International Paper Co (IP) 2012 Q3 法說會逐字稿

Good morning, my name is Phyllis and I will be your conference operator today. At this time, I would like to welcome everyone to the International Paper third quarter 2012 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session.

(Operator Instructions) Thank you. I would now like to turn the call over to Mr. Glenn Landau, Vice President of Investor Relations. Sir, you may begin your conference.

Thanks, Phyllis, and good morning, and thank you for joining International Paper's third quarter earnings conference call. Our key speakers this morning are John Faraci, Chairman and Chief Executive Officer; Carol Roberts, Senior Vice President and Chief Financial Officer; and Tim Nicholls, Senior Vice President, Printing Papers, the Americas. 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, a reconciliation of which will be found on our website. Our website also contains copies of the third quarter 2012 earnings press release and today's presentation slides. Lastly, given our expanded disclosure around the Ilim JV, slide 4 provides context around the joint venture's financial information and statistical measures. With that, I will now turn the call over to John Faraci.

Thanks, Glenn, and good morning, everybody. As you all know, this morning we announced our third quarter results. I characterize them as strong results despite a challenging macroeconomic backdrop. We increased our EBITDA sequentially by $100 million to over $975 million, while continuing to generate excellent cash flow from operations. And I'd note this is after the divestment of the three containerboard mills which took about $45 million of EBITDA out of the quarter.

In line with our commitments around capital allocation, we've reduced our balance sheet debt by $800 million in the quarter, partially funded by the proceeds from the building products -- from the three mill sales, containerboard mills, as well as increased our dividend by 14% to $1.20 a share, reiterating our confidence in our outlook for free cash flow into 2013. And, as Tim will speak about, after we wrap up earnings, we've strengthened our global portfolio by announcing yesterday our strategic entry into the corrugated packaging market in Brazil. Within our North American industrial packaging business, during the quarter, we successfully implemented a $50 a ton containerboard price increase and, importantly, achieved our original merger benefit target of $300 million 15 months ahead of schedule. So the headline there is more, faster.

While maintenance outages were low in the third quarter across really all of our businesses, seasonally softer demand in our corrugated box business because of our heavy concentration of ag business in the second quarter, coupled with overall slow growth in North America and a lot of the markets we compete in around the world, our packaging businesses were a little slower and we took a lot more downtime in industrial packaging which you will see during the quarter. On the strategic front, Franklin continued its successful production ramp-up and qualification of fluff pulp in the Sun joint venture started up the fourth coated paperboard machine in September.

Let me just move to the next slide which is the financial snapshot. Revenues were in line with last quarter and up more than 6% versus the third quarter of last year. That is principally due to the Temple-Inland acquisition. EBITDA margin compression was primarily due to the lower pulp prices. Pulp prices hit their bottom during the third quarter and lower export price realizations, really, in all the places where we make paper and export it, which is principally North America and Brazil, and they were offset partially by the Temple merger benefits. As I said earlier, really the story in the quarter is continued strong cash flow from operations, nearly $900 million. Let me turn it over to Carol now to kind of go through the details.

Thanks, John, and good morning, everyone. As John mentioned, and as you can see on slide 7, we continue to make significant progress on our balance sheet, reducing our debt a further $800 million in the quarter. And this brings our total debt paydown since the Temple-Inland acquisition to $1.5 billion, and that puts us on track to meet our debt reduction target by the year-end of 2013. Taking a closer look at the third quarter financial bridge, on page 8, as you see we earned $0.75 per share from continuing operations and before special items, and that is versus the $0.46 we earned in the second quarter.

The primary headwind we faced this past quarter, besides the expected loss of operating profits associated with the divested mills, was volume, which was down sequentially by $0.05. And as John noted, this was largely due to seasonally lower box sales, noted by our heavy mix of agriculture in the second quarter. And as John said, also impacted by continued overall slow growth across North American packaging businesses. The operations and cost line, while positive, does include a couple of items worth noting. There is $0.04 of downside exposure due to an unfavorable, but non-cash, LIFO inventory valuation adjustment and a further $0.02 of Temple-Inland purchase accounting true-ups.

We were able to more than offset these items with good operations, incremental Temple-Inland synergies of $15 million, and the Franklin start-up. And lastly, as you can see on the bridge, outages were lower in the quarter and our share of the Ilim JV earnings were favorably impacted by currency versus the negative adjustment we saw in the second quarter. In terms of downtime, we did have fewer scheduled outages which meant increased market-related downtime to effectively match our supply to our customers' demand in the quarter. Across our packaging businesses, this did result in increased market-related downtime quarter-over-quarter. Conversely, in our papers and pulp business we continued to run full, leveraging higher export shipments.

Moving to global input costs, on slide 10, costs were largely balanced quarter-over-quarter. Industrial packaging did benefit from lower OCC, but the upside was largely offset across the enterprise by higher natural gas costs, as well as wood prices. Looking at industrial packaging, as we have already shared, the business was impacted by seasonally weaker sales volumes and associated incremental market-related downtime. The unfavorable inventory valuation adjustments and purchase accounting true-ups in the quarter cost $30 million and these are reflected in the operations line. We did offset this by fewer outages, lower inputs, and continued positive progress on our Temple-Inland synergies.

