Jay Royalty - International Paper Co. Mark S. Sutton - International Paper Co. Glenn R. Landau - International Paper Co. Tim S. Nicholls - International Paper Co. Jean-Michel Ribiéras - International Paper Co. W. Michael Amick Jr. - International Paper Co..

Mark Weintraub - The Buckingham Research Group, Inc. Brian Maguire - Goldman Sachs & Co. Philip Ng - Jefferies LLC George Leon Staphos - Bank of America Merrill Lynch Mark William Wilde - BMO Capital Markets (United States) Chris D. Manuel - Wells Fargo Securities LLC Gail S.

Glazerman - Roe Equity Research Anthony Pettinari - Citigroup Global Markets, Inc. Adam Jesse Josephson - KeyBanc Capital Markets, Inc. Chip Dillon - Vertical Research Partners LLC.

Good morning. My name is Sarah and I will be your conference operator today. At this time, I would like to welcome everyone to the Second Quarter 2017 International Paper 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. Thank you. Mr.

Jay Royalty, Vice President of Investor Relations, you may begin..

Thanks, Sarah. Good morning, everyone, and thank you for joining International Paper's second quarter 2017 earnings conference call. Our key speakers this morning are Mark Sutton, Chairman and Chief Executive Officer; and Glenn Landau, Senior Vice President and Chief Financial Officer.

During this call, we will make forward-looking statements that are subject to risks and uncertainties, which are outlined on slide 2 of our presentation. We will also present certain non-U.S. GAAP financial information. A reconciliation of those figures to U.S. GAAP financial measures is available on our website.

Our website also contains copies of the second quarter 2017 earnings press release and today's presentation slides. Lastly, relative to the Ilim JV, slide 4 provides context around the joint venture's financial information and statistical measures. With that, I'll now turn the call over to Mark Sutton..

Thank you, Jay, and I had my thanks to everyone calling in for our call. We appreciate your interest in International Paper. Starting off on slide 5, the transitional quarter that I spoke about on the last call came in as we expected. International Paper delivered solid results overall, driven by Industrial Packaging and Global Cellulose Fibers.

In our Industrial Packaging business, favorable market conditions and healthy demand underpinned the solid quarter. Results in Global Cellulose Fibers were driven by strong global demand along with record fluff pulp sales, favorable pricing trends and synergies which are being realized in a faster rate than originally conveyed.

The recent price increases are coming in as we expected with most of the benefits coming in the second half of the year. OCC with the greater headwind than we had originally expected, driven by stronger global demand.

We successfully executed our heavy maintenance outage schedule in the second quarter and as we sit here today about 75% of our planned maintenance outages were completed in the first half of the year. The Ilim joint venture delivered another strong quarter of operational EBITDA.

However, IP's equity earnings were negatively impacted by a non-cash FX charge related to this joint venture's U.S. dollar denominated net debt. All in all, we finished the second quarter as we expected and we're well positioned for a very strong second half.

On slide 6 and continuing with the financials, I would like to point out a couple of key metrics. First, year-over-year revenue growth in the quarter was 9%. This was driven by the pulp acquisition, overall volume growth in our businesses and increased pricing in several of our businesses.

You can also see the negative $0.04 impact of ruble that I mentioned earlier in the quarter. With that, I'll turn it over to Glenn to discuss each of our business segment's results and our outlook.

Glenn?.

Yes. Thanks, Mark, and good morning, everyone. I'm on slide 7, which is the overall enterprise bridge from the first quarter to the second quarter. So starting from the left to right, price improvement in the quarter was significant, driven by North American Industrial Packaging and Global Cellulose Fibers. Volume was seasonally stronger as expected.

Operations and other costs improved quarter-over-quarter and maintenance outage expenses were significantly higher again as we planned. Input costs in aggregate were a modest headwind as higher OCC up $24 million quarter-over-quarter were largely offset by lower wood, chemicals and energy costs.

Corporate expenses were lower and the effective tax rate was more favorable due to the benefit of the catch up of a state tax rate change. And lastly, as Mark already noted, earnings contribution from the Ilim JV were a headwind this past quarter, this was driven by a non-cash FX charge on their U.S.

denominated debt although somewhat offset by solid operations. Now, turning to the businesses and beginning with Industrial Packaging, earnings were higher driven by seasonally stronger as well as higher underlying demand along with improving prices in North American domestic and export containerboard markets, and of course North American box.

As these price increases continue to ramp up, we will see the majority of the benefits hit in the second half of 2017.

Operations and other cost improved but were negatively impacted by cost associated with Tropical Storm Cindy, a few isolated reliability events in the quarter and higher LIFO inventory reevaluation charges primarily related to increasing prices.

I would also note that IP receives $13 million in insurance proceeds related to the Pensacola incident in the quarter, which is roughly the same as those received in the prior quarters. Input costs in the second quarter were higher, driven by OCC that was up roughly $20 per ton on average quarter-over-quarter.

And lastly, closing up the first half, we successfully executed our heaviest planned maintenance quarters with nearly 70% of our maintenance outages behind us for the year.

So moving to slide 9 and taking a look at our history in North America and the portion of our Industrial Packaging business, we are entering a period of significant market expansion in the second half of this year as our price and cost initiatives continue to be realized.

