International Paper Company

Good morning and thank you for standing by. Welcome to today's International Paper Third Quarter 2021 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. To ask a question, please press star 1 on your telephone keypad. To withdraw your question, press the pound key. I would now like to turn the conference over to Guillermo Gutierrez, Vice President, Investor Relations. Please go ahead, sir.

Thank you, Angie. Good morning, and thank you for joining International Paper's third quarter 2021 earnings call. Our speakers this morning are Mark Sutton, Chairman and Chief Executive Officer, and Tim Nichols, Senior Vice President and Chief Financial Officer. There is important information at the beginning of our presentations on slide two, including certain legal disclaimers. For example, during today's call, we will make forward-looking statements that are subject to risks and uncertainties. We will also present certain non-U.S. GAAP financial information. A reconciliation of those figures to U.S. GAAP financial measures is available on our website. Our website also contains copies of the third quarter 2021 earnings press release and today's presentation slides. Lastly, relative to the ULM joint venture, slide two provides context around the joint venture's financial information and statistical measures. I will now turn the call over to Mark Sutton.

Thank you, Guillermo, and good morning, everyone. We will begin our discussion on slide three. In the third quarter, international paper grew revenue, earnings, and margins, and we continue to generate strong cash from operations. We continue to see strong demand for corrugated packaging and solid demand for absorbent pulp. We're making strong progress on price realization from our prior increases. Having said that, the supply chain and input cost environment remains very challenging, and it impacted our results much more than we anticipated. The widespread supply chain constraints limited our ability to capture the full opportunity that comes with a strong level of demand that we're seeing. Our mills performed well. However, stretched supply chains impacted volume in our industrial packaging and global cellulose fibrous businesses. Container board inventories in our packaging network improved in the latter part of the third quarter, and we are in a much better position as we enter the seasonally strong fourth quarter. Input costs in the third quarter rose by about $230 million, or 46 cents per share, which was more than two times what we had anticipated, with cost pressure in just about every category. Our Illum joint venture delivered another strong performance with equity earnings of $95 million. On capital allocation, we continue to make significant progress, strengthening our balance sheet, In the third quarter, we reduced debt by $235 million. I would also highlight that our pension plan is fully funded. This is a significant milestone that further strengthens the company. In the third quarter, we also returned $411 million to our shareholders, including $212 million of share repurchases. On October 1st, we completed the spinoff of the printing papers business. IP received a $1.4 billion payment from Silvamo, and we retained a 19.9% interest in the new company, which we intend to monetize within one year. The teams did an outstanding job executing the transaction in a very challenging environment. The printing papers business delivered a strong performance in the third quarter, and we wish Silvamo all the best as they move forward as a standalone company. We are laser-focused on strengthening the company and building a better IP for all of our stakeholders. Tim and I will share more about the progress we're making during today's discussion. Turning now to slide four, we delivered EBITDA of $938 million and free cash flow of $519 million in the third quarter, which brings our free cash flow nearly $1.6 billion year-to-date. Revenue increased by nearly $600 million, or 12%, when compared to last year. And if we exclude the printing papers business, third quarter revenue grew by 14% as compared to last year. We also expanded our margins in the third quarter with realization of our prior price increases. We expect continued margin expansion in the fourth quarter. I will now turn it over to Jim to cover our business performance and our fourth quarter outlook. Kim?

