International Paper Co (IP) 2002 Q3 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the International Paper's third quarter earnings conference call. At this time all participants are in a listen-only mode. Following the formal presentation, instructions will be given for the question and answer session. If anybody needs assistance at any time during the conference, please press the star followed by the zero. As a reminder, this call is being recorded Wednesday, October 23, 2002. I would now like to turn the call over to Ms. Darial Snead, vice-president of investor relations

Darial Snead (ph): Good morning and thank you for joining International Paper's Q3 2002 earnings conference call. Some of the statements we make may be forward-looking and subject to risks and uncertainties that could cause actual results to differ materially. Among these risks, are whether our efforts relating to initiatives will have the anticipated results, the timing and strength of an economic recovery in the United States and changes to International economic conditions. The relative strength of the U.S. dollar compared to other foreign currencies, especially the Euro. Economic conditions in developing countries, particularly brass I will and Russia. Other changes in overall demands, changes in domestic competition, changes in the costs or availability of raw materials and the cost of compliance with environmental laws and regulations. I will now turn the call over to John Faraci, Executive Vice-President and Chief Financial Officer. John?

Thank you, Darial (ph). Good morning, everyone. I am going to go through, we have customarily gone through the slide presentation that should have been on our Web site this morning. I am going to start with page three, which is the earnings per share charge and just let me set up how I think we would characterize the quarter. From our perspective, it was a very good quarter, especially when we look at how we got our earnings. Earnings of 32 cents from operations are more than, almost three times what they were last year on a return on investment basis, one of our key metrics you have heard us talk about. We out performed all our U.S. competitors. The three few quarters, 32 cents against 35 last quarter clearly demonstrate we changed our cost structure and improved earnings without the benefits of real improvement in demand and price. As we go through the presentation, you'll see that. Let me just move to the next page which is page four. As I say, we believe we really moved the needle as far as International Paper goes relative to our competitors. We said some time ago our objective was to improve the absolute level of earnings and relative earnings. We had a lot of success in improving the relative in terms of improving the R O I rank.

The companies below are the ones we have in the peer group. Several North America companies and several European ranks, our R O I was number eight an we finished last year at number six. The first quarter of this year we moved to number four. The last two quarters we have been at number three. By no means are we satisfied with 32 cents, but we are pretty pleased that in the absence of any demand and pricing strength, that is broad based and significant we have been able to improve relative performance. Cost reductions appeared mix initiatives continue to be the story about improving the bottom line. Year-over-year our total cost and mix improvement is about $600 million. I'll come back and talk about that in detail later on.

Volumes have improved in North America seasonally from the second quarter of this year and we will talk about that in a minute. We feel good that we have announced price increases and are implementing them in uncoated and coated papers and container board both domestically and exports in the box business and (inaudible).. Some of those show that effect in the quarter and some will show more in the fourth quarter. We did take special charges in the third quarter of two cents a share principally for the ongoing restructuring efforts. We are at the tail end of what we called our initiative last summer to take out about $300 million in costs from our S&A. Most of that was front ended. This represents the tail end of that. There are a couple hundred jobs associated with these head count reductions. We had true ups on divestitures and other items that netted to two cents. A fairly clean quarter without a lot of significant charges.

Looking at the earnings change or EBIT change by business, this is slide seven operating profits were $508 million, 523 in the third quarter. Printing paper up $74 million. Packaging down 17, forest products down 40 an all other was about $2 million. The way we have been talking to you about our, trying to show you how we have been making progress on what we call the cost and mix improvement, which we talked about previously as our non-price initiatives and how that plays out against what is going on in volume and in price across all the businesses has shown up in the water fall chart. Thirty-five cents in the third quarter of this year. Our cost and mix improvement quarter over quarter added another nickel. We got two cents of volume. You see that as you go through the business. It's clear in some cases it's very strong on a seasonal basis. Overall it's mixed. That's two cents and offset by price, the net is about a wash. We had probably the biggest capital project we had going on in the company this year is one of our consumer packaging mills. We started the first day of the quarter in July and have continued to go through the ramp up. But we expense all the start up costs associated with that. That cost us about two cents a share. Then you'll remember last quarter we had the release of a countervailing duty accrual net effect gains in Brazil that totaled five cents a share. We didn't have those this quarter. We had the ongoing countervailing duty charge that will show up in our forest products earnings for the Canadian segment. That left us at 32 cents a share for the quarter. Again what we feel pretty darn good about giving the operating environment we have been competing in. Let me take a minute and put a little color on what is going on in the various business segments.

You know, first, printing papers, our uncoat the white system here in North America, coated papers business, pulp business, Europe and Brazil. In the uncoated segment volume was up 7percent. We were pretty pleased with how we saw volume in July, August, and September in the uncoated business. We think there is some underlying improvement in demand behind that. Not just buying ahead of a price increase. And we feel pretty good about how we look at the backlogs right now. We are getting the 40 to 50-dollar increase that was announced in some grades in September and some grades it was effective earlier in October. We are getting that in coated free sheet and ground wood volume was quite strong. This is the high point of the catalog season for lightweight coated. That is showing up. We announce and implemented a (inaudible) increase that will show up in October and basically prices in the quarter stopped sliding in the coated papers business. Europe while volume was down we had a very strong first half of the year. We got pricing improvement.

