International Paper Company (IP) Q2 2010 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the International Paper 2010 Second Quarter Earnings Call. [Operator Instructions] I would now like to turn the conference over to Mr. Tom Cleves, Vice President of Investor Relations. Sir, you may begin your conference.

Thanks, Paula. Good morning, everyone, and thanks for joining our second quarter earnings conference call. Our speakers this morning are John Faraci, Chairman and Chief Executive Officer; and Tim Nicholls, Senior Vice President and Chief Financial Officer. During this call, we will make forward-looking statements that are subject to risks and uncertainties. These are outlined on Slide 2 of the presentation. We'll also present certain non-U.S. GAAP financial information. A reconciliation of those figures to U.S. GAAP measures is available on our website, and our website also contains copies of the second quarter 2010 press release and today's presentation slides. With that, I'll turn the call over to John.

Thanks, Tom, and good morning, everybody. Thanks for joining us for the second quarter results call. As we typically do over the next 20 to 30 minutes, Tim Nicholls and I are going to review our second quarter results with you and the performance of the individual businesses. We'll also share our third quarter outlook, and then we'll open it up to your questions with a Q&A session. I start out by saying we're very pleased with the results we achieved in the second quarter. Coming out of the deep recession in 2009 and operating in an overall economic environment, it's improving but certainly not robust. We significantly improved our earnings in the second quarter. Before special items, earnings more than doubled versus the second quarter of 2009, and they were far better than the earnings in Q1, which is the low point for International Paper. So quickly, the headlines. Revenues increased by 6%. This is the first quarter of revenue growth since late 2008. It was both volume and price. Margins expanded in all businesses. We had strong free cash flow generation, and importantly, all businesses both in North America and around the world, turned in strong second quarter profits. EPS in the second quarter was $0.42, up from $0.04 in the first quarter and $0.20 in the second quarter of 2009. Our second quarter results benefited from our global balance with all of our businesses outside the U.S. recording strong operating results. Our European Paper and Packaging business, which includes our Russian operations in Svetogorsk, also generated record earnings in the second quarter as did our Asian operations. Our milling-converting operations performed very well in the quarter, which made a contribution to earnings, and profits continue to come from our ongoing cost-reduction efforts. Fiber costs declined during the quarter, but they remain high compared to historical levels. And I also like to point out that we generated our strong second quarter results despite a $120 million in maintenance outage expenses, about $38 million more than the first quarter or about $0.05 a share, and the second quarter was our high watermark for maintenance outages during the year. So quickly, on the numbers. On second quarter sales were $6.1 billion. It's at the highest level since the fourth quarter of 2008. EBITDA increased 40% to close to $800 million, $782 million to be exact. Free cash flow improved over $350 million, and importantly, we continue to reduce our long-term debt. In the quarter, we reduced it by $100 million and increased our cash balance on hand by $200 million from $1.7 billion to $1.9 billion. So we're on Slide 7 now and that's comparing the second quarter of 2010 to the first quarter of 2010, and this slide shows our sequential operating improvement. As you can see, realized price increases added the most to second quarter earnings at $0.29 a share, improved volumes in Paper and Packaging added $0.05, strong mill operations and cost-reduction activities, and what you're seeing here is a flow-through of the facility decisions in May, both in the Containerboard business and box plants. And in Europe, we're starting to flow-through, adding to our earnings. We continue to monetize our Forest Resource assets. In this case, in the second quarter. We sold some mineral rights, which added $0.05 to our earnings. A bit of a headwinds here, our largest envelope customer filed for bankruptcy during the quarter, which led to a $0.05 charge. And in our North American Premium Papers business, we hope to recover some of this amount in the future, and if we do, we'll recognize it in future periods. And finally, the Ilim joint venture continue to improve. And remember, that's on a one quarter lag, and they added $0.02 to our earnings compared to the first quarter. I think it's also instructive to look at kind of the first half of this year versus first half of last year, and they are of somewhat different story. Again, a lot of improvement, $0.46 year-to-date this year versus $0.28 for the first six months of 2009, but you see the impact of volume here. As the global economies have recovered, we've been able to sell more volume in almost all of our Global businesses, and that increased earnings by almost $0.40 a share, $0.37. Selling prices however fell in 2009. And while it had been recovering, it's important to note selling prices still remain below 2009 levels. This reduced earnings by $0.10. The operating costs are very favorable, again reflecting good operations. The smaller footprint we have, we would've made adjustments to reflect the supply and demand and also ongoing cost-reduction activities, headcount reductions across the company and fewer converting facilities. Maintenance outages reduced earnings by $0.05, and we've already completed 2/3 of our 2010 outages. Input costs, first six months of this year versus last year were unfavorable. Fiber costs were up a lot, and freight costs were also unfavorable. And this is somewhat offset by a decline in chemical costs. And again, over on the right, you can see the impact of the earnings improvement from the Ilim joint venture. On Slide 9, which shows our EBITDA trend, I think it support the [ph] Chart, and we've been showing you this for several calls now. We're continuing to improve our EBITDA and, importantly, our EBITDA margins. Despite the kind of the lag effect of the recession 2009, we generated EBITDA in 2009 of $2.8 billion or 12%. In the first quarter, that was the -- I did a low-tide mark, EBITDA was at a run rate annualized $2.3 billion, margin just 10%. In the second quarter, our EBITDA run rate improved to $3.1 billion and a margin of 13%. Again, that's reflecting the combination of price, volume and ongoing cost reductions and very strong operations. During the first quarter call, we said that we expect the input cost to decline during the second quarter but on average, we thought they'd remain about the same as the first quarter levels, and that's exactly what happened. Input costs were about $0.02 unfavorable per share in the second quarter. These next two slides will show what's been happening to two of our biggest input costs, wood cost and recycled fiber cost. Slide 11 shows you our wood costs. They declined from first quarter levels but still remained a lot higher than they were in 2008 and 2009. Harvesting conditions has returned to normal because we've had more normal weather patterns. Harvest levels have increased and wood costs have started to decline. Slide 12 shows the pattern for OCC cost, and OCC costs have risen significantly. They rose significantly 2009 and in the first quarter of 2010, but they've started to decline. But like wood costs, they remained significantly higher than 2009 levels. As I mentioned up front in our headlines, what we call our EMEA business, that's Europe, the Middle East and Africa, had posted very strong results. I just want to highlight it in here, because I think it shows the benefit of the global balance International Paper has. These businesses generated $245 million from operating profits in the first half, a 55% increase over 2009, and they accounted for 11% of our sales but 18% of our total EBITDA. So think of that as our European and Russian Paper business and our European-Turkey-Morocco Corrugated Box business. And EBITDA margins improved from 12% last year to 19% this year. Both these businesses, Paper and Packaging, generated well above cost-of-capital returns. And the results include the benefit of the permanent shutdowns of the Inverurie uncoated freesheet mill, which is part of the Paper business, and the Etienne recycled containerboard mill, which is part of the Packaging business. We got two facilities out and improved our earnings as a result. And there are a lot of other things going on in that business as well, and we're very positive. So with that, I'll turn it over to Tim Nicholls who will discuss the second quarter results in a little bit more detail by business segment. Then we'll talk about the outlook for the third quarter and your questions.

