International Paper Co (IP) 2002 Q4 法說會逐字稿

Good morning, ladies and gentlemen and thank you for standing by. Welcome to the fourth quarter 2002 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 anyone needs assistance at any time during the conference, please press star zero. As a reminder, this conference is being recorded on January 30th, 2003. I would now like to turn the conference over to Dario Snead Vice President of Investor Relations. Please go ahead.

Good morning and welcome to International Paper's fourth quarter 2002 conference call. The main speakers this morning will be International Paper's Chairman and Chief Executive Officer, John Dillon and Executive Vice President and Chief Financial Officer, John Faraci.

Before we begin, let me call your attention to our forward-looking statements. As you know, we may talk about the future, which contains risks and uncertainties. The forward-looking statement that's contained on page two of our handout and on page four of our fourth quarter earnings press release outlines these risks and uncertainties. So please review those statements.

This morning, John Dillon will start with an introduction. John Faraci will then go into a fuller discussion of the quarterly earnings and full year results. Then John Dillon will return and sum up and talk about what he sees for this company going forward. Then we'll be happy to answer your questions. I will now turn the call over to John Dillon. John?

Thanks, Dario. It's my pleasure to be here and review with you the fourth quarter and importantly how International Paper did for the year. You've had a chance to look at our results that we had published this morning, and would I have to say from our perspective, I think it was a great year for International Paper. And an important continuation of the improvement trend that we have been on over the last three or four years.

Full-year operating earnings improved, you know, in spite of what I would say was a lackluster and weak economy with demand improving in the third quarter but falling off as we went through the fourth quarter. We did it and we made these promises that we have been standing behind by continuing to manage what we have control of and focusing on an intense focus on costs. John will share with you as we go through the numbers, the amount of price that we lost during the year and we more than offset that in terms of our cost improvements.

Customers continue, our effectiveness with customers continued to be a key part of our strategy and I continue to be pleased and with the progress that we made there. And then the notion of operating this company in every single thing we do on an improved basis. I will share with you towards the end of this presentation our competitive position, but, you know, I'm very, very pleased with how we have come out on an ROI ranking and moved ourselves up over the period significantly from last year and tremendous improvement over the last three or four years.

As everybody knows, you know, we're all concerned about the economy. I would say that the fundamentals in this industry continue to improve but improve modestly. I think when it's all said and done, we'll find demand for products coming out of 2002 about flat with where we were in 2001 with packaging up a little bit and paper about flat. That will be the third year of two years of declining demand and one year of flat demand, so certainly a disappointment from a demand perspective. You know, on the other hand, you know, some products, particularly uncoated free sheet in the United States, operating rates are very solid.

Inventories, I think, both at our customer and at the mill levels are in pretty darn good shape. And I continue to be positive, feel positive about the situation of the U.S. dollar. The weakening of the dollar is clearly changing the competitive landscape with respect to U.S. competitors against some of our offshore competitors who are clearly seeing the positive effect of the dollar from an export perspective, and I would anticipate as we move through this coming year, we'll begin to see the effect of the dollar in the U.S. economy.

Turning to the next slide that's titled operating earnings per share, you can see that in 2002, you know, we have been able to make a step change in earnings versus where we were last year and effectively, you know, we're operating this company at about a 30 cent plus or minus cents per share on a quarter-to-quarter basis. When you adjust 2002 to put it on the same basis from a goodwill perspective against last year, our operating earnings were up 40% over 2001. As I indicated, you know, that's very impressive, given that we lost about $600 million in price during the year and consequently, all of the internals more than offset that huge price variance.

We had a leadership meeting with the key leaders of International Paper last week, and, I will share with you the tremendous enthusiasm and energy in that group to recognize what we have accomplished. But perhaps most importantly, we spent the time last week talking about what we're going to accomplish in front of us, and there's not a doubter in the whole organization in terms of our ability to be able to improve the results of International Paper regardless of what's going on in the external world.

And we'll come back at the end of this discussion to talk a little bit about our expectations for next year. So with that is as an overview, I'd ask John to take us through the details of the numbers and review the performance in the quarter.

Thanks, John. For those of you who are following along on the slides, I'd be on slide eight.

And before I go into the quarterly results and the results of each of the major segments, let me first cover the special charges that we took in the fourth quarter. The amount is 60 cents a share. The largest one, which is the addition of the legal reserve Jim Melican and I covered with you several weeks ago.

So let me just skip to the next one which is the $46 million for debt retirement costs. We took advantage of 40-year low interest rates last fall and refinanced $1.2 billion of Champion acquisition debt that would have come due at the end of the second quarter of this year. And for that reason, we had to pay a slight premium to call in that debt ahead of time. That $46 million is related to that activity.

