International Paper Co (IP) 2007 Q2 法說會逐字稿

Good morning. My name is Cynthia and I will be your conference operator today. At this time I would like to welcome everyone to the International Paper second quarter 2007 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 session. (OPERATOR INSTRUCTIONS) I would now like to turn the call over to Brian McDonald, Vice President of Investor Relations. Please go ahead, sir.

Good morning, and thank you for joining International Paper's second quarter 2007 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 slide 2 of the second quarter 2007 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 2007 earnings press release, our presentation slides, and a reconciliation of non-GAAP financial measures to Generally Accepted Accounting Principles. I'll now turn the call over to John.

Thanks, Brian, and good morning, everybody. Today Marianne and I are going to review second quarter results with you and the performance of our individual businesses. We'll talk about the third quarter outlook and we'll also update you on our 2007 priorities and then we'll take your questions.

Overall we had what I would call a very solid quarter. In fact, it was our best absolute quarter since the year 2000. Margins continued to expand with cost reductions, volume and pricing all contributors to the quarter-over-quarter increase in profitability.

On an EPS basis we're up 15% compared to the first quarter and up over 70% compared to the same quarter last year. Again, global manufacturing operations performed well in the second quarter. Compared to the first quarter our volumes were strong in packaging and in xpedx. Our North American paper volumes, however, were down as we began Pensacola conversion from uncoated free sheet to lightweight liner board. Our pricing momentum remains good as we continue to make progress in product pricing for our global pulp and paper businesses and a number of our announced price increases were either partially or fully implemented.

As I said, the Pensacola mill conversion and outage expenses started to occur in the second quarter. They negatively impacted our second quarter earnings as we expected. We also had a lower tax rate and a lower share count in the second quarter versus the first quarter. On slide 6 you can see our diluted earnings per share from continuing operations and before special items.

In the second quarter we reported $0.52 a share, again, 15% higher than the first quarter earnings of $0.45. We're pleased with the progress we've made delivering these earnings and importantly the strength of our global paper and packaging businesses.

We're about 18 months into our transformation plan and so far so good, but we're not finished. We know there is more work to be done but we are on the right track and we're making good progress against our expressed targets. I'll now ask Marianne to comment in more detail about the numbers and the businesses.

Thanks, John, and good morning. Let's start with slide 7 that compares second quarter results with those of the first quarter. So, if you move left to right, higher price realization for our pulp and paper grades improved earnings by $0.04 per share. As John mentioned, we had strong volumes in packaging and seasonally higher xpedx sales and these increased earnings by $0.03. Our North American paper volumes were down as we began the Pensacola conversion from uncoated free sheet to lightweight liner board.

We continued to make progress in reducing manufacturing costs and in improving our sales mix during the quarter, increasing earnings by $0.06 per share, the largest improvement lever of the quarter. Expenses related to the conversion of the Pensacola mill to lightweight liner board and planned maintenance shutdown lowered earnings by $0.04 per share.

The caption "cash redeployment" includes the combination of interest expense, lower share count, and selective reinvestment, which, taken together increased earnings by $0.03. Corporate/other decreased earnings by $0.06 per share. Corporate items were slightly higher quarter-to-quarter reducing earnings by $0.02 per share driven primarily by benefits-related expenses.

Other items include several small unfavorable adjustments in the second quarter. The tax rate in the second quarter was 29% versus the 32% tax rate in the first quarter of 2007, and this lower tax rate increased earnings by $0.03 a share.

Turning to slide 8, this compares diluted earnings per share from continuing operations and before special items for the first six months of 2007 versus the same period in 2006. Before I walk you through the six-month year-over-year earnings, I would like to just step back for a minute and point out that the total earnings loss from businesses divested as part of our transformation plan six months year-over-year is $0.38 per share. Now this is a combination of the $0.21 per share labeled divestments on the chart, and another $0.17 per share that's not on the chart from those businesses divested where we did not maintain a retained interest. And I think the good news here is that we have more than replaced all those earnings.

So if you look at the chart in more detail then, moving left to right, paper and packaging prices were significantly higher on average in 2007 versus 2006 and this added $0.41 per share. Year-over-year we have improved our prices substantially more than our costs. Slightly lower volumes reduced earnings by $0.01 in 2007 as increases in European and Brazilian papers were offset by the Pensacola mill uncoated free sheet shutdown in North America. Our mill ran very well in the first half of 2007 with manufacturing costs and mix $0.21 per share favorable versus 2006. Together, volume, cost, and mix improved earnings by $0.20 per share or $150 million year-over-year.

Why we're behind on volume is primarily the result of our Pensacola mill uncoated free sheet shutdown and we're seeing the benefits in improved prices. Pensacola mill conversion expenses and costs related to planned maintenance shutdown lowered earnings by $0.03 and $0.02 per share respectively.

