International Paper Co (IP) 2003 Q2 法說會逐字稿

Welcome to the International Paper second quarter earnings conference call. Following today's formal presentation, instructions will be given for the question-and-answer session. If you need technical assistance at any time during the call, please press the star followed by the zero on your push button phone. As a reminder, this conference is being recorded today, Thursday, July 24, 2003. And now I would like to you turn the conference over to Darial Sneed, Vice President of Investor Relations. Please go ahead.

Well, good morning and welcome to International Paper's second quarter 2003 earnings webcast. I'm joined this morning by our chairman and Chief Executive Officer, John Dillon, and our Chief Financial Officer, Chris Liddell. Before we begin, please note that we may make forward-looking statements that are subject to risks and uncertainties that are outlined on Slide 2 of the presentation which is available on our website. Forward-looking statements are also contained at the end of our second quarter 2003 earnings press release. We will also use non-GAAP financial measures. A reconciliation of these numbers to U.S. GAAP is available at web www.internationalpaper.com under investor information. Now I'll turn the call over to John and Chris. John?

Thanks, and let me add my good morning and thanks for taking your time to be with us. I'll take a couple seconds and summarize the quarter. Chris then will take us through the numbers and I'll come back and share with you an outlook going forward, and then of course we'll take your questions.

As I think about the second quarter, you know, the top line that I would have to share with you, I was -- I was disappointed in volume. You know, frankly, I had expected to see an upturn in volume in the second quarter as we moved out of the conflict in Iraq, combined with what normally is a seasonally stronger quarter, and we didn't see it. In fact, when we add up all of the volume, it comes out flat to perhaps down a little bit. The good news from International Paper's perspective is we turned our operating performance around and recovered from weather-induced operations we had in the first quarter and from just an operation's perspective we exceeded our planned operations in the second quarter by somewhat. As I said, second quarter demand was soft, volumes were about flat with the first quarter. A disappointment.

You know, to manage our supply with demand we took some additional downtime, both from a downtime -- from a curtailment perspective, as well as some additional maintenance in the second quarter. Because of these market conditions, you know, prices were flat to down, trending down over the quarter and we'll talk more about that as we move through the presentation. Energy and fiber costs remain high. Energy came down a bit during the quarter, but our fiber costs went up during the quarter. And so on balance these two areas continue to be one of our major earnings problems. When I wrap that all together I'm pleased with the fact that we're continuing to wring performance out of the company, our cost programs got back on track in the second quarter, made up some of the deficiencies for the first quarter, we continue to do well with our customers, we're working hard on mix, we continue to be dedicated to improving this company from the inside out regardless of the external conditions that we're facing.

So on an earnings basis, turning to the next slide, earnings in the second quarter were 19 cents a share as compared with 14 cents in the first quarter, and on a comparable basis, EPS in second quarter 2003 were below the second quarter of 2002, due largely to these higher raw material and pension costs, as well as poor product pricing. And then we had a 4-cent gain in -- at that period on foreign exchange. So Chris will take us through the numbers, and then we can come back and talk about this in more detail. Chris, please?

Thanks, John. I'll start by discussing the key factors driving the change in operating earnings from the first to the second quarter and then I'll give you some more detail on a business-by-business basis. But as you can see from the results, earnings overall improved from 14 cents a share to 19 cents a share and looking at how that's made up, we saw an improvement of 5 cents a share as we got our operations back to normal from some of the first quarter winter disruptions that we saw. So that 5 cents was virtually exactly equal to what we lost in the first quarter.

On top of that, we saw cost reduction mix and margin improvement in our converting businesses which contributed around 7 cents a share. We also saw raw material costs remaining high, and they were up around 1 cent a share, which offset slightly lower energy costs of around a cent. So they offset each other and we saw a 7-cent increase overall in cost mix and margin improvement.

In terms of tax rate, we now believe we'll look at a rate for the year around 28%, we originally forecast 31%, but we're now forecasting 28%. So the improvement in the quarter of 26%, which gets us down to that 28% rate for the year will contribute around 2 cents for the quarter.

On the negative side, pricing as John mentioned was weaker quarter on quarter. We saw an improvement in pulp but that was more than offset by lower prices in uncoated paper, liner board and corrugated boxes. The sum total was a 4-cent decrease. We also saw a 1 cent as a result of flat to slightly lower volumes and lack of order downtime which I'll give you more detail on on the next slide. We also had a 2-cent impact from the strike at Carter Holt Harvey, a loss of income with that. That strike was settled in June, so we won't have that impact going forward but a 2-cent impact in the quarter.

