Good morning and thank you for standing by. Welcome to today's Second Quarter 2019 International Paper Earnings Conference Call. [Operator Instructions]. I'd now like to turn today's conference over to Guillermo Gutierrez, Vice President, Investor Relations..

Thank you, Mollie. Good morning, everyone, and thank you for joining International Paper's Second Quarter 2019 Earnings Call. Our speakers this morning are Mark Sutton, Chairman and Chief Executive Officer; and Tim Nicholls, Senior Vice President and Chief Financial Officer.

There is important information at the beginning of our presentation on Slide 2, including certain legal disclaimers. For example, during this call, we will make forward-looking statements that are subject to risks and uncertainties. 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 2019 earnings press release and today's presentation slides.

Relative to the Ilim joint venture and Graphic Packaging investment, Slide 2 also provides context around the financial information and statistical measures presented on those entities. I will now turn the call over to Mark Sutton..

Thank you, Guillermo, and good morning, everyone. I appreciate you joining our call today. We'll begin our discussion on Slide 3. International Paper delivered solid earnings and outstanding free cash flow in the second quarter.

Our performance again demonstrates the strength of International Paper to generate strong cash flows and take full advantage of our system flexibility to deliver solid results in a more challenging environment. Taking a look at demand in North America.

Our box shipments improved seasonally in the second quarter but were weaker than we expected with sluggish demand in a few of our nondurable and durable goods segments. Uneven global demand and continued customer destocking affected our containerboard and pulp volume in the second quarter.

Operational performance was strong and we managed costs well across our businesses while executing our highest maintenance outage quarter of the year. Through the first half of the year, we generated nearly $1.2 billion in free cash flow and returned $810 million to shareholders through dividends and share repurchases.

Continuing with the second quarter performance on Slide 4. Revenue was down about 3% year-over-year, largely due to the impact of the lower price and volume for export containerboard and pulp. We operated well in the quarter and controlled cost effectively to deliver $948 million of EBITDA and continued strong margins.

Our equity earnings were $80 million in the quarter, which includes $67 million from our Ilim joint venture and $13 million from our investment in Graphic Packaging. Free cash flow was $732 million in the second quarter, and this does include cash dividend of $239 million from our Ilim joint venture.

I'll now turn it over to Tim who will cover performance across our business sectors and our third quarter outlook.

Tim?.

Great. Thank you, Mark. Good morning, everyone. I'm on Slide 5, which shows our quarter-over-quarter operating earnings per share bridge. As Mark said, we delivered solid earnings in the second quarter while navigating through a more challenging environment.

Price and mix decreased mainly due to lower prices for containerboard and pulp, which was partially offset by increased prices in our North American papers business. Volume increased on seasonally stronger demand in our North American packaging and Latin American papers businesses, which was partially offset by lower export containerboard volume.

Operations and cost performance was strong. Our mills performed well in our heaviest maintenance outage quarter of the year and we executed downtime efficiently. Input costs were favorable with lower fiber and energy cost across our businesses.

I'd note that wood costs were favorable quarter-over-quarter after a steep run-up in 2018 and early 2019 due to severe wet conditions in the Southern U.S. Corporate and interest expenses were favorable and taxes were as expected at about 25% effective tax rate in the quarter.

Lastly, equity earnings were $0.09 lower sequentially, which include the $0.03 quarter-over-quarter drag from the noncash FX impact on Ilim's U.S. dollar denominated net debt. I'll now turn to the segment starting with Industrial Packaging on Slide 6. Our business performed well against an uneven demand backdrop.

Price and mix were favorable mostly due to lower export pricing, which was partially offset by improved margins in our European packaging business. Volume in our North American box business improved seasonally, but as Mark mentioned, we saw weaker-than-expected demand in the second quarter. I'll provide a little color on that in just a few minutes.

In general, export containerboard volume was also weak with inventory destocking and lower demand in the Middle East and Asia. Operations and cost performance was strong. We ran well, we managed costs effectively to mitigate the impact of downtime in the quarter.

Our performance again demonstrates the strength of our system and our ability to flex production to efficiently meet our customers' needs. We also completed our highest maintenance outage quarter of the year, and we now completed about 80% of planned outages for the year. Taking a look at input cost.

Wood, recovered fiber and energy were favorable versus the prior quarter and softwood inventory normalized in the second quarter as we expected. On Slide 7, I'd like to come back to the North American corrugated packaging ban and take a closer look at what we're seeing from our customers. Demand in e-commerce and protein segments was strong.

E-commerce continues to grow at double-digit rates as we work closely with our customers to optimize packaging design to meet their specific supply chain needs. Protein, mostly pork, chicken and beef is benefiting from shifting consumer preferences as well as increased export demand.

And fresh produce demand has normalized after the late start to the season. Processed food is a large category with many consumer segments. But broadly speaking, demand was softer in the first half of the year. This is in large part due to a drawdown of finished goods inventories for food manufacturers which have trended down since late 2018.

