PART I.

ITEM 1. BUSINESS

GENERAL

International Paper Company (the “Company” or “International Paper,” which may also be referred to as “we” or “us”), is a global paper and packaging company that is complemented by an extensive North American merchant distribution system, with primary markets and manufacturing operations in the United States, Europe, South America and Asia. We are a New York corporation, incorporated in 1941 as the successor to the New York corporation of the same name organized in 1898. Our home page on the Internet is www.internationalpaper.com. You can learn more about us by visiting that site.

In the United States at December 31, 2006, the Company operated 18 pulp, paper and packaging mills, 94 converting and packaging plants, 24 wood products facilities and six specialty chemicals plants. Production facilities at December 31, 2006 in Europe, Asia, Latin America and South America included six pulp, paper and packaging mills, 51 converting and packaging plants, and five specialty chemicals plants. We distribute printing, packaging, graphic arts, maintenance and industrial products principally through over 268 distribution branches located primarily in the United States. At December 31, 2006, we owned or managed approximately 500,000 acres of forestlands in the United States, approximately 370,000 acres in Brazil and had, through licenses and forest management agreements, harvesting rights on approximately 500,000 acres of government-owned forestlands in Russia. Substantially all of our businesses have experienced, and are likely to continue to experience, cycles relating to industry capacity and general economic conditions.

For management and financial reporting purposes, our businesses are separated into six segments: Printing Papers; Industrial Packaging; Consumer Packaging; Distribution; Forest Products; and Specialty Businesses and Other. A description of these business segments can be found on pages 23 and 24 of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. A discussion of the Company’s Transformation Plan to concentrate on two key global platform businesses, Uncoated Papers (including Distribution) and Packaging, can be found on pages 33 through 35 of Item 7.

From 2002 through 2006, International Paper’s capital expenditures approximated $5.1 billion, excluding mergers and acquisitions. These expenditures reflect

our continuing efforts to improve product quality and environmental performance, lower costs and improve forestlands. Capital spending for continuing operations in 2006 was approximately $1.0 billion and is expected to be approximately $1.2 billion in 2007. This amount is about the same as our expected annual depreciation and amortization expense. You can find more information about capital expenditures on page 30 of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Discussions of acquisitions can be found on page 30 of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

You can find discussions of restructuring charges and other special items on pages 20 through 22 of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Throughout this Annual Report on Form 10-K, we “incorporate by reference” certain information in parts of other documents filed with the Securities and Exchange Commission (SEC). The SEC permits us to disclose important information by referring to it in that manner. Please refer to such information. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, along with all other reports and any amendments thereto filed with or furnished to the SEC, are publicly available free of charge on the Investor Relations section of our Internet Web site at www.internationalpaper.com as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. The information contained on or connected to our Web site is not incorporated by reference into this Form 10-K and should not be considered part of this or any other report that we filed with or furnished to the SEC.

FINANCIAL INFORMATION CONCERNING INDUSTRY SEGMENTS

The financial information concerning segments is set forth on pages 43 and 44 of Item 8. Financial Statements and Supplementary Data.

FINANCIAL INFORMATION ABOUT INTERNATIONAL AND DOMESTIC OPERATIONS

The financial information concerning international and domestic operations and export sales is set forth on page 44 of Item 8. Financial Statements and Supplementary Data.

COMPETITION AND COSTS

Despite the size of the Company’s manufacturing capacity for paper, paperboard, packaging and pulp products, the markets in all of the cited product lines are large and highly fragmented. The markets for wood and specialty products are similarly large and fragmented. There are numerous competitors, and the major markets, both U.S. and non-U.S., in which the Company sells its principal products are very competitive. These products are in competition with similar products produced by other forest products companies, and in some instances, with products produced by other industries from other materials.

Many factors influence the Company’s competitive position, including prices, costs, product quality and services. You can find more information about the impact of prices and costs on operating profits on pages 14 through 29 of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. You can find information about the Company’s manufacturing capacities on page A-3 of Appendix II.

MARKETING AND DISTRIBUTION

The Company sells paper, packaging products, building materials and other products directly to end users and converters, as well as through agents, resellers and paper distributors. We own a large merchant distribution business that sells products made both by International Paper and by other companies making paper, packaging and graphic arts supplies. Sales offices are located throughout the United States as well as internationally.

DESCRIPTION OF PRINCIPAL PRODUCTS

The Company’s principal products are described on pages 23 and 24 of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

RESEARCH AND DEVELOPMENT

The Company operates its primary research and development center at Loveland, Ohio, with smaller facilities in Savannah, Georgia, a regional center for applied forest research in Bainbridge, Georgia, and several product laboratories. Additionally, the Company has a 1/3 interest in ArborGen, LLC, a joint venture with certain other forest products and biotechnology companies. We direct research and development activities to short-term, long-term and technical assistance needs of customers and operating divisions and to process, equipment and product innovations. Activities include studies on innovation and improvement of pulping, bleaching, chemical recovery, papermaking and coating processes; packaging design and materials development; reduction of environmental discharges; re-use of raw materials in manufacturing processes; recycling of consumer and packaging paper products; energy conservation; applications of computer controls to manufacturing operations; innovations and improvement of products; and development of various new products. Our development efforts specifically address product safety as well as the minimization of solid waste. The cost to the Company of its research and development operations was $45 million in 2006, $63 million in 2005, and $67 million in 2004.

We own numerous patents, copyrights, trademarks and trade secrets relating to our products and to the processes for their production. We also license intellectual property rights to and from others where necessary. Many of the manufacturing processes are among our trade secrets. Some of our products are covered by U.S. and non-U.S. patents and are sold under well known trademarks. We derive a competitive advantage by protecting our trade secrets, patents, trademarks and other intellectual property rights, and by using them as required to support our businesses.

ENVIRONMENTAL PROTECTION

Information concerning the effects of the Company’s compliance with federal, state and local provisions enacted or adopted relating to environmental protection matters is set forth on pages 40 and 41 of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

EMPLOYEES

As of December 31, 2006, we had approximately 60,600 employees, 42,000 of whom were located in

the United States. Of the U.S. employees, approximately 27,700 are hourly, with unions representing approximately 16,300 employees. Approximately 13,000 of the union employees are represented by the United Steel Workers under individual location contracts.

During 2006, new labor agreements were ratified at four paper mills, with one paper mill, Savannah, Georgia, carrying over to be ratified in early 2007. In addition, negotiations at the Terre Haute, Indiana, mill have also been carried over into 2007. During 2007, labor agreements are scheduled to be negotiated at three additional paper mill operations including Georgetown, South Carolina; Vicksburg, Mississippi; and Riverdale, Alabama.

During 2006, 25 labor agreements were settled in non-paper mill operations. Settlements included paper converting, chemical, distribution, consumer packaging and woodlands operations. During 2007, 20 labor agreements are scheduled to be negotiated in 19 non-paper mill operations, plus eight non-paper mill contracts are carrying over from past years.

EXECUTIVE OFFICERS OF THE REGISTRANT

John V. Faraci, 57, chairman and chief executive officer since 2003. Prior to this, Mr. Faraci was president since 2003, and executive vice president and chief financial officer from 2000 to 2003. Mr. Faraci joined International Paper in 1974.

Newland A. Lesko, 61, executive vice president-manufacturing and technology since 2003. Mr. Lesko previously served as senior vice president-industrial packaging from 1998 to 2003. Mr. Lesko joined International Paper in 1967.

Marianne M. Parrs, 62, executive vice president since 1999 and chief financial officer since 2005. Ms. Parrs previously served as executive vice president-administration since 1999 responsible for information technology, investor relations, global sourcing, logistics and a large supply chain project. She continues to oversee those areas in her current role. Ms. Parrs joined International Paper in 1974.

John N. Balboni, 58, senior vice president and chief information officer since 2005. He previously served as vice president and chief information officer from 2003 to 2005, and vice president-ebusiness from 2000 to 2003. Mr. Balboni joined the Company in 1988.

Michael J. Balduino, 56, senior vice president of the Company responsible for consumer products converting business and president of the Company’s Shorewood Packaging Corp. subsidiary since 2004. Mr. Balduino joined the Company in 1992 and previously served as the Company’s senior vice president of sales and marketing from 2000 to 2003.

H. Wayne Brafford, 55, senior vice president-printing and communications papers since 2005. Previously, Mr. Brafford served as senior vice president-industrial packaging from 2003, and as vice president and general manager-converting, specialty and pulp from 1999 to 2003. Mr. Brafford joined International Paper in 1975.

Jerome N. Carter, 58, senior vice president-human resources since 1999. Since 2005, Mr. Carter is also responsible for overseeing the communications function of the Company. Mr. Carter joined International Paper in 1999.

C. Cato Ealy, 50, senior vice president-corporate development since 2003. He previously served as vice president-corporate development from 1996 to 2003. Mr. Ealy joined International Paper in 1992.

Thomas E. Gestrich, 60, senior vice president and president-IP Asia since 2005. Previously, Mr. Gestrich served as senior vice president-consumer packaging from 2001 to 2005. Prior to that, he served as vice president and general manager-beverage packaging from 1999 to 2001. Mr. Gestrich joined International Paper in 1990.

Paul Herbert, 57, senior vice president-strategic initiatives since 2005. He previously served as senior vice president-printing and communication papers from 2000 to 2005. Mr. Herbert joined International Paper in 1992.

Thomas G. Kadien, 50, senior vice president and president-xpedx since 2005. Previously, Mr. Kadien served as senior vice president-Europe from 2003 to 2005, and as vice president-commercial printing and imaging papers from 2001 to 2003. Mr. Kadien joined International Paper in 1978.

Mary A. Laschinger, 46, senior vice president since 2007 and president-IP Europe since 2005. Ms. Laschinger previously served as vice president-wood products from 2004 to 2005 and as vice president-pulp from 2001 to 2004. Prior to that, she served as the general manager-industrial papers from 1999 to 2001. Ms. Laschinger joined International Paper in 1992.

Andrew R. Lessin, 64, senior vice president-internal audit since 2002. Mr. Lessin previously served as vice

president-finance from 2000 to 2002. Mr. Lessin joined International Paper in 1977.

Maximo Pacheco, 54, senior vice president since 2005 and president-IP do Brasil since 2004. Previously, Mr. Pacheco served as senior vice president-IP do Brasil from 2003 to 2004. Prior to that, he was president-IP Latin America from 2000 to 2003. Mr. Pacheco joined International Paper in 1994.

Carol L. Roberts, 47, senior vice president-IP packaging solutions since 2005. She previously served as vice president-container of the Americas from 2000. Ms. Roberts joined International Paper in 1981.

