International Paper Company Q3 2008 Earnings Call Transcript

Oct.30.08 | About: International Paper (IP)

International Paper Company (NYSE:IP)

Q3 2008 Earnings Call

October 30, 2008 10:00 am ET

Executives

Tom Cleves - VP IR

John Faraci - Chairman and CEO

Analysts

Claudia Hueston - J.P. Morgan

Peter Ruschmeier - Barclays Capital

Richard Skidmore - Goldman Sachs

George Staphos - Bank of America Securities

Mark Connelly - Credit Suisse

Steve Chercover - D.A. Davidson

Mark Weintraub - Buckingham Research

Mark Wilde - Deutsch Bank

Gail Glazerman - UBS

Operator

Good morning. My name is [Lorrie] and I will be your conference operator. At this time, I would like to welcome everyone to the International Paper third quarter 2008 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 will now turn the call over to Tom Cleves, Vice President, Investor Relations.

Tom Cleves

Thanks, Lorrie. Good morning everyone and thanks for joining our third quarter earnings conference call. This call is also being webcast. John Faraci, our Chairman and Chief Executive Officer and I will also conduct the call. Tim Nicholls will not be with us today. Tim was injured in a bicycle accident and currently he is in outpatient surgery to repair his shoulder.

During this call, we will make forward-looking statements that are subject to risks and uncertainties, which are outlined on slide two of our earnings presentation. We will also present certain non-U.S. GAAP financial information. A reconciliation of those figures to U.S. GAAP measures is available on our website. Our website contains copies of the third quarter earnings press release and today's presentation slides.

I will now turn the call over to John Faraci.

John Faraci

Thanks, Tom and good morning everybody and thanks for joining us. Today, Tom and I with Tom was standing in for Tim, we will cover our third quarter results. The performance of individual businesses and we will also talk about business conditions and our outlook going ahead.

So, just turning to the third quarter and I am now on page four. Despite continuing input cost escalation and tough market conditions, we delivered solid results. The third quarter earnings from continuing operations before special items are $0.84 a share which is 47% higher than the third quarter of 2007.

Revenues in the third quarter compared to the second quarter are up $1 billion dollars. That is mostly the result of having Weyerhaeuser and part of our revenue base for the quarter. We achieved these strong results despite input cost that increased $0.47 a share since the third quarter of 2007 that is the quarter-to-quarter comparison.

The sale of our Haynesville Shale mineral rights increased our earnings substantially, which we told you about on the second quarter conference call. Earnings from our Operating Businesses that is businesses excluding Forest Products were $0.36 per share. Our solid third quarter results reflect the increased selling prices, some weakening in volumes and addition of Weyerhaeuser’s packaging earnings, as well as reduced operating cost. Finally, I think, very important, we generated nearly $700 million of free cash flow during the quarter more than twice that we delivered in the second quarter.

So, slide five here compares our third quarter results with the third quarter 2007. We achieved $0.56 of improvement in price, volume; cost and mix, but these improvements were largely offset by the $0.47 of increased input costs, which I talked about a minute ago. So, in essence, despite price increases, we continue to have a lot of cost inflation flowing through.

Interest costs increased as well reflecting the additional debt from the acquisition of Weyerhaeuser's packaging business, but there is good news there we paid off more debt faster than we thought during the quarter So, let me just give you a couple of details about the factors that impact our earnings before I turn it over to Tom.

In the third quarter, global input costs increased by $286 million, that is the $0.47 per share I was talking about with energy and chemicals continuing to account for the largest increases. The appendix of the material that you will have has got additional detail in input costs by element, if you want to look at that.

Slide seven here shows the North American price increase and input cost comparison. We see the in green price increases, in red input cost increases. During the first six months of 2008 our selling prices only equaled 78% of our input costs. We have got a lot of pricing, but we have got more cost inflation.

We lost a bit of ground in the third quarter during which our selling price is running 60% of our input cost inflation. We have got some price contribute coming out of the quarter, but during the quarter more at even.

So, now I will turn it over to Tom to review the business segment results and I will come back and sum up and talk about the outlook at the end.

Tom Cleves

Thanks, John. Slide, eight please. Third quarter Printing Paper earnings declined to $210 million reflecting input costs inflation that exceeded the selling price increases by $50 million. North American Paper earnings were flat, but North American market Pulp earnings declined by $27 million.

Higher pulp selling prices were offset by higher manufacturing costs. Escalating input and trade costs and the costs for the two week market related shutdown of our Louisiana mill.

Brazilian earnings increased $4 million benefiting from higher prices and $16 million in foreign exchange gains, but hurt by input costs, lower export demand and a nine day maintenance outage at our Luiz Antonio mill. European earnings declined slightly as higher prices were offset by lower volumes, higher raw material costs and foreign exchange losses of $26 million.

I would like to mention that in October, we announced that we will begin a consultative process with our employees to conduct a review of the strategic alternatives for our uncoated freesheet mill in Scottland. Inverurie is a high cost, unprofitable mill competing in oversupplied markets. We will study the options for this mill and we will be prepared to discuss our plans for this facility late in the first quarter of 2009.

Slide nine, please. Year-over-year, North American Printing Papers volume declined due to the conversion of Louisiana mill from uncoated freesheets to market pulp production. This conversion led to the 22% increase in North American market pulp volume.

By the way, on Monday, we announced that we will take at least seven weeks of market related downtime at the Louisiana mill in November and December. This downtime is necessary to continuing to match our productions with our customers pulp needs.