Thanks, Mark. Moving to the quarter-over-quarter earnings bridge on slide five, third quarter operating earnings per share were $1.35 as compared to $1.06 in the second quarter. Price and mix improved by 43 cents per share with strong price realization across the three businesses. Volume decreased sequentially. Supply chain constraints limited our ability to capture the full benefit of a strong demand backdrop. We replenished our container board inventories in the latter part of the third quarter, which positions us well entering the seasonally strong fourth quarter. In our cellulose fibers business, demand for absorbent pulp is solid. Our pulp shipments were constrained due to significant port congestion, and our backlogs remained stretched. Our mills performed well. Operating costs benefited by about $35 million of one-time items, including the sale of nitrogen credits and insurance recovery related to the winter storm earlier this year. Supply chains are stretched, and transportation costs are elevated for both inbound materials and outbound shipments. Every mode of transportation is tight, and we expect the transportation environment to remain tight for the foreseeable future. Maintenance costs decreased as expected. Input cost rose by 46 cents per share, or about $230 million, which is more than double what we had anticipated for the quarter. Higher fiber and energy costs accounted for about 80% of this increase. Corporate expenses were essentially flat. Tax expense was lower by 4 cents per share in the third quarter, with an effective tax rate of 18% as compared to 21% in the second quarter. Most of this was related to adjustments to our federal tax provision after finalizing our 2020 tax return in the third quarter. Equity earnings were lowered sequentially following the final monetization of our stake in GPK in the second quarter. Turning to the segments, I'll start with industrial packaging on slide six. We're seeing strong demand across all channels, including boxes, sheets, and container boards. Third quarter shipment across our U.S. channels improved by 1.3% year over year. However, box shipments were hampered by low container board inventories and stretched supply chains. We successfully replenished inventories across our box system in the latter part of the third quarter, which puts us in a much better inventory position as we enter the seasonally strong fourth quarter. We expect supply chains to remain stretched for the foreseeable future, which requires us to carry more inventory given the slower velocity across our network. To put the velocity into context, our middle to box plant container board supply chain is currently running three to four days longer than our normalized flow, and in some lanes, even longer. Taking a look at third quarter performance, price and mix was strong. Our March increase is essentially fully implemented with $128 million of price realization in the third quarter. Volume was lower by $45 million. Box shipments in North America were impacted by low container board inventory, especially in the first half of the quarter. Volume in EMEA was seasonally slower, as expected, representing about $10 million of a sequential decrease. Operations and costs were essentially flat sequentially. Our mill system performed at 100% and provided much-needed inventory relief to our box system. In the third quarter, we also received insurance proceeds of about $15 million related to the winter storm. These benefits were largely offset by unplanned maintenance costs. We are not seeing any relief on supply chain costs and are managing risk associated with transportation capacity and congestion across the rail and truck networks. Input costs increased by nearly $190 million in the quarter. OCC and wood fiber accounted for $120 million of that total. Energy accounted for another $45 million, primarily in our recycled container board mills and our box plants. Taking a closer look at fiber, our North American packaging fiber mix is around 65% version wood and 35% OCC. Wood fiber costs rose sharply in the third quarter due to continued wet conditions across the southern and eastern regions, as well as inbound transportation constraints. Wood inventories are below our control limits, and we expect difficult operating conditions again in the fourth quarter. We expect demand for OCC to remain strong with no cost relief even as generation gradually improves. As a reminder, we consume about 4.5 million tons annually in the U.S. and nearly a half million tons in EMEA. Moving to global cellulose fibers on slide seven, the business delivered earnings of $96 million. Third quarter segment earnings included $13 million from the Savalmo subsidiary and quids and mill, which are no longer part of our operations in the fourth quarter. Looking at our sequential earnings, price and mix improved by $59 million. Volume improved by $11 million sequentially. Demand for flood pulp, which represents about 75% of our mix, remained solid. Our shipments continue to be negatively impacted by unprecedented port congestion and vessel delays. Keep in mind that we exported about 90% of our volume in this business. The majority of this is flood pulse that ships in containers, which is where port congestion is especially challenging. We have systems in place to manage through this environment, however, expected to continue for the foreseeable future. Our mills performed well. We also benefited from about $20 million of one-time items related and lower corporate costs in the quarter. These benefits were largely offset by $15 million of higher supply chain costs for export operations. Unit's outage costs decreased sequentially, while input costs were a significant headwind in the third quarter, driven primarily by higher wood and chemical costs. Turning to printing papers on slide A, the business delivered earnings of $106 million in the third quarter with strong momentum ahead of the spin-off. Third quarter results include the quids and mill until the sell on August 6th. Performance in the third quarter was strong with continued demand recovery globally and price realization outpacing rising input costs. Now that the spinoff is complete, the historical results of the business will be treated as a discontinued operation with a full recast of previous periods. And going forward, activity pertaining to the printing paper's off-take agreement for Riverdale and Georgetown will be included in our packaging and global cellulose fiber segment earnings. I do want to echo Mark's sentiment and thank our teams for successfully executing the span in a very challenging environment. Looking to the results on slide nine, the joint venture delivered another quarter of strong performance with equity earnings of $95 million and an EBITDA margin of 44%. Solid price realization for pulp and container work were partially offset by lower volume due to high planned maintenance outages in the quarter as expected. Volume in the fourth quarter is expected to improve. However, shipping capacity remains tight and supply chains to China are stretched. So now we'll turn to the fourth quarter outlook on slide 10. In industrial packaging, we expect price and mix to improve by $70 million, mostly on the realization of our August 2021 price increase. That includes a negative mix impact as we start to recover some export backlogs. Volume is expected to improve by $65 million sequentially on strong seasonal demand, even as we step down three shipping days. Operations and costs are expected to improve by $5 million, with the North American system benefiting from improved container port inventory levels, partly offset by one-time benefits in the third quarter. Staying with industrial packaging, maintenance outage expense is expected to increase by $3 million. Input costs are expected to increase by $50 million, mostly on the flow through of higher third quarter input costs for fiber and energy. In global cellulose fibers, we expect price and mix to be stable. Volume is expected to decrease by $5 million. Operations and costs are expected to decrease earnings by $25 million due to the non-repeat of one-time benefits in the third quarter.

Maintenance outage expense is expected to increase by $37 million, and input costs are expected to increase by $15 million on higher wood and energy costs.