Our business in Europe continues to perform at very good earnings levels. That business on third quarter earnings is earning well into digit return on investment. The Into double digit. Cost per ton in the uncoated three sheet business, the biggest one was down about $28 million. In coated papers, our costs are down $15 a ton quarter over quarter. That added about $6 million. So a lot of progress on pulling all the levers that are important to improve our margins when demand and pricing are still pretty weak. Turning to the packaging businesses, earnings were off what they were in the second quarter. I'll comment on that in a minute. Basically going to container board, U.S. container bleach board, first on pricing. Container board, the $30 a ton increase announced in June was implemented. We are getting more in each month. We got $15 over the quarter and our September realizations were up $26 from where they were in June. Basically what that says, it's all in.

We announced and implemented a box price increase in the corrugated business. That is going a little slower. Some accounts, as you know, there are lags, contract delays that show up there. Box prices in September were up 3percent from where they were in August. And in bleach board we announced a 40 to 50-dollar a ton increase in July. And we are starting to get some of that. Our actual realizations in bleach board will be down in the quarter. That is directly associated with the start up effect of selling some lower quality start up board off of the machine that we started up in consumer packaging. Again, the story here is the same as it was in the printing papers business. What we have been able to do on the cost side. In the container board system, mill costs are down $22 quarter over quarter. That is coming from the same levers that are getting pulled in the printing papers business. Operational improvements, raw material cost productions, quantity reductions in terms of usage of chemicals on energy, wood. Really, a fine job on all fronts there.

In a consumer packaging business, as I said, the pipeline bluff start up cost us $12 million. One of the highlights in consumer packaging is shore wood. Shore wood had the best sales and earnings since we acquired it. Their sales of home entertainment, which would be DVDs and software were up 60 percent in September over the July/August average. We would expect to see some improvement there, but the music business, an important part of shore wood's product line is down eight percent year-over-year. Shore wood has been aggressively gaining new sales from new product development essentially and some of these other segments, and it's starting to pay off. Again, the mill system in consumer packaging tips to perform very well. Our manufacturing costs in that part of the business were down ten dollars quarter over quarter. In forest products, you recall that segment is, our U.S. wood products, forest research business, and Canadian wood products business. Earnings were down significantly quarter over quarter, most of that attributable to what is going on in the wood segment both in North America and -- both in the U.S. and Canada, but hitting us harder in the U.S. That's a bigger business. Volume has been flat in lumber, which is the biggest component there. Price has been off more than 10percent. So we have the same phenomena, 1.7, 1.8 million housing starts but an over supplied market which is depressing earnings in that business. Wood products business in North America is, you know, is in the red right now. So putting that all together, I'm on page 12 for those of you who are following.

Looking at nine months of this year versus nine months of last year, we earned 32 cents year to date last year. Seventy-nine cents year to date this year. And rather than going through each of the bars, the thing that jumps out shall we have been able to offset all of the price erosion by improving the cost structure and mix side of the equation. Again, it fundamentally weak demand environment. Good will, which we are not amortizing this year, added 28 cents. We have been able to pay down some debt and lower interest costs in working both of those things. That is at 18 cents. We've gotten a bit of volume. We have to say that clearly business has stopped getting weaker. In fact, the fundamentals of some of our businesses are looking better. But it's mixed and certainly not broad based at this time. We talked about managing what we control. I think this chart illustrates that quite well. Versus the second quarter of this year, we were able to improve in the third quarter about $30 million, that's net. Some things go up in cost as well. $30 million quarter over quarter. And relative to the third quarter of last year, our cost structure is about $126 million better. Some of that is due to energy. As you can see, the quarter over quarter improvement, third quarter versus second quarter, none of it was energy. Our energy is about flat now quarter over quarter.

To give you some flavor of, because we have been asked where is this all coming from? We included this chart on page 14 to show that the operating cost improvement is broad based. It's really a number of levers in each business. It's businesses all around the world. The biggest chunk of that is coming from the printing papers business as it should since that's the biggest part of International Paper is the one where we have a pretty big, set pretty big target in terms of improving returns, packaging accounts were nine months over nine months cost improvement gaped, coated papers, 11 percent, forest products 15 and the other business is the remaining ten. This is not just a one-business focus or North America focus. It's all businesses all around the world are making real strides in improving our cost structure. One of the common themes across all businesses is managing S&A overhead.

As you can see we made progress in doing what we said we would do last July, taking out more than 8 million in annualized basis out of our cost structure. That basically is done. We would expect the, it will continue to look for opportunities, but we've gotten what we said we would do in terms of costs out of the business and our S&A costs as a percent of sales continued to come down, even though sales are still weak. We will get a lot of leverage here when sales and volume comes back. Before I get to the wrap up and questions, I thought I would take a minute here and talk a bit about pensions. I'm sure if I didn't, I would get questions on it. There really are three elements to pension accounting. I am not going to try to make everybody here an expert on pension accounting in a couple short minutes, but when we think about it, there's three elements. There's a cash impact of having to put cash in the pension fund. There's the income statement and balance sheet impact.