Lastly, the impact of interest costs associated with a bond issue that we had earlier in the year, and then the progressive repayment of the -- of debt through the quarter, slightly higher interest expense and other smaller items contributed to a 2-cent negative. The sum of those increases, improvements in winter fix, cost and mix and tax rate change, offset by slightly lower volumes and price and the Kinleith effect, overall a 5-cent improvement quarter-to-quarter. In terms of downtime, as I mentioned we took more at our mills in the second quarter than we did in the first. 90,000 tons overall within that and container board we took 35,000 tons, uncoated 30,000 tons which 11,000 of that was in Europe and pulp, 25,000 tons. Given the demand in wood situation, we accelerated maintenance shutdowns in the first half of the year.

As a result of that, we had 90,000 tons of downtime for the quarter but our inventory position was essentially flat to slightly down. Domestically it was flat, up in coated and uncoated, freesheet, but down in the others and essentially flat overall in tons. Over seas we were down over all in tons so as a company, it's down. When we introduce foreign exchange impacts on a dollar sense we were slightly up in dollars but down in tons overall. Special items for the second quarter, we saw restructuring and other charges of $81 million, the biggest piece was a $43 million associated with the shutting down of our Spring Hill and Tuscaloosa wood products plants and also our Natchez pulp mill. The employees impacted there were 198.

The balance of the $81 million is $38 million for severance costs associated with organizational restructuring programs, some debt extinguishment costs-we borrowed money at more favorable rates and we were able to call more expensive debt but there were prepayment costs associated with that, and also additions to our legal reserves. Special items also included a $10 million adjustment for previous divestitures offset by a $9 million reserve reversal, so essentially those two offset each other. The tax and minority interest impactable of that $81 million was $31 million positive, and also we had a $50 million tax adjustment associated with two settlements, one in the U.S., one offshore. We had taken previous reserves, the settlements were more favorable so we bought back those reserves. The sum total both negative and positive was negative $1 million after tax, so essentially flat on an earnings per share basis. Which meant our GAAP earnings and our operating earnings are equal for this quarter.

Turning to individual businesses, the printing papers earnings improved in the second quarter mainly because of improved operational performance and we saw cost reductions in particular across all parts of the business which offset lower volumes and flat overall pricings. As John mentioned, we were disappointed with flat volumes in uncoated freesheet after what we saw as a seasonally slow first quarter, and on the pricing side, exiting the second quarter we've essentially given up most of the price increase that we got in the fourth quarter of last year.

Coated volumes were below first quarter levels and that was due to a combination of continued impacts associated with the Iraqi war, deferred promotion, and advertising spending there. And also continued higher imports. Despite the lower U.S. dollar. Pulp revenues improved due to higher prices, however, volumes were negatively impacted by some maintenance outages and also wood fiber shortages. And in Europe, earnings were relatively flat. We had weak demand there and that caused local currency prices to erode by the time we had those lower earnings in Europe translated back at a better exchange rate into the U.S., essentially a flat U.S. dollar performance.

On packaging, earnings for the packaging business also improved in the second quarter, about half of that increase was due to seasonally higher volumes in container board boxes and bleach board and also higher consumer packaging price realizations. The other 50% of the improvement was due to good cost reduction in the business. While container board pricing was on average down on our benchmark rates, our realizations were flat due to an improved mix and a similar situation in bleach board, whereas the pure -- on a pure grade basis prices were flat, we managed to get price increases on a mixed adjusted basis.

And finally, in forest products sales revenue was increased due in particular to higher wood products volumes but given the low margins in that business, it didn't have a substantial impact in terms of earnings. And earnings, in fact, declined due to lower harvest volumes and also adverse Canadian foreign exchange impacts, our well wood operations translated back into U.S. dollar gave us lower earnings. The timber harvest operations were clearly adversely affected by the continued weather that we've seen in particular across the South, and harvest volumes were 15% lower and clearly the soggy conditions continued to make logging difficult and more expensive.

Earnings from land sales and other nonharvest operations, for example, recreational income were essentially flat for the first quarter. With that summary, I'll hand it back to John and give us our thoughts on the third quarter outlook.

Thanks, Chris. You know, in the near term, that's as we move through the summer, I think we're going to continue to face a tough external environment. And you know, the combination of not seeing any real signs in economic improvement with the seasonal slow time in July and August, you know, I think we'll experience business conditions pretty much as we've seen here over the last couple of months. Demand will remain flat, I do not see any improvement in demand with perhaps the exception of coated paper, which is coming into its seasonally stronger period. I do, however, I guess remain you know, positive on this economy, I think as we move into September and the fall, I would be very surprised if we don't start to see some modest demand improvement.

