International Paper Co (IP) 2010 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. And welcome to the International Paper 2010 second quarter earnings 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 would now like to turn the conference over to Mr. Tom Cleves, Vice President of Investor Relations. Sir, you may begin your conference.

Thanks, Paula. Good morning, everyone, and thanks for joining our second quarter earnings conference call. Our speakers this morning 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 the presentation. We'll also present certain non-US GAAP financial information. The reconciliation of those figures, the US GAAP measures, is available on our website, and our website also contains copies of the second quarter 2010 press release in today's presentation slide. With that, I'll turn the call over to John.

Thanks, Tom, and good morning, everybody. Thanks for joining us for the second quarter results call. As we typically do over the next 20 minutes to 30 minutes, Tim Nicholls and I are going to review our second quarter results with you and the performance of the individual businesses. We'll also share our third quarter outlook and then we'll open it up to your questions for the Q&A session. I'd start out by saying we're very pleased with the results we achieved in the second quarter. Coming out of the deep recession of 2009 and operating at an overall economic environment that's improving but certainly not robust, we significantly improved our earnings in the second quarter. Before special items earnings more than doubled versus the second quarter of 2009 and they were far better than the earnings in Q1, which is the low point for International Paper.

So quickly to headlines, revenues increased by 6%. This is the first quarter of revenue growth since late 2008 with both volume and price. Margins expanded in all businesses. We had strong free cash flow generation. And importantly, all businesses, both in North America and around the world, turned in strong second quarter profits. EPS in second quarter was $0.42 up from $0.04 in the first quarter and $0.20 in the second quarter of 2009. Our second quarter results benefited from our global balance with all of our businesses outside the US recording strong operating results. Our European paper and packaging business, which includes our Russian operations at Svetogorsk, also generated record earnings in the second quarter as did our Asian operations.

Our mill and converting operations performed very well in the quarter which made a contribution to earnings and profits continued to come from our ongoing cost reduction efforts. Fiber costs declined during the quarter but they remained high compared to historical levels. And I would also like to point out we generated our strong second quarter results despite a $120 million in maintenance outage expenses, about $30 million more than the first quarter or about $0.05 a share and the second quarter was our high watermark for maintenance outages during the year.

So quickly on the numbers. Second quarter sales were $6.1 billion, this is at the highest level since the fourth quarter of 2008. EBITDA increased 40% to close to $800 million, $782 million to be exact. Free cash flow improved over $350 million and importantly, we continue to reduce our long-term debt. In the quarter, we reduced it by $100 million and increased our cash balance on hand by $200 million from $1.7 billion to $1.9 billion. So, we're on slide seven now and that's comparing second quarter of 2010 to the first quarter of 2010. And this slide shows our sequential operating improvement. As you can see, realized price increases added the most to second quarter earnings, $0.29 a share, improved volumes in paper and packaging added $0.05. Strong mill operations and cost reduction activities. What you're seeing here is the flow through of the facility decisions we made both in the container board business, and box plants, and in Europe are starting to flow through, adding to our earnings.

We continue to monetize our forest resources assets, in this case in the second quarter. We sold some mineral rights, which added $0.05 to our earnings. A bit of headwinds here. Our largest envelope customer filed for bankruptcy during the quarter which led to a $0.05 charge in our North American printing papers business. We hope to recover some of this amount in the future. And if we do, we'll recognize it in future periods. And, finally, the Ilim joint venture continued to improve. Remember, that's on a one quarter lag and they added $0.02 to our earnings compared to the first quarter.

I think it's also instructive to look at the first half of this year versus the first half of last year. And they're a somewhat different story. Again, a lot of improvement. $0.46 year-to-date this year versus $0.28 in the first six months of 2009, but you see the impact of volume here. As the global economies have recovered, we've been able to sell more volume in almost all of our global businesses and that increased earnings by almost $0.40 a share -- $0.37 a share. Selling prices, however, fell in 2009. And while they had been recovering, it's important to note selling prices still remain below 2009 levels. This reduced earnings by $0.10.

Operating costs are very favorable, again reflecting good operations. The smaller footprint we have, we've made adjustments to reflect the supply and demand and also ongoing cost reduction activities, headcount reductions across the Company and fewer converting facilities. Maintenance outages reduced earnings by $0.05 and we've already completed two-thirds of our 2010 outages. Input costs, first six months of this year versus last year were unfavorable. Fiber costs were up a lot and freight costs were also unfavorable and this is somewhat offset by a decline in chemical cost. And, again, over on the right you can see the impact of the earnings improvement from the Ilim joint venture.

Slide nine which shows our EBITDA trends, I think it's an important chart. And we've been showing you this for several calls now. We're continuing to improve our EBITDA and importantly, our EBITDA margins. Despite the lag effect of the recession 2009 , we generated EBITDA in 2009 of $2.8 billion or 12%. In the first quarter, that was the, I'd say, the low tide mark. EBITDA was at a run rate annualized at $2.3 billion, a margin of just 10%. In the second quarter, our EBITDA run rate improved to $3.1 billion at a margin of 13%. Again, that's reflecting the combination of price, volume and ongoing cost reductions and very strong operations. During the first quarter call, we said that we expected input cost to decline during the second quarter but on average we thought they would remain about the same as the first quarter levels. And that's exactly what happened. Input costs were about $0.02 unfavorable per share in the second quarter.