The $100 million of restructuring charges, there are actually a number of items in there. The largest one being a $24 million charge to consolidate one of our facilities in our packages businesses, but all in, those are -- that's the impact of a number of actions we either took in the fourth quarter or we plan on taking in 2003 to further improve our cost structure and consolidate facilities. There are about 1200 positions that will come out as a result of these actions. They will generate $48 million, close to $50 million in annual earnings improvement.

We also had a reversal of $58 million. Basically, when we went back and zeroed out the reserves we had taken over the past several years, we found out that on a total of $1.7 billion, we were $60 million over, so we took that back in as a credit.

The final significant item is the $46 million change in the deferred tax rate. We've got a deferred tax liability for state taxes of about $270 million. Looking at that we concluded that the rate we ought to assume on that should be 5%, instead of 6%, we which we reduced that liability by $46 million. Those are the major charges for the fourth quarter.

Let me turn now to the fourth quarter and our operating basis and kind of take you through some of the puts and takes during the quarter. We earned 32 cents in the third quarter of 2002. For the first time in, I'd say nine quarters, we had positive quarter-on-quarter price improvement. That's the four cents a share. As we indicated in the press release, our tax rate was lower in the fourth quarter. It was 24% in order to bring the full year in at 29, so on a quarter-to-quarter basis, that added 4 cents.

Land sales activity and our forest business were about $20 million and 3 cents higher than they normally are. We took a lot more down time in the fourth quarter than we did in the third. In the third quarter, we just about ran full and we took over 250,000 tons in the fourth quarter. That was a negative 3 cents.

The negative 2 cents on nonprice improvement really relates to a number of things going on. First of all, energy prices were up by about $11 million quarter-to-quarter. Wood costs were up $10 million.

And the start up and shutdown of a number of our facilities associated with the downtime we took also, you know, led to less than third quarter operating performance. So all in, that was about 2 cents a share. We weren't able to bring our nonprice improvement activities to the bottom line, but there's still a lot going on. We think, you know, wood costs will come back into line and gas prices will come down as we get out of the cold weather season.

And then the 5 cents you see here on the right really relates to two items. In the third quarter, we had a sizable foreign exchange pickup in Brazil, and that's 3 cents. Then we had a penny of interest costs. That was the dual interest costs we were paying when we borrowed that $1.2 billion. We couldn't pay off the Champion debt for about five weeks, so we're carrying duplicate interest there. Frankly that will be accretive for us this year.

So let me go to the three segments now and quickly summarize what was going on from sales and operating earnings standpoint. First, Printing Papers. You can see earnings were slightly down. Our pulp segments included in here and losses because of volume and the price erosion in pulp increased during the quarter. Printing Papers would have been flat basically without the pulp business in there. But pulp losses widened in the fourth quarter.

In Europe, we're showing that prices were up on a local currency basis. Basically prices were flat and that reflects some foreign exchange pickup and some positive mix impact.

In Packaging, earnings were also slightly off. That's just about entirely attributable to the significant downtime we took in our industrial packaging business in the fourth quarter to keep our inventories where we wanted them to be.

Looking at Forest Products, earnings were also off and the reason here is, you know, larger losses in the wood products business, which offset, more than offset the increased land sales out of our forest resources business.

And I mentioned downtime as you can see, in the third quarter, we took 50,000 tons of downtime in the fourth quarter. We were back up to over 250,000 tons. Most of that being in our Container Board business, which is the bar on the bottom there on the right. We also took some downtime in pulp papers in Europe.

You know, John talked about the strong financial performance, especially given the weak macro environment. This slide on page 14, really shows how we overcame the challenges in the marketplace and delivered improved earnings in 2002, despite the fact we lost a lot of price, over $600 million. This charge here summarizes where most of that price erosion occurred. Over $200 million in our coated business and 130 to $150 million in the uncoated white business in the U.S. and in container board. Although, we did get some price increases in the fourth quarter for the first time at the end of the year.

You know, the next page really is, you know, the story for International Paper in 2002, and it's what we did to, as we say, manage the things that we can control internally. The nonprice improvement that we got across the company and all businesses around the world was close to $700 million. Some of you may have heard John mention that, you know, our target was close to $600 million for last year, and we overdelivered on that target and as you can see here, you know, all businesses, you know, made a significant contribution.

So looking at just the full-year earnings, on an operating basis, 2001 was 44 cents a share. We were able to bring to the bottom line, net of any cost increases, about $1 a share of nonprice improvement. Obviously, we did not have the goodwill amortization in 2002 that we had in 2001. That is 38 cents a share.

