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Executives

Tom Cleves - VP of IR

John Faraci - Chairman & CEO

Marianne Parrs - EVP & CFO

Brian McDonald - Deputy CEO - Ilim

Analysts

Gail Glazerman - UBS

Mark Wilde - Deutsche Bank

Claudia Shank - JP Morgan

Chip Dillon - Citi

Mark Connelly - Credit Suisse

George Staphos - Banc of America

Richard Skidmore - Goldman Sachs

Peter Ruschmeier - Lehman Brothers

Mark Weintraub- Buckingham Research

Steve Chercover - D.A. Davidson

John Tomazo - John Tomazos Endophagic Research

International Paper Co. (IP) Q3 2007 Earnings Call November 2, 2007 10:00 AM ET

Operator

Good morning. My name is Amanda and I will be your conference operator today. At this time, I would like to welcome everyone to the International Paper Third Quarter 2007 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. (Operator Instructions). Thank you.

I would now like to turn the call over to Tom Cleves, Vice President of Investor Relations. Please go ahead, sir.

Tom Cleves

Thanks, Amanda. Good morning, and thank you for joining International Paper's third quarter 2007 earnings conference call. This call is also being webcast.

Our key speakers this morning are Chairman and Chief Executive Officer, John Faraci; and Chief Financial Officer, Marianne Parrs.

During this call, we will make forward-looking statements that are subject to risks and uncertainties. These risks and uncertainties are outlined on slide 2 of our earnings presentation and at the end of our earnings press release.

Please go to our website under the investors tab to find copies of our third quarter 2007 earnings press release, the presentation slides, and a reconciliation of non-GAAP financial measures to Generally Accepted Accounting Principles.

I'll now turn it over to John.

John Faraci

Thanks Tom, and good morning. This morning as usual Marianne and I are going to do a couple of things. We'll review our third quarter 2007 earnings results and the performance of our individual businesses. We'll discuss the fourth quarter outlook, we'll talk about where International Paper is and its transformation plans. And then, we'll take your questions.

We had a solid third quarter, in fact our best absolute quarter since the second quarter of 2000. For the third consecutive quarter, we posted the best absolute earnings in the last seven years.

North America printing papers, posted its best quarter since 1995, benefiting from average prices, reduced maintenance outage cost and good cost performance all around the system.

Brazil's EBIT improved significantly driven by higher average prices, improved volume and mix. Once again, xpedx reported solid quarterly earnings benefiting from higher prices, increased volumes and market share, and the addition of some Central Lewmar earnings which we bought into the company in the third quarter.

Product pricing improved versus second quarter and uncoated papers, pulp and packaging grades has realized some or all of the announced price increases.

Overall operations were fair, but I think we can do better. We began producing lightweight linerboard in September, at Pensacola. I was there on Monday, and were already ahead of our ramp plan.

Raw material cost particularly in North America continue to be somewhat higher driven by increasing chemical, wood and waste cost, a little bit offset by favorable energy cost. I think it's very important and we feel good about the fact we were able to offset these cost increases with increased realizations. In volume, land sales and tax rate was flat quarter-to-quarter.

Slide 5 shows our diluted earnings per share from continuing operations before special items. We reported third quarter earnings of $0.57, 10% higher than the second quarter of $0.52 and 26% above our last years third quarter of $0.45.

We are pleased with our progress on increasing earnings and improving our global paper and packaging businesses. We said two years ago that a key element of our transformation plan was improving margins and improving earnings in our existing businesses, and over the last two years as you can see from the slide, we've done just that. But we want you to know we are not finished yet, we still have more earnings runway and even as our forestland sales tell-off over the next few years.

Next, turn to slide 6, some highlight how we performed in each global region in the third quarter versus the second quarter. As I said earlier, we had strong performance in the US and Brazilian printing papers and that drove our earnings improvement over the second quarter. We did not expect a strong third quarter in Europe, even having said that, we still expect very good earnings for Europe versus 2006, when it's all set and done.

I'll now ask Marianne to comment on our third quarter results by business in little more detail.

Marianne Parrs

Thanks, John and good morning everyone. Slide 7, compares diluted earnings per share from continuing operations and before special items for the nine months of 2007 versus the nine month of 2006. Moving from left to right, paper and packaging prices were significantly higher on average in 2007 and this added $0.51 per share to our earnings. Year-over-year, we have improved our prices more than our input costs by $0.33 per share.

Slightly lower volumes reduced earnings by $0.02 per share in 2007. Volume increases in Brazil, European papers and US pulp were offset by lower North American paper and packaging volume. We've intentionally passed on volume in favor of balancing our capacity with customer's demand and this has enabled us to realize higher average selling prices.

America joined very well in 2007, with manufacturing cost and mix, $0.22 per share favorable versus 2006. One-time Pensacola machine conversion expenses reduced earnings by $0.06 per share. Input ad distribution costs were unfavorable reducing earnings by $0.19 per share or $129 million and I will give you that in a little bit more detail in a moment. Lower land sales in 2007 reduced earnings $0.17 per share versus 2006.

The combination of lower interest expense, lower share count and earnings from selected reinvestment increased earnings by $0.59 per share. Unallocated and other expenses favorably impacted results by $0.15 per share year-over-year and this is driven primarily by lower pension expenses.