We expect customer inventory to normalize as the third quarter progresses, which should lead to improved demand for boxes. Nondurables, excluding food and beverage, represents about 30% of the U.S. box demand.

This is a wide-ranging category with many consumer and industrial products such as agriculture chemicals, resins, plastics, rubber products, paper and printing, towels and tissue and textiles and apparel.

Again, a large category for which underlying box demand is closely tied to nondurable manufacturing activity, which has been soft in the first half of the year. The weak demand we've seen does have some secular elements such as printing and writing and environmental concerns for plastic consumption.

However, the broader weakness is driven by high finished goods inventory since we exited 2018 and lower exports due to weaker global demand and ongoing trade tensions. We do anticipate improved demand as the year progresses and nondurable manufacturing recouples with the strength in personal consumption. Taking a look at durable goods.

Box demand has lagged the general economy through the first half of the year. This segment includes building materials, furniture and other products for which demand is closely tied to housing starts, which has trailed the strength of the broader U.S. economy in the first half of the year.

So no doubt, our box demand has been softer than we expected coming into 2019.

When we look at the underlying drivers of box demand, there is a disconnect between otherwise healthy consumption, expenditures for nondurable goods and demand for corrugated packaging that we believe is largely rooted in finished goods inventory levels which continue to unwind.

Stepping back for a moment, we are confident that secular drivers such as sustainability, e-commerce and consumer preferences will continue to drive healthy growth for corrugated packaging over the long term. More importantly, International Paper is well positioned.

We have the scale and footprint to serve just about every corrugated segment in a material way, and we apply our vast network of packaging design and innovation expertise to understand and exceed our customers' needs. Turning to Global Cellulose Fibers on Slide 8.

The effect of price and mix lowered earnings by $32 million in the second quarter due to continued trade and tariff uncertainty and persistently high inventory levels. Given that this business mostly serves export markets, today's trade uncertainty certainly weigh on us.

Taking a look at underlying demand, we continue to see growth in softwood and absorbent pulp even as trade and inventory destocking pressures supply/demand dynamics. Operations were strong and we managed our cost well. We did have a $10 million insurance recovery in the second quarter related to Hurricane Florence last September.

We executed our high maintenance outage quarter well and have completed 80% of our planned outages for the year, and input cost improved $10 million on lower softwood and energy costs. On Slide 9, I'll turn to Printing Papers. Our North American cut size business performed well.

We're ramping up shipments with new customers, and realization of previous price increases are following through as expected. Our roll business is more challenging due to weaker commercial printing demand and increased imports. Taking a look at underlying demand for uncoated free sheet in North America.

Through June, demand was down about 3%, which is in line with our view of about 3.5% secular decline. In Brazil, we had stronger seasonal volume and cut size as expected, however, demand for offset was weak due to delays in the government textbook program, which started in June but was about 3 months later than the normal start.

Overall, the business performed well and we executed the heaviest planned outage quarter of the year. Looking at Ilim on Slide 10. The joint venture delivered solid commercial and operational performance in the second quarter with EBITDA of $222 million and EBITDA margins of 40%.

EBITDA was sequentially lower driven primarily by lower average pulp prices and higher planned maintenance outage expense in the quarter. Equity earnings were $67 million and benefited from a noncash foreign exchange gain on Ilim's U.S. dollar denominated net debt, of which IP's portion was $7 million or about $0.02 per share in the quarter.

Now in terms of the outlook on Slide 11. Overall, we expect lower price and mix, improved seasonal volume and export shipments, lower planned maintenance outages and lower input cost. Now I'll take you through the changes business by business.

So let's start with Industrial Packaging where we expect price and mix to lower earnings by $110 million on the impact of prior year index movement in North America and export pressure. Volume is expected to improve by $20 million on seasonally stronger demand in North America and improved export volume.

Operations and costs are expected to lower earnings by $15 million due to higher seasonal labor cost in our North American box system. And also within Industrial Packaging, lower maintenance outage expense is expected to improve earnings by $68 million while input costs are expected to improve by $10 million on lower fiber and energy costs.

In Cellulose Fibers, we expect price and mix to lower earnings by $45 million. Operations and costs are expected to lower earnings by $20 million due to the non-repeat of the second quarter insurance recovery and higher unabsorbed fixed costs.

Lower maintenance outage expense is expected to improve earnings by $52 million and input costs are expected to improve by $5 million on lower wood costs. Shifting to Printing Papers. We expect price and mix to lower earnings by $20 million, mostly related to export pressure in Latin America and geographic mix.

As an offset to this, volume is expected to improve $20 million on seasonally stronger demand in North America and Brazil and lower maintenance outage expense is expected to improve earnings by $33 million. To recap, planned maintenance outages, as expected, we completed about 75% of our outages during the first half of the year.

Details by business and quarter are included in the appendix. And lastly, under equity earnings, you will see the outlook for our Ilim joint venture, which includes $10 million higher maintenance outage expense versus the second quarter. If we look at the full year on Slide 12.