The takeaway here is simple, this is a business that's resilient and able to relatively consistently deliver value across a broad range of economic conditions.

The key drivers of this large improvement in the second half includes good growth, driven by both domestic and export demand, increasing prices in North America and also on exports, lower maintenance outages especially in this period and ongoing cost reduction initiative.

So with that said, we are returning to peak historical margins in the face of higher input costs, which point to a healthy and growing global market environment and ultimately sets us up for an excellent run rate going into 2018.

Turning to slide 10, I'd also want to take a moment to highlight the current state of our kraft linerboard exports from North America. As we talked about often, our export channels for kraft linerboard out of the US network are strategic for IP and provide us with many options to fully capture the value of our total containerboard system.

Drawing your attention to the chart, we predominantly serve the globe's kraft linerboard needs in three regions; Latin America, Southern Europe and Asia. As you can see, global demand growth for kraftliner continues to be robust in 2017, up 3% to 4%.

Further pricing trends have been favorable in all the regions and we expect that momentum to continue, which is another key driver enabling us to restore margins into the mid-20% level. Moving to slide 11, I wanted to briefly highlight an attractive acquisition that we recently closed in Morroco.

We purchased Europac's Tangier facility, which was only recently started up in 2016, so quite modern facility. With this acquisition, IP received a very solid set of assets and an attractive portfolio of customers that are a great complement to IP's existing EMEA packaging business and customer base.

This acquisition allows for significant optimization and growth opportunities and again, underlines our commitment to the region. I can share that we are off to a great start in the first month of ownership.

Now turning to Global Cellulose Fibers, lots of green on this chart, coming off a transitional quarter in Q1, the business turned in very solid performance across the board. Earnings improved by $63 million quarter-over-quarter, driven by increased prices, improved mix, solid operational performance, and greater synergy benefits.

The business saw a record fluff pulp volume and continue to grow within the Specialty Products segment. All in, with consideration of a light outage month in June, we exited the second quarter with EBITDA margins north of 20%.

Going a bit deeper on synergies on slide 13, we delivered $34 million of synergies to the bottom line in the second quarter, bringing the year-to-date total to $48 million and approaching quickly our full-year target for 2017.

Further, we exited the second quarter at an annualized rate of $126 million, well ahead of our full-year run rate target of $100 million. This gives us a lot of confidence in our ability to meet and ultimately beat the original $175 million synergy target and get there more quickly than we originally thought.

This alone is really another key driver to our year-over-year improvement. On slide 14, moving to Printing Papers, financial results came in largely as expected as earnings were modestly lower due to heavy planned maintenance outages which were partially offset by higher volume out of Brazil mostly export and Europe.

Slightly lower pricing and less favorable mix in North America was also largely offset by the increased prices in Europe.

Turning to slide 15 and the Consumer Packaging business, results were significantly lower in the second quarter, much of which was driven by a significant planned outage expense of about $30 million predominantly at our Augusta Georgia Mill.

As is typical to our initial inspections at the start of any outage, we identified at Augusta incremental opportunities for maintenance and we made the decision to extend the outages to perform additional work on the boiler. Coming out of the outage, we also incurred more costs associated with the start-up.

But these events are behind us, and we expect normal operations from this point forward. Commercially, results in the quarter were solid.

Pricing improved as implementation of the recent price increases continued, and we continue to see the underlying drivers of demand improve as we experience increased backlog, although much of this upside was delayed in the quarter by production constraints at Augusta.

So, now on page 16, moving to Ilim, the JV delivered a very solid quarter of results, driven by seasonally higher volume and improved pulp pricing. However, as we've said a couple of times already, the equity earnings were negatively impacted by a non-cash balance sheet charge related to FX, as I discussed earlier.

Looking ahead, the JV expects seasonally lower volume and lower average pulp prices to impact earnings for the third quarter. Equity earnings are projected to be $35 million assuming no change in FX from the second quarter equity raise. We're now on page 17 which is our third quarter outlook.

Turning to it, we expect to see significant benefits associated with the execution of the March $50 per ton North America containerboard and box price increases, along with continued price realization on North America containerboard exports, as well as benefits from ongoing implementation of price increases in Consumer Packaging.

With all combined, should improve earnings by about $80 million quarter-over-quarter. And additionally in the price/mix section, continued benefits from the pulp price increases, partially offset by seasonality and the recent dip in softwood pulp prices, will drive a net benefit to our Global Cellulose Fiber business of roughly $10 million.

And in North American Papers where demand is softer, mix is expected to be a modest headwind due to a higher percentage of export shipments. Moving to volume, while we expect demand to stay strong for boxes, we will be unfavorably impacted by one less shipping day.

In terms of operational performance and costs, we expected Industrial Packaging to improve $40 million quarter-over-quarter. This is due to lower operating costs and lower LIFO charges. Operational costs are expected to be lower in Consumer Packaging as well as we pass the impact from the extended outage in Augusta, and that's now behind us.

So, net-net, this represents an improvement in earnings in Consumer of about $10 million. As we discussed earlier, outage expenses are scheduled to be lower by $165 million across the enterprise while input costs, driven primarily by OCC and energy, are expected to be higher by about $25 million.

