International Paper Co (IP) 2009 Q3 法說會逐字稿

Good morning, my name is Laurie, and I will be your conference operator. At this time, I would like to welcome everyone to the EDS International Paper third quarter 2009 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) Thank you.

I will now turn the call over to Tom Cleves, Vice President, Investor Relations. Please go ahead, sir.

Thank you, Laurie. Good morning everyone, and thanks for joining International Paper's third quarter 2009 earnings conference call. Our speakers today are John Faraci, Chairman and Chief Executive Officer and Tim Nicholls, Senior Vice President and Chief Financial Officer.

During this call, we will make forward-looking statements that are subject to risks and uncertainties. These are outlined on slide two of our presentation. We will also present certain non-US GAAP financial information. A reconciliation of those figures to US GAAP measures is available on our website. The website also contains copies of the third quarter 2009 earnings press release and today's presentation slides. Now I'll turn the call over to John Faraci.

Thanks, Tom, and good morning, everybody. Thanks for joining us this morning. Today, as our usual practice, in the next 20 to 30 minutes Tim and I are going to review our third quarter results with you and the performance of our individual businesses, and we'll also talk about our outlook for business ahead in the coming quarters. Once again, for the third consecutive quarter, International Paper delivered solid results during a quarter that is still very challenging market conditions, especially in North America. Despite the continuation of those weak economic conditions, though, we demonstrated that we can continue to perform well in a tough economic environment.

While demand is essentially flat, and here I'm talking North America, we expanded our margins and generated strong free cash flow which we used to accelerate our debt reduction efforts, and we reduced debt significantly during the quarter, which we'll touch on later. We increased our earnings from $0.20 a share in the second quarter to $0.37 a share in the third quarter. And for the first nine months of what I think we all would say was a tremendously challenging year, we increased our EBITDA margins over 2008 levels and generated nearly $1.3 billion of free cash flow.

These strong results, along with the addition of alternative fuel and tax credits which were not included in the numbers just referred to, enabled us to double the pace of our reduce debt reduction during the third quarter. Our operations continue to run very well, and we continue to make progress in taking costs out and getting those results of those cost reductions to the bottom line.

So slide five, if you're following the slides, contains third quarter summary. Sales were up slightly from second quarter levels at $5.9 billion but down sharply from the third quarter of last year which included six weeks of Weyerhaeuser 's packaging volume. EBITDA increased 13% from $729 million in the second quarter to $822 million in the third quarter, and EBITDA margins expanded by 800 basis points -- 80 basis points, excuse me. Free cash flow held healthy at $600 million, again, before alternative fuel credits and $1.3 billion of debt repayment occurred during the quarter while we maintained a $1.7 billion cash balance. What we feel very good about is through the first nine months of 2009, we generated $1.7 billion of free cash flow, again, before fuel credits, which is more than all of 2008.

Going back to EBITDA in slide six, despite industry demand remains well below 2008, again, mostly in North America we've continued to expand EBITDA margins in our operating businesses. Our year-to-date EBITDA margins are 12.1%, which is 150 basis points higher than our 2008 EBITDA margins. And if we set aside margins in xpedx, our distribution business, our EBIT margins improved 160 basis points to 16.4%. This improvement is basically driven by our ongoing restructuring and overhead cost reduction efforts and our success in systematic improvement to drive manufacturing efficiencies not only across our mill businesses globally, but all of our converting operations as well.

So turning to cash flow, we're generating strong free cash flow, and that remains one of our top priorities. And despite the continuing challenging economic conditions, our operations generated over $700 million in cash during the third quarter in addition to the cash received from the alternative fuel mixture credits. We continue to manage our working capital and to limit capital spending while spending capital on things that we need to to maintain our facilities. And all of this resulted in our second consecutive cash -- quarter of cash flow of nearly $1.3 billion. And it was this strong free cash flow that allowed us to make significant progress on debt reduction.

Slide eight shows our continued progress on this since we acquired the Weyerhaeuser packaging assets in August of last year. In the third quarter we reduced debt by an incremental $1.3 billion. Since we have completed the acquisition of Weyerhaeuser packaging business, we have reduced our debt by $3.1 billion. We remain committed to further strengthening our balance sheet and will continue agressive debt repayment in the near term. Matching our production to our customers' immediate needs remains the foundation of our strategy in our paper and packaging business here in North America. During the third quarter, we took more than 550,000 tons of lack of order downtime in North America which was in addition, almost 100,000 tons of maintenance downtime.

We also took more than 520,000 tons of downtime in our North American containerboard system, which is about 18% of our total capacity. We took 72,000 tons of downtime in our North American uncoated free sheet systems, or approximately 10% of our total capacity. We took 51,000 tons of total downtime in our North American coated paperboard system, or roughly 11% of our capacity. While our downtime in the third quarter was less than it had been in the second quarter by about 300,000 tons, domestic demand remained relatively flat. The increased paper and packaging export shipments really are the drivers of the reduction in downtime. What is significant on the at front is the containerboard export shipments have returned to levels stronger than we've seen in seven years. That, I think, is significant going forward and speaks to what is going on in terms of global demand. We continue to take significant amounts of lack of order downtime to manage our inventories and manage our margins because the cumulative cost of downtime is far less than a negative impact of chasing volume or building unneeded inventories which don't sell just because prices are different. We will continue to manage our production to meet our customers' immediate needs.

