $250 million, the maximum committed amount of the facility.

Our unused borrowing capacity for 2010 ranged from a high of $871 million to a low of $708 million. This fluctuating capacity results primarily from the change in our total committed credit agreements and our cash flows, which impact our accounts receivable securitization facility. This facility is used primarily to fund our operating cash needs, which fluctuate due to timing of collection of receivables, payment of payables and expenses, capital expenditures, and dividends, and to a lesser extent, to seasonal fluctuations in our operations.

Our debt agreements, accounts receivable securitization facility, and credit agreements contain terms, conditions, and financial covenants customary for such agreements including minimum levels of interest coverage and limitations on leverage. At year-end 2010, we had complied with the terms, conditions, and financial covenants of these agreements. We do not currently anticipate any change in circumstances that would impair our ability to continue to comply with these covenants.

Under the terms of our Senior Notes due 2016 and Senior Notes due 2018, the interest rates on the notes automatically adjust if our long-term debt rating is decreased below investment grade by Moody’s Investors Service, Inc. (Moody’s) or Standard & Poor’s Financial Services, LLC, a subsidiary of McGraw-Hill Companies, Inc. (S&P). Our long-term debt is currently rated BBB by S&P and Ba1 by Moody’s. If Moody’s upgrades our long-term debt rating to investment grade (Baa3), the interest rates on these notes will decrease 25 basis points. A downgrade in our debt rating by either Moody’s or S&P would result in the interest rates on these notes being increased 25 basis points per ratings level for each rating agency. The interest rates on these notes cannot be increased more than 2 percentage points above the original issue rate.

We believe the amount available under our credit facilities along with our existing cash and cash equivalents and expected cash flows from operations will provide us sufficient funds to meet our operating needs for the foreseeable future. In light of the current conditions in financial markets, we closely monitor the banks in our credit facilities. To date, we have experienced no difficulty in borrowing under these facilities and have not received any indications that any of the participating banks would not be able to honor their commitments under these facilities.
 
 
 
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Contractual Obligations

At year-end 2010 our contractual obligations consist of:

 
 
Payments Due or Expiring by Year
 
 
 
Total
   
2011
      2012-2013       2014-2015    
Thereafter
 
   
(In millions)
 
Long-term debt (including current maturities)(a)
  $ 718     $ 25     $ 333     $ 5     $ 355  
Nonrecourse financial liabilities of special purposes entities(a)
    2,140                         2,140  
Less, related financial assets of special purpose entities(a)
    (2,140 )                       (2,140 )
Principal portion of capital lease obligations(a)
    188                         188  
Less, related municipal bonds we own(a)
    (188 )                       (188 )
Contractual interest payments on fixed-rate, long-term debt and capital lease obligations, net of interest on related municipal bonds we own
    180       39       54       48       39  
Operating leases(b)
    161       37       50       32       42  
Purchase obligations
    1,536       323       239       226       748  
Other long-term liabilities(a)
    66       15       39       4       8  
    $ 2,661     $ 439     $ 715     $ 315     $ 1,192  
____________

(a)
Items included on our balance sheet.
   
(b)
The present value of future operating lease payments of $48 million is included on our balance sheet.

Our contractual obligations due in 2011 will likely be repaid from our operating cash flow or from our unused borrowing capacity.

In 2007, we received $2.38 billion in notes from the sale of timberland, which we contributed to two wholly-owned, bankruptcy-remote special purpose entities. The notes are secured by irrevocable letters of credit and are due in 2027. The special purpose entities pledged the notes and irrevocable letters of credit to secure $2.14 billion in nonrecourse loans payable in 2027. In the event of liquidation of the special purpose entities, these creditors would be entitled to satisfy their claims from the pledged notes and irrevocable letters of credit prior to distributions back to us. Please read Financial Assets and Nonrecourse Financial Liabilities of Special Purpose Entities.

In the 1990s, we entered into two sale-lease back transactions of production facilities with municipalities. We entered into these transactions to mitigate property and similar taxes associated with these facilities. The municipalities purchased these facilities from us for $188 million, our carrying value, and we leased the facilities back from the municipalities under capital lease agreements, which expire in 2022 and 2025. Concurrently, we purchased $188 million of interest-bearing bonds issued by these municipalities. The bond terms are identical to the lease terms, are secured by payments under the capital lease obligations, and the municipalities are obligated only to the extent the underlying lease payments are made by us. The interest rate implicit in the leases is the same as the interest rate on the bonds. As a result, the present value of the capital lease obligations is $188 million, the same as the principal amount of the bonds. Since there is no legal right of offset, the $188 million of bonds are included in other assets and the $188 million present value of the capital lease obligations are included in other long-term liabilities. There is no net effect from these transactions as we are in substance both the obligor on, and the holder of, the bonds.