Okay. Thanks, John. Good morning, everyone. I'll start with Industrial Packaging. Industrial Packaging had a significant jump in earnings from the first quarter to the second quarter, ending the quarter with $193 million in earnings. And it was really driven by box volumes and price realizations. In North America, our box volumes were up 8% from the first quarter levels and shipments were at the highest levels since before the economic crisis began. Export has continued to be strong, although we did make some decisions around pulling export volume, some of our export volume back to make sure that our integrated chain have the liner board that it needed given the strong demand. Price realizations were right on the pace that we expected, both here in North America and also in export markets where we've seen a rapid increase in selling prices over the past quarter, and we had fewer mill maintenance outages in the quarter in North America. That drove the $30 million in earnings. But the first half of the year was a very heavy outage period for Industrial Packaging, and through the first half, the business has now completed 80% of its maintenance outages for the year. European box shipments were flat quarter-on-quarter but really probably stronger than we thought they would be, because the second quarter starts to seasonally slow given the fruit and vegetable seasons, the way they run, and we had flat box shipments. So they turn in a strong performance, and the business there again generated a cost-of-capital return in the quarter and has for the first half of the year. If you turn to the next slide, I just like to talk about the North American Industrial Packaging business for a moment. Second quarter EBITDA margins were up 70% from the first quarter trough, and we expect margins to continue to grow in the third quarter. And our second quarter exit rate for the business was approaching a cost-of-capital return. So if you turn to Slide 16, it shows the EBITDA progress for our North American business. And after coming through what's been really the worst recession we've seen with box demand falling off more than 10% then back to overall, back to 1993 levels and coming into the first part of this year, where we had elevated fiber cost, operating profits have held up reasonably well. And if you focus on the green columns there, we had a run rate in the first half of $1 billion of EBITDA, and we ended coming out of June at $1.5 billion. So I think the business is positioned for a strong second half, and I'm very confident to the earnings power that we have going forward here. Let me shift to Printing Papers now. And even with flat volume in what was a very heavy maintenance-outage quarter, higher input costs and the large bad debt expense that John referenced earlier, we still increased earnings by 25%, and it was really due to price realizations as well as strong operations and fixed cost savings. The elimination of the fixed cost at the Franklin mill and the strong ops in the U.S. mills and Brazil added $23 million. Europe performed well, and we really saw strong performance across all of the Printing Papers businesses. European margins expanded by 150 basis points. Earnings recovered in Brazil with higher shipments, price improvements and very good operations. And given the bad debt expense, our margins in North America were down 100 basis points. But if you take that out and look at it on a run rate basis, we were up by 250 basis points. I'll now turn to Consumer Packaging, where margins improved by 150 basis points and earnings were up nearly 60%. Even though we had much higher input costs, especially at Texarkana, given the hardwood mix there and we also had higher pulp costs at the Sun joint venture in China. We had strong volumes in all the regions. North American order backlogs through the quarter were over 2x what they were at the height of the economic crisis. Price realizations were right on pace, right in line with what we had expected for the quarter. And operations improved significantly, mostly in the North American mills. We did have a heavy outage quarter for Consumer Packaging, and in the quarter, they accomplished about 50% of the total mill outages that they'll have for the year. Let me just spend a moment on fixed cost reductions. By the end of this last quarter, we had completed all of the announced permanent closures in the North American mill system and have eliminated all of the fixed cost from these mills. The operating costs that we're experiencing around some of the closures is temporarily higher given some of the transition of grades and supply chains to move the grades into the mills where they're going to be produced, but those expenses we expect to come down over the balance of the year. And we've also eliminated all of the fixed cost in the European mills that we shutdown, the Inverurie uncoated freesheet mill and the Etienne recycled board mills. So by the end of the second quarter, from a fixed cost standpoint, we had hit the $225 million run rate of fixed cost reductions globally. xpedx earnings increased to $26 million. And we're seeing some pickup in volume, and it seemed to accelerate slightly at the end of the quarter. But the real story here, at this point, is still waiting for pricing to continue to improve and still managing costs very aggressively. And it's really, at this point, the aggressive cost management that has driven the earnings improvement. On the Forest Products side, we announced the mineral rights sale, which closed in the quarter, generating $39 million in operating profits. And we also have recently announced that we've signed an agreement with Rock Creek Capital Partners to sell the majority of the remaining land for $200 million, plus an ongoing profits interest, and we expect that sale to close this quarter. And once we do that, that'll effectively complete our land sales program. Now let me turn to the joint ventures, and I'll start with the Sun joint venture. The joint venture generated record operating profit in the second quarter and has had above cost-of-capital returns for the first half of this year. International Paper's share of the profit was $13 million, which was similar to our first quarter levels, but double that of the second quarter last year, continuing to see very strong demand growth and expect that demand will continue to grow in China in the 8% to 9% range. And recently, the joint venture and the IP boards have approved the addition of a new 550,000-ton board machine, which should start up in early 2012. If I shift to Ilim, and again, I'll remind you that we report the results of Ilim on a one-quarter lag, sales at the joint venture increased by 10%, and our share of the earnings increased to $5 million. We saw Pulp shipments increased by 4% and Containerboard by 1%. And prices began to move up with a $56 increase in the quarter, which is really from our fourth quarter to our first, and Containerboard prices increased by $22 a ton. So when we look at Russia, we see an economy that has stabilized. Demand and prices for our market pulp continued to improve in the quarter. Domestic demand for paper and board also improved. In July, we received a $34 million cash dividend from the joint venture, which brings our total dividends received since we've been a part of the joint venture to $152 million or approximately 25% of our original investment. Recently, the board, the Ilim board has approved the resumption of the original strategic capital plan, which was focused on value-added paper products for Koryazhma and also leveraging the pulp assets in Siberia. And so those two projects, the first one is the $700 million new pulp line at the Bratsk Pulp Mill, which is scheduled for start-up in the second quarter of 2012. The joint venture has improved the installation of an uncoated freesheet, a machine at the Koryazhma mill, which will have 220,000 tons of paper, including 165,000 tons of uncoated freesheet, and with the approval of a coating line, 55,000 tons of coating base paper. So that will also start up in 2012. So before I turn it back over to John, let me just touch on capital allocations for a moment. The slide here shows some of the actions that we've taken this year around the dividend and the investments that we've recently announced, both for SCA Packaging in China and the Sun joint venture coated paperboard machine. Earlier this week, we continued our debt-reduction efforts by making a $500 million cash contribution to our pension fund. And through the quarter, we reduced long-term debt by $100 million. So with that, John, I'll turn it back over to you.