On the demand side, we entered the seasonally stronger second half of the year in our North American packaging business. We're also seeing improved shipments for containerboard exports to all major regions as inventory destocking progresses and underlying demand improves.

In Global Cellulose Fibers, underlying demand for bleached softwood kraft and absorbent pulp is growing. However, we continue to see a difficult environment as we enter the second half of the year due to trade uncertainties and high industry inventory levels. And our paper business is performing well.

We're ramping up cut size business with new customers and for the full year expect to see benefits of recent price increases in North America. Outside of North America, we are seeing increased pressure in export markets and our Latin American business.

Against this backdrop, our revised forecast includes the impact of prior index moves in North American packaging as well as the impact of lower realized prices for export containerboard and for our pulp business. For the full year, we're projecting EBITDA of $3.9 billion and free cash flow of $1.9 billion.

Our outlook demonstrates International Paper's strong and resilient free cash flow. Through the first half of the year, we've returned $810 million to shareowners through dividends and share repurchases.

You can expect that we will use cash for debt repayment and returns to shareholders in keeping with our principle of maintaining a strong balance sheet and an investment-grade rating. With that, let me turn it back over to Mark..

Thanks, Tim, for the details on the quarter and the outlook, particularly given all the moving parts. The way I'd summarize where we are today is our businesses are well positioned and we're operating very well. But clearly, what the market is presenting to us at the current time has lots of ripples to it.

There's no question we're operating in a more challenging environment this year relative to 2018. Through the first half, International Paper has been able to navigate very well, delivering results better than might be expected in this environment, including a strong level of free cash flow generation, and this didn't occur by happenstance.

Instead, our results are the product of the work we've done to improve our portfolio, we've established advantaged positions with low-cost flexible manufacturing systems and we have a laser focus on customers.

As we enter the second half of the year and face continuing challenges, we are well positioned to navigate through them as we work on further improving our company. Our focus is on the free cash flow generation, which is the basis of shareholder value creation. Our expectation for free cash flow generation is strong at $1.9 billion.

This enables us to further improve our balance sheet and return cash to shareholders. I'm confident that the company we build will allow us to succeed in practically any set of conditions at any point in time. I think about International Paper's future often.

And given our company's longevity, sometimes my view of our future is prompted by an important event from the past. The Apollo 11 lunar landing 50th anniversary media coverage that we've seen over the past week is an example of this. I remember watching the live TV coverage on July 20, 1969, on my eighth birthday.

We were leaving that day on a family vacation, but we were all glued to our black and white television watching. What I didn't know at the time and only learned recently was that IP had an important connection to that broadcast.

2 weeks prior to the mission, the sole sponsor on CBS reduced its support, and International Paper stepped in to sponsor 1/3 of the live broadcast on the lunar landing and moonwalk day. 50 years ago, we could not dream of using the phone in our pocket to honor almost anything and have it safely to our homes in a corrugated box.

Disposable diapers were just beginning to gain traction with consumers and have led to other absorbent products that make people's lives better. Just imagine the role renewable, sustainable fiber-based products will play in the future.

For International Paper, the products, ideas and services we provide to our customers in more than 80 countries around the globe truly make a difference in people's lives every day. As a company, we've had many milestones during our 120-year history to be proud of, but I'm just excited about the ones that are ahead of us.

As the world continues to change, and we know it will, International Paper remains resilient and committed to improving people's lives, the planet and our company's performance. So with that, we're ready to take your questions..

[Operator Instructions]. Our first question is going to come from the line of Chip Dillon, Vertical Research..

The first question I have is if you could just talk a little bit about how the conversion at Ash [ph] in Alabama is going -- at Riverdale, I should say, at that mill and how you see that start up.

And then as we look at CapEx for 2020, I know it's early days, but directionally, do you see it going higher or lower than the $1.4 billion you're guiding to this year? And actually, I hate to keep piling on there, but you did lower the EBITDA guide from -- by about $350 million from last quarter, but the free cash flow is only going down $100 million.

And so maybe you could help us understand that change, especially since you're not changing the CapEx guidance for this year..

Yes. So just on the free cash flow, a couple of things changed as we lowered the guidance. First of all, we were expecting a bigger recovery of working capital and also lower taxes for that matter. So we had some headroom in the $2 billion that we had talked about. We had never quantified that, but we feel good at a real solid $1.9 billion on cash flow.

On capital for next year, all of that work is underway at this point and so we're still in the planning stage, and we have typically given that guidance as we report fourth quarter earnings in January, and I expect that'll continue to be our cadence. But I don't see it being higher.

We had some big projects over the past couple of years that have pushed the number up a little bit, so I don't see it being higher. The degree to how much lower it will be, we're looking at right now, and we can give you more on that early next year.

And then I'll just give you my perspective -- turn it over to Mark, I know that he will want to talk about Riverdale, but I think it's going extremely well. We're still on track. Everything's coming together from my standpoint, the way we expected it to, on the conversion..

