International Paper Co (IP) 2010 Q3 法說會逐字稿

Good morning. My name is Latricia and I will be your conference operator for today. At this time, I would like to welcome everyone to the International Paper 2010 third quarter earnings call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a Q&A session. (Operator Instructions) I would now like to turn the conference over to Mr. Tom Cleves, Vice President, Investor Relations. Please go ahead, sir.

Thanks, Latricia. Good morning, everyone, and thanks for joining our third quarter 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 our 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 financial measures is available on our website. The website also contains copies of our third quarter 2010 earnings press release and today's presentation slides. With that, I'll turn the call over to John.

Thanks, Tom. Good morning, everybody. Thanks for joining us. As we usually do in these calls, over the next 20 minutes to 30 minutes, Tim and I will review our third quarter results and the performance of our individual businesses. We'll also talk about how we see the fourth quarter shaping up and then we'll open it up for your questions. I'll just start by saying International Paper had a very good third quarter. We generated strong earnings per share, more than double second quarter levels, and also generated very strong free cash flow, over $750 million. Our strong results in the third quarter were broad-based, both in terms of business segments and geographic regions. Our results, importantly, were not just about price.

Volume was also up in North America, and outside North America, and we continue to realize the benefits of our restructuring efforts and operate our mills and converting plants very efficiently, all which led to very solid and meaningful margin expansion. We consider our third quarter results as one more step in our journey to generating sustainable cost-of-capital returns for International Paper over the business cycle. Also during the quarter, we used our strong free cash flow to contribute nearly $1.2 billion to our pension plan and to repay $200 million of balance sheet debt. So third quarter earnings were $0.91 a share compared to $0.42 in the second quarter, and $0.37 in the third quarter of 2009.

Earnings in all three of our US mill businesses were excellent. In fact, our North American industrial packaging business and coated paper board businesses posted record earnings. Our EMEA paper packaging businesses continue to generate strong earnings, and we also received a strong contribution in terms of EPS from our Ilim joint venture. Our earnings also benefited from reduced fixed costs driven by our mill and converting plant and distribution restructuring programs, which were initiated in 2009 and continue to deliver results into 2010. We continue to realize announced price increases and our mills and converting plants have been operating very well.

Volume increases were broad based, 5% up in North America versus the third quarter of 2009, 5% up outside North America versus the third quarter of 2009. So third quarter sales were $6.7 billion, up 10% from the second quarter, and 14% from the third quarter of last year. EBITDA increased by 33% to $1.1 billion, while EBITDA margins improved 16%. Third quarter free cash flow improved to more than $750 million and this figure includes about $150 million cash from land sales, but also includes about $150 million increase in cash consumed by working capital, so basically the two offset each other.

We ended the quarter with $1.4 billion in cash on hand as we used some of our cash to reduce long-term debt by $200 million, and made a $1.2 billion pension plan contribution. Said another way, had we not made that $1.4 billion contribution pension plan and debt reduction, our cash balance at the end of the quarter would have been close to $2.8 billion, and I just mentioned that to emphasize our cash flow was strong. As International Paper and the industry and all industries continue to recover from the global recession, we continue to improve our return on investment, which is the key metric for International Paper.

In the slide you're looking at here shows that prior to our transformation plan, our return on investment averaged about 4% and I'll remind you that includes land sales. Since we began to implement our transformation plan, the returns improved steadily until late 2008 just before the global recession. We were approaching cost-of-capital returns and then we hit the last part of 2008 and 2009. As we've come out of the recession, our returns have recovered and recovered quickly. And we've achieved cost-of-capital returns in the third quarter.

As we look ahead, our efforts are focused on maintaining cost-of-capital returns for International Paper over the business cycle. The $0.91 of earnings in the third quarter represents a new record of quarterly earnings for International Paper and if we exclude earnings from land sales, we earned $0.83 in the third quarter, which is still the highest quarterly earnings ever from our operating businesses. We feel very positive about what strong EPS achieved in the early stages of an economic recovery, just coming out of the deepest and longest recession we've had in the US in over 80 years. We don't see 2010 as mid-cycle demand environment. And our biggest market which is North America. The box business is a good example of why we see it that way. Industry demand is up 6% from the low point during the recession, but is still 4% below pre-recession levels of early 2008. So in this environment, we continue to increase our EBITDA and our margins.

The slide you're looking at here, the bars on the left side of the slide. This is slide nine, show our steadily quarterly progress in 2010 improving our EBITDA margins and all these exclude earnings from land sales. We ended the third quarter at $3.9 billion annualized EBITDA run rate, 15% EBITDA margins. The bars on the right of the chart compared our annualized nine months year-to-date run rate for 2009 and 2010. So I'll stop here and turn it over to Tim to discuss our third quarter results in more detail and come back at the end. Tim?

