International Paper Company

Ladies and gentlemen, good morning. Thank you for standing by. At this time, we would like to welcome everyone to the International Paper's first quarter 2023 earnings 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. If you would like to ask a question during this time, simply press 1, then 0 on your telephone keypad. To withdraw a question, please press one, then zero. We do ask that you limit yourself to one question and one follow-up question. It is now my pleasure to turn the call over to Mark Nellison, Vice President, Investor Relations. Sir, the floor is yours.

Thank you, Leah. Good morning, and thank you for joining International Paper's first quarter 2023 earnings call. Our speakers this morning are Mark Sutton, Chairman and Chief Executive Officer of and Tim Nichols, Senior Vice President and Chief Financial Officer. There's 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. A reconciliation of those figures to U.S. GAAP financial measures is available on our website. Our website also contains copies of the first quarter earnings press release in today's presentation slides. I will now turn the call over to Mark Sutton.

Thank you, Mark, and good morning, everyone. We will begin our discussion on slide three where I will touch on our first quarter results. Let me begin the discussion by saying how proud and appreciative I am of all the hard work of our employees and for our strong customer relationships as we manage through a dynamic and challenging macro environment. Looking at our performance, International Paper delivered $65 million of year-over-year incremental earnings benefits from our Building a Better IP initiatives. And our mill system continued to perform very well as we successfully executed our highest planned maintenance outage quarter of the year and continued to optimize our system while taking care of our customers. On capital allocation, we returned $319 million to share owners during the quarter, including $157 million of share repurchases. We continue to navigate a challenging demand environment as our customers and the broader supply chain work through elevated inventories of their products. We also believe consumer priorities remain focused on services as well as non-discretionary goods, which has been influenced by inflationary pressures, rising interest rates, and the pull forward of goods during the pandemic. Margins were also under pressure from lower prices across our portfolio, partially offset by additional benefits from lower input costs. Now I'll turn to slide four and talk more about the current operating environment, as well as our ongoing commitments going forward. As we entered the year, we recognized there were macroeconomic uncertainties ahead of us, and our businesses are not immune to these risks. These macro trends shifted in the quarter, resulting in a weaker than expected demand environment through the first part of this year. Much of this was influenced by greater inventory destocking across the whole supply chain, weaker export markets, and unfavorable weather impacts on the fresh produce segment. In addition, Lower prices across our portfolio today have put additional pressure on margins relative to what we expected in our full-year outlook. Although we believe most of the destocking through the retail channel has been resolved, the destocking continues throughout the rest of the supply chain, especially with manufacturers and many of our customers. We believe this will run its course through the second quarter resulting in an improved demand environment in the second half of the year. I want to reinforce that our teams at International Paper know what it takes to successfully manage through a business cycle by leveraging the wide range of options and capabilities across our large system of mills, box plants, and supply chain to really variabilize our costs while continuing to take care of our customers' needs. We've demonstrated our ability to do this in prior business cycles. And our ongoing commitment is to continue operating our company the IC way. We remain focused on our key priorities of taking care of our employees, our customers, and maximizing value for our shareholders. This includes preserving our strong financial foundation and maintaining our dividend. Before I turn it over to Tim, I also want to provide an update on ILM. We have made good progress toward closing the sale of our ILM investment. Buyers received an important required approval from the Russian Sub-Commission overseeing exits by foreign companies, but we are still awaiting the approval of the Russian Competition Authority. We are optimistic that this final required approval will be received soon, and we plan to close shortly thereafter. I will now turn it over to Tim, who will provide more details about our first quarter performance as well as our outlook. Tim?

