International Paper Co (IP) 2011 Q3 法說會逐字稿

Good morning, my name is Laurie, and I will be your conference operator. At this time, I would like to welcome everyone to the International Paper Third Quarter 2011 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session.

(Operator Instructions)

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

Thanks, Laurie, and good morning, and thank you for joining International Paper's Third Quarter Earnings Conference call. Our key speakers are John Faraci, Chairman and Chief Executive Officer, and Tim Nicholls, Senior Vice President and Chief Financial Officer. During this call, as always, we will make forward-looking statements that are subject to risks and uncertainties which are outlined on Slide 2 of our presentation. We will also present certain non-US GAAP financial information and a reconciliation of those figures to US GAAP financial measures will be available on our website. Our website also contains copies of the third quarter 2011 earnings press release and today's presentation slides to follow. I will now turn the call over to John Faraci.

Thanks, Glenn, and good morning, everybody. Yes, let me just start by saying we're pretty pleased, very pleased, with our third-quarter results. I think the $0.92 a share reflects the global balance of International Paper. Our focus business continue to produce strong earnings and free cash flow. Basically it was steady volumes in a weak economic environment, stable pricing, outstanding operations, very strong contributions from our joint venture in Russia. We offset input cost escalation and achieved cost of capital returns. If you think about our earnings, they were substantially up from the second quarter, and adjusting the third quarter 2010 for a land sale, they were up 11% relative to the third quarter of last year.

This next chart here just shows what I mean about balance in the global portfolio. We had strong contributions from both our paper and packaging businesses. As you can see, 30% of our operating earnings are coming from platforms we have outside North America that have a lot of volume, revenue, and earnings growth in them. EBITDA margins improved across all of our global manufacturing businesses, up strongly 300 basis points from where they were in 2010, and again, that just set the stage for -- I think underscores International Paper's ability to perform in a challenging economic environment.

So with that as just a brief introduction, I'll turn it over to Tim to go through the businesses.

Okay, thanks, John. Good morning, everyone. I'm on Slide 7 and I wanted to just start out by saying that we had, as John said, really strong results in the quarter in what's been a difficult environment. The third quarter of last year has been adjusted for the land sale. You see revenues up nearly 2% versus same time last year. Margins continue to remain very solid and cash has been strong, up from the second quarter and very close to the third quarter last year, even with $130 million more in capital investment in the third quarter of this year than last year. Cash balance grew from the end of last quarter to this quarter by another $300 million.

If you look at the second quarter versus third quarter earnings performance, strong quarter in a tough environment, price and volume basically flat despite the weak backdrop. Volume was weaker earlier in the quarter and then showed some improvement as we moved toward the end of the quarter. Operations continued to improve after a very strong performance in the second quarter. So the facilities are running extremely well at the moment. We did have a lighter maintenance outage scheduled but we executed it extremely well and the tax rate was slightly lower because of a couple of discrete items in the quarter that won't repeat in the fourth quarter.

Just turning to our year-over-year performance, and I think this is a real story of improvement. If you take out the land sales from last year, $0.83 versus the $0.92 that John mentioned, price offset softer volume and really, as I mentioned on the operations, operations and cost management have completely offset the higher input costs that we faced year-over-year. Lower interest and taxes, along with another quarter of really strong results from Ilim added head room.

If you look at the next slide, I think what's even more impressive are the year-to-date results from continuing operations. Top-line growth is 7%, EBIT growth up 56%, a doubling of EPS, and a 50% improvement in cash provided by operations. If you look at the cash balancing, again, these numbers from last year have been adjusted for land sales, but $1.2 billion in cash last year, and up to $2.7 billion this year, 125% improvement, of course, the building of cash in part because we're looking to bring cash to the Temple close.

All of that, what it's meant is five quarters now of really strong improvement in term of earnings, starting in the third quarter of last year, and we've put together five quarters that are really in the cost of capital zone, and feel good about where we are as we go into the fourth quarter and 2012.

Now let me turn back to the quarter itself. Input costs -- the increases have moderated in most categories. We did see the exception in OCC during the quarter, but in most other categories, chemicals, energies, we saw smaller increases than we've seen in previous quarters, and that was not only here in North America but in other parts of the world. But because of the OCC, nearly two-thirds of the increase in the quarter was felt in industrial packaging.

Now I'll turn to the segments and start with industrial packaging. Even with that increase, posted another strong quarter with EBIT moving from $269 million to $301 million in the quarter. North American prices were relatively stable in the quarter. We did see a little bit of erosion in export container board. Volume was down slightly, and I think it is a slight decrease. It was roughly split half in North America, where we saw a slight decrease in box shipments and a slight decrease in domestic container board shipments, and the other half was in Europe, where the third quarter is seasonally a weaker quarter in Europe. We've seen a little bit of softness in the industrial segment, but fruit and vegetable continues to perform well.

