RAYONIER ADVANCED MATERIALS INC. (RYAM) FY 2022 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our Financial Statements, the notes thereto, and the other financial information appearing elsewhere in this 2022 Form 10-K. The following discussion includes forward-looking statements that involve certain risks and uncertainties. See Forward-Looking Statements and Item 1A — Risk Factors in this 2022 Form 10-K.

This section primarily discusses 2022 and 2021 items and comparisons between these years. For a discussion of year-over-year comparisons between 2021 and 2020 and other financial information related to 2020 that is not included in this 2022 Form 10-K, refer to Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations of our Annual Report on Form 10-K for the year ended December 31, 2021 filed with the SEC on March 1, 2022.

Overview

We are a diversified global leader of cellulose-based technologies that operates in the following business segments:

•High Purity Cellulose

•Paperboard

•High-Yield Pulp

Our High Purity Cellulose business has leading positions in the cellulose specialties markets. In addition, our other business segments provide a more diversified earnings stream.

High Purity Cellulose

We manufacture and market high purity cellulose, which is sold as either cellulose specialties or commodity products. We are the leading global producer of cellulose specialties, which are primarily used in dissolving chemical applications that require a highly purified form of cellulose. Pricing for our cellulose specialties products is typically set by contract for a duration of at least one year, based on discussions with customers. Our commodity products primarily consist of commodity viscose and absorbent materials. Commodity viscose pulp is a raw material required for the manufacture of viscose staple fibers which are used in woven and non-woven applications. Absorbent materials, typically referred to as fluff fibers, are used as an absorbent medium in consumer products. Pricing for commodity products is typically referenced to published indices or based on publicly available spot market prices. Sales of chemicals and energy, a majority of which are by-products of our manufacturing processes, are included in the High Purity Cellulose segment.

Our four production facilities, located in the U.S., Canada and France, have a combined annual production capacity of 1,045,000 MTs of cellulose specialties and commodity products. Of our total annual capacity, we dedicate 270,000 MTs of annual production to commodity products, primarily absorbent materials.

Wood fiber, chemicals and energy represent approximately 50 percent of our per MT cost of sales. Labor, manufacturing and maintenance supplies, depreciation, manufacturing overhead and transportation costs represented our remaining cost of sales.

Paperboard

We manufacture paperboard that is used for packaging, printing documents, brochures, promotional materials, paperback book and catalog covers, file folders, tags and lottery tickets.

Pricing for paperboard is typically referenced to published indices and marketed through our internal sales team. Our production facility, located in Canada, has an annual production capacity of 180,000 MTs of paperboard. Wood pulp, chemicals and energy represent approximately 80 percent of our per MT cost of sales. Labor, manufacturing and maintenance supplies, depreciation, manufacturing overhead and transportation costs represent our remaining cost of sales.

High-Yield Pulp

We manufacture and market high-yield pulp, which is used by paper manufacturers to produce paperboard, packaging, printing and writing papers and a variety of other paper products. Pricing for high-yield pulp is typically referenced to published indices marketed through our internal sales team. Our production facility, located in Canada, has an annual production capacity of 290,000 MTs of high-yield pulp.

Wood fiber, chemicals and energy represent approximately 40 percent of our per MT cost of sales. Labor, manufacturing and maintenance supplies, depreciation, manufacturing overhead and transportation costs represent our remaining cost of sales.

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Recent Business Developments

•During the second, third and fourth quarters of 2022, we repurchased a total $47 million of our Senior Notes through open-market transactions and retired the notes for $47 million in cash.

•During the third and fourth quarters of 2022, we repaid CAD fixed interest rate term loans in the total amount of CAD $24 million (USD $18 million).

•During the second quarter of 2022, we sold the 28.7 million shares of GreenFirst common stock we received in connection with the August 2021 sale of our lumber and newsprint assets for $43 million. The shares sale agreement contains a purchase price protection clause whereby we are entitled to participate in further stock price appreciation under certain circumstances until December 2023.