Operating leases represent pre-tax obligations and include $109 million for the lease of particleboard and MDF facilities in Mt. Jewett, Pennsylvania, which expires in 2019. In 2007, we recorded an impairment charge for the portion of the long-term operating lease related to the particleboard facility. This charge did not affect
 
 
36

 
 
our continuing obligations under the lease, including paying rent and maintaining the equipment. The present value of the future payments is included on our balance sheet, of which $7 million is included in current liabilities and $41 million in other long-term liabilities at year-end 2010. The remainder of our operating lease obligations are for facilities and equipment.

Purchase obligations are market priced obligations principally for pulpwood, timber, and gypsum used in our manufacturing and converting processes and to a lesser extent for major committed capital expenditures. Purchase obligations include $1.1 billion related to pulpwood and sawtimber supply agreements. These purchase obligations are valued using minimum required purchase commitments at year-end 2010 market prices. Our actual purchases may exceed our minimum commitments and will be at the then current market prices. Through year-end 2010, our purchases under these contracts have exceeded the minimum requirements. As a result, we have no liability for unfulfilled commitments.

We have other long-term liabilities, principally liabilities for pension and postretirement benefits, unrecognized tax benefits, and deferred income taxes that are not included in the table because they do not have scheduled maturities. Please read Pension, Postretirement Medical and Health Care Matters.

At year-end 2010, our net deferred income tax liability was $592 million, including $281 million of alternative minimum tax credits related to the 2007 sale of our timberland and $30 million of cellulosic biofuel producer credits. We do not expect any significant changes in our deferred tax liability in 2011. Our cash tax rate is impacted by utilization of our cellulosic biofuel producer credits and our alternative minimum tax credits.

At year-end 2010 we do not have any significant outstanding derivative instruments.

Financial Assets and Nonrecourse Financial Liabilities of Special Purpose Entities

We sold our strategic timberland in October 2007 for $2.38 billion. The total consideration consisted almost entirely of notes due in 2027 issued by the buyer of the timberland. The notes are secured by $2.38 billion of irrevocable letters of credit issued by four banks, which are required to maintain a credit rating on their long-term unsecured debt of at least A+ by S&P and A1 by Moody’s. The letters of credit are secured by the buyer’s long-term deposits with the banks of $2.38 billion of cash and cash equivalents.

In December 2007, two wholly-owned, bankruptcy-remote subsidiaries formed by us borrowed $2.14 billion repayable in 2027 from a group of lenders affiliated with Citibank, N.A., and led by Citicorp North America, Inc., as agent, under substantially similar loan agreements. The loans are nonrecourse to us and are secured only by the $2.38 billion of notes and the letters of credit. The loan agreements provide that if a credit rating of any bank issuing letters of credit is downgraded below the required level, the letters of credit issued by that bank must be replaced within 30 days with letters of credit from another qualifying financial institution.

In 2009, two banks were replaced as issuers of letters of credit securing the notes we received in connection with the sale of timberland. In each case, the credit ratings of the letter of credit issuer had been reduced below the required minimums. As a result of these substitutions, we recognized $17 million of other non-operating expense in 2009, which consisted of $15 million in fees that we paid in connection with the issuance of the letters of credit, which were being amortized over the life of the letters of credit, and $2 million of other fees associated with terminating the transaction with the substituted bank.

Following these substitutions, the four banks issuing letters of credit in the transaction are now: Barclays Bank plc, Société Genéralé, and Rabobank Nederland, each of which has issued letters of credit totaling about $500 million, and The Royal Bank of Scotland plc, which has issued letters of credit totaling $865 million. Currently each of these banks meets the required minimum credit ratings. However, in light of current conditions in financial markets, there is no assurance that these credit ratings will be maintained.

In 2010, we entered into two separate three-year agreements, one with JP Morgan Chase Bank, National Association and one with Crédit Agricole Corporate and Investment Bank, whereby each of these banks agrees to issue up to $1.4 billion in irrevocable letters of credit in substitution for letters of credit issued by a bank
 
 
37

 
 
whose credit ratings get reduced below the required minimums. For each agreement, we paid an upfront fee, which is being amortized over the three-year term of the agreement, and also agreed to pay a quarterly fee on the unused commitment. The aggregate expense related to the amortization of the upfront fees and the quarterly fees for both agreements total about $5 million per year. This expense is recorded in net interest income (expense) on financial assets and nonrecourse financial liabilities of special purpose entities.