In the Other Items category, we have provided our assumptions for corporate expense, interest expenses, tax rate and equity earnings from the Ilim JV. So, now let me turn the call back over to Mark..

Thanks, Glenn. You've all heard and talk about the strong second half that we envisioned in front of us, and as we sit here today, it's now upon us. International Paper is positioned for margin expansion over the balance of the year, which also should set us up very nicely as we move into 2018.

There are several drivers of this step change in results, a healthy demand outlook, particularly for our Industrial Packaging and Global Cellulose Fibers businesses, the realization of recent price increases across many of our IP businesses, solid operational performance and cost reduction initiatives, coupled with significantly lower maintenance outage expenses, and finally commercial and synergy momentum in our Global Cellulose Fibers business.

As we've been saying since the recent pulp acquisition, we will continue to allocate capital to create value, and in the near term debt reduction is our priority. Putting all this together, I continue to be highly confident in our full-year view of delivering year-over-year EBITDA growth with upside to the 10% target I shared earlier this year.

With that, we'll open the floor to questions..

And your first question comes from the line of Mark Weintraub with Buckingham.

Thank you. Good morning..

Good morning, Mark..

First question, any sense – in July, first part of July how business is looking? We just heard from a competitor of yours who seems to have had a very strong start to July.

Are you seeing similar trend?.

Mark, I would assume – is there a particular business? I'd assume you're talking about the box market, but I don't want to ....

Exactly, yes..

So, yeah, I'll let Tim just talk about July but I think that our story is similar.

Tim?.

Yeah. Hey, Mark. We are seeing a strong start to July for our box system. As of today, our cut-up's running 5-plus percent year-over-year and we're also seeing strong demand continue in the export markets as well. So, it feels like it's pretty robust at the moment..

And just any thoughts, any color – I mean, it just really seems to be just such a fast pace, but certainly the price increases should be in now, so you wouldn't think there's any inventory building going on.

What do you think is behind what really just seems to be an exceptionally fast pace?.

You know it feels pretty broad-based to us. We're getting some help on the West Coast in terms of our agricultural position in the first quarter. Some crops that normally start coming in in March got pushed out into the second quarter and even some in the second quarter are being pushed into the third.

So, we're seeing heavy ag shipments this month and we expect it again in August. But, that being said, we're seeing pickup in industrial accounts as well. So, it feels pretty broad-based. In terms of price, you were talking about it.

I mean, we don't have any sense that our customers are building inventory, probably have no way to know that full stop but it's kind of hard to build inventory and hold inventory for box customers. They typically – manufacturers just don't have the space. Our price increase you referenced, it's going extremely well.

We're right on top of what the expectation was and we've got a lot of flow-through coming in the third quarter..

And then just one last quick one. You'd mentioned you expect to see the full or pretty much all the benefit in the second half of 2017 on that price increase.

Should I take that to mean that some of it will be showing up in the fourth quarter or does it really almost all show up by the third quarter?.

Almost all of it in the third quarter. We'll be 90-plus percent through the third quarter and there's a little bit of residual that flows through into fourth quarter but not a whole lot..

Great. Thanks very much..

And your next question comes from the line of Brian Maguire with Goldman Sachs..

Just with the strong volumes you're reporting in the number you just gave for July, just wondering how the system is operating on an operating rate basis? And are there any debottleneck or expansion opportunities that you might be looking a green light or might be getting a second look, given the accelerated pace of demand we're seeing?.

Yeah. A great question. We're thankful that 2 years ago we embarked on adding capacity and flexibility in our system where we needed to. We're continuing to execute against that, we've only brought on about half at this point. We've got another increment that will come on in the third quarter, and then the last one will be completed next year.

So, we still have the opportunities that we referenced back in 2015 that are coming online, as well as debottlenecking opportunities across our mill system. We've got a pretty broad and flexible system with a lot of capability. And so, we continue to evaluate additional opportunities there..

Brian, this is Mark. Just to add to Tim's comment the other flexibility we have in our system is International Paper serves all the major channels for kraftliner, so the U.S.

domestic market, and our own box plant, the open market and the export market and our ability to move our production to where our demand signal is the strongest and our margins at the highest, gives us very flexible system including where capacity is deployed at different point in time..

And Tim, would you characterize those expansions as adding maybe 1% to your capacity every year or something a little bit lower than that?.

A little bit lower but that's in the order of magnitude..

Okay. Great. And just one last one from me, the consumer volume is a little bit light I take it that, that had to do with the extended maintenance outage. But, overall (18:52) seem like they've been pretty healthy for the industry and the backlogs have improved. Just wondering, if you could comment on what you're seeing in the market there.

And any thoughts on the strategic importance of that asset to the company?.

So, Brian, your take on the market is accurate. The demand has been pretty solid. Our issues of just making the product during that month with such a large asset out for such a long period of time; it's really an issue with our volume.

We have seen a pick up, we convert, as you know, a percentage of our boards to make cups and fruit containers that business is doing very well. And our customers in the open market in different segments has shown some strength.

We've said a number of times the Consumer Packaging business, while it's small relative to other parts of our company, it's a business and a market that we like. We think there are some synergies with other things we do. We've been working to figure out what the right role for International Paper is.

When we talk about strategy and IT, we talk about building advantaged position it's an attractive market. And at any point in time, you can take a snapshot and not every part of your company meets that test.

