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International Paper Company (NYSE:IP)

Q4 2009 Earnings Call

February 3, 2010 10:00 am ET

Executives

Tom Cleves - VP of IR

John Faraci - Chairman & CEO

Tim Nicholls - SVP & CFO

Carol Roberts- SVP, Industrial Packaging

Analysts

Gail Glazerman - UBS

Mark Wilde - Deutsche Bank

Claudia Hueston - JPMorgan

Mark Connelly - Sterne Agee

Rick Skidmore - Goldman Sachs

Steve Chercover - DA. Davidson

Chip Dillon - Credit Suisse

Peter Ruschmeier - Barclays Capital

George Staphos - Bank of America

Mark Weintraub - Buckingham Research

Gail Glazerman - UBS

Mark Wilde - Deutsche Bank

Operator

Good morning. My name is Brandy and I will be your conference operator today. At this time, I would like to welcome everyone to International Paper's fourth quarter and full year 2009 earnings call. All lines have been placed on mute to prevent any background noise. After the speaker’s remark, there will be a question and answer session. (Operator Instructions). I would now like to turn the call over to Tom Cleves, Vice President Investor Relations. Please go ahead sir.

Tom Cleves

Thanks Brandy. Good morning everyone and thanks for joining our fourth quarter and full year’s earnings review. Our speakers this morning are John Faraci Chairman and Chief Executive Officer and Tim Nicholls Senior Vice President and Chief Financial Officer. During this call, we will make forward-looking statements that are subject to risks and uncertainties and these are outlined on slide two of the presentation. We also will present certain non U.S. GAAP financial information. You can find a reconciliation of those figures to U.S. GAAP Financial measures on our website. Our website also contains copies of the fourth quarter and full year earnings press release and today's presentation slides. So with that, I'll turn the call over to John Faraci.

John Faraci

Thanks Tom and good morning everybody and thanks for joining us. As usually we do, over the next 20 to 30 minutes, Tim and I will review our full year and fourth quarter results and the performance of each of our businesses. Then we’ll talk about our first quarter outlook and open it up to your questions. Let me start by saying, we performed very well in 2009 especially considering the magnitude of the challenges we faced here and around the world. Despite the steak drops in demands, we made IP better and stronger in 2009. In 2009 and going forward, it is all about cash flow and 2009 in the fourth quarter; we are strong in that measure. We generated $2.2 billion of cash flow before fuel credits in 2009 that’s more than $5 a share, improved our balance sheet by $4.3 billion, reducing our logs of debt by $3.1 billion, reducing our pension obligation by $400 million and increasing our cash balance by $800 million.

We continue to match our production to our customer’s need to limit pressure on pricing. By the time we complete our announced permanent capacity adjustments earlier this year, we will shutdown more than 2.6 million tons containerboard, uncoated free sheet and coated paper board capacity in North America and Western Europe. We also generated more than $500 million in industrial packaging of synergies including $200 million of overhead cost reductions and further reduced our overhead cost by $300 million around the rest of the company of wide industrial packaging. And our 2009 results also include the favorable impact of $600 million of reduced input costs. Slide five is a busy one, but it picks the four major points of our 2009 improvement plan.

Let’s just start up in the upper left with capacity management and move clockwise to review our progress. On capacity management, this remains a key component of our efforts to protect margins and earnings. We incur the cost at 2.7 million tons of lack of order downtime in the North American mill system and more than 2.1 million tons of permanent capacity shutdowns. These efforts have begun to payoff in the form of higher operating rates and lower fixed cost and the fixed cost flow really occurred in 2010. The permanent shutdown of our excess capacity in North America, we have reduced our fixed cost by about $170 million annually. Back to integration synergies, increased our earnings from integration synergies by more than $500 million. We say the integration of Weyerhaeuser Industrial Packaging business over now it is turning to optimize the business.

Our Industrial Packaging team executed excellent integration of the Weyerhaeuser Packaging business and exceeded our synergies go well ahead a original three-year plan, basically got more merger benefits faster. In addition to these synergies, we are also targeting another $300 million in cost reductions from optimizing the entire Industrial Packaging business.

Cost reduction also played a key role and generating the bottom line earnings and cash flow for International Paper in 2009. We’ve reduced our overhead expenses by $500 million including $200 million in the Weyerhaeuser packaging integration. Through the combined efforts of integration synergies and overhead cost reductions, we took out more than 6000 positions including 2500 salary positions in 2009 and finally used our strong free cash flow to strengthen our balance sheet significantly throughout the year.

We’ve reduced debt by 3.1 billion increased our cash balance by 800 million and refinanced more than 2.75 billion in long-term debt. Turning to slide 6, this shows our continued progress and reducing long-term debt since we acquired the Weyerhaeuser packaging assets in 2008. In the fourth quarter, we have reduced balance sheet debt by incremental $600 million and since we completed the acquisition of the Weyerhaeuser packaging assets, we’ve reduced our balance sheet debt by 3.7 billion or more than 60% of the debt we took on to make the acquisition. We remain committed to further strengthening our balance sheet and we continue to pursue our goal debt-to-EBITDA ratio including our unfunded pension obligations of less than 3 throughout the cycle.

So, turning to our cash flow results in full year 2009, sales declined by 6% to just over $23 billion. EBITDA was $2.8 billion despite $400 million decline in EBITDA from forest resources. We reduced our outstanding debt by 25% to $9 billion and ended up the year with $1.9 billion cash on hand which is up 65% from the end of the year of 2008. And finally, again, this is the story about international paper for the second consecutive year, we generated record free cash flow $2.2 billion and that’s without benefit of fuel credits, a 29% increase over 2008.