Brazilian Paper shipments declined due to lower demand in export markets. Selling prices were higher in all regions with the exception of a slight decline in Western Europe. The five euro decline in European Papers reflects Western European Paper Pricing only.

Year-over-year Industrial Packaging earnings increased by $69 million despite the negative impact of $80 million in increased input costs. Higher selling prices increased earnings by $37 million. Higher volumes including the Weyerhaeuser packaging volumes added $64 million and improvements in cost and mix increased earnings by $47 million.

We achieved these strong results even after absorbing the costs of 35,000 tons of market related downtime in September, which we took to continue to match our containerboard productions to our customers needs and to avoid an inventory build. In early October, we began an extended shutdown of the 250,000 ton machine in our Albany, Oregon mill. This machine will remain idle for at least 90 days.

Also, we will shut down the 430,000 ton machine at our Valliant, Oklahoma mill. We intend to restart our Vicksburg mill in early November about the same time that we will shutdown the Valliant machine. Most importantly, we will continue to match our productions to our customer needs.

Slide 11, please. Year-over-year, North American Containerboard volume was flat. While North American Box shipments declined by 1%., although shipments dropped significantly at the end of the third quarter. European Box shipments declined by 5%. Board and box prices increased in North America and Europe. In the legacy IP system, September containerboard prices were $55 per ton higher than July average prices and September box prices were $45 per ton higher than July average prices. We expect higher average box prices during the fourth quarter.

I would also like to comment on the progress of our Weyerhaeuser packaging integration project. After this transaction closed on August 4th, we successfully separated the packaging assets from Weyerhaeuser. The new leadership team was in place on day one and they hit the ground running.

We are utilizing transitional services provided by Weyerhaeuser for certain finance, human resources and IP functions. The sales teams and the supply chain systems for both businesses have been merged into single entities. We are on track to archive the forecasted synergies and are very pleased with the progress of the integration.

Page 12, shows that consumer packaging earnings declined to $6 million, input cost inflation was 65% greater than the cumulative improvements in selling prices and cost/mix. Year-over-year, North American Coated Paperboard shipments increased by 2% and selling prices increased by $67 per ton.

Foodservice volume is holding up well as consumers’ trade down the quick service dining and as our Ecotainer cups continue to gain share. Revenue in our converting businesses increased by 4%.

Slide 14, please. xpedx posted strong operating profits of $35 million benefited from solid volumes in paper, packaging and facility supplies. xpedx earrings also benefited from continuing operating cost reductions that reflect our ongoing business redesign efforts. These structural cost savings partially offset $20 million in fuel and freight surcharge inflation during the quarter.

Forest Product earnings were $305 million including $260 million in earnings from the sale of the mineral rights in the Haynesville shale. We were able to coordinate this mineral rights sale with the purchase of Weyerhaeuser asset such that the sale was a tax free exchange of like-kind asset. Therefore, the cash taxes will be deferred for a significant amount of time.

In the third quarter, we also sold 33,000 acres of land, which generated earnings of about $45 million. The mix of land sales includes Timberland which led to the decline in the average price. We continue to sell our land at or above the original 2006 appraised value. At the end of the third quarter, we have 237,000 acres remaining in our land portfolio. Given the weakness in U.S. credit and real estate markets, we expect land sales in the fourth quarter to be less than half of third quarter levels.

Slide 16 please. Sales at are joint venture with Ilim declined by 5% due to lower export demand and annual maintenance outages at the two Siberian market pulp mills. Due to the expense of the two outages and an $18 million unfavorable swing in foreign exchange impact earnings declined to $5 million.

Slide 17 contains an overview of our special items for the third quarter. We recorded an $84 million after-tax charge for the impairment of the Inverurie mill asset. We recorded $69 million in after-tax charges related to the acquisition of Weyerhaeuser’s packaging asset and for a write-off of supply chain initiative development costs. We have made the decision to scale back our plans to implement our supply chain projects throughout our combined box plant system. We also recorded a $29 million after-tax charge for the U.S. taxes on the gain on sales of assets of our Ilim joint venture.

Ilim sold shares of a Russian subsidiary and U.S. federal tax law treats the gain on sales of stock of foreign subsidiaries as taxable income. Finally, we also recorded a $0.2 million after-tax charge for legal reserves for costs associated with the end of our siding and roofing claims period.

Slide 18 shows our nine month 2008 earnings relative to nine months 2007. Earnings per share increased from $1.54 to $1.80 excluding Forest Products in both periods, earnings increased from a $1.08 per share to $1.21 per share. 2008 earnings were reduced by $1.07 in increased input costs, which were offset by $1.07 in increased selling prices and improvements in cost/mix.

Our earnings also benefited from improvements in volumes, reduced corporate expenses and the addition of Ilim earnings, increased interest expenses mainly reflecting the incremental debt incurred with the Weyerhaeuser assets reduced earnings by $0.14 per share.

Slide 19 please. In addition to the earnings per share improvement through the first nine months of 2008, we increased our free cash flow by more than $600 million over 2007 levels excluding the cash flow from the mineral right sale, 2008 free cash flow increased by 60% over 2007 levels. Working capital reductions are driving this improvement in free cash flow. We use this free cash flow to pay down nearly $1 billion-dollars of the $6 billion acquisition price of the Weyerhaeuser assets.

Now, I will turn the call back to John.

John Faraci

Thanks, Tom. Before I talk about the fourth quarter, I would like to talk a bit about the recent deceleration of global economic activity and its expected impact on our fourth quarter. There is no question from my perspective that the world changed in the third quarter and International Paper was not immune from these changes.