Let me run through each of those. The one that we put in or highlighted in the earnings release this morning is the balance sheet impact. The volumibility (ph) of International Paper, being required to put cash into the pension fund is low for the next several years. Frankly, we were way out ahead of this before it became a head line. And mid last year we conducted an asset liability study with investment advisors and our actuary and concluded we were in good shape from a cash contribution standpoint for the next several years. Beyond that the probability goes up that we have to put some cash into the pension fund. We are certainly prepared and able to do that. The income statement impact we talked about is relatively small.

Most of our earnings, most of our revenue is real earnings, real revenue. Pension income this year will be less than 5 percent of EBITDA. I will talk in a minute, but the way we see it with the combination of lower interest rates and returns, there is likely to be a strong expense next year. The balance sheet impact is the one we put in the press release. This results from lower investment returns and declining interest rates that we think it is highly likely we will be writing off the pre-paid asset that we put on the balance sheet. That tax write off will be about a billion and a half dollars. The way that pre-paid asset got created, the assets are going up over time faster than liabilities.

As interest rates have come down, which makes the present value of the liabilities higher, and returns have fallen off given what has been happening in the investment markets over the last three years now, that's the result. There is no cash impact. And there is no accepts impact. Page 18 just gives you a sensitivity, going back to pension income and expense now, of the rate of return for this year, 2002, is nine and a quarter percentage and the discount rate is 7.25. We haven't finalized what will be the rate, the return asset assumption for next year or the discount rate. But I would say in both cases it's likely to be lower.

To give you a sensitivity on this, the change of 50 basis points up or down on return in assets, changes our pension income an expense by about $35 million. The discount rate going own or up by 50 basis points also has a plus or minus $30 million impact. Holding everything else constant there are other things that influence this. If the return on asset assumption were to go down by 50 basis points and the (inaudible) rate goes down by 50 basis points, there would be a (inaudible) change in income expense. We will record about $80 million of pension income this year. What is that? Oh, 75. We could easily as we look out see pension income going from a slight contribution to EBIT to a wash or slightly minus. Summing up pensions, and I'll come back to this if you like, the pension, we have pension income this year, we think we could have pension expense next year. It is all non-cash. By our calculations if we were to have pension expense next year, it is likely to be in the four cents a quarter range relative to the amount of the EPS impact of the income we reported this year. The balance sheet charge is a reduction in equity. No cash impact and no issue regarding any of our bank covenants or discussions of the rate agencies. They are well aware of this. We have been talking to them about it for some time. You will remember we alluded to this in our annual report last year saying that if 2002 turned out to be a repeat or worse than 2001, we need to be looking at this. Here we are in October closer to the end of the year.

So let me sum up before I go to questions. I think we are making great progress in making these core business in International Paper stronger. Just go back and each one of the big North America businesses we showed very strong progress on products performance in consumer packaging, coating and uncoated. Europe has continued to do run well all year at record levels in the first quarter. They are holding the operating performance. Managing what we can control is a major contributor to the bottom line. I didn't have a slide in here on fix discipline, but we continue to hold capital to the 1 billion to $1.1 billion range. Working capital compared to this time last year is $500 million better. We lowered it from close to 19 percent of sales to about 17 percent of sales. Our liquidity is fine. We have no short-term debt. The most important thing is .3. We think there are more cost an mix opportunities to come. When you look at what we have done in the past year, a lot of that is -- yeah, we had merger benefits associated with the two big acquisitions, but we see on the horizon in terms of opportunities for International Paper go far beyond that. That is the exciting part. The economy remains tough. We got a little demand improvement, volume improvement in the second quarter, third quarter. Most of that in the North America businesses and in the export side of container board. I think we need to be realistic about the outlook and think p it in two pieces.

Internally we remain positive of what we are going to do to improve International Paper's performance. Externally the reality is the fourth quarter beginning about my November always turns into what it is in the winter, seasonally slow. We expect that this year to be no different than any other year. But we are extremely well positioned to demonstrate significantly improved profitability and cash flow generation when the economy improves. And I think while there are lots of clouds on the horizon and things that dip things over, we don't think there's a double dip scenario out there. There are indications that business, all be it slowly, is getting better for some of our customers than getting worse. So let me open it up to questions.

SPEAKER1Operator, we are ready to take questions.

Thank you. Ladies and gentlemen, at this time we will begin the question and answer session. If you have a question, please press the star followed by the one on your push button phone. If you would like to decline from the polling process, press the star followed by the two. Your questions will be polled in the order they are received. If you are using speaker equipment you need to lift the hand set before pressing the numbers. One moment please for the first question. Our first question comes from the line of Rich Snyder (ph) with UBS Warburg.

Rich Snyder (ph): John, I was wondering on the pension situation if you look at the, with liabilities going up and obviously with returns down this year, are we -- I'm curious why you weren't in a situation where you would have to have a cash contribution, you know. I know it's complicated, but it looks like, you know, possibly you would be down to a level where you would be on a book value basis about 80 percent funded. Isn't that the level that they start to require cash contribution?