On our outlook slide, we include the sequential earnings adjustment associated with the printing paper spend and quits and sell for a total of $134 million across the three sectors. With regard to cash flow, I would note that our cash flow operations in the second half 2021 includes cash taxes of about $450 million associated with the various monetization transactions from earlier this year. Remember that the proceeds for these transactions are not captured in our free cash flow. However, the resulting cash taxes are included in free cash flow and the majority will be paid in the fourth quarter. Turning to slide 11, I'll take a moment to update you on our capital allocation actions in the third quarter and what you can expect from international paper following the recent papers down. We will maintain a strong balance sheet. As we previously said, we're comfortable taking our leverage below the stated target of 2.5 to 2.8 times that EBITDA on a Moody's basis. In the third quarter, we reduced that by $235 million, which brings our year-to-date debt reduction to $1.1 billion. We will also complete an additional $800 million of debt repayment by the end of this month. Taking a look at pension, we are very pleased with the performance of our plan this year. Our qualified pension plan is fully funded, and we feel really good about the actions we've taken to improve performance and de-risk the plan. Returning cash to shareholders is a meaningful part of our capital allocation framework. In the third quarter, we returned $411 million to shareholders through dividends and share repurchases. Share repurchases were $212 million, which represented about 3.6 million shares and an average price of $59.13. Also, earlier this month, the Board of Directors approved an additional $2 billion share repurchase program, which raises our total available authorizations to $3.3 billion. We will continue to execute on that authorization in a manner that maximizes value for shareholders over time. With regard to the dividend, our policy does not change. We are committed to a competitive and sustainable dividend with a payout of 40 to 50 percent of free cash flow, which we will continue to review annually as earnings and cash flow grow. Earlier this month, we decreased our dividend by 9.8 percent to $1.85 per share annually following the stint off of the papers business. This adjustment is well below the 15 to 20 percent proportion of cash previously generated by the papers business as we outlined when we announced the spin last year investment excellence is essential to growing earnings and cash generation we expect capex in 2021 to be around 600 million dollars which is less than our original plan primarily due to the timing of equipment delivery and a more challenging contract labor environment We will continue to proactively manage CapEx and have the ability to increase or put back as circumstances warrant. You can expect strategic capital to be deployed mostly to our packaging business to build up capability and capacity needs to drive profitable growth. We will continue to assess discipline and selective M&A opportunities to supplement our goal of accelerating profitable growth. You can expect M&A to focus primarily on bolt-on opportunities in our packaging business in North America and Europe. Any potential opportunity we pursue must be compelling value for our shareholders. And with that, I'll turn it back over to Mark.

Thanks, Tim, for all the details. I'm on slide 12 now. Let's talk about the future and how we're going to accelerate value creation for IP and our shareholders. We are building a better IP. With the recent spinoff of the papers business, IP is really a corrugated packaging-focused company. We are significantly less complex with a much narrower geographic footprint. In addition, we have strengthened the company's financial footing, as Tim has described, significantly over the past few years. Our focus profile and financial strength will further enable us to make sustainable, profitable growth and accelerate value creation. As I said earlier in the process, we've been actively working on multiple streams of earnings initiatives over the past year. We established a dedicated team that's been working closely with our businesses and external partners over the past year to identify, develop, and pilot a wide range of highly attractive opportunities, which are now moving to scaled implementation. Let's turn to slide 13 to see how our earnings drivers ramp up over the next few years. We will deliver $200 to $225 million of gross incremental earnings in 2022. That represents more than two times the disenergies resulting from the spinoff. Our value drivers ramp up in 2023 and 2024 with net incremental earnings of $350 to $400 million in 2024. These include around $300 million in cost reduction initiatives and at least $50 million through commercial and investment initiatives. Our earnings catalysts are front-loaded with significant benefits coming in 2022 from streamlining and simplifying the company and scaling a wide range of process optimization initiatives. Streamlining with a more focused footprint, we are aligning our talent to expand accelerate performance. We've also examined our processes to increase efficiency and reduce cost. We are implementing and scaling new approaches for areas such as sourcing, supply chain, and operations by leveraging technology and data analytics.

Let me give you a few examples of these value drivers for 2022. We redesigned our sourcing process for our 200 converting facilities. We're using data analytics and third-party partners to deploy an automated catalog of sourcing options for operating and repair materials in our box plants.

This program will deliver meaningful value in 2022. We're also using data analytics to unlock capacity in our converting facilities by improving our planning and order execution process. This includes, for example, how we aggregate and plan smaller orders and how we can optimize our manufacturing mix in each plant and each network of plants. We've also developed a new application to further optimize container board replenishment to our box plants. The system anticipates potential roll inventory stockouts, which have been a big issue for us this year, and recommends the lowest cost replenishment option to reduce premium freight. There are many initiatives that contribute to our value drivers and the savings. We have really good line of sight on the expected benefits in 2022 and the ramp up as we move forward. Our 2022 value drivers not only deliver meaningful benefits in the near term, they are also setting the foundation for IP going forward to accelerate commercial and investment excellence to drive profitable growth. So with that, we're ready to take your questions.

As a reminder, to ask a question, please press star 1 on your telephone keypad. Again, to ask a question, please press star 1. Thank you. We'll pause for a moment to compile the Q&A roster. Your first question comes from the line of Phil Ng with Jefferies.

Hey, guys. It's been a challenging few quarters in industrial despite a pretty healthy demand backdrop. With inventory normalizing for you guys and pricing flowing through, wouldn't you actually expect EBIT margins and EBIT dollar to be up year-over-year in industrial? Now that you have inventory at a more respectable level, do you expect your box to track more in line with the broad industry in the fourth quarter?

That's a great question, Phil. What we talked about in our second quarter is we thought it would take at least to the end of the year to get the inventory situation where it wasn't constrained. I think we made a little more progress than we expected in the third quarter.

And most importantly, with the progress we made in the third quarter, to really track our own box ship with the market.