Thank you, Mark. Turning to our first quarter key financials on slide five. Revenue was down slightly versus prior periods while operating earnings per share came in above prior year and better than the outlook we provided last quarter. Operating margins in the quarter were impacted by weaker demand and seasonally high planned maintenance outages. Free cash flow for the first quarter included a use of cash totaling 193 million for the final settlement with the IRS related to our timber monetization actions we highlighted during our last earnings call. This settlement allowed us to further de-risk our balance sheet. Also, about 31% of our annual capital expenditures occurred in the first quarter. Moving to the first quarter sequential earnings bridge on slide six, first quarter operating earnings per share were 53 cents as compared to 87 cents in the fourth quarter. Price and mix was lowered by 10 cents per share due to the index movements across our portfolio. Lower export sales prices and unfavorable product mix in our global cellulose fibers business as a result of lower absorbent pulp showings. Volume was flat sequentially as weaker demand and customer inventory be stocking across both businesses was offset by four additional shipping days in our North American industrial packaging business. In our global cellulose fibers business, the first quarter was also lower due to the Chinese New Year. In operations and cost, our mills ran very well. However, quarter over quarter was unfavorable because the fourth quarter benefited from favorable one-time items totaling $71 million, or 15 cents per share, related to lower employee benefit costs, workers' comp expenses, and medical claims. In addition, our cellulose fibers business was impacted by higher economic downtime due to the lower demand environment I mentioned earlier. Maintenance outages were higher in the first quarter as planned, and we saw significant relief from input costs which were $134 million or $0.28 per share lower in the first quarter, primarily driven by lower energy and OCC costs. Corporate and other items was impacted by FX and timing of spend, partially offset by a lower tax expense. Turning to the segments and starting with industrial packaging on slide seven, price and mix was lower due to index movements and lower export prices. This was partially offset by benefits from commercial mix initiatives focused on margin improvement. Sequentially, volume benefited from four additional shipping days. However, demand for packaging weakened in March across most channels and segments, from lower consumer demand and ongoing destocking across the supply chain. Even 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 segments. Sequentially, ops and costs were impacted by the non-repeat of approximately $57 million of favorable one-time items I mentioned earlier, as well as timing of spend. Overall, our mill system ran very well. The lower demand environment impacted operations and costs in the quarter as we adjusted our system to align our production with customer demand. These actions resulted in approximately 421,000 tons of economic downtime across the system. Input costs were significantly lower and improved earnings by 105 million sequentially. Almost two-thirds of the benefit was from lower energy costs in North America and Europe, and the remainder was primarily from lower OCC and freight costs. Overall, we continue to face very 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, we are 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 slide eight, we thought it would be helpful to share some additional perspective on underlying segment trends for our corrugated packaging business. As shown on the previous slide, our U.S. box shipments were down 8.5 percent year-over-year in the first quarter and down almost 12 percent year-over-year in the month of March. We saw demand decline across all in-use segments on a year-over-year basis and experienced another demand shift in March that impacted all segments except for e-commerce. Furthermore, demand declines were more pronounced in segments that generally are more discretionary in nature as consumers had to make choices while dealing with high inflation and rising interest rates. The yellow indicators represent segments where the demand decline was less than our overall average of 8.5%, and the red indicators represent declines that were greater than the average decline. For example, processed food and protein were more resilient, down low to mid-single digits as consumers focus on essentials and value, and poultry serves as a low-cost consumer staple. Fresh produce was impacted by poor weather conditions on the West Coast and also in Florida. On the other side of the spectrum, segments like durables and other non-durable consumer goods are more discretionary in nature. Along with shipping and distribution, these segments came under the most pressure with declines in the mid-teens. These segments also tend to be more affected by the inventory destocking efforts across the longer supply chains. E-commerce was down mid-single digits versus last year, but showed more resilience through the quarter and is still up 50% from pre-pandemic levels. Based on feedback from our customers, we believe the majority of retailer inventory destocking has been completed through the first quarter. However, manufacturers are still reducing inventories as a result of lower demand levels, improved supply chain velocity, and focus on working capital given higher interest rates. We also believe the majority of destocking will be completed in the first half of the year, and considering our performance in April and looking at order backlogs, we expect sequentially higher volume in the second quarter. Despite these near-term headwinds, we understand the critical role corrugated packaging plays in bringing essential products to consumers, and believe that IP is well-positioned to grow with our customers over the long term. Moving to cellulose fibers on slide nine. Taking a look at our first quarter performance, price and mix was relatively flat sequentially. Our strategic initiative related to contract restructuring generated significant earnings improvement in the first quarter. However, this was offset by a less favorable mix due to lower fluff volumes in the quarter and a higher percentage of commodity grades, as well as the unfavorable impact from index movements. Volume is lower due to customer inventory destocking in response to improvements in the supply chain velocity from less port congestion and improved vessel reliability, and also impacted by the Chinese New Year. Feedback from our customers suggests the majority of destocking will be completed in the second quarter. With that said, we believe fluff demand will continue to grow over the long term. This is due to the essential role that absorbent personal care products play in meeting consumer needs. The lower demand environment significantly impacted operations and costs in the first quarter as we adjusted our system to align our production with our customer demand. These actions resulted in approximately 130,000 tons of economic downtime across the system and accounted for approximately two-thirds of the ops and cost variance. Sequentially, option costs were also impacted by inflationary pressures, as well as the non-repeat of approximately $14 million of favorable one-time items in the