I've been wrong on this before and my crystal ball is no better than anybody else's but I do think that with all of the stimulus that's in this economy, and as we continue to move through working out the excesses of the latter part of the 1990's that we're going to start to see some improvement. Our operating performance will continue. I feel very good about what we did in the second quarter. And so I -- I'm positive on operating performance during the remainder of the year. As we get moving on a bit further, as I said, I think we'll see some demand improvement. And I'm very positive about the outlook for International Paper. All of these actions that we've taken. And continue to take are just building a stronger business, we're moving vis-a-vis our competition, and you know, when we get a little wind in our sails from some better economic conditions, things are going to be -- there's going to be a lot of fun around here.

Despite all of this, we continue to work hard on our costs, we've announced that we're going to take another $500 million out of our S & A costs. This is part of this three-year program that we've shared with you to improve the non-price performance of the company by a $1.5 billion. These are hard, difficult choices to make but ones that we're committed to do and ones that we recognize are needed in the environment that we're in to, you know, turn in the kind of performance that we promised to you. So we've made enormous reductions in the cost structure, I see more coming, and on top of that, the customer focus that we work hard on every day is -- are both going to show up in improved performance of International Paper. So with that, let's take some questions. Darial, do you want to manage this?

Okay. We're ready to take questions now.

Okay, 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 1 on your push button phone. If you would like to decline from the polling process, please press the star followed by the 2. You will hear a three-tone prompt acknowledging your selection. Your questions will be polled in the order received and if you're using speaker equipment, lift the handset before pressing the numbers. One moment, please, for the first question. It comes from the line of Chip Dillon. Please go ahead with your question.

Yes, good morning. Looking at the printing paper segment, it looks like you had a pretty strong number when you consider how the volumes in almost every grade-- the pricing was flat to down. I was wondering if, in addition to the pulp price rise was there any particular cost improvement that helped you show such nice gain in that one particular segment over the first quarter? Hi, Chip, yes, there was. We've been sharing with you some -- for some time, you know, the view that we had considerable operational opportunities, operational improvement opportunities in printing papers, and that business facilities ran very, very well in the second quarter. They had some of the same weather problems early in the year, but I was very pleased with their operational performance. And every one of our facilities had nice gains in their cost structure. Okay. And maybe even more so in that segment than, say, in the container and the packaging segment? Well, you know, we've got, I would say, we've got more upside in our printing papers, mills and operations and supply chain perhaps than we do in our container board mills, but our container board mills also had a good quarter. We were positive to our budget, they made up the shortfall that they had in the first quarter, so our mills ran well in the second quarter. If we could only deal with energy and wood cost, we would have had a great quarter. And then shifting to forest products you were down 18 million from the first quarter with better volumes and probably flat pricing, and the harvest level really seems to have hit you hard there, is it certainly reasonable to say unless lumber continues to fall that we probably see a bump there given that things have at least started to dry out a little bit in the third quarter? Well, I think so, Chip, demand is going to be very, very good in the third quarter. We have experienced some pricing improvement although modest, at this point. And so I'm confident we're going to have better performance in our wood products business in the third quarter. Okay. Thank you.

Our next question comes from the line of Richard Skidmore. Please go ahead.

Thank you. Just a couple of questions first on the cost side. John, can you talk about the areas that you think costs will be coming out in the third quarter? Perhaps if you can quantify where those costs will be coming from? And then comment on what the expectation is for downtime across the businesses in the third quarter? And then I'll have a follow-up on just strategy.

Well, we're working on cost in every single part of International Paper. As I've indicated, we made good improvement in the second quarter on an operational basis. I'm also pleased with our S & A reduction. When we saw the purchase price and operation problems that we had in the first quarter, we went to the organization in March and asked them to take a re-look at S & A and we set some additional targets. The reaction to that was very fast. And so S & A is down below our budget for the second quarter and as I've indicated a minute ago we've announced another S & A reduction program. So the cost drive is just going to continue and it will come from, you know, from every single part of the company. We don't forecast downtime. Chris related to you what we had taken in the past. We match our production to our orders and, you know, we'll have to leave that at that.

And given your outlook on demand being flat quarter-over-quarter, would it be unreasonable to assume that it would be a similar number in the third quarter versus the second on downtime or --

Well, I'll stay with what I had said that we don't forecast downtime.

Okay. On the strategic side, John, if you could just talk to thoughts on growth for International Paper, or is the focus over the next year or so just on getting the costs down and really realizing the earnings improvement that you're targeting?