Plant closure cost in our packaging businesses reduced earnings by $0.03 per share and lost earnings from sales at Arizona Chemical and coated paper and the loss of harvest incomes from the sale of our forestlands reduced earnings by $0.33 per share.

This chart on slide 8 now compares third quarter results with second quarter results. Moving left to right. Higher average price realization for our paper grades across all region improved earnings by $0.04 per share. Third quarter volumes were flat. Strong paper volumes in Brazil were partially offset by weaker volume seasonally in European container.

In the third quarter, our mills ran as well as in the second quarter. Cost mix improved by $0.04 per share due to lower maintenance outage expansion partially offset by higher cost in our converting systems.

Expenses related to the conversion of the Pensacola machine to lightweight linerboard reduced earnings by $0.02 per share quarter-to-quarter. Chemicals and wood costs were unfavorable reducing earnings by another penny. Land sales were flat quarter-to-quarter, and as you know below our original guidance of $110 million to $140 million.

Lower interest expense increased earnings by $0.01 per share and other items decreased earnings by $0.01.

Slide nine provides details on the $129 million increase in input and distribution costs for the nine months of 2007 versus the same period for 2006. We’ve actually increased our year-over-year EPS by $0.67, despite this $0.19 in input cost headwind.

Wood cost increased by $59 million due primarily to the south central west weather conditions. As you know it’s been very wet there, tight supplies and lower inventories. And I did want to note that this slide does not include OCC, Old Corrugated Containers.

Our OCC cost this year is up about $29 million on a net basis, increased cost to the mills, higher realization and sales from our box plant.

For more information on input costs, see slides 38 to 41 in the appendix.

Now, let me turn to how our business has performed in the third quarter and slide 10 shows that earnings in printing papers improved from $249 million in the second quarter to $307 million in the third quarter, and that was due to improved results both in North America uncoated and in Brazilian papers.

North America uncoated paper earnings were 45% higher in the third quarter versus the second quarter. Earnings improved primarily due to lower maintenance outages expenses and higher average uncoated free sheet prices. These savings were partially offset by higher raw material cost and slightly lower volume. Pulp earnings were flat during the quarter, it benefits from higher average prices and improved operation were offset by higher cost of planned maintenance outages.

European papers earnings declined by 19% and that was again due to higher maintenance outage expenses at our Saillat and Kwidzyn mills partially offset by higher prices and favorable foreign exchange.

Brazil earnings improved due to greater volume, higher prices, better mix and a $7 million book timber sales. We currently estimate fourth quarter earnings in Brazil to be about flat with third quarter results and that fourth quarter 2007 EBITDA run rate to be approximately $375 million.

Slide 11, shows our global paper earnings by region. And as you can see, lower European paper earnings resulted from higher maintenance outage expenses that I mentioned are partially offset by higher prices and favorable foreign exchange. And if you'd like to see more detailed information on earnings by region, please turn to slide 35 in the appendix.

Slide 12, shows that industrial packaging earnings declined from $139 million in the second quarter to $115 million in the third quarter.

So, let's turn to slide 14, for additional detail on our industrial packaging results. The lower industrial packaging earnings were driven primarily by seasonally lower European container volumes as expected. Towards American container volumes were down slightly versus the second quarter but were better than the industry average.

High other items including higher raw material cost were partially offset by lower maintenance outage expenses. Pensacola conversion startup cost also impacted earnings by $10 million versus last quarter, and we incurred restructuring cost to $7 million, which is early rationalization.

Export container board markets remained strong, our inventory levels are low, our backlogs are strong and we are realizing our announced box price increases. In fact in October, our average price per box has increased by almost $30 a ton versus our September average. We expect Pensacola conversion cost to be about $5 million to $10 million less in the fourth than the third quarter of 2007.

Turning to slide 14, consumer packaging earnings were essentially flat. US coated paperboard benefited from improved pricing and lower maintenance outage expenses but this was offset somewhat by higher input cost, especially wood.

Looking at the converting businesses, food services earnings were slightly lower than the seasonally strong second quarter driven by slightly higher raw material and manufacturing cost and show all these results were about flat quarter-to-quarter.

On slide 15, xpedx continues to build momentum posting another strong quarter. Third quarter operating profits were $40 million compared with $38 million in the second quarter. This marks eight consecutive quarter of record earnings for xpedx. Earnings included about $2 million from our Central Lewmar acquisition.

Slide 16, shows the forest products earnings were relatively flat, as you know, land sales can be lumpy and hard to predict, precisely because transactions can move from quarter-to-quarter. We do expect full year 2007 earnings from land sales to be approximately $450 million. Our objective continues to maximize value not the timing of sales. At the end of the third quarter, we had about 390,000 acres remaining in our portfolio.

Turning to cash flow on slide 17. We were not pleased with our working capital performance in the second quarter, but in the third quarter our working capital metrics improved and we generated more than $380 million in free cash flow. As sales increased and prices increased the value of our inventories and receivables increased as well but our ending working capital and as excluding cash and current debt maturities as a percent of sales declined from 11.2% in the second quarter to 10.3% in the third quarter.

I should note, we now expect full year CapEx to be about $1.3 billion and that will include $210 million of spending on our new Tres Lagoas paper machine in Brazil, the third Sun joint venture paper machine and the Svetogorsk BCTMP mill.