fourth quarter that I mentioned earlier. Planned maintenance outages were higher by $11 million sequentially and represents one of the highest outage quarters of the year. In addition, input costs were lower by $29 million due to lower energy and fiber costs. Turning to slide 10, our global cellulose fibers business continues to make progress, executing our strategy to deliver value-creating returns over the business cycle. Business increased earnings by approximately $100 million in 2022 and is focused on driving incremental earnings growth this year, despite operating in a more challenging macro environment. Our team successfully deployed a commercial strategy focused on building strategic relationships with key global and regional customers and aligning the most attractive regions and segments. In the fourth quarter, we finalized our fluff pulp contract negotiations, which is contributing meaningful commercial benefits this year. Going forward, we believe there are significant opportunities to improve our cost to serve by reducing supply chain costs, which had increased significantly during the past couple of years. We expect to see these benefits will start to show up in our second quarter outlook. We are focused on creating value for our customers by delivering products that meet their stringent performance and product safety standards and deliver innovative value. In addition, we are driving structural margin improvement by ensuring we get paid for the value we provide. We believe this is reflected in the premium we earn for fluff pulp over commodity grades, which has expanded over time. We are committed to building on this momentum and expect to drive additional earnings growth going forward. Turning to slide 11, I'd like to update you on the building of better IP initiatives. We're making solid progress and delivered $65 million of year-over-year incremental earnings improvement in the first quarter. Our lean effectiveness initiative was mostly completed early in the program, generating $110 million of cost savings since we began our Building a Better IP program. By streamlining our corporate and staff functions to realign with a more simplified portfolio, we more than offset 100% of the dis-energies from the printing paper spinoff. The most significant driver of the year-over-year results was strategy acceleration, as we delivered profitable growth through commercial and investment excellence. As I mentioned earlier, we generated solid earnings growth in our global cellulose fibers business on a path to deliver value-creating returns. We're also focused on profitably growing our industrial packaging business by improving margins and investing for the long term. 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 meaningful benefits going forward as we finish implementing new capabilities across our business. Turning to slide 12, I want to take a moment to update you on our capital allocation actions. As Mark highlighted 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. And finally, even in this environment, the risk mitigation strategies we've taken help ensure our pension plan remains fully funded. Turning cash to shareholders is a meaningful part of our capital allocation framework. In the first quarter, we returned $319 million to shareholders, including $157 million through share repurchases, which represents 4.3 million shares, or about 1.2 percent of shares outstanding. At the end of the quarter, our total authorization was approximately $3 billion. Going forward, we're committed to returning cash through maintaining our dividend and through opportunistic share repurchases. Investment excellence is essential to growing earnings and cash generation. We invested $341 million in our businesses in the first quarter, which includes funding for cost-reduction projects with attractive returns and for strategic projects to build out capabilities in our box system. Going forward, we plan to make additional investments across our box system to support long-term profitable growth. and we will remain disciplined and selective when assessing M&A opportunities. Turning to slide 13 in our second quarter outlook, I'll start with industrial packaging. We expect price and mix to decrease earnings by $110 million, mainly as a result of prior index movement in North America and lower average export prices based on declines in the first quarter. Volume is expected to increase earnings by $30 million due to normal seasonal increase in daily shipments in North America, offsetting one less shipping day. Operations and costs are expected to decrease earnings by $35 million due to the timing of spending. Maintenance outage expense is expected to decrease by $10 million. Second quarter should represent approximately 30% of the total planned outage cost in 2023. And through the first half of the year, we will have completed about 70% of expected annual outages. The second quarter includes approximately $19 million of spend associated with the Riverdale Mill printing papers outage. This cost will be fully recovered as part of the charges to Silvamo over the course of the year. And lastly, input costs are expected to decrease by $30 million from lower average costs for energy and freight. Switching to global cellulose fibers, we expect price and mix to decrease earnings by $45 million as a result of prior index movements. Volume is expected to increase earnings by $5 million, primarily based on seasonally higher demand. Operations and costs are expected to increase earnings by $40 million due to lower supply chain costs and lower unabsorbed fixed costs from higher volume. Maintenance outage expense is expected to decrease by $33 million. And lastly, input costs are expected to decrease by $15 million, mostly due to lower energy and fiber costs. Moving to our foliar outlook on slide 14. As Mark discussed earlier, as we entered the year, we recognized there were macroeconomic uncertainties ahead of us and that our businesses are not immune to these risks. The macro trends have shifted, resulting in weaker than expected demand for our products and price reductions across our portfolio through the first quarter, including prior index changes that will be implemented over the remainder of the year. As a reminder, our previous outlook represented price indexes at that time. We are now projecting full-year 2023 EBITDA for the company to be in the range of $2.3 to $2.5 billion. We continue to optimize our system by reducing high marginal costs and driving additional benefits from our Building a Better IP initiatives. This includes delivering continued earnings growth in our global cellulose fibers business despite cycle headwinds. I would also note that our outlook includes only the impact from published price changes to date. Free cash flow is expected to be $800 million to $900 million, which includes a one-time tax payment of $193 million in the first quarter related to our timber monetization settlement. In addition to free cash flow, we also expect to receive approximately $500 million of cash proceeds from the ILM sale. For 2023, we are targeting CapEx of $1 billion to $1.2 billion with increased investments in our U.S. box system to build additional capabilities and position us for long-term profitable growth with our customers. We will also focus on high return cost reduction projects across our system. With that, I'll turn it back over to Mark.