These next two slides just show what has been happening to two of our biggest input costs -- wood costs and recycled fiber costs. Slide 11 shows you our wood costs had declined from first quarter levels but still remain a lot higher than they were in 2008 and 2009. Harvesting conditions has returned to normal because we've had more normal weather patterns. Harvest levels have increased and wood costs have started to decline.

Slide 12 shows the pattern for OCC costs. And OCC costs have risen significantly -- they rose significantly in 2009 and in the first quarter 2010 but they've started to decline. But like wood costs, they remain significantly higher than 2009 levels.

As I mentioned upfront in our headlines, what we call our EMEA business, that's Europe, the Middle East and Africa have posted very strong results. I just want to highlight them here because I think it shows the benefit of the global balance International Paper has. These businesses generated $245 million of operating profits in the first half, a 55% increase over 2009. And they accounted for 11% of our sales but 18% of our total EBITDA. So think of that as our European and Russian paper business and our European, Turkey, Morocco corrugated box business. And EBITDA margins improved from 12% last year to 19% this year.

Both these businesses, paper and packaging generated well above cost-of-capital returns and the results include the benefit of the permanent shut down of the Inverurie freesheet mill, which is part of the paper business. And the Etienne recycled container board mill, which is part of the packaging business. We got two facilities out and improved our earnings as a result and there were a lot of other things going on in that business as well that were very positive. So with that, I'll turn it over to Tim Nicholls who will discuss the second quarter results in a little bit more detail by business segment and then we'll talk about the outlook for the third quarter and your questions.

Okay. Thanks, John and good morning everyone. I'll start with industrial packaging. Industrial packaging had a significant jump in earnings from the first quarter to the second quarter, ending the quarter with $193 million in earnings. And it was really driven by box volumes and price realizations. In North America, our box volumes were up 8% from the first quarter levels and shipments were at the highest levels since before the economic crisis began. Export has continued to be strong, although we did make some decisions around pulling export volume -- some of our export volume -- back to make sure our integrated chain had the liner board that it needed given the strong demand.

Price realizations were right on the pace that we expected, both here and North America and also in export markets where we've seen a rapid increase in selling prices over the past quarter. And we had fewer mill maintenance outages in the quarter in North America that drove to $30 million in earnings. But the first half of the year was a very heavy outage period for industrial packaging. And through the first half, the business has now completed 80% of its maintenance outages for the year.

European box shipments were flat quarter-on-quarter, but really probably stronger than we thought they would be because the second quarter starts to seasonally slow given the fruit and vegetable seasons, the way they run. And we had flat box shipments so they turned to strong performance and the business there, again, generated a cost-of-capital return in the quarter and has for the first half of the year.

If you turn to the next slide, I would just like to talk about the North American industrial packaging business for a moment. Second quarter EBITDA margins were up 70% from the first quarter trough. And we expect margins to continue to grow in the third quarter. And our second quarter exit rate for the business was approaching a cost of capital return. So if you turn to slide 16, it shows the EBITDA progress for our North American business. And after coming through what has been really the worst recession we've seen with box demand falling off more than 10% back to overall back to 1993 levels and coming into the first part of this year where we had elevated fiber costs, operating profits have held up reasonably well. And if you focus on the green columns there, we were at a run rate in the first half of $1 billion of EBITDA and we ended coming out of June at a $1.5 billion So I think the business is positioned for a strong second half and I'm very confident of the earnings power we have going forward here.

Let me shift to printing papers now. And even with flat volume in what was a very heavy maintenance outage quarter, higher input cost and the large bad debt expense that John referenced earlier, we still increased earnings by 25% and it was really due to price realizations as well as strong operations and fixed cost savings. The elimination of the fixed cost of the Franklin mill and the strong ops in the US mills and Brazil added $23 million. Europe performed well and we really saw strong performance across all of the printing papers businesses. European margins expanded by 150 basis points. Earnings recovered in Brazil with higher shipments, price improvements and very good operations. And given the bad debt expense, our margins in North America were down 100 basis points. But if you take that out and look at it at on a run rate basis, we were up by 250 basis points.

I'll now turn to consumer packaging where margins improved by 150 basis points and earnings were up nearly 60%. Even though we had much higher input cost, especially in Texarkana, given the hardwood mix there and we also had higher pulp cost at the Sun joint venture in China. We had strong volumes in all of the regions. North American order backlogs through the quarter where we're over two times what they were at the height of the economic crisis. Price realizations were right on pace, right in line with what we had expected for the quarter and operations improved significantly, mostly in the North American mills. We did have a heavy outage quarter for consumer packaging and in the quarter they accomplished about 50% of the total mill outages that they'll have for the year.

Let me just spend a moment on fixed cost reductions. By the end of this last quarter, we had completed all of the announced permanent closures in the North American mill systems and have eliminated all of the fixed costs from these mills. The operating costs that we're experiencing around some of the closures is temporarily higher, given some of the transition of grades and supply chains to move the grades into the mills where they're going to be produced. But those expenses, we expect to come down over the balance of the year. We've also eliminated all of the fixed costs in the European mills that we shut down, the Inverurie uncoated freesheet mill, and the Etienne recycled board mill. So by the end of the second quarter, from a fixed cost standpoint, we had hit the $225 million run rate of fixed cost reductions globally.

