International Paper Co (IP) 2008 Q2 法說會逐字稿

Good morning. My name is Crystelle and I will be your conference operator today. At this time, I would like to welcome everyone to the International Paper second quarter 2008 earnings call.

All lines have been placed on mute to prevent any background noise. After the speaker's remarks there will be a question-and-answer session. (OPERATOR INSTRUCTIONS) I would now like to turn the call over to Tom Cleves, Vice President of Investor Relations. Please go ahead.

Thank you, Crystelle. Good morning, everyone, and thanks for joining International Paper's second quarter 2008 earnings conference call. This call is also being webcast. Our key speakers this morning are Chairman and Chief Executive Officer John Faraci; and Senior Vice President and Chief Financial Officer Tim Nicholls.

During this call, we will make forward-looking statements that are subject to risks and uncertainties which are outlined on slide two of our earnings presentation and at the end of our press release. We will also present certain non-US GAAP financial information.

A reconciliation of those figures to US GAAP financial measures is available on our website at internationalpaper.com under Investors. Our website also contains copies of the second quarter earnings press release and today's presentation slides. I will now turn the call over to John Faraci.

Thanks, Tom. And good morning, everybody. Thanks for joining us. This morning Tim Nicholls and I will review our second quarter results and performance of the individual businesses.

We will also discuss our third quarter outlook including an update of our acquisition of Weyerhaeuser's packaging business which we expect to complete shortly. And then we will take your questions. So summing up the second quarter, I would say despite very tough market conditions we delivered solid results.

Total earnings per share increased 8% versus the second quarter of 2007 and by 37% versus the first quarter of 2008. Second quarter earnings from continuing operations before special charges were $0.56 a share. And we achieved these strong results despite input costs that increased by $0.34 a share since the second quarter of 2007.

Earnings from our operating businesses, that is businesses excluding forest resources, were $0.50 a share. Our strong second quarter results reflected strong mill operations around the world, good cost reduction and global balance. When I say that I mean earnings from our businesses outside North America.

Turning to the next slide here, if you look at this $0.56 a share it represents our second best quarter since 2000. And now I will ask Tim to comment on our results in more detail and I'll come back in a couple of minutes and talk about the outlook.

Thank you, John, and good morning, everyone. I'm on slide six. And if you look at the comparison of our second quarter results with the second quarter of 2007, we achieved improvements in price, cost and mix, but improvements were offset by the continuing increase of input costs. Corporate and other category includes $0.05 which was a favorable pension adjustment, or favorable pension expense, which reflects the benefit of our $1 billion pension contribution at the end of 2006.

The other item in there is the benefit of $0.02 from the sale of our Natchez Mill property. Ilim contributed $0.08 per share and Vicksburg reduced earnings by $0.02. During the third quarter we expect to begin receiving our business interruption payments from our insurance providers and that will offset the loss of Vicksburg profits.

Now let me turn to some of the factors that impacted earnings in the quarter. On slide seven we are showing sales revenue by operating business. All of the segments had increases in revenue with the exception of Forest Products and selling prices were higher in all businesses. Total sales revenue increased by about 10%.

Slide eight we show the breakout of input cost inflation that we typically show. And another large increase in the quarter, global input costs, increased by $211 million or $0.34 per share, as John mentioned, with Energy and Chemicals continuing to account for the large increases. But even looking at Freight, most of that is related to fuel surcharges and other fuel related costs. Comparing selling price increases to input costs looking at North America in 2006 and 2007, our price increases exceeded input cost escalation.

However, we have fallen behind in the first six months of 2008 as input costs are rising at a faster rate. And just looking at the businesses, Printing Papers, prices are nearly keeping pace with input costs but inflation is lagging behind.

So with that, let me turn to the business segments themselves and I will start with Printing Papers on slide 10 where you see earning increased by $38 million despite the $119 million increase in input cost. Prices increased by $95 million and operating cost improvements in the US, Brazil and Europe added to $51 million. And a big portion of this is related to the fact that we've now taken out our high cost capacity in North America by shifting it to liner board production and pulp production. North American Printing Papers earnings improved by $32 million.

Slide 11, just showing a little bit more data on the segment's earnings and relative to the second quarter 2007 earnings increased by 20% and margins increased to 12.6% of sales. North American Paper volumes, of course, were down. A big part of this was selecting the conversion of the Pensacola Mill to liner board production, and the conversion of our Louisiana Mill to market pulp, but also impacted by the sluggish demand given the weak US economy.

Market pulp volumes increased reflecting the conversion of the Louisiana Mill again, but also reflecting our volume increases at Riegelwood. And year-over-year our prices increased in all of the global regions with the significant increase in North America.

Turning to Industrial Packaging, from slide 12, highlights the year-over-year Industrial Packaging earnings which decreased by $21 million. We did have improvements in price, volume, cost mix which totaled $66 million, but these were largely offset by $57 million of input cost increases. The $28 million improvement in cost mix includes the positive year-over-year impact of $13 million in one-time costs at Pensacola during the second quarter of last year.

We had increased maintenance outages and that reduced earnings by $21 million. However, it was a little bit better than what we had projected as we took an abbreviated outage at one of our mills as a reaction to the Vicksburg explosion. And Vicksburg did impact us by $15 million.

