Overview

Packaging Corporation of America, or PCA, is the fifth largest producer of containerboard and corrugated products in the United States, based on production capacity. We produce a wide variety of corrugated products ranging from basic corrugated shipping containers to specialized packaging, such as wax-coated boxes for the agriculture industry. We also have multi-color printing capabilities to make high-impact graphics boxes and displays that offer our customers more attractive packaging. Our operating facilities and customers are located primarily in the United States.

In analyzing our operating performance, we focus on the following factors that affect our business and are important to consider when reviewing our financial and operating results:

• corrugated products demand;

• corrugated products and containerboard pricing;

• containerboard inventories; and

• cost trends and volatility for our major costs, including wood and recycled fiber, purchased energy, labor and fringe benefits, and transportation costs.

The cost to manufacture containerboard is dependent, in large part, on the costs of wood fiber, recycled fiber, purchased fuels, electricity and labor and fringe benefits. Excluding the cost of containerboard, labor and benefits costs make up the largest component of corrugated products' manufactured costs.

The market for containerboard is generally subject to changes in the U.S. economy. Historically, supply and demand, as well as industry-wide inventory levels, have influenced prices of containerboard. In addition to U.S. shipments, approximately 10% of all domestically produced containerboard has been exported annually for use in other countries.

Industry Conditions

The U.S. economy experienced a severe downturn in the fourth quarter of 2008 which continued through the first quarter of 2009 with some improvement seen in the second and third quarter. Industry-wide shipments of corrugated products decreased 8.0% for the three months ended September 30, 2009 compared to the same period in 2008, but were up 1.5% compared to the second quarter of 2009. Reported third quarter 2009 industry containerboard production decreased 7.4% from the third quarter of 2008. However, export shipments of containerboard decreased only 1.7% over the same time period. Industry published prices for containerboard stabilized during June, July and August, but fell $10 per ton in September. Third quarter average published transaction prices for linerboard were $73 per ton lower than third quarter 2008. Reported industry containerboard inventories at the end of September 2009 were approximately 200,000 tons below September 2008, the lowest September-ending level in nearly 30 years.

PCA Operations Summary

During the third quarter of 2009, we produced approximately 588,000 tons of containerboard at our mills, of which about 80% was consumed in our corrugated products manufacturing plants, 12% was sold to domestic customers and 8% was sold in the export market. Production in the third quarter was down about 33,000 tons compared to the third quarter of 2008, primarily due to market-related downtime.

Our corrugated products manufacturing plants sold about 7.5 billion square feet ("bsf") of corrugated products during the third quarter of 2009. Corrugated products shipments were up 1.5% compared to the second quarter of 2009, but were 4.8% below third quarter 2008. Sales prices of containerboard and corrugated products prices were lower than the third quarter 2008 primarily due to the published price decreases during the first half of 2009. In addition, recycled fiber, transportation and energy costs were lower than last year's third quarter. However, the improvement from decreased costs was more than offset by the impact of lower sales prices due to the weaker economy.

Looking ahead to the fourth quarter, our earnings are expected to be impacted by lower volume due to three less shipping days than the third quarter along with normal seasonality that typically results in lower fourth quarter

volume. Prices are expected to be lower as a result of previously published containerboard price changes. We also expect wood costs and energy usage to increase with colder and wetter weather. Considering these items, and excluding any income from alternative fuel mixture tax credits, described in Note 13 to the financial statements included elsewhere in this report, we expect our fourth quarter 2009 earnings to be lower than our earnings in the third quarter of 2009.

Results of Operations

Three Months Ended September 30, 2009 Compared to Three Months Ended
September 30, 2008

The historical results of operations of PCA for the three months ended
September 30, 2009 and 2008 are set forth below:


                                    Three Months Ended September 30,
                                       2009                   2008            Change
    (In thousands)

    Net sales                    $        553,573       $        620,785     $ (67,212 )

    Income from operations       $         96,331       $         68,705     $  27,626
    Interest expense, net                  (8,961 )               (8,071 )        (890 )

    Income before taxes                    87,370                 60,634        26,736
    Provision for income taxes            (14,715 )              (22,532 )       7,817

    Net income                   $         72,655       $         38,102     $  34,553

Net Sales

Net sales decreased by $67.2 million, or 10.8%, for the three months ended September 30, 2009 from the comparable period in 2008, primarily as a result of the impact of decreased sales volume of corrugated products and containerboard to third parties ($35.0 million) and decreased sales prices ($32.2 million). Sales prices decreased as a result of monthly published industry containerboard price decreases from December 2008 through May 2009 and also in September 2009, which reduced linerboard and corrugating medium transaction prices by a total $80 per ton (or 13.1%) and $90 per ton (or 15.3%), respectively, compared to November 2008 published price levels.

