International Paper Co (IP) 2006 Q2 法說會逐字稿

At this time I would like to welcome everyone to the International Paper second quarter 2006 earnings conference call. (OPERATOR INSTRUCTIONS). I would now like to turn the conference over to Brian McDonald, Vice President of Investor Relations. Please go ahead, sir.

Good morning. Thanks for joining International Paper's second quarter 2006 earnings conference call. This call is being webcast. Our two key speakers this morning are Chairman and Chief Executive Officer, John Faraci, and Chief Financial Officer, Marianne Parrs.

During this call we will make forward-looking statements that are subject to risks and uncertainties. These risks and uncertainties are outlined on page 2 of the second quarter 2006 earnings slide presentation and at the end of our earnings press release.

Please go to our website at www.internationalpaper.com under the tab marked Investors to find copies of the second quarter 2006 earnings press release, presentation slides, and a reconciliation of non-GAAP financial measures to generally accepted accounting principles. I will now turn it over to John.

Good morning everybody. Today Marianne and I will go over -- first we will go over the second quarter earnings results and the performance of our individual businesses. Then we will talk a bit about the third quarter outlook. I will update you on where we are in our transformation plan and then we will take your questions.

We have a solid second quarter, principally driven by our key platform businesses -- that is Packaging and Paper in North America, with strong topline growth. Our product pricing improved versus the first quarter across all pulp, uncoated paper and packaging grades, as a number of IP announced price increases were partially or fully implemented.

Second quarter volumes were comparable to the first quarter levels. We still got low inventories and that constrained volume in containerboard and market pulp. Our global manufacturing operations again performed well in the second quarter.

On the raw material cost side, overall costs were lower, driven by declining natural gas and wood prices. Fuel oil prices are essentially flat in the second quarter, but freight costs were higher, and those continued to move up on us. And we reported lower land sales and a higher tax rate in the second quarter, again, versus the first quarter.

Our coated papers business, which was identified as discontinued operations the first quarter is included in continuing operations, and Marianne will explain that more later in this call. However, we did close the coated papers sale this morning.

On slide 6 now you can see our earnings per share from continuing operations and before special charges. We reported earnings of $0.41 a share in the second quarter versus $0.20 a share in the first quarter of 2006. This is our best second quarter since 2000, so best second quarter in over five years, and it is the best quarter we have had in several years.

We're still not satisfied with the absolute level of earnings, however, but we are encouraged by the continuing supply demand balance in our Uncoated Paper's business and Industrial Packaging businesses in North America. And we expect additional improvement in those key platform businesses both in North America and globally.

Now I will turn it over to Marianne to comment in a little bit more detail about the second quarter.

Good morning. If you turn to slide 7, it compares second quarter results to those of the first quarter. Moving left to right, higher price realizations for our paper and packaging grades improved earnings by $0.10 per share. As John mentioned, volumes were stronger across many key grades. But the total quarter to quarter earnings impact was neutral, as higher shipments of pulp, coated board and corrugated boxes were offset by lower shipments of uncoated paper in Containerboard.

We continue to make progress in reducing manufacturing costs and in improving our sales mix during the first quarter, and this increased earnings by $0.09 per share. Lower natural gas, wood and chemical costs improved earnings by $0.05 per share in the second quarter.

Lower forestland sales in the second quarter reduced earnings $0.02 per share versus the first quarter. Now I should note that these results do not include the land sales that we announced as part of the transformation plan.

Corporate items were unchanged in the second quarter. The tax rate in the second quarter was 34% versus the 30% tax rate in the first quarter, which lowered earnings by $0.01 per share. The higher tax rate reflects the higher percentage of total Company earnings in our US operations. Other items noted to 0, but included a $0.04 per share benefit from the elimination of coated papers depreciation expense, since that business is now treated as held for sale. This was offset by a number of smaller items.

Slide 8 compares diluted earnings per share from continuing operations and before special items for the first six months of 2006 versus the same period in 2005. Again, moving left to right, paper and packaging prices were higher on average in 2006 versus 2005, adding $0.08 per share. Higher volumes increased earnings by $0.16 in 2006, due primarily to increased uncoated paper, corrugated boxes and coated paperboard shipments, and improved volume from xpedx.