Our interest costs are down because we had less debt and we did some refinancing to lower our overall interest costs. That was 22 cents a share. We took less downtime in 2002. And this is, you know, the result of some of that facility rationalization coming through. It's less costly for us to take down time because we don't have that much idle capacity.

We also had a net gain on volume in 2002 versus 2001, which is 8 cents a share. Then we lost a huge chunk of price, but were able to offset all of that with what we did on the nonprice improvement side.

And then we did have a swing in pension income from year-to-year. We did report income last year of about $80 million. That was down from the prior year. That's 13 cents a share, which leads us to $1.12 for the full year. So with that, I'll turn it back to John to, you know, talk about summarize and talk about the outlook.

Thanks, John. Just in summary, let me reiterate, I think we had great operating performance, and, you know, indeed, we're delivering on, you know, we feel strongly about the promises that we've made to the external world to our shareholders and ourselves. And without question, we're delivering on those promises.

And we're doing it by building stronger businesses, the strategic moves that we've made over the last period of time have fallen in place very nicely, so we've got a series of much stronger businesses and importantly improving our competitive position. In a minute, I'll just share with you how that has worked out. And all of that, you know, has resulted in an improvement in our rate of return versus our peers.

This next slide, slide 19 for those that are following, you know, shows what is happening to International Paper relative to our peer group. And the point here is not only are we improving our performance in an absolute sense, but we're improving our performance vis-a-vis our peer group. That's a series of eight companies that you see on the right hand of that slide of that chart.

And, you know, last year in 2001, we were in number six position and in 2002, we come out, the year will be in the number third position. Up dramatically from where we were towards the bottom of the heap when we started on this mission.

And although all competitor fourth quarter earnings are just starting to come out, but as we look at the fourth quarter, I think it's pretty clear that we will have moved into the number two position in the fourth quarter. So very, very pleased with this as the ultimate result of what we've been doing. And the result of, you know, consolidation, the rationalization that we have pursued, the intense cost improvement that we've got in the company, the drive to do a better job with our customers and then importantly, all of the people programs that we've got directed at making all of this happen.

So going forward, you know, our promise to ourselves and the world is to continue what we've been doing. And managing what we control, recognizing that it certainly would be helpful and important to see some improvement in this macro environment that we are competing in. And, you know, frankly, you know, I think with some of the things that we've seeing happen in the public policy arena, that we've got a very good chance of seeing a turn around in the coming year.

But we're not waiting for that and focused on what we can do to improve our performance. And we'll continue to drive on this nonprice improvement, you know, with a view that if we make ourselves better in this arena, you know, we'll continue to improve ourselves, vis-a-vis our competition.

I was on CNBC this morning and, you know, they criticized us and said, well, you certainly do not have any more cost improvement opportunity in the company. And I take strong exception to that. Even though, for instance, in the last year we took $250 million out of our S&A, we've got another series of initiatives to bring our S&A down. We've reduced our operating costs, you know, on a volume basis or on a tonnage basis, on a per ton basis. We're also taking significant costs out of our indirects, and as we look across this manufacturing system, we see a huge opportunity to continue to make progress in both of those areas.

We shared, you know, with you the work that we're doing on supply chain. Now, that has now moved in the study phase to the beginning of the implementation phase. Over the next two or three years, I expect significant improvements. Most importantly in customer satisfaction and service, but we're also going to be able to take some significant costs out as a result of that.

Wood costs, obviously is our big component of cost is one that we work every day on. Wood costs crept up on us a little bit in the fourth quarter and here at the end of the year as we ran into some severe weather problems and some impending wood shortages. But I'm comfortable as we come out of the first quarter, we're going to be able to pull wood costs back, you know, in line.

As I indicated, certainly, we were disappointed by the weakness that we saw or the weakening that we saw in demand as we moved into the fourth quarter. You know, we're in January, which is always a seasonal weak year and indeed, we have winter again that's causing some modest operating problems. So the first quarter will be a seasonally difficult quarter. But as I think about the year with the probability of some help from the public policy arena and stimulus area, I'm moderately positive in terms of seeing some improved demand as we move later into the year.

You know, just going across the company, you know, Europe right now is probably the weakest part of our business in the uncoated printing paper area. We are experiencing some price pressure in Europe. I'm pleased, you know, as we come out of the year in our container board business, demand is about where we thought it would be given where we were in November and October.

Market pulp, stock prices moved up aggressively in market pulp at the end of the year. And there's some price increases out in market pulp that I'm comfortable that we're going to be able to realize as we move through the first quarter.

In uncoated paper, you know, here in January, we're essentially operating at our capacity level. Demand has recovered quite nicely. And so I feel good about where we are in our uncoated paper area. But with all of that, why don't we open this up to questions and we'll talk about what's on your minds.

