Directors’ report

The Board and CEO of Billerud AB (publ), corporate identity number 556025-5001, herewith submit the Annual Report and consolidated annual accounts for the 2010 financial year.

Billerud’s operating profit improved substantially in 2010, advancing to SEK 1 037 million, up SEK 737 million from 2009. This was chiefly a result of significantly better selling prices (in each respective sales currency) and an improved product mix. The rise in prices was partly offset by negative exchange rate effects and increased costs.

Billerud’s corporate governance report is presented separately on pages 100–107.

Markets

Billerud’s business activities comprise the production and sale of market pulp and niche products in packaging paper. Customers are primarily in Europe, although an increasing share of deliveries is made to other parts of the world.

Billerud’s activities are divided into three business areas: Packaging & Speciality Paper, Packaging Boards and Market Pulp.

The year began with robust demand in all segments for packaging paper and with repeated price increases. Demand strengthened further during the year for some segments and remained strong at year-end. Additional price increases were implemented for all products in the packaging paper business area. Thus efforts to restore prices to levels sustainable in the long-term have succeeded.

In the market for Nordic long-fibre sulphate pulp, demand remained robust in the beginning of the year. However, global production decreased, chiefly as a result of the earthquake in Chile in February that caused the Chilean pulp mills to temporarily shutdown production. This led to consumers and producers having extremely low inventory levels. During the second and third quarters, demand from Asia – mainly China – decreased, but consumers and producers continued to report lower inventory levels. The pulp market remained healthy toward year-end, and demand from China increased in the last quarter.

Prices in USD rose steadily during the year, from a relatively high level, to a very high level in the third quarter. Toward year-end, prices declined slightly in USD.

For 2010, deliveries of packaging paper totalled 1 006 000 tonnes, compared with 996 000 tonnes in the previous year, an increase of 1%.

Deliveries of market pulp totalled 301 000 tonnes for 2010, compared with 316 000 tonnes in the previous year, a decrease of 5%. The decrease was largely attributable to a labour conflict that resulted in production losses during the second quarter.

Billerud’s total deliveries for 2010 amounted to 1 307 000 tonnes, a decrease of 5 000 tonnes compared with the previous year.

Net sales and profits

Net sales totalled SEK 8 828 million, up 14% from the previous year. Despite industrial action that caused production losses of about 26 000 tonnes, 2010 deliveries totalled 1 307 000 tonnes, on a par with 2009 deliveries. Billerud has received full compensation from the Confederation of Swedish Enterprise for costs related to the strike. Compensation of SEK 77 million was paid by the Confederation to Billerud in the fourth quarter.

Operating profit reached SEK 1 037 million, an increase of SEK 737 million, which was mainly attributable to better prices and an improved product mix. The impact of higher variable costs equalled SEK -228 million, including SEK -110 million owing to changes in wood prices and SEK -51 million to changes in electricity prices. Fixed costs increased SEK 99 million, chiefly as a result of increased costs for maintenance. The operating margin equalled 12% (4).

Net financial items amounted to SEK -77 million (-114), an improvement of SEK 37 million as a result of lower debt.

Profit before tax amounted to SEK 960 million. Estimated tax was SEK -255 million, making net profit SEK 705 million.

Return on shareholders’ equity in the period was 17% (5), and the return on capital employed was 21% (6). A dividend of SEK 3.50 (0.50) per share is proposed.

For quarterly data see page 110.

Earnings per operating segment

Since 2009 Billerud has applied IFRS 8 Operating Segments, which replaced IAS 14 Segment Reporting. Billerud has identified its operating segments in accordance with IFRS 8 to reflect Billerud’s three business areas: Packaging & Speciality Paper, Packaging Board and Market Pulp. See Accounting policies on page 76.

Packaging & Speciality Paper

Operating profit increased SEK 31 million, or 8%, to SEK 417 million. A deterioration in exchange rates and increased costs were offset by improved prices in local currency and higher delivery volumes. The operating margin equalled 10% (10).