If you ever wanted to make a case for how Wall Street is connected to Main Street, I think the impact of the credit markets freezing up, as ultimate impact on what is happened to economies around the world is a good indication of how close the connection is.

So, for us, we experienced a sharp decline in demand for our paper and packaging products in North America and mostly around the world and also for market pulp globally. Market pulp prices declined during the quarter. We do not think they hit the bottom yet. The combination of decreased economic activity and really we saw this start to happen about the second week of September. So, more or less, we had 10 weeks of continued weak economic activity which is to happen all year, last two weeks of September, and last two weeks of the third quarter and the first three and half weeks of October had been dramatically weaker than the prior nine months.

Despite these challenges we are going to continue to manage our capacity to meet our customers’ needs and to maximize or generate positive cash flow. We are going to produce the volumes required by our customers. We are not going to tie up working capital inventories and as a result of taking the significant market downtimes in the fourth quarter are included in our North American uncoated freesheet system and our North American Industrial Packaging business.

Currently, we are taking 350,000 tons of downtime that is right now in our Industrial Packaging business to balance our supply with our customers’ demand. So, just with that perspective in context, it is very important to understand how things have changed dramatically in the last six weeks.

Let me turn to the fourth quarter and we have got a couple of charts here trying to show what is going on with pictures and colors. With respect to pricing, we expect the average North American prices for uncoated freesheet prices to improve as we continue to realize the third quarter price increases. Our uncoated freesheet prices in Brazil will improve. We will implement our announced 7% domestic price increase and we expect uncoated freesheet prices in Europe to be more or less flat.

Overall, as I said, I do not think we have hit the bottom on pulp prices. We expect fourth quarter prices for boxes to be higher as we continue to realize our third quarter price increases and as Tom indicated, we have gotten good flow, very good flow through of our announced priced increases both on board and very importantly on boxes. If you do not get it on boxes, it does not matter.

Our U.S. credit paper prices will also benefit from the continuing implementation of announced price increases and a lot of our contracts have been restructured. So we will get pricing improvement as we go into the first quarter of next year. Global demand for market pulp declined significantly in the third quarter and we expect this is going to continue.

The slowdown in the U.S. now and the major global economies has also led to a sharp decline particularly in Industrial Packaging late in the third quarter. If the economy plays out the way everybody is thinking it is going to, which is sharply weaker in the fourth quarter from the third, I think, we will see that volume decline with us throughout the quarter. We do expect to see little improvement though for demand in our European container business driven by the agricultural markets.

So, I would like to spend a minute. Now turning to the next slide here, and I am on slide 22 and talk about what is going on with input costs inflation, because there are a lot of moving parts here and I just want to be clear on what we see today.

So far, input costs and that is including transportation. So, double input costs is our commodity inputs plus transportation, it reduced our 2008 earnings by more than $1 a share. While costs for energy and OCC are moderating in our North American system, we continue to face high prices with further inputs.

However, input costs in Brazil and Europe are expected to be unfavorable in the fourth quarter. Prices for natural gas, electricity, and oil are declining, but for other input costs, they are expected either to remain high or to increase. The Weyerhaeuser system uses more natural gas and OCC, so are going to get more benefit on that side of the equation.

Wood and we use wood everywhere. Wood costs are going to continue to go up driven by the lack of residuals from the weak housing market and the result and need to go out further to procure wood and we feel surcharges on top of that, we have got additional miles and additional cost per mile.

So, when we look at our input costs today without making a forecast. Our input costs today are about equal to our input costs for the average of the third quarter. So, we do not see any dramatic decline in input costs yet from where they have been during the quarter.

So, looking ahead, our fourth quarter, our earnings will reflect a decrease in the total maintenance outage expenses and we are going to continue to run our facilities very well. We expect earrings from our Operating Businesses that is excluding Forest Products to be less than third quarter innings how much less is going to be a function, not a downtime required to balance our production with our customers needs, which is in turn a function of how the economies play out, how federal markets behave and how long consumers which are two-thirds of our GDP sit on the sideline. It is very clear that they stop spending.

Equity earnings from our Ilim joint venture are going to be less than third quarter earnings primarily due to foreign exchange losses and remember there that we will continue to report on a one quarter basis. So, before we start the question-and-answer period, I would like to summarize the third quarter performance because, while, we are heading into a different set of market business conditions, I think we are heading into it off a pretty strong platform.

Despite very tough conditions in the third quarter, we delivered solid results. We absorbed the continued input cost increases and the effect of weakening global economy activity, yet our earnings and our cash flow were up. We achieved price improvements from most of our major products and our strong third quarter results continue to reflect efforts to reduce our costs and run our big facilities well.

We are very pleased with the strong start to the integration of Weyerhaeuser indeed. Day one was almost seamless. Separation of Weyerhaeuser, it took practically no time. We have been planning it for six months and I have to say this was the best integration given the first three months that I have seen over a number of sizeable transactions.

We are going to get more benefits faster and we are confident, we have got good momentum in those combined businesses going into the fourth quarter and into next year. Finally, we generated nearly $700 million of free cash flow during the third quarter significantly up from the second quarter even without the impact of the gas sale. In every quarter, this year, our free cash flow as continued to improve.

So with that, I will turn it back to Tom and we will take the rest of your time answering your questions.

Tom Cleves

Thank you, John. Lorrie, we are now ready to entertain questions please.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Claudia Hueston of J.P. Morgan.

Claudia Hueston - J.P. Morgan

Thanks very much. Good morning.

Tom Cleves

Good morning.