Since we're talking about lack of order downtime, I'd like to comment on last week's announcement concerning our permanent capacity closures. Demand in 2009 contracted far deeper and has lasted far longer than we thought it would. Given the severe declines, our views is that demand will come back, but it won't be all at once. And we know now that we've been running our systems, especially the new industrial packaging system, that we can product more volume with our existing mill footprint and as a result, we've made tough decisions to permanently close three facilities in North America. We certainly recognize closing these facilities creates significant hardships for our employees and its surrounding communities, especially where we've been, for a long time, a big factor in the local communities. And we are providing severance and other assistance to our employees. We'll shift manufacturing from Franklin, Virginia to our printing papers mill and the two industrial packaging mills, Pineville and Albany, to our remaining facilities and feel confident we can not only service our customers' existing needs and demands, but also their future needs, and reducing our manufacturing footprint will allow us to take out $170 million in fixed costs over time.

Before I give you an overview of the third quarter earnings and turn the call over to Tim, let me also make another point about managing and reducing costs. This slide here shows our headcount over the last several years. And over the last several years, we have had an aggressive systemic initiative throughout International Paper, not only in North America, but on a global basis to reduce headcount, which is about 20% of our cost structure.

All in since we began taking actions to really transform International Paper, our global headcount is down almost 30%, and this graph on slide 12 shows our progress in reducing the number of employees that we have in International Paper. Relative to the end of the second quarter, we've reduced the total number of employees by about 8,000, representing a 12% reduction in 12 months. We have already achieved our year-end goal of 58,000 employees and will continue to improve on this metric during the fourth quarter.

Slide 11 provides details on our third quarter earnings. This is the usual waterfall chart we show you every quarter. Earnings per share before special items were $0.37 a share in the third quarter, that's on the far right, compared today $0.20 a share in the second quarter on the far left. Increased volumes, which as I said was primarily due to exports, added $0.09 a share which was offset by $0.12 a share of lower selling prices. Input and operating costs were $0.06 favorable and were offset by some mix erosion, again, reflecting the impact of the increased exports which had lower margins. Lower maintenance outage expense, which we talked about in our second quarter call, increased earnings by $0.11 and a significant improvement in our Ilim equity earnings increased third quarter earnings by $0.07, and I will just remind you that Ilim is reporting on a one quarter lag, so what you are seeing there is their second quarter results.

So with that, I will turn it over to Tim for a discussion on the each of the businesses, and we will come back talk about the outlook later on.

Okay, thanks, John. Good morning, everyone. I will take you through segment performance today, and I guess I would make a summary statement up front and say, for the environment that we are in, we had really solid performance across all of the business segments in the third quarter. Starting with industrial packaging, we earned $214 million in the quarter, and volume was higher, as John mentioned, primarily as a result of the higher export shipments, which added about $12 million. On the pricing front, containerboard prices were flat in the quarter, but the third quarter average was a little bit less than the second quarter average. What we saw was box pricing decreasing by $33 a ton as box price caught up to previously announced linerboard reductions, and just to put it in perspective, from the peak, average box prices down about $70 or about 8%. So lower box prices accounted for the majority of the $74 million decline in price. Then we had higher input cost, primarily around OCC, which reduced earnings by $9 million. And then as we mentioned at the end of the second quarter, lower mill outages which added $42 million to earnings.

Now on the next page, going back to margins, when we acquired to Weyerhaeuser packaging assets, we set a goal for ourself of earning the highest margins in the industry, and our combined industrial packaging team has generated the highest margins at a faster pace in a very challenging environment. So we think it is a very good news story. Despite 18% of total downtime that we took, our third quarter EBITDA margins were 19%, which was 350 to 450 basis points greater than our major competitors.

We turn to printing papers, printing papers overall increased earnings from $86 million in the second quarter to $138 in the third. Increased volumes again driven by export shipments reduced lack of order downtime and that improved earnings by $27 million, but reduced mix cost us 29, and I will put a little bit more color on that on the next slide. We also benefited from lower input costs and improved operations and across all of our printing papers businesses, the regional businesses in North America, Europe, and Brazil, we showed improvement. So if you go to the next slide, I would just like to break it down by region for you and break out pulp.

In North America, the printing papers business improved earnings by $31 million. Basically on lower input costs and reduced lack of order, and we expanded our EBITDA margins by more than 300 basis points to 19.8%. The pulp business earnings deteriorated by $4 million, but that was really the result of a $9 million negative hit based on increased export raw pulp sales. And it hurt our pulp business, but it benefited our coated paperboard earnings by $9 million by reducing lack of order down time. So if you exclude that charge around market pulp, we actually showed an increase of $5 million in the quarter, basically reflecting the impact of increased selling prices. European papers earnings increased by $12 million and again, saw improvements in volume prices, input costs and operating costs, and Brazil's earnings increased by $13 million. We did see some reduction in prices, but it was offset by improved volumes and lower operating costs.

