International Paper Company

Good morning and thank you for standing by. Welcome to today's International Papers fourth quarter 2022 earnings call. All lines have been placed on mute to prevent background noise. After the speaker's remarks, you will have an opportunity to ask questions. To ask a question, press one then zero on your telephone keypad. To remove yourself from the question queue, repeat the one zero command. As a reminder, today's conference call is being recorded. I'd now like to turn today's conference over to Mark Nellison, Vice President, Investor Relations.

Thank you, Paul. Good morning, and thank you for joining International Paper's fourth quarter 2022 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 presentation on slide two, including certain legal disclaimers. For example, during this call, we will make forward-looking statements that are subject to risks and uncertainties. We will also present certain non-U.S. GAAP financial information, and a reconciliation of those figures to U.S. GAAP financial measures is available on our website. Our website also contains copies of the fourth quarter earnings press release and today's presentation slide. I will now turn the call over to Mark Sutton.

Thank you, Mark, and good morning, everyone. We'll begin our discussion on slide three, where I will touch on our full year of 2022 results. First of all, as I think about 2022, I'm very proud and appreciative of all the hard work our employees have done during the year and for our strong customer relationships as we've managed through a very dynamic and uncertain market environment. Looking at our performance, international paper grew revenue and earnings driven by solid commercial and operational execution, while facing significant inflation and lower demand in the second half of the year. We also made solid progress in building a better IP. We delivered $250 million of earnings benefits from our initiatives, focused on lowering our cost structure and accelerating profitable growth. And as a result, we exceeded our full-year target and have strong momentum going forward. We're also confident in the profitable growth opportunities across our industrial packaging business and have made strategic investments to support this growth. We will continue to invest to grow earnings and cash generation by building additional capabilities and capacity in our U.S. box system during the next few years. I'm also pleased with the significant progress we made toward achieving value creating returns in our global cellulose fibers business. We delivered $100 million of earnings growth in 2022 and we expect significant earnings improvement this year. This past year, we also returned $1.9 billion of cash to shareholders, and our balance sheet is very strong. This allows International Paper to navigate the uncertain macroeconomic environment from a position of strength, and we believe it will give us opportunity to continue to invest through the cycle to grow earnings and cash generation while also returning cash to our shareholders by maintaining our dividend and through opportunistic share repurchase. Turning to our full year key financials on slide four, revenue increased by 9% year over year, driven by strong price realization in our two business segments. Operating earnings per share improved by 32%. Operating margins were impacted by lower volumes from weaker demand for packaging and elevated supply chain and input cost. Overall, EBIT improved by about $300 million year-over-year. In terms of segment performance, both our industrial packaging and global cellulose fiber segments contributed to our earnings growth by about $100 million each as our profit improvement initiatives and price realization offset significant inflationary cost headwinds. Our corporate expenses were also lower by about $100 million, primarily driven by our building a better IP initiatives and some favorable FX. And for the year, we also generated $1.2 billion of free cash flow, which was above our prior outlook, driven by higher earnings and improved working capital in the fourth quarter. Turning to slide five, I would like to comment on the press release we issued last week regarding the progress we were making related to our Illum joint venture. We have entered into an agreement to sell our 50% interest in Elam SA to our JV partners for $484 million. This transaction reflects a total enterprise value for Elam of approximately 3.5 billion and approximately 3.1 times EBITDA, the EBITDA multiple for 2022 full year results. The JV partners have also expressed interest in purchasing all of IP shares in JSC ILM Group, which represents a 2.39% stake for $24 million. We also intend to divest all other residual and non-material interest associated with ILM to our JV partners. The deal is subject to regulatory approvals in Russia. We are making good progress and will provide you with additional information when it becomes available. Upon finalizing this deal, IP will no longer have any investments in Russia. Turning now to slide six and our fourth quarter results, earnings and free cash flow for the quarter were above prior periods and came in better than the outlook we provided last quarter. Demand for our products played out as we expected. In industrial packaging, our U.S. Fox shipments were down about 6% year-over-year on a daily basis, similar to what we experienced in the latter part of the third quarter, after consumer priorities shifted toward non-discretionary goods and services. In addition, our customers and the broader retail channel continued to work through elevated inventories of their products, which constrained packaging demand in the quarter. Underlying demand for absorbent pulp was stable. On a positive note, we did see meaningful relief from lower input costs, and our fourth quarter earnings also benefited from our building of better IP initiatives and some favorable one-time items in the quarter, which Tim will speak to later in the presentation. And finally, we generated solid free cash flow and returned $355 million to shareholders during the quarter. I will now turn the call over to Tim to cover our business segment performance as well as our outlook. Tim?