Maura A. Smith, 51, senior vice president, general counsel and corporate secretary since 2003. Since 2005, Ms. Smith is also responsible for overseeing the public affairs function of the Company. From 1998 to 2003, she served as senior vice president, general counsel and corporate secretary of Owens Corning and, in addition, from 2000 to 2003, as chief restructuring officer of Owens Corning. Ms. Smith joined International Paper in 2003.

Robert J. Grillet, 51, vice president-finance and controller since 2003. He previously served as group senior vice president-xpedx from 2000 to 2003. Mr. Grillet joined International Paper in 1976.

RAW MATERIALS

For information on the sources and availability of raw materials essential to our business, see Item 2. Properties.

FORWARD-LOOKING STATEMENTS

Certain statements in this Annual Report on Form 10-K, and in particular, statements found in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, that are not historical in nature, may constitute forward-looking statements. These statements are often identified by the words, “will,” “may,” “should,” “continue,” “anticipate,” “believe,” “expect,” “plan,” “appear,” “project,” “estimate,” “intend,” and words of a similar nature. Such statements reflect the current views of International Paper with respect to future events and are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied in these statements. Below, we have listed specific risks and uncertainties that you should carefully read and consider. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.

ITEM 1A. RISK FACTORS

In addition to the risks and uncertainties discussed elsewhere in this Annual Report on Form 10-K (particularly in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations), or in the Company’s other filings with the Securities and Exchange Commission, the following are some important factors that could cause the Company’s actual results to differ materially from those projected in any forward-looking statement.

RISKS RELATING TO INDUSTRY CONDITIONS

CHANGES IN THE COST OR AVAILABILITY OF RAW MATERIALS AND ENERGY. We rely heavily on certain raw materials (principally wood fiber, caustic soda and polyethylene) and energy sources (principally natural gas, coal and fuel oil) in our manufacturing process. Our ability to increase earnings has been, and will continue to be, affected by changes in the costs and availability of such raw materials and energy sources. We may not be able to fully offset the effects of higher raw material or energy costs through hedging arrangements, price increases, and productivity improvements or cost reduction programs.

CHANGES IN TRANSPORTATION AVAILABILITY OR COSTS. Our business depends on the transportation of a large number of products, both domestically and internationally. In the United States, an increase in transportation rates or fuel surcharges could adversely affect our earnings, and/or a reduction in transport availability in truck and rail could negatively impact our ability to provide products to our customers in a timely manner. While we have benefited from supply-chain initiatives that reduce usage and improve transportation availability, there is no assurance that such availability can continue to be effectively managed in the future.

COMPETITION. We face intense competition, both domestically and internationally, for our products in all of our operating segments. Because our outlook depends on a forecast of our share of industry sales, an unexpected reduction in that share due to pricing or product strategies pursued by competitors could negatively impact our revenues and financial results.

PRODUCT MIX. Our results may be affected by a change in the Company’s sales mix. Our outlook assumes a certain volume mix of sales as well as a product mix of sales. If actual results vary from this projected volume and product mix of sales, our operations and our financial results could be negatively impacted.

PRICING. Our outlook assumes that we will be successful in implementing previously announced price increases as well as other price increases that we may in the future deem necessary and/or appropriate. Delays in the realization of these price increases would negatively impact our results. Moreover, price discounting, if required to maintain our competitive position and our share of industry sales, could result in lower than anticipated price realizations.

DEMAND FOR OUR PRODUCTS. Demand for our products is affected by general economic conditions in North America, Europe, Latin America and Asia. Changes in industrial non-durable goods production, consumer spending, commercial printing and advertising activity, white-collar employment levels, interest rates and currency exchange rates may adversely affect our businesses and our financial results.

RISKS RELATING TO MARKET AND ECONOMIC FACTORS

CHANGES IN CREDIT RATINGS ISSUED BY NATIONALLY RECOGNIZED STATISTICAL RATING ORGANIZATIONS. Maintaining an investment grade credit rating for our long-term debt continues to be an important element in our overall financial strategy. Our debt ratings are, from time to time, reviewed by the rating organizations and remain subject to change, and a downgrade in rating of our debt could increase our interest cost and negatively affect our earnings.

PENSION AND HEALTH CARE COSTS. Our pension and health care costs are dependent upon numerous factors resulting from actual plan experience and assumptions of future experience. Pension plan assets are primarily made up of equity and fixed income investments. Fluctuations in actual equity market returns as well as changes in general interest rates may result in increased or decreased pension costs in future periods. Likewise, changes in assumptions regarding current discount rates and expected rates of return on plan assets could also increase or decrease pension costs.

NATURAL DISASTERS. The occurrence of a natural disaster, such as a hurricane, tropical storm, earthquake, tornado, flooding or other unanticipated problems, could cause operational disruptions which could impair our profitability.

CHANGES IN INTERNATIONAL CONDITIONS. Our results could be substantially affected by foreign market risks in the countries in which we have

manufacturing facilities or sell our products. Specifically, Brazil, Russia, Poland and China, where substantial manufacturing facilities exist, are countries that are exposed to economic and political instability in their respective regions of the world. Downturns in economic activity, adverse foreign tax consequences or any change in social, political or labor conditions in any of these countries or regions could negatively affect our financial results.

CHANGES IN CURRENCY EXCHANGE RATES. We are impacted by the movement of various currencies relative to the U.S. dollar. From time to time, we may hedge a portion of the risk from our transactions and commitments denominated in non-U.S. dollar currencies when we deem it appropriate to do so. There can, however, be no assurance that we will be able to fully protect ourselves against substantial foreign currency fluctuations.

RISKS RELATING TO THE COMPANY’S TRANSFORMATION PLAN

THE ABILITY TO SUCCESSFULLY EXECUTE SALES TRANSACTIONS CURRENTLY UNDER CONTRACT. The Company’s ability to successfully execute sales transactions under contract (including contracts executed pursuant to the Transformation Plan) and to realize the anticipated sales proceeds is dependent upon many factors, including the ability to successfully consummate the transactions without a purchase price adjustment, the successful fulfillment (or waiver) of all conditions set forth in the sales agreements, and the successful closing of the transactions within the estimated timeframes.

THE ABILITY TO INVEST PROCEEDS WITH ATTRACTIVE FINANCIAL RETURNS. The Company will selectively seek attractive investment opportunities for a portion of the proceeds from divestitures. The Company may be unable to identify and negotiate acceptable investments with attractive returns.

ABILITY TO REALIZE ANTICIPATED PROFIT IMPROVEMENT FROM THE TRANSFORMATION PLAN. The profitability of the Company’s two platform businesses, uncoated papers (including distribution) and packaging, is subject to variable demand and the Company’s ability to execute internal profit improvement initiatives, including ongoing manufacturing, supply chain and overhead cost reduction initiatives, as well as volume/mix improvements. There can be no assurance that profit improvements will be achieved.

RISKS RELATING TO LEGAL PROCEEDINGS AND COMPLIANCE COSTS

UNANTICIPATED EXPENDITURES RELATED TO THE COST OF COMPLIANCE WITH ENVIRONMENTAL AND OTHER GOVERNMENTAL REGULATIONS. Our operations are subject to significant regulation by federal, state and local environmental and safety authorities, both domestically and internationally. There can be no assurance that the costs of compliance with existing and new regulations will not require significant capital expenditures, or that existing reserves for specific matters will, if regulations change, be adequate to cover future unanticipated costs.

RESULTS OF LEGAL PROCEEDINGS. The costs and other effects of pending litigation against the Company cannot be determined with certainty. Although the disclosure in Item 3. Legal Proceedings contains management’s current views of the impact such litigation will have on our financial results, there can be no assurance that the outcome of such proceedings will be as expected.

This discussion of uncertainties is by no means exhaustive, but is designed to highlight important factors that may impact our outlook. Obvious general economic factors throughout the world (such as inflation, a sudden drop in consumer or business confidence, or an unexpected collapse in stock markets) do not warrant further discussion, but are noted to further emphasize the many contingencies that may cause our actual results to differ from those currently anticipated.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

FORESTLANDS

The principal raw material used by International Paper is wood in various forms. As of December 31, 2006, the Company or its subsidiaries owned or managed approximately 500,000 acres of forestlands in the United States, approximately 370,000 acres in Brazil, and had, through licenses and forest management agreements, harvesting rights on approximately 500,000 acres of government-owned forestlands in Russia. During 2006, in conjunction with the Company’s Transformation Plan, approximately 5.6 million acres of forestlands in the United States were sold under various agreements, principally in October and November, for proceeds

totaling approximately $6.6 billion of cash and notes. A further discussion of these sales transactions can be found on page 21 of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, and on page 65 of Item 8. Financial Statements and Supplementary Data.

During 2006, the Company’s U.S. forestlands supplied 10.2 million tons of roundwood to its U.S. facilities, representing approximately 17% of its wood fiber requirements. The balance of our fiber requirements came from residual chips supplied by our Wood Products operations, other roundwood and chips purchased from other suppliers, and from other private industrial and nonindustrial forestland owners, with an insignificant amount coming from public lands of the U.S. government. In addition, in 2006, 3.4 million tons of wood from our forestlands were sold to other users. In 2007, the Company expects that approximately 65% of its fiber requirements will come from roundwood, with over 80% purchased on the open market and less than 20% obtained under existing fiber supply agreements. The remaining 35% of our fiber requirements will come from wood chips obtained from other suppliers and other private and nonindustrial forestland owners and through chip supply agreements.

MILLS AND PLANTS

A listing of our production facilities, the vast majority of which we own, can be found in Appendix I hereto, which is incorporated herein by reference.

The Company’s facilities are in good operating condition and are suited for the purposes for which they

are presently being used. We continue to study the economics of modernization or adopting other alternatives for higher cost facilities.

CAPITAL INVESTMENTS AND DISPOSITIONS

Given the size, scope and complexity of our business interests, we continually examine and evaluate a wide variety of business opportunities and planning alternatives, including possible acquisitions and sales or other dispositions of properties. You can find a discussion about the level of planned capital investments for 2007 on page 33, and dispositions and restructuring activities as of December 31, 2006, on pages 20 through 22, of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, and on pages 59 through 67 of Item 8. Financial Statements and Supplementary Data.

ITEM 3. LEGAL PROCEEDINGS

Information concerning the Company’s legal proceedings is set forth on pages 40 and 41 of Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, and on pages 69 through 73 of Item 8. Financial Statements and Supplementary Data.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 2006.

PART II.

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Dividend per share data on the Company’s common stock and the high and low sales prices for the Company’s common stock for each of the four quarters in 2006 and 2005 are set forth on page 89 of Item 8. Financial Statements and Supplementary

Data. The Company’s common shares are traded on the following exchanges: New York, Swiss and Amsterdam. International Paper options are traded on the Chicago Board of Options Exchange. As of February 23, 2007, there were approximately 23,669 record holders of common stock of the Company.