Chris, we're ready to take questions now.

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 star followed by the two. You will hear a three-tone prompt acknowledging your selection and the question will be polled in the order they are received. If you are using speaker equipment, you will need to lift the hand set before pressing the numbers. One moment, please, before our first question. Our first question comes from the line of Don Roberts with CIBC World Markets. Please go ahead.

Yes, John. Just a couple of questions. In terms of going forward on the supply chain management, could you flush out a little more in terms of the actual quantification of the numbers we might be looking at?

Well, we've got a target, you know. We set an internal target to take $500 million out of the supply chain cost arena. The scoping that we have done suggested, you know, there's an opportunity perhaps as much as $700 or $800 million. And now recognize that it's, you know, there's a significant cost associated with doing that, but we're also running this on a pay as you go basis. And, you know, in 2002, during the scoping phase, we have something called quick hits and we about matched our costs last year with the quick hits and that's what we'll do about in 2003. And then the real benefit of this will start accruing to us there after.

Okay. Over on the pulp side, you got more agressive than all the other pulp producers, at least the focused ones. What did you see that none of them saw?

More aggressive, in what respect, Don?

With the price increase that was announced was higher.

Well, you know, we expect, you know, demand for market pulp started to slide at the tail end of last year, largely because the Chinese stepped out of the market. And you know, we've got pretty good understanding of what's going on in China with respect to inventories, and we thought inventories were pretty low and anticipated that the Chinese customers would have to come back into market and acted accordingly.

Mm-hmm. Just lastly --

Don, I'm going to have to -- why don't we come back to you so we don't -- so we give everybody a chance to get questions in. So I promise to come back to you.

Yep.

Thank you.

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

Yes, good morning. Congratulations in a tough environment. I have three quick questions I'll ask up front. One is, you mentioned there is an insurance company demutualization gain in the corporate line. If you could just quantify that. Secondly, the increase in the balance sheet accounts due to the Washington state SPE, does that relate to the Champion 300,000 acres that we understood were sold a couple of years ago or is that something else? And thirdly, if you could just tell us what the book value of the Natches mill is that you plan to close at mid year.

Let me answer the first two. The demutualization is about $20 million, and there are lots of pluses and minuses that are going through that corporate account, but that's about $20 million. You're right, the balance sheet increase is putting that Washington state timber sale that we did that was acquired, you know, was part of Champion which we sold back on the balance sheet because we had a previously nonconsolidated ASP that was used to [INAUDIBLE] some installment notes.

So, you know, we got assets go up. Debt goes up and minority interest goes up and you see that on the balance sheet in the fourth quarter.

Chip, Natches, we had previously written Natches down when we were going through the sale process of Natches. So the fixed asset account is essentially written down. We've got something on the order of 20, $25 million of working capital that we would, you know, expect to recover.

Okay. And last thing on the force --

That's the fourth question, chip.

Okay, with the assets coming back on from Washington, does that take your forest account, I guess, back up to about $4.2 billion give or take, the forest lands on balance sheet?

I'm not sure, Chip. You know, it adds about $480 million back on the asset side.

It will end up being in an installment note so it won't affect the forest asset.

Okay, I'll stop at four. Thanks.

Thanks, Chip. Next question, please.

Thank you. The next question comes from the line of Mark Weintraub with Goldman Sachs. Please go ahead.

First, John, have you guys done any work that would attempt to quantify the impact that the weaker dollar can have on your bottom line? For instance, if the dollar were to stay where it's at and you would compare it to where it was last year and kind of flow through the various impacts on your business over time. Any sense as to how big an impact that could have? I would imagine it could be quite large.

I'll let John take the point of direct impact. I think the important thing here, Mark, and the calculation that is very difficult to make is the second and third order effects of the dollar. We're beginning, as I said earlier, we're beginning to see our ability to compete in the export markets and be competitive on volume as a real plus.

And then the other thing that I don't think there's any question that we're going to see is, you know, the exodus of demand and manufacturing from the United States that we've seen over this strong dollar period is going to moderate. I don't expect all of those industries and jobs to come back, but I certainly would expect that we will see a moderation in the exodus. So it's going to be a real plus to the demand side of the equation, you know, here in North America.

And then, you know, the other effect is the competitive effect. It's, you know, clearly going to have a balancing effect on some of our some of our competitors around the world. John, have you got any quantification?

Mark, we haven't done any work but I've read some, you know, some people have written about the industry in terms of its dollar impact on profitability. From what people have written, it's the over-a-dollar a share for us.