Xpedx earnings increased to $26 million. And we're seeing some pick up in volume and it seemed to accelerate slightly at the end of the quarter. But the real story here at this point is still waiting for pricing to continue to improve and still managing costs very aggressively. And it's really at this point, the aggressive cost management that has driven the earnings improvement. On the forest product side, we announced the mineral rights sale which closed in the quarter, generating $39 million in operating profits. And we also have recently announce that we've signed an agreement with Rock Creek Capital Partners to sell the majority of the remaining land for $200 million plus an ongoing profits interest and we expect that sale to close this quarter. And once we do that, that will effectively complete our land sales program.

Now let me turn to the joint ventures, and I'll start with the Sun Joint Venture. The joint venture generated record operating profit in the second quarter and has had above cost-of-capital returns for the first half of this year. International Paper Share, the profit was $13 million which was similar to our first quarter levels but double that of the second quarter last year. Continuing to see very strong demand growth and expect that demand will continue to grow in China in the 8% to 9% range. And recently the joint venture and the IP boards have approved the addition of a new 550,000 ton board machine which should start up in early 2012.

If I shift to Ilim, and again, I'll remind you that we report the results of Ilim on a one quarter lag, sales at the joint venture increased by 10% and our share of the earnings increased to $5 million. We saw pulp shipments increase by 4% and container board by 1% and prices began to move up with a $56 increase in the quarter which is really from their -- from the fourth -- our fourth quarter to our first quarter and container board prices increased by $22 a ton. So when we look at Russia, we see an economy that has stabilized demand and prices for our market pulp continues to improve in the quarter. Domestic demand for paper and board also improved. In July, we received a $34 million cash dividend from the joint venture which brings our total dividends received since we've been a part of the joint venture to $152 million or approximately 25% of our original investment.

Recently the board, the Ilim board has approved the resumption of the original strategic capital plan which was focused on value-added paper products for Koryazhma and also leveraging the pulp assets in Siberia. And so those two projects, the first one is the $700 million new pulp line at the Bratsk pulp mill which is scheduled for start-up in the second quarter of 2012. And we've also -- the joint venture has an improved installation of an uncoated freesheet machine at the Koryazhma mill which will have 220,000 tons of paper including 165,000 tons of uncoated freesheet and with the approval of a coating line of 55,000 tons of coating-based paper. That will also start-up in 2012.

So before I turn it back over to John, let me just touch on capital allocations for a moment. The slide here shows some of the actions that we've taken this year around the dividend and the investments that we've recently announced both for SCA Packaging in China and the Sun joint venture coated paper board machine. Earlier this week, we continued our debt reduction efforts by making a $500 million cash contribution to our pension fund and through the quarter we reduced long-term debt by $100 million. So with that, John, I'll turn it back over to you.

Okay, Tim, thanks. I'm going to take a minute and try to describe how we see the current global macroeconomic conditions and we've got a map here that we tried to color in and just give you a sense of how we're seeing the business environment. I would say overall it's positive, but it's mixed.

Our biggest market is here in the US where we have 70% of our sales and I think the best we can say about the US economy is it's out of a recession but it's in a transition. Growth has been positive, but as we look at what's happened in June and July, we would say the economy is still growing but it's growing at a slower rate. The outlook for economic growth is better elsewhere, especially in Russia, Latin America and China. Europe, where we do business, it's mixed. Germany and Poland are quite strong and Turkey. The balance here for the most part looks like North America.

There is some better news, though. I think all of the concern about whether some of these countries in Europe are going to really pull Europe back into a recession both Greece and Portugal have been able to raise money recently. China, as we all know, is very, very strong. Russia is growing at about a 4% to 5% rate this year. And Latin America is also expected to grow in the 5% range which obviously is very important to us since we're the major paper producer in that part of the world.

So looking ahead to the third quarter, we expect volumes to continue to grow, although at a slower pace. We expect to continue to realize our announced paper and coated board price increases and we expect significant incremental realization of our announced North American corrugated packaging price increases. The third quarter is also going to be our latest maintenance outage quarter in North America and we'll see a slight increase in European outages but overall it's going to be a plus for us. We expect input cost to flatten out but stay relatively high. We do, however, expect a favorable trend in our wood costs. And we're less certain about the outlook for OCC.

We also see in the third quarter a significant increase in other costs, and these are primarily quarterly true-ups of annual estimates for LIFO, legal cost and compensation. So I'm on slide 29, and let me just summarize here. The second quarter was a good quarter. Volume recovery was in line with the economic recovery. We've got significant price increase realizations. We've reduced our fixed cost. We had strong operations. In fact, the operations International Paper expects every quarter and we had declining wood costs. Our third quarter outlook, as I said, North America demand will continue to grow or as we say in the paper business be stable, although that growth will be at a slower rate.

Supply and demand, this is important, remains very, very tight. Inventory levels, in some cases, are 30-year lows. And as we with go around the world and look at the inventory -- supply and demand balance of inventory in all of our businesses -- container board, coated paper board, uncoated freesheet and pulp, inventories are in a good spot. We expect further realizations of our announced price increases, moderating wood costs, less certainty about OCC as I said and a reduction in maintenance outages. So all in, we expect third quarter revenues and earnings to be meaningfully better than the second quarter. And now, we'll stop right there and open it up to your questions.