I would echo what Tim said. We are well down the path of final engineering work. Preconstruction is on plan. The project's being executed very safely. Obviously, we have additional workforce on the project of this size. So, so far, I'm very pleased with the progress that we're making and the schedule that we're on.

On the comment on CapEx, Chip, I'd just take you back to the big picture on what we said long term about CapEx is.

We look at our capital allocation based off of our EBITDA and hence, the cash from operations and that, that CapEx tended to be around half of that cash from operations to reinvest in today's cash flows, and its facilities we have today, to take structural cost down, to meet any environmental regulations and then occasionally, to make some strategic investments like the Riverdale project or the Madrid mill.

And so that at a high level how we think about it. And the balance of that cash then goes back through share repurchases and the dividend. So we don't see a big change in those relative ratios of where we move the cash that we generate from operations..

Okay. Very helpful. And a quick follow-up. We're -- we've been reading about Amazon making some changes to their packaging requirements or requests, and I'd say at least half the boxes I get from Amazon have your logo on the box. I do look. I get funny looks from my wife and others when I'm -- that's the first thing I look for on the box.

But how do you see that impacting both the company and the industry, sort of some of these moves to streamline packaging with e-commerce?.

I think the big picture is e-commerce is growing at a rapid rate as a way of doing commerce for consumers, so that's the first thing. And corrugated plays a really important role in a lot of those supply chain solutions.

We've said oftentimes that the packaging environment in e-commerce is built for speed through the supply chain right now, not packaging optimization. But packaging optimization is coming.

And the good thing is, not only with that particular company but with most of the major e-commerce players, we are at the table and have a very strong position and are helping them to design. We think the right size and the right type of packaging and the sustainable approach is the right answer for the market.

We're not afraid of the changes that occur. The overall segment is going to continue to grow and corrugated is going to play a really important role.

And we have the ability to help our customers as they're ready to make changes in the packaging design so that they keep the speed to the supply chain, which the consumer wants, 1-day delivery and so forth, and reduce waste and reduce overpackaging over time. And we have a lot of design capability to do that.

So we see it as complementary to what we offer..

Our next question will come from the line of Anthony Pettinari, Citigroup..

In containerboard export markets, I think you indicated customers are destocking inventories and demand is maybe improving or expected to improve.

Just wondering if you could sort of reconcile that with the price erosion that we've seen in July? And then do you see stabilization or maybe some inflection in export market prices? And then I think last quarter, you provided some detail on where you thought export customer inventories were by sort of global region.

I think Europe in particular was quite elevated. Wonder if you could just sort of update that as well..

Anthony, it's Tim. Yes, the fundamentals seem to be improving more or less as we expected. If you remember last quarter, we had said we think it's going to take a little bit longer and it did. But now we see that starting to turn. If you remember, the agriculture season in Europe was particularly weak last year. This year, it's much stronger.

So I think people stocked up more -- for more containerboard than what they ultimately needed, but the strength of the season earlier in the spring and now the big season coming up looks to be very good. Those inventories seem to be -- have been worked through and people are coming back to the market. So I think Europe's improving.

Latin America is continuing to be strong. Asia was a little bit weaker, but not to the degree that the European -- region-wise. In terms of price, I mean when you get to this point in a cycle, there's a lot of fluidity.

But I guess rather than trying to forecast price, which we wouldn't do, we just say we see fundamentals improving and customers returning to place orders and begin building for this upcoming season, which will be late third quarter or fourth..

Okay. Okay. That's very helpful. And then the detail that you've given on corrugated demand trends by end market is very helpful.

When you talk about other nondurables, I think you said that demand might be impacted by secular trends and you mentioned the decline in print, which I think is understandable, but you also talked about I think environmental concerns around plastic consumption. Just wanted to get any more detail on that comment.

Are you actually seeing lower shipments of certain plastic products or is that more of a general comment? Just wanted to follow up on that..

I think it's more of a general comment. I mean what we would have, we'd probably have to characterize it as anecdotal at this point. But the trend seems to be there from a social standpoint. So probably to a greater degree in Europe where it's getting a lot of air time, but we usually follow Europe on a lot of these trends.

And so I think the environmental concerns are starting to pick up, and we'll see what patterns develop over the next few quarters..

I think Anthony, the purpose of Tim taking us through that detail was trying to get some perspective from International Paper on what we see through the eyes of our customers in the box market, largely the domestic U.S. box market.

And to answer the question or give some perspective on the question, why is demand where it is in 2019 versus what we saw in 2018, and obviously, we know there's a very strong correlation between nondurable manufacturing to the manufacturing to nondurable goods in the U.S. and box demand.

And when you dig into that detail, and we serve customers in every one of those segments and Tim ran through some of those, what our customers are seeing is softer demand for their products for certain reasons but no major conclusions on that.