And we will continue to see EBITDA margin and absolute EBITDA improvement as we go forward. As you know, and as we outlined in Tim talked about, we got it wrong on a number of our cost initiatives in our outlook for the third quarter, and that obviously took a bite out of our EBITDA margins. We really expected to be EBITDA margins in the 20-ish plus percent in the third quarter, and we didn't get there, primarily on the back of some costs that were, as I said, in some cases twice as much as we thought they would be.

Some of those supply, demand, and generation and where we're going to buy it from.

And some of those costs are simply public information that I think all investors use, like the natural gas strip and things that are kind of publicly available.

And in a big way, we sort of all got it wrong on that sense. I'm encouraged that we're making progress.

We're going to get the, as we mentioned, the price flow through is going well, and we're going to see our margins expand. And we're positioning the company to have no reason why we can't grow in box and in our other channels, which we've had a lot of success. board that goes, whether it's to our equity partners or whether it's pure open market, and that goes into the U.S. box business as well. That overall three-channel approach we're doing quite well.

Our own box plants have suffered primarily from the ability of us to get the right container board into the right plant at the right time.

It may show up two weeks late and the order had to be made two weeks earlier.

So that's an a lot better shape, and I feel good about that right now.

Got it, Mark. That's helpful. As a school of thought, I mean, I think a lot of people have thought four weeks of inventory is about balance, but, you know, appreciating the challenges the entire industry is seeing from a supply chain. It really perked up a bit.

It raised some alarms, but, you know, given some of the supply chain dynamics, Help us understand what's a good level in this backdrop.

Hey, fellas, Tim. So right now, I think we've mentioned in some of the comments as we went through the slides, but we're three to four days longer. Just think about the size of our system. That's a pretty big number just to make sure that board is arriving in time to be consumed for box customers.

So I think the man of Tim's comments is we don't know if that three to four days is going to go to five. It depends on velocity through trucking and rail primarily for container board. Ports are more of an issue for cellulose fibers.

But planning for that... one, two, and three months out is what we're doing now.

And I think you're going to probably see, for IP, I know, inventory above our normal historical.

Got it. That's helpful. And just one last one for me. You know, you're certainly generating a lot of cash. You've announced a sizeable buyback program and have about $3 billion buyback available.

Any color on the pace and will you look to use vehicles like ASRs? And just broadly, how do you kind of plan on deploying some of that excess cash on your balance sheet in the near term?

Yeah, that's a good question. So, you know, I think the summary comment would be we have not changed the framework of how we think about capital allocation and deployment. We've done a lot to try to de-risk the company through balance sheet and pension. As I mentioned in the comments, our qualified plan is now fully funded, and it's been a long time since we've been in that position. So going a little bit lower on leverage is something we've been pointing to for probably more than a year now. On share repurchases, We are, you know, the good news is we have the added authorization to work with. We're going to constantly be looking at, you know, how we're trading versus our view of intrinsic value and we'll modulate as we go through in time based on that view.

I think the thing I would add to Tim's comments, Phil, on the capital allocation piece, we've never been in recent memory or even distant memory in the position we are in today relative to our balance sheet, the cash generation, and the ability to really consistently move cash through all elements of our value creation framework. Have that be consistent, as Tim said, based on our view of intrinsic value and how we think about trying our best to do that as smartly as we can, but it will be consistent. And then on the investment in our own business, investing in our current cash flow, meaning our current facilities, investing in cost reduction, and investing in smart growth, which tends to be in our system bolt-on type of growth, that's really what we're planning on doing.

And we're in a position for the first time in a long time to be able to actually do that and do that well and do it consistently.

That's great color. Great to have all that optionality. Really appreciate it. Thank you.

Your next question comes from the line of Anthony Pensionary with Citigroup.

There's a reference on the slide to meet the driver's performance. I'm just wondering if you can talk maybe broadly about the drivers to improve that performance. And then, you know, we've seen other paper and packaging companies where, You know, the benefits from some of these large initiatives maybe ultimately get competed away. I'm just wondering if you could talk about your confidence that you'll see this, you know, fully fall to the bottom line.

Our plan, obviously, is to not let them get competed away. Some of the initiatives are, we believe, a bit unique to our organization. scale and footprint, and it's going to be our job not to let them get competed away. On the cellular cyber question specifically, this is an ongoing story that operates the way the business goes to market. And as I mentioned, I think two quarters ago, we should expect a steady quarter-by-quarter improvement in the performance of the business. And we're seeing that. We're seeing that despite some of the unforeseen supply chain issues, which don't worry me so much strategically because I don't believe that'll be a permanent state of port velocities and all of those kinds of things. So I think we will have a much better business commercially on the customer mix, the pricing strategies, the contract mechanisms. And as I mentioned a couple of quarters ago, that's a multiple quarter process. And I said we should see quarterly check-in points like we're doing today, and we should see continued improvement. And we had a really strong third quarter. And so I think we'll continue to see that. I think the supply chain will normalize. No one knows for sure when. Maybe second half of next year. I don't know. But the running of the business for the long term with the right customers and the right commercial arrangements will continue to produce long-term improvement in the business. And so the value drivers I outlined that are in the data analytics category, a lot of paper-specific initiatives.