Well, we're working hard with our customers. You hear us talk a lot about, you know, a belief that a strong customer initiative is as important as anything else. And so you know, we're working hard every day with customers trying to eke out share where we can. But at the same time, you know, the leverage, a lot of the leverage of course is in an operational perspective.

And so we're working both on the customer side of the equation as well as operations. You know, frankly, I'm looking forward to a better economy and as I indicated before, I think we're very well positioned for that. And I'm not sure when it's coming, or with what force, but I guess I'm safe to say I think it's coming.

Thank you very much.

And our next question comes from the line of Rich Schneider with UBS Warburg. Please go ahead with your question.

Chris, I was wondering if you could possibly quantify what severance charges you may have related to the $500 million S & A reduction goal?

Well, again, we don't forecast those numbers. Clearly, there will be some people associated with that in terms of the numbers that we have, but that's not a number -- we don't have any of those people in the numbers that I talked about in the second quarter so those will be future charges.

And when does this program actually commence, John? Is that starting now and we haven't had any effect of that so far?

Well, we've had some, Rich. It's a $500 million reduction. The way we're managing that, it's a $500 million reduction over the budget that we had set for this year. And so we will -- as I've indicated, we've accomplished some of that so far, but we are now, you know, going through every part of International Paper looking at our organizational structure, looking at our initiatives, at our programs, and making a determination of what else do we have to do to accomplish in total this $500 million number.

Obviously, you know, there will be personnel changes associated with it. And as we told you, this question of ongoing reserves, you know, we don't know any other way to do it other than continue to improve this company. And in so doing, as we deal with facilities and people, some of these reserves are inevitable.

Could you also comment on your views on the coated paper markets, imports are still at extremely high levels and they're clearly up from a year ago. And it looks like, you know, I'm trying to figure out how you're positioning yourself here. It looks like you've announced a capital project at Andrew Scoggan in the coated area, could you go through how you're playing around or looking at the dynamics of this market?

We're not playing around with it. We're working harder than that.

Only analysts play around.

Yeah, the announcement of a machine, of a pulp mill and machine rebuild at Andrew Scoggan is part of what we've been sharing with you of our plan for coated papers for some time in the sense that we realize that are cost opportunities in that business, and that there were initiatives that we wanted to pursue to bring our cost structure down and get it -- and take advantage of these opportunities. So that's a cost reduction program of, you know, pretty significant magnitude. And we're going to have to continue those kind of things things.

Rich, we've got a great market position, but we do have, you know, some cost opportunities that we want to take advantage of. You know, imports are, as you pointed out, are just pouring into North America. I think what's happening there is the very weak European markets are causing competitors to look at the North American market, which is not all that strong, but is certainly stronger than Europe. And I -- they're making the choices to export an awful lot more paper into this market.

And just a last question: In the packaging area, earnings were much better than I thought they would be, and as Chris said, 50% came out of costs, but it looks like you made some clear improvements on the converting side. Could you just discuss that briefly?

Yeah. Again, you know, we've said in that business we've got a terrific mill system, but our converting system was not where we wanted it to be. And that's part of the strategy for getting the industrial packaging business performance where we want it. And I'm pleased that the organization is making nice improvement there. You know, it's a tough market. So we're not getting much help from the market side or from the customer side. But the cost, the productivity, the efficiency programs within those converting operations are starting to show.

Thanks.

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

Good morning. I had a couple of questions. I wondered if you can give us any color on the impact, both in Europe and down in Australia and New Zealand.

Mark, can you talk up a bit?

Can you hear me better now?

Yes.

Can you give us a color on what you might be doing or what impact a stronger currency might be having in the European business, and then down at Carter Holt as well? You've seen appreciating currencies in both of those markets.

Well, against the Euro, where we have seen it so far, Mark, is clearly in export share and export profitability. I don't think there's any question that the currency changes have, you know, have helped in both of those areas and helped with the price movements that we saw earlier in the year in market pulp. I think obviously it's having an impact on the performance of some of our, you know, companies, European competitors that are Euro denominated, of course we've got a European business as well. You know, Chris is our down under expert, I'll let him speak to what's going on in those currency in that world.

Sure, Mark. Carter Holt Harvey is in the fortunate position of having locked in some very favorable exchange rates from a forward contract perspective so they are still trading or averaging in the mid-40s for their exchange rate, that's the new Zealand dollar to the US dollar, compared to a spot rate in the high 50's. At the moment, they're shielded from the impacts of the appreciating New Zealand and Australian dollar. Clearly that will roll out over time and what they are doing is going back and in the same way as we are doing here in the U.S., looking at every aspect of their operation and how they can take cost out so that they can offset the ongoing effect of foreign exchange. So initiatives, for example, such as the Kinleith restructuring are really a part of that.