Through June Industrial Packaging is, in terms of outages, has already completed 80% of the planned outages for this year. And if you look at the earnings and normalize for outage expense across the year, and also add back the Vicksburg expense, we feel pretty good about performance. We would have posted year-over-year earnings that were slightly improved.

Industrial Packaging margins decreased as a result of not being able to keep up with the input cost inflation. Volumes declined slightly in North America for boxes. European container volumes also declined due to a combination of both weak industrial demand and also a weaker than normal fruit and vegetable harvest. However, our board and box prices increased in all of our regions.

Consumer Packaging relative to the second quarter earnings declined by $4 million. Coated paperboard and food service earnings declined as, again, input costs ate into margins. Consumer Packaging did absorb $38 million in input cost inflation which looks like an inordinate amount but we did suffer from higher wood costs at our Texarkana Mill, energy-related costs at Riegelwood and heavy use of chemicals for bleaching and coating.

Polyethylene prices have increased significantly during the quarter. And Shorewood's results improved but the division still posted a loss for the quarter, so still work to do there. On slide 15, highlights US coated paperboard volumes that grew slightly and prices increased, but, again, not enough to overcome the inflation that the business experienced.

On slide 16 I will turn to xpedx where we are showing a sales revenue increase relative to second quarter of last year. But sales volumes in commercial printing and packaging declined reflecting the weakening US economy especially in the financial sector. Sales volumes for facility supplies increased by 2%.

And, again, even in xpedx we're facing cost pressure related to fuel and freight costs and we've experienced about a $1.5 million per month in increased operating costs. On the next slide, just to share a little bit more about xpedx, while a lot of the paper distribution channels are struggling with slow growth in the traditional commercial printing markets, xpedx has been successful in increasing its sales revenue with a diverse offering of printing, packaging and facility supplies.

Xpedx is a market leader paper merchant in North America and continues to pick up market share. Commercial printers primarily use coated free sheet and while the industry demand for coated free sheet has declined by 11% in the first half, xpedx has increased its shipments by 3%. Despite the weak US economy on commercial printing volumes, xpedx continues to win customers and to increase its overall sales.

Forest Products, again, the focus here is to continue maximizing value. We show that year-over-year Forest Products' earnings decreased by $53 million reflecting the changes in volume and mix of the land that we currently hold versus what we had last year. During the quarter, though, we did continue to sell our land at or above the original appraised values per acre.

With that let me turn to some of our international operations. I would like to start with Asia. You know, we are building new capabilities in Asia. And our investments in China are going to allow us to capitalize on a high demand growth market where margins tend to be lower, but we also benefit from very low capital cost. For instance, we just completed the construction of a world class coated paperboard machine at a dramatically lower cost than what it would have cost to build it just about anywhere else in the world.

And if you turn to slide 20, you can see pictures of the facility. This is a 420,000-ton machine which has started up. It's been running for a couple of weeks now. The machine was from start to finish built in just over a year's time.

And even in the first two weeks of start-up we have already had 1,000-ton day which would be 100% of the ramp curve and A-1 production. So a great story here. During the quarter, we also had the start-up of a new box plant and also a folding carton plant in China.

Our Ilim Joint Venture had a very good quarter. Their first quarter earnings, $32 million, reported in our second quarter was $0.08 per share. This did include a $14 million after tax foreign exchange gain and also a $3 million after tax charge to write-off a share repurchase option.

Relative to the quarter, Ilim benefited from increased paper and containerboard volumes, steady pulp volumes and prices that were increasing in both domestic and export markets. However, Ilim is facing the same input cost increases that are being experienced in other parts of the world and they showed higher costs for wood, chemicals, energy and freight which were partially offset by very good manufacturing operations.

So we, just as a reminder, we continue to report Ilim's earnings on a one quarter lag and we will be reporting their second quarter earnings in our third quarter numbers. And we expect a decline of some significance since they had extended maintenance outages in their second quarter at the mills. And also we don't expect the foreign exchange benefit to repeat. So earnings are going to be lumpy quarter-to-quarter, but we expect solid earnings for the full year.

One other item related to Ilim, during the quarter Ilim did sign an agreement to sell its share its share of a waste paperboard mill to Knauf, which is its joint venture partner in that mill. This is a 220,000-ton per year mill that manufacturers folding box board and wall paperboard. And we are expecting, or they are expecting, the transaction to close in the third quarter.

This mill really was not part of our reason for investing in the joint venture and really not strategic to the business plans, so after the divestiture we will expect Ilim to continue concentrating on the core businesses of market pulp, industrial packaging and paper.

With that I will turn to cash flow. On slide 23, cash flow for the quarter increased three-fold from the second quarter of 2007. We saw changes in the working capital components, accounts receivable, inventory payables that were significantly more favorable in 2008, reflecting improved working capital management. In fact, year-over-year, our operating working capital as a percent of sales improved by 70 basis points.

So looking at the first six months of this year, input costs are a big part of the story and we've experienced about $380 million in increased costs, which has decreased our earnings by $0.60 per share for the first half of 2008. Increased energy costs account for the majority of it. Prices for oil and natural gas, coal have increased our costs directly, but energy costs are also indirectly driving cost increases for wood and for chemicals.

