Note 17. Stock-Based Compensation Plan

The company's Long-term Incentive Compensation Plan (the "Plan") was approved at the 1992 Annual Meeting of Shareholders. The Plan provides for the purchase of the company's common stock at its market price on the date of grant by certain key officers and other employees of the company and its subsidiaries who are selected from time to time by the Compensation Committee of the Board of Directors. No more than 10 million shares may be issued under the Plan. The term of options granted under the Plan may not exceed 10 years from the grant date. Grantees are 25 percent vested after one year, 50 percent after two years, 75 percent after three years, and 100 percent after four years.

The company accounts for all options under APB Opinion No. 25 and related interpretations, under which no compensation has been recognized. Had compensation costs for the Plan been determined consistent with SFAS No. 123, "Accounting for Stock-Based Compensation," net income and earnings per share would have been reduced to the following pro forma amounts:

 

1998 1997 1996       Net income (in millions):       As reported $ 294 $ 342 $ 463       Pro forma 279 332 454             Basic earnings per share:       As reported $ 1.48 $ 1.72 $ 2.34       Pro forma 1.40 1.67 2.29             Diluted earnings per share:       As reported $ 1.47 $ 1.72 $ 2.33       Pro forma 1.40 1.66 2.28

Because the SFAS No. 123 method of accounting has not been applied to options granted prior to fiscal year 1995, the resulting pro forma compensation cost may not be representative of that to be expected in future years.

The fair value of each option grant is estimated on the date of the grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants:

1998 1997 1996                 Risk-free interest rate   5.60% 6.42% 5.81%       Expected life   4.3 years 4.9 years 6.4 years       Expected volatility   27.08% 26.21% 25.61%       Expected dividend yield   3.03% 3.44% 3.48%                     Changes in the number of shares subject to option are summarized as follows:                             1998 1997 1996       Shares (in thousands):           Outstanding, beginning of year   5,848 6,243 5,972         Granted   1,981 1,563 1,222         Exercised   512 1,864 925         Forfeited   95 91 26         Expired   -- 3 --         Outstanding, end of year   7,222 5,848 6,243         Exercisable, end of year   5,304 4,309 5,022                     Weighted average           exercise price:           Outstanding, beginning of year   $43.32 $40.56 $38.17         Granted   52.85 46.54 45.94         Exercised   38.98 36.70 32.11         Forfeited   50.37 44.68 43.46         Expired   -- 37.75 --         Outstanding, end of year   46.15 43.32 40.56                   Weighted average grant date fair value of options   12.31 11.26 11.40

Note 18. Business Segments

The company is principally engaged in the growing and harvesting of timber and the manufacture, distribution and sale of forest products. The business segments are timberlands (including logs, chips and timber); wood products (including softwood lumber, plywood and veneer; composite panels; oriented strand board; hardwood lumber; treated products; doors; raw materials; and building materials distribution); pulp, paper and packaging (including pulp, paper, containerboard, packaging, paperboard and recycling); and real estate and related assets.

The timber-based businesses involve a high degree of integration among timber operations; building materials conversion facilities; and pulp, paper, containerboard and paperboard primary manufacturing and secondary conversion facilities. This integration includes extensive transfers of raw materials, semi-finished materials and end products between and among these groups. The company's accounting policies for segments are the same as those described in "Note 1. Summary of Significant Accounting Policies." Management evaluates segment performance based on the contributions to earnings of the respective segments. Accounting for segment profitability in integrated manufacturing sites involves allocation of joint conversion and common facility costs based upon the extent of usage by the respective product lines at that facility. Transfer of products between segments is accounted for at current market values. >