Okay, Tim, thanks. I'm going to take a minute and try to describe how we see the current global macroeconomic conditions. And we've got a map here, we've tried to color it and just give you a sense of how we're seeing the business environment. I'd say, overall, it's positive but it's mixed. Our biggest market is here in the U.S., where we had 70% of our sales. I think the best thing we can say about the U.S. economy is, it's out of the recession but it's in a transition. Growth has been positive. But as we look at what's happened in June and July, we'd say the economy is still growing, but it's growing at a slower rate. The outlook for economic growth is better elsewhere, especially in Russia, Latin America and China. Europe, where we do business, it's mixed. Germany and Poland are quite strong, and Turkey. The balance of Europe, for the most part, looks like North America. There is some better news though, I think all the concern about whether some of these countries in Europe are going to really pull Europe back into a recession, both Greece and Portugal have been able to raise money recently. China, as we all know, is very, very strong. Russia is growing at about a 4% to 5% rate this year, and Latin America is also expected to grow in the 5% range, but obviously, that's very important for us since we're the major paper producer in that part of the world. So looking ahead to the third quarter. We expect volumes to continue to grow, although at a slower pace. We expect to continue to realize our announced paper and coated board price increases, and we expect significant incremental realization of our announced North American corrugated packaging price increases. The third quarter is also going to be our latest maintenance outage quarter in North America, and we'll see a slight increase in European outages. But overall, it's going to be a plus for us. We expect input costs to flatten out but stay relatively high. We do, however, expect a favorable trend in our wood costs and we're less certain about the outlook for OCC. We're also seeing a third quarter significant increase in other cost, and these are primarily quarterly true-ups of annual estimates for LIFO, legal cost and compensation. So I'm on Slide 29, and let me just summarize here. The second quarter was a good quarter. Volume recovery was in line with the economic recovery. We got significant price increase realizations. We've reduced our fixed cost. We had strong operations, in fact, the kind of operations International Paper expects every quarter, and we had declining wood costs. Our third quarter outlook, as I said, North American demand will continue to grow or, say, in the Paper business, be stable. Although that growth will be at the slower rate. Supply and demand, this is important, remained very, very tight. Inventory levels, in some cases, are 30-year lows. And as we go around the world and look at the supply-demand balance, inventory in all of our businesses, Containerboard, Coated Paperboard, Uncoated Freesheet and Pulp, inventories are in a good spot. We expect further realizations of our announced price increases. Moderating wood cost, less certainty about OCC as I've said and a reduction in maintenance outages. So all in, we expect third quarter revenues and earnings to be meaningfully better than the second quarter. And now we'll stop right there and open it up to your questions.