Even with that, we had a solid first half as we increased our profits by $0.20 per share excluding Forest Products. We felt like we had a good solid quarter and a solid first half of the year.

With that I will shift from earnings to giving you a bit of an update on the Weyerhaeuser acquisition. Right now we are on schedule to close the transaction early next month. We have got the management team in place right down to the facility level and they are ready to start executing on day one. Having worked with the integration teams over the past four months, we are even more confident now in our ability to generate synergies at a faster pace than originally planned.

The acquisition in 2008 is going to be slightly dilutive to our earnings, but we are expecting that cash flow will be positive this year. We will start to also enjoy the reduced cash taxes immediately in 2008. If you recall, this is the tax benefit that we had estimated a net present value of $1.4 billion as we step up the assets because of the nature of the transaction being an asset sell.

On the next page, just to cover the financing plan, when we announced the acquisition, we talked about $2 billion of five-year term loan and a $4 billion 18-month bridge. And since the announcement, we've been able to have a very successful bank syndication. So we are now increasing the five-year term from $2 billion to $2.5 billion.

We also issued $3 billion in bonds in late May and we are expecting that we will bring about $500 million in cash and short-term debt to the close. During the third quarter, we expect that we will repay the short-term debt. And we are also thinking that we will be able to deleverage some of the incremental debt more quickly than we had originally forecasted.

On slide 28. Just to give you a few financial statistics here. Based on the work that we have already completed we are expecting the acquisition to dilute our earnings this year, as I mentioned, but to be cash flow positive. And we are expecting about $50 million in merging benefits by the end of the year.

It will cost us $80 million in one-time integration costs this year to achieve those. And there is also a $35 million non-cash charge related to the write-up of the inventory at the acquisition date. Interest expense is expected to be incrementally higher of $160 million to $180 million. But feel very good about where we are with the team and the forecast for the back half of the year.

Separate from the $400 million in synergies that we have talked about, if you recall we had $400 million in synergies identified by the end of year three on a run rate basis. We are also targeting other improvements in the Company and we were expecting by 2010 to reduce overhead by somewhere between $150 million and $200 million. So we aren't just focusing on Weyerhaeuser. We are focusing on other opportunities around the Company.

So with that I will turn it back over to John and he will wrap up with the outlook for the third quarter.

Thanks, Tim. For those of you following along I am now on slide 29. Just looking ahead and talking about the third quarter for a minute, I anticipate that we are going to continue to face a challenging environment. No question about it. We expect some continuing escalation of input costs especially for wood, chemicals and freight.

We also expect energy costs to remain high during the quarter. And we will manage our capacity to meet our customers' needs and manage pricing to stay ahead of this input cost escalation, which we think is going to be with us for awhile.

With respect to pricing in the third quarter, we expect prices for uncoated free sheet, coated paperboard, containerboard and corrugated boxes to increase as we continue to realize our announced price increases.

But we don't expect the full benefit of the price increases until the fourth quarter. So in essence, we are still looking at a margin squeeze. We do expect volume for printing papers to remain similar to the second quarter levels. We could see a slight seasonal lift, but at this point in time that's not what we are expecting. Demand for market pulp is expected to increase and we expect demand for containerboard and boxes to be basically flat with where it's been.

Our third quarter earnings will reflect a significant decrease in our North American maintenance outages and a $15 million increase in outages in our European papers operations. So despite the anticipated price improvements which are coming we expect third quarter earnings from our operating businesses, that is excluding Forest Resources, to be less than second quarter as input costs are still going to outpace price increases and I think that will be the case as we get into the fourth quarter.

Now let me give you a separate outlook or update on our outlook for Forest Resources earnings. We had signed an agreement to sell certain mineral rights on land in Louisiana, it's called part of the Hanesville Shale, that's the name that it goes by, for about $260 million. These are mineral rights that we have retained on land that we sold earlier.

We expect to close this transaction in the third quarter. At the end of the second quarter our Forest Products portfolio includes 270,000 acres of land and some oil and gas rights with a total net present value of $675 million to $775 million. That range includes the sale I just spoke to.

So with this Hanesville sale we now expect 2008 Forest Products earnings to be in the $350 million to $400 million range. Obviously, those increased earnings will enable us to pay down the acquisition debt faster than we anticipated.

So let me just sum up before I take your questions. Despite a very tough market environment, especially in North America, International Paper delivered solid results. We experienced unprecedented input cost increases and a weakening US economy at the same time. But despite that we increased our earnings by 8% versus the second quarter and 37% versus the first quarter of this year.

We achieved those earnings despite input costs that increased our costs by $0.34 a share compared to the second quarter last year. We've announced price increases for all of our major products in order to offset the input cost inflation over the balance of the year.

Our strong second quarter results reflect reduced mill operating costs and the benefit of our global operations which Tim talked about. We are cautious about the third quarter. We are increasing prices for all of our products. As I said earlier, I don't think we will realize the full benefit of these increases until we get to the fourth quarter.

Over the last couple weeks, energy costs have moderated, if you can call $125 a barrel of oil moderating, but we were very uncertain which direction these are going to go going forward. We expect chemical costs and wood costs to continue to increase.

