Executive Summary
Our revenues, operating income and cash flows are primarily derived from three core business segments: Forest Resources, Real Estate and Performance Fibers. We own or lease (under long-term agreements) approximately 2.4 million acres of timberland and real estate in Alabama, Arkansas, Florida, Georgia, Louisiana, Mississippi, New York, Oklahoma, Texas and Washington. We also manage and have a 26 percent interest in a joint venture with 0.3 million acres of timberland in New Zealand. We believe we are the seventh largest private landowner in the United States. Our Real Estate business seeks to maximize the value of our properties which are more valuable for development, recreational or conservation uses than for growing timber, and sell our non-strategic timberland. Our Performance Fibers business has been a supplier of premier cellulose specialty grades of pulp for over eighty-five years and we are on schedule to complete the cellulose specialties expansion ("CSE") at our Jesup, Georgia mill in mid-2013. We have consistently generated strong cash flows and operating results by focusing on the following critical financial measures: segment operating income and EBITDA, cash available for distribution in total and on a per-share basis, debt to EBITDA ratio, debt to capital ratio, return on equity, return on fair market value (Forest Resources and Real Estate) and return on capital employed (Performance Fibers). Key non-financial measures include safety and environmental performance, quality, production as a percent of capacity and various yield statistics.
Our focus is on cash generation, effective allocation of capital and maximizing returns for shareholders. Our strategy consists of the following key elements:
• Increase the size and quality of our timberland holdings through timberland acquisitions while selling timberland that no longer meets our strategic or financial return requirements. This strategy, which requires a disciplined approach and rigorous adherence to strategic and financial metrics, can result in significant year-to-year variation in timberland acquisitions and divestitures. For example, we acquired 88,000 acres of timberland in 2012, 308,000 acres in 2011, 3,000 acres in 2010, none in 2009, and 110,000 acres in 2008. We sold approximately 14,000, 12,000 and 45,000 acres of non-strategic timberland in 2012, 2011 and 2010, respectively.

• Extract maximum value from our HBU properties. In prior years our focus on development properties was to obtain entitlements. Our entitlement efforts are largely complete as we have approximately 39,000 acres entitled in Florida and Georgia. We now will continue to work on monetizing these properties. For our prime industrial and commercial properties, we have focused on mega-site certification. In 2012 we achieved certification of 1,400 acres in Bryan County, GA as development-ready for large industrial or commercial uses. We have also made significant progress on certification of an 1,800 acre industrial site in Nassau County, FL. We will continue our rural HBU program of sales for conservation, recreation and industrial uses. Our primary markets are in our Southern U.S. holdings.

• Maintain our global leadership in high purity cellulose specialties through investments to increase capacity, and improve product quality and technical expertise. In May 2011, our Board of Directors approved the CSE to convert a fiber line at our Jesup, Georgia mill from production of absorbent materials to cellulose specialties. The CSE will add approximately 190,000 metric tons of cellulose specialties capacity, bringing total cellulose specialties capacity to about 675,000 metric tons. Production of cellulose specialties is expected to gradually increase to capacity by 2015. Customer commitments for the additional volume exceed 85 percent. Upon completion of this $375 million to $390 million project, we will be exiting the more commodity-like absorbent materials business (estimated 260,000 metric tons of capacity). This expansion will help further differentiate our business as we will be able to increase our focus on high-end specialty pulp and the development of customer specific applications. The project remains on schedule for a mid-2013 start-up.

As part of our strategy to focus only on specialty manufacturing, we agreed to sell our Wood Products business for $80 million. This sale is expected to close in the first quarter of 2013.
Management and our Board of Directors have developed a long-range planning process for the growth of our three core businesses. Our long-range planning process incorporates strategic factors such as allocation of capital, market forces and risks, access to capital, the competitive landscape and continued compliance with REIT requirements (particularly in view of the continued growth of our Performance Fibers business). We are committed to having an unencumbered approach to grow each of our three core businesses. Any actions we may take in the future with respect to changing strategic factors will be focused on ensuring each of our businesses can take advantage of growth opportunities while maximizing value for our shareholders.
We continuously evaluate our capital structure. Our year-end debt-to-capital ratio was 47 percent and our debt-to-EBITDA ratio was 2.3 times, while our net debt-to-EBITDA ratio was 1.8 times. We believe that a debt-to-EBITDA ratio of up to three times is appropriate to keep our weighted-average cost of capital low while maintaining an investment grade debt rating as well as retaining the flexibility to actively pursue growth opportunities.