Thanks, John. Thanks, Tim. Paula, we're ready for our first question, please.

(Operator Instructions)

Your first question comes from Mark Wilde of Deutsche Bank.

Good morning.

Mark.

Nice quarter. I wondered, first of all, can you talk a little bit about where you stand on cellulosic biofuel?

Yes. I'll let Tim talk to that, Mark.

Hey, Mark. Thanks. We've looked at it and the early work that we've done, we don't see a huge benefit for the Company. In fact, we think it's mostly a push on the map, but then when you layer in the consideration that we would have to return the credits that we filed for last year under the alternative mixed for tax credit. And then accrue those benefits over some period of time, we don't see the rationale for making any kind of change from what we've previously done at this point. We're going to continue to look at it, and if anything changes we'll let you know. But we don't see a big benefit right now.

Okay. And if I could, Tim, you also mentioned that other costs are likely to be up in Q3? Could you quantify that at all for us?

Yes. We're going to have -- it's going to be LIFO and it's also going to be accruals for incentive compensation as business performance improves. So those are the big items that are going to shift.

Is there any way to give us an order of magnitude so we have some sense of how those might move quarter-to-quarter?

I mean, it's going to be a meaningful increase. I don't want to get into forecasting what the actual number is going to be. But we're going to see a meaningful increase from second quarter to third quarter.

Okay. And then just one final question for John, a little longer term. I was down in Georgia a couple weeks ago and one of the European utilities is helping build a huge wood pellet plant down there because they've got a lot of incentives over in Europe for biofuel. And I just -- how do you think this affects the long-term competitiveness of IP if we've got a lot of -- or of the US industry generally if we've got a lot of incentives for either domestic or offshore power companies to generate bioenergy?

Basically, we think that the incentives are probably on the wrong end of the curve here. The incentives ought to be on the supply side. We'll compete with anybody on the demand side with competitive facilities. But if we wanted to have more biomass and more biofuel, what we better be doing is put in the incentives on the supply side or encouraging people to grow more fiber. And the International Paper, we think we're a competitive buyer of fiber. If we have to compete with people to have an advantage and they're -- they've got an ocean between them, that's just a fact of life.

But the arguments we're making to people and I think people are starting to listen, is the way to really do this and do it effectively, is to increase the supply side. Because nobody really wants to see the forest shrink. And there is a supply-demand balance on the forest side too.

Okay. I'll turn it over. Thanks, John.

Your next question comes from Gail Glazerman of UBS.

Hi. Good morning.

Hi, Gail.

Hi. Can you talk a little bit about the recent softening in the pulp markets, how you see that developing and particularly how you see that impacting profitability moving through the second half?

Yes. I think what we need to keep in mind, Gail, is we all knew that the impact in Chile wasn't going to last forever. And frankly, the prices that -- the runoff in prices went further and lasted longer than actually we thought. I mean, nobody knew. So the Chilean capacity is coming back on. I think the recent results -- the recent statistics just came out on pulp in terms of demand and inventories are positive. But the run-up in pulp prices that was attributable to the interruption of a big chunk of global capacity where they weren't structural, they weren't permanent and they were going to moderate and they are starting to moderate. So I'm not surprised at all and I think the moderation of pulp prices will be a function as we go forward with supply and demand and inventories and inventories are in good shape. And demand is still relatively healthy.

I mean, I guess I'm more interested in how it would flow through to your profitability, for instance. How sensitive is that strong European result, do you think, to pulp pricing and influence on paper pricing and even in the US when you look at what you did in the second quarter, it's still significantly below where you were in 2007, despite record pricing. And I'm just wondering if there are any operational offsets there?

I think, well, in North America, 70% of our production is fluff. So that's a lot less volatile than market pulp or paper pulps, although they do move together but there's less volatility. I think the connection in paper prices in Europe to pulp prices is harder than it is in North America but I think it's becoming looser. So I think what is driving supply -- what is driving prices in Europe is not pulp prices as much as the operating rates and supply demand balance for paper in Europe. And at the -- in Russia, Ilim has got their pulp business -- has got the major exposure to pulp prices. And we all knew that prices, whether it's $100 a ton or $125 a ton, they ran up, partly as a result of taking out a huge chunk of capacity, associated with the Chilean earthquakes.

Okay. And just one last question, on use of cash, would you envision putting more money into the pension in the foreseeable future or do you think the contribution you just made is probably it for a while until you start having mandatory contributions next year?

I think it's an open item, Gail. We made what we thought was significant and meaningful contribution earlier this week and we have the option to make additional contributions as we go through the rest of this year and early next year. But we'll evaluate it as we go.

Okay. Thank you.

Your next question comes from Richard Skidmore of Goldman Sachs.

Good morning. Can we just talk maybe slide 26 just for a second under the use of free cash flow? It looks like you highlight about $950 million of use of cash flow. It looks like you're at a run rate something north of $1.3 billion, $1.4 billion. Can you talk about what you might be using cash flow for -- that additional cash flow?

