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Meadwestvaco 10-K 2007
Form 10-K
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


FORM 10-K

 


 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006

 

¨ 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 1-31215

 


MeadWestvaco Corporation

(Exact name of registrant as specified in its charter)

 


 

Delaware  

11013 West Broad Street

Glen Allen, VA 23060

Telephone 804-327-5200

(Address and telephone number of

registrant’s principal executive offices)

(State of incorporation)  

 

31-1797999

 
(I.R.S. Employer Identification No.)  

 


SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

 

Title of each class

 

Name of each exchange

on which registered

 
Common Stock- $0.01 par value   New York Stock Exchange
Preferred Stock Purchase Rights   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  x    No  ¨

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

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 a shorter period, the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

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.    x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  x    Accelerated filer  ¨    Non-accelerated filer  ¨

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

At June 30, 2006, the aggregate market value of common stock held by nonaffiliates was $5,038,719,945. Such determination shall not, however, be deemed to be an admission that any person is an “affiliate” as defined in Rule 405 under the Securities Act of 1933.

At January 31, 2007, the number of shares of common stock of the Registrant outstanding was 182,463,734.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s Proxy Statement for the Annual Meeting of Shareholders scheduled to be held on April 30, 2007, are incorporated by reference in Part III; definitive copies of said Proxy Statement will be filed with the Securities and Exchange Commission on or before March 26, 2007.

 



Table of Contents

TABLE OF CONTENTS

 

  PART I   
Item        Page

1.

  Business    1

1A.

  Risk factors    5

1B.

  Unresolved staff comments    7

2.

  Properties    8

3.

  Legal proceedings    10

4.

  Submission of matters to a vote of security holders    10
  PART II   

5.

  Market for registrant’s common equity, related stockholder matters and issuer purchases of equity securities    13

6.

  Selected financial data    15

7.

  Management’s discussion and analysis of financial condition and results of operations    17

7A.

  Quantitative and qualitative disclosures about market risk    45

8.

  Financial statements and supplementary data    46

9.

  Changes in and disagreements with accountants on accounting and financial disclosure    102

9A.

9B.

 

Controls and procedures

Other information

   102
103
  PART III   

10.

  Directors, executive officers and corporate governance    104

11.

  Executive compensation    104

12.

  Security ownership of certain beneficial owners and management and related stockholder matters    104

13.

  Certain relationships and related transactions, and director independence    104

14.

  Principal accounting fees and services    104
  PART IV   

15.

  Exhibits, financial statement schedules    105
  Signatures    112


Table of Contents

Part I

 

Item 1. Business

General

MeadWestvaco Corporation (“MeadWestvaco” or the “company”), a Delaware corporation, is a global company with leading positions in the packaging, consumer and office products, specialty chemicals and specialty papers markets. MeadWestvaco’s principal operating business segments are (i) Packaging Resources, (ii) Consumer Solutions, (iii) Consumer and Office Products, and (iv) Specialty Chemicals. In the fourth quarter of 2006, the company completed the change in its management and operating structure such that its previously reported Packaging segment was replaced by the Packaging Resources and Consumer Solutions segments. This structure reflects the company’s internal reporting to its chief decision makers and aligns the segment disclosure with management’s analysis of results of operations and the process utilized to allocate resources. The company has presented its reportable segments in 2005 and 2004 to conform to the new reporting structure adopted in 2006.

Packaging Resources

The Packaging Resources segment produces bleached paperboard, Coated Natural Kraft® paperboard (CNK), kraft paperboard, linerboard and saturating kraft, and packaging for consumer products including packaging for media, beverage and dairy, cosmetics, tobacco, pharmaceuticals and healthcare products. This segment’s paperboard products are manufactured at four domestic mills and two mills located in Brazil. Bleached paperboard is used for packaging high-value consumer products such as pharmaceuticals, cosmetics, tobacco, food service, media products and aseptic cartons. CNK paperboard is used for a range of packaging applications, the largest of which for MeadWestvaco is multi-pack beverage packaging. Kraft paperboard is used for folding carton applications. Linerboard is used in the manufacture of corrugated boxes and containers. Saturating kraft is used in the manufacture of decorative laminates for kitchen countertops, furniture, flooring, wall panels, as well as pad stock for electronic components.

Consumer Solutions

The Consumer Solutions segment offers a full range of converting and consumer packaging solutions including printed plastic packaging and injection-molded products used for packaging media products such as DVDs and CDs; cosmetics and pharmaceutical products; and plastic dispensing and spraying systems for personal care, healthcare, fragrance and lawn and garden markets. This segment designs and produces multi-pack cartons and packaging systems primarily for the beverage take-home market and packaging for the tobacco market. Paperboard and plastic are converted into packaging products at plants located in North America, Brazil, Asia and Europe. In addition, this segment manufactures equipment that is leased or sold to its beverage and dairy customers to package their products.

Consumer and Office Products

The Consumer and Office Products segment manufactures, sources, markets and distributes school and office products, time-management products and envelopes in North America and Brazil through both retail and commercial channels. MeadWestvaco produces many of the leading brand names in school supplies, time-management and commercial office products, including AMCAL®, AT-A-GLANCE®, Cambridge®, COLUMBIAN®, Day Runner®, Five Star®, Mead® and Trapper Keeper®.

 

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Specialty Chemicals

The Specialty Chemicals segment manufactures, markets and distributes specialty chemicals derived from sawdust and byproducts of the papermaking process. Products include, but are not limited to, activated carbon used in emission control systems for automobiles and trucks, printing ink resins, and emulsifiers used in asphalt paving and dyestuffs.

For a more detailed description of our primary segments, including financial information, see Note R of Notes to Financial Statements included in Part II, Item 8.

Specialty Papers

The specialty papers business produces highly engineered materials that provide solutions for more technically demanding needs. These products and applications include overlay materials and saturating papers for the decorative laminate industry, friction papers used in the automotive industry, base papers for pressure sensitive tapes, coated covers for demanding commercial printing jobs and a variety of special application papers designed to meet the customized needs of our customers.

Forestry

The principal raw material used in the manufacture of paper and paperboard is wood. The company’s strategy, based on the location of our mills and the composition of surrounding forestland ownership, is to provide a portion of our wood fiber from company-owned land and to rely on private woodland owners and private contractors and suppliers for the balance. As of December 31, 2006, we owned 135,000 acres of forestland in Brazil (more than 1,200 miles from the Amazon rainforests); and approximately 1,116,000 acres of forestland in the U.S., including 377,000 acres in the Appalachian region and 739,000 acres in the Southeast. An additional 102,000 acres are managed in the Southeast. We buy and sell land to maintain certain levels of fiber self-sufficiency.

We expect to continue to obtain our wood requirements from company-owned or controlled forestlands, from private woodland owners and private contractors or suppliers, including participants in our Cooperative Forest Management Program (CFM) which provides an additional source of wood fiber from acreage owned by participating landowners and managed with assistance from company foresters. We believe that these sources will be able to adequately supply our needs.

On January 31, 2007, the company announced that it plans to sell approximately 300,000 acres of its forestlands throughout West Virginia, Alabama and Georgia. The company expects to complete the sales during 2007. The land sales will include 82,000 acres in Alabama, 145,000 acres in Georgia, and 63,000 acres in West Virginia, and will continue to function as forestland under new ownership. The company will work with potential buyers to ensure that the land continues to be managed sustainably through the Sustainable Forestry Initiative (SFI). The company will retain strategic fiber supply agreements to support its mills in Alabama and Virginia.

Marketing and distribution

The principal markets for our products are in the United States, Canada, Latin America, Europe and Asia. We operate in over 30 countries and serve customers in approximately 100 nations. Our products are sold through a mixture of our own sales force and paperboard merchants and distributors. The company has sales offices in key cities throughout the world.

 

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Intellectual property

MeadWestvaco has a large number of foreign and domestic trademarks, trade names, patents, patent rights and licenses relating to its business. While, in the aggregate, intellectual property rights are material to our business, the loss of any one or any related group of such rights would not have a material adverse effect on our business, with the exception of the “Mead®” trademark and the “AT-A-GLANCE®” trademark for consumer and office products.

Competition

MeadWestvaco operates in very challenging domestic and international markets and competes with many large, well-established and highly competitive manufacturers and service providers. In addition, our business is affected by a range of macroeconomic conditions, including industry capacity changes, a trend in the packaging, paperboard and forest products industry toward consolidation, global competition, economic conditions in the U.S. and abroad and currency exchange rates.

We compete principally through quality, price, value-added products and services such as packaging solutions, customer service, innovation, technology and product design. Our proprietary trademarks and patents, in the aggregate, are also important to our competitive position in certain markets.

MeadWestvaco’s Packaging Resources segment competes globally with manufacturers of value-added bleached and unbleached paperboard for packaging and graphic applications, as well as specialty paperboards. The Consumer Solutions segment competes globally with numerous packaging service providers in the package design, development, and manufacturing arenas, as well as the manufacture of plastic dispensing and spraying systems. The Consumer and Office Products segment competes with national and regional converters, as well as foreign producers, especially from Asia. The Specialty Chemicals segment competes on a worldwide basis with producers of activated carbons, refined tall oil products, lignin-based chemicals and specialty resins.

Research

MeadWestvaco conducts research and development in the areas of packaging, chemicals, specialty paper and forestry. Innovative product development and manufacturing process improvement are the main objectives of these efforts. New and emerging technologies which may enable new product development and manufacturing cost reductions are evaluated and adapted for use. Increased timber and fiber production on a sustainable basis is the major thrust of the forestry research.

Environmental laws and regulations

MeadWestvaco’s operations are subject to extensive regulation by federal, state and local authorities, as well as regulatory authorities with jurisdiction over foreign operations of the company. Due to changes in environmental laws and regulations, the application of such regulations, and changes in environmental control technology, it is not possible for us to predict with certainty the amount of capital expenditures to be incurred for environmental purposes. Taking these uncertainties into account, we estimate that we will make approximately $19 million of environmental capital expenditures in 2007 and approximately $27 million in 2008. Approximately $34 million was spent on environmental capital projects in 2006.

We have been notified by the U.S. Environmental Protection Agency (the “EPA”) or by various state or local governments that the company may be liable under federal environmental laws or under applicable state or local laws with respect to the cleanup of hazardous substances at sites previously operated or used by MeadWestvaco. The company is currently named as a potentially responsible party (“PRP”), or has received third-party requests for contribution under the Comprehensive Environmental Response,

 

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Compensation and Liability Act (CERCLA) and similar state or local laws with respect to numerous sites. Some of these proceedings are described in more detail in Part I, Item 3. There are other sites which may contain contamination or which may be potential Superfund sites, but for which MeadWestvaco has not received any notice or claim. The potential liability for all of these sites will depend upon several factors, including the extent of contamination, the method of remediation, insurance coverage and contribution by other PRPs. We regularly evaluate our potential liability at these various sites. At December 31, 2006, MeadWestvaco had recorded liabilities of approximately $22 million for estimated potential cleanup costs based upon its close monitoring of ongoing activities and its past experience with these matters. The liabilities do not include the anticipated capital expenditures previously stated. Management believes that it is reasonably possible that costs associated with these sites may exceed amounts of recorded liabilities by an amount that could range from an insignificant amount to as much as $20 million. This estimate is less certain than the estimate upon which the recorded environmental liabilities were based. After consulting with legal counsel and after considering established liabilities, it is management’s judgment that the resolution of pending litigation and proceedings is not expected to have a material adverse effect on the company’s consolidated financial condition or liquidity. In any given period or periods, however, it is possible such proceedings or matters could have a material effect on the results of operations.

Additional matters involving environmental proceedings for MeadWestvaco are set forth in Part I, Item 3.

Employees

MeadWestvaco employs approximately 24,000 people worldwide, of whom approximately 14,000 are employed in the U.S. and approximately 10,000 are employed internationally. Approximately 8,000 employees are represented by various labor unions under collective bargaining agreements. Additionally, most of MeadWestvaco’s European facilities have separate house union agreements or series of agreements specific to the workforce at each facility. MeadWestvaco has not recently experienced any work stoppages and considers its relationship with employees, including those covered by collective bargaining agreements, to be good. The company engages in negotiations with labor unions for new collective bargaining agreements from time to time and at present the company is in negotiations for a new agreement at one location where an existing contract has expired covering approximately 1,100 bargaining unit employees. Furthermore, the company will begin negotiations for other locations covering approximately 1,200 bargaining unit employees in 2007. While it is the company’s objective to reach agreements without work stoppages, it cannot predict the outcome of these negotiations.

International operations

MeadWestvaco’s operations outside the U.S. are conducted through subsidiaries located in Canada, Latin America, Europe and Asia. While there are risks inherent in foreign investments, we do not believe at this time that such risks are material to our overall business prospects. MeadWestvaco’s sales that were attributable to domestic operations were 72%, 72% and 74% for the years ended December 31, 2006, 2005 and 2004, respectively. Export sales from MeadWestvaco’s U.S. operations were approximately 14%, 13% and 13% for the years ended December 31, 2006, 2005 and 2004, respectively. Sales that were attributable to foreign operations were 28%, 28% and 26% for the years ended December 31, 2006, 2005 and 2004, respectively. For more information about domestic and foreign operations, see Note R of Notes to Financial Statements included in Part II, Item 8.

Available information

Our Internet address is www.meadwestvaco.com. Please note that MeadWestvaco’s Internet address is included in this Annual Report on Form 10-K as an inactive textual reference only. The information contained on our website is not incorporated by reference into this Annual Report on Form 10-K and should not be considered part of this report. MeadWestvaco makes available on this website free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to

 

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those reports as soon as reasonably practicable after we electronically file or furnish such materials to the U.S. Securities and Exchange Commission (SEC). You may access these filings via the hyperlink to the SEC website provided on the Investor Information page of our website.

The MeadWestvaco Corporation’s Corporate Governance Principles and our charters (Nominating and Governance Committee, Audit Committee, Compensation and Organization Development Committee, Finance Committee, and Safety, Health and Environment Committee) are included on our website at the following address: http://www.meadwestvaco.com/corporate.nsf/investor. Our Code of Conduct can be found on our website at the following address: http://www.meadwestvaco.com/corporate.nsf/investor/conduct, and printed copies are available upon request.

 

Item 1A. Risk factors

Risks relating to our business

Certain of the company’s businesses are affected by cyclical market conditions which can significantly impact operating results and cash flows.

Certain of the company’s businesses are affected by cyclical market conditions that can significantly influence the demand for certain of the company’s products, as well as the pricing we can obtain for these products. The company’s paperboard business is particularly subject to cyclical market conditions. The company may be unable to sustain pricing in the face of weaker demand, and weaker demand may in turn cause us to take production downtime, particularly at our paperboard facilities. In addition to lost revenue from lower shipment volumes, production downtime causes unabsorbed fixed manufacturing costs due to lower production levels. As a result, the company’s results of operations and cash flows may be materially impacted in a period of prolonged and significant market weakness. Moreover, the company is not able to predict market conditions or its ability to sustain pricing and production levels during periods of weak demand with any degree of certainty. Market conditions will also impact the company’s ability to achieve its planned or announced price increases.

The company’s businesses are subject to significant cost pressures. Our ability to pass higher costs on to our customers through price increases or other adjustments is uncertain and dependent on market conditions.

The pricing environment for raw materials used in a number of our businesses continues to be challenging, as suppliers of certain raw materials have implemented price increases. Additionally, energy costs have risen significantly and remain volatile and unpredictable.

Further increases in the cost of raw materials or energy may materially impact our results of operations as depending on market forces and the terms of customer contracts, our ability to recover these costs through increased pricing may be limited.

Certain of the company’s consumer packaging converting businesses are affected by new technology which can significantly impact operating results and cash flows.

 

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Changes in technology for the distribution of consumer products, such as music and video entertainment, can have a dramatic impact on the demand for packaging products produced by the company’s packaging converting businesses.

The company faces intense competition in each of its businesses, and competitive challenges from lower cost manufacturers in overseas markets. If we can not successfully compete in an increasingly global market place, our operating results may be adversely affected.

The company operates in competitive domestic and international markets and competes with many large, well-established and highly competitive manufacturers and service providers, both domestically and on a global basis. The company’s businesses are facing competition from lower cost manufacturers in Asia and elsewhere. In addition, there is a risk that growth in paperboard capacity could outpace demand. All of these conditions can contribute to substantial pricing and demand pressures, adversely affecting the company’s operating results.

The company’s operations are increasingly global in nature, particularly in our consumer packaging businesses. Our business, financial condition and results of operations could be adversely affected by the political and economic conditions of the countries in which we conduct business, by fluctuations in exchange rates and other factors related to our international operations.

Approximately 42% of the company’s annual revenues in 2006 were derived from export sales and sales from locations outside of North America. As our international operations and activities expand, we face increasing exposure to the risks of operating in many foreign countries. These factors include:

 

   

Changes in foreign currency exchange rates which could adversely affect our competitive position, selling prices and manufacturing costs, and therefore the demand for our products in a particular market.

 

   

Trade protection measures in favor of local producers of competing products, including government subsidies, tax benefits, trade actions (such as anti-dumping proceedings) and other measures giving local producers a competitive advantage over the company.

 

   

Changes generally in political, regulatory or economic conditions in the countries in which we conduct business.

These risks could affect the cost of manufacturing and selling our products, our pricing, sales volume, and ultimately our financial performance. The likelihood of such occurrences and their potential effect on the company vary from country to country and are unpredictable.

The company has recently announced a plan to realign and restructure its consumer packaging converting businesses. Although the company is engaged in intensive planning as it implements these actions and believes that it will manage the reorganization effectively to achieve substantial savings for the company, these major changes have attendant inherent risks, including the potential for disruption in our packaging converting businesses and operations as we implement the realignment.

The company’s consumer packaging converting businesses are being transitioned into a focused consumer packaging converting group. The company’s leadership is engaged in intensive planning and expects to successfully and seamlessly manage these

 

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transitions. However, any major reorganization presents challenges and it is possible that there could be disruptions in our business and operations during the transition period. Disruptions in production, quality control, customer service and innovation, as well as in other aspects of our operations, such as internal controls, could negatively impact our results of operations.

The company has announced a Cost Reduction Initiative. If we fail to fully execute on this initiative, we may not fully realize all the improvements we have publicly announced.

In the second quarter of 2005, the company announced a cost reduction initiative with the goal of achieving $175 million to $200 million of cost reductions, pre-tax and before inflation, on an annual run rate basis by the end of 2007. The company now anticipates achieving cumulative run-rate savings of $175 million to $185 million by the end of 2007 with the balance expected in 2008; however, we will look for every opportunity to pull forward more savings into 2007. This initiative is described more fully in Part II, Item 7. Although we believe that these results are reasonable and achievable, if we do not fully achieve these goals within the expected time frame, or at all, we may not fully realize the improvements we expect in our operating earnings and cash flows.

The company is subject to extensive regulation under various environmental laws and regulations, and is involved in various legal proceedings related to the environment. Environmental regulation and legal proceedings have the potential for involving significant costs and liability for the company.

The company’s operations are subject to a wide range of general and industry-specific environmental laws and regulations. Changes in environmental laws and regulation, or their application, could subject the company to significant additional capital expenditures and operating expenses. However, any such changes are uncertain and, therefore, it is not possible for the company to predict with certainty the amount of additional capital expenditures or operating expenses that could be necessary for compliance with respect to any such changes.

The company is also subject to various environmental proceedings and may be subject to additional proceedings in the future. In the case of known potential liabilities, it is management’s judgment that the resolution of pending litigation and proceedings is not expected to have a material adverse effect on the company’s consolidated financial condition or liquidity. In any given period or periods, however, it is possible such proceedings or matters could have a material effect on the results of operations. The company could also be subject to new environmental proceedings which could cause the company to incur substantial additional costs with resulting impact on results of operations.

Additional information regarding environmental proceedings involving MeadWestvaco are set forth in Part I, Item 3.

Our business could be adversely affected by strikes or work stoppages and other labor issues.

Approximately one-third of our employees are represented by various labor unions under collective bargaining agreements. The company engages in negotiations with labor unions for new collective bargaining agreements from time to time. If we are unable to negotiate new agreements without work stoppages, it could negatively impact our ability to manufacture our products and adversely affect results of operations.

 

Item 1B. Unresolved staff comments

None.