We have historically maintained conservative leverage and believe in keeping ample liquidity and financial flexibility. Maintaining an investment grade debt rating has been a key element of this overall financial strategy as it historically allowed access to corporate debt markets even in difficult economic conditions. Our activity in capital markets the past year included the following:
• In March 2012, we issued $325 million of 3.75% Senior Notes due 2022. Approximately $150 million of the proceeds from these notes were used to repay borrowings under our revolving credit facility.

• The 3.75% Senior Exchangeable Notes matured in October 2012 and the outstanding principal balance of $300 million was paid in cash, financed through borrowings on the Company's revolving credit facility.

• In October 2012, we amended the revolving credit facility to take advantage of better pricing, improve covenants and change the debt ceiling calculation to provide additional borrowing capacity. The April 2016 expiration date was not changed.

• In December 2012, the Company entered into a $640 million term credit agreement, which allows borrowings up to $640 million through December 2017 under a maximum of five advances. At closing, TRS borrowed $300 million and used the proceeds to pay down borrowings on the revolving credit facility, leaving $340 million of available capacity under the term credit agreement.

We had $171 million of available borrowing capacity on the amended revolving credit facility as of December 31, 2012. See Note 11 - Debt for additional information on these transactions.
We maintain four qualified defined benefit plans and one unfunded plan to provide benefits in excess of amounts allowable in qualified plans under current tax law. At December 31, 2012, our qualified plans were underfunded $98 million versus $86 million at December 31, 2011 primarily due to a decrease in the discount rate from 4.20 percent to 3.70 percent. Our unfunded plan's liabilities increased from $31 million at December 31, 2011 to $35 million at December 31, 2012, also due to the decline in the discount rate. Although we have no pension contribution requirements in 2013, we may make discretionary pension contributions.
Our strategic capital is expected to be allocated primarily to our Performance Fibers segment for completion of the Jesup mill CSE and to the Forest Resources segment for timberland acquisitions. We do not have any debt repayment requirements in 2013 but may incur additional debt in conjunction with strategic opportunities that would cause us to exceed the debt-to-capital ratio mentioned above.
In 2012, our annual dividend was $1.68 per share, reflecting a third quarter increase in the quarterly dividend from $0.40 per share to $0.44 per share. Our 2013 dividend payments are expected to total $223 million assuming no change in the current rate.
Overall, we believe we have adequate liquidity and sources of capital to run our businesses efficiently and effectively and to maximize the value of assets under management. We expect cash flow from operations, proceeds from the Wood Products sale and debt available under our term credit agreement to adequately cover planned capital expenditures (including strategic outlays), interest expense and dividends in 2013.
Operational Strategies
Timber is sold primarily through an auction process, although it is also marketed through log supply agreements (primarily in the Northern region). We operate Forest Resources as a stand-alone business, requiring our Performance Fibers and lumber mills to compete with third-party bidders for timber, primarily at auction. This promotes realizing market value and generating a true measure of fair value returns in Forest Resources while minimizing the possibility of our manufacturing facilities being subsidized with below-market cost wood. We focus on optimizing Forest Resources returns by continually improving productivity and yields beginning with genetically superior seedlings from our own nurseries and through advanced silvicultural practices which take into account soil, climate and biological considerations. We also actively pursue other non-timber sources of income, primarily hunting and other recreational licenses. Finally, we evaluate timberland acquisitions and pursue those that meet various financial and strategic criteria.
A significant portion of our acreage is more valuable for development, recreational or conservation purposes than for growing timber. To maximize the value of our development properties, our strategy has been to engage in value-added entitlement activities versus selling real estate in bulk without entitlements. Our entitlement efforts are largely complete as we now have approximately 7,900 acres of entitled land in Georgia and 31,200 acres of entitled land in Florida. We will now begin to actively market these properties in order to monetize them. Additionally, in 2012 we continued our strategy of selling non-strategic timberland holdings, which enables us to redeploy capital to higher returning assets.
In Performance Fibers, our focus is to differentiate our business by developing and improving products for customer specific applications and to improve our position as a premier supplier of cellulose specialties. In 2012, cellulose specialties accounted for