The third quarter's earnings were favorably impacted by the lower mill outage schedule. As I mentioned we executed that very well, and it was also impacted by the avoidance of the Vicksburg charge that we had in the second quarter. Although I would say that there's still some small residual supply chain cost impacts as we try to recover from that down time and get product back in the right places. Then, as I mentioned, the OCC costs were up, and that was about $14 million of the negative impact in input costs.

Another quarter, IPG posted the highest margin in the industry again this quarter, and it has for the entire year, as well as eight out of the last 11 quarters. On a sequential basis quarter-on-quarter, we added 200 basis points by executing well and taking advantage of the lighter maintenance schedule. The spread between competition in the quarter was 280 basis points. That's the largest we've had in over two years.

Turning to consumer, consumer packaging had another very good quarter, a string of quarters that they're putting together now, on steady volume, improved price realizations associated with the pass-through of previous announcements. Operational performance was down slightly in the quarter, but again, off of a very strong second quarter, so they continue to perform at a very high level. This business also benefited from the lighter maintenance outage schedule.

If you turn the slide to the next one, just to highlight where some of this operating performance is coming from. It's really being driven in significant part by outstanding manufacturing and supply chain performance. You can see that this year we've generated $30 million of cash cost savings. That's roughly $20 a ton in the manufacturing operations, and it's coming from improved reliability in energy usage, better up-time availability, and basically just running a more consistent manufacturing operation.

The supply chain improvements are really -- all the metrics are moving in the right direction, and as you can see on the slide. The result is we're generating nearly a million dollars a month of savings, so the business is operating very well, the key levers that it can control. What that's resulted in is business results that are continuing to be strong and consistent and in the cost of capital zone now for the last five quarters, and year-to-date the business has earned 75% more in the first three quarters of this year than in all of 2012.

Additionally, coated paperboard, our North American coated paperboard business, is realizing the benefits on the commercial side from our food service business. It's not a business that we highlight very often, but just sharing some history here, if you look at the next slide, food service basically makes paper cups and food containers, and the business sources roughly 100% of its board from the North American business.

We saw a significant decrease in demand during the economic crisis, but this year the business is on pace to return to pre-recession volume levels, and it's doing it really on innovative products like the Ecotainer and the Hold N' Go hot beverage cup. With those products, margins are up. Year-to-date margins are up 250 basis points from the low of 2008. It's up 60 basis points year-over-year, and now higher than what we had before the economic crisis.

Printing papers a great quarter, had exceptionally good quarter in North America. Our operations in Europe were basically flat quarter-on-quarter. Brazil was roughly flat quarter-on-quarter, mostly because of seasonality and how the seasons flow in those two businesses. North America really lifted results by posting strong manufacturing operations.

Now turn to Xpedx, and while year-over-year revenue is down, clearly we saw Xpedx bounce back in the quarter, nearly doubling its earnings on seasonal demand lift and good volumes around printing and packaging quarter-on-quarter.

If you look at the next slide, you'll see really we are getting some help from the market, but we're also seeing the beginnings of the benefits from the strategy implementation that Mary took you through a quarter or so ago, Average daily shipping rates on printing were up 8% on strong seasonal rebound in the publishing grades. We've also been managing our costs effectively, and have good realization of S&A costs and head count reductions, with head count being down 7% year-to-date. We think the strategy is starting to take hold, and as we promised, Mary will be back at the end of the fourth quarter to update you on the strategy and how the implementation is going.

Now I'll turn to Ilim. Another strong quarter from the Ilim joint venture. Just as a reminder, it's their second quarter, our third quarter, as we continue to report on the lag. So in their second quarter, prices were higher for both pulp and container board. We did see lower volumes and we had higher outage costs and input costs in the quarter. We did receive another dividend in the quarter as our second dividend from the joint venture this year, and it brings our total cumulative dividends to $234 million since the beginnings of the joint venture, so we've roughly recovered a little bit more than a third of the original investment through dividends.

One item that I would note about what will be our fourth quarter, the joint venture's third quarter, we did see a significant weakening in the quarter of the ruble, and because the joint venture has dollar-denominated debt, it had to mark that to market, and so we'll see about a $50 million charge in their third quarter, our fourth quarter reported. It's an non-cash charge and we really like the movement in the ruble as it weakens, because it makes the business more competitive and enhances margins over time.