You all remember the new accounting treatment for planned maintenance shutdowns which are now driving these kinds of quarter-to-quarter swings. Input and distribution costs were unfavorable, reducing earnings by $0.11 per share or $77 million and I'll review that in more detail in a moment. Lower land sales in 2007 reduced earnings $0.12 per share versus 2006.

The combination of lower interest expense, lower share count and earnings from selected reinvestment increased earnings by $0.36 per share. And corporate items favorably impacted results by $0.05, driven primarily by lower pension expenses.

You can see the sale of Arizona Chemical, coated papers and the loss of harvest incomes from the sale of our forest lands reduced earnings by $0.21 per share. And, as I mentioned a moment ago, both Arizona and coated remain in continuing operations because we did retain a 10% equity interest in each.

The tax rate was $0.02 per share favorable due to the lower tax rate of 30% for six months 2007, versus $0.32 -- percent for six months 2006. Now on Slide 9 you can see the breakout of the $77 million or $0.11 per share of higher input and distribution costs for the first half of 2007, versus the same period of 2006. Distribution costs represented the largest change period to period and this was primarily due to increased rail and truck rates. For more information on input costs, please see slides 34 through 38 in the appendix.

Turning to how our businesses performed in the second quarter, Slide 10 shows that earnings in printing papers improved from $231 million in the first quarter to $249 million in the second quarter, and this was due to improved results in European papers, U.S. pulp and Brazilian papers, as well as the first full quarter of operating results from our recent addition of the Luiz Antonio mill in Brazil. U.S. uncoated papers earnings were actually $10 million lower in the second quarter versus the first quarter . This was the result of higher costs associated with a higher level of planned maintenance outages which adversely affected earnings by $20 million. So without the outages U.S. papers would have been higher.

Prices in mix were very strong during the quarter and were partially offset by higher raw material costs and the slightly lower volumes, again, due to the Pensacola mill conversion. Pulp earnings improved in the second quarter due to higher prices and improved operations and productivity at the Regal Wood Mill. And Regal Wood, by the way, has improved $30 million on an annualized basis compared with last year. And this was partially offset by slightly lower volumes and higher raw material costs.

European papers earnings improved due to higher prices and better mix, partially offset by higher raw material costs and lower volumes associated with planned maintenance outages. And IP Brazil earnings improved significantly due to the full quarter of the Luiz Antonio mill, slightly higher volumes and higher prices. Now, Luiz Antonio integration continues to go very well.

In fact, both Brazilian mills ran well during the quarter and we set new monthly mill production records for paper and sheeting at Luiz Antonio. Operating synergies continue to be realized consistent with our integration plan and our cost performance remains strong.

In Brazil we did face about $14 million of head winds during the quarter with unfavorable foreign exchange as well as lower mix in volume as we were still in pipeline filling mode during April. There were also some one-time items mainly associated with our integration.

We did receive a cash payment from VCP during the quarter as compensation for swapping the Luiz Antonio mill to us without inventory. So, on Slide 11, if you look at Brazil's performance versus our target, our second quarter operating profit run rate annualizes to about $240 million. We expect earnings in the third quarter to be about $65 million to $70 million, and that's about $275 million annualized. And we currently estimate our fourth quarter annualized run rate to be about $300 million. So when you add back the $100 million of Brazil's depreciation, that gets us to our EBITDA run rate of $375 million to $400 million. We continue to be on -- look on Slide 12, and you can see -- actually we continue to be pleased by our better balance of earnings. You can see that in our uncoated free sheet business, our second quarter earnings were actually about equal between North America and the combination of our European and Brazilian businesses.

Now slide 13 shows that industrial packaging earnings were strong, increasing 35% to $139 million in the second quarter from $103 million in the first quarter. On slide 14, higher reported earnings were driven -- and this is in industrial packaging -- were driven by greater container board and U.S. box shipments, better manufacturing operations, and less planned mill maintenance outages.

Pensacola conversion and outage expenses negatively impacted earnings by about $0.03 per share. Per workday, box shipments were up 5% on an MSF basis in the second quarter. And our European container business had a solid quarter with better prices and lower energy costs. Now turning to consumer packaging on slide 15, planned outages caused the reduction in earnings of $13 million quarter-to-quarter.

U.S. coated paper board had strong performances in volume, price, and manufacturing operations, and this was somewhat offset by higher input costs. Overall, our mill operations ran well with our Texarkana mill setting a new all-time production record on its paper machines.

Looking at the converting businesses, food service posted record second quarter earnings with across the board strength in volume, price, and cost. Sherwood's earnings were about flat quarter-to-quarter. Sherwood's first half of the year is seasonally much weaker than the second half of the year, and this normal seasonal weakness was compounded by a weak overall music market. On slide 16, xpedx continues to build momentum with record second quarter operating profits of $38 million compared with also a record operating profit for the first quarter of $29 million.