Claudia Hueston - J.P. Morgan

I was hoping you could talk just a little bit about trade flows across your business just given the changes that we have seen in currency and obviously just a globally slower economy. Have things changed at all on uncoated or bleached board or containerboard at this point?

John Faraci

Not, as of yet. Just to remind you, how volatile the currency is. The euro was 124 three days ago and now it’s 20, it was over $1.30. So, we are going to see a lot of volatility in currency and as of yet, Brazil, Russia, North America. China, we haven't seen change in trade frees. I would say in China, there is no question that exports from China, but the rest of the world has slowed down that’s not currency related. That’s reflective of what’s happening in Western Europe and North America as far as demands goes.

Claudia Hueston - J.P. Morgan

Thanks. And then just looking at the Consumer Packaging business, you cross sell a little bit more significant than I had expected. I was just wondering, if you can provide a little bit more color on what’s the cost input pressures are specifically in that business?

John Faraci

We have got more polyethylene, polystyrene costs in that business. Wood costs are sharply up in that business relative to others based on geography. And we are using more coal, which is lower cost, but costs for coal are going up, well prices for oil and gas has been coming down.

Claudia Hueston - J.P. Morgan

Okay. And you talked a little about restructuring some of your contacts in that business. Is there an opportunity there to maybe better match some of the cost measures you are seeing?

John Faraci

Yes, yes, and yes.

Claudia Hueston - J.P. Morgan

John Faraci

And most of that will show up in the first quarter of 2009.

Claudia Hueston - J.P. Morgan

Okay. And then just lastly on free cash flow, it’s just very strong in the quarter. Your working capital has improved a lot over the last several quarters. How much more room do you feel like you have to go on that side of things?

John Faraci

We don't know. That’s a great question. And I think, we will keep up pushing it because on that one, I don’t think, we know how far we can take it with our supply chain capabilities now. We really had the ability to manage our inventory down to levels, we thought weren’t able both in containerboard and in freesheet. There is going to be pressure on accounts receivable, but we will have to manage that.

Claudia Hueston - J.P. Morgan

Okay. Thank you very much.

Operator

Your next question comes from the line of Peter Ruschmeier of Barclays capital.

Peter Ruschmeier - Barclays Capital

Thanks. Good morning.

John Faraci

Hi, Pete.

Peter Ruschmeier - Barclays Capital

John, I was hoping, you could help us with the $286 million of cost pressures you indicated, if we were to assume that cost pressures remained flat today, how long would it take to feed in and how much would drop?

John Faraci

That’s right. Say that again, Pete.

Peter Ruschmeier - Barclays Capital

So the $286 million of cost, if oil prices stay constant from here, how much benefit could you get from that overtime? And how long, do you think it would take given the lag effect?

Tom Cleves

Well, there is a lag effect on the fuel surcharges, which is 10 to 30 days. I am just still not sure of what you are asking about in terms of the flow through effect. I mean our pricing, we are not asked more than a month or quarter on any of the big commodities. So, we will see a change and with gas, we are buying gas every month.

We are doing a bit of hedging that were partially in the stock market, partially hedged. And you will see on the page 50, the last sheet, it’s got our consumption of inputs costs. So you can make your own assumptions about pricing because you have the quantities there.

Peter Ruschmeier - Barclays Capital

Okay. I am not sure what you are asking.

Tom Cleves

I didn’t answer your question because really I am not sure what you are asking.

Peter Ruschmeier - Barclays Capital

Well, I guess, I am suggesting that the oil price today is down 50% and a lot of these costs are going to be direct and indirect derivatives of oil.

John Faraci

Well, chemical products are still remained very high. Caustic soda is five times what it was a couple of years ago and hasn’t come down yet. Now, if we have a significant global recession, you would expect that impact commodity chemical costs. So, I think it is a question of how much inventory exists in those businesses and some of them got disrupted by the hurricanes. Its $106 barrel oil, we didn't see that go in right away and it was almost like $1,000 pulp. Remember, when we had $1000 pulp and everyone said only one container probably in the world sort of 1000 bucks and then the price went down. I am not sure; we are able to saw that the full impact of $150 barrel oil because it didn't stick around long enough.

Peter Ruschmeier - Barclays Capital

Okay, that’s helpful. And then shifting to the containerboard integration. I am curious, if you can remind us John on the amount and timing of the packaging synergies that you targeted and maybe share some if you could of what you have learned so far through the integration process maybe positive and negative surprises, and how that would impact your thinking on those synergies going forward?

John Faraci

Well, I have got Carol Roberts sitting right here, who has joined the middle of that business. So I will ask her to comment. But I will just say, from my perspective, we are getting more merger benefits faster and Carol just wanted to briefly talk about what you are seeing.

Carol Roberts

Yes. Sure, John. And Pete thanks for the question. As you might recall, we had said that our target synergies for Weyerhaeuser, was $400 million with the first 12 month target of $175 million. What I would say there is that we are off to a very good start. So, I feel very confident about the durability of that goal. We are off to a good start.

Relative to the acquisition, I am very pleased. The good news is that the separation was a non-event and what I would be most pleased with it’s the strong best start we have gotten. Now, we fielded our leadership team on day one, which speaks to the positive attitude of the employees out of the Weyerhaeuser packaging business. They are actually very pleased to join forces with them and to build a strong business. That’s gone very good.

The assets are very good and probably the profile that we got as we continue to anticipate this market will be and we will manage through that. So, I think, we are doing very well. One of the big areas that we have got a great opportunity is on the S&A side and we have been aggressive there and we already added $90 million annualized write-off on S&A reduction rate. So all in all, it’s gone very well.