Market development

The market trend for orders and deliveries improved in the beginning of the year but stagnated somewhat during the rest of the year, compared with the previous year. However, order bookings remained excellent for sack and kraft paper at the end of the year. Efforts to restore prices from the low levels of 2009 continued throughout 2010. Prices on all products steadily increased in local currency in 2010, compared with the previous year.

Packaging Boards

Operating profit increased SEK 41 million, to SEK 271 million, compared with the previous year. Improved prices in local currency offset a deterioration in exchange rates and increased costs. The operating margin equalled 11% (10).

Market development

Early in the year, the market trend was strong, and that set the tone for all of 2010. Price increases were implemented at the end of 2009 and had a positive impact on earnings in the first quarter of 2010. Thereafter the price level for all products steadily increased in local currency during the year.

Market Pulp

Operating profit increased SEK 424 million, to SEK 276 million, compared with the previous year, chiefly as a result of greatly improved prices that offset slightly higher costs. Exchange rates had a negative impact but not to the same extent as for paper products. The operating margin equalled 16% (-11).

Market development

The market for market pulp (NBSK) remained strong in the beginning of the year and improved steadily during the year. Despite a slight slowdown at the end of the year, the market remained healthy. The improvement resulted in increased prices. The price at the beginning of the year was about USD 800 and advanced to a high of USD 980 during the third quarter. At the end of the fourth quarter, the price decreased to about USD 950.

Investments and capital employed

Gross investment in property, plant and equipment and intangible assets including company acquisitions totalled SEK 334 million (306).

Billerud’s capital employed totalled SEK 4 792 million at 31 December 2010, compared with SEK 5 148 million at 31 December 2009.

Return on capital employed, calculated over the past 12-month period, amounted to 21% (6). If the effects of currency hedging are excluded, return on capital employed was 14% (6). Return on equity after tax was 17% (5).

Cash flow and financial position

Cash flow from operating activities totalled SEK 1 393 million in 2010, compared with SEK 854 million in the previous year.

Operating cash flow totalled SEK 1 062 million, compared with SEK 562 million in the previous year.

Interest-bearing net debt equalled SEK 155 million at 31 December 2010, compared with SEK 1 152 million at 31 December 2009. The Group’s net debt/equity ratio at the end of the period was 0.03, compared with 0.29 at 31 December 2009. Billerud’s financial target for the debt/equity ratio is between 0.60 and 0.90 over a business cycle. Thus the current net debt/equity ratio is substantially less than the average debt/equity ratio Billerud aims at over time. Cash and cash equivalents were SEK 740 million (818) at 31 December 2010.

Significant risks and uncertainties

Billerud’s products are generally dependent on the business cycle in terms of both price development and delivery volumes. The Group is exposed to changes in exchange rates because most of its revenues are invoiced in foreign currency while operating expenses are incurred in SEK.

Billerud’s mills have higher capacity for production of sulphate pulp than it requires to produce packaging paper. To produce efficiently, Billerud is largely dependent on being able to sell surplus sulphate pulp as market pulp.

For an analysis of business sensitivity and further details of risks, see pages 71–75.

Tax position

The Group’s effective tax rate is normally about 26.5%–27%. Effective 1 January 2009, the Swedish statutory tax rate was reduced, from 28%, to 26.3%. The tax rate in the foreign subsidiaries is on average somewhat higher than the Swedish tax rate. The tax expense for 2010 is estimated at SEK 255 million, equivalent to a tax rate of 26.6%.

Parent company

Billerud AB comprises the Gruvön mill, the sales organisation for the Nordic markets and markets outside Europe and the head office functions.

In 2010, net sales totalled SEK 3 760 million (3 278). Operating profit was SEK 525 million (85), an increase of SEK 440 million compared with the previous year, mainly because of improved results from currency hedging in the parent company and improved operating profit for Gruvön mill. This profit included SEK 9 million (44) in dividends received from subsidiaries.