The net result was an operating profit before special items of $342 million in the third quarter versus $367 million in the second quarter of '12. And I would like to note that the LIFO inventory valuation change is primarily a result of the containerboard price increase as we value our inventory at our box plants at the new price. With that said, and despite the downtime, the impact of the LIFO and purchase accounting charges on slide 12, it shows that our North American business compares favorably to the best of the competitive set once again this quarter. And I truly believe this really demonstrates our ability to navigate seasonality and run our business both operationally and commercially extremely effectively.

Moving your attention to the synergy run rate ramp chart depicted on slide 13, on a run rate basis we have met our original target of $300 million in synergies within the first eight months of closing the transaction, an impressive achievement by Mark and his team with more to come as they capture the identified incremental opportunity of $100 million by the end of '13. Relative to where the synergies are coming from, with more than 75% of the synergies already achieved in overhead, box and sourcing buckets, the runway in '13 is largely about paper machine optimization and efficiency improvements at the mills, and these realizations will be timed with our planned outages that are primarily in the first half of the year.

Moving onto Consumer Packaging, operating profits before special items were $67 million in the third quarter compared to $63 million in the second quarter of '12. Continued weak demand and pressure on pricing, primarily in Asia, impacted the quarter but they were more than offset by lower planned maintenance outages expenses. Earnings in the third quarter for the food service business continued to be strong and were in line with the prior quarter. Relative to our competition, the North American business continued to out perform the best of the competitive set in the quarter.

Moving to slide 17, as John mentioned earlier, the new coated paperboard machine at the Sun JV started up ahead of schedule on September 19. While we will begin qualifying the A-grade products in the market over the next several months, we do expect that we will have incremental ramp-up costs in the fourth quarter, and as we start up and we line out the machines we will be making primarily the commodity of grades and we know that we are bringing those grades and that volume into a softer market. But we do expect earnings to gradually improve in '13 as the grade A premium product is qualified with our core customers and the markets begin to improve over the course of the year.

Moving onto slide 18, Printing Papers & Pulp nearly doubled their earnings before special items in the third quarter delivering $201 million in operating profit and that compares very favorably to the $106 million in the second quarter of '12. Volume improved across all geographic segments including export and Franklin added $12 million in the quarter as it began to produce and sell primarily commodity softwood pulp to the market.

We did see higher input costs, primarily for energy and wood, of $21 million. That did offset the significant reduction in expenses associated with the lower planned outages in the quarter. Looking at the year to date volume change on slide 19, of our Printing Papers & Pulp business around the world, our global demand is up just over 5% across all of our segments compared to the same period of last year. So while uncoated freesheet demand is down in line with expectations in North America, our emerging market businesses are growing at or above market. We've been able to take advantage of our global market access to increase our exports out of North America as opportunities arise.

And let me give you a great example of that. When the export volume from Brazil is repatriated back into Latin America to meet our growing local demand, we've been able to use our North American exports to fill the void for some of our core customers. This synergistic opportunity to leverage our global footprint really does differentiate IP from our regional competitors, and we believe that this will continue to afford us some advantages in the medium and the long term.

On the strategic front, we continue to make progress at the Franklin Mill as manufacturing and the sales teams work together to qualify our premium fluff pulp with our core customers. To date, the team is ahead of plan, and as the chart on slide 20 shows, the current projection of the ramp-up of fluff pulp sales to our core customers will exceed our original expectations. Now with that said, we expect our customers' demand to match our incremental annual capacity for fluff pulp by 2014. So in the meantime, given our swing production capability across the system, we will continue to make and sell softwood commodity pulp until we reach this end state and match our supply to our customers' growing demand.

Moving on to xpedx, the Company's North American distribution business, reported operating profits of $24 million in the third quarter compared to $17 million in the second quarter of '12. Seasonal quarter-over-quarter volume improvement, we experienced that across all segments, but that was partially offset by lower commercial print margins while packaging and facility solutions margins improved. Regarding our Ilim joint venture, operational results were impacted by the continued depressed pulp pricing and lower volume to the Chinese market in the third quarter. IP's equity earnings were further impacted by an after-tax foreign exchange gain of $21 million in the current quarter, resulting in total after-tax equity earnings of $33 million in the third quarter.

So let me summarize on slide 23 some of the key points from the quarter. We did deliver solid results in the third quarter despite the challenging global environment, and there is a couple of things I would like to highlight. John said it, we did generate excellent free cash flow from operations. We continue to make great progress with the Temple-Inland integration, achieving our initial two-year synergy run rate target in month eight.

The building products sales process moves closer to the finish line and we are very pleased with how that is proceeding so well. We signed a settlement agreement related to the Guaranty Bank litigation for $80 million that we are confident can be partially covered with some insurance proceeds. And most importantly, we successfully implemented a containerboard price increase which will provide significant earnings runway for our Industrial Packaging business in '13. So let me provide a little bit more detail on our outlook for the fourth quarter.

Looking ahead to the fourth quarter, we expect seasonally stronger volume in our EMEA box business and our Brazilian paper business which will offset some of the normal seasonal demand declines that we will see in packaging in North America. Moving to price, box price realization associated with the North American containerboard increase and mix improvements from higher domestic sales in Brazil will more than offset the negative North American paper mix due to a higher volume of export shipments in the quarter.

Operations will be relatively stable quarter-over-quarter, with the exception of the modest benefit Industrial Packaging will realize from the non-repeat of a portion of the Temple-Inland purchase accounting true-up. And also there will be an incremental ramp-up in cost that will hit the Sun JV in the fourth quarter. Regarding inputs, we do expect to see some higher wood cost and OCC and energy costs amounting to an incremental $15 million to $20 million of expense. And lastly, we are moving from the third quarter which was our lightest maintenance outage quarter to a more average quarter, so our expenses for outages will increase by $82 million as we move to a more normalized level. So with that, let me turn it back over to John Faraci.