That's right. There are different calculations, rich. Again, you probably know more about pension accounting than I do, but there is, the test you use for cash funding is a current liability and shut-down scenario, which is a little bit different than what you use for the equity test. And the measurement is also different. As opposed to the end of the year measurement there's the beginning of the year measurement. The funding requirement is the subsequent year. When you go through all those machinations, we are confident because we have been through it several times that we won't be required to put cash into the pension fund for several years.

Rich Snyder (ph): Okay. And.

Another thing about that, forget about the market returns. I mean, this thing is sensitive to interest rate p and we have interest rates at 40-year lows.

Rich Snyder (ph): Okay. Switching gears and looking at Europe, obviously a good quarter from Europe and pricing up $40. That was in uncoated free sheet and primarily. I was wondering what the outlook is from here, you know, going into the fourth quarter in Europe and the situation with pricing there.

We are going to lose some pricing in Europe. I mean, I think that is pretty clear. The question is, you know, how much. It is not going to fall off the cliff by any means, but we are going to lose some pricing in Europe.

Rich Snyder (ph): Where is that pressure coming from? You know, I'm just curious about the reversal. Usually when you get something, you don't turn around and ...

(inaudible) is falling off a bit. Germany, the economy is slow there. Europe has slowed down. It's really a change in demand associated with some economics weakness across the really the E U countries. The dmabd (ph) in eastern Europe is still pretty good.

Rich Snyder (ph): The last question. One thing that we are not used to in your slide presentation is seeing a down time chart. Could you go through what happened in the quarter relative to down time and what your -

I should have added one, I wanted to take out one. (inaudible) in most of that in Europe. It didn't take down time anywhere else. Speaker spar your outlook for the fourth quarter?

We don't forecast down time, as you know, rich out ahead. But our policy and view on how we are going to manage the business has changed. We are not going to build inventories.

Rich Snyder (ph): Thanks a lot.

You can connect the dots there. If things are seasonally weak, we are not going to build inventories. That would mean more down time.

Rich Snyder (ph): Thanks.

Thank you. Our next question comes from the line of Chip Dillon from Salomon Smith Barney. Please go ahead with your question.

Yes, good morning, John. How are you?

Fine.

I have three quick questions hopefully interrelated. One, could you tell us if you felt with the strong volumes in the third quarter, especially in the printing and writing area, how much slack there could be if things get really good? Do you have more volume potential that would be above four, 5percent? The second question is, when you look at the book value charge you mentioned for pension, is it likely that we will see in the fourth quarter impairment for good will as well? Could that all be roughly five dollars? I guess the one to 1.4 plus the one and a half. And the third question is with the level of bulk timber sales, were they materially different from the second quarter?

The land sales and pension and what was the third one?

Volume.

Oh, how much. Yes, we do have some more, no question we've got, if demand came back strongly we will have a little more capacity available to us. One of the, the last merger benefits to come from Champion, what we facilities by lining out certain grade of machines. It takes longer in the coated business because of the qualifications. There's no question we have more capacity. It's not as much as we had before because we shrunk the system. We are taking Hudson River down the first of November. We both -- we have incremental demand, but equally important is we have a huge opportunity to improve the mix. That's something that in a business as large as ours, the mix improvement opportunities, when you look across all the customer bases and market segments are really powerful. The answer there is yes, but not as much as we had. Volume up side in the first quarter when we were taking 200,000 tons of down time. On pensions, the question there was just -- run that by me again?

You mentioned the good will charge could be, I'm sorry, the pension charge would be roughly three bucks a share. In the last Q you mentioned you might have to take a good will impairment charge.

We are pretty, we haven't finished the good will analysis yet, but it's drilling in on that 1.1 to $1.4 million. I would say we have to get that finalized, but that's going to be the range. So there will be a good will charge at the end of the year and there is very likely to be a pension charge. You know, when you roll up both of those, it's --

Andy Lessin (ph): The pension charge goes directly to equity and does not flow through P & L. It will not show --

You said five bucks, you won't see it in -- good will get restated in the first quarter. Both of those are non-cash items and both of those we covered with the rate agencies and all the credit folks are very aware of it and understand.

Okay. Then on the timber sale changes?

Timber sales, the land sales income which we have said before, when it's up or down relative to where it has been, we flag it. It basically has been flat for the last three quarters. I think the fourth quarter was the last time we said we had land sales that were above the rate we have been running at.

Okay. That's what, four, five cents a quarter?

The last time we talked to that, chip, we said our land sales increase is about five cents a quarter. Over and above the normal level.

Now it's back down to the normal level?

Back down to the normal level.

Okay, thank you.

Chip, it has been running at that level for the last three or four quarters.

Got you.

Does this answer your question, Sir?

Yes, thanks very much.

Our next question comes from the line of Mark Wintraub (ph) from Goldman Sachs. Please go ahead with your question.

Mark Wintraub (ph): Having accomplished a lot of internal improvements, where do you stand now in your thinking about potentially going back into the M and A market? Could you update us on your thoughts there?

Well, we are going to be very careful about what we do, Mark. Our focus is to improve International Paper. We have looked at, I think we said this. We looked at some things over the last period of time and chosen not to do anything. And we continue to -- we think that Champion and union camp are both acquisitions that made International Paper a much stronger, much more competitive company. When we get a mid cycle, mid demand scenario, we will benefit from better earnings and better cash flow. If there are opportunities that look like they can meet our financial criteria and help us improve our core businesses appeared we think we can create some shareholders value and decide that's a good use of cash, we will look at those. We haven't seen anything in awhile.