John Faraci

Pete that S&A came from all the planning we did. There was a whole of bunch of Weyerhaeuser S&As stayed with Weyerhaeuser. It served their business, but we didn’t take on. So, we didn’t have the severance costs. We didn’t have any of that because we have got ourselves organized to run without it.

Peter Ruschmeier - Barclays Capital

Okay, that’s helpful. And just last one please, and I will turn it over. John, I know, you have had a lot of discipline on running to demand. And I am curious without showing your hand, and what you may or may not do given the macro environment can you remove enough tons in containerboard, if needed to stabilize the market? Or do you think that you have really done what you need to do for now?

John Faraci

Well, we are going to run our system to match demand and manage our own. For instance I don't want to speculate about what we might do or others might do or what the industry situation might be. This is just not something we can do. But we are committed to manage our capacity.

And I think, what I have told you, we are doing right now that’s not a forecast, what we are doing right now. We are doing it. And we would expect our inventories to stay in checking. Industry inventories are in good shape. In fact our inventories will come down in the fourth quarter.

Peter Ruschmeier - Barclays Capital

Very good. I will turn it over. Thanks.

Operator

Your next question comes from the line of Richard Skidmore of Goldman Sachs.

Richard Skidmore - Goldman Sachs

Good morning. John, can you talk a little bit about what you are seeing in the uncoated freesheet markets, the volumes there is for the industry, we are pretty weak, for the first part of the quarter. And as you look out how you see that business evolving here in North America?

John Faraci

Well. Shipments are down at 6% year-to-date that’s kind of an aggregate across the board. If you look at the different grades, it’s different in some of the different grades. Imaging papers were up. Some of our key brands like HP are up. We will align with some of the stronger merchants and some of the strong retail channels, where we are down less than the market. But there is no question in the last six weeks, the same thing I talked about in terms of what’s happened to demand and packaging is happened in paper. Commercial printing has had a sharp pullback. And as you know, envelope and direct mails really have been hurt by what’s going in the financial services market.

Richard Skidmore - Goldman Sachs

Okay. And did you give a number for downtime, you are taking in uncoated freesheet or it’s the downtime number was that just in containerboard?

John Faraci

The downtime number was just in container board.

Richard Skidmore - Goldman Sachs

Okay. And then just on the uncoated freesheet maybe in Brazil as you look at what’s happening in Brazil with some of the large market pulp producers there. Any concern with regards to supply of pulp for your paper machines there. And any view about maybe doing something strategic in Brazil in front of those pulp producers maybe [now] a little bit more distressed.

John Faraci

But we are glad. We are only a net pulp seller. I think about 100,000 tons in Brazil out of Luiz Antonio. So, I think, right now, we are in the right business. We are in paper not in pulp. And the paper businesses, I was in Brazil about 10 days ago.

I would have to say all around the world probably that the demand dynamic is best in Latin America then it is anywhere else in the world now then I isolate it from what’s going on. But I was with a 150 of our customers in the region and they were feeling pretty good about their business, which was two weeks ago, but not today.

There are lower exports going out of Brazil, little bit of weakness in the surrounding economies, but the Real strengthening has helped us. So, as regarded to opportunities for the pulp market down there. Our focus right now is to run what we have. Pay down debt, generate strong free cash flow and manage through this downtown and come out of this better, stronger.

Richard Skidmore - Goldman Sachs

Thanks, John.

Operator

Your next question comes from the line of George Staphos of Bank of America Securities.

George Staphos - Bank of America Securities

Thanks. Hi everyone. Good morning. Hey, congratulations on the Weyerhaeuser integration thus far and the cash flow generation. I guess, first question maybe piggybacking off Pete’s question. Did you mention what the Weyerhaeuser synergies were if any in the quarter?

John Faraci

What they are going to be for the year, Carol?

Carol Roberts

For the year…

John Faraci

This calendar year.

Carol Roberts

Calendar year about $50 million, $60 million.

John Faraci

So, $50 million in the first four, five months.

George Staphos - Bank of America Securities

Okay. So, you would say you that you got about pro rata amount of that in the quarter if I am implying correctly what you are saying.

Carol Roberts

Yes. Basically, but those are billed into the fourth quarter (inaudible).

George Staphos - Bank of America Securities

Okay.

John Faraci

We got $6 million, $7 million a month right away, which was the impact of not taking on the Weyerhaeuser S&A. so in a way, we got it, a whole bunch of it kind of day one. Some of the other stuff takes a little while to ramp up like transportation getting the system realigned and we have announced four box plants to shutdown and the savings of those who will come as we take those plants down.

George Staphos - Bank of America Securities

Right. John, Carol, given your experience and your conversations with customers in recent weeks the pullback that you are seeing in boxes and paper for that matter as well. Does it match what you have seen in past recessions or at this juncture, does the downturn seemed better or worse than what you have seen in other periods?

Carol Roberts

I think, George that it is worse than we have seen in prior period because it was so sudden and the magnitude was so large. As you would expect some segments were hit less than others. If you look at say processed foods, the processed foods are off a percent or two, not real bad.

But durables fell off much dramatically and they were already down, due to very slow housing and other impacts. So, I wouldn't say that it’s deeper and quicker, which really speaks to the behavior of the consumer. They just made decision not to shop. The good news is, it won't last forever and they will be come back when things settle down.

John Faraci

This is a much sharper downturn than we have seen in the last six weeks. I mean our box business is off double-digits.