Thanks, John. Thanks, Tim. Paula, we're ready for our first question please.

[Operator Instructions] Your first question comes from Mark Wilde of Deutsche Bank.

I wondered, first of all, can you talk a little bit about where you stand on cellulosic biofuel?

Mark, we've looked at it, and the early work that we've done, we don't see a huge benefit for the company. In fact, we think it's mostly a push on the map. But then when you layer in the consideration that we would have to return the credits that we filed for last year under the alternative extra tax credits and then accrue those benefits over some period of time, we don't see the rationale for making any kind of change from what we've previously done at this point. We're going to continue to look at it. And if anything changes, we'll let you know, but we don't see a big benefit right now.

And if I could, Tim, you also mentioned that other costs are likely to be up in Q3. Can you quantify that at all for us?

Yes. We're going to have -- it's going to be LIFO, and it's also going to be accruals for incentive compensation as business performance improves. So those are the big items that are going to shift.

Is there anyway to give us in kind of an order of magnitude so we have some sense to how those might move quarter-to-quarter?

I mean it's going to be a meaningful increase. I don't want to get into forecasting what the actual number is going to be, but we're going to see a meaningful increase from second to third quarter.

And then just one final question for John, little longer term. I was down in Georgia a couple of weeks ago, and one of the European utilities is helping build a huge wood pellet plant down there because they've got a lot of incentives over in Europe for biofuel. How do you think this affects the long-term competitiveness of IP if we've got a lot of -- or view as industry generally, if we've got a lot of incentives for either domestic or offshore power companies to generate bioenergy?

I mean, basically, we think that the incentives are probably on the wrong end of the curve here. This incentive is ought to be on the supply side. We'll compete with anybody on the demand side with competitive facilities. But if we wanted to have more biomass and more biofuels, what we got to be doing is putting the incentive on the supply side or encouraging people to grow more fiber. And the International Paper, we think we're a competitive buyer of fiber. If we have to compete with people to have an advantage and they got an ocean between them, that's just a fact of life that the arguments we're making to people, and I think people are starting to listen, is the way to really do this and do it effectively is to increase the supply side because nobody really wants to see the forest shrink. And there's a supply-demand balance on the forest side too.

Your next question comes from Gail Glazerman of UBS.

Can you talk a little bit about the recent softening in the pulp market? How you see that developing? And particularly, how you see that impacting profitability moving through the second half?

Yes, I think what we need to keep in mind, Gail, is we all knew that the impact of Chile wasn't going to last forever and frankly, the prices, the run up in prices went further and lasted longer than actually we thought. I mean nobody knew. So the Chilean capacity is coming back on. I think the recent statistics that just came out on Pulp, in terms of demand and inventories, are positive. But the run up in pulp prices, that was attributable to the interruption of the big chunk of global capacity where they weren't structural, they weren't permanent. And they were going to moderate, and they're starting to moderate. So I'm not surprised at all. And I think moderation of pulp prices will be a function as we go forward at supply and demand and inventories. And inventories are in good shape, and our demand is still relatively healthy.

I mean I guess I'm more interested in how it flow through to your profitability. For instance, how sensitive is that strong European result do you think to pulp pricing and as well on some paper pricing. And even in the U.S., when you look at what you did in the second quarter, that's still significantly below where you were in 2007 despite record pricing. And I'm just wondering if there might -- are there any operational offset there?

I think, well, in North America, 70% of our production is fluff. So that's a lot less volatile than market pulp or paper pulps, although they didn't move together, but they're less volatility. I think the connection in paper prices in Europe to pulp prices is harder than it is in North America, but I think it's becoming looser. So I think what's driving prices in Europe is not pulp prices, it's much as the operating rates and supply-demand balance for paper in Europe. And in Russia, Ilim has got the -- with their Pulp business, has got the major exposure to pulp prices. And we all knew that prices, whether it's $100 or $125 a ton, they ran up, partly as a result of taking out a huge chunk of capacity associated with the Chilean earthquakes.

On use of cash, would you envision putting more money into the pension in the foreseeable future? Or do you think the contribution you just made is probably it for a while until you start having mandatory contributions next year?

I think it's an open item, Gail. We made what we thought was a significant and meaningful contribution earlier this week, and we had the option to make additional contributions as we go through the rest of this year and early next year. But we'll evaluate it as we go.