•During 2022, our business experienced a significant increase in the costs for wood, chemicals, energy and supply chain. In response, we implemented a $146 per MT cost surcharge applicable to all shipments of our cellulose specialties, effective starting with shipments made on April 1, 2022 and later. In connection with contract negotiations, the cost surcharge was phased out in early 2023.

•As of March 2022, our fluff pulp qualifies as an “Inspected Raw Material” by Nordic Swan Ecolabelling. The Nordic Swan Ecolabel sets strict environmental requirements in all phases of manufacturing, including requirements for eco-friendly chemicals used in ecolabeled products. The status will appear on products made with our fluff pulp and indicates to consumers and commercial buyers that the product is sustainably produced and environmentally friendly.

•On March 21, 2022, our Board of Directors adopted a stockholder rights plan and declared a dividend of one preferred share purchase right for each outstanding share of our common stock, par value $0.01 per share. See Note 13 — Stockholders’ Equity to our Financial Statements for further information.

Market Assessment

This market assessment represents our best current estimate of our business segments’ future performance.

High Purity Cellulose

Demand for cellulose specialties and commodity products is mixed. Strength in acetate, casings, filtration and nitrocellulose end markets are offsetting softness for construction ethers, food additives in microcrystalline cellulose and tire cord. Fluff market demand remains resilient but at lower prices than fourth quarter levels. Viscose markets started the year soft, with signs of improvement as China’s economy reopens. Average sales prices for cellulose specialties in 2023 are expected to be high single-digit percent higher than average 2022 sales prices. Commodity sales prices are expected to decline versus 2022 levels, in line with industry forecasts for fluff and viscose cellulose pricing. Commodity sales volumes are expected to increase as production and logistics constraints improve. Raw material prices are expected to remain elevated, offset by benefits expected from prior strategic capital investments.

Paperboard

Paperboard prices for 2023 are expected to continue to increase from 2022 levels, driven by strong demand in both the packaging and commercial printing end markets. Sales volumes are expected to increase slightly, driven by improved logistics, while raw material prices reduce as pulp markets decline.

High-Yield Pulp

High-yield pulp markets have declined as global economic demand slows, impacting sales price. The reopening of the Chinese economy may provide catalyst for more stable pricing. Sales volumes are expected to improve slightly in 2023, primarily due to improved productivity and logistics.

A Sustainable Future

For over 95 years, we have invested in renewable product offerings and our biorefinery model provides a platform to grow existing and new products to address the needs of the changing economy. We continue to focus on growing our bio-based product offering. In 2022, other sales in our High Purity Cellulose segment were $115 million, primarily related to sales of bioelectricity and lignosulfonates. We expect to grow these sales and increase overall margins over time.

Our bioethanol facility at our Tartas, France facility is anticipated to be operational in 2024. The total estimated cost of the project is approximately $39 million, with $29 million to be spent in 2023. We plan to utilize $28 million of low-cost green loans to help fund the project, including $8 million already raised in 2022, and $4 million in grants. The project is expected to provide $9 million to $11 million of annual incremental EBITDA beginning in 2024.

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Results of Operations: Year Ended December 31, 2022 versus December 31, 2021

Net Sales

Net sales increased by $309 million or 22 percent, in 2022 compared to 2021, driven primarily by higher sales prices across all segments. See Operating Results by Segment below for further discussion.

Operating Income (Loss)

Operating results for 2022 improved by $36 million when compared to 2021 due to higher sales prices across all segments, partially offset by increased costs resulting from inflation on chemicals, wood fiber, energy and logistics costs.

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Non-operating Expenses

Included in non-operating expenses for 2022 was a $5 million gain associated with the GreenFirst shares received in connection with the sale of lumber and newsprint assets in August 2021. A loss of $4 million was recognized on these shares during the year ended December 31, 2021. See Note 12 — Fair Value Measurements to our Financial Statements for further information.

Included in non-operating expenses for 2021 was $8 million in pension settlement losses.

