International Paper Co (IP) 2013 Q2 法說會逐字稿

Good morning. Many is Kristi and I will be your conference operator today. At this, I'd like to welcome everyone to the International Paper second quarter 2013 earnings call. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question-and-answer session.

(Operator Instructions)

Thank you. I would now like to turn the call over to Jay Royalty, Vice President Investor Relations. Please go ahead, sir.

Thanks, Kristi. Good morning, everyone, and thank you for joining International Paper second quarter earnings conference call this morning. Our key speakers this morning are John Faraci, Chairman and Chief Executive Officer; and Carol Roberts, Senior Vice President and Chief Financial Officer.

During this call 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 those figures to US GAAP financial measures are available on our website. Our website also contains copies of the second quarter 2013 earnings press release and today's presentation slides. Lastly, given our expanded disclosure around our 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, Jay, and good morning, everybody. Let me just jump right in and say in the second quarter International Paper delivered solid performance, increasing our EBITDA by $100 million, about 10% over the first quarter of this year and the second quarter last year at over $1 billion and importantly, we continue to generate very strong cash flow from operations and free cash flow and I'll talk about that in a minute.

I've got strong results from industrial packaging driven by increased pricing, seasonally stronger volumes coupled with, I would say, very solid results out of Brazil and our European Russian paper business. Those were the biggest drivers of our improved results during the quarter. We continue to see improved business conditions in our coated paperboard business, as evidenced by increased volume and pricing momentum that increased through the quarter. Additionally, we executed our peak outages, this was the peak quarter for outages around the world, and as we come to expect with International Paper, we did that on time, on budget and in some cases came up early.

We continue to control costs effectively and are challenging both US market and global environment. And last week, as we reported last Friday, we closed on the sale of the Temple building products business. This $710 million transaction with Georgia-Pacific, in addition to the sale of our share in the joint venture that was embedded in that building products business for $20 million, resulted in net proceeds of IP of $730 million as we expected. Additionally, the business generated $40 million of free cash flow during the time we operated it in 2013. So I'm pleased with the results of that. That process took a little longer than we thought but I want to wish everybody in that business all the best as they join the GP team.

We did have a couple of sizable one time items in the quarter. We took a bad debt charge of $28 million attributable to our expected exposure with a large customer in our North American printing papers business, National Envelope. They filed for bankruptcy during the quarter and we will speak to more of the details on that shortly. And secondly, we realized an unfavorable non-cash foreign exchange swing in our Ilim joint venture related to a stronger dollar in the JV's US dollar denominated debt. But all in, a very good quarter in terms of executing well and delivering solid results and importantly, as I'll come to at the end, I think we are set up well for a significant improvement in our earnings, cash from operations and free cash flow in the third quarter.

So moving to our financial overview on Slide 6, our revenues were up about 3% quarter over quarter. EBITDA margins improved by 70 basis points and cash from operations was up substantially quarter on quarter and year on year. As I said at the outset, most importantly free cash flow continues to grow with strong results in the second quarter, $450 million. That is up 70% from the second quarter 2012 and up 50% from the first quarter of 2013. As I said in the first quarter, our cash flow story remains intact and we are on track to deliver full-year free cash flow for International Paper in 2013 approaching [$2 billion]. Now let me turn it over to Carol. She will give you a closer look at the quarter and I'll come back and talk about the outlook for the third quarter and then we will all answer your questions at the end. Carol?

Thanks, John, and good morning, everyone. Taking a look at the second quarter bridge from Q1, we are $0.64 per share from continuing operations for special items. As John said, it was a good quarter with good improvement in pricing, seasonally stronger volumes largely driven in industrial packaging, but we also saw that in our consumer packaging and Brazilian paper business. Additionally, our operations and cost performance across the businesses was solid and we executed our outages very well, as John mentioned. Miscellaneous corporate costs were lower than the higher-than-expected costs that we saw in Q1 and taxes return to a more normalized level during the quarter of roughly 30%.

As John mentioned, the charge for the National Envelope bankruptcy hit us in the quarter. At the time of NEC's bankruptcy filing we had a total exposure of about $42 million. We have taken steps to mitigate and we are confident that we should be able to reduce that potential impact by about $14 million once the bankruptcy process plays out. So that for net-net we booked a bad debt charge of $28 million in the quarter. And finally, for the Ilim JV, we did experience non-cash FX swing that negatively impacted EPS by $0.05.

Moving to Slide 8, we experienced our heaviest planned maintenance outage quarter of the year. We executed 11 mill outages in total, all which went as expected, and this resulted in nearly 200,000 tons of capacity idled during the quarter over which about half was in the industrial packaging business.