Our mills ran well in 2006 with manufacturing costs [index] $0.05 per share favorable versus 2005. Together, the combined $0.21 per share for volume costs and mix shows us making solid progress against our targeted 400 million per year for three-year profit improvement goal.

Higher raw material and freight costs were a significant factor in 2006, reducing earnings by $220 million or $0.30 per share. I will give you more details in a moment.

Higher forestland sales more than offset lower real estate sales and increased earnings by $0.07 per share versus 2005. Higher corporate expense unfavorably impacted earnings by $0.08 per share. Now this was primarily due to higher pension and benefit expense and some supply chain costs. Interest expense was favorable $0.05 per share as a result of our ongoing debt repayment effort.

The tax rate was $0.06 per share unfavorable due to the higher tax rate of 33% for six months 2006 versus 26% for six months 2005. And by the way, you should use the 34% tax rate for the last two quarters of this year.

Other was $0.04 per share unfavorable, with outside containerboard purchases, foreign exchange and other individually small one-off items more than offsetting the $0.04 per share favorable effect of the coated papers' depreciation expense elimination I mentioned a minute ago.

Slide 9 breaks out the 220 million or $0.30 per share of higher raw material and freight costs in the first half of 2006 versus 2005. As you can see, energy represented almost 50% of the cost inflation as natural gas, No. 6 fuel oil, and coal prices all rose year-over-year. Freight costs represented the second-largest change period to period due to rising rail and truck rates and fuel surcharges. For more information on input costs take a look at slide 31 to 34 in the appendix.

Turning to how our businesses performed in the second quarter, slide 10 shows the Printing Papers earnings improved to 254 million from 128 million in the first quarter. That is due primarily to strong results in U.S. uncoated paper. The second quarter results do include a $31 million benefit from the elimination of coated papers depreciation expense that I mentioned earlier.

U.S. uncoated paper's earnings grew in the second quarter due to higher price realizations, better mix, improved manufacturing operations, and lower raw material cost. Volume was slightly lower due to high maintenance downtime taken in the second quarter.

Pulp earnings were up in the second quarter due to higher price realizations on comparable shipments. European papers earnings were stronger in the second quarter due to higher price realizations. Volumes were a little lower as the first quarter traditionally is the stronger sales quarter in Europe. It has got less public holidays and typically low pipeline inventories at year-end. And IP's Brazil's operations were good relative to the same quarter to quarter.

Slide 11 shows Industrial Packaging earnings increasing to 100 million in the second quarter from 38 million in the first quarter, driven by stronger results in the US, Europe and Asia. US earnings were driven by higher containerboard and corrugated box prices resulting from the implementation of previously announced IP price increases, lower input costs and better operation. IP US box shipments were up 3% in the second quarter despite one less shipping day in the first quarter. On an average day basis our box shipments were up yearly 5% in the second quarter.

Third-party Containerboard sales volumes were lower in the second quarter as we redirected [tones] from the export market to our US box system for internal consumption. Our Containerboard mills also took more maintenance downtime in the second quarter.

On slide 12 Consumer packaging earnings improved to 41 million in the second quarter from 35 million in the first quarter due to higher earnings in US coated paperboard, beverage packaging and foodservice. Included in second quarter earnings is an $8 million charge for our Shorewood Packaging asset write-off. U.S. Coated Paperboard benefited from higher sales volumes in the second quarter of 2006.

Looking at the converting businesses, beverage packaging and foodservice earnings improved in the second quarter due to higher prices, while Shorewood Packaging experienced some weakness in domestic home entertainment sales due to delayed game launches by our customers.

On slide 13 our Distribution segment's earnings were sequentially higher as xpedx reported record monthly, quarterly and first half year earnings. Sales revenues improved 8% versus the second quarter 2005 due to higher pricing. In addition to the stronger revenues, margins improved due to lower expenses.