Just an update on capital expansion. Couple of pictures here, one from the Bratsk mill where we're putting in the new pulp line. You see the digester coming out of the ground there. Right now we're still on track for a start-up in 2012. Again, as a reminder, this is about a $700 million project with projected returns above 20%. The other picture you see is from the Koryazhma mill and it's for uncoated free sheet capacity. Although we will also have an opportunity to become the first producer of coated paper in Russia, by putting and installing a coater at the end of the line, this also is scheduled for 2012 start-up, and again, nearly $300 million in capital being invested, with a greater than 20% return. So we've talked about this for a few quarters now. I thought it would be interesting for people to see that there is structure coming out of the ground at this point.

So just summarizing third quarter, I think John covered this at the beginning, but we do feel very good about a very strong quarter in the third quarter. Global balance is paying off, and will continue to pay off as we go through the balance of this year and into next year. Volumes, pricing, steady. We continue to operate our facilities extremely well and manage costs tightly.

The strong contribution from Ilim that I mentioned will decrease in the fourth quarter because of the non-cash currency charge, but in terms of their operating performance, they continue to operate very well. Again, five quarters now in the cost of capital zone, and feel good about where we are. Even though inputs are up, we're managing, so far, to offset them in with our cost management and operating capabilities.

If you look at the last slide, just showing you ROI, so far year-to-date we are at 8%. In the quarter, we're actually over 9%. Feel very good about posting a cost to capital result for 2011. With that, I'll turn it back over to John for the outlook.

Okay, thanks, Tim. I'm on page 26 for those of you who are following along with the slides. The fourth-quarter outlook, and what this says, to us when you look at it is, volume is going to be seasonally slower. It always is as we get into the fourth quarter. We've got more maintenance outages. More of the same in terms of the overall economic environment. Pricing looks to be stable, with the exception of lower pulp prices which have been occurring over the last several quarters. As Tim said, we've got the currency hit of $55 million, because of the 12% weakening of the ruble. We'll also going to start to incur some start-up costs as we get ready to complete the project in Franklin, Virginia, which is going to convert that mill to a pulp line.

I think more importantly, looking beyond the normal seasonal slowdown of the fourth quarter, I'm quite positive -- in fact, very positive -- about International Paper going into 2012 for a number of reasons. We've got India, which Tom Kadien will talk about in a minute that is coming on line. We've got major investments in Russia that Tim talked about. Remember, those are being financed off the Ilim balance sheet. Not by International Paper, but by the joint venture that will begin to contribute to results toward the end of next year. We've got the -- importantly, Temple on either late this year or early next year, which is going to significantly contribute to our ability to further take costs out of our important North American industrial packaging business.

All in, while the fourth quarter is going to be the usual kind of fourth quarter, and the economic environment is more of the same, we're very positive at thinking about International Paper as we end this year and go into next year. So Tom Kadien, do you want to give everybody an update on India?

Sure, John, thanks. We closed on our transaction on October 14, and we're now owner of 75% of the shares of Andhra Paper Company. We had day-one activities with employees at both mills, with government officials, with over 200 of the tree farmers that supply fiber to the mill, and reactions have been really good thus far. We're in the process of establishing governance over the Company. We have a team of IP folks on the ground in Hyderabad since July, really, led by Paul Brown, who is one of our most experienced global executives. We have integration plans that are at full tilt right now and finance and capital build-out plans, manufacturing excellence, as well as IT, forestry, environment health and safety, compliance.

In their most recent quarter, or last quarter, APPM had a good quarter, revenues growing 10%, and as we look forward to 2012, we think we're looking for double-digit increases in tons, earnings, and we feel like we've got a got a lot of runway in front of us.

Some of you asked Glenn about the dispute, I guess, over the non-compete fee, and $25 million that's held in escrow right now. There is a date set of November 16 with the Securities Appellate Tribunal that will make that decision and again, our advisors think that we're on strong ground and it will go in our favor. That said, in India happens quite as scheduled, so we're hoping it comes off on November 16.

The last thing, we're still evaluating when we're going to report out on results and how we can sync that up. You'll hear more about that on future calls.

Okay, thanks, Tom. Let me just give you a quick update on where we are with Temple. We continue to move forward to a closing date. We think that's likely to be towards the end of the year or early in 2012. Two gates remain -- regulatory approval and a final vote by Temple share owners, and they've (inaudible - technical difficulty) their proxy base and comments they get back from the initial filing.

Our internal integration steering teams are working on post-closing plans, and the leadership and Management of this integration are and experienced and capable bunch of IT people. They know what to do, and we're getting good cooperation from Temple. This chart just shows you on the top the regulatory time frame and on the bottom the merger time frame.