George Staphos - Bank of America Securities

John does that in turn if we hold input costs constant sequentially. You have got some pricing momentum in your businesses, but obviously the demand is weak. Should we expect that within your paper, paperboard and packaging businesses that earnings should be flat to down in the fourth quarter? Or do you think with the Weyerhaeuser synergies and benefits that in total you would be up sequentially. Or is it too hard to call it at this juncture?

John Faraci

Well, I think, when I went through the other, I said we expect earnings to be down.

George Staphos - Bank of America Securities

Okay. I didn’t catch up then.

John Faraci

We got a fourth quarter with negative 4% to 5% GDP growth versus basically flat GDP growth in the third quarter. It’s probably the scenario is that their earnings go up, but I don't know what it is.

George Staphos - Bank of America Securities

Okay.

John Faraci

Now Consumer Packaging is probably the one bright spot in terms of demand. We are seeing still good backlogs there, good order book and we are running full, but that I think reflect the fact that most of its customer base is in the processed foods and fast consumer good staples as supposed to that kind of stuff. There are some places where golf balls are off but by and large our Consumer Packaging business is pretty solid.

George Staphos - Bank of America Securities

Okay. Two quick ones in sequential turnover. The decision on the supply chain system in the U.S box network, can you give us some color in terms of why you decided not to roll it out? And then any additional impressions with Ilim? What things can you do in the business as markets slow to continue the progress there? Thanks, guys.

Carol Roberts

George, let me answer this why we changed the decision. When we were pre-Weyerhaeuser, we were working on building that capability and its going to add a lot value. But I think it is quite simply that with Weyerhaeuser, we just had much higher priorities right now and where our resources need to be applied.

One thing we did learn about Weyerhaeuser, a lot of the supply chain benefit comes from both through the roll rooms and the box plants with some tools that we are going to continue with. So, while we are stopping on their overall deployment of the big operating model, we are going to continue to get a lot of benefit out of the things that link our mills to the box plants. But we just had some higher needs right now and better opportunity to improve the business.

John Faraci

George, would you repeat your question about Ilim, please?

George Staphos - Bank of America Securities

Yes. Just obviously, markets around the world have gotten soft or volatile. Ilim what are your impression with it thus far. What do you do to continue the progress and improve the performance there in light of the slowdown? Thanks.

John Faraci

George, Mary Laschinger is here, who is right in the middle of that business. So I am going to ask her especially from Russia to talk about what’s going on there.

Mary Laschinger

Well, first of all, George, on the more positive note demand as we have look forward for the next outlook has been strong domestically. And so, we are seeing the shortfall more coming to us from the Asian market.

And we are dealing with that on a daily basis in terms of how we are responding to that. Our operations are solid. But again we are starting to see some weakness in demand and pricing in export market and some of that being offset by continued good demand in pricing domestically.

George Staphos - Bank of America Securities

Okay.

Mary Laschinger

Currencies probably have had the biggest impact on the business.

George Staphos - Bank of America Securities

All right. Thanks for all the details. Good luck on the quarter, guys.

John Faraci

Thanks, George.

Operator

Your next question comes from the line of Mark Connelly of Credit Suisse.

Mark Connelly - Credit Suisse

Thank you. Two questions. I mean, following on that last question about Ilim your partner over there has made some comments suggest that the expansion might not go forward. We have learned not to believe everything we hear out of Russia. But I wonder if you could comment of that?

And second, I wonder John, if could you talk broadly about the competitive position of your white paper system? Certainly, as pulp prices were going up, integrated producers, like yourself, were getting some real competitive advantage. How much do you think declining prices are going to affect you competitively? I mean, obviously demand is lousy, but where does that really hit you.

John Faraci

Well, I will let Mary, Mark to talk about Russia and then I will come back and answer the printing paper side.

Mary Laschinger

All right. Mark, with regarding the expansion plans, again things have changed dramatically in Russia. To say that, it’s not going forward, I think is a fairly bold comment. The way we were looking at this today is that, we are going to make decisions based on what we see, what the market condition and/or ability to secure financing.

But we still feel strongly that this is, if we have, it’s more likely to be delays versus stocks and we will look at prioritizing projects in terms of providing the best generation tools to improve the business.

John Faraci

Looking at printing papers market, for me to look at it around the world. In Brazil, in Russia and in Poland, we have got very low cost systems. So and we are not competing in Russia and in Poland against nonintegrated producers. But we are very low cost delivered in those countries. And that's where most of the product goes.

In Western European, it is not a big deal for us. In Brazil, we are very low cost. And with a significant market position again we are not competing with nonintegrated producers. In Brazil, we are competing with other integrated producers and there is not much in the way of exports or imports coming into Brazil.

In the U.S., you can look at our numbers, where our return on sales is about 500 basis points better than the next best. And I haven't calculated that’s probably four digits better than the nonintegrated. Some of that will get eaten up by lower pulp prices for sure. But I can't see where some of the smaller nonintegrated is going to have better margins than we have, given that we are thousand basis better than they are now. 500 basis points better than one of the big players that we compete with. But you are right. The pulp prices will give them some cost release.

Mark Connelly - Credit Suisse

But is it fair to say that, both domestically and globally, the decline in pulp prices isn't going to hurt you that much. Is that fair? I mean competitively.

John Faraci

I don't think so.

Mark Connelly - Credit Suisse

Okay.

John Faraci

It is going to hurt us in our pulp business obviously, but not in the paper business.

Mark Connelly - Credit Suisse

Thanks John.

Operator

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

Steve Chercover - D.A. Davidson

Thank you, just two quick questions. First of all given your significant exposure both in Brazil and in Europe, are you doing any hedging to mitigate the change in currencies?