The table below presents information regarding the Company’s purchase of its equity securities for the time periods presented.

PERFORMANCE GRAPH

The performance graph shall not be deemed to be “soliciting material” or to be “filed” with the Commission or subject to Regulation 14A or 14C, or to the liabilities of Section 18 of the Securities Exchange Act of 1934, as amended.

The following graph compares a $100 investment in Company stock on December 31, 2001 with a $100 investment in each of our ROI Peer Group and the S&P 500 also made on December 31, 2001. The graph portrays total return, 2001–2006, assuming reinvestment of dividends.

ITEM 6. SELECTED FINANCIAL DATA

FINANCIAL GLOSSARY

Current ratio—

current assets divided by current liabilities.

Total debt to capital ratio—

long-term debt plus notes payable and current maturities of long-term debt divided by long-term debt, notes payable and current maturities of long-term debt, minority interest and total common shareholders’ equity.

Return on equity—

net earnings divided by average common shareholders’ equity (computed monthly).

Return on investment—

the after-tax amount of earnings from continuing operations before interest and minority interest divided by the average of total assets minus accounts payable and accrued liabilities (computed monthly).

FOOTNOTES TO FIVE-YEAR FINANCIAL SUMMARY

2006:

2005:

2004:

2003:

2002:

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

EXECUTIVE SUMMARY

International Paper’s operating results in 2006 benefited from strong gains in pricing and sales volumes and lower operating costs. Our average paper and packaging prices in 2006 increased faster than our costs for the first time in four years. The improvement in sales volumes reflects increased uncoated papers, corrugated box, coated paperboard and European papers shipments, as well as improved revenues from our xpedx distribution business. Our manufacturing operations also made solid cost reduction improvements. Lower interest expense, reflecting debt repayments in 2005 and 2006, was also a positive factor. Together, these improvements more than offset the effects of continued high raw material and distribution costs, lower real estate sales, higher net corporate expenses and lower contributions from businesses and forestlands divested during 2006.

Looking forward to 2007, we expect seasonally higher sales volumes in the first quarter. Average paper price realizations should continue to improve as we implement previously announced price increases in Europe and Brazil. Input costs for energy, fiber and chemicals are expected to be mixed, although slightly higher in the first quarter. Operating results will benefit from the recently completed International Paper/Sun Paperboard joint ventures in China and the addition of the Luiz Antonio paper mill to our operations in Brazil. However, primarily as a result of lower real estate sales in the first quarter, we anticipate earnings from continuing operations will be somewhat lower than in the 2006 fourth quarter.

Significant steps were also taken in 2006 in the execution of the Company’s Transformation Plan. We completed the sales of our U.S. and Brazilian Coated Papers businesses and 5.6 million acres of U.S. forestlands, and announced definitive sale agreements for our Kraft Papers, Beverage Packaging and Arizona Chemical businesses and a majority of our Wood Products business, all expected to close during 2007. Through December 31, 2006, we have received approximately $9.7 billion of the estimated proceeds from divestitures announced under this plan of approximately $11.3 billion, with the balance to be received as the remaining divestitures are completed in the first half of 2007. We have strengthened our balance sheet by

reducing debt by $6.2 billion, and returned value to our shareholders by repurchasing 39.7 million shares of our common stock for approximately $1.4 billion. We made a $1.0 billion voluntary contribution to our U.S. qualified pension fund. We have identified selective reinvestment opportunities totaling approximately $2.0 billion, including opportunities in China, Brazil and Russia. Finally, we remain focused on our three-year $1.2 billion target for non-price profitability improvements, with $330 million realized during 2006. While more remains to be done in 2007, we have made substantial progress toward achieving the objectives announced at the outset of the Plan in July 2005.

Results of Operations

Industry segment operating profits are used by International Paper’s management to measure the earnings performance of its businesses. Management believes that this measure allows a better understanding of trends in costs, operating efficiencies, prices and volumes. Industry segment operating profits are defined as earnings before taxes and minority interest, interest expense, corporate items and corporate special items. Industry segment operating profits are defined by the Securities and Exchange Commission as a non-GAAP financial measure, and are not GAAP alternatives to net income or any other operating measure prescribed by accounting principles generally accepted in the United States.

International Paper operates in six segments: Printing Papers, Industrial Packaging, Consumer Packaging, Distribution, Forest Products and Specialty Businesses and Other.

The following table shows the components of net earnings (loss) for each of the last three years:

Industry segment operating profits of $2.1 billion were $452 million higher in 2006 than in 2005 due principally to the benefits from higher average prices ($476 million), higher sales volumes ($143 million), and cost reduction initiatives, improved operating performance and a more favorable product mix ($187 million), which more than offset the impacts of higher energy and raw material costs ($101 million), lower earnings from land sales ($27 million), higher distribution costs ($113 million), reduced earnings due to the sale of the Coated and Supercalendered Papers business and loss of harvest income from our divested forestlands ($53 million), and other items ($60 million).

Segment Operating Profits

(in millions)

The principal changes in operating profits by segment were as follows:

Corporate items, net, of $746 million of expense in 2006 were higher than the $607 million of expense in 2005 and $477 million of expense in 2004 due to higher pension expenses, benefits-related expenses and supply chain initiative costs, partially offset by lower inventory-related costs.

Corporate special items, including gains on sales of forestlands, restructuring and other charges, losses on sales and impairments of businesses, impairments of goodwill, insurance recoveries and reversals of reserves no longer required, increased to a gain of $2.4 billion from an expense of $134 million in 2005 and an expense of $141 million in 2004. The increase in 2006 principally reflects $4.8 billion of gains on the sales of forestlands included in our Transformation Plan, partially offset by $1.4 billion of net charges related to the divestiture of certain operations, principally the U.S. Coated and Supercalendered Papers business, and $759 million of goodwill impairment charges.

Interest expense, net, of $521 million in 2006 decreased from $595 million in 2005 and $712 million in 2004 reflecting lower average debt balances from repayments made under the Company’s Transformation Plan and lower interest rates from debt refinancings and repayments. Additionally, the 2006 total includes a pre-tax credit of $6 million for interest received from the Canadian government on refunds of prior-year softwood lumber duties. Interest expense, net, in 2005 includes a pre-tax credit of $43 million related to an agreement reached with the Internal Revenue Service concerning the Company’s 1997 through 2000 federal income tax audits, and a pre-tax credit of $11 million related to the collection of a note receivable from the 2001 sale of the Flexible Packaging business.

The 2006 income tax provision of $1.9 billion consists of $1.6 billion of deferred taxes (principally reflecting deferred taxes on the 2006 Transformation Plan forestland sales) and a $0.3 billion current tax provision. The tax provision also includes an $11 million charge related to 2006 special tax adjustment items. The $407 million benefit in 2005 included a $454 million tax benefit related to 2005 special tax adjustment items. The tax provision of $114 million in 2004 included $32 million of expense related to special items. See “Income Taxes” on page 19 for a further discussion of these items.

Discontinued Operations

In the first quarter of 2006, management determined that the future sale of the Kraft Papers business was in the best interest of the Company’s shareholders. A definitive agreement to sell this business was signed during the second quarter. In the third quarter, International Paper completed the sale of its Brazilian Coated Papers business. During the fourth quarter, International Paper determined that the sales of its Beverage Packaging and Wood Products businesses were in the best interests of the shareholders. A definitive agreement to sell its Beverage Packaging business was announced during the quarter, and the Company announced two separate definitive agreements to sell 13 lumber mills and five wood products plants.

During the 2005 third quarter, International Paper completed the sale of the Carter Holt Harvey Limited business. During 2004, International Paper completed the sale of its Weldwood of Canada Limited business in the fourth quarter.

As a result of these actions, the operating results of these businesses and the associated gains/losses on the sales are reported in discontinued operations for all periods presented.

Liquidity and Capital Resources

For the year ended December 31, 2006, International Paper generated $1.0 billion of cash flow from continuing operations, compared with $1.2 billion in 2005. The 2006 amount is net of a $1.0 billion voluntary pension plan cash contribution. Capital spending from continuing operations for the year totaled $1.0 billion, or 87% of depreciation and amortization expense. We repaid approximately $5.2 billion of debt during the year, including various higher coupon-rate debt, that will result in lower interest charges in future years. Our liquidity position remains strong, supported by

approximately $3.0 billion of unused, committed credit facilities that we believe are adequate to meet future short-term liquidity requirements. Maintaining an investment grade credit rating for our long-term debt continues to be an important element in our overall financial strategy.

Our focus in 2007 will be to continue to maximize our financial flexibility and preserve liquidity.

Capital spending for 2007 is targeted at $1.2 billion, or about equal to estimated depreciation and amortization.

Critical Accounting Policies and Significant Accounting Estimates

Accounting policies that may have a significant effect on our reported results of operations and financial position, and that can require judgments by management in their application, include accounting for contingent liabilities, impairments of long-lived assets and goodwill, pensions and postretirement benefit obligations and income taxes.

In recent years, the assumption estimates used for pensions have resulted in increases in reported pension charges. Pension expenses for our U.S. plans increased to $377 million in 2006 from $243 million in 2005 due principally to a change in the mortality assumption and the use of a lower assumed discount rate. A decrease of approximately $182 million is expected in 2007, reflecting earnings on the $1.0 billion voluntary cash contribution made by the Company in 2006 and an increase in the assumed discount rate. Our pension funding policy continues to be, at a minimum, to fully fund actuarially determined costs, generally equal to the minimum amounts required by the Employee Retirement Income Security Act (ERISA). Unless changes are made to our funding policy, it is unlikely that any contributions to our U.S. qualified plan will be required in 2007.

Legal

An analysis of significant litigation activity is included in Note 10 of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data.

CORPORATE OVERVIEW

While the operating results for International Paper’s various business segments are driven by a number of business-specific factors, changes in International Paper’s operating results are closely tied to changes in general economic conditions in the United States,

Europe, South America and Asia. Factors that impact the demand for our products include industrial non-durable goods production, consumer spending, commercial printing and advertising activity, white-collar employment levels and movements in currency exchange rates.

Product prices tend to follow general economic trends, and are also affected by inventory levels, currency movements and changes in worldwide operating rates. In addition to these revenue-related factors, net earnings are impacted by various cost drivers, the more significant of which include changes in raw material costs, principally wood fiber and chemical costs; energy costs; salary and benefits costs, including pensions; and manufacturing conversion costs.

The following is a discussion of International Paper’s results of operations for the year ended December 31, 2006, and the major factors affecting these results compared to 2005 and 2004.

RESULTS OF OPERATIONS

For the year ended December 31, 2006, International Paper reported net sales of $22.0 billion, compared with $21.7 billion in 2005 and $20.7 billion in 2004. International net sales (including U.S. exports) totaled $5.6 billion, or 25% of total sales in 2006. This compares to international net sales of $5.3 billion in 2005 and 2004.

