International Paper Co (IP) 2005 Q3 法說會逐字稿

Good morning. My name is Aleen, and I will be your conference facilitator today. At this time I would like to welcome everyone to the International Paper third quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period.

If you would like to ask a question during this time, simply press star then the number 1 on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you.

I would now like to turn the conference over to Ms. Darial Sneed, Vice President of Investor Relations. Ms. Sneed, you may begin.

Thanks, Aleen. Good morning and thank you for joining International Paper's third quarter 2005 earnings conference call. This call is being Webcast. During this call we will make forward-looking statements that are subject to risk and uncertainties. These risks and uncertainties are listed on slide 2 of the presentation and also shown at the end of our earnings press release. On our website at www.InternationalPaper.com under the tab marked investors, you will find copies of the third quarter 2005 earnings press release, conference call slide presentations, a reconciliation of nonGAAP financial measures to generally accepted accounting principles and an excel spreadsheet of quarterly sales and earnings for the last two years, excluding Carter Holt Harvey, which was sold in September.

I want to call your attention to several items. This quarter Carter Holt Harvey is reported as a discontinued operation and is no longer consolidated. This affects the balance sheet and the income statement. For example, looking at the earnings by segment, Carter Holt is no longer shown as a segment and minority interest and interest expense are different numbers from what was reported last quarter and last year because they exclude Carter Holt Harvey amounts.

To help you understand trends, the press release contains a balance sheet for this quarter, last quarter, and last December without Carter Holt Harvey. Slide 24 in the slide presentation appendix shows earnings by segment before special items and without Carter Holt Harvey. Also in the appendix, slides 35 to 38 shows details on IP's energy usage and IP's annual volume purchases of key raw material.

Our two key speakers this morning are Chairman and Chief Executive Officer, John Faraci, and Chief Financial Officer and Executive Vice President, Marianne Parrs. Here's John Faraci.

Thanks, Darial, and good morning everyone. Today Marianne and I will review the third quarter earnings results with you, and the performance of our individual businesses as we usually do. We'll also talk about the impact of the hurricanes on International Paper, discuss our fourth quarter outlook, and I'll give you an update on the transformation plan that we announced in July, and then we'll answer your questions.

Before I get into the earnings results, I'd just like to say a few words about our CFO search. We've concluded that and our decision to again fill that key role in our Senior Management Team with Marianne Parrs. And, over the last four or five months we've conducted an intensive external search using a top-notch executive search firm, and I met with a number of very talented candidates from various industries outside the [inaudible] industry. We also conducted a parallel internal search.

At the end of the process it was clear to me and clear to our board that Marianne Parrs was the most qualified candidate. Having served as our CFO previously, and most recently as interim CFO, Marianne is the right person to lead IP's finance functions going forward. She's the center of our strategic planning and decision making over the past two years, which makes he the ideal person to take the CFO role now as we go to the execution phase of our transformation strategy.

Let me begin by summarizing the third quarter. On our earnings call in July, we told you that the third quarter operating earnings should be in line with the second quarter with some upsides from higher land sales. In that sense we were partially correct. In the volume by segment were mixed in the quarter as expected and overall higher than the second quarter. While we targeted overall pricing to be flat quarter to quarter, pricing pressures in containerboard and corrugated boxes, uncoated papers and pulp were greater than expected, and more than offset higher prices in [coated] papers and plywood. Mill operations around the world continue to improve. The third quarter was one of the best operating quarters we ever had. And, as we've indicated, higher land and real estate sales, combined with the lower tax rate, had a favorable impact on our third quarter results.

However, what we didn't anticipate three months ago was the extreme margin pressure we experienced in September from rising energy costs as a result of Hurricane Katrina and Rita. I guess we're fortunate that Wilma decided to go for Florida rather than the gulf again. Despite the margin squeeze we experienced in the third quarter, as a result of price pressures and high input costs, I, frankly, am very pleased with the progress we've made on the cost side of this company as our manufacturing systems I indicated is performing extremely well.

Just to put that in context, high input costs remained at the already high 2004 actual levels, IP earnings would be 50% higher than what we're reporting today. Having said that, I believe we're much better positioned to generate higher earnings and higher returns once input costs return to more normalized levels -- more normalized levels, which I believe they will at some point.

Now, as you can see from Slide 6, which is the four-year, five-year trend of earnings per share, our earnings per share, before special items were $0.33 in the third quarter of this year. And as Darial mentioned, all periods have been restated to exclude the result of Carter Holt Harvey which is now treated as a discontinued operation. As previously announced, International Paper completed -- successfully completed the sale of Carter Holt Harvey in September of 2005.

Now, I'll turn it over to Marianne to review our results in more detail. I'll come back and talk about the fourth quarter and answer your questions later. Marianne?

Thanks very much John, and good morning everyone. Just to comment about John's comments about me in the CFO position, I just want to say I'm very excited to be in the role. I'm looking forward to working with John, the Senior Management Team, the entire finance organization, and especially in helping to execute our transformation strategy. I also look forward to meeting with you, our share owners, to discuss our progress.