Thanks, Tim. Now I'm going to turn to slide 15. I want to reinforce my confidence in the resiliency of IP and our ability to navigate through this dynamic environment from a position of strength. As I mentioned earlier, our teams at International Paper know what it takes to successfully manage through a business cycle. by leveraging the wide range of options and capabilities across our large system of mills, box plants, and supply chain to optimize our costs while continuing to take care of our customers. Also, we are 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. And finally, we have significantly enhanced our financial strength and flexibility. The strong foundation that we have built makes IP well-positioned for success across a wide spectrum of economic environments and to deliver profitable growth over the long term. With that, we're going to move to Q&A, and I'd like to note that I've invited our senior business leaders to join me for this portion of the call. Given the dynamic environment we're in, I thought it would be helpful for you to hear some additional perspective from these leaders. So, operator, we are ready to go to questions.

Thank you. Ladies and gentlemen, if you would like to ask a question, simply press 1-0 on your telephone keypad. If you would like to withdraw a question, press 1-0. We do ask that you limit yourself to one question and one follow-up question. One moment, please. Our first question comes from the line of Anthony Petanari with Citi. Please go ahead.

Good morning. Hey, Mark, you know, Tim, you talked about, you know, confidence in global cellulose fibers earnings growth this year, you know, assuming the list prices that have been published, I guess, as of, you know, today. You know, what gives you confidence that, you know, we won't either see, you know, further meaningful deterioration in fluff prices or, you you know, the confidence that you have, you know, the offsets like the commercial initiative to kind of offset, you know, any further deterioration. I'm just wondering if you can give us kind of any sense there. And then if you can kind of remind us the lag from, you know, price change in the pulp index to your contracts and earnings.

Okay, great question, Anthony. I'm going to take the first part of that, and then I'm going to ask Clay Ellis, who leads our global cellulose fibrous business, to give you a little perspective on some of the changes we've made. I mean, the source of our confidence is we've really changed the way we go to market. And as we've explained many times, there's this contract portion, which is generating significant earnings uplift in the contract large global multinational customer base. There is a portion of our business that's open market, that's traded more monthly or shorter term, less contractual, that's also absorbance. We have a specialty business that's not tracking exactly those markets. And then the last piece, which is the most volatile, we still have exposure to market pulp, which is where a lot of the pricing issues have hit the business and will likely hit the business. So if we focus on the core, that's where our confidence is around the absorbance, strategic customers, and the profit improvement, and the changes we made really in the last 18 months that are coming to fruition As far as the flow through and a little bit more about how we see the year happening, there's a story similar to what I described in my prepared remarks and what Tim described with the stocking and where we think demand, the real demand from the end-use customer is going to go. Clay, I'd ask you to maybe add some color to that. Sure, Mark.

Anthony, good question. lag time that you mentioned. And around a quarter, if you think about our index pricing, just think around a quarter lag in general. And around what gives us confidence, I think Mark was hitting on it there. Our in-use demand of absorbent hygiene products we see, our customers see, is still solid. I was in Geneva last week at an index conference where we had many of our customers, talk to many of our large global, and also all the way to some small regional. And across the board, it's the same outlook on what consumers are doing in this space, and I'm sorry, but is good, and the outlook is strong, and think about historical levels of growth. Disinventory destocking is the story. It's what's happened. It's certainly... more than we expected, a little longer and deeper. We do expect it to come mostly to an end in the second quarter. And so second half gives us confidence returning to more normal volumes, improved mix, and then also the economic downtime that we're experiencing in the first half should largely be gone by then. And we expect to be able to drive profitable growth even over last year.

Okay, that's very helpful. And then switching to industrial packaging, you talked about confidence that destocking could run its course in the second quarter or by the end of the second quarter. I guess that's a comment on the domestic market. I'm wondering, when you think about the export channel, which I think you indicated remains weak, is it possible to think about where customer inventories are there? Is there any sort of light at the end of the tunnel or regions that are maybe improving or maybe getting worse. I don't know if there's any general comments there.

Yeah, that's a great question, Anthony. You're right. Both Tim and I's prepared comments were primarily focused on the largest market we're in, which is North America. But Jay Royalty is here. Jay runs our global container board business as well as our EMEA packaging business. And I think Jay has been working very feverishly with the teams to try to understand just that. So, Jay, if you want to comment a bit on Anthony's question about export markets and the non-U.S. phenomena of destocking and demand.

Sure, Mark. Hi, Anthony. So, yeah, I think, you know, when you look at the export channel, it's been and remains particularly weak. You know, we've seen very low demand for the last several months due to a lot of different factors, whether it's geopolitical, high inventory levels, low consumer activity as it relates to inflation and And then also weather for fruit and vegetable goods has been not cooperating really around the globe, the US, Europe, even into places like Morocco. We are seeing inventory levels improving and we can start to see some stabilization there in terms of any signs of improvement. I think those are few and far between, maybe a little bit in Latin America, which is one of the markets we serve. You know, these markets will rebound at some point. You know, our positions across Europe, Latin America, Asia, these are with customers who really value Kraft Liner Board, heavily oriented to fruit and vegetable segments, and those are going to grow with consumer activity and consumption over time. So, you know, we feel good about the future, but certainly in this moment it's particularly weak, and that's putting pressure on both demand as well as pricing.

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

And our next question is from Matthew McKellar with RBC Capital Markets. Please go ahead.

Yeah, thanks very much. I was wondering if you could add a little bit of just color in terms of what you're seeing in demand in the industrial packaging business to start Q2, maybe compared to both March and Q1 as a whole. And particularly thinking about your different customer segments and where you're seeing areas of relative strength and weakness.

That's a great question, Matthew. This is Mark. I mean, we look at demand in two components. There's the final end-use consumer. I think we term that, our marketers term that organic demand. And then there's the demand ahead of that in the manufacturers and the supply chain ahead of the consumer. Those manufacturers are really our customers. And then when you break it down by segment, Tim had that that colorful chart where he looked at the broad segments. But Tom Hammack, who leads our North American box business, is here. And I'd ask him to give some insight on your question about how we see it going forward, what gives us confidence on our comments about the destocking piece, and then maybe some segment comments, Tom.