Thanks, Carol. So let me just summarize our fourth quarter outlook which I see as really a more of the same type of demand environment. But is going to be impacted by the normal expected seasonal slowdown in North America that we see every year after Thanksgiving, and then it's either more of a slowdown if the weather is bad or the usual slowdown if it's not.

So with that, let me talk to -- just at a high level about how we are seeing 2013. At this point in time, we still expect and are going to be planning next year for more of the same global economy. I am quite positive and quite confident that our earnings run rate will materialize in 2013 is quite positive. It's going to be led by the trajectory of the North American Industrial Packaging business with year-over-year earnings improvement due to the pricing increase Carol talked about, as well as continued synergy realization.

And we've also got other strategic and cost-savings projects and initiatives in Brazil, Russia, China, and North America, that we've talked to you about, that are all going to turn from costs this year into contribution next year. We do expect higher fiber and energy costs in the new year, probably $100 million to $200 million, as well is a non-cash pension expense which is going to be sizable of $250 million to $300 million as a result of lower discount rates, historic return on assets and amortization of gains and losses.

So net-net, as we look at 2013, and, again, I'd say, with the continuation of slow growth around the world, we think IP is very well-positioned for significant improvement in EBITDA, free cash flow and return on capital as we get into 2013. Before I turn it over to Tim to talk about the announcement we made yesterday that is in the corrugated packaging business in Brazil, let me just take an opportunity to underline our commitment to the balanced use of cash that we think drives shareholder value creation and talk about what we've done over the last year.

So over the last nine months, International Paper has used its free cash flow in line with what we shared to investors on investor day in May, and we will continue to do so. We've returned more cash to shareholders in the form of a 14% increase in the dividend, which we plan to review annually, and will continue to adjust in line with our principles of sharing 30% to 40% of mid-cycle free cash flow in the form of dividends. We are going to deliver on our dividend growth commitment as free cash flow permits.

We've aggressively reduced our debt on our balance sheet by $1.5 billion, as we've said we would, and we will continue to do more of that throughout 2013. Keep in mind, however, though, with Temple we've got more debt capacity because we've got more EBITDA. And finally, we've reinvested in our businesses very selectively in domestic markets and growing regions in our core businesses. And those will continue to be a significant portion of our earnings profile going forward. So with that, let me turn it over to Tim to talk briefly about the corrugated packaging acquisition that we announced yesterday.

Okay, thanks, John. I'm excited that I can talk to everyone about the strategic entry into corrugated packaging in Brazil that we announced yesterday. Yesterday, IP and Grupa Orsa formally agreed to form a corrugated packaging business expanding IP's leading global platform to Brazil. IP will hold a 75% stake in the newly formed Company which will hold Grupa Orsa's current containerboard and box assets and that share is valued at approximately $470 million.

But before I discuss the Brazilian corrugated market and specifics around the deal in more detail, let me also update everyone on a change to our paper business which is good news. We have an option, as you know, to build a second uncoated freesheet machine at the Tres Lagoas mill site and that supply agreement that we have with Fibria and the option to build that second machine was set to expire in January of 2013. We have now agreed with Fibria to extend the timing on that. So the new agreement gives IP the option to start the second machine between 2016 and 2018, which we think better matches the incremental capacity that we are going to need to supply our customers' demand. And if you remember to investor day, we were talking about needing that capacity in the '15 to '16 timeframe, so this enables us to better time capital investment.

Now let me turn to the packaging investment and talk about why we think this makes sense for International Paper. First of all, it's a market that we know well and it allows us to expand a core IP business into a growing market where we already have a meaningful presence with our paper business. It gives us the opportunity to earn good margins and an attractive return with industry margins in the corrugated packaging business between 20% and 30% in Brazil. So said another way, we can generate greater than cost of capital returns and increase shareholder value in a business and in a region that we know well.

If you move to slide 29, the case for growth is made easy. Per capita consumption in Brazil in both our core platforms have significant potential for growth as this emerging market continues to expand its middle class. Note that Brazil today is below China on per capita consumption in both businesses, or both products. Consumption in the packaging side will increase as non-durable production increases, and in both businesses, as the middle class continues to expand, which over the next three years is expected to grow by 15 million people.

Growth should also be enhanced by two events, significant events, the 2014 World Cup and the 2016 Olympics. If you move to the next slide, looking at the growth rates over the medium term RISI is currently forecasting approximately 3.5% compounded growth rates for both grades which will create 1 million tons and 300,000 tons for new containerboard and uncoated freesheet through 2017.

Now let me turn to Grupo Orsa and just talk about the Company itself. We look at the Company and say that the Company has good people, good assets, and a good customer base. It is currently earning 20% EBITDA margins and the customer base is made up of a lot of household name consumer products companies. Customers representing roughly 20% of the volume have been served by Grupo Orsa for 15-plus years, so really good relationships on the commercial side. The box plants are located in what is the largest consumer and industrial center in Latin America. So proximity to the market also good.

And the opportunity here is to grow organically, in line with market growth and optimize manufacturing operations, which, when we benchmark against our IP facilities around the world, we think there is a significant opportunity. All of that, we believe, will allow us to take a business from 20% margins to a range of between 25% and 30% margins. If I turn to the deal specifics, purchase price is roughly $470 million at today's exchange rates and is going to be financed by cash on hand in Brazil and also some financing which may be local financing that we will be able to repay quickly.