Some of it, we believe, for example, the agricultural chemicals example that Tim gave, is really about the amount of rain and flooding and the delayed planting seasons that have occurred in the Midwest.

So those products are delayed in their shipping, and some of them may get skipped this year because of the lack of ability to plant in the flooded plains. But that's not demand destruction, that's just life happening.

So that was the purpose of that, to give some color around what might explain what we're seeing as a major provider of these products through the eyes of our customers..

Our next question will come from the line of Mark Connelly, Stephens Inc..

Two things.

First, Mark, when you think all about the work that you and your customers are doing on supply chains, do you think there is a shift in the amount of inventory that constitutes healthy? We're at 3.8 weeks, and is that the right level or does it need to go lower? And have you changed the way you think about the relationship between inventories and price stability?.

It's a great question, Mark. I think the -- what we've seen is when there's ample logistics and transportation velocity in our own company and our customer supply chain, we see the ability to operate with significantly lower inventories.

Last year is an example where the problems in the rail and truck and ship transportation lanes actually caused inventories to go up, partially to compensate for that. That's loosened up a bit now.

So I think part of what we're learning -- industrial companies are learning is that the variables aren't fixed anymore and you have tightness in transportation, how fast things flow through that you didn't have in the past, a wide variability on that. And part of it is self-inflicted with U.S.

rail companies implementing their scheduled changes, and some of it's just supply and demand in the trucking industry that may never completely be where it used to be. So higher inventories are necessary when the velocity is slower, and lower inventories are possible.

So that's going to take a while to figure out what condition are you in and how do you think about inventories and pricing because I don't think it's a single number anymore. I don't think it's this many weeks. It's this many weeks against this backdrop in the supply chain..

That's helpful. And one other question. We've clearly seen fluff prices move more closely with commodity pulp prices than they used to.

Do you think that's simply the new relationship? Or is that just a function of all the supply and demand disruptions we've been having lately?.

I think it's the latter, best guess we can look at based on our experience and customers. There's always a certain amount of flexible capacity that can make qualified fluff products or make market pulp, whenever the economics are better and certain parts of the market move in and out.

I think China's change in demand and their overall fiber influence on the world is still sorting itself out. So I don't think anything's fundamentally changed other than the softwood fiber market is a little bit disconnected right now, and there are some -- maybe some temporary unnatural flows.

And so that has created a little bit more dynamics around specialty fluff -- fluff and specialty pulps that are kind of the top of the pyramid and the more general market grades..

Our next question will come from the line of Brian Maguire, Goldman Sachs..

Just to follow on some of the earlier questions on inventory. Just obviously, you took a lot of economic downtime in containerboard and a little bit in the fibers in the quarter.

Just wonder if you could kind of characterize where your own inventories were at the end of the quarter and whether you think you'll still need to take some downtime in 3Q to get them back to normal.

Or were they in a pretty good spot?.

Well, Brian, it's Tim. We don't disclose what level our inventories are at. Specifically, I would say that at containerboard, we're running our system as we always do. We typically run a very lean supply chain.

Disruptions with transportation can cause it to fluctuate a little bit, but we don't like to carry any more inventory than we have to or to serve our customers' needs. I'd say pulp inventories, as you've seen, systematic around the world, are a little bit higher and ours were a little bit higher too.

So -- but within line of -- in 1 mill or 2, slightly higher inventory is what we would like to have over some period of time but within a reasonable range in total..

Okay. And then just on volume growth trends in corrugated, actually, the box shipments were -- because you noted down 2.1% in the quarter, a little bit weaker than you're expecting. But it sounds like the outlook for the middle of the year, back half of the year, I think most of what I've been hearing has been pretty optimistic.

Just wondering if you can comment on anything you're seeing so far in July, if there's a way to quantify any kind of pickup you're seeing and any specific end markets you're seeing some strength in..

Yes. The comments that we made were focused on the second half where we do expect to see pickup. July has been soft. We came out of June, and it's continued more or less in line with how we exited the quarter. But it's one of the slowest seasonal months of the year. It has the holidays at the beginning of the month.

And so our expectation is that we get into the seasonally stronger periods. In third and fourth quarter, we will see the pickup that we're expecting..

Our next question will come from the line of Mark Weintraub, Seaport Global..

On the customer destocking, would you say we're pretty much at the end of that now or are we still seeing a little bit more of it? And would you be willing to hazard a guess as to the magnitude of impact that might have had on the box business in the first half of the year?.

It's Tim. Let me just start with export, and I think that's where we are seeing a turn.

One thing that we did mention earlier, and this is not so much an inventory question, but it is a demand question, the reversal of tariffs into Turkey, which is a large kraftliner containerboard market and a big one for us that we had essentially pulled out of in large ways, has had an immediate effect.

The day after tariffs were lowered, we were getting calls for orders. So I think in the export markets, the destocking is running its course and nearing its end on the back of a really strong agricultural season, especially in Europe and some of the tariff relaxation around Turkey has definitely been helpful.