Before we open up to your questions, I'd just like to make a couple of comments on the people moves we announced this week. We have a strong and deep and capable Management team at International Paper, and I think our results over the last several years, going through the transformation plan, coming out of it, managing through the downturn, and now the slow recovery, demonstrates that. These moves are really the result of a lot of discussion, a lot of thought on my part, and making them now gets us ready for 2012 and beyond. So I've got absolute confidence that going forward what you're going to see from International Paper is IP-style execution and IP-style results.

So with that, Glenn, why don't we just open it up for questions?

Okay, John. Operator, please begin the question-and-answer session?

(Operator Instructions)

First question is from Gail Glazerman of UBS.

Good morning.

Hi, Gail.

I was a little curious about the comments about demand actually getting stronger toward the end of the quarter. That's a little bit in contrast of what we've heard from some other companies. I was wondering if you could give a little bit more color on the demand environment, and also maybe specifically touch on the exports on the container board front?

Carol, do you want to comment on that?

Yes, Gain, I guess stronger is all around expectations of what you're expecting them to be. I think what I would say is box demand continues to move sideways, and relative to some of the headlines and the bad news you read, that's actually pretty good news. I feel like box demand is pretty stable, and that continued really through the quarter and into October for us.

How is October looking?

October is looking okay. Relative -- well, we're almost done with the month, compared to last year, it is looking reasonable, and sequentially from September it's down slightly, but you would expect that seasonally. So October box demand is continuing to hold, and I feel pretty good about that.

On relative to exports, the export market has got a combination of two things going on. In the export market there has been some slowdown in box demand in some of these markets. That's combined with the pipe for exports kind of a long pipe. So orders gets placed and it take 2 to 3 months for them to get there. That, combined with some extra supply that's hitting those markets has caused a little deterioration in pricing, but I think that's just a temporary supply-chain activity and I don't see any real decline in demand in the export markets through time.

Mark, would you make a comment on printing papers?

Yes, I'd be happy to. So for North American printing papers, in the third quarter we saw demand relatively stable, the published data says the market is down a little over 3% year-over-year, but the combination of some capacity shuts and some temporary interruptions that occurred early in the year, with exports up and imports down, it's been pretty well in balance.

I guess, Gail, overall, we don't see -- things in the second half of the year got a little weaker relative to the first half from a macro standpoint and that showed up in our businesses, but from here it just seems like more of the same.

Okay, thank you. Mark, can you talk a little bit about uncoated free sheet pricing? There has been an awful lot of noise in some of the trade press and it doesn't seem to be showing up in your numbers. I'm just wondering if you are experiencing any of the weakness that's being reported?

We have seen a pretty stable pricing environment. Pricing announcements went out earlier in the year, and depending upon the grade, the channel, and the customer, and there's all kinds of different realization schedules, but there but we've seen pretty stable pricing on the paper side.

Okay. Just one last question. Tim, can you talk a little bit about interest expense? You continue to be guiding towards a pickup, and it's not showing through. Has there been something unusual going on this year? Is there any real reason to think it is going to pick up? Also, can you just give an update on potential financing costs associated with the Temple deal?

Yes, I mean, I'll start there. We've talked about it for a couple of quarters now, it moves around. But 10-year money looks like it's roughly 5.3% to 5.5%, and 30 years, probably going to be 6.7%, 6.8% to 7%. But it's so volatile right now, it's changing day-to-day. We have seen base rates move up a little bit, of course, and credit spreads tightening a little bit. On interest expense, we did benefit a little bit. We were able to put some swaps on, and we saw a little bit of benefit from our floating debt, but it's -- you've seen three quarters now, I don't expect it to be dramatically different in the fourth.

Okay, thank you.

Your next question comes from the line of Mark Connelly of CLSA.

Thank you, just two things. Ilim has actually been in the news quite a bit lately over in Russia and recently they've been highlighting their container board performance. You've talked about Russia as an attractive place to potentially expand container board to. I'm curious if that's still your opinion, that's the first question. Second question, is there anything changing in your outlook for capital spending ex-Temple as you start thinking about 2012 in this new economic environment.

Well, we like container board in Russia. In Siberia, we're going to make less container board and make more pulp, that's what the Bratsk expansion is all about. But we continue to make container board in Kotlas and the Russian packaging market is growing. So that's a business that you'll see us continue to try to take advantage of our low-cost position in Russia.

On the capital side, the -- I think we've outlined what our capital spending plans over the cycle will be, about a billion dollars a year. We've been well under that for a couple of years. We're likely to be a little over that as we go into 2012 because we've got the paper machine in China that we're building, but roughly over the five-year period we talked about a couple of years ago, our capital spending, when were get to the end of the day will still be about a billion dollars a year, but we'll be a little bit over that next year.