Okay. And John, I wondered coming back to that question about kind of growth for International Paper going forward, over the last two or three years you've really been quite internally focussed on getting costs out of the company, integrating things like Champion and I just wondered if you could give us some sense of whether you think you're ready to start looking at kind of external opportunities again?

Mark, our nose is to the grind stone. And you know, we're working in all of the areas that we have talked about. I guess I would say we never stopped looking at external opportunities, and haven't seen anything that is of any interest to us.

Okay. And finally, Chris Liddell mentioned an increase in legal reserves, I know that's just a small issue but I wondered if you could give us a little color on what that involved?

It's a small increase as we've, you know, as we looked across the things that are going on in that area, we wanted to make a small increase in one of the reserves.

For a particular issue, John?

Yeah. We -- these reserves are identified by issue, you know, it's not relating to masonite or asbestos, it's just another case that we're working on.

Okay. Great, thank you.

Our next question is from the line of Lise Shonfield with JP Morgan. Please go ahead with your question.

Good morning. Just a question on Natchez. I wanted you to confirm that it has been closed down and won't be reopened or sold? Because I have heard some talk around a management buyout.

Natchez is down. I think we produced our last paper, oh, sometime Tuesday or Wednesday of last week. The employees are, you know, in the process of -- we have got still people in the mill, and in the process of cleaning out lines, et cetera. So the mill is down.

And it's not going to be sold or reopened or anything like that in the sort of in the future?

Well, I guess I would -- I don't know. I know that there are some efforts on the part of an employee group. We have talked to them, and it's premature, I would say, to determine whether or not there's anything that will happen there.

Okay. And just on pricing, I just wondered if you could give us a sense of where pricing is today, for your major product lines versus perhaps the second quarter average?

Well, you know, I guess what I'll just share with you the dynamics. You know, there is some price pressure in the uncoated white area, that started early in the quarter in offset grades, has moved into cut-size pricing and some into the envelope area. So there is some price pressure in that arena. In container board, again, I would same some modest price pressure. As we move through this weak period, in the box business, there's literally negotiations, numerous negotiations every day in the box business with prices going up and down, I would say overall in the box container board area, I would refer to it as modest. Coated paper is flat, you know, obviously there's a lot written about what's going on in the pulp market and I think you're familiar with that.

Plywood prices have moved up some, lumber prices moved up some. We've lost a bit of that. So as you go across International Paper, you know, there is price pressure in a number of our grades, it's -- I would categorize it as modest, not overly intense, but yes, there's price pressure.

Thank you. And just one final question: I'm hearing from some of you're European competitors in the bleach board market that you've been perhaps gaining a bit of share in some of the export markets, some mentioned Asia and I just wondered if you could give us a little bit of color in what you're seeing in the overseas market on the bleach board and folding carton side?

Well, I haven't got the volumes right here, so I can't really respond to the volume questions specifically, I mean, we have been and are -- you know, we are and have been a large, pretty large exporter of bleach board. You know, I -- there's been no substantial change in share positions in that arena. As I'd indicated earlier, the FX things in some part of the world are having some positive effects, but in, you know, in some of the Asian, anything that's going to China, of course that's essentially dollar denominated business. So we work hard and in our bleach board area, back to the general question, you know, I would say pricing has been flat in our bleach board area here in North America. We continue to work on our customers and if we can gain share by doing a better job with our customers, that's what it's all about . There another question?

No, that's it. Thank you very much.

Okay, thanks.

Our next question comes from the line of Mark Connelly with Credit Suisse First Boston. Please go ahead with your question.

Thank you. John, obviously something went right this quarter because there are sure enough things went wrong that you could have hidden behind.

Thanks, Mark.

I wonder if you could give us a little more detail on what's going on in the consumer packaging business? We talk about bleach board but we haven't heard much about the specifics about the shore wood assets lately and what's going on in food service and what your outlook is there.

Yeah, sure. Both of those areas had a tough quarter from a demand perspective. You know, with the horrible weather, the food service business was negatively impacted people weren't out doing the kind of things they typically do in the spring. Our volume in food service was, you know, I would say was weak in the second quarter. In shore wood, it's a mixed story. You know, we're big in music and entertainment and the music business continues to be negatively impacted by all the Internet stuff that we hear about.