The parent company hedges its own net currency flows and those of the Group. The parent company’s profit includes the results of these hedging measures. Those results totalled SEK 344 million (-18).

Investments in property, plant and equipment and intangible assets excluding shares amounted to SEK 128 million (78) in 2010. The average number of employees was 924 (933). Cash, cash equivalents and investments in securities etc. equalled SEK 644 million (741).

Environment and permit issues

Billerud has three operations in Sweden and one in the UK that require permits under Swedish and UK environmental legislation. These permits apply for the production of pulp and paper. Billerud has all permits necessary to conduct operations at the volumes produced in 2010.

The environmental impact of operations is mainly in the form of emissions to air and water and the creation of waste and noise.

No new permits were awarded in 2010. Billerud’s Swedish mills have been awarded emission rights for carbon dioxide within the EU. The allocation for the five-year period starting in 2008 exceeds in total the calculated emissions.

Long-term incentive programme (LTIP 2007)

The 2007 AGM agreed to introduce a long-term incentive programme for Billerud and a related transfer of shareholdings. The programme comprised both a share matching programme for all employees, involving “matching shares”, and an incentive scheme with “performance shares” for senior executives and other key individuals within the Billerud Group. The main purpose of the proposed longterm incentive programme was to strengthen Billerud’s ability to retain and motivate staff. The programme was aimed at helping Billerud achieve its financial targets and came into effect as previous program- mes came to an end. The purpose of the performance share programme was to encourage senior executives and other key individuals whose activities have a direct impact on Billerud’s earnings, profitability and growth in value, by linking their interests and perspective with those of the Company’s shareholders.

The opportunity to buy performance shares was linked to financial performance in 2007–2009 as well as to continued employment at Billerud. In 2007 this meant that Billerud’s operating margin had to be 7%–11% and surpass that of certain comparable companies. In 2008 and 2009 this meant that Billerud’s operating margin had to be 8%–12% and surpass that of certain comparable companies. For 2007–2009 overall, Billerud’s total return to shareholders had to exceed the total return for certain comparable pulp and paper companies in the Nordic region.

Within the framework of the programme, Billerud’s employees bought 58 527 shares at a price per share of SEK 104.50 from Billerud AB during May 2007.

The LTIP 2007 incentive programme was concluded in 2010, and the total cost of the programme was SEK 6 million. For 2010, net profit was marginally affected positively because of the reversal of former provisions. The vested rights to acquire shares totalled 144 414, of which 131 159 were exercised to purchase shares in Billerud AB. The purchase price totalled SEK 5 million.

Long-term incentive programme (LTIP 2010)

The 2010 AGM agreed to introduce a long-term incentive programme (LTIP 2010) for Billerud and a related transfer of shareholdings.

The Board’s main objective in proposing LTIP 2010 is to strengthen Billerud’s ability to retain the best talent for key leadership positions. The purpose is also to encourage senior management and other key individuals whose efforts have a direct impact on Billerud’s earnings, profitability and growth in value, by aligning their interests and perspectives with those of the shareholders.

LTIP 2010 will include in total a maximum of 90 senior managers and other key individuals within the Billerud Group, who are deemed to have a significant impact on the future development of the Group. To participate in LTIP 2010, a person must own Billerud shares referred to as “saving shares”. Following a three-year vesting period that begins on the date the agreement for LTIP 2010 takes effect and ends when Billerud releases its interim report for the first quarter of 2013, the participants will be allocated at no charge one right to matching shares and three rights to performance shares for each saving share. These rights entitle holders to Billerud shares provided certain criteria are met. For both types of rights, throughout the vesting period the participant must remain an employee of the Billerud Group and must not divest the saving shares. For the rights to performance shares, additional financial performance targets must be achieved. These targets are related to Billerud’s average operating margin for the period 2010–2012 in absolute terms and in comparison with a benchmark group consisting of specially designated companies, as well as Billerud’s total return for the period 2010–2012 in comparison with the total return for the same period for a benchmark group consisting of specially designated listed companies in the Nordic region.