Sure. Thanks, Mark. And good morning, Matthew. You know, we've We exited or entered the second quarter very strong relative to March. So we've got good momentum moving from March to April. You could think about shipments being up maybe 5% to 6%. And our backlogs are actually better than that. So we see that almost double digit improvement in backlog. So I think that indicates how we've thought about these stocking is it's not going to go away immediately. but it is going to transition through the second quarter because as Mark mentioned and Tim mentioned, different segments have different levels of destocking that they're having to work through. And so it's not a uniform everyone has too much in inventory. It depends on the segment and if it's perishable goods or something like that. I think our confidence in understanding destocking is we triangulate between macro data a lot of customer conversations about what they're seeing in the near term, as well as our experience in these segments over time and how they're growing and how we understand their supply chain to work. And on a positive sense, all of those point us in the same direction as this plays out through the second quarter. Obviously, there's a component of that that's demand dependent, but in large part, we feel good about the momentum for where the box business is headed.

Great. Thanks. That's helpful. And then shifting over, can you give us a sense of how you're thinking about share repurchases here? Should we continue to expect them to sort of trend in line with Q4 and Q1 levels, or do you maybe see more limited room for repurchases given the downward revision to free cash float look, or do you even accelerate repurchases given where the shares are trading? Thanks.

Yeah. Hey, Matthew. It's Tim. So I would just step back from the specific on share repurchases and say I think you're familiar with our capital allocation framework, and we take that into consideration across all the uses of cash in everything that we do. As Mark said, you know, starting with a strong balance sheet, it gives us tremendous financial flexibility. Maintaining the dividend is a complete commitment. And we target opportunistic share repurchases. We're constantly looking at the environment, and in any moment in time, we're making decisions around where is the best place to deploy cash for value creation and maximization. So nothing's going to change in terms of how we think about that framework through the cycle. All parts of the cycle, it comes into consideration.

Okay, thanks. I'll turn it back to you.

And our next question is from Gabriel Hadji with Wells Fargo Securities. Please go ahead.

Mark, Tim, good morning. Thanks for taking the question. I wanted to revisit, I think, Tim's prepared remarks on slide seven. I want to make sure I heard what you wanted us to hear, which was, I think you talked about facing higher supply chain costs and then sort of the current low environment. There was... I think, Tim, your words were further opportunity to optimize the system. I'm assuming that means continue to take out variable costs of the system. Or has there been sort of a change in philosophy in thinking about your mill system or maybe the box system overall where you can make some permanent adjustments?

No, you had it right. I mean, we're talking about how we run the system we have as efficiently as possible. And when you're taking... this amount of downtime, you're constantly trying to optimize on the marginal cost and get out the high marginal cost. And so it's something that we started, well, we started years ago, but more recently we started looking at marginal cost in the second half of last year and it continued in the first half of this year. And just given the dramatic nature and shift in demand and the way we've responded, It's taken a little bit more time than normal, but we're starting to see how it plays through not only in inputs and buying the highest cost inputs, but now into transportation as well. it's a real focus on just getting out as much cost as possible.

Yeah, Gabe, you know, sometimes, this is Mark, sometimes we get, and we may get it later in the call, we get a question about would we consider changing the way we operate in lower demand environments versus the current approach to running most of our system at different levels of output instead of running part and not running part. And we evaluate that, I mean, really almost on a continuous basis. And Depending on what's happening, as Tim described, the supply chain environment we're in and then the cost gradient we have at most of the mills on fiber and OCC and other inputs, there is huge savings for eliminating the high marginal cost across, you know, 17 different mills. And you can imagine if you decided to, you know, temporarily close one or two of them, then you have to add back all that marginal cost at the others because in theory they're going to run full. And then depending on geography and logistics, you end up with no net savings. So we are continuing to look at that. I didn't think we could get a lot better, but our teams have gotten better at marginal cost takeout across systems running much lower than full capacity. But we don't take anything off the table in terms of figuring out the best way to operate for the quarter ahead or the two quarters ahead with the best information we have about the demand signal. But it's really an optimization of the total cost, and the value in that marginal cost reduction is really powerful.

Thank you for that. And then I guess a little bit more short-term in nature here, you talked about input costs being $30 million favorable in industrial packaging. I suspect an element of that is maybe lower natural gas. And do you have an explicit assumption for kind of OCC hovering where we are today? You know, and I sort of asked the question because one of your peers talked about some pretty healthy rail price increases that came into effect April 1. Curious if that's something that impacts you. And then sort of for the implied second half guidance, Is there anything explicit in there that you would instruct us towards in terms of underlying assumptions for some of your bigger inputs, whether it's, again, virgin fiber, recycled fiber, or energy?

Yeah. So, hi, it's Tim again. I think the headline is we're not – second quarter is going to be better. It depends on which category of input costs that you're talking about. On natural gas, we – pretty much follow the strip. There's some distribution charges and things like that that impact it, but the movement is very similar, and so you can see how that plays out. On OCC, we have a modest, we believe there could be a modest increase over time, but the whole environment is so fluid and dynamic, it's going to depend on how it plays out over this quarter and as we go into the third quarter. Chemicals, for us, are getting a little bit better. And transportation, I don't know the reference you mentioned on the contract. These contracts come and go at different points in time. And it's a mixture across all the modes of transportation that we're seeing. But I'd say, on balance, we get another benefit on input cost in the second quarter. And depending on the scenario, it's kind of flattish as you go out through the second half of the year. But again, it's going to depend on the backdrop.

All right. Thank you for that and good luck.

And our next question is from Kyle White with Deutsche Bank. Please go ahead.