That represents an eight times EBITDA multiple and an 18% IRR for the investment which well exceeds our local risk adjusted cost of capital. And the returns are going to be driven by 3% market box growth and 2% cash cost savings, which is only about half of what we achieve in our Brazilian operations and about two-thirds of what we are able to achieve across International Paper. So summing it up, the opportunity is to create shareholder value by earning attractive returns and increasing cash flow and the real nature of this investment is all about buying a good business and making it better.

And we will do that by growing organically and optimizing manufacturing operations. So with that, Glenn, I'll turn it back over to you.

Thanks, Tim. And with that, operator, please open the lines for questions.

(Operator Instructions) Your first question comes from the line of Phil Gresh with JPMorgan.

Hello, Phil.

A couple of questions here, one is the margin targets that you laid out there, the 25% to 30% EBITDA margins, is there any capital required to get to those margins? And the second question on the transaction is, this is obviously still a pretty fragmented industry down in Brazil, so should we be thinking of this as kind of a step one of a multi-step process or is this -- are you pleased with the transaction as it stands?

On the capital side, Phil, what I really like about this deal is, it is really minimal capital. There is a lot of process improvements we think we can make and there is some capital that will be required, but I'd say it is in line with just running the business day to day. So it will revolve around debottlenecking, usage improvements on chemicals and energy and fiber. So in my view it is minimal capital.

In terms of the market itself, it is fragmented, but it is probably in terms of the operating model a market that is closest to the US in terms of how it looks. It is integrated. Producers producing containerboard and corrugated boxes, you really need board supply to be a player in the corrugated box market, and I think the opportunity here is to make this investment and improve what it is and if there are other opportunities, they will have to be financially viable and earn the right to be part of the business.

Phil, I would just add, this is not -- don't think of this as a consolidation strategy for the industry in Brazil. Think of it as we bought the number two or number three player, depending on how you want to measure it, and we think there is good growth opportunities with this business as the Brazilian market grows.

Got it, okay. And then the second question is just on containerboard in North America. Obviously, some significant market-related downtime there. And if we kind of add it up here, year-to-date you are tracking ahead of last year on the amount of downtime that you have been taking. So is this a cost savings opportunity? Is there an opportunity to take capacity out here or are you still holding out hope in the growth of that we might see in the next couple of years and you would rather wait?

Good morning, Phil, this is Mark. I think the way we think about the current, let's say, last two or three quarters in downtime is really trying to optimize the system that we have post-Temple integration. We are making some choices on channel, segments and customers and in the process of doing that we make the board we need for that particular customer demand. But we do have a pretty good system for taking any downtime, whether it is market-related downtime or how we plan our maintenance, to really drive to the lowest marginal cost production that we can have in any given period of time.

So I think we are managing it very well. It is a big system, over 13 million tons, and the level of downtime that is market-related plus planned maintenance is still resulting in a pretty decent operating rate. We do believe the market is going to improve beyond what it's been doing in 2012, and I think that will obviously follow as the US economy, hopefully, picks up.

Okay, thank you. I will turn it over.

The volume we had to purchase from the containerboard mills wasn't available for us to ship from our own mills.

Right, so that is the other added dynamic for a period of time as we go forward is as we executed the divestiture of the three mills that we were required to sell, we do purchase a good portion of that board back into our system, especially the two mills on the West Coast, they are in proximity to our box business there. So that is another added dynamic of the 900,000 tons or so that we effectively had in our system at a diminishing rate over time. So really just trying to manage the whole supply chain. If you look at -- just look at the past few quarters, I think we've got the ability to manage and flex our capacity with all of those variables playing into it.

Okay, that is helpful. Thanks a lot.

Your next question comes from the line of George Staphos.

George, how are you?

Hi, everyone. Hi, John. Doing well, hope you guys are doing well as well. Two questions, first off, on Orsa, can you discuss what the age of the mill is right now? My guess is it is relatively a young fleet of machines given that you mentioned, I guess, to Phil's question, there is not a lot of incremental investment that needs to be done. And can you mention what the level of vertical integration is? Perhaps you had said it and I missed it and I had a follow-on.

Yes, the vertical integration is around 80% plus or minus. I would characterize the machines as being good assets. They are run fairly well, but just as a for instance, they have more than two times the amount of unplanned downtime across their system that we would typically expect. So we see a huge reliability opportunity just in terms of how you run -- how you maintain the machines, how you run the machines.

And then there is out also some opportunities around cost improvements from, as I mentioned, energy and chemical uses. So I think we like not only the mill assets, but the box plant assets. It is actually a very, in terms of housekeeping, it would rival what we look like in our Brazilian mills which is probably Company standard. So we think we've got a good fleet to work with.

Okay. Tim, to the extent that you will have less unplanned outages, does that suggest that perhaps the level of vertical integration will drop as you will be producing paper at a greater rate or greater efficiency than is currently being done? And if so, where do those tons go? Are they being largely sold domestically or are they being put into the export market?

No, they are primarily sold domestically. And, yes, it could drop a little bit, but I don't think it will be something that will be material for a long period of time.

Okay. My last question and I'll turn it over, can you comment at all on how early trends are in terms of your key businesses, corrugated and printing papers? From what we have been seeing thus far in earnings season, trends seem like they have been perhaps sequentially getting better if you adjust for seasonality, and that is across a broad array of packaging and paper markets, but what are you seeing? Thanks, and good luck in the quarter.