There are other initiatives that are maybe more generic, and then we're scaling. Okay, that's very helpful. And then just maybe staying on cellulose fiber, this dual control policy, which I think is shut down a lot of capacity, maybe including some converters that are buying pulp.

But it's hard for us to fully gauge what's going on on the ground.

Can you just remind us the percentage of control policy? It seems like prices have actually shown a fair amount of stability.

So just wondering any comments there.

So the percentage of our fluff that goes to China is in the 30-ish percent of our and we have really, I mean, the majority of that 30% is premium customers. So we haven't seen a major impact from those issues. Those that are affected more are call it Chinese-only companies, not multinationals.

And the benefit of dealing with a multinational predictable customers who get with wherewithal to navigate those things, the challenge is it's large buyers with sophisticated purchasing procedures and contracts. But we like the customers we have, especially given some of these things that are going on.

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

Mark Brody with Bank of Montreal.

Thanks. Good morning, Mark. Good morning, Tim.

Hi, Mark.

Tim or Mark, I wondered if you could just help us unpack the cost pressures in industrial packaging with maybe a little more detail and maybe segment it between

North America and Europe.

It looks like, if we go back through your last four quarterly bridges, that your costs in industrial packaging are approximately $100 a ton over the last four quarters. So maybe just a little more detail around that.

Yeah, I mean, between the U.S. or North America and Europe, just given the scale of the business, most of it is going to be in North America. And really, it's been the exposure to OCC energy and chemicals. I mean, more recently, wood, but the longer-term stories before the wood impact and energy costs, primarily natural gas. So and it's moved rapidly and so I think that's what you're pointing out on your cost per ton number and just trying to keep up with that with price. So year over year we're a little bit our opportunity now is as we're implementing this current price increase that margins can expand beyond what the input costs have done most recently.

And Tim, how much of that cost increase would you say is at the converting level? Like if you just looked at your kind of cost per thousand or per ton in the box business, you think about labor, you think about transportation, you think about all those inputs, how much would those cost you?

Yeah, I mean, we don't break it out like that, but there is an impact. A lot of it goes to the mills, just thinking about the inputs that you mentioned and their consumption. But in the box system, you have materials that are unique to converting. Think about wax and other things where we have seen price escalation. Also, you know, we're seeing higher labor costs kind of across all of our businesses, and converting is important. is impacted there as well. So it's lower on the middle side in converting, but converting for the cost structure that the converting plants have, it's not immaterial.

I think, Mark, on your converting question, Mark, the unique thing that's happening in converting, given the demand, is on the labor side, You know, our employees showed up every day and done a fabulous job through this entire pandemic. In some cases, we had plants that were designed pre-pandemic to run five days a week, which is not uncommon in the box industry. Some work has accepted the challenge while we try to hire permanent employees, which has just been a real challenge in certain parts of the country.

So that elevates a big portion of converting cost is labor, unlike in a mill system where the costs tend to be the inputs.

And then transportation has been a real challenge. And again, some of it's regional, but I think the cost increases on the labor side, whether it's overtime or new employees, it's still the right thing to do because it allows us to get more revenue and more sales.

Yeah. And I guess for following, I'm just curious, Mark, it's been a while since we talked about kind of the ownership at Illum. And, you know, a few years ago, there was a lot of debate about whether it makes sense to have a bigger stake and to be able to consolidate the EBITDA. I'm also conscious that you've got kind of a single partner on the other side who, you know, may have some estate planning to do. Can you just help us think? about the ownership structure for ILM.

Calls are in meetings in our department. I think the structure we have right now is considered, so all things considered, the way the business is run in geopolitics, the whole risk profile of the company, the other things we had going on in the last couple of years to streamline IP. We believe that 50-50 joins. And the LM team is doing a great job investing in their business.

one competitive position to serve softwood fiber products to China. And we want to try to find ways to get as much of that value reflected for that 50% ownership position into the shares of IP that we can. So the strong dividend we get, the equity earnings, the exposure to a fast-growing Chinese market in an innovative way, we hope will resonate over time. Ownership changes are always under consideration, but I obviously wouldn't talk about something we haven't done. We are very comfortable with the structure we have right now. We have very good partners, and we have a great management team that's running the business very, very well.

Okay, that's really helpful. I mean, I think all of us on the outside can see why in a lot of respects that having a strong local market partner over there makes sense for IP. I'll turn it over. Thanks.

Thank you, Mark.

Your next question comes from the line of George Staffos with Bank of America.

Thanks. Hi, everyone. Good morning. Thanks for the details. Mark and Tim, I want to go back to slide six. And, you know, there's been this narrative from a lot of people in the industry that labor shortages and supply chain, all the things that we've been reading and hearing about, have not only increased costs but also prevented converters, integrated companies, from hitting demand that they see ahead of them. And certainly you pointed that in that slide. Would it be fair to say that, recognizing there are going to be some apples and oranges in this, that the difference between the 1.7% box shipment trend and that you saw in the third quarter relative to the channel growth that you saw or i think you saw at 1.3 was largely those constraints and you know maybe that's putting too fine a point on it but what do you think was the lost volume opportunity in boxes in the u.s for you because of that and the related question would be you know how much of that um lost sales whatever the number winds up being recaptured. And how much is permanently lost? Because, you know, some things that we're shipping boxes for right now, you know, we're not going to be, you know, having Hanukkah.