Even if input costs remain high, we will be able to regain our margins but probably not until the fourth quarter. Now let's turn it back to Tom and we'll open up the session for questions and answers.

Thanks, John. Crystelle, we are now ready to entertain questions.

Thank you, sir. (OPERATOR INSTRUCTIONS) We will pause for a moment to compile the Q&A roster. Your first question comes from the line of Chip Dillon with Citi.

Yes, good morning. And congratulations on a nice quarter. As we look ahead, my first question has to do with the forest land that you still have left. And also with the mineral rights.

John, did you have any idea like a year or two ago that you had this kind of value? Or this is something that's kind of come up more recently in terms of what people would pay for them?

Then secondly, I'm sort of calculating that you have about $400 million to $500 million left. Is it still a good guess to assume you will get that realized, that is in income in forest lands, over the next three years assuming the demand is there?

Well, Chip, we knew we had mineral rights and the reason we held back at roughly half a million acres that wasn't straight commercial timberland is we knew there were values there that were beyond straight commercial timberland. Some of it in the land and some of it in the mineral rights which we knew we had.

To be honest with you, the price we got for those rights were substantially better than we would have gotten had we sold them earlier in the year. Transactions have gone from $1,000 an acre up to $20,000 an acre and we are at the high end of that. Our timing was good and that's why we kept some of the land and some of the mineral rights out of the large sale that we did a year or so ago.

In terms of the remaining portfolio, the objective here is to maximize the value. We will monetize it very quickly if we think that's the way to maximize the value or we'll monetize it slower if that's what gives us the best values.

The land that we continue to hold is not commercial timberland and it's not all what I would call conventional real estate development land. It's a mix and we have been getting sales at prices that have been above appraisal. We just haven't been selling very much of it.

Got it. Now second question quickly is, we have seen natural gas prices drop about 25% in the last month. And I certainly can appreciate your caution for the third quarter.

Are you building in this drop, recent drop, in energy prices and how that might impact your chemical and freight as well in the third quarter? Or is your forecast more based on where we saw prices a few weeks ago?

We do hedge our gas purchases kind of on a rolling basis. We are going to get the benefit of lower gas prices if they stick around for a bit in terms of our hedge strategy. But we aren't reforecasting -- we aren't smart enough, Chip, to figure out what's happening to energy prices and the flow-on effect.

They are a lot higher than we anticipated when we put together our operating plan last November. What we are telling everybody in the Company is assume they will be high. And we'd love to be surprised on the upside, the upside being that they go lower.

Got you. And last question. You didn't have this table in this quarter because maybe things are kind of moving around. But could you give us your best guess as to what the tax rate will be the third quarter and maybe for the year and then update on where you might see depreciation for both -- and Cap Ex for both this year and next year?

Chip, hi, it is Tim. The tax rate we are still estimating between 32%, 33% for the year. Capital, we've said that we are -- this is for IP stand alone, not including Weyerhaeuser -- that we would be around $1 billion for the year. Depreciation about $1.1 billion. It's really too early to start estimating or giving out a lot of forecast on what Weyerhaeuser is going to do to that, but we will update it in the third quarter.

Your next question comes from the line of Claudia Hueston with JPMorgan.

Hi. I was hoping you could just talk a little bit more about the Industrial Packaging business. The results there were very strong. Can you just talk a little bit about what drove the strength there?

You want to comment on that?

Sure. Well, volumes held up reasonably well even though we had the strong, softening economy. We also had good mill performance. And as I mentioned in my comments, even though it was down from last year, and we did take a little bit less in terms of maintenance outages, when you normalize for the Vicksburg impact and maintenance outages it was very strong.

We had weaker volumes in Europe, but margins improved. And increased box pricing in both the US and Europe.

Claudia, I would just add to that all around our North American businesses, what we saw in the second quarter was a lot of cost reduction efforts getting to the bottom line.

And there are things we have been working on that are longer term and they are also some short-term things we asked the organization to kind of call belt tighten and all that stuff started to show up.

Do you think there still is more room to go from here just on sort of the legacy IP business in that regard?

Absolutely. As Tim said, we obviously have Weyerhaeuser coming in, so we are going to get the merger benefits associated with that, and as Tim said, probably more faster. But beyond that in kind of the rest of International Paper we are looking to take another $150 million to $200 million of S&A costs out over the next 12 to 18 months.

We will doing that, not in one day, but we will be doing it kind of as we are ready all around the businesses at IP, both domestically and internationally. But a lot of it will be here in North America.

And Claudia, if you look to the back half of this year, the business has already taken 80% of the outages they had scheduled for the year. So that's going to help the second half of the year.

Plus, we will get recovery on business interruption starting in the third quarter. There is, not only in terms of the performance business in the second quarter but going forward there should be a little bit of upside there.

Thanks. That's helpful. Then just quickly on the corporate expense. Is there any guidance for that either for just IP stand alone or for IP plus Weyerhaeuser?

Not from the standpoint of IP plus Weyerhaeuser yet. Corporate expense in the second quarter was flat with the first quarter.

Is that a good run rate to use going forward?