Moving onto global input cost, it was kind of a bit of a mixed bag in the quarter with fiber and energy providing a bit of a headwind, while chemicals actually decreased slightly in the quarter. OCC costs were up during the quarter and wood cost negatively impacted our printing papers business. And I would say, looking forward, due to the whether challenges that continue to plague the Eastern US, we see wood cost as a growing concern and a cost headwind as we move into Q3.

Now let me turn to the businesses and start with industrial packaging. As you can see, our industrial packaging business posted a strong second quarter as we got to see the benefit of the implementation of the April price increase. The board price increase was implemented and box prices in North America were up on average $10 per ton quarter over quarter. We did see seasonally strong volume in North America and that was predominantly in our agricultural markets, which is a big part of our second quarter business. And this did contribute to the improved results as well.

Across the other side of the ocean, the economic conditions in our EMEA packaging business continued to be challenged and this impacted both pricing and volume in the quarter. What we're seeing in Europe is our margins that are under pressure due to some rising board cost and lower box prices. This was made more difficult for us because of a sub par agricultural season which was really impacted by the weather that had transpired over winter and into the spring, and this impacted our sales volume in the strong fresh fruit and vegetables segment for us. Once again, we executed the planned annual maintenance outage as well and operation remain solid throughout the quarter for the overall business.

Slide 11 is one that we feel particularly good about. Improved prices, combined with solid operating results, added over 300 basis points across our business in the second quarter and this is for our North American industrial packaging business. EBITDA margin for this business is poised to grow further as we get further price improvement and as we will talk about, continued optimization of this very important and large business for the Company.

Let's talk a little bit about pricing on Slide 12. As we look at the expectations around the current North American price increase, we will see significant realization in the third quarter. The timing issue that we saw with the board purchases from the divested mills is largely behind us and we saw that in the second quarter as we begin to realize the box price increases associated with those board purchases. We do expect to more than double our realization of the box price increase in the third quarter and we have line of sight of full recovery as we head into the fourth quarter.

Chart 13 shows the significant growth that IP has had in the industrial packaging business through the acquisitions of Weyerhaeuser and more recent, Temple-Inland. We're on a path to increase total EBITDA dollars in our North American business by more than five times from the 2005 to 2007 level. And key to that is that has come as a result of the delivery of nearly $1 million of synergies to the bottom line, along with other key improvements to the base business. The great news is we are not done. As we have discussed previously, we, Mark and the team, have been extremely busy integrating two big acquisitions over the last five years. So there remains a tremendous opportunity to optimize this greatly expanded business that we have built.

Just to put a face on that, we have a manufacturing system that comprises 17 board mills and over 160 converting plants. We shipped to more than 15,000 customers in nearly 44,000 locations. So the scale and complexity of the system is great. And that is a good thing because with that comes a lot of opportunity for improvement. And we believe that we can deliver in excess of another $200 million in additional benefits over the next few years. This comes in the areas that you would expect, improved mill performance, improved box plant efficiencies, reduced costs, streamlining the supply chain and upgrading the commercial portfolio. So all in all, a great story.

Talking some more about industrial packaging, let's shift our focus to the new Brazilian packaging business, Orsa IP, which we are reporting on our first full quarter since the close of the acquisition that happened on January 15. And I will remind you that we are reporting this business on a one-month lag so the results represented here are for the period of March ending in May. We're very excited that the Brazilian box market continues to grow at a strong pace, roughly 4%. While we saw higher OCC cost in the second quarter that did impact our margins, we have announced and have begun implementing a box increase on the basis of that strong demand and increased input cost. And we do expect the price increase to more than recover those increased costs and improve our margins. Additionally, the Orsa IP team has structured earnings improvement plans around the synergies that we have line of sight on, productivity improvements, particularly in the mills that provides good opportunity, and we should see those kinds the benefits accruing in the third quarter. So all in all, we are very excited about the acquisition and we remain very confident in the prospects that this business has and our ability to deliver on the commitments that we have made.

Moving on to consumer packaging on Slide 15, in our consumer packaging business we saw inproved volumes and operations, which was primarily in North America, that improved overall segment profits absent the very high heavy outage season that we saw. Market conditions in North America continue to be strong. We are seeing some price momentum through the quarter that also contributed to the results.

And as many of you have seen, I have shown on Slide 16, you can see the significantly improved market conditions that we have been seeing over the last couple of months. This is the industry data as reported by the AF&PA and it shows that the backlog of unmade SBS orders has increased significantly over the last couple of quarters. And really remains at the highest level that we have seen in the last two years. We have implemented price increases since Q1 and based on this continued strong fundamentals and tight market conditions, we have announced an additional $45 per ton increase on folding carton board that we announced on July 9. So all in all, we feel good about our North American consumer packaging business and really feel that we have hit an inflection point and are heading in a good direction.