Mark Wintraub (ph): Okay, great. Just you mentioned on capital spending, I believe you said one to .11 bill (inaudible). Is that good for this year annex?

What we try to do, Mark, is think about capital spending over a cycle, the strategic cycle. As we look over the next three years our capital spending will probably move up a bit. But it will remain bell below depreciation. I would say, yeah, 70 to 80percent. We are running probably 60 now. Some years it is will be below that and some years a bit above that. As we think about improving the business going forward, we are confident we can do that, improve it and maintain it with capital spending in the 70 to 80percent range in depreciation on average

Mark Wintraub (ph): Great, thank you.

Thank you. Our next question comes from the line of Mark Wild (ph) with Deutsche Banc.

Mark Wild (ph): I have a couple of questions. One the big quarter to quarter drop in mill costs that you cited. It's pretty unusual in this kind of industry to see just a quarter to quarter move with the sort of ten to 20-dollar a ton range. How much of that had to do with just less down time, John?

Not a lot there. I mean, there certainly is some. You know, we have, spreading the cross over more units. But when you get underneath that, looking at what is happening with fixed costs and look at what is happening to quantity consumption, we are not getting any energy improvement. But I would say, I would be guessing here, but I would say probably it will vary by business. The printing papers business, maybe half of that.

Mark Wintraub (ph): Okay. What were the other elements? What would they be?

Lower energy consumption, lower wood cost, higher wood yields, lower maintenance cost, taking people out, lower indirect costs, less spending.

Mark Wintraub (ph): Okay.

It is not one lever that is being pulled. I think that's the point that I know it's hard for us to communicate this to help you understand. It's a lot of levers and a lot of businesses and a lot of facilities around the world. It adds up to something that is pretty powerful, once it gets going.

Mark Wintraub (ph): Another question. Could you update us on where we're at in terms of timber lands? You talked about (inaudible) sizing two or 3 acres of timber lands over the next few years?

We sold, we had 12 million-acres. We bought Champion and now we are down to about ten. We said we were going to sell more than a million acres of timber land. We sold two and we still have some to go.

Mark Wintraub (ph): Can you quantify --

There is not a specific target, when we get to the acre, we are going to stop. We are constantly looking at what land to we own, where do we own it, what are the economics? As the facilities change, say with moss point Mobile, as those change, so do our views on where we own land.

Mark Wintraub (ph): I wonder if we could talk about Carthold (ph) Harvey. Your prot Jay will be leaving Carter hotel and going to IP. I know you have been looking at Carthold (ph) Harvey. Can you tell us about that?

Chris is going to be moving into an executive assignment with International Paper. He will be coming into IP as VP of finance. He will be helping us to improve International Paper. The leadership change there really has nothing to do with any kind of major move from Carter Holt Harvey's standpoint. We continue to expect improvements. They had a good quarter, basically because of the money they have tied up in trees. The rest of the businesses down there are earning the cost of capital or better. The individual going in there is going to be what it should be. A combination of continuity and change to improve that business. That's the, as share owners that's what we expect and are confident we will get.

Mark Wintraub (ph): Thanks, John.

Thank you. Our next question comes from the line of Mark Connelly from CSFB.

Hi, John. A couple of things on container board and packaging. From my model, at least, that's the one place where we expected performance to be better. I'm wondering if you can help us understand the split between container board and consumer packaging a little better. You mentioned shore wood doing well, but that's not a big piece. Can you give us more color on food service, things like that, and try to compare what you guys saw in the container board business versus some of your competitors?

I think we were, I saw something the other day that had our competitor, a comparison of how we did vis-a-vis our competitors on volume and price. I think we lined up more or less the same. You know, we don't break out the consumer packaging and container board businesses, Mark, but on balance, container board shipments were up. Most of that strength is in the export market. We got a lot late in the quarter. We had most of the container board price increase through, but that didn't come until late in the quarter. It's, we are getting the box price increase. That has been even a little slower. As I said, in September our box prices were up $17 over where they were in the previous months.

The trouble I'm having --

What you had was box prices going down early in the quarter an coming back up.

Is it fair to say that the weakness from second to third quarter is on primarily the container side and not in the consumer packaging business?

The earnings change?

Yeah.

Yeah, there's a pretty big chunk there. The start up was $12 million.

Right, right.

Our food service rings were off a little bit. We had a one-time adjustment in food service. That's not significant enough to make a difference to the overall IP results, but it is significant enough to make a difference in food service.

That helps. One more thing, John. Energy as we approach winter and potentially war, is IP taking a different approach to hedging than it did last year?

Yeah, we've topped up our hedges for December, January, and February a bit to, typically carrying about a 50percent hedge. Sometime ago we went up closer to 70percent.

Okay, okay.

Mark, I'm looking at the packaging comparison. I would say on -- versus the second quarter, our box (inaudible) what I've heard, our box voms (ph) don't look all that different than what has been going on in the industry. Our container board volumes are probably up more. And what I have heard on bleach board, it's all the same.

