International Paper Company

Good morning and thank you for standing by. Welcome to today's International Paper's second quarter 2023 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 1 then 0 on your telephone keypad. To withdraw your question, press 1 then 0. As a reminder, to ask a question, press 1 then 0. Again, that is 1 then 0 on your telephone keypad. To withdraw your question, press 1 then 0. It is now my pleasure to turn the call over to Mark Nellison, Vice President, Investor Relations. Sir, the floor is yours.

Thank you, Alan. Good morning, and thank you for joining International Papers' second quarter 2023 hearings call. Our speakers this morning are Mark Sutton, Chairman and Chief Executive Officer, 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 second quarter earnings press release and 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 highlight our results. In the second quarter, our operations ran very well, and we managed our businesses effectively in a challenging demand environment while taking care of our customers. Looking at our performance, International Paper delivered $55 million of year-over-year incremental earnings benefit from our Building a Better IP initiatives. This program contributed $120 million of benefits through the first half of the year, and we were on track to exceed our full-year target for the second year in a row. Underlying demand for our products improved throughout the quarter, but remained constrained by inventory destocking as our customers and the broader supply chain worked through elevated inventories of their products. Based on discussions with our customers and trends observed across the various end-use segments for packaging and pulp products, we believe consumer priorities in the second quarter remained focused on services as well as non-discretionary goods. This trend has been influenced by the pull forward of goods during the pandemic, as well as inflationary pressures and rising interest rates. However, based on feedback from our customers, we also believe that destocking is finally coming to a close. Margins remained under pressure due to the resulting weak volumes and lower prices across our portfolio. However, this was partially offset by lower input and distribution expenses as our team worked to reduce our marginal cost. On capital allocation, we returned $200 million to shareholders in the core. And with respect to the sale of our ILM investment, I reported last quarter that the Russian buyers received an important required approval from a Russian sub-commission overseeing exits by foreign companies. They are still awaiting the approval from the Russian Competition Authority. The buyers continue to pursue this approval, and we expect to close as soon as all regulatory approvals are secured. I will now turn it over to Tim, who will provide more details about our second quarter performance and our third quarter outlook. Tim?

Thank you, Mark. Good morning, everyone. Turning to our second quarter key financials on Class IV. Operating earnings per share increased sequentially and also came in better than the outlook we provided last quarter, as we effectively optimized our system through commercial and operational initiatives. Operating margins continued to be impacted by low volumes, but improved sequentially as lower outage expense and favorable input costs more than offset the impact from lower sales prices. In the second quarter, we generated $261 million in free cash flow. Recall that free cash flow from the first quarter was impacted by a $193 million final settlement payment to the IRS related to our timber monetization, which allowed us to further de-risk our balance sheets. Moving to second quarter sequential earnings on Life 5, second quarter operating earnings per share was 59 cents as compared to 53 cents in the first quarter. Price and mix was lower by 29 cents per share due to index movements across our portfolio. Lower export prices and unfavorable product mix in our global cellulose fibers business as a result of lower absorbent pulp shipments. Volume was flat sequentially as improved demand in our North American industrial packaging business was offset by weaker demand in our global cellulose fibers business. Volume in both businesses were impacted by customer inventory destocking. Operations and costs were also flat as our mills continued to run very well. Higher ops and costs in our industrial packaging business, primarily due to economic downtime, was offset by lower ops and costs in our global cellulose fibers business. Maintenance outages were lower by $88 million, or 19 cents per share, in the second quarter, and we saw significant relief from input costs, which were $83 million, or 18 cents per share lower, primarily driven by lower energy, wood, and distribution costs. Turning to the segments and starting with industrial packaging on slide six, price and mix was lower with index movements and lower export prices. This was partially offset by benefits from commercial initiatives focused on margin improvement. Sequentially, volume was higher despite one less shipping day as demand continued to improve throughout the quarter from the March trough. Our U.S. box shipments were down 8.3% year-over-year in the second quarter as demand for packaging continued to be impacted by ongoing inventory destocking by our customers. However, June was down 5.9% year-over-year as the quarter improved. Lower demand environment impacted operations and cost in the quarter as we aligned our production with our customer demand. while also optimizing our inventories and taking fewer planned maintenance outages. These actions resulted in approximately 622,000 tons of economic downtime across the system, which accounted for approximately two-thirds of the oxen cost variance. The remainder was primarily due to timing of spending for materials and services. Overall, our mill system ran very well. Land maintenance outages were lowered by $54 million sequentially, partially reflecting deferral or some outages in the second half of the year as we continue to optimize our outages. Significantly lower input costs improved earnings by $66 million in the quarter. We benefited from lower energy, wood, and distribution costs, some of which was due to the relentless efforts by our business teams to claw back high marginal costs, while optimizing our systems in the current demand environment. To give you an example of this, our mill and fiber procurement teams have made tremendous progress reducing fiber costs by optimizing mix and