On the -- it's a little bit harder to gauge on the box side, and Mark may want to provide some color here. But you're dealing customer by customer with what they're telling you about their position and their demand levels. And so it's anecdotal and it's looking across a lot of customers segment by segment.

And it's our best read from the conversations that we're having -- that we've had that a lot of the destocking had seemed to work its way through, and it will depend on demand levels in the second half and then an increase in nondurables manufacturing activities..

I think the key sign is going to be, and we see it in some of the subsegments, not in all of them, but when we start to see order pick up, that means the nondurable manufacturing is picking up. And again, there's a lot of segments in there. We see the pickup in some.

We don't see -- I mean I think in one of the examples I gave around the chemicals related to crop planting, that's a gap that's going to be hard to recover because the season is passing us by. It's just one example where we don't expect a quick turnaround.

But we are seeing positive order pickup in some of the other segments, which means those products are now being manufactured again..

I really appreciate you highlighting the export side first because actually, just mathematically, the decline in export has had a bigger impact on containerboard demand than what we've seen domestically.

So just focusing back in on that, are you suggesting that perhaps, as we get things rebounding, we could get the export business back to where it had been? Or do you think it ends up being somewhere between the quite low levels in the first half of this year and the very strong levels we saw last year?.

Yes. I think for our business and the customer base that we're serving, we think we can get back..

Our next question will come from the line of Edlain Rodriguez, UBS..

Just one quick one on the printing paper market.

Like what's your outlook in the -- on the market in the medium -- no, near to medium term? And also, why do you think it was like so difficult for the industry to hold on into the price increases in uncoated free sheet? And could they have done something better to manage supply/demand and pricing?.

Edlain, this is Mark. I think overall, we don't see a whole lot of change in the Printing Papers business. We're a large producer in the North American market and in the Latin American market. We don't see a major change in the overall long-term demand trend. There are some ups and downs in that secular decline.

And when you have these kinds of issues, when you're raising prices in one region and demand might be slower, for example, in Brazil with their economic challenges, you will then see some products move around. So you got a little bit of imports coming into the U.S. We always expect that depending on economics in other places.

And I think all that factors into how pricing flows through and how resilient it is. But we see the business as -- in secular decline but stable and we're operating very well. We've actually improved our position with key customers.

And inside of -- grades, like cut size, we've actually grown in the market based on the customers we've aligned ourselves with..

Our next question will come from the line of Mark Wilde, BMO Capital Markets..

Mark, I wondered if you could just help us with how you think about the economic downtime. If you look at the first half, you took nearly 0.75 million tons.

And I wondered, is that coming through just flowbacks? Or have you taken some smaller machines out? And I also wondered if there's a point here where you think about just like indefinitely idling a given mill..

It's a great question, Mark. So on the how we do it, we look at our system as a system, and it produces many different grades and types of containerboard based on box design requirements. So they're not all alike or each mill, each unit operation isn't exactly like. So it's a combination of -- and all of our mills have a throttle on them.

That's not on, off, so we can run fast, slow, faster than fast like we did last year and we can shut down.

And we use all of those tools depending on the marginal cost algorithm that I talked about quite often and whether or not we can combine it with some other things that we need to do, whether or not we can lower our transportation cost, wood cost, take advantage of recovered fiber versus virgin.

All of that goes into a marginal cost algorithm that allows us to look over our 16 mills, look over our order book for the coming month or two and then decide with enough time to shed the cost, what to run and at what output level.

A lot of it is just running less than full output and balancing to maximize our energy production in the integrated mills and so forth. The second part of your question is hypothetical in the sense that we have the system we need. It's very low cost, it's very capable.

And we believe the box market long term and the containerboard market globally is growing. So our view is we have the right capacity in the right places. For today, we don't make those kind of a strategic decisions in 1 year or 1 quarter. We had it for today and we had it for the future, and we feel real good about that.

We really worked hard to build a system that, as you can see from the results, can do really, really well in a year like 2018 where we were probably running beyond our capacity and a year like 2019 where we're needing less than 100% of it for a period of time and we've adapted very, very well to it..

Okay. And then for my final one, I just wondered, Tim, if you can talk about the second quarter Ilim dividend.

And I guess what I'm wondering is, a, was a dividend of this magnitude in your planning for kind of free cash flow estimates for the year? And then secondly, does the size of this dividend tell us anything about sort of timing and cadence on the capital projects that have been talked about for Ilim?.

No, I don't think it impacts any of their plans strategically about the types of projects that they're planning. The business is throwing off a lot of cash. So this was just a way of returning it to the investors in the joint venture. We did have it in our -- I think we even talked about it. I can't be 100% sure. I didn't go back and look.

But I think we alluded to it on the first quarter call that we knew we were getting it. We had just not received it at that point and then it came through during the quarter..

Our next question will come from the line of George Staphos, Bank of America Merrill Lynch..

The first question is really more a point of clarification. And I just want to make sure that I heard it directly.