Looking ahead to 2008, we expect CapEx including the Tres Lagoas and Sun Joint venture spending to be roughly equal to depreciation and amortization. There are no spending numbers for Ilim included in these numbers.

I also want to mention that we have updated some other full year key financial statistics, in the appendix, on slide 13.

And slide 18, third quarter special items and discounted operations are detailed. Special items after tax in the third quarter of 2007 totaled a loss of $23 million or $0.05 per share.

Slide 19 shows you how you get from the $0.57 of diluted earnings from continuing operations and before special items to the $0.51 per share of net earnings that we reported this morning.

Now, before I turn this back to John, let me remind you that we expect to report the Ilim joint venture results on a one quarter left. So, the joint venture's fourth quarter 2007 results will be included in our first quarter 2008 results. There will be no impact from Ilim in our fourth quarter 2007 earnings.

So, now let me turn this back to John.

John Faraci

Thanks, Marianne. I am on slide 20 for those who are following along. Another one to start with, just show the EBIT margin percentages over the last several years and as you can see we steadily increased margins in our core businesses and when I say core businesses, I mean, all of our businesses with the exception of forest products, forest resources and our divested businesses.

These improvements as you can see here have been significantly consistent and even in North America where market conditions and cost pressures has been challenging. We remained focused on our non-price improvement initiatives, but the most important thing we can do is continue to expand their margins, that’s why we've been aggressively balancing our supply with our customers demand resulting in significant price improvement here in North America and lower costs.

Earnings both in Brazil and Eastern Europe were also contributing to this overall margin expansion. For example, our nine months EBITDA margins in Brazil are in the 40% range and in Eastern Europe in the 30% range, well above North America. Our increasing mix of global earnings is also helping to balance our earnings capacity.

Slide 21 shows that we continue to increase our North American EBITDA, which we expect will account for 30% of our total EBITDA this year versus only 20% in 2002. Where is it growing? Well, it’s growing in Brazil with the addition of Luiz Antonio, it will further increase with the addition of Tres Lagoas Paper Machine in 2009; that capacity will be primarily dedicated to Latin America.

EBITDA is growing in Asia, but it’s still growing from a small number. We expect Sun Joint Venture's third coated paperboard machine to start-up later in 2008. We are increasing our EBITDA in Eastern Europe and Russia. Our BCTMP line is expected to start up in December of this year, that’s being built permission to Svetogorsk and we've closed on our Ilim Joint Venture and as Marianne said, we will report the earnings for Ilim on a one quarter lag.

Slide 22 shows how the transformation plan is making a difference for International Paper and it shareholders. We are now nine months to the year and our year-to-date earnings had surpassed our full year 2006 earnings of $1.34 a share. We are not getting the volume we expected in North America, but we are growing margins and EBIT and we are trading volume for price by matching again our supply to our customers demand.

The largest component as this slide shows of our improvement, it has been the improvement of our core businesses which has added $0.69 shared earnings on a year-over-year basis. Lower interest cost and lower share count have also contributed significantly the improvement, but as you can see here, we’ve been able to offset all the earnings the one away with the best of businesses.

Looking at the fourth quarter, we expect the fourth quarter will be better than the fourth quarter of last year and slightly better than the third quarter. North America's containerboard volumes will benefit from the Pensacola capacity, as Marianne said, we’ve already gotten $30 of box price increase into our October results.

Europe volumes will be better, seasonally the fourth quarter is better than third quarter. But all the other segments, we expect to slow down, as we move into the quarter, Thanksgiving is right around the corner and we know once we get passed Thanksgiving, it gets pretty slow until we pull out of January.

In addition to the box pricing, we will be getting some improvements in pricing in pulp and paper. We expect wood and transportation cost to continue to increase and we think energy is going to stay high, so with that all said, we do expect fourth quarter earnings to be slightly better than the third quarter and we expect forest resources earnings will be higher than the third quarter levels, as well.

Interest and taxes will also be higher, interest will be higher because of debtless cash, so less interest income and as we look at our tax-rate and sources of earnings our tax-rate will probably be a little bit higher in the fourth quarter.

So, summing up, as I said, we expect earnings from continuing operations and before special items in the fourth quarter would be slightly better than they were this quarter.

Looking beyond 2007, slide 24 shows how we're building the capacity to continue to increase our earnings. Taking our cost and improving mix that's about $0.28 a share year-to-date before the outage impact. So, that continues to be a big, big lever, plus, we are selectively reinvesting in high margin, low cost and high growth areas with projects to produce good returns and let me talk about few of them.

The Luiz Antonio mill will have a full year benefit next year, it will be ramping up our production in Lightweight Linerboard of Pensacola, Riegelwood will be on Fluff Pulp and that's sold out already. And we'll have the BCTMP mill at Svetogorsk running. And our share of Ilim earnings will contribute to our 2008 results.

Beyond 2008, our earnings will continue to benefit in the addition of the third coated paperboard machine at our Sun Joint venture in Shandong province and our new uncoated freesheet machines as far as it goes in Brazil. So, in closing before we go to your questions, our goal is what it has been for the last couple of years continuing to be a more profitable cost of capital earnings company in our global paper and packaging businesses that has superior returns on an absolute and related basis over the cycle.

So Tom, lets open it up to questions.

Tom Cleves

Thanks John. Amanda, we are now ready to take questions, please.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question is from Gail Glazerman with UBS.