70 percent of our sales volume, with the balance in absorbent materials consisting primarily of fluff pulp. We are a market leader in cellulose specialties, utilizing our considerable technical applications expertise to customize products to exacting customer specifications, which allows differentiation from most competitors. Fluff pulp is a semi-commodity with limited opportunity for differentiation other than by price and customer service. There are a number of much larger companies in the fluff pulp market and we are not a market leader. These factors were major considerations in our decision to proceed with the CSE project and exit the fluff market. Cost control is a critical element to remaining competitive in the Performance Fibers markets. The keys to success are operating continuously, safely, and efficiently while closely managing raw material and conversion costs. Capital expenditures typically are directed toward cost reduction, product enhancements, environmental requirements and efficiency projects.
In January 2013, we reached an agreement to sell our Wood Products business consisting of three sawmills. The sale is expected to close in the first quarter of 2013.
Our capital expenditures totaled $158 million in 2012, excluding the CSE and strategic acquisitions. For 2013, non-strategic capital expenditures are expected to range from $140 million to $145 million and will be invested primarily in Performance Fibers on cost reduction and efficiency projects and in silvicultural investments in our timberlands. In 2013, spending is expected to decrease from the prior year primarily due to the completion of a number of projects at our Fernandina mill at the end of 2012 and the first half of 2013. We expect 2013 spending on completion of the CSE to range between $130 million and $145 million.
Industry and Market Conditions
In 2012, demand for pulpwood was strong in the Gulf States and Atlantic regions as pulp mills continued to operate at full capacity and demand for bioenergy continued. The market was impacted by a decreased supply of pulpwood in the Gulf States with poor logging conditions due to wet weather. Domestic demand for sawtimber gained strength due to slight improvements in the housing market. Export sawtimber markets in the Pacific Northwest region showed continued weakness during the first half of the year primarily due to reduced Chinese demand for logs with some price recovery exhibited in the fourth quarter. We anticipate Chinese demand for logs will continue to strengthen during 2013. Overall, we expect 2013 timber demand and pricing to exceed 2012 levels as general economic conditions improve in the U.S. and Chinese demand returns. In Real Estate, we expect the demand for development property to slowly return with the modestly improving housing market and overall economic climate. However, there are indications of increasing development interest in some local markets.
In Performance Fibers, demand remains strong for our cellulose specialties fibers. Sales are typically made under multi-year contracts, which establish target volumes at the beginning of each year and buffer some of the changes in supply and demand typically seen in worldwide commodity pulp and paper markets. We have long-term contracts with the world's largest manufacturers of acetate-based products and other key customers that extend through 2013 to 2017 and represent a significant majority of our high value cellulose specialties production. Our recognized technical and market leadership has allowed us to maintain strong pricing across our cellulose specialties product lines. Absorbent materials prices declined during 2012 as market conditions weakened. We expect average 2013 prices to be below 2012. Sales of absorbent materials are typically made with an annual volume agreement that allows price to move with the market during the year. During 2013, we will exit this market when we complete the CSE project.
Critical Accounting Policies and Use of Estimates The preparation of financial statements requires us to make estimates, assumptions and judgments that affect our assets, liabilities, revenues and expenses, and to disclose contingent assets and liabilities in our Annual Report on Form 10-K. We base these estimates and assumptions on historical data and trends, current fact patterns, expectations and other sources of information we believe are reasonable. Actual results may differ from these estimates. Merchantable inventory and depletion costs as determined by forestry timber harvest models
Significant assumptions and estimates are used in the recording of timberland inventory cost and depletion. Merchantable standing timber inventory is estimated by our land information services group annually, using industry-standard computer software. The inventory calculation takes into account growth, in-growth (annual transfer of oldest pre-merchantable age class into merchantable inventory), timberland sales and the annual harvest specific to each business unit. The age at which timber is considered merchantable is reviewed periodically and updated for changing harvest practices, future harvest age profiles and biological growth factors.
An annual depletion rate is established for each particular region by dividing merchantable inventory book cost by standing merchantable inventory. Pre-merchantable records are maintained for each planted year age class, recording acres planted, stems per acre and costs of planting and tending. Changes in the assumptions and/or estimations used in these calculations may affect our timber inventory and depletion costs. Factors that can impact timber volume include weather changes, losses due to natural causes, differences in actual versus estimated growth rates and changes in the age when timber is considered merchantable. A