Yes, I think it's in the range that we said. It was $21 million in the quarter or $21 million in the first quarter, and I think that's consistent with the range that we had provided before.

Your next question comes from the line of Mark Wilde with Deutsche Bank.

I wondered if we could dig in a little bit on Consumer Packaging. And you could give us sort of some sense of kind of how the mill versus the converting sides of that business are working?

Well, let me talk about the mills. There are three mills in the Consumer Packaging business, Riegelwood, Augusta and Texarkana. Texarkana is running very well. Riegelwood had a good quarter.

Augusta had a bunch of operating problems. The real issue in Consumer Packaging -- that is the bleachboard business -- the mill side of it is our costs are going up more than our prices are. And we are working on that account by account.

Industrial Packaging and Consumer Packaging had the big margin squeezes in North America when you look at price versus cost. We are making progress on those and we have got to deal with them one customer at a time.

Okay. John, over in the Industrial Packaging area, is it possible to give us some sense of what the Vicksburg restart looks like right now?

We are looking at the fourth quarter.

Do you know when in the fourth quarter?

No, we don't. That's just going to depend on timing. We have got materials ordered, labor scheduled and we are mobilizing to get that done.

And I noticed you haven't put out a date yet on the Weyerhaeuser closing. I'm just curious, once the deal does close, will you be able to talk with us a little more clearly about sort of plans for the business and plans for the integration going forward? Or should we just wait to see kind of how that rolls out through press releases and things?

We will announce the Weyerhaeuser closing when it occurs and we expect that to be early next month. And early next month is just around the corner since today is the last day of the month.

And I think what we will do is on our third quarter release which [will be at] the end of October, the 31st, Carol Roberts will be here, and we will give you as deep a dive as we can give you into Weyerhaeuser based on the first couple months of operation.

Would you say, John, just because the backdrop looks more difficult from an economic standpoint than it did when you announced the deal that you are more inclined to take action sooner rather than later as you integrate these businesses?

That's really not the reason, Mark. Though you are right, the economic environment is worse. Though looking at the GDP numbers this morning it actually feels to us like it's not a 1.9% GDP growth quarter. Really the fact that we can move faster is the integration planning we have done.

We have all of the management named right down to the facility managers. And as you know in this business you want good alignment because it's a decentralized business when you get out to the box plants. And people know what their jobs are. There is no uncertainty.

We've announced the leadership team. We've named a Weyerhaeuser employee, an officer of the Company, he's going to run a big chunk of the box business. It's the planning we have done, both on the mill side and box side, that gives us the confidence that we can get more faster.

Okay. And final question, anything that you can tell us about freight and fuel surcharges that you were looking at in the business? I think you had an invoice charge over at xpedx. I don't know whether that is stuck. I don't know whether you are doing anything in the manufacturing businesses to try to recoup transport costs?

It's account by account, business by business. We are not as successful as getting the surcharges in as our suppliers are at getting surcharges into us. We've got some freight caps, but our pricing practices really don't work in high inflation. One of the lessons we've learned is we are going back and rethinking how we are doing pricing -- again, very aggressively. In some businesses we are moving faster because the pricing decisions that we used to make don't work in a high inflation environment.

Well, listen. Good luck with Weyerhaeuser.

Can't wait to give you an update on it in a couple months.

Your next question comes from the line of Gail Glazerman with UBS.

Going back to Industrial Packaging, can you talk a little bit about the sequential price improvement you had and just give a sense of how much of that would just be normal seasonal mix versus maybe something related to how you shifted your business to cope with Vicksburg?

If you look at slide -- I think it is 13, Gail, we really didn't get much price at all in North America. Most of what you are looking at there, that $2 a ton on board and $5 a ton on containers is going to be mix. So our prices, the way I think about them is they were flat quarter-to-quarter and input costs went up $21 million.

So we have announced a price increase to our customers. And that will flow in a little bit in the third quarter but most of it will flow into the fourth quarter. We were behind the curve on Industrial Packaging.

I know you are behind the curve. I was just wondering if there was anything sustainable in terms of mix improvement.

Just another question looking at the slides in the back on wood costs. There is a pretty steep trajectory, I guess, in the last data point. I'm just wondering is that really just diesel or is there something going on with the underlying cost of the wood?

No, it's mostly transportation driven, Gail, by two things. Lack of chips because of what's happening in the housing market. We are having to go further for our wood because we don't have the chips available to us that we were getting, and fuel surcharges. With diesel over $5, wherever it is today, our surcharges start in the low 2's.

And harvesting costs --.

Which impacts harvesting costs and transportation.

Okay. Just last question, if you can give a little more color on demand both in terms of Industrial Packaging and uncoated free sheet. I mean in uncoated free sheet the reported data has been very, I guess, choppy at best. I'm just wondering if you could help us figure out what the real timeline might be?

The real timeline. If I knew that, Gail, it will be out there on our website. We are down 5% year to date, the industry. The AFT, I think, just updated the statistics. We couldn't figure out how 7 was working when we looked at our business. I would ask Tom Kadien who is here, and he's right in the middle of commercial printing kind of all around the country, to talk about what he sees with customers because it does vary market to market and customer to customer.