Sales revenues increased during the quarter as we entered a seasonally stronger period for facility and packing supplies. Compared to first quarter, margins in mix were slightly stronger with continued excellent cost controls. We're winning new business and growing with existing customers, and we continue to be pleased with the improved return in xpedx and think this can certainly be a cost of capital business.

Forest products earnings, on slide 17, were relatively flat versus the first quarter. While land sales are difficult to forecast within a quarter, we expect earnings to be someplace in the $110 million to $140 million range in the third quarter and we are still targeting $500 million for the full year. Importantly, our objectives remain the same which is to maximize the net present value of our holdings.

On slide 18, you can see second quarter special items and discontinued operations. Special items after tax in the second quarter of 2007 totaled a loss of $23 million or $0.06 per share. Slide 19 shows you how you get from the $0.52 of diluted earnings from continuing operations and before special items to the $0.44 per share of net earnings that we reported this morning.

This concludes my remarks, and I'll turn it back over to

Thanks, Marianne. Again, I think we had a solid second quarter. And like I said it was our best absolute quarter since 2000. We continue to expand our margins with operating margins of 60 basis points versus first quarter, and 120 basis points versus the second quarter of 2006.

European papers, xpedx and food service all had record second quarters. And importantly we began converting the Pensacola mill from uncoated free sheet to lightweight liner board. We're benefiting from our global footprint. In paper we saw healthy markets in Brazil and Europe and achieved record second quarter earnings in Europe .

In our uncoated free sheet business the combination of Europe and Brazil equaled North America earnings in the second quarter. That's the first time that's happened and with Brazil continuing to improve, probably we'll see North American earnings in the third quarter. For packaging export board markets are strong. The Sun joint-venture in bleach board is on track. Our European container business continues to have a very, very good year, and we have price increases in the market for container board and carton board.

So our core businesses continue to improve and are offsetting the earnings and divested businesses that Marianne referred to. And I think that's a very important sign of how well we are doing with these platform businesses. Slide 21 shows that our transformation plan is making a difference in International Paper and [assurance]. And if you remember Marianne's comments from our December investor day meeting, she said that holding price and cost at December 2006 levels, we felt we had initiatives in place to drive about $1 a share of earnings improvement in 2007.

We're now six months into the year and while both prices and costs are higher than December 2006, we have achieved about $0.55 a share of improvement. We're short on the volume part of this but we're trading volume for price by matching our capacity with our demand.

The largest component of our improvement has been the improvement of our existing businesses, which is shown on Slide 21. That's $0.43 a share of year-over-year improvement. Lower interest expense and a lower share count have also significantly contributed to the results.

This last week obviously shows us how volatile and sensitive the markets are to anything that happens. And looking at the third quarter, we would expect volumes to be about the same. Some a little better, some maybe not as good, but overall about the same. Average price realization should improve modestly as we continue to implement IP's previously announced paper, pulp, container board and carton board price increases. We're going to continue to make progress in improving the performance of our global manufacturing operations.

I expect input costs will probably inch up a bit, not across the board but the net result will be higher input costs. Our maintenance outages will be lower in the second half of the year and in the third quarter than they were in the second quarter. And we've got about $20 million to $25 million of cost associated with the Pensacola conversion and startup. Also in the third quarter, forest resources earnings should be a little bit higher in the second quarter due to the timing of some of the land transactions. So when you add it all together as a result of everything I talked about, we would expect earnings from continuing operations to be somewhat higher in the third quarter compared to the second.

Let me briefly give you an update on our Russia joint venture discussions, specifically Ilim. We continue to be very excited about this opportunity. The Ilim business is performing very well, EBITDA is substantially improved over the past year, which means we would expect a more attractive multiple, and we expect to be updating you on the results of those negotiations in the near future.

Also, in addition moving in to 2008, we have got several new projects which will contribute to our earnings growth. The 500,000 ton lightweight liner board machine at Pensacola, the new 300,000 ton coated board machine at our IP/Sun joint venture in China, the 200,000 ton VCT&P line at our mill in Svetogorsk, our fluff-project -- our fluff-pulp conversion at Regal Wood, three new packaging plants which we're building in Asia, and a new box plant in Turkey. And all of those investments outside North America are at attractive returns and all are aimed at serving markets that are growing at attractive rates.

So, in closing, our priorities in 2007 remain the same. We're aimed at significantly improving our profitability and our returns and returning value to shareowners. To improve our profitability, we're going to remain focused on matching International Paper's capacity with the demand of our customers. As you know, conversion of that Pensacola mill shrunk our uncoated free sheet footprint by about 350,000 tons and we also announced the closure of our Terre Haute container board mill which will reduce our liner board capacity by 200,000 tons.

We're committed to targeting $400 million of improvement on our existing businesses in the areas of operating cost, volume, mix, and overhead. Together, those items improved about $0.20 a share on a year-over-year basis.

As Marianne said, we're a little short on the volume component of our non-pricing initiative this year, but we're making a profitable tradeoff of creating volume for price by matching our supply to our demand. The net result is margin expansion, which is what we're really aimed at.