 

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Item 2. Properties

MeadWestvaco is headquartered in Richmond, Virginia. MeadWestvaco believes that its facilities have sufficient capacity to meet current production requirements. For information concerning our forestlands, see Part I, Item 1. The locations of MeadWestvaco’s production facilities are as follows:

 

Packaging Resources     

Blumenau, Santa Catarina, Brazil

   North Charleston, South Carolina  

Cottonton, Alabama

   Pacajus, Ceara, Brazil  

Covington, Virginia

   Silsbee, Texas  

Evadale, Texas

   Summerville, South Carolina  

Fiera de Santana, Bahia, Brazil

   Tres Barras, Santa Catarina, Brazil  

Low Moor, Virginia

   Valinhos, São Paulo, Brazil  

Manuaus, Amazonas, Brazil

   Venlo, The Netherlands  

 

Consumer Solutions     

Agua Branca, São Paulo, Brazil

  

Littlehampton, United Kingdom (Leased)

 

Ajax, Ontario, Canada

  

London, United Kingdom (Leased)

 

Atlanta, Georgia

  

Louisa, Virginia (Leased)

 

Bilboa, Spain

  

Manaus, Amazonas, Brazil

 

Bristol, United Kingdom

  

Mebane, North Carolina

 

Bydgoszcz, Poland

  

Melrose Park, Illinois (Leased)

 

Caguas, Puerto Rico (Leased)

  

Moscow, Russian Federation (Leased)

 

Chateauroux, France

  

Pittsfield, Massachusetts (Leased)

 

Chicago, Illinois

  

Roosendaal, The Netherlands

 

Corby, United Kingdom

  

San Luis Potosi, Mexico

 

Deols, France

  

Shimada, Japan

 

Dublin, Ireland (Leased)

  

Slough, United Kingdom (Leased)

 

Elizabethtown, Kentucky

  

Smyrna, Georgia

 

Enschede, The Netherlands

  

Svitavy, Czech Republic

 

Freden, Germany

  

Swindon, United Kingdom (Leased)

 

Grandview, Missouri

  

Talgau, Austria (Leased)

 

Graz, Austria

  

Trier, Germany

 

Grover, North Carolina

  

Troyes, France

 

Hemer, Germany

  

Uden, The Netherlands (Leased)

 

Jacksonville, Illinois

  

Valinhos, São Paulo, Brazil

 

Krakow, Poland

  

Warrington, Pennsylvania (Leased)

 

Lanett, Alabama

  

Wuxi, People’s Republic of China

 
    
    

 

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Consumer & Office Products     

Alexandria, Pennsylvania

   Indianapolis, Indiana  

Atlanta, Georgia

   Kenosha, Wisconsin  

Bauru, São Paulo, Brazil

   Los Angeles, California  

Dallas, Texas

   Sidney, New York  

Enfield, Connecticut

   Toronto, Ontario, Canada  

Garden Grove, California

   Williamsburg, Pennsylvania  
Specialty Chemicals     

Albuquerque, New Mexico

   North Charleston, South Carolina  

Covington, Virginia

   Waynesboro, Georgia  

DeRidder, Louisiana

   Wickliffe, Kentucky  
Specialty Papers     

Potsdam, New York

   South Lee, Massachusetts  
Forestry Centers     

Rupert, West Virginia

   Tres Barras, Santa Catarina, Brazil  

Summerville, South Carolina

    
Research Facilities     

Raleigh, North Carolina (Leased)

   North Charleston, South Carolina  

Summerville, South Carolina

    

Leases

For financial data on certain MeadWestvaco leases, see Note H of Notes to Financial Statements included in Part II, Item 8.

Other information

A limited number of MeadWestvaco facilities are owned, in whole or in part, by municipal or other public authorities pursuant to standard industrial revenue bond financing arrangements and are accounted for as property owned by MeadWestvaco. MeadWestvaco holds options under which it may purchase each of these facilities from such authorities by paying a nominal purchase price and assuming the indebtedness of the industrial revenue bonds at the time of the purchase.

MeadWestvaco owns all of the facilities listed above, except certain warehouses and general offices, as noted, and pending purchases.

 

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Item 3. Legal proceedings

In 1998 and 1999, the EPA issued Notices of Violation to eight paper industry facilities, including Westvaco’s Luke, Maryland mill, alleging violation of the PSD regulations under the Clean Air Act. On August 28, 2000, an enforcement action in Federal District Court in Maryland was brought against Westvaco asserting violations in connection with capital projects at the mill carried out in the 1980s. The action alleges that Westvaco did not obtain PSD permits or install required pollution controls, and sought penalties of $27,500 per day for each claimed violation together with the installation of control equipment. MeadWestvaco strongly disagrees with the EPA’s allegations of Clean Air Act violations by Westvaco and is vigorously defending this action. On April 23, 2001, the Court granted Westvaco’s Motion for Partial Dismissal and dismissed the EPA’s claims for civil penalties under the major counts of the complaint. The Court held that these significant penalties were barred by the applicable statute of limitations. Following initial discovery, and in response to Motions for Partial Summary Judgment filed by Westvaco, the government abandoned several of its claims for injunctive relief. Motions for summary judgment on discrete issues were filed and a hearing was conducted in 2005. The motions remain pending. No trial date has been set, but a trial, if needed, is not expected to commence before late 2007. Based on information currently available, MeadWestvaco does not expect this proceeding will have a material adverse effect on our consolidated financial condition or liquidity. In any given period or periods, however, it is possible such proceeding could have a material effect on the results of operations.

In 2004, the company and other potentially responsible parties (PRPs) reached a settlement and signed a Consent Decree with the U.S. EPA concerning the Chattanooga Creek Superfund Site. Under the terms of the Consent Decree, the private PRPs, including MeadWestvaco, are implementing final remedial action at the Creek Superfund Site, which is expected to be completed in 2007. MeadWestvaco does not expect this proceeding will have a material adverse effect on our consolidated financial condition or liquidity. In any given period or periods, however, it is possible such proceeding could have a material effect on the results of operations.

MeadWestvaco has established liabilities of approximately $22 million relating to environmental proceedings. Additional information is included in Part I, Item 1, and Note O of Notes to Financial Statements included in Part II, Item 8.

MeadWestvaco is involved in various other litigation and administrative proceedings arising in the normal course of business. Although the ultimate outcome of such matters cannot be predicted with certainty, we do not believe that the currently expected outcome of any proceeding, lawsuit or claim that is pending or threatened, or all of them combined, will have a material adverse effect on its consolidated financial condition or liquidity. In any given period or periods, however, it is possible such proceedings or matters could have a material effect on the results of operations.

 

Item 4. Submission of matters to a vote of security holders

There were no matters submitted to a vote of security holders of MeadWestvaco, through the solicitation of proxies or otherwise, during the fourth quarter of 2006.

 

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Executive officers of the registrant

The following table sets forth certain information concerning the executive officers of MeadWestvaco:

 

Name

   Age*   

Present position

  

Year in which

service in present

position began

John A. Luke, Jr.**

   58    Chairman and Chief Executive Officer    2002

James A. Buzzard

   52    President    2003

E. Mark Rajkowski

   48    Senior Vice President and Chief Financial Officer    2004

Mark S. Cross

   50    Senior Vice President    2006

Linda V. Schreiner

   47    Senior Vice President    2002

Mark T. Watkins

   53    Senior Vice President    2002

Wendell L. Willkie, II

   55    Senior Vice President, General Counsel and Secretary    2002

Donna O. Cox

   43    Vice President    2005

Robert E. Birkenholz

   46    Treasurer    2004

John E. Banu

   59    Controller    2002

* As of March 1, 2007
** Director of MeadWestvaco

MeadWestvaco’s officers are elected by the Board of Directors annually for one-year terms.

John A. Luke, Jr., President and Chief Executive Officer 2002-2003, Chairman of the Board, Chief Executive Officer and President of Westvaco 1996-2002;

James A. Buzzard, Executive Vice President 2002-2003, Executive Vice President of Westvaco, 2000-2002, Senior Vice President, 1999, Vice President, 1992-1999;

E. Mark Rajkowski, Vice President, Eastman Kodak Company and General Manager Worldwide Operations for Kodak’s Digital and Film Imaging Systems Business 2003-2004; Chief Operating Officer of Eastman Kodak’s Consumer Digital Business 2003; Vice President, Finance of Eastman Kodak 2001-2002; Corporate Controller of Eastman Kodak 1998-2001;

Mark S. Cross, President of Europe, Middle East and Africa Region, JohnsonDiversey 2003-2006;

Linda V. Schreiner, Senior Vice President of Westvaco 2000-2002, Manager of Strategic Leadership Development 1999-2000, Senior Manager of Arthur D. Little, Inc. 1998-1999, Vice President of Signet Banking Corporation 1988-1998;

Mark T. Watkins, Vice President of Mead 2000-2002, Vice President, Human Resources and Organizational Development of the Mead Paper Division 1999, Vice President, Michigan Operations of Mead Paper Division 1997;

Wendell L. Willkie, II, Senior Vice President and General Counsel of Westvaco 1996-2002;

Donna O. Cox, Director, External Communications 2003-2005, Manager, Integration / Internal Communications 2002-2003, Public Affairs Manager of Westvaco’s Packaging Resources Group 1999-2002;

 

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Robert E. Birkenholz, Assistant Treasurer 2003-2004; Assistant Treasurer, Amerada Hess Corporation 1997-2002;

John E. Banu, Vice President of Westvaco 1999-2002, Controller 1995-1999.

There are no family relationships among executive officers or understandings between any executive officer and any other person pursuant to which the officer was selected as an officer.

 

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Part II

 

Item 5. Market for the registrant’s common equity, related stockholder matters and issuer purchases of equity securities

 

(a) Market and price range of common stock

MeadWestvaco’s common stock is traded on the New York Stock Exchange under the symbol MWV.

 

    

Year ended

December 31, 2006,

  

Year ended

December 31, 2005,

STOCK PRICES

   High    Low    High    Low

First quarter

   $ 28.70    $ 25.27    $ 34.33    $ 28.50

Second quarter

     30.85      26.21      32.13      27.80

Third quarter

     28.15      24.76      29.87      26.93

Fourth quarter

     30.50      26.35      28.77      25.06

This table reflects the range of market prices of MeadWestvaco common stock as quoted in the New York Stock Exchange Composite Transactions.

 

(b) Approximate number of common shareholders

At December 31, 2006, the number of shareholders of record of MeadWestvaco common stock was approximately 27,400. This number includes approximately 15,600 current or former employees of the company who were MeadWestvaco shareholders by virtue of their participation in our savings and investment plans.

 

(c) Dividends

The following table reflects historical dividend information for MeadWestvaco for the periods indicated.

 

DIVIDENDS PER SHARE

  

Year ended

December 31,
2006,

  

Year ended

December 31,
2005,

First quarter

   $ .23    $ .23

Second quarter

     .23      .23

Third quarter

     .23      .23

Fourth quarter

     .23      .23
             

Year

   $ .92    $ .92
             

MeadWestvaco currently expects that comparable cash dividends will continue to be paid in the future.

 

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(d) Common stock repurchases

In November of 2003, under Item 703 of Regulation S-K, the SEC adopted rules requiring disclosure of all repurchases of registered equity securities in the preceding fiscal quarter made by or on behalf of the issuer.

During the quarter ended December 31, 2006, the company had no common stock share repurchases except for stock option swaps as follows:

 

    

(a)

Total Number

of Shares

(or Units)

Purchased

  

(b)

Average

Price Paid

per Share

(or Unit)

  

(c)

Total Number of

Shares (or Units)

Purchased as Part

of Publicly

Announced Plans

or Programs

  

(d)

Maximum Number (or

Approximate Dollar

Value) of Shares (or

Units) that May Yet Be
Purchased Under the

Plans or Programs

October 1, 2006 – October 31, 2006

   —        —      —      4,707,422

November 1, 2006 – November 30, 2006

   1,416    $ 28.52    —      4,707,422

December 1, 2006 – December 31, 2006

   95,792      29.90    —      4,707,422

In October 2005, the company’s Board of Directors authorized the future repurchase of up to 5 million shares, primarily to avoid dilution of earnings per share relating to the exercise of employee stock options. The number of shares outstanding under this program at December 31, 2006, was 4,707,422.

 

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Item 6. Selected financial data

In millions, except per share data

 

     Years ended December 31,  
   2006     2005     2004     2003     2002  

EARNINGS

          

Net sales

   $ 6,530     $ 6,170     $ 6,060     $ 5,566     $ 5,289  

Income from continuing operations

     93       119       224       84       89  

Discontinued operations

     —         (91 )     (573 )     (62 )     (128 )

Cumulative effect of accounting change

     —         —         —         (4 )     (359 )

Net income (loss)

     93 1     28 2     (349 )3     18 4     (398 )5

Income from continuing operations

          

Per share—basic

     0.52       0.62       1.11       0.42       0.46  

Per share—diluted

     0.52       0.62       1.10       0.42       0.46  

Net income (loss) per share—basic

     0.52       0.14       (1.73 )     0.09       (2.07 )

Net income (loss) per share—diluted

     0.52       0.14       (1.72 )     0.09       (2.07 )

Depreciation, depletion and amortization

     517       491       489       479       451  

COMMON STOCK

          

Number of common shareholders

     27,410       29,630       34,730       36,740       37,200  

Weighted average number of shares outstanding:

          

Basic

     181       192       202       200       192  

Diluted

     181       193       204       202       192  

Cash dividends

   $ 167     $ 178     $ 186     $ 184     $ 206  

Per share:

          

Dividends declared

     0.92       0.92       0.92       0.92       0.92  

Book value

     19.40       19.20       21.17       23.46       23.76  

FINANCIAL POSITION

          

Working capital

   $ 550     $ 988     $ 882     $ 910     $ 794  

Current ratio

     1.4       1.9       1.5       1.6       1.5  

Property, plant, equipment and forestlands, net

   $ 4,523     $ 4,487     $ 4,688     $ 7,378     $ 7,834  

Total assets

     9,285       8,908       11,646       12,470       12,904  

Long-term debt, excluding current maturities

     2,372       2,417       3,282       3,969       4,233  

Shareholders’ equity

     3,533       3,483       4,317       4,713       4,753  

Debt to total capital

     42 %     41 %     46 %     47 %     49 %

OPERATIONS6

          

Primary production of paper, paperboard and market pulp (tons, in thousands)

     3,950       3,945       6,702       6,318       6,034  

New investment in property, plant, equipment and forestlands

   $ 302     $ 305     $ 317     $ 393     $ 424  

Acres of forestlands owned (in thousands)

     1,251       1,251       2,179       2,347       3,182  

Employees

     24,000       22,200       29,400       29,500       30,700  

 

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1

2006 results include after-tax restructuring charges of $85 million, or $.47 per share, after-tax one-time costs of $26 million, or $.14 per share, a gain on the sale of a PIK note of $13 million, or $.07 per share, and an after-tax gain of $11 million, or $.06 per share, from the sale of corporate real estate.

2

2005 results include an after-tax loss from discontinued operations associated with the sale of the printing and writing papers business of $91 million, or $.48 per share, after-tax charges of $56 million, or $.29 per share related to the retirement of debt, and after-tax charges of $20 million, or $.10 per share, for restructuring activities.

3

2004 results include an after-tax loss from discontinued operations associated with the sale of the printing and writing papers business of $573 million, or $2.82 per share, and after-tax charges of $67 million, or $.33 per share, for restructuring activities.

4

2003 results include an after-tax loss from discontinued operations associated with the sale of the printing and writing papers business of $62 million, or $.31 per share, an after-tax charge of $4 million, or $.02 per share, for the cumulative effect of the initial adoption of SFAS No. 143, after-tax charges of $42 million, or $.21 per share, for restructuring activities, after-tax charges of $17 million, or $.08 per share related to the early retirement of debt and after-tax gains of $8 million, or $.04 per share, on the recovery of insurance settlements.

5

2002 results include an after-tax loss from discontinued operations of $128 million, or $.66 per share, a charge for the impairment of goodwill (due to the initial adoption of SFAS 142) of $359 million, or $1.87 per share, net after-tax restructuring and merger-related expenses of $95 million or $.49 per share and after-tax costs related to the early retirement of debt of $4 million, or $.02 per share.

6

Certain data for 2004 and all data for 2003 and 2002 have not been revised to exclude discontinued operations.

 

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Item 7. Management’s discussion and analysis of financial condition and results of operations

Management’s discussion and analysis of financial condition and results of operations (MD&A) discusses the results of operations and general financial condition of MeadWestvaco. MD&A should be read in conjunction with the consolidated financial statements included in Part II, Item 8.

OVERVIEW

For the year ended December 31, 2006, MeadWestvaco Corporation (“MeadWestvaco” or the “company”) reported net income of $93 million, or $0.52 per share. Net income for the year included after-tax restructuring charges of $85 million, or $0.47 per share, related primarily to employee separation costs, facility closures and the permanent shutdown of two previously idled paperboard machines, and after-tax one-time costs of $26 million, or $0.14 per share, related to the company’s cost reduction initiative. Also included in net income for 2006 was an after-tax gain of $13 million, or $0.07 per share, on the sale of a note (PIK note) received as part of the consideration for the sale of the printing and writing papers business in 2005, and an after-tax gain of $11 million, or $0.06 per share, on the sale of corporate real estate. Comparable amounts for prior periods are noted later in this discussion. The amounts related to the items noted above are reflected in corporate and other for segment reporting purposes.

During 2006, the company generated strong revenue growth from higher selling prices and an improved product mix in many of its businesses. In addition, the results for 2006 were favorably impacted from the acquisition of Calmar. These improvements were partially offset by significant inflation in energy and raw material prices. In 2006, the pre-tax cost for the principal inputs of energy, raw materials and freight was approximately $159 million higher than in 2005, offsetting improvements in price and mix of $142 million. Cash flow provided by operating activities from continuing operations grew to $567 million in 2006, compared to $305 million in 2005, reflecting higher earnings and improvements in working capital.

MeadWestvaco’s principal business segments are (i) Packaging Resources, (ii) Consumer Solutions, (iii) Consumer and Office Products, and (iv) Specialty Chemicals. In the fourth quarter of 2006, the company completed the change in its management and operating structure such that its previously reported Packaging segment was replaced by the Packaging Resources and Consumer Solutions segments. This segment structure reflects the company’s internal reporting to its chief decision makers and aligns the segment disclosure with management’s analysis of results of operations and the process utilized to allocate resources. The company has presented its reportable segments for 2005 and 2004 to reflect the new reporting structure adopted in 2006. Also in 2005, the company exited its printing and writing papers business, which is recorded as discontinued operations in the consolidated financial statements.

In the Packaging Resources segment, sales in 2006 increased 4% compared to 2005 and segment operating profit increased 18% during the same period. The Packaging Resources segment sales increased primarily as a result of higher selling prices and an improved product mix. Volume in 2006 increased slightly as compared to 2005. Segment operating profit increased in 2006 compared to 2005 as higher selling prices and improved product mix and productivity more than offset higher costs for raw materials, energy and freight.

 

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In the Consumer Solutions segment, sales in 2006 increased 7% compared to 2005, but segment operating profit decreased 9% during the same period. The 2006 results include the impact of Calmar, which was acquired in July 2006. Excluding Calmar, segment sales in 2006 decreased 3% compared to 2005. Increased sales in beverage and the positive impact of Calmar offset weaker demand for media packaging. Segment operating profit decreased in 2006 versus 2005 as the positive results from Calmar and the operating profit increases in beverage, personal care and tobacco were more than offset by declines in the media business, and higher energy, freight and other input costs.

In the Consumer and Office Products segment, sales in 2006 increased 2% compared to 2005, but segment profits decreased 2% during the same period. Sales in 2006 were positively impacted by improvements in price and mix, partially offset by lower volume due in part to supply chain activities at large office products customers. Segment operating profit decreased slightly in 2006 versus 2005 as improved mix and better performance in the Brazilian school and office products business were offset by higher manufacturing and paper input costs.

In the Specialty Chemicals segment, sales in 2006 increased 16% compared to 2005 and operating profit increased by 31% during the same period. Increased sales in 2006 were due to higher selling prices and improved volume in the pine chemical businesses. Sales in the carbon-based businesses were flat as U.S. auto manufacturing declined slightly. Segment operating profit increased in 2006 versus 2005 as the positive effects of higher selling prices and lower selling, general and administrative expenses were partially offset by higher input costs for raw materials, principally crude tall oil, which increased significantly from the prior year.