Full year 2006 net income totaled $1.1 billion ($2.18 per share), compared with net income of $1.1 billion ($2.21 per share) in 2005 and a net loss of $35 million ($0.07 per share) in 2004. Amounts include the results of discontinued operations.

Earnings from continuing operations after taxes in 2006 were $1.3 billion, compared with $684 million in 2005 and $238 million in 2004. However, included in earnings from continuing operations in 2006 was an incremental benefit of $292 million compared with 2005 from the special items discussed on pages 20 through 22. Excluding this benefit, earnings in 2006 were $306 million higher than in 2005. This increase was driven by higher average prices, improved sales volumes, favorable operating performance, benefits from cost reduction initiatives and improved mix, lower net interest expense and the incremental benefit from special items. These favorable items more than offset the impact of higher average raw material costs, lower earnings from land sales, higher Corporate expenses (including pensions), higher distribution costs, reduced earnings due to the sale of the Coated and Supercalendered Papers business, the loss of harvest income from our divested forestlands and higher tax expense.

See Industry Segment Results on pages 24 through 29 for a discussion of the impact of these factors by segment.

Earnings From Continuing Operations

(after tax, in millions)

The following table presents a reconciliation of International Paper’s net earnings (loss) to its total industry segment operating profit:

Discontinued Operations

2006: In 2006, after-tax charges totaling $317 million were recorded for net losses on sales or impairments of businesses reported as Discontinued operations.

During the fourth quarter of 2006, the Company entered into an agreement to sell its Beverage Packaging business to Carter Holt Harvey Limited for approximately $500 million, subject to certain adjustments. The sale of the North American Beverage Packaging operations subsequently closed on January 31, 2007, with the sale of the remaining non-U.S. operations expected to close later in the 2007 first quarter. Also during the fourth quarter, the

Company entered into separate agreements for the sale of 13 lumber mills for approximately $325 million, expected to close in the first quarter of 2007, and five wood products plants for approximately $237 million, expected to close in the first half of 2007, both subject to various adjustments at closing. Based on the commitments to sell these businesses, management determined that the accounting requirements for treatment as discontinued operations were met. As a result, net pre-tax charges of $18 million ($11 million after taxes) for the Beverage Packaging business and $104 million ($69 million after taxes) for the Wood Products business (including $58 million for pension and postretirement benefit termination benefits) were recorded in the fourth quarter as discontinued operations charges to adjust the carrying value of these businesses to their estimated fair values less costs to sell.

During the third quarter of 2006, management had determined that there was a current expectation that, more likely than not, the Beverage Packaging and Wood Products businesses would be sold. Based on the resulting impairment testing, pre-tax impairment charges of $115 million ($82 million after taxes) and $165 million ($165 million after taxes) were recorded to reduce the carrying values of the net assets of the Beverage Packaging and Wood Products businesses, respectively, to their estimated fair values. Also during the 2006 third quarter, International Paper completed the sale of its interests in a Beverage Packaging operation in Japan for a pre-tax gain of $12 million ($3 million after taxes), and the sale of its Brazilian Coated Papers business for approximately $420 million, subject to certain post-closing adjustments. As the Company had determined that the accounting requirements for reporting the Brazilian Coated Papers business as a discontinued operation were met, the resulting $100 million pre-tax gain ($79 million after taxes) was recorded as a gain on sale of a discontinued operation.

During the first quarter of 2006, the Company determined that the accounting requirements for reporting the Kraft Papers business as a discontinued operation were met. Accordingly, a $100 million pre-tax charge ($61 million after taxes) was recorded to reduce the carrying value of the net assets of this business to their estimated fair value. During the 2006 second quarter, the Company signed a definitive agreement to sell this business for approximately $155 million in cash, subject to certain closing and post-closing adjustments, and two additional payments totaling up to $60 million payable five years from the date of closing, contingent upon

business performance. A $16 million pre-tax charge ($11 million after taxes) was recorded during the second quarter to further reduce the carrying value of the assets of the Kraft Papers business based on the terms of this definitive agreement. The sale of this business was subsequently completed on January 2, 2007.

Additionally during the fourth quarter, a $38 million pre-tax credit ($23 million after taxes) was included in earnings from discontinued operations for refunds received from the Canadian government of duties paid by the Company’s former Weldwood of Canada Limited business.

2005: During the 2005 third quarter, the sale of the Company’s majority share of Carter Holt Harvey Limited (CHH) was completed resulting in a $361 million after-tax gain. This amount is included in gain on sale of discontinued operations.

2004: In the fourth quarter of 2004, International Paper sold its Weldwood of Canada Limited (Weldwood) business for approximately $1.1 billion. As a result of the sale, a $323 million pre-tax loss on the sale ($711 million after taxes) was recorded as a loss on sale of discontinued operations. In the 2004 second quarter, a $90 million discontinued operations gain after taxes and minority interest was recorded from the sale of the Carter Holt Harvey Tissue business.

Prior-period results for all periods presented have been restated to present the operating results of these businesses as earnings from discontinued operations.

Income Taxes

The Company recorded an income tax provision for 2006 of $1.9 billion, consisting of a $1.6 billion deferred tax provision (principally reflecting deferred taxes on the 2006 Transformation Plan forestland sales) and a $300 million current tax provision. The tax provision also included an $11 million provision for special item tax adjustments. Excluding the impact of special items, the tax provision was $272 million, or 29% of pre-tax earnings before minority interest.

An income tax benefit of $407 million was recorded in 2005 including a $454 million benefit related to special tax adjustment items, consisting of a tax benefit of $627 million resulting from an agreement reached with the U.S. Internal Revenue Service concerning the 1997 through 2000 U.S. federal income tax audit, a $142 million charge for deferred

taxes related to earnings repatriations under the American Jobs Creation Act of 2004 and $31 million of other tax charges. Excluding the impact of special items, the tax benefit was $83 million, or 20% of pre-tax earnings before minority interest.

The income tax provision for 2004 was $114 million, or 30% of pre-tax earnings from continuing operations before minority interest. This included a $32 million tax provision related to an adjustment of deferred tax balances. Excluding the impact of special items, the tax provision was $98 million, or 19% of pre-tax earnings before minority interest.

The higher income tax rate of 29% in 2006 reflects a higher proportion of earnings in higher tax rate jurisdictions.

Corporate Items and Interest Expense

Minority interest expense, net of taxes, was $17 million in 2006, compared with $9 million in 2005 and $24 million in 2004. The increase in 2006 reflects the Company’s acquisition of the Moroccan box plants in the fourth quarter of 2005, and the formation of the International Paper & Sun Cartonboard Co., Ltd. joint ventures in the fourth quarter of 2006. The decrease in minority interest from 2004 reflects a reduction related to preferred securities that were replaced by debt obligations in 2004.

Interest expense, net, of $521 million includes a pre-tax credit of $6 million for interest received from the Canadian government on refunds of prior-year softwood lumber duties. Interest expense, net, for 2005 of $595 million includes a pre-tax credit of $43 million for interest related to the agreement reached with the U.S. Internal Revenue Service concerning the Company’s 1997 through 2000 U.S. federal income tax audits, and a pre-tax credit of $11 million related to the collection of a note receivable from the 2001 sale of the Flexible Packaging business. Excluding special items, interest expense, net, of $527 million in 2006 decreased from $649 million in 2005 and $712 million in 2004 reflecting lower average debt balances and lower interest rates due to debt refinancings and repayments.

For the twelve months ended December 31, 2006, corporate items totaled $746 million of expense, compared with $607 million in 2005 and $477 million in 2004. The increased expenses in 2006 compared with both 2005 and 2004 are due to higher pension expenses, benefits-related expenses and supply chain initiative costs, partially offset by lower inventory-related costs.

Special Items

Restructuring and Other Charges

International Paper continually evaluates its operations for improvement opportunities targeted to (a) focus our portfolio on our core businesses, (b) rationalize and realign capacity to operate fewer facilities with the same revenue capability and close high cost facilities, and (c) reduce costs. Annually, strategic operating plans are developed by each of our businesses to demonstrate that they will achieve a return at least equal to their cost of capital over an economic cycle. If it subsequently becomes apparent that a facility’s plan will not be achieved, a decision is then made to (a) invest additional capital to upgrade the facility, (b) shut down the facility and record the corresponding charge, or (c) evaluate the expected recovery of the carrying value of the facility to determine if an impairment of the asset value of the facility has occurred under SFAS No. 144. In recent years, this policy has led to the shutdown of a number of facilities and the recording of significant asset impairment charges and severance costs. It is possible that additional charges and costs will be incurred in future periods in our core businesses should such triggering events occur.

2006: During 2006, total restructuring and other charges of $300 million before taxes ($184 million after taxes) were recorded. These charges included:

Earnings also included a $19 million pre-tax credit ($12 million after taxes) for net insurance recoveries related to the hardboard siding and roofing litigation, a $6 million pre-tax credit ($3 million after taxes) for

the reversal of reserves no longer required, and a $6 million pre-tax credit ($4 million after taxes) for interest received from the Canadian government on refunds of prior-year softwood lumber duties.

2005: During 2005, Corporate restructuring and other charges of $285 million before taxes ($175 million after taxes) were recorded. These charges included:

Additionally, pre-tax restructuring charges totaling $55 million ($38 million after taxes) were recorded in business segment operating results.

Also recorded were pre-tax credits of $258 million ($151 million after taxes) for net insurance recoveries related to the hardboard siding and roofing litigation and a $4 million pre-tax credit ($3 million after taxes) for the net adjustment of previously provided reserves.

2004: During 2004, restructuring and other charges of $164 million before taxes ($102 million after taxes) were recorded. These charges included:

In addition, credits of $123 million before taxes ($76 million after taxes) for insurance recoveries related to the hardboard siding and roofing litigation and $35 million before taxes ($21 million after taxes) for the net reversal of restructuring reserves no longer needed were recorded.

A further discussion of restructuring, business improvement and other charges can be found in Note 6 of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data.

Gain on Sale of Forestlands

During 2006, in connection with the previously announced Transformation Plan, the Company completed sales totaling approximately 5.6 million acres of forestlands for proceeds of approximately $6.6 billion, including $1.8 billion in cash and $4.8 billion of installment notes supported by irrevocable letters of credit. The first of these transactions in the second quarter included approximately 76,000 acres sold for cash proceeds of $97 million, resulting in a pre-tax gain of $62 million. During the third quarter, 476,000 acres of forestlands were sold for $401 million, including $265 million in cash and $136 million of installment notes, resulting in a pre-tax gain of $304 million. Finally, in the fourth quarter, the Company completed sales of 5.1 million acres of forestlands for $6.1 billion, including $1.4 billion in cash and $4.7 billion of installment notes, resulting in pre-tax gains totaling $4.4 billion. These transactions represent a permanent reduction in the Company’s forestland asset base and are not a part of the normal, ongoing operations of the Forest Resources business. Thus, the net gains resulting from these sales totaling approximately $4.8 billion are separately presented in the accompanying consolidated statement of operations under the caption Gain on sale of forestlands.