Okay, so you're not pulling back any of your spending plans at this point, given economics, then?

No, our spending plans -- we're generating a lot of cash. Our spending plans in North America are aimed at taking costs out of the system, and very selectively around the world we're adding capacity or modernizing capacity where markets are growing. We're generating a lot of cash and we're going to use it in a balanced way.

Outstanding, thank you.

Your next question comes from the line of Stephen Atkinson of Bank of Montreal.

Good morning.

Hi, Steve.

First of alI, I really wanted to thank Tim for all his time spent, it was much appreciated. In terms of -- what I was looking at in terms of China, where I'm reading about slowdowns and so on, can you talk about where you're at in terms of your bleached board business and your box converting business?

Tom, do you want to comment on China?

Sure. Steve, we have seen a slowdown in China, from 10% growth to 9% growth, or 8% growth. The box business has slowed down, but we still -- we're growing our box business. I think in the third quarter we were up 4% or 5% on volume year-over-year, and there is a lot of price on that year-over-year, as well. In our joint venture with Sun on coated paper board, we really haven't seen a slowdown manifest itself in volumes at all.

There is some pricing pressure because of the pulping -- the pulp prices that are coming down in the market and were non-integrated, and that kind of rattles around the market, but we remain fully sold out on the coated board side, and we're actually having a very good year. We've got cost of capital return so far year-to-date. Our new machine, we're under construction as John said, and we expect to start that up in the fourth quarter of next year.

It's interesting, people talk about a slowdown in China, and it is slowing, but 8% growth on a $5 trillion economy is the same as 10% growth on a $4 trillion economy. I think we need to remember that China's economy has been growing at a very large rate. The economy's getting bigger, so the aggregate growth in GDP is still significant, which is what we're seeing.

Okay. In terms of India, I know you are just starting. Are you able to talk about the paper business in India?

Sure. The Andhra Pradesh is an uncoated free sheet company. On the slide, you see the Raja Mundri mill is integrated, and then the other mill, the Coastal mill has (inaudible) and makes recycled papers. The market over there has been growing 10% to 15%, probably cut sizes growing at 15% a year. We think that we can continue to grow with that market. It's a huge country, 1.2 billion people. The government's committed to educating folks, and a lot of them don't have access to electricity, so we think the uncoated free sheet future is very good over there, and we've got a great position with the farm forestry program in the state of Andhra Pradesh, where most of the fiber in the country lies. We're pretty bullish about that, but it's also, we're two weeks into this, so we have a lot of work to go. But it's a great market with, I think, a strong future.

Yes, we look at India from a paper and packaging standpoint as probably where China was 10 to 15 years ago. One of the really interesting things about Andhru Pradesh is, India, like China, is going to be a net fiber importer, probably for as far as we can see. But Andhru Pradesh paper has got not the only, but one of the few successful farm forestry programs, which gives us a real advantage over imported pulp. As we build out that program, we'll be able to take advantage of that.

I expect in the near term you're going to optimize the existing production, and that's why you're able to get a double-digit growth in production, and down the road, work on, shall we say, the integration?

Yes, that's right. The market's growing double-digits. We certainly think we can optimize the existing manufacturing operations. There's a lot of talented folks over there, but they're not quite sure what excellence looks like in manufacturing, and we're pretty confident we can show them.

Thank you so much.

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

Hi, John. Congratulations to everyone and best of luck with the new roles, as well. A couple of questions here. First, you mention that the mills ran well, and certainly the operating performance was better than we were forecasting, congratulations on that. You are taking more maintenance down time this quarter. I don't know if you have a bead on that yet, but so far how is it progressing? Any unforeseen issues, or are things progressing fairly smoothly there?

I would say overall our outage execution continues to be very good. International Paper has got over 30 mills around the world, and we intensely plan for these outages, we track the costs, the time we're down, the work that gets completed, and the ramp-up. We spent close to $400 million on maintenance outages a year, so a 10% shortfall, or 10% improvement on getting the work done in the time and at the cost level makes a big difference.

John, aside from the planning and maybe this isn't the reason, but what do you think IP does differently than other companies, if anything at all, in terms of planning for maintenance outages?

We probably -- we invest in technology and engineering, we call it the Improve Organization. As we've bought some other paper and packaging companies into IP, most of them have what we call a run organization. They have people that run the mills and they do that very well to the best of their bill abilities. We also think it makes sense to spend some money, and we'll make more money by having resources that really go around the world.

Some are in India right now and they're already helping, as Tom said, Andhru Paper, that are really subject matter experts and can work on the improve side of the business, as well as the run side. When you put those two together, a capability to run very well, but also an experienced (inaudible) and people that can plan for improvement, I think you get the best of both worlds, and something that International Paper frankly does better than a lot, if not all, of our competitors.