In 2005, the company launched a cost reduction initiative to improve the efficiency of our business model. As part of the initiative, we are focusing on reducing the cost structure across the company by redesigning general and administrative services with a plan to move to a more simplified, standardized, global model. We are also reducing our real estate footprint and streamlining our warehousing and logistics network. The goal of this initiative is to reduce the overall cost structure of the company by $175 million to $200 million, before inflation, on an annual run-rate basis by the end of 2007. Through 2006, specific actions were completed that resulted in annual run-rate savings of about $125 million, before inflation. The company anticipates achieving run-rate savings of $175 million to $185 million by the end of 2007 with the remaining balance of the $200 million run-rate savings expected to be achieved in 2008; however, the company will look for every opportunity to pull forward more savings into 2007. In February 2006, the company announced plans designed to accelerate progress toward a new packaging platform, create a new center for packaging innovation, and consolidate corporate activities to a new corporate headquarters located in Richmond, Virginia. Through year end, the company made substantial progress in these initiatives by realigning its packaging business into two focused groups, establishing the new innovation center in Raleigh, North Carolina, and completing the corporate consolidation plan.

 

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RESULTS OF OPERATIONS

The following table summarizes our results for the years ended December 31, 2006, 2005 and 2004, as reported in accordance with accounting principles generally accepted in the United States (GAAP). All references to per share amounts are presented on an after-tax basis.

 

In millions, except per share data    Years ended December 31,  
     2006     2005     2004  

Net sales

   $ 6,530     $ 6,170     $ 6,060  

Cost of sales

     5,399       5,087       4,925  

Selling, general and administrative expenses

     905       756       800  

Interest expense

     211       208       209  

Other income, net

     (83 )     (16 )     (197 )
                        

Income from continuing operations before income taxes

     98       135       323  

Income tax provision

     5       16       99  
                        

Income from continuing operations

     93       119       224  

Discontinued operations

     —         (91 )     (573 )
                        

Net income (loss)

   $ 93     $ 28     $ (349 )
                        

Income (loss) per share - basic:

      

Income from continuing operations

   $ 0.52     $ 0.62     $ 1.11  

Discontinued operations

     —         (0.48 )     (2.84 )
                        

Net income (loss)

   $ 0.52     $ 0.14     $ (1.73 )
                        

Income (loss) per share - diluted:

      

Income from continuing operations

   $ 0.52     $ 0.62     $ 1.10  

Discontinued operations

     —         (0.48 )     (2.82 )
                        

Net income (loss)

   $ 0.52     $ 0.14     $ (1.72 )
                        

Sales for the year ended December 31, 2006, were $6.5 billion compared to $6.2 billion for the year ended December 31, 2005, and $6.1 billion for the year ended December 31, 2004. Increased sales in 2006, compared to 2005, were the result of higher selling prices and improved product mix in many of our businesses, partially offset by weaker demand for certain products compared to 2005. The current-year sales include $206 million from the addition of Calmar, which was acquired in July 2006. Refer to the individual segment discussion that follows for detailed sales information for each segment.

Cost of sales for the year ended December 31, 2006, was $5.4 billion, compared to $5.1 billion and $4.9 billion for the years ended December 31, 2005 and 2004, respectively. Our gross margin in 2006 was approximately the same as 2005 and was down about one percentage point from 2004. The decline in gross margin from 2004 was primarily related to increased input costs in 2006 and 2005 for raw materials, energy, and freight and higher market-related downtime in 2005. During 2006, the pre-tax input cost of energy, raw materials and freight was approximately $159 million higher than in 2005. Restructuring charges included in cost of sales were $53 million, $18 million and $89 million for the years ended December 31, 2006, 2005 and 2004, respectively.

 

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Maintenance costs and the effects of market-related downtime are reflected in cost of sales. Total maintenance costs in 2006 were $234 million, compared to $244 million in 2005 and $242 million in 2004. In 2006, the company took no significant market-related downtime, while in 2005 and 2004 the company took 109,000 tons and 17,000 tons of market-related downtime which had a negative impact on results of $31 million and $3 million, respectively. In 2005 and 2004, the mix of market-related downtime varied by business, but primarily occurred in the Packaging Resources segment. The effects of market-related downtime consist of the unabsorbed fixed manufacturing costs due to lower production, but do not include lost profits due to lower shipment levels.

Selling, general and administrative expenses were $905 million, $756 million and $800 million for the years ended December 31, 2006, 2005 and 2004, respectively. Selling, general and administrative expenses as a percentage of sales were 13.9%, 12.3% and 13.2% for the years ended December 31, 2006, 2005 and 2004, respectively. Higher expense in 2006 was due primarily to increased restructuring charges and one-time costs, the addition of Calmar in July 2006 and higher share-based compensation. Restructuring charges included in selling, general and administrative expenses were $60 million in 2006 and $11 million in both 2005 and 2004. Incremental costs in selling, general and administrative expenses in 2006 compared to the prior year included certain one-time costs, the addition of Calmar and share-based compensation in the amounts of $42 million, $26 million and $15 million, respectively. Additionally, beginning in 2005, about $30 million of certain costs classified as cost of sales, were, in prior years, included in selling, general and administrative expenses for the consumer packaging business, as the company integrated the business and shifted certain functions to production.

Pension income for continuing operations, before settlements, curtailments and termination benefits was $50 million in 2006 compared to $67 million in 2005 and $86 million in 2004. Pension income is reflected in cost of sales and selling, general and administrative expenses, and is reported in corporate and other for segment reporting purposes.

Interest expense from continuing operations of $211 million in 2006 was similar to 2005 and 2004 interest expense of $208 million and $209 million, respectively. The increase in interest expense in 2006 as compared to the prior years was the result of the incremental short-term borrowings obtained in connection with the Calmar acquisition. For the years ended December 31, 2005 and 2004, interest expense associated with the company’s papers business, which was sold in the second quarter of 2005, was included in discontinued operations in the consolidated statements of operations in the amount of $20 million and $69 million, respectively.

Other income, net, was $83 million in 2006, compared to $16 million and $197 million for 2005 and 2004, respectively. Gains on the sale of forestland were $29 million, $60 million and $176 million for 2006, 2005 and 2004, respectively. In 2006, the company recorded gains on the sale of corporate real estate of $18 million and gain on the sale of a PIK note of $21 million, as well as a loss of $20 million on asset impairments. The results for 2006 and 2005 include transition services income of $5 million and $25 million, respectively, related to the services provided to NewPage. The results for 2005 include a loss on extinguishment of debt of $90 million related to the company reducing debt by approximately $1 billion. The Company’s proportionate share of the net income or (losses) of its equity-method investments, before other than temporary impairments, was $(6) million, $(4) million and $2 million for 2006, 2005 and 2004, respectively. Other items, including interest income and foreign currency exchange gains and losses, netted to income of $36 million, $25 million and $19 million in 2006, 2005 and 2004, respectively.

 

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For the years ended December 31, 2006, 2005 and 2004, the company’s annual effective tax rate was approximately 5%, 12% and 31%, respectively. The decline in the rate for 2006 compared to 2005 was primarily due to a shift in the level and mix of domestic versus foreign earnings. The decline in the rate for 2005 compared to 2004 was due to a lower proportion of domestic earnings in 2005, a change in the allocation of state taxes as a result of the sale of the printing and writing papers business, and tax credits.

Comparison of Years ended December 31, 2006 and 2005

In addition to the information discussed above, the following sections discuss the results of operations for each of our business segments and corporate and other.

Packaging Resources

 

In millions    Years ended December 31,
     2006    2005

Sales

   $ 2,953    $ 2,836

Segment profit1

     275      234

1

Segment profit is measured as results before restructuring charges and one-time costs, pension income, interest income and expense, income taxes, minority interest, discontinued operations, extraordinary items and cumulative effect of accounting changes.

The Packaging Resources segment produces bleached paperboard, Coated Natural Kraft® paperboard (CNK), kraft paperboard, linerboard and saturating kraft, and packaging for consumer products markets including packaging for media, beverage and dairy, cosmetics, tobacco, pharmaceuticals and health care products. This segment’s products are manufactured at four domestic mills and two mills located in Brazil. Bleached paperboard is used for packaging high-value consumer products such as pharmaceuticals, cosmetics, tobacco, food service, media products and aseptic cartons. CNK paperboard is used for a range of packaging applications, the largest of which for MeadWestvaco is multi-pack beverage packaging. Kraft paperboard is used for folding carton applications. Linerboard is used in the manufacture of corrugated boxes and containers. Saturating kraft is used in the manufacture of decorative laminates for kitchen countertops, furniture, flooring, wall panels, as well as pad stock for electronic components.

Sales in the Packaging Resources segment increased to $3.0 billion in 2006, compared to $2.8 billion in 2005. The sales increase of 4% for 2006 over 2005 was a result of higher selling prices realized and strengthening demand for many products. Product mix improvement also favorably impacted sales in 2006. Shipments of bleached paperboard in 2006 were 1,646,000 tons, down 2% from the prior year, reflecting the permanent shutdown of two machines in 2006. Shipments of CNK in 2006 were 1,082,000 tons, up 4% from 2005. Shipments of unbleached paperboard in 2006 were 838,000 tons, down 2% from the

 

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prior year, reflecting the intentional shift away from less profitable products. Compared to 2005, bleached paperboard prices in 2006 were up 3%, CNK open market prices were up 3% and unbleached paperboard prices were up 9%. Sales of the company’s Brazilian packaging operation, Rigesa Ltda., increased 8% in 2006 over 2005 driven by improved mix and improved volume, partially offset by lower prices.

Segment profit for 2006 increased to $275 million compared to $234 million in 2005. The 18% improvement reflects improvements in pricing, volume and mix and productivity, partially offset by higher prices for raw materials and energy. Earnings in 2006 benefited by $54 million from price increases and mix improvements, $5 million from volume improvement and $70 million from favorable cost productivity. Earnings for 2006 were negatively affected by $77 million from higher input costs for energy, wood and freight and from $11 million in other operating cost increases compared to the prior year. The prior year results reflect the impact of higher market-related downtime and the impact of two hurricanes.

Consumer Solutions

 

In millions    Years ended December 31,
     2006    2005

Sales

   $ 2,170    $ 2,021

Segment profit1

     93      102

1

Segment profit is measured as results before restructuring charges and one-time costs, pension income, interest income and expense, income taxes, minority interest, discontinued operations, extraordinary items and cumulative effect of accounting changes.

The Consumer Solutions segment offers a full range of converting and consumer packaging solutions including printed plastic packaging and injection-molded products used for packaging media products such as DVDs and CDs; cosmetics and pharmaceutical products; and plastic dispensing and spraying systems for personal care, healthcare, fragrance and lawn and garden markets. This segment designs and produces multi-pack cartons and packaging systems primarily for the beverage take-home market and packaging for the tobacco market. Paperboard and plastic are converted into packaging products at plants located in North America, Brazil, Asia and Europe. In addition, this segment manufactures equipment that is leased or sold to its beverage and dairy customers to package their products.

Sales in the Consumer Solutions segment increased 7% to $2.2 billion in 2006, compared to $2.0 billion in 2005. Sales for 2006 include the results of Calmar, acquired in the third quarter of 2006. Excluding the impact of Calmar, sales in 2006 declined 3% as compared to 2005. Sales improved slightly for our beverage business, but declined for other specialty packaging lines. Sales were particularly weak for media as demand for music packaging declined, game volumes decreased due to delayed next-generation console releases and the absence of DVD packaging business for the year’s “blockbuster” filmed entertainment titles.

 

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Segment operating profit for 2006 decreased 9% to $93 million, compared to $102 million in 2005. Earnings benefits from the acquisition of Calmar, improved results in our beverage, personal care and tobacco businesses and certain cost improvements were offset by $6 million in higher input costs for energy and freight, $7 million in volume decreases, $5 million in unfavorable price and mix and $19 million in higher other material and operating costs compared to the prior year.

Consumer and Office Products

 

In millions    Years ended December 31,
     2006    2005

Sales

   $ 1,143    $ 1,125

Segment profit1

     127      130

1

Segment profit is measured as results before restructuring charges and one-time costs, pension income, interest income and expense, income taxes, minority interest, discontinued operations, extraordinary items and cumulative effect of accounting changes.

The Consumer and Office Products segment manufactures, sources, markets and distributes school and office products, time-management products and envelopes to retailers and commercial distributors. This segment’s operations are conducted predominantly in North America and Brazil.

Sales for this segment increased slightly to $1.14 billion in 2006, compared to $1.13 billion for 2005. The 2% sales growth from 2005 reflects solid performance in the segment’s value-added branded consumer product lines, improved overall mix and a solid performance in the Brazilian school products business partially offset by customers shortening their supply chain, which caused sales delays in certain products into the first quarter of 2007.

Year-over-year operating profit was down $3 million in 2006 compared to the prior year. Results in 2006 were positively impacted by $45 million from price increases and mix improvements, offset by the negative impact of higher input and operating costs of $35 million and volume decreases of $13 million. This segment’s operating profit continues to be impacted by low-priced Asian imports.

Specialty Chemicals

 

In millions    Years ended December 31,
     2006    2005

Sales

   $ 493    $ 425

Segment profit1

     51      39

1

Segment profit is measured as results before restructuring charges and one-time costs, pension income, interest income and expense, income taxes, minority interest, discontinued operations, extraordinary items and cumulative effect of accounting changes.

The Specialty Chemicals segment manufactures, markets and distributes specialty chemicals derived from sawdust and byproducts of the papermaking process. Products include, but are not limited to, activated carbon used in emission control systems for automobiles and trucks, printing ink resins, and emulsifiers used in asphalt paving and dyestuffs.

 

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Sales increased in 2006 to a record $493 million from $425 million in 2005 due to higher selling prices and strong demand for the segment’s industrial pine chemicals used in asphalt paving, dyes and proprietary publication ink resins and other industrial markets. Year-over-year volumes for carbon-based products were essentially flat due to lower automobile production volumes in North America. Increased segment operating profit reflects the positive effects of pricing and volume of $50 million and reduced selling, general and administrative expenses of $4 million, partially offset by higher prices of $42 million for raw materials, principally crude tall oil, freight and energy.

Corporate and other

 

In millions    Years ended December 31,  
     2006     2005  

Sales

   $ 219     $ 213  

Corporate and other loss 1

     (448 )     (370 )

1

Corporate and other loss may include goodwill impairment charges, minority interest, debt retirement charges, restructuring charges and one-time costs, net pension income, interest income and expense, and gains on asset sales.

Corporate and other includes the company’s specialty paper business, forestry operations and corporate support staff services, and related assets and liabilities. The results also include income and expense items not directly associated with segment operations, such as certain legal charges and settlements, restructuring and one-time charges, pension income, interest income and expense, and other charges.

The loss for corporate and other was $448 million in 2006, compared to a loss of $370 million in 2005. The higher loss in 2006 compared to 2005 was the result of higher restructuring charges of $104 million, lower gains on forestland sales of $31 million, lower transition service income from NewPage of $20 million, lower pension income of $17 million, one-time costs in 2006 of $42 million, offset by debt retirement charges of $90 million in 2005, the gain from the sale of the PIK note of $21 million in 2006, gains on the sale of corporate real estate of $18 million in 2006 and lower other costs of $7 million in 2006 compared to 2005.

Comparison of Years ended December 31, 2005 and 2004

The information in the discussion below has been restated on a continuing operations basis and to reflect the new segment reporting structure adopted in 2006.

Discontinued Operations

In connection with the sale of the company’s printing and writing papers business that occurred in 2005, the company recorded an after-tax loss from discontinued operations for the years ended December 31, 2005 and 2004 of $91 million and $573 million, respectively. Results in 2005 and 2004 were negatively impacted by sale-related costs, including lease termination charges, asset

 

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impairments, debt extinguishment costs, pension settlement and curtailment losses, and other related costs included in discontinued operations.

Packaging Resources

 

In millions    Years ended December 31,
     2005    2004

Sales

   $ 2,836    $ 2,754

Segment profit1

     234      270

1

Segment profit is measured as results before restructuring charges and one-time costs, pension income, interest income and expense, income taxes, minority interest, discontinued operations, extraordinary items and cumulative effect of accounting changes.

Sales in 2005 for the Packaging Resources segment increased 3% compared to 2004, while segment earnings decreased 13%. Revenue in the mill-based business, compared to the prior year, was impacted by a decline in shipments of bleached paperboard as a result of the impact of two hurricanes. Bleached paperboard shipments of 1.7 million tons were down 7% from 2004, while the business realized a year-over-year net price improvement of about 5% across the bleached paperboard grades. Shipments of CNK paperboard of over one million tons were similar to shipments in 2004, with open market pricing increases of 3% over the prior year. Linerboard shipments increased 17% from 2004, with pricing similar to the prior year. The company’s Brazilian packaging operation, Rigesa Ltda., had an increase in sales in 2005 over 2004 driven by higher prices and a stronger Brazilian currency. The decline in segment earnings in 2005 reflects significantly higher input costs for raw materials and energy, higher market-related downtime and the impact of two hurricanes.

Consumer Solutions

 

In millions    Years ended December 31,
     2005    2004

Sales

   $ 2,021    $ 2,030

Segment profit1

     102      161

1

Segment profit is measured as results before restructuring charges and one-time costs, pension income, interest income and expense, income taxes, minority interest, discontinued operations, extraordinary items and cumulative effect of accounting changes.

Sales in 2005 for the Consumer Solutions segment were slightly less than in 2004, and segment earnings decreased 37%. This segment reported lower sales growth of print and plastic packaging for the media and entertainment industries, but increased demand for cosmetics and tobacco packaging in Europe. In the beverage packaging business, sales in 2005 were down compared to 2004 due to weaker soft drink demand in Northern America and weaker demand in beer markets worldwide. A weaker euro had a negative impact on sales for the European operations. The positive impact of improved volume and mix in tobacco and cosmetics packaging in Europe was offset by weaker volume in media and entertainment packaging as a result of a lack of blockbuster titles in 2005, weakness and some share loss in games, DVD and music markets, and increased resin costs that could not be passed on to customers. Operating profit in 2005 was positively impacted by growth in nonbeverage dairy packaging from our European acquisition in 2004.

 

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Consumer and Office Products

 

In millions    Years ended December 31,
     2005    2004

Sales

   $ 1,125    $ 1,090

Segment profit1

     130      137

1

Segment profit is measured as results before restructuring charges and one-time costs, pension income, interest income and expense, income taxes, minority interest, discontinued operations, extraordinary items and cumulative effect of accounting changes.

Sales in 2005 for the Consumer and Office Products segment were up 3%, driven by 2004 acquisitions and improved demand for time-management products, offset in part by global competitive pressures from lower priced Asian-based imports, especially related to commodity-based paper products. Sales and operating profit in 2005 benefited from the addition of the Brazilian school and office products business acquired in 2004, additional contribution from the segment’s Canadian business and cost savings from facility consolidations made in 2004. Segment profit was negatively impacted by Asian import price pressures and higher raw material input costs, primarily uncoated paper, which could not be fully passed on to customers in 2005. Year-over-year profit results were positively impacted by $25 million from price increases and mix improvements, and $2 million from other cost reductions; offset by the negative impact of higher input costs of $26 million and volume decreases of $8 million.

Specialty Chemicals

 

In millions    Years ended December 31,
     2005    2004

Sales

   $ 425    $ 410

Segment profit1

     39      57

1

Segment profit is measured as results before restructuring charges and one-time costs, pension income, interest income and expense, income taxes, minority interest, discontinued operations, extraordinary items and cumulative effect of accounting changes.

Sales in 2005 for the Specialty Chemicals segment increased 4% from 2004, while operating profit declined 32%. Sales in 2005 were higher primarily as a result of higher selling prices and strong demand for the segment’s chemicals used in asphalt paving, dyes, printing inks and industrial pine chemical markets. These positive effects were offset by lower volumes for some activated carbon products as a result of changes in design of emission systems by an automaker customer. Higher raw material and energy input costs were the primary drivers of the decline in the segment’s operating profit compared to 2004. Year-over-year profit results were positively impacted by price increases and mix improvements of $15 million, offset by the negative impact of higher costs for raw materials and energy of $23 million, volume decreases of $6 million, and other cost increases of $4 million.

 

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Corporate and other

 

In millions

   Years ended December 31,  
     2005     2004  

Sales

   $ 213     $ 216  

Corporate and other loss 1

     (370 )     (302 )

1

Corporate and other loss may include goodwill impairment charges, minority interest, debt retirement charges, restructuring charges and one-time costs, net pension income, interest income and expense, and gains on asset sales.