I think on the reason for the shortfall, the quarter involves something like this. July, we still had more container board shortages in different parts of the box system, and we had a heavy order intake. And in some cases, we just couldn't take the orders. But I will tell you, the majority of the business that we're not getting is new and incremental business. We're not seeding share in our existing customer base. So we're unable to always say yes to an order when a new customer wants to give us additional business for the next few months or something, not a long-term contract. The biggest issue, July was very difficult. August was better. And we were much closer to the market in August. And in September, we were basically tracking with the market. So we improved through the quarter. And for us, it wasn't labor. Labor was a cost issue for us. For us, it was mostly the container board availability in the right box plant at the right time. So our inventory recovered nicely in the quarter, but the majority of that recovery occurred in the last month of the quarter. So the foregone sales really occurred in July and August and it was hard to go, you couldn't go back and get those. That's why I'm confident, even though it wasn't smooth through the quarter, we are entering the fourth quarter in a much healthier position. There are still, as I mentioned on my remarks, a few areas and a few segments that use a specific type of board that we might make at only two mils that we're still tight on. And depending on where demand is and how slow trucks and trains are, we may end up in an issue, but we are in a much better position. So labor wasn't our demand or growth issue. Labor is a cost issue because we're asking people to work overtime to make more product. The board availability was our primary issue.

So, Mark, would it be fair to say that, hey, again, there is – 2% plus that was perhaps foregone, but you're in a pretty good position to recapture that in the fourth quarter. Is that an oversimplification?

It is an oversimplification, but I know what question you're trying to ask, and I would say yes. We don't believe we've lost demand, the kind of demand that we couldn't take in many cases is not demand that's lost. Our network is so flexible. Many, many customers that don't buy from us today want us to be a part of their supply base, and they still want us to be a part of their supply base in November when they come back to us.

Okay, thanks for that. One question on pulp and then one question just in terms of other things that you're doing at the company to improve value. So as regards to pulp, and we cover this a lot on these calls, we and our colleague analysts, you know, yes, you saw improvement in the third quarter, but if we do the waterfall into the fourth quarter, We're back to relatively low EBIT levels for global cellulose fibers. Yes, fluff is less volatile, but we're seeing, obviously, paper-grade prices dropping pretty sharply. Can you remind us what, ultimately, you would like to see, what you think would be a fair EBIT return for the business for it to be a value creator within the IP portfolio. And then my other question, you're obviously doing some tremendous things to improve costs and improve value within the company, the spin of Silvamo, the cost reduction and commercial initiatives. I think you mentioned at least a couple of times on this call today, and we've heard it throughout earnings season already, these are unprecedented times in terms of costs and supply chain inflation. What other things might you be contemplating away from cost but on the commercial side that might be reflective of a new paradigm and how IP might need to address these challenges to improve return and value for its shareholders going forward? Thank you, and good luck in the quarter.

Thank you, George. On the first question on cellulose fibers, the business is a value-creating enterprise for IP when the EBITDA margins are just north of 20%. And we had that in the third quarter, actually. We had value-creating returns. There were some oddities and one-offs. We've got a cost structure right now that no forest products business has ever seen at a supply chain level. coming up that no one's ever seen. I don't believe any of that will be permanent. And so thinking about the business strategically, at the current price levels, at the improving commercial arrangements where we're getting paid for the value we provide for our customers, And a future cost structure that is a little more normalized, I think we're going to be a lot closer to, and we will hit some quarters where it's a purely value-creating enterprise. And then the question is, how do you get it to be there permanently like we have our packaging business? And that's what we're working on. On the other investment question you asked, an example of some of the things we're working on that are not cost-related will be primarily, almost all of our near-term investments will be in the converting system, aside from just normal investments. protection of cash flow in your real investments. But things like ideas that we have started to pilot and we've now done and it's working well, the wide range of customer segments we have. So e-commerce as a general set of customers in a segment is an entirely different set of demands in a plant than more general food demands. uses, for example, in boxes. And having e-commerce only small focused facilities that are located almost co-located with our customers is an example of investments that we're beginning to develop that will help us on the commercial side. It does two things. It puts the right assets for the right segments. in place, and it keeps that business from detracting from the efficiency of the larger plant, which was never maybe built to do that type of packaging at that kind of throughput. And so you immediately unlock capacity by making investment A, you've essentially made investment B by just not running all that stuff in the current plants that it's running in. And you'll see more of that as we go forward.

All right. Thank you, Mark. Thank you, Tim. I'll turn it over. Have a good quarter. Thank you.

Your next question comes from the line of Mark Weintraub with Seaport Global.

Thanks, Mark, Tim. So a couple follow-ups. First, just on George's question, and you answered, impairment for your relative performance, particularly in July. I think part of the question also is relating to the overall industry looked lower than what people had been anticipating, and how much of that's being impacted by supply chain or labor issues in the industry or perhaps with the customer. And, you know, particularly given the cost environment that we're in, people are just trying to figure out what can be next steps here to get to the types of margins. And so specific to sort of from a more overall industry perspective, is there a view you can share as to how much demand may have been temporarily depressed versus, Maybe there's just more generic slowing going on in the business environment.