Maybe just following up. John, you mentioned how it changes the competitive landscape. At what type of exchange rates are your various businesses would you say on equal footing with the better positioned Europeans?

Oh, Mark, boy, I don't want to sort of -- it's obviously, you know, product line by product line. And I guess I don't want to sort of just get into that without some discussion about it with you.

Sure.

But, you know, at $1.07 here, $1.06, wherever we are now, you know, it certainly is making a difference. You know, the big grade, you know, the big import grade into North America that's been causing the North American problems, of course, is coated paper. And, you know, it will be different, I think, you know, when one looks at European competitors versus, you know, continental competitors versus some of the Finnish and Swedish competitors versus some of the paper that's coming from Korea and other parts of the world.

The other positive thing that we have seen already from an import perspective is lumber. You know, there was a big increase in the volume of lumber that came in from Europe last year, and in the lumber markets right now, we are seeing less European lumber than we did last year. So, you know, not only from the export perspective, but, you know, here is one product that from an import perspective we are now beginning to see a difference in.

And just a mundane quick item to finish up. On the Natches, do you expect any environmental or any other type of closure costs?

Well in all of these, in all of these facilities, Mark, we do have some closure costs. And Natches will have some. You know, we get these closed facilities in the right condition and we've experienced some expense in every one of these facilities. Natches is not going to be a huge number.

Okay. I'll come back around after others have had a chance.

Thanks.

Thank you. Our next question comes from the line of Mark Wilde of Deutsche Bank. Please go ahead.

Good morning, John, John and Dario. I wonder if you can explain to us where the $300 million of incremental capital spending is going to be going in 2003? And also to come back to currency one more time, I wondered if you could give us some sense of whether this might either lead to restart or more investment in some assets in the U.S. and whether you might have to restructure any of your operations over in Europe?

Well, on the CAPEX side first, Mark, you know, we have said that, you know, over the cycle that we plan on running the company, you know, with CAPEX in the 75% to 80% of depreciation range. Over the last couple of years, we pulled it down, you know, given the cash flow situation of the company and the other needs that we had with cash. We've got a huge number of very, very attractive projects that have got high return that we have been sitting on. And, you know, we'll move forward with those.

As we -- the big projects for next year, you know, there's a cost reduction project in our coated paper business that we're looking at. You know, there's some projects that we've got to complete in Poland. We're doing a project in France that will give us the capability to run some different grades in [SYOT]. We've got a new product development project that we're working on in Poland that's pretty exciting. We are building a new sawmill in Brazil that's about $25 million that will be in next year that was not in the previous one.

You know, we have made some provisions and we're studying them, you know, one by one to look at some selective modernizations of our sawmill system in the United States. So it's moving, you know, more, you know, toward the, you know, if you will, the normal category. And putting us in a position to start to take advantage of, you know, of some of the cost reduction productivity projects that, you know, we've been maintaining the system well but, you know, have not been working on some of these projects. The CAPEX question or the dollar question again, Mark, come back?

I was just curious about whether this might lead to you to bring some capacity here in the U.S. or whether you might have to rationalize some stuff over in Europe?

Well, the capacity that we have shut down in the United States, you know, you should think of that as being down permanently. You know, in Europe, we have been working diligently in getting our European uncoated system.

So it's got the best cost structure of any system in Europe, and you know, clearly, the change of the dollar will have a negative impact on our business. But I do not anticipate that there is any major facility consideration that this will cause. You know, we still got some work to do in Europe in terms of making the western European system what we want, but that's relatively small.

Okay. Just so we're clear on this again, one of the concerns I think that investors have had is that when times get better over here, all of this capacity that's been shuttered is going to restart. From an IP perspective, the capacity that you pulled out of the market you don't foresee putting back into the market?

That's what I said, Mark.

Very good. Thanks, John.

Thank you, our next question comes from the line of Peter Rushmeyer with Lehman Brothers.

Thanks, good morning. Two questions if I could. Maybe a follow-up on the last question as it relates to capacity. I was curious, you mentioned that uncoated free sheet is running fairly full. I understand you are not going to bring capacity back on that's down. I guess the question relates to, you know, if and when demand comes back strong, you know, how much productivity gains can you have? I'm curious on where your operating rates are by major business today and how much slack you have going forward. Are you, in fact, fairly close to real capacity constraints or not? I guess that's really the first question. The second question has to do with working capital. Was it a source or use of cash in the fourth quarter? And based on your comments on supply chain management, I assume you expect to get some improvement in '03 just to clarify that.

Yes, Peter. I mean, the working capital question, John, have you -- I mean, over the course of the year, we've brought our working capital down well. I just don't happen to know --

I don't have the fourth quarter, Peter at the tip of my fingers, but we'll see if we can dig that up for you.