Moving onto printed papers on Slide 17, in our printing papers business operating profit came in at $76 million, versus $149 million in the first quarter. We did see improved pricing driven largely by pulp in Brazil, along with seasonally stronger volumes in Brazil. Along with some benefit for market pulp price increases, we really saw an improvement in our pulp mix and this was driven largely by the successful start up and qualification of the Franklin mill on fluff pulp. This just, once again, speaks to system flexibility and system capability. Due to the pulp system that we have and the flexibility that we have, we were able to run Franklin full on 100% fluff because Riegelwood has alloted capabilities. But I want to say that we have only added and introduced to the market the fluff that is required by the demand that is warranted by our customers. So at Riegelwood we have been able to swing from fluff to softwood bails for an overall system benefit. And that is just really good news about the strength of our pulp system. In this business, as we expected, it was our heaviest maintenance outage quarter and additionally, as we've already talked about, we did experience the bad debt write-off of $28 million related to National Envelope.

Moving to 18, here is the results on Brazil. Brazil built on a very strong first-quarter result with even better results in the second quarter. EBITDA margins expanded to 34% and this was driven by an increased mix of domestic business, which has better margins, some favorable FX gains and then lower operating costs associated with the new biomass boiler at Mogi which has gone very well. I will note, however, that we did see some key export paper markets soften a bit as we headed into the end of the quarter.

Xpedx on page 19 had a much better quarter due to improved cost in the face of really, what I would categorize as continued challenging business conditions. And this resulted in an overall operating profit improvement of $15 million quarter over quarter. And the team definitely remains focused on executing the things they can control and they are executing well against our business improvement plan. Just a comment, as we continue to work towards our transaction with Unisource to spin and merge the businesses, as a reminder, we signed the LOI with Unisource on April 19. Since then we have done a very significant amount of work on a number of fronts, parallel path, including the continued preparation of financial information needed to facilitate the potential transaction. We continue to believe that the proposed transaction will be beneficial to both businesses and definitely to the IP share owners, and we are working towards a deal and will see this process play out over the next few months and through the end of the year.

Talking about our Ilim joint venture, the joint venture has seen significant progress in the second quarter with the start up of the capital project at both Bratsk and Koryazhma. We have now moved from start up to ramp up and we plan to reach full production of capacity of these projects by year end. Outside of the business operations, the JV did experience a negative FX impact associated with the $1 billion of US denominated debt that we mark to market at the end of each quarter.

Taking a look at Slide 21, this clearly illustrates where the JV is with the start up and the ramp-up of the project and what is expected over the next couple of quarters. The second quarter saw the greatest impact with start up costs roughly double what we saw in the first quarter. And although the start up cost will be significantly less in the third quarter, there are still costs that are associated with ramping up the new capabilities to full production that continues to be somewhat of a headwind. Ilim does expect to have the vast majority of these start up and ramp-up costs behind us by the fourth quarter, at which time we will really start to see the more significant benefits from the project. All in all, Ilim expects the benefits that were realized from the projects in '13 to outweigh the costs. However, there is no doubt that the benefits are going to be heavily weighted toward the fourth quarter and more importantly, a flow into next year, 2014.

So let me shift the focus now to the third quarter outlook as depicted on Slide 22. We see seasonally lower volumes and importantly, one less shipping day which for us is about 40,000 tons of production in North American industrial packaging. And you have to remember that for us, we have a heavy ag mix and the second quarter for this industry is just a big agricultural quarter. While we continue to see seasonally higher volumes in Brazil papers, business conditions in Western Europe will continue to provide challenges, particularly in our EMEA packaging business. Overall on price, we will be higher in the third-quarter and that is driven primarily by the North American box increase that we discussed earlier. All in all, other price mix will be largely flat while we expect continued pressure of potentially in Europe.

We continue to see solid operations which the largest quarter to quarter swing coming as a result of the non-recurrence of the National Envelope bad debt expense. We do expect some headwinds on input costs, primarily fiber and that comes in a number of places, wood in North American papers, higher wood and energy in European and Russian papers, and higher in OCC and wood in our industrial packaging business. Maintenance outages will be significantly less, $94 million lower than the second quarter which was our peak. And while the start up costs associated with Ilim project will be substantially less, as we spoke, ramp-up costs, along with some potential near-term risk to pulp prices in China, will likely result in a relatively flat operational quarter and we will then have the benefit of the non-recurrence of the second quarter currency swing. So with that outline, what I would like to do now is turn it back over to John to summarize and wrap up.