And our question that we have to answer is, is there a way to get to the advantaged position standpoint and that's what we're looking at and evaluating..

Great. Thanks so much..

And your next question comes from the line of Phil Ng with Jefferies..

Hi. I think, Glenn you mentioned earlier you're getting back to peak margins in the containerboard, in light of peak OCCs prices. But, it seems like there's a new paradigm in an issue whether it's demand, obviously limited supply and the steepening cost curve.

So, bigger picture and longer term, what's the opportunity set for further margin expansion in medium term, like what do you think the next peak could be?.

Well, I think we speak to that broadly. While referring to the second half and the second half notably has low outages so there's an annualized impact of outages that we need to apply there. But, we're going to see that margin expansion and we're going flirt with if not beat our last peak. And so we're not considering it a maximum peak by any means.

The three components that are going to drive margin and EBITDA growth in the company are growth, volume and our ability to meet that volume.

The reality of a steepening cost curve in a high OCC environment and the fact that we have a lot of cost savings opportunities in this big network that Tim spoke to across our system, and combine those, we see that 3% or 5% EBITDA growth over time.

The other thing that I would add to Glenn's comments since I agree with it of course is looking at export markets. Over the last period of time as export pricing was under pressure, we lost rough order $200 million of value just through selling price decreases and that's starting to come back. So, this year, we think we'll recapture half of that.

And on a run rate basis going out to the year, we should be close to whole..

Okay. That's really helpful. And I guess for the synergy ramp for your Weyerhaeuser has been really impressive.

Is that driven by this really good execution on your front or you're just finding more opportunities and I guess longer term, could you see upside to your long term synergy target for Weyerhaeuser?.

Philip, I'm going to attempt to have Jean-Michel Ribiéras answer that question. He's in Asia right now with Cellulose Fiber customers, but we'll give it a shot. And if it doesn't work, I'll come back and answer it.

Jean-Michel?.

Yes. Good morning. I hope you can hear me fine. I would say the synergies are kind of have been better than we expected everywhere. We had a lot of customers in fact which were not overlapping much more than we originally thought and with our Riegelwood 18 new capacity for example, we had a much faster ramp up than we expected.

Then on the supply chain, logistics, scoping it really went well. So, if you look at our numbers today, we are already at $48 million year-to-date. Our target was $60 million for the year which we clearly – we are going to beat that target. Our current run rate is about, we think end of the year $126 million.

So, we feel very comfortable about the $175 million target and actually much faster than we had original planned. So, we're discovering much more opportunities than we already thought..

Okay. That's helpful. And just one more question on that, Cellulose Fiber segment. I guess even (23:52) for that matter, pricing in softwood appears to have kind of peaked, I understand part of that's seasonality.

But, there is some capacity that's coming on in the medium term, as well as the market is absorbing some of that new fluff capacity that's being qualified at this point.

Just, what's your view in the next 12 months to 18 months on softwood and fluff pulp prices and that correlation dynamic? And any color on how you're thinking about rebates going forward? Thanks and good luck in the quarter..

Thank you. Quite different I would say on softwood or fluff, I would say, there are some new capacities which are ramping up which are going to come up, which will impact for 6 months to 12 months, maybe the global operating rate in softwood.

In fluff, with the growth we're having with the market demand which is kind of clearly stronger than we expected. I am less worried. I don't think we're going to be on an extremely tight market for 12 months to 18 months.

But, I think that between the good growth of the market and the ramp up, which you know is always longer than many times people think in fluff. It really takes time to get qualified to ramp up. I think fluff is going to continue to be quite well balanced for this coming 12 -months to 18-months and probably after..

Okay. Very helpful. Thank you..

And on the rebate, I'm sorry..

Oh, yeah..

And your next question....

I believe that's your question?.

Yeah, rebate..

I'm sorry. I think we have to be careful this year so there is a big difference between market pulp and fluff. So, I would say the trend on the last year has been an increase in the rebate, there is no doubt. But, in fluff, we really don't sell the same way we market fluff. Almost every customer has a different contract size, some are (26:10).

So, it's very difficult to mix both of them. I would not do that. If I need to explain on rebate, I would be happy to..

And your next question comes from the line of George Staphos with Merrill Lynch..

Hi, everyone. Good morning. Jean-Michel, good evening. I just want to maybe piggyback on the fluff and cellulose fiber questions.

Recognizing that you might not want to get into a mark-to-market exercise, given that the synergies are coming quicker than you thought, and congratulations to you on that, when do you think you'll be in a position to maybe update whether the $175 million is the right number or maybe they could wind up being higher given the progress that you're seeing? And you enumerated a number of places where you've been getting more progress on CF synergies.

Is there one or two that in particular was beneficial to you in terms of the progress so far? And then I had a couple of follow-ons..

Glenn, why don't you take the first part?.

Yeah. So, just on a macro basis, George – this is Glenn. I think it's preliminary right now. We're seeing, more than anything else, the rate of improvement cutting on fast.

While we have expectations and it looks good relative – like I said earlier relative to the opportunities to do better; we're not in a position today – we're not in a position today to really speak to the rate which is again the underlining point of the quarter. But, we should be ready as we get closer to the end of the year..