Now turning to the next slide, which is a waterfall chart on year-over-year earnings, 2009 earnings per share were $0.88, including just $0.04 from forest resources compared to $0.01 a year earlier that had $0.66 of forest resources earnings in it. Selling prices drifted down throughout the year in eroded earnings while input cost reductions up just to improve earnings. Lower sales volumes in North America and higher sales of lower margin experts had a negative impact on earnings. The addition of Weyerhaeuser packaging business and aggressive cost management coupled with outstanding operations all improved their bottom lines. In our first full year of integrated operations the acquisition of Weyerhaeuser’s taxing business was accretive on a full cost basis, really important.

And finally, on the higher interest expenses were a drag on earnings and our share of volumes results also declined. So in sum, you know, this is solid performance and what was the sharpest, deepest and longest downturn we have experienced in decades. Before I turn it over to Tom, I would just like to spend a minute on this next slide here. It really shows what happened since we announced our transformation plan for International Paper several years ago.

We’ve really changed the quality of the earnings profile for International Paper as we transformed IP into a focused global paper packaging company. Slide 9 shows that it shows our continued progress improving the quality and sustainability of EBITDA. Just looking at the slide for a minute, on average 2003 to 2007, 40% of our EBITDA was generated by asset sales in our forest resources business.

In 2008 only 24% of our EBITDA was generated by forest resources asset sales and in 2009 land sales accounted for only 2% of our EBITDA. Today IP is a stronger better company with cash generated from a competitive global papers packaging business.

So with that I'll turn it over to Tim who will talk about fourth quarter results and results of our individual businesses and then I’ll come back to talk about the outlook and take your questions.

Tim Nicholls

Okay thanks John. Good morning everyone. Fourth quarter earnings per share were $0.24 and if you exclude the impact land sales earnings from our operating businesses were actually up 50% from the fourth quarter of 2008 while these results were inline with our original expectations for the quarter, we were definitely not satisfied with our manufacturing operations performance. We had had four consecutive quarters of strong operations but in the fourth quarter experience on isolated mill specific operating issues in North America. During the quarter we did generate 500 million in free cash flow and reduced debt by 600 million one of the story there was input cost which after falling all year long hit a turning point and became a $36 million headwinds for the fourth quarter.

We turn to slide 11 those are swing in earnings from the third quarter to the fourth quarter, volume and mix essentially offset each other, volume was better in Europe and North American exports for Containerboard and also printing papers out of Brazil exports increased. North American industrial packaging prices declined reflecting the impact of the previously published decreases and uncoated free sheet price erosion affected our Brazilian business.

Higher input costs as I mentioned effect earnings by $0.06 and operations were negatively impacted by both extreme cold weather conditions and wet weather conditions as well as wood shortages in the U.S. south, particularly west of Mississippi river where we have most of our packaging mills.

Our fourth quarter earnings were favorably impacted by foreign exchange, lower interest, tax expenses and also improved performance from the Ilim joint venture. So with that let me turn to the individual business segments and I will start with industrial packaging. And you know we are disappointed with the earnings in fourth quarter of $84 million, however, we did have strong cash flow of about $350 million out of the business and there is a couple of stories here. First of all on the volume side, export Containerboard volumes improved significantly but we had three less shipping days, which affected our box business in North America.

So the combination of the export volume and the lower box shipments improved volume by $11.0 million but it reduced our mix by $16.0 million. As I mentioned there is a couple of major stories that impacted results. The first one is input cost, we have higher than expected input cost increases for both fiber and energy which reduced earnings by $30 million, the second story was around our operations and that’s closely related to the extreme cold weather conditions but also the low wood inventories, weather related operating cost increases we had kiln outage at one of the mills and generator outage of another all decreased earnings by 25 million and then we had some higher freight cost moving some materials between mills that impacted results by about 10 million.

But if you will turn to slide 13, I want to put the fourth quarter in perspective and the whole year. So, if you look at this chart what it is showing is quarterly EBITDA margin performance for each of the quarters throughout 2009 and the year-over-year change in margins for 2008, 2009. In the fourth quarter, we generated EBITDA margins of 12.4%, which is comparable with our next best competitor but the important point here is that despite bearing the cost of 90% total downtime in our system. Our 2009 EBITDA margins were 17.5% that is 330 basis points greater than 2008 and it is 220 basis points greater than our next best competitor and outside North American our European box business we generated record EBIT and achieved cost capital returns in 2009 and if you turn to printing papers on the next slide, printing papers actually performed quite well what’s usually a seasonally weak quarter, sector earnings of 139 million were comparable to the third quarter.

North American paper volume decreased while European and Brazilian volumes increased. Prices were relatively flat higher input cost decreased earnings by 8 million and for this segment no operations remain solid. Part of the region being that most of our uncoated tree sheet mills in North America in the eastern part of the country and we are not impacted by as much of these extreme weathers we had in the central and western part of our regions. Overhead spending was favorable. We have fewer maintenance outages which increased earnings by $13 million and we have higher export shipments from the U.S. and Brazil that reduced earnings by $8 million. So, for the year uncoated tree sheet business in North America and our European paper’s business both generated cost to capital returns for the full year and our Russian paper’s business after a very slow start due to the economic crisis into the year having achieved record EBITDA in 2009.

Turning to consumer packaging, earnings were $49 million, our volumes were flat, slightly lower selling prices reduced earnings by $2 million. We did some of the same issues around mill operations that we had in industrial packaging relating to the bad weather. The main reason for the decreased in earnings was the higher maintenance outages, which reduced earnings by $10 million and one of the highlights in this segment in China is our Sun joint venture, which increased shipments by more than 50% in 2009 and increased our earnings by more than $37 million during the year.