If we turn now to Slide 7, that compares third quarter results with those of the second quarter. Moving left to right, lower price realizations for containerboard, corrugated boxes, uncoated paper, pulp, and wood products more than offset higher coated papers prices and reduced earnings by $0.07 per share. Volumes were mixed. Box higher overall due to improved demand from our customers for uncoated and coated paper, pulp and containerboard.

We continued our nonprice improvement initiatives and delivered $0.04 per share of lower costs primarily from our U.S. mill operation. This was mostly offset by a $0.01 per share of higher costs elsewhere in the system and a negative $0.02 of a less favorable sales mix. Higher energy costs lowered earnings by $0.06 per share, partly offset by lower wood costs. Average natural gas costs in our U.S. mills were $8.50 per million BTUs in the third quarter of 2005.

Now, just to give you a sense, that compared to $6.75 in the second quarter. As a result of our efforts to mitigate the impact of the rising costs through conservation and substitution, natural gas consumed per ton of paper produced in 2005 actually fell 55% and total energy consumed per ton fell about 13% since 2000. Just a reminder, as Darial said, we do have slides in the appendix that break out our annual usage of pre raw materials.

Forestland sales were $0.09 per share hirer in the third quarter and sales of higher and better use land by our land utilization real estate group were $0.04 higher. These higher earnings numbers reflect a lot of large transactions completed during the quarter. Just for example, in the higher and better use category, we sold slightly over 7,000 acres in South Carolina to a real estate developer at a price of over $7,000 per acre. We also sold a large tract of 33,000 acres of nonHBU acreage. The unusually low tax rate of 23% we experienced in the third quarter versus the 35% tax rate in the second quarter increased earnings by $0.06 per share. The lower tax rate reflects a change in our full-year tax rate to 27%, and we do expect our fourth quarter rates to be at that 27% level. Other was a negative $0.06 per share and included various one-off items.

If you turn to Slide 8, you'll see diluted earnings per share for continuing operations and before special items for the first nine months of 2005 compared with the same period in 2004. Again, moving left to right, improved pricing for our paper packaging grades more than offset lower wood products pricing and it improved earnings $0.71 per share. Lower volumes reduced earnings by $0.30 in 2005, due primarily to lack of order downtime taken in our U.S. uncoated paper and containerboard mills. We also had some downtime in eastern Europe, as our (indiscernible) and system were down for machine rebuild.

Cost and mix improvement added $0.27 per share in 2005 driven by improved operations in our paper and packaging businesses. Rising raw materials negatively impacted earnings by 387 million. Now that's $0.58 per share for the first nine months, and that was due to higher wood, energy, caustic soda, and other input costs. Earnings for forestland sales in the first nine months were about equal to a year ago up $0.02, earnings -- at $0.13 per share higher respectively than the same period last year in real estate.

Corporate expenses were $0.17 per share higher primarily due to higher pension expenses and increased supply chain project initiative spending. Interest expense was $0.06 per share favorable due to ongoing debt repayment. As of September 30, 2005, IP's gross debt was 11.6 billion, down 1.8 billion from the 13.4 billion at the end of June and down 6.3 billion from 17.9 billion at the end of June 2000. As a result, we've successfully achieved the gross debt level target of 12 billion that we set last year and had targeted to achieve by year-end 2006. Despite achieving this target one year earlier than planned, debt repayment will remain a key priority to continue to improve coverage ratios.

Our tax rate was favorable by $0.05 a share due to a 27% tax rate versus 31% in 2004. We expect full-year 2005 earnings to include a higher proportion of earnings from lower tax rate jurisdiction. Other was $0.05 per share lower and was mainly foreign exchange. Now, while we're not at all satisfied with our year-to-date performance, we are successfully improving those factors within our control. We successfully delivered $0.27 of cost mix improvement to the bottom line. As a company, our operations are running better than ever, and we continue to improve. Had input costs simply remained at last year's elevated levels we would have earned $1.55 through the nine months, an earnings increase of 87% over 2004. We'll continue to focus on the things we can control, plus we'll continue to pursue initiatives to mitigate the unprecedented jumps in raw materials costs. If you look at slides 35, 36, 37 in the appendix, you'll see some of the results of our energy conservation efforts.

Turning to slide 9, as part of our effort to improve disclosure, we'll continue to provide information to the investing public that may be useful for modeling purposes as soon as possible. Just for example, we typically see your pension expense projections for the following year during our fourth quarter earnings call. However, given what we know today about the impact of change into a new mortality table for projecting benefit obligations, we can share with you our estimate that this change will increase our annual pension expense from the current level of about 240 million in 2005 by an additional 85 million in 2006. Of course, any additional changes in planned earnings, and importantly what the discount rate is at December 31st, could also impact pension expense up or down for 2006, and we'll share that information during the fourth quarter earnings call.

Slide 10 shows IP's lack of order downtime. We took 270,000 tons of lack of order downtime, which is similar to the amount taken last quarter. We did, however, take less maintenance-related downtime, 130,000 tons in the third quarter compared to 220,000 tons in the second quarter. As we announced earlier this year, we indefinitely shut down three uncoated paper machines at our mills in Florida, Maine and Louisiana. These three paper machines have a combined annual capacity of 430,000 tons and they accounted for over 100,000 tons of the third quarter downtime.