I can -- North America, George?

I think that is largely North America because basically the companies that we track probably are more North America than international, but, yes.

Yes, I will start it on printing papers and then hand it off to Mark. October looks pretty good so far. In terms of order intake, backlogs, and shipments. So if you look across all of the segments that we supply, we feel pretty good about October and we will see how the beginning of November shapes up.

Yes, on the corrugated packaging side, I would echo what Tim said. October is picking up sequentially over September, a couple of spots we see improvement in our online retailing customers or Internet sales look better. We did see some pickup in our durables and building material-related segments and that seems to have been kept at a sustained higher level. There are some offsets in some of the food segments we are in.

Everybody knows what's going on in the meat and poultry industry relative to corn prices and their ability to bring their products to market. But I would say, October this year has got a couple of more days than last year's October and I think we like what we see so far as the quarter starts.

Tom Kadien do you want comment on coated paperboard?

Sure, John, and George. In coated paperboard the market, I would say, is still pretty soft but sequentially, I think, for a couple of quarters now we have seen, I think, 2% improvements in volumes quarter-over-quarter. So we are not where we would like to be. I think we are off about 4% versus prior year, but sequentially it's getting better.

Thanks, Tom. Thanks, everyone.

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

Hi, good morning.

Hi, Gail, how are you?

I'm good, thanks. Looking at containerboard, just, I guess, starting there, a couple of quick questions. Looking at the downtime that you've taken relative to industry inventories there is a little bit of the disconnect, can you give some perspective on where you see your inventories relative to the industry? And also I think you kind of referenced this, but maybe a little bit more color, as you transition in the Temple business, how is that going in terms of retaining customers relative perhaps to the experience with Weyerhaeuser?

Okay, Gail, good questions. On the inventory side, we do our best with our supply chain systems to predict what we need to make in the quarter or coming months. I would say in the third quarter we probably got a little tighter than we wanted to from a service platform standpoint, so we will try to fix some of that as we go forward. But our inventories, we believe, are in good shape at an absolute level. The challenge, of course, is always having the right stuff in the right places, and we can continue to improve that.

But we do like the ability to run the business with a good tight supply chain, but we need to make sure our service levels are where they need to be. On business retention, we've done a number of things this year, and I'd say largely we are satisfied. We have been able to earn some business that both companies had before and retain some of that. In some cases, customers have diversified a little bit, but we've been able to replace some of that business. We have been in the process of closing about nine plants and changing some shift structure with some of the others, and our goal is to retain about 95% of the revenue during those processes. And that is where we are at right now on that.

So I would say by and large, given we are making some choices about channels and customers, we feel pretty good about it, and our overall objective is to sustain our EBITDA margins and we've been able to do that given we've got these commercial dynamics while we integrate Temple.

Gail, we lost some business, or Temple was in the process of losing some business in the fourth quarter last year, so as Mark said, we feel pretty good about how we've operated with customers since we closed, but by the time we got Temple, they were in the process of losing some business in the third and fourth quarters of last year.

Yes, that is a good point, John. Some of that actually materialized in -- during the summer, but they were notified at the end of last year that some changes were being made. But we've worked real hard to try to replace as much of that as we can.

Okay, and actually, just sticking on that, you referenced expecting to be at 100% run rate on the price increase exiting the year, can you give a little bit color how you see that playing out in the fourth quarter relative to the first quarter next year?

Well, I think it is just a general statement that we are working real hard with our customers and we are making good progress with the box. And every customer is an individual and you work with each customer. We are making good progress. So I think in general, we will be heading into the year, into 2013, in good shape on the pricing across our box business.

Okay, and just one last one, actually sticking on pricing. Tim, RISI has been reporting price weakness across a couple of uncoated freesheet grades, it seems maybe a bit more severe than what you are seeing, but can you just confirm that?

Well, I would characterize pricing as stable, Gail. Yes, there are pockets here and there and everybody knows we're heading into a seasonally slower period of the year, but right now if I had to characterize the business as a whole I would say it is stable.

Okay, and actually let me just throw in one last one, there was something referenced, I think, in the charges about European packaging restructuring, is that something that has been ongoing or is that something new and incremental?

Gail, this is Carol. That is something that has been ongoing. We've had our Spain -- we built our new box plant in Spain -- so we've closed a plant and we are doing some things to realign that business and take cost out. So it is not a long-term project but it was something that did hit us in the quarter.

Okay, thank you.

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

Thanks, good morning. Just a couple quick questions, first on Grupo Orsa. I assume that it is going to be fully consolidated on the income statement?

Yes, it will be fully consolidated in all of our financials.

And do you have the opportunities or any agreement with respect to the remaining 25%?

There is language in the shareholders agreement, but it is really kind of a stand still for the first three years, and then there is an opportunity past the third anniversary to either -- to own more either through a put or a call.

And you indicated that the Brazilian corrugated market or, I guess, the containerboard is structured somewhat like the US. How would you characterize the actual box plants? Do they suffer from over capacity, as well?

It is a typical type of converting business. There is always latent capacity in converting facilities, but I think that if you look at industry margins and you look at it over a period of time, industry has been between the low 20%s and the high 20%s in terms of margins. So there is roughly 500,000 tons of containerboard that gets exported out of Brazil to other parts of the world, and there is less than 1% of containerboard that gets imported in. So I think it is a pretty stable market.