Consumer packaging also posted a good result in the third quarter. Earnings were up from $38 million in the second quarter to $68 million in the third, and we saw some small signs over demand recovery reflected in the higher shipments, and that improved earnings by $8 million. That was mostly offset by lower selling prices but again, to put it in context for you, selling prices in the third quarter of this year are still $31 a ton higher than they were in the third quarter of 2008. And then favorable input and operating costs improved earnings by a combined $13 million and lower maintenance outages added $19 million.

Turning to distribution, xpedx earnings increased to $21 million, driven by improving business process improvements and also operating cost reductions, and the xpedx team has been very aggressive throughout the year of trying to take costs out and right size their cost structure. We did see shipment of volumes improve -- improved across all of the segments. The printing segment was up 9%, packaging was up 9% and facility supplies were up 2%. The volume gains were partially offset by reduced selling prices, particularly for coated paper so as a result, sales revenue per day improved in the quarter, but was up smaller. It was up 3% in August versus July, and 5% in September over August. We continue to win with new business at xpedx as well, including new paper volume that we picked up with AT&T and with Roush Pharmaceuticals.

Let me turn to international operations now. Slide 18 provides a summary of Ilim 's second quarter results. As John mentioned, we thinks we bottomed there in the first quarter and started seeing some improvement in the second. You will recall that we report on a one quarter lag basis, so we're looking at their second quarter results. IT's share of Ilim 's second quarter earnings improved by $30 million. We saw sales of joint venture increase by 5%, reflecting the beginning of the recovery in pulp shipments and prices in China and Russia. Pulp shipments improved by -- 3% prices increased by $5 a ton.

Containerboard shipments increased by 7% while prices continue to decline in the second quarter by $26 a ton. And I'd also like to also take you back to something we mentioned on our second quarter call. During that call, we talked about the joint venture structure agreement that allowed each partner the right to reassess ongoing participation in the joint venture at any point in time after October of this year. And that we and our partners were discussing potential revisions to the original agreement, including the scope and timeline for our capital investment program. At the present time, the partners remain interested in continuing the structure and discussions continue about a revised partnership agreement, and we expect that there will be such a revision sometime in early 2010.

Now I will turn to Asia, and we are highlighting Asia here because we think we have hit a significant milestone in our Asian business. In the quarter, we it a run rate that would put us over $1 billion in sales revenue on an annual basis. We generally report those results in the respected business product segment, so you don't always get a view of what is happening in the Asian businesses.

Our Sun joint venture, which now is the largest producer of coated paperboard in China. We have in new machine fully ramped at this point, and all of those sales are going to customers in China. We are also recording significant organic growth in consumer packaging, our converting businesses for shore wood and food service, and we now have 12 corrugated packaging plants in Asia. The final piece of the business is our distribution business which markets, among other things, uncoated free sheet from our US and Brazilian mills in the Asian region and also pulp and packaging grades. So our Asian operations are starting to build a critical mass that we think is going to be important to sales growth and earnings growth in International Paper going forward. And on slide 21, I will just share a couple of numbers with you.

In the third quarter, as I mentioned, we passed a run rate of more than $1.1 billion for sales, in Asia. That's 70% higher than our 2007 sales revenue. During the quarter, we also achieved an earnings run rate that was $62 million higher than 2008 earnings. Let me finish up with Brazil on slide 22. In the quarter, sales revenue at the Brazilian operations increased by 28% to $275 million, again, reflecting here the full ramp up of the operations at the new uncoated free sheet paper machine in Tres Lagoas.

Earnings increased by $13 million as I mentioned to $36 million, and domestic and export shipments increased in the quarter over second quarter levels, but we did see some slippage in selling prices a little bit in Brazil and we saw prices in the export markets come down by $48 a ton. Looking at EBITDA margins, we think that even though margins have been impacted by lower prices than a higher mix of export shipments, we expect those margins to recover as export prices improve and also as demand for the product in the region grows and we start shifting a greater mix of our production back into the region. So that's the segment overview. I will turn it back over to John for summary and wrap up.

Thanks, Tim. So, just let me sum up for a minute. I think we posted solid results in the third quarter despite very challenging and difficult economic conditions, principally in North America. We continue to match our production to our customers needs to avoid tying up working capital and unneeded inventories that only put pressure on pricing. Volume stabilized and as we exited the third quarter, we began to see some improvement, most noticeable in our xpedx distribution business, which is a very short cycle business. We expanded our margins and generated $1.3 billion in free cash flow which we use to reduce long term debt by just about an equal amount of $1.3 billion.

In the year since we acquired Weyerhaeuser -- Weyerhaeuser's packaging assets, we have reduced debt by $3.1 billion, more than 50% of the total acquisition debt. Before I talk about the fourth quarter outlook, I am just going to take a minute to make a couple of comments on two items that many investors have asked about, so I thought we would just cover it now rather than wait for a question. And that is on the biomass crop assistance program and cellulosic ethanol tax credits. Both are things that have been talked about as replacing these black liquor fuel credits. Let me just comment on each of those and share with you our perspective.

