International Paper Co (IP) 2004 Q3 法說會逐字稿

Ladies and gentleman, thank you for standing by and welcome to the third quarter 2004 earnings release conference call. At this time all participants are in a listen-only mode. Later in today's presentation we will conduct a question-and-answer session. If you should require assistance at any time during today's presentation, please press star followed by zero and an operator will assist you. As a reminder, this call is being recorded today, Tuesday, October 26, 2004. I would now like to turn the conference over to Ms. Darial Sneed, Vice President of investor relations. Please go ahead.

Good morning and welcome to International Paper's third quarter 2004 earnings conference call. With me are Chairman and Chief Executive Officer, John Faraci, and Chief Financial Officer, Chris Liddell. During this morning's call, we will make forward-looking statements that are subject to risk and uncertainty. These risks and uncertainties are described on page two of the presentation and are also detailed at the end of our third-quarter 2004 earnings press release. We will also be using non-GAAP financial measures. A reconciliation of these non-GAAP financial measures to generally accepted accounting principles along with a copy of the third-quarter 2004 earnings press release, the presentation slides, and an excel worksheet that shows 2003/2004 quarterly shipment volumes excluding Weldwood can be found on our website at www.internationalpaper.com under investor information.

Now I will turn the call over to John Faraci. John?

Thanks, Darial. Good morning everybody. Today Chris Liddell and I are going to review our third-quarter results and talk about the individual business performances during the quarter, then I'll review the outlook of our major businesses. Let my start by summarizing the third quarter. Revenues grew and sales volumes remained strong, reflecting healthy customer demand for our paper packaging and wood products. In most of our businesses, volumes increased versus the same period last year. We continue to implement the IP announced price increases in our paper and packaging businesses as we move closer to trend line prices and key grades but still not there yet. Raw material costs remained high with energy, chemicals, and wood costs rising as we exited September. The hurricanes that hit Florida and the Gulf Coast region earlier in the quarter had a negative impact in the third quarter. Although direct damage to three mills -- three paper mills, two box plants, seven wood products plants, and four Arizona chemical facilities was relatively small, we lost some volume due to the temporary shut downs and logistical problems, and all in, it cost us about $18 million or 3 cents a share for the quarter. We're continuing to focus on our non-price improvement initiatives in third quarter, and obviously that is an important part of the agenda in the fourth quarter and going forward into 2005.

Let me turn it over to Chris Liddell to review our third-quarter earnings in more detail.

Thanks, John. As John just mentioned and as shown on slide six, the revenues are growing, and third-quarter 2004 sales were actually the highest we've seen since the first quarter of 2001. This is clearly a combination of not only the inclusion of Box USA, but in particular, better pricing and a much better market environment.

If you look at slide seven, you'll see also profitability has been improving and despite higher costs, as you can see, earnings per share from continuing operations and before special items were 43 cents a share in the third quarter. This is the highest quarterly earnings we have achieved since the third quarter of 2000. Please note all figures in this presentation and on this page have been restated to exclude the results of Weldwood of Canada, which is now treated as earnings from discontinued operations. As you know, we have reached an agreement to sell Weldwood, and we would expect that transaction to close in late November, so we’ve netted all of those figures out of our presentation.

Turning to slide eight, that compares the third quarter of 2004 results with the second quarter in the format that we traditionally show to you. So moving from left to right, the continued progress in implementing price increases in paper and packaging contributed 15 cents in the third quarter, but were offset by 5 cents of lower wood products prices for a net increase relative to the second quarter of 10 cents a share. Also note, this is the first quarter since the fourth quarter of 2000 that prices on average were higher than the comparable period of one year ago. Higher volume added 4 cents a share and improved cost and mix added 2 cents a share, compared to the very second quarter that we had. These positives were offset by higher raw material costs, including 2 cents of higher chemical costs and 1 cent a share of higher energy costs. Wood costs were (indiscernible) flat quarter to quarter.

As John mentioned, there was a negative impact from the hurricanes, which totaled 3 cents a share, made up primarily of lost volume. More detail on that is included in the appendix. Gains from timberland and other real estate sales in the third quarter were flat. The lower tax rate of 29% in the third quarter produced a benefit of 1 cent a share. Now for the nine months of the year, the effective tax rate is 30%, and would expect it to continue at that rate for the remainder of this year.

Finally other included an unfavorable foreign exchange impact in Europe.

The wood (Inaudible) chart on slide nine compares the same earnings per share before special items but for the nine months of 2004 compared to the same nine-month period in 2003. Again, moving left to right, earnings improved 8 cents a share from higher prices, which comprised, in this case, 30 cents from higher wood products prices offset by 22 cents from lower paper and packaging prices. Higher volumes across all product lines contributed an additional 28 cents per share, and the continued progress on our internal non-price improvement initiatives to lower costs and improve mix accounted for a positive 19 cents a share. This has more offset higher wood, energy, and chemical costs, which in the nine months have reduced earnings by 14 cents a share compared to the comparable period last year. And as previously mentioned, the hurricane impact was a negative 3 cents a share.