Now, turning to xpedx earnings, xpedx earnings were favorably impacted by $17 million LIFO adjustment and while xpedx’s fourth quarter earnings benefited significantly from the adjustment through the total company. LIFO adjustments during the fourth quarter were earnings neutral. We continued to reduce the overhead costs in xpedx even while experiencing higher selling commissions, advertising and freight in the fourth quarter related to higher volumes and starting in the third quarter continuing in the fourth we saw ourselves improved, in fact average daily sales in the fourth quarter were up 8% from the low point that we experienced in the second quarter of last year. So, quarter-on-quarter in the fourth, printing papers sales per day increased by little over 1% reflecting the improvement in volume that was partially offset by slight declines in selling price. We also saw a rebound in the direct mill segment of the business, the packaging supplies increased by 5.5% and facility supplies as well as smaller portion of xpedx’s business saw an increase of 9% in the quarter.

Turning to IP Brazil in the fourth quarter sales revenue at the Brazilian operations increased by 9% to $300 million and that reflects the full ramp up of the new paper machine in [indiscernible]. Our earnings decreased by $3 million reflecting the impact of decreased domestic and export selling prices. So, our 2009 EBITDA margins having been impacted by the lower prices and also a higher mix of export shipments. We expect these margins to recover in the first quarter as one domestic and export prices improved in the Latin American Uncoated tree sheet demand increases and consumes greater portion of our incremental production. The on joint venture on slide 18 had a better quarter in their third quarter our fourth; remember we report on one quarter lag, their sales increased by 15% showing the continued improvement in pulp prices in both Russia and China. IP share of Ilim third quarter earnings improved by $6 million, we saw a pulp pricing increased by $65 a ton and Containerboard prices increased by 18. And again as we discussed in our third quarter call, the joint venture agreement allows each partner the right to reassess their ongoing participation in the joint venture at any time after October 2009 and those discussions are continuing.

One final thing that I would like to point out that we did receive a $51 million dividend from Ilim in the fourth quarter which brings our total dividends received from the joint venture to $118.0 million to date. Let me wrap up on slide 19 with input cost. Our global input cost increased by $36 million in the fourth quarter. Our prices for wood in the U.S. South driven by inability to harvest because of rainfalls and the extremely cold weather was the main reason, we did have higher OCC prices at the end of the quarter and we saw a jump in energy prices as well. Our North American industrial packaging business is- most of these increases 30 out of the 36 with a large portion of that being because of mill locations. So with that, I’ll turn it back over to John for the summary and our first quarter outlook.

John Faraci

Thanks Tim. Let me take a minute to summarize the quarter. We had a solid quarter. We’ve accomplished a great deal during the fourth quarter, but the worse and pluses and minus, we ship higher volumes at exports in North America, which reduced our lack of order downtime costs. Our print papers business in North America, Europe and Russia performed very well during the fourth quarter. We announce price increases in all of our global pulp, paper and packaging businesses and are implementing those during the first quarter. We will start to see the real impact from that on our bottom line in March. We continue to match our production to our customer’s need and made the tough but necessary decisions to make permanent capacity reductions in North America and Western Europe. These reductions let the higher operating rates at the end of the quarter and as I said earlier we could get even more benefits from this capacity management strategy in 2010 as we take out the fixed cost tied up in these facilities.

We continue to aggressively manage costs in the fourth quarter and throughout the year and took out 5600 positions in 2009 and 10,000 jobs since June of 2008. We also reduced our CapEx spending by about $500 million in 2009. And we used the resulting free cash flow to continue to pay down debts $600 million in the fourth quarter and $3.1 billion for the full year. On the minus side, during the quarter, input cost went from a tailwind to a headwind. Actually for wood and OCC and as Tim said we’ve experienced some significant isolated operating issues associated with bad weather and wood shortages at our mills in the U.S. So, with that let me move to the first quarter outlook. In a nutshell, January and February, January has already done, are going to be tough. On top of the fourth quarter input cost increases, we anticipate the input cost inflation is likely to continue in the first quarter. Continued poor wood harvesting conditions in U.S. South and competition for OCC could lead to another jump in fiber cost. To hope the wrong and we may be wrong, but we could see input cost worked by another $100 to $120 million in the quarter. We have announced price increase for all of our global manufacturing businesses and we are getting good implementation, but not as quickly as input cost may go up. It is a timing issue, but it is only for the next 30 to 45 days.

The impact of these price increases will start to show up as we acted the first quarter and will be substantial in terms of impact on our second quarter results. When these increases are fully implemented and not only in North America, they are on a global basis, the impact could be a $150 million to $200 million per quarter. What’s really important about the quarter is how we finished the quarter and at this point in time the finish looks a lot better than January and February. So, as slide 22 illustrates, we had a solid fourth quarter despite the input cost headwinds and isolated operating issues. First quarter is going to be tough, but we anticipate positive momentum in the second quarter and remained optimistic about earnings for 2010. All things considered, we feel a lot more positive and confident about 2010 than we felt about 2009 at this time last year. Now let us take a look at out detailed first quarter outlook which is on slide 23. The first quarter is always seasonally slow. On top of that we anticipate only modest U.S. economic recovery. It is fair to say the U.S. economy has stabilized and in some cases improving, but is not out of the woods yet. The economies in Latin America, China and Russia where we also had business positions are growing again. On prices, pulp prices will continue to improve and we expect to realize the announced price increases on paper and packaging grades as the quarter progresses. As I said, most of that will start to show up in March. Maintenance outages will increase by about $25 million in North America. Xpedx earnings will not be strong in the first quarter because of the LIFO adjustment that Tim mentioned and we expect the contribution from Ilim joint venture to decrease reflecting the impact of higher input cost and an extended mill outages and some foreign exchange movements.