Your next question comes from Richard Skidmore of Goldman Sachs.

Can we just talk maybe at Slide 26, just for a second, under the use of free cash flow? It looks like you highlight about $950 million of use of cash flow. It looks like you're at the run rate something north of $1.3 billion, $1.4 billion. Can you talk about what you might be using cash flow for, that additional cash flow?

Yes, well, you see what we've done here so far this year. We've also, which is not on the slide, increased our plans around capital investment organically across the company this year, so we'll end up spending probably $300 million more this year than we spent last year. And debt reduction continues to be something that is a potential use of cash as we go through the second half of the year and into early next year.

Rich, we've continued -- and I think it's important for investors to understand that we have not changed our view on cash allocations, it's going to be balanced. And we've been saying our priority is to have a strong balance sheet and get some great credit rating. Their balance sheet debt is getting close to where we want it, but we got pension liability to fund, which we will. Returning cash to share owners is part of the balanced use of cash, selective reinvestment, to make International Paper stronger is a balanced use of cash, and selective capital reinvestment in the existing businesses to keep our best assets competitive is also a balance use of cash. The how much of that we do in each of those buckets is going to be a function of the opportunities and how much cash flow we generate, but we're pretty positive about how we see the free cash flow story going forward.

Yes, we are. And the other point that I would make on the increase in capital spending this year, as we've said in the past, a big chunk of that is devoted to cost-reduction, consumption-reduction projects that we think had very high returns. And they're not huge projects, they're smaller and easier to execute. So in the event that we can identify more of those and pull some of those for, we'll do that as well.

And as you look maybe out to 2011 and the use of free cash flow, would you expect that there be less debt reduction and more cash to share owners, or more cash to reinvesting in the business?

Well, we understand how important the dividend is to share owners. It's important to us. We made an increase earlier this year, the motivation is to continue to get more of the cash back to share owners over time. So yes, I think that not calling a date certain but as we go forward and make progress on debt reduction, we'll see that shift.

Your next question comes from Mark Connelly of CLSA. Mark Connelly - Credit Agricole Securities (USA) Inc.: Two sort of big-picture questions. You talked about low inventories across your system, and what has struck me so far with company's reporting is that it has cost the money to have these low inventories in the last quarter, but nobody seems to be terribly concerned about it as we go into the third. And I'm wondering, is that a function, do you think, as you think about your own system and broadly, is that a function of us getting better at managing with low inventories? Or I mean, we could describe it, to some extent, just the seasonality but these inventory levels are extremely low and nobody seems to be all that concerned about what it might do to costs.

But we are. We're trying to get ahead of building a little bit inventory in Industrial Packaging, and we can. I mean, we've got strong demand, we're running well, but demand is still stronger than supply. And I think we will get ahead of it as we come out of some maintenance outages, but we don't want to be -- we want to be the best of both worlds, supply and demand and balance, which it can be, but not inventory that we're not shipping paper from box plant to box plant. We're using paper that we don't need to use to make a box just to get it to a customer. So the cost, Carol, so far this year?

The cost probably $4 a ton. [indiscernible] really it's in the couple of million a month, at least.

So that's the work we've got to do, Mark. Mark Connelly - Credit Agricole Securities (USA) Inc.: I'm sorry, I didn't catch that. I didn't catch Carol's comment.

Mark, it's definitely been very costly. Shipping, you get the paper to the box plant, you need it in another plant, you're touching it sometimes three times, sub-optimal routes. And so we estimate -- that's one of our areas of improvement that we've been unable to improve. And we estimate that it's probably, I would say, $2 million, $3 million a month of extra cost we've been carrying. And I'm viewing that as upside going into the second half, and we can capture that if we can get our inventory back to reasonable levels.

So we've gotten better at operating the whole industry as of lower inventories. We haven't got enough better to be operating International Paper today at the inventory levels we're at. Mark Connelly - Credit Agricole Securities (USA) Inc.: Our sense looking at the data is that we've seen a pretty nice recovery in roll grades on the uncoated freesheet side, maybe a little less progress on cut-size lately. When you think about your machine balance, is that recovery that we're seeing in roll helping you or making it more difficult to optimize your machines?

Well, it's a little bit of a drag because we've got some unused or we probably have more sheeter capacity than we have demand right now. Overall, the supply and demand are imbalanced, and we got a little less flexibility than we had before without Franklin. But the Courtland mill is making a lot of progress of kind of achieving the same customer service platform that we had when we had both Courtland and Franklin. But that's not as to expected with unemployment being saying frustratingly high at nine-plus percent. White collar employment is a big driver of cut-size consumption. So I think it's healthy that we're seeing the commercial print market actually show positive signs because that means the advertising and economic activity is coming back a bit. Mark Connelly - Credit Agricole Securities (USA) Inc.: So it'd be fair to say that as we do see pick-up in employment, you'll have room for further gains because this has been slowing you down a bit?

Well, as improvement for mix opportunities. And we'll, if we have to try to squeeze that incremental production to meet customer demand, we'll attempt to do that.

Your next question comes from Steve Chercover of DAD [D.A. Davidson]. Steven Chercover - D.A. Davidson & Co.: I want to get back to Ilim for one quick second. They seem to be more aggressive in terms of cutting their pulp prices. Is that something specific to the Eastern European market? Or does that permeate your views on pulp in general?