Our volume in the general folding category in shore wood was okay, about where we thought it would be. Our personal products business was also about where we thought it would be. Tobacco is off a little bit. So those two areas from a volume perspective were, I would say were disappointing in the quarter. I'll make the same point there that we did on the box plants, intense focus on internal improvements. We took a huge amount of cost out of our food service business, big inventory reduction and a big S & A reduction. So in spite of weak demand, our earnings sort of on an ongoing basis in food service are up a bit.

Okay. And switching gears, John, but sticking with the weather, we talk about the hardwood shortage in the southeast but it seems that there's actually two issues. First we've got the weather and second, you know, there's an indication that we have a serious structural issue with hardwood chip availability in the southeast. Can you talk about that and how much you think it's affecting you now or is going to affect you over the next couple of years?

Well, I mean, the big, you know, the big compact of course is the weather and all of the rain. And I worry about inventories as we, you know, come into the fall. Inventories have recovered beginning to recover sort of in the midpart of the South, but over along the Atlantic coast we're still very, very tight on hardwood. From a -- there's, I guess I would say there's two issues perhaps from a structural perspective.

One, of course, is just the work force and the amount of production, number of contractors that are available. And when you get in a shortage period, you know, an intense weather period where we've lost a lot of days, we don't have the capacity and the logging -- in the logging part of the system to make up. So that is a constraint, from an availability perspective, certainly hardwood in the U.S. South is becoming less available than it has been over time. You know, we're beginning to convert some of our products back to soft wood.

You know, for years the economics drove us to use more hardwood, and you know, we're now in certain places, converting back to pine because of the economics have crossed over. And in certain regions of the South, the hardwood situation is stressed more than others. So there are those -- I guess I'd say those three dynamics at work.

Are we likely to see hardwood being brought in from Latin America over the next couple of years?

It wouldn't surprise me. Yes. In fact, you know, we're looking at that. We're looking at the possibility of bringing wood up from Brazil. You know, we've got extensive plantations in Brazil. You know, that's something that's been in the book, on the shelf for a while and we're rejuvenating that look and determining, does it make sense to do that.

Great, thanks very much, John.

The next question is from the line of Peter Ruschmeier with Lehman Brothers. Please go ahead with your question.

Thanks and good morning. John, I wanted to ask a question about your opening comments about demand. Clearly we've had a U.S. trade deficit problem for years, we've had a trend of manufacturing companies moving offshore which has plagued the industry. I'm curious if you could talk broadly about your outlook, the effect of these trends on your business, and whether any lobbying effort in Washington is warranted, or likely any time soon.

Well, I'm concerned about it, Peter. In fact, I was in Washington this week on that very subject. And you know, it's a, I guess in my mind, a pretty complex subject that inevitably there is a, you know, a change in the economy, you know, where manufacturing is moving to lower cost regions of the world. It's having an impact on demand for our products. You know, you've seen this data that's around on what's happened to production of nondurable goods that have moved outside the United States and how much that has cost in terms of corrugated box demand. It's a substantial number. And so, yeah, I'm worried about it.

The solutions are, you know, are more complicated, perhaps, but you know, I think it's pretty clear that wage rates in the United States have moved to the point of being, you know, noncompetitive with a number of places in the world where our products can be produced. The whole medical cost thing is a real problem and on a benefits base, we've got an issue in terms of the cost of medical insurance or medical protection for our employees. As you know, I'm -- I've been on the dollar here for some time. The strength of the U.S. dollar that we've experienced during the latter part of the 1990s aggravated this in a major way and, you know, provided an opportunity for some parts of the world to make investments because of the benefit that they had from the dollar.

Exchange rates continued to be an issue, you know, I was pleased to see the Koreans come out here earlier this week and talk about their belief that the Chinese rate should be unpegged from the dollar. I think it's pretty clear if that happened we would see an appreciation and would help again take this dollar effect, you know, out of consideration. So it is an issue, it's one that I'm concerned about, it's one that I've spent a lot of time working on and talking with policymakers. And at the same time, it's also very clear, you know, that the dynamics that are going on wouldn't happen except for the ability to access this U.S. market.

You know, and that's not to say that we should get ourselves into a protectionist realm, but I think it's incumbent that we make it clear to our trading partners that -- and in particularly developing countries -- that this U.S. market is the best market in the world. A lot of these wonderful things would not be happening around the world without access to this market, and we've just got to be sure that all of this is done on the up and up, and that the playing field is level.