Okay.

Because we invest in it.

Yes. I appreciate that. Two last questions. Again, on the same theme, you've done a wonderful job over the last number of years improving performance in uncoated free sheet in the printing writing paper segment overall. Obviously demand has been a head wind at times. We've talked about that in our research.

Do you feel that if you have to manage the manufacturing footprint yet again at some point in the next few years, that paper machine or mill might be the straw that alters the camel's back, and perhaps leads to a lower profit per ton on a going-forward basis, because whatever logistical or other issues that would arise from that, or do you feel pretty comfortable about being able to manage the capacity, and at the same time managing the profitability trend where it is right now?

This is Mark. That's a tough question to answer, obviously, because you really are speculating about what you might do in the future. But I think at a high level, we've found a way to change our footprint in the past, whereas in some cases costs temporarily go up, but using our supply-chain tools and some other operating tactics, we've been able to mitigate a lot of that. I feel like we can probably do that again. Our mills are where they are, and our customers are where they are. There's not a dramatic geographic change that would happen if we had to take additional capacity out.

Okay, last question on the mills or -- let me back up. In container board in North America in particular, where do you feel you have more opportunity to improve returns from here, on the mills side or on the converting side? Thanks, guys, good luck on the quarter.

George, this is Carol. I think there's opportunity on both sides of that business. The mills, the key to getting superior results is you've got to have a low-cost system for a competitive advantage. I mean, you just can't be low cost, but you have to be lower. So we continually work. The great news for us is we've got a good fleet of mills with options to make it better, and I'm very hopeful post-Temple Inland we'll have even more opportunities there.

That said, we sell boxes. The box business is very important. In the box business, you got to be good, my sports analogy is, both sides of the ball. You've got to have low cost box plants that do whatever they're going to do well, and so we call that competitive and profitable box. You've got to have facilities that do the job well, effectively better than the competition. At the same time, you've got to sell it effectively. That means you are getting paid for the value you bring. We really believe there's opportunity on both sides and clearly, we're excited after Temple Inland we'll have more opportunity to drive more costs out of the business and make it even stronger.

I would just add that there's another area where we've got a lot of runway that frankly our competition doesn't have because they don't have the Temple opportunity, and that's on the procurement side. OCC, we've gotten really good at OCC procurement, because Weyerhaeuser bought us a capability we didn't have. We already see wood fiber opportunities with Temple. Then again, on transportation, we've got a huge logistics system shipping container board to box plants and boxes to customers. We got a lot of saving over Weyerhaeuser and over time, we'll reload that system, and you will flush out more supply chain savings, as well.

Thank you.

Our next question comes from the line of Anthony Pettinari of Citi.

Good morning.

Hi, Anthony, how are you?

On the uncoated free sheet side, I had a question on the Brazilian market. You've seen some strengthening in the real, which I guess makes the market more attractive for importers, and you saw some domestic price erosion in the quarter. I think some local producers have talked about this year maybe being a tougher comp year, because I guess they had an election last year. I wonder if you could kind of give us some color on the current state of the market in Brazil, and sort of what you're seeing in October?

Anthony, this is Mark. Yes, I think your summary is pretty accurate. The market is actually up, demand-wise, in a decent way. Cut size much better than offset. However, given the currency changes and just the sort of global price levels, the market has attracted more imports, and that's eaten up some of the growth. So the local producers aren't enjoying all of the growth that they might have had a couple of years ago.

I think the market is still very healthy and strong. We view it very positively and we are looking at a fourth quarter that is going to be what we expect seasonally. So far, I think we're pretty pleased with the overall development. It's naive to think a market that's growing like that is never going to attract an import, so we try to plan for that in our thinking.

We did see currency move in our direction during the quarter, Anthony. I mean, if memory serves, roughly around the beginning of August the real was trading in the mid-$1.50s, and it weakened almost all the way to $1.90 before carving some back. So that was some help.

Right. You got some movement that way.

Our strategy in Brazil is not just a Brasilia one, it's a regional one. We really have a great footprint in Brazil, but we can serve the region more cost-effectively than anybody else in the region can. If you look at Brazil by far and away the biggest market in the region, obviously, but our strategy down there is to build a leading position in all of the markets and supply those markets out of Brazil. When you think about the World Cup being in Brazil and the Olympics being in Brazil, there is going to be a lot of activity over and above elections for the next several years.

Yes, that's very helpful. Maybe switching gears and following up on Mark's question on Ilim, does it make sense for Bratsk to maybe expand its footprint into fluff, and sell fluff into China, and maybe what are the potentials there over the near mid-term? Thanks.