Okay, great.

On the capacity question, and these are really, you know, dynamic kinds of questions. And, you know, what happens as demand improves, you know, you get the capability, you know, to improve mix, you know, length of orders and all of the operational kinds of things that happen with a, you know, with a better mix and a stronger order book. And it's difficult to say exactly how much additional capacity you can get out of those systems as a result of that.

You know, on the downtime side, you know, we put that chart in the packet of slides that we sent out to you. We've obviously have got the amount of capacity that corresponds to the down time that we've got and that has largely been in our container board system where we've continued to take over time a considerable amount of downtime. So we've got a lot of -- a fair amount of capacity in container board.

In the uncoated white system, you know, we've got a great uncoated white system both in the United States, Europe and Brazil. The Brazilian system, I would say, is running very close to its effective capacity. We've got some upside in Europe as we continue to bring the Russian mill up to the levels of productivity that it's capable of.

And then in this U.S. system, I don't know what it is, Peter, but it's, you know, it's something greater than 1 or 2% and less than 5%, probably that we can get out of this system by the continuation of the activities that we've been working on to bring machine efficiency up. Plus this question of improving mix.

I'd just add to that if you annualize the fourth quarter, we've taken over a million tons of downtime. The other side of that is, paper capacity only represents, you know, say 35 to 40% off our revenues. We've got a lot of capacity in our other business that we can, you know, if there's demand out there, we can generate sales without adding a lot of costs and without putting capital in place to meet it.

Mm-hmm.

So there's more volume upside as demand comes back than just the downtime number you see.

Right. Okay, great. That's very helpful. Thanks very much.

Thank you. Our next question comes from the line of Rich Snyder with UBS Warburg. Please go ahead.

This morning, a lot of the European producers have reported somewhat disappointing results and at least one or two have painted a pretty weak outlook for 2003 and I was wondering if you could discuss and you did very briefly on what's going on in your European operations and in particular, the comments on orders in uncoated free sheet in Europe from these producers have been indicating that we're starting the year at pretty weak levels.

Well, as I indicated, Rich, you know, we did see a fall off in demand in Europe really over the course of the second half of the year. The first half of the last year in Europe was terrific in terms of the order situation and it weakened over the course of the year. In reflection of what's going on in the European economy. And, you know, I don't think one can, you know, discount the problems that exist in some of the European economies, and the recollection that there's very, very low growth. They're having a difficult time wrestling with their fiscal policies. And so, you know, Europe certainly from a growth perspective is pretty meager.

You know, I, as I indicated, you know, we've seen some price pressure. In Europe here at the tail end of the year, although, on balance, you know, from a mix perspective, we came out pretty well on our results in Europe as you see in that slide that we shared with you. In fact, our European business, I would say, had a terrific year.

You know, we've been working hard on our cost structure and think, you know, more than think, know that we've got the best uncoated white system in Europe. You know, we're going to continue to run the business as we do, you know, staying with our marketing plans and our sales plans and we took some production curtailment in the fourth quarter.

I don't know what will happen in the first quarter, but you know, our plans will be to, you know, match our orders with production and you know, and compete in that business. So you know, right now, I would say yes.

I don't expect European results in the aggregate to be as strong in the early part of this year as they were last year. But we're doing the same thing in Europe that we are every place else. We're driving for internal improvement. It is, you know, I would say the weakest part of our company right now from a demand perspective.

You indicate you expect improvement to take place overall in the spring. Could you be a little more specific or are you just making a statement about seasonally things are better in the spring?

We should recognize that you know, first quarter is seasonally a very weak quarter. And, you know, it's impossible to understand the impact of the situation that's going on in Iraq. And so I, you know, I just expect the first quarter from a demand perspective to reflect those conditions.

At the same time, you know, business will get better as we come out of the first quarter. And Rich, I am encouraged with the public policy response that we're seeing today and the recognition that we've got an economy that's got a heck of a lot more potential than we -- than it is currently operating at. And I'm just hopeful that we get on with the public policy issue and, you know, limit the political side of the debate and move to get some of these things passed so they will begin to reflect later in the year.

Great. Just last question. If you look at your realizations, a little surprise that your box prices were only up $5 and bleach board was actually down $10 in the quarter when we had been getting bleach board price increases and the box price increase looked, you know, like it was going to be more like $15 to $20. Is that a mix issue?

Yeah. Don't -- those numbers that we share with you are realization numbers and you have to be very, very careful to recognize, you know what's happening to mix.

Okay. So those were mix issues there?

Yeah, mix is flowing through all of those numbers.

Okay. All right. Thank you.