Well, I think the way you need to look at that is to draw a conclusion from that. You need to see where everybody's starting pulp price was and also by market. Most of what Ilim sells is into China, and I would say Ilim is selling at the market price now. And the market price in pulp, in a particular market, whether it's Europe or Asia or the U.S., there is some variation but they're not $100 a ton variations for the same grade. So I think what that's suggesting is a lot of the competition globally caused Ilim to make the price adjustments they made to get their prices in line with the competitors. Steven Chercover - D.A. Davidson & Co.: Your third quarter outlook, does that include much of the third containerboard price hike? Or is it mainly the full implementation of the second one?

Well, we are seeing the price increase on the second one come through, and we're not going to forecast what might come towards the end of the year is going to roll out. But I would say, the supply-demand balance is very, very tight. Steven Chercover - D.A. Davidson & Co.: And finally, with the land sales now complete, should Forest products as a segment go away? Or would there still be a little dribs and drabs of minerals?

Think of it as going away.

Yes, and it will definitely go away at the beginning of the year.

Your next question comes from Chip Dillon of Crédit Suisse. Chip Dillon - Crédit Suisse AG: I just want to make sure we're clear on home mineral rights. I guess two questions. Were the rights you sold this quarter tied to the land that was just involved with the deal that you just announced? And are there any more mineral rights you still hold, even though you've sold all of your lands.

Think of this as the Rock Creek transaction winds it up. It winds up everything and the transaction is going to close in the third quarter. 163,000 acres isn't tied to the mineral rights transactions, different lands. Chip Dillon - Crédit Suisse AG: But basically, it's both mineral rights, as well as the Timberland is gone now.

Yes, that's right.

We're finished. Chip Dillon - Crédit Suisse AG: And then I noticed on Slide 39, you indicated that your price improvement in boxes were up $70 from December. And obviously, you can't talk about forward pricing. But if we just look for a second at the two you've already announced, in the wake of the January and April board price increases, and consider that I think box prices probably edged down a little bit in the first quarter. Sort of how much is left from these two announced price rounds? I mean, would there be another, say, $10 or $20 left? Or would that be a good guess?

Chip, this is Carol. I would say that I'm hopeful that there's more than that left, and I'm not going to speculate on a number. But if you think about it, we announced 50 and we announced 60. So it's pretty clear that the first 50 is all the way in and we started to get the impact of the 60. We have a lot of contracts that are quarterly, so we're going to see a pretty good increase in July just because of timing. We still have some that'll flow through in August, and actually a little bit into September. So we'll continue to see that second $60 increase flow through into the third quarter. Chip Dillon - Crédit Suisse AG: On one of the slides where you talked about the downtime for the year being about 348 million as the impact, is that a good proxy to use going forward? Or with the fact that Franklin is gone and few other mills are out the system that maybe next year, the maintenance might be lower?

Well, Chip, we typically run between 350 million and 400 million. So yes, we'll see a beneficial impact from some of the capacity coming out. But as a rule of thumb, I'd say you're still going to be around about 350 million. If we can make it less, we will though.

I would just add on to that, Chip, that's something we manage very, very intensely, every outage, in terms of how long, what gets done, how much production do we get, how fast it is to startup and get back on grade. And there is some headroom there for us to get the work done and spend less. And we did a good job on that in the second quarter with a lot of outages going on. I think it's managed very, very intensely because it's a lot of money. Chip Dillon - Crédit Suisse AG: Just to be clear on the whole Ilim pulp announcement, I know that Ilim sells, I believe, the bulk of its pulp to China. And I know China historically has been more of a, if you will, spot market, and obviously, it was more than average impacted by the Chilean quake. So is it kind of fair to say that maybe for a while, Ilim was getting prices generally higher than what we might have seen in other parts of the world, Western Europe and the U.S.? And is that what you mean when you say you're kind of catching back to where the rest of the market is?

Absolutely.

Your next question comes from Mark Weintraub of Buckingham Research.

A couple of questions on the Slide 28 where you've got the green, yellow and red. And by the way, the yellow, just to clarify that, that means kind of a neutral view, is that right?

No, it means something between strong growth and negative.

Pretty wide band.

Yes, pretty wide band.

The Ilim, is the yellow, and I know you have -- I guess I would have expected it to be pretty strong growth and profitability from Ilim, given what's going on with pulp pricing, et cetera, and there is that one quarter lag. So I'm just curious as to how a month I'm supposed to interpret?

You're not on the map, you're on the outlook slide. Well, Ilim is going to see a one quarter lag, where you could see the flow through of higher pulp price, I think they've got some outages coming up. So Ilim earnings are probably will have peaked in the May, June, July period.

Mark, this is Tom. Keep in mind, on that slide, the color is meant to comment on the impact to International Paper, not the impact to Ilim. So the strong increase of Ilim is still more muted increase for overall IP earnings.