You put in pipeline bluffs and a little weakness in --

Pipeline blufs (ph) is a significant number when you think about the start up volume. That will be behind us pretty shortly.

Thanks very much, John.

Thank you. Our next question comes from the line of Peter Wishmeyer with Lehman Brothers. Go ahead with your question.

Thanks. Hi, John. I had a question, I guess, on Masonite (ph). If you can update us on the payments you have you have made to date, the level on the insurance an the balance on the reserve?

Let me simply put it, we added $225 million to the Masonite (ph) reserve late last year, I think it was the third quarter of last year. We had a projection on the, what the settlement payment curve would look like going forward. And right now we are slightly blow below that in terms of projections. We will look again at Masonite (ph) at the end of the year when we have a good history behind us and see how things look. At this point in time right now, the actual settlement payments are slightly below the projections.

Okay. Is it accurate that the insurance also has been beefed up a bit?

Andy Lessin (ph): We haven't been able to, you know, we can't go back an get insurance that operates retrospectively. So we have not made any change in the insurance coverage. The one thing you may be referring to, Pete, is that we have been pretty aggressive in pursuing lawsuits against our insurance carriers. And we have one going to trial early next year in an attempt to get back a lot of the money that was paid out in indemnity payments.

That's helpful. And John, another question, just big picture on the dating back a couple years ago, the multi year $1.8 billion cost cutting plan. You were suggesting we are winding down that program. I'm curious if you think that's still the case, that we are winding down that program by the end of this year and thoughts about, you know, other opportunities as you look at cost cutting as not going part of your business plan.

Well, we are going to meet the 400 basis points improvement target. Last year we lost ground an frankly made it um all up this year. We feel terrific about that and are in the process of finalizing how we build on top of that. To hold what we got and build more improvement in. This time around we set our target not just on our forest products peers, but the industrial peer group. That will be the objective. We will talk more about that early next year with you. But our objective over the next three years is a Roy return on investment related to our investors.

You had 100,000 employees worldwide and have been rationalizing capacity. With that you have had some lay offs and what not. But curious, can you comment on whether you have the right size organization in terms of employees? You know, whether there's opportunity to kind of match what you have done on the rationalization of capacity?

Actually we have fewer than 100,000 employees. It's closer to 94.

Okay.

We made tough calls and tough choices. We tried to do the right thing with people with severance plans and helping them find jobs and work with them. That's an ongoing process, trying to figure out how to change the work and get the work done with fewer people. We made great progress there, but we're not finished.

Okay, great. Thanks very much.

Thank you. Our next question comes from the line of Matt Berler from Morgan Stanley.

Hi, how are you?

Fine, thanks.

Capital spending, 60percent today (inaudible). We could see that go up to about DD&A, which would be about $700 million increase from current levels. Should we -- no, that's not the right way to read that?

No. When you think about over a cycle, spending about 70 to 80 percent of DNA. In any one year it won't be next year. I guess it's possible, we are not going to deviate from the average. We will figure out what makes sense in any one year. But we don't, we are thinking about spending now over cycle, not on an annualized basis.

If you average 80 and you're at 60 now --

Right.

-- doesn't that 19 you go over that at some points?

We could.

You're not going to make that jump in one year? Probably not in '03, right?

No, no. The '03 spending is going to be in the 1.2 to 1.3 range.

No change from prior guidance really. And I wanted to also follow up on timber lands. It looks as though your timber land, your forest line item on the balance sheet dropped 136 million Q3 versus Q2 and PP and E also dropped 179 million. I see shore wood's equity dropped almost 300 minimum. Can you walk through those changes with me?

Andy Lessin (ph): The shore wood equity drop is primarily the translation (inaudible) of primarily in brass I will. The FX, the equity changes primarily are related to the impact of the decline in the real on our balance sheet.

Okay, that makes sense. And the forest lands? Would that be the same thing? Your brass I William (ph) forest lands?

Andy Lessin (ph): No, it's a combination of our sales, our normal cost of timber harvest and also some translation impacts on Brazil and New Zealand.

Just as a follow-up, John, you said that your land sales continue at roughly normal levels. How much are harvest levels? If I heard you right, you said wood or building products is in the red, but you reported 160-some odd million dollars of EBIT in the quarter, 160 million in that forest product line. I assume most if not all of that is from timber land?

We were profitable in wood business in Canada and with the wood products business in the red, most of the earnings are coming out of the forest research segment. I don't have the harvest items off the top of my head, Matt.

But directionally, have you pushed those up?

Harvest will volumes were up in the second quarter. I can't remember what they were in the third quarter. P.

Okay.

My sense is they wouldn't be significantly different or it would have gotten flagged.

Okay. Staying on that, my recollection is that you talked in the last quarter about hitting the 3 billion-dollar asset sale target?

Right.

We used to talk about a 5 billion-dollar number. I thought I heard you say then that to get from three to five over the next couple of years will largely come from timber land sales?

That's right.

Have you changed that outline of what you intend to do?

Oh, we are going to continue to sell timber land as we see the opportunities arise in the market. And the that will continue to occur. When we talked about this 18 months ago, we said we will probably sell a couple billion dollars of timber land. We didn't put a time frame on it, but it's not five to ten years. The timing of that will be a function of the market opportunities.