Maybe as a follow-on there, John given work you've done and really pushing for exchange rate improvement, are you surprised at all given the weaker exchange rate, the weaker dollar in the last six to 12 months, are you surprised we have not seen that translate to improving trade flows as you talk with your peers in the business round table and others? Are you seeing any anecdotes yet that the lag effect we normally experience is finally arriving, that we are finally starting to get some benefits there, or is it still out there in the future?

Well, I mean, we've certainly not seen much happen to the current account deficit, and I guess, on the one hand, Peter, I would say yeah I'm disappointed perhaps. On the other hand these are very long-cycle phenomena and, you know, I think we are seeing -- beginning to see some trade flow effect in terms of making U.S. exports more competitive than they were. Now, we've not seen the second order effect yet of, you know, some of the business dislocation and the jobs that have -- that are moving from United States to lower-cost regimes. China is, you know, is a very, very competitive place to produce an awful lot of these products. And so I think we have to recognize that these things are not going to change overnight.

Okay.

The other thing that is at play here, and wishing no bad luck on anybody, but, you know, I would think the effect of SARS and the effect of some of these other phenomenon will cause people to ask the question: Do I really want to have all of my production in any particular geography? And I think we'll see maybe a little more balancing of some of that just from a risk perspective.

Okay. Great.

This dollar thing -- it's positive, it's going to work, it's disappointing perhaps that it hasn't worked more aggressively, actively than it has so far, but it is decidedly positive for U.S. manufacturing.

Okay. If I could just ask a last question, specific question for Chris: The approximate $32 million sequential improvement in the packaging business, is it possible to indicate how much of that came from a consumer side versus the industrial side?

Let me see if I can get a number by the time we finish.

Let's see if we've got another question, Peter and just be sure we get the right order of magnitude for you.

Thanks very much.

Thank you. Our next question comes from the line of John Tumazos with Prudential Securities.

How are you?

Good, thank you.

Your container board business is very competitive with strategies that are different than some of the other companies. For example, you may be consume 10% OCC as opposed to much larger percentages. You only have 50 or 60% going to your own box plants. Smurfit and Packaging Corp customize a great deal, SMURFIT has 20,000 employees in box plants customizing for customers. Could you explain which segments of customer service you think the customers pay you for? And explain how IP has evolved to organizing its container board business in this manner, which looks good, because other companies are not making money in the business and you are?

Well, I think your questions, John, predominantly had to do with the box business, not with container board, per se. And I mean, what we're doing is like what we do in all of our businesses, is a very, very strong segment focus, we identify the segments that we think either are product mix, are technology, are facilities or location, will let us have the best chance of competing in, and then we work like hell with our customers, with those customers to determine what we can do to provide them value. And work on it pretty intently. So that's the way we approach all of our businesses, but certainly our box business. Our paper mill system is a very good system, you know, as you point out, we have perhaps a little bit different fiber strategy than others, but when you think about it, John, it costs you roughly as much to produce a box and to get it to a customer as it does to produce liner board. And so the internal operation and cost management areas, the opportunities are great, both in the mills as well as the box plants. And that is certainly, you know, one of our major focuses.

Are there particular customer service segments that you stay out of because they're not cost-effective?

You mean customer segments?

Customer service segments? Are there degrees of customization or national accounts or particular parts of the market that you find less remuniative or better or worse in terms of -- some of the other companies spend enormous efforts on customer service with benefits or without benefits.

Well, I mean, I guess I really don't want to talk about which segments we target and which segments we don't target, but you know, clearly we do a targeting effort. And so implicitly, you know, there are some that we don't target. And, you know, that's just the belief on our part that that's a marketing strategy that, you know, targeting a segment and figuring out what you have to do to provide value to that segment, that customer -- services to that segment that customers value is just a marketing strategy that we pursue throughout the company.

Thank you.

Okay, John.

Just coming back on that question, we don't split the numbers by segment levels but directionally to help you we had a stronger performance in the industrial side as opposed to the consumer. So that hopefully that helps you directionally and as you can see from the volumes and realizations we've given you numbers there that you can work through.

Thank you. Our next question is from Mark Weintraub with Buckingham Research. Please go ahead with your question.

Good morning. First I just wanted to follow-up, Pete had asked a question where John you'd responded the importance of geographic mix diversity from a risk perspective. How do you feel International Paper's portfolio is from a long-term basis from a geographic mix perspective?

Well, we want to compete own a global basis Mark, you know, obviously the part of the globe that we got a good solid business in Europe, both in paper and packaging, and we'll take advantage of opportunities as they present themselves there. Latin America and Brazil we're -- we're pleased with that business, we look at other parts of Latin America to determine if we think we can compete.