Great. Thank you, Mark, and good morning, everyone. I'm on slide seven, which shows our year-over-year earnings bridge. Price and mix improved significantly with strong price realization across all channels and benefits from our commercial initiatives. Volume was lower in 2022 as consumers shifted priorities toward non-discretionary goods and services while dealing with high inflation, following a period of demand pull-forward during the pandemic. Operating costs were negatively impacted by high inflation on materials and services and significantly higher supply chain costs across all of our businesses, as well as lower volumes in our industrial packaging business. This was partially offset by improved mill performance and reliability. Maintenance outages increased as planned, impacted by high inflation on equipment, parts, and contracted services. Input costs rose sharply across just about every category, with more than half of the increase directly related to higher energy and fuel costs. Total corporate expenses and other items decreased by 33 cents per share as follows. Corporate expenses declined by 19 cents per share and benefited from our Building a Better IP initiatives, as well as some effects. Interest expense was lower by 14 cents per share, benefiting from significant debt reduction in the prior year. Tax expense was 20 cents higher per share, with a normalized effective tax rate of 24 percent as compared to 19 percent in 2021. Lastly, share repurchases impact earnings by 20 cents per share year over year. Moving to the fourth quarter sequential earnings bridge on slide eight. Fourth quarter operating earnings per share were 87 cents as compared to 83 cents in the third quarter. Price and mix improved by six cents per share from better mix in our industrial packaging business and additional price realization in our global cellulose fibers business. Volume was lower in industrial packaging as a result of softer demand across all channels. In global cellulose fibers, demand was stable. However, volume was lower sequentially due to higher pull-through of shipments in the third quarter as supply chain velocity began to improve. Operations and costs were impacted by the lower volume resulting in higher economic downtime and unabsorbed fixed costs as well as seasonality. Some of the downtime in our global cellulose fibers business was caused by winter storm Elliott, and also some isolated reliability issues. Ops and costs also benefited from favorable one-time items in the quarter related to lower employee benefit costs, workers' compensation expenses, and medical claims. These favorable one-time items added about $71 million, or 15 cents per share, which is not expected to repeat in the first quarter. Maintenance outages were higher in the fourth quarter as planned. As Mark mentioned earlier, we saw significant relief from input costs, which were $144 million, or 31 cents per share lower in the fourth quarter, driven by lower energy and OCC costs. Corporate and other items includes benefits from lower interest expense, favorable FX, and other corporate items, partially offset by a sequentially higher tax expense. Turning to the segments, and I'll start with industrial packaging on slide nine. Price and mix improved in the quarter primarily from commercial mix initiatives focused on margin improvement. The recent publication changes did not have a material impact on the fourth quarter. As Mark mentioned earlier, demand for packaging was in line with our expectations. Fourth quarter volumes remained at lower levels due to constrained consumer demand and ongoing retailer inventory destocking. Sequentially, volume was also impacted by four fewer shipping days. However, in this dynamic demand environment, international paper is well positioned due to our diverse portfolio of products and services and our strategic relationships with a large number of national and local customers across a broad range of attractive end-use segments. Overall, our mill system ran well, and we managed through Winter Storm Elliott very effectively. The lower demand environment impacted operations and costs in the quarter as we adjusted our system to align our production with our customer demand. These actions resulted in approximately 530,000 tons of economic downtime across the system, resulting in higher, unabsorbed fixed costs. Option costs were also seasonally higher. However, this segment benefited from approximately 57 million of favorable one-time items I mentioned earlier. Input costs were significantly lower and improved earnings by 139 million sequentially. About half of the benefit was from lower energy costs in North America and Europe, and the remainder was primarily from lower OCC costs. Overall, we continue to face elevated supply chain costs as well as the impact from high inflation on materials and services during the past couple of years. In a lower demand environment, when we aren't running at full capacity, we believe there is a large opportunity to further optimize our system and take out high marginal costs. This remains a key lever in 2023. Turning to cellulose fibers on slide 10, taking a look at the fourth quarter performance, price and mix improved by $17 million due to the previously announced price increases. Volume was lower sequentially due to higher pull-through of shipments in the third quarter as supply chain velocity began to improve. Operations and costs were negatively impacted by disruptions from winter storm Elliott and some reliability incidents at two of our mills. These were partially offset by approximately $14 million of favorable one-time items I mentioned earlier. Plan maintenance outages were higher by $39 million sequentially, coming off of the third quarter, which represented the lowest outage quarter of the year. In addition, input costs were lower by $5 million. As we look forward, feedback from our customers indicates they are seeing in-transit inventory pull through at a faster pace due to improvements in supply chain velocity from less port congestion and improved vessel reliability. Combined with seasonal demand decline related to the Chinese New Year, we expect some customer inventory destocking to impact demand through the first quarter. With that said, fluff pulp inventories remain below historical levels, and we believe fluff demand will continue to grow. This is due to the essential role that absorbent personal care products play in meeting consumer needs. Turning to slide 11, our global cellulose fibers business continues to make significant progress, growing earnings and executing on our strategy to deliver value-creating returns over the business cycle. The business increased earnings by approximately $100 million in 2022 and was near cost of capital returns in the second half of the year, despite significant supply chain cost headwinds. Our team successfully deployed a commercial strategy focused on building strategic relationships with key global and regional customers and aligning with most attractive regions and segments. We are focused on creating value for our customers by delivering products that meet their stringent product safety standards and deliver an innovative value. In addition, we are driving structural margin improvement by ensuring we get paid for the value we provide. In the fourth quarter, we made solid progress in our fluff pulp contract negotiations, which will provide additional commercial benefits going forward. We are committed to building on this momentum and expect to deliver significant earnings growth in 2023. On slide 12, I'd like to update you on building a better IP set of initiatives. We're making solid progress and delivered $75 million of earnings in the fourth quarter for a total of $250 million in 2022, which exceeded our target for the year. About half of the benefits to date are from our lean effectiveness initiative. By rapidly streamlining our corporate and staff functions to realign with our more simplified portfolio, we have offset 100 percent of the dis-synergies from the printing paper spinoff. Although most of these benefits have been achieved, we will continue to pursue additional opportunities. Another significant driver of full-year results was strategy acceleration. as we delivered profitable growth through commercial and investment excellence. Going forward, we continue to focus on getting our global cellulose fibrous business to deliver value-creating returns. We are also focused on profitably growing our industrial packaging business by improving margins and investing for organic growth. Finally, the process optimization initiative has the potential to reduce costs across areas such as maintenance and reliability. distribution and logistics, and sourcing as we leverage advanced technology and data analytics. We believe these initiatives will deliver benefits going forward as we finish implementing new capabilities across our business. Turning to slide 13, I want to take a moment to update you on our capital allocation actions. As Mark mentioned earlier, we have a very strong balance sheet, which we will preserve. because we believe it is core to our capital allocation framework. Our 2022 year-end leverage was 2.1 times on a Moody's basis, which is below our target range of 2.5 to 2.8 times. Looking ahead, we have limited medium-term debt maturities with about $1.6 billion due during the next 10 years. And finally, even in this environment, our pension plan remains fully funded. Returning cash to shareholders is a meaningful part of our capital allocation framework. In the fourth quarter, we returned $355 million to shareholders, including $191 million through share repurchases, which represents 5.4 million shares, or about 1.5% of shares outstanding. As a result, we've returned approximately $1.9 million of cash to shareholders in 2022. In October, our board of directors authorized an additional $1.5 billion of share repurchases. At year end, our total authorization was approximately $3.2 billion. Going forward, we are committed to returning cash through maintaining our dividend and through opportunistic share repurchases. Investment excellence is essential to growing earnings and cash. We invested $931 million in our businesses in 2022, which includes funding for cost reduction projects with attractive returns and for strategic projects to build out capabilities and capacity in our box system. As an example of this, the successful startup of our new corrugated box plant in eastern Pennsylvania, which has an expected return on investment of 20 percent, And going forward, we plan to make additional investments across our box system to support long-term profitable growth. We will continue to be disciplined and selective when assessing M&A opportunities that may supplement our goal of accelerating profitable growth. You can expect M&A to focus primarily on bolt-on opportunities in our packaging businesses in North America and Europe. Any potential opportunity we pursue must create compelling long-term value for our shareholders. So turning to slide 14, we'll look at our first quarter outlook. I'll start with industrial packaging. We expect price and mix to decrease earnings by $65 million as a result of prior index movement in North America and lower average export prices based on declines in the fourth quarter. Volume is expected to increase earnings by $20 million due to four more days sequentially in North America, partially offset by the normal seasonal decline in daily shipments in North America. Operations and costs are expected to decrease earnings by $65 million due to the non-repeat of favorable one-time items in the fourth quarter. In addition, we expect seasonally higher energy consumption and some additional inflation on materials and services. Ops and costs will also benefit from lower unabsorbed fixed costs due to higher volumes and more planned maintenance outages. Maintenance outage expense is expected to increase by $91 million. The first quarter will be our highest outage quarter this year, representing approximately 40 percent of planned outage costs in 2023. And lastly, input costs are expected to decrease by $70 million from lower average costs for energy, fuel, and fiber. Switching to global cellulose fibers, we expect price and mix to improve by $15 million on the realization of prior increases. Volume is expected to decrease earnings by $15 million based on seasonally lower demand and customer inventory destocking in response to increased supply chain velocity. Operations and costs are expected to decrease by $30 million due to the non-repeat of favorable one-time items in the fourth quarter. In addition, ops and costs will be impacted by higher unabsorbed fixed costs due to lower volumes as well as seasonally higher energy consumption and some additional inflation on materials and services. Maintenance outage expense is expected to increase by $13 million, which is largely associated with the Georgetown mill printing paper's outage. This cost will be fully recovered as part of the transfer price to Sylvano over the course of the year. Again, the first quarter will be our highest maintenance outage quarter this year, representing almost 40% of total planned outages in 2023. Lastly, input costs are expected to decrease by $15 million, mostly due to lower energy and fiber. Moving to our full-year outlook on slide 15. We are projecting full-year 2023 EBITDA for the company of approximately $2.8 billion. As I mentioned earlier in this presentation, we believe we have significant opportunities to reduce high marginal costs across our system and capture more benefits from our building a better IP set of initiatives. This includes meaningful earnings growth in our global cellulose fibers business as a result of our commercial strategy execution. I would also note that our outlook includes only the impact from previously published price changes. Free cash flow is expected to be between $900 million and $1.1 billion, which includes a one-time tax payment of $190 million related to our timber monetization settlement. In addition to free cash flow, we expect to receive approximately $500 million of cash proceeds from the ILM sale. Regarding this transaction, for reporting purposes, the ILM-JV has been classified as discontinued operations And in the fourth quarter, we took an impairment charge, which was treated as a non-cash special item. For 2023, we are targeting capital spending of between $1 billion and $1.2 billion, with increased investments in our U.S. box system to build additional capabilities and support profitable growth with our customers. We will also focus on high-cost cost reduction projects across our system. And with that, I'll turn it back over to Mark.