Thus summing up, we made substantial progress in 2009 and we still have a lot of earnings runway from internal initiatives, the price flow through from announced price increases and from volume both as U.S. economy gradually improves and from our leading positions in Latin America, China, and Russia. In 2010, despite our challenging first quarter, we expect to improve our earnings and our returns in all of our businesses from 2009 levels. We will capture the benefit of higher operating rates in form of reduce lack of order downtime and lower fixed cost from permanent closures that we announced in the fourth quarter of last year and we will continue to focus on aggressive cost management and remain- priority is generating strong free cash flow. We are going to use that cash to invest in high-return consumption reduction projects, to fund our pension plan and when the timing is right to increase our dividend. Goal remains the same, to reduce total debt including our unfunded pension obligation to less than 3 times EBITDA over the cycle. The 2010 in North America may not be a midcycle year, but for sure International Paper’s coming out of 2009 into 2010 in much better shape. So with that I’ll turn it back over to you Tom, please.

Tom Cleves

Thanks John. Thanks Tim. Brandy we are now ready to begin the Q&A. But before we start let me say that we asked each caller to limit the question to one plus a follow-up, so that everyone has a chance to participate. Okay Brandy, we are ready for our first question.

Question-and-Answer Session

Operator

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

Gail Glazerman - UBS

Hi, good morning. If you please speak on the operating issues and a quick follow-up on downtime. Are you know, you brought into the first quarter, are you seeing relief from these issues, the weather is still choppy or you still having operating problems.

John Faraci

January was just the repeat of December, you know Gail, in terms of cold weather. We had basically 2 weeks of below 20 degree of weather across the South, just had another ice storm come through Texas and Oklahoma and we have had a huge amount of wet weather that is not going to last forever, but that is- January is kind of a repeat of December.

Gail Glazerman - UBS

Okay and looking for the first quarter in terms of the downtime cost, with the mills closed in the late in the quarter, so if you are seeing any improvement there and could you help us to quantify it at all?

John Faraci

We don’t forecast downtime because don’t know what’s going to be. It’s going to be what it needs to be the balance supplying demand and frankly this is not all the way down yet, Albany and Pineville are so I think you are asserting at that on operating rate through International Paper in the first quarter, just on the basis of those two things, we will have to see how demands rates are. Right now, it’s looking okay.

Gail Glazerman - UBS

Okay, I guess I will get back in the queue at this time.

John Faraci

All right.

Operator

(Operator Instructions). The next question comes from the line of Mark Wilde with Deutsche Bank.

Mark Wilde - Deutsche Bank

Good morning.

John Faraci

Hi, Mark.

Mark Wilde - Deutsche Bank

John, I wondered if you can just give us some sense of why the corporate items are going to go up in 2010, it looks like you are forecasting kind of 20 to 40 - I see, $20 to actually $70 million of increase and then also is the follow on to that, can you give us some sense of how much incentive comp might have moved in ‘09 versus ‘08 and also in the fourth quarter over the third quarter?

John Faraci

Let me start with the reason for the increase Mark. It is primarily pension related, you know, as the non-cash item but we will see our pension expense increased in 2010 versus 2009 and incentive comp I don’t have right in front of me. The incentive comp plans to our board, Mark in February which is next February board meeting so you are not position of quantify those but I would expect that the incentive comp numbers will be up in 2009 versus 2008 and they were probably slightly up in the fourth quarter relative to the third quarter but for the full year up.

Mark Wilde - Deutsche Bank

Okay but I was wondering about John specifically is one of your competitors last week showed a big quarter-to-quarter jump in incentive comp in the fourth quarter now whether you had anything of the like in your numbers?

John Faraci

Yeah I agree there is a huge quarter-to-quarter change that the fourth quarter was probably higher. There is a year-to-year change that’s done significant this week obviously covered with other cost production.

Mark Wilde - Deutsche Bank

Okay. Great. I will get back in the queue

Operator

Your next question comes from the line of Claudia Hueston with JPMorgan

Claudia Hueston - JPMorgan

Morning thanks very much.

John Faraci

Claudia good morning.

Claudia Hueston - JPMorgan

I just had a question on the input on fixed cost you talked about on slide 23 about 120 million sequential increase, can you just talk a little bit about what you are assuming for things like OCC and then John I think you have said you could see an additional 100 to 120 million, was that in addition to that 120 that you have talked about in the chart?

John Faraci

That is 100 to 120.

Claudia Hueston - JPMorgan

Okay and then could you just talk about what you are assuming for those component?

John Faraci

(Inaudible)

Claudia Hueston - JPMorgan

Excuse me.

John Faraci

We saw an OCC onward thinking about what’s going to happen with that quarter-to-quarter OCC can go up by 50 bucks and it hasn’t yet, you know, it is moved up and now moving sideways so I hope we are wrong, we could easily wrong, you know, we are not buying any wood, any OCC other than what we need on the spot basis.

Claudia Hueston - JPMorgan

Okay thanks very much.

Operator

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

Mark Connelly - Sterne Agee

Thank you. Hi John. Couple of things you talked about 300 million of additional optimization in industrial packaging, and I wonder if you could tell us a little bit more about that is that, is that more on the supply chain side, or is it more of a driven now and my second question comes back to your first comment which was, you told that cash on - -we see your CAPEX coming in under $600 million this year which is found, an amazing drop particularly you have given where IP has been in the past. I tend to assume that maintenance system were between 300 and 350, and as you talk about your cash priorities is a billion still the right number for us to be thinking about over the next couple of years?