Thanks, Carol. The way to summarize is I feel good about where we are and how the second half of the year is shaping up. Not based so much on a robust economic outlook, but more on our ability to execute and deliver results in the second quarter and kind of the run rate momentum we came out of the second quarter kind of June going into July. The US and global economies are still recovering. But the cash flow we are able to generate I think gives me encouragement that we are going to have a substantially better second half of the year than the first half.

As Carol described, we realized about 20% of the benefits to the price increase in industrial packaging in the second quarter and have line of sight to the rest of it in the third and fourth quarter, and that is going to continue to further expand our already industry-leading EBITDA margins. Trends in our North America consumer packaging business are improving. We expect to realize the improved supply demand conditions that Carol referred to in the industry and, as you know, we made the tough decision to take on a machine at Augusta earlier in the year and that certainly improved our supply demand balance as we look at our customer base.

The third quarter is the lowest maintenance outage period of the year and I am pleased and positive that the heavy lifting is behind us on the Ilim capital projects. We completed those projects, as Carol said, we're into the start up mode now and we will have start up costs. We had a lot in second quarter, we will have a significant amount in the third quarter but as we get to the end of the year, those will be behind us. And that is a big tailwind, those projects completed, a big tailwind for International Paper and for the JV as we go into 2014. But most importantly, we are generating strong free cash flow and we will continue to build on this in the third and fourth quarters.

As I said last quarter, we expect to have free cash flow approaching $2 billion this year and that outlook remains intact. Additionally, we have more clear now, which we are one year into it, a more clear line of sight into the $5 billion EBITDA we talked about last year and I'll describe on this last slide here. As I wrap up the call, I want to give you an update on that. This slide shows our expected EBITDA potential at mid-cycle margins. We are probably going to get there a different way than we outlined, but the reality is International Paper has a lot of levers to pull. So the good news is when things change we can take advantage of opportunities and offset the challenges. So there are some headwinds and some tailwinds. There is more runway in industrial packaging which Carol shared with you. We continue to see margin expansion opportunities within that business. The optimization opportunities are huge when you think about five years ago IP had a $3 billion to $4 billion business and now it is a $12 billion business. Beyond that we can capitalize on our global footprint and capabilities in the printing papers business as we effectively and profitably move mix around the world to optimize margin opportunities. Those are some of the tailwinds.

We have got headwinds as well, mainly in the form of softer demand, probably everywhere in the world. And pulp prices that continue to be well below mid-cycle levels. The over supply situation that exists in coated paperboard in China is going to be with us for a while. That joint venture is operating well but there is a lot of excess capacity and we did not see all of that at the time. So we've got pluses and minuses but importantly, with all that said, we continue to see the potential of our portfolio as generating over $5 billion EBITDA and that is not counting Ilim, which you know is equity earnings and dividends. Let me turn it over to the operator now and I'll take your questions.

Thank you.

(Operator Instructions)

George Staphos, Bank of America Merrill Lynch.

Thanks, everyone. Good morning and congratulation on the progress so far. My first question is around pricing within the North American box market. I know discussion on pricing can be sensitive to talk about on a conference call. But is the pace of the increase and its implementation pretty much going as you would expect, more quickly or less quickly? If you could give some color around that if there's any variance that would be great. And I have a couple follow-ups.

Good morning, this is Mark Sutton. Box price realization, if you remember what we said at the end of the first-quarter, is about where we thought it would be. So we are on track. The $10 in the second quarter really manifested itself in the last month of the quarter. As we left Q2, our run rate was North of $30 a ton. So we're pretty much on schedule. We have confidence we will have the whole price increase realized just as we did on the first one from last year before the end of this year.

Okay. And a related question just on North American container board and boxes, can you give us some update early in the quarter in terms of what you have seen in terms of volume, booking or whatever you feel like talking about thus far within July?

I would be happy to. July has started off good for us. We had talked about our year-over-year comps for the last couple of quarters. And we have been tracking below our prior year comps. We are beginning to see that turn, as I mentioned a quarter ago, as we now have kind of lapped ourselves in some of the business that we were restructuring right after the Temple close. So, so far in July we are up over last year and we are up sequentially. So we feel pretty good about -- it's early in the quarter but we feel pretty good about it.

Okay last one and I'll turn it over. Clearly National Envelope had an impact on you in the quarter in the printing papers business. But if I look at the detail that you provide regionally and again, we really appreciate that and detail you provide during your presentation, it certainly was not a great profitability quarter for North American printing papers. What mile marker should we look to, what factors should we consider relative to what you are looking at as you look at your mill system in North American printing papers and whether over time you might need to further adjust that system? Thanks and good luck in the quarter.