The loss for corporate and other was $370 million in 2005, compared to a loss of $302 million in 2004. The increase in the loss reflects lower forestland sales gains in 2005 of $116 million, lower pension income of $17 million, and higher debt retirement cost of $89 million. These negative effects were partially offset by $71 million of lower restructuring charges in 2005, higher transition services income of $25 million, higher interest income of $21 million, reduced corporate spending of $33 million, and lower other costs of $4 million.

Other items

Selling, general and administrative expenses were $756 million in 2005 compared to $800 million in 2004. A portion of the decrease in 2005 was a result of various activities which focused on reduced spending and staff reductions throughout the company. Selling, general and administrative expenses included $11 million of restructuring charges in both 2005 and 2004.

Interest expense of $208 million in 2005 was similar to interest expense of $209 million in 2004.

Pension income for continuing operations, before settlements and curtailments, was $67 million before taxes in 2005 compared to $86 million in 2004, reflecting the company’s continued overfunded position in its qualified plans.

Other income, net, decreased in 2005 to $16 million from $197 million in 2004. Included in other income, net, in 2005 are gains on the sales of forestlands of $60 million compared to $176 million in 2004. Debt retirement costs were $89 million higher in 2005, offset by higher transition service income of $25 million.

The company’s annual effective tax benefit rate for 2005 was 12% compared to 31% in 2004. The decrease in the 2005 annual effective tax rate reflects a lower proportion of domestic earnings in 2005, a change in the allocation of state taxes as a result of the sale of the printing and writing papers business, and tax credits.

 

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Outlook

Packaging Resources

MeadWestvaco’s Packaging Resources group’s high-quality paperboard products are marketed globally. Overall demand remains solid relative to the seasonally weaker first calendar quarter. The company continues to experience steady order levels from its key lines of business, which include global tobacco, beverage and aseptic applications. As such, the company’s focus is on realizing price increases to offset continued historically high costs for raw materials, energy and freight. The company also is focusing on continuing to improve its productivity by consolidating its customer service and by pursuing other global supply chain initiatives, including enhancing transportation efficiency and optimizing its warehouse footprint. Any achieved benefits are expected to help further offset historically high input cost inflation.

Throughout the year, outages for routine maintenance are planned, with two such outages scheduled for the bleached paperboard system in the first quarter of 2007. Future outages will be communicated in a timely fashion by the company through its periodic broad disclosures with the investment community.

Consumer Solutions

In 2006, overall profitability in MeadWestvaco’s Consumer Solutions segment was below the company’s expectations. In 2007, the company has broadly communicated a profit improvement plan for this business, which includes optimizing its manufacturing capacity, refocusing its media business on higher value specialty packaging for music, DVDs and games, eliminating operating redundancies and enhancing materials procurement through the company’s shared services function. MeadWestvaco expects to demonstrate meaningful year-over-year operating profit improvement beginning in the second half of 2007 as it executes the aforementioned plan and continues to generate strong growth and profitability in the company’s global dispensing and spraying systems business that targets the personal care, healthcare, fragrance and lawn and garden markets. The company also plans to expand its current operations in China and enter other emerging markets, including India, which is expected to require modest investments in capital and in selling, general and administrative functions.

Consumer & Office Products

The Consumer and Office Products segment historically incurs a small loss in the first calendar quarter as the business builds inventory for its back-to-school selling season in the second and third quarters and for the peak selling season for time-management products in the second half of the year. Price and mix improvements from the company’s branded consumer product lines are expected to be partially offset by continued high costs for uncoated paper, the segment’s principal raw material. In addition, supply-chain activities by major customers and unpredictable order patterns for the company’s back-to-school and time management products may distort segment operating profit quarter-to-quarter.

 

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Specialty Chemicals

In 2007, global demand for MeadWestvaco’s pine chemicals, including proprietary ink resins, asphalt emulsifiers, rosin and other industrial pine-based chemicals, is expected to remain solid. However, costs for crude tall oil, the principal input for pine chemical products, are expected to largely offset increases in selling prices. The company also will continue to seek growth opportunities for its carbon technology through new products and geographic expansion to offset continued U.S. auto declines.

Cost initiative and restructuring activities

As part of its $200 million cost initiative, MeadWestvaco achieved through 2006 annual run rate savings of about $125 million, before inflation. The company anticipates achieving cumulative run-rate savings of $175 million to $185 million by the end of 2007 with the balance of the $200 million expected to be achieved in 2008. The company will, however, look for every opportunity to pull forward more savings into 2007. The key components of the 2007 reduction will be the continued execution of our North American shared services platform, IT reduction and supply chain improvement.

In February 2006, the company announced plans designed to accelerate progress toward a new packaging platform, create a new innovation center, and consolidate corporate activities to a new corporate headquarters located in Richmond, Virginia. Through year end, the company made substantial progress in these initiatives by realigning its packaging business into two focused groups, establishing the new innovation center in Raleigh, North Carolina, and completing the corporate consolidation plan. The resulting operational efficiencies, customer focus and market driven product innovation will strengthen our position in the packaging industry. The changes began in the second quarter of 2006 and are expected to be completed by early 2007. As part of these initiatives and the planned restructure and realignment of the company’s consumer solutions business, the company expects to incur between $50 million and $75 million in restructuring charges and other related costs in 2007.

Other items

Capital spending was $302 million in 2006 and is expected to increase to $360 million in 2007 due to the addition of Calmar, expansion initiatives into emerging markets, and capital requirements for safety and energy related projects. Depreciation, depletion and amortization expense was $517 million in 2006 and is expected to be about $525 million in 2007.

Interest expense totaled $211 million in 2006. Management expects interest expense to be in the range of $210 million to $215 million in 2007.

Management currently estimates overall pension income in 2007 to be approximately $53 million which is derived primarily from the domestic plans. This estimate assumes a discount rate of 5.75%, a salary increase rate of 4.0% and an expected rate of return on assets of 8.5%.

 

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Land sales

The company generated gross proceeds of $30 million and $68 million from the sales of forestland in 2006 and 2005, respectively.

On January 31, 2007, the company announced plans to sell approximately 300,000 acres of its forestlands throughout West Virginia, Alabama and Georgia. The company expects to complete the sales during 2007. The land sales include 82,000 acres in Alabama, 145,000 acres in Georgia, and 63,000 acres in West Virginia, and will continue to function as forestland under new ownership. The company will work with potential buyers to ensure that the land continues to be managed sustainably through the Sustainable Forestry Initiative (SFI). MeadWestvaco will retain strategic fiber supply agreements to support its mills in Alabama and Virginia. Additional plans are being finalized to further maximize value from our forestlands.

Certain statements in this document and elsewhere by management of the company that are neither reported financial results nor other historical information are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Refer to the “Forward-looking Statements” section later in this document.

LIQUIDITY AND CAPITAL RESOURCES

Cash generated from operations provided the major source of funds for the company in 2006. The primary use of funds in 2006 was the acquisition of Calmar, a leading global manufacturer of high-quality and innovative plastic dispensing and spraying systems. As disclosed in Note P of Notes to Financial Statements included in Part II, Item 8, the purchase price for Calmar was $714 million, of which $374 million was paid in cash and the remaining $340 million was financed through commercial paper borrowings. Of the $340 million in initial borrowings, approximately $190 million was paid down as of December 31, 2006. During 2005, proceeds of $2.2 billion from the sale of nonstrategic assets provided a major source of funds for the company. Cash and cash equivalents totaled $156 million at December 31, 2006 compared to $297 million at December 31, 2005.

Operating activities

Cash provided by continuing operations was $567 million in 2006, compared to $305 million in 2005 and $633 million in 2004. The increase in operating cash flow in 2006 was primarily attributable to cash provided by changes in working capital of $129 million in 2006, compared to cash used by changes in working capital in 2005 of $271 million. Included in 2005 cash flow from working capital changes was approximately $160 million in tax payments related to the sale of the printing and writing papers business. See Note Q of Notes to Financial Statements included in Part II, Item 8 for further discussion relating to changes in current assets and liabilities. Net income from continuing operations was $93 million, $119 million and $224 million in 2006, 2005 and 2004, respectively. There was no cash flow from discontinued operations in 2006, compared to cash used by discontinued operations of $78 million in 2005 and cash provided by discontinued operations of $289 million in 2004.

 

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Investing activities

Cash used in investing activities was $761 million in 2006, compared to cash provided by investing activities of $2 billion in 2005 and cash used in investing activities of $207 million in 2004. The primary use of funds in 2006 was the acquisition of Calmar for $714 million, while the primary source of the funds in 2005 was proceeds of $2.2 billion from the sale of the printing and writing papers business. Capital spending totaled $302 million in 2006, compared to $305 million in 2005 and $317 million in 2004. Management anticipates that capital spending will be about $360 million in 2007. Depreciation, depletion and amortization expense is expected to be about $525 million in 2007.

During 2006, we acquired Calmar, a leading global manufacturer of high-quality and innovative plastic dispensing and spraying systems, with manufacturing facilities in North America, Europe, Latin America and Asia. During 2005, we acquired DZN, The Design Group, a full service design and marketing company which will enhance MeadWestvaco’s package design capabilities, enabling the company to provide a more competitive and comprehensive set of creative design services. During 2004, we acquired Aries Packaging, a machinery systems company which supports the company’s dairy packaging systems business in Europe, and Tilibra, a manufacturer of school, office and time-management stationery products in Brazil.

Asset sales, including the sales of forestlands, generated $165 million of proceeds in 2006 compared to $109 million in 2005 and $281 million in 2004. Proceeds of the sale of a debt security generated $109 million of cash in 2006.

Financing activities

Cash provided by financing activities was $35 million during 2006, compared to cash used in financing activities of $2.2 billion during 2005 and $672 million during 2004. In 2005, proceeds received from the sale of the company’s printing and writing papers business were used to retire approximately $1 billion in debt and to repurchase approximately 24 million shares of outstanding common stock at a cost of $700 million. All of the repurchased shares of common stock were retired. In October 2005, the company’s Board of Directors authorized the future repurchase of an additional five million shares primarily to avoid dilution of earnings per share relating to employee equity awards. In 2006, the company repurchased and retired 1.3 million shares, related to an obligation under a share put option to the former owner of a subsidiary. The cash impact of this transaction was approximately $47 million. The 1.3 million shares repurchased under the put option were not a reduction of the share repurchases authorized by the Board of Directors.

At December 31, 2006, the company had a $750 million bank credit facility that expires in December 2010. Borrowings under this agreement can be in unsecured domestic or eurodollar notes and at rates approximating prime or the London Interbank Offered Rate (LIBOR) at the company’s option. The $750 million credit agreement contains a financial covenant limiting the percentage of total debt to total capitalization (including deferred taxes) to 55% as well as certain other covenants with which the company is in compliance. The company’s commercial paper program is supported by its $750 million revolving credit facility which was undrawn at December 31, 2006. The company had $148 million of commercial paper borrowings outstanding at December 31, 2006.

 

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At December 31, 2006 and 2005, the company had $211 million and $13 million of notes payable and current maturities of long-term debt. There were $148 million of commercial paper borrowings outstanding at December 31, 2006, and no commercial paper borrowings outstanding at December 31, 2005 and 2004. The maximum amounts of combined commercial paper outstanding during the years ended December 31, 2006, 2005 and 2004, were $355 million, $115 million and $53 million, respectively. The average amount of commercial paper outstanding during the years ended December 31, 2006, 2005 and 2004, was $136 million, $1 million and $4 million, respectively, with an average interest rate of 5.5%, 3.1% and 1.4%, respectively. In the past, these borrowings funded seasonal increases in inventory and receivables at the company’s Packaging Resources, Consumer Solutions and Consumer and Office Products segments. At December 31, 2006 and 2005, approximately 22% and 15% of the company’s debt was variable rate, after factoring in the company’ interest-rate swaps, respectively. The weighted average interest rate on the company’s variable-rate debt was approximately 5.3% in 2006, compared to 4.9% in 2005. The percentage of debt to total capital was 42.2% and 41.1% at December 31, 2006 and 2005, respectively.

In the period from January 1, 2007 to February 1, 2007, the holders of the company’s 6.84% debentures, due 2037, were entitled to elect early repayment, in whole or in part, at 100% of the principal amount outstanding. Holders elected early repayment of $45 million, which will be paid by the company on March 1, 2007, and the repayment amount is included in current maturities of long-term debt as of December 31, 2006.

In 2006, the Board of Directors declared dividends of $0.92 per share, paying a total of $167 million of dividends to shareholders in 2006. During 2005 and 2004, the company paid $178 million and $186 million, respectively, of dividends to shareholders. On January 23, 2007, the company declared a quarterly dividend of $0.23 per share payable on March 1, 2007 to stockholders of record at the close of business on February 2, 2007.

Effects of inflation

Prices for energy, including natural gas, oil and electricity, and input costs for certain raw materials and freight, increased significantly in 2006 and 2005. The increase in these costs affected many of the company’s businesses. During 2006, the pre-tax input cost of energy, raw materials and freight was approximately $159 million higher than in 2005. During 2005, the pre-tax input cost of energy, raw materials and freight was approximately $150 million higher than in 2004.

Environmental and legal matters

Our operations are subject to extensive regulation by federal, state and local authorities, as well as regulatory authorities with jurisdiction over foreign operations of the company. Due to changes in environmental laws and regulations, the application of such regulations, and changes in environmental control technology, it is not possible for us to predict with certainty the amount of capital expenditures to be incurred for environmental purposes. Taking these uncertainties into account, we estimate that we will incur

 

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approximately $19 million in environmental capital expenditures in 2007 and approximately $27 million in 2008. Approximately $34 million was spent on environmental capital projects in 2006.

We have been notified by the U.S. Environmental Protection Agency (the “EPA”) or by various state or local governments that we may be liable under federal environmental laws or under applicable state or local laws with respect to the cleanup of hazardous substances at sites previously operated or used by the company. The company is currently named as a potentially responsible party (“PRP”), or has received third-party requests for contribution under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) and similar state or local laws with respect to numerous sites. There are other sites which may contain contamination or which may be potential Superfund sites, but for which MeadWestvaco has not received any notice or claim. The potential liability for all these sites will depend upon several factors, including the extent of contamination, the method of remediation, insurance coverage and contribution by other PRPs. The company regularly evaluates its potential liability at these various sites. At December 31, 2006, MeadWestvaco had recorded liabilities of approximately $22 million for estimated potential cleanup costs based upon its close monitoring of ongoing activities and its past experience with these matters. The company believes that it is reasonably possible that costs associated with these sites may exceed amounts of recorded liabilities by an amount that could range from an insignificant amount to as much as $20 million. This estimate is less certain than the estimate upon which the environmental liabilities were based. After consulting with legal counsel and after considering established liabilities, it is our judgment that the resolution of pending litigation and proceedings is not expected to have a material adverse effect on the company’s consolidated financial condition or liquidity. In any given period or periods, however, it is possible such proceedings or matters could have a material effect on the results of operations.

As with numerous other large industrial companies, the company has been named a defendant in asbestos-related personal injury litigation. Typically, these suits also name many other corporate defendants. All of the claims against the company resolved to date have been concluded before trial, either through dismissal or through settlement with payments to the plaintiff that are not material to the company. To date, the costs resulting from the litigation, including settlement costs, have not been significant. As of December 31, 2006, there were approximately 350 lawsuits. Management believes that the company has substantial indemnification protection and insurance coverage, subject to applicable deductibles and policy limits, with respect to asbestos claims. The company has valid defenses to these claims and intends to continue to defend them vigorously. Additionally, based on its historical experience in asbestos cases and an analysis of the current cases, the company believes that it has adequate amounts accrued for potential settlements and judgments in asbestos-related litigation. At December 31, 2006, the company had recorded litigation liabilities of approximately $22 million, a significant portion of which relates to asbestos. Should the volume of litigation grow substantially, it is possible that the company could incur significant costs resolving these cases. After consulting with legal counsel and after considering established liabilities, it is our judgment that the resolution of pending litigation and proceedings is not expected to have a material adverse effect on the company’s consolidated financial condition or liquidity. In any given period or periods, however, it is possible such proceedings or matters could have a material effect on the results of operations.

 

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The company is involved in various other litigation and administrative proceedings arising in the normal course of business. Although the ultimate outcome of such matters cannot be predicted with certainty, management does not believe that the currently expected outcome of any matter, lawsuit or claim that is pending or threatened, or all of them combined, will have a material adverse effect on the company’s consolidated financial condition or liquidity. In any given period or periods, however, it is possible such proceedings or matters could have a material effect on the results of operations.

Contractual obligations

The company enters into various contractual obligations throughout the year. Presented below are the contractual obligations of the company as of December 31, 2006, and the time period in which payments under the obligations are due. Disclosures related to long-term debt, capital lease obligations and operating lease obligations are included in the footnotes to the consolidated financial statements of the company. Also included below are disclosures regarding the amounts due under purchase obligations. Purchase obligation is defined as an agreement to purchase goods or services that is enforceable and legally binding on the company and that specifies all significant terms, including fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction.

The company has included in the disclosure below all normal and recurring purchase orders, take-or-pay contracts, supply arrangements as well as other purchase commitments that management believes meet the definition of purchase obligations above.

 

In millions    Payments due by period
     Total   

Less than

1 year 2007

   1-3
years 2008
and 2009
   3-5
years 2010
and 2011
   More than
5 years 2012
and beyond

Contractual obligations:

              

Debt

   $ 2,521    $ 211    $ 83    $ 30    $ 2,197

Interest on debt

     2,834      176      347      337      1,974

Capital lease obligations

     164      4      9      8      143

Operating leases

     222      52      74      50      46

Purchase obligations

     851      649      123      63      16

Other long-term obligations

     738      —        168      149      421
                                  

Total

   $ 7,330    $ 1,092    $ 804    $ 637    $ 4,797
                                  

On January 11, 2007, the company entered into a lease agreement with a third party pursuant to which the company will lease a facility for its corporate headquarters in Richmond, Virginia with an initial term of 13.5 years. It is expected that the lease commencement date will be in the third quarter of 2009, after about a two-year construction period. The annual minimum rental payments associated with this agreement, which will depend largely in part on the final cost of the facility and the amount of square footage leased, are estimated to be between $9 million and $10 million, beginning in the second half of 2009. The estimated minimum

 

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lease payments associated with this agreement are not included in the above table, as such table reflects contractual obligations entered into by the company on or before December 31, 2006.

SIGNIFICANT TRANSACTIONS

Restructuring charges

Year ended December 31, 2006

For the year ended December 31, 2006, MeadWestvaco recorded total pre-tax charges of $133 million for asset writedowns, facility closures and employee separation costs, of which $53 million, $60 million and $20 million were recorded within cost of sales, selling, general and administrative expenses, and other income, net, respectively. In the fourth quarter of 2006 the company recorded total pretax charges of $53 million of which $16 million, $26 million and $11 million were recorded within cost of sales, selling, general and administrative expenses, and other income, net, respectively.

Although these charges related to individual segments, such amounts are reflected in corporate and other for segment reporting purposes.

The following table and discussion present additional detail of the 2006 charges by business segment:

 

In millions   

Asset
writedowns and

other costs

   Employee
costs
   Total

Packaging Resources

   $ 25    $ 2    $ 27

Consumer Solutions

     5      25      30

Consumer and Office Products

     4      4      8

All other

     49      19      68
                    
   $ 83    $ 50    $ 133
                    

Packaging Resources:

During the year, the company incurred charges of $27 million for asset writedowns, employee separation costs and various other restructuring activities in its packaging operations in the U.S. The charges included employee separation costs of $2 million related to approximately 40 employees. All of the affected employees will be separated by the end of 2007. The remaining $25 million related to asset impairments.

Consumer Solutions:

During the year, the company incurred charges of $30 million for asset writedowns, employee separation costs and other restructuring costs related to the closing of a packaging converting plant in the U.S. and various other restructuring activities in its packaging converting operations in the U.S. and Europe. The charges include separation costs of $25 million related to approximately 860 employees. The majority of the affected employees had separated from the company by December 31, 2006, and the remaining

 

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employees will be separated by the end of 2007. The remaining $5 million included asset writedowns and other facility closure-related costs.

Consumer and Office Products:

During the year, the company incurred charges of $8 million for asset writedowns, employee separation costs and other restructuring costs incurred in connection with various restructuring activities in its consumer and office products manufacturing operations in North America. The charges included employee separation costs of $4 million, related to approximately 150 employees, and $4 million for asset writedowns including asset impairments and other costs. The majority of the affected employees had separated from the company by December 31, 2006, and the remaining employees will be separated by the end of 2007.