First, on the biomass crop assistance program, like many others, we are trying to understand what the program is all about. But we really need written regulations from the authors of that program to understand what it is about more clearly. These regulations are expected to be issued in the near future. So I think at this point in time, it is wait and see. We believe these regulations should provide a narrow definition of biomass so they don't distort the market for what we've not lobbied for the program, but we feel it's important that any legislation or subsidy insures a level playing field for the pulp and paper industry. We do encourage the implementation of Phase II of program which would promote the increase in supply of biomass crops, so there should be, and it's a good thing to have incentives that incent people to grow more fiber. With respect to the cellulosic ethanol tax credits, we do not believe that the pulp and paper producers qualify for these tax credits and International Paper will not pursue these tax credits.

So, let me just shift gears now and make a couple of comments about the fourth quarter, and then we will open it up for your questions.

In the fourth quarter, we anticipate only a very modest recovery in economic conditions in North America, principally given the seasonality of our business and the fragility of whatever recovery we are beginning to see in North America. All you have to do is just pick up the newspaper in fact this morning to see how fragile that recovery which many believe is occurring, really is. With respect to volumes, we expect seasonal decreases in North America paper and packaging demand and stable to modestly increasing demand in other global markets where we participate.

Looking at prices, we expect stable paper prices, improving pulp prices and we expect box prices to adjust down, reflecting the impact of the already published containerboard price decreases. We expect stable North American coated paperboard prices. Maintenance outages in the fourth quarter will increase by $31 million in North America and decline by $10 million in Europe. On the input costs side, we expect costs for natural gas to increase, they have moved up from their low point which occurred early in the third quarter, and more or less we expect other energy costs to remain about flat.

Wood costs are going to increase given the wet weather we have in the south and the low inventories, OCC costs have moved up, but we expect it to more or less remain flat as well, and chemical costs remain at about third quarter levels. We expect freight costs to increase somewhat. xpedx earnings should remain stable and we expect modest improvement in our equity earnings from Ilim . Forest products earnings should remain similar to third quarter levels, not much going on there. We don't expect the pending -- we don't expect 140,000-acre transaction that we talked about, I think on the previous conference call, to close in the fourth quarter, although the interested parties are continuing their due diligence. So all things considered, we expect fourth quarter earnings to be significantly less than third quarter, and I would say that's really a seasonal effect of -- our industry has always had a slow fourth quarter after Thanksgiving, demand is really off the table until after January.

So going forward, our priorities remain the same. We are going to continue to focus on aggressive cost management and we will continue to match our production with our customers needs. We've now shifted the focus industrial packaging from integration of two companies to optimization of a large business, and we think there's a lot of EBITDA and earnings runway in that business. And finally, we will continue to strengthen our balance sheet by continuing to pay down debt. Our goal in that front remains the same, to reduce debt to less than three times EBITDA over the cycle. And everything we're doing at International Papers is about making International Paper stronger, better and creating more shareholder value. So with that, I'll turn it back over to Tom and we'll take your

Thanks, John, thank you, Tim. Laurie, we're ready for our first question, please.

(Operator Instructions). Your first question comes from the line of Gail Glazerman of UBS.

Hi, good morning. Congratulations on the quarter. John, I just wanted to dig a little bit more into the demand comments you made where you are into the downturn and it doesn't seem like domestically you are seeing much of an uptick. Now obviously, you've reflected that in your announcements. I am just wondering if there are any anecdotes or thoughts that you could give, and if you could give us any insight into some of the key businesses you mentioned, xpedx, but any of the businesses, kind of what you are seeing in October relative to September in the third quarter average.

Tom Kadien, who runs our distribution business, I will let him talk about xpedx, and he can give you some color on what's happening right now across the segments.

Yes, hi, Gail. We are seeing, I would say a seasonal improvement that is typical on the print side. The year-over-year comps are still pretty disappointing, but as Tim said, our print business got better after probably eight months of no -- almost no activity. We saw an improvement in August over July and then September was again better than August. I guess the positive side, our packaging business was up also, about 8% in Q3 over Q2. We are seeing some more quote activity in packaging equipment. I still think it is more of a seasonal improvement than any sort of real recovery, and we're, I would say cautious about the fourth quarter because after Thanksgiving, as John said, it is going to slow down again, particularly the print business. Carol, you want to talk about boxes?

Sure. Hi, Gail. I remain cautiously optimistic on packaging demand. From the second to the third quarter there was an increase in nondurable production, which was a good sign, and that translated into industry box shipment. We were down a little bit from second to third, but we have a large agricultural condition and while we had a very good ag season in the second quarter, it is just seasonally a bit slower for us. Very hard to tell what the fourth quarter will bring because it is such a strange quarter with three less days and traditionally a fairly slow November and December. But September was our strongest month in the quarter, so as the economy recovers, I am confident that packaging demand will recover along with it. It is just a matter of when and how much.

Something about paper in North America.