Okay, thanks, John. Good morning, everyone. We did have a very strong quarter and the earnings that I'm about to cover resulted in cost-of-capital or better returns in North America and our European businesses, and including industrial packaging, coated paper board and our printing papers businesses. We posted modest increases in volume coming from North American printing papers, consumer packaging and xpedx but equally important was a very strong performance out of Europe, where we didn't see as large a seasonal drop as we normally do from second to third quarter for both our box business and printing papers business.

Price realizations continue for our businesses and they neared the completion of the announced price increases from earlier this year. Additionally, we have increases out for North American coated paper board, and our European papers businesses in the fourth quarter. Operations continue to perform very well and we had fewer maintenance outages in the quarter. In the second quarter, you'll recall we recorded a $33 million receivables write-off for North American printing papers business.

In the third quarter, we were able to recover $16 million of that bad debt, and so the net change quarter-on-quarter is an improvement of $0.08 The Ilim joint venture delivered earnings improvement in line with our expectations, which resulted in $17 million of improved earnings to equity earnings, and finally, you'll notice that on the chart, there's no bar for input costs, which were essentially flat quarter-on-quarter.

To go to slide 11, I'll cover earnings performance on a year-over-year basis. Earnings doubled in the first -- more than doubled in the first nine months of the year versus last year, and that's even with a very large increase in input costs, nearly a $0.5 billion. Volume improvements account for about one-third of the earnings improvement, and in North America, it's been a slow, gradual recovery. Outside North America, it's been a quicker recovery and a stronger recovery, and our European box business, shipments are up 8% year-over-year and Brazil and Asia are up double digits. Selling prices have improved, as we expected, and operations, after getting off to a very slow start in the first quarter, where we had low wood inventories and weather issues, and resulting in both mill problems and ability to run for lack of wood have recovered quite nicely.

Our manufacturing team since then have delivered $150 million in year-over-year improvement and that really came in the second and the third quarter of this year. Input costs, as I mentioned, increased. We've managed to increase more than double earnings, increase by $0.72 even with $0.76 in input cost headwinds. And 90% of the quarter's $475 million year-over-year input cost inflation was due to the higher fibers that I mentioned earlier. Finally, the Ilim joint venture added $81 million to our results, swinging from a loss of $56 million in the first nine months of 2009, to $25 million in equity earnings in 2010.

If you turn to slide 12, it shows the changes in input costs relative to the second quarter. As I said, we had basically a flat level of inputs quarter-on-quarter. Wood and OCC costs declined, but were offset by higher energy, freight and chemicals. Wood continued to decrease through the quarter. OCC dropped early and then increased near the end of the quarter, and our energy costs on a unit cost basis increased in July and August, but then ended up at the end of the quarter, below second quarter levels. Chemical costs increased primarily due to increases in [caustic] soda and corn starch.

So with that overview, let me turn to the segment business performance. And I'll start with industrial packaging. Industrial packaging's earnings increased 72%. Volumes were down slightly. This was really a seasonal drop. We now have such a large agricultural mix, not only in the US, but as we've had historically in Europe, that the second quarter is now seasonally our strongest quarter for corrugated packaging demand. Our operations remain strong, but we had higher overhead accruals, primarily for incentive compensation, also for LIFO, by about $18 million. Earnings continue to reflect the ongoing merger benefits in our operations, and the improved fixed costs results from mill and box plant rationalizations. Earnings improved to the continued realization of announced price increases, and to the significant reduction in maintenance outages due to timing.

On slide 14, it shows that our volumes in North American box business declined 1% from the second quarter, reflecting the end of the agricultural season. Box price increased by $38 during the third quarter, and North American box volumes were up 4% versus the third quarter of 2009. Box volumes in our Europe, Middle East, and Africa business were up 6% year-over-year. So from the end of 2009, our average box price in North America has increased by $95 per ton. All of that led to higher margins in the quarter. You can see that in the third quarter, industrial packaging in North America posted EBITDA margins of 21% in the quarter as compared with 22% from one competitor and 17 from the other. In the third quarter, our North American industrial packaging business generated an 11% return on investment.

Let me turn to printing papers, and I thought printing papers had an outstanding quarter as well. The stronger volumes primarily in the market pulp business and improved price of mix increased earnings by $60 million. Also in Europe, the third quarter is normally a seasonally lower quarter, but our volumes were actually slightly higher than the second quarter. Earnings also increased due to price realizations in North America, Europe, and Brazil. And I think it's important that in Europe, since the end of the year, our prices are up about EUR80 per ton. But we're still not back at the pre-crisis levels of 2008. In Brazil, we continued to see price increases for export shipments to Latin America and Europe, at higher input costs, mostly in Brazil and Europe.