Turning to slide 24, the IP/Sun joint venture is right on target. And IP Brazil, our new investments down there are also making progress and, as Marianne said, we would expect our EBITDA run rate to be in the $375 million to $400 million level.

We remain committed to returning value to shareowners. We bought back $2.5 billion of stock. We have an open market plan in place to buy back additional shares which expires on Friday, and we intend to have another open market plan in place shortly. Our goal remains to be a more focused paper and packaging company and one that you will consider among the best industrial companies in the world.

So, I'm going to end right there, go back to Brian, and we'll take your

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

Thank you, ladies and gentlemen. (OPERATOR INSTRUCTIONS). Your first question comes from Eding Siebalt with Morgan Stanley.

Thanks very much and good morning.

How are you?

Doing well, thank you, John. John, a couple of questions No. 1, I always like to start with what you might be seeing in the overall markets in the month of July. Whether or not you are seeing any changes or any particular reason to be spooked. But -- so I'll start with that one and one more follow-up, if you don't mind.

I don't think so, Eding -- as I talked about the third quarter, I think volumes would be more of the same. You know, the U.S. market, you know, we all know what the macro numbers are. Box shipments are off a percent or two. Paper shipments are off a little more than that. So the markets are large, but they are flattened down, and we're going to have to manage our business that way. Outside of North America, which is increasing important part of our profitability markets from the volume standpoint are much better.

Okay so no change in July as you look at some of these segments, the paper, the packaging, you're not picking up material improvement?

No, I think the inventory is importantly for packaging, and for paper, inventories are in very good shape. And I think that's, you know, summer is always a little bit slow, but inventories globally in good shape.

Okay. And then the follow up would be one of the things you talked about returning value to shareholders with the open market plan. Clearly, you also have a decision at Ilim to make in the near term. Do you have a target for what you think your cash balance should be at year send I mean, $1.6 billion is a lot of cash.

The -- we have a forecast of what we think our cash balance will be at the end of the year. Where it comes out will depend upon whether or not we go ahead are the Ilim transaction. The timing of when we make the payments and other things that we might do with our cash during the course of the next several months.

We're not running the company to a cash balance target.

No.

Maybe better -- you know, as an adjunct to that, what do you, how much cash do you think you need to run the company day-to-day?

Probably someplace in the 3 to $400 million range.

Got it. Thank you.

Your next question comes from Claudia Shank with J.P. Morgan.

Thanks very much. Good morning, hi. I was hoping you could just talk a little bit about your comments around pricing for next quarter. I was a little bit surprised that you weren't talk about higher paper prices, so maybe you could talk a little bit about initiatives outstanding in Europe and here and if prices went up in May shouldn't we then expect sort of average prices to be higher in the next quarter?

Well, I would say if you look around globally, Claudia, you know, prices are, you know, stable to improving just about everywhere, all prices are moving up. We have announced a container board price increase in North America and for export. Our bleach board prices are moving up. Paper prices in North America had been stable. We have announced a 4 to 7% increase in Western Europe and in Eastern Europe, and I think those -- those will be successful. So the pricing environment is pretty good because supply and demand are in balance. And inventories are in check.

Okay.

Is there -- specific --

Just as we look at --

Improved realizations, Claudia you are correct from the cut size increased in the U.S. that we announced in May, and that was pretty fully implemented as of July, took about 45 days, which was about half the normal time, so a very positive dynamic --

Okay. But then we should see sort of the rest of that come through as we look at third quarter realization.

That's correct.

As I said, Claudia, you know, the pricing direction is generally up.

Okay. That's good to hear.

Not great.

Yes. And then maybe you could just talk a little bit about working capital. It was a little high I thought, year to date, it looked a little high. What is driving that, and, you know, can it be clouded back a little bit as we go forward over the course of the year.

Sure, our objective is to call back some of that. Some of what you are seeing there is the impact of the Luiz Antonio on our export shipments from Brazil. Which we're moving through supply chains that create the maximum value, we think, in both the United States and in Western Europe. You also see the impact of a little bit of an increase in exports from the United States, and actually the export markets as you probably know particularly liner board are quite good right now, and the terms on export markets are a little bit longer. Similarly pulp, as our pulp volume moves up that tends to have longer terms as well. So there has been a little bit of structural shift that has driven some of that increase in working capital. We do have major working capital management initiatives underway in the company though that we think will be able to help us claw back some of that, as you put it, later on this year.

What were your shares outstanding at the end of the quarter.

$422 million.

Okay, perfect, thanks a lot.

Your next question comes from Rich Schneider from UBS.

Good morning.

Good morning, Rich.

I was wondering if you could talk or give us a little more detail on the change from first quarter to second quarter in the printing papers area, just maybe if you could similiarly to the waterfall chart that you give on the industrial packages area? Obviously, you said that U.S. was down because of the $20 million of maintenance, and you also described the $14 million FX and another hit in Brazil, but could you give us some of the other big pieces in that?