Gail Glazerman - UBS

Good morning. I was wondering if you could talk in a little bit more detail about the decline in uncoated freesheet demand in North America the last couple of months. And I think you'd mention that your box volumes, your order books are pretty strong, I think you may be talk about that as well?

John Faraci

Well, uncoated freesheet demand Gail it has been weak all years, so I don’t think there is any pronounced trend here at all. We are seeing more of the same, top-line off the cliff, but its down, I think the real numbers in terms of commercial print are down quite that much because you've got some other uncoated freesheet grades that are going into the low-end of commercial print, but there is no question the year-over-year numbers are negative. They have been negative for a couple of years and we are planning that the market is not going to grow in North America.

On the box side, our box volume is down about little less than 2% year-to-date. On a quarter-to-quarter basis, our box volume was up about 1%, but you have to adjust that for the number of days, as well. So, box volume is certainly in better shape if you just look at the overall market than uncoated freesheet.

Gail Glazerman - UBS

Okay. Just on the North American printing papers, can you quantify Marianne the benefit from less downtime in the quarter, was that a big contributor to the earnings improvement?

Marianne Parrs

The benefit of less outages, is that what you are talking about, maintenance outages?

Gail Glazerman - UBS

It is, yes.

Marianne Parrs

Third quarter to second quarter it was approximately $17 million. We've got big price realizations in the quarter, prices were up about $22 million, so that was the single strongest driver of improvement quarter-to-quarter.

Gail Glazerman - UBS

Okay. Thank you.

Operator

Your next question is from Mark Wilde with Deutsche Bank.

Mark Wilde - Deutsche Bank

Good morning.

John Faraci

Hi, Mark.

Mark Wilde - Deutsche Bank

The numbers in Europe still seem kind of weak to me even with that seasonal stuff that you mentioned and in light of the OpEx?

John Faraci

Mark, you are talking about boxes or paper?

Mark Wilde - Deutsche Bank

Talking more about the packaging side of the business, John.

John Faraci

Okay. Alright.

Mark Wilde - Deutsche Bank

I think you exited the UK and I don’t know how much of that UK exit contributes to that year-over-year volume drop in the European container business?

John Faraci

Well, it does contribute to, remember we had a fire at a plant in Turkey. So, we lost a big chunk at Turkey -- our capacity in Turkey, that plant has been rebuilt and is starting up now. So, you were on our way to having a record year in the box business in Europe, Northern Africa and the Middle East, Turkey and we are in pretty good shape there. So, I’m not worried about the box volume in Europe.

Mark Wilde - Deutsche Bank

Okay, and John. Any sense with these ISM numbers out yesterday that continue to soften in North America, are you seeing any reflection of that in any of your packing-related businesses?

John Faraci

Well, it’s a mix bag, Mark. The jobs numbers this morning was very good. We'll have to say that that’s probably a sign that people feel optimistic about the holiday season with retail sales standpoint. The weak dollar is helping us in some segments because our customers in the box packaging businesses are more export competitive. We've got an overweight slightly in our durables component of our box business and the market is about 80, 20 and we are probably 25% durable, so that segment is still very weak. And I think that the purchasing index suggest that manufacturers doesn’t feel like 4% GDP growth, I guess this is where I’ll be at.

Mark Wilde - Deutsche Bank

Okay. And last thing, John just a follow up. Can you talk a little bit about the uncoated freesheet pricing because your quarter-to-quarter gains seemed a little smaller than I would have expected, yet your earnings were up nicely?

John Faraci

Well, we ran well and it was continuing to take cost out, the uncoated freesheet the roll side of the pricing increase really is a fourth quarter number. We got about $10 a ton on offset in October versus September and about $30 and on below. So, we get in that price increase as flowing through which is flowing through in the fourth quarter.

Mark Wilde - Deutsche Bank

Okay, very good. Thanks John.

Operator

Your next question is from Claudia Shank with JP Morgan

Claudia Shank - JP Morgan

Hi, thanks very much, good morning.

John Faraci

Hi, Claudia.

Claudia Shank - JP Morgan

Could you just provide a little bit more color on the consumer packaging business and how should think about that going into next quarter? List prices for bleach board keep moving up, volumes little bit better than I thought and then there was less maintenance in third quarter, so I guess even with --

John Faraci

You said an important word there Claudia, list prices. What really important.

Claudia Shank - JP Morgan

So, what's going on?

John Faraci

Our transaction prices, its up, there are couple of different segments, you've cup stock, you've got folding carton, and then you've got tobacco board and some of the grades, tobacco board tends to be priced on an annual basis, cup stock has been moving up, but there have been a lot of cost increases in cup stock and folding carton prices have been moving up, but they are a lot stickier because there is a lot more competition, there are alternative materials. So, list prices going up is the good thing, but what we need to get is transaction prices up to same as list prices. For us, we got significant more outages coming up in the fourth quarter and we expect sure we would have a better fourth quarter than third quarter food service will tail-up with the seasonal part of this and we are also incurring some restructuring cost and I’m sure which is substantially shutdown, two plants in North America and in the third quarter as we are transitioning more of that business to Mexico, and I believe the cost to doing that were about $7 million.

Claudia Shank - JP Morgan

And how, so you still got a little bit of a seasonal pick up and ensure right what you would think in the fourth quarter?

