International Paper Co. on Thursday reported a 40 percent drop in second-quarter profit but said the worst of the global recession appears to be over and that demand is steadying.

IP, North America’s top cardboard box parts maker, has been leading peers in cutting production as the recession slashed demand. That strategy paid off as IP boosted its profit margin, generated $1.31 billion in free cash flow and paid down $600 million of debt during the quarter ended in June.

Net income totaled $136 million, or 32 cents per share, reflecting slightly lower sales and a slew of one-time charges. In the same period last year, IP earned $227 million, or 54 cents per share.

The latest results included restructuring charges from mill closures and reorganizations that totaled $244 million, as well as a big gain of $294 million from a federal credit for using alternative energy sources.

Quarterly sales edged down to $5.8 billion from $5.81 billion.

“When we look at global economic conditions today, it appears the worst is behind us,” said CEO John Faraci. “We have not seen any signs of sustainable progress in North America, but it appears demand has stabilized at lower levels.”

He noted improvement in Latin American paper markets and solid packaging demand growth in China. Inventories are also lean for both paper and cardboard box material.

Before special items, the Memphis, Tenn.-based company earned $86 million, or 20 cents per share, compared with $235 million, or 56 cents per share, in the year-earlier period.

That beat Wall Street expectations for profit of less than a penny per share on sales of $5.75 billion.

Falling prices, especially outside the U.S., were a key drag on earnings, IP said.

The company’s largest segment, industrial packaging, posted an operating profit gain of 36 percent to $255 million as stronger volume, lower input costs and more efficient operations offset falling selling prices.

Operating profits for the printing paper business fell 15 percent to $86 million as improved volume, input cost relief and strong operations were offset by higher annual maintenance outages, a less profitable mix of products and pricing pressure in global paper and pulp markets.

The company’s consumer packaging unit recorded $38 million in operating profit, up 73 percent from a year before.

IP’s distribution and forest products segments, its two smallest businesses, each had gains of about a third.

Besides paying off $600 million in debt during the second quarter, IP paid down another $600 million in July, reducing to $10.3 billion the $12.7 billion the company had a year ago from buying Weyerhaeuser Co.’s packaging business.

Analysts were impressed by the company’s performance.

“They are running the company better than I have ever seen it run,” Deutsche Bank analyst Mark Wilde said.

UBS analyst Gail Glazerman, who has a “Buy” rating on the shares, called the results “encouraging in a tough environment, especially the cash generation.”

IP reduced its head count by 1,000 during the second quarter.

The company’s shares rose 35 cents, or 1.9 percent, to $18.74.

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