Okay. Thanks for that, Glenn. A couple of questions on paperboard broadly. I just wanted to confirm, so aside from it sounded like there was maybe $5 million of additional outage expense within Consumer. The performance in the segment was pretty much where you had expected it.

Would that be fair?.

Yeah. That's definitely fair. Speaking on behalf of the businesses, this is Glenn. We had strong demand. We had operational issues and had a big outage in the quarter that certainly set us back and then also put a tap on our volume, as our backlog expanded, we ultimately have delayed some of that into the next quarter.

So net-net, we're comfortable with the market backdrop that was really the assignable cause of this..

Okay. And you'd mentioned some – I forgot how you said it. But, it sounded like there's some operating issues minor, but nonetheless some issues in the containerboard system in the quarter.

Can you comment to what those were and if there's been any carry over? And piggybacking, I think on a question that Brian had asked earlier, the capacity expansions and really is more – mill system optimization flexibility that you're building in.

If memory serves, it was about 250,000 tons and if I heard you correctly, you've gotten half of it now, you'll get half of it next year and there are incremental benefits you'd expect to get and if you could put some sort of number on that incremental that would be helpful..

Yeah. Hi, George, it's Tim..

Hi, Tim..

We've gotten half of it. We've got more coming on in the third quarter of this year. And then so we'll be at about 70% implemented by the end of the year and the balance will come on next year. And then the operational issues that you referenced earlier, almost all of them were related to weather.

We had Cindy, Tropical Storm Cindy that came through and knocked some of the mills down. But then we just had – towards the end of the quarter, we had some significant thunderstorm activity and weather comes through taking the utilities down which blacked a number of our mills, and then we had to scramble to get them back up. I think it's behind us.

But they were pretty much all situational..

Okay. My last question, can you comment a little bit about how Europe is going, specifically Madrid? And then before turning it over, just want to say thanks again, Jay, for all your great work in IR. We really appreciate it working with you and, Guillermo, welcome aboard. Thanks..

Thanks, George..

George, this is Mark. On Europe, we're right on plan for the Madrid conversion. So the equipment is all spec'd, ordered and showing up and we're ready with the team to phase out the newsprint manufacturing and convert to containerboard.

We've got some exciting new technology that will go into that conversion, making it really, really high performance board.

And as we showed on that slide with the small box plant acquisition in Morocco and looking at Spain and Morocco and the food basket there that uses kraftliner and high-performance recycled, it's a perfect example of building an advantage position in a really attractive market.

So we're excited about the conversion and ready to get on with making containerboard and everything is right on target..

When are you producing first commercial ton, Mark?.

So the first commercial ton, we should be in December....

Okay..

...of this year. I hesitated, because I was thinking about when we would have kind of a reasonable ramp. It's going to be through December. Our target was always getting it converted in the fourth quarter and having it fully ramped into our system as we enter 2018..

All right. Thank you so much..

Thanks, George..

And your next question comes from the line of Mark Wilde with BMO Capital..

Good morning..

Good morning. Hey, Mark..

I wondered if we could kind of just jumping back to containerboard and containerboard capacity, I'm kind of reminded of that old Dr. John song about it. I don't do it, somebody else will.

With the industry running at 97% right now, just it seems like the market is getting a signal that we need more capital in the business or we need more capacity in the business.

Can you talk about sort of beyond that 2018 debottlenecking, what else you guys are looking at or might think about to bring on additional capacity?.

Hey, Mark. It's Tim. Yeah, I mean, we look at a number of things in terms of how we create value in this business. And certainly, given market conditions and the growth that we see in both boxes and in board, growing with market is a significant component of our value creation strategy.

Mark's talked in the past about the breadth of capability across International Paper. We've got a great organization. We've got great assets with a lot of flexibility. So, we constantly evaluate how to deploy those assets and when to deploy them for the greatest value creation. So there's opportunities there.

Not ready to speak about anything specifically, but we do have opportunities..

So just to kind of follow that a little further along though, Tim, can you say just generally right now, does it look like the better opportunity is kind of incremental debottleneck at existing mills or it might involve kind of conversions which you guys have talked about in the past..

We've got multiple opportunities, Mark. I wouldn't want to single any one out, but I think we've got multiple opportunities..

Okay.

And then, Tim, just one short follow- on, I just wonder if you can talk at all about what you might be doing to kind of help mitigate risk of another Kleen Products settlement?.

Great question. One of the things that we do is we have a very robust pricing mechanism and pricing governance protocol within Industrial Packaging.

So on a regular basis, every month, we are updating the macro factors, the metrics that we look at and evaluating how we feel about our pricing posture and that is there's a lot of analytics involved, and there's a lot of discussion and we do it religiously every month no matter what..

Okay.

And then, Tim, also just on Brazil, can you give us some sense of what you saw in your box business in Brazil in the second quarter?.

Generally, improvement across the board. Not as much as we would like, but we did get pricing improvement, our operations ran better. Volume was better, but not as good as it could have been given some of the segment issues down there around protein and then the just general market conditions.

But on balance, I think we're performing better in the market, and certainly from pricing and volume, commercial excellence, the team is doing a better job down there..

Okay. And then, Glenn, I think you guys mentioned that $13 million insurance recovery on Pensacola in the second quarter.