Well, just looking at printing papers here in North America, you know, volume was off and these are EBIT numbers, about $7 million. Costs were better, about $13 million, outages -- outages cost us little over $20 million. Those are the big pieces, in printing papers in North America. In Europe, you know, we had a PPV was about $12 million higher, and, you know, price was about equally, equally favorable. And obviously in Brazil, you know, you go from where we were to almost double the earnings because of -- not quite double the earnings -- because of the addition of VCP for the entire month. For the entire quarter. Although we bought the mill as Marianne said with no inventory, which we got compensated for, but we had to sell the pipeline in Europe and North America. Go ahead, Rich.

On the Brazilian segment you said you were running $20 million a month in the second quarter of EBIT. What were you running in the first quarter in Brazil?

Well we didn't have Luiz Antonio for one month, so --

We made about $38 million in the first quarter in total in Brazil for EBIT, Rich. So significantly less than the second quarter.

Okay. And second quarter, I guess was around 60 then?

Correct.

Okay. Also could you talk little bit about this unfavorable adjustment that you indicated, Marianne, in your waterfall chart of about $0.04 per share. I imagine it is a bunch of little stuff --

You got it.

But it is a big number.

There there was a little bit in industrial packaging it was balancing of some inter-company eliminations. We had some inventory adjustments in a couple of our businesses. We had some environmental costs, and a little bit of inventory adjustments in some of our DCs. So it was little tag ends of things that just all happened to add up to negatives in this particular quarter. Sometimes they go the other way.

Okay, you know, in total it turned out to be a fairly large number. And then just last question on Ilim, the spike there, improved profitability, if you do the deal, are we still looking at $400 million investment?

We're not finished negotiating, Rich. So at this point in time, there's -- you know, nothing to change from what we have previously said.

Okay. Okay. Thank you.

Your next question comes from Chip Dillon with Citigroup.

Yes, good morning.

Hey, Chip, how are you?

Good. Good.

First question is -- could you -- as we look at next year, could you tell us what you think your CapEx will do directionally and, and if you could just confirm -- I would assume that the pulp mill that you are technically building for VCP is not in that number, but you can confirm that, but the two machines are. I guess the last element of the question could you update us on the exact timing of when you think that VCP pulp mill will start up in 2009.

Well the direction of capital spending will be down. We haven't fine tuned it all yet but we have got some big projects that are completing this year. Most of them outside North America. With the exception of Pensacola and Regal Wood being the two projects in North America. We are not building the pulp mill for VCP -- they are building it themselves. And that's a 2009 startup. You know, the big project we'll have next year that will be continuation of some spending this year is the paper machine in Brazil. And, again, that's scheduled to start up to coincide with the startup of VCP's pulp line.

Got you. And then -- so down, but you don't have a specific -- or a rage of numbers you can give us.

I think importantly, Chip, if you look at our spending this year, it's about equal to depreciation. Inside North America, we're spending far less in depreciation, probably less than 70% of depreciation. You know, it varies by business, but some businesses it's 40% depreciation. In our spending in Eastern Europe and Brazil it's well over 100% of depreciation. So when you look at the aggregate, I mean, we're making very careful decisions about where to spend capital, put capital in the businesses and where to take cash out.

Got you. Now when you look at slide 30, the one on the downtime, just to make sure I understand that. The tons listed or what you actually took in the second and the third quarter, is sort of the earnings improvement by not making as much downtime.

Actually correct, Chip. The tons are and we expect to take in the third quarter, and the column to the right is the dollar quarter-to-quarter difference, Q3 versus Q2.

Right. And that $30 million is -- based on what -- I think John you have mentioned that should be $30 million less of earnings, of more earnings or less hit from the downtime.

That's right.

That's correct.

And because these addages all get charged in the quarter we take them as both amortized and depending on how we schedule outages we've had big year-over-year swings.

I know in the past few years, Marianne you had some idea I think at this point of what corporate expense might look like for next, for the following year. And I didn't know if you had, sort of a range to give us that we could think about for 2008.

I -- we're in the process of looking at that right now, so we'll have it by -- a good indication by the time we have the next earnings call, but it's a little early to give you that right now. Pension expense is a big number that runs through that, and that gets determined in part by interest rates, and right now I'm not feeling extremely comfortable about trying to forecast year-end interest rates.

How about next weeks? And speaking of interest, last question, is -- I noticed from the last call, or -- you know, May when you gave us guidance for the full year you had interest expense coming in at 330, now you are saying 310, which is a nice positive move. What would you say is causing you to rethink that to that degree?

It's primarily the timing at which we spend cash, and what we do with our cash. We have -- as somebody pointed out a few minutes ago, we have a fairly substantial cash balance, so that's one of the things that's benefiting us.