Thanks, Tim. Now I'll turn to slide 16. I want to reinforce my confidence in the resiliency of international paper and our ability to navigate through this dynamic environment from a position of strength. As Tim mentioned earlier, we're well positioned due to our diverse portfolio of products and services and our strategic relationships with a large number of national and local customers across a broad range of attractive and youth segments. Also, our teams at IP know what it takes to successfully manage through a business cycle by leveraging options and capabilities across our large system of mills, box plants, and supply chain to optimize cost while continuing to take care of our customers. In addition, our Building a Better IP initiatives are focused on continuing to invest in projects to drive structural cost reduction through efficiency improvements and accelerating profitable growth. We exceeded our target in 2022, and we have solid momentum as we enter 2023. Finally, as I mentioned earlier, we have significantly enhanced our financial strength and flexibility. This strong foundation makes IP well positioned for success across a spectrum of economic environments and to deliver profitable growth over the long term. And turning to slide 17, as we look to 2023 and all of the dynamic conditions at hand, I draw confidence from an incredible milestone that reflects the resiliency of our company. To be precise, today marks our company's 125 year anniversary. On this date in 1898, 17 pulp and paper mills in the northeastern part of the United States joined to form International Paper Company. I think our founders would be amazed at how our enterprise has evolved through the years, including the incredible products we make and the expansive list of customers we serve. They would also appreciate our longstanding commitment to the pursuit of excellence in safety and environmental stewardship. While the world has changed, our commitment to providing essential products people depend on every day and the talent and dedication of our team has not changed. As we embark on our next 125 years, our principles and resilience will continue to serve us well. I'm excited about how we are re-engaging our company. We haven't performed to our full potential, but that's behind us. We are committed to take our performance to a higher level. We recently made talent and leadership adjustments to match the right skills to the right opportunities we have in front of us. It's the right team to execute our strategy. We continue to make a lot of traction on our build a better IP focus areas. The things we're going after will set us apart and will drive our results. In essence, we are proud and well-positioned to build on our 125-year legacy in the days, months, and years ahead. I'm confident you'll like what you see. With that, operator, we're ready to take questions.