Yes, I think that commercial printing is still weak. And I would put it all together and say call it printing and writing, including coated and uncoated, but we are seeing, I'll say, a flat spot in the market.

It has not gotten worse from where it was in May and June. July is not a month where you will see anything get better either. It's kind of a weak market out there in print and office supplies.

If you look at the segments, Gail, offset, envelope, forms, imaging, they are all down about the same amount. There's nothing that's positive and something down double digits. Our box business, again, it is segment by segment. We were up a little bit quarter-to-quarter, 2%.

The industry is down and I think that goes back to the mix of durables and non-durables and whose customers are winning in the marketplace.

We have got some customers we are growing with even though the market is down because they are growing their business. And no question the weak dollar, or the dollar is helping some of our customers who are much more export competitive, which when we are lined up with the right customers and have the business, that helps on the demand side.

But fundamentally it all feels like a very, very weak economy coupled with high inflation.

Okay, but similar to the comment about flat in printing and writing, is the trend relatively a stable -- weak trend, but stable, or are you seeing any acceleration?

We've got summer which is slow. We've got back-to-school which may be a bit of a lift. The elections are going to happen but -- that usually supports paper demand.

But nothing enough for us to say we will see improvement. We just see a continuation of the trends we have been living with since about April. The first part of the year started off a little stronger and then it got progressively softer as the economy got softer and that's kind of where we are.

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

Good morning, George.

Hey, guys. Very good quarter. Congratulations on it.

I guess the first quarter more of a nit type of question. The one-time costs associated with Weyerhaeuser, I think you said $50 million or so, will that largely hit third quarter or fourth quarter or will it be spread pretty evenly as we try to model out?

Hey, George, it's Tim. It's going to be a bit lumpy. It's not $50 million, we were expecting $50 million in merger benefits this year. It's $80 million. And it's a variety of things. I think it is going to depend as we close on the transaction and get in and start implementing, we will be dealing with a number of factors. I'm not comfortable splitting that out at this point between the third and the fourth quarter.

That's fine, that's fine. You mentioned that with Weyerhaeuser implied the synergies look to be in line or better than you expected. And you clearly -- it sounds like you are more enthusiastic with the transaction. What have you found, if you can share some of that detail?

I know we will have to wait until October 31 to get more of the detail. But what have you found thus far that is incrementally a bit better than perhaps what you would have even expected?

We think we have gotten the organizations organized and defined quicker than we thought. Everybody knows their jobs, so we were able to make all the changes that we thought might take several months to make, make them faster. Weyerhaeuser has some good facilities and some good operations.

We never thought we were going to have to go in for a fix it up type thing. But we also found some things that I think were going to benefit International Paper. The [KBR] boiler project, they are doing. We see some upside in that in terms of capabilities going forward.

But I think rather than right now, George, and think about the merger benefits are going to be bigger, we are thinking they are going to be faster. And we are going to try to make them bigger, but I think the news here is when we said the $400 million, we had it -- I think we had $175 million in the first year. And usually those things, not much happens for the first couple months. We are going to get out of the chute faster than we thought. That's the good news which makes Weyerhaeuser positive cash flow, as Tim said.

The other thing that helps us is the Weyerhaeuser people are pretty darn enthusiastic about their packaging business becoming part of International Paper's. I think from our previous experience that is a huge plus. We have everybody wanting to row the boat the same way day one.

It's nice to be loved. And, John, is any of that shared learning, if you want to call it that, part of the incremental IP reduction you are talking about by 2010, or is that really separate and away?

That's just -- of the $400 million of merger benefits associated with Weyerhaeuser, about $200 million of that, and that's rounding here to make it simple, about $200 million of that is costs that is going to come out of S&A. Some out of Weyerhaeuser and some out of IP, just depending on how we do it.

Over and above that, we are looking at our cost structure even if Weyerhaeuser wasn't happening to get another $150 million to $200 million. And some of that will happen through attrition.

Some of it is actually happening now in different businesses. But we were committed to taking out some additional costs over and above the merger benefits.

All right. Last question and I will turn it over. Switching gears to uncoated free sheet -- within papers you are doing a terrific job in managing the decline and raising prices to offset inflation.

Is there a demand environment, either a magnitude of decline or a greater than expected sustained period of decline that would begin to test your overall thesis regarding uncoated free sheet -- within North America here I'm speaking -- and your strategy? Thanks, guys. Good luck in the quarter.

I'm just not going to speculate on how that would play out, George. We are committed to balancing our capacity with our demand. We think we now have low cost assets which we should run, but we are going to balance supply and demand for our customers' demand. And so far that's working out. I don't want to forecast what we do if. We will wait to see what if is, and then we will respond to it.

Your next question comes from the line of Peter Ruschmeier with Lehman Brothers.

Congratulations on a very good quarter. Maybe a question for Tim, if I could. For raw materials, I believe that you are using primarily LIFO accounting. But can you remind us roughly what the split is between FIFO, LIFO on your inputs?

Off the top of my head, Pete, no.

We have some other experts sitting around the table here, maybe --.

We have our Chief Accounting Officer sitting here with us, Pete. I suspect he is willing to say something on it.

Principally the raw materials and work in process in finished goods in our North American operations are on a LIFO basis, whereas the non-US operations are on a different FIFO cost basis.