You do have the Texas properties on the market, don't you?

They are sold.

They are gone?

They are gone.

Is anything on the market now?

We have properties on the market, yeah. I mean, the Texas timber land was roughly 600,000 acres of Champion timber land that we sold?

Okay.

We sold it early in the year.

I guess I wanted to ask one final question about fourth quarter seasonality. You picked up two cents a share, Q3 versus Q2 from vl (ph). I think I heard you say that the volume mix isn't (inaudible) relate the. In the fourth quarter say we give up the two cents, you are not suggesting that you are going to see a major hit to the P&L from a seasonal standpoint? Major meaning in excess of five to --

I didn't say that.

Okay.

My crystal ball is no better than yours, Matt. It will be seasonally slow. We are going to lose some price of pulp. We are going to lose some price in Europe. We've got the price increases are, they look like they are coming through in the uncoated business, and in coated. And you know, it's taking time on the packaging businesses. So that will probably continue to come slow and it will be tougher if things are more seasonally slow than you are. I don't know how to feel about the wood businesses. We have great housing starts and awful earnings and we know that if winter weather comes in, construction is going to shut down. So it's not -- it's the usual picture in the fourth quarter.

Okay. Very good. Thank you.

Thank you. Our next question comes from the line of John Dumagay (ph) from Financial Prudential.

John Dumagay (ph): Congratulations on the financial results. I have two questions. Could you work through the mechanics of the balance sheet entry for pensions? I don't know what the number is, is it a billion dollar increase in reduction to equity alone? And secondly, could you explain the coated paper 17 percent volume that you enjoyed in yesterday meet with Veggay (ph) they said 14 percent. The markets didn't appear to change that much. Presumably you must be displacing domestic competitors or imported coated paper. If you could explain just how the two biggest producers enjoyed so much volume gain.

Maybe I'll ask my colleague, Andy Lessin, to take you through in a simple way the balance sheet entries.

Andy Lessin (ph): The balance sheet entries are fairly simple. We will be writing off our pre-paid asset. We will be establishing a liability for the differential and then it will be tax effective, there will be a deferred tax benefit on the balance sheet an the net effect is the billion five.

John Dumagy (ph): Billion five reduction to equity?

Andy Lessin (ph): Yes, it will show up as a (inaudible) asset in the, it will be on the balance sheet.

John Dumagy (ph): Thank you.

I can't comment on what others did. All I can do is talk about our business this quarter, John. We, in the lightly coated segment, if you look at the total shipments, it's probably 40 percent lightweight coated. And that lightweight coated, our targeted segments for that are publishers and catalogs. Catalog season is coming out, you know, quite well. I mean, if you are heavy into commercial printing, then that is a different story. Commercial printing in a relative sense has been a lot weaker. I don't know how everybody else is shaking out. We picked up we believe a couple share points. But more because we've picked the segments and the customers within those segments whose business is getting better, more than anything else.

John Dumagy (ph): So we shouldn't be looking at the total printing and writing paper shipments per S&A and pa which are down. We should be looking at a subset that is more catalog papers as opposed to magazine publishers?

We are in both of those segments. I think the uncoated, the statistics that came out the other day showed a decline year-over-year. I think that was uncoated, wasn't it?

John Dumagy (ph): I was actually focusing a little more just in the total printing and writing paper segment.

All right. John Dumagy (ph): My last recollection is year-to-date both coated and uncoated are down.

We don't look at the aggregate because they are different businesses. We look at coated, uncoated free sheet and coated ground wood. Speaker per do you think your customers are building inventory or do you think they are buying less from a broad because the Euro is up in the high 90s?

I know they are not building inventory, that's for sure. We feel good about where inventories are at, probably with the exception of pulp. It doesn't look as of yet, the statistics I have seen, that there has been a meaningful decline in the amount of imported paper coming in. I think it has flattened off a bit. The statistics I have seen, which, you know, would suggest that as demand has come back, there is, you know, some U.S. producers may have picked up the volume.

John Dumagy (ph): More than anything, it's the seasonal improvement in the catalog business?

Seasonal improvement in the catalog business and some strength in advertising.

John Dumagy (ph): Thank you very much.

Thank you. Our next question comes from the line of Least Shownfield (ph) from JP Morgan. Please go ahead with your question.

Least Shownfield (ph): I'm following up on the coated paper mart market. Where would they normal look like this time of year? Are you actually seeing any indication that the recovery that we have seen is anything more than seasonal? Are you hearing any indications from the commercial printers that they are expecting a pickup in the fourth quarter?

We have good backlogs in coated papers, both in free sheet and in ground wood, lista (ph). We are not out so far we can't service our customers, but we have good backlog. Most of the strength is in seasonal. Some of it is advertising. As we talk to our customers, the retail advertising has been I would say okay, but better than business to business advertising. That is really the one taking a huge hit. If you are with customers who have titles that are aimed at consumers as opposed to business to business, then you are going to, it's -- it's the mix of customers you are with. It's always strong in the catalog business this time of year. That's not unusual. And I mean, it reflects the fact that retailers are expecting that consumer confidence will hold up and they are advertising to stimulate demand, which is good.