Yes. Well, you see what we've done here so far this year. We've also, which is not on the slide, increased our plans around capital investment organically across the Company this year. So we'll end up spending probably $300 million more this year than we spent last year. And debt reduction continues to be something that is a potential use of cash as we go through the second half of the year and into early next year.

Yes, Rich. We've continued -- I think this is important for investors to understand that we've not changed our view on cash allocation. It's going to be balanced. And we've been saying our priority is to have a strong balance sheet and that's with great credit rating. Their balance sheet debt is getting close to where we want it, but we've got a pension liability to fund, which we will. Returning cash to shareholder is part of the balance use of cash. Selective reinvestment to make International Paper stronger is a balance use of cash.

And selective capital reinvestment in the existing businesses to keep our best assets competitive is also balance use of cash. And how much of that we do in each of those buckets is going to be a function of the opportunities and how much cash flow we generate. But we're pretty positive about how we see the free cash flow story going forward.

Yes. We are. And the other point that I would make on the increase in capital spending this year, as we said in the past, a big chunk of that is devoted to cost reduction consumption reduction projects that we think have very high returns. And they're not huge projects. They're smaller and easier to execute. So, in the event that we can identify more of those and pull some of those forward, we'll do that as well.

And as you look maybe out to 2011 and the use of free cash flow, would you expect that there be less debt reduction and more cash to share owners or more cash to reinvesting in the business?

Well, we understand how important the dividend is to share owners. It's important to us. We made an increase earlier this year. The motivation is to continue to give more of the cash back to share owners over time. So, yes, I think that not calling it a date certain but as we go forward and make progress on debt reduction, we'll see that shift.

Okay. Great. Thank you.

Your next question comes from Mark Connelly of CLSA.

Thank you. John, just two questions, both big picture.

Mark , could you speak up a bit?

Can you hear me better now?

That is much better.

Apologies. Sorry. Two sort of big picture questions. You talk about low inventories across your system and what has struck me so far with companies reporting is that it has cost them money to have these low inventories in the last quarter but nobody seems to be terribly concerned about it as we go into the third quarter. And I'm wondering is that a function, do you think, as you think about your own system and broadly, is that a function of us getting better at managing with low inventories? Or, I mean, we could ascribe it to some extent just to seasonality but these inventory levels are extremely low and nobody seems to be all that concerned about what it might do to cost.

Well, we are. That's -- we're trying to get ahead of [buildable] inventory and industrial packaging and we can't. I mean, we've got strong demand, we're running well but demand is still stronger than supply. I think we will get ahead of it as we come our of some of these maintenance outages but we don't want to be -- we want to have the best of both worlds, supply and demand in balance, which it can be. But enough inventory that we're not shipping paper from box plant to box plant. We're using paper that we don't need to use to make a box just to get it to a customer. So -- Carol so far this year.

Probably $4 a ton so you're figuring it's really -- it's in the couple million a month at least --

So that's work we've to do, Mark.

I'm sorry. I didn't catch that. I didn't catch Carol's comment .

Mark, it's definitely been very costly. Shipping -- you get the paper to the box plant, you need it in another plant, you're touching it twice, sometimes three times. Sub-optimal routes. So we have to make -- that is one of our areas of improvement that we've been unable to improve. And we estimate that it's probably, I'd say, $2 million, $3 million a month of extra cost we've been carrying. And I'm viewing that as upside going into second half if we can capture if we can get our inventories back to reasonable levels.

So we've gotten better at operating the whole industry as of lower inventories. We haven't gotten enough better to be operating International Paper today at the inventory levels we're at.

Okay, okay. That's very helpful. And just a second question . Our sense looking at the data is that we've seen a pretty nice recovery in roll grades on the uncoated freesheet side and maybe a little less progress on cut size lately. When you think about your machine balance, is that recovery that we're seeing in roll helping you or making it more difficult to optimize your machines?

Well, it's a little bit of a drag because we've got some unused or we've got -- we probably have more feeder capacity than we have demand right now, overall supply and demand are in balance. But we can -- and we've got a little less flexibility than we had before but without Franklin. But the Courtland Mill is making a lot of progress, achieving the same customer service platform that we had when we had both Courtland and Franklin. So, but that's not -- it's to be expected with unemployment being -- staying frustratingly high at 9% plus. White collar employment is a big driver of cut size consumption.

Sure.

I think it's healthy we're seeing the commercial print mark actually show positive signs, because that means advertising and economic activity is coming back a bit.

Right. So it'd be fair to say as we see pick up in employment you'll have room for further gains because this has been slowing it down a bit?

We'll have improvement for mixed opportunities.

In mix, right.

And if we have to try to squeeze that incremental production to meet customer demand, we'll attempt to do that.

Got it. Okay. Very helpful. Thank you.

Your next question comes from Steven Chercover of D.A.D.

Thank you and good morning. I wanted to get back to Ilim for one quick second. They seem to be more aggressive in terms of cutting their pulp prices. Is that something specific to the eastern European market or does that permeate your views on pulp in general?