Okay. That's helpful. And then, John, I was curious if you could share a view that you may have on whether Russia will implement the export duties on logs. If so, how will this affect Ilim, if at all, going forward?

Whatever they do it can only be positive. It can't be a negative because we are both in the Ilim Joint Venture and in our 100%-owned IP, or almost 100%-owned IP operations we are processing all of the fiber in Russia and then shipping the product. Not shipping any fiber outside of the country where you process.

Russia announced a set of log import duties, or wood import duties with export duties that go up significantly. And those are being negotiated with the affected countries right now. I think it is more of an issue in Scandinavia than it might be in China. But wherever -- regardless of how that plays out, it can't be anything but a positive for us.

And we are also, Ilim has moved ahead and started to apply capital to some of its forestry operations which would substantially reduce their wood costs because these are infrastructure and equipment related investments which will lower wood costs significantly.

You know, Pete, just to add on to that, this is all designed, of course, to increase investment in Russia for adding value to fiber. Probably the most likely types of investments first out will be on the wood product side.

If you think about saw mills and plywood increasing residual chip availability, it's a good thing for the paper and pulp mills as well.

And I guess on a related point, can you provide an update on the timing and amount of the various growth initiatives of Ilim? Do you have much of a time frame yet for the pulp and packaging expansions going forward?

Well, I think Ilim has announced, because they've had the opening ceremony -- they just opened a box plant which was part of the strategy to expand the Industrial Packaging business. They are working on the business plan, that the Ilim Board is involved with. CapEx in 2008 is going to be about $350 million for Ilim, which is far and away more than they have spent before and they are working through that now.

A big chunk of that on the forestry side to upgrade harvesting capabilities.

Your next question comes from the line of Mark Weintraub with Buckingham Research.

Thank you, and also congrats on a solid quarter in a challenging economy. Just quickly following up on the Russia, do you truck much of your product through Finland?

You mean -- most of what we produce in Russia at Svetogorsk is sold in Russia. I think we may sell a little bit in the Ukraine, but it's CIF country (multiple speakers).

So you're not trucking a lot through Finland?

No. The border is about three miles west of where our mill is.

Second, on the Weyerhaeuser acquisition, I guess one of the things that really captures my attention is that it can generate a lot more free cash than earnings in the year ahead.

It got our attention too.

Right. Can you help us a little bit better to understand the spreads between where cash taxes and book taxes will be? And also to the extent you can give us more color on cap spending needs for the Weyerhaeuser business versus the DD&A?

What we've said is that for 2009 our capital spending will be $1 billion which will include the incremental spending for Weyerhaeuser. So if you think about $200 million -- $200 million to $250 million for Weyerhaeuser and the rest of the Company being around the $800 million level.

I don't want to provide a forecast looking out at this point, but what we've said is the big benefit is in the tax [shell] getting a step up on the assets. But we think it's a very powerful cash flow story.

And the book DD&A for the Weyerhaeuser business, is that close to $500 million?

Yes. Right around that.

Okay. Can you -- are you willing to [guesstimate] what cash -- the cash tax rate for the overall Company might be next year?

No, not yet.

Okay. Fair enough. And then lastly on the mineral rights, what you were selling here to Chesapeake, was that land that you owned or is that from land which you had previously sold but you held on to the subsurface mineral rights?

It's land that we previously owned. We sold and we held on to the subsurface mineral rights.

And when you listed in that slide the net present value, et cetera, of your land and mineral right holdings, was that just for land that you owned or did that also include your view on potential value for mineral rights that you still hold from lands that you had sold?

It is what you said, Mark. It includes the land plus the value of the mineral rights that we have on that land, including the transaction that we anticipate will close in the third quarter with Chesapeake Energy Corporation.

Your next question comes from the line of Steve Chercover with Davidson.

Thank you. First of all, still on free sheet, the improvement we saw in June, is there any chance there was some prebuying? Do you have any opinion on that?

There's no question there was some prebuying. Tom Kadien is shaking his head here, he probably did some of that.

Okay. And can you give us a status of those machines that are under construction in Brazil?

Well, there's one machine, start-up is planned for February. There's one machine and right on schedule. The really good news is we are seeing really strong growth in the Latin America market, both in Brazil and in the surrounding countries.

Growing our volume in the region, which that is what that machine was built to do is to serve the region. As the Brazilian economy grows, consecutively now for a couple years, you will see less and less of that capacity go outside the region.

That would be nice. (inaudible).

And the machine that is under construction in China, as Tim said, it started up last week a couple months ahead of schedule. And we are already making close to production quantities of bleachboard. Again, almost all of that product is going to be sold in the local market.

So that will be a little bit of accretion for the current quarter and then ramping from there?

Yes. Capital is already in the ground. And the story in Asia is the margins aren't as good if you look at return on sales, but the capital you need to invest to get a dollar of revenue is 30% to 40% of what it is here in North America or in Brazil.

Okay, and switching gears kind of a follow on to Mark Weintraub's question, the minerals rights that you just sold to Chesapeake apparently went up almost 20-fold in the last year. But I'm not sure that your NPV for all of the land changed all that much. Could there be some incremental value elsewhere? Or did something change that you got a lot more for the mineral rights, and yet the NPV didn't change that much?