And the $49 million improvement on the chart is the swing in bad debt that I discussed earlier, so if you exclude that, printing paper's earnings were up about 40%. We had improvements in all regions and 85% of the improvement came from the North American printing business -- printing papers business, which was evenly split between both paper and pulp earnings. Consumer packaging on slide 17, earnings increased by $49 million to $71 million -- increased from $49 million to $71 million in the third quarter. Improved volumes contributed $7 million and price & mix improvements contributed $10 million . And we continue to see strong backlogs of unmade orders currently running at about four weeks of supply. Overall, we ran well, although we had higher operating costs in short wood and that was the primary driver of the $8 million unfavorable number there. And we did have fewer outages in the quarter.

Xpedx had, again, a good quarter as it recovers its business from the crisis, It earned $22 million. Volumes improved steadily as the quarter progressed, but the favorable impact was somewhat offset by margin squeeze, as paper producers increased selling prices more quickly than the xpedx resell prices increased. It was encouraging, though, to see volumes increase through the quarter. We saw volumes for the printing segment increase by 9%. In packaging and facility supplies, grew at 7% and 4% respectively.

And on a revenue per day basis, we averaged $29 million per day, but ended the quarter at $29 million per day in September, which was the highest level since the fourth quarter of 2008. We also completed in the quarter the last significant land sale. We received $160 million in cash and extended a three-year loan for $39 million. We also retained a small interest in the partnership. So with this transaction, we've essentially completed the land sales and at the end of this year, we'll stop reporting on forest products segment.

Let me turn to the Ilim joint venture, which as you recall, we report on a one-quarter lag. Sales at the Ilim joint venture increased to $465 million and our share of the earnings increased from $5 million in the second quarter to $22 million in the third. Third quarter volumes -- our third quarter, their second quarter, were lower due to maintenance and the Bratsk mill, lower pulp shipments to China, primarily in June. Operations improved in the quarter, reflecting lower seasonal energy consumption, and we did see a significant improvement in price for both market pulp and containerboard. And as we exit our third quarter looking into the fourth, we're expecting similar performance out of the Ilim joint venture for the quarter.

Now I'll turn back to Europe, Middle East, and Africa on slide 21. And just take a minute to highlight what I thought was outstanding performance by all of the businesses there. Our operations are on track to have a record year this year, and it's important to understand that from 2008, this business was the only one that did not see a drop in earnings year-over-year. Earnings in 2010 are $364 million versus $249 million in 2009, an improvement of nearly 50%. Strong earnings have been driven by continued demand recovery, good pricing momentum, and very good manufacturing and converting operations. And if you look at the table in the lower righthand corner of the slide, it shows the returns for all of the businesses, all generating above cost-of-capital returns for the year.

Let me switch gears a minute and talk about fuel credits for a moment. There's been a lot of news about what will be allowed or may be allowed. We're currently looking at the potential cellulosic biofuel tax credits, the recent IRS ruling, the company's ruling -- that companies may qualify for both the alternative fuel mixture credits and the cellulosic biofuel tax credits within 2009 means that International Paper may now qualify, which would be used as an offset against future income tax. We're currently assessing where we are. We can't quantify the potential benefit of the cellulosic tax credit at this time, but we think that potentially could be significant.

So I'll end my comments on the capital allocation slide. As John mentioned, during the third quarter, we contributed $1.2 billion to our pension plan continued to repay balance sheet debt and all of the decisions that we're making are a reflection of our commitment to increasing share owner value through a balanced use of capital. So with that, I'll just wrap up with a brief summary of the quarter. I thought we had great results overall, both market performance and in our operations, our execution was strong and the organization remains focused on continuing improvement.

So as we look out to the end of this year and into next year, we're focused on more operational improvements, mix improvements, and cost savings opportunities, and the focus of the organization is about sustaining the level of performance that we have quarter-by-quarter. So we had a great quarter, but it's the first step on the path of building sustainable returns. With that, I'll turn it back over

Okay, Tim, thanks. I'm on slide 24 now. Looking ahead to the fourth quarter, we expect to continue to generate strong earnings and free cash flow, but it's seasonally lower levels than the third quarter and that's why a lot of this chart you're looking at shows yellow. We're into the fourth quarter and we all know from experience that November, December, January are usually the seasonally slowest quarters in our industry. We expect paper packaging volumes to decline in line with those seasonal demand trends. We expect stable paper packaging pricing. Maintenance outages are going to be about $30 million higher in the fourth quarter than they were in the third.

We do expect higher OCC costs because we ended the quarter with higher OCC costs, and we expect slightly higher caustic and corn starch costs in the fourth quarter. Xpedx earnings, like the rest of our paper and packaging businesses in North America will also experience a seasonal slowdown after we get through October, and we expect stable contributions for mill, if you can't remember, that's on a one-quarter lag. And obviously since we completed the last of our forest land sales, forest products earnings are going to be off by $50 million.