Corrugated products shipments on a total and per-workday basis for the third quarter decreased 4.8% compared to the third quarter of 2008. The number of workdays were the same in the third quarters of 2008 and 2009. Containerboard volume sold to domestic and export customers was 6.0% lower for the three months ended September 30, 2009 compared to the three months ended September 30, 2008. Containerboard mill production for the three months ended September 30, 2009 was 588,000 tons compared to 621,000 tons during the same period in 2008, down 33,000 tons as a result of the market-related downtime taken during the third quarter.

Income from Operations

Income from operations increased by $27.6 million, or 40.2%, for the three months ended September 30, 2009 compared to the three months ended September 30, 2008, primarily due to an alternative fuel mixture tax credit ($47.1 million). Please see Note 13 to the financial statements included in this report for a description of the alternative fuel mixture tax credit. Excluding the alternative fuel mixture tax credit, income from operations was $19.5 million below the previous year's third quarter primarily as a result of the impact of decreased sales prices of corrugated products and containerboard ($32.2 million) and lower sales volume ($10.2 million). These items were partially offset by decreased costs of transportation ($8.8 million) energy ($7.8 million), recycled fiber ($3.2 million) and chemicals ($2.7 million).

Gross profit decreased $21.5 million, or 16.3%, for the three months ended September 30, 2009 from the comparable period in 2008. Gross profit as a percentage of net sales decreased from 21.3% of net sales in the three months ended September 30, 2008 to 20.0% of net sales in the current quarter due primarily to the decreased prices described above.

Selling and administrative expenses decreased $0.5 million, or 1.2%, for the three months ended September 30, 2009 compared to the same period in 2008, as a result of reduced salary and fringe benefit expenses ($0.7 million) partially offset by other items which were individually insignificant.

Corporate overhead decreased $2.9 million, or 18.0%, for the three months ended September 30, 2009 compared to the same period in 2008, primarily attributable to a decrease in salary expense due to the timing of both share-based compensation and incentive compensation ($2.4 million) and lower fees for professional services related to tax, audit and human resource matters ($0.3 million).

Other expense for the three months ended September 30, 2009 increased $1.4 million or 57.6% compared to the third quarter of 2008, primarily due to increased fixed asset disposals in the third quarter of 2009 ($1.4 million).

Interest Expense, Net and Income Taxes

Net interest expense increased $0.9 million, or 11.0%, for the three months ended September 30, 2009 from the three months ended September 30, 2008, primarily as a result of lower interest income ($1.0 million) earned on PCA's cash equivalents. The $1.0 million decrease in interest income was primarily due to lower interest income rates during the three months ended September 30, 2009 compared to the same period in 2008.

PCA's effective tax rate was 16.8% for the three months ended September 30, 2009 and 37.2% for the comparable period in 2008. The effective tax rate varies from the U.S. federal statutory tax rate of 35% principally due to the impact of the alternative fuel mixture tax credit, state and local income taxes, and the domestic manufacturers' deduction.

Nine Months Ended September 30, 2009 Compared to Nine Months Ended September 30, 2008

The historical results of operations of PCA for the nine months ended September 30, 2009 and 2008 are set forth below:

                                For the Nine Months Ended September 30,
                                    2009                      2008               Change
(In thousands)

Net sales                    $         1,615,332       $         1,814,442     $ (199,110 )

Income from operations       $           281,655       $           190,024     $   91,631
Interest expense, net                    (26,529 )                 (22,571 )       (3,958 )

Income before taxes                      255,126                   167,453         87,673
Provision for income taxes               (47,914 )                 (62,086 )       14,172

Net income                   $           207,212       $           105,367     $  101,845

Net Sales

Net sales decreased by $199.1 million, or 11.0%, for the nine months ended September 30, 2009 from the comparable period in 2008 primarily as a result of decreased sales volume of corrugated products and containerboard to third parties ($185.6 million) and lower average prices for the first nine months of 2009 ($13.5 million) compared to the first nine months of 2008. Sales prices decreased as a result of published price reductions since December 2008 described earlier.