John Faraci

Yeah. Food service is going to be weaker, because we are going into the weak time of the year and we've got outages coming up in consumer and in the bleach board system.

Claudia Shank - JP Morgan

Okay. That's helpful. And then I was just hoping -- I know it's little early but can you provide any guidances on corporate expense for next year. I think in the slide you said that supply chain expense is going to be about $200 million this year, which I think is a little bit lower than what you've said before so, does that mean next year it goes to sort of I think you've been talking about 225 numbers for this year so does that mean that you got a little bit more next year on that supply chain initiative?

Marianne Parrs

Claudia, we are just in the process of finalizing the budgets for next year. So, directionally you are right. Supply chain spending was little bit lower this year than we had expected at the beginning of the year. And directionally, it's partly going to be roughly the same but we haven't finalized the budgets, yet. I will be able to share more information with you on the next quarterly call and what we think corporate will be.

Claudia Shank - JP Morgan

Okay. Thanks a lot.

Operator

Your next question is from Chip Dillon with Citi.

Chip Dillon - Citi

Yes. Good morning. What do you see the land, you mentioned that your land portfolio and what do you think that acreage will be at year end?

John Faraci

Well, it's 300,000 plus acres now.

Marianne Parrs

90,000 at the end of third quarter.

Chip Dillon - Citi

And then how many more acres you think will be sold by year end?

John Faraci

I just don't know, Chip. Those sales were coming in now. Pretty lumpy, not so much related to the market, just it is much smaller portfolio and the sales were a lot more targeted. So, I would want to make a forecast about the acres we have are up, we are only doing deals that we think that is the right values.

Chip Dillon - Citi

Got you.

Marianne Parrs

And the values have kept up very well, compared to what we expected in appraisals.

John Faraci

That's an important point. We haven't seen any value leakage at all in selling.

Chip Dillon - Citi

And could you give us just some ballpark as to what, I mean, I know this is mainly real estate higher better usage or is something that is several times what straight timberland is worth on a per acre basis or is it may be twice as much.

John Faraci

It really depends Chip, and I wouldn’t characterize, it's not really near-term real estate. A lot of it is recreational land, a lot of it is landowners blocking up where we've got adjacent ownership and some of it is longer-term development. When I say longer-term development five years plus. You are getting over $2000 an acre on average for that land but the range will be very high, it will be from 1,500 over 4,000 and then you've got different parcel sizes.

Chip Dillon – Citi

Got you. And last just as follow-up. You mentioned that you would see 450 for this year, if I understood you, does that not mean that you will have somewhat of an increase in the fourth quarter. It looks like if you did 297 so far this year, you'd get like a 150 or so in the fourth, is that reasonable?

John Faraci

I think you can do the math, but you don't get it.

Chip Dillon - Citi

Yeah. Okay just want to make some our calculator works. Thank you.

Operator

Your next question is from Mark Connelly with Credit Suisse.

Mark Connelly - Credit Suisse

Thanks. Just one question, John. With respect to Brazil, you talked about all the good things that are going on there, and clearly both the volume and the price realizations are stronger. Can you talk a little bit about where that paper is going and whether it is principally a domestic market issue? And can you talk a little bit about what you are seeing cost wise they are relative to North America?

John Faraci

About 50% of this is domestic, Mark. And then, the big chunk of what's not domestic is in the region. And then the third largest piece would be or kind of that, after that would come Europe and North America. I remember, BCP was selling a lot of paper into Europe and in North America, we are selling less in North America now, maybe a little bit more into the Europe but what's really important is the Latin American markets are growing, so they are increasingly taking a bigger share of total production into the region.

Mark Connelly - Credit Suisse

So, as you look at the bump in volumes you got is most of that bump coming in the region, that’s what I am really trying to get at?

John Faraci

Yes. Remember we had a lot of pipeline filling so, we weren’t selling our production and actually we oversold our production, I think in the third quarter, we grew that inventories.

On the cost side, we are getting hit with higher energy costs that I believe is in a global phenomenon it’s just that what’s going on in Brazil and currency is not going our way because obviously we've got Rial cost base and we've got some portion of our revenues are dollar denominated.

Mark Connelly - Credit Suisse

Okay. That’s very helpful. Thank you.

John Faraci

Having said that Mark, our EBITDA margins still on the 40% range.

Marianne Parrs

And also we are getting very good production out of Luiz Antonio, the Luiz Antonio's mill has been performing very well.

Mark Connelly - Credit Suisse

Perfect. Thanks for your help.

Operator

Your next question is from George Staphos of Banc of America

George Staphos - Banc of America

Hi everyone, good morning. I am wondering, my first question piggy back on Mark’s question regarding Europe you had said in your comments that the box business slowed seasonally and then as far as the papers business where that maintenance spending was largely the factor for profits being lower. Were there any other factors John, Marianne in terms of profits being it’s typically within papers lower than last year, were there any businesses or trends that are little bit below, where you would have expected them three months ago? And seasonally, as we look out to the fourth quarter, you are obviously looking for better performance, but does it look like Europe will be up on a year-on-year basis?

John Faraci

Absolutely. George, Europe is going to be way up on a year-on-year basis. Year-to-date at Europe it’s just severe and we are running almost double last year’s earnings in Europe through the first nine months.

George Staphos - Banc of America

Okay. But….