All other:

During the year, the company also recorded charges of approximately $19 million related to employee separation costs covering approximately 290 employees. The majority of the affected employees had separated from the company by December 31, 2006, and the remaining employees will be separated by the end of 2007. Additionally, the company incurred charges of $49 million in connection with asset impairments, charges associated with ceased-use facilities and a write-down of an equity investment.

Year ended December 31, 2005

For the year ended December 31, 2005, MeadWestvaco recorded total pre-tax charges of $29 million for asset writedowns, facility closures and employee separation costs, of which $18 million and $11 million were recorded within cost of sales and selling, general and administration expenses, respectively. Of these charges, $9 million related to the company’s productivity initiative and $20 million related to its cost initiative. These charges included the closing of a Consumer Solutions converting plant in the United States and various other restructuring activities in the Packaging Resources, Consumer Solutions and Consumer and Office Products operations in the United States and Europe, including asset impairments and employee separation costs covering approximately 300 employees. The company also recorded employee separation charges of $6 million in corporate and other covering approximately 190 employees. As of December 31, 2006, actions related to these charges were substantially paid. Although the charges were not recorded as part of segment results, $3 million related to the Packaging Resources segment, $11 million to the Consumer Solutions segment, $8 million to the Consumer and Office Products segment, and $9 million to corporate and other. Additionally, in 2005, the company sold previously written-down Consumer and Office Products assets, resulting in a gain of $2 million.

Year ended December 31, 2004

For the year ended December 31, 2004, MeadWestvaco recorded total pre-tax charges of $100 million for asset writedowns, facility closures and employee separation costs, of which $89 million and $11 million were recorded within cost of sales and selling, general and administrative expenses, respectively. The charges related primarily to the closing of a domestic packaging systems plant and

 

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various consolidation activities in the company’s packaging facilities, primarily in Europe; actions taken to consolidate the consumer and office products operations in North America and close several facilities; and the reorganization of corporate functions and other business units. As of December 31, 2005, all of the actions related to these charges were complete, and the accruals for employee and other costs were substantially utilized. Although the charges were not recorded as part of segment results, $1 million related to the Packaging Resources segment, $38 million to the Consumer Solutions segment, $45 million to the Consumer and Office Products segment, and $16 million to corporate and other. Additionally, in 2004, the company sold a previously written-down corporate asset, resulting in a gain of $2 million.

Acquisition

On July 5, 2006, the company completed its acquisition of Calmar from Compagnie de Saint-Gobain. Calmar is a leading global manufacturer of high-quality and innovative plastic dispensing and spraying systems, with manufacturing facilities in North America, Europe, Latin America and Asia. The business generates sales in 43 countries and employs approximately 2,700 people worldwide.

The base purchase price at the date of acquisition was $710 million in cash in exchange for the stock of various Calmar entities, and was subject to adjustment for cash received, debt assumed and certain minor items. Excluding cash acquired, the adjusted purchase price including direct transaction costs was $714 million. The results of Calmar are included in the consolidated financial statements from the acquisition date and are included in the company’s Consumer Solutions segment.

Discontinued operations

In connection with the sale of the company’s printing and writing papers business that occurred in 2005, the company recorded an after-tax loss from discontinued operations for the years ended December 31, 2005 and 2004 of $91 million and $573 million, respectively. Results in 2005 and 2004 were negatively impacted by sale-related costs, including lease termination charges, asset impairments, debt extinguishment costs, pension settlement and curtailment losses, and other related costs included in discontinued operations.

 

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Critical Accounting Policies

Our principal accounting policies are described in the Summary of Significant Accounting Policies in the Notes to Financial Statements filed with the accompanying consolidated financial statements. The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of some assets and liabilities and, in some instances, the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. Management believes the accounting policies discussed below represent those accounting policies requiring the exercise of judgment where a different set of judgments could result in the greatest changes to reported results. Management has discussed the development and selection of the critical accounting estimates with the Audit Committee of the Board of Directors, and the Audit Committee has reviewed the company’s disclosure.

Environmental and legal liabilities: We record accruals for estimated environmental liabilities when remedial efforts are probable and the costs can be reasonably estimated. These estimates reflect assumptions and judgments as to the probable nature, magnitude and timing of required investigation, remediation and monitoring activities, as well as availability of insurance coverage and contribution by other potentially responsible parties. Due to the numerous uncertainties and variables associated with these assumptions and judgments, and changes in governmental regulations and environmental technologies, accruals are subject to substantial uncertainties, and actual costs could be materially greater or less than the estimated amounts. We record accruals for other legal contingencies, which are also subject to numerous uncertainties and variables associated with assumptions and judgments, when the loss is probable and reasonably estimable. Liabilities recorded for claims are limited to pending cases based on the company’s historical experience, consultation with outside counsel and consultation with an actuarial specialist concerning the feasibility of reasonably estimating liabilities associated with claims that may arise in the future. We recognize insurance recoveries when collection is reasonably assured.

Restructuring and other charges: We periodically record charges for the reduction of our workforce, the closure of manufacturing facilities and other actions related to business improvement and productivity initiatives. These events require estimates of liabilities for employee separation payments and related benefits, demolition, environmental cleanup and other costs, which could differ from actual costs incurred.

Pension and postretirement benefits: In August 2006, the President signed into law the Pension Protection Act of 2006 (PPA). The PPA establishes new minimum funding rules for defined benefit pension plans beginning in 2008. The company does not anticipate any required funding to the U.S. qualified retirement plans in the foreseeable future as a result of this legislation and due to the overfunded status of the plans.

In September 2006, the FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – An Amendment of FASB Statements No. 87, 88, 106, and 132(R). SFAS No. 158 requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan in its balance sheet and to recognize the changes in the

 

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plan’s funded status in comprehensive income in the year in which the change occurs. These provisions of the Statement are effective as of the end of the first fiscal year ending after December 15, 2006. SFAS No. 158 also requires an employer to measure the funded status of a plan as of the date of its fiscal year end, which is consistent with the company’s measurement date. The impact of adopting SFAS No. 158 as of December 31, 2006 was an increase to accumulated other comprehensive loss in the amount of $57 million, net of tax, which principally represents the impact of recognizing previously unrecognized prior service cost and net actuarial losses.

Assumptions used in the determination of net pension cost and postretirement benefit expense, including the discount rate, the expected return on plan assets, and increases in future compensation and medical costs, are evaluated by the company, reviewed with the plan actuaries annually and updated as appropriate. Actual asset returns and compensation and medical costs, which are more favorable than assumptions, can have the effect of lowering expense and cash contributions, and, conversely, actual results, which are less favorable than assumptions, could increase expense and cash contributions. In accordance with generally accepted accounting principles, actual results that differ from assumptions are accumulated and amortized over future periods and, therefore, affect expense in such future periods.

In 2006, the company recorded pre-tax pension income for continuing operations, before settlements, curtailments and termination benefits, of $50 million compared to $67 million in 2005. The company currently estimates overall pre-tax pension income in 2007 will increase by approximately $3 million, primarily attributable to an increase in the discount rate. The estimate assumes a long-term rate of return on plan assets of 8.50%, and a discount rate of 5.75%. If the expected rate of return on plan assets were to change by .5%, annual pension income in 2007 would change by approximately $38 million. Similarly, if the discount rate were to change by .5%, annual pension income would change by approximately $36 million.

At December 31, 2006, the aggregate value of pension fund assets had increased to $3.4 billion from $3.2 billion at December 31, 2005, reflecting overall equity market performance.

Prior service cost and actuarial gains and losses in the retirement and postretirement benefit plans subject to amortization are amortized over the average remaining service periods, which are about 11 years and 6 years, respectively, and are a component of accumulated other comprehensive loss. In 2004, the company modified certain postretirement healthcare benefits to be provided to future retirees. This change reduced the postretirement benefit obligation by approximately $68 million, and is being amortized over the remaining life of the eligible employees, which is approximately 24 years.

Long-lived assets

Useful lives: Useful lives of tangible and intangible assets are based on management’s estimates of the periods over which the assets will be productively utilized in the revenue-generation process or for other useful purposes. Factors that affect the determination of lives include prior experience with similar assets, product life expectations and industry practices. The determination of useful lives dictates the period over which tangible and intangible long-lived assets are depreciated or amortized, typically using the straight-line method.

 

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Tangible assets: We review long-lived assets other than goodwill and indefinite-lived intangible assets for impairment in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-lived Assets. The statement requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The review for impairment involves management to predict the estimated cash flows that will be generated by the long-lived asset over its remaining estimated useful life. Considerable judgment must be exercised as to determining future cash flows and their timing and, possibly, choosing business value comparables or selecting discount rates to use in any value computations.

Intangible assets: Business acquisitions often result in recording intangible assets. Intangible assets are recognized at the time of an acquisition, based upon their fair value. Similar to long-lived tangible assets, intangible assets are subject to periodic impairment reviews whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. As with tangible assets, considerable judgment must be exercised.

Goodwill: Goodwill arises in business combinations when the purchase price of assets acquired exceeds the appraised value. As with tangible and other intangible assets, periodic impairment reviews are required, at least annually, as well as when events or circumstances change. As with its review of impairment of tangible and intangible assets, management uses judgment in assessing goodwill for impairment. We will review the recorded value of our goodwill annually in the fourth quarter or sooner, if events or changes in circumstances indicate that the carrying amount may exceed fair value. The review for impairment involves management to predict the estimated cash flows that will be generated by the long-lived asset over its remaining estimated useful life. Considerable judgment must be exercised in determining future cash flows and their timing and, possibly, choosing business value comparables or selecting discount rates to be used in any value computations.

Revenue recognition: We recognize revenue at the point when title and the risk of ownership passes to the customer. Substantially all of our revenues are generated through product sales, and shipping terms generally indicate when title and the risk of ownership have passed. Revenue is recognized at shipment for sales when shipping terms are FOB (free on board) shipping point. For sales where shipping terms are FOB destination, revenue is recognized when the goods are received by the customer. We provide for all allowances for estimated returns and other customer credits such as discounts and volume rebates, when the revenue is recognized, based on historical experience, current trends and any notification of pending returns. The customer allowances are, in many instances, subjective and are determined with significant management judgment and are reviewed regularly to determine the adequacy of the amounts. Changes in economic conditions, markets and customer relationships may require adjustments to these allowances from period to period. Also included in net sales is service revenue which is recognized as the service is performed. Revenue is recognized for leased equipment to customers on a straight-line basis over the estimated term of the lease and is included in net sales of the company.

Income taxes: Income taxes are accounted for in accordance with SFAS No. 109, Accounting for Income Taxes, which recognizes

 

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deferred tax assets and liabilities based on the estimated future tax effects of differences between the financial statement and tax basis of assets and liabilities given the enacted tax laws.

We evaluate the need for a deferred tax asset valuation allowance by assessing whether it is more likely than not that the company will realize its deferred tax assets in the future. The assessment of whether or not a valuation allowance is required often requires significant judgment, including the forecast of future taxable income and the valuation of tax planning initiatives. Adjustments to the deferred tax valuation allowance are made to earnings in the period when such assessment is made.

The company has tax jurisdictions located in many areas of the world and is subject to audit in these jurisdictions. Tax audits by their nature are often complex and can require several years to resolve. In the preparation of the company’s financial statements, management exercises judgments in estimating the potential exposure to unresolved tax matters. While actual results could vary, in management’s judgment, the company has adequate accruals with respect to the ultimate outcome of such unresolved tax matters.

Each quarter, management must estimate our effective tax rate for the full year. This estimate includes assumptions about the level of income that will be achieved for the full year in both our domestic and international operations. The forecast of full-year earnings includes assumptions about markets in each of our businesses as well as the timing of certain transactions, including forestland sales gains and restructuring charges. Should business performance or the timing of certain transactions change during the year, the level of income achieved may not meet the level of income estimated earlier in the year at interim periods. This change in the income levels and mix of earnings can result in significant adjustments to the tax provision in the quarter in which the estimate is refined.

New accounting standards

In December 2004, the FASB issued SFAS No. 123-revised 2004 (SFAS No. 123R), Share-Based Payment, which replaces SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. SFAS No. 123R requires the measurement of all employee share-based payments to employees, including grants of employee stock options, using a fair-value-based method and the recording of such expense in the consolidated statements of operations. The accounting provisions of SFAS No. 123R are required to be applied no later than the beginning of the first fiscal year beginning after June 15, 2005. The company adopted SFAS No. 123R effective January 1, 2006, using the modified prospective method. This Statement requires the recognition of compensation expense when an entity obtains employee services in share-based payment transactions. Under this new Statement, pre-tax share-based compensation for the year ended December 31, 2006 was $21 million, including the incremental pre-tax cost of $10 million, relating to stock options and stock appreciation rights. The incremental impact was a reduction to net income of $6 million, or earnings per share of $0.03, net of tax. Substantially all of this compensation expense is recorded as a component of selling, general and administrative expenses.

In March 2005, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 107, Share-Based Payment (SAB No. 107). SAB No. 107 addresses the interaction between SFAS No. 123R and certain SEC rules and regulations and provides

 

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the SEC staff’s views regarding the valuation of share-based payment arrangements for public companies. The company followed the interpretive guidance set forth in SAB No. 107 during its adoption of SFAS No. 123R.

In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, which replaces APB Opinions No. 20, Accounting Changes and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements - An Amendment of APB Opinion No. 28. SFAS No. 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes retrospective application, unless impracticable, as the required method for reporting a change in accounting principle and the reporting of a correction of an error and for reporting a change when retrospective application is impracticable. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005, and was adopted by the company in the first quarter of 2006. The adoption of SFAS No. 154 did not have an impact on the company’s consolidated financial statements.

In July 2006, the FASB issued Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes, which clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with SFAS No. 109, Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. It also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. This Interpretation is effective for fiscal years beginning after December 15, 2006. The cumulative effects, if any, of applying FIN 48 will be recorded as an adjustment to retained earnings as of the beginning of the period of adoption. The company is currently evaluating the effect that the adoption of FIN 48 will have on its consolidated results of operations and financial condition and is not yet in a position to determine such effects.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This Statement does not require any new fair value measurements, but applies to existing accounting pronouncements that require or permit fair value measurement as the relevant measurement attribute. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The company has not yet determined the impact of adopting this standard.

In September 2006, the FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – An Amendment of FASB Statements No. 87, 88, 106, and 132(R). SFAS No. 158 requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan in its balance sheet and to recognize the changes in the plan’s funded status in comprehensive income in the year in which the change occurs. These provisions of the Statement are effective as of the end of the first fiscal year ending after December 15, 2006. SFAS No. 158 also requires an employer to measure the funded status of a plan as of the date of its fiscal year end, which is the Company’s measurement date. Pursuant to the Statement’s adoption, the net after-tax charge to accumulated other comprehensive loss in the fourth quarter of 2006 was $57 million. This adjustment

 

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principally represents the recognition of previously unrecognized prior service costs and net actuarial losses and the impact of recording additional minimum liabilities for certain under-funded plans. This Statement will not affect the company’s ERISA funding obligations and we do not currently anticipate any required company contributions to the qualified retirement plans in the foreseeable future.

In September 2006, the SEC issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB No. 108). SAB No. 108 requires that public companies utilize a “dual-approach” to assessing the quantitative effects of financial misstatements. This dual approach includes both an income statement focused assessment and a balance sheet focused assessment. The guidance in SAB No. 108 must be applied to annual financial statements for fiscal years ending after November 15, 2006. The adoption of SAB No. 108 did not have a material effect on the company’s consolidated financial position or results of operations.

There were no other new accounting standards issued in 2006 that had or are expected to have a material impact on the company’s financial position or results of operations.

 

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Forward-looking Statements

Certain statements in this document and elsewhere by management of the company that are neither reported financial results nor other historical information are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such information includes, without limitation, the business outlook, assessment of market conditions, anticipated financial and operating results, strategies, future plans, contingencies and contemplated transactions of the company. Such forward-looking statements are not guarantees of future performance and are subject to known and unknown risks, uncertainties and other factors which may cause or contribute to actual results of company operations, or the performance or achievements of each company, or industry results, to differ materially from those expressed or implied by the forward-looking statements. In addition to any such risks, uncertainties and other factors discussed elsewhere herein, risks, uncertainties and other factors that could cause or contribute to actual results differing materially from those expressed or implied for the forward-looking statements include, but are not limited to, events or circumstances which affect the ability of MeadWestvaco to realize improvements in operating earnings expected from the company’s cost reduction initiative; competitive pricing for the company’s products; changes in raw materials pricing; energy and other costs; fluctuations in demand and changes in production capacities; changes to economic growth in the United States and international economies; government policies and regulations, including, but not limited to those affecting the environment and the tobacco industry; the company’s continued ability to reach agreement with its unionized employees on collective bargaining agreements; adverse results in current or future litigation; currency movements; and other risk factors discussed in the company’s Annual Report on Form 10-K for the year ended December 31, 2006, and in other filings made from time to time with the SEC. MeadWestvaco undertakes no obligation to publicly update any forward-looking statement, whether as a result of new information, future events or otherwise. Investors are advised, however, to consult any further disclosures made on related subjects in the company’s reports filed with the SEC.

 

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Item 7A. Quantitative and qualitative disclosures about market risk

Interest rates

It is management’s objective to manage its interest expense through a blend of fixed and floating interest rate instruments. The company primarily funds itself with long-term debt, having final maturities ranging from two to 40 years at date of issue, a portion of which has variable interest rates, and with variable interest rate commercial paper. The company uses interest-rate swaps in managing its mix of fixed and floating rate debt. See Note G of Notes to Financial Statements included in Part II, Item 8.

Foreign currency

The company has foreign-based operations, primarily in Brazil, Canada, Mexico, Europe and Asia, which accounted for approximately 28% of its 2006 net sales. In addition, certain of the company’s domestic operations have sales to foreign customers. In the conduct of its foreign operations, the company also makes intercompany sales and receives royalties and dividends denominated in many different currencies. All of this exposes the company to the effect of changes in foreign currency exchange rates.

Flows of foreign currencies into and out of the company’s domestic operations are generally stable and regularly occurring and are recorded at fair market value in the company’s financial statements. The company’s foreign currency management policy permits it to enter into foreign currency hedges when these flows exceed a threshold, which is a function of these cash flows and forecasted annual operations. During 2006, the company entered into foreign currency hedges to partially offset the foreign currency impact of these flows on operating income. See Note G of Notes to Financial Statements included in Part II, Item 8.

The company also issues intercompany loans to its foreign subsidiaries in their local currencies, exposing it to the effect of changes in spot exchange rates between loan issue and loan repayment dates. Generally, management uses foreign-exchange hedge contracts with terms of less than one year to hedge these exposures. When applied to the company’s derivative and other foreign currency sensitive instruments at December 31, 2006, a 10% adverse change in currency rates would have about a $14 million effect on the company’s results.

Natural gas

In order to better predict and control the future cost of natural gas consumed at the company’s mills and plants, the company engages in financial hedging of future gas purchase prices. Gas usage is relatively predictable month-by-month. The company “locks in” the cost of a portion of its future natural gas usage by entering into swap agreements. See Note G of Notes to Financial Statements included in Part II, Item 8.

 

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Item 8. Financial statements and supplementary data

Index

     Page

Report of independent registered public accounting firm

   47

Consolidated statements of operations for the years ended December 31, 2006, 2005 and 2004

   49

Consolidated balance sheets at December 31, 2006 and 2005

   50

Consolidated statements of shareholders’ equity for the years ended December 31, 2006, 2005 and 2004

   51

Consolidated statements of cash flows for the years ended December 31, 2006, 2005 and 2004

   53

Notes to financial statements

   55

 

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Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders

of MeadWestvaco Corporation

We have completed integrated audits of MeadWestvaco Corporation’s consolidated financial statements and of its internal control over financial reporting as of December 31, 2006, in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.

Consolidated financial statements

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, stockholders’ equity, and cash flows present fairly, in all material respects, the financial position of MeadWestvaco Corporation and its subsidiaries at December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

As discussed in Notes J and K to the consolidated financial statements, the Company changed the manner in which it accounts for share-based compensation in fiscal 2006 and the manner in which it accounts for defined benefit pension and other postretirement plans effective December 31, 2006.