Turning to how our business has performed in the third quarter, Slide 11 shows that earnings in printing papers declined to 132 million from 149 million last quarter. Now, included in third quarter earnings is a $6 million special charge, and that's related to severance and other charges associated with the indefinite machine shutdowns I just mentioned. The second quarter 2005 results include 17 million for severance charges. Now, excluding these special items, earnings declined to 141 million from 166 million in the second quarter of 2005, and again, on Slide 24 you will see all the adjustments corrected. Earnings did decline due to lower earnings in the U.S. uncoated paper, market pulp and European papers, which were partially offset by improved coated paper and IP's original results. U.S. uncoated papers earnings fell due to lower price realizations. The cost of 185,000 tons of lack of order downtime and higher input costs.

Now, I should note importantly that prices did begin to stabilize in August. Despite taking 60,000 tons for lack of order downtime in the third quarter than second quarter, US uncoated paper shipments were actually higher sequentially, and that was due to less maintenance downtime and drawing down inventories in advance of the VIP uncoated free sheet product launch in August. And I'm pleased to note that customer reaction to the VIP announcement has been overwhelming positive. We have a strong order book in the fourth quarter associated with this product launch across all of our U.S. uncoated free sheet facilities. Pulp earnings were also lower in the third quarter as lower price realization and higher mill energy costs offset stronger volumes.

European paper earnings were down versus the second quarter due in part to the downtime to western Europe, market related, and the annual outage of our Kwidzyn mill in Poland, as well as somewhat higher input costs. These earnings declines were somewhat offset by our coated papers business which reported its best quarter since the third quarter of 2001. Higher coated paper earnings were driven by seemingly higher volumes from a strong catalog season, higher price realizations and improved manufacturing operations. Our Brazilian operations also reported improved earnings due to higher volumes and price realizations.

Turning to Slide 12, industrial packaging earnings declined to $33 million in the third quarter and included in third quarter earnings is a $4 million special charge to adjust reserves previously provided. Excluding special items, earnings declined to 37 million in the third quarter, and that reflected lower corrugated box volumes, higher input costs, and lower price realizations for both containerboard and corrugated boxes. Despite firm containerboard demand and 6% higher volume, price realization fell $45 a ton due to downward revisions of published industry prices for containerboard in June and July. Our U.S. container business lost a little share as volumes fell 3% versus the second quarter, and this was a result of our attempt to get prices higher on our business earlier in the year compared to the second quarter box realizations fell $25 a ton.

Consumer packaging earnings showed on Slide 13 decreased to 37 million in the third quarter from 41 million in the second quarter, a slightly lower bleachboard results more than offset overall improvement in our converting businesses. In bleachboard weak folding carton demand and annual maintenance outages at two mills negatively impacted third quarter earnings. The converting business has improved. Sherwood had very good earnings in the third quarter due to the seasonal upturn in home entertainment and beverage packaging earnings also were higher.

As far as products earnings, shown on slide 14, increased from 191 million in the second quarter to 272 million. Results included a $2 million special third quarter charge related to the relocation of foreign products headquarters from Savannah to Memphis, and a 14 million second quarter charge for the same reason. Excluding these charges, earnings improved from 205 million to 274 million. Our forest resource business earnings improved due to 58 million of higher earnings from timberland sales and 26 million of higher earnings from the sales of higher and better use land, offset partly by slightly lower harvest volumes. Wood products earnings were flat quarter to quarter, as 2% higher lumber and 21% higher plywood volumes were offset by a $15 decrease in lumber realizations and a $5 decrease in plywood realizations partly reflecting a weaker mix.

If you turn to Slide 15, you will see third quarter special items details. Under special items we had credits totaling 603 million or $1.19 per share. Special items in the third quarter included a 5 million pretax charge, that's 3 million after taxes, for adjustments of losses on businesses previously sold. We had a pretax charge of 67 million, 46 million after taxes, for organizational restructuring charges, loss on debt extinguishments and some adjustments of previous reserves. Regarding debt extinguishment, slide 28 in the appendix, shows the significant progress we've made in reducing our total debt level by $6 billion in 2002. We also had a pretax credit of 188 million, that's the 109 million after taxes, for insurance recoveries related to the hard board siding and roofing products litigation. We had a 517 million income tax benefit principally as a result of an agreement reached with the U.S. Internal Revenue Service concerning the 1997 through 2000 U.S. federal income tax audit. Note, by the way, that interest expense net includes a $43 million pretax credit that's 26 million after taxes also relating to this agreement. So taken altogether, the net effect of these special item was a credit of $1.19.

Slide 16 outlines the impact of discontinued operations in the third quarter. There were a number of CHH adjustments, as you understand, during the third quarter the Company completed the sale of its majority share in Carter Holt Harvey to Rank Group with cash proceeds totaling 1.1 billion U.S. The estimated pretax gain on the sale is approximately 29 million with a tax benefit of 332 million, or 361 million after tax. The tax benefit was generated because the tax basis was larger than the book basis in the U.S. In sum, the total impact for the quarter was $278 million.