Gains from land sales and other real estates were 11 cents a share larger in the first nine months, and interest expense, the amount recorded in 2004 on our income statement, is about 3 cents lower than in 2003. However, taking into consideration the amounts that have been reclassified from preferred dividend exchange to interest fees (ph) in the second quarter of 2003, the total comparable decrease in interest costs due to debt refinancing and refinancements was about 13 cents a share. A higher tax rate this year of 30% in the first nine months of 2004 versus 25% last year negatively impacted earnings per share by 5 cents and reflects a higher proportion of in particular U.S. generated income. Pension expenses were 7 cents per share higher than in 2004. And finally, other included favorable corporate expenses largely drive by lower overhead and benefit-related costs.

Slide ten shows the impact of higher raw material costs, which is clearly a big issue for us this year. It compare our actual 2002 costs with our projected costs for the full year of 2004. As you can see, wood costs are expected to be $175 million higher than they were two years ago, followed an impact by natural gas, which is projected to be $140 million higher. Higher costs in other chemical costs are expected to hurt earnings by $55 million, while higher low density polyethylene costs and higher oil and coal costs, each we expect to reduce earnings by a further $30 million. So in total we are having to overcome $430 million of higher raw material costs relative to two years ago. This equates to a drag on returns of around 1 cent ROI or about 60 cents a share.

In response to the headwinds created by these increases, we have undertaken cost reduction initiatives to reduce wherever possible our purchased energy consumptions across all of our businesses. Slide 11 illustrates an example. In this case, the progress from our printing and communications papers business and bleached board business and what progress they have made in reducing the energy purchased per ton of paper and board produced. As the slide shows, these two business reduced their purchased energy consumption per ton by 8 to 10% since 2002 by improving the overall machine efficiency and energy conservation. A combination of these efforts plus a return to more normal cost levels will be one driver of ROI growth over the medium term.

Slide 12 demonstrates how our earnings have increased since the end of 2003 and its impact on ROI. Please note that the data excludes Weldwood, which, as I mentioned before, is now treated as a discontinued operation. As you can see earnings and return on investment improved to 5% in the third quarter on an annualized basis.

What I'd like to do now is discuss from slide 13 onward how our individual businesses performed in the third quarter versus the previous quarter. In printing papers, earnings increased due the higher prices for uncoated free sheet, coated paper, and pulp. We also had good operational performance across the U.S. mill system, excluding the hurricane impacts. The earnings would have been $11 million higher in this sector excluding those hurricane impacts. Uncoated paper volume dropped slightly in the third quarter due primarily to the impact of the hurricanes, but average price realizations continued to improve across all grades. Excluding the hurricane impacts, volume would have been about flat quarter to quarter. While our average price realizations including the impact of mix were up $35 a ton, realization increases varied by product. And what we have done is show you on the right of the chart how that variation has occurred. On an operation -- operating basis, coated paper earnings were slightly profitable for the first time since the third quarter of 2002. That reflected coated paper sales volume increases from the second quarter, in turn reflecting improved orders from direct mail and catalog paper as well as improved advertising. Average price realizations rose, reflecting the implementation of the announced price increases.

North American pulp demand remained strong in third quarter but softened in Asia and Europe causing some price pressures in September. European papers was down in the third quarter due to seasonality, and European (inaudible) paper prices declined as the strong Euro continued to attract imports from Brazil and Asia. And finally in this sector, IP Brazil's performance and earnings remain steady quarter to quarter.

In packaging, turning to slide 14, earnings increased by 55% in the third quarter, reflecting in particular, sharply higher earnings in industrial packaging. Industrial packaging earnings were driven by $40 per ton higher container board and corrugated box prices as we continued to implement our announced price increases. Our box shipments increased 21%, but as you know we acquired Box USA in July and our third quarter '04 figures include Box USA operations for the full three months. If we excluded Box USA, our box volume and tons shipped would have been down 2%. This was largely due to a shift in mix away from higher basis weight agricultural business and hurricane-related outages at three box plants. Volumes were flat on a square footage basis excluding Box USA.

In consumer packaging, bleach board earnings improved, driven by increased price realization and slightly higher volume. We also had stronger earnings in the converting business.

On slide 15 in forest products, sales and earnings declined as lower prices more than offset slightly higher lumber and plywood volumes and higher timber and harvest volumes. Lumber prices decreased slightly while averaged plywood prices eroded about 20% quarter to quarter. However, September plywood prices trended higher by about 7% due to increased demand in the southeast. Gains from timberland and real estate sales were flat with the second quarter. As I mentioned before these earnings exclude the contribution from (indiscernible) Weldwood of Canada subsidiary.

Turning to slide 16, we show a reconciliation to net earnings and it shows how we get from the 43 cents of earnings from continuing operations and before special items to the $1.13 net loss that we reported this morning. A net discontinued operation charge of $757 million or $1.56 per share was recorded in the third quarter to reflect the write down of the assets of Weldwood net of its operating earnings for that quarter.