Corrugated products shipments per workday for the nine months ended September 30, 2009 decreased 7.4% compared to the same period in 2008 and were 8.3% lower on a total shipments basis due to the fact that the first nine months of 2009 contained two fewer workdays than the same period in 2008.
Containerboard volume sold to domestic and export customers was 19.9% lower for the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008. Containerboard mill production for the first nine months of 2009 was approximately 1,658,000 tons compared to 1,820,000 tons produced in the first nine months of 2008, a decrease of 162,000 tons as a result of market-related downtime, planned annual maintenance outages and machine slowbacks.

Income from Operations

Income from operations increased by $91.6 million, or 48.2%, for the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008, primarily attributable to the alternative fuel mixture tax credit of $126.8 million described previously. Excluding the alternative fuel mixture tax credit, income from operations decreased $35.2 million for the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008 primarily attributable to lower sales volume ($66.4 million), decreased sales prices of corrugated products and containerboard ($13.5 million) and increased labor and fringe benefit costs ($7.7 million). These items were partially offset by decreased costs of recycled fiber ($19.7 million), transportation ($18.6 million), energy ($11.8 million) and starch and wax ($1.9 million).

Gross profit decreased $38.4 million, or 10.2%, for the nine months ended September 30, 2009 from the comparable period in 2008. Gross profit as a percentage of net sales increased from 20.8% of net sales in the nine months ended September 30, 2008 to 21.0% of net sales in the nine months ended September 30, 2009 due primarily to the cost decreases described above.

Selling and administrative expenses decreased $1.6 million, or 1.2%, for the nine months ended September 30, 2009 compared to the same period in 2008, primarily as a result of lower expenses related to travel and entertainment ($1.0 million), warehousing costs ($0.4 million) and salary and fringe benefits ($0.3 million).

Corporate overhead for the nine months ended September 30, 2009 decreased $2.4 million or 5.4% compared to the same period in 2008, primarily due to decreased salary and incentive compensation expense ($1.7 million), reduced fees paid for professional services related to tax, audit and human resource matters ($0.4 million) and other items which were individually insignificant.

Other expense for the nine months ended September 30, 2009 increased $0.8 million or 7.3% compared to the same period in 2008, primarily due to increased fixed asset disposals ($1.0 million).

Interest Expense, Net and Income Taxes

Net interest expense increased $4.0 million, or 17.5%, for the nine months ended September 30, 2009 from the nine months ended September 30, 2008, primarily as a result of lower interest income ($4.9 million) earned on PCA's cash equivalents, partially offset by lower interest expense ($0.9 million) related to PCA's outstanding debt balances. The $4.9 million decrease in interest income was primarily due to lower interest income rates during the nine months ended September 30, 2009 compared to the same period in 2008. The $0.9 million decrease in interest expense was primarily due to a decrease in interest expense related to the Company's receivables credit facility due to lower interest rates.

PCA's effective tax rate was 18.8% for the nine months ended September 30, 2009 and 37.1% for the comparable period in 2008. The effective tax rate varies from the U.S. federal statutory tax rate of 35% principally due to the impact of the alternative fuel mixture tax credit, state and local income taxes, and the domestic manufacturers' deduction. The Company had no material changes impacting FIN No. 48 during the first nine months of 2009.