George, this is Tim. Just looking at North American printing papers, I would say we had, outside of National Envelope, the quarter that we kind of expected that we would. We could have run a little bit better but if you look at the fundamentals around price and volume and mix, we were kind of flat from first-quarter to second quarter. So we knew we were going to have a big outage quarter. We had almost $40 million more in outages. We executed those outages very well. We continue to leverage the export markets at an enterprise level to make sure that we are managing our capacity effectively and I think that is the plan going forward. We still got opportunities to work with Europe and Brazil and make sure that we're producing product in the right place for the right markets. I also believe there is an opportunity around operations in the second half now having our outages behind us.

George, this is John Faraci. I would just quantify that, there is $70 million of quarter to quarter change in that segment that is solely attributable to the North American printing papers business. You take the outages in North America and National Envelope.

Fair point. So are you at cost of capital within North American printing papers?

We are as we look out for the year. Obviously in the second quarter, we had a heavy outage quarter, but I think we're looking at it more than just quarter by quarter.

Fair point Thanks very much.

Thank you. Philip Ng, Jefferies.

Good morning. After accounting for $1 billion of debt pay down and proceeds from your $1 billion product sales and free cash flow that you are generating, it would imply that you probably have $1 billion of excess cash to spend. How should we be thinking about that cash being deployed over the course of the year?

Hi, Philip, this is Carol. Yes, that is exactly the math that we see as well. So as we continue to look at that capital allocation, the first thing we will do is we will continue to reevaluate the dividend relative to that free cash flow and today we are on the low-end of our target range of the 30% to 40% of free cash flow, so that is certainly an option. We will continue to look at the debt. That always presents an option to see where we want to go with that. Obviously, another mechanism for returning cash to shareholders could be through the form of a share buyback so that is something that we will look at and talk about. And that we will also continue to look at what are the best investments for creating value for our share owners for today and for tomorrow. So I think the great news is that we have options and all of those options remain on the table.

Okay and then for consumer packaging, demand is decent for bleached board but I'm kind of surprised that backlogs have been that robust. Certainly guys played a role in that. Can you just give us a little more perspective what is driving that pick up there? Have you seen any impact from the ivory board capacity that is coming on from China?

Kadien, do you want to take that one?

Sure. I would characterize demand as much better than decent. We have seen, as you see in the chart that is in the deck, backlogs have really skyrocketed. I would say that they're not sustainable at 600,000 tons, but clearly we have seen some rebuilding of inventory in the channels. But more importantly, our customer activity is very strong, particularly in the folding and plate areas and also in the food service. So we took out about capacity, there was a little bit of inventory rebuild. But we and our customers, most importantly, are feeling some real strong demand.

On the build up of capacity in Asia, we're not seeing a lot of impact on that in North America. Clearly we are feeling it with our JV in China. But there is, I think, inventory -- imports are up probably 20% but on a small base and I think we're running on 100,000 ton rate for the year. So that is really not impacting us and certainly not in our core segments like cup stock and folding carton.

And taking sticking on that them on China and you guys flagged there could be some downside of risk on pulp prices in China. Could that weigh on your Asia business out there because your box board prices due move with pulp purposes historically, right?

Yes, we are largely non-integrated in our joint venture and we certainly follow pulp costs. And right now, supply and demand is way out of balance and it is driving the pricing. So pricing is very, very competitive and frankly, I don't think it can go a whole lot lower from where it is without impacting a large part of the cost curve. So I think it is bouncing around near the bottom.

Thanks, guys. Good luck in the quarter.

Mark Connelly, CLSA.

Thank you, two things. Can you talk about your pan-European, North Africa container footprint? You made a strategic decision there and this quarter is, maybe sloppier performance aside, that those seem to have been the right decision. Are you satisfied with that footprint or do you want to grow further in converting there? And also, would you consider expanding in folding carton? I'm not thinking about MeadWestvaco, I'm just thinking about carton in general and your consumer packaging footprint.

Mark, this is John. Let me take the boxed business in Europe first. Our box business in Europe is France, Italy, Spain, Morocco and Turkey. Morocco and Turkey are doing quite well from a demand standpoint and from a profitability standpoint. We are going to have a record year in Morocco. The geographic footprint is really the fruit and vegetable segment for Europe and what Europe, Southern Europe experts to other parts of the world like Russia. We like that. There's no getting around the fact of the industrial segments in France, Italy and Spain are just what you would expect they would be, very soft. So we are going to have to manage a difficult time.