Internal control over financial reporting

Also, in our opinion, management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A., that the Company maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control - Integrated Framework issued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was

 

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maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

As described in Management’s Report on Internal Control Over Financial Reporting, management has excluded certain elements of the internal control over financial reporting of the Saint-Gobain Calmar (Calmar) businesses that the Company acquired from Compagnie de Saint-Gobain from its assessment of internal control over financial reporting as of December 31, 2006 because it was acquired by the Company in a purchase business combination during 2006. Subsequent to the acquisition, certain elements of Calmar’s internal control over financial reporting and related processes were integrated into the Company’s existing systems and internal control over financial reporting. Those controls that were not integrated have been excluded from management’s assessment of the effectiveness of internal control over financial reporting as of December 31, 2006. We have also excluded these elements of the internal control over financial reporting of Calmar from our audit of the Company’s internal control over financial reporting. The excluded elements represent controls over accounts of approximately 7% of consolidated assets, 3% of consolidated liabilities, 3% of the consolidated revenues and 3% of the consolidated operating expenses of the related consolidated financial statement amounts as of and for the year ended December 31, 2006.

/s/ PricewaterhouseCoopers LLP

PricewaterhouseCoopers LLP

Richmond, Virginia

February 28, 2007

 

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FINANCIAL STATEMENTS

CONSOLIDATED STATEMENTS OF OPERATIONS

 

In millions, except per share data    Years ended December 31,  
     2006     2005     2004  

Net sales

   $ 6,530     $ 6,170     $ 6,060  

Cost of sales

     5,399       5,087       4,925  

Selling, general and administrative expenses

     905       756       800  

Interest expense

     211       208       209  

Other income, net

     (83 )     (16 )     (197 )
                        

Income from continuing operations before income taxes

     98       135       323  

Income tax provision

     5       16       99  
                        

Income from continuing operations

     93       119       224  

Discontinued operations

     —         (91 )     (573 )
                        

Net income (loss)

   $ 93     $ 28     $ (349 )
                        

Income (loss) per share - basic:

      

Income from continuing operations

   $ 0.52     $ 0.62     $ 1.11  

Discontinued operations

     —         (0.48 )     (2.84 )
                        

Net income (loss)

   $ 0.52     $ 0.14     $ (1.73 )
                        

Income (loss) per share - diluted:

      

Income from continuing operations

   $ 0.52     $ 0.62     $ 1.10  

Discontinued operations

     —         (0.48 )     (2.82 )
                        

Net income (loss)

   $ 0.52     $ 0.14     $ (1.72 )
                        

Shares used to compute net income (loss) per share:

      

Basic

     180.8       191.7       201.9  

Diluted

     181.2       192.7       203.6  

The accompanying notes are an integral part of these financial statements.

MEADWESTVACO CORPORATION AND CONSOLIDATED SUBSIDIARY COMPANIEs

 

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FINANCIAL STATEMENTS

CONSOLIDATED BALANCE SHEETS

 

In millions, except share and per share data    December 31,  
     2006     2005  

ASSETS

    

Cash and cash equivalents

   $ 156     $ 297  

Accounts receivable, net

     1,011       922  

Inventories

     715       714  

Other current assets

     133       97  
                

Current assets

     2,015       2,030  

Property, plant, equipment and forestlands, net

     4,523       4,487  

Prepaid pension asset

     920       994  

Goodwill

     851       559  

Other assets

     976       838  
                
   $ 9,285     $ 8,908  
                

LIABILITIES AND SHAREHOLDERS’ EQUITY

    

Accounts payable

   $ 552     $ 416  

Accrued expenses

     702       613  

Notes payable and current maturities of long-term debt

     211       13  
                

Current liabilities

     1,465       1,042  

Long-term debt

     2,372       2,417  

Other long-term obligations

     738       814  

Deferred income taxes

     1,177       1,152  

Commitments and Contingencies

    

Shareholders’ equity:

    

Common stock, $0.01 par

    

Shares authorized: 600,000,000

    

Shares issued and outstanding : 182,107,136 (2005 – 181,418,672)

     2       2  

Additional paid-in capital

     3,370       3,294  

Retained earnings

     168       243  

Accumulated other comprehensive loss

     (7 )     (56 )
                
     3,533       3,483  
                
   $ 9,285     $ 8,908  
                

The accompanying notes are an integral part of these financial statements.

MEADWESTVACO CORPORATION AND CONSOLIDATED SUBSIDIARY COMPANIES

 

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FINANCIAL STATEMENTS

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

 

In millions   

Outstanding

shares

   

Common

stock

Balance at December 31, 2003

   200.9     $ 2

Comprehensive income (loss):

    

Net loss

   —         —  

Foreign currency translation

   —         —  

Minimum pension liability adjustment

   —         —  

Comprehensive loss

    

Tax benefit on nonqualified stock options

   —         —  

Cash dividends

   —         —  

Restricted stock grants issued

   0.2       —  

Unamortized restricted stock

   —         —  

Exercise of stock options

   2.8       —  
            

Balance at December 31, 2004

   203.9       2

Comprehensive income (loss):

    

Net income

   —         —  

Foreign currency translation

   —         —  

Minimum pension liability adjustment

   —         —  

Unrealized gain on derivative instruments, net

   —         —  

Unrealized loss on investment in debt security, net

   —         —  

Comprehensive income

    

Tax benefit on nonqualified stock options

   —         —  

Cash dividends

   —         —  

Foreign operations concurrent reporting

   —         —  

Restricted stock grants issued

   0.3       —  

Stock repurchased

   (23.9 )     —  

Share put option

   (0.3 )     —  

Unamortized restricted stock

   —         —  

Exercise of stock options

   1.4       —  
            

Balance at December 31, 2005

   181.4       2

Comprehensive income (loss):

    

Net income

   —         —  

Foreign currency translation

   —         —  

Minimum pension liability adjustment

   —         —  

Unrealized loss on derivative instruments, net

   —         —  

Reversal of unrealized loss on investment in debt security, net

   —         —  

Comprehensive income

    

Adoption of FASB Statement No. 158

   —         —  

Tax benefit on nonqualified stock options

   —         —  

Cash dividends

   —         —  

Foreign operations concurrent reporting

   —         —  

Share-based employee compensation

   —         —  

Share put option

   (1.3 )     —  

Exercise of stock options

   2.0       —  
            

Balance at December 31, 2006

   182.1     $ 2
            

The accompanying notes are an integral part of these financial statements.

MEADWESTVACO CORPORATION AND CONSOLIDATED SUBSIDIARY COMPANIES

 

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Additional

paid-in

capital

 

Retained

earnings

 

Accumulated other

comprehensive loss

 

Total shareholders’

equity

$3,870  

  $929    $(88)   $4,713 

—    

  (349)   —      (349)

—    

  —      60    60 

—    

  —      (3)   (3)
       
      (292)
       

6  

  —      —     

—    

  (186)   —      (186)

8  

  —      —     

(6) 

  —      —      (6)

74  

  —      —      74 
             

3,952  

  394    (31)   4,317 

—    

  28    —      28 

—    

  —      (20)   (20)

—    

  —       

—    

  —       

—    

  —      (9)   (9)
       
     
       

2  

  —      —     

—    

  (178)   —      (178)

—    

  (1)   —      (1)

8  

  —      —     

(701)

  —      —      (701)

—    

  —      —      —   

(3) 

  —      —      (3)

36  

  —      —      36 
             

3,294  

  243    (56)   3,483 

—    

  93    —      93 

—    

  —      109    109 

—    

  —      (7)   (7)

—    

  —      (5)   (5)

—    

  —       
       
      199 
       

—    

  —      (57)   (57)

  —      —     

—   

  (167)   —      (167)

—   

  (1)   —      (1)

21 

  —      —      21 

—   

  —      —      —   

53 

  —      —      53 
             

$3,370 

  $168    $(7)   $3,533 
             

 

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FINANCIAL STATEMENTS

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

In millions    Years ended December 31,  
     2006     2005     2004  

Cash flows from operating activities

      

Net income (loss)

   $ 93     $ 28     $ (349 )

Discontinued operations

     —         91       573  

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

      

Depreciation, depletion and amortization

     517       491       489  

Deferred income taxes

     (56 )     (17 )     58  

Gain on sales of assets

     (60 )     (56 )     (165 )

Gain on sale of debt security

     (21 )     —         —    

Loss on early retirement of long-term debt

     —         90       1  

Pension income before settlements, curtailments and termination benefits

     (50 )     (67 )     (86 )

Impairment of long-lived assets

     43       10       35  

Appreciation of cash surrender value policies

     (32 )     (12 )     (13 )

Changes in working capital, excluding the effects of acquisitions and dispositions

     129       (271 )     78  

Other, net

     4       18       12  
                        

Net cash provided by operating activities of continuing operations

     567       305       633  

Discontinued operations

     —         (78 )     289  
                        

Net cash provided by operating activities

     567       227       922  

Cash flows from investing activities

      

Additions to property, plant and equipment

     (302 )     (305 )     (317 )

Payments for acquired businesses, net of cash acquired

     (714 )     (5 )     (101 )

Proceeds from sale of a business

     —         2,186       —    

Proceeds from sale of debt security

     109       —         —    

Proceeds from dispositions of assets

     165       109       281  

Purchase of short-term investments

     —         —         (701 )

Sale of short-term investments

     —         5       706  

Other

     (19 )     (7 )     (8 )

Discontinued operations

     —         2       (67 )
                        

Net cash provided by (used in) investing activities

     (761 )     1,985       (207 )

The accompanying notes are an integral part of these financial statements.

MEADWESTVACO CORPORATION AND CONSOLIDATED SUBSIDIARY COMPANIES

 

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Cash flows from financing activities

      

Proceeds from issuance of long-term debt

     7       1       2  

Repayment of long-term debt

     (2 )     (1,133 )     (525 )

Stock repurchased and put option

     (47 )     (711 )     —    

Dividends paid

     (167 )     (178 )     (186 )

Notes payable and other short-term borrowings, net

     148       (19 )     (20 )

Changes in book overdrafts

     43       (14 )     22  

Proceeds from issuance of common stock and exercises of stock options

     53       36       74  

Discontinued operations

     —         (163 )     (39 )
                        

Net cash provided by (used in) financing activities

     35       (2,181 )     (672 )

Effect of exchange rate changes on cash

     18       (4 )     12  
                        

Increase (decrease) in cash and cash equivalents

     (141 )     27       55  

Cash and cash equivalents:

      

At beginning of period

     297       270       215  
                        

At end of period

   $ 156     $ 297     $ 270  
                        

 

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NOTES TO FINANCIAL STATEMENTS

 

Summary of significant accounting policies

Basis of consolidation and preparation of financial statements: The consolidated financial statements include all majority-owned or controlled entities, and all significant intercompany transactions are eliminated. During 2006 and 2005, certain foreign entities reported results using a November 30 year end. As of December 31, 2006 and 2005, those foreign entities converted to a reporting year end of December 31. The December 2006 and 2005 results associated with these entities were recorded directly to retained earnings. These changes had no material effect to the presentation of the financial statements.

Segment reporting: MeadWestvaco’s principal business segments are (i) Packaging Resources, (ii) Consumer Solutions, (iii) Consumer and Office Products, and (iv) Specialty Chemicals. In the fourth quarter of 2006, the company completed the change in its management and operating structure such that its previously reported Packaging segment was replaced by the Packaging Resources and Consumer Solutions segments. This segment structure reflects the company’s internal reporting to its chief decision makers and aligns the segment disclosure with management’s analysis of results of operations and the process utilized to allocate resources. The company has presented its reportable segments for 2005 and 2004 to reflect the new reporting structure adopted in 2006.

Discontinued operations: Effective April 30, 2005, the company completed the sale of its printing and writing papers business, including its coated and carbonless papers operations consisting of five mills, and approximately 900,000 acres of related forestlands to an affiliate of Cerberus Management LLC, a private investment firm. See Note P for further information. In the quarter ended March 31, 2005, the company began reporting the printing and writing papers business as a discontinued operation. The results for 2004 have been presented on a comparable basis.

Estimates and assumptions: The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of some assets and liabilities and, in some instances, the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.

Translation of foreign currencies: The local currency is the functional currency for substantially all of the company’s significant operations outside the United States. The assets and liabilities of the company’s foreign subsidiaries are translated into U.S. dollars using period-end exchange rates, and adjustments resulting from these financial statement translations are included in accumulated other comprehensive income or loss in the consolidated balance sheets. Revenues and expenses are translated at average rates prevailing during the period.

Cash equivalents: Highly liquid securities with an original maturity of three months or less are considered to be cash equivalents.

Accounts receivable and allowance for doubtful accounts: Trade accounts receivable are recorded at the invoice amount and do not bear interest. The allowance for doubtful accounts is the company’s best estimate of the amount of probable credit losses in the existing accounts receivable. The company determines the allowance based on historical write-off experience by industry. Past due

 

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NOTES TO FINANCIAL STATEMENTS

 

balances over a specified amount are reviewed individually for collectibility. Account balances are charged off against the allowance when it is probable that the receivable will not be recovered.

Inventories: Inventories are valued at the lower of cost or market. Cost is determined using the last-in, first-out (LIFO) method for substantially all raw materials, finished goods and production materials of U.S. manufacturing operations. Cost of all other inventories, including stores and supplies inventories and inventories of non-U.S. manufacturing operations, is determined by the first-in, first-out (FIFO) or average cost methods.

Property, plant, equipment and forestlands: Owned assets are recorded at cost. Also included in the cost of these assets is interest on funds borrowed during the construction period. When assets are sold, retired or disposed of, their cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is reflected in cost of sales. Gains on the sales of forestland are recorded in other income, net. Costs of renewals and betterments of properties are capitalized; costs of maintenance and repairs are charged to expense. Costs of reforestation of forestlands are capitalized. These costs include the costs of seedlings, site preparation, planting of seedlings and early-stage fertilization.

Depreciation and depletion: The cost of plant and equipment is depreciated, utilizing the straight-line method, over the estimated useful lives of the assets, which range from 20 to 40 years for buildings and five to 30 years for machinery and equipment. Timber is depleted as timber is cut at rates determined annually based on the relationship of undepleted timber costs to the estimated volume of recoverable timber. Timber volumes used in calculating depletion rates are based upon merchantable timber volumes at a specific point in time. The depletion rates for company-owned land do not include an estimate of either future reforestation costs associated with a stand’s final harvest or future volume in connection with replanting of a stand subsequent to the final harvest.

Impairment of long-lived assets: The company periodically evaluates whether current events or circumstances indicate that the carrying value of its long-lived assets, including intangible assets, to be held and used may not be recoverable. If such circumstances are determined to exist, an estimate of undiscounted future cash flows produced by the long-lived asset, or the appropriate grouping of assets, is compared to the carrying value to determine whether an impairment exists. If an asset is determined to be impaired, the loss is measured based on quoted market prices in active markets, if available. If quoted market prices are not available, the estimate of fair value is based on various valuation techniques, including a discounted value of estimated future cash flows. The company reports an asset to be disposed of at the lower of its carrying value or its estimated net realizable value.

Goodwill: The company has classified as goodwill the excess of the acquisition cost over the fair values of the net tangible and intangible assets of businesses acquired. The company has determined its reporting units to be components within its Packaging Resources, Consumer Solutions, Consumer and Office Products and Specialty Chemicals segments. In accordance with Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets, goodwill is required to be tested at least annually. SFAS No. 142 requires that goodwill be tested for impairment using a two-step process. The first step is to identify a

 

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NOTES TO FINANCIAL STATEMENTS

 

potential impairment and the second step is to measure the amount of the impairment loss, if any. Goodwill is deemed to be impaired if the carrying amount of a reporting unit’s goodwill exceeds its estimated fair value. See Note C and Note P for further information.

Other assets: Capitalized software, equipment leased to customers and other amortizable and indefinite-lived intangible assets are included in other assets. Capitalized software and other amortizable intangibles are amortized using the straight-line and cash flows methods over their estimated useful lives of three to 21 years. Equipment leased to customers is amortized using the sum-of-the-years-digits method over the estimated useful life of the machine, generally 10 years. Revenue is recognized for the leased equipment on a straight-line basis over the life of the lease and is included in net sales. The company records software development costs in accordance with the American Institute of Certified Public Accountants’ Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. See Note C and Note D for further information.

Financial instruments: The company has, where appropriate, estimated the fair value of financial instruments. These fair value amounts may be significantly affected by the assumptions used, including the discount rate and estimates of cash flow. Accordingly, the estimates presented are not necessarily indicative of the amounts that could be realized in a current market exchange. Where these estimates approximate carrying value, no separate disclosure of fair value is shown. The company utilizes well-defined financial derivatives in the normal course of its operations as a means to manage some of its interest rate, foreign currency and commodity risks. For those derivative instruments, the company has formally designated each as a hedge of specific and well-defined risks. See Note G for further information.

Investment in debt securities: Investments in debt securities are classified as either held to maturity, trading or available-for-sale in accordance with SFAS No. 115, Accounting for Investments in Debt and Equity Securities, as determined by management on an annual basis. Those investments classified as trading or available-for-sale securities shall be measured at fair value in the balance sheet. Unrealized gains or losses on trading securities are recorded to the statement of operations. Unrealized gains or losses on available-for-sale securities are reported in accumulated other comprehensive loss unless it is determined that a loss exists and that loss is determined as “other-than-temporary” in accordance with Staff Positions No. 115-1 and SFAS No. 124-2, The Meaning of Other-than-Temporary Impairment and Its Application to Certain Investments.

Environmental and legal liabilities: Environmental expenditures that increase useful lives of assets are capitalized, while other environmental expenditures are expensed. Liabilities are recorded when remedial efforts are probable and the costs can be reasonably estimated. The company records accruals for other legal contingencies when loss is probable and reasonably estimable. Liabilities recorded for claims are limited to pending cases based on the company’s historical experience, consultation with outside counsel and consultation with an actuarial specialist concerning the feasibility of reasonably estimating liabilities associated with claims that may arise in the future. The company recognizes insurance recoveries when collection is reasonably assured. See Note O for further information.

 

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NOTES TO FINANCIAL STATEMENTS

 

Asset retirement obligations: The company records obligations associated with the retirement of tangible long-lived assets as liabilities when incurred. Subsequent to initial measurement, the company recognizes changes in the amounts of the obligations, as necessary, resulting from the passage of time and revisions to either the timing or amount of estimated cash flows. Effective December 31, 2005, the company adopted Financial Accounting Standards Board (FASB) Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations – an Interpretation of FASB Statement No. 143 (FIN No. 47), which clarifies that the term conditional asset retirement obligation, as used in SFAS No. 143, refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. Thus, the timing and/or method of settlement may be conditional on a future event. Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. The company has certain conditional and unconditional asset retirement obligations associated with owned or leased property plant and equipment, including leases, surface impoundments, asbestos, and water supply wells. Management does not have sufficient information to estimate the fair value of certain obligations, primarily associated with surface impoundments and asbestos, because the settlement date or range of potential settlement dates have not been specified and information is not available to apply expected present value techniques.

Revenue recognition: The company recognizes revenues at the point when title and the risk of ownership passes to the customer. Substantially all of the company’s revenues are generated through product sales and shipping terms generally indicate when title and the risk of ownership have passed. Revenue is recognized at shipment for sales where shipping terms are FOB (free on board) shipping point unless risk of loss is maintained under freight terms. For sales where shipping terms are FOB destination, revenue is recognized when the goods are received by the customer. The company provides allowances for estimated returns and other customer credits such as discounts and volume rebates, when the revenue is recognized, based on historical experience, current trends and any notification of pending returns. Also included in net sales is service revenue which is recognized as the service is performed. Revenue is recognized for leased equipment to customers on a straight-line basis over the estimated term of the lease and is included in net sales of the company.

Shipping and handling costs: Shipping and handling costs are classified as a component of cost of sales. Amounts billed to a customer in a sales transaction related to shipping and handling are classified as revenue.

Research and development: Included in cost of sales and selling, general and administrative expense are expenditures for research and development of approximately $65 million, $50 million and $55 million for the years ended December 31, 2006, 2005 and 2004, respectively, which were expensed as incurred.

Income taxes: Deferred income taxes are recorded for temporary differences between financial statement carrying amounts and the tax basis of assets and liabilities. Deferred tax assets and liabilities reflect the enacted tax rates in effect for the years the differences are expected to reverse. The company evaluates the need for a deferred tax asset valuation allowance by assessing whether it is more likely than not that it will realize its deferred tax assets in the future.

 

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NOTES TO FINANCIAL STATEMENTS

 

For tax-advantaged transactions, the tax benefits are recognized when it is probable that the tax position will be sustained. Otherwise, a tax contingency is recorded and classified in other long-term liabilities.