Thank you. Thank you. As a reminder, to ask a question, if you have not already done so, press 1, then 0 on your telephone keypad. To withdraw a question, repeat the 1, 0 command. Again, that's press 1, then 0 on your telephone keypad to get into the question queue. Repeat the 1, 0 command to remove yourself from the queue. We will pause for a moment to compile the Q&A roster. And our first question will come from Wells Fargo Securities and the line of Gabe Haji.

Good morning, Mark, Tammy. I had one specific one on, I guess, energy use. And when I look at kind of the sequential math and what you guys kind of beat by in the quarter, I'd say at least in the corrugated or industrial packaging segment, half was from these one-timers. and maybe half was from lower natural gas. Has anything changed kind of with your – so I guess first question is can you confirm that, and second, has anything changed with IP's perspective on mediating risk kind of across the organization given, you know, geopolitical tensions and a potential impact on commodity inputs?

I think you sound like you got it about right on the split between the one times, which usually gets – corrected in the last quarter, but through a lot of efforts, especially on things like the medical cost and all of that. On the question about energy and geopolitical, I mean, part of the reason we have lower energy costs is our energy usage can be optimized actually when we're running less than full capacity because a higher percentage of our energy is our own make energy, and so we can actually just stop consuming as much purchased energy, whether that's raw natural gas to power the auxiliary boilers or whether it's the electricity we buy that we don't make ourselves. Our view on geopolitical is no better or worse than anyone else's. As we look out ahead, part of it is what's happening with weather and what's happening in Europe in terms of demand for some of the fuel natural gas being the main one. We feel like it's a more stable environment going forward, but what we've been able to do is really manage and optimize our consumption. And as you know, Gabe, in the integrated mills, at the right output level, we are generating from wood biomass fuel most of our own steam to generate most of our own electricity. Not that we don't want better demand, but when it is lower, we can optimize our energy profile, which is what we're doing.

Okay. And then, I mean, if I take Tim's commentary, I think directionally, maybe implied EBITDA for the first quarter is somewhere in that 540 range, which obviously suggests a pretty significant ramp to get to your full-year outlook. I wanted to know if you'd be willing to parse out, you know, I think the term used was significant improvement in global cellulose fibers, if you maybe put a finer point on what's implied there. And then I appreciate, again, some of the maintenance costs are somewhat front-end loaded, so we've got visibility there. But then it sounds like a lot of this improvement in the back half maybe, or as the year progresses, is, you know, based on your ability to run more efficiently and take these these costs out that seemingly kind of crept into the system. And to use your words, Mark, and you guys were kind of not pleased with the performance necessarily. So just maybe the building blocks of how you think about maybe magnitude of getting to that full year number.