And I guess on the other cost, and I now recognize you don't want to be projecting up to decimal points of what things are going to be. But the second quarter, you had the bad debt included in the Printing Paper business. You also had about $34 million or so, I think it was, of true-ups in LIFO in the Packaging business. And so you kind of already had a $70 million of, I guess, what I would have thought were other costs. So when you talk about significant increases, are you taking that into account and you're saying that there would be significant increases above and beyond that type of level? Or were you not including those numbers when you were making that assessment?

No, we have the LIFO charges, we have series of revisions, we have incentive comp accruals. Because remember, we're coming from a very low base in the first part of the year in terms of how we were performing against our targets. So you have all of that. And I don't like to put numbers out, but it's going to be in the $0.15-plus per share range. So I think it's significant.

And again, that would be $0.15 above and beyond the $0.10 that were recognized?

Yes, it's going to be a net change quarter-on-quarter, $0.15 per share in that range.

And just a reminder, it's not all cash. And with that, we still expect to meaningfully improve our third quarter results over the second quarter.

Right.

Your next question comes from George Staphos of Bank of America.

I wanted to go first through the progress you're making in terms of mill optimization. And Carol, could you remind us what the goal on a run rate basis is within the containerboard system? And then more broadly, I remember a $300 million goal, can you just confirm or update those figures?

Yes, George. Relative to the mill optimization with the two closures of Pineville and Albany, and that was $60 million for the year or $15 million per quarter. And that's complete, done and we're doing well. And that was important part of our $300 million improvement. The other pieces of our improvement was consumption in our mills on fiber, energy and chemicals, and we're making significant progress there. We're on track. Other part of our plan was the efficiency and productivity improvements in our box plants. That's on track. And in fact, we just announced the closure of our Jonesboro facility, which brings total 17 facilities we've closed as we restructure and continue to drive down cost and optimize sales and productivity. So we're making good progress on all those fronts, and there's a significant improvement when you have a system as big as ours. The area where we remain challenged that I feel we're going to turn it around in the second half, and as I referenced, the supplies chain or distribution cost, which was a big opportunity out of the warehouse or acquisition. We just yet been unable to hit stride there, but we're optimistic we can get our inventories in line. And that's also translated to high waste in our box plants because we haven't have the right rolls at the right time. So that's an other opportunity to get that lined up. But all in all, I'm very optimistic and feel very good about our progress.

One other comment on containerboard, this isn't asteroids, but I think the point to make is we sell into a whole bunch of markets, not just the U.S. box market and to independents in the U.S. And we think that strategically is the right thing for International Paper. Our net mill margins now inside of our export markets are better than our net mill margins in North America. And I think that's really important to understand because obviously, that is always the case. But with the global supply-demand balance we have, we've been able to substantially improve our realizations on linerboard sales outside the U.S. And some geographies are better than U.S. now.

Are you in a position to improve those net mill margins, John, given the supply chain constraints in the U.S.? Or have we likely seen a peak in that relative to the export market?

I'll let Carol answer that.

I think, clearly, there's more opportunity, and particularly, there's flow through. The way the export market as you negotiate for production and then those tons flow through. So we're still going to be seeing rising revenue and cost, our price per ton in the export channel through into the third quarter.

Back to the run rate and the goal for the year, I remember earlier in the presentation a figure of 225 being reported. I would just want to double check if that was the goal for this year? And if not, what is the goal in total for mill optimization run rate by the end of the year?

Yes, you're right, that was the goal for this year. So we've hit it on a run rate basis at the end of the second quarter.

Two last questions, one shorter term and one longer term. In terms of early third quarter trends within Industrial Packaging, can you comment at all in terms of what kind of shipments or bookings or billings you're seeing right now? The longer-term story, there is no denying, at least from the numbers that you posted that you've made tremendous progress in improving return on capital and productivity and returns. From here, John, to get to cost of capital on a sustained basis, do you think it's going to require more strategic moves, i.e. restructuring and/or acquisitions, or realignment for that matter across the geographies? Or you think it would be more, you have what you need in place right now, and it's just a function of managing net price cost?

I'll let Carol answer the first part, George, and I'll come back for the second part.

Yes, George, as you know, demand in the second quarter was very solid, up sequentially, up year-over-year both for us and for the industry. But we did see somewhat of a slowdown from May to June. But June was still a good month with 22 days, and we've similarly a slowdown in July, still well above last year levels but slow. But at summertime, you're in between ag season, there's a summer doldrums. I have a theory, it's very hot in the country, people eat less, they get out less. It's just a little slower, but we're still optimistic. And I think we're going to continue to see positive year-over-year comps. And we build our plan around pretty modest growth. So we think it's going to be fine, particularly with the very continued tight supply and demand dynamics that we saw.

The reflection of it is the rate of economic activity in the U.S., that the North American market is slowing. The people in Washington recognize that. We're seeing it. So box demand will be positive but it may not be as positive as it was in Q1 and Q2, but it will be positive. And there's a big difference between being positive and being negative. Longer term, George, we think we've got the portfolio that we need to get the company to an average of cost of capital returns over the cycle. All of that execution, obviously 2010 is not a mid-cycle year from a macro standpoint, it's a transition year. Our Box business slipped double-digit rates in 2007, and we're back up four. So if you're down 14 and up four, you're really not in a mid-cycle kind of an environment. But we don't see the having to make major realignments in the portfolio, acquisitions or divestments to get the cost of capital returns and meet the challenges. And what we think we're up for is to do what ever we got. We need a macro environment to continue to get better, and we'll slowly, we should -- we'll get better faster. And we need to execute on the improvement plans and realize all the margin improvement that's part of International Paper's earnings runway going forward with the businesses we have. To anything we do above that, George, I would view as headroom. It's just building the opportunity to be stronger and better and improve our returns.