Last -- I guess last, last question on the buyback, could you just update us on what you would assume would be sort of a range of additional shares you drop buyback back for the rest of the year?

That will be a function, Chip, of, you know, how the businesses are doing, what we think the cash re-deployment options are. We have done $2.5 billion to date when we announced the transformation plan on $8 to $10 billion, we said about 1/3 of that we thought would go to returning value to shareholders through a share buyback, and we have done just what we said we are going to do. And how much more we do will be a function of how things play out over the next 6 to 12 months.

Thank you very much.

Your next question comes from Mark Weintruab with Buckingham Research.

Thank you. John, wanted to get a sense on how you anticipated man aging the bringing on the Pensacola machine. You talked about more in the past exporting more to Europe, et cetera. Could you walk through us -- since that market is pretty balanced at present what you intend to do to make sure it doesn't have a negative impact on the market?

Well, that's a very good point, Mark, and I think we have got a good plan. The -- you know, we're actually short some board in Europe, and light weight liner board is what we need for our European box plants, and so -- I mean at the end of the day, we'll have to see what the supply/demand situation looks like, and we're committed to balancing our capacity with our demand. But our prospects right now, as we look at bringing on that machine, you know, look pretty good with the, you know, taking out the Terra Haute mill. That could change but right now the demand for craft liner board around the world is pretty strong.

I guess -- as I see it, there's about a $300,000 net increase Pensacola minus Terra Haute.

Yes.

And so where, is a lot of that going to go in to the export markets? Or do you feel comfortable that you can absorb more of it into your domestic needs or how is that 300 going to play out as you see it.

Well I think right now quite a bit of it will go into the export market. If you are looking at what is going on with box demand in North America, box demand is off a point or two, year-over-year, and that means the box market isn't growing, so we're not going to sell more liner board into a market that's got adequate supply . But it -- our European container business buys a lot of liner board in the outside market, and in Turkey that market is growing at double-digit rates. We're starting up a new box plant in Turkey, we need capacity, same thing is true in Morocco. And again, both of those markets are light weight board craft

What is the 10% box decline --

10% box increase in demand in Turkey.

I'm sorry, I'm just looking at the statistics you gave out -- I don't know if something had been sold or something --

Yes, we sold our UK plants, three plants in the UK in the past year. So that's why European box demand is down.

Understood.

On a same plant basis demand is up.

Okay. And then lastly --

As our earnings.

Right. Lastly, kind of similar questioning on the uncoated free sheet side, when -- obviously we have seen now -- first initiatives on rationalizing, et cetera. How far away do you think the market is from balance at this point? And do you have any updated information or thinking that you can give us about (basket) or are you basically decided on that at this point?

I think the only thing we can talk about, Mark, is how we see our supply demand situation with our customers, and the --you know, right now, as we see the markets, supply and demand are in balance. -- press size, price increase was fully implemented, and I think that is a reflection of what is going on with supply and demand.

Okay. Thank you.

And the speed of that cut size price increase was pretty rapid in terms of announcement to implementation from our perspective.

Your next question comes from George Staphos from Banc of America Securities.

Thanks, hi, everyone, good morning. I had a question, maybe similar topic in terms of the fleet of mills, John. How do you see Pineville fitting in? Obviously you have elected to keep it running. You said in the past it has done some remarkable things, I guess on the cost curve.

Yes.

What other color can you give us Pineville and the strategy to keep it open? Are you using a lot of those tons for places outside of North America, Asia, what have you.

Yes, we are exporting more liner board this year than we did in 2006, I don't have the numbers right in front of me. Our exports are up substantially and Pineville is part of that strategy. We'll probably look at how the exact -- the export mix as we bring up Pensacola, you know Pineville is not a first core tile mill. We have taken about at $60 a ton out there without spending any capital. They've really done a great job. So Pineville is -- you know, at this point in time is a competitive mill and if the world supply/demand balance stays where it is, we'll run Pineville. If something changes we'll relook at our system again.

Fair enough.

We're not locked in to having to do something, but we're very flexible both on the liner board side and the increased free sheet flow in North America to adjust our capacity if we need to.

Coul you use Pineville for something else than container board? or are you or s it just currently container board?

It can make unbleached pulp.

Okay. Are you using it at all for pulp?

We have. We're not right now.

All right. Can you remind us, John, with Regal Wood how much improvement is left there? You had nice improvement. I think you said $30 million annualized. What is left to go within, with Regal Wood?

Quite a bit. We're still spending probably $13 million over our targets on the spending side of Regal Wood, but what we decided is we're going to spend the money we need to keep that pulp mill running, and we have got some catch-up work to do. There's still some run rate for Regal Wood. It cost us about $ 50 million bucks - $40 or $50 million on costs and volume. We have regained well over half of that.

So do you think you can easily exceed that if you're about halfway done plus you're making some improvements to the mill?