Slide 17 breaks out the special items and the impact of discontinued operations in more detail. Under special items, offsetting gains and losses resulted in the loss of $1 million, and these items included insurance recoveries from our hardboard siding and roofing claims, which totaled $103 million; a loss of $38 million from the sale of some European assets; and a loss of $49 million due primarily to restructuring and other items including our S&A cost reduction program. Under discontinued operations, the impending sale of Weldwood represents the loss previously mentioned. (Inaudible) a combination of loss on sale in Texas has been associated with the sale offset slightly by third-quarter earnings.

What I will do now is pass it back to John to wrap up our comments for this morning.

Thanks, Chris. Let me sum up so we can get to your questions. The third-quarter results reflect continued improvement in our earnings and in our sales revenues. Looking forward, in aggregate demand appears solid for paper packaging and forest products. We have good backlogs and pretty solid fourth-quarter volume, again when you look at it in aggregate. Previously announced IP price increases in paper and packaging are being implemented. However higher prices in paper and packaging are going to be partially offset by lower prices in wood products as we move into the fourth quarter, and we are going to continue to face high energy, wood, and chemical costs in the fourth quarter and probably into the first quarter of next year, although I would expect wood costs to start coming down as we get out of the winter months in the South. Mill and converting operations continue to improve. Fourth-quarter corporate expenses should be approximately $130 million, and as Chris mentioned earlier, we are projecting a 30% tax rate before special charges for 2004.

Going forward we are going to continue to maintain our focus on internal improvements, even though the external environment, we believe, is going to continue to be pretty solid going out of this year and into next year.

So, with that that why don't we pass it back to the operator and take some questions.

Andrew, we are now ready to take questions.

All right. Very good. Thank you. Ladies and gentlemen, at this time we will begin our question-and-answer session. (OPERATOR INSTRUCTIONS) Our first question comes from the line of Chip Dillon of Barney. Please go ahead with your question.

Good morning.

How are you?

Doing pretty well. I had two questions. One was you mentioned the tax rate being 30% for the year. I would guess that would mean probably for the fourth quarter it also be about that level; is that right?

Yes. Yes. That's correct, Chip.

Okay. And then the second thing is, can you talk a little bit about the bleach board business? It seems like in recent years when you step back that we've seen quite a business of restructuring in the industry and a lot of consolidation and perhaps a bit more stability in pricing power. Could you talk about how that business is today, and with the dollar now starting to fall again, does that bode well for that business as we go into 2005?

Well, we feel pretty good about the bleach board business. Chip, you are right. That business has had more stable earnings than, say, industrial packaging and printing papers. One of the -- while the board side of the business is relatively strong on a global basis, I have to say that it's been -- you are in a bunch of segments here. You are in beverage, you are in food service, you are in folding cartons. It has been tougher to get pricing improvement or price recovery down to the converting businesses than some of the other converting businesses.

How much of your board are you converting versus what you sell in the open market?

It is a pretty small percentage.

So you are mostly converting then?

Well, beverage would be fairly -- I guess I'm thinking about folding carton. Beverage, we convert a lot. Food service, we convert a lot from a converting standpoint, and folding carton not a lot.

Okay. Lastly on the pulp, I notice that you had a $10 increase versus the second quarter, and I know you sell a lot of specialty pulps, which would probably insulate you from what's going on in the paper grade market, but we have seen prices drop there. It looks like that's stopped. If prices stayed where they were now or only recovered a little, would you expect that to be down $10, $20 in the fourth quarter versus the third? Could you give us a feel for that?

Chip, if you go to page 21 in the handout -- or slide 21, page 28, it shows pulp prices in September.

Yes, $4 down.

Yes. If you just want to get an indication of where pulp prices were as we came out of the quarter. They are down a bit, but for us it varies. North America, Europe, and Asia, and actually we see some signs of firming in Asia.

And while we are on this page, it would look like your coated probably has -- would look a bit higher if you were to show us October prices; is that fair? Maybe $20 to $30 higher?

I haven't looked at October, to be honest with you, yet.

But they are trending up, Chip. You are correct in that.

Okay thank you very much.

All right. Thank you, sir. Our next question comes from the line of Edings Thibault of Morgan Stanley. Please go ahead with your question.

Just a few quick questions. I wanted to touch base on land sales and kind of pick up any change that might have occurred there on a quarter-to-quarter basis?

I mentioned that in my prepared comments they are flat quarter to to quarter.

Flat quarter to quarter. Okay. Can you talk about the outlook for capital spending and on the energy side? The two are probably related to some degree. Can you talk about your outlook for capital spending in 2005 and also what you might expect in terms of the impact of higher energy costs, both in the fourth quarter? You mentioned seasonally usage goes up, costs are also higher. Have you guys been able to mitigate your exposure to potential spikes? How are you going into the winter season in terms of your protection?

I'll start with capital expenditure. We spent around $800 million year to date, but the fourth quarter is typically a high capital spending quarter. So we would expect to come in at the number we have been indicating so far, around the $1.3 billion range for the full year. That's, broadly speaking, the number that we're looking for for next year as well. We're putting our final capital budgets together at the moment, but I would use that as the starting focus for next year.