Income Taxes

The effective tax rate on the loss from continuing operations for 2022 was an expense of 4 percent. The most significant items creating a difference between the 2022 effective tax rate and the statutory rate of 21 percent were changes in the valuation allowance on disallowed U.S. interest deductions, nondeductible executive compensation, U.S. tax credits and tax return-to-accrual adjustments on filed returns.

The effective tax rate on continuing operations for 2021 was a benefit of 42 percent. The 2021 effective tax rate differed from the statutory rate of 21 percent primarily due to a tax benefit recognized by remeasuring the Canadian DTAs at a higher Canadian blended statutory tax rate. The Canadian statutory tax rate increased as a result of changing the allocation of income between the Canadian provinces after the sale of our lumber and newsprint assets. See Note 19 — Income Taxes to our Financial Statements for further information.

Discontinued Operations

In 2021, we received $193 million of cash upon closing of the sale of our lumber and newsprint assets to GreenFirst. In the first quarter of 2022, we trued-up certain sale-related items with GreenFirst for a total net cash outflow of $3 million, as expected and previously disclosed. Pursuant to the terms of the asset purchase agreement, we had been engaged with GreenFirst in efforts to finalize the closing inventory valuation adjustment, which could have impacted the final purchase price. In November 2022, the arbitration proceeding was resolved in our favor and no changes were made to the gain on sale recorded during 2021.

During the third quarter of 2022, the USDOC completed its third administrative review of duties applied to Canadian softwood lumber exports to the U.S. during 2020 and reduced rates applicable to us to a combined 8.6 percent. We recorded a $16 million pre-tax gain in connection with this development and increased the total long-term receivable related to the USDOC’s administrative reviews to date to $38 million. In January 2023, the USDOC released the preliminary results of its fourth administrative review, which indicate a reduction in rates to a combined 8.2 percent. We will adjust its long-term receivable as appropriate when these rates are finalized and issued, expected later in 2023. In total, we paid approximately $112 million in softwood lumber duties from 2017 through 2021. Although no assurances can be given, we expect to receive all or the vast majority of these duties upon settlement of the dispute.

See Note 3 — Discontinued Operations to our Financial Statements for further information.

Operating Results by Segment

High Purity Cellulose

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Net Sales

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(a) Includes sales of bioelectricity, lignosulfonates and other by-products to third parties.

Net sales of our High Purity Cellulose segment increased $245 million in 2022 when compared to 2021. Cellulose specialties sales prices increased 19 percent, inclusive of the $146 per MT cost surcharge effective April 2022, due to the impact of contract negotiations, and sales volumes increased 2 percent due to improved demand. Commodity products sales prices and volumes increased 19 percent and 7 percent, respectively, driven by higher demand. Included within net sales for 2022 was $115 million of other sales, primarily from bio-based energy and lignosulfonates.

Operating Income

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(a) Computed based on contribution margin.

Operating income of our High Purity Cellulose segment increased $11 million in 2022 when compared to 2021, driven by higher sales prices and volumes. Sales prices for the segment increased 19 percent, driven by 19 percent increases in both cellulose specialties, inclusive of the $146 per MT cost surcharge, and commodity products. Total volumes increased 4 percent, driven by 2 percent and 7 percent increases in cellulose specialties and commodity products, respectively. Costs increased compared to 2021 as the result of inflation on chemicals, wood fiber, energy and logistics costs. Partially offsetting higher energy costs in both 2022 and 2021 were $12 million of sales of excess emission allowances related to our operations in Tartas, France. Additionally, 2022 included $8 million of sales of certificates of energy savings associated with Tartas operations.

Paperboard

Net Sales

Net sales of our Paperboard segment increased $42 million in 2022 when compared to 2021, due to a 27 percent increase in sales prices, driven by strong demand, partially offset by a 6 percent decrease in sales volumes driven by the timing of sales and lower productivity.

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Operating Income

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(a) Computed based on contribution margin.

Operating income of our Paperboard segment increased $24 million in 2022 when compared to 2021, due to higher sales prices, partially offset by higher logistics, raw material pulp and chemicals costs and lower sales volumes.