So this is the last slide I have here. This summarizes our third quarter results and our outlook for the fourth quarter. Volumes continue to recover in line with the economic recovery and finished stronger at the end of the third quarter. Our average selling prices increased as the quarter progressed, reflecting the continued realization of our announced price increases. Our mills and converting plants continue to operate very well. Input costs primarily OCC and chemicals at the end of the quarter were flat, but slightly higher than we expected. We've capitalized and continue to capitalize on restructuring efforts, and that shows up in our increased margins, in the generation of very strong earnings and free cash flow.

Looking ahead to the fourth quarter, we expect to be strong, but seasonally slower, as I said. We anticipate the fourth quarter performance will basically be similar to the third quarter, after we adjust for the seasonal volume declines and the higher maintenance outages, some minimal input cost inflation, and the impact of the recurring items which we already talked about, including the land sale and the bad debt recovery. So I'll sum up saying, we're very pleased with our post-recession progress. Our earnings and free cash flow come back faster and stronger than prior recovery periods, despite the fact that this latest recession was the deepest and longest in 80 years and I call 2010 a transition year, not a full recovery year. So as Tim said, I think we're setting the stage for continued improvement in earnings, free cash flow, and returns, as we go into 2011. With that, Tom, I guess we'll open it up for questions.

Latricia, we're now ready for our first question.

Thank you. Our first question comes from the line of Rick Skidmore with Goldman Sachs.

Good morning, John and Tim. Maybe a two-part question, coming back to the balanced capital allocation. In 2010, looks like most of the free cash flow went to either pension and debt reduction, a little bit to dividends. Can you talk about how that might change in 2011? Will you be a little bit more tilted to returning cash to shareholders, or more focused on debt reduction and pension?

Well, it's a good point, Rick. We talked about balance. It doesn't mean that it comes in a sequential fashion. Clearly we're making progress on debt reduction. And we're the targets that we had set for ourselves. Dividends continue to be a priority and I'd say that nothing has changed in our thinking there. What we're trying to do is make choices that drive shareowner value longer term and we want to get to a dividend level that's affordable, sustainable for the long-term. We will be talking to our Board about that as we exit the year this year and go into 2011. And we'll talk about that when changes have been made. But I would just remind everyone, it looks like -- or feels like the second quarter was a long time ago, but that's when we took the last action on the dividend to increase it to the $0.50. It's only been one quarter at this point.

I'm going to just jump in and be -- guess say what Tim's already said. Part of our capital allocation process is returning cash to shareowners. Just want to be really clear with shareowners about that. And as we move into 2011, we'll be speaking with the Board of Directors about moving our dividend from where it is to a higher level, which we think is sustainable over the cycle.

And maybe just one follow-up on the pension contribution, Tim. Do you expect that there would be any need for pension contribution in 2011? And then can you just remind us what, if any, share repurchase authorization you have outstanding?

Well, on the share repurchase, I think we still have $250 million or $300 million from the last authorization, which goes back I guess to the 2007 timeframe. On the pension, we don't expect any required cash contribution in 2011, and at the moment, we really don't expect any significant one in 2012. We could, based on these, we could continue to make voluntary contributions as we go into next year.

Thank you.

Thank you. Your next question comes from George Staphos with Bank of America.

Thanks, everyone. Good morning. Congratulations on the quarter. I had three quick questions. First of all, as you look the a the business and the fact that you're now more or less earning cost-of-capital and the fact that you want to sustain that level of performance, John, do you see any areas perhaps across the businesses, even though they are performing well right now, that might be candidates for further disinvestment or perhaps some capacity closures, whether it's in making paper or shutting conversion capacity? And then I had a couple follow-ons.

I wouldn't want to speculate, George, about what we're going to do going forward. I would say we sized our footprint in North America and in Europe to what we think is demand, and that's having a huge impact on the Company's cost structure. We're now running full instead of taking a lot of downtime. We're going to continue to manage our capacity very carefully. The good thing about International Paper at this point in time is we've got a set of businesses that earn cost-of-capital returns over the cycle. I don't think the cycle has disappeared, but hopefully the cycles aren't as volatile as they have been, given our geographic balance and the fact that we're managing our capacity very closely to demand.

Switching gears, John, I appreciate that color. If we look at Europe, what do you attribute the -- if you would, better than expected demand in shipment trends there to, and how sustainable do you think that trend is more broadly within papers? I realize you don't think you're at peak year and we're not even at mid-cycle yet, but do you worry that perhaps papers and aggregates might be closer to peak?

No, I don't, George. For this reason, we're really tilted in Europe to the -- our European business is heavily weighted to eastern Europe and Russia, Poland, and (inaudible) where eastern Europe demand growth is still positive and the markets are growing. In the box business there, our unit volume is up 7% I believe, and to really position ourselves in the ag business in southern Europe, Northern Africa and Turkey. Turkey volume is up 20% year-over-year and we're also doing a good job in the industrial margins, in places like France, of winning business. So with the focused sales effort, even in a weak economy, you can win some business. So clearly Western Europe, and we've got one mill in Western Europe, Saillat, which is in France, is serving a market that is mature like the US market, although it doesn't look like it's got the same structural decline underlying as maybe down 1% to 2%. So we think we're well positioned over there.