Thanks. Good morning. Thanks for taking the question. I just wanted to go to the outlook and was wondering if you can kind of walk us through some of the moving parts. regarding the new updated outlook versus the initial target. Any way to kind of size how much of that reduction is driven by the corrugated packaging business versus cellulose fibers? How much is driven by the change in pricing versus maybe, you know, the weaker demand environment that we're in?

Yeah, so you're talking about the 2.8 versus the new range of 2.3 to 2.5, Kyle?

Yeah, that's correct.

Yeah, it's Tim. March was, I think there's no other way to say it, it was a surprise to us in terms of demand drop-off and the resulting economic downtime that we took to balance out our system. But, you know, when you look at it, we had further price, published price decreases for pulp. Export prices came down. We had lower volume and we had more ADT, which means more costs. And then you look at how that evolves as we go through the second quarter and the second half of the year. Those things are going to be present, but we also get, as I mentioned, a little bit better on input cost. We have a significant drop off in maintenance outages because we're really front end loaded, front half loaded on our maintenance outages. And then there's some additional costs that come out. When we looked at all of it, there was some pretty significant moves in the month of March that even though it's getting better, you know, uh, still impact the first part of the second quarter.

Got it. And then I guess if we go back to last quarter, I think you guys talked about pocketments potentially, you know, to, uh, come back to being flat for, for 2023. And that was, uh, assumed in maybe the outlook that you had initially. Obviously, destocking has been a little bit more than everyone has anticipated and provided for a weaker demand environment. But are you able to kind of help us understand what is embedded in terms of the new outlook on where you think box statements could be for the full year now?

Tom Hammack Sure, Colin. This is Tom Hammack again. Our view on boxes, and we say this a lot, is that economic activity drops box demand. And so as we see the economy recover, we expect box demand to tie directly to it. There really isn't a near-term substitute for a box when you're thinking about delivering to a retail channel or to really any channel in the U.S. So we're confident about that rebound. I would say in terms of the full year, most of the difference we have between what we thought for the full year and what we think now is happening in the first half due to this destocking. So it's really hard to forecast the full year exactly. I think it's going to depend on us being correct about the second quarter and the destocking playing out because the economy is also going to be an open question. But in general, we see this improving.

Got it. That makes sense. I'll turn it over.

And next we go to Mark Weintraub with Seaport Research Partners. Please go ahead.

Thank you. Obviously, one of the concerns investors have had is about the new supply that's coming into the marketing container board. I particularly thought we'd try and take advantage of the fact that you've got some industry leaders on the call. Just getting an update on your thoughts as to where that capacity perhaps is right now. Is it already being absorbed? And or things to think about how that might play out as you see it.

Yeah, Mark. This is Jay Royalty. Good to talk to you. I think that a few things to keep in mind relative to this new capacity that's coming in. First of all, the open market is relatively small, as you know. Our position in that market is really made up of long-term strategic relationships. And including, in some cases, some equity positions. So we've got very little spot business. And it's important to remember that at the end of the day, people buy boxes. And they don't buy container board. Producers may buy some container board. But at the end of the day, it's about having an integrated system, which is what we have. And customer needs are complex. And so you think about what customers value and what they're looking for and what IP brings to to customers. It's about comprehensive offerings. There's a wide grade mix there, geographic reach, redundant capabilities, having the ability to surge and flex with their needs. All of these things are important. It's really about more than a single mill. It's about having a system and those capabilities, and that's what customers value. When you think about Our relationships, you know, our customers are looking for those things. That's what allows us to have these long-term strong relationships. And so, you know, the new entrants are going to be trying to compete with that in some form or fashion.

Okay, that's helpful. Thanks, Jay. And just maybe if I could follow up on the distinction between the shipments, which I think you mentioned were up 5%, 6% so far in April, so encouraging. and then backlogs being double-digit. What should we make of that? Does the backlog, is that a lead indicator for where shipments likely would go to? And recognizing we've had some very, very difficult demand environment, so we don't want to get ahead of ourselves, but could this mean that we're actually closer to being through on the D-stock? But why that sort of the conservativeness Again, what we've gone through, good reason enough right there. But just trying to get a little bit more color and thoughts on the shipments and the backlog data you were talking about for April to date.

Sure, Mark. This is Tom again. Just for some clarity, you had it right. The shipment comment I had was about 6%. And that's sequential from March. And obviously, as Tim talked about earlier, March was weaker than the second quarter. But it's still a strong sign of momentum today. Backlogs tend to be more volatile because as the market gets better, you get more and more orders because customers see that lead times are normalizing. So it's a good indicator more of the future than it is in the moment, but I think you combine the shipment outlook we have with the backlogs improving. It points you to where probably pretty close on the second quarter play out that Mark and Tim talked about because if we're not seeing it in this month, you probably have a bit of a delay. So it feels like, to me, it all fits together, and that's what we're hearing from customers.

That's super. One real quick follow-up then. Have you seen, in the last, say, six months when we've been in this really difficult demand environment, have you seen where the shipments and backlogs went up and then they just rolled back over again, or is this the first time you've really seen this?

I think this is the first time we've seen a significant shift from what you would think about seasonally. You certainly can have a segment that, And it might affect, if it's big enough, it might affect your total mix. But I would say we have, thinking about it, I, you know, don't have the numbers in front of me. I don't think we've had a false start.

Okay. Super. Appreciate it.

Next, we go to the line of George Staffos with Bank of America. Please go ahead.