John Faraci

And then container even though we’ve sold some of them mentioned, we sold our UK box plants. Our packaging earnings in Europe are up about 20% year-to-date versus last year. So, in both businesses, run away to having a record year. It's not gangbusters growth in Western Europe, what it is, is growth in Russia, we're selling more of the board that we are producing in Poland and we’ve had a capital project to build more folding box board, we sign more that in Eastern Europe with those export end, which is improving our realizations and we are getting some pricing, we got some pricing improvement in Europe as well, but its not a Western Europe volume driven thing at all.

George Staphos - Banc of America

John, the best that you can analyze this if you could on a same store or same business basis, will the markets be up on a demand basis, Europe is not gangbuster as you mentioned?

John Faraci

In the fourth quarter?

George Staphos - Banc of America

Yeah.

John Faraci

Yeah.

George Staphos - Banc of America

Okay. Now, just on non-price improvement you've done remarkable job there over the last several years, you've had a very good year this year, but when I compare the slide on the nine months versus the 3Q basis, it looks like the performance there slowed a little bit in the quarter, was that largely just driven by the volumes being sluggish in a couple of businesses? Were there some other factors there? Thanks.

John Faraci

Well, one of the things is we had a fantastic second quarter.

George Staphos - Banc of America

Right.

John Faraci

Really, it mean, we way outperformed our budget in the second quarter. We kind of came on budget in the third quarter, which meant the third quarter wasn’t that much better than the second quarter.

George Staphos - Banc of America

Okay. Thanks, I'll be back guys.

Operator

Your next question is from Richard Skidmore of Goldman Sachs.

Richard Skidmore - Goldman Sachs

Good morning, John and Marianne. John, can you just talk about the strategy of International Paper within containerboard in North America, and somewhat specifically with regards to the volume that's coming up in Pensacola and where that volume is going?

John Faraci

Well, the volume coming out of Pensacola which is in the Lightweight Linerboard, so it's very targeted to specific customers they weren't Lightweight Linerboard. The export markets are quite good for Linerboard now. So, not specifically the Pensacola although we think we will export some out of Pensacola to selected markets but we will rebalance the system and we took their hoe down so, that came out and as Pensacola ramps up, there will be some addition to our containerboard production capacity, but as we look out in the marketplace where inventories are where orders are domestically and globally we feel very good about being able to sell what we are making?

Richard Skidmore - Goldman Sachs

Thanks. And as following up on that and as you look to the recent weakness of the US dollar versus the Euro, are you seeing a lot more opportunities for exports both in containerboard and in paper to Europe from North America?

John Faraci

Well. We've seen that for the last couple of quarters where the dollar has been related to other global currencies, it has been good for exporting from the US, but that's all function the demand and we are matching our supply to our demand on a global basis and there is no question that dollar word is helping US producer to be more export competitive.

Richard Skidmore - Goldman Sachs

Okay. And is that having much of an impact on your European business particularly in the packaging business, is that part of the reason that packaging in Europe was a bit weaker?

John Faraci

No. I think its probably putting more pressure on the paper side in terms of the capacity in Europe and some of that was exported, has been exported, with the strong Euro the margins on exporting paper from Europe to other parts of the world aren't as good, so that paper is tending to stay, in Western Europe which a lots of the operating rates and the inventories in Western Europe.

Richard Skidmore - Goldman Sachs

Okay. Thank you very much.

Operator

Your next question is from Peter Ruschmeier with Lehman Brothers.

Peter Ruschmeier - Lehman Brothers

Hi, thanks, good morning. John, I wanted to ask if I could about Ilim, if you could give us a little more color, update on Ilim, both in terms of how you plan to report results in terms of consolidating, where we might find that in the income statement. And importantly I guess, remind us about the spending plans going forward and what kind of growth trajectory we should expect from Ilim?

John Faraci

Well, let me just comment on the first part of that Pete, then Brian McDonald happens to be here today, who is heading up one of the big piece of Ilim. So, let him talk about how he sees business there right now. As Marianne said, we are going to report Ilim on a one quarter lag. We haven't decided yet, how we are going to account for Ilim and we are working that through, and so we'll back to you probably when we get on our next quarterly call, when get that resolved, but it will be on a one quarter lag. So, the fourth quarter results for Ilim you will see in our first quarter results. So, Brian why don't you talk about what you see, you just got back from Russia.

Brian McDonald

I just got back Pete from couple of weeks in Russia and a week in China, visiting with our customers and I would say business over there is very robust and our customers and our employees in Group Ilim are very excited about the partnership with International Paper and Ilim Group. Our partners in China where we do almost the 1 million tons a year from Ilim understand the value that International Paper can bring to the partnership and ability to produce more products to produce better products and to improve service levels. So, it’s a very different dynamic and I think you get a flavor for that International Paper when John went through how good Brazil was in the quarter. We see the same things in Russia and we see the same things in China, its very strong right now.

John Faraci

Pete on the capital spending side, we are still finalizing our plans but I think the good news here is Ilim is earning good money and so the more money it earns, it just gives us more debt capacity, more cash flow to finance the capital program and I suspect at the end of the day, the speed of the capital program is going to be making sure we got the projects really well defined not financing, but we'll have to see.

Peter Ruschmeier - Lehman Brothers

How about on a trailing basis, John, can you remind us the LTM EBITDA for the business and what the CapEx kind of run rate has been?