Share-based compensation: The company adopted SFAS No. 123R, Share-Based Payment, as of January 1, 2006, using the modified prospective method and therefore, prior periods were not restated. This statement requires the recognition of compensation expense to be measured based on the estimated fair value of the share-based awards and recognized as expense over the requisite service period, which is generally the vesting period. The company has elected to record the expense for graded and cliff vesting awards on a straight-line basis over the requisite service period. Substantially all of this compensation expense is recorded as a component of selling, general and administrative expenses. Under this new Statement, pre-tax share-based compensation for the year ended December 31, 2006 was $21 million, including the incremental pre-tax cost of $10 million, relating to stock options and stock appreciation rights. This incremental impact was a reduction to net income of $6 million, or earnings per share of $0.03, net of tax. Substantially all of this compensation expense is recorded as a component of selling, general and administrative expenses. See Note J for further detail on share-based compensation.

Prior to January 1, 2006, the company measured compensation cost for share-based compensation awards issued to employees and directors using the intrinsic value-based method of accounting in accordance with Accounting Principles Board Opinion (APB) No. 25. The company applied APB Opinion No. 25, Accounting for Stock Issued to Employees, as amended, in accounting for its plans. In January 2003, the company adopted the disclosure provisions of SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure. SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value-based method of accounting for share-based employee compensation and amends the disclosure requirements of SFAS No. 123, Accounting for Stock-Based Compensation.

 

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NOTES TO FINANCIAL STATEMENTS

 

If compensation cost for the company’s share-based compensation awards had been determined based on the fair value method in periods prior to 2006, the company’s net income (loss) and net income (loss) per share would have been reduced to the pro forma amounts as follows:

 

In millions, except per share data    Years ended December 31,  
     2005    2004  

Net income (loss) - as reported

   $ 28    $ (349 )

Add: Share-based compensation expense included in reported net income (loss), net of related tax effect

     3      1  

Deduct: Total share-based compensation expense determined under fair value-based method for all awards, net of related tax effect

     11      8  
               

Pro forma net income (loss)

   $ 20    $ (356 )
               

Net income (loss) per share – basic

     

As reported

   $ 0.14    $ (1.73 )

Pro forma

     0.11      (1.77 )

Net income (loss) per share – diluted

     

As reported

   $ 0.14    $ (1.72 )

Pro forma

     0.11      (1.76 )

The pro-forma amounts and fair value of each award grant were estimated on the date of grant using a binomial option pricing model with the following weighted-average assumptions used for grants in 2005 and 2004: risk-free interest rates of 3.98% and 3.30%, respectively; expected dividend yields of 3.05% and 3.21%, respectively; and expected lives of six years and expected volatility of 32% for each year presented.

Income (loss) per share: Basic net income (loss) per share for all the periods presented has been calculated using the weighted average shares outstanding. In computing diluted net income (loss) per share, incremental shares issuable upon the assumed exercise of stock options and other stock-based compensation awards have been added to the weighted average shares outstanding, if dilutive. For the years ended December 31, 2006, 2005 and 2004, 12.4 million, 8.0 million and 7.3 million equity awards, respectively, were excluded from the calculation of weighted average shares, as the exercise price per share was greater than the average market value, resulting in an antidilutive effect on diluted earnings per share.

Related party transactions: The company has certain related party transactions in the ordinary course of business that are insignificant and the terms of which are no more or less favorable to the company than the terms of any other arms-length transaction.

 

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NOTES TO FINANCIAL STATEMENTS

 

New accounting standards

In December 2004, the FASB issued SFAS No. 123-revised 2004 (SFAS No. 123R), Share-Based Payment, which replaces SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. See Note J for further detail on share-based compensation.

In March 2005, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 107, Share-Based Payment (SAB No. 107). SAB No. 107 addresses the interaction between SFAS No. 123R and certain SEC rules and regulations and provides the SEC staff’s views regarding the valuation of share-based payment arrangements for public companies. The company followed the interpretive guidance set forth in SAB No. 107 during its adoption of SFAS No. 123R.

In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, which replaces APB Opinions No. 20 Accounting Changes and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements - An Amendment of APB Opinion No. 28. SFAS No. 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes retrospective application, unless impracticable, as the required method for reporting a change in accounting principle and the reporting of a correction of an error and for reporting a change when retrospective application is impracticable. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years ending after December 15, 2006, and is required to be adopted by the company in the first quarter of 2006. The adoption of SFAS No. 154 did not have an impact on the company’s consolidated financial statements.

In July 2006, the FASB issued Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes, which clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with SFAS No. 109, Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. It also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. This Interpretation is effective for fiscal years beginning after December 15, 2006. The cumulative effects, if any, of applying FIN 48 will be recorded as an adjustment to retained earnings as of the beginning of the period of adoption. The company is currently evaluating the effect that the adoption of FIN 48 will have on its consolidated results of operations and financial condition and is not yet in a position to determine such effects.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This Statement does not require any new fair value measurements, but applies to existing accounting pronouncements that require or permit fair value measurement as the relevant measurement attribute. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The company has not yet determined the impact of adopting this standard.

 

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NOTES TO FINANCIAL STATEMENTS

 

In September 2006, the FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – An Amendment of FASB Statements No. 87, 88, 106, and 132(R). SFAS No. 158 requires an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan in its balance sheet and to recognize the changes in the plan’s funded status in comprehensive income in the year in which the change occurs. These provisions of the Statement are effective as of the end of the first fiscal year ending after December 15, 2006. Pursuant to the Statement’s adoption, the net after-tax charge to accumulated other comprehensive loss in the fourth quarter of 2006 was $57 million, which principally represents the impact of recognizing previously unrecognized prior service costs and actuarial losses. This Statement will not affect the company’s ERISA funding obligations and the company does not currently foresee a need for company contributions to the qualified plans. Funding obligations for non-qualified and non-U.S. plans are discussed in Note K.

In September 2006, the SEC issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB No. 108). SAB No. 108 requires that public companies utilize a “dual-approach” to assessing the quantitative effects of financial misstatements. This dual approach includes both an income statement focused assessment and a balance sheet focused assessment. The guidance in SAB No. 108 must be applied to annual financial statements for fiscal years ending after November 15, 2006. The adoption of SAB No. 108 did not have a material effect on the company’s consolidated financial position or results of operations.

There were no other new accounting standards issued in 2006 that had or are expected to have a material impact on the company’s financial position or results of operations.

 

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NOTES TO FINANCIAL STATEMENTS

 

A. Current assets

Cash equivalents of $39 million and $162 million at December 31, 2006 and 2005, respectively, are valued at cost, which approximates market value. Trade receivables have been reduced by an allowance for doubtful accounts of $15 million and $18 million at December 31, 2006 and 2005, respectively. Receivables also include $64 million and $114 million from sources other than trade at December 31, 2006 and 2005, respectively. Inventories at December 31, 2006 and 2005, are comprised of:

 

In millions    December 31,
     2006    2005

Raw materials

   $ 182    $ 170

Production materials, stores and supplies

     107      101

Finished and in-process goods

     426      443
             
   $ 715    $ 714
             

Approximately 60% and 66% of inventories at December 31, 2006 and 2005, respectively, are valued using the LIFO method. If inventories had been valued at current cost, they would have been $838 million, $813 million and $798 million at December 31, 2006, 2005 and 2004, respectively. The effect of a LIFO layer decrement in 2006 was an increase of $0.02 to earnings per share for the year ended December 31, 2006. The effects of LIFO layer decrements in 2005 and 2004 were not significant to the company’s results of operations.

B. Property, plant, equipment and forestlands

Depreciation and depletion expense was $433 million, $404 million and $409 million for the years ended December 31, 2006, 2005 and 2004, respectively.

 

In millions    December 31,  
     2006     2005  

Land and land improvements

   $ 276     $ 281  

Buildings

     947       903  

Machinery and other

     6,083       5,799  
                
     7,306       6,983  

Less: accumulated depreciation

     (3,501 )     (3,167 )
                
     3,805       3,816  

Forestlands

     488       490  

Construction in progress

     230       181  
                
   $ 4,523     $ 4,487  
                

 

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C. Goodwill and other intangible assets

Unless otherwise deemed necessary by changes in circumstances, the company performs its annual impairment review during the fourth quarter of each year.

On July 5, 2006, the company completed its acquisition of Saint-Gobain Calmar from Compagnie de Saint-Gobain. As a result of the purchase price allocation, goodwill in the amount of $302 million was recorded. See Note P for further discussion.

In the second quarter of 2005, the company sold its printing and writing papers business to an affiliate of Cerberus Management LLC. The net proceeds from the sale were less than the carrying value of the net assets sold, resulting in an impairment of all goodwill related to those operations ($238 million, or $1.18 per share), which was recorded in 2004. The goodwill impairment charge for 2004 is included in discontinued operations. See Note P for additional details associated with the sale of the printing and writing papers business.

No additional goodwill impairment charge was necessary as a result of the 2006, 2005 or 2004 annual impairment reviews.

As of December 31, 2006, goodwill allocated to each of the company’s business segments was $68 million to Packaging Resources, $540 million to Consumer Solutions, $234 million to Consumer and Office Products, and $9 million to Specialty Chemicals.

The changes in the carrying amount of goodwill for the years ended December 31 are as follows:

 

In millions    2006     2005

Beginning balance

   $ 559     $ 557

Acquired goodwill1

     302       —  

Adjustments2

     (10 )     2
              

Ending balance

   $ 851     $ 559
              

1

Represents goodwill associated with the acquisition of Calmar.

2

Represents adjustments to tax contingencies, foreign currency translation and certain purchase price allocations.

The following table summarizes intangible assets subject to amortization included in other assets:

 

In millions    December 31, 2006,    December 31, 2005,
     Gross carrying
amount
   Accumulated
amortization
   Gross carrying
amount
   Accumulated
amortization

Intangible assets, subject to amortization:

           

Trademarks and trade names

   $ 208    $ 53    $ 207    $ 41

Customer contracts and lists

     278      46      105      35

Patents

     59      28      40      21

Other – primarily licensing rights

     30      15      36      10
                           
   $ 575    $ 142    $ 388    $ 107
                           

 

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In connection with the company’s acquisition of Saint-Gobain Calmar in July 2006, the company acquired indefinite-lived intangible assets of $91 million, in addition to amortizable intangible assets of $186 million. See Note P for further discussion.

The company recorded amortization expense of $37 million, $33 million and $30 million for the years ended December 31, 2006, 2005 and 2004, respectively, relating to intangible assets subject to amortization.

Based on the current carrying value of intangible assets subject to amortization, the estimated amortization expense for each of the next five years is as follows: 2007 - $41 million, 2008 - $37 million, 2009 - $36 million, 2010 - $35 million, and 2011 - $30 million.

D. Other assets

 

In millions    December 31,
     2006    2005

Identifiable intangible assets

   $ 524    $ 281

Cash surrender value of life insurance, net of borrowings

     197      229

Capitalized software, net

     62      60

Equipment leased to customers, net

     95      86

Available-for-sale securities

     —        70

Other

     98      112
             
   $ 976    $ 838
             

As part of the consideration from the sale of the printing and writing papers business in 2005, the company received $100 million in aggregate principal amount of senior unsecured payable-in-kind (PIK) promissory notes (fair value of $75 million at date of issuance) of a subsidiary (NewPage Corporation) of the purchaser. These securities were floating rate notes that bore interest at a rate of six-month LIBOR (London Interbank Offered Rate). The PIK notes were classified as available-for-sale securities and to be repaid to the company by the purchaser before there were any distributions made to the equity holders of the purchaser. During 2006, the company reclassified to net income an after-tax gain of $13 million ($21 million pre-tax) associated with the sale of the PIK notes. The unrealized holding gain related to the PIK notes arising during 2006 was $22 million, net of taxes. During 2005, the company recorded a net unrealized holding loss of $9 million on these PIK notes. That net unrealized loss was included in accumulated other comprehensive loss at December 31, 2005.

 

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E. Accounts payable and accrued expenses

 

In millions    December 31,
     2006    2005

Accounts payable:

     

Trade

   $ 465    $ 374

Other

     87      42
             
   $ 552    $ 416
             

Accrued expenses:

     

Taxes, other than income

   $ 28    $ 35

Interest

     64      60

Payroll and employee benefit costs

     264      201

Accrued rebates and allowances

     118      126

Environmental and litigation – current portion

     30      35

Income taxes payable

     12      13

Freight

     11      15

Restructuring

     50      11

Other

     125      117
             
   $ 702    $ 613
             

F. Notes payable and long-term debt

Notes payable and current maturities of long-term debt consisted of the following:

 

In millions    December 31,
     2006    2005

Commercial paper borrowings

   $ 148    $ —  

Other short-term borrowings

     11      11

Current maturities of long-term debt

     52      2
             
   $ 211    $ 13
             

The maximum amounts of combined commercial paper borrowings outstanding during the years ended December 31, 2006 and 2005 were $355 million and $115 million, respectively. The average amount of commercial paper borrowings outstanding during the years ended December 31, 2006 and 2005 was $136 million and $1 million, respectively, with an average interest rate of 5.5% and 3.1%, respectively. Approximately $190 million of the $340 million initial commercial paper borrowings related to the acquisition of Saint-Gobain Calmar were paid down in 2006 from cash flow from operations. There were $11 million of short-term borrowings at December 31, 2006 and 2005 related to certain foreign operations.

In the period from January 1, 2007 to February 1, 2007, the holders of the company’s 6.84% debentures, due 2037, were entitled to elect early repayment, in whole or in part, at 100% of the principal amount outstanding. Holders elected early repayment of $45 million, which will be paid by the company on March 1, 2007, and the repayment amount is included in current maturities of long-term debt as of December 31, 2006.

 

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Long-term debt consisted of the following:

 

In millions    December 31,  
     2006     2005  

Notes, rates from 6.85% to 7.10%, due 2009-2012

   $ 676     $ 679  

Debentures, rates from 6.80% to 9.75%, due 2017-2047

     1,227       1,227  

Sinking fund debentures, rates from 7.50% to 7.65%, due 2008-2027

     299       299  

Medium-term notes

     6       6  

Pollution Control Revenue Bonds:

    

Rate 6.375%, due 2026

     6       6  

Industrial Revenue Bonds:

    

Rate 7.67%, due 2027

     80       80  

Other bank term loans

     58       58  

Capital lease obligations

     62       61  

Other long-term debt

     10       3  
                
     2,424       2,419  

Less: amounts due within one year

     (52 )     (2 )
                

Long-term debt

   $ 2,372     $ 2,417  
                

As of December 31, 2006, outstanding debt maturing in the next five years is (in millions): 2007 - $211, 2008 - $17, 2009 - $66, 2010 - $15, and 2011 - $15.

Capital lease obligations consist primarily of Industrial Development Revenue Bonds in the amount of $51 million that mature in May 2035 with an average effective interest rate of 6.4%.

In December 2005, MeadWestvaco amended its bank credit agreement. The agreement was amended to reduce the credit facility from $1 billion to $750 million and to extend the maturity date to December 1, 2010. Borrowings under the agreement can be unsecured domestic or eurodollar notes and at rates approximating prime or the London Interbank Offered Rate (LIBOR) at the company’s option. The $750 million credit agreement contains a financial covenant limiting the percentage of total debt to total capitalization (including deferred taxes) to 55%, as well as certain other covenants with which the company was in compliance at December 31, 2006. The company’s commercial paper program is supported by its $750 million revolving credit facility which was undrawn at December 31, 2006. The company had $148 million of commercial paper borrowings outstanding at December 31, 2006.

The company utilized a portion of the cash proceeds from the sale of its printing and writing papers business in 2005 to retire approximately $1 billion of debt. The charges incurred to retire the debt in 2005 were approximately $90 million, compared to insignificant debt retirement fees in 2006 and 2004.

The percentage of debt to total capital was 42.2% and 41.1% at December 31, 2006 and 2005, respectively.

At December 31, 2006, the book value of financial instruments included in long-term debt was $2.4 billion, and the fair value was estimated to be $2.6 billion. At December 31, 2005, the book value of financial instruments included in long-term debt was $2.4 billion, and the fair value was estimated to be $2.7 billion. The difference between book value and market value is derived

 

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from the difference between the period-end market interest rate and the stated rate for the company’s fixed-rate, long-term debt. The company has estimated the fair value of financial instruments based upon quoted market prices for the same or similar issues or on the current interest rates available to the company for debt of similar terms and maturities.

G. Financial instruments

The company uses various derivative financial instruments as part of an overall strategy to manage exposure to market risks associated with interest rate, foreign currency exchange rate and commodity price fluctuations. The company does not hold or issue derivative financial instruments for trading purposes. The risk of loss to the company in the event of nonperformance by any counterparty under derivative financial instrument agreements is not considered significant by management. Although the derivative financial instruments expose the company to market risk, fluctuations in the value of the derivatives are mitigated by expected offsetting fluctuations in the matched instruments. All derivative instruments are required to be recorded on the consolidated balance sheets as assets or liabilities, measured at fair value. If the derivative is designated as a fair-value hedge, the changes in the fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in earnings. If the derivative is designated as a cash-flow hedge, the effective portion of the change in the fair value of the derivative is recorded in other comprehensive loss and is recognized in the statements of operations when the hedged item affects earnings. Ineffective portions of changes in the fair value of cash-flow hedges and financial instruments not designated as hedges are recognized in earnings.

Natural gas

In order to better predict and control the future cost of natural gas consumed at the company’s mills and plants, the company engages in financial hedging of future gas purchase prices. Gas usage is relatively predictable month-by-month. The company “locks in” the cost of a portion of its future natural gas usage by entering into swap agreements. The hedging instrument is futures price contracts of NYMEX gas. The company does not hedge basis (the effect of varying delivery points or location) or transportation (the cost to transport the gas from the delivery point to a company location) under these transactions.

Unrealized gains and losses on contracts maturing in future months are recorded in accumulated other comprehensive loss and are charged or credited to earnings for the ineffective portion of the hedge. Once a contract matures, the company has a realized gain or loss on the contract up to the quantities of natural gas in the forward swap agreements for that particular period, which are charged or credited to earnings when the related hedge item affects earnings.

 

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Details on the natural gas hedges are included below:

 

In millions    December 31,
     2006    2005

Estimated pre-tax losses to be recognized in operations within:

     

2007

   $ 4    —  

2008

     1    —  

Maximum remaining term (in years) of existing hedges

     2    —  

 

In millions    Years ended December 31,
     2006    2005    2004

Net unrealized losses in accumulated other comprehensive loss, net of tax

   $ 3    —      —  

Net losses reclassified to operations, net of tax

     1    —      —  

Amount of gain or loss recognized in operations due to the probability that forecasted transactions will not occur

     —      —      —  

Interest rate risk

The company utilizes interest-rate swap agreements to manage a portion of its interest-rate risk on its debt instruments. As part of an overall strategy to maintain an appropriate level of exposure to interest-rate fluctuations, the company has developed a targeted mix of fixed-rate and variable-rate debt. To efficiently manage this mix, the company may utilize interest-rate swap agreements. The company has interest-rate swaps designated as fair-value hedges of certain fixed-rate borrowings. There were no interest-rate swaps designated as cash-flow hedges at December 31, 2006 and 2005. The maturity dates on these swaps match the maturity dates of the underlying debt. During the years ended December 31, 2006, 2005 and 2004, the interest-rate swaps were an effective hedge and, therefore, required no charge to earnings due to ineffectiveness in accordance with SFAS No. 133. Details on the interest-rate swaps are included below:

 

In millions    December 31,
     2006     2005

Notional amount

   $ 525     $ 475

Fair value

     (3 )     2

Carrying amount

     (1 )     1

Net unrealized (loss) gain

     (2 )     1

Foreign currency risk

The company uses foreign currency forward contracts to manage some of the foreign currency exchange risks associated with certain short-term foreign intercompany loans, some foreign currency sales and purchases of its international operations, and some foreign sales of its U.S. operations. Using such forward contracts, the company receives or pays the difference between the contracted forward rate and the exchange rate at the settlement date. These contracts are used to hedge the variability of exchange rates on the

 

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company’s cash flows. The forward contracts related to certain intercompany loans are short term in duration and are not designated as hedging instruments under SFAS No. 133. Other forward contracts, which are for terms of up to one year, are designated as cash-flow hedges under SFAS No. 133. Information related to the company’s foreign currency forward contracts is as follows:

Intercompany loans, without hedge accounting:

 

In millions    December 31,
     2006     2005

Notional amount

   $ 55     $ 98

Fair value

     (.4 )     1

Carrying amount

     (.4 )     1

Foreign currency sales and purchases, with hedge accounting:

 

In millions    December 31,
     2006     2005

Notional amount

   $ 62     $ 106

Estimated amount to be recognized in operations within the next year

     (.3 )     2

Maximum remaining term (in years) of existing hedges

     1       1

 

In millions    Years ended December 31,
     2006     2005    2004

Net unrealized losses in accumulated other comprehensive loss

   $ (.3 )   $ 2    —  

Net (losses) gains reclassified to operations

     (1 )     4    —  

Amount of gain or loss recognized in operations due to the

probability that forecasted transactions will not occur

     —         —      —  

 

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H. Leasing activities and other commitments

The company leases a variety of assets for use in its operations. Leases for administrative offices, converting plants and storage facilities generally contain options, which allow the company to extend lease terms for periods up to 25 years or to purchase the properties. Certain leases provide for escalation of the lease payments as maintenance costs and taxes increase. Minimum rental payments pursuant to agreements in force as of December 31, 2006, under operating leases that have noncancellable lease terms in excess of 12 months and under capital leases are as follows:

 

In millions    Operating leases    Capital leases  

2007

   $ 52    $ 4  

2008

     41      4  

2009

     33      5  

2010

     29      4  

2011

     21      4  

Later years

     46      143  
               

Minimum lease payments

   $ 222      164  
         

Less: amounts representing interest

        (102 )
           

Capital lease obligations

      $ 62  
           

Rental expense under operating leases was $83 million, $75 million and $86 million for the years ended December 31, 2006, 2005 and 2004, respectively.