In terms of how we have dedicated capital, you are correct in that what we've taken is a pool of money and dedicated it towards capital -- to energy-saving projects. So we have been spending 50 to $70 million a year for the last couple of years on higher return energy efficiency based projects. And that is part of the reason why, in the slides I have showed, we've been able to reduce energy consumption in some of our businesses by 8 to 10% over the last couple of years. And we would expect, certainly with the prices that we've to got to continue to spend capital in that area and there is still, from our perspective, a good pipeline of very good, high return projects in that area as well.

Edings, maybe you heard us talk at this before, a whole bunch of projects that didn't get funded when gas was $3.00 because they had low returns and long payback now look very attractive with gas at $6.00 plus, even if gas only stays there for a little while because the pay backs are so short. So we are going to continue to fund those. If the futures market’s rate in gas is $8.00 in the fourth quarter. We are going to have energy difficulties in the fourth quarter because, obviously, we won't be able to offset that kind of increase with consumption.

And at this stage -- I think part of your question was, do we have any hedging in place. At this stage we don't have any hedging for the fourth quarter.

Okay. But you are not going to be -- I mean, given John's comments on how the funding hurdles for energy projects and the fact they are clearly lower because of the higher prices, you wouldn't expect that 50 to 70 million of spending over the last couple of years to double or go up substantially? It doesn't sound like that is currently in the cards.

As I say, we are literally working through our capital budgets for next year over the next month, so we may, if the pricing outlook continues to be as high as it is, we might increase it slightly, but I wouldn't think of doubling it, no.

What we're doing, Edings, is we've got projects competing for capital. So we're not going to increase our capital spending. It just may mean more energy reduction projects get into the capital spending because they got the best returns.

Got it. Great. Thanks very much.

All right. Very good. Thank you. Our next question will come from Mark Connelly with Credit Suisse. Please go with your first question.

Thanks. I just have two things. I was wondering if --

Mark, can you speak up a bit.

Sure can you hear me now? I was wondering if can you help us with a little bit of a sense of cash flow. I know you don't have the full statement here, but are there any cash flow details you could give us to give us a sense of what cash flow looked like?

I'm not sure what level of detail you're looking for, Mark. If I look at the debt levels -- that is probably the easiest way to look at it -- broadly speaking in the quarter our debt levels remained the same, but that was a combination of operating cash flow and then the purchase of Box USA, which helped to increase our (inaudible) a capital repayment. So we have got an inflow from that which repaid some debt and then some natural cash flow coming in. So a combination of all of those things lifted our net debt position broadly flat by the end of the quarter. Now, clearly, in the fourth quarter that position is going to change quite considerably with the proceeds from the Weldwood transaction coming in and being used to repay our debt, plus also the cash inflows that we'll get from the business. So it will be a different picture in the fourth quarter, but broadly flat in the third quarter.

Okay.

The way I think about it is pretty simple-minded; I recognize that. But, you know, on an annualized basis, our EBITDA was about $400 million better in the third quarter than it was in the second quarter, and in the second quarter it was another $300 million better than it was annualized for all of 2003.

Okay. Okay. That is helpful. Just two more quick questions. Xpedx surprised us on the upside. I am curious if it surprised you and whether we should expect it to continue.

We've been waiting for that surprise for a couple of quarters.

I was going to say -- I was thinking, you know, four or five years. Is this the kind of level you think this business can perform at? Is this peak performance? Obviously there is seasonality, too.

Well, it can do better than that. It doesn't have the kind of the cycle impact that we have got in some of these other businesses. I mean, xpedx, it's hard work, but it has been pretty simple what we are trying to do. We had a business that needed $7 billion of revenues to make the kind of returns that xpedx made in the third quarter. It is about a 7% ROI in the third quarter and better than that in August and September. And we've been at work trying to get the business' cost structure to where it can make decent returns in $6 billion in sales, and now we're growing the sales. And that's – remember, we have got a business that is principally paper, but it has got a $700 million packaging business and a couple hundred million dollars of facility supplies. So it is not just a paper house. When you get the combination of growing revenues and cost structure under control, we can make some decent returns there.

So this number is not a fluke?

No. Ask me that question again next quarter.

The last question is whether you can just give us any sense of what is flowing in minority interest that may change in the fourth quarter?

The main minority interest at this stage is the CHH the 49% that we don't own of (inaudible), and so it would be principally their earnings. I wouldn't think there is anything significant or unusual going to flow through on the fourth quarter –- (multiple speakers) --.

Okay. Thank you.

Does that answer your question sir?

Yes.

Outstanding. Our next question comes from the line of Mark Weintraub with Buckingham Research. Please go with your question.

Good morning. First, could you give us a little more color on what is happening in Europe? I know it is typically seasonally slow in the third quarter. Were profits down for you in this third quarter in Europe? And how much -- what is the outlook for the fourth quarter? Do you see the potential for some pick-up there?