Hi, everybody. Good morning. Thanks for the details. Jay and Tom, good to hear your voices. Hope you're doing well. I had some technical difficulties getting on the call and you may have mentioned this but the last call in our Q&A you had suggested that fluff GCF could see you know roughly a couple hundred million dollar improvement in profitability is there an update to that and then kind of the granularity if I look at the waterfall and your outlook and I look at what maintenance is going to look like sequentially the next couple quarters in GCF. I don't get much of an improvement in earnings this year. And so just thinking about what is the embedding your guidance for GCF, where should we see earnings move? And as we sit here today realizing destocking has been a big factor, and hopefully the revision of that will allow earnings to improve, Talk about why you still see this as a real good business to have for IP to be in for its shareholders, Mark, structurally. And that, a question on Container Board.

Okay, George, thanks. Great question. Let me just hit the headline, and then I'll ask Clay to comment on what's embedded in our outlook and really ask him to remind and separate the absorbent and specialty core part of the business and then the rest of the business, which tends to be more volatile and commodity-driven. The 200, you know, had certain assumptions aligned with it. Some of those assumptions have changed. We still see line of sight somewhere in the neighborhood of 50-plus million improvement in the business, and so there's still going to be earnings improvement in the business, and we just have to, you know, adjust what the timing of those improvements are given the change in some of the pricing assumptions and the way we're operating. So, Clay, you might want to talk a little bit about the puts and takes that make up that full-year outlook.

Yeah, thanks, Mark. Hey, George. So you mentioned you may have missed some of the early part, but just to re-tread a minute on what we see causing the issue in the first half is almost all destocking. We do have a lot of confidence in the end-use consumer demand of absorbent hygiene products, and we see that future being a lot like historical. and growth. And so while we're confident about it or excited about it, this is a very in-the-moment kind of current issue, really an unprecedented issue with the inventory flow through. We believe we'll come out of that, have a stronger second half. And you made mention of the $200 million from the last call. Those changes have been made, and they're flowing through in the pricing. So that's there. But, you know, with the low volume that we've had, the low customer order rate, taking the EDT that we're taking, you know, and the price moves, it has, you know, eroded about $150 million of the $200 as we see as those prices flow through the year. So, to Mark's point, the $50 million still creative to last year earnings is what we see on top of $100 million in 22 versus 21. We're confident as we get that the consumer demand is there. We get through this issue. We'll get our volumes more normalized, our mix more normalized, get away from the EDT cost that Tim had mentioned. We feel confident. We feel strong about it moving forward. George, I'll just wrap the

question you asked that said the last part about why we still believe it's a good business and a good thing for IP shareholders. I mean, when you look at the business that we're in now, corrugated packaging, cellulose fibers for absorbent products, we've got two natural resource-based businesses both facing growing end-use markets, both directly in our wheelhouse from a manufacturing and process standpoint, And when you then layer out, forget about the product and look at the customer and the supply chain, you layer out the types of customers and what they value, solutions, technical design, the same kinds of things they value in the box business they value in the cellulose fibers business. It's a more global customer base in cellulose fibers than it is in our box business, but we believe that starting with that softwood fiber, renewable, a very, very good, well-positioned manufacturing base, turning that into products that are facing growing markets is giving IP a higher quality of value creation than a single product line type of company. And we believe that that's valuable in the long term. And we don't think about just single moments like one year or a couple of quarters. We look at this down the road over the next decade. Where are things headed? where the types of products that both businesses are making are headed. And we think that's exciting for investors as they sort out where sustainable natural resource type companies fit in their portfolios.

Thanks, Mark. On packaging, recognizing ultimately customer spec boxes, the box spec then dictates how the substrate and the sheet of paper you're going to run on the cargator to make the box and everything else that follows. Given that we've seen the cost curve shift a bit towards recycled versus virgin in terms of who's lower on the cost curve right now, and also given the shifts that are occurring in the end markets where realizing this is really kind of a one-quarter issue, not a structural issue, nonetheless we're seeing weakness in durable goods, weakness in ag. Is there... Anything we should take away about what your mix might look like in industrial over the next two, three quarters, or more structurally, or do you think relative to the mill fleet, relative to what you're doing on converting, do you think your mix of business will be as rich, if not richer, over time than what we've seen the last couple of years? Thanks, and good luck in the year.

Sure, George. This is Tom. Hey, Tom. You talked about, hey, how are you? You talked a little bit about the different substrates, and I think as a customer of the container board system, that's a huge advantage for us because we've got this huge base of manufacturing different products, different grades. And so since we have direct access to those, we can design the box and the box plant mix directly around that. In terms of the, you know, the destocking and how we feel about these different segments, I think we're going to see different levels of destocking by segment like we talked about, but I think we should expect a normalization of demand because the U.S. economy is going to recover. That may take a little longer given economic conditions, but certainly it's coming. And then maybe a little bit of a specific piece to your question is one of the biggest improvements we've seen coming into April is ENAC. So that has been a really tough business because of weather over the last couple of quarters, and we're starting to see that pop back up, which I think is a very good sign.