Yes, we -- hey Gail, we have four segments I will take each of the four. The commercial print side in the third quarter was up about 7% for the whole industry, that confirms what Tom was saying to you. In the converting grades we did not see a lift in the third quarter, but here in October, direct mail has begun to come alive. We are seeing the -- more and more advertising on the direct mail front, the envelope converters are starting to see some lift, which is a good sign on the advertising front. On the imagining paper side, fairly flat, not a whole lot of lift on the cut size, and we wouldn't have expected that because that's much more employment related and employment, as you know, has not seen a whole lot of lift in the country. And I would just add on the pulp side, the pulp data came out -- most of you saw this -- surprisingly strong offshore, but again, it is mainly China and somewhat Latin America. But pulp inventories continue to fall, and another round of increases have been launched through November.

Okay. Thank you. Just one last question -- just (inaudible)last questions.

You are fading in and out.

Sorry. Can you give any update on where the pension stands to date, and just slightly related on that, I appreciate you are still talking about that three times kind of EV/EBIT over the cycle, but you did say that 2009 goal, which I think you are pretty much at at the end of the third quarter. I am wondering if you have any update (inaudible).

Well, the pension, we have seen really good returns. You can look at the returns in the marketplace, and our pension fund has enjoyed a lot of those returns. And if you were measuring it at the end of September, we would have seen double digit returns in pension and assets, but interest rates stepped down. So from a funding standpoint, if we were marking it at the end of the third quarter, we would be roughly in line from a funded standpoint as we were at the beginning of the year. And you rightly mentioned that when we look at debt, we look at not only balance sheet. but we look at debt-like obligations which would include pensions. So while we said we thought we would be around $9.5 billion of balance sheet debt at the end of the year, we are very close to that now. The focus is still on paying down all debt and debt-like, and you can see us continue to pay down balance sheet debt, maybe maybe a voluntary pension contribution or do a combination of the two.

Okay. Thank you.

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

Good morning, and congratulations. First question is just involving kind of capital. As we move into next year, wondered if you can give us some guidance on where you think capital spending may end up for the full year. And also, just update us on your thinking on that option you've got on another machine down in Brazil.

Do you want to talk about capital and I will talk about Brazil?

Sure. Hey, Mark. For capital this year, it looks like we had a target to be around $600 million. I think we will be somewhere between and $500 million and $600 million. We have actually found as we have gone through the year that we have been able to do the projects that we had slated for this year more cost effectively than we thought when we were putting the plan together last year. We haven't finalized our capital plans for next year just yet.

We would probably have are a slight increase. I don't know exactly how it is going to be, but it might be $100 million, $200 million higher because we have got a whole backlog of really good cost reduction projects that have extremely high returns. So we want to see our primarily our mill assets, but there's a little on the converting side, but mill assets continue investing in cost competitiveness.

Mark, as we said before, I think investors ought to continue to think about International Paper spending about $1 billion on average over the cycle in capital. Some years will be a lot less like this year, some years it will be slightly more, but $1 billion a year, which is about 65% to 70% of depreciation over the cycle. And that comment Tim made about getting more work done, we didn't have inflated costs and what's happening is with the economic recession and deflation, materials are coming down in price we're doing all of our construction activities and capital work on straight time because we don't need to get the jobs done quickly, it saves us a lot of money on labor and installations. You are see this across all of heavy industry. If you talk to people in the chemicals business, they would be saying the same thing.

On Brazil, we don't have to make that decision until sometime in the first quarter, and we do have an option and we'll see what our outlook is at that point in time for future capacity. But the machine we have, we are pleased with. We are selling out to volume. A lot of it is going in export markets which I think has hit the bottom. The Brazilian currency isn't helping us right now, but we are in global businesses, so we are going to have currency move in all sorts of directions and we just have got to make a decision not for the short term, but for the medium to long term about what the right thing to do is.

John, just one other thing on capital. One of your competitors is talking about a couple of large energy related projects, and they're pointing to very, very large returns. Do you have any of those types of projects out there? Can you giver us -- if you do, can you give us a sense of how much they might aggregate to?

In fact, our projects, I think the one you are referring to is in the 15% to 20%, 25% range. Our projects we are looking at are in the 40% to 50% range. They're not $200 million a project. They're, $5 million, $10 million, $15 million, and they're energy consumption reduction projects or wood fiber consumption reduction projects or chemicals consumption reduction projects. They're not big $100 million projects, which projects which is good because we can get more of them done then.

And then just one other question. Tim, can you give you some thoughts on that cash balance that you're carrying right now and whether we are likely to see that continue?

You broke up a little bit. Can you repeat the question, please?

Yes, the question really is just that almost $1.7 billion in cash that you are carrying and whether we should expect to see you continue to carry large cash balance over the next few quarters.

I don't expect that we will carry balances like that going forward. Will we carry a little more than we have historically carried? Yes, because we are still managing in a slightly conservative fashion. But, the goal again is to continue reducing debt. So, we are not trying to build large cash balances, we're trying to take out debt where we can.