We're going -- our spending is going to continue to be higher than we would like it to be for the rest of this year.

Those improvement numbers are net of the spending. So when spending gets normalized that's more spending that you'll get.

Got you.. That's helpful, Brian. Last question I have for you - you've obviously done a really good job balancing supply and demand in uncoated free sheet over the last couple of years, and you have made no secret about the fact that if you need to you'll continue to do that. When you talk to, John, some of the larger paper users in the market and larger corporations, what are they telling you about their longer-term appetite for printing papers, and how they are weaving that in their overall information and archival strategy?

Well, it depends on the customer, George. We think we have got ourselves lined up -- take HP for example. HP is -- is investing in ink technology, and we're investing in paper surface capabilities that match up with the next generation of inks, and, you know, that business -- that brand continues to grow on a global basis, we're really excited about the growth of the HP brand in Europe this year. So, you know, there is -- there is one strategy. You know, Xerox has got a different one, although Xerox is a very important customer of ours. We're a major supplier to Xerox. If you are hooked up with the right commercial printers, as we are, with Expedex and Printing Papers, even in a shrinking commercial print market, you can win if your customers are winning. So we don't -- I mean, the trends that have been out there as far as the conversion of forms to electronics, and, you know, the whole market has gone from print and distribute to distribute and print. So as you get more electronic technology out there, you're having more, we'll call it print on demand as opposed to print and distribute.

Right, I guess. And that's helpful, John, I guess as corporations over time think more and more about how they can become more productive, lack of a better term, with the information they have in hand within the organizations, the manner which they keep that information, whether it's on paper or somewhere else probably changes as well.

Well, see that is true if you are just North American focused. More than half of our earnings in the third quarter this paper will come from outside North America. Those markets are growing some of them at double-digit rates. I know that we can't fathom that in North America because it has been decades since that has been happening. But that in fact is happening in Eastern Europe, in Russia, in China, they're coming off small bases, and Brazil -- Brazil is growing at about 5% a year over -- on average, so those are the market we're thinking about where paper consumption per capita is very low, we probably won't get to the North American Western levels, but it can double and triple from where it is.

It's a big world out there.

Yes.

All right, guys, thanks very much.

Your next question comes from Mark Conley with Credit Suisse.

Thank you have, John just two things. First, can you give us a sense of what kind of initiatives are going on within the supply--chain project right now, obviously the freight costs are making it tough to bring it out there bottom line. But can you just give us a sense of what kind of efforts are underway there --

We went live in our, three of our box plants in the second quarter. So we're going to spend probably the rest of the year making sure we have got that system capable to roll out to the rest of the box plants. (RG Merge) -- is way down, and that's -- I think we talked about. We used to have 3,000 rail cars in the system to ship liner board around out of North America. We now have half that. Our miles per shipment are less, and our rail tons per shipment are more. Those are the things we are now managing. We pay for liner board by the car, not by the ton. So being able to plan to maximize the number of tons you put in a car, and ordering big cars is all capability we now have that we

didn't used to have. We just took cars as they showed up and had a lot more cars in the system than we needed. So the we have been able to do a very good job in our container business. And we see those opportunities ahead for our bleach board business and uncoated free sheet business and we put the supply chain capable in to those businesses.

In fact our fact our freight costs were down second quarter compared to first.

Right, can you --

Just one more point there, Mark, we're talking about a cost base of over $1 billion.

Right. It's a huge, huge number for you guys. Huge opportunity. As you look, John, at the time line, could you give us a sense, maybe sort of proportionately in terms of benefits gained where you are on that line as opposed to I joist know chronologically.

I would say through early deployments of new processes we have realized over $300 million of annual improvement. You don't see that on the bottom line yet, because we're still incurring expenses for the supply chain work we're doing. But when we finish the supply chain work we're doing obviously you'll see all the benefits flowing through the bottom line.

Sure.

2007 is the high water mark for spending.

Yes, for spending.

Right.

So we're -- we're well over 50% spending against our target for completion, but we have got several more years to go to get this operation across all of our businesses in North America.

Sure. Sure. That's very helpful. And John, if we were to look at the performance of your U.S. operations versus international, I know it's a little tough with the acquisitions you have done, but for the second half of the year, should we expect the international businesses to continue to show greater performance gains than the North American side?

Yes, you should because we have got more volume ramping up in Brazil. We're going to continue to get the integration benefits, the synergies. We got the BPVMT -- plant starting up in probably late August, early September in Russia. That's going to cost us some money as we start that up, but as we move in to the first quarter, that will start to generate more earnings. So, you know, the capital we're putting in to those markets give us the platform to grow our earnings more significantly than we will in North America, because we're working on the cost side of North America and energy and capacity and then you have got Sun paper, which is, you know-- that joint venture we made funded the construction of the -- bleach board machine which is aimed at the Chinese market, not the export market. This is capacity we're putting to satisfy local markets. We're going to see more earnings improvement in those areas driven by volume. Improvement in North America driven by continued cost reduction, mix improvement and some pricing.