three percent company-wide change in estimated standing merchantable inventory would cause 2012 depletion expense to change by approximately $2 million. Acquisitions of timberland can also affect the depletion rate. Upon the acquisition of timberland, we make a determination on whether to combine the newly acquired merchantable timber with an existing depletion pool or to create a new separate pool. The determination is based on the geographic location of the new timber, the customers/markets that will be served and species mix. In the fourth quarter of 2012, we acquired an additional 62,600 acres in the Gulf States region. Although 2012 depletion expense was not significantly impacted, we anticipate 2013 depletion to change by approximately $0.5 million. In 2011, we acquired approximately 308,000 acres of timberland mainly located in the Gulf States region resulting in a higher depletion rate. The acquisition did not significantly impact 2011 depletion expense but increased 2012 depletion expense by $2.2 million.
Depreciation and impairment of long-lived assets Depreciation expense is computed using the units-of-production method for the Performance Fibers plant and equipment and the straight-line method on all other property, plant and equipment over the useful economic lives of the assets involved. We believe that these depreciation methods are the most appropriate under the circumstances as they most closely match revenues with expenses versus other generally accepted accounting methods. Long-lived assets are periodically reviewed for impairment whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable. Cash flows used in such impairment analyses are based on long-range plan projections, which take into account recent sales and cost data as well as macroeconomic drivers such as customer demand and industry capacity. The physical life of equipment, however, may be shortened by economic obsolescence caused by environmental regulation, competition or other causes.
Environmental costs associated with dispositions and discontinued operations At December 31, 2012, we had $82 million of accrued liabilities for environmental costs relating to past dispositions and discontinued operations. Numerous cost assumptions are used in estimating these obligations. Factors affecting these estimates include changes in the nature or extent of contamination, changes in the content or volume of the material discharged or treated in connection with one or more impacted sites, requirements to perform additional or different assessment or remediation, changes in technology that may lead to additional or different environmental remediation strategies, approaches and workplans, discovery of additional or unanticipated contaminated soil, groundwater or sediment on or off-site, changes in remedy selection, changes in law or interpretation of existing law and the outcome of negotiations with governmental agencies or non-governmental parties. We periodically review our environmental liabilities and also engage third-party consultants to assess our ongoing remediation of contaminated sites. A significant change in any of the estimates could have a material effect on the results of our operations. Typically, these cost estimates do not vary significantly on a quarter to quarter basis, although there can be no assurance that such a variance will not occur in the future. In 2012 and 2011, we increased the liability by $1 million and $7 million, respectively. See Note 15 - Liabilities for Dispositions and Discontinued Operations for additional information.
Determining the adequacy of pension and other postretirement benefit assets and liabilities
We have four qualified benefit plans which cover most of our U.S. workforce and an unfunded plan to provide benefits in excess of amounts allowable under current tax law to certain participants in the qualified plans. All plans are currently closed to new participants. Pension expense for all plans was $19 million in 2012. Numerous estimates and assumptions are required to determine the proper amount of pension and postretirement liabilities and annual expense to record in our financial statements. The key assumptions include discount rate, return on assets, salary increases, health care cost trends, mortality rates, longevity and service lives of employees. Although there is authoritative guidance on how to select most of these assumptions, we exercise some degree of judgment when selecting these assumptions based on input from our actuary. Different assumptions, as well as actual versus expected results, would change the periodic benefit cost and funded status of the benefit plans recognized in the financial statements.
In determining pension expense in 2012, a $25 million return was assumed based on an expected long-term rate of return of 8.5 percent. The actual return for 2012 was a gain of $42 million, or 14 percent. Our long-term return assumption was established based on historical long-term rates of return on broad equity and bond indices, discussions with our actuary and investment advisors and consideration of the actual annualized rate of return from 1994 (the date of our spin-off from ITT Corporation) through 2012. At the end of 2012, we reviewed this assumption for reasonableness and determined that the 2012 long-term rate of return assumption should remain at 8.5 percent. At December 31, 2012, our asset mix consisted of 66 percent equities, 31 percent bonds and three percent real estate equity funds. We do not expect this mix to change materially in the near future.
In determining future pension obligations, we select a discount rate based on information supplied by our actuary. The actuarial rates are developed by models which incorporate high quality (AA rated), long-term corporate bond rates into their calculations. The discount rate decreased from 4.20 percent at December 31, 2011 to 3.70 percent at December 31, 2012.