Off-Balance Sheet Arrangements

From time to time, we enter into off-balance sheet arrangements to facilitate our operating activities. At year-end 2010, our off-balance sheet unfunded arrangements, excluding contractual interest payments, operating leases, and purchase and other obligations included in the table of contractual obligations, consists of:

 
 
Expiring by Year
 
 
 
Total
   
2011
      2012-2013       2014-2015    
Thereafter
 
   
(In millions)
 
Joint venture guarantees
  $ 15     $ 15     $     $     $  
Performance bonds and recourse obligations
    64       64                    

We participate in one joint venture that produces medium density fiberboard in El Dorado, Arkansas. Our partner in this venture is a publicly-held company unrelated to us. At year-end 2010, this venture had $29 million in long-term debt. We guaranteed $15 million of the joint venture debt. Our joint venture partner also provided guarantees of the debt. Generally we would be called upon to fund the guarantees due to the lack of specific performance by the joint ventures, such as non-payment of debt.

Performance bonds and recourse obligations are comprised of $43 million of letters of credit to support workers compensation obligations, an $11 million letter of credit to support an operating lease obligation, and $10 million of letters of credits primarily to support environmental cleanup obligations.
 
Pension, Postretirement Medical and Health Care Matters

Our non-cash defined benefit net periodic pension expense was $59 million in 2010, $44 million in 2009, and $37 million in 2008. The increase in net periodic pension expense in 2010 and 2009 was primarily due to higher amortization of actuarial losses, driven by lower discount rates and the difference between expected and actual returns on plan assets. In addition, we recognized $4 million of expense in 2010 and $15 million of expense in 2008 related to payments of lump-sum benefits from our supplemental defined benefit plan. We expect our 2011 noncash defined benefit net periodic pension expense to be about $60 million.

Our asset allocation strategy matches the duration of about 80 percent of our pension assets to our pension liabilities and also matches the overall credit quality of our pension assets to the implied credit quality of the yield curve used to discount our liabilities. This matched approach reduces the volatility of our defined benefit expense and our funding requirements. The remaining plan assets are targeted to be invested in assets that provide market exposure to mitigate the effects of inflation, mortality and actuarial risks.

The funded status of our defined benefit plan was a liability of $313 million at year-end 2010 and $291 million at year-end 2009. The change was principally due to a decrease in the discount rate from 5.79 percent at year-end 2009 to 5.28 percent at year-end 2010, partially offset by a higher than expected return on plan assets and $30 million in voluntary, discretionary contributions we made in 2010. Unrecognized actuarial losses, which are included in accumulated other comprehensive income and principally represent the delayed recognition of changes in the discount rate and differences between expected and actual returns, were $344 million at year-end 2010 and $340 million at year-end 2009. These losses will be recognized over the average remaining service period of our current employees, which is about 9 years. We expect about $21 million of these losses to be recognized in 2011, compared with $21 million in 2010, $13 million in 2009, and $5 million in 2008.

Our expected long-term rate of return on plan assets is 6.00 percent for 2011 and 6.50 percent for 2010. The expected long-term rate of return on plan assets is an assumption we make reflecting the anticipated weighted average rate of earnings on the plan assets over the long-term. In selecting that rate particular
 
 
38

 
 
consideration is given to our asset allocation that reflects our matched position between the assets and liabilities of our qualified defined benefit plan. Our actual return on plan assets was 12.5 percent in 2010, 1.25 percent in 2009, and 0.4 percent in 2008.

The discount rate we used to determine the present value of the benefit obligations was 5.28 percent at year-end 2010, and 5.79 percent at year-end 2009. We determined these rates using the Citigroup Pension Discount Curve, which we believe reasonably reflects changes in the present value of our defined benefit plan obligation because each year’s cash flow is discretely discounted at a rate at which it could effectively be settled.

Due to credit balances we have accumulated from our voluntary, discretionary contributions in prior years, we anticipate having no funding requirement under ERISA in 2011. However, we anticipate making a $30 million voluntary, discretionary contribution to our pension plan in 2011.

Beginning in 2008, benefits earned under the supplemental defined benefit plan are paid upon retirement or when the employee terminates. Our lump-sum supplemental defined benefit plan payments to retirees totaled $10 million in 2010 and $6 million in 2009. In 2008, we made lump-sum payments of $42 million to existing retirees who elected to receive lump-sum payments of supplemental benefits earned.

The funded status of our postretirement medical plans projected benefit obligation was a liability of $121 million at year-end 2010 and $116 million at year-end 2009. We expect our 2011 payments to participants in our postretirement medical plans, net of retiree contributions and Medicare subsidies, to be about $10 million compared with $10 million in 2010, $11 million in 2009, and $15 million in 2008.

Please read Critical Accounting Estimates and Note 10 to the Consolidated Financial Statements.