Okay.

And what's contributed to improving the returns are really three things. We have done the restructuring to get two mills that were high cost and losing money out of the system. We've improved our mix at Svetogorsk, significantly by making more liquid packaging board and aseptic packaging and we're growing our volume in the box business. And those three things internally have really been a big driver of the earnings in addition to the price improvement.

Last question, and I'll turn it over. Consumer packaging, what two or three elements of the strategy do you expect should get you to close to cost-of-capital or above that in the next year or two? Thanks, guys. Good luck on the quarter.

Well, there, and the biggest piece of consumer packaging was the coated paper board business. That's where the capital was tied up. The food service is right on the edge and we're pretty confident that we've got plans that are really volume and mix to get the cost-of-capital returns. Our challenge is Sherwood but Sherwood's got very little capital tied up in Sherwood. So it's not a need mover. What we need to do is stabilize revenues there and rightsize the North American footprint for the level of demand we have.

Okay. Thank you very much, guys.

The next question comes from Mark Connelly with CLSA.

Thank you. Two questions, John. Following on George's question, if we disaggregate some of the business segments and look at container boards, mills and boxes together, can you give us a rough estimate of where the cost-of-capital return is, where the return is there relative to cost-of-capital? And a second question, just a bigger picture, what is your medium term view on the outlook for North American containerboard demand? We've just gone through a decade where demand really didn't do much of anything and [RICI] talking about steady growth over the next decade. I'm wondering how you think about preparing for the next ten years of containerboard domestically.

Well, we've run the business on the containerboard business on an integrated basis, Mark. Although we measure all the box plans on their own stand-alone profitability, so it's the general manager challenge to make stand-alone profit with the capital tied up there. But at the end of the day, you look at the return for all the capital we have invested in the business because we're about 80% integrated. So on that basis, Tim said he made an 11% return in the third quarter and we think we can build on that going forward. As far as box demand goes, I -- you can draw these charts any way you want. I think the simplest way to do it is look at US box shipments over the last 15, 20 years. 2008 was not a great year for box demand. I think box demand was down relative to the 2004, 2005, 2006 and 2007.

We say that maybe represents the mid-cycle year and we're still 4% where we were in the first part of 2008, and that's with 20% of the market, which is the durable segment being really, really soft. And you take the housing-related sectors. We're not going to have 500,000 housing starts forever. Who knows when they are going to return to more of a normal level, but that normal level is like 1.5%. And so I think there's a lot of pent-up box demand associated with the US economy over time, returning to its more normal level of economic activity. So we don't see the box business as one that can't have 1% to 3% growth over the next five to ten years. There will be a cycle in it for sure, and just using that comparison I gave you of today versus beginning of 2008 I think is a good reference point.

Very good. Thanks, Tim.

The next question comes from Mark Wilde with Deutsche Bank.

Good morning. It's Mark Wilde.

Hi, Mark.

Hi. I've got two questions. One is just on the Asian packaging business, I wondered if you can address both profitability in that business, which still seems to me to be relatively low, and then growth plans in the business. You bought the SCA business and I think you're in the process of building another fairly large, very large machine in the Sun joint venture.

Well, we've announced that machine, we haven't started it yet. In the box business, the objective is not to grow, the objective is to make money. We've got plenty of capacity. Those SCA plants were running about 40% of capacity. So the objective there is to profitably sell that volume out and we think we can do that. Our business, our legacy business that is part of our packaging business over there was growing in double-digit levels this year and we think going forward, we can get the SCA business to do the same thing.

And I think, Mark, if you look at it, we see some of the same types of opportunities combining those two businesses that we saw around the synergies in warehouse and combining with our legacy business. So we've had it for 90 days and I think it takes time, but it will -- I think it will come quickly.

Okay, and then I have just a couple questions around industrial packaging. One, I wondered if you could just give us some sense of whether the business over in Europe just got squeezed as containerboard prices have run up so sharply in Europe and Europe mainly not integrated. So you're just buying containerboard, selling boxes, and then secondly, in the North American business, it strikes me, if you look at the EBITDA margins for you and some of your competitors in the third quarter, I'm thinking about one that had a 22% margin in the third quarter. If I go back and look at, say, 2000, when containerboard prices averaged about $450, actually EBITDA margins were higher then than what we've got right now with containerboard prices north of $600. Have costs gone up that much, or is there something that's gone on with the margins in the converting business?