John Faraci

It may not be Mark. I will kind of touch in that and then like I will take about Industrial Packaging, because Carol, Robert sitting right across to me. You know, we’ve used a billion dollars as the placeholder for you know, capital spending over the cycle, which is well above the average 65% to 70% of depreciation. You know, we got some very high return projects, there are no really big projects but a couple of hundred million dollars we really have return projects, we have got in the pipeline the fund in 2010 for cost reduction they are none of them are volume related all, you know, they are energy, wood yield, chemicals, people cost reduction projects. Using much stuff to make the product but I think your as we continue to get better at getting the production we need out of fewer facilities whether it’s paper mills or box plants, our distribution centers, I wouldn’t be surprised if we find a way to get all our work done for less than a billion that we thought was going to take a billion to get done. We got a great deal of capital productivity at about $500 million so we basically got all the work done we thought it was going to cost us $700 million for little over $500 million and that’s just you know, kind of the impact that were pretty deep perception what that does to the cost to get the jobs done plus the fact that we do jobs and a lot of this is maintenance capital. We are not doing that overtime in 24x7 when we take a likelihood of downtime. We are doing them on straight time significantly reducing the cost of those maintenance related edits of some, which get capitalized. Yeah, I think we could be under a billion.

Tim Nicholls

And Mark I just to add to that we won’t see a significant decrease in capital for the close the mill closure that we announced because we had already started retailing capital in those operations. We will pick up reduction and maintenance terms.

Mark Connelly - Sterne Agee

Right great.

John Faraci

So Carol, you want to talk about it.

Carol Roberts

Hey Mark this is Carol. Relative to the continued improvement that we can achieve now I think what is the most exciting is, we are done integration and we are really moving onto optimization and there is a bit of differentiation and if you look that where a lot of synergies savings came from given how we operated last year one year that we really have not had a chance to really optimize yet, it is a new system. We ran with the significant amount of downtime last year and so with our footprint change and then getting our new system to run away we know we can’t that’s a lot of upside there. Unfortunately, we are not operating in that condition right now. We are not at our best yet due to the conditions and challenge as John and Tim talked about.

In addition to that there is more supply chain upside. Once again that is not an area that we have been able to optimize yet. We have made some progress but will be better there. We also see more opportunity to improve the box plan. We made a lot progress but there is continued cost improvement there as well as box composition, which reflects itself in margin and then the other piece that really not a significant part of the 300 but due to influence but it’s upside to it and just going back into our volume overtime. We have a lot of potential to do the right things overtime and increase our volume because you know where, you know, we can start run for even with our new- we haven’t been full. So all that says there is a lot of upside run away in the Industrial Packaging business to make the business better.

Mark Connelly - Sterne Agee

Perfect, it’s really helpful, thank you.

Operator

Your next question comes from the line of Rick Skidmore with Goldman Sachs

Rick Skidmore - Goldman Sachs

Thank you, good morning. John could you just elaborate a little bit on just how you see the timing of what the 300 million of optimization and also the 100 million of fixed cost that are coming out just how you see the timing of that happening?

John Faraci

Well, like Carol talked about the Industrial Packaging stuff and then I will come on in the free mills came out.

Carol Roberts

Yeah, when the timing, you know, our goal is to hit that, you know, run rate basis by the end of this year, that’s our goal.

John Faraci

On the fixed cost associated with the mills, Rick, we shut down two mills in Europe in the beginning of the year, so we got most of the benefit, I say, we took a nine months benefit in 2009, we shut down our small recycle mill in France Etienne in November and that’s going to be a $10 million plus year-over-year for us, and that just not have any loss associated with that and you know, the biggest chunk of fixed cost reduction comes to Franklin, Franklin mill does not come full y out until end of the second quarter and that’s about $90.0 million bucks and the rest of it of the amount which is probably 50 or 60 is Pineville and Albany and those mills are shut so we will see how that savings flow in the first second, throughout the year.

Rick Skidmore - Goldman Sachs

Right and then just a follow up question on previous question about the operating cost in the packaging business in the quarter that $56 million of operating issues did that primarily occur in December or is that

John Faraci

I see that the weather related stuff was worsened of in December that’s on wood, on energy, we had one big mill in Louisiana, the campy mill that was- we took it that for an average and all of a sudden we got two weeks of 10 degree weather and that’s not a good thing to have it down in 10 degree weather or it’s even more difficult thing to try to start it up in 10 degree weather. And Carol, I don’t know if you have anything else to add.

Carol Roberts

Yeah, our tight wood situation started to manifest itself in November until we started to see you know, some higher cost as we move things around in freight cost and what not but really December was the more difficult challenge. We had like another example of the weather we had Springfield, Springfield mill down for their annual outage, out in Oregon and believe it or not when we went to start up it was below freezing for un extended in Oregon that we just don’t expect that so that was difficult so I would say the majority were of the operating issues were December but some of the wood issues started to really show up in the November time frame.

John Faraci

And the wood issues aren’t structural and we are not out buying wood from month at a time, I mean, this is really transportation, there is a little bit of stoppage on the hardwood side, it has gone up and the real incremental wood cost is around transportation because everybody is going out further to buy wood, so w will cut that off real quick as you know, weather conditions improve and they will.

Carol Roberts

And as John said that you know the challenging condition as he mentioned after tentative January but I am very optimistic that they are working on layout, and we are going to end the first quarter in a heck of a lot of better condition than we ended the quarter.