Slide 17 shows you how you get from the $0.33 of diluted earnings from continuing operations and before special items to the $2.07 net earnings per share that we reported this morning. Although we've already referenced some of the impacts of hurricanes Katrina and Rita on IP's businesses I will briefly summarize on slides 18 and 19.

The hurricanes are expected to negatively impact or results in the fourth quarter due primarily to higher input costs. Now, thankfully, none of our employees were physically injured by either storm. Our facilities sustained no meaningful damage, although we did have temporary outages at some places. And unlike hurricane Ivan one year ago, hurricanes Katrina and Rita caused no material damage to our forestlands, however, fuel shortages will impact both wood procurement and transportation in the region at some level, putting significant pressure on scarce resources.

As you all know, slow recovery from the hurricane is causing skyrocketing prices for natural gas and fuel, and that has weakened our margin. Natural gas is the biggest problem, and to put it in perspective, each $1 per mill BTU increase in natural gas adds 40 to 45 million of higher costs on an annualized basis, about $0.06 a share. We're also experiencing shortages of a number of chemicals used in our manufacturing operations, and that includes on the optical brighteners, sulphuric acid, caustic soda and wax for corrugated boxes.

Truck and rail availability remain an issue, but our supply chain organization is doing a great job securing transportation. Lower diesel fuel supply and higher fuel prices are an issue we're dealing with as it impacts both inbound and outbound freight. For example, our delivered wood costs are up $0.30 to $0.50 per ton due to fuel adjustment surcharges, and we buy over 5 million tons per month of wood. In sum, the hurricanes are likely to squeeze our margins in the near turn. So, John will now review the fourth quarter outlook and update you on our transformation plan.

Thanks, Marianne. You covered a lot of ground there.

Looking at the fourth quarter, we expect earnings and continuing operations and before special items to be lower than third quarter due to a number of factors which Marianne has alluded to. Much higher raw materials costs, especially energy, in 10 to 15 -- $0.15 to $0.20 higher than the third quarter. We'll probably have a lower level of land and real estate sales and overall volumes should be flat. Maybe stronger earlier, but weaker as we enter the seasonally slow period during the holidays.

Average price realization should be flat to down because it began the fourth quarter with lower prices for many grades other than the prices which we began the third quarter, although there are a number of pricing initiatives which we feel are pretty good out there now. International Paper's announcement will continue to implement price increases in bleachboard, containerboard, corrugated boxes, coated paper and market pulp. We would expect to see more benefit from these increases in the first quarter of 2006. We may get some in the latter half of the fourth quarter. We also anticipate continued progress in improving our manufacturing operations globally, which do have a big impact on the Company, unfortunately not big enough to offset the input costs.

Let me turn now and move away from the fourth and just give you a brief update on the transformation plan, and then we'll go to your questions. We'll well on track. Sales books for our two largest businesses to be the best at U.S. Forestland and coated papers will go out this week. And the beverage packaging sales book is scheduled to go out next week. As we previously announced that we completed the sale of our stake in Carter Holt Harvey to the Rank Group on September 21st. We got the over $1.1 billion, and as Marianne mentioned, our after tax gain on that was over 360 million.

To maintain or investment grade rating and to achieve debt reduction targets we previously outlined, the majority of the CHH proceeds, as well as the cash proceeds from some other smaller asset sales were used to pay down debt.

Now, turning to the overall program on the strategic options side, assuming $8 to $10 billion investment proceeds, we remain committed to returning 30% of the after sale proceeds to share owners over the course of the divestment program. We're also looking closely at our reinvestment plans, we'll review as we always have, to taking a caution approach toward selective reinvestment. We believe that global growth in the packaging and paper market around the world is a key component of our strategy to increase share owner value, but in light of the recent demand and raw material cost trends, we're going to take a very measured and cautious approach to that.

For example, we're going to defer making a decision on whether to build -- buildout this project we've been talk about in Brazil, which is currently scoped as pulp and/or paper from later this year until the second half of next year. We're going to look at different project options, get more clarity on proceeds, and also put that in the context of other selective reinvestment options that we have in other parts of International Paper's businesses. In the meantime, we're also going to continue to work increasingly on the profitability of our key platform businesses right here in North America, uncoated paper and packaging. We'll continue to maintain our focus on improving our North American operations, because this is where our majority of our capital is employed, and where we have the greatest opportunity for profit improvement, although we've got some good profit improvement opportunities both in Europe and Brazil.

For example, we recently closed our high-cost 100,000 ton per year medium mill at Fort Madison, Iowa, in the second quarter as part of our announced facility rationalization plan that we spoke to you about in July.

So, just in closing up, we made a lot of progress in the cost side of this company and our manufacturing system was very important to International Paper is performing better than it ever has. However, as Marianne mentioned, input costs [inaudible] was $400 million higher for the first nine months of this year than the first nine months of last year. Another way to look at that, to re-emphasize; is that our earnings per share to the third quarter would have been 60% higher at 2004 input costs than what we experienced in 2005, and they were already high. We're positioning the Company to perform well from an earnings and cash flow generation perspective, once input costs return to more normalized levels, and we're excited about the prospects of the Company going forward.

So, with that let me just stop and turn it back to Darial and open the line for questions.

Thanks, John. Aleene, we're now ready to take questions.