Yeah, hey Mark, it's Tim. So first of all, third quarter, fourth quarter comps are tougher given what happened last year. But I think what we're seeing, supply chain's affecting everyone. So you look across not only what we're doing in terms of trying to supply customers, but there are supply chain issues across almost every segment that we serve. And that probably, I can't quantify it for you, but we know anecdotally that it exists.

So would you say, though, specific to the contained border box business, those supply chain issues and labor issues are also an impediment, or is it more just more the customer level from where you sit?

No, I mean, we have experienced our own supply chain constraints, and there have been at least

These anecdotally issues of customer constraints as well.

I mean, you know, hiring and being able to source and move product is...

An issue that I think is widespread across the economy.

Yeah, I think part of what you're hearing, Mark, about the concerns about maybe the U.S. holiday season, will you be able to get everything you want? Because people are probably going to operate on their prior patterns, and they'll start to look at shopping, whether it's brick and mortar or online. in the November time period, I think there's going to be is customers have told us they could sell and ship more if they had more employees to run their factories. So they're working, they're doing just what we're doing. They're working overtime, they're trying to hire people, but everybody's trying to hire the same people if you're in an industrial supply chain because it's semi to very skilled labor. And everybody's competing for the same people, and there aren't that many of them out there. So that will, at some point, I believe, correct itself, because there's a ton of money, as you all know, pent up in people and companies to buy things. And I don't think that that pent-up demand is going to go anywhere. you're probably going to pass through a period of frustration where people can't get everything they want. You see that in a number of segments. But I think the demand driver is the money people have to spend and consume, and that's not going anywhere. And I think once we can all produce what the demand level is through the value chain, we'll see, I think, robust demand in the kinds of products that use corrugated for the foreseeable future.

Okay, great. Sometimes you have in the past given an indication of where you thought year ahead box demand might be. I realize this is incredibly difficult to be predicting that right now. Perhaps why I'm asking the question, do you have a view that you can share?

Six to 12 months is looking out in this environment, looking out quite a long way. I think we feel good in the moment. We, you know, are cut up as we. as we're in October sequentially is up between four and five. You know, we're taking it month by month, quarter by quarter.

What is that year over year? I'm curious if you could share that for the October.

Probably flattish on a strong. Great. And one last quick one. Follow up to, you mentioned three to four days more cycle time in the, you know, again, increases that relative to normal? We move roughly 40 plus thousand tons a day, so, you know, it's three to four, so 120 to 160, but in some lanes it's more than four days, but it's a big number.

I'm sorry, is it normally two weeks, three weeks, and it's an extra three or four days, or what would the

Yeah, we don't typically talk about how we move product in between our facilities, but the increment is a big increment.

Okay.

Thanks, Ken. With KeyBate Capital. Thanks.

Hi, Adam.

Hey, Mark. Just one on the dividend issue. So can you just talk, your initial expectation, obviously, last December is that you'd reduce the dividend by 15 to 20%. In conjunction with the paper spend, you ultimately decided it would only be 10%. Can you just walk us through your thought process? Why 10 as opposed to the initial 15 to 20 or no dividend reduction for that matter? So can you just walk us through anything, what transpired since then? last December along those lines?

Yeah, I think at the time we were looking at historically the performance that papers had contributed to overall earnings and cash flow performance. And then as we've gone through the year, even though we would have wanted to perform better had we not had some of these constraints and issues around supply chain, we felt good about the performance and we felt good about, as we look out into the next couple of years, the performance of the company from a cash flow standpoint. So the key message was, you know, returning cash to shareholders is an important part of our capital allocation. And we do it partly through dividend and partly through share repurchases. And we felt like we had latitude to reduce the dividend by a smaller amount than what we originally pointed to.

I appreciate that. Tim, one more for you and then just one for Mark. Just on the topic of guidance, I've asked you this on previous calls, but just given the enormous uncertainty, supply chain, inflation, demand, you name it, how comfortable do you think you would be getting full year guidance come next year now that the paper spin is behind you, quids and sales behind you, et cetera? Or are you concerned that there's just so little visibility that it may create more problems than it helps you by doing so.

Yeah, well, you know, probably a lot of time and events transpire between now and let's say the end of January when we report fourth quarter and think about 2022. So I think seeing some normalization to some of these issues that everyone's pointing to would be helpful and probably necessary to give a longer-term outlook for performance of the business in a quantifiable way. But I do think, given, you know, just the issues that we've come from and where we are, having repaired the supply chain, starting to scale the initiatives that Mark covered in his commentary, felt pretty good. So let's see. Let's see where we are by the time we get to the end of January.

I appreciate that. And just, Mark, one more on box demand for me, which is I think we're all caught upsized by what happened in the third quarter. We all expected some growth, or speaking for myself at least. These supply chain issues don't seem to be going away anytime soon. Is it reasonable to expect, embedded in your volume, Guidance 3Q to 4Q of, I think, $65 million of growth in industrial packaging. Are you expecting to be up year-over-year in the fourth quarter or flattish? Or can you just give us any sense of what you think you're going to do or the industry might do relative to the third quarter, which was obviously unexpectedly flat because of some of the issues you flagged?