Actually, you know, our Industrial Packaging our wood situation is probably a little bit better now than it was three years ago.

Carol Roberts

Absolutely.

Rick Skidmore - Goldman Sachs

Thank you.

Operator

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

Steve Chercover - D.A. Davidson

Thank you, just question on your view on global pulp market. Are you surprised how tight things are and do you think that pulp prices are going to be less volatile going forward that they have been historically?

John Faraci

Oh, one thing (indiscernible) was very good at, that’s predict in the pulp market because you don’t have seen all that, demand signals a co-transparency that are going on in China but I would say International Papers got a pretty (indiscernible) side and you know, we buy pulp in China for the Sun JV, we sell pulp in China through Ilim and we also had a trading operation, big distribution business which by themselves pulp in China and as best we can tell, so we are kind of being in all three parts of that business, the demand is real, you know, China is, you know, a huge increment of all the world’s increase in pulp shipments and that’s going into the domestic economy and so I think that’s going to be the driver the engine of the pulp demand going forward and that economy now, China is now the biggest paper and packaging market in the world, just in Containerboard now they have a box market in the U.S. so it’s real and it start shrinking.

Steve Chercover - D.A. Davidson

Thank you.

Operator

Your next question comes from the line of Chip Dillon with Credit Suisse

Chip Dillon - Credit Suisse

Yes, good morning, I just had a question about the pension plan, you mentioned that you have no cash contribution this year and so, I would imagine that $234.0 million expenses is obviously a cash you know, in flow relative to earnings could you just refresh our memories last year how much did you put into the pension plan?

Tim Nicholls

We didn’t put anything into the last year ship and we were not required to make the contribution this year, we may do so in a voluntarily basis. The last time we put money into the pension plan was at the end of 2006.

Chip Dillon - Credit Suisse

Okay and then I send you remember in you please refresh your memory that in June when you all are in New York you were, I think indicating that when your net debt got down close to 7 billion and may be this was my interpreting your statement that that would be a level where you start think about the dividend, I know you said that you have the pension under funny that can shift about 9.9 billion and you are not quite at that 3 level but what are your thoughts about raising at least partly back up where it was and on that point I have your thoughts changed given the uncertainly with tax rate next year on dividends as to whether you might want to recalibrate any payout to be more year toward buybacks in the future?

Tim Nicholls

Just on the last point some potential for changing tax follow ups you probably impacts a lot of the analysis that we do around many things so will pick that into account. We will have those price conversation about how people do this potential tax changes but what we try to communicate in June of last year and have done so since then was that we were looking through the cycles or less than three times debt EBITDA and that was including not only balance sheet debt but our unfunded pension obligations as well. So around the dividend there is a motivation that we want to see the dividend, read the dividend policy changed and reinstated but we have taken the view that until we have more clarity and certainly around economic performance and how viable it is and how sustainable on what pace and until we see ourselves with line of side meaning we have accomplish to debt target objective but we can see clearly how we get there that we would forego making a change in dividend policy.

Chip Dillon - Credit Suisse

Got it. Thank you.

Tim Nicholls

Yeah. Chip one way to think about the debt, the balance sheet debt is given how the refinancing we have done is not because toward needs today. The additional debt funding is going to come on funding retention plan, we look at timing of when and how we do that the over thinking about is, these things do not need to happen in sequence, they can happen in parallel and as Tim said I think a lot of companies like to see is some clarity around how the U.S. economy is going to be performing as I said we are not out of the woods yet we did not have deep depression or pretty forecast but we did have a pretty severe long and sharp recession.

Chip Dillon - Credit Suisse

It is pretty amazing I mean, your net debt is almost back to the free Weyerhaeuser acquisition level and of course it is turned out better so thank you.

Tim Nicholls

We did see an improvement on our unfunded pension against the obligation of 400 million, it is in the package so I think in the appendix somewhere but Tom is telling me on page 32 but we have very strong return on assets and that was that 400 million improvement with a slight deterioration in the discount rate.

Tim Nicholls

So these assets last year this time or in the first quarter when we look at reinstating the dividend. We would have said we have no idea because frankly we had no idea but it is probably not soon. I think we feel very differently about that now. It cannot be specific but it is always tough we were worried about this it is behind us.

Chip Dillon - Credit Suisse

Got you. Thank you.

Operator

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

Peter Ruschmeier - Barclays Capital

Thank you and good morning. Wanted to come back to the question of fiber cost, I am curious on the 44 million tons of wood that you buy, can you remind us on how you buy, is it basically the quarterly prices in the marketplace or do you have some percentage of that those purchases that are on longer term contracts?

Tim Nicholls

We do not have any meaningful long-term contracts I say meaning I cannot take if any of it we have, the wood that we used to buy is about 25% of our wood come from IP forest with the long-term contracts and net wood’s price of what we buy the remaining 75% so that works I think on a quarter or monthly like I think it is quarter like but 75% we were buying is basically gate wood we were out there buying wood everyday and one of the things we got done is may long-term permissions for wood at a fixed price.

Peter Ruschmeier - Barclays Capital

Okay so is it fair John in your outlook that perhaps the first quarter fiber cost if you have a couple of months of high fiber cost might be higher than the fourth quarter but then as you looked to the second quarter and things try out if you are expecting out to come back down.

John Faraci

You map out fiber cost over the last five years. There is a lot of seasonality whether fiber cost are 40 bucks down to 25 bucks at a time winter months are always higher than the summer months so no question about that.

