By Jan Stoddard of Raine Consulting November 3, 2003 -- International Paper (NYSE: IP) today reported third-quarter 2003 net earnings of $122 million ($0.25 per share), compared with net earnings of $145 million ($0.30 per share) in the third quarter. Net sales for the third quarter totaled $6.4 billion, the same as the third quarter of 2002 and up from $6.2 billion in the second quarter of 2003. John Dillon, International Paper Chairman and Chief Executive Officer, John Faraci, President and Christopher Liddell, SR VP and CFO, conducted the quarterly investor analyst call. Editor’s Note: This analyst call not only reported positive results for the third quarter, but signaled a changing of the guard at International Paper. John Dillon is retiring from CEO and will be replaced by current President, John Faraci. Mr. Dillon has successfully executed a strategy of cost controls while refocusing International Paper into a more customer-centric organization. Perhaps John Faraci said it best… “”John Dillon fostered a belief, and a commitment, that International Paper can control its destiny regardless of what is going on in the outside world’ and in doing so changed the IP culture forever.” Topics: * Chairman Comments * Business Segments * Next Quarter Outlook * Questions and Answers Chairman Comments John Dillon, retiring CEO, opened the call with a “thanks” to all of the analysts that have been following the company. Referencing the last two years of changes within International Paper, he noted “fundamentally the company is far more focused than it has ever been and each of these three businesses is very well positioned with accountability to results to return on investment driving the return calculation to increasing shareholder value. All of the units are far more accountable. He also stated that one of the things that he is most excited about is the company’s customer focus that he feels is a fundamental component of business success. The work of the company’s 80,000 employees is showing results, accomplishing what they have wanted to do, and understanding the criticality of the shareholder equation.” Citing the challenges remaining, Dillon stated that “Frankly, as I have stated before, I am disappointed that we have not seen a little better demand growth here in 2003.” Demand weakened during the War, and while it is coming back, it is more slowly than anticipated. At the same time, Dillon remains convinced that we are going to see improved increments of demand and, given the IP position with relatively low inventories around the world and very little new capacity, there is huge upside because of this. IP is extremely well positioned. Third Quarter Results John Faraci summarized the third quarter highlighting these topics: 1. Managing what was in our control • Operational performance improvements particularly at the U.S. mills by focusing on costs, reliability and overall productivity. • Overhead cuts were announced with another 3,000 more jobs to be cut. • Energy conservation projects are underway to battle continued high-energy costs by funding $20 million in projects, all of which will be functioning between now and June 2004. These projects will reduce natural gas consumption by $50 million per year (or approximately 78 cents per share). 2. Volume • The economy remains challenging. Volumes were higher in some grades more due to seasonal factors than cyclical ones. • The season began slower than normal and still in many of the grades are lower than 2002 on a year-over-year comparison. The struggle continues with ‘flat’ demand. 3. Downtime • Balancing flat customers demand, increased downtime was taken in third quarter. A total of 240,000 tons, mainly in the containerboard, uncoated paper and pulp sectors was taken in the Third quarter. (This compares to 90,000 tons of downtime in the previous quarter.) 4. Prices • Paper/packaging prices down again due to weak demand. • Wood products were the exception with a very strong quarter as prices rallied, due to a combination of shortage of logs and weather in Canada. 5. Raw materials • Energy and fiber costs remain high. • Energy costs were flat quarter-to-quarter, although wood costs were up for the quarter (citing issues in the Mid-Atlantic areas.) • Overall wood costs are up $70 million dollars. 