Yeah. Hey, Gabe, it's Tim. And I think you actually summarized it quite well. We are front end loaded in the first quarter on maintenance outages. So we get a step down if you look at it on average across the quarters two through four. But really, the benefits to GCF come through the contract negotiations that were closed in the fourth quarter. And so, we're going to see a step up in profitability based on those. And then, given Build a Better IP and what we expect to achieve this year, and just clawing back some of these marginal costs. I mean, the past two years, the costs have been going up almost relentlessly. across every category. Supply chain cost has proven to be a little bit stickier, but we think both from a rate and fuel standpoint there could be an opportunity. But the real opportunity for us is just on the operations side, just getting back to more of a normalized mode mix. type of scheduling of transportation and taking out the premium freight and higher marginal supply chain and logistics costs to move product to customers.

Great. Thank you, guys, and congrats on the quarter.

Thank you. Then next we go to Bank of America and the line of George Staffos.

Please go ahead. Thanks, everyone. Good morning. Thanks for the details, and congratulations on the quarter, much better than we were looking for. Hey, guys, one thing first. Point of clarification for cellulose fibers. Did you say price and mix in the quarter would be a plus 5-0 or a plus 1-5? I couldn't quite tell.

Sorry about that. Plus 1-5.

Okay. Thanks, Tim. So I want to piggyback on Gabe's questioning on GCF. Again, to the extent that you can provide a bit more color, What else do you have embedded in the discussion on a significant improvement? I take from your comments that you're assuming current levels of pricing. You're not really making a forecast, at least internally, on the direction of pricing. Or are you? Anything that you could provide us there, anything that you could provide us with the current snapshot, right, in terms of costs and operations, what you might see in terms of a profit delta, 23 versus 22?

I'm sorry, I missed the last part of that, George. I mean, I think it's no different than what I was just talking about with Gabe. We got big structural changes in the contract negotiations in GCF in the fourth quarter, so that hits now. That starts as we go through first and second quarter. And then, you know, just in terms of most of the initiatives, their internal self-help, whether they're structural through build a better IP or they're just getting back to more normalized levels of operation across a number of categories, including supply chain usage in the mills on inputs and the like. So, you know, we're not immune from the macro environment, but there's a lot that we think we have in front of us that we can work on, especially as it relates to the marginal costs that were incurred in a more run-full type of environment.

Would it be fair to say, Tim, if I just very simplistically annualize what you're seeing in industrial packaging on price mix as kind of a headwind you need to manage against that GCF to basically close the gap? You know, is maybe a couple hundred million dollars or better profit-wise in 23 versus 22? X any changes in pricing in the market?

Order of magnitude, yeah, it's close.

George, this is Mark. I think that's a good way to think about it, although they're not the same market. Of course it's not. The numbers work out that way. One way to just verbalize what you should be thinking about with cellulose fibers, a lot of commercial changes on all types of accounts and customers and regions of the world occurred through 2022. And those benefits now are largely locked in in our commercial agreements for the full year of 2023, coupled with improving our cost position. So that's where the expansion comes from. Commercial is the driver, layered on top of a much more sane, higher velocity supply chain and lower cost structure. And that gets you the significant earnings improvement.

Makes sense. Two last ones and I'll turn it over. One related to GCF and then one to the industrial packing business. So for GCF, Tim and Mark, you mentioned that inventories are low, you believe, at your customers' levels, I thought you said, but also that there's a potential for destocking in the first quarter. So can you help us reconcile those two points? And then in industrial, as you're bringing on the Pennsylvania box plant and as you have been targeting potential other converting investments, what are the implications and how are you managing against the, you know, what are the implications for the rest of your box business, and how do you keep retention at high levels as you perhaps adjust your converting footprint in any given region, including in Pennsylvania and New Jersey? Thank you so much. I'll turn it over.

Thanks, George. Yeah, on the inventory side, it's a combination of two things. So, we believe inventories are historically low. They've been that way for the past couple of years. But you've got a little bit of a phenomenon going on with the accelerated velocity in supply chain through the third quarter that people were able to recover a little bit, but still not get back to what would be historical levels of inventory. So they've got a little bit more to work with, but they're low on a historical basis. And then we believe once you get through Chinese New Year, buying picks up again on GCF. The labor issue, yeah, that's been a battle through 22, but the business is deploying a lot of strategies there.

I think, George, the way to think about the example of the Pennsylvania box plant coming on and then with it, you know, obviously a softer demand environment. I'll take you back to the last maybe three quarterly calls where I commented on our running to meet demand required structural overtime in a lot of our plants. In that particular part of the country, we don't have enough capacity, even with our employees working a fair amount of overtime. So this plant is going to help us not only gain business we've had to turn away in some cases, but stabilize the entire region of plants around it. by getting onto a more sustainable operating schedule for our employees. So customer retention, because we're stretched on our capacity, and it's not an average statement. It's in different parts of the country. This is one of them. This will actually have benefits from the incremental volume of the plant and secondary benefits by stabilizing the nearby operations into a more sustainable schedule. So I think we feel really good. It's a total net add. an improvement in our operating cost and our operating efficiency and our employee resiliency. So we've got several other examples in different parts of the markets where we're going to be doing the same thing.

Thank you, Mark. Good luck in the quarter.