Perfect. Thanks very much.

Your next question comes from Mark Wild with Deutsche Bank.

Good morning.

Hey, Mark, how are you?

Good. Marianne first a question on FX with the dollar having been so weak lately, is it possible to get handle on what FX translation may have done on a quarter-to-quarter basis?

FX translation in total on a quarter-to-quarter was a couple million dollars. There are pluses and minuses in our system now. Brazil, when the real strengthens it's a minus for us. Western Europe when the dollar weakens it's net-net a plus for us. It tends to balance out somewhat around the world.

So the rise in the Hey-Ai against the dollar, you weren't doing sales in Brazil in Hay-Ai, so that you would have had a positive translation effect.

We have two things going on in Brazil, remember with the addition of Luiz Antonio we export a lot from Brazil. We export in US dollars, we also export in euros. What we sell in Brazil, we sell in -- you have two phenomenon. You have the strengthening, reducing the margin on your dollar and euro denominated sales, and then you have the gain on the actual real earnings in Brazil. So net-net is negative.

All right. John, just switching over to the printing paper business. I notice in the industry data, it looks like imports in to the U.S. are going down this year and exports are going up. And I wondered if you could just help us understand how if you could just International Paper's white paper business is moving on both of those counts.

You are right the imports in to the U.S. are coming down, because there's continued growth in some these markets outside of North America. We manage our paper business now as the uncoated free sheet side of it as global business, particularly on cut size. So, you know, we'll make decisions to make paper in Brazil and ship to Europe and ship it to North America-- depending on, you know, what gives us the best margins, and the lowest costs. The -- you know, there's been some capacity rationalization in Europe on the uncoated free sheet side, less capacity there looking for market. I think the important thing to really understand is the markets outside of North America are growing, and there hasn't been a lot of paper capacity wad the exception of non-integrated paper capacity in China.

I guess what I'm trying to figure out is are you actually however, importing more this year in to the U.S. because you've got the Brazilian operation.

The Brazilian operation is importing about the same, I think.

It's just a different brand and different channel, Mark, but it's about the same level --

80,000 tons?

60,000

Last question I had, John, and it gets to the issue of Sun. It seems like when we look at many of the new projects that are going in, particularly in Asia, the unit capital cost seems lower than what we would have assumed maybe 10 or 15 years ago.

Assume forever.

Yes. Is there something structural going on here? And you know, what are all of the implications of that.

Well, the Chinese model for construction in some cases is not true -- I think with every paper machine you look at, is very different than the U.S. So engineering might be 1% of project costs not 10% of project costs. If you don't -- you can guy narrower machines at 40% of the cost of the biggest, fastest, widest one. We have taken some of that learning and used it in Brazil on our Topaz project. which is is one reason we didn't put a one in there. We have also taken some of those learnings back to Pensacola on specifications for things like valves. But the speed of which the Chinese are available to build these fall facilities and they build them and they operate for more than a year. They may not operate for 50 years, but they don't need to operate that long. So you see the same thing true if you look at chemical plants and some assembly operations, the capital cost will be -- can be 30 to 40% of what it is in Europe or the United States.

Okay. All right. Thanks that's very helpful.

Your final question today comes from Richard Skidmore with Goldman Sachs.

Good morning, John. Just a couple of quick questions on the paper business primarily. Was the decline in the U.S. just related to Pensacola, or was there lost volume because you were firm on pricing.

No, it's pretty much Pensacola.

And seasonal- is that something else? And can you just reconcile the growth that you are talking about in Europe with the volumes being done.

Those are mostly, Rich, the maintenance outages.

Okay. And then just lastly, the Wall Street journal had the article about Xerox and a bit of uncoated being able to have better printing qualm quotients that paper. Can you talk about what your marketing people might be saying about that particular product and the impact it might have on your U.S. paper business?

The uncoated ground wood segment in the low-end commercial print like for free-standing inserts in newspapers and magazines, that's -- they have got about -- oh, it's 700,000 ton position in the uncoated free sheet market that's 12 to 13 million tons. Most of that market is sensitive to conversion. In other words where that paper is fit for use, we think it has been converted.

Okay. So you wouldn't expect it to have much of an impact?

Not much on an incremental impact. I think one of the points that's worth stating, when we look at uncoated free shipments and not looking at -- 70,000 tons of ground wood containing product that's going in to commercial printing. So the commercial printing market is probably a little bit healthier than one might think if you just look at uncoated free sheet shipments to that segment because of the ground wood product.

Thank you, John. Appreciate it.

Ladies and gentlemen, we have reached the end of the allotted time for the question-and-answer session. I would now like to turn the call back over to management for close remarks.

Thanks, Operator, and as usual investor relations is ready to take any additional calls after this call, and thank you for your participation today.

Ladies and gentlemen, this concludes