Tom Cleves

Steve, it is Tom. You cut off for a minute there. Could you repeat the question.

Steve Chercover - D.A. Davidson

Sure, sorry. Just wondering whether you are doing any hedging to avoid any losses or exposure to currency changes both in Brazil and in Europe?

Carol Roberts

First of all with regard to Europe, we are doing some hedging more related to the zloty and Euro, but not a significant amount.

John Faraci

In Brazil. Let me say very emphatically that we don't have some of the positions that you probably read about some of the industrial companies in Brazil. So, you know, we have done some hedging on a small portion of our export receivables, which are dollar dominated but it is not significant at all. And we have looked at, we have got none of what you are reading about.

Steve Chercover - D.A. Davidson

Yes, I was kind of thinking of some of those folks. And secondly, and I realize the delicate position. But with respect to Inverurie I know that one of the folks in your midst will say, you will never see IP selling a mill for pennies on the dollar. And having a turnaround and compete with us. Do you have the same viewpoint for your European assets?

Carol Roberts

We will not be selling this facility to manufacturing paper. We are looking at strategic other alternatives for other industrial uses.

Steve Chercover - D.A. Davidson

Perfect. I am glad you are consistent in different continents. Thank you.

Operator

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

John Faraci

Hi Mark.

Mark Weintraub - Buckingham Research

Good morning, John. When you were talking about operating profits being lower in the fourth quarter, was that just an overall statement. Or would that be applicable to each of the segments?

John Faraci

That was not broad statement there the profitability in the fourth quarter.

Mark Weintraub - Buckingham Research

So, I would assume that since you got another month on Weyerhaeuser, and you got pricing your Industrial Packaging business would be better in the fourth quarter than third quarter..

John Faraci

I was talking about International Paper overall. If get in the segment we have got pluses and minuses. But international paper overall -- and on this is a function of how weak does the economy get in the fourth quarter. And I think we are going to be surprised with how weak this economy is. I really do. I mean we are going to be shocked at how weak it is.

Mark Weintraub - Buckingham Research

And presumably, you are tacking the – you’re supply to demands and hence that is….

John Faraci

We are taking 350,000 tons of down time industrial packing right now. You can figure our what that annualized number is. Its huge.

Mark Weintraub - Buckingham Research

So I ask you what was that number in the third quarter. You’ve been moving parts in Vicksburg. I am not fully sure how to interpret that 350?

John Faraci

35,000 tons plus Vicksburg wasn't running.

Mark Weintraub - Buckingham Research

Okay. So if I try and go from Q3 to Q4, obviously, I have got a downside small hopefully but uncertain on the operating line, and then I don't have my $0.42 for mineral rights. If I understand it rightly lands sales would be about half. So that's another $0.03-cents. And then there just two other items, I was real unclear about. And one is interest expense. If I look at the slide on the key financial statistics, it looks like that is going to be up like $40 million or $45 million in the fourth quarter. Is that about right?.

John Faraci

If it is on the slide, I think you should assume it is about right. Why don't you call up [Steve] and he can take you through that Mark.

Mark Weintraub - Buckingham Research

Okay. Then lastly on the corporative. It looks like there is a significant increase expected in the fourth quarter and I wasn't sure what that would have been about?

John Faraci

I think again, I would ask you to give a call to Tom and he can give you clarity on that.

Mark Weintraub - Buckingham Research

But bottom line, if I take all the numbers I just put together the $0.42 for mineral rights, and just without the land sales, the interest expense, I am kind of in the low 30s and what ever I can do operationally. Are there any other big drivers that could move this different from that for the fourth quarter?

John Faraci

Absolutely. Volume. And down time. Absolutely.

Mark Weintraub - Buckingham Research

Okay. That’s where the risk is operationally?

John Faraci

Yes.

Mark Weintraub - Buckingham Research

Okay. Fair enough. Thank you.

Operator

Your next question comes from the line of Mark Wilde from Deutsch Bank.

Mark Wilde - Deutsch Bank

Good morning. I have got a couple of questions for Carol and then one for John. Carol, can you just talk about with all the changes in these input costs, it looks like OCC and the yellow sheet is down another 30 to $60 in November. With that, and gas prices, is it changing where you are thinking about taking downtime or any kind of longer term capacity decisions that you might make. And can you talk just generally about this process of renegotiating some of the box contracts.

Carol Roberts

Yeah. Mark, thanks you are absolutely right on the inputs and that’s one of the reasons, why we are actually quite glad, we are going to be facing the headwinds with the largest system because, as you can image, we have a lot of options. Lot of (inaudible) use a combination of both OCC with fiber.

So, we had a chance to try and figure out how to balance and how to take the highest marginal costs out and how to balance it back into the mills to get good energy efficiencies. And so, we are looking at that and we have got a lot of engagement on the part of our manufacturing team with our commercial team.

And we are working it, I wouldn’t say daily, but certainly weekly, as we figure out what to do. On the short term, we can manage that and what’s happening make it think hard about any long term decisions we make factoring that volatility, we want to make the right long term decision.

And regarding customers. My comment there would be that, we had good dialogue with the customers and we of course, that was one of the things we did was get out in front of the new customers and with our existing customers and quite honestly, we feel very good about our ability to deliver great value to them and be a very valued supplier, and we are having very good conversation on that.

So, I think that's going to go fine. We are in the midst of raising prices, which has gone very well as John commented on. So, I think there is a lot of work to do there. But we are having a good dialogue with our customers right now.