Well, let me just talk about Europe for a minute. Our -- we are not integrated there, Mark. And our earnings in Europe are up significantly year-over-year, even with higher containerboard prices. So we call -- this is called Delta P, the difference between price of paper and the selling price. We've done a great job of managing the mix of business so that we've had marginal erosion on Delta P, because there's no way we could have improved our earnings by almost 50% in that business year-over-year, just on volume. It's on being able to maintain margins.

Okay.

The -- I think the industry, both paper in North America and I'll let Carol jump in here, Carol Roberts, if she wants to add anything. In both of the businesses, the nature of the business and the industry has changed. So I don't think looking back at history is necessarily the determining factor in saying what margins will be or can be. I think it's all about what the industry shape and the supply and demand look like going forward. We're a dramatically different Company in terms of our structure and though we think about the business than we were five, ten years ago. That's true both in paper and in packaging. So I don't think the past is any indicator of what margins will be or could be. They are going to be determined by what happens going forward.

Okay, and finally, John, would you have any thoughts on the recent weakening we've seen in the dollar and how that's going to affect IP over the next few quarters?

Well, the full-on effect really impacts our customers more directly than it impacts us. It certainly has (inaudible) order effective implications of keeping products out of the US, the stronger currencies let's say in Europe. But to the extent that our customers are export oriented and then our consumer packaging business, and our industrial packaging business, we have a lot of customers who are export oriented, that helps them grow their business and that helps us grow our business. Obviously, our business can only be as good as our customers.

Okay. Thanks. I'll pass it on.

The next challenge, Mark, is in Brazil.

The next question comes from Gail Glazerman with UBS.

Hi, good morning.

Hi, Gail.

I was wondering if you could talk more about the current environments in industrial packaging, where you stand in terms of your inventories and also just how the market feels compared to maybe six months ago?

Carol, do you want to take that?

Yes, sure. Gail, I would say the current environments still feels very good. We saw pretty good demand in the third quarter, with the industry's stats up 2.6% year-over-year, and we've seen that growth continue. September was a strong month. So as I look at the overall picture, the things that we say are important, balancing our supply to our demand, remains the number one priority. So when you look across, you see slow, steady box growth. We see strong export demand. We see still inventories at still historically low levels, particularly on weeks of supply, so it still feels very much in balance for us and we're going to continue to manage that. So I feel very good about the fundamentals in the industrial packaging right now.

Okay, and just a quick follow-on on that, can you talk a little bit about the export opportunities for board? Are those, are those holding up? Is it still something that would be potentially better mill [nets] than what you're seeing domestically?

Well, Gail, as you know, even when we went through the tight times, we strategically view -- we view exports strategically as an important part of our portfolio with a ten million-ton footprint. So we did not exit the export markets through this past year. So our export shipments have held up pretty well. We did get an opportunity to grow with that this past year, which has been good. So we've been in those markets this whole time, and as you -- as everybody knows, the pricing on those markets has gone up due to supply/demand balance and that's been good for us. So those markets remain good. They remain strong for us. And the fact that we were there throughout has helped us with our customer relations.

In some of the markets, Gail, the mill nets are better than they are domestically, but that is typically the spot part -- spot market in export, not the, as Carol said, the strategic market. But margins have improved there to where they are comparable, which is what you would expect in a tight supply/demand market globally. That's where we are for kraft liner board.

Okay. And just a couple of questions on costs. You talked about OCC, you talked about chemicals, can you talk about your outlook for wood costs moving forward?

Tim?

Yes, Gail, we expect it's been coming down since the peak during the second quarter and right now we've got great conditions to keep managing it down. So I think it will keep drifting down through the fourth quarter and into the first unless all of a sudden the weather changes dramatically. But if you recall, this time last year, the mid-south and southeast was pretty much underwater. We couldn't even get into the woods to harvest. We took the opportunity during the summer to build better inventory levels going into the wet season and now we've had the benefit of the wet season not coming so quickly. So I expect it will keep moving down into next year.

It's probably going to be a drift down, Gail. We've had a step change in wood costs. We don't see another step change in wood costs until chip supplies come back on. There's a huge chunk of the wood supply in the south. It's still on the sidelines because of the weak demand in housing, and that's a big source of our fiber and we don't have that, we've got to go further to get wood. So I don't think there's going to be -- even though we have good inventories, it's a big step change in wood cost. It would just be drift.

Okay, and just one last question. On the compensation accruals, in aggregate, did those come in, in line with what you expected and how should we think about that as a swing factor moving into the fourth quarter?

Yes, they did come in line pretty much with what we were expecting and they are reflected in all of the business results. What didn't come through quite as much as we thought it would, would be the change in LIFO expense, and that can be somewhat volatile. But that came in a little bit better than what we were thinking.

And for the fourth quarter, is there some things that should come down or is it going to remain at that level?

I think it will be at the same level. I don't expect a big quarter-on-quarter Delta.

Okay, thank you.

Next question comes from Chip Dillon with Credit Suisse.

Yes, good morning.

Hi, Chip.