We provide health care benefits to substantially all our eligible employees. Each employee can make an election for group coverage under various health, life, dependent care, accident and disability benefit options. For health benefits employees have an option to choose from either a preferred provider organization plan or a consumer driven health plan. About 21 percent of our employees participated in a consumer driven health plan in 2010 compared with 23 percent in 2009.
 
A summary of the cost of providing health benefits follows:

 
 
For the Year
 
 
 
2010
   
2009
   
2008
 
   
(In millions)
 
Cost incurred by us 
  $ 68     $ 71     $ 65  
Cost incurred by employees
    27       28       31  
    $ 95     $ 99     $ 96  

Energy and the Effects of Inflation

Our energy costs were $286 million in 2010, $273 million in 2009, and $361 million in 2008. The increase in energy costs for 2010 compared with 2009 is primarily attributable to higher market prices. The decrease in 2009 is primarily attributable to lower market prices and reduced usage as a result of lower operating rates at our building products facilities. The increase in 2008 is primarily attributable to higher market prices and our acquisition of PBL. We continue to reduce our dependency on natural gas by utilizing biomass fuels. Our energy costs fluctuate based on the market prices we pay. We hedge very little of our energy needs. It is likely that these costs will continue to fluctuate in 2011.

Inflationary increases in compensation and certain input costs such as fiber, energy and freight have had a negative impact on our operating results. However, we have managed to offset a portion of the impact of inflation through increased productivity. Our fixed assets are carried at historical costs. If carried at current replacement costs, depreciation expense would have been significantly higher than what we reported.
 
 
 
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Environmental Protection

Our operations are subject to federal, state, and local provisions regulating discharges into the environment and otherwise related to the protection of the environment. Compliance with these provisions requires us to invest substantial funds to modify facilities to assure compliance with applicable environmental regulations. Please read Business — Environmental Protection.

Litigation Matters

We are involved in various legal proceedings that arise from time to time in the ordinary course of doing business. We do not believe it is reasonably possible that the effect of these proceedings will be material to our financial position, results of operations, or cash flow. It is possible however, that charges related to these matters could be significant to results of operations or cash flows in any single accounting period. Please read Legal Proceedings.

 
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Calculation of Non-GAAP Financial Measures

 
 
 
 
Consolidated
   
Corrugated
Packaging
   
Building
Products
 
   
(In millions)
 
Year 2010
                 
Return:
                 
Segment operating income (loss) determined in accordance with U.S. GAAP
  $ 314     $ 333     $ (19 )
Items not included in segments:
                       
General and administrative expense
    (70 )     N/A       N/A  
Share-based and long-term incentive compensation
    (33 )     N/A       N/A  
    $ 211     $ 333     $ (19 )
Investment:
                       
Beginning of year total assets or segment assets determined in accordance with U.S. GAAP
  $ 5,709     $ 2,295     $ 545  
Adjustments:
                       
Current liabilities (excluding current portion of long-term debt)
    (471 )     (276 )     (44 )
Financial assets of special purpose entities
    (2,475 )     N/A       N/A  
Municipal bonds related to capital leases included in other assets
    (188 )     N/A       N/A  
    $ 2,575     $ 2,019     $ 501  
ROI
    8.2 %     16.5 %     (3.8 )%
                         
Year 2009
                       
Return:
                       
Segment operating income (loss) determined in accordance with U.S. GAAP
  $ 320     $ 347     $ (27 )
Items not included in segments:
                       
General and administrative expense
    (70 )     N/A       N/A  
Share-based and long-term incentive compensation
    (58 )     N/A       N/A  
    $ 192     $ 347     $ (27 )
Investment:
                       
Beginning of year total assets or segment assets determined in accordance with U.S. GAAP
  $ 5,869     $ 2,366     $ 580  
Adjustments:
                       
Current liabilities (excluding current portion of long-term debt)
    (445 )     (257 )     (45 )
Financial assets of special purpose entities
    (2,474 )     N/A       N/A  
Municipal bonds related to capital leases included in other assets
    (188 )     N/A       N/A  
    $ 2,762     $ 2,109     $ 535  
ROI
    7.0 %     16.5 %     (5.0 )%
                         
Year 2008
                       
Return:
                       
Segment operating income (loss) determined in accordance with U.S. GAAP
  $ 185     $ 225     $ (40 )
Items not included in segments:
                       
General and administrative expense
    (76 )     N/A       N/A  
Share-based compensation
    2       N/A       N/A  
    $ 111     $ 225     $ (40 )
Investment:
                       
Beginning of year total assets or segment assets determined in accordance with U.S. GAAP
  $ 5,942     $ 2,301     $ 623  
Adjustments:
                       
Current liabilities (excluding current portion of long-term debt)
    (887 )     (311 )     (63 )
Financial assets of special purpose entities
    (2,383 )     N/A