But I think we like the fact that we bought out. Our partner wanted to sell us their stake in the joint venture we had in Turkey, so now we own 100% of it. We are able to do that at, what we thought, was a fair price and a good price, and so we own 100% of that business. And we certainly are glad that we invested in Morocco when we did. Would we expand in that business? Yes, we would if we saw the right opportunity that capitalized on our existing strengths, which is really serving the fruit and vegetable market. But everything between Morocco and Turkey right now looks a little bit unstable. I think we are going to sit back and watch. Folding cartons, we like -- in North America we like the fact that we are in the coated board business and we like being in the food service business, and don't see any need or reason to be the folding carton business.

Okay fair enough and just one quick question for Tim. You talked a bit about white paper. Can you talk about whether you are seeing more pressure in cut size? We are starting to hear that there are more deals again in cut size relative to roll, just curious if you are seeing that.

Before Tim takes that one, Mark, the other thing is we bought out our partner in Turkey but we still have 12% held by the public. And we don't own all of it.

Hi, Mark, this is Tim. We have not seen any significant pressure on cut size. There is a lot of chatter in the market around imports, the threat of imports and what might be about to happen. That has been maybe a constant theme over quarter by quarter over the past year or year-and-a-half. It has not materialized to date in a significant way. So I think it is more buzz at this point. But there is no doubt there is some marginal tons that are flowing in. But it is marginal tons, very low quantities that are showing up episodically. I think just one shipment gets talked about 10 times. So, no, we have not seen any major pressure on cut size prices.

Very helpful. Thank you, Tim.

Phil Gresh, JPMorgan.

Hi, good morning. Just starting with the free cash flow target for the year of approaching $2 billion. In the first half of the year here you have about a $400 million headwind from working capital. Understanding some of that is seasonal and you also have this container board price increases that are flowing through that can impact that. So, Carol, I was hoping maybe you could kind of help us think through how you think about working capital for the year in terms of hitting that number given the $750 million free cash in the first half.

Phil, you are correct that the consuming of the free cash for working capital in the first half of the year was driven by those two phenomenon's, the seasonality of the business, as well as the industrial packaging price increase. Obviously the industrial packaging price increase will stay with us but your December sales are just very different than your end of your second quarter and even the end of your first quarter. So that will naturally reverse. And if you look underneath, we feel very good about our metrics relative to days sale outstanding, days of inventory and whatnot. So all of those metrics we feel are in pretty good control. So we should see a flip back on that by year-end.

Okay, so you would expect to get closer to neutral?

I would not speculate on exactly what the number is because, like we said, we do have a price increase in North American industrial packaging, that is a pretty big business. But it won't be the consumption of working capital that we have had so far through the first six months.

Okay and, John, I know you're not trying to manage the consensus here, understood. But if I just look at all these moving pieces around the third quarter, the street said $1.15 and it seems to me that there are some headwinds here. So any way you can put a bogey around how we should think about the earnings side of things for this quarter, just to kind of calibrate? It seems like it might be closer to $1 to me but I may be off. I was hoping you could put a little bit of parameter on that.

We don't give guidance, as you know, and what I think about it is where are we going from the second quarter. We see significant improvement in earnings and cash from operation, and free cash flow in the third-quarter, and that is based on how we executed in the second quarter, the run rate in June and what we see in the beginning of July. So I think about significant improvement in earnings from the second quarter.

Okay, fair enough. Last question, on input costs, any change to your view on this $200 million headwind I think you had thought about before for the year and in light of what you have talked about with these higher wood prices and other inputs?

So I would say things come and go and so I still think that is a good planning assumption for the full year.

Okay thanks a lot.

Adam Josephson, KeyBanc.

Mark, how would you characterize your North American container board inventories at this point? Are they as high as you would like them to be?

I would say we had a big outage first half of the year, so it was very difficult for us to make any real progress in inventories. So I say, in general, we are still a bit on the lean side. We probably learned something in the fourth quarter last year that we will try not to repeat this year in terms of heading into heavy outages, not only the amount but the quality of the inventory, meaning the right grades in the right locations. I would say we're still a little bit on the lean side right now.

That's helpful. And, John, just two for you, one is, could you characterize the changes in economic trends in the regions in which you operate in recent weeks? Any notable changes in June or this point in July?

I think it's more the same. Every place is a little different but it's really more of the same.

And just one more, John, as you know the Wall Street Journal published an article not too long ago about the Ilim joint venture and about the risks associated with that investment, would you care to comment on that?

Yes, I would. Our view -- my view, is the article missed important aspects of the story around the joint venture with our Russian partners and first of all, that joint venture is unique in our industry, but we are in year six of what has been very successful commercially if you look at the impact on International Paper. We have got good governance and we have got a strong and effective board and joint venture management. And the reality is, here is an example of a Russian company and US company coming together and doing something that neither of us could do on our own. We just completed $1 billion of capital projects to expand, upgrade and modernize and improve the environmental footprint of an important industry Russia.