Can you help us understand sort of what other impacts from Pensacola we might have seen in the second quarter?.

Yes. Yes, I can, Mark..

Just give us kind of bridging first quarter to second quarter, so we understand sort of how Pensacola kind of played into second quarter results..

Sure. So the net earnings impact was just $3 million in the quarter, Mark. The $13 million was the insurance recovery, but we had continued business interruption, this is more on the supply chain area moving through the quarter. So that was really how it affected the second quarter.

If I put the whole thing in perspective, the impact we looked at for the whole year is around $63 million, $50 million of that is business interruption, the other $13 million is capital investments. We expect to recover on the earnings line $46 million of that $50 million. Insurance recovery to-date is $25 million.

So the net earnings impact is miniscule, and the cash impact is at best basically the size of the deductible..

Okay. Right. That's fine.

And finally, Mark Sutton, can you just update us on kind of thoughts around Ilim both in terms of IP's ownership stake there, but also I think you've got some potential expansion opportunities at Ilim, and I just wondered where those sit right now?.

Sure, Mark. As we said before, we think Ilim is a powerful example of building an advantage position in a number of businesses, serving really attractive markets. So the pulp side of Ilim is really all about the Chinese and Asian softwood market.

We just came off of a big capacity expansion, and we're ramping that up and getting it into the hands of the right customers in the right segments. There are more opportunities longer term in the future. We would time that when and if the market needed it in the targeted segments we have.

But the opportunity is there and the advantage of fiber and logistics are just really, really compelling. The balance of Ilim is really an International Paper microcosm. We make containerboards in the Ilim business and we're working to expand that today as we speak.

We also make boxes in Russia with our partners in Ilim and we make some uncoated free sheet and some other forest products. And so, those businesses are growing, serving the local market and certainly some of the markets in Eastern Europe. It's a 50/50 joint venture, right now. We really believe it's best to operate in Russia with partners.

We have great partners today that are not just generic business people, they are forest industry professional that have been in the industry their whole life. And they're educated in forestry and sustainability.

So the common view on how one should run a forest products company from a renewable natural resource all the way through (38:41) carbon-neutral energy generation to recoverable and recyclable products matches the IP value proposition perfectly.

So ownership stakes will be discussed over time when it makes sense, but what we do like is we like the business and we like our partners and we like the potential that that business has. Under normal CapEx, inside of the normal scheme of things, we're de-bottlenecking, we're improving capacity.

We're looking at things together in the industrial packaging market and that's all going very, very well and you'll continue to see a really powerful EBITDA generation out of that business..

Okay, fair enough. Thanks and good luck in second half..

Thanks, Mark..

And your next question comes from the line of Chris Manuel with Wells Fargo..

Good morning, gentlemen. I just wanted to follow up with couple of questions regarding the fluff business. So as we think about the path to – you guys have talked about longer term getting this to a $600-ish million of EBITDA business.

A couple elements that will improve things, I think, 2018 versus 2017, so if you kind of help me with the size or scale or buckets of these. I mean, one is going to be your synergy stuff, which you're telling us you're ahead of and have identified new things.

The second is, it was earlier you talked about some of the rebates or discounts and I guess, my question here is most of your contracts are – those only get addressed when the contracts get renewed, meaning, if there are 3, 4, 5-year, what's kind of a 10-year component to that is kind of my question.

And then the second is what portion kind of just get an automatic bump when base price for fluff as we would see in the market that's up a good chunk here reflects through.

So just kind of help me understand the cadence or the pace as to how this change goes?.

Jean-Michel would you take a shot at answering Chris' question around contract versus non-contract and the synergy component?.

Yeah. Yeah. I will. Hi, Chris. I hope you can hear me fine..

Yeah..

Let me try to make something which is a little bit complex a bit easier. When we have price increases, those encompass being with a formula, being with an index, ultimately, we'll get about the same net price increase, it's just a question of timing.

One might be immediate, another might be a three to four month maximum, I would say, before it gets applied. So the way to look at it in fluff is whatever the mechanism we have in place, ultimately you do get about the same price increase.

The second question, which is more kind of the contract side, we have most of our contracts, I would say, are one to two years. So we have many of our contracts two years. And some of these contracts are not formal. Some are very formal, some are in countries where they're usually more so, hey, this year the target is, let's say, 57 tons.

And I can tell you, it's works as well as a very contractual contract because we are partners for long time and we inter depend on one from the other. So it's a mix of different things, it's not just one way to do it, which is why maybe sometimes it's confusing.

But at the end, it's the same result to the long-term commitments with our customer, and the pricing goes through as the market can accept it depending on our demand versus our supplies. So the normal things of market applies with different mechanism but the same result..

Okay.

So ultimately, we're still – it maybe – it's still a couple year process to get towards your big picture target of $600-ish million?.

Yes. I mean, this is – if you take the average, I would say, cycle prices, which we had around 2015, you can see we're not that yet there. We are progressing significantly this year, but we might be on the pricing only side halfway. On the synergy side, we are ahead.

So, yeah, I would say, a couple of years, which is as we said on a normalized price market is what we need to get there..

Okay. That's helpful. And then one question for Glenn, usually this is the time a year or so when you guys take a look ahead at the pension. I know you did a big settlement last year.