If we go to Slide 11, which is your outlook slide, the operations and costs delta sequentially for Industrial Packaging, was that a $1-5 million negative or a $5-0 million negative? I thought I heard $1-5 million, which in turn would mean that EBITDA, you're forecasting flat sequentially.

But if you could provide just some commentary there and remedial math, I guess, that would be helpful, and then I have a bigger picture question..

Yes. So George, you're talking about the seasonal labor cost? Just to make sure I heard you correctly..

No, the option cost..

The option cost, that delta that you cited..

It's $1-5 million and driven mostly by seasonal labor cost in the box system..

Okay.

So then we're looking more or less flat sequentially in EBITDA 3Q versus 2Q, that would be fair?.

Yes..

Okay. The bigger picture question, and this in part piggybacks on the question that Mark just teed up, recognizing that you don't make decisions on your mill system quarter-over-quarter and you're obviously doing extremely well running the business this year in a choppier demand environment.

Is there a practical limit that arise, I don't think you'll give me the timing of that here, in terms of the running to demand? Or can you run to demand as long as you need without any kind of impact on labor, your mill footprint, obviously capacity coming on? When would you have to make some changes? Or would there be a point where you'd have to look at your mill footprint and see what you do from a running demand standpoint? And then the related question, I guess at one point in time, obviously in the last couple of years, you looked at expanding geographically.

How would you guide us in terms of your latest thoughts on that? Would cycle timing and macroeconomic play into that? If you can remind us where would that be independent of how you would use that or view that as an opportunity going forward?.

Okay. That's a lot, George. I'll just....

Last in the line here, so I had to get it all in there..

No. It's good. That's a very good use of one question and one follow-up. On how long can you run, look, we talked about it before at a high level.

We think we -- our system runs best when we take about 3% of our available capacity out on a scheduled basis to maintain our assets and then about another 3% for flexibility in order to serve because we're making boxes with this stuff. It's a short-cycle business. You need to be able to turn on a dime sometimes.

And so running wide open, except when you're down for maintenance, usually results in higher costs and disappointed customers. So if you take 3% and 3%, and you say -- if we run 94% over time strategically, we're at our best. But could we run lower than that for a period of time? And I won't define the periods, you're right, absolutely.

And then as we put more technology in our mills, as we put more sensors and we have more predictive maintenance, I think we'll change the equation on that again. And so the labor piece is important but for a different reason than you're probably asking. It is a cost, but we view our labor as a true asset.

These are technically trained people that run and maintain our equipment.

And so we do everything we can to keep them fully engaged -- paced and fully engaged, whether we're running like last year at a 100-plus percent of our capacity or whether we're running like this year at something less than that because that's a particular part of our value proposition that's really difficult to replace.

So we can run at a flexible level for quite some time. But just to give you the high-level way we'd think about it, flexibility, maintenance and then really using our people and our marginal cost algorithm to make the best decisions we can.

On the strategic question about expansion, I think every major element of how we would make a decision, including cycle time and the macro conditions, factors into it. But strategic decisions like you're referring to are really about opportunities to create value over the long term by increasing International Paper's intrinsic value.

And so if it's an acquisition, then it should be clear that it has strong synergies and a strong return and a complementary industrial logic. If it's organic, strong return and the ability to -- obviously, it's not -- doesn't have the same risk profile, but the ability to generate strong returns immediately with the investment.

So the cycle time is important obviously because it affects sentiment, it affects your balance sheet, it affects your cash flow. But I would say all of that is in consideration whenever we contemplate that type of action..

Our next question will come from the line of Steve Chercover, D.A. Davidson..

So it's good to hear that e-commerce will continue to be a source of growth, both short and long term, and I had just a couple of questions on that.

As we think about the Riverdale whitetop project, was this done in anticipation or maybe in consultation with your e-commerce clients so that products can be placed in high graphic boxes that can also be robust enough for shipping?.

I think in general, it -- the need for that type of high-quality printable liner was definitely developed in consultation with lots of customers, not just e-commerce..

Okay. And make sure it's related on e-commerce. To the extent that some of the smaller packaging might go to pouches, I don't think that plastic is the answer.

So are you working on anything that might involve kraft paper?.

Yes. We work on almost everything that is fiber related for our customers. And we actually have products that are already in the marketplace that are using essentially what you would refer to as kraft-type paper..

Our next question will come from the line of Adam Josephson, KeyBanc..

Tim, just back to the box demand commentary for a moment. Just to make -- so I understand it better, so in the first half, it was weaker than you expected, I guess partly because of weather, partly because of economy, partly because of finished goods inventory destocking.

In terms of the latter part, how do you know -- what kind of visibility do you have into your customers' inventory levels because I thought they only kept a few days of a box inventory on hand? So I don't understand how they would be reducing their inventories throughout the first half of the year and then suddenly build it up in the second half.

So can you just help me with how much of the first half shortfall was attributable to each of those factors and then why exactly you think there will be an inventory restocking in the second half?.