Tim, first question is,you've put quite a bit into the pension plan this year, and obviously a headwind as we look at 2011 as the lower corporate interest rates. But as you look at it today, can you give us a rough idea, do you think that with the contributions that you put in this year of $1.2 billion, that your pension expense has a shot at coming down next year if we looked at where the markets were today, and interest rates?

I think it does, but we'll see at the end of the year when we remeasure everything. On a net-net-net basis, I think we've made some ground with pension contributions this year. Our performance return on assets has been pretty good. We're -- right now, if I had to estimate it, I would say we're somewhere between 10% and 11% return on assets in the plan. We'll see what happens with interest rates. That's the big, that's the number that can move the gap dramatically. But I'm feeling pretty good about where we are right now.

And then I noticed on the slide, you were looking for stable packaging prices, which in containerboard is pretty obvious. But when you look at bleached board, we've seen a lot of strength there including the October pricing data from [RICI] and I know you guys are close to 400,000 tons here. I don't know if any of the European paper board is bleached, but could that be a slight up, if you look at this bleached board and it would seem like you could see $50 a ton there on average, at least in the fourth quarter versus the third?

Just to clarify on the European piece, it is bleached board.

Okay.

Chip, right now the backlogs are very strong here in North America. We're still over 500,000 tons on made orders. We will get realization on the folding increase that is announced, and in the marketplace already in the month of October. So that -- our exit rate will be higher coming out of the fourth quarter than it was coming out of the third, and we feel pretty good going into the next year from a demand and from a pricing standpoint.

Got you. And this is the last question. As you guys look at the whole black liqueur situation, at least is the thought process where you decide if and how much you want to switch from the alternative minimum to the cellulosic biofuels, you would take the $0.50 that you do switch and, in essence you would have to pay that back to the government. And then you would have to I guess apply for the higher credit and if you did that, would that first have to go against an amended 2009 return, or could you use it in fact, to reduce your estimated taxes on 2010 or 2011?

Yes, you can carry it forward and that's what we -- that's exactly what we would look to do. And, if we see that there's a benefit there that we can realize, we'll try to time it such that anything that we're giving back is timed close to when we would file an amended return and get the benefit from the cellulosic biofuel credit.

Got you, thank you.

The next question comes from Peter Ruschmeier with Barclays Capital.

Thank you. Good morning. Couple of questions. I was curious if you could help us with the exit prices of some of the key products relative to the third quarter averages.

Yes, I mean, without going through them number by number, we were realizing price increases right through the quarter. So, I don't know if each of the business managers want to speak to their own piece. I guess the way I would summarize it, Pete, is we're pleased with where we are. On containerboard, for instance, on a year-to-date basis,, we're up $95 through the end of the quarter. So, we had a very large number of announced increases, and I think at this point, we're 85% of those announced increases for the operating businesses.

Pete, I was looking here. I would say Europe was up. Boxes were up just at the end of the quarter. Pulp was down. Bleached board, Tom just talked about, was up. In Asia, bleached board was down. And in export markets, it was stable. Export markets and paper out of Brazil, and containerboard out of the US.

Okay. That's helpful. Maybe a question for Carol. On industrial packaging, clearly very strong performance. As you look at this business on a year-over-year basis, looks like you're up $72 year-on-year on price and I think you mentioned 5% on volume. So I would think that the price variance and the volume variance alone would drive at least the variance we saw, not to mention you had some cost cutting. Are there certain cost elements as I look at this year-over-year that held that back? Anything one way that -- one-time that held back the third quarter, or any light you can shed on that comparison?

Yes, Pete. That's a good question. If we look at the operations, we have done better. We've got the full benefit of the rationalization. Our consumption costs in our mills for fiber, energy are down, and I'm sitting next to my boss here. But what really held us back is if you just look at the incentive comp and some of the corporate charges year-over-year, that they are quite different. And that's masking a bit the on the ground improvement that we're getting in our box plants and in our mills. But I think over time, that, that will become transparent and work its way out. But those are put into the same bucket, because they are costs, from wherever they come from. But I do feel good about the progress we're making in our operations and in the cost lines that matter over time.

Pete, if you look in the Appendix, I think it's slide 47, you see what's happened to OCC prices index. And OCC prices in 2009 were a huge tailwind. This year is a headwind. That said, we actually benefit from higher OCC prices because it moves the cost curve up and we're running 35% OCC relative to [virgin] fiber.

Okay, that's helpful. Maybe lastly, John, you mentioned earlier that you've taken steps to rightsize the footprint, even uncoated freesheet, you're still enjoying growth in eastern Europe, Russia, Brazil. Can you share your views, though, on a secular basis? I mean, is the growth in these emerging markets enough to offset the mature nature of Western Europe and the US for uncoated free sheet? And how do you think about on a going forward basis managing supply, along the lines of what you've done at Franklin?