Turning to slide 14, our Forest Products earnings were down from 226 million in the first quarter to 184 million in the second quarter, due to reduced earnings in both Forest Resources and Wood products. In Forest Resources lower timber harvest and real estate earnings negatively impacted results. Wood Product earnings were down 12 million quarter to quarter despite higher volume. And this was due to lower lumber and plywood pricing.

Second quarter special items and discontinued operations are detailed on slide 15. Special items after taxes in the second quarter of 2006 totaled a loss of 84 million or $0.17 per share, and included a charge of 70 million. Now that's that 26 million of transformation plan costs, 37 million to write down certain assets in Brazil to estimated fair value, and 7 million for both the salaries depreciation for the mill optimization and a legal settlement. It has also got a gain of 39 million on the sale of conservation land tract -- that was mainly in Wisconsin -- and a charge of 53 million for adjustments of estimated losses on the sale of coated paper. That amount will be finalized in the third quarter. And discontinued operations earnings for Kraft Papers nearly offset the projected loss on the sale.

Slide 16 shows you how you get from $0.41 of diluted earnings from continuing operations and before special items to the $0.24 per share we reported this morning. We mentioned on our conference call two weeks ago that we were expecting to make announcements that could affect businesses listed in both continued and discontinued operations over the next 90 days. We expect today -- we did announce today completion of the sale of our coated papers business.

You may recall that in the first quarter we reported the coated papers business as a discontinued operation. That was in anticipation of selling it. In the second quarter the Company signed a definitive agreement to sell, agreeing to acquire a 10% limited partnership interest in the parent company that will own this business. Because of this continuing interest, results for this business are now back in continuing operations.

This concludes my remarks and I'll turn it back to John for reviews of third quarter outlook and provide an update on the transformation plan.

Looking at the third quarter, we expect the economy to slow somewhat. You see the -- I think all of you saw the second quarter GDP growth rates. The economy is slowing, but we still expect earnings from continuing operations to record special items to be higher than the second quarter due to a number of factors.

We continue to expect good volume in our key platform businesses. Our inventories are in very good shape; in fact, they are a little lower. Improving price realizations are going to continue to happen. We ended June a lot stronger then we ended the second quarter from a pricing perspective in most of our businesses, and we still got some pricing flow through that we are capturing in July. We're going to get continued progress in improving the performance of our local manufacturing operations. But raw materials costs and freight costs were going to remain high. And that is going to offset some of that pricing improvement.

As part of our transformation plan we continue to focus on these key platform businesses, Paper and Packaging, employing a fewer, bigger, better strategy by deploying capital to realign both our uncoated and packaging mill operations here in North America. That project is underway and will benefit us as we go into to 2007, but it is going to continue to enable us to reduce our costs and improve our product offerings.

We're continuing to target improving margins of around $400 million a year of nonprice improvement. Think of that as 2% of our cost base, and we are well on our way to achieving that for this year, which is year one of the transformation plan.

On July 13 we talked to many of you about our plan to return value to shareowners using divestment proceeds and free cash flow generated from operations. And let me just recap that for a minute. Our Board authorized an up to $3 billion share repurchase, with a significant portion of that to be completed before the end of 2006. We plan to spend about 6 to $7 billion of our cash from operations and proceeds to strengthen our balance sheet by repaying debt and contributing cash to our pension plan.

We also are going to take a very disciplined approach to evaluating attractive strategic opportunities for selective reinvestment, because we think that is a key part of improving International Paper's earnings. We're looking at good low-cost, good return projects in uncoated papers in Brazil. Partnering in China to expand our coated paperboard business there. And also looking at the possibility of a low-cost, relatively small uncoated freesheet machine. We are looking at opportunities to grow our paper and packaging operations in Russia. In addition to our solid platform in place at Svetogorsk, we're also investing to put a DCTMP plan into place. And our divestment program is on track, which is shown on slide 19.

We sold our 50% stake in Carter Holt Harvey last year. As Marian mentioned, we completed the sale of the coated papers business this morning for $1.4 billion. We recently announced a deal for our Kraft Papers business, and could reach decisions regarding the coated papers assets in Brazil of beverage packaging and wood products within the next 90 days.