Thank you. Our next question comes from the line of Mark Connolly with Credit Suisse First Boston. Please go ahead.

John, I promise I just have two questions.

Okay.

Listening to your comments, it sounds like we might be expecting more downtime in Europe in the first quarter. I wonder if you could just comment on the relative outlook for downtime?

Well, Mark, I really don't know what it's going to be. You know, we're going to manage this system consistent with our orders so I can't predict, you know what downtime is going to be on you know, on a going forward basis. But we took some downtime in our European system in the fourth quarter. We're taking some in, you know, right now, and that will be just a subject of how much orders we've got. And we don't try to forecast what happens with downtime.

Okay. Fair enough. And the second question. I won't add a third. Is xpedx. It's been a long time since we've seen as strong a contribution from distribution as this. Is there something new happening or is this a one-time item or has distribution actually finally turned a corner?

Distribution has made a tremendous recovery. And it has happened by changing our cost structure. And, you know with growth that we had been experiencing in distribution, we had a cost structure that could compete and was set up for sales in the $7 billion category and we've got sales in the $6 billion category. And so the xpedx team has recognized that and had changed the entire cost structure of that business to put us in a situation where we're, you know, beginning to operate at respectable returns.

So are you confident that we can start to see distribution looking more respectable across years rather than quarter by quarter?

Well, it's going to continue to improve. It reports to John. I'll let John share with you and take a little bit of the glory of what's happened in the distribution business.

There hasn't been a lot.

Well, take it when you can get it, Mark. Better days are ahead, Mark. Yes, that business earnings come out of the year at a run rate ROI of 6% to 7%. Its target is to earn a double digit return. We've got to get the cost structure right, get the working capital right. We also need a little bit of help on the demand side, but the capability of xpedx to sustain or support $7 billion in revenues is still there. It's just we've got a cost structure now we can make money at a much lower level.

Very good. Thanks very much.

Thank you. Our next question comes from the line of Lisa Schonfeld with J P Morgan.

Good morning, I've got two questions as well. You gave some guidance on outlook for the container board and the uncoated free sheet business. I just wondered, can you do something similar with the coated paper market and with the bleach board market just giving us an idea of how volumes and realizations are going to trend in the first quarter? And then secondly I just wondered, could you give us an idea of what the tax line is going to look like next year? Is 29% a good number to use there?

Lisa, I guess I would say I didn't, you know, in terms of talking about the product businesses, I -- if I gave guidance, I didn't intend to. What I was trying to share with you is just what's going on in the market. And in coated paper, in the fourth quarter, you know, the end of the year, you know, demand recovery in coated paper particularly in coated free sheet was just phenomenal.

Now, you know, still on a year-over-year basis, growth was very modest, but the last half of the year was very, very good. Coated papers had a tough year in the pricing environment. It moderated in the fourth quarter and as you know, there was a presheet price increase announced and quoted ground wood prices stopped going down.

There is a free sheet price announced for the beginning of this year, and, you know, I would expect, you know, I don't expect -- we may see the same kind of quarter-over-quarter comparables in free sheet and what happens there is a function of commercial printing. And the encouraging part of that was the strength we saw in the latter part of the year suggests that we've got a commercial printing beginning to come back a little bit.

On the ground wood side, you know, we go through this calendarization and ground wood demand, you know, the catalog season is at its low right now, and so demand in the [INAUDIBLE] to ground wood will be seasonal as we always see it.

Lisa, I'd use 31% as the tax rate going forward. We were at 29 for the year. And as our operating income goes up, our effective tax rate will sneak up as well.

Thank you. Just any comments on the bleached board markets given that the realizations, I know it sounded like it was mixed, were down $10. Just any comments on volume?

Yeah, the bleached board order backlogs shrank in bleach board in the second half of the year. We maintained it looks like January backlogs are about where they were in the November/December period. You know, not dangerously low, but I certainly would like our backlogs to be a little bit stronger in all of these products, you know, here in the early part of the year. And I think what you've got to recognize is, you know, when you wrap all of our businesses together from a demand perspective, you know, we reflect what's going on in the economy.

And, you know, this economy weakened in the second part of the year and, you know, we saw demand weakening in the second half of the year, and now we've got, you know, the seasonal January, February first quarter phenomena. So I just, you know, we just have to recognize where we are from a demand perspective and where we are from a calendar. At the same time, I obviously would like to see demand stronger. But, you know, given the level of demand, things are okay right now.

On the bleached board pricing thing, you know, as I just think about our bleached board business, I'd say, you know, we got a little price improvement from that price increase late in the summer, and then I'd say, you know, bleached board pricing has been, you know, sort of on a grade to grade basis about flat over the last half of the year.