Thank you. Then next, from Seaport Research Partners, the line of Mark Weintraub is open.

Thank you. So two quick questions. One was on the cellulose fibers. With the changes that you're making, do you think that pricing beyond 2023 is going to be less impacted by shifts we see in PPW, for instance? Are these more fixed, or are we still going to be moving quite a bit with where open market transactions are going.

Yeah, I mean, so, hey, Mark, it's Tim. You know, I don't want to start making forecasts or predictions, but we do believe, as we've said, that the business is structurally taking efforts to get paid for the value that they're delivering. And you do have a mix across the different channels and segments that we serve of This last piece that we referenced in terms of the contract negotiations in the fourth quarter were structurally something that needed to be corrected by the business, and it took a little bit of time to do it. So, not making a prediction, but we believe that the actions that we're taking, we're taking consistent with how we get paid for value. And so, you can read into what you think that means as we go through 23 and 24.

Okay, so I guess I'd read that hopefully it leads to reduced volatility. Is that a fair, that that's the intent of the contracts?

Well, I think it's the intent of the approach that we've taken with each of our customers and just recognizing that the value equation doesn't change dramatically over time.

Mark, I think it's fair to say our commercial objective is to improve profitability, as Tim just described, And there's multiple ways to do that, depending on the segment and the type of customer. And then secondly, obviously, to reduce volatility in the way that we make. When we throw words like strategic customer relationships, that's partly what we mean by the word strategic versus transactional, that there is a longer-term view, which usually comes with less volatility, versus playing a very transactional market by the month or by the quarter. You need probably a mix of all of it, but our objective is to improve profitability, which we are doing, and reduce volatility.

Understood. And then just quickly on the industrial packaging, when you talked about volume, you talked about the four more seasonal days. You talked about the seasonality typically being a negative, of course. Now, are you not seeing any signs that maybe the destock, which negatively impacted the third quarter and then again the fourth quarter by your customers, any signs that we may be getting toward an end, and might that become a positive, or any indications from customers as to when that might start working less against you?

Yeah, I think that's right, Mark. You know, a large... portion was taken care of in the fourth quarter. It feels like maybe there's some remnants, but that it's getting close to the end. And if you look at where we are just in January, you know, year over year, it looks like we're, we don't have numbers yet, but just following cutoff, it looks like we're, you know, down 5% year over year, but stabilizing from fourth to first.

Okay. Thank you.

Thank you. Then next, we go to Truist Securities in the line of Mark Roxland. Mike Roxland, please go ahead.

Thanks, Mark, Tim, and Mark. Congrats on a very good quarter. Last quarter, you mentioned you had an internal algorithm you used to figure out how and where to take downtime. And one of the items that's part of the algorithm is natural gas. So with domestic natural gas down as much as it has been with the decline in OCCs, How have you shifted your downtime plans, if at all? And, you know, just trying to get a sense of whether you've been able to more efficiently take downtime and whether that was a benefit in the quarter as well.

That's a great question, Mike. We shifted it to the algorithm for marginal cost, and so that's one of the important ones. Also, logistics and transportation costs, which haven't relaxed as quickly, is an important one. And then, of course, fiber, wood fiber costs as well as OCCs. And I would say, yeah, you saw more of our production shift to the lower cost energy mills, but not in a material way. We ran everything. We didn't make any dramatic shifts, but you can see the efficiency and cost reduction showed up in our numbers. Because again, as I said, at certain sweet spots in an integrated mill where you're making at full capacity 80% of your energy, at less than full capacity, you can make almost all of your energy. And then you're not subject to the open market for purchased electricity or gas virtually at all. So that might even trump a lower gas price when you have a mix of integrated mills and recycled mills like we do.

Got it. And then just quickly on China, with the country easing its strict zero COVID policies, Can you give us a sense of what you're seeing from a demand perspective in GCF? And I know it's early stage, and I know that you're also attending with Chinese New Year, so you may not have a good line of sight, but any early read on how demand may or may not be impacted from the elimination of those policies?

Yeah, I think it's probably a bit too early, although we agree that there is an opportunity past Chinese New Year as China reopens. We see that as a positive.

Thank you. Thank you. Then next we go to RBC Capital Markets and the line of Matthew McKellar. Please go ahead.

Hi, thanks very much. First, I just wanted to ask around the sale of your stake in Ilum. Are you able to talk about the timeline to close that transaction? It sounds based on your guidance that you're looking for it to close this year, but is there any additional color on that? And Also, any thoughts on key hurdles to clear in terms of receiving regulatory approval?

Yeah, I mean, I don't want to speculate. It's such a fluid environment, but I think we look to it closing sometime this year. The regulatory approval process will take what it takes. So, as we know more, we'll report it.

Okay, thanks. And then just in industrial packaging with line of board and medium prices, we see benchmark prices coming down. Can you just remind us to what degree your typical kind of contract pricing lag on realization would be versus those benchmark prices?

Yeah, it usually runs a couple of quarters. It's all over the map, but when you look at it in total on average, you usually see it coming through over a two-quarter period.

Okay, thanks. That's all I had.

Thank you. Then next, we go to Cleve Rueckert of UBS. Please go ahead. Cleve Rueckert, UBS Administrator.