Well, I think the way you need to look at that is to draw a conclusion from that, you need to see where everybody's starting pulp price was and also by market. Most of what Ilim sells is into China. And the -- I would say Ilim is selling at the market price now and the market price in pulp in a particular market whether it's Europe or Asia or the US, there is some variation but they're not $100 a ton variations for the same grade. So I think what that is suggesting is a lot of the competition globally caused Ilim to make the price adjustments they made to get their prices in line with the competitors. And --

Okay. And just two other really brief ones. Your third quarter outlook, does that include much of the third container board price hike or is it mainly the full implementation of the second one?

Well, we are seeing the price increase on the second one come through and we're not going to forecast how -- what might come toward the end of the year is going to roll out. But I would say the supply-demand balance is very, very tight.

And, finally, with the land sales now complete, should forest products as a segment go away or will those still be little dribs and drabs of minerals?

Think of it as gone away.

Yes. And it will definitely go away at the beginning of the year.

Great. Thank you both.

Your next question comes from Chip Dillon of Credit Suisse.

Hi, Chip.

Good morning. Hey, I just want to make sure we're clear on the whole mineral rights. I guess two questions. Were the rights you sold this quarter tied to the land that was just involved with the deal that you just announced? And are there any more mineral rights you still hold, even though you sold all of your lands?

Think of this as the Rock Creek transaction winds it up. It winds up everything and the transaction is going to close in the third quarter, 163,000 acres isn't tied to the mineral rights transactions -- different lands.

Got you. But basically it's all -- both mineral rights as well as the timberland is gone now?

Right. We're finished.

We're finished.

Got you. Okay. And then I noticed on slide 39 you indicated that your price improvement in boxes were up $70 from December and obviously you can't talk about forward pricing. But if we just look for a second at the two you've already announced in the wake of the January and April board price increases and consider that, I think, box prices probably edged down a little bit in the first quarter, how much is left from these two announced price rounds? Would there be another, say, $10 or $20 left or would that be a good guess?

Hey, Chip. This is Carol. I would say that I'm hopeful that there is more than that left. And I'm not going to speculate on a number. But if you think about it is, we announced $50 and we announced $60, so it's pretty clear that the first 50 is all the way in and we started to get the impact of the $60. We have a lot of contracts that are quarterly, so we're going to see a pretty good increase in July just because of timing. We still have some that'll flow through in August and actually a little bit into September. So we'll continue to see that second $60 increase flow through into the third quarter.

Okay. And then I guess the last question is on one of the slides where you talk about the down time for the year being about $348 million as the impact. Is that a good proxy to use going forward or with the fact that Franklin is gone and a few other mills are out of the system that maybe next year the maintenance might be lower?

Well, Chip, we typically run between $350 million and $400 million. So, yes, we'll see a beneficial impact from some of the capacity coming out. But as a rule of thumb, I'd say you're probably still going to be around about $350 million

Okay. Got you. Thanks very much.

If you can make it less, we will, though.

I'll see what I can do.

I would just add on to that, Chip, that's something we managed very, very intensely. Every adage in terms of how long, what gets done, how much production do we get, how fast does it start-up and get back on grade. And there is some head room there for us to get the work done and spend less and we did a good job of that in the second quarter with a lot of outages going on. It's a cross bucket that gets managed very, very intensely because it's a lot of money.

Got you. Just to be clear on the whole Ilim pulp announcement, I know that Ilim sells, I believe, the bulk of its pulp to China. And I know China has historically has been more, if you will, a spot market and obviously was more than average impacted by the Chilean quake. So is it fair to say that maybe for a while Ilim was getting prices generally higher than what we might have seen in other parts of the world, western Europe and the US and that -- is that what you mean when you say you're kind of catching back to where the rest of the market is?

Absolutely. Absolutely.

Thanks.

Your next question comes from Mark Weintraub of Buckingham Research.

Thank you. A couple questions on the slide 28 where you've got the green, yellow and red. And, by the way, the yellow just to clarify that, that means a neutral view, is that right?

No. It means something between strong growth and negative.

Pretty wide band.

Yes, pretty wide band.

The Ilim is a yellow. I know you have an -- I guess I would have expected there to be pretty strong growth in profitability from Ilim given what is going on with pulp pricing, et cetera, and there is that one quarter lag. So I'm just curious how I'm supposed to interpret.

You're not on the map. You're on the --

He is on the outlook.

Yes, the outlook slide. Ilim is going to see one quarter lag. We're going to see the flow through of higher pulp prices. I think they've got some outages coming up. So the Ilim earnings probably will have peaked in the May, June, July period.

Okay.

Mark, this is Tom. Keep in mind now on that slide the color is meant to comment on the impact to International Paper, not the impact to Ilim. So the strong increase at Ilim is still a more muted increase for overall IP earnings.

Fair enough. And I guess on the other costs, and I recognize you don't want to be projecting to decimal points what things are going to be, but the second quarter you had the bad debt included in the printing paper business. You also had about $34 million or so I think it was of true ups and LIFO in the packaging business. So you already had a $70 million for what I would have thought were other costs. So when you talk about significant increases, are you taking that into account and you're saying that there would be significant increases above and beyond that type of level or were you not including those numbers when you were making that assessment?

Well, we have the LIFO charges. We have standard revisions. We have incentive comp accruals . Because, remember, we're coming from a very low base in the first part of the year in terms of how we were performing against our targets. So you have all of that. And I don't like to put numbers out, but it's going to be in the $0.15 plus per share range. So I think it's significant. Okay.