You know, that business has got a lot of long-term contracts. And the contracts that we've negotiated, you know, the longer termed contracts that we've negotiated going forward, the pricing is about flat.

You know, looking at it from another angle, the only business that we've got right now where prices are even close to trend line is the uncoated white business. In all of the other businesses, prices are significantly below trend line.

Great, thanks very much.

Thank you, our next question comes from the line of Steve Chekover of D.A. Davidson. Please go ahead.

Good morning. Just a couple of questions if you will. First of all, back to currencies. When we look at the performance of the European economies with slow growth and weak profitability, and even some kind of strange bedfellows in that union. Is it logical to expect the Euro to keep gaining against the U.S. dollar or even to maintain those gains?

I guess with respect to forecasts in the Euro I will defer to Chairman Greenspan who says he hasn't the vaguest idea. You know, what's going to happen to the Euro. You know, my advocacy with respect to the Euro is, you know, the dollar was too darned strong. And as I have said, I'm encouraged to see the rebalancing of it. But I'm going to stay out of the foreign exchange forecasting business. That's fair. I'm not an [INAUDIBLE] analyst, either.

Secondly, John Dillon said he still sees huge cost savings available. Can you quantify it? Like, can we repeat the kind of gains that you've made in the last year or two and over what time frame?

Well, we expect to experience the same kind of improvement that we've seen over the last few years. That's the order of magnitude of improvement that we've got our sites set on. And, you know, we've got our sites set on improving return relative to our competition, so it's going to take those kind of annual increments to make that happen.

Think of it this way. We look at it as we're operating on a $24 billion cost base. So, you know, like peeling back the onion, there's always opportunities to look at that cost base a different way and improve it.

So even a 98 cent kind of benefit in '03 is feasible?

Well, we had energy going with us in '03 and, you know that's not going to go with us every year. And we're off to a start where energy is now higher than it was in 2002. But, you know, energy was, you know, maybe $100 million, you know, better in 2002 than it was in 2001. Okay.

And one quick one then. Have you taken any charges yet for Natches or is that all still ahead of us and how much?

We've taken the charges for Natches. You know, John said earlier, we've written the assets down to zero. And we've got the, you know, severance ahead of us.

Yeah, severance to take.

That's what I meant.

Yeah, we've got the severance obligations to take when we actually shut that facility down.

So it's around 600 people. What would the severance be?

Well, it's 600 people, $25 million --

$20 to $30 million, something in that category.

Chris, we have time for one more question.

Thank you. Our next question is a follow-up question from the line of Mark Weintraub with Goldman Sachs. Please go ahead.

Thanks. Maybe just following up with the point that you make. A lot of additional opportunity for cost improvements. Do you expect to be able to do that with less in the way of nonrecurring charges or do you expect that there will continue to be a lot of severance and rationalization consolidation in getting to that point?

Well, we've certainly been through a period of a lot of change in this company, Mark. And, you know, although the magnitude of improvement will improve, I wouldn't expect the same magnitude in rationalization. Now, at the same time, you know, these programs and improvement that we are managing will result in staffing changes. And may result in, you know, some modest changes in our physical assets. And so I can't promise that we will be -- well, these are important things to do.

And as you know, the accounting rules require that we respond to reserves for staffing and people reductions at the time that we make the decision. And so I would expect that we'll continue to see some of those, but, you know, the big major rationalizations and facility changes, I would hopefully are behind us.

You know, the payback on those charges are really reflected in the matter of nonprice improvement we got this year. That's the benefits of those cost reductions and facility rationalizations that have enabled us to do what we did. Those are savings that are permanent going forward.

Hey, Chris, I promised Don Roberts to come back to him, and since we're starting to go around, let me take the last one from him if he's still on.

Unfortunately, Mr. Roberts has not queued for questions.

I apologize. Mr. Roberts did go ahead and queue.

Mr. Roberts, please go ahead with your question.

John Dillon, I wondered if you just -- I understand in the Congress if you introduced legislation to increase the duty on the cane and lumber form 27% to 45%. I wanted to get your sense on whether that will likely go through and what are the potential closures perhaps on the Wellwood operations?

I'm not familiar with that. I do not -- I guess I'm just not familiar with anything with respect to the duty happening in the U.S. Congress, Don.

Okay. Thank you.

Okay.

Well that concludes our fourth quarter earnings conference call. Thank you for joining us. If you have follow-up questions, I'm available. Thanks. Bye-bye.

Thanks, everybody. Appreciate you being on the line.

Thank you. Ladies and gentlemen, this concludes the fourth quarter, 2002 earnings conference call.

Thank you for participating, you may now disconnect.