John Faraci

Well, the Ilim's EBITDA is running at over $400 million. So, I think our share of that is $200 million and we've invested slightly over $600 million for a 50% stake in a company that's earning over $400 million EBITDA.

Marianne Parrs

That still have to be adjusted for US GAAP.

Peter Ruschmeier - Lehman Brothers

All right.

John Faraci

And what was the CapEx spending in kind of base loaded Ilim?

Brian McDonald

Pretty low, it would be a 100ish less than a $100 million.

Peter Ruschmeier - Lehman Brothers

Okay.

John Faraci

So, company has been spending less than $100 million. We want to make sure that we are well organized to step that up because we anticipate it will step up quite a bit on specific projects and the race isn't here to spend as fast as we can, it is to spend it well and spend it on the right things.

Peter Ruschmeier - Lehman Brothers

Okay. Just last question if I could on that, John. At a high level, I know you haven't committed to all this, but I believe you have indicated in the past that over a multiyear period is it roughly $1.05 billion type of spending at the JV, I understand it's non-recourse to IP, but is that the ballpark to number and ballpark what kinds of the million tons goes that what kind of number over roughly what timeframe?

John Faraci

Well, the $1.05 billion is still the number. You know, roughly in five year timeframe and the projects some of them will be capacity expansion, other part would be printed paper in Russia, pulp for China. There will be product quality upgrades around paper for Russia and there may be some containerboard expansion. Most of these will be bottlenecks. It's not big new paper machines. They are going to be upgrading what we have and there will be a lot of cost reduction.

Peter Ruschmeier - Lehman Brothers

John thanks very much.

Operator

Your next question is from Mark Weintraub with Buckingham Research.

John Faraci

Good morning, Mark.

Mark Weintraub- Buckingham Research

Good morning. Just real quick Marianne, just wanted to make sure when you said the EBITDA are not adjusted for US GAAP, et cetera. I assume that when you do make those adjustments, you are not having big changes, not more than 10% or something like that, is that fair?

Marianne Parrs

It would be things like depreciation.

Mark Weintraub- Buckingham Research

Which shouldn’t affect the EBITDA.

Marianne Parrs

Yeah. It doesn’t affect cash.

Mark Weintraub- Buckingham Research

Okay.

Marianne Parrs

As the key way to think about it, it's just switch in how the numbers on a non-cash basis might look.

Mark Weintraub- Buckingham Research

Okay. Just pursuing the impact of the weak dollar a little bit more, do you have a sense John, of where mill nets are selling say liner or for that matter the uncoated free sheet products that might get exported? Will they compare now for your European experts or is this your domestic business?

John Faraci

Well, I think where prices are right now in Europe and in North America, it still doesn’t make sense for most Europeans to ship from Europe to the US. There is more profitability in Europe than there is -- and maybe with one or two exceptions, mill would have great logistics going into the US. And that's why understanding global pricing and we are in a great position to do that since we are selling in all markets, Asia, Brazil, Russia, Eastern Europe, Western Europe and North America. And I'd say right, now pricing is at a point where it makes sense for the regional producers to be focusing on their local markets.

Mark Weintraub- Buckingham Research

Okay. So, it doesn’t make sense quite yet for US mills and linerboard to be shipping it to Europe.

John Faraci

I was talking about paper, Mark. On linerboard, the US dollar for virgin linerboard, the US dollar puts US linerboard producers in very good shape because on the virgin side, we've got a competitive cost structure and we are mostly virgin we don't have a high recycle component.

Mark Weintraub- Buckingham Research

Right. And so, mill nets to Europe might be fairly comparable now to anything?

John Faraci

Yeah, we are not shipping much to Asia at all. At any place for mill mets are little bit lower than our North America and Latin America.

Mark Weintraub- Buckingham Research

Okay. And then just lastly I don't know if you have a perspective on this but the spread between test liner and class liner in Europe is unusually now actually maybe even test liners are little higher than class liner? What implications, what relevance might that have, is this we are thinking about this business from your perspective?

John Faraci

Just looking around Mark, to see if anybody knows more about that than I do, may be Tim Nichols -- love to get back to you on that.

Mark Weintraub- Buckingham Research

Okay. Thank you.

Operator

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

Steve Chercover - D.A. Davidson

Good morning. It looks like your profits are kind of ramping towards $3 hopefully on the sustainable basis, and you had a great balance sheet. Is you are at point at which you are going to start to reconsider the dividend?

John Faraci

Yeah. There is. I don't think we are right there, right now but that's something we have been, and we will continue to talk to our board about.

Steve Chercover - D. A. Davidson

Thank you.

Operator

Your next question is from [John Tomazo with John Tomazos Endophagic Research].

John Tomazo - John Tomazos Endophagic Research

Could you just walk us through the capital to be employed and seven important growth projects on your slide 24. And in the aggregate, were the 20% return for EBIT return be a reasonable goal on the aggregate capital employed in this projects?

John Faraci

Well, let me just go through the numbers with you, John on the projects. The Pensacola conversion is about $350 million and the Riegelwood fluff pulp project was about $80 million, Svetogorsk BCTMP about $150 million. The Sun joint venture machine, the last piece of that was 70 or 80 is in my head, $70million or $80 million for that machine and then Tres Lagoas is about $290 million.

John Tomazo - John Tomazos Endophagic Research

Of course buying into Brazil and buying into Russia were big commitments?