LTIP 2010 consisted per 31 December 2010 of 65 729 saving shares, which entail the allocation of in total a maximum of 262 916 Billerud shares. Moreover LTIP 2010 consists of an additional 109 000 Billerud shares that are related to shares that can be trans- ferred by Billerud for the purpose of covering certain costs, chiefly social fees. Thus the maximum number of Billerud shares included in LTIP 2010 is 371 916, which corresponds to about 0.4% of the total number of Billerud shares outstanding. On the allocation date, the programme comprised 67 150 saving shares, which initially entitled their owners to an allotment of a maximum of 268 600 Billerud shares in total.

Based on a theoretical assumption of an annual 10% increase in share price, from SEK 47.2 when the programme started, and a vesting period of three years, the cost of LTIP 2010 including social fees is estimated at about SEK 10 million, which, on an annual basis, corresponds to about 0.3% of Billerud’s total employee benefits expense during financial year 2009. The maximum cost of LTIP 2010 based on the above assumptions is estimated at about SEK 33 million, including SEK 22 million in social fees. For 2010, earnings were charged SEK 2 million.

For further information about the content of the programme, please refer to the press release dated 24 March 2010 and the documents for the 2010 AGM, which are available on Billerud’s website.

Product and process development

The costs of product and process development, to the extent attributable to research activities, are charged to expenses in the year that they occur and in 2010 they corresponded to about 0.5% of Billerud’s operating costs.

Seasonal factors

Billerud’s activities are relatively unaffected by seasonal variations. Order flows are usually highest during the spring but, because available capacity determines deliveries, they are relatively constant over the year. Annual maintenance shutdowns have the largest impact, as each mill stops production for around one week. This means that deliveries are somewhat lower for quite some time before, during and after the shutdown. Billerud’s costs are relatively stable throughout the year. Fixed costs are slightly lower in the summer, when fewer maintenance jobs are performed. Energy costs are slightly higher in the winter because of higher energy consumption and normally higher energy prices, especially for electricity.

Maintenance stops

In addition to continuous maintenance while machines are running, Billerud’s mills normally require more extensive maintenance at some point during the year. To perform this maintenance, production of pulp and paper is stopped – known as a maintenance shutdown. Estimates of planned maintenance shutdowns and those already carried out are shown below.

The effect of the stoppage on earnings varies depending on the extent of measures carried out, their character and the actual length of stoppage. Billerud works continually to spread the cost of maintenance shutdowns more evenly over the year.

Other seasonal factors

A significant part of Billerud Flute^® volumes are used to package fruit exports from the Mediterranean area. Demand from this customer group varies with the fruit seasons and is normally highest from September to March. A significant portion of Billerud’s sack paper and QuickFill^® sack paper is used as packaging for cement and building materials. Demand for building materials in Europe is generally higher during the period May to October.

Financing

In the first quarter of 2010, Billerud reduced the credit limit for its syndicated credit facility maturing in 2012, from SEK 1 800 million, to SEK 1 200 million. In the third quarter, a new seven-year credit facility for SEK 800 million maturing in 2017 was raised with AB Svensk Exportkredit. The credit facility is not being utilised at present. In the fourth quarter, SEK 150 million of the syndicated bank loan was repaid. After the end of the year, the SEK 1 200 million syndicated credit facility maturing in 2012 was replaced by a new five-year facility for SEK 801 million with a consortium of banks.

Interest-bearing loans amounted to SEK 948 million at 31 December 2010. Of this amount, utilisation of the syndicated credit facility (maximum: SEK 1 200 million) accounted for SEK 121 million, bond loans for SEK 825 million, utilisation of Billerud’s commercial paper programme (maximum: SEK 1 500 million) for SEK 0 million and other interest-bearing liabilities for SEK 2 million.