Impairments of Goodwill

During the fourth quarter of 2006, in connection with annual goodwill impairment testing, charges of $630 million and $129 million were recorded to write down the carrying values of goodwill of the Company’s coated paperboard and Shorewood packaging businesses, respectively, based on the estimated fair values of these businesses determined using projected future operating cash flows.

Net Losses on Sales and Impairments of Businesses

Net losses on sales and impairments of businesses included in Corporate special items totaled $1.4 billion in 2006, $111 million in 2005 and $135 million in 2004. The principal components of these gains/losses were:

2006: During the fourth quarter of 2006, a charge of $21 million before and after taxes was recorded for losses on sales and impairments of businesses. This charge included a pre-tax loss of $18 million ($6 million after taxes) relating to the sale of certain box plants in the United Kingdom and Ireland, and $3 million of pre-tax charges (a $6 million credit after taxes) for other small asset sales.

During the third quarter of 2006, a net pre-tax gain of $61 million ($38 million after taxes) was recorded for gains (losses) on sales and impairments of businesses. This net gain included the recognition of a previously deferred $110 million pre-tax gain ($68 million after taxes) related to a 2004 sale of forestlands in Maine, a pre-tax charge of $38 million ($23 million after taxes) to reflect the completion of the sale of the Company’s Coated and Supercalendered Papers business in the 2006 third quarter, and a net pre-tax loss of $11 million ($7 million after taxes) related to other smaller sales.

During the second quarter of 2006, a pre-tax charge of $138 million ($90 million after taxes) was recorded, including a pre-tax charge of $85 million ($52 million after taxes) recorded to adjust the carrying value of the assets of the Company’s Coated and Supercalendered Papers business to their estimated fair value based on the terms of a definitive sales agreement signed in the second quarter, a pre-tax charge of $52 million ($37 million after taxes) recorded to reduce the carrying value of the assets of the Company’s Amapa wood products operations in Brazil to their estimated fair value based on estimated sales proceeds since a sale of these assets, which was completed in the third quarter, was considered more likely than not at June 30, 2006, and a net charge of $1 million before and after taxes related to other smaller items.

During the first quarter of 2006, a charge of $1.3 billion before and after taxes was recorded to write down the assets of the Company’s Coated and Supercalendered Papers business to their estimated fair value, as management had committed to a plan to sell this business. In addition, other pre-tax charges totaling $3 million ($2 million after taxes) were recorded to adjust estimated losses of certain smaller operations that are held for sale.

At the end of the 2006 first quarter, the Company had reported its Coated and Supercalendered Papers business as a discontinued operation based on a plan to sell the business. In the second quarter of 2006, the Company signed a definitive agreement to sell this business for approximately $1.4 billion,

subject to certain post-closing adjustments, and agreed to acquire a 10 percent limited partnership interest in CMP Investments L.P., the company that will own this business. Since this limited partnership interest represents significant continuing involvement in the operations of this business under U.S. generally accepted accounting principles, the operating results for Coated and Supercalendered Papers were required to be included in continuing operations in the accompanying consolidated statement of operations. Accordingly, the operating results for this business, including the charge in the first quarter of $1.3 billion to write down the assets of the business to their estimated fair value, are now included in continuing operations for all periods presented.

Additionally during the fourth quarter, a $128 million pre-tax impairment charge ($84 million after taxes) was recorded to reduce the carrying value of the fixed assets of the Company’s Saillat mill in France (included in the Printing Papers segment) to their estimated fair value, and in the third quarter, a pre-tax gain of $13 million ($6 million after taxes) was recorded related to a sale of property in Spain (included in the Industrial Packaging segment).

2005: In the fourth quarter of 2005, a pre-tax charge of $46 million ($30 million after taxes) was recorded for adjustments of losses of businesses held for sale, principally $45 million to write down the carrying value of the Company’s Polyrey business in France to its estimated net realizable value.

In the second quarter of 2005, a net pre-tax credit of $19 million ($12 million after taxes) was recorded, including a $25 million credit before taxes ($15 million after taxes) from the collection of a note receivable from the 2001 sale of the Flexible Packaging business and final charges related to the sales of Fine Papers and Industrial Papers. In addition, interest income of $11 million before taxes ($7 million after taxes) was collected on the Flexible Packaging business note, which is included in Interest expense, net.

During the first quarter of 2005, International Paper had announced an agreement to sell its Fine Papers business to Mohawk Paper Mills, Inc. of Cohoes, New York. A $24 million pre-tax loss ($13 million after taxes) was recorded in the first quarter to write down the net assets of the Fine Papers business to their estimated net realizable value. The sale of Fine Papers was completed in the second quarter of 2005.

Also during the first quarter of 2005, International Paper announced that it had signed an agreement to

sell its Industrial Papers business to an affiliate of Kohlberg and Company, LLC. A $49 million pre-tax loss ($35 million after taxes) was recorded in the first quarter to write down the net assets of the Industrial Papers business and related corporate assets to their estimated net realizable value. The sale of Industrial Papers was completed in the second quarter of 2005.

Also in 2005, pre-tax charges totaling $11 million ($7 million after taxes) were recorded to adjust previously estimated gains/losses of businesses previously sold.

2004: In December 2004, International Paper committed to plans for the sale in 2005 of its Fine Papers business and its Maresquel mill and Papeteries de France distribution business in Europe. As a result, charges of $11 million before taxes ($8 million after taxes), $34 million before and after taxes, and $11 million before taxes ($12 million after taxes), respectively, were recorded to write down the assets of these entities to their estimated fair values less costs to sell. In October 2004, International Paper sold two box plants located in China to International Paper Pacific Millennium, resulting in a pre-tax loss of $14 million ($4 million after taxes).

In the third quarter of 2004, International Paper signed an agreement to sell Scaldia Papier B.V., and its subsidiary, Recom B.V. in the Netherlands, to Stora Enso for approximately $36 million in cash. This sale was completed in the third quarter and resulted in a loss of $34 million (no impact from taxes or minority interest). In addition, a $4 million loss (no impact from taxes or minority interest) was recorded to adjust the estimated loss on sale of Papeteries de Souche L.C. in France. This sale was completed in the second quarter of 2005 for approximately $14 million in proceeds.

In the second quarter of 2004, a $27 million loss before and after taxes was recorded to write down the assets of Papeteries de Souche L.C. in France to their estimated realizable value.

In addition, a $4 million loss before taxes ($2 million after taxes) was recorded to write down the assets of Food Pack S.A. in Chile to their estimated realizable value (included in the Consumer Packaging segment).

Industry Segment Operating Profits

Industry segment operating profits of $2.1 billion in 2006 improved from both the $1.6 billion in 2005 and the $1.7 billion in 2004. The benefits of significantly

higher sales price realizations ($476 million), increased sales volumes including the impact of reduced lack-of-order downtime in our U.S. containerboard, coated paperboard and uncoated papers businesses ($143 million), the favorable impacts of cost reduction initiatives, improved operating performance and a more favorable product mix ($187 million) and other items ($15 million) were partially offset by higher energy, wood and other raw material costs ($101 million), higher freight costs ($113 million), lower earnings from forestland and real estate sales ($27 million) and an impairment charge to reduce the carrying value of the fixed assets at the Saillat, France mill ($128 million).

Lack-of-order downtime in 2006 totaled approximately 155,000 tons, compared with 830,000 tons in 2005 and 70,000 tons in 2004, as the Company adjusted production in line with customer demand. The 2005 total included approximately 290,000 tons related to uncoated paper machines at our mills in Pensacola, Florida; Jay, Maine; and Bastrop, Louisiana; that were permanently closed in the fourth quarter of 2005.

Looking forward to the first quarter of 2007, we expect operating profits to be lower than in the 2006 fourth quarter, principally due to lower earnings from real estate sales. Sales volumes should be seasonally better in the quarter, and average price realizations are expected to improve as previously announced paper price increases in Europe and Brazil, and for containerboard in the U.S., are implemented. Input costs for energy, wood and chemicals will be mixed, but should average slightly higher in the first quarter. The first quarter will benefit from contributions from our recent International Paper/Sun coated paperboard joint ventures in China, and earnings from the Luiz Antonio operations in Brazil acquired during the quarter.

DESCRIPTION OF INDUSTRY SEGMENTS

International Paper’s industry segments discussed below are consistent with the internal structure used to manage these businesses. All segments are differentiated on a common product, common customer basis consistent with the business segmentation generally used in the Forest Products industry.

Printing Papers

International Paper is one of the world’s leading producers of printing and writing papers. Products in this segment include uncoated and coated papers, market pulp and uncoated bristols.

UNCOATED PAPERS: This business produces papers for use in desktop and laser copiers and digital imaging printing as well as in advertising and promotional materials such as brochures, pamphlets, greeting cards, books, annual reports and direct mail publications. Uncoated papers also produces a variety of grades that are converted by our customers into envelopes, tablets, business forms and file folders. Uncoated papers are sold under private label and International Paper brand names that include Hammermill, Springhill, Williamsburg, Postmark, Accent, Great White, Ballet and Rey. The mills producing uncoated papers are located in the United States, Scotland, France, Poland and Russia. These mills have uncoated paper production capacity of approximately 5.4 million tons annually.

COATED PAPERS: This business produces coated papers used in a variety of printing and publication end uses such as catalogs, direct mailings, magazines, inserts and commercial printing. Products include coated free sheet, coated groundwood and supercalendered groundwood papers. This business was sold in the third quarter of 2006.

MARKET PULP: Market pulp is used in the manufacture of printing, writing and specialty papers, towel and tissue products and filtration products. Pulp is also converted into products such as diapers and sanitary napkins. Pulp products include fluff and southern softwood pulp, as well as northern, southern and birch hardwood paper pulps. These products are produced in the United States, France, Poland and Russia, and are sold around the world. International Paper facilities have annual dried pulp capacity of about 1.2 million tons.

BRAZILIAN PAPER: Brazilian operations function through International Paper do Brasil, Ltda, which owns or manages approximately 370,000 acres of forestlands in Brazil. Our annual production capacity in Brazil is approximately 435,000 tons of uncoated papers.