This is a trial that Ilim is experimenting with, I would say we're a long way from having a commercial operation of fluff pulp in that part of the world. If we end up there that will be a good outcome, because we'll be right on the doorstep of the biggest tissue market in the world. So that would be a good outcome for International Paper, but I'd say it's really early days, and if we can make good quality fluff out of larch, that will be a real breakthrough.

That's something that would be something that would be years away?

Yes, that's down the road.

Okay, great. Thank you.

Our next question comes from the line of Chip Dillon of Vertical Research Partners.

Good morning.

Good morning, Chip.

When you look at the situation in some of the emerging markets, I mean, China for one. We've heard about one of the big board producers, and I know you've got a big presence with the SCA box plants deferring some of their capacity expansions. We're also hearing rumblings in Latin America that some of the pulp projects might be pushed out, too, all because of financial strains. Without naming names, are your people on the ground getting more evidence that some of the board in China and pulp in Latin American capacity might be pushed out, or even postponed indefinitely?

Let me make an overall comment, and then, Tom Kadien can chime in on China. I think as global growth slows, the stretching out of capacity additions is a logical thing for companies to do, especially ones that had capacity plans in excess of market growth. You remember a number of years ago when all of this pulp capacity was getting added in Latin America and everybody was worried about where it was going to go. China, growing at the rate it is, having a fiber deficit, basically took most of that capacity up in a shorter period of time. Global growth outlook has not gone negative but it is slowing, and I think people adjust their capacity plans accordingly. Tom, would you want to comment about what we're seeing in China?

Chip, clearly we read and we buy from some of the folks who have slowed up the capacity expansions. I think as a buyer of recycled container board over there, I don't think the slowing down of additional capacity is going to impact the market that much. I mean, frankly, the biggest suppliers over there have been taking down time and slowed back for quite a while. I mean, there has been excess capacity in container board, but they're managing supply and demand pretty well. I think what we're more sensitive to, and we've seen a little bit of price coming down in the recycled container board is the OCC pricing that goes into China. That's probably more -- has more impact on pricing of container board in China than on the machine slow-back, although certainly that's probably a good thing for the market overall.

Got you, okay. Then shifting gears, it may be a little early, and I'm not sure if this is for Tim or Carol, I'll let you guys decide. You all had entered 2009, as you know, with I think something like a $7 a share under-funded pension position, and you've done a lot of hard work on getting that down. I guess given that some of -- that the long-term corporate rates are down a bit, and hopefully this market keeps going up on the asset side, but any early look as to how you think the funded position might look at year-end, and what your change in expense will be for next year? And if you covered that I apologize, there are dueling calls here.

No, we haven't covered it. Basically, we'll update all of those with harder numbers when we report fourth quarter. But I mean, you've seen the volatility both on the asset side and on the interest rate side, and so if we market today, we would have a larger gap than we had at the beginning of the year. I don't think that's a big surprise to anyone. Still manageable, and we still feel very confident about how we're managing our pension assets, and we'll update at the end of the fourth quarter, but I think it's pretty reasonable to assume that there will be -- not to the degree we did last year with the $1.2 billion contributions we made -- but there will be additional contributions on a smaller scale that will get made over time.

After the first of the year, is what you're saying, right?

Potentially, yes.

Okay, got you. Then the last one, just so we're all on the same page, you mentioned the Ilim charge because of the currency, the ruble. Is that something that when you report you'll count as a special item, or is that something that will kind of flow through as a normal item?

No, it will flow through as a normal item.

Got you.

What will also flow through as a normal item the benefit of that, as we sell pulp in US dollars going forward.

We don't -- the joint venture, and it would really be for the joint venture to do -- they don't really hedge currency because there is a natural hedge in terms of the dollar-denominated sales that John just mentioned. So you get some of these short-term dislocations in terms of currency movement, but longer term we like a weaker ruble because of the margin benefit.

Just to be, so we're on the right path, obviously you're reporting the operations on a one-quarter lag. Does the adjustment for the currency also happen on a one-quarter lag, or is that more concurrent?

It does. That's why I was pointing it out. It actually happened in their third quarter which will be reported in our fourth.

Got you. Thanks, guys. (Inaudible - multiple speakers)

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

Thank you, two -- first quickly following up on the currency in Ilim. Presumably, after you see that hit in the fourth quarter, that essentially goes away, and so essentially the Ilim report earnings would then be up by that $55 million the next quarter, is that the way to think of it?

Well, you wouldn't have the $55 million -- assuming no movement, you wouldn't have that charge, that's right.