6. Earnings per Share • Earnings per share were $0.24 for the quarter compared to $0.19 in the Second quarter due to improved operations, lower overhead costs, and lower tax rate. • Compared to third quarter last year (earnings of $0.32), earnings were down due to increased material costs, pension costs, and overall lower pricing. Business Segments: John Faraci reviewed results for each of primary business groups. * Printing Papers: o Uncoated volume had a slight seasonal improvement (3%); however pricing pressures remain, particularly in uncoated rolls. o Volumes are up in ground woods and free sheets for Coated papers (18% increase overall) and IP is closer to break-even. John anticipates a good catalog season, but the commercial printing and advertising is still pretty weak relative to where it should be. Imports continue to impact the U.S. due to weak overseas demand. Prices are moving up in the Fourth quarter for ground wood. o Pulp losses in the quarter also narrowed due to higher volumes (13%). o Earnings in Europe remain healthy, not due to demand but because IP is offsetting losses with currency, operations are going well and strides in improving both country and product mix. * Packaging: Earnings were lower in the quarter due to weakness in both pricing and volume in industrial packaging that offset earnings improvement from the consumer packaging business. o Containerboard volume was down 7%. o U.S. container box was up 3% due to agricultural segment and share gains in specific accounts. o Bleached board reflect increased price in raw materials. o Shorewood Packaging (largest converter in segment) reported its best quarter. Music is still weak, but home entertainment and general consumer packaging offset this. * Forest Products: o Lumber volume increased 5% due to a late summer rally. o Plywood increased 2% due to strong housing starts and some shortages. Next Quarter Outlook Mr. Faraci summarized the upcoming quarter by noting: * October should remain strong, but there is a typical November-December slowdown. Fourth quarter is typically slower than this quarter. To date, macro economic signs suggest that improving demand may occur with the start of 2004. * Pricing outlook remains mixed. Price increased in pulp and coated papers will be implemented. Packaging prices will be flat to down. * Energy costs will continue to remain relatively high. Wood costs will also remain high due to hardwood costs (particularly on the Atlantic side) and harder seasonal logging conditions. Questions & Answers with the Analysts: 1. The increase in corporate items from $96 million to $138 million quarter-over-quarter comes from an increase in pension benefits (changing actuarial data demographics and a labor settlement of new rates going forward), coming off more favorable hedge rates and miscellaneous single items. Changes associated with pension costs will be $15-$20 million per quarter. Year-to-date, IP is reaching its targets on pensions. 2. Currency impact overall was $10 million positive quarter-over-quarter. 3. The remaining 2,300 employee headcount reduction is targeted for completion by Q4 in 2004, although most of the cost impact will be in the next six months. Much of the reduction is also happening through attrition. The reductions are across all areas including business and corporate levels. 4. IP will not forecast downtime for the Fourth quarter but will match it against customer demand. 5. Preliminary capital expenditure for 2004 will be approximately $1.1-1.3 billion. 6. Inventories are in good shape for paperboard and container. IP has drawn down inventories over the summer. Consumer and industrial packaging have been flat so IP has made appropriate inventory adjustments. 7. Price slippage in the roll-offset market has affected other grades. The market is moving sideways. John has heard different things from customers based on geography. “Clearly, markets are stronger in the East coast and South than the Midwest and West looking at commercial printing activity.” 8. IP continues to review the best way to make money from its timberland business (“the right land in the right spot”). 9. For the Fourth quarter, IP expects higher energy and wood costs. IP is hedged 40-50% and expects it to offset some costs. IP is looking at all cost centers for energy reductions (including switching of coal and wood waste to reduce consumption of gas and fuel oils, and also replace pine for hardwoods in mills). 10. If demand remains weak, there would be additional capacity demand review. Unneeded capacity has already been removed. IP wants to ensure there is adequate capacity to accommodate stronger advertising demands. 11. A report states that industrial production has picked up. Growth in the U.S. economy is required to increase hiring and consumption. Trends in currency (both packaging and currency) are favorable to IP. 12. Returning the coated business to profitability is a function of volume (aligning the right customers in the right channels), as well as continued portfolio restructuring. 13. There was less maintenance downtime in the Third quarter versus the Second quarter. Maintenance expense is amortized. More overall downtime was taken in this quarter. 14. Some box accounts are up because their businesses are stronger. Other segments, such as agricultural, are higher due to seasonal demand. This business is all about aligning customers with specific assets.