I think our profits -- our earnings were down in the quarter. We obviously had a little bit lower sales volume, and we had continued leakage on pricing. We've been -- while there's no formula here, we've been looking at relative pricing of the (inaudible) grades in North America and Europe, and they are kind of moving into what I would call balance, if you try to equate these, which isn't perfect. We are still making very solid returns in the east, and, you know, the margin pressure is most apparent in the west because that's where the volume is weak and there's been most of the price slippage. So it is still a tale of two stories -- strong business in the east and a tougher business in the west.

Do you have any pricing of that that can come through in the fourth quarter that's been announced?

We're not betting on pricing to solve this problem in the fourth quarter. We didn't have a great operating month in Europe. We operated much better in North America than we did outside North America in our paper business, but the way we are going to improve European earnings near term is better operations. And we will get some better volume. The first quarter is one of the strongest quarters, typically, in Europe. And the third quarter is one of the weakest because you have got the summer holidays right in the middle there.

Chris, coming back on the cash flow, do you happen to have a preliminary cash from operations number?

In term of cash flow from operations, the way that we define it, I'm not sure if it is the same as in your model, we look at $80 million for the quarter.

Mark, I also want to add something. On Europe, the other thing we had -- someone reminded me of this -- we took some outages -- some plant outages in Europe in the third quarter. So we had a bunch of machines down that we didn't have down in prior quarters. They were scheduled outages.

Okay. So if you were to normalize Europe for seasonality, some of these outages, et cetera, any sense as to what type of magnitude that might be?

Sorry magnitude of --

Of earnings.

Well, they are going to be better in the fourth quarter, but we are not going to make a forecast for the pieces of the paper business for the fourth quarter. They will be better.

Okay. Thank you.

Very good. Our next question comes from the line of Rich Schneider with UBS. Please go with your question.

I was wondering if you could possibly try and quantify as you are looking out to the fourth quarter the impact of higher wood and energy costs relative to where you've been in the third quarter?

Let's go back to the bar chart that Chris showed. I think that pretty well dimensionalizes where we are. And energy is tougher to figure out, Rich, because it is really going to sling on what happens to gas prices, and your guess is probably better than ours. What was happening on wood is wood prices were coming down as we expected they would pretty nicely in the South now, which is where most of our wood consumption is both for hardwood and pine from March, really, through August. Then we got into the perfect storm, so to speak, or four of them in a row, and we had pretty good inventory positions, but we lost our ability to continue to reduce wood costs. So wood cost in September was up a bit from where it was in the second quarter, July and August are kind of flat. I would expect wood costs to be up slightly in the fourth quarter from where they were in the third quarter. They will start coming back down again, but it is going to be weather-dependant kind of through the winter time. We have got some pretty good inventories, so I'm not worried about wood over the longer term. We've got to get -- we've lost some momentum that we had because we just were out of woods for a while, and everything was under water. Energy is -- frankly, we've been wrong on energy. I didn't think energy prices would be as sticky as they’ve turned out to be, but I also didn't think oil would be $55 a barrel either.

Where are you on hedge position as you go through the winter on things like natural gas?

At this stage we are unhedged.

We just didn't think it made any sense to lock in $8.00 gas or to pay the kind of premium you have to pay for an option -- to take an option out on $8.00 gas.

To give you a sense of order of magnitude on the gas side, we use -- depending on the quarter and the season, we use around 15 billion units of gas, so for every dollar that it is higher than quarter on quarter, that is about a $15 million impact to us in the quarter.

Okay. And I was wondering, Chris, if you can go through and give us a little more detail on what's in that 40 million -- $49 million restructuring other expense charge. Were there lay offs? And I know this is part of your effort to reduce things like SG&A. Could you go through that in a little more detail?

Sure. It is primarily the people -- costs associated with the people that we are taking out of the organization, so that's correct. And part of the lower overhead cost that we're showing through the year is obviously the benefit of taking those people out. So, that's one. There was also a goodwill write off of flow through from Carter Holt Harvery accounts. They bought a --an (indiscernible) plant in China called PTP, and the way we that we account for CHH, if there's any goodwill associated with any acquisition that we do -- that they do, then we write that off in the quarter that it happens. So that flowed through, too. I think offsetting it -- sorry there were some early debt extinguishing costs, so we continue to refinance some high cost debt. That was around $8 million. There was also a positive impact from some reserves that were no longer needed. So there were four items flowing through in that net total.

What was the reduction in head count in terms of numbers?

Number of people?

Right.

Let me get that -- 351 people in the quarter.

Our S&A cost, Rich, is going to be lower this year than it was last year. That is even after funding close to $100 million of increased supply chain project spending.

Just one comment on trends in the printing and writing and maybe pulp business. In September the industry numbers came out, and they were lackluster. Was -- give us your interpretation of those printing and writing numbers. Was that some prebuying? And what is your view on the outlook for pulp from here?