And, again, that would be $0.15 above and beyond the $0.10 that we're recognized --

Yes, it's going to be a net change, quarter-on-quarter, $0.15. $0.15 per share in that range.

Okay. Thank you.

Just a reminder, it's not all cash. And with that, we still expect to meaningfully improve our third quarter results over the second quarter.

Right.

Okay. Thank you.

Your next question comes from George Staphos of Bank of America.

Thanks. Hi, guys. Good morning.

Good morning.

I wanted to go first through the progress you're making in terms of mill optimization. And, Carol, could you remind us what the goal on a run rate basis is within the container board system and then more broadly, I remember a $300 million goal. Can you just confirm or update those figures?

Yes, George. Relative to the mill optimization there was the two closures of Pineville and Albany, and that was $60 million for the year or $15 million per quarter. And that is complete, done and we're doing well. And that was an important part of our $300 million improvement. The other pieces of our improvement was consumption in our mills on fiber, energy and chemicals, and we're making significant progress there. We're on track. Other part of our plan was the efficiency of productivity improvements in our box plan. That's on track and, in fact, we just announced the closure of our Jonesborough facility which brings 17 -- a total of 17 facilities we've closed and we restructure and continue to drive out cost and optimize sales and productivity.

So we're making good progress on all of those funds, and those are significant improvements when you have a system as big as ours. The area where we remain challenged that I feel we're going to turn it around in the second half as I'd referenced was the supply chain, our distribution cost which was a big opportunity out of the warehouse. Our acquisition we've just been yet to hitch drive there but we're optimistic we can get our inventories in line and that is also translated to high waste in our box plants because we haven't had the right rolls, the right time so that is another opportunity to get that lined up. But all in all, I'm very optimistic and feel very good about our progress.

One other comment on container board you didn't ask, George, but I think it's important to make, is we sell into a whole bunch of markets. Not just the US stock market and to independents in the US. And we think that strategically is the right thing for International Paper. Our net mill margins now in some of our export margins are better than our net mill margins in North America. And I think that is really important to understand because, obviously, that isn't always the case. But with the global supply-demand balance we have, we've been able to substantially improve our realizations on wider board sales outside the US and some geographies are better than the US now.

Are you in a position to improve those net mill margins, John, given the supply chain constraints in the US or have we likely seen a peak in that relative to the export market?

I'll let Carol answer that.

I think clearly there is more opportunity, and particularly, there is flow through. The way the export market is, you negotiate for production and then those tons flow through. So we're still going to be seeing rising revenue and cost -- or price per ton in the export channel through into the third quarter.

Okay. Back to the run rate and the goal for the year, I remember earlier in the presentation a figure of $225 million being reported. I just want to double-check if that was the goal for this year and, if not, what is the goal in total for mill optimization run rate by the end of the year?

You're right. That was the goal for the year. So we've hit it on a run rate basis at the end of the second quarter.

Okay. Two last questions, one shorter term and one longer term. In terms of early third quarter trends within industrial packaging, can you comment at all in terms of what kind of shipments or bookings or billings you're seeing right now? The longer term story, there is no denying at least from the numbers that you've posted that you've made tremendous progress and improving return on capital and productivity in returns. From here, John, to get to cost-of-capital on a sustained basis, do you think it's going to require more strategic moves, ie, restructuring and/or acquisitions or realignment for that matter across the geographies? Or do you think it will be more you have what you need in place right now and it's just a function of managing net price cost? Thanks very much, guys. Good luck on the quarter .

I'll let Carol answer the first part, George, and we'll come back for the second part.

George, as you know, demand in the second quarter was very solid, up sequentially, up year-over-year both for us and the industry. But we did see somewhat of a slow down from May to June. But June was still a good month with 22 days. And we've seen a corollary slow down in July of still well above last year levels, but slow. But that's summertime. You're in between [high] seasons. There's the summer doldrums. I have a theory it's very hot in the country, people eat less, they get out less, it's just a little slower. But we're still optimistic and I think we're going to continue to see positive year-over-year comps and we plan our year around pretty modest growth, so we think it's going to be fine, particularly with a very tight -- continued tight supply-demand dynamics that we've got.

Okay.

The question of the rate of economic activity in the US, this is the North American market is slowing. And I think people in Washington have recognized that and we're seeing it. So box demand will be positive but it may not be as positive as it was in Q1 and Q2 but it will be positive. And there is a big difference between being positive and being negative.

Yes.

In longer term, George, we think we've got the portfolio that we need to get the Company to an average across the capital of returns over the cycle. All of that execution and obviously 2010 is not a mid-cycle year from a macro standpoint. It's a transition year. Our box business slipped double digit rates in 2007 and we're back up 4%. So if you're down 14% and up 4%, you're really not at a mid-cycle environment. But we don't see the having to make major re-alignments in the portfolio, acquisitions or divestments to get the cost-of-capital returns. The challenge is and we think we're up for it is to do it on what we've got. We need a macro environment that continues to get better, and we'll slowly -- we wish we could get better faster. And we need to execute on the improvement plans and get the all -- realize all of the margin improvement that's part of International Paper's earnings runway going forward with the businesses we have.

Okay. Thank you very much. Best of luck.