High-Yield Pulp

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(a) Average sales prices and sales volumes for external sales only. During the years ended December 31, 2022 and 2021, the High-Yield Pulp segment sold 66,000 MTs and 68,000 MTs of high-yield pulp for $29 million and $28 million, respectively, to the Paperboard segment.

Net Sales

Net sales of our High-Yield Pulp segment increased $24 million in 2022 when compared to 2021, driven by a 25 percent increase in sales prices, partially offset by a 3 percent decline in sales volumes.

Operating Income

——————————————

(a) Computed based on contribution margin.

Operating income of our High-Yield Pulp segment increased $9 million in 2022 when compared to 2021, driven by higher sales prices, partially offset by higher chemicals and logistics costs and lower sales volumes.

Corporate

The operating loss of our Corporate segment increased $8 million in 2022 when compared to 2021, driven by an increase in severance and variable stock-based compensation costs, partially offset by favorable foreign currency exchange impacts.

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Liquidity and Capital Resources

Overview

Cash flows from operations, primarily driven by operating results, have historically been our primary source of liquidity and capital resources. As operating cash flows can be negatively impacted by fluctuations in market prices for our commodity products and changes in demand for our products, we maintain a key focus on cash, managing working capital closely and optimizing the timing and level of our capital expenditures.

Our Board of Directors suspended our quarterly common stock dividend in September 2019. No dividends have been declared since. The declaration and payment of future common stock dividends, if any, will be at the discretion of our Board of Directors and will be dependent upon our financial condition, results of operations, capital requirements and other factors that the Board of Directors deems relevant. In addition, our debt facilities place limitations on the declaration and payment of future dividends.

In January 2018, our Board of Directors authorized a $100 million common stock share buyback program. We did not repurchase any shares under this program during the years ended December 31, 2022 and 2021, and do not expect to utilize any of the remaining $60 million in unused authorization in the near future.

As of December 31, 2022, we were in compliance with all financial and other customary covenants under our credit arrangements. We believe our future cash flows from operations, availability under our ABL Credit Facility and our ability to access the capital markets, if necessary or desirable, will be adequate to fund our operations and anticipated long-term funding requirements, including capital expenditures, defined benefit plan contributions and repayment of debt maturities.

Our non-guarantor subsidiaries had assets of $507 million, liabilities of $177 million, year-to-date revenue of $248 million and a trailing twelve month ABL Credit Facility covenant EBITDA for continuing operations of $37 million as of December 31, 2022.

Our liquidity and capital resources are summarized below:

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(a)    Cash and cash equivalents consisted of cash, money market deposits and time deposits with original maturities of 90 days or less.

(b)    Amounts available under the ABL Credit Facility fluctuate based on eligible accounts receivable and inventory levels. At December 31, 2022, we had $166 million of gross availability and net available borrowings of $130 million after taking into account outstanding letters of credit of $36 million. In addition to the availability under the ABL Credit Facility, we have $19 million available under our accounts receivable factoring line of credit in France. See Note 9 — Debt and Finance Leases to our Financial Statements for further information.

(c)    See Note 9 — Debt and Finance Leases to our Financial Statements for further information.

Other Sources of Cash

In May 2022, we sold our GreenFirst shares for $43 million. See Note 3 — Discontinued Operations to our Financial Statements for further information.

In 2022, we received net tax refunds of $15 million. See Note 19 — Income Taxes to our Financial Statements for further information.

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Cash Requirements

We experienced increased operating expenses and capital expenditures during the year ended December 31, 2022, including for the extensive planned maintenance outages performed in the first half of the year.

Contractual Commitments

Our principal contractual commitments include standby letters of credit, surety bonds, guarantees, purchase obligations and leases. We utilize arrangements such as standby letters of credit and surety bonds to provide credit support for certain suppliers and vendors in case of their default on critical obligations, collateral for certain of our self-insurance programs and guarantees for the completion of our remediation of environmental liabilities. As part of our ongoing operations, we also periodically issue guarantees to third parties. Our primary purchase obligation payments relate to natural gas, steam energy and wood chips purchase contracts. As of December 31, 2022, our noncancellable unconditional purchase obligations totaled $894 million. See Note 21 — Commitments and Contingencies to our Financial Statements for further information.