We're still committed to managing our supply base wherever we are. The -- and we don't see a -- Franklin was a very tough decision to make. It was a hard one to make, the impact on community and the employees, but we needed to make it, and the benefits of having made that tough decision are showing up now. We really haven't looked at demand offsetting what's going on in the US because the only supply decision we've had that's inter-region is Brazil and Europe. And that's replacing the high cost mill, not integrated mill, we shut down in Scotland and we're going to pull that volume back in Latin America, as the Latin American region grows.

So we've got -- we're practically out of capacity in Russia, so between Ilim and International Paper, we're looking at how we can meet the demand in that market. We continue as eastern Europe grows. All we do is tighten up our mix to the highest margin markets for paper and bleached board out of Poland, and we know that western Europe is going to be flat at best and the US over time will -- it's going to decline, but this year and next year could be, flat to up. Flat with unemployment at 10% and with [cut size] being attached to white collar employment in terms of consumption. That's pretty good outcome.

Very helpful. Congratulations on the quarter.

Next question comes from Steve Chercover with DA Davidson.

Thank you. Good morning. Wondering how much integration benefits do you yet have to be realized within the containerboard system?

On the integration benefits, we pretty much have gotten the integration benefits, so we're not calling that integration anymore. We really completed that fast and early. What we're working on now is continuing to unlock the potential of the combined business. So that's our continuing improvement efforts. And there's still a lot yet to be done. Examples are great rationalizations through the system. The closure of the two mills that we did, we just in the box side announced the tough stuff that we did, another plant closure in Spartanburg, a downsizing at Shreveport. So we've still got a lot of opportunity of what the combined businesses can do together and what we can leverage both in the market and on the cost side. But I would say that from an integration perspective, we're done.

Okay, Steve, International Paper, the future earnings runway is not just volume and price. We've got pretty healthy, sizable margin expansion strategies in each of the business, which are independent of what happens to volume and price, which is good news, because it means we've got a platform for improving our margins and earnings going forward, no matter what the macro environment is.

Great, and one other question. I guess it's also pertains to containerboard, but philosophically, if you are earning your cost-of-capital in containerboard in Q3, would it be reasonable to say that you were seeking economic rents with the third price increase?

Pricing in this business, in all our businesses is a function of demand, supply, and inventory levels. And I guess I would just say we don't think about it as economic rents, we think about what are the fundamentals of the business. Export demand remains healthy. Inventories, as Carol said, are at historic lows. Box demand in the US is positive, and those are all good.

Great. Well, thanks. I look forward to next quarter and next couple years I think.

The last question comes from Mark Weintraub with Buckingham Research.

Thank you. First, quick follow-up on that cellulosic biofuel question. In terms of timing, do you have to make a decision on whether you're going to make a shift by a certain point? And does it all have to be at once? Or basically as you see how profitable you are, can you be making piecemeal decisions along the way?

I think we'll be looking at it year-by-year, Mark. We -- that doesn't mean that we won't come to potentially its termination at a point in time and say what we think the overall benefit is and then reflect that in our earnings, but we're still sorting through all of that. So, it's just not clear at this point whether there will be one quarter where we estimate the benefit and take the benefit, or whether we'll work it out over time.

Okay, and is there --

The benefit itself, if it comes, will likely be over time.

Understood. And is there a date by which that benefit will have to have been accomplished? Where essentially--

By 2015.

Okay, and then second, I guess mostly for Carol, were you surprised that, that third price increase -- as you were looking at your business, did you come away with anything instructive as to how that third price increase ultimately did not get put in place, or got rescinded? And were you surprised, just maybe provide some color on your thoughts on that whole process?

Sure, Mark. To be honest, yes, we were surprised that the increase was rescinded. We had announced and implemented with our board customers, and we were actively talking to our box customers. That said, it has not changed our view of what we believe is important for International Paper, which is balancing our supply to our demand. And today, once again, we see slow, steady box growth, see strong export demand, we see historically low levels of inventory, given the current box demand. And these are all good indicators for the health of our business and the actions that we're going to take going forward. You have to remember, we're running fairly full right now, but it's in a footprint that's 10% smaller than it was when we started this journey. So it's not going to change the path that we stay on and what we're trying to get done here.

Okay, and so is it fair to say that there was an experience that's going to necessarily make you gun shy related to having to rethink when markets are appropriate to be raising prices, et cetera?

I think you just have to evaluate points in time for the merits of them at that point in time. I think John said earlier, history isn't necessarily the dictator of the future and you just have to manage your business as it presents itself and our fundamentals and our beliefs, I think, are pretty clear.

Thank you.

Latricia?

Yes, sir. That was the last question. Are there any closing remarks?

The only thing I would say is thanks for joining our call today, and Emily Nix and I will be available by phone for follow-up questions. Thanks, Latricia.

Thank you for participating in today's conference call. You may now disconnect.