Great, and just switching gears, it is encouraging, I guess, not surprising, that wood products, you've got a nice window of opportunity. Any sense on the timing?

That depends on how -- whether we sell the business in pieces, which is one option, or sell it all in one shot, which is another option. We have -- the good news is we have bidders for both, so it could go faster if it's one sale, it could go a little slower if it's three sales. Either way, we expect to have it closed in the first quarter and I think we are looking at the bidding process. We have got a very healthy process going on, so we like the hand we've got.

Terrific, okay, thank you.

Your next question comes from the line of Albert Kabili with Credit Suisse.

Hello?

Out there, Albert?

Oh, yes, sorry, somehow got cut off there. Yes, just a question, I guess, on Grupo Orsa. Why structure it as a JV, why not buy the whole business, along those lines? And then, secondly, I know capital needs are going to be meaningful, but to the degree they are, do you see that as self-funding at this point?

Yes, I do see it as self-funding, more than self-funding and why 75/25, well, you have got a person who started the business and he doesn't want to leave it entirely. So we will be -- we will have a management team in place that runs the business on a day-to-day basis, but he is a local businessman who has built the business up from the ground and wants to continue to be a part of the business.

And I think that in our discussions with the major shareowner and these discussions have been going on for quite some time, we've come to believe that we can be -- we can make a good partner. So we are not -- his preference was to keep the stake and we were okay with that.

He really knows the local market, he knows the customers. They have a very good commercial organization. I think you take the power of their commercial organization and our manufacturing and process know how and it will be a pretty powerful combination.

Okay, got it. That is helpful. Thanks. And just along -- M&A and capital allocation, at this point with this acquisition, with still integrating Temple-Inland, how do you see future M&A playing out versus the capital allocation priorities that you've laid out?

This is not an M&A agenda. Orsa has been on the radar screen for quite some time in terms of discussions. So we like the hand we have. We've got a lot going on, as you said, around the world, and, as I said, we are poised to deliver significant improvement in EBITDA, free cash flow, and ROI next year with everything we've got. So the balance allocation of cash is going to continue and don't think of a big M&A pipeline ahead.

Okay, okay, got it. And then final question for Carol, I may have missed it, but on the initial read on pension expense next year, is that -- did you indicate that was $200 million higher or $200 million to $250 million is going to be the total expense for pension next year? Thanks.

Al, you heard it correctly, that it is $250 million incremental expansion expense. And you know where that is coming from, that is really just driven by the discount rate when you look at the interest cost calculation and then you look at the amortization of gains and losses, it is impacted by the discount rate. So unfortunately it is an expense, but fortunately it is not cash. And if you go back and you look at the cash requirements, we -- it looks like for '13, we've got a very small $40 million required cash contribution to the pension.

Okay, all right, and that is with the help of the Highway Bill, as well, I take it?

Yes.

Okay. Terrific, thank you. I will turn it over.

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

Thank you. With just a couple of uncoated freesheet producers it is striking how different people's view of the market is. I wonder if you could give us your perspective on some of the sub-markets and how IP is performing relative to your view of the overall market? And also, if you could tell us how you're thinking about the substitution risk from some of the new stuff that we're seeing out there, whether that is going to affect you in specific places or whether it's just going to affect the fringe players?

Hello, Mark, it is Tim. A couple of things, one it is not uniform across all uncoated freesheet segments of the market, you're absolutely right. Printing paper is and has been a little bit weaker than some of the other segments. But we look at our footprint here in North America and the customers that we are supplying, and then the second major point is we are able, given our footprint globally, to look out to other regions and take advantage of our presence in Latin America, our presence in Europe. And so where there has been soft places in the US market, we've had an export opportunity, not at the same margin structure, but an export opportunity to either backfill Brazil in Europe or supplement Brazil's capabilities in Latin America.

Can you give us a sense of whether the roll market looks very different from you versus cut size at this point? Again, I'm just trying to get a sense because it seems like every producer we talk to has got a different view and that seems awfully strange in this market.

Maybe strange a little bit, but I don't think so. You have to look at weighting of position in terms of where people -- what part of the market different companies are supplying. I can only speak to ours, we don't have a huge roll offset exposure to the market. So we're big on cut size and we are big on converting papers, and then we have a huge specialty business that is embedded within printing and communications papers. So I think it depends on business mix across companies.

Is it fair to say that you are probably not very concerned about the substitution risk from some of these lower end grades?

Well, I think you are always -- you look at the market, you want to make sure you are competitive. But we look at the fact that we consider ourselves a long-term strategic supplier with good quality and a great service platform and that's how we are going to compete. We are not going to look at every competitor as an equal.

Okay, thank you very much.

Your next question comes from the line of Scott Gaffner with Barclays Capital.

Good morning.

Good morning, Scott.

First question is really just around capital allocation and more specifically around the debt reduction. You have that slide 7 where you show currently at 3.5 times net debt to EBITDA on an adjusted basis for the Moody's target. And, John, I think you might have even alluded to this a little bit on the call, just the growth in EBITDA as we move into 2013 should, as you have Temple-Inland for the full year, should move that number down slightly. How are you thinking about debt paydown versus actual just reduction in the leverage ratio going forward and maybe more cash for other capital allocation priorities?

Carol, why don't you talk about how we finance Temple and then I'll come back and kind of share some thoughts on capital allocation going forward.