Industrial Packaging

INDUSTRIAL PACKAGING: With a world-wide production capacity of about 4.9 million tons annually, International Paper is the third largest manufacturer of containerboard in the United States. Over one-third of our production consists of specialty grades, such as BriteTop. About 70% of our production is converted domestically into corrugated boxes and other packaging by our 65 U.S. container plants. In Europe, our operations include one recycled containerboard mill in France and 22 container plants in France, Italy, Spain, Turkey and Morocco. In Asia, our operations include eight container plants in China and one container plant in Thailand. Our container plants are supported by regional design centers, which offer total packaging solutions and supply chain initiatives. Unbleached Kraft Papers, with an annual capacity of 405,000 tons, was sold on January 2, 2007.

Consumer Packaging

CONSUMER PACKAGING: Our coated paperboard business produces high quality coated paperboard for a variety of packaging and commercial printing end uses. Our Everest^®, Fortress^®, and Starcote^® brands are used in packaging applications for everyday products such as food, cosmetics, pharmaceuticals, computer software and tobacco products. Our Carolina^® brand is used in commercial printing end uses such as greeting cards, paperback book covers, lottery tickets, direct mail and point-of-purchase advertising. International Paper is the world’s largest producer of solid bleached sulfate board with annual U.S. production capacity of about 1.9 million tons. Mills producing coated board in Poland, Russia and China complement our U.S. capacity, uniquely positioning us to provide value-added, innovative products for global customers.

Shorewood Packaging Corporation utilizes emerging technologies in 18 facilities worldwide to produce world-class packaging with high-impact graphics for a variety of markets, including home entertainment, tobacco, cosmetics, general consumer and pharmaceuticals. Our Foodservice business offers cups, lids, bags, food containers and plates through three domestic plants and six international facilities.

Distribution

Through xpedx, our North American merchant distribution business, we provide distribution services and products to a number of customer markets, including the commercial printer with printing papers and graphic art supplies; the building services

and away-from-home markets with facility supplies; manufacturers with packaging supplies and equipment; and to a growing number of customers, we exclusively provide distribution capabilities including warehousing and delivery services. xpedx is the leading wholesale distribution marketer in these customer and product segments in North America, operating 126 warehouse locations and 142 retail stores in the U.S. and Mexico.

Forest Products

FOREST RESOURCES: International Paper owns or manages approximately 500,000 acres of forestlands in the United States, mostly in the South. All lands are independently third-party certified under the operating standards of the Sustainable Forestry Initiative (SFI^TM). As part of the Company’s Transformation Plan, approximately 5.6 million acres of forestlands were sold in 2006. Our remaining forestlands are managed as a portfolio to optimize the economic value to our shareholders. Most of our portfolio represents properties that are likely to be sold to investors and other buyers for various uses or held for real estate development.

Specialty Businesses and Other

CHEMICALS: Arizona Chemical is a leading producer of specialty resins based on crude tall oil, a byproduct of the wood pulping process. These products, used in adhesives and inks, are made at 11 plants in the United States and Europe. This business is currently subject to a definitive sale agreement expected to close in the first quarter of 2007.

Products and brand designations appearing in italics are trademarks of International Paper or one of its affiliates.

INDUSTRY SEGMENT RESULTS

Printing Papers

Demand for Printing Papers products is closely correlated with changes in commercial printing and advertising activity, direct mail volumes and, for uncoated cut-size products, with changes in white-collar employment levels that affect the usage of copy and laser printer paper. Market pulp is further affected by changes in currency rates that can enhance or disadvantage producers in different geographic regions. Principal cost drivers include manufacturing efficiency and raw material and energy costs.

PRINTING PAPERS net sales for 2006 decreased 3% from both 2005 and 2004 due principally to the sale of the U.S. coated papers business in August 2006. However, operating profits in 2006 were 43% higher than in 2005 and 33% higher than in 2004. Compared with 2005, earnings improved for U.S. uncoated papers, market pulp and European Papers, but this was partially offset by earnings declines in Brazilian papers. Benefits from higher average sales price realizations in the United States, Europe and Brazil ($284 million), improved manufacturing operations ($73 million), reduced lack-of-order downtime ($41 million), higher sales volumes in Europe ($23 million), and other items ($65 million) were partially offset by higher raw material and energy costs ($109 million), higher freight costs ($45 million) and an impairment charge to reduce the carrying value of the fixed assets at the Saillat, France mill ($128 million). Compared with 2004, higher earnings in 2006 in the U.S. uncoated papers, market pulp and coated papers businesses were offset by lower earnings in the European and Brazilian papers businesses. The printing papers segment took 555,000 tons of downtime in 2006, including 150,000 tons of lack-of-order downtime to align production with customer demand. This compared with 970,000 tons of total downtime in 2005, of which 520,000 tons related to lack-of-orders.

U.S. UNCOATED PAPERS net sales in 2006 were $3.5 billion, compared with $3.2 billion in 2005 and $3.3 billion in 2004. Sales volumes increased in 2006 over 2005, particularly in cut-size paper and printing papers. Average sales price realizations increased significantly, reflecting benefits from price increases announced in late 2005 and early 2006. Lack-of-order downtime declined from 450,000 tons in 2005 to 40,000 tons in 2006, reflecting firm market demand and the impact of the permanent closure of three uncoated freesheet machines in 2005. Operating earnings in 2006 more than doubled compared with both 2005 and 2004. The benefits of improved average sales price realizations more than offset higher input costs for freight, wood and energy, which were all above 2005 levels. Mill operations were favorable compared with 2005 due to current-year improvements in machine performance, lower labor, chemical and energy consumption costs, as well as approximately $30 million of charges incurred in 2005 for machine shutdowns.

U.S. COATED PAPERS net sales were $920 million in 2006, $1.6 billion in 2005 and $1.4 billion in 2004. Operating profits in 2006 were 26% lower than in 2005. A small operating loss was reported for the business in 2004. This business was sold in the third quarter of 2006. During the first two quarters of 2006, sales volumes were up slightly versus 2005. Average sales price realizations for coated freesheet paper and coated groundwood paper were higher than in 2005, reflecting the impact of previously announced price increases. However, input costs for energy, wood and other raw materials increased over 2005 levels. Manufacturing operations were favorable due to higher machine efficiency and mill cost savings.

U.S. MARKET PULP sales in 2006 were $509 million, compared with $526 million and $437 million in 2005 and 2004, respectively. Sales volumes in 2006 were down from 2005 levels, primarily for paper and tissue pulp. Average sales price realizations were higher in 2006, reflecting higher average prices for fluff pulp and bleached hardwood and softwood pulp. Operating earnings increased 30% from 2005 and more than 100% from 2004 principally due to the impact of the higher average sales prices. Input costs for wood and energy were higher in 2006 than in 2005. Manufacturing operations were unfavorable, driven primarily by poor operations at our Riegelwood, North Carolina mill.

BRAZILIAN PAPER net sales for 2006 of $496 million were higher than the $465 million in 2005 and the $417 million in 2004. The sales increase in 2006 reflects higher sales volumes than in 2005, particularly for uncoated freesheet paper, and a strengthening of the Brazilian currency versus the U.S. dollar. Average sales price realizations improved in 2006, primarily for uncoated freesheet paper and wood chips. Despite higher net sales, operating profits for 2006 of $122 million were down from $134 million in 2005 and $166 million in 2004, due principally to incremental costs associated with an extended mill outage in Mogi Guacu to convert to an elemental-chlorine-free bleaching process, to rebuild the primary recovery boiler, and for other environmental upgrades.

EUROPEAN PAPERS net sales in 2006 were $1.5 billion, compared with $1.4 billion in 2005 and $1.5 billion in 2004. Sales volumes in 2006 were higher than in 2005 at our Eastern European mills due to stronger market demand. Average sales price realizations increased in 2006 in both Eastern and Western European markets. Operating earnings in 2006 rose 20% from 2005, but were 15% below 2004 levels. The improvement in 2006 compared with 2005

reflects the contribution from higher net sales, partially offset by higher input costs for energy, wood and freight.

Entering 2007, earnings in the first quarter are expected to improve compared with the 2006 fourth quarter due primarily to reduced manufacturing costs reflecting the completion of the mill optimization project in Brazil in the fourth quarter. Sales volumes are expected to be seasonally better in the U.S. uncoated paper and market pulp businesses, but seasonally weaker in the Russian paper business. Average sales price realizations should improve as we continue to implement previously announced price increases in Europe and Brazil, although U.S. average price realizations are expected to remain flat. Wood costs are anticipated to be higher due to supply difficulties in the winter months, and energy costs will be mixed. The first-quarter 2007 acquisition of the Luiz Antonio mill in Brazil will provide incremental earnings. During 2007, the Pensacola, Florida mill will be converted to produce containerboard, reducing future U.S. production capacity for uncoated freesheet paper.

Industrial Packaging

Demand for Industrial Packaging products is closely correlated with non-durable industrial goods production in the United States, as well as with demand for processed foods, poultry, meat and agricultural products. In addition to prices and volumes, major factors affecting the profitability of Industrial Packaging are raw material and energy costs, manufacturing efficiency and product mix.

INDUSTRIAL PACKAGING net sales for 2006 increased 6% compared with 2005 and 8% compared with 2004. Operating profits in 2006 were 82% higher than in 2005 and 7% higher than in 2004. Benefits from improved price realizations ($156 million), sales volume increases ($29 million), a more favorable mix ($21 million), reduced market related downtime ($25 million) and strong mill performance ($43 million) were partially offset by the effects of higher raw material costs ($12 million), higher freight costs ($48 million), higher converting operations costs ($21 million) and other costs ($26 million). In addition, a gain of $13 million was recognized in 2006 related to a sale of property in Spain. The segment took 135,000 tons of downtime in 2006, none of which was market-related, compared with 370,000 tons of downtime in 2005, which included 230,000 tons of lack-of-order downtime.

U.S. CONTAINERBOARD net sales for 2006 were $955 million, compared with $895 million in 2005 and $950 million for 2004. Average sales price realizations in the first quarter of 2006 began the year below first-quarter 2005 levels, but improved significantly during the second quarter and were higher than in 2005 for the remainder of the year. Sales volumes were higher throughout 2006. Operating profits in 2006 were more than double 2005 levels, and 68% higher than in 2004. The favorable impacts of the higher average sales price realizations, higher sales volumes, reduced lack-of-order downtime and strong mill performance were only partially offset by higher input costs for freight, chemicals and energy.

U.S. CONVERTING OPERATIONS net sales totaled $2.8 billion in 2006, $2.6 billion in 2005 and $2.3 billion in 2004. Sales volumes throughout the year in 2006 were above 2005 levels, reflecting solid market demand for boxes and packaging solutions. In the first two quarters of 2006, margins were favorable compared with the prior year as average sales prices outpaced containerboard cost increases, but average margins began to decline in the third quarter as containerboard increases outpaced the increase in box prices. Operating profits in 2006 decreased 72% from 2005 and 86% from 2004 levels, primarily due to higher distribution, utility and raw material costs, and inventory adjustment charges.