Just in closing, the leadership team at International Paper remains focused and committed to executing on the transformation plan and delivering both improved profitability and higher returns to our shareowners. Both Marian and I look forward to updating you on our progress in the coming months. So with that I will turn it back to you, Brian, and we're ready to take questions.

Yes, operator, we're ready to take questions now please.

(OPERATOR INSTRUCTIONS). George Staphos, Banc of America Securities.

Can you give us a little bit more color in terms of why you needed to include I guess some elements of coated and (indiscernible) papers in this quarter? But if I understand it right, you also didn't include the depreciation -- perhaps I have got it mixed up here, but if you can give us a little more color to on (multiple speakers).

You have got it right. It's kind of hard to believe, but the way you have to account for a business held for sale, which the coated papers was, as part of your continuing operations you are not allowed to take depreciation. It is just the accounting rules.

You had the EBIT, but didn't have the depreciation? Is that (multiple speakers).

That's correct. Yes.

On a going forward basis, you have this remaining interest. What will actually be reported within your results on a going forward basis?

The result of the coated papers business without depreciation will be in July because we just completed the sale today. Going forward we will have a 10% equity interest in the coated papers business, so it will reflect 10% of what ever the earnings of the business is.

Fair enough. Switching to containerboard, were you pleased with the operations overall within Industrial Packaging between box (technical difficulty) and containerboard?

Say that again. You cut out there on something.

I apologize. Were you happy with the operations I guess bottom line in corrugated and containerboard during the quarter?

No, they weren't bad, but they weren't as good as we -- as they could have been. We're still working through some supply issues frankly. And we've got ourselves over sold and we're continuing to work out of that. We're leaving some money on the table. The mills ran very well, but we're still incurring some extra costs because of some supply issues. We've had to get board to our outside customers and to our box plants.

It seemed a little bit -- in this segment -- a little bit below our forecast, and the pricing was just pretty much in line. What do you think the pick up will be in the third quarter from that do you think?

I can't give you a forecast, but we're working out of the supply problems. We're going to be in much better shape in the third quarter than we were in the first and second. We will have less maintenance downtime. Our volume was down in industrial packaging about 15,000 tons because we took more maintenance downtime. And we're continuing to run very well. I expect better earnings in the third quarter.

Last question and I will turn it over. Prices on boxes overall, were they in line with your expectation in terms of the progression? Obviously you've got, whatever it is, $20 some odd more dollars per ton incrementally into the third quarter. (multiple speakers).

Yes, they are going in the right direction. There is a table in the back. I think it is slide 26 or something that shows you where prices were in June compared to where prices were for the second quarter. As you can see, we're getting good flow-through on boxes. We've got more to come, and it is coming.

Peter Ruschmeier, Lehman Brothers.

Congratulations on the improved results. I wanted to ask if I could on the supply chain costs whether you see those as still on the upswing or on the down swing? And I guess a related question, do you have any updated guidance for us on the corporate expense charges going forward?

Yes, let me update you first where we are with supply chain. Right now we're expecting the costs will be higher this year than they were last year. Maybe not quite as much we anticipated at the beginning of the year. It is probably going to be maybe $10 million less this year than we originally thought. That will probably fall over into next year, however, so supply chain expense next year should peak and it be a little bit higher than this year.

As far as corporate other is concerned for the remainder of year, we're looking at corporate other in total to be in 700 to $750 million range now. We would expect corporate other in the second -- in the third and fourth quarters to be order of magnitude 20 millionish higher than it was in the first and second.

Let me just make a comment about S&A, because it is not a line item you see there, but we're making really good progress. Our S&A this year is going to be lower than last year, despite the fact we have probably got $100 million of increases just from costs going up. We're still making very good progress of reducing headcount and getting more done with less. Part of that $400 million we talked about.

Shifting gears, John, you mentioned that one of the areas of potential growth might be the Russian market. You're growing the Svetogorsk mill. I was curious if you could comment on your view of the fundamentals of that market demand and pricing trends in Russia, and how much of a growth opportunity you see there?