Senior Notes

During the year ended December 31, 2022, we repurchased $47 million of our Senior Notes through open-market transactions and retired the notes for cash of $47 million.

Our next significant debt maturity is in June 2024. We withdrew our opportunistic offering of senior secured notes earlier this year as terms and conditions were not sufficiently attractive at the time. We continue to monitor the capital markets and are prepared to opportunistically refinance the Senior Notes at the appropriate time and at acceptable terms, considering market conditions and all other relevant factors. We are confident that by executing on our strategy to improve our credit profile, we can obtain a refinancing at acceptable terms based on market conditions. We may also use a portion of our cash balance to repay debt or assist in a holistic refinancing of our capital structure.

CAD Term Loans

During the year ended December 31, 2022, we repaid CAD fixed interest rate term loans in the amount of CAD $24 million (USD $18 million).

Cash Flows

Cash provided by operating activities of continuing operations decreased $5 million during 2022 when compared to 2021. Operating cash flows in 2022 were driven by net tax refunds of $15 million, partially offset by increased cash outflows from working capital, driven by inflation and logistics constraints, and expenditures related to extensive planned maintenance outages through the first half of the year. Operating cash flows in 2021 included the receipt of $35 million of net tax refunds and $20 million related to CEWS claims, partially offset by an increase in working capital.

Cash used in investing activities of continuing operations increased $41 million during 2022 when compared to 2021, due to increased capital spending related to the planned maintenance outages in the current year.

Cash provided by investing activities of discontinued operations decreased $139 million during 2022 when compared to 2021. The cash inflow in 2022 was the result of the sale of GreenFirst common stock and the first installment on the credit note associated with the sale of our lumber and newsprint assets in August 2021. The cash inflow in 2021 consisted of the net cash received in connection with the sale of our lumber and newsprint assets.

Cash used in financing activities decreased by $84 million during 2022 when compared to 2021, primarily due to a decrease in repayments of long-term debt.

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Performance and Liquidity Indicators

The discussion below is presented to enhance the reader’s understanding of our operating performance, liquidity and ability to generate cash and satisfy rating agency and creditor requirements. This information includes the non-GAAP financial measures of EBITDA, adjusted EBITDA and adjusted free cash flows. These measures are not defined by GAAP and our discussion of them is not intended to conflict with or change any of our GAAP disclosures provided in this 2022 Form 10-K.

We believe these non-GAAP financial measures provide useful information to our Board of Directors, management and investors regarding our financial condition and results of operations. Our management uses these non-GAAP financial measures to compare our performance to that of prior periods for trend analyses, to determine management incentive compensation and for budgeting, forecasting and planning purposes. Our management considers these non-GAAP financial measures, in addition to operating income, to be important in estimating our enterprise and stockholder values and for making strategic and operating decisions. In addition, analysts, investors and creditors use these non-GAAP financial measures when analyzing our operating performance, financial condition and cash-generating ability. We use EBITDA and adjusted EBITDA as performance measures and adjusted free cash flows as a liquidity measure.

We do not consider non-GAAP financial measures an alternative to financial measures determined in accordance with GAAP. The principal limitation of these non-GAAP financial measures is that they may exclude significant expense and income items that are required by GAAP to be recognized in our Financial Statements. In addition, they reflect the exercise of management’s judgment about which expense and income items are excluded or included in determining these non-GAAP financial measures. In order to compensate for these limitations, reconciliations of our non-GAAP financial measures to their most directly comparable GAAP financial measures are provided below. Non-GAAP financial measures should not be relied upon, in whole or part, in evaluating our financial condition, results of operations or future prospects.

EBITDA and Adjusted EBITDA

EBITDA is defined as earnings before interest, taxes, depreciation and amortization. EBITDA is not necessarily indicative of results that may be generated in future periods. Adjusted EBITDA-continuing operations is defined as EBITDA-continuing operations adjusted for a settlement of certain pension plans, severance costs associated with an executive departure and gain on debt extinguishment.