I think Tim mentioned the October experience so far, and on a year-over-year, he called it flattish. We would expect it to be pretty close to last year, so flattish on a year-over-year basis, which is on a pretty, as you know, Adam, a pretty tough comp. For us, the confidence in that $65 million of earnings improvement from volume that Tim talked about is primarily kind of, again, IP-specific. We are in a much better position with container board inventory going into this quarter so that we won't have to forego some of the sales opportunities we just couldn't meet in really the second end of the third quarter. So that's why we feel confident. Again, our restriction was primarily our container board available. I mean, in theory, we could have pushed container board to our box plants by cutting off other customers that are just as profitable and just as strategic. Of course, we didn't do that and we wouldn't do that. to take these very high value open market channels that have really been growing nicely and our own box business and not be as constrained as we have been by container board. Downstream from us and including us, the labor component that our customers are dealing with, I think We'll begin to improve. I think the demand environment and the supply chain issues in the third quarter and the labor challenges I think surprised a lot of people in a lot of different value chains. And, of course, they've been working on it. There's a lot of innovative approaches to hiring people right now. And that will produce some positive results, I believe, in the fourth quarter. And at least from what our customers are telling us about their expected demand and what they want us to prepare for, they're planning on solving some of their, for them, mainly labor issues to have enough people to work to make the products they have demand for. So we think some of that will be getting better over the next few months.

Thanks a lot, Mark.

Our final question comes from the line of Mike Waxman with Truist Securities.

Thanks very much. Good morning, Mark, Kim, and Guillermo. I appreciate you guys taking my questions today. Hi, Mike. Just two quick ones. Just realizing the supply chain obviously has tremendous headwinds and volumes. Can you talk just a little bit more about the specific end markets themselves and if there are any sectors that either stood out as being advantageous or disadvantageous? And then just specifically on e-commerce, What are you seeing there, particularly if some of the larger e-commerce players, whether it be Amazon or Etsy, have indicated more modest growth?

Well, we deal with most of the major players in e-commerce, whether it's B2C e-commerce or B2B e-commerce, and our customers, the ones we have, and we don't speak for any of the industry, the ones we have are still pretty bullish on their fourth quarter and are asking us to prepare for levels of demand that are still very, very strong. The first part of your question around supply chain, I think anybody who's transportation heavy, like some of the food companies, are struggling with some of the same velocity issues that we're struggling with. Anybody who's taking in products from outside the US and has to get through the ports are running into product availability. And then on the labor side, I think it's a smattering really everywhere. The competition is most heated in the more populated areas. So you might have a distribution center for an e-commerce player and a box plant from IP and two box plants from other people and another light manufacturing of some type, all competing for skilled labor. If you're a food manufacturer in the middle of a rural area, your labor situation is probably more manageable. And that's what we see. Our labor situation primarily shows up in our box plants, which are near cities and near a lot of labor competition, Our mills are more rural, and they are in much better shape from a continuity of labor.

Just following up on that quickly, so would you say that your demand and your ability to satisfy your demand, let's say, is better away from major cities?

No, not really. No, I was just making the comment on labor. The problem with being away from major cities in the box business, unless it's a food processor that's located rurally, that's where the customers and box users are. So it's a theoretical statement to say, I wish my box plants were away from cities. Most of the manufactured products are near population centers on the box side. But if you go upstream in the value chain, to where the container board is made. It's made near the forest, of course, in most cases. And so it's just a less populated area. So labor availability and long-term labor loyalty to their employer is a lot higher.

Got it. And just one quick follow-up. Just on your fee, your industrial packaging interest was negative. Think about four million for the quarter. Just some of the issues that Joe, that loss was critical.

I think the biggest issue in Europe, I think that's what you asked about, Europe packaging, there's two issues going on. We have one large recycled container board, so they're 100% exposed to the recovered fiber market, and that cost really, really rose. And then you have the kind of unprecedented natural gas cost issues in Europe, and it'll take a little bit of time for product pricing to kind of catch up with that. So it was more of a timing quarter issue than a structural issue.

Got it. Thanks again, and good luck in the fourth quarter.

Thank you, Mike. Well, listen, you can tell from our conversation this morning, the questions and even our prepared remarks, it's really easy to live in this moment of craziness in the supply chain and really kind of dwell on it. But I'm personally confident that we'll continue to manage and overcome what we're dealing with today. We've got a tremendous team that's skilled and operating, and they do a great job every day, every week, every month. We do expect, as I mentioned in prepared remarks and in some of the answers to the questions that we in the fourth quarter and we expect to be heading into 2022 with significant momentum. I'm equally confident and very optimistic about our future. We just showed you two slides today on some of the value drivers. We have a lot more to share with you as we go forward. We have the right plan, the right people to deliver on our commitments to build a better IP. Tim took you through our capital allocation framework. I'll say it again. We haven't been in this position on cash generation and cash return ability in almost forever. And we're excited about building a good portion of our total shareholder return on cash return of cash to shareholders, dividend share repurchase. And then the value drivers and the focused IP delivers the other half, which is going to come with the profitable growth that we have in our sites. So thank you for your interest in International Paper. We really look forward to speaking with you again in the future.

Thank you for participating in today's International Paper third quarter 2021 earnings conference call. You may now disconnect.