But how would you view or think to the appetite as you sit here today to doing another kind of pre-fund component of the pension as you have in the last couple years or do you think you're pretty well set for the next few?.

Well, as you know, we have no mandatory contributions in the near term. But with that said, we are in a deleveraging mode and we're looking at all our options to most efficiently deleverage to bring our ratios back in line with our target. So I would say that's an option that's still on the table..

Okay. Thank you. Good luck, guys..

Thanks, Chris..

And your next question comes from the line of Gail Glazerman with Roe Equity Research..

Hey. Good morning..

Hi, Gail..

I guess, Tim, can you maybe offer some perspective on what you're thinking about in terms of OCC? What's been driving it? What you expect maybe over the balance of this quarter and just fundamentally, is this a new normal?.

Well, certainly, over the long term, we've always said we expect OCC pricing to move to higher levels. Our crystal ball is probably not any better than anyone else's in the short term. We think we're going to see some modest uptick in the quarter, in the third quarter. You read a lot and you talk to your people on the ground a lot.

I think, first of all, demand which has been pretty strong is one component of it. And then generation, supply being tighter is another component. And what I think I understand is that traditional retailers' generation is not growing. It's holding, but it's not growing. And so there's an e-commerce impact.

There's probably a distribution or redistribution impact as well. But I think quite frankly, up at this level and sustained, we see that in the future. This time last year, I don't think any others would have predicted it for this year..

And I mean, any sense of how much of what's been going on, it's been domestic versus pull from China?.

I think, it's both, China pulled back earlier in the year and maybe there's some timing here as they kind of race to catch up. But I think, it's broad based and you look to other markets around the world and OCC is up in those markets as well, so other countries in Asia.

And so I think this is – you can find pockets where there maybe anomalies, but I think it's fairly widespread..

Gail, this is Mark. Just to add to what Tim said. If you just take it up a level and look at, this OCC phenomena is a great example of this whole business model and you can't look at it in isolation. Kraftliner and OCC go together.

OCC begins its life as virgin fiber and as the market for packaging – sustainable packaging grows, where it grows determined what type of fiber is used, but the feedstock for that fiber is virgin fiber largely generated in the southeast U.S., some in Brazil, some in Northern Europe.

And so the dynamic is China, let's take that as an example, China surprised everyone by really ramping up their collection rate beyond what people thought they could do. And it reached very, very world-class levels and they're there now.

So any incremental growth has to be fed with strong fiber coming from other regions and then you got the dynamics that Tim described where we might recycle as individual consumers a little less diligently than a large retailer would. So generation suffers for a while.

But at these prices, the market will find its place and OCC becomes really, really valuable. And I know where we live in this area of the country.

OCC generation is actually increasing because the municipalities have really stepped up curbside, making it easy for consumers to do it, may not be the same in dense large cities, but that's something that we will see play out.

But it all starts with this pretty good business model of renewable natural resources, making products that are using the by-products to make energy in a carbon-neutral way with biomass. And then in the case of the corrugated box in the U.S., 90% captured and recovered and recycled.

So the amount of attractiveness that has with customers and segments is just not to be underestimated..

Okay. And just one last one. A European producer has just announced an acquisition of a U.S. player and they're talking about being a multi – a supplier to multinational customers.

And I'm just wondering as someone that has a toehold in the European market, the Latin American market, is that a real trend and opportunity that you see in the market or is it more in local terms?.

I'll take the first part. And Mark may have something he wants to add, Gail. But this is – it's not new necessarily, we've been talking about this for a long time. Certain companies are more equipped and capable of taking advantage of it than others, customers, I mean.

Where we can and it adds value for us and it adds value for the customer, we certainly do those kind of things. We do it between our footprint in Brazil, our footprint here and in Europe. So there's certainly opportunities. I personally don't see it as a broad brush type of seismic shift, if you will.

And having the capability broadly to meet those customers' needs is sometimes a significant hurdle to get over as well..

Okay. Thank you..

And your next question comes from the line of Anthony Pettinari with Citigroup..

Good morning and congratulations to Jay and Guillermo on the new roles..

Thanks..

Pulp and paper we showed a $20 a ton increase in corrugated medium prices this past month, I was just wondering if you could quantify the impact, if any, that you anticipate..

Yeah. Hey, it's Tim. It'll be minimal to us. We don't sell a lot. We don't buy a lot. We break for a little bit. So it'll have a minimal impact, not all of our customer contracts reference medium. And so where they do, you can pass through, where they don't, you won't get it but it's single-digit millions on an annual basis for us. Yeah..

Okay. That's helpful. And then, you referenced the very strong export pricing that we've been seeing in the slides, but I'm guessing your margins domestically are still better.

Is it possible to quantify how much you pulled out of the export market in 2Q, if you anticipate pulling incremental tons out in 3Q, just kind of the mix of export versus the domestic market given the very strong demand we've seen in the U.S..

Yeah. We export between, say, 12% and 15%, depending on the time of the year, but year by year, it's in that range. We didn't really pull back a lot during the second quarter.

Given Pensacola and its exposure to the export markets, we were working hard to meet all of our demand here in North America and also working to catch up with customers that we have commitments to in other parts of the world. So it was a strong push across all the channels in the second quarter..