Mark, just to go back on capital, I think the other thing that investors should think about that's different for International Paper I think from many of our competitors, we are going to continue to benefit from the portfolio choices we made, and the balance that International Paper has around the world. So, as Tim was talking about around Asia, we have got investment opportunities in growing parts of the world which will offset lower growth that we are going to see in North America and Europe.

Okay, very good. I will pass it on. Thanks.

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

Good morning. John, can you talk about the containerboard operations? Specifically, you mentioned in the end of the second quarter, that you had achieved the synergies that you had targeted. Can you talk about what additional opportunities lie ahead for you there? You talked about the capacity shuts that are coming, but can you elaborate a little bit more on the potential opportunities in containerboard?

I'm sitting right next to the leader of the containerboard business, so I think I will let her talk about those, since she's right on top of it.

Thanks.

Yes, Richard, this is Carol. We remain excited about the opportunity to improve the industrial packaging business. As we said, our goal on synergies when we started was the $440 million, and we have achieved in the $500 million range already. So we are, what I would say is beyond integration and we are onto optimization. And as I had shared previously, and I am looking at my colleagues here, we had shared conservatively an opportunity to create another $300 million of just sheer improvement inside the business. That's going to come from a number of areas. On one of the big areas John had already mentioned is in the mill system. While we have a very good mill system and a low cost mill system, we have an opportunity to make it even better.

There's energy projects, particularly in Weyerhaeuser system. There's a chemical and fiber usage, these are a lot of usage projects. We have also got, with the tough decision we made this past week with our footprint decision, that's clearly going to help us next year. In converting, we haven't talked about a major converting transformation, but we have made a huge improvement in the cost division in our converting plants. Our focus has been on labor usage per unit of production. We've had an over 40% improvement in that metric, and that's just more productivity through fewer machines with less people. So that's a big opportunity for us, and we're going to continue there. Then we're going to keep working on the total overall headcount. That's another opportunity for us. So we have opportunities across the system to make it stronger and better, and we're going to keep pushing all those levers, and we're not out of room to continue to make it better.

Rick, what I think about that is the -- we have a business that for the last 15 months, we have been 100% focused on putting the two business together. It is now an $8 billion business, more than double what it was before, and we have got a huge number of optimization opportunities which we haven't been thinking about because we have been working on integration. So think about we had six mills, now we have got 15. We are going to have two fewer with the shut down decisions we made, and we went from 60 box plants to over 100. The optimization opportunities there are huge, and that's what we are turning our attention to now.

Great, thanks for the detail. Just turning to Ilim, just one other question. What was the key driver of the magnitude of the improvement there, because it doesn't look like it was really driven by price, and pulp prices have improved pretty significantly. Should we expect that you are going to see another meaningful improvement in the Ilim business? (inaudible)

(inaudible) significant amount of costs out of Ilim, Rick. As, you're right, it's not showing up in price. Remember, Ilim's on a one quarter lag. So the sharp run up in pulp prices has really all occurred in the last three to four months (inaudible). So that's ahead for Ilim, but they have made huge progress on their cost structure and accelerated plans we had in place to improve the cost structure, but that's what's enabled Ilim to show better margins even before prices rebounded.

Thank you.

Your next question comes from the line of Chip Dillon of Credit Suisse.

Hi, good morning. I had a question regarding sort of the question regarding the cash. You showed on the slide, this is more for Tim the benefits of the black liquor program actually adding up to about $1.15 billion, if you take the $688 million in the third and the $463 million in the -- I mean $688 million in the second, $463 million in the third. And yet I know you have accrued pretax $1.5 billion and after tax less than $1 billion. So I guess my real question is, is there some associated tax payment that you have not made that you anticipate making either in the fourth quarter or next year tied to black liquor, or could explain the numbers in the accruals you are taking?

Yes, you are absolutely right, Chip. Our thinking at the moment is that we will use some of the credits in the fourth quarter to offset whatever income tax liability we would have for the benefit of the fuel credits for the year.

So the way to think about it is that you're basically going to get -- end up not paying really these taxes that you will get a refund next year? Or not a refund, but you won't have to pay the taxes?

Right. On a cash tax basis, what we will do is try to forego receiving the cash for the portion of fuel credits that we need to offset whatever cash tax liability we would have.

Got you. And then just back to the VCAP program, and I appreciate the update on your view. I know it would be nice to have the taxpayers pay like 75% of the cost of goods sold to make pulp, but I don't know, then you will have to negotiate with Congress for your bonuses. So I can understand that the black liquor to comment, totally. But on the VCAP, I guess the big concern aside from the rules is, any thought as to how much money would actually be put into this? Because I understand it was pretty light this year, $25 million. What sort of realistic range that you hear about in Washington for the future?

Yes I'm not trying to listen to all of the realistic ranges because I don't think there are any until we see the detailed regulations. What I am hoping is that this is -- if there is an incentive program, that is aimed at incremental fiber residues which aren't currently being used. And that in some parts of the country, that's a lot. In some parts, it is a little. So that all, at the end of the day, that would drive the value, if it is driven toward incremental forest residues that aren't being used. So I have given no thought to the size of this. What we are waiting to see is what the regulation are going to look like.