Yes. It's a great question, Adam. I wasn't really referring to their inventories of our product. I was referring to the consumer products that they're making and workings through their own supply chains. So that's really the commentary about destocking as we look at our set of consumer products oriented customer base.

And parsing it out and quantifying each one though, I mean it's a variety of those factors where the business is looking at it segment by segment and customer by customer and understanding all of the movements for the 10,000-plus customers that we have, but it's all of the things that you mentioned..

Got it. And just on OCC, Tim or Mark, I think you've been of the view in years past that OCC costs were biased up out over the long term. Obviously, we're sitting here at 25-year lows and they're not -- OCC prices don't appear to be moving anytime soon. And obviously, what China is doing is playing a major role in that.

Do you have any reason to think that OCC is going to go up much from here? And if it doesn't, what impact do you think that will have on the domestic supply/demand situation, considering how much of the new capacity has been of the recycled variety, not only domestically but also in other markets?.

Adam, that's a great question. It's a strategic question.

You're right, we had -- have and had the long-term view that if you just look at fiber balances around the world where the growing markets are -- tend to need to use recovered paper as their fiber source and the producing regions of the world that are making that virgin fiber that becomes recovered fiber are slower growing.

We don't see a major change in that. I think China's position on recovered paper has definitely created a dislocation. The question is how long it lasts. But our long-term strategic view is fiber-based products, especially packaging, are going to continue to grow, which would lend itself to a demand for recovered paper over time.

The supply of recovered paper is virgin paper. So if -- in any scenario you can think of, it results in the world taking out virgin paper. In a few months, you've just taken out recovered paper because one is apparent than the other.

So I think if you look at the way the system works together, it may take longer and it may not be the time line we had been discussing earlier. But we think over time, the two types of fiber, original tree fiber and its recovered sibling, are going to work hand-in-hand. There'll be some temporary dislocation.

What I want is in excess supply, but if the way you solve that is by reducing the original supply, it corrects itself pretty quick..

Our last question for today will come from the line of Gabe Hajde, Wells Fargo Securities..

Two quick ones for you. One is, I guess pricing mechanisms are a little more opaque in the cellulose fibers business.

And given sort of the decline that we've seen since late 2018, can you talk about how that might flow through? I mean you gave us third quarter obviously, but maybe thoughts on 2020 in terms of how these price declines that we see on this may impact the business.

And then maybe bigger picture, appreciating that the long-term growth for those types of products is something in the 2% to 4% range, how do you think that business trajectory could be to get to that $600 million EBITDA figure that you guys had been targeting prior to some of the, I'll call, global malaise?.

Yes. We're not going to try to project the 2020 pricing, but the growth rate is accurate, what you've talked about in that 2% to 4% range. And we think that this year is the disconnect for the industry and also for our company specifically.

But we don't see any reason why with that growth rate and the role that these products play for the consumer, products companies that are making them, that we can't get on that -- back on that trajectory. It's just going to take a little bit longer..

I'm sorry, Mark.

I was more referencing just changes in price that we've already seen, how that plays through from a contractual standpoint given, again, some of the discounting factors that occur as well as timing lags?.

So the contract pricing is customer by customer, and some of what you've seen in the marketplace doesn't always affect that. And then the balance of the customers that are using indexes -- and it's not as predominant as you would see on the containerboard the side of the indexes, the pricing driver for the discussion.

So it's a bit of a different market. And again, not -- I'm not going to pin July or this year, try to forecast what effects, from what has already happened, it's going to have in 2020. It's not appropriate to do that..

Okay. And then the last question revolves around an initiative by one of the large e-commerce providers to charge folks back for not being qualified for frustration-free packaging or what have you. I think takes effect in a few days. Is it your view -- or have you -- I'm assuming the answer is yes.

But maybe elaborate on any magnitude of dialogue that you had with your customers to respond to that.

Or do you think that's something that is still on the come when it actually goes into effect and starts to hit people's wallet?.

I think it's going to be a little bit of both. I think that the amount of products that were designed, the packaging was designed for a retail display, probably isn't capable of navigating the supply chain for e-commerce direct to someone's house.

So that packaging will change, and that we see more likely to change more toward the corrugated or micro-corrugated side and we see some benefit there. But I think people got it figured out. There's some tooling costs and there's some design changes, and then the supply chain is complicated.

Can you make a product and put it in your package and guarantee that it's going in one supply chain, i.e., e-commerce versus the retail channel? That's not as easy to do for some companies as it sounds. So it will take a while to work through this..

Thank you. That concludes the Q&A portion of today's call. I'll turn the call back over to Guillermo Gutierrez for closing comments..

Thank you again for joining International Paper's Second Quarter Earnings Call. As always, Michele and I will be available for your follow-up questions. Thank you..

Once again, we'd like to thank you for participating on today's Second Quarter 2019 International Paper Earnings Conference Call. You may now disconnect..