Loss from Continuing Operations is reconciled to EBITDA and adjusted EBITDA as follows:

EBITDA and adjusted EBITDA from continuing operations increased $53 million and $50 million, respectively, compared to 2021, primarily driven by higher sales prices across all segments, partially offset by higher key input and logistics costs. See Results of Operations for additional discussion of the changes in our operating results.

Adjusted Free Cash Flows

Adjusted free cash flows is defined as cash provided by operating activities of continuing operations adjusted for capital expenditures, net of proceeds from the sale of assets and excluding strategic capital expenditures deemed discretionary by management. Adjusted free cash flows, as defined by us, is a non-GAAP financial measure of cash generated during a period which is available for debt reduction, strategic capital expenditures, acquisitions and repurchases of our common stock. Adjusted free cash flows is not necessarily indicative of the adjusted free cash flows that may be generated in future periods.

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Cash flows of operating activities of continuing operations is reconciled to adjusted free cash flows as follows:

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(a)    Net of proceeds from the sale of assets and excluding strategic capital expenditures. Strategic capital expenditures were $34 million and $16 million for the years ended December 31, 2022 and 2021, respectively.

Adjusted free cash flows of continuing operations declined due to changes in working capital and other items and higher capital expenditures. See Liquidity and Capital Resources — Cash Flows for additional discussion of our operating cash flows.

Critical Accounting 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 Financial Statements. 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.

Revenue Recognition and Measurement

Revenue is recognized when performance obligations under the terms of a contract with a customer are satisfied. The majority of our contracts have a single performance obligation to transfer products. Accordingly, we recognize revenue when control has been transferred to the customer. Generally, control transfers upon delivery to a location in accordance with terms and conditions of the sale. Changes in customer contract terms and conditions, as well as the timing of orders and shipments, may have an impact on the timing of revenue recognition.

Revenue is measured as the amount of consideration we expect to receive in exchange for transferring our products and is generally based upon contractual arrangements with customers or published indices. We sell our products both directly to customers and through distributors and agents typically under agreements with payment terms less than 90 days.

The nature of our contracts may give rise to variable consideration, which may be constrained, including sales volume-based rebates to customers. We estimate the level of volumes based on anticipated purchases at the beginning of the period and record a rebate accrual for each purchase toward the requisite rebate volume. These estimated rebates are included in the transaction price as a reduction to net sales.

Property, Plant & Equipment

Depreciation

Depreciation expense is computed using the units-of-production method for our high purity cellulose, paperboard and high-yield pulp plant and equipment and the straight-line method for all other property, plant and equipment over the useful economic lives of the assets involved. The total units of production used to calculate depreciation expense is determined by factoring annual production days, based on normal production conditions, by the economic useful life of the asset involved. Our estimate of useful lives and salvage values are based on assumptions and judgments that reflect both historical experience and expectations regarding future use of our assets, including wear and tear, obsolescence, technical standards, market demand and geographic location. The use of different assumptions and judgments in the calculation of depreciation, especially those involving useful lives, would likely result in significantly different net book values and results of operations.

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Asset Impairment

Long-lived assets are reviewed annually for impairment or whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Recoverability of assets that are held and used is measured by net undiscounted cash flows expected to be generated by the asset. An impairment loss may exist when the estimated recovery value is less than the carrying amount. Should a review for impairment be required, determining whether the carrying amount of an asset is recoverable requires judgments regarding long-term forecasts of future revenue and costs related to the asset subject to review. These forecasts are uncertain, as they require significant assumptions about future market conditions. Significant and unanticipated changes to these assumptions could require a provision for impairment in a future period. Property, plant and equipment are grouped for purposes of evaluating recoverability at the combined plant level, the lowest level for which independent cash flows are identifiable.

Environmental Liabilities

At December 31, 2022, we had $171 million of accrued liabilities for environmental costs relating to disposed operations. Numerous price, quantity, cost and probability 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. Quarterly, we review our environmental liabilities related to assessment activities and remediation costs and adjust them as necessary. Liabilities for financial assurance, monitoring and maintenance activities and other activities are assessed annually. A significant change in any of these estimates could have a material effect on our results of operations and financial condition. See Note 10 — Environmental Liabilities to our Financial Statements for further information.