The Russian market, while it is still small -- you have got to remember it is relative to markets in North America it is a small market. It continues to grow at double-digit rates. I just got back from Russia last week, and I would say the economy there is doing very well. It is fueled by more than just the -- well, the energy sector obviously is making a huge impact on the Russian economy, but that is spilling over in demand for other products, including paper. We are seeing double-digit rates of growth there. In fact, the capacity we added at Svetogorsk late last year, we're going to be sold out next year.

Just lastly, if I could, for Marianne perhaps. You did mention that prices in June were higher than the 2Q average. Any quantification for white papers and brown papers?

It is on slide 26. In the back of the GAAP you can see the Printing Papers second quarter earnings.

I'm sorry. Okay, got it.

Got it? Good.

Edings Thibault, Morgan Stanley.

John, I think you hit the nail on the head a little bit when you talked about the expectations for the second half -- when you talked about slowing economy. But one of the things that struck me with the recent GDP numbers just how much it had already slowed in the second quarter certainly relative to the first quarter. Can you talk about whether you are seeing signs of a slowdown and how you might interpret that? And whether or not you thought 3Q to 2Q whether or not you think this type of volumes and growth we saw in 2Q is indicative of an economy that is in fact already slow?

I think that is a mixed bag. If you drill down the paper side, paper demand is -- hasn't been following GDP. And I think that is -- demand is okay. It is not great, but supply and demand are in balance. That is the issue. And when supply and demand are in balance there's opportunity for margin improvement.

On the box side I think the economy looks pretty healthy. Currency is helping us. And the customers we are lined up with their business is doing okay. You look at our Consumer Packaging segment, home entertainment is slow. But that is really driven by the economy. That is just driven by the fact that a lot of movie releases haven't come out yet.

Certainly we see it on the Wood products side. Our Wood products business is relatively small, but we have seen interest rates move up, all the builders revising their forecasts, and as a result prices have been coming down. It is a mixed bag.

But you are not sounding -- outside of Wood products, are you seeing businesses that perhaps looks slower today than they were in May, for example?

Certainly, July and August are seasonally slow in our industry, so we are seeing that across the board. I think xpedx is a pretty good barometer. They sell packaging. They sell to commercial printers. They sell facility supplies. We had record sales in the second quarter, but a lot of that is we're picking up new business. We just won a very big contract with Starbucks in our foodservice business. We're getting some wins out there that are important ones, regardless what the economy is doing.

Great, that is good news. If I could, two detailed questions to Marianne. Marianne, share count was lower than I thought. Did you buy back any shares in the quarter or is that the convert that you bought in (multiple speakers).

It is the convert.

It's all the convert?

Yes.

The second -- you booked a gain from the sale of Wisconsin forestlands. Can you just talk -- that was part of the sale of nonstrategic forestlands.

That's correct.

Can you just talk about the total proceeds that you realized in the second quarter?

The total proceeds?

From the nonstrategic sales.

That was the only major one, just that transaction. We expect most of the rest of the sales to close -- begin to start closing this quarter and then closing in the fourth quarter.

That was about 70 million -- I don't have the number right in front of me?

Yes.

Chip Dillon, Citigroup Investment.

My first question is do you still expect to have ongoing land sales through about the middle or later part of 2008? Is that pretty much what we should model in our models?

We do have some land that was not included in the land transactions that are part of the transformation, and those lands will continue to be sold over the course of the next several years. We're doing it in a way that we think will get us the maximum value from these lands, and they tend to be more higher, better use lands.

And then the second question is, I know you -- and I can't unfortunately see the slide from where I am -- could you give us an idea of how much you think the third quarter box realizations will be above the second quarter? In other words, will you get something above where they were in June? And do you think there's even more left in the fourth quarter, assuming no further industry price (technical difficulty).

I think we will have most of what we're going to get in the third quarter with what has been announced. But there still is some flow-through to come on top of the June numbers.

And then another question is when you look at the uncoated business, is it fair to say -- it seems to be this way, assuming my perception is correct, that you would prefer to grow outside of North America rather than grow inside North America in terms of possible acquisitions or capacity.