John Faraci

Luiz Antonio, I think about that as there was a big swap, where we swapped trees, swapped the project through that VCP you've got to routine with $1.1 billion in capital and got Luiz Antonio mill, plus all the timberland around the area and then we talked about the Ilim joint ventures.

So the returns on those projects are all well above the cost to capital and they do vary, but they are all very healthy returns well into high double-digits or better. And the good news is the fluff pulp projects are already sold out. BCTMP markets in Eastern Europe are very strong. The Sun joint venture machine we are ready to sell that. Pensacola, we've got more orders right now in containerboards than we can ship and Tres Lagoas starts up in 2009.

So they are not, they are really not North American driven projects with the exception of fluff pulp I would say and like I said we've already have got all that volumes sold in the contract, that answer your question John.

John Tomazo - John Tomazos Endophagic Research

Yes, thank you very much.

Operator

We have a follow-up question from Mark Wilde with Deutsche Bank.

Mark Wilde - Deutsche Bank Securities

Yeah. Hi. I wondered Marianne if it's possible for you to estimate just the FX translation effect that you've had in the third quarter and then through nine months?

Marianne Parrs

It's not a very big number. There are pluses and minuses. It's pretty much a wash. There are pluses and minuses if you go around the world.

Mark Wilde - Deutsche Bank Securities

Well, it would seem like the dollar is weaker against almost every currency around the world, so it seems like on a translation of offshore earnings it should be a net positive this year.

Marianne Parrs

One of the things that makes it a little bit more complex than that is if you take a country like Brazil for example, Brazil exports in dollar, so you don't get all the benefit that you might be thinking of the weak US dollar for the translation effect of earnings. It does benefit Europe and then in Europe we have cross-country translation as well, so we will have the translation effect of shipping from Eastern Europe, Europe or Poland into Western Europe, or into Russia. So the plays of currency are a little bit more complicated than they might seem on the surface and when you let everything out, it may be a small cost, $5million to $10 million.

Mark Wilde - Deutsche Bank Securities

Okay. All right. And John, you've talked about bringing down the overhead in IP as you can shrink the domestic footprint. Can you just give us some sense of where you are adding that process right now?

John Faraci

Our total overhead is running flat year-on-year, that's total overhead dollars. As a percent of sales we are a little bit lower than we were last year and I would say every time, we still got about a percent of sales of overhead that we are going to get out over a period of time. We are going to do that through attrition, through Europe facilities and/or midst to doing that right now and in Shorewood in the container division and in xpedx.

Mark Wilde - Deutsche Bank Securities

Okay.

John Faraci

Mark, I'd also just come back to your question on currency, there is a big flaw on effective currency in our packaging business and despite the fact that box business is down the market is down 1.9% or close to 2% year-to-date I think with the dollar where were it was we would be looking at different numbers. So that doesn't show up in our financial statements as a FX line but it's really there.

Marianne Parrs

I think it also helps pulp pricing the weak dollar.

Mark Wilde - Deutsche Bank Securities

Yeah, I think it' going to help pulp and a lot of other things next year if we stay where, we are [ahead] right now.

John Faraci

I agree with you.

Mark Wilde - Deutsche Bank Securities

Okay, thanks John, thanks Marianne.

Operator

We have time for one final question. Your last question is a follow-up from George Staphos with Banc of America.

George Staphos - Banc of America

Just a quick one, I really this isn't the outlook right now, but if you're in a weaker environment next year, would we expect distribution earnings xpedx to be following pretty much on pace with what you had be seeing in paper or board, do you think that given what you've onto restructure of the business, asset business improve it through NPI as well that it should be a fairly, trend line stay business against the other businesses?

John Faraci

George, as Tom Kadien, who runs that business is sitting right here so I am going to let him answer that.

George Staphos - Banc of America

Hey, Tom.

Tom Kadien

Hi, George. I think we can do better than the trend line that you would be watching for uncoated or coated paper. We have many restructuring activities going on throughout xpedx, John mentioned the S&A we were down year-over-year significantly in headcount and yet we are growing the business relative to the markets we are competing in, we are gaining some share, so I think we can do better than the markets that you'd looking at for say uncoated free sheet or coated paper.

George Staphos - Banc of America

For kind of just dampened growth but not a whole heck of a lot of volatility on the downside of impact that's what we had last -- next year.

John Faraci

Yes. I would agree with that.

George Staphos - Banc of America

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

John Faraci

Well let me before we hang up here to say that IR is able to answer any additional question for us, so I just want to take this opportunity to tell you this will be Marianne's last earnings call and as I think all of you know Marianne is retiring after 33 years with International Paper. I don't have to tell you she is been an influential leader in our organization throughout her carrier and from my perspective she has been a valued colleague and advisor and a personal friend and then very variable to our transformation plans. So I know all of you will join me in wishing her well in the next chapter of whatever is coming next so. Marianne if want to add anything to that you can.

Marianne Parrs

All right. I would add to that is that Tim Nicholls is going to be taking over CFO the 1st of December. I have been working with him for several months now here back in the United State and I think you all are going to find that he is extremely good for you to work with and you'll enjoy it.

Tom Cleves

Okay. Thank you everybody. That's it.

Operator

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

Tom Cleves

Thank you, Amanda.

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Source: International Paper Q3 2007 Earnings Call Transcript
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