Liquidity and Capital Resources

The following table presents a summary of our cash flows for the periods
presented:


                                                            Nine Months Ended
                                                              September 30,
                                                          2009            2008          Change
(In thousands)

Net cash provided by (used for):
Operating activities                                    $ 209,293      $  182,175      $  27,118
Investing activities                                      (73,649 )      (100,388 )       26,739
Financing activities                                      (60,754 )      (161,963 )      101,209

Net increase (decrease) in cash and cash equivalents    $  74,890      $  (80,176 )    $ 155,066

Operating Activities

Net cash provided by operating activities for the nine months ended September 30, 2009 was $209.3 million compared to $182.2 million for the nine months ended September 30, 2008, an increase of $27.1 million, or 14.9%. Net income, excluding the impact of the alternative fuel mixture tax credits described in Note 13 to the financial statements included in this report, was $79.7 million for the first nine months of 2009 compared to $105.4 million for the comparable period in 2008, a decrease of $25.7 million that reduced net cash provided by operating activities. This decrease was more than offset by reduced cash requirements, including a $22.4 million reduction in federal tax payments in the second and third quarters of 2009 as a result of the alternative fuel mixture tax credits. Cash requirements for operating activities are subject to PCA's operating needs, which were impacted by the weakened business conditions during the first nine months of 2009, the timing of collection of receivables and payments of payables and expenses, and seasonal fluctuations in the Company's operations.

Investing Activities

Net cash used for investing activities for the nine months ended September 30, 2009 decreased $26.7 million, or 26.6%, to $73.6 million, compared to the nine months ended September 30, 2008. The decrease was primarily related to lower additions to property, plant and equipment of $29.7 million during the nine months ended September 30, 2009 compared to the same period in 2008, partially offset by a $3.1 million acquisition completed during the third quarter of 2009.

In October 2009, the Company announced that its Board of Directors had approved a major energy optimization project at its Counce and Valdosta mills. The total capital is expected to be about $295 million to be spent over the next two years. The project is expected to be funded with existing cash and cash generated from operating activities and is expected to be completed in the fourth quarter of 2011.

Financing Activities

Net cash used for financing activities totaled $60.8 million for the nine months ended September 30, 2009, a decrease of $101.2 million, or 62.5%, compared to the same period in 2008. The difference was primarily attributable to lower debt payments of $169.7 million in 2009, $45.3 million in repurchases of PCA common stock during the first nine months of 2008 and lower common stock dividends paid of $32.5 million during the first nine months of 2009 compared to the same period in 2008, partially offset by $145.2 million in net proceeds received from PCA's notes offering in 2008 described below.

In connection with the senior notes offering in March of 2008, PCA received proceeds, net of discount, of $149.9 million and paid $4.4 million for settlement of a treasury lock that it entered into to protect it against increases in the ten-year U.S. Treasury rate, which served as a reference in determining the interest rate applicable to the notes. PCA also incurred financing costs in the amount of $0.3 million in connection with the senior notes offering. PCA later used the proceeds of this offering, together with cash on hand, to repay all of the $150.0 million of outstanding 43/8% senior notes due 2008 on August 1, 2008.

PCA's primary sources of liquidity are net cash provided by operating activities, borrowings under PCA's revolving credit facility, and additional borrowings under PCA's receivables credit facility. As of September 30, 2009, PCA had $172.2 million in unused borrowing capacity under its existing credit agreements, net of the impact on this borrowing capacity of $18.8 million of outstanding letters of credit. Currently, PCA's primary uses of cash are for capital expenditures, debt service and declared common stock dividends, which it expects to be able to fund from these sources.

The following table provides the outstanding balances, excluding unamortized debt discount of $1.3 million, and the weighted average interest rates as of September 30, 2009 for PCA's revolving credit facility, the receivables credit facility, and the senior notes:

                                                                                                Projected
                                                     Balance at            Weighted              Annual
                                                    September 30,           Average           Cash Interest
Borrowing Arrangement                                   2009             Interest Rate          Payments
(In thousands)

Revolving Credit Facility                          $             -                  N/A                  N/A
Receivables Credit Facility                                109,000                 2.05 %    $         2,236
53/4% Senior Notes (due August 1, 2013)                    400,000                 5.75               23,000
61/2% Senior Notes (due March 15, 2018)                    150,000                 6.50                9,750

Total                                              $       659,000                 5.31 %    $        34,986

The above table excludes from the projected annual cash interest payments, the non-cash income from the annual amortization of the $22.8 million received in July 2003 and the non-cash expense from the annual amortization of the $4.4 million paid in March 2008 to settle the treasury locks related to the 53/4% senior notes due 2013 and 61/2% senior notes due 2018. The amortization is being recognized over the terms of the 53/4% senior notes due 2013 and 61/2% senior notes due 2018 and is included in interest expense, net.