Great. Good morning. Thanks for taking my questions. Just a couple of follow-ups from me. Firstly, Tim, in your prepared remarks, you had a comment about taking out high marginal costs. And obviously, you've been pretty dynamic about that over the last couple of quarters. I'm just wondering if there's an opportunity for some more permanent restructuring in the container board system. If that's something you're considering or if it sort of remains dynamic right now.

Cleve, if you mean – this is Mark. Thanks for the question. If you mean permanent, like, adjustments of capacity, we don't see that on the horizon given the types of products we make, the different grades. cost structure of our mills, we're quite capable of running them at 105% of nameplate rating and 85% of nameplate rating. And we do believe long-term the fiber-based packaging market's growing. So structural cost reduction, where we can now say it's worth making a capital investment to take out this permanently, this marginal cost that ends up only coming out when we are taking economic downtime, yes, there's opportunities for that. But there's no There's no consideration right now of any major adjustment in our asset base because it's very competitive. It makes the products we need. And I think we've got to figure out also industry in general and IP in particular, what's the new normal in supply chain? Because location of facility near converting or near market matters a lot more now than it used to. So we've got a lot to figure out on that. But lots of cost reduction opportunities through technology. modest capital investment would be our focus on taking it out for good.

Yeah, that makes a lot of sense. I was wondering if you've made any discoveries through this process of being more dynamic over the last couple of quarters, but it sounds like that's a work in progress. Maybe just two more quick ones. You've laid out a four-year guidance. I'm just wondering if there's any economic downtime built into the plan that you've laid out or if it's mostly maintenance and Q1.

Yeah, we don't comment on any plans we have or don't have about economic downtime going forward, but we have a view of, you know, the market growth and how we'll need to run the system as we go through the year.

Okay, that's fair enough. And then, you know, just finally from me thinking a little bit bigger picture, I'm just curious and I'm just sort of wondering conceptually here how frequently you evaluate through-cycle free cash flow. I think it looks like you need about another $200 million to $300 million in free cash flow to support the dividend within that 40% to 50% payout that we've talked about before. I'm just curious how you plan to get there from here, just on a conceptual basis.

Yeah, I mean, we look at free cash flow through the cycle. We do trough testing around sustainability of the dividend. But, I mean, we feel very good about our ability to meet the dividend requirement. And the 40-50% is not a hard and fast rule that will always be within that. Sometimes it could be a little bit above, and sometimes it might be a little bit below. But over time, through the cycle, we think, averaging 40 to 50 across a number of years is an appropriate range to shoot for.

Would you say that CapEx is running like a little bit above average in 23? I mean, is that something we should expect to come down?

I think it's, you know, within 100 or 200 million, it's probably in the zone. I mean, we We were trying to spend more last year, but just given supply chain difficulties and long lead times, it was impossible. And so, we were just short of a billion last year. We're targeting, you know, between 1 and 1.2 this year. But again, it depends on suppliers and vendors' ability to deliver within a timeframe. But, you know, DNA runs about a little over 1.1 billion. We've looked at average. that over time in terms of capital spending.

Thanks very much.

Thank you. Then next, from Jeffries, we go to the line of Philip Ng. Please go ahead.

Good morning. This is John Dunnigan on for Phil. Congratulations, guys, on a great quarter. I wanted to first ask about the container board inventories for IP. Where are they now? I mean, 1Q is your biggest maintenance outage, but do you see them in a decent spot with kind of this continuing weak demand environment, or do you actually see the need to build up a little bit just because of 1Q being your largest maintenance outage?

Yeah, I mean, without getting into the numbers, they came down a little bit in the fourth quarter. You know, we're going into heavy maintenance outage season first quarter for sure, but into second quarter. So we'll, you know, we'll look at inventories and make sure that we're at an appropriate level to support our outages. But I don't expect a lot of movement.

Okay. And then just with the new – capacity for the industry that's coming online. Have you seen any impact from that? Any businesses coming up for bid more frequently or Anything along those lines? And just in terms of how IP is maybe responding to all the capacity that's heavily coming on here in the latter half of the quarter, have you been able to lock in any customers for a longer period of time or kind of shore up some of your contracts to avoid some of the potential instability in the supply domain?

John, I think the way we think about it is our container board, and box system obviously is an integrated system for the board that we use to make our boxes. And the balance is what we would call our open market position. There's two pieces to that, domestic market and export market. And for the domestic market, all of our customers that buy board from us are long-term strategic agreement type customers. We do very little in just kind of what would be considered a spot market. And so we really don't have some of that churn issue that you're talking about. And then we look at demand for virgin craft liner board, which is all that we export. And we oscillate our output on that to match the demand signal. So we've seen capacity come on in the past, and it comes on in varying degrees of velocity and varying degrees of success. And we'll just navigate this one like we've done in the past. But we really do run, for all practical purposes, we run a pretty integrated operation from fiber to box, whether we're making the box or whether a long-term strategic open market box maker is making it.

Okay, understood. And just one point of clarification. In the deck, it says there's no dividend expected from ILM in 2023. I mean, given the closing is just expected sometime this year, is there no cash dividend that could come from just holding on to the ILM for a longer portion of this year, depending on the closing, or that's kind of off the table and included in the sale price?