The open question in our mind is China. Big market, growing market. We've looked at an awful lot of different opportunities in China. We've got some relatively small packaging positions in China that we're learning from. We have a merchant business, a distribution business in China that we entered in an effort to learn more about that market. Obviously we've not done anything in the paper manufacturing arena in China because we haven't figured out how to make, if you will, the risk adjusted returns that we think we have to have there.

But, you know, that's a part of the world that one has to keep their eye on and determine if there are opportunities that we can be successful in. We don't think about this thing in a sense that you have to be here or there. We think about it in a sense that we do want to be a global competitor, we know we have competencies to do so, and we move to where there are a set of opportunities that, you know, we think we can make the returns that we need to make. And so as interesting as China is, if we can't figure out how to make returns we're not going to invest in China just for the sake of saying we're there.

Sure. Would you expect, over time, to see your mix of assets increasingly overseas on a percentage basis? Relative to where it is today?

I would say I hope so. I would think so, Mark. You know, we do not have hard objectives of we want "X" business internationally and "Y" business in the U.S. or even on a country-by-country basis. But I -- there are other parts -- there are parts of the world that are growing more rapidly than North America, and consistent with success, I would hope that we will be there. In a bigger way.

And shifting gears quickly you mentioned energy and fiber being two issues right now. I was hoping to get a little more color on energy. One thing I noticed, there was a slight benefit second quarter to first quarter. Was that because of reduced consumption as opposed to the energy prices? And just wanted to get a sense of where you are from a hedging perspective. And finally, if possible, order of magnitude, how many BTUs of natural gas are you buying a year, company-wide?

You know, quarter over quarter, natural gas prices came down a bit. So we benefited from a price change in our purchased energy. The conservation programs are, you know, are big and important. We allocated an extra amount of capital this year to energy reduction projects. They are all, you know, relatively short implementation, quick payback projects.

And so we're working hard to on the conservation side of the equation. You know, I'm pleased to see that natural gas prices are beginning to come down. The fill rate is pretty aggressive, the futures prices have come down some and as I said earlier, I really do think that we'll find some additional benefit in gas cost reductions as we move through the year. We have hedged some of our energy purchases. You know, we think about that of, you know, something perhaps in the order of 30 to 50% of our purchases we hedge, you know, as just part of a purchasing strategy.

How far out do those hedges go? And lastly, if you had a number for what your consumption of natural gas a year is roughly?

I don't know how much gas we buy, Mark. It's a lot. I just -- I don't know how many units we buy. Somebody can get that for you.

Okay.

On the hedge thing, we put rolling hedges on and, you know, we tend to be out a number of months.

Great. Thank you, John.

We have time for one more question.

Okay. Our final question of today's session is from the line of Joshua Zarod with Oppenheimer Funds.

Oppenheimer Securities. I know that some of your timber owning colleagues have been pressing the case for reinstatement of preferential timber capital gains for corporations, which would obviously be a big plus for your company; is this an issue you've been spending any time on? If so do you see any momentum building in this area?

Well, we spend a lot of time -- we spend a lot of time on all of the tax areas. We've got a couple of programs we're working on in the timber tax area that I think will be beneficial. One of the interesting things that work is there's a very -- obviously a very different tax regime in timber for some of the pension funds versus the operators, that's causing, if you will, some economic dislocation. So, yes, we have got some work underway on timber taxes. I guess I won't predict. This is a pretty dangerous area to predict in. And I guess I won't predict whether -- what I think the probability of success would be.

But do you see any growing momentum in the industry as this being a lobbying issue for the reinstatement of this preferential treatment?

Well, we are -- the industry is working in a couple, that is one. And a couple other areas relating to taxation of timber. So there -- I would say there is a lobbying effort, how strong wind is in its sails, I guess I would say it's more than a modest effort. Is it something that we all spend 100% of our time on? You know, I would say it's not. But it's important.

Thank you.

And there are no further questions at this time. You may continue with any closing remarks.

Well, just again thanks for being with us, appreciate it. The quarter was a two-headed quarter. I was disappointed from a demand perspective, and obviously disappointed from an absolute earnings perspective, on the other hand I'm pleased that in spite of all the difficulties that we have faced and that we've talked about that we were able to show a quarter-over-quarter improvement. We continue to do the things that we think are necessary to make International Paper a better company. I know we're doing the right things, I know we're making progress. I understand how frustrating it is to you that earnings are not improving at a more rapid rate. We take any help you can provide in the policy arena to get this economy moving again, but when we do, everything that has been done is going to turn into some pretty fun times around here. So thanks, thanks for your time, thanks for being part of International Paper. Appreciate you being with us this morning.