Let me talk about printing and writing first, Rich. You are right; the numbers were lackluster. When we look at our segments, and I've been out talking to a lot of customers. We're hearing different things. And we're in so many -- remember, we are in all the channels. We are in the direct segments, we are in the merchant segment, we are in the retail segment, we're in the commercial printing segment in a big way with printing bristols and a lot of roll offs, and I'd have to say it is not the same thing in every segment. Right now, I'm surprised I'm saying this, is commercial printing is probably better than retail. And four months ago, it was exactly the opposite. Commercial printing seemed like it was slow as could be, that is why Xpedx sales were so weak. So, our backlogs are still pretty solid. We have lost about a day. We picked up maybe a day of inventory, and we feel pretty good -- we feel better about our uncoated free sheet business when we talk to our customers and we look at our backlogs and our inventories than the statistics would say. But I have got to agree with you, they are pretty lackluster.

On pulp, the pulp markets are moving in different ways both in Europe, North America, and in Asia. I think the most significant thing on pulp is that -- what we're hearing out of Asia both our own pulp people and our colleagues in New Zealand is that pulp markets are tightening a bit and there is more buying activity in the marketplace, and that is a good sign. But as you know, the pulp prices are never -- don't stay flat for very long. They are either moving up or moving down.

Thank you.

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

Good morning.

Mark, how are you?

Good. John, I wondered if you can you give us a little color on the increase in the corporate expense that you are projecting for the fourth quarter? Then I wanted to just ask a follow on question.

Why don’t I ask Chris to answer that. I told you overhead was going to be down year-on-year.

I would characterize the third quarter as being positively low as opposed to the fourth quarter being high. We've been talking about corporate costs running at around that 120-130 million level for the second half of the year. So the third quarter was a little lower. That reflected some savings we were able to achieve and also lower spending on our supply chain project, edge. So the fourth quarter is probably a return to the figures that we would have expected in the third quarter, and they primarily come from, in particular, increase or some end of year spending in that project.

The way we think about this market, is we have got a little over $3 billion of S&A, and that is our selling and admin costs plus all our manufacturing admin at facilities. And we've shared that with you before. That cost goes up just by doing nothing by 60, $70 million a year just with salary increases. So for us to come in year-over-year lower is -- you are making a lot of progress on managing that very, very aggressively, which is all about productivity improvement and head count management.

Okay. Now I wanted to follow up on some things that you said last month in terms of where you are going to grow the company. You talked about the growth in offshore markets and wanting to move that to 50% of the company. You also showed some capital spending numbers by region, and the capital spending numbers by region make it appear that you are spending, on a relative basis, much more heavily in Latin America and eastern Europe, and I wondered if you could give us a little color on that. And then I also noticed on the EBITDA margins down in Latin America, they are still lower than some of the other publicly traded Brazilian companies. And I wondered if you could just make a comment or two on that.

I said all of that in the second quarter?

I think that was in September.

Okay. Sure. Well talking about capital for a minute. We are sold out of eastern Europe for all intensive purposes. As we look at in the market place, it is one of the few places in world where we think it makes sense to add capacity. And we have projects going on both in Poland and in Russia to add coated board capacity and uncoated free sheet capacity at those two locations because, basically we have sucked all of the product we were shipping from east to west back into the east, and we're still short. I was over in Russia earlier this year, and every customer I ran into said, We need more product. Now you have got to remember it is still a small market. So for our businesses there, we are pretty optimistic about spending money to increase capacity, and that is not the case in -- obviously not the case in North American.

In Brazil it is a little different. What we are doing is we are still -- we are planting some trees, obviously. We are doing a little more of that now than we were before because we have a better notion of what we want to do both at Tres Lagoas and Amapa on the forest forestry side. And we are building -- we just finished the completion of a saw mill at Brazil. So, in that business we're spending a little differently than we are in eastern Europe, but in both businesses, you are right, we are spending more than depreciation, and we will continue to do that going forward. We have got some projects -- we have got a project at Mogi Guacu that is going to give us a little bit more capacity there, which we need. We are going to take Mogi Guacu ECF, which we need to do. So you will see us directing capital to the parts of International Paper where we think the cost structures and the marketplace need the capacity and away from places where we don't need the capacity and we don't see the growth prospects.

On EBITDA margins, I saw that, and I think every business, whether it is the -- the publicly traded companies, whether it is Veracruz or others are in somewhat different businesses, I would say we have a higher mix probably of forestry assets to some of the others since we are probably the only people down there that are net tree sellers. I haven't gone into it in a lot of detail. We are pretty satisfied with our margins. We look at it on an apples-to-apples basis. Of uncoated free sheet around the world, we think we have got a great set of margins down there. Also, we are in the coated papers business where we are the only ones in the ground wood business in that part of the world. It is hard to get as clean comparisons as you get in North America because you are looking at Brazilian companies which are making a whole bunch of grades, and they are not necessarily the grades we are making. You have to admit they are pretty good margins though just on an absolute basis.

We would take those kind of margins across the company any day, John.

We would agree with you.

All right. Thanks.

Very good. Thank you. Our next question will come from the line of Rick Skidmore with Goldman Sachs. Please go with your question.

Good morning. John, just a follow up on a prior answer to a question with regards to Weldwood. Can you talk about the use of proceeds? I think you mentioned that you would use that to pay down debt. Could you quantify the amounts and can you talk about a little bit of why the timing may be a little bit later than what was originally expected from the closing of the transaction?