Right, okay. I know it's kind of petty, but is that an after-tax -- the $55 million is that, the way you're going to run it through your P&L?

Right, because we report it on an equity accounting basis, so yes.

Okay. Then lastly, you're talking a little bit about OCC waste paper. Where are those costs now, and do you have any insights as to where they look like they're trending through the balance of the quarter?

Hi, Mark, this is Carol. Yes, they're trending down some, and I really think that's a result, probably less of a US phenomenon because as we look at operating rates at US mills, they have been running fairly strong, and although the OCC mills are going to be the higher-cost mills, so there will be some pulling back of OCC there. I really think it's probably more of a China effect of a slowing down of a point in time. So they are trending down some. Boy, if I could predict OCC prices out 3, 4 months, that would be a great crystal ball. I don't have that, but I do think they're trending down, and we'll just see where they go.

And can you give us where are they today, versus say, the third quarter average?

I would probably not comment on it today because folks are going to publish in a few days, and I might get it wrong, because it's unclear. But I would say that it's going to definitely move down from October to November.

Okay, thank you.

Our last question will come from the line of Mark Wilde from Deutsche Bank.

Hi, Mark. How are you?

Good. I wonder if we could go back to Brazil for a minute or two. I think that you've got that decision to make on the second machine down there at some point. I wondered if you could just update us on that, particularly in light of the strength of the currency down there? Also, talk to us about any plans for thoughts about being in the packaging business in Brazil and elsewhere in Latin America.

I'll let Mark Sutton talk about the second paper machine, and then I'll just comment about packaging, Mark.

Hello, Mark. We have a couple of years before we have to make the final decision on that additional capacity. Obviously, the way we're thinking about that is based on market growth and the other dynamics of how that market's served, if we need the additional capacity for not only Brazil, as John said earlier, but for the greater Latin America region, that would be an attractive thing for us to do. But we do have a little more time on that, and we're monitoring the market. The currency is obviously a factor, but we would make a decision like that obviously for the long-term.

I think that's the important point, Mark, as Mark Sutton said about the long term. This will be a 20-year investment, so you don't want to make it just on a spot currency. Spot currency at the point in time and currency in Brazil has been from $1.50 to $3.00. None of us are smart enough to figure out what it's going to be in 2025, but the investment we male will be around in 2025, so we could be dealing with that as the time comes.

From a packaging perspective, we will have a stronger packaging presence in Latin America with Mexico. We've got one box plant in Chile. We'd like to be in the packaging business, both in bleached and unbleached packaging in Latin America, and if the right opportunity -- again, it's all about valuation and great value for International Paper -- we'll consider it. If it's not the right valuation, it's a place in the world we'd like to be, but won't be.

Okay. John, can we just, with what Tom Kadien is working on now in India, you're in all the bricks at this point. I wondered if you could just give us thoughts on how you'll allocate capital in all of those different countries? Then, when we think about your CapEx budget, how much of that is really going to be focused, just in ballpark terms, in the US and Western Europe, and how much of it will be allocated to some of the emerging markets that you're in?

Well, that's a very good question, and I think the -- we've talk about a balanced allocation of cash, and that includes our approach to CapEx. We're going to continue to have a balanced allocation of cash. Cash back to share owners, cash re-invested in our existing business, a strong balance sheet, and selectively re-investing. Russia's a great example of being able to do that aggressively on not on IP's balance sheet but on joint venture's, which has got that capacity.

India, we're going to need to get in there and figure out how to grow with the market, both in paper and packaging, and we're going to continue to spend only on cost reduction in North America and on regulatory capital, we've got some of that coming down the pipe with boiler maps. We are going to force -- there's going to continue to be capital rationing in IP, and we're going to skew the capital to where we think the strategic investments ought to be made, but we'll keep the right assets in North America competitive and modern.

I think we've been able to do that with this $1 billion spending over the last couple of years, and going forward for the next couple on average. With Temple, we're going to have a little more capital spending, so we'll be updating you on kind of the next five years, how you should think about CapEx relative to depreciation. In some places, the world would be a lot higher and some places the world would be a lot lower.

Okay, very good. Good luck in the third quarter.

Okay, well listen. Let me just wrap it up by saying that International Paper's pretty pleased about the fourth quarter. It was on flat revenues. It was -- the third quarter, rather -- quite strong, relative to where it had been, and we're pretty positive -- I say quite positive, at how we're looking at 2012, even though the macro environment feels to us like it's going to me more of the same, but with what we have on our plate, we think International Paper's best days are still ahead of us. So thanks for tuning in on the call, and we'll talk to you next quarter.

Thank you for participating in the International Paper Third Quarter 2011 Earnings Conference call. You may now disconnect.