Anything we do to -- anything we do above that, George, I would view as head room. It's just building the opportunity to be stronger, better and improve our returns.

Thanks very much.

Your next question comes from Peter Ruschmeier of Barclays Capital.

Thank you and good morning. John, I was curious if you could comment on, in light of the uncoated freesheet supply growth at Ilim, what is your longer term secular view of end market demand for the markets you serve?

We see positive growth in eastern Europe and Russia, in China and Latin America that's been the 4% or 5%, 6% range. We just had actually a consultant do a global survey for us. We don't see that obviously in North America. But these emerging markets still have a lot of growth in them because per capita consumption is so low and the economies are improving. And when the economies improve, things like paper consumption go up. They'll never get to levels per capita as we have in North America, but they don't need to, to show that kind of demand growth for probably the next decade.

Okay. So would you expect that the growth in the non-North American markets would be enough to offset the secular decline in North America so that you see positive growth?

(inaudible) Mills because if you think about it, North America isn't the supplier to China, Latin America, Europe -- eastern Europe and Russia. I mean, those markets are going to get supplied regionally from production there. So I don't think you can think about it in a global sense as it all netting out. North America basically it's not like container board where a big chunk of North America can go around the world because it's not competitive under a delivered cost basis.

Okay.

We're sold out in Russia. Between Russia and CIS, we don't have any extra capacity. So we have to be thinking longer term about how do we supply that market.

Okay. That's helpful. Maybe a quick question for Tim, if I could. On the cash flow items, the special charges in the quarter for Franklin and other items, what was the cash impact of those charges in the quarter?

Pete, off the top of my head I think it was around $60 million -- $60 million to $65 million. Something like that is what I recall.

Okay. And then also cash flow question is you look at your -- coming back to your inventories in your system, you look at the second half of the year, can you comment on whether you expect working capital to be a contribution or a drag to cash?

I don't think it's going to be a drag. I think it's -- my line of sight is probably not any better than the third quarter. But as I look out to third quarter, I don't see a big consumption in working capital.

They pick up a little bit. It depends on how much we grow our revenues.

Yes. Very good. Thanks very much, guys.

Your final question comes from Mark Wilde of Deutsche Bank.

John, I just wanted to follow up on the packaging business and I was very -- I've been very struck that your EBITDA per ton is almost as high in Europe as you're seeing in North America right now and you don't have nearly as much capital per unit tied up there. Do you -- what do you make from that?

Well, we've been reconfiguring Europe for the better part of the decade. We've gone from living out of Russia -- we've gone from ten mills to two mills. Saillat and Kwidzyn and Kwidzynis a very good facility. So we've got less capital tied up there. We're in a different position relative to the industry. We're a small player. And we've made a lot of improvements. Russia -- Svetogorsk is going to have a record year. So I think the -- it shows you that we can by restructuring the business and optimizing and this has been done over a series of years, not just something that happened in the last six months, we've now got a platform over there that's right sized for the market and both paper and packaging are firing on all cylinders.

I was more thinking of just your box business which I think is more sort of north Africa, western and central Europe.

Yes. Think of it as southern Europe and the Mediterranean. We've -- France, Spain, Italy, Turkey and Morocco. We're winning industrial business so we're clearly gaining some market share and that fruit and vegetable strategy over there is paying off because we've got no -- well, the fruit and vegetable strategy is paying off because we targeted specific segments that are doing well in the Mediterranean and we also have no mills. So the right strategy over there is to be a net board buyer because there has been a structural surplus of recycled liner board and Europe is heavy to recycle in terms of the end markets. And we like being a board buyer over there, which has been helpful. That's not our strategy in North America, but it's a different market and a different supply-demand balance.

Okay. And then finally you mentioned the slower growth that you're seeing in the US in June and July and you talked about that specifically in container board. Can you tell us what you're seeing in the other businesses in the US over the last couple months? Is that consistent with what you've seen in the box business?

We're seeing it in Xpedx. And when you think about Xpedx, our second quarter sales were up 3% compared to first quarter. It's still down 17% compared to the second quarter 2008. So the -- Xpedx serves almost every different -- almost every major metropolitan market across the United States and not just commercial print but packaging and facility supplies so they're a really good barometer of economic activity. And if you look at first quarter compared to second quarter, it's about flat. And so that would say economic -- the rate of economic activity has slowed down, maybe still positive but slowed down.

Are you seeing it anywhere else, John?

Tom, what are you seeing in consumer packaging?

Mark, the consumer packaging businesses are seeing pretty good demand for all SBS grades. The numbers are out there pretty public. But we're looking at, I think, 4% quarter-over-quarter growth and 12% year-over-year. The cup stock markets are strong. Foldings are improving. You're seeing price announcements in all of the folding grades, not just SBS. So particularly on the consumer side, we've seen some pretty good strength in the second quarter.

Okay.

When you look across all of our businesses that GDP growth is 3% plus. It feels more like it's around 2%. We'll see how the numbers play out, but I think that's what it feels like in the third quarter.

Okay. Very good. Good luck in the third quarter.

Thanks, Mark. Paula, that ends our call for today. For those of you still on the line, Emily Nix and I will be available in our offices for follow-up questions. Thank you for joining us today.

Thank you. This concludes your conference. You may now disconnect.