I'll answer that, Rick. The amount is just over $900 million we're anticipating. Obviously foreign exchange plays a little bit on the exact amount. And we would look to use that to repay debt. So we have a number of opportunities to call some debt and to repay and refinance some other debts. So that is the primary purpose when it arrives. In terms of it being later, I don't think there is anything in particular there other than just a relatively slow regulatory process that we are working through.

Okay. So, just to clarify that, essentially the entire proceeds would go into debt reduction.

Certainly in terms of when they arrive, that is going to be their direct usage, yes.

John, if I might ask a follow up question. About a year ago you talked about a mid-cycle earnings number of $4.00 and non-price improvement of 1.5 billion, and you had some offsetting costs in there, but it seems that costs have gone up, as you articulated, maybe $430 million more than your anticipated. Would that be a correct statement, and therefore would your mid-cycle number be a little bit lower or are there some opportunities where you can offset those rising costs that you mentioned?

Well, you are right, Rick. When we put together the plan saying $4.00, we assumed energy costs and wood costs would be at 2002 levels, and as Chris pointed out, they are not. Now, what we have got to do is we have got to find out ways to offset that. That is the realty of being in this business business, and we are in the midst of doing that with some of our energy projects. I don't think we are going to offset $8 gas. We're still -- you have got -- oh, it is not $.5 billion but it's more than $250 million between where we are now in pricing and trend line pricing. Remember we talked about that that being reflective of a mid-cycle pricing and demand scenario. We have got 2005, and we're putting it into our budgets now. We've got a pretty big chunk of non-price improvement built into next year's plan, but, I mean, the reality is if we can't figure out a way to get that $470 million back, we have got a gap.

Okay. Great. Thank you.

Very good. Thank you. Our next question comes from the line of Karen Gilsenan of Merrill Lynch. Please go with your question.

Thanks and good morning. Kind of as a follow up to that, your cost mix item was about a 2 cent benefit between second quarter and third quarter, which is the slimmest benefit we've seen so far this year. I'm wondering if you could comment on some the progress you are making in some of these manufacturing and cost reduction efforts?

Well, let me take a crack of that Karen, and Chris can add in. You are right, the second quarter was one of the strongest operating performance quarters that we had. So I would steer you to look at the 19 cents year to date. And we have talked about getting 5 cents plus a quarter, kind of quarter in quarter out. And frankly, we just had a -- we had a superb second quarter and the third quarter was okay in term of North America, kind of netting out the hurricane, which we isolated, but it wasn't a great operating quarter in Europe and across our non-paper businesses. And it wasn't a disaster, but it wasn't the kind of quarter that we expect. So, there's no big problem in there, it is just some quarters are better than others, but the second quarter was a great one. And the 19 cents year to date is reflective of what we say we have to got to be able to do year in year out, which is turn in that kind of non-price improvement.

Did you look for further improvement in fourth quarter versus third quarter, though, John?

Yes.

Okay. And then if I can be so bold, in your press release you talk about some guidance for fourth quarter in terms of trends, demand in pricing solid offset by some other items, and the word you used was specifically offset. Are you suggesting that fourth-quarter earnings will be fairly similar to third quarter?

I not sure -- I'm not sure we want to give that specific a guidance. It is a difficult question to answer any more specifically than that. We tried to help in terms of the cost side of things and the pricings is reasonably well out there, too. So, I guess that is probably the most guidance we'd like to give.

Karen, our guess would be as good as yours, because if you think about what is going on with energy and wood prices, those are the two big variables. And frankly, to sit here and talk about a forecast just doesn't make any sense because our basis for saying that is no better than yours. We think we have a pretty good handle. Demand is okay and solid in our paper and packaging businesses. After Thanksgiving every year it is predictable, things get slower, but our backlogs are good. Our inventories are in good shape. We see continued price flow through. We have not gotten all the price realization we would expect to get from price increases that we announced, so, that is in front of us. But it depends on what happens. If wood prices go up in wood products, that will be a plus, but I wouldn't say that is the bet we're making right now, but we'll see.

Okay. Thanks.

Thank you. Our next question comes from the line of Peter Ruschmeier of Lehman Brothers. Please go with your question.

Thanks and good morning. I had a question for Chris, if you could possibly comment on your discount rate assumptions going forward or possibly your expected return assumptions as it relates to your pension.

We do that at the end of the year, so we haven't made an estimate or a change. Clearly from the discount rate point of view, we are guided by (indiscernible) corporate bond index. So we are going do that calculation. To the extent there are two months still in the year, that may move around a bit. But, I haven't looked, to be honest with you, if we did it as of today what the change would be. I think it would be a slight decrease. We were 6.25 at the end of last year. If we did it today -- I am going only guessing here -- I would think it would be in the low 6s. But we'll do that as of the end of the year, and obviously off of the figures that are out there at that stage.