Peter Ruschmeier - Barclays Capital

That’s helpful. John could you also, last question, could you just provide an update strategic update on where you stand on the Ilim venture on how you would like to proceed going forward in the mix to that but where would you like to take it and what are the difference scenarios that we can expect the possible outcome we can expect?

John Faraci

Well, we are well into the second year or I guess into the third year, the Ilim joint venture of the first year financially was a great year, record year for Ilim. The second year was not a great year because what happened to the pulp markets and so average do we are right back, just about bang on where we thought would be. We had the delay of the business plan. We remember we invest $650 million at the initial investment that gives us the opportunity to invest off Ilim’s cash flow and balance sheet to reduced cost and improved product quality, and expand capacity. We still want to do those projects, had a (indiscernible) business of what happened in the credit markets and we are well along on getting that capital playing together and Ilim’s well along on getting the financing together and I would expect as we go to 2010, decline in the- come together and we will likely get started. So the same strategy we had and I would say the Ilim joint venture has gone well. We are working well with our partners. We now know each other a lot better than we did 2 years ago and you know, so far so good. And I say today, we are pretty positive about demand in Russia and demand in China 65% of what Ilim sells is export, most of that is China.

Peter Ruschmeier - Barclays Capital

Okay. Thanks very much John.

Operator

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

John Faraci

Hi George. George didn’t show up. Operator your line goes to the next question. I think the George is in the queue.

Operator

Okay his line is now open.

George Staphos - Bank of America

Hi folks. Good morning and congratulations again. I guess 2 question, one longer term, you know if we look at recent performance you have done a wonderful job through supply management of really taking the edge off of what have otherwise would have been a much more difficult year through capital plan and supply management, but all industries are doing that to some degree and we could expect them to do that as we go into the recovery including your supply. So, as we think about you know earnings in the cycle, John, do you think that if you have taken out some of the drop that you might see in trough and a recession, have we also seen or we like to see some what would have been a normal peak number taken away from the industry. How would you think about it and what would you have us think about.

John Faraci

Well our input cost, if you look at input cost over a 3-4 year period, are still significantly up. We got $600 million that has been for cost release last year, but that was against a runoff of about close to $2 billion in total input cost. So, yeah, you know your point about supply management is true, but there is a lot of input cost kind of inflation or kind of access to normal inflation that’s we are still sticking with this. That may stick around for a while. I mean it may stick around forever. So, we got to be prepared to improve our margins with that input cost, those input costs kind of currently where they are and that is what our plan is based on. We are not assuming that we are going to get a lot or margin expansion from lower input cost.

George Staphos - Bank of America

Well I guess the question, I think you answered it. You know, as we go into the recovery demands picks up, your pricing improves. Do you expect that your suppliers would be in a position to take away what would have been a normal upturn the incremental profitability that you would have seen in past years. Do you think you would be able to after this transition, you know, outrage those potential input cost down the road?

John Faraci

I think we are going to get margin expansion as we look forward. Certainly in the industrial packaging, we have done a very hard wire program as Carol said you know improving our earning and cash flow in that business from internal initiates by $300 plus million and none of that based on lowered input cost. We have got $200 million of capital projects that are great short payback consumption reduction projects and so, using less caustics, using less chemical, using less woods, using less energy is a great way to offset input cost inflation (indiscernible).

George Staphos - Bank of America

Okay. Well we hope your success on those efforts. I guess the last question I had regarding China, you mentioned given the three windows you have into the market relative to pulp and (inaudible) initially, you feel that demand for pulp is real relative to the amount of production that we are seeing in terms of board and paper in the market. From what you can see at least over the intermediate term. Do you think the mastic consumption of paper and board is in line with the production of paper and board in China. Thanks.

John Faraci

Well, the best way to answer that is to talk about the Sun joint venture. Our volume is up 60% year over year. There is, I don’t think any of the Sun board that is being explored that there is might be a couple of thousand tons that of 800, so we are exporting very little and most of our customer base in China are companies that are selling products domestically, not selling products and exporting them. So, as we see and look at the Chinese economy, it could get even stronger because the export sector really has not come back and China is growing an 8 to 9% really on the basis of domestic demand, not export demand. It is pretty clear the Chinese government trying to slow down there growth which is probably the wise thing to do. So, it is very-very strong domestically. Our box business in China has waited to domestic customers and that is the double digits. So, the demand there is real. It is not real estate that is driving the economy, you know some of it is demand for products and our bleach board business and our box business that’s what we are doing, making packaging for products.

George Staphos - Bank of America

Okay thanks very much guys. Good luck in the quarter.

Operator

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

Mark Weintraub - Buckingham Research

Thank you. Looking at the industry statistics for the corrugated box and container board business. It looks like we saw a little bit of improvement in December. Did you see that in your business and can you give us a sense of how 2010 has started out?

John Faraci

I think I will let Carol answer that as Mark since she is right on it every day.

Mark Weintraub - Buckingham Research

Superb.

Carol Roberts

Yeah Mark, we did see a better December than the month before and so we’ve seeing that improvement. I will call the improvement modest but nonetheless it is improvement. That improvement continued into the first part of January which is pretty strong. It slow down a little bit in the later part, but I believe that had lot to do with some of the weather and some of the other condition. So, we remained cautiously optimistic about the outlook for box demand.

Mark Weintraub - Buckingham Research

And presumably with the price having gone up in January that is indicative that supply demand balance is in good shape. What are the risks that you see, because I guess one thing that struck me is that John you talked about, I think that John you said 2010 you expected to do better in each of your businesses than in 2009 and given that cost inflation has probably eaten up a lot of January in the Industrial Packaging business that the price increase. To get there either you got to have enormous amounts of internal improvements or you have got another price increase and what are kind of variables that we have got a keep a eye almost closely that would either enable you or not enable you to get another price increase?