Your next question comes from Peter Ruschmeier of Barclays Capital.

John, I was curious if you could comment on in light of the uncoated freesheet supply growth at Ilim, what is your longer-term secular view of end market demand for the markets you serve?

We see positive growth in Eastern Europe, in Russia, in China and Latin America. That's been in the 4%, 5%, 6% range. We just had actually a consultant do a global survey for us. We don't see that obviously in North America, but these emerging markets still have a lot of growth in them because per capita consumption is so low and the economies are improving. And when the economies improve, things like paper consumption go up. They'll never got to levels per capita as we have in North America, but they don't need to, to show that kind of demand growth probably in the next decade.

So would you expect that the growth in the non-North American markets would be enough to offset the secular decline in North America so that you see positive growth?

[indiscernible] mills because if you think about it, North America isn't the supplier to China, Latin America, Europe, Eastern Europe and Russia. And those markets are going to get supplied regionally from production there. So I don't think you can think about it in a global sense of it all netting out. North America, basically, it's not like containerboard where a big chunk of North America can go around the world because it's not competitive on a delivered cost basis. We're sold out in Russia. Between Russia and CIS, we don't have any extra capacity, so we've got to be thinking longer term about how do we supply that market.

Maybe quick question for Tim, if I could, on the cash flow items, the special charges in the quarter for Franklin and other items, what was the cash impact of those charges in the quarter?

Pete, off the top of my head, I think it was around $60 million to $65 million, that's what I recall.

And then also cash flow question, as you look at your -- coming back to inventories in your system, when you look at the second half of the year, can you comment on whether you expect working capital to be a contribution or a drag to cash?

I don't think it's going to be a drag. I think it's -- my line of sight is probably not any better than the third quarter. But as I look to the third quarter, I don't see a big consumption in working capital. They pick up a little bit.

It depends on how much we grow our revenues.

Your final question comes from Mark Wilde of Deutsche Bank.

John, I just want to follow up on the Packaging business. And I was been struck that your EBITDA per ton is almost as high in Europe as you're seeing in North America right now, and you don't have nearly as much capital per unit tied up there. What do you make from that?

Well we've been configuring Europe for better part of the decade. Leaving out Russia, we've gone from 10 mills to two, Saillat and Kwidzyn. And Kwidzyn is a very good facility. So we've got less capital tied up there. We're kind of in different position relative to the industry. We're a small player, and we've made a lot of improvements. I mean, Russia, Svetogorsk can have a record year. So I think it shows you that we can by restructuring the business and optimizing, and this has been done over series of years, not just something that happened in the last six months. We now got a platform over there that's rightsized for the market. And both Paper and Packaging are firing on all cylinders.

I was more thinking of just your Box business, which I think is more sort of North Africa, Western and Central Europe.

Yes. So think of it as Southern Europe and the Mediterranean, France, Spain, Italy, Turkey and Morocco. We're winning Industrial business. So we're clearly gaining some market share, and the fruit and vegetable strategy is paying off because we targeted specific segments that are doing well in the Mediterranean. And we also had no mills. So the right strategy over there is to be a net board buyer because there's been a kind of a structural surplus of recycled linerboard. Europe is heavy to recycle in terms of the end markets, and we like being a board buyer over there, which has been helpful. That's not our strategy in North America, but it's a different market and a different supply-demand balance.

You mentioned the slower growth that you're seeing in the U.S. in June and July, and you talked about that specifically in containerboard. Can you tell us what you're seeing in the other businesses in the U.S. over the last couple of months. Is that consistent with what you've been seeing in the Box business?

Well, we're seeing it in xpedx. And we think of xpedx, our second quarter sales were up 3% compared to first quarter, but still down 17% compared to the second quarter of 2008. So xpedx serves almost every major metropolitan market across the United States and not just commercial print but packaging and facility supplies. They are really good barometer of economic activity. And if you look at first quarter compared to second quarter, it's about flat. So that was a -- the rate of economic activity has slowed down, maybe still positive, but slowed down.

And are you seeing it anywhere else, John?

Tom, what do you see in the consumer packaging?

Mark, the Consumer Packaging businesses are seeing pretty good demand for all SBS grades, the numbers are out there pretty public. But we're looking at I think 4% quarter-over-quarter growth and 12% year-over-year. The cupstock markets are strong. Foldings are improving, you're seeing price announcements in all of folding grades, not just the SBS. So particularly in the consumer side, we've seen some pretty good strength in the second quarter.

Mark, when you look across all of businesses, the GDP growth is three-plus percent. It's more like it's around 2%. We'll see how the numbers play out but I think that's what it feels like in the third quarter. Paula, that ends our call for today. For those of you still on the line, Timothy Nicholls and I will be available in our offices for follow-up questions. Thank you for joining us today.

Thank you. This concludes your conference. You may now disconnect.