That is all a question of economics. Both businesses are strategic. There are a lot more -- or just plain growth. The market is growing outside North America, particularly in Asia, in Eastern Europe, Russia and Latin America. There we've got that option. In North America it is a big market. It is a mature market, and it is not growing. We got to be very careful about how we think about that business. But it all comes down to a matter of economics. We're not going to overpay for anything.

Last question is, you mentioned the corporate expense going up about 20 million per quarter above the first half runrate. What is an early look to '07, especially as you think about your pension expense?

You're right. The pension expense is one of the big drivers of what is going to happen with corporate. It is premature to really forecast pension expense for next year because a lot of it is driven by the interest rate at year-end and by the performance of our plant assets. But I think we're probably at the peak this year, and I think there's a good chance our pension expense will start coming down next year.

If it stayed the same that would come down.

It would come down, yes.

Rich Schneider, UBS.

I just wanted to check on what you had said about you expect the third quarter to be better than second. Are you using second as the $0.41 or the $0.35 without the coated operations? It gets confusing. How do you factor in timberlands if some of that is going to be sold here in the third quarter?

Actually, I tend to use $0.37 as a base for thinking about what earnings were for the second quarter, because it doesn't have the -- I am just going to call it funny accounting treatment for depreciation. The base timberlands sales that are part of the transformation plan we wouldn't consider to be part of regular operating earnings. The smaller timberlands sales that are the higher better use lands will probably be ongoing, and they are part of our normal operations.

We're not going to try to forecast third quarter earnings because we can't. But I think to Marianne's point, you think about $0.37, and we would expect the third quarter to be better than the second quarter, but we will have to see how it all plays out.

I guess I was looking at it with not having some of the timberland profits. And I guess we should assume as soon as the 10-Q is published you will be offsetting some of the loss with the timberland profits that are sold in the third quarter with the share buyback. There should be some balancing effort in the third quarter from those two factors.

Are you thinking about the harvest, the earnings that come from harvest as opposed to the earnings that come from land sales? So gradually as we close -- you're absolutely correct. If we gradually close the sales of the timberland we will not be getting that harvest income.

That was factored in your thought process what you said about (multiple speakers)?

Yes. We have got to replace the earnings from the businesses we're selling with growing earnings in the other businesses, which is just what we're doing.

John, I don't know if I heard you correctly, but did you say you were considering a small uncoated freesheet machine in China?

Yes, we're looking at it.

How would that fit in terms of timing with potentially something down in Brazil? Could both those occur simultaneously?

They could. They could. They're both driven by very different markets, but we see -- our customers -- we're going to be a global supplier in those business we need to be profitably -- but we need to be serving those markets locally.

And then in terms of bleached board, your prices look like they were flat in the quarter. Was that mix, because the bleached board prices are going up?

Yes, they are moving up. Caustic stock prices are up. Folding carton prices aren't up by as much. Our tobacco prices are pretty much flat because those are on a contract basis. What you're looking at there is principally the impact of mix.

Just a last question. You have your Wood products converting operations up for sale. Do you think with the weakness that we are seeing in Wood products right now there any problems with the either the potential to sell that or having to deal with some lower realizations on what you could get for it?

I don't think so. That sale is progressing -- discussions. And some of the buyers know that the business is cyclical. The earnings will go up and down in that business as a function of housing starts and supply and demand and lumber and plywood.

Richard Skidmore, Goldman Sachs.

Just a couple of quick questions. First, in the timberlands that you are not selling, how much land do you still have going forward to sell?

We had 850,000 acres at the beginning of this year. We have sold some in the first and second quarters. I don't think we've given out the acreage numbers precisely for the quarter.

Then second question, moving just to the maintenance downtime in the second quarter, John, can you quantify the amount of volume in either uncoated and containerboard that you had in the second quarter?

Yes, it was about 35,000 tons more maintenance downtime in uncoated freesheet North America, and about 15,000 tons more downtime in containerboard.

In terms of just your normal maintenance would that be expected to continue -- would you have that in the third quarter?

No.

Would that go away?

Yes.