On April 15, 2009, PCA extended its $150.0 million receivables-backed credit facility through April 14, 2010.

The instruments governing PCA's indebtedness contain financial and other covenants that limit, among other things, the ability of PCA and its subsidiaries to:

• enter into sale and leaseback transactions,

• incur liens,

• incur indebtedness at the subsidiary level,

• enter into certain transactions with affiliates, or

• merge or consolidate with any other person or sell or otherwise dispose of all or substantially all of the assets of PCA.

These limitations could limit corporate and operating activities.

In addition, PCA must maintain minimum net worth and maximum debt to total capitalization and minimum interest coverage ratios under the revolving credit facility. A failure to comply with the restrictions contained in the revolving credit facility could lead to an event of default, which could result in an acceleration of any outstanding indebtedness and/or prohibit PCA from drawing on the revolving credit facility. Such an acceleration may also constitute an event of default under the senior notes indentures and the receivables credit facility. As of September 30, 2009, PCA was in compliance with these covenants.

PCA currently expects to incur capital expenditures of about $120.0 million in 2009, including $20.0 million for major energy projects at its Counce and Valdosta mills. These expenditures will be used primarily for maintenance capital, cost reduction, business growth and environmental compliance. As of September 30, 2009, PCA spent $68.6 million for capital expenditures and had committed to spend an additional $37.3 million in the remainder of 2009 and beyond.

On February 26, 2009, PCA announced that it had reduced its quarterly common stock dividend from $0.30 per share to $0.15 per share effective for the dividend payable April 15, 2009 to shareholders of record as of March 13, 2009.

PCA believes that net cash generated from operating activities, available cash reserves and available borrowings under its committed credit facilities and available capital through access to capital markets will be adequate to meet its liquidity and capital requirements, including payments of any declared common stock dividends, for the foreseeable future. As its debt or credit facilities become due, PCA will need to repay, extend or replace such facilities, which will be subject to future economic conditions and financial, business and other factors, many of which are beyond PCA's control.

Market Risk and Risk Management Policies

PCA is exposed to the impact of interest rate changes and changes in the market value of its financial instruments. PCA periodically enters into derivatives in order to minimize these risks, but not for trading purposes. As of September 30, 2009, PCA was not a party to any derivative instruments.

The interest rates on approximately 84% of PCA's debt are fixed. A one percent increase in interest rates related to variable rate debt would have resulted in an increase in interest expense and a corresponding decrease in income before taxes of $1.1 million annually. In the event of a change in interest rates, management could take actions to mitigate its exposure to the change. However, due to the uncertainty of the specific actions that would be taken and their possible effects, the sensitivity analysis assumes no changes in PCA's financial structure.

Environmental Matters

PCA is subject to, and must comply with, a variety of federal, state and local environmental laws, particularly those relating to air and water quality, waste disposal and the cleanup of contaminated soil and groundwater. The most significant of these laws affecting the Company are:

• Resource Conservation and Recovery Act (RCRA);

• Clean Water Act (CWA);

• Clean Air Act (CAA);

• The Emergency Planning and Community Right-to-Know-Act (EPCRA);

• Toxic Substance Control Act (TSCA); and

• Safe Drinking Water Act (SDWA).

PCA believes that it is currently in material compliance with these and all applicable environmental rules and regulations. Because environmental regulations are constantly evolving, the Company has incurred, and will continue to incur, costs to maintain compliance with these and other environmental laws. PCA works diligently to anticipate and budget for the impact of applicable environmental regulations, and does not currently expect that future environmental compliance obligations will materially affect its business or financial condition.

Impact of Inflation

PCA does not believe that inflation has had a material impact on its financial position or results of operations during the three- and nine-month periods ending September 30, 2009 and 2008.

Off-Balance Sheet Arrangements

PCA does not have any off-balance sheet arrangements as of September 30, 2009 that would require disclosure under SEC FR-67, "Disclosure in Management's Discussion and Analysis About Off-Balance Sheet Arrangement and Aggregate Contractual Obligations."

Critical Accounting Policies and Estimates

Management's discussion and analysis of PCA's financial condition and results of operations are based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an ongoing basis, PCA evaluates its estimates, including those related to bad debts, inventories, intangible assets, . . .