Carol Roberts

Let me comment on that once again. I cannot comment on future price increases but I will talk about how I view the outlook generally for our business and I remained very optimistic about where we are heading in our ability to our earnings capability. We are not at our best right now. We are not at our best in December. We were not at our best in January relative to our operations. The things that are important, operating rates in the industry, inventory levels in the industry, inventory levels down at (indiscernible) are all very good things. So, once again I just remained optimistic about our ability to perform better than we are performing today with potential for the future that I feel very confident and good about.

John Faraci

Mark at other place where there is a lot of margin expansion that people probably overlook somewhat there we think about boxes. You know, there has been a huge spread in the export and domestic line of board price and you know that spread is shrinking rapidly and for us we are big exporter of line of board and have been and will continue to be and so there is easily $50 to $100 bucks a ton of you know price gap to be made up and which will get made up in a tight situation between export and domestic pricing and that’s a million and half ton gross and that is a big number.

Mark Weintraub - Buckingham Research

And I believe some of that already is being made up. Can you give us a sense as to if we were to look today or perhaps more easily. What you look at your export pricing in February. How does that contrast to where it was in fourth quarter?

John Faraci

It is getting better, but it is very by reaching the world and we does still want to go into regional pricing, but as I said some part of world are tighten up a lot faster than others, but there are all going to get tighter.

Mark Weintraub - Buckingham Research

Okay and then one real quick one. Obviously, you got a lot of cash on the balance sheet right now, what is the thought process there?

Tim Nicholls

Well, primarily we continued to reduce out debt levels, Mark. I mean we made a significant improvement in the fourth quarter and nothing has really changed as we entered in 2010. I guess the one thing that has changed as John mentioned is the balance sheet is quickly approaching the kind of shape that we would want to have it down on a sustainable basis. So, mostly the debt reduction is going to come, could come around potential pension contributions.

Mark Weintraub - Buckingham Research

Okay. Thank you.

Operator

Your next question is a follow-up question from the line of Gail Glazerman with UBS.

Gail Glazerman - UBS

Hi. Just a couple of quick follow-ups. You talked in depth of box demand. Can you talk may be a little bit about some of what turns you are seeing in early 2010 and some of the other business?

John Faraci

Yeah I can just (indiscernible). Gail we are seeing the paper business which kind of way into pretty deep recession last year in terms of year-over-year volume. I think like direct mails are coming back. Our envelope (indiscernible) more optimistic, you know, we could not really tell last year is how much of the paper decline was structural, and inventory correction related and you know there were huge declines in direct mail especially in the financial services sector which in financial services sector there is a big user of direct mail and that stuff is showing some signs of not just stabilizing but getting better. So, you know that is the plus. Our businesses outside North America, all feel pretty good from the demands standpoint. We had a very strong fourth quarter in Europe, our box demand, our industrial, you know, we not had a strong investable session in Europe, but we had strong industrial growth which has frankly surprised us. Turkey had its best fourth quarter ever. In North America, it does not feel like 5% to 6% GDP growth. You looked at this fourth quarter GDP numbers, where was it. You look at xpedx sales per day, you know, they are not up. You are up 5% from the second quarter, but they are not up 5 or 6% in the fourth quarter compared to the third and you know we are in the 100 geographies with 100s of customers buying lots of products and so you see what FedEx and UPS are saying about package volume. If that is real, we are going to start to see in some of our business, but we have not yet. That’s make us feel good that means there is upside and we are not running full and some of our competitors may be closer to running full than we are, so we’ve got more volumes upside than anybody else and whatever the economic conditions are. I think that is the last, one more question.

Operator

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

Mark Wilde - Deutsche Bank

John, I wondered if you could just talk briefly about what the potential is for IP over the next 2 or 3 years from energy related products and projects and then also what your opportunity might be in terms of state by state renewal energy credits?

John Faraci

Well, we don’t have time for the 2 hour answer or 2 hour discussion. We still have that is probably close to a $1 billion in total in terms of energy cost on a global basis. Lots of opportunities to reduce energy consumptions, I cannot say right at the top of my head, but there are $200 million of cost reductions we are spending. I would say most of it is aimed at energy and at $6 gaps those projects are darn good projects. So, we are going to continue to manage consumption reduction as aggressive as we can, but running going to invest in projects where we got long term competitive facilities. We are not going to be investing facilities. We don’t think they are going to be part of IP future. So, I feel we get pretty capital runway there, but it is not billions of dollars.

Mark Wilde - Deutsche Bank

Okay. Those renewal energy credits because some other companies are starting to report gains on the sales of those credits

John Faraci

We are getting energy credits at Europe because of the cap-and-trade system that is in place there, but I am not really sure what are you talking about there, Mark.

Mark Wilde - Deutsche Bank

Take it that offline then.

John Faraci

Thanks.

We are not just defining it differently then somebody else is, but we will get back to you on that.

Mark Wilde- Deutsche Bank

Okay.

Operator

At this time, I would like to turn the call back to Tom Cleves for closing comments.

Tom Cleves

Thank you Brandy. Emily Nicks and I will be available for follow-up questions via the telephone and we will not ask you to limited to one plus follow-up. So, if you like to talk more, give us a call. Thank you for joining our call today. Thanks Brandy.

Operator

This concludes today’s International Paper’s Fourth Quarter and Full Year 2009 earnings call. You may now disconnect.

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Source: International Paper Company Q4 2009 Earnings Call Transcript

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