Got you. Thank you.

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

Thanks very much. Good morning. How are you? I was hoping you could comment just a little bit on where your inventories stand and then importantly, if you have got any color on where customer inventories are right now, particularly in the printing papers business. That would be great.

Our inventories are year low levels. We are down in all of the large businesses in North America, coated paperboard, industrial packaging and in printing papers, our inventories are coming down in Brazil. I don't -- Europe doesn't come to mind right now. On the customer side, maybe I will let Tom comment on that because he -- xpedx is closer to a lot of our customers, it is a customer. So they reflect probably what's going on in the marketplace.

Maybe Wayne can too. Claudia, xpedx inventories are at a 18 month low, and we would -- I would say we've gotten our inventories back to the kind of metrics in terms of BIOH to where we were when our business was much bigger, say in 2008. So, I would say, at least in the merchant channel, the inventories are low and many of our competitors, frankly, don't have the cash to have in their inventory tied up in their inventory, anyway. So I don't think there's much in either the channel inventory in either the merchant channel or out in the printer channel. I would say that's lower than it has been in a long, long time.

Okay.

Claudia, this is Wayne. I would just add, what Tom Just said, I would echo for our other merchant partners. And I would also say that the data that we have around the converter group, which is not as robust, but the data we have which suggests those pipelines are pretty lean as well. And in the cut size world, inventories are pretty much not there. So, our view is the pipeline is fairly empty, and it is running pretty much in and out.

Which is all good news for any pick up in demand we are going to see right away, because in the segments we're really significant in, bleach board, uncoated free sheet and containerboard, inventories are in very good shape.

Okay. That's helpful, thank you. Then just -- could you just remind me your energy hedging position is? That would be great.

Hey Claudia. It's Tim.

Hi.

We are close to 50% hedged for this year, and a little bit less than that going into next year. I think you know we don't really take a point of view on where energy prices are going and just try to smooth volatility.

Okay. Thank you.

Your next question comes from the line of George Staphos of Bank of America/Merrill Lynch.

Thanks, hi everyone. Good morning, nice job on the quarter and details. First question I had was back to Brazil, obviously, it has been a tougher year, although there has been a little bit of a rebound sequentially. Next year, there's some reason cyclically why you should see perhaps better industry demand. John, at this juncture, do you think it will be a tight enough market next year where you could overall improve returns and margins back to where you would like them to be, say --

A lot of that, George, as you know, is currency related. Every time the (inaudible) gets stronger --

Yes.

-- our margins are under pressure, and we write up the value of the asset. So, and I guess we've concluded we're lousy currency forecasters.

Join the back of the line.

We are seeing demand in the Brazilian market grow. Now I think year-over-year, it is about flat but in the third quarter, demand in Brazil grew. That's the most important market for us.

Right.

We're going to see growth in the region, which is the second most important market for us. So our strategy is more than a Brazilian strategy, is a Latin American strategy that is focused in Brazil. Because that is the low cost place to produce, and it's the biggest market.

Makes sense. We will keep in mind the currency factors, I guess. Switching here to Asia, can you remind us what kind of return on capital you are getting in that business right now, in the region overall. And given the progress that you have seen, could there be some investment in capacity, in Asia in 2010, or would that be too soon to see that kind of priority show up?

Well, what we have got in the business model in Asia in terms of making returns a little different than it is North America. North America, you have got capital turnover of one and to get decent returns, you have got to have EBITDA margins in the 15% to 20% range. In Asia, you have got capital turns that are 2 and 3 times, on paper mill type assets. So the margins are a lot lower, but we're getting double digit returns out of Sun because we've only got $170 million, that's our half. So $340 million invested for close to 900,000 tons of new capacity, and you can't do that in North America. Sure.

Sure. If you could, and this is probably available somewhere, but what amount of capital do you have in total tied up in Asia right now?

Can we get back to you on that? The biggest piece is in the Sun JV, which is about 170.

Okay. And last question, I will turn it over. Carol, what kind of timing do you think we should think about, related to the incremental benefits we should see from optimizing industrial packaging over the next several years. Obviously, it is not going to show up all in 2010, or maybe it will, but help us think about the right rate of progress should be there. Thanks a lot, good luck in the quarter.

George, the capital in Asia is about $400 million in total.

Okay, thanks, John.

And George, I am going to put myself out on a limb and hopefully not take a saw with me, but I would think that improvement should be in our run rate by the end of next year.

Okay. So rate will be improving and all in by fourth quarter, would that be fair?

That's my expectation.

Okay. Thanks, guys.

Your next question comes from the line of Mark Connelly of Sterne Agee.

Thank you. Just two things.

Morning, Mark.

John, your consumer packaging numbers, I think are the best we have ever seen, better than 2006 in Q3. That's a business that has been very hard for us to see the end game. How excited should we be about this pick up? I guess I'm really asking, how excited are you about the pick up?