In our view of the land values it is down a little bit, and our view is the mineral value obviously is way up. And, as I said, we aren't selling land below our appraised prices. We are just selling less of it. We are being very selective here about how we go at this. But I would say the conservative way to look at this would be the mineral values have offset any leakage we've had in the land values.

Well, it is funny that you should say that. Why do you think the land values are going down? Is it because some of it is development land or because timber values are going down so people are doing an NPV, because I think some your other friends in REIT land haven't been talking that way.

Have what?

Haven't necessarily been saying that land values are going down.

Well, we can't speak to that because we sold all our land about a year and a half ago, and you know what price we sold it for. We aren't selling a lot of straight timberland.

I think hurdle rates or discount rates have gone up. What people are looking at if they will invest in land that's got some development potential, whether it's commercial or residential, down the road. The unique properties that we have that are adjacent to some land owner or recreation properties really are in a different market.

But I think to be conservative since we haven't banked all of the value yet because we have monetized at all, we are saying we still see about $1.5 billion of value in that whole portfolio which we talked to you about two years ago. And maybe there will be a little more, and maybe not, but we think that there certainly is some buffer to whatever happens on the real estate side with what's happened on the mineral rights and the energy side.

Okay, great. Last two questions on that front. Will you still be willing to crystallize the entire NPV today if the right bid came along? And are you seeing any friction from the people who would finance these transactions?

The answer to that is yes and no. Yes, we would, and, no, we haven't.

Thank you very much. Congratulations.

Your next question comes from the line of Richard Skidmore with Goldman Sachs.

Just a quick question on slide nine, which is the price cost slide. If you were to look at the end of 2008, and given what you've currently announced for price and your expectations for inflation, would you expect pricing cost to be in line at the end of the year or do you need some additional price to offset cost inflation?

Richard, it's Tim. I think you have to look at the different businesses. It would be closer on papers, be behind on packaging and probably need more price to catch up given the current view of input costs.

And just maybe to clarify on the paper side of things. Would you expect that you are closer to the cost inflation in paper in the third quarter given that the pricing was going in in June?

I'm sorry, Richard. Say that one more time?

I guess in just terms of the price cost for the printing papers business with the price increase that was announced and it being implemented in June, would you expect that in the third quarter you would be closer to in line with the inflation?

Yes.

Okay. Thank you.

Your last question comes from the line of Joshua Zaret with Longbow Research.

Thank you. I want to sort of look at what you are doing to lower your energy cost in terms of energy related projects. And I will ask that by -- the question I have is what percentage of your $1 billion CapEx this year is dedicated to energy related projects? And can you give us an example of your most potent project? And then going forward your CapEx goes down for the Weyerhaeuser business.

Will you be expanding that given the environment we are in? So if you can address that, please?

Well, it's probably a couple hundred million dollars over the last two years. Roughly say maybe 15% to 20% of our capital budget has been going to energy consumption reduction projects. They vary by mill. But what we are doing is we are working on substituting lower cost energy sources, but the best way to attack this is to reduce the BPUs per ton of paper made and we were down about 25% over the last couple of years. And Tim's just saying a little more than that.

The hurdle rate we're using on these projects is about 35%. So we are investing in ones that are very, very attractive with short paybacks. And we will be looking at the Weyerhaeuser mills to see if there are any opportunities to do that.

The fall off in capital spending for IP's base business before Weyerhaeuser is just a reflection of the conclusion of some of the strategic projects we've been investing in like the paper machine in Brazil and the board machine in China. We still have room for energy consumption reduction projects in our capital plan.

Is that something you see accelerating given the current environment?

We are going to continue to apply a high hurdle rate and a short payback on these things because I think you have to look at energy prices over the last five or six years and say they were volatile. No one thought they would go as low as they did go and certainly no one though, at least we didn't think they'd go as high as they currently are.

We aren't going to invest in sizable capital projects that have seven-year paybacks. We are going to do all of the ones that have short paybacks with very attractive returns first. And we have got a long list of those to work on. As we get into the Weyerhaeuser mills and their box plants, we will see what those opportunities are and try to pick off the low hanging fruit first.

I feel pretty good about our capital spending, Josh, in terms of being able to do the things we need to do to keep our facilities competitive, but also take advantage of some of the cost reduction opportunities. We aren't investing in North America to add any capacity. And as Tim said, our two capacity projects will be completed by the -- basically the end of this year.

Okay. And final question, there seems to be a jump in your intercompany pulp sales, where does that occur and what was the reason?

Say it again, Josh, I'm sorry?

There seems to be a jump in the quarter in your intercompany pulp sales and I was wondering where that was occurring and the reason?

I will follow-up with you, Josh. I'm not sure we know that level of detail, but I will find out and come back to you.

Okay, thank you.

Don't know.

You stumped the panel on the last question, Josh.

Okay, great. Thanks.

You're welcome. Thanks, everybody. This is Tom again. Crystelle, thanks for your help today. Ann-Marie, Emily and I will be available via phone for any follow-up questions. Thank you.

Thanks a lot.

This concludes today's conference call. You may now disconnect.