EUROPEAN CONTAINER net sales for 2006 were $1.0 billion, compared with $883 million in 2005 and $865 million in 2004. The increase was principally due to contributions from the Moroccan box plants acquired in the fourth quarter of 2005, although sales volumes for the rest of the business were also slightly higher. Operating profits in 2006 were up 31% compared with 2005 and 6% compared with 2004. This increase included a $13 million gain on the sale of property in Spain as well as the increased contributions from the Moroccan acquisition, partially offset by higher energy costs.

INTERNATIONAL PAPER DISTRIBUTION LIMITED, our Asian box and containerboard business, had net sales for 2006 of $182 million. In 2005, net sales were $104 million subsequent to International Paper’s acquisition of a majority interest in August 2005. This business generated a small operating profit in 2006, compared with a small loss in 2005.

Earnings for the first quarter of 2007 are expected to be lower than in the fourth quarter of 2006. Containerboard export sales volumes are expected to decline due to scheduled first-quarter maintenance outages. Sales volumes for U.S. converted products will be higher due to more shipping days, but expected softer demand should cause the shipments per day to decrease. Average sales price realizations are expected to be comparable to fourth-quarter averages. An additional containerboard price increase was announced in January that is expected to be fully realized in the second quarter. Costs for wood, energy, starch, adhesives and freight are expected to increase. Manufacturing costs will be higher due to costs associated with scheduled maintenance outages in the containerboard mills. European Container operating results are expected to improve as seasonally higher sales volumes and improved margins more than offset slightly higher manufacturing costs.

Consumer Packaging

Demand and pricing for Consumer Packaging products correlate closely with consumer spending and general economic activity. In addition to prices and volumes, major factors affecting the profitability of Consumer Packaging are raw material and energy costs, manufacturing efficiency and product mix.

CONSUMER PACKAGING net sales increased 9% compared with 2005 and 7% compared with 2004. Operating profits rose 8% from 2005, but declined 15% from 2004 levels. Compared with 2005, higher sales volumes ($9 million), improved average sales price realizations ($33 million), reduced lack-of-order downtime ($18 million), and favorable mill operations ($25 million) were partially offset by higher raw material costs ($19 million) and freight costs ($21 million), unfavorable mix ($14 million) and other costs ($21 million).

COATED PAPERBOARD net sales of $1.5 billion in 2006 were higher than $1.3 billion in 2005 and $1.1 billion in 2004. Sales volumes increased in 2006 compared with 2005, particularly in the folding carton board segment, reflecting improved demand for coated paperboard products. In 2006, our coated paperboard mills took 4,000 tons of lack-of-order downtime, compared with 82,000 tons of lack-of-order downtime in 2005. Average sales price

realizations were substantially improved in the current year, principally for folding carton board and cupstock board. Operating profits were 51% higher in 2006 than in 2005, and 7% better than in 2004. The impact of the higher sales prices along with more favorable manufacturing operations due to strong performance at the mills more than offset higher input costs for energy and freight.

FOODSERVICE net sales declined to $396 million in 2006, compared with $437 million in 2005 and $480 million in 2004, due principally to the sale of the Jackson, Tennessee plant in July 2005. Sales volumes were lower in 2006 than in 2005, although average sales prices were higher due to the realization of price increases implemented during 2005. Operating profits for 2006 improved over 2005 and 2004 levels largely due to the benefits from higher sales prices. Raw material costs for bleached board were higher than in 2005, but manufacturing costs were more favorable due to increased productivity and reduced waste.

SHOREWOOD net sales of $670 million were down from $691 million in 2005 and $687 million in 2004. Sales volumes in 2006 were down from 2005 levels due to weak demand in the home entertainment and consumer products markets, although demand was strong in the tobacco segment. Average sales prices for the year were lower than in 2005. Operating profits were down significantly from both 2005 and 2004 due to the decline in sales, particularly in the higher margin home entertainment markets, higher raw material costs for bleached board and certain inventory adjustment costs.

Entering 2007, coated paperboard first-quarter sales volumes are expected to be seasonally stronger than in the fourth quarter 2006 for folding carton board and bristols. Average sales price realizations are expected to rise with a price increase announced in January. It is anticipated that manufacturing costs will improve versus an unfavorable fourth quarter. Foodservice earnings for the first quarter of 2007 are expected to decline due to seasonally weaker volume. However, sales price realizations will be slightly higher, and the seasonal switch to hot cup containers will have a favorable impact on product mix. Shorewood sales volumes for the first quarter of 2007 are expected to seasonally decline, but the earnings impact will be partially offset by pricing improvements and an improved product mix.

Distribution

Our Distribution business, principally represented by our xpedx business, markets a diverse array of products and supply chain services to customers in

many business segments. Customer demand is generally sensitive to changes in general economic conditions, although the commercial printing segment is also dependent on corporate advertising and promotional spending. Providing customers with the best choice and value in both products and supply chain services is a key competitive factor. Additionally, efficient customer service, cost-effective logistics, and focused working capital management are key factors in this segment’s profitability.

DISTRIBUTION 2006 net sales increased 6% from 2005 and 12% from 2004. Operating profits in 2006 were 52% higher than in 2005 and 47% higher than in 2004. Sales volumes rose for all segments, but were particularly strong for packaging and facility supplies. Average sales prices also increased in all segments. The improvement in operating results reflects the higher revenues and improvements in operating expenses resulting from facility realignments and cost reduction actions begun in the second half of 2005 designed to increase the ongoing efficiency of the xpedx distribution system.

Looking ahead to the first quarter of 2007, earnings are expected to be comparable to strong 2006 fourth- quarter results. Sales volumes should experience a slight seasonal decline, but operating expense improvements should lead to comparable operating profits.

Forest Products

Forest Products currently manages approximately 500,000 acres of forestlands in the United States. Forest Resources operating results have historically been largely driven by demand and pricing for softwood sawtimber, and to a lesser extent for softwood pulpwood, by the volume of merchantable timber harvested from Company forestlands, and by demand and pricing for specific forestland tracts offered for sale. With the significant decline in forestlands acreage in 2006, future operations will primarily consist of retail forestland and real estate sales.

FOREST RESOURCES sales in 2006 decreased 23% from 2005 and 13% from 2004. Operating profits were down 6% from 2005, but were up 25% from 2004. As part of the Company’s announced Transformation Plan, 5.6 million acres of forestland were sold in 2006, primarily in the fourth quarter, resulting in a significant decline in forestland acreage. The Company intends to focus future operations on maximizing proceeds from the sale of the remaining forestlands.

Operating profits from stumpage sales and recreational income were $222 million in 2006, compared with $269 million in 2005 and $281 million in 2004, reflecting the significant reduction in acreage in the fourth quarter. Operating profits from forestland sales were $447 million in 2006, compared with $400 million in 2005 and $315 million in 2004. Operating expenses decreased to $115 million from $146 million in 2005 and $178 million in 2004, reflecting the continuing effects of restructuring efforts and cost reduction initiatives. Operating profits for the Real Estate division, which principally sells higher-and-better-use properties, were $124 million, $198 million and $124 million in 2006, 2005 and 2004, respectively.

Looking forward to 2007, operating results will be significantly impacted by the forestlands sold in 2006. Earnings from harvest and recreation income

will no longer be significant contributors to business operating results, while expenses should also decline significantly reflecting the reduced level of operations. Operating earnings will primarily consist of retail forestland and real estate sales of remaining acreage.

Specialty Businesses and Other

The Specialty Businesses and Other segment includes the results of the Arizona Chemical business and certain divested businesses whose results are included in this segment for periods prior to their sale or closure.

This segment’s 2006 net sales increased 2% from 2005, but declined 17% from 2004. Operating profits in 2006 were up substantially from both 2005 and 2004. The decline in sales compared with 2004 principally reflects declining contributions from businesses sold or closed.

ARIZONA CHEMICAL sales were $769 million in 2006, compared with $692 million in 2005 and $672 million in 2004. Sales volumes declined in 2006 compared with 2005, but average sales price realizations in 2006 were higher in both the United States and Europe. Operating earnings in 2006 were significantly higher than in 2005 and more than 49% higher than in 2004. The increase over 2005 reflects the impact of the higher average sales price realizations and lower manufacturing costs, partially offset by higher prices for crude tall oil (CTO). Earnings for 2005 also included a $13 million charge related to a plant shutdown in Norway.

Other businesses in this operating segment include operations that have been sold, closed or held for sale, primarily the Polyrey business in France and, in prior years, the European Distribution business. Sales for these businesses were approximately $166 million in 2006, compared with $223 million in 2005 and $448 million in 2004.

In December 2006, the Company entered into a definitive agreement to sell the Arizona Chemical business, expected to close in the first quarter of 2007.

LIQUIDITY AND CAPITAL RESOURCES

Overview

A major factor in International Paper’s liquidity and capital resource planning is its generation of operating cash flow, which is highly sensitive to changes in the pricing and demand for our major products. While changes in key cash operating costs, such as energy and raw material costs, do have an effect on operating cash generation, we believe that our strong focus on cost controls has improved our cash flow generation over an operating cycle.

As part of the continuing focus on improving our return on investment, we have focused our capital spending on improving our key paper and packaging businesses both globally and in North America. Spending levels have been kept below the level of depreciation and amortization charges for each of the last three years, and we anticipate spending will again be slightly below depreciation and amortization in 2007.

Financing activities in 2006 have been focused on the Transformation Plan objective of strengthening the balance sheet through repayment of debt, resulting in a net reduction in 2006 of $5.2 billion following a $1.7 billion net reduction in 2005. Additionally, we made a $1.0 billion voluntary cash contribution to our U.S. qualified pension plan in December 2006 to begin satisfying projected long-term funding requirements and to lower future pension expense. Our liquidity position continues to be strong, with approximately $3.0 billion of committed liquidity to cover future short-term cash flow requirements not met by operating cash flows.

Management believes it is important for International Paper to maintain an investment-grade credit rating to facilitate access to capital markets on favorable terms. At December 31, 2006, the Company held long-term credit ratings of BBB (stable outlook) and Baa3 (stable outlook) from Standard & Poor’s and Moody’s Investor Services, respectively.

Cash Provided by Operations

Cash provided by continuing operations totaled $1.0 billion for 2006, compared with $1.2 billion for 2005 and $1.7 billion in 2004. The 2006 amount is net of a $1.0 billion voluntary cash pension plan contribution made in the fourth quarter of 2006. The major components of cash provided by continuing operations are earnings from continuing operations

adjusted for non-cash income and expense items and changes in working capital. Earnings from continuing operations, adjusted for non-cash items and excluding the pension contribution, increased by $584 million in 2006 versus 2005. This compared with a decline of $63 million for 2005 over 2004.