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We will pause for just a moment to compile the Q&A roster. Your first question comes from George Staphos with Banc of America.

Thanks. Hi, everyone.

Hi George. How are you?

Not too bad. Not too bad. I got through earnings. Marianne, maybe a question for you, and I realize there's a lot of moving part here. Could you give us --

George can you speak up a little bit?

Darial I will try. Is that better?

That's better.

Good morning, again. Marianne, could you give us a feel for how some of the operating line items and cash from operations, and for that matter, capital spending, maybe you provided but I missed it, did in the quarter? Again, I realize there are a lot of moving parts here, but can you tell us how the Company did on cash?

Okay. Just a second there, George, and I'll give you the capital spending numbers. We are targeting capital spending, as you know for the year at between $1.2 and $1.3 billion.

Right.

You've got the earnings numbers, of course, on an EBIT basis. Depreciation and amortization is running just under $1.4 billion for the year. So, if you take that for the quarter, you take approximately a quarter of that. From a cash flow perspective, you have to bring in the proceeds from Carter Holt Harvey, which is not operating. I know you weren't asking about that.

Right. I guess maybe you said differently, what capital, I realize again we're still early days in the supply chain, but how did you do in working capital in the quarter?

Working capital was not significantly different in the quarter.

Okay.

Our inventories were -- I would say finished goods inventories were down just a little bit across each of our product lines.

Okay. That's helpful. Now, next question I had regarding Europe, there's been some mixed tone maybe ultimately some improving tone in terms of the outlook for European paper demand. Seasonally it tends to pick up later on in the year. What are your thoughts here as we go into the fourth quarter and look out to 2006?

I'd certainly like to see that, George, but we're not taking it to the bank yet.

Okay. Have you seen any kind of pickup in the run rate, or you know what your're -- you're hearing what we're hearing, but you haven't seen it in your numbers yet?

Our shipments are solid but flat. They're not -- we're still shipping at pretty good rates, but there's no significant upper momentum, particularly in the West. I mean, the East has still got good demand growth to it.

Okay. Fair enough. I guess the last question I had on consumer packaging, if I recall, the operating profit level last year's third quarter was more in the range of $50 million. I think this quarter you posted something in the range of $30 million. Could you remind us what the largest piece of the variance was there, if we got the numbers right? It was mostly input costs or was there something else going on [inaudible]?

A lot was higher input costs. That would be the lion's share of the change.

Okay. Was there any other operating issues? You said the converting operations did well, but were there any other things going on in bleachboard aside from that?

Nothing of note.

George, all of our mill operations around the world, including consumer packaging are running extremely well, best they ever had.

That's what I was kind of getting at. Okay, guys. Thanks very much. I'll return.

Your next question is from Chip Dillon with Citigroup.

Quick couple of three questions here. First of all, how much was the debt that you were able to remove off your balance sheet from the sale of Carter Holt above and beyond the cash proceeds?

It was about $500 million.

Okay. And then, John, you gave a good rundown of sort of the challenges in the fourth quarter, and maybe I missed it. Do you have sort of a number you would use for energy cost differentials in the fourth versus the third? I know you told us raw material would be up 15 to 20 million.

Most of that will be energy. But, some of it will be -- some of it will be wood but most of that will be energy, Chip.

So the 15 to 20 includes energy?

Yes.

I see. Okay. And then, lastly --

I hope so. [Laughter]

I know. I hope so too. And then, on the real estate side, you mentioned, I think Marianne you mentioned the HBU sale in south Carolina. What was the other timberland sale? How many acres was that?

I happened to mention one that wasn't higher better usage, was approximately 33,000 acres. We have -- We had a few more larger transactions in the third quarter than we did earlier in the year. And I think the key thing there is that we're seeing very good value for the land we're selling. The average price we got for our not higher-better use land in the third quarter was actually up about 50 bucks an acre from the second quarter.

And then, when you look at the fourth quarter, will that level of real estate and land sell activity probably go back to similar numbers of what we saw in, say, the first and second quarter?

It's very difficulty to predict that number, because we work on some of these transactions particularly in higher better use over a period of time. I would say, as John said, off a little bit from where we were in the third quarter, maybe someplace between the first and second quarters and the third quarter level. But that one we'll see as the quarter unfolds.

Okay. And then, last question, John. As you contemplate Brazil, we see after a little bit of hesitation the [Dizano] project going forward, certainly a lot of money that they're spending. My question to you is, do you have any feel for what's going on in Uruguay, especially with the [Metsabatnia] project and some of the politics down there? If you think that might be delayed? And, secondly, when you look at your project, if you were to make a decision in the second half of '06 to go forward, when would you say is a good guess as to when your plant would start up?

Well, you probably know more about Metsabatnia than I do, Chip, so I don't have anything to add on that. But the two to three years is kind a good time frame for beginning to startup.

And this would be not at an existing location; this would be at a Greenfield site, I believe

Yes.

Okay. Gotcha. Okay. Thanks.

Chip, this is Darial. You asked a question about Carter Holt and the debt, there is no debt on our September balance sheet, but, as of -- when we last reported June 30th back in July, Carter Holt had 458 million of long-term debt and 183 million of short-term debt for a total balance of about $640 million.

Gotcha. But, you're saying on the restated statement that you have now, none of that's there?

So the balance sheets you now have in the press release excludes Carter Holt.

For all period.

For all period.

Thank you.

Your next question is from Rich Schneider with UBS.

Hi John. I was just a little surprised that the number for the fourth quarter in terms of higher energy and chemical and other costs. I mean, if you look at it on a pretax basis, it looks like incrementally about close to $120 million incremental. And, I know natural gas is up, like $4 or so per MMBTU. Could you sort of give us more of an idea on this? Chemical costs, when you look at your third quarter, it didn't seem like that moved much going from the second to third, at least you didn't break it out. Obviously, this increase in the fourth seems to be very high.

The gas prices that we're looking at, right now we're looking at the strip, we'll probably be paying about $13.50, just to give you -- and we paid on average $8.50 in the third quarter just to calibrate that for you. The other thing that we're seeing, is we are seeing some chemical cost increases in the fourth quarter. Polyethylene, for example, has bounced a lot. Caustic soda looks like it might be up a little bit, and it had moderated a little bit in the third quarter. It looks like caustic soda prices will be up again too. So, it's not only energy, it's also our chemical costs are moving in.

Are some of the carryover effects from the hurricane, other than input costs, having any impact in that number of $0.15 to $0.20 per share?

Yes. There's no question that the transportation system is getting stretched, Rich, down in that area. We've got -- diesel prices are high, but there's lot of competition for transportation because of all the cleanup activities. So, I mean, there's a pretty wide range there, 15 to 20, but there's not a lot of clarity right now as to how things are going to look in December. We've got a pretty good snapshot of how they're looking in October.

And can you tell us where you are right now in your hedging program, particularly on natural gas?

We're not hedged.

Chip, the other thing that's in that too that we think of being energy-related is that the transportation surcharges that we're paying will also be higher in the fourth quarter, and that's diesel fuel price driven

You mention you've relooked at your mortality tables and your pension expense to be up $85 million next year. Could you talk through some of the issues with that, what happened there, and also what you may be doing to try and control pension expense?

Let me just take the mortality table for a minute there. We've been using what was called the 1983 Group Annuity Mortality Table, commonly used by many large companies. I think you'll find that in this year, last year going into next year, most companies will moving to a more current mortality table, and it just simply reflects the longer life expectancies that now people are experiencing. So that's the reason for the adjustment in the mortality table. Frankly, one of the biggest drivers of what happens to your pension expense is the change in the discount rate. That's very difficult to predict. Now, of course, what we're talking about here is all a noncash cost, as you know. We aren't expecting it will make any cash contributions to the pension fund until about in the 2007 time period.

Okay.

In terms of controlling pension costs expenses, we did change our pension plan for all new employees hired after July 1 of last year, and we've gone to a defined contribution type of plan, away from a defined benefits plan.

Okay. Any updates on your overall efforts to take annually under the transformation program $400 million of costs out per year, or is a lot of that attached with the overall program in the asset sales.

I think we're -- with the fact that we are, as I said, Rich, we're running our mill system better than we ever had. Despite the fact we're taking a lot of downtime in the U.S., a big chunk of that quarter million, in fact half of it comes from manufacturing operations, and we're right where we want to be, in fact probably a little bit ahead. We're going to beat the goal that we had set for this year, which was a couple hundred million dollars of year-over-year cost improvement, and all that's good news in terms of good traction and good momentum on going into 2006.

Just last quick question. I know you're having success with volume on the VIP program. If you look at the realizations that you give in the back, it actually shows that unquoted prices were up something like $14 a ton, but then, in your presentation you had it down 20. Is that due to mix, and could you explain what happened here?

Yes. The differences are mixed.

Okay. Is that mix related to this VIP program?

Very little. We began shipping under the VIP program at the very end of August, so there's not a whole lot of VIP in the third quarter. There will be a lot of VIP products shipped in the fourth quarter. In fact, we're essentially on the VIP product.

Okay. Thanks.

Your next questions comes from Edings Thibault with Morgan Stanley.

Good morning John. Just a question about the restructuring program. You mentioned books out on the Forestland side, in addition to the coated paper business. Could you give us a sense of -- I think you've staged, you indicated in your prepared remarks that the Forestland sales will be staged out over a prolonged period. Can you give us a sense, are you sort of traunching these Forestland sales, and how much of the -- how many total acres are in the first round of books or is the whole business?

Sign a confidentiality agreement and we'll send you a CD. When we talked about the plan on Forestland, we talked about that being over an extended period of time. In order to see how that plays out we've gotten a huge amount of interest from people interested in parts of the Forestland to people interested in all of it. This will come down to we'll see how things turn out in terms of interests and values, but it possibly could sell in large chunks, if those values are competitive, and it's possible we could go the way we'd indicated that we thought it might turn out, which is smaller pieces over an extended period of time. The interest level has been so high for, like I say, large and small, that it's too soon to call that, but we'll have a better feel in a couple months.

Without pressing on it, I'm more curious about, do you have books out on all acres?

Yes. Yes.

Okay. Great. Thanks very much.

Your next question comes from Mark Weintraub with Buckingham Research.

How are you doing, John. Two questions. One, on the overall corporate spend, I understand Marianne you addressed what's going to be happening with pension. Where's your thought process on the supply chain initiatives in terms of how that spend is going to affect, both, I guess, the fourth quarter and, perhaps, more importantly next year?

It might be modestly higher in the fourth quarter as we continue to start up functionality. We do expect that the project spends, in terms of an EBIT impact, will be somewhat higher next year. But, by the same token, we have a very aggressive program underway across the Company to look at our S&A spend in other categories. And our goal is to balance out -- it's really a question of putting your resources where you think you're going to get the most value. So, we're working on curtailing spending in other areas, so that will be a major offset.

Mark, despite the fact that we're spending more on our supply chain project, our overall S&A costs in the Company are going to come out about level with last year. That's after increasing spending on edge, after higher salaries, the whole 9 yards because just what Marianne said, we'll spend more in one area and we'll spend less in another area. That's businesses, and that's across all the support groups.

And you're referring to '05 versus '04 there?

Yes.

And when you think about '06, is it a reasonable expectation to think you can continue to create these offsets so that we can keep spending, again excluding pension, pretty flat for the corporate? Is that the way we should look at it?

Well, go back to that $400 million a year of earnings improvement we said was associated with the current businesses going forward. A slice of that is continuing to look at ways that we can get more effective around our total S&A spending. That's 20% of the total. That's $80 million a year.

Okay. Great. Also, Marianne, on the share count, I noticed that it was 506 or 509 or something this quarter. I wasn't quite sure why that changed from a prior quarter. Can you just help me with that?

I think what you're talking about is the difference between diluted and basic shares. So, if you look at our second quarter earnings on a GAAP-reported basis, there was no diluted effect. A diluted EPS was identical to base to EPS with 487 million shares. We had sizable gains in the third quarter on a GAAP basis, and that accounted for the difference.

Okay. Understood. Basically, when you're making a lot of money, the diluted kicks in and when you're not it --

You got it.

Yes, that's correct.

Okay. And then, lastly, just one point of clarification. You were talking about the containerboard price, and you indicated that the price had come down to reflect what had happened in pulp and paper week. I guess I'm just trying to understand, what drives what? I understand that a lot of box prices tend to be tied to the pulp and paper week containerboard price index. Are actually your third-party containerboard prices also largely tied to that?

Mark, when you get that figured out, write a piece on it. Would you? I'd like to read it.

Okay. Well, can you help me a little bit to start that piece?

I don't think so. [LAUGHTER]

All right.

Your next question comes from Peter Ruschmeier with Lehman Brothers.

Thanks, good morning. I wanted to ask a question, if I could on the balance sheet. I didn't quite get these numbers right. It looks like the Carter Holt benefit was 1.001 billion, and the removal of debt from the balance sheet may have been as large as 600 million. From the balance sheet you had it looks like a 200 million benefit from working capital changes, so we're up to 1.9 billion. The delta between 2Q and 3Q was 1.066 billion, which would imply a cash burn of 240 million. I just wanted to clarify if I'm doing my math right on that?

I think we have to work back through the working capital impacts of Carter Holt Harvey. That gets very confusing, because we had to take Carter Holt Harvey out of all balance sheet accounts. Not just the debt account.

Why don't we get back to you on that, Pete.

Okay, okay. Maybe secondly, if I could, on the capital spending, I'm curious of how much of your capital spending budget is actually geared towards energy projects which I would think would be high return projects, and then more broadly, it does appear that your CapEx to D&A ratio is above average. I'm curing if you can give us a sense as to what you think is kind of bare bones level of capital spending?

When you say "above average," Pete what are you referring to?

Well, just in terms of industry averages, I think, or maybe closer to two-thirds the level of D&A and you're up closer to 90% plus.

Well, I think what you need to look is not year-to-year capital spending, but look at it over the cycle. We had a couple years where we spent 1 billion, $1.1 billion in capital, and we've been saying all along that over a cycle, not year-to-year, over a cycle we're going to average in the 75 to 80% of depreciation. And, so, that's the way to look at that. And, on energy projects, we've been upping that. It's probably somewhere between $50 to $75 million of projects we've got in the pipeline. You're absolutely right. At $14 gas, everything looks terrific, but we're not going to make decisions on energy projects on $14 gas unless they're six-month pay back projects.

The pay back is exceptionally high.

Just to get a view on what we've been doing, Pete, if you look at Slide 36, it shows you that natural gas has gone from 31% of our total energy usage down to 18%. That's just a percentage because of -- we are burning a lot more wood waste. That's the principal one. Also more fuel out oil, but it's principally wood waste.

Okay. And then, just lastly, on this CapEx the 75 to 80% figure, is that --

The other thing that's in there Pete for this year are a couple hundred million dollars of CapEx projects in Eastern Europe which are very good projects. They're actually volume projects. The earnings in those are starting to come in now after we've started them up. We said we were investing $250 to $300 million between Poland and Russia. We're about halfway through that.

Maybe that's the answer. That your maintenance CapEx probably is closer to two-thirds, but you've got some growth capital included in that 75 to 80%? Is that a fair way of thinking about it?

Sure. There are a bunch of projects in Brazil that are compliance projects, there's the [Eastover] project which is $125 million and then, like you said, there's $300 million of stuff in Eastern Europe. What you're looking at is well beyond a maintenance budget.

Okay. Very good. Thanks very much.

Pete, this is Darial. Our CapEx target was actually 75 to 85% an event over a cycle. You said 80%.

Okay. I stand corrected. [LAUGHTER]

Your next question comes from Mark Wilde with Deutsche Bank.

Good morning.

Hi, Mark, how are you?

Good. I wondered if we can look a little more closely at the printing paper business. If you could give us just in rough terms a sense for how much of that $141 million of adjusted EBIT in the quarter was domestic versus Brazil and Eastern Europe?

We don't break that out, Mark.

Can you give us even just a ballpark, John?

If we give you a ballpark, we're breaking it out.

All right. Another question about that business, then. Is just uncoated free sheet pricing, I know that there's a lot of thing that's going to go into a decision there, but it's striking that it's one of the few areas that you're not trying to move prices right now, and prices seem to be pretty ugly in some portions of that business. So, can you just talk to us a little bit why you'd move pulp and move containerboard and try to move bleachboard and wouldn't do it one of your two biggest businesses, particularly after taking so much supply out?

We didn't say we wouldn't. We haven't at this point in time. We didn't sway wouldn't. You're right, all those businesses get assessed separately. We're looking at the uncoated free sheet situation in North America, and timing and amount is an important part of the decision-making process. So we're looking at it, and at this point we haven't made a call either way, but timing and amount is a critical piece of looking at that

Okay. John, finally, if I could on that same business, I think we've all been surprised at quite how weak the industry numbers were, have been for uncoated free sheet this year. Do you guys have a view that you'd be willing to share with us about where you think trend demand in that business is going domestically now? It really has been quite amazing that we're looking at kind of 4%-type volume declines this year. I think that's much bigger than almost any of us would have ever assumed.

I think so. It's probably more than a 90-second answer, Mark, to do it justice. I don't have a 90-second version, but you're right. We're surprised by the -- that it's a lot weaker than any of us anticipated, but I'll tell you, we're going to size our capacity going forward to what we think the market demand is, and we've shown, I think by our prior actions, we're ready, willing, and able to do that. We're going to do it. We've currently got three machines that are indefinitely idled and they amount to about 3% of capacity. They're still in the capacity numbers, but there are no plans to start those up. In the operating rate effectively, if you think about it, the operating rate one could appreciate is probably in the low to mid-90s now with the capacity we're not operating with no plans to operate it, and what others in the industry have already announced, and it's that kind of operating rate with demand down at 4%, it's not going to take much to get the operating rates back up to very healthy levels.

Can you say whether, John, just whether you think that the trend in that business is now flat, down, or up domestically?

I think you need to look at it by channel and by product, Mark, because it is very -- direct mail is different than the forms market. The cut-size market is different in the merchant channel than it is in the superstore channel than it is in Wal-Mart and the brands are different. Hewlett-Packard has a different trend to it than some of the private label business. So it's a much longer explanation than 30 seconds.

Okay. Very good. Maybe we can talk about that in December.

Yes. Yes.

Aleen, we've got time for one more question.

Your final question comes from Heather McPherson. T. Rowe Price.

Hi, Heather. How are you?

Good. How are you guys? I was wondering, in terms of the proceeds from Carter Holt Harvey, I thin you say in one of the slides, that it's -- at least in you press release recently, you said that the proceeds were primarily going to debt reduction. Have you guys completely decided where all those proceeds are going? And can you give us some insight into as you sell these assets, what point do the shareholders start to see some of this 30% get returned to them in terms of share buyback? Is it going to be sort of pro rata as we go along?

Heather, when you said -- I think there were two questions there. You said have we already made the decisions on the Carter Holt Harvey proceeds?

Yes.

Yes, we have. The answer to the second part of the question is we are still planning to do what we said we would do. We [inaudible] to $10 billion in proceeds, but you were not going to necessarily do it on a prorated basis. So, you shouldn't assume that every dollar coming in will be 50, 30, 20. When we have the proceeds in a more meaningful way, we'll be talking about the options of what to do with that. As we've indicated share buybacks are certainly on the radar screen, in the amounts we talked about assuming the proceeds are in the range we talked about. So, there's no sense talking about what we're going to do before we're ready to do it, and that's why we're getting closer, as we've got the books out at some of these businesses where we expect there's quite a bit of value.

And if all the proceeds for Carter Holt Harvey went for debt, what -- did you guys actually take out the debt already? Did you call some debt? What should we model as the interest expense or I guess the interest rate savings?

Let me ask Marianne to answer that, Heather.

We've taken out about 500 million so far with the Carter Holt Harvey proceeds, Heather, and we're continuing to work that in the marketplace. The short-term kickup in interest rates is helpful, because it of course reduces the costs.

Okay

Did that help you?

Yep.

Okay. Thanks, everybody.

We have now reached the end of the allotted time for questions and answer. Ms. Sneed, are there any closing remarks?

No. For those of you who still have questions, Brian and I will certainly be available. Thank you very much.