Yeah, that wouldn't be base case. We don't expect it.

Okay. Thank you very much, and good luck in the quarter.

Thank you. Then next from Deutsche Bank, I'm sorry, from KeyBank, Adam Josephson. Your line is open.

All right. Thank you. Mark and Tim, good morning. Hope you're well. Just a couple questions about the assumptions embedded in your full year guidance. One on demand, I think, Tim, you mentioned you're thinking underlying box demand will be flattish sequentially 4Q to 1Q. Can you talk about what your expectations are thereafter? Just given the destocking that you talked about affecting the fourth quarter, one would think that demand would be getting better sequentially at some point over the course of 2023. So just wondering what exactly your expectations are beyond 1Q and for full year shipments, 23 versus 22, if you're able to talk about that.

I mean, we do see a modest recovery. I think we're looking at something in the neighborhood of maybe 1% absolute over the course of the year. So as we get out of the first quarter, going into the latter part of the year, a pickup is anticipated, but modest.

Got it. And on price, Tim, just given the lags you mentioned with respect to when the previously published price changes hit your P&L, Is it reasonable to assume that your realized prices in industrial packaging will fall sequentially, not only from 4Q to 1Q, but also from 1Q to 2Q? I would assume so, but I just want to confirm that.

Yeah, I think that's reasonable.

Okay. And my last question is just, if I think about the implied 1Q guidance, I think around $530 million, maintenance will be higher by about $120 million compared to the latter three quarters. So if I take the 530, I go up to 650, all else equal, if you assume the last three quarters of that, you get to about $2.5 billion for the year. So obviously there is additional improvement embedded in your guidance, I assume from higher realized pull prices or otherwise. So you're assuming that even though prices in industrial packaging will likely be lower from 1Q to 2Q and thereafter. I just want to make sure I'm clear on the moving parts from one queue onward.

Yeah, it all sounds reasonable.

Got it. And just last one for me is, what is your sense, Tim, or Mark, as to how the extent to which the customer destocking has played out in terms of box demand? Do you think you're 90% of the way there, 70%? What are you hearing from your customers as to what their inventory levels are in their expectations are.

I think, Adam, we're hearing there is a range, but we're hearing, as Tim, I think, mentioned in the earlier question, a large portion of the restocking did occur in the fourth quarter. There are a couple of segments that are maybe still going through it, but in some cases, we've had orders pick up in certain segments to kind of replenish So it feels like, based on what we're hearing qualitative and what we're seeing in order book, that the destocking story of demand change is played out largely, and now the question mark on everybody's mind is, well, What does the consumer do as we move through the first half of the year with respect to disposable income? What happens with inflation? They're getting some relief on fuel prices. And does the consumer move back into the goods economy? And more than likely, everybody who looks at it will get it wrong, and it'll probably come back faster, or it'll take longer to come back, but we won't get it precisely right. But that's what we're hearing.

Thanks so much, Mark.

Thank you. Then our last question will come from Citi and the line of Anthony Pedonari. Please go ahead.

Good morning. Just a couple quick ones. Maybe following up on Adam's question on the outlook, I think over the last few years when you've given a full year outlook, you've given kind of a range of $300 million EBITDA You know, this year you're giving $2.8 billion, which is maybe a bit more of a specific number. I'm just wondering if there's sort of a different way that you're formulating or presenting the outlook. You know, is 2.8 kind of an internal target, or how do you think about sort of upside-downside there?

No, hey, Anthony, it's Tim. We said approximately 2.8. It could be a little bit higher or a little bit lower. It's just a dynamic environment, and we think it'll be around that $2.8 billion level.

Okay. And then, you know, you talked about lower fiber costs in the OneQ Outlook slide. You know, I was wondering if that's just a function of seasonality or if you're seeing real, you know, deflation or maybe price declines there. And then I was just wondering if you're seeing any uptick in OCC and if you could just kind of comment on Southern Virgin fiber costs, you know, understanding those are kind of local markets.

No, I think it's OCC and virgin fiber. We're expecting, you know, to be down modestly. You've had a lot of transportation cost impact on, really on both, but on virgin fiber and our inventories are in good shape. And so we think we have an opportunity to bring virgin wood cost down slightly as well.

Okay, that's helpful. I'll turn it over.

Thank you. Then I'll now turn the call back over to Mark Sutton for closing comments.

Thank you and thanks everyone for joining our call today. Just to kind of wrap up with a couple of key points. We're excited about 2023. We believe in our outlook. We've got opportunities to maximize our performance in this uncertain environment. A lot of opportunity to get our cost structure back to something that we would consider more normal on different cost ratios. And then looking at the commercial improvements we are making throughout 2022 and into 2023, we expect to see dividends on improving our profitability regardless of the demand environment. And then the investments we're making are primarily in our box system. We'll continue to make those, and we will be ready with a more sustainable operating model when demand returns to a more normal level with the appropriate level of converting capacity and capability in the right geographic location. So a lot to do. We're excited about it, and we look forward to updating you along the way. Thanks for joining our call today.

Once again, we'd like to thank you for your participating in today's International Paper's fourth quarter 2022 earnings call. You may now disconnect.