International Paper’s investments in accounts receivable and inventory less accounts payable and accrued liabilities, totaled $997 million at December 31, 2006. Cash used for these working capital components increased by $354 million in 2006, compared with a $558 million increase in 2005 and a $117 million increase in 2004. The increase in 2006 was principally due to decreases in accounts payable and accrued liabilities.

Investment Activities

Investment activities in 2006 included $1.8 billion of net cash proceeds received from divestitures, $1.6 billion of net cash proceeds received from the sale of U.S. forestlands under the Company’s Transformation Plan, and $1.1 billion of deposits made to pre-fund project development costs for a pulp mill project in Brazil.

Capital spending from continuing operations was $1.0 billion in 2006, or 87% of depreciation and amortization, comparable to $992 million, or 78% of depreciation and amortization in 2005, and $925 million, or 73% of depreciation and amortization in 2004.

The following table presents capital spending from continuing operations by each of our business segments for the years ended December 31, 2006, 2005 and 2004.

We expect capital expenditures in 2007 to be about $1.2 billion, or about equal to estimated depreciation and amortization. We will continue to focus our future capital spending on improving our key platform businesses in North America and on investments in geographic areas with strong growth opportunities.

Acquisitions

In October and November 2006, International Paper paid approximately $82 million for a 50% interest in the International Paper & Sun Cartonboard Co., Ltd. joint venture that currently operates two coated paperboard machines in Yanzhou City, China. In December 2006, a 50% interest was acquired in a second joint venture, Shandong International Paper & Sun Coated Paperboard Co., Ltd., for approximately $28 million. This joint venture was formed to construct a third coated paperboard machine, expected to be completed in the first quarter of 2009. The operating results of these consolidated joint ventures did not have a material effect on the Company’s 2006 consolidated results of operations.

On July 1, 2004, International Paper completed the acquisition of all of the outstanding common and preferred stock of Box USA Holdings, Inc. (Box USA) for approximately $189 million in cash and a $15 million 6% note payable issued to Box USA’s controlling shareholders. In addition, International Paper assumed approximately $197 million of debt, approximately $193 million of which was repaid by July 31, 2004. The operating results of Box USA are included in the accompanying consolidated financial statements from that date.

Other Acquisitions

In October 2005, International Paper acquired approximately 65% of Compagnie Marocaine des Cartons et des Papiers (CMCP), a leading Moroccan corrugated packaging company, for approximately $80 million in cash plus assumed debt of approximately $40 million.

In 2001, International Paper and Carter Holt Harvey Limited (CHH) had each acquired a 25% interest in International Paper Pacific Millennium Limited (IPPM). IPPM is a Hong Kong-based distribution and packaging company with operations in China and other Asian countries. On August 1, 2005, pursuant to an existing agreement, International Paper purchased a 50% third-party interest in IPPM (now renamed International Paper Distribution Limited) for $46 million to facilitate possible further growth in Asia. Finally, in May 2006, the Company purchased the remaining 25% from CHH interest for $21 million.

Each of the above acquisitions was accounted for using the purchase method. The operating results of these acquisitions have been included in the consolidated statement of operations from the dates of acquisition.

Financing Activities

2006: Financing activities during 2006 included debt issuances of $223 million and retirements of $5.4 billion, for a net debt reduction of $5.2 billion.

In December 2006, International Paper used proceeds of $2.2 billion to retire notes with interest rates ranging from 3.8% to 10.0% and original maturities from 2008 to 2029. Also in the fourth quarter of 2006, International Paper Investments (Luxembourg) S.ar.l, a wholly-owned subsidiary of International Paper, repaid $343 million of long-term debt with an interest rate of LIBOR plus 40 basis points and a maturity date in November 2010.

In August 2006, International Paper used approximately $320 million of cash to repay its maturing 5.375% euro-denominated notes that were designated as a hedge of euro functional currency net investments. Other debt activity in the third quarter included the repayments of $143 million of 7.875% notes and $96 million of 7% debentures, all maturing within the quarter.

In June 2006, International Paper paid approximately $1.2 billion to repurchase substantially all of its zero-coupon convertible debentures at a price equal to their accreted principal value plus interest, using proceeds from divestitures and $730 million of third-party commercial paper issued under the Company’s receivables securitization program. At December 31, 2006, International Paper had repaid all of the commercial paper borrowed under this program.

In February 2006, International Paper repurchased $195 million of 6.4% debentures with an original maturity date of February 2026. Other reductions in the first quarter of 2006 included early payment of approximately $495 million of notes with coupon rates ranging from 4.0% to 8.875% and original maturities from 2007 to 2029.

International Paper utilizes interest rate swaps to change the mix between fixed and variable rate debt and to manage interest expense. At December 31, 2006, International Paper had interest rate swaps with a total notional amount of $2.2 billion with maturities ranging from one to 10 years. In 2006, these swaps increased the weighted average cost of debt from 6.05% to an effective rate of 6.18%. The inclusion of the offsetting interest income from short-term investments reduced this effective rate to 4.95%.

Other financing activity in 2006 included the repurchase of 39.7 million shares of International

Paper common stock for approximately $1.4 billion, and the issuance of 2.8 million shares under various incentive plans, including stock option exercises that generated $32 million of cash.

2005: Financing activities during 2005 included debt issuances of $1.0 billion and retirements of $2.7 billion, for a net debt and preferred securities reduction of $1.7 billion.

In November and December 2005, International Paper Investments (Luxembourg) S.ar.l., a wholly-owned subsidiary of International Paper, issued $700 million of long-term debt with an initial interest rate of LIBOR plus 40 basis points that can vary depending upon the credit rating of the Company, and a maturity date in November 2010. Additionally, the subsidiary borrowed $70 million under a bank credit agreement with an initial interest rate of LIBOR plus 40 basis points that can vary depending upon the credit rating of the Company, and a maturity date in November 2006.

In December 2005, International Paper used proceeds from the above borrowings, and from the sale of CHH in the third quarter of 2005, to repay approximately $190 million of notes with coupon rates ranging from 3.8% to 10% and original maturities from 2008 to 2029.

In September 2005, International Paper used some of the proceeds from the CHH sale to repay the remaining $250 million portion of a subsidiary’s $650 million long-term debt with an interest rate of LIBOR plus 62.5 basis points and a maturity date of June 2007, and $312 million of commercial paper that had been issued in the same quarter. Other reductions in the third quarter of 2005 included $662 million of notes with coupon rates ranging from 4% to 7.35% and original maturities from 2009 to 2029, and the repayment of $150 million of 7.10% notes with a maturity date of September 2005.

In June 2005, International Paper repaid approximately $400 million of a subsidiary’s long-term debt with an interest rate of LIBOR plus 62.5 basis points and a maturity date of June 2007.

In February 2005, the Company redeemed the outstanding $464 million aggregate principal amount of International Paper Capital Trust 5.25% convertible subordinated debentures at 100.5% of par plus accrued interest, and made early payments of approximately $295 million on notes with coupon rates ranging from 4% to 7.875% and original maturities from 2006 to 2015.

Other financing activity in 2005 included the repatriation of $900 million of cash in the fourth quarter and $1.2 billion of cash in the second quarter from certain of International Paper’s foreign subsidiaries, and the issuance of approximately 3.0 million common shares under various incentive plans, including stock option exercises that generated $23 million of cash.

2004: Financing activities during 2004 included debt issuances of $2.5 billion and retirements of $4.2 billion, including repayments of $193 million of debt assumed in the Box USA acquisition in July, and approximately $340 million of debt that was reclassified from Minority interest in 2004 prior to repayment. Excluding these repayments, the net reduction in debt during 2004 was approximately $1.0 billion.

In December 2004, Timberlands Capital Corp. II, a former wholly-owned consolidated subsidiary of International Paper, redeemed $170 million of 4.5% preferred securities. In August 2004, International Paper repurchased $168 million of limited partnership interests in Georgetown Equipment Leasing Associates, L.P. and Trout Creek Equipment Leasing, L.P. Both of these securities had been reclassified from Minority interest to Current maturities of long-term debt prior to their repayment.

Also in August 2004, an International Paper wholly- owned subsidiary issued 500 million euro-denominated long-term debt (equivalent to approximately $619 million at issuance) with an initial interest rate of EURIBOR plus 55 basis points and a maturity in August 2009.

In June 2004, an International Paper wholly-owned subsidiary issued $650 million of long-term debt with an interest rate of LIBOR plus 62.5 basis points and a maturity date of June 2007, which refinanced $650 million of long-term debt having an interest rate of LIBOR plus 100 basis points and a maturity date in August 2004. In April 2004, $1.0 billion of 8.125% coupon rate debt was retired using the proceeds from the March 2004 issuance of $400 million of 5.25% notes due in April 2016 and $600 million of 4.00% notes due in April 2010.

In January 2004, approximately $1.0 billion of debt with an 8.05% blended coupon rate was retired, including all of the outstanding $805 million principal amount of International Paper Capital Trust III 7.875% preferred securities, using the proceeds from the two December 2003 issuances of $500 million each of notes.

In addition to the preceding repayments, various other International Paper borrowings totaling approximately $1.0 billion were repaid in 2004.

Other financing activity in 2004 included the issuance of approximately 3.6 million treasury shares and 2.3 million common shares under various incentive plans, including stock option exercises that generated $164 million of cash.

Dividend payments totaled $485 million in 2006, $490 million in 2005 and $485 million in 2004. The International Paper common stock dividend remained at $1.00 per share during the three-year period.

Common shareholders’ equity decreased by $388 million during 2006, principally reflecting repurchases of common stock ($1.4 billion) and payments of dividends ($485 million), partially offset by net earnings for the year ($1.1 billion) and the change in cumulative foreign currency translation adjustment ($220 million).

Cash and temporary investments totaled $1.6 billion at both December 31, 2006 and 2005.

Off-Balance Sheet Variable Interest Entities

During 2006 in connection with the sale of approximately 5.6 million acres of forestlands under the Company’s Transformation Plan, the Company exchanged installment notes totaling approximately $4.8 billion and approximately $400 million of International Paper promissory notes for interests in entities formed to monetize the notes. International Paper determined that it was not the primary beneficiary of these entities, and therefore its investments should be accounted for under the equity method of accounting. During 2006, these entities acquired an additional $4.8 billion of International Paper debt securities for cash, resulting in a total of approximately $5.2 billion of International Paper debt obligations held by these entities at December 31, 2006. Since International Paper has, and intends to affect, a legal right to offset its obligations under these debt instruments with its investments in the entities, International Paper has offset $5.0 billion of interest in the entities against $5.0 billion of International Paper debt obligations held by the entities.

International Paper also holds variable interests in two financing entities that were used to monetize long-term notes received from sales of forestlands in 2002 and 2001.

See Note 8 of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data for a further discussion of these transactions.