That project in Siberia is one of the biggest ones in the industry and Russian industry I think in over 30 years. And in way we are helping to diversify the Russian economy in a business and an industry where they are very competitive, and that is forest products industry. And finally, it's a huge favor by both the Russian and US government. And finally, I would say that the working relationship and trust and mutual respect that we've built together over the last six years is real, it is important and it is the key reason the joint venture has been successful. So overall, we think the story about the joint venture is a positive one with a lot of upside, so we are pleased with both the JV and the partnership.

I appreciate that, thank you.

The joint venture has been successful.

Anthony Pettinari, Citigroup.

Good morning. In industrial packaging, you had good price realization but you also called out 3% volume decline year-over-year in North American container. I am just wondering, is there anything that happened in the quarter in terms of share shift or maybe some account rationalization with Temple that you can point out that would explain the volume decline, especially in light of what sounded like a pretty good ag season?

Anthony, the year-over-year volume decline has been a bit of a trend for the last several quarters. And most of it is related to two things really, the acquisition and integration of Temple. In the first half of last year we made some changes commercially to some business that we had. There was some business that Temple was in the process of losing as we closed on the deal. And then as we implemented the price increase last fall, we made further commercial decisions. So all that business was in last year's comps and it's not in this year's.

But we feel really good about our volume trend now, in the first quarter and in the second quarter. We have rebuilt some of that volume that we moved away from and we talk about this, we are over-weighted in some segments as a result of two big acquisitions and maybe some segments that are struggling a little bit more in this economy versus some other segments. So we're working to rebalance our segment portfolio and then we have the other two channels that we believe are important and I think our margins show the results of that. We feel strongly about the open market in the domestic sense and we feel strongly about the export open market for craft liner board. So we look at all three of those segments and adjust our sales revenue through those segments on a continuous basis to optimize the business and looking at the margins and a few other metrics as our guide.

Okay that's very helpful. Maybe just switching to the box side in Europe. You referenced some pressure on box prices and a weaker ag season in Europe. I am just wondering as you exited the quarter and into July, are you seeing that price pressure continue? Are you seeing any stabilization or any kind of comments you can give on European box prices currently?

I don't think we are seeing a lot -- there's always pressure to competitive business, so to say there's no pressure box prices would not be correct. But we're not seeing week box prices. What's happened is there has been a little bit of compression on margins because container board prices have gone up and box prices haven't. There has been a bit of a mix shift so some of the realization loss we have is not price related, it is mix related. We had a plant in Italy that was destroyed by an earthquake. We rebuilt that plant and then in the process, we kept most of the customers but some of the customers moved some business in other directions. So we have got some work to do to rebuild our mix. But I would not say there is a lot of pressure on box prices in Europe other than the normal competitive activity.

Okay that's helpful. I will turn it over.

Gail Glazerman, UBS.

Good morning. Carol, can you talk a little bit more about how you think debt and specifically where you see the pension falling and as you look towards applying the GP building product sale proceeds and the rising EBITDA that you are expecting in the back half, how you think you will be looking at debt exiting the year?

Sure, Gail. Let me just talk about the pensions real quickly. And as you know, within interest rates rising, the higher discount rate helps on the liability side and so the rule of thumb for International Paper is about 100 basis points is equivalent to $1.5 billion of liability. So given where the treasury has ended at the end -- or at least a point in time today, that is probably a $1.2 billion to $1.3 billion reduction in our unfunded liability and that is all good news. That helped primarily from a credit metric perspective and in longer-term it should help on the funding side.

So that said, the way we think about debt is we want to pay some more debt down, we want to pay that debt down effectively and we have got a number of choices to do that. Now that we have gotten the funds from the building products, we are in a position to work on that. We have a great treasury group who is looking at those options. So we are still thinking that the debt reduction for the Company this year is going to be in the $600 million to $700 million range of net debt reduction by the time the year is over. That is kind of our planning at this point. We have also made the one pension cash contribution that was required for 2013. That was only $31 million but we have taken care of that and that is done.

Still a lot of room, Gail, for this year and certainly more next year for a very balanced use of cash that we have talked about with all of you over time. We are still committed to that and I think we're generating the cash to be able to make decisions consistent with that.

Okay and, Mark, can you talk a little bit about what you are seeing in terms of export markets for board? Any changes there?

Gail, good morning. The export markets, we saw price increases through the second quarter. I think we are heading into what is generally is a seasonally slower period in some of the export markets. We're in pretty much all of them to some degree. So I think we see a stable outlook as we head into the second half of the year, both on a volume and probably a pricing standpoint. But the third quarter in particular tends to be on balance across the export regions, a bit of a seasonally slower period from a demand standpoint.