Okay. And maybe just a strategy question coming back to John on growth opportunities, especially as it relates to South America. It seems like you have three basic possible strategies. One would be to block and tackle and spend CapEx slightly above D&A. One would be to spend more aggressively -- to grow more aggressively through either pulp line or the paper line, et cetera, or to grow through acquisition. I just want to better understand your thought process as you think about those various scenarios in South America.

Well, we are -- obviously as we think about our strategy for South America we are looking at all of those options. Each of them have some advantages and disadvantages. Some things we can do on our own and some things that we can't. We're excited about the prospects for Latin America, specifically Brazil. We recognize the cost of capital there is higher than doing business in North America, although we have been there for a long period of time and are very successful. I think we are in somewhat of a unique position because we have we have got two good business positions, one in uncoated free sheet and one in coated papers, and we have got a great resource position both at those two facilities and then the plantations at Amapa and at Tres Lagoas. So, we've got lots of possibilities. I mean we are in no rush to make a choice. We have got some options, and I think we'll see how that plays out and what the business looks like down there and what some of the export opportunities are and keep our eye on the world, too.

Okay. Maybe if I could, just the flip side of that question. You have certainly repositioned the portfolio over the last 12 to 18 months and you've obviously pruned some non-strategic businesses. Do you see a need or an opportunity to prune additional assets going forward, or do you think that you have your asset base where you want it to be?

Well, we said we are going to continue to make choices, and I think that is, without getting specific, you should expect us to continue to make some choices as to where we think International Paper can compete and compete successfully. I think the objective is to improve the returns in this company. It is not a bigger or better strategy, it is improving performance, both absolute and relative. If we think we need to make choices to do that, we will continue to make them.

Very good. Thanks very much.

Very good. Thank you. And ladies and gentlemen, at this time we have time for one final question, and that should come from the line of Steven Chercover of D.A. Davidson. Please go with your question.

Good morning. Thanks. I also wanted to drill into that mid-cycle target of $4.00 per share. Just if I understand it, since you kind of made those statements, your costs have gone up about 430 million on the inputs. And was it your belief that in term of pricing on the commodities, you are $250 million away from mid-cycle; is that accurate?

I said we are probably more than 250 and less than 500 million away from mid-cycle when you look at all. Pulp and wood are probably a little bit above mid-cycle, and all of the other businesses are either close to it or a bigger gap away. Depending upon where you pick trend line price, and we look at the range of your forecasts and our own, it is probably 3 to $500 million away.

Perfect. Yes, that is what I understood. And the final piece of the puzzle, perhaps, for next year, then, how much do you believe you can get costs down through your various initiatives?

We haven't set our budgets for next year yet, but we are going to continue to look to improve our ROI. What we do is, the way we set objectives in terms of annual performance in the company is every business is expected to turn in ROI improvement that doesn't have price in it. So, if you get any pricing, that is great, but it doesn't count in terms of ROI improvement. Right now we are at 4 to 5%, and we have to get to 9, so some of that is going to come with price. But, a big chunk of it has got to come with non-price improvement. We also have to figure out how we are going to offset -- if we can't get offsets in the marketplace with pricing, how are we going to offset this $400 million of raw material costs? Wood will come back; I am not worried about wood. It may take a little longer than we thought, and I guess I would have to admit I am more uncertain about energy now than I was in 2002, but we are in the real world, so here we are.

Aren't we all more uncertain on energy? Maybe since I've got the floor, can you tell us with respect to your timberlands, are you pretty comfortable with your asset base right now? Or how is that blue sky initiative coming along? Are you still selling?

It is going well. Our tree business is doing okay. Prices are still below trend line for wood, which, frankly, also surprises me given how strong the product markets are on lumber and plywood. Stumpage prices are coming up a little bit, but not as much as I would have expected. But having said that, remember International Paper is a net fiber buyer, so we are better off as a company with lower fiber prices.

Would you say prices are above trend line in terms of per acre values, making it a sellers market?

I really haven't thought about trend line prices on a per acre basis. We look at -- stumpage you can get long term trends for, for stumpage going back to the early 1900's, and we are just about below every trend line that you could construct.

One thing we have been successful in doing through that blue sky entity is selling at relatively high levels per acre by selling smaller parcels in a more retail-orientated structure. So, I don't know whether you can call that above trend line or not, but it certainly would be above what we would otherwise expect on a wholesale basis.

Great. Thanks so much.

Let me sum up here before -- I know you have all got to run. I think it was -- our quarter was an okay one. We finally got some top line improvement of revenues. Our earnings are the best they have been since one of the quarters in 2000. The improvement is coming. It is coming gradually, but as I look out over the next several quarters, unless you get really worried about the economy, and I guess there is the scenario that you could, as I talk to customers, I think business conditions next year will be solid, and if they are, we are expecting our business to improve, and even if they aren't, we are expecting our business to improve. So, more to come on that, and we'll see you at the end of the fourth quarter.

Okay, gentry (ph), that concludes our conference. Thank you, very much.

Thank you. And ladies and gentlemen, this does conclude the third-quarter 2004 earnings conference call. Thank you for your participation and have a wonderful day.