George, I'll just end Tom's comments with the long-term question you asked about do we see our mix as a richer mix for the whole value chain, the packaging paper, the container board we make, and the types, and then the ultimate box and packaging solution we provide and Our strategy has pointed to a richer mix over time, and our mill system will evolve in the type of products we make. Where we make them, we've got a heavy concentration in the southeastern part of the U.S., but we've got a market that covers the entire, you know, of North America, really. And so you'll probably see in the future slightly different locations over time and probably definitely higher quality recycle being feathered into our mix. And I'll point to our most recent container board investment is a game-changing level of quality white top liner that brings us into a whole new set of segments where we were purchasing some of that paper before. It was good paper. And we were making some ourselves, which was second tier. And now we have some of the best printable white liner. And so you'll only see investments that incrementally improve us on quality and product capability, which again, to Jay's point, only matters if you turn it into a box that people want and are willing to pay for. So that's the focus. We see the business getting better over time with a richer mix and a good end-to-end from natural resource to finished product value chain that we can be the best at every part of that for our customers.

Thank you very much.

And our final question for today comes from the line of Phil Ng with Jefferies. Please go ahead.

Hey, guys. Thanks for fitting me in. Despite a pretty challenging backdrop, Tim, the free cash flow is still showing to be pretty resilient here, and you should be getting, I believe, 500 million cash proceeds from LLM. Karish, what's the game plan in deploying that excess cash, hopefully coming very soon?

Hey, Phil. It is Tim. It's like we always do. We have our capital allocation framework and we look at where we are in the moment and then make decisions on how to best deploy cash for value. So it'll be the same type of construct as free cash flow comes in and incremental cash for middle.

Gotcha. Okay, that's helpful. And from a pulp side of things, you know, Curious your confidence in maintaining that large premium versus fluff. And supply chain logistics certainly was very choked up last year. So being mindful of how hard it was to kind of see through the destocking container board, your level of confidence that the destock will be done in 2Q. And I'm just curious, have you started seeing any lift in China starting to reopen here?

So, Phil, let me quarterback here. Clay's going to take the question on the premium and the work we've done to change our go-to-market and fluff and our confidence in maintaining that. And then I'll ask Jay to comment on the container board. Actually, the question on supply chain really covers both businesses, maybe even more cellulose fibers in terms of getting things through the port and the velocity has improved. That does give better visibility. But you asked specifically about container board in China. Jay will take that one.

So Clay, if you would answer the question about... Mark, my question on the supply chain was really more on fluff. I just made the point on container board because it was pretty hard to see through that. It's just your confidence to kind of see through the fluff side of it.

Sorry, Phil. I misunderstood your question. So Clay will take both of them.

Hey, Phil. This is Clay Ellis. Good to talk to you. Your first point on market pulp... Yeah, pricing on market pulp, paper grade pulps, they were down in the first quarter, somewhat resilient in Q1. And then in April, we've seen a huge decline. And you can see that in the publications through the month of April. And so over time, you can see the fluff pricing being resilient, keeping a pretty good high premium over market pull. We expect that to continue. You know, I think when you look at the whole ecosystem of the fibers in the pulp, clearly going down through the first quarter and then paper grade as we set on through April. You know, fluff isn't immune to that, of course. Fluff prices have moved down some as well, but I think I think that fluff prices will continue to be less volatile. They'll continue to maintain a premium. But to be realistic, in the whole ecosphere of the fibers, when they go down, there's a gravity on fluff, too. So it's why it's more important for us to be higher integrated into fluff, to have the capacity to grow with our customers, future growth in that space. remove or mitigate some of our susceptibility to the more paper-grade or to the market commodity pulse.

And then your confidence of working through the supply chain and seeing through the D-stock?

Yeah, very good confidence. Again, I mentioned on the call earlier last week with a lot of customers, the Geneva conference, you know, even our customers did not see the level of stocks, and when I talk about stocks, it's not just fluff, it's through the entire absorbent hygiene supply chain, so all the way from retailers, converters, our customers, and then all the way back into the raw materials like fluff. It was higher, more than anyone saw, but So we see our customers, they're seeing the retailers order more, get more normal. So they're seeing that slack has come out of the rope. We're seeing our inventories of fluff getting really down to historically, lower than historical. So we see also part of this, I think, has been lowering the inventories across the supply chain, the targets from where they were in the past. So I think that's caused even prolonging this a bit more. Everybody sees more of the slack out of the system now, and they see it coming out, and everyone's seeing their orders, no matter where they are in the supply chain, begin to pick up and moving into the second half.

And has that China reopening dynamic given you a little more confidence, or has it really had much of an impact quite yet?

Yeah, it gives us more confidence that, one, it's not a consumer demand issue. that it is destocking and that we can see the end. So yeah, that gives us confidence.

Okay. Thanks a lot. Great call.

Thank you. I will now turn the call back over to Mark Sutton, Chairman and CEO, for closing comments.

Thank you, Leah. And I'd like to thank everyone for your time today and for your continued interest in international paper. I look forward to updating you on our progress as the year unfolds. And again, I would just like to thank our employees for the hard work through these challenging times, which really you can argue started a couple of years ago. They continue to show up every day taking care of our customers, running safe and efficient plants, and selling and delivering products to our customers. And I couldn't be prouder and happier to be leading this great team of people at International Paper. So thanks again for your interest in our company. And have a great day.

And once again, we'd like to thank you for your participating in today's International Papers first quarter 2023 earnings call. You may now disconnect.