The Company's pension plans were underfunded by $134 million at December 31, 2012, a $16 million decrease in funding status from December 31, 2011 due primarily to the decreased discount rate. We had no mandatory pension contributions and did not make discretionary contributions to our qualified pension plans in 2012 or 2011. We made discretionary contributions of $50 million in 2010. Future requirements will vary depending on actual investment performance, changes in valuation assumptions, interest rates and requirements under the Pension Protection Act. See Note 20 - Employee Benefit Plans for additional information.
In 2013, we expect pension expense to be slightly above 2012 due to an increase in the amortization of actuarial losses resulting from a decrease in the discount rate. Future pension expense will be impacted by many factors including actual investment performance, changes in discount rates, timing of contributions and other employee related matters.
The sensitivity of pension expense and projected benefit obligation to changes in economic assumptions is highlighted below:

                                                          Impact on:
                                                                 Projected Benefit
            Change in Assumption             Pension Expense        Obligation
25 bp decrease in discount rate                + 1.5 million      + 15.8 million
25 bp increase in discount rate                - 1.5 million      - 14.9 million
25 bp decrease in long-term return on assets   + 0.7 million
25 bp increase in long-term return on assets   - 0.7 million

Realizability of both recorded and unrecorded tax assets and tax liabilities As a REIT, our Forest Resources operations are generally not subject to income taxation. As such, our income taxes can vary significantly based on the mix of income between our REIT and TRS businesses, thereby impacting our effective tax rate and the amount of taxes paid during fiscal periods. Therefore, our projection of estimated income tax for the year and our provision for quarterly income taxes, in accordance with generally accepted accounting principles, may have significant variability. Similarly, the assessment of the ability to realize certain deferred tax assets, or estimate deferred tax liabilities, may be subjective.
We have recorded certain deferred tax assets that we believe will be realized in future periods. These assets are reviewed periodically in order to assess their realizability. This review requires us to make assumptions and estimates about future profitability affecting the realization of these tax benefits. If the review indicates that the realizability may be less than likely, a valuation allowance is recorded at that time.
Our income tax returns are subject to examination by U.S. federal, state, and foreign taxing authorities. In evaluating the tax benefits associated with various tax filing positions, we record a tax benefit for an uncertain tax position if it is more-likely-than-not to be realized upon ultimate settlement of the issue. We record a liability for an uncertain tax position that does not meet this criterion. The liabilities for unrecognized tax benefits are adjusted in the period in which it is determined the issue is settled with the taxing authorities, the statute of limitations expires for the relevant taxing authority to examine the tax position or when new facts or information becomes available. See Note 8 - Income Taxes for additional information about our unrecognized tax benefits.

Summary of our results of operations for the three years ended December 31:

Financial Information (in millions)   2012        2011        2010
Sales
Forest Resources
Atlantic                            $    64     $    71     $    72
Gulf States                              45          31          29
Northern                                110         102          67
New Zealand                              11          11           9
Total Forest Resources                  230         215         177
Real Estate
Development                               2           4           3
Rural                                    39          33          28
Non-Strategic Timberlands                16          34          65
Total Real Estate                        57          71          96
Performance Fibers
Cellulose specialties                   935         824         686
Absorbent materials                     158         196         195
Total Performance Fibers              1,093       1,020         881
Wood Products                            88          68          68
Other Operations                        105         122         102
Intersegment Eliminations                (2 )        (7 )        (9 )
Total Sales                         $ 1,571     $ 1,489     $ 1,315
Operating Income (Loss)
Forest Resources                    $    46     $    47     $    33
Real Estate                              32          47          53
. . .