Sure, when we financed Temple we did a bond offering in the fourth quarter of '11 and we did short-term debt this year, which we are paying back pretty aggressively. Our plan for next year is to continue to actually pay down debt. We've got targeted another $1 billion of debt repayment in '13 and we will take the opportunity to pay down what debt is the most effective for us because we don't have a lot of maturities coming right at us. And with the cash flow generation that we have for next year, which will be strong, that will be a good plan and we will have opportunities to look at other options for cash.

We have will have paid down most of the bank debt by the end of next year.

Well, we will actually pay down most of the bank debt by, yes, by the beginning of next year. And we also have the proceeds then of the building products coming in along with strong cash flow from the business, so we should be in good shape.

So we remain committed to an EBITDA-to-debt target of 3.0 or less and we are making good progress moving in that direction. We are going to be able to carry more balance sheet debt because of the increased EBITDA, and if you think about -- go back to investor day -- we think our mid-cycle EBITDA targets just North of $5 billion, we are not there yet, but we are moving in that direction. So I think we -- it's playing out the way we financed it and we like where we are at.

Okay. And just to follow up on that, the pension gap, you have listed here $2.7 billion, you did note that the pension expense goes higher, $250 million to $300 million, how does that pension gap change as we move into 2013 if your current assumptions around pension expense hold?

Well, of course, what we will do at the end of the year, we will calculate the pension gap based upon asset returns through the end of the year and whatever the discount rate is at the end, so I wouldn't speculate on what that will be, but we will do that calculation and we will do that at year end.

At some point, in our lifetime, interest rates will turn up. A 200-basis-point increase in interest rates wipes out that pension gap. So we have been incorrectly thinking that interest rates at some point will move up, last year, this year, next year. The answer is probably they are not going to, but we don't want an over funded plan, so we will put cash in as needed. That is all part of our cash allocation plan and our free cash flow is strong enough that we can be increasing the dividend while we're paying down debt, funding the pension plan while we're paying down debt, and spending the appropriate amount of CapEx to keep the business competitive.

Right, hopefully, the Highway Bill allows you to not over fund the pension a little bit, and maybe have those interest rates come back in the next year, gives you some time for that to correct itself.

Yes.

Just lastly, on the Temple-Inland synergies, you noted $15 million of Temple-Inland synergies in Industrial Packaging in the quarter. You noted that you are at the $300 million run rate, are there synergies outside of the actual Industrial Packaging segment? I just would have thought you would have been higher than $15 million in the quarter based off of the, attaining the $300 million run rate at the end of 3Q?

Scott, this is Mark. I think there are synergies that obviously accrue, some of it is in the sourcing areas. And I don't have that number for the third quarter handy, but there are some synergies relative to the Temple acquisition that is not captured just in the Industrial Packaging business, but the lion's share is in the Packaging business.

But think of it this way, the second quarter run rate was about $240 million. Another $15 million in the quarter means that the third quarter run rate is about $300 million, so that the kind of annualized impact of what happened during the quarter is $60 million.

Okay, no, that make sense.

Scott, we're not done.

Okay, appreciate it.

Your next question comes from the line of Paul Quinn with RBC Capital Markets.

Hi, Paul.

Hey, thanks for taking the question. Just wanted to follow up on the Temple's building materials business and for sale, and lots of earnings reports this morning, so I might have missed it in your stuff, but if you could tell us the contribution from this business in Q3 and year-to-date?

Well, it is not reported as part of our business because it is a business held for sale.

Right.

And it is -- its EBITDA numbers are quite -- are pretty good and quarter-over-quarter they keep on improving.

All right, that is all I had. Thanks.

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

You had kind of alluded to increasing the dividend and, obviously, you just did that. But is it fair for us to think if you can deliver on the ramp and earnings you are expecting that what we saw is going to be the first of what hopefully is going to be a series of significant dividend increases?

As I said, Mark, earlier, we've told investors that we think 30% of 40% of free cash flow with the cycle is the appropriate dividend. We are going to be reviewing the dividend with the Board on an annual basis and absolutely I think as we make progress, and I think I've said this, we are quite confident in the earnings runway for next year, even in a confusing and sideways global environment, that we can improve our EBITDA, our free cash flow, and our return on capital. As that happens, we will be looking at the dividend in due course next year.

And, obviously, getting the box price increase is an important part of that ramp in 2013 earnings-wise. If you look back historically, have there been times when you've been able to get better than full pass-through of a containerboard price increase? And I realize you are still in process, so I'm sure you can't answer this question yet, but what tend to be the characteristics in place that have enabled that to happen and how would that compare to the types of situations we see today?

Well, I think -- I don't have every past price increase on the top of my mind, but there probably have been some examples where the box price increase, depending on the segment it goes into and how the value chain is constructed, box versus sheets, that there have been some higher pass-throughs. But I would say, if you think about this particular price environment as a normal price environment from a board through a box standpoint, not anything out of the ordinary.

Okay, great. And then real quick, Carol, you had mentioned the true-ups going away, did that include the LIFO inventory adjustments going away in the fourth quarter?

No, Mark, the LIFO will be into the fourth quarter. What we had is we did have a catch-up of some purchase accounting and I think that was around $0.02, so about $10 million, that was catch-up for previous quarters. That does go away, but the LIFO will be -- we split that over the two remaining quarters of the year, so we will see that again in the fourth quarter.

Okay, so don't want to get too much in the weeds, so in the first quarter it goes away?

Yes, we will just start over.

Great, thank you.

Your next question comes from the line of Chip Dillon with Vertical Research.