Okay and just in terms of inflation, the wood cost inflation that you are discussing, is that really just weather-related or is there anything more fundamental whether it be mills restarting and anything else that would be pressuring prices?

It is weather-related, Gail. We have seen that OSB and wood products pressure all year because housing has been coming back quite strong. I think we've got 20 inches of rain in the Riegelwood area in a 40 day period. And we have got a lot of mills over in that area, Eastover, Georgetown, Augusta, Riegelwood. So the East side is getting hit harder for us than the West.

Okay, just one last question. In terms of fluff pulp, are you starting to see any benefit or impact in the market with Rayonier having completed the conversion at Jesup?

Yes, Gail, this is Tim. I would not characterize it that way. I think we're generally seeing fluff pulp continue to grow at the rate that we expect it to. For us, we are bringing on capacity this year. Carol referenced it, we are bringing on, trying to in the most intelligent way possible. So out of 300,000 ton increment of additional capacity, we're probably going to be around 200 that flows to the fluff pulp markets. Having said that, we will get a better benefit out of Franklin because we are going to try to run and we will be out of 300,000 run rate on Franklin on fluff but we will balance it out with other mill operations on the softwood side. So we still see 4% annual growth on fluff and no real new capacity coming on so as capacity comes up, it should help but we have not seen it materially yet.

Okay, thanks.

Mark Wilde, Deutsche Bank.

Just have some segment questions. First of all, you mentioned that you are seeing some weakness in some of the export, uncoated free sheet markets toward the end of the second quarter. Can you give us a little color on that?

Hi, Mark. It is Tim. I think a part of it is just seasonal impact. We are in the dog days of summer and we saw some markets slow toward the end of the second quarter, continue into the first part of July. I do not expect that to last for the rest of the quarter or the rest of the year. And it is not a significant downturn, it's just on the margin.

For Mark Sutton, I noticed, Mark, on some of the presentations recently, you guys have been putting in a little dotted line for that idled machine up at Valliant. I just wondered if you could give us a little color on how you think about that machine, particularly with the industry operating at a very high operating rate right now?

The machine at Valliant, along with a number of other small opportunities, are things we constantly evaluate to make sure we have the right capacity in the right geographic locations and the right mix between virgin and recycled liner. So we will monitor the market. We also -- John mentioned and Carol mentioned, the optimization opportunities. A big part of that is really examining that 17 mill system and ending up with the best footprint that we can. So we don't have any immediate plans for that particular asset that you mentioned, but it is definitely something that if we need to for either volume or cost reasons to deploy it, we would.

Would the roll off, Mark, of that new India agreement, would that make that restart at Valliant more attractive to you?

It could. Part of what we're doing right now is what you mentioned, new Indian also from hood container we are buying on a three year plan, two years left, product from these divest mills. And if it makes sense for us to internalize some of that demand in the future, and it likely could, that might play into our plans for internalizing that.

Think of it this way, Mark, if we had to -- it takes 18 months plus to do a retrofit of some machine or Greenfield, we could bring on valuing capacity very quickly, very cost effectively if the demand was there and we are going to manage the business, as we always have, to our supply and demand. But we can move very quickly and it would be very cost effective because we kept the machine and capability basically intact.

Lastly, since we have got Tom Kadien on the line, Tom, can you give us a little color on how the Sun joint venture is operating right now? What kind of volumes, where that product is being sold and pricing?

Tom may not be on, but let me answer that, Mark, quickly. The joint venture is operating well. Operationally everything is running very well. It always happens when the market is over supplied. Pricing, as Tom said, has probably hit bottom but there are no signs that it is going to improve next quarter so we're seeing more of the same. That volume is staying in China. There's very little of it that -- some is going outside of China to the region but we are not exporting it all over the world. We have coated paperboard business in Russia and Poland and the US and in China. So we know what we're all doing. And that capacity was set up to serve the high-end of the Chinese market, not necessarily the commodity and folding box board market.

John, in the bleach board market, is the Augusta machine gone forever given the tightness in the market? Could you ever see bringing that back?

Consider that out. We don't consider that an idle machine like Valliant. Let me just summarize for everybody. Solid performance in the first quarter. We are pleased but important thing is we have more runway ahead and you are going to see that in the third quarter. We are set up well for a significant improvement in earnings, cash from operations and free cash flow in the third quarter, and we will be starting to talk to you about how we see 2014 as the year unfolds. So thanks for being on the call and we will talk to you next quarter.

Thanks to all. Thanks for taking the time to join us this morning and as always, Michele and I will be available after the call. Our phone numbers are on page 25 of the appendix. Have a great day.

Thank you. This does conclude today's conference call. You may now disconnect.