Mark Wilde - Deutsch Bank

I wondered Carol, it looked like A, maybe your prices are up a little more than other folks prices so far. But B, that double-digit decline in boxes that John mentioned, was bigger than a lot of your public competitors have reported and so I just, trying to get a sense of is, the economy is hitting you harder or is that shutting off some marginal business.

John Faraci

Mark, nobody has reported buying it for October, have they?

Mark Wilde - Deutsch Bank

Lot of people have mentioned, the numbers that they have seen through the first three weeks of October on their calls. And I would say the average probably been running 6% to 8%.

Carol Roberts

Yes, Mark, we looked hard at that. First let me comment on the pricing. I think one of the reason that our pricing realization is good is, our principals around the business are -- we don't do fixed pricing, we were mindful of contract structures on having to --so we didn't have any barriers in our legacy business on our ability to push for pricing.

That's been very helpful on the realization side. And regarding the [optional], I thought about that at a 29% or 30% supply position. To me, it would be hard to believe that we would be significantly different than the marketplace, because we are in everything. And some markets are hit more than others, but we kind of done a sensitivity on the segments. So, I don't believe we lost share and I don't believe we are significantly different than what the market should be experiencing.

John Faraci

The one thing we say is, having a strategy to run our box plants full, it makes absolutely no sense.

Mark Wilde - Deutsch Bank

Okay. John, just from a bigger picture perspective. We are looking at a much bigger backdrop than when you made the Weyerhaeuser acquisition announcement earlier in the year or when the deal closed in early August. Can you just step back a couple of steps and tell us what you are doing differently right now to deal with this environment. You already mentioned downtime here. You have mentioned the closure in Europe and you mentioned throttling back a little on capital in Ilim but other things that you are doing to weather this environment.

John Faraci

We are throttling back more on capital around the company and we will share that with you when we have our next conference call. I am very glad that we get to start it back in April, frankly on something called belt tightening, which is an effort to just look at discretionary spending and save us about $10 million a months and beyond that, I think I mentioned in this last conference call.

We got an initiative again that we started last December before Weyerhaeuser to take about $400 million of our cost our S&A cost. That would be the same number as Weyerhaeuser merger benefit. But 200 of it comes from Weyerhaeuser and the other 200 comes from IP. So there’s a big chunk of cost savings is going to come to International Paper and some our businesses are already implemented those plans.

So, that just going on around rest of the company. And Carol just talked about what we are doing in Weyerhaeuser. We have got more levers to pull. I really believe that what we want to have in a time of difficulty is lots of options to improve your cost structure. With Weyerhaeuser, we have a lot more options than we had with just the legacy industrial packaging business we had before Weyerhaeuser

So, yes, the world has changed and we are getting more and more to benefits faster. We are running our system differently than we were. As you pointed out, OCC prices are dropping. So we have got lots of options to be looking at.

Mark Wilde - Deutsch Bank

Okay, very good, John. Good luck.

Operator

Our final question today will come from the line of Gail Glazerman of UBS.

John Faraci

Hi, Gail.

Gail Glazerman - UBS

Hi, thank you. Sticking on containerboard for a minute, you have talked about the domestic volumes and what's happening there. Can you talk a little about your key export market for liner board?

Carol Roberts

Yes, Gail. We haven't seen any big change relative to demand. The markets that we participate in are generally much that require crack liner. They tend to be agricultural market. So from a demand perspective while obviously things are slowing, we haven't seen any significant decline in our market access or demand for our products. Of course, that is something that we will monitor very carefully but so far it's okay.

Gail Glazerman - UBS

Okay. And when you look at the July, August, price increase. It has already been commented, you had good experience. I am just wondering, do you think you can pass through more than the board price increase into boxes and several other competitors have mentioned.

Carol Roberts

I feel very good. Of course, I talked or Tom mentioned that point-to-point, we had already seen $45 and then we saw booking more in the fourth quarter. So I feel very confident that we will get some box price higher than the board price.

Gail Glazerman - UBS

Okay. And just a couple of quick questions for Mary. Mary, given what has happened in the economy over the last month or so, do you think there is any change in Russia and how they consider the wood export tariff and just a reminder if you think that is going to really make a difference for you it that goes through?

Mary Laschinger

With regards to the wood expert tariff, we do not anticipate that there will be a directional change from the government in terms of their intentions around the log export tariff. As it relates to (inaudible) we actually further anticipate that to be a benefit to our business.

Gail Glazerman - UBS

Okay. And just final question. Are the comments you made about the demand environment of Russia, do those hold for the rest of the Eastern European business?

Mary Laschinger

Eastern European business has been strong for us and continued to be strong. We are anticipating some back off of demand but it's still robust relative to other regions of Europe.

John Faraci

You just might talk about box packaging business.

Mary Laschinger

Packaging business is a different situation. The packaging business, we are in fact seeing a drop off, in particular, in the industrial segment, double-digit drop offs. Our volume should not drop off that much because we are anticipating a more robust fruit and vegetable season then what we saw last year. We talked of course, what Carol was saying around the crack liner, as the crack liner goes into that fruit and vegetable segment.

Gail Glazerman - UBS

Okay. Thank you.

Operator

I will now turn the call to Tom Cleves for any final remarks.

Tom Cleves

Thank you, Lorrie. Thanks for joining our call today. If you have additional questions Emily Ann-Marie and I will be available via phone. This wraps up today’s call.. Thank you.

Operator

That does conclude today's International Paper Third Quarter 2008 Earnings Conference Call. You may now disconnect.

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