As you think about the supply chain or the challenges that you had perhaps meeting some of the customer needs in containerboard that should ease up some in the third quarter?

Yes, that will get better.

Then lastly, as you look at the proceeds, as you mentioned you had some -- the three businesses that you may have an announcement over the next 90 days. Any thoughts to update the proceeds number, around 11 billion, or you're still comfortable with that 11 billion number?

We're still comfortable with that.

Mark Wilde, Deutsche Bank.

Just one short-term question. When we think about the third quarter, there is a white paper price hike that has been announced by at least one of your competitors for August, I think. Have you made any announcements about further price on white paper in the third quarter?

Not at this point we haven't.

And then a couple of longer-term questions. If you look at your capital spending it is roughly equivalent to D&A, which is still pretty high compared with most of your peers. What are your thoughts on being able to take that number down lower? You have got -- most of the assets that remain are pretty large, pretty new facilities.

Think of how we are managing that capital. We're spending well below depreciation in North America and we are well above depreciation in South America and Eastern Europe. Our competition, not all of our competition has cut that same business mix. But we're spending somewhere between 40 to 70% of depreciation, and most of North American businesses on top of that recognize we have a great opportunity to have fewer, bigger, better facilities in North America.

And the facility rationalization project that we talked about in previous quarters, that spending begins late this year and goes all through next year, which is close to $300 million. But it is going to enable us to convert Pensacola from uncoated freesheet to lightweight linerboard, and to take some additional capacity and additional facilities out of the combination of printing papers and packaging.

But over time our objective is to spend only the capital we need to to improve our businesses, and we will be very, very selective about where we add volume. Right now the only volume we are adding is outside North America.

Then final question just about Brazil. Would you consider buying white paper capacity down there versus building? And can you also talk about what your competitive advantage is in building a paper machine in Brazil if you have to pay something close to market price for the pulp -- for the fiber. Because it seems like the real competitive advantage in Brazil is in the fiber. And if somebody else is selling you the fiber doesn't it really reduce the advantage of building a paper machine down there?

To answer your first part of the question, we look at anything that fits with our strategy that makes economic sense. That is how I guess you ought to think about that one.

On the fiber side, it is a good question, but it is all about how much capital it takes to get advantage of that fiber cost. We're looking at trading off capital versus cost position. And if it turns out that we think it is capital efficient to reduce the capital and buy the pulp at market, given that we will be right next door to the pulp mill, that is what we ought to be doing because it will be a good capital trade-off for us. If it doesn't turn out to be that way, then we alternatively think about investing in pulp to capture the advantage of the low-cost fiber. But it is all about capital effectiveness and how much have to pay to get that cost advantage.

Claudia Shank, JP Morgan.

Just one question first on the interest expense guidance, the 600 million, which given where you're tracking through the first two quarters seems a bit high. I just wondered if you could put some color on that please.

I think the key thing to think about there is that a lot of the proceeds that we will be receiving from the asset sales will be coming in late this year. So there won't be that much more debt reduction until we get well into the fourth quarter.

Then just in terms of uncoated freesheet market, one, I was hoping you could comment on trends Europe, particularly with regard to pricing. And then I was just wondering if given the strengths in U.S. markets if you're saying any evidence of changing trade flows? If there's more paper coming in from Latin America or Asia? That's it.

Pricing in Europe is moving up more slowly than it is in North America, but it is kind of inching up. We have been getting for the last several quarters pricing improvement across the business there.

Looking at imports into North America, they are still relatively low if you look at the aggregate numbers. Some producers may choose to export from some place into North America, but in aggregate the percent of the North American market, if you take out Canada, I think it is less than 5%.

Mark Weintraub, Buckingham Research Group.

A few follow-up questions. First, Marianne, you talked on the corporate expense on Chip's question, but if you were to ex out pension, do you have a sense as to what the corporate number would be next year, assuming all the divestitures take place compared to this year?

We're not ready to give an indication of what that number will be yet, I'm afraid. We typically will do that when we announce the earned earnings.

Second, John, you had talked about the -- noted the Pensacola conversion project. I think you had at one point talked about potentially bringing a containerboard mill down roughly the same time. Can you just update us on your thought process there as well?