Currency hedging

During 2010, net flows were hedged at EUR/SEK 10.56 (9.95), USD/ SEK 7.56 (7.58), GBP/SEK 11.46 (12.12) and DKK/SEK 1.45 (1.36). Currency hedging had an overall earnings impact of SEK 344 million (-18) (compared to no hedging having been in place).

Billerud AB:s forward currency contracts outstanding at 31 December 2010 had a market value of SEK 202 million. The contracts matching accounts receivable affected earnings in the fourth quarter. Other contracts had a market value of SEK 144 million.

For its Swedish operations, Billerud hedges around 50% of forecast net flows over the coming 12-month period, but in line with its financial policy the Company has the possibility to increase currency hedging to 100% of net flows over the coming 15 months.

The hedged amount of currency flows and the SEK exchange rates for EUR, USD and GBP at 31 December 2010 are shown in the table on page 60. DKK accounts for less than 0.1% of total hedged flows and is therefore not included in the table.

Besides the hedging of net currency flows in the Swedish operations, Billerud Beetham Ltd hedges its net inflow of USD and EUR against GBP.

Share structure

At 31 December 2010, the share capital totalled SEK 774 173 065, divided among 104 834 613 shares. There were 103 114 299 shares in the market.

Since the end of 2004 there have been no share buy backs.

Financial targets

In November 2006 Billerud’s Board established the following long-term financial targets.

• Organic growth of at least 3% on average per year.
• Operating margin of 10% over a business cycle.
• Investments shall produce a return well above the Company’s weighted cost of capital.
• Debt/equity ratio of between 0.60 and 0.90 over a business cycle.
• Over the business cycle, 50% of net profit to be passed on in dividends to shareholders.

The targets focus on long-term growth. The target for operating margin creates greater transparency in the governing of the Company and a better link between the financial targets communicated internally and those communicated externally.

The Billerud share

The share capital of Billerud AB is divided among 104 834 613 ordinary shares, of which 1 720 314 are owned by Billerud AB. Each share entitles one vote at the AGM. Transfer of shares is not restricted by law or by the Company’s articles of association. The 2010 Annual General Meeting (AGM) authorised the Board of Directors to decide whether the Company would issue new shares or acquire its own shares.

The largest shareholder, Frapag Beteiligungsholding AG, owned 21 621 400 shares, corresponding to 21% of shares in the market, as of 31 December 2010. No other shareholder owned 10% or more of the total number of shares at 31 December 2010. The Company knows of no agreements between shareholders that may restrict the right to transfer shares. Appointment and dismissal of Board members, and changes to the articles of association, are made by the AGM. No significant agreement to which the Company, or other Group company, is a party would come into effect, be changed or cease to be valid if control of the Company changed as a result of a public acquisition bid. There are agreements between the Company, other Group companies and senior executives that entail compensation if they were to resign, be dismissed without reasonable grounds or if their employment were to end due to a public bid to acquire shares in the Company. These agreements are described in note 24. Agreements between the Company and other employees that regulate their own resignation or dismissal by the Company follow normal labour market practice.

Guidelines for remuneration to senior executives

The Board proposes that the 2011 AGM approve the following guide- lines for remuneration to senior management. Senior management includes the CEO and other members of the senior management team.

Billerud shall apply market-related remuneration levels and employment terms that are appropriate in order to recruit and keep a senior executive team that has the competence and capacity to achieve set goals. Remuneration forms shall motivate senior managers to do their best to secure shareholders’ interests. Remuneration may be in the form of fixed or variable salary, long-term incentive programmes and other benefits such as company car and pension. Fixed and variable salaries shall be established with regard to skills, area of responsibility and performance. Variable remuneration shall be based on meeting clearly set targets, and shall be a maximum of a fixed percentage of fixed annual salary and vary between 30% and 45%. The incentive programme shall primarily be related to financial performance criteria, ensure long-term commitment to the development of the Company and be implemented on commercial terms. For further information about the current long-term incentive programme adopted by the 2010 AGM, see the Billerud website as well as the section “Long-term incentive programme (LTIP 2010)”. Pension benefits shall either be defined-benefit or defined-contribution plans and will normally give a pension entitlement after age 65. In certain cases, the age may be reduced but never lower than 62. Notice of termination is normally 6–12 months, and if the company gives notice severance pay shall be a maximum of 12 months’ salary.