Hi, good morning. Forgive me if someone has asked this, good morning, sorry. Forgive me if someone has asked this, but Pulp & Paper Week, as you know, is changing the way that they are going to report the board prices with their acquisition of Official Board Markets, and I just wanted to just check and see how that might affect your contracts given, at least the ones that are indexed, given that they might go to a different way of looking at where prices are. And if your contracts anticipate something like this?

Chip, RISI has been working on this for a while, I guess, since they bought OBM and they are doing a process to get input from all of the stakeholders. And we will participate and live through that process, but we have done some changes over time, has been involved in changes with indexes, and I'm sure we will figure something out that works for customers and for us. It is hard to speculate on exactly what they're going to do because they haven't done it yet. But I think we believe we will be fine with whatever we do to merge those, and it will work for us and it will work for customers.

Got you. And then, I guess, as -- maybe as a related question, do you all have a thought about -- a high-level thought, obviously -- about how closely you believe your prices should be tied to what RISI says or puts out there, or do you -- and I guess that would take time to even implement if you even felt that was something you wanted to move away from?

We are comfortable with the structure that we have right now. A lot of our customers like to have index, and it is more for change than -- indexes at an absolute level in almost any industry are hard to tie down. But adding something that starts a discussion around change, I think, works for a lot of our customers, and so we have a lot of contracts that have that and we have a lot of business that doesn't have it. And we are able to do fine with either kind of structure.

Got you, thank you.

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

Good morning.

Hi, Mark, how are you?

Good. Hey, Mark, just a couple of clean-up things in the containerboard business. One, if you look at the industry numbers for the third quarter, in terms of operating rates and production, it looks like there was about 335,000 tons of total industry downtime in the third quarter, again, just working off the AF&P data, and you guys look like you have taken out 319,000, so it would look like you have taken 95% of all the downtime in the industry in the third quarter which seems kind of surprising to me. Am I missing something?

While we took 319,000 tons of downtime, that part you got right. We have a production plan that made what we needed to make to fill our orders. We do have a segment mix that is not the same as every other company, obviously, and seasonally since our ag business is so big in the second, we were down probably more than the industry itself in the third quarter and we are just kind of learning the new seasonality and optimizing the segments we have.

But as I said earlier, the plan that we operated under in the third quarter, when you look at the total mix of market and maintenance was, I think, incrementally 70,000 tons, or so, 75,000 more than what we've been tracking the last few quarters in basically a kind of flat market.

And, Mark, I would also suggest you take a few things. First of all, it is now a 13-million-ton system, so what is a big downtime number is a smaller piece of the total capacity. And we've also got 900,000 tons that we are contractually obligated to buy back. Contractually that ramps down over time.

Yes, I guess, John, what I'm trying to figure out is, it would only leave like 15,000 tons of total downtime in the third quarter for the rest of the industry, which is about 65% or 70% of capacity. I know at least one of your competitors has kind of an ongoing issue at a mill down in Louisiana. I don't know what everybody else is doing, so I'm trying to figure out if there is something that is not right in the industry data, because it does just seems so unlikely to me that you would be 95% of the industry downtime in the quarter.

Well, all we can tell you is what we did. But I think, importantly, look at our margins. Despite that downtime, our margins were as good or slightly better than the competition.

All right, listen, I've got no problem with margins, I'm just trying to understand what you're telling us and what the industry data is reporting and trying to figure out is something is screwy in the industry data. Do you have more capacity -- is there more capacity out there than the industry is showing right now?

When you get the answer let us know.

Okay. Well, I had another question for Mark and that is just on this box price increase, just so that we are all clear. You said you'd have it substantially in place at the end of the fourth quarter. We know that there is a number of customers out there that kind of reprice on -- at the start of the quarter or the start of the year, is that a significant portion of your mix so that we would think about your price as moving up through the fourth quarter and then at the end of a meaningful stair-step if this lead pricing occurs for January 1?

Mark, we've got a number of different realizations (inaudible) as you can imagine, and, I think, as you just mentioned, depending on the segment and the customer and the individual agreement, I would say based on our normal realization schedule we are working through and very satisfied with the progress we are making with our customers and we should be at a run rate as we leave the year with the announced price increase largely in place. That is about all I can say in terms of detail.

Looking at our business, Mark, we see the full impact for International Paper in 2013.

Yes, I'm just trying to think about sort of how much we might be pricing in for the fourth quarter as we think about the trajectory through the quarter and trying to figure out if there is this stair-step at the end. The one other question I had, just on Orsa, is there an opportunity, Tim, to perhaps move some equipment from other IP locations around the world down to Brazil to put into the JV?

Hello Mark, this is Tim. There might be, but that is not the primary focus. We've got good assets in this business and it's just a matter of optimizing what we have at the moment.

Okay, and could you just -- I think both [Klobine and Rijasa], [Rijasa] just added capacity, [Klobine] is, I think, is actually talking about a new mill down there. Can you just talk about a little bit about what you see on the supply side down in Brazil over the next few years?

I don't know any more than what's been publicly stated by the other players down there. So it's -- what I read is that people are bringing on new capacity and shutting down old capacity.

Okay. All right. Sounds good. Well, listen, good luck in the fourth quarter and good luck with the new venture down in Brazil.

Great. Thanks, Mark.

This concludes today's Q&A session. I would now like to turn the call back over to Mr. Glenn Landau.

Thanks, Phyllis, and thanks to everybody for joining our third quarter conference call. As always, we will be available post the call at the numbers listed on the first page of the appendix. Have a great day.

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