On January 11, 2007, the company entered into a lease agreement with a third party pursuant to which the company will lease a facility for its corporate headquarters in Richmond, Virginia with an initial term of 13.5 years. It is expected that the lease commencement date will be in the third quarter of 2009, after about a two-year construction period. The annual minimum rental payments associated with this agreement, which will depend largely in part on the final cost of the facility and the amount of square footage leased, are estimated to be between $9 million and $10 million, beginning in the second half of 2009.

I. Shareholders’ equity

The value included in common stock at December 31, 2006 and 2005, reflects the outstanding shares of common stock at the $0.01 par value per share.

During the year ended December 31, 2005, approximately $700 million of the approximately $2.2 billion in proceeds from the sale of the company’s printing and writing papers business, was used to repurchase a total of almost 24 million, or 12%, of the company’s outstanding common shares. The repurchased shares, upon retirement, were recorded as a reduction of common stock and additional paid-in capital pursuant to the regulations of the State of Delaware, the state of incorporation, and the approval by the company’s Board of Directors.

 

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The cumulative components at year end of accumulated other comprehensive loss for 2006 and 2005 are as follows:

 

In millions    December 31,  
     2006     2005  

Foreign currency translation

   $ 70     $ (39 )

Minimum pension liability (see Note K)

     —         (10 )

Adoption of FASB Statement No. 158 (see Note K)

     (74 )     —    

Unrealized holding loss on debt security (see Note D)

     —         (9 )

Unrealized gain/(loss) on derivative instruments (see Note G)

     (3 )     2  
                
   $ (7 )   $ (56 )
                

At December 31, 2006, there were approximately 181 million preferred stock purchase rights outstanding, each representing the right to purchase 1/100th of a share of Series A Junior Participating Preferred Stock for an exercise price of $150. Pursuant to a Rights Agreement approved by the company’s Board of Directors in 2002, in the event a person or group were to acquire a 15% or greater position in the company, each right would become exercisable for 1/100th of a share of preferred stock which would entitle its holder (other than the acquirer) to buy that number of shares of common stock of MeadWestvaco which, at the time of the 15% acquisition, at a market value of two times the exercise price of the rights. If, after the rights have been triggered, an acquiring company were to merge or otherwise combine with the company or MeadWestvaco were to sell 50% or more of its assets or earning power, each right would entitle its holder (other than the acquirer) to buy that number of shares of common stock of the acquiring company which, at the time of such transaction, would have a market value of two times the exercise price of the rights. The rights have no effect on earnings per share until they become exercisable. The rights expire in December 2012. At December 31, 2006, there were authorized and available for issue 30 million shares of preferred stock, par value $0.01 per share, of which six million shares were designated as Series A Junior Participating Preferred Stock and reserved for issuance upon exercise of the rights.

Dividends declared were $0.92 per share in each of the years ended December 31, 2006, 2005 and 2004.

The company had an original obligation to the former owner of a subsidiary to buy back approximately 1.6 million shares (share put) of MeadWestvaco stock issued as part of the purchase price at a fixed rate; the value of this share repurchase approximated $58 million. During 2005, the company purchased and retired 0.3 million of these shares for approximately $11 million and in 2006, the company repurchased and retired the remaining 1.3 million shares for approximately $47 million.

In October of 2005, the company’s Board of Directors authorized the future repurchase of up to 5 million shares, primarily to avoid dilution of earnings per share relating to the exercise of employee stock options. The 1.6 million shares repurchased under the put option are not a reduction of the share repurchases authorized by the Board of Directors. The number of shares available for repurchase under this program at December 31, 2006, was 4,707,422.

 

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J. Share-based compensation

The company adopted SFAS No.123R, Share-Based Payment, as of January 1, 2006, using the modified prospective method and therefore, prior periods were not restated. This statement requires the recognition of compensation expense when an entity obtains employee services in share-based payment transactions. Under this new standard, pre-tax share-based compensation for the year ended December 31, 2006 was $21 million, including incremental pre-tax cost of $10 million relating to stock options and stock appreciation rights. This incremental impact was a reduction to net income of $6 million, or earnings per share of $0.03, net of tax. Substantially all of this compensation expense is recorded as a component of selling, general and administrative expenses. The cumulative effect of a change in accounting principle associated with the adoption of SFAS No. 123R was immaterial to the consolidated financial statements. For all awards granted by the company, compensation expense is recognized on a straight-line basis over the vesting period, generally three years. The company has used the “long-haul” method to determine the pool of tax benefits or deficiencies resulting from tax deductions related to awards of equity instruments that exceed or are less than the cumulative compensation cost for those instruments recognized for financial reporting.

Officers and key employees have been granted share-based awards under various stock-based compensation plans, all of which have been approved by the shareholders. At December 31, 2006, MeadWestvaco had five such plans under which share-based awards are available for grant. There were an aggregate of 28 million shares initially reserved under the 1991 and 1996 Stock Option Plans, the 1995 Salaried Employee Stock Incentive Plan, the 1999 Salaried Employee Stock Incentive Plan and the 2005 Performance Incentive Plan for the granting of stock options, stock appreciation rights (SARs), restricted stock and restricted stock units to key employees. For all of the employee plans, there were 11 million shares available for grant as of December 31, 2006. The vesting of such awards may be conditioned upon either a specified period of time or the attainment of specific performance goals as determined by the plan. Grants of stock options and other share-based compensation awards are approved by the Compensation and Organization Development Committee of the Board of Directors. The exercise price of all stock options equals the market price of the company’s stock on the date of grant. Stock options and SARs are exercisable after a period of three years and expire no later than 10 years from the date of grant. Under certain employee plans, stock options may be granted with or without stock appreciation rights or limited stock appreciation rights, which are exercisable upon the occurrence of certain events related to changes in corporate control. Granting of stock appreciation rights is generally limited to employees of the company who are located in countries where the issuance of stock options is not advantageous.

Options to purchase 1.3 million shares issued under the 1996 Stock Option Plan are accompanied by a feature that allows option holders who exercise their stock options and hold the common shares they received at exercise to receive an additional stock option grant with an exercise price at the then-current market price.

The MeadWestvaco Corporation Compensation Plan for Non-Employee Directors provides for the grant of stock awards up to approximately 500,000 shares to outside directors in the form of stock options or stock units. Non-employee members of the Board of Directors are currently granted restricted stock units, which vest immediately and are distributed in the form of stock shares on the

 

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date that a director ceases to be a member of the Board of Directors. A restricted stock unit is the right to receive a share of company stock. In 2006, 2005 and 2004, the total annual grants consisted of 25,558, 24,710 and 28,071 restricted stock units, respectively, for non-employee directors. There were 91,519 of these shares of restricted stock units issued and outstanding as of December 31, 2006. There were 335,367 shares remaining for grant under this plan at December 31, 2006.

Stock options and stock appreciation rights

The company has estimated the fair value of its stock option and SAR awards granted after January 1, 2006, using a lattice-based option valuation model. Lattice-based option valuation models utilize ranges of assumptions over the expected term of the options. Expected volatilities are based on the historical and implied volatility of the company’s stock. The company uses historical data to estimate option and SAR exercises and employee terminations within the valuation model. The expected term of options granted is derived from the output of the option valuation model and represents the period of time that options and SARs granted are expected to be outstanding. The risk-free rate for the period within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. A summary of the assumptions is as follows:

 

Lattice-based option valuation assumptions

   2006  

Weighted average fair value of stock options granted during the period

   $ 7.64  

Weighted average fair value of SARs granted during the period

   $ 7.06  

Expected dividend yield for stock options

     3.27 %

Expected dividend yield for SARs

     3.38 %

Expected volatility

     28 %

Average risk-free interest rate for stock options

     4.71 %

Average risk-free interest rate for SARs

     4.78 %

Average expected term for options and SARs (in years)

     8  

 

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The following table summarizes stock option and SAR activity in the plans.

 

Shares in thousands    Options     Weighted
average
exercise
price
   SARs    

Weighted
average
exercise

price

   Weighted
average
remaining
contractual
term
   Aggregate
intrinsic value
(in millions)

Outstanding at January 1, 2004

   18,108     $ 28.60    127     $ 26.60      

Granted

   1,095       28.65    —         —        

Exercised

   (2,811 )     26.72    (5 )     26.74       $ 13.6

Cancelled

   (475 )     28.57    (9 )     24.00      
                       

Outstanding at December 31, 2004

   15,917       28.94    113       26.80      

Granted

   1,518       30.18    143       30.21      

Exercised

   (1,462 )     26.52    (9 )     25.48         5.6

Cancelled

   (960 )     29.36    (20 )     29.69      
                       

Outstanding at December 31, 2005

   15,013       29.27    227       28.75      

Granted

   1,050       28.13    309       27.46      

Exercised

   (2,096 )     26.90    (2 )     25.51         4.9

Cancelled

   (972 )     30.21    (44 )     29.28      
                       

Outstanding at December 31, 2006

   12,995       29.49    490       29.55    4.2 years      17.3

Exercisable at December 31, 2006

   10,989       29.58    131       27.88    3.2 years      14.4

Exercisable at December 31, 2005

   12,531       29.27    84       27.57    3.3 years      6.6

Exercisable at December 31, 2004

   13,413       29.35    72       28.11    3.6 years   

At December 31, 2006, there was approximately $18 million of unrecognized pre-tax compensation cost related to nonvested stock options and SARs, which is expected to be recognized over a weighted-average period of 1.6 years. Pre-tax compensation expense for stock options and SARs was $10 million for 2006 and the tax benefits associated with these expenses were $4 million.

The company measures compensation expense related to the stock appreciation rights at the end of each period. Changes in the fair value are reflected as an adjustment of accrued compensation liability and compensation expense in the periods in which the changes occur.

Total cash received from the exercise of share-based instruments in 2006 was approximately $53 million.

Restricted stock and restricted stock units

A restricted stock unit is the right to receive a share of company stock. Restricted stock and restricted stock units granted vest over three years. The awards granted in 2006 and 2005 consisted of both service and performance vesting restricted stock units. The total compensation expense is being recorded over the shares’ three-year vesting period. Under the plans, the owners of the stock are entitled to voting rights and to receive dividends, but will forfeit the stock if the individual holder separates from the company during the three-year vesting period or if predetermined goals are not accomplished relative to return on invested capital, revenue from new products, total procurement savings and reduction in selling, general and administrative expenses. The fair value of each share of restricted stock and restricted stock unit is the market price of the company’s stock on the date of grant, and is charged to operations over the vesting period. Performance-based awards granted in 2006 and 2005 were 510,170 and 281,420, respectively. None of these

 

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grants were vested as of December 31, 2006.

The following table summarizes restricted stock and restricted stock unit activity in the plans (excluding non-employee director plans).

 

Shares in thousands    Shares    

Average grant

date fair market

value

Outstanding at January 1, 2004

   —       $ —  

Granted

   246       28.59

Forfeited

   (3 )     28.59

Released

   —         —  
        

Outstanding at December 31, 2004

   243       28.59

Granted

   281       30.21

Forfeited

   (4 )     29.33

Released

   —         —  
        

Outstanding at December 31, 2005

   520       29.06

Granted

   823       28.12

Forfeited

   (77 )     27.70

Released

   (25 )     28.59
        

Outstanding at December 31, 2006

   1,241       28.82
        

As of December 31, 2006, there was approximately $19 million of unrecognized pre-tax compensation cost related to nonvested restricted stock and restricted stock units, which is expected to be recognized over a weighted-average period of 1.6 years. Pre-tax compensation expense for restricted stock and restricted stock units was $11 million for the year ended December 31, 2006, and $5 million for the year ended December 31, 2005, respectively, and the tax benefit associated with this expense was $4 million and $2 million, respectively. Dividends, which are payable in stock, accrue on the restricted stock unit grants and are subject to the same specified terms as the original grants.

K. Employee retirement, postretirement and postemployment benefits

Retirement plans

MeadWestvaco provides retirement benefits for substantially all U.S. and certain non-U.S. employees under several noncontributory trusteed plans and also provides benefits to employees whose retirement benefits exceed maximum amounts permitted by current tax law under unfunded benefit plans. Benefits are based on a final average pay formula for the salaried plans and a unit benefit formula for the bargained hourly plans. Prior service costs are amortized on a straight-line basis over the average remaining service period for active employees. Contributions are made to the funded plans in accordance with ERISA requirements.

In August 2006, the President signed into law the Pension Protection Act of 2006 (PPA). The PPA establishes new minimum funding rules for defined benefit pension plans beginning in 2008. The company does not anticipate any required funding to the U.S. qualified retirement plans as a result of this legislation in the foreseeable future due to the overfunded status of the plans.

 

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In September 2006, the FASB issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—An Amendment of FASB Statement Nos. 87, 88, 106, and 132(R). SFAS No. 158 requires an employer to recognize the overfunded or underfunded status of a defined benefit and postretirement plan in its balance sheet and to recognize the changes in the plan’s funded status in comprehensive income in the year in which the change occurs. These provisions of the Statement are effective as of the end of the first fiscal year ending after December 15, 2006. SFAS No. 158 also requires an employer to measure the funded status of a plan as of the date of its fiscal year end, which is consistent with the Company’s measurement date. The impact of adopting SFAS No. 158 as of December 31, 2006 was a net increase to accumulated other comprehensive loss in the amount of $57 million, net of tax.

In October 2006, the Board of Directors approved the creation of a cash balance formula within the Company’s existing retirement plans for salaried and non-bargained hourly employees. The formula will provide cash balance credits at the rate of 4%—8% of eligible earnings, depending upon age and years of service points, with interest credited annually at the 30-year Treasury rate. Effective July 1, 2006, all U.S. Calmar employees began accruing cash balance credits under this new formula. Effective January 1, 2007, all newly hired U.S. employees will accrue benefits under this new formula. Effective January 1, 2008, all U.S. employees age 40 and over at that time will be provided the opportunity to make a one-time choice between the existing final average pay and cash balance formulas and all U.S. employees less than age 40 at that time will begin accruing cash balance credits under this formula. The adoption of this change reduced retirement plan liabilities by $25 million as of December 31, 2006 and increased net periodic pension income for 2006 by $1 million.

Net periodic pension cost (income) relating to employee retirement benefits was $(49) million, $48 million and $(36) million for the years ended December 31, 2006, 2005 and 2004, respectively. In accordance with the provisions of SFAS No. 88, Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits, settlements, curtailments and termination benefits associated with merger-related and restructuring activities were recorded. Net periodic pension cost (income) reflects cumulative favorable investment returns on plan assets. Prior service cost and actuarial gains and losses subject to amortization are amortized on a straight-line basis over the average remaining service, which is about 11 years.

 

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The components of net pension cost (income) for each of the periods presented are as follows:

 

In millions

   Years ended December 31,  
     2006     2005     2004  

Service cost-benefits earned during the period

   $ 59     $ 53     $ 67  

Interest cost on projected benefit obligation

     142       141       148  

Expected return on plan assets

     (262 )     (273 )     (298 )

Amortization of prior service cost

     7       7       11  

Amortization of net loss (gain)

     4       2       (1 )
                        

Pension income before settlements, curtailments and termination benefits

     (50 )     (70 )     (73 )

Settlements

     —         115       —    

Curtailments

     —         —         37  

Termination benefits

     1       3       —    
                        

Net periodic pension cost (income)

   $ (49 )   $ 48     $ (36 )
                        
The components of other changes in plan assets and benefit obligations recognized in other comprehensive loss:  
     2006              

Net actuarial loss

   $ 111      

Prior service cost

     41      
            

Total recognized in other comprehensive loss

   $ 152      
            

Total recognized in net periodic pension cost (income) and other comprehensive loss

   $ 103      
            

The estimated net actuarial loss and prior service cost for the defined benefit retirement plans that will be amortized from accumulated other comprehensive loss into net periodic benefit cost in 2007 is $5 million and $6 million, respectively.

In January 2005, the company reached an agreement to sell its printing and writing papers business and related assets. As a result, the company recorded a charge of $37 million relating to special termination benefits and a curtailment loss in the retirement plans at December 31, 2004. In 2005, a settlement loss in the retirement plans of $110 million was also recorded. Tabular amounts were not adjusted for discontinued operations resulting from the sale. Net pension income from continuing operations, before settlements, curtailments and termination benefits, was $67 million and $86 million in 2005 and 2004, respectively.

Postretirement benefits

MeadWestvaco provides life insurance for substantially all retirees and medical benefits to certain retirees in the form of cost subsidies until Medicare eligibility is reached and to certain other retirees, medical benefits up to a maximum lifetime amount. The company funds certain medical benefits on a current basis with retirees paying a portion of the costs. Certain retired employees of businesses acquired by the company are covered under other medical plans that differ from current plans in coverage, deductibles and retiree contributions. Prior service cost

 

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and actuarial gains and losses subject to amortization are amortized over the average remaining service, which is about 6 years. In 2004, the company modified certain postretirement healthcare benefits to be provided to future retirees. This change reduced the postretirement benefit obligation by about $68 million, and is being amortized over the remaining life of the eligible employees, which is approximately 24 years.

The components of net postretirement benefits cost (income) for each of the periods presented are as follows:

 

In millions    Years ended
December 31,
 
     2006     2005     2004  

Service cost-benefits earned during the period

   $ 3     $ 5     $ 7  

Interest cost

     8       9       12  

Expected return on plan assets

     —         —         —    

Net amortization

     (1 )     —         5  
                        

Postretirement expense before curtailments and termination benefits

     10       14       24  

Curtailments

     —         (29 )     —    

Termination benefits

     —         —         (1 )
                        

Net periodic postretirement benefits cost

   $ 10     $ (15 )   $ 23  
                        
The components of other changes in plan assets and benefit obligations recognized in other comprehensive loss:  
     2006              

Net actuarial gain

   $ (15 )    

Prior service benefit

     (33 )    
            

Total recognized in other comprehensive loss

   $ (48 )    
            

Total recognized in net periodic postretirement benefit cost (income) and other comprehensive loss

   $ (38 )    
            

The estimated net actuarial gain and prior service benefit for the postretirement plans that will be amortized from accumulated other comprehensive loss into net periodic postretirement benefit cost in 2007 is $(1) million, allocated equally between components.

In 2005, a curtailment gain of $29 million, related to the sale of the printing and writing papers business, was recorded. Tabular amounts were not adjusted for discontinued operations resulting from the sale. Net periodic postretirement benefit cost from continuing operations, before curtailments and termination benefits, was $13 million and $21 million in 2005 and 2004, respectively.

The following table also sets forth the funded status of the plans and amounts recognized in the Consolidated Balance Sheets at December 31, 2006 and 2005, based on a measurement date of December 31 for each period.

 

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Obligations, assets and funded status

 

In millions    Qualified U.S.
Retirement Plans
    Nonqualified U.S.
and Non - U.S.
Retirement Plans
    Postretirement
Benefits
 
     Years ended
December 31,
    Years ended
December 31,
    Years ended
December 31,
 
     2006     2005     2006     2005     2006     2005  

Change in benefit obligation:

            

Benefit obligation at beginning of period

   $