Remuneration and other employment terms for the CEO are prepared by the compensation committee and decided by the Board. Remuneration and other employment terms for members of the senior executive team are determined by the CEO following approval by the compensation committee. The Board of Billerud is entitled to deviate from these guidelines in an individual case if there are particular reasons to do so. See note 24 for 2010 guidelines.

Risk management, parent company

For a description of the Group’s risk management, see the section titled “Risk management and sensitivity analysis”. The description applies, where appropriate, to both the Group and parent company. Specific differences concerning the parent company receive comment under this heading.

For an understanding of the risk exposure in the parent company, the following should be taken into account.

Customer credit

The parent company’s accounts receivable represent more than 90% of the Group’s accounts receivable, because the mills’ accounts receivable are taken over by the parent company after invoicing and the monies collected by the parent company. However, the risk of any bad debts remains with the invoicing company. Of total provisions within the Group for doubtful accounts receivable in 2010, SEK 15 million (11) was attributable to the parent company.

Currency exposure

All forward foreign exchange contracts for the Swedish operations are taken out by the parent company, while the exposure to payment flows in foreign currency is borne by all the Swedish mills. Exposure for the parent company is thus less than that of the forward contracts taken out. This applies up to the invoicing date, because the parent company takes over the accounts receivable for the Swedish mills. At year-end 2010, foreign exchange contracts not yet recognised in the parent company’s profit and loss statement totalled a nominal SEK 2 633 million (2 558), all of which will be recognised in 2011. The corresponding net currency flows in the parent company in 2011 are estimated at approximately SEK 7 200 million (5 900).

Interest rate risk

The Group’s borrowing is conducted primarily via the parent company and accounted for 97% of the Group’s total borrowing at 31 December 2010. As a result, the parent company has largely the same exposure to changes in interest rates as the Group. All interest derivatives are attributable to the parent company.

Expenses

Energy

The parent company is the contracted party in all electricity hedging contracts, which are based on electricity consumption at the three Swedish mills. The parent company’s exposure is therefore less than the total hedged amounts. However, when the contract is settled, any profit or loss on the contract is distributed in proportion to the forecast consumption of each mill. Consequently the parent company’s earnings are only affected by the amount corresponding to the parent company’s (Gruvön mill) electricity consumption. During 2010, the Company had no electricity hedging contracts, and no contracts have been signed for 2011.

Proposed allocation of profit

As reported on page 98 of this Annual Report, non-restricted equity in the parent company, Billerud AB, amounted to SEK 2 992 million at 31 December 2010.

According to Billerud’s financial targets, the dividend shall equal 50% of the net profit and the net debt/equity ratio shall be between 0.60 and 0.90 over a business cycle. At the end of 2010, the Company’s net debt/equity ratio was 0.03, a decrease of 0.26 compared with the end of 2009 and significantly less than the target range. Billerud’s Board proposes that, of the earnings per share of SEK 6.84, SEK 3.50 per share be paid to shareholders and that the remaining amount be carried forward.

Events after the close of the financial year

A new SEK 801 million syndicated credit facility maturing in 2016 was raised, replacing the previous facility of SEK 1 200 million maturing in 2012.

Outlook

• Order bookings remain good or excellent in most areas for Billerud’s packaging paper, providing the basis for ongoing progress in Billerud’s segments for packaging paper and solutions.
• The outlook is bright for additional price increases in local currency for packaging paper to counter the negative impact of a weaker EUR exchange rate.
• A weaker USD will reduce the operating margin for the Market Pulp business area.