Pension and Other Postretirement Benefit Assets and Liabilities

Our defined benefit pension and postretirement plans for employees in the U.S. and Canada require numerous estimates and assumptions 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 authoritative guidance on how to select most of these assumptions exists, we exercise judgment when selecting these assumptions based on input from our actuary and other advisors. 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.

Our assumed long-term return on plan assets 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 historical annualized rate of returns. 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 weighted average discount rate increased from 2.82 percent at December 31, 2021 to 4.95 percent at December 31, 2022.

Our defined pension plans were underfunded by $87 million at December 31, 2022. The underfunded status decreased by $39 million in 2022, primarily due to actuarial gains as a result of increased discount rates. In 2023, pension expense is expected to increase slightly as lower amortization of actuarial losses is offset by higher interest cost. 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. See Note 17 — Employee Benefit Plans to our Financial Statements for further information.

In 2022, we made mandatory contributions and benefit payments to plan participants of $8 million. During 2023, we expect to make mandatory and discretionary benefit payments to plan participants of $9 million. Future mandatory contribution requirements will vary depending on actual investment performance, changes in valuation assumptions, interest rates and legal requirements to maintain a certain funding status.

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The sensitivity of pension expense and projected benefit obligation related to our pension plans to changes in economic assumptions is presented below:

Realizability of Recorded and Unrecorded Tax Assets and Liabilities

Our income tax expense, deferred tax assets and liabilities and reserves for unrecognized tax benefits reflect management’s best assessment of estimated current and future taxes to be paid. Significant judgments and estimates are required in determining consolidated income tax expense.

Realizability of Deferred Tax Assets

We have recorded certain DTAs that we believe will be realized in future periods. The recognition of these DTAs is based on our analysis of both positive and negative evidence regarding the future realization of the tax benefit of each existing deductible temporary difference or carryforward. Future realization is based on the existence of sufficient taxable income, of the appropriate character, within the appropriate taxing jurisdiction (for example country, state or province) and within the carryback and carryforward periods available under applicable tax laws. In projecting future taxable income, we evaluate historical earnings, excluding results from discontinued operations, along with future earnings forecasts, the reversal of temporary differences, and the implementation of feasible and prudent tax-planning strategies.

The vast majority of our DTAs are in Canada, including $505 million of NOLs subject to expiration after 20 years and other DTAs which can be carried forward indefinitely. We evaluate the realizability of these Canadian DTAs in two steps.

The first step determines the realizability of the Canadian NOLs prior to expiration. This is done by forecasting Canadian taxable income in each year to confirm each NOL pool is more-likely-than-not to be realized before its respective expiration, which ranges from 2025 to 2037. The forecasted taxable income excludes depreciation, which can be deferred indefinitely under Canadian tax law.

The second step evaluates future projected Canadian earnings from continuing operations to confirm the Canadian operations are more-likely-than-not to be profitable in future years, inclusive of depreciation. This second step establishes that the NOLs are not realized due solely to the suspension of Canadian tax depreciation. Although this step does not require earnings be realized before any set time period, the Canadian operations would eventually need cumulative profits (excluding permanent tax adjustments) sufficient to utilize the indefinite-lived DTAs.

Evaluation of all available evidence supports the realizability of most recorded DTAs. If the review of evidence indicates the realizability may be less than likely, then a valuation allowance is recorded, with the exception of DTAs for suspended U.S. interest deductions, which do not have a full valuation allowance in accordance with specific AICPA guidance. See Note 19 — Income Taxes to our Financial Statements for further information.

Unrecognized Tax Benefits

Our income tax returns are subject to examination by U.S. federal and state taxing authorities as well as foreign jurisdictions, including Canada and France. 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 or an offset to the corresponding DTAs for any 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 become available. See Note 19 — Income Taxes to our Financial Statements for further information.

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