Least Shownfield (ph): You don't feel that there is sort of a very can't risk that we get into the middle of November and suddenly hit a brick wall as the catalog season ends?

I think that's the way it works. The significant risk is, that's the way it works every year. Once they bought the paper and shipped the catalogs, the orders stop seer.

Least Shownfield (ph): There's no indication that we will have a pick up as we go into next year? I am obviously aware this is seasonal. You is there anything underneath it that reflects confidence.

(inaudible) were up about 5 percent a day in September. And our paper sales reflected that. Xpedx (ph). is supplying the paper, the majority is being paper. There is no question that there is underlying demand improvement. That will get overwhelmed by a seasonal slow down on the coated side. On the uncoated side, you know, it's -- if demand continues to improve and this recovery gets some legs out more than just a couple different industries and goes beyond just the consumer side, I would say that we will go into next year with slow but steady demand growth improving fundamentals.

Least Shownfield (ph): Thank you. Just quickly on the container board side, we are sort of getting mixed signals from container board. Could you just comment on sort of maybe what demands look like in the last few weeks for you and kind of what you read into that going forward into the fourth quarter?

Well, the agricultural season is over. Industrial demand is sort of not over but it's coming to an end. That's seasonal. The industrial side is very spotty, depending on which kind of customer base you are shipping. We have seen the export demands stay relatively strong. Container board will not have the degree of slow down you see in coated, but it will slow down as it typically does. I would say right now we, the box business looks okay in October. October usually is a pretty good month seasonally. It's far out from September, but it's the last solid month you see for the rest of the month because of holidays and everything else that happens. I would say there has been no fundamental change in how we see the container board business now versus three weeks ago. We are getting price increases of boxes. We've gotten most of the container board price increase. As I said, we are up $27 in September. So I can't comment on anything other than what we are seeing ourselves.

Least Shownfield (ph): That's very helpful. Finally, do you have any guidance for the corporate line going forward? It has been bouncing around recently.

Andy Lessin (ph): I think it will tend to be at the current level or slightly higher going forward.

Least Shownfield (ph): Thanks very much.

Thank you. Our next question comes from the line of Timothy Gary (ph) from Arc Asset Management (ph). Please go ahead with your question.

Timothy Gary (ph): A couple of things on the pension. The covenants in terms of debt to total cap ratio, could you tell us what might be out there?

We have car debts on those in terms of debt and total cap as it relates to the non-cash adjustments.

Timothy Gary (ph): Would that also include good will write downs?

Yes

Timothy Gary (ph): Okay. And the car routes are such that none of that is held against you? Or only a portion of that?

I think the answer is we are in good shape in terms of debt to total cap with the rating agencies and with the banks. The issue with the rating agencies, what they want to see is better coverage ratios. Better coverage ratios will allow us, give us cash to pay down debt. Frankly, right now the, you know, we don't have any -- our debt matures until the end of the second quarter of next year.

Timothy Gary (ph): Okay. And then the second question, in calculating the, when you look at pension expense and which component is the expected rate, or the expected return on land assets, that calculation is your expected rate of return which you say is likely to go down times the market value of the assets. Do you use a smoothing average in terms of market value of assets? Or are you using the current market value of assets?

That's not a calculation you are making. You are looking at the equity reduction test which is the charge we are taking. We expect to be taking at the end of the year. That's not a point in time value.

Timothy Gary (ph): No, in calculating what the pension expense or income was for the year.

Smoothing, yes.

Timothy Gary (ph): The smoothing, is that three or five year smoothing.

Andy Lessin (ph): Five years. Timothy Gary (ph): Five year smoothing. So as the year 2000, which would have been the peak, drops out, there is the potential that we can continue to see some pressure on the expense side in pension over the next couple of years?

If interest rates stay at 40-year lows, you're right as it goes through an averaging process here. High years drop out an more low years come in. Everything else stays the same. You will see expense, you will see expense grow from where it's going to be.

Timothy Gary (ph): Okay. The final question, in your chart showing the change to expense or income, depending on change in return on assets or discount rate, with the discount rate, if it goes down by 50 basis points, does that mean that the impact is a negative 30 million on pre-tax?

Yes, discount rate goes down, the value of the liabilities goes up.

Timothy Gary (ph): But would you multiply it by something less, though? So that's why --

Andy Lessin (ph): The interest rate goes down, the expense goes up.

Timothy Gary (ph): Okay, thank you very much.

: Thank you. At this time there are no further questions. Please continue.

Well, if there are no further questions, we'll end it here. Thanks for joining. I would like to wrap up saying, you know, solid quarter from our perspective. Lots of progress on the internal side. Some signs that we've gotten some demand pick up in some of our businesses. Kind of a mixed bag. We feel pretty good about where we are internally headed into the fourth quarter and as we said, when our cost structure is ready, willing and able to enjoy the benefits of the demand improvement, when the economy I am pleased and we are confident that that will happen as well.

Darial Snead (ph): This is Darial Snead (ph). If you have follow-up questions call me or Carol Tutundgy (ph). Thank you very much.

Ladies and gentlemen, this concludes the International Paper's third quarter earnings conference call. You may now disconnect.

END