Well, we are pleased. Remember, we had no maintenance outages in the quarter. So that was a contributing factor, but that's not all of the contributing factor. Shore wood results were better, bleach boards results were better, food service probably wasn't better during the quarter, but had a -- is going have a strong year. And we are getting some benefit in the pulp business there because we are taking less downtime. So the consumer packaging business not the biggest leg of the company, but it is an important leg of the company. We like the bleach board business. We have been struggling with shore wood, but we have got a plan now to make that business profitable on a current revenue base, and it is improving year-over-year. So, we still have got -- we had two facilities, we've only got three facilities in bleach board. We have two of them that weren't running well, and now we have got one of them that's not running well. So we have more internal improvement opportunities in consumer packaging, even with no change in demand. And as you recall, we fixed a lot of the commercial decisions that were holding that business back through 2008.

So relatively speaking, you sound reasonably bullish versus some previous comments about the outlook for this. Is that fair?

I don't think we are ever bearish on consumer packaging. We've had some operating problems at Riegelwood and August, we solved Riegelwood, we're working on August. We've got a big bleach board business in Asia, we are the largest bleach board producer in Asia and we have got a significant bleach board business in both Poland and Russia. So we're probably the only bleach board player with a global footprint. The numbers don't come together all that way when we talk about the businesses. But we like the business.

Okay, that's helpful. John, your slide about the strategic importance of Asia was helpful too. Moving past George's question about Sun, it seems to me that you still have got a lot of runway with your existing investment across the world to grow into Asia before you need to put a lot of additional investment on the ground there. If you think about the Asian opportunity across all of those businesses that you listed on the slide, is that a fair characterization?

We are tapped out at Sun. So, investing on the Sun would be more -- we would have to put some more hardware in the ground or go invest in something. We have been adding -- these have been small capital amounts, $10 million. So we haven't been talking about them a lot. We have been adding box plants about two a year, we are now moving some corrugaters that are available from North America over to Asia so we can make those box plants correlating plants, because the volume is growing. We started up a shorewood plant last year, so we have got a significant amount of organic growth opportunity there because it is not full year. And we are adding another press in South Korea, another facility because the first two presses are sold out. So, you are right in the sense that we are -- when you are growing the business, you are really never full on the revenue side because the business is growing at 15%, 20% a year side. You're trying to keep capacity available ahead of your customer demand so they don't go somewhere else. So we are pretty excited about what we see in the packaging side. Paper is a little bit more complicated because we haven't found an opportunity yet that we are convinced makes money. Obviously at Ilim, we like sitting right across the Chinese border with low cost softwood pulp, and that's -- it was tough in the first quarter, but that market has come back.

Very helpful. Thank you, John.

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

Thank you. First a big picture question for you, John. Obviously, during this downcycle you have done a tremendous job with proactive supply management matching supply to demand, et cetera, and it really seems to have paid dividends. If we look back to the last upcycle, you did okay, the industry did okay, but it certainly didn't do nearly as well as a number of other industries, the steel, copper or what have you. Hopefully, we are now getting close that that point in time we are going to be thinking about behavior during an upcycle. Do you think there's anything you need to be doing differently when the upcycle comes than you did in the past?

That's I good question. I'm trying to remember the last upcycle. We want to make sure we have got capacity for our customers, and I think one of the pieces of good news is even with this adjustment, these big decisions in North America, we think we have got a lot of volume runway. And as you think about just what's going on in printing papers, industrial packaging, we are taking more than our capacity share of downtime. And some of our competitors are running full, which means we have got more volume runway. We don't have a big fill price decline because prices haven't collapsed, they have drifted, and I think that's really important. We have also got no inventory hangover to work off. So I think industry is in a much better position now, and International Paper is a much better position as demand comes back and I believe it will, it is a question of when and how fast, to capitalize on that.

Okay, great. Then just a question on the fourth quarter outlook. It is pretty interesting to see your stock react when you said significantly less than third quarter. And one thing is if I look at the slide on 25, I see,I think it is six reds and five greens, and normally that would suggest yes, it is going be lower, but not necessarily dramatically lower. Can you give us a little more color on when you say significantly less, what you mean by that?

We don't give guidance, Mark. It depends on the colors of red and green. It can be dark red and light green and the size of the business. We all know that the fourth quarter is never a great quarter on an annual basis for our industry because it is one of the slowest quarters seasonally.

Let me ask the question a little bit differently. With your third quarter results, do you think that you have some improvements there relative to what your expectations and presumably the market expectations were that are sustainable, or do you think that it was mostly a one-time thing and it comes back undone in the fourth quarter?

It's not -- the stuff going on on the cost side are not one-time things. This is really what's happening to demand, and the fourth quarter, even in a midcycle environment or a top of the cycle environment, the fourth quarter is always lower than the third quarter. And I think if you go back the last ten years, you would find that. Seasonality by far and away is the biggest factor in the fourth quarter.

Okay. Thank you.

Thank you. I will now return the call to Tom Cleves for final remarks.

Thanks Laurie. Thanks to everyone who joined our call today. For those of you who have follow up questions, Emily Nix and I will be available via telephone. Have a great day.

Thank you. That does conclude today's EDS International Paper third quarter 2009 earnings conference call. You may now disconnect.