Okay. That's helpful. I'll turn it over..

And your next question comes from the line of Adam Josephson with KeyBanc..

Thanks. Good morning, everyone. Glenn, just a clarification on the bridge you gave us. If we take all those pieces, would that get us to about $1.1 billion for the third quarter on EBITDA? I didn't catch everything, so I just wanted to confirm that with you..

Well, I think we outlined the areas on our outlook that we have a clear line of sight on. And if you can pick that back up in the transcript, we don't come out and just give a broad-based number.

But directionally, I think if you look at and do the math on the pieces that we've built up, you'll get it in that range, and you could speak to Jay and Guillermo afterwards..

Okay.

Regarding the bridge as well, what exactly is your pulp price forecast for the second half? And secondarily, what is the flow-through or the anticipated flow-through in the third quarter from your previous price increases that had a, call it, two to three-month lag?.

Well, again, we're not going to be forecasting, looking forward on pricing.

We gave you the macro view of net-net in the pulp business for the third quarter, an incremental $10 million that has all the pass-through that that's going to come through from what's been announced and that's net from some of the situation relative to volume and the seasonality, as well as the dip in softwood prices.

So, again, that's a round number of $10 million net-net..

Okay. And just two others, one, in terms of what Jean-Michel was saying, because historically, I believe, softwood and fluff pulp have moved basically exactly in line with each other.

So is he saying that he thinks that will de-couple to some extent in the future?.

Jean-Michel, do you want to take that?.

Jean-Michel speaking here. Yeah, I would take it. When we look at softwood and fluff, you do see some conversion long term but not immediate. There can be a broad band of difference between softwood and fluff, and they don't move at the same speed at all.

So I would say a plus 30% or 50% or what is going today on softwood and what is going today on fluff is really not related. We have very different situation in fluff.

Even if we have like every year a little bit of seasonality in the summer, which is a bit lower, fluff prices run lower, very stable with the end of the pricing season in fluff versus the slight decrease you have in softwood. So we need a big difference between the two before you can see one of them affecting the other.

This level of swing you have in softwood today does not affect fluff at all..

Thanks for that Jean-Michel. And just, Glenn, one last one for your on cash flow.

Do you expect a meaningful step-up second half versus first half in terms of cash flow?.

Yeah. We don't forecast cash flow either, Adam. But at the end of the day, you could see that there's a significant step-up across the board and cash flow should fall in line with that as well..

Thank you..

And our final question comes from the line of Chip Dillon with Vertical Research..

Hi. Good morning, everyone..

Good morning..

Good morning..

Yes. If you could talk a little bit about a couple of markets we haven't talked a lot about in terms of the markets and that is especially the fluff market as you see the growth there. I know you mentioned Riegelwood is ramping up on the production side a little better than you expected.

But what's the demand look like out there? Is it something that's still looking 3% to 4% up? Or is it varying from what the recent past has been? And then also on uncoated, if you could talk about the fact that outside the U.S. we seem to have prices going up, I believe that's true. Certainly, RISI is saying that.

And is that having any impact at all in the U.S.

market in terms of us not being as attractive for some of the importers?.

Jean-Michel, do you want to take the first question on fluff demand globally?.

Yeah. Yeah. So fluff demand globally is actually very stable growth. I would say the recent trends are even... [Technical Difficulty] (56:40-56:47).

I think we might have lost – I think we might have lost him. So I'll finish this sentence. Fluff growth, we're seeing in our customer portfolio and I think the public numbers are close, but more than 4% growth. We had built our model in the 3% or so range and we're north of 4%. Some regions did 4%.

Some regions even more than that and across a broad-base of uses from baby diapers all the way through the adult incontinence and hygiene products. And so part of that just have to do with, we just track GDP per capita in different parts of the world with tight correlation when people can afford these products.

That's where the highest growth rates are. So we feel really good, Chip, about what we're seeing, there's innovation going on in those products that are making them more accessible to more people around the world. And we are right there in the middle of all that innovation.

And that's part of what the combination of IP and warehouse of those products is a much, much stronger innovation DNA inside of our company that we had as IP alone..

Got you..

Chip, this is Mike Amick. Your question around this particular market, if you look at the data imports into the U.S. whether on a quarter-to-quarter or year-over-year they're roughly flat. There's not been a whole of change there..

Understood. But are you – do you anticipate or are you feeling – because I know you sell paper around the world. Are you feeling the strength or stronger pricing outside the U.S.

in uncoated?.

We are, we've seen some modest increases as we reported. You see in the appendix pages and also in EMEA as well..

So Mike, you've been a little bit modest you've got strong pricing pressure in Latin America. And Chip, obviously, it's the differential that makes the U.S. less attractive to Mike's point. We probably will see in the quarters probably stay in the range.

It's typically how the market incremental trade flows have worked in the past and that we don't see anything that would say or they would work differently..

Okay. Got you. Thank you..

And now, I would like to turn it back over to Jay Royalty for closing remarks..

Well, thanks everyone for taking the time to join us this morning. Michele, Guillermo and I will be available after the call. Our phone numbers are on slide 19 of the presentation and have a great day..

And this does conclude today's conference call. We thank you for your participation and ask that you please disconnect your lines..