We're working through that now in terms of how much capacity we need. This whole thing is driven by sizing our footprint or our capacity with fewer, bigger, better facilities to what we think the market demand is. How much capacity will come out will be a function of how much capacity we think we need, but we're not going to carry excess capacity throughout the cycle like we used to.

Have you been pleasantly surprised by the demand side of the corrugated equation, or has it played out pretty much as you would have expected so far?

It has played out pretty much like we expected. Again, it varies by segment. You have to look at all the different end use segment for boxes, but we expected that there was growth in the box business over the cycle, and that is what we are seeing.

Then lastly, the distribution business looks to be doing terrifically well. I am just curious. Do you think you have established new runrates of earnings power? Is there some cyclicality affecting this business? How should we be thinking about the earnings power going forward do you think of the distribution business?

I think we have established a new level of earnings capability from that business for two reasons. That organization has done a great job of really dramatically changing its cost structure. And we used to have to have $7 billion of earnings to revenue to make earnings. We have changed our cost structure so now we can make decent earnings on $6 billion of revenue, and we're also getting revenue growth.

Is a great combination of not only getting our cost structure right and winning new business. It is not the earnings lever of International Paper, given how much capital we have in the business, but it certainly is an important and strategic contributor, and we're very pleased with xpedx performance.

Steve Chercover, DA Davidson.

Two quick ones at this stage. First of all, if you were to invest in a new machine in China, should we look at that as a kind of a copy of the 220,000 ton machines at cost of 300 million that you might go for Brazil, or is there something that you dismantle and bring over there?

I would say what ever way we choose to go at it, it is not going to be the big mega -- let's build the biggest paper machine in the world. We're going to size -- figure out how to do this to match our capacity with what we think our demand is going to be.

Do you have a site or would that coexist in one of your existing partners there already?

It most likely would coexist.

Secondly, with respect to your guidance for the third quarter, does a lower share count play into that at all, or is it the raw number gets higher and then any repurchase is accretive over and above?

We work on a weighted average share count for the quarter. We may well begin share buyback in the third quarter, but that is not going to be a big factor in terms of the share count for the third quarter.

Ted Isaac, Bear Stearns.

Congratulations on your earnings report. I had a couple of questions here First of all, on the debt reduction, what is the -- again, of the total amount you said you would reduce, how much have you actually done? So what is left to go?

Our debt outstanding at the end of the second quarter was $10.8 billion. We have applied order of magnitude 600ish million to debt reduction. As a result of proceeds, we're targeting a total of 6 to 7, but some of that may turn out to be funding of our pension plans. You shouldn't assume that absolutely every penny will go for debt reduction per se. As you probably know, if you have funding to do of your pension plan the rating agencies consider that to be comparable to debt.

Right. So far though only 600 million has been done. Between the pension and the debt reduction we could take a total of 6 to 7 billion is what you are saying?

Yes.

Do you plan to in that debt reduction buy back any bonds or are you going to do it in open market, or what is your --?

We're going to -- it depends upon the market at a particular point in time. And we will be looking at all the different ways that we could potentially retire that debt.

As far as your credit ratings go, one, where do you feel like you stand with the agencies? And two, where would you guys like to be from a credit rating standpoint in terms of what you need for your business and so forth? I'm asking that -- I'm kind of wondering if the fact you're becoming more and more international would be a factor in you wanting to have a better credit rating, or is that not a fair comment?

We want to be an investment-grade credit. That has been part of our strategy because we think it gives us greater flexibility. That really hasn't changed. As far as the rating agencies are concerned, I think that they are very interested in watching how our transformation plans proceeds, and that is a key part of this. And at the present time we think where on track with the transformation plan. So I think we're about -- just about where people expect us to be.

(OPERATOR INSTRUCTIONS).

Operator?

Yes, sir?

I would like to thank everyone for joining our second quarter earnings call. And this concludes the first call from our new headquarters in Memphis. Thank you very much.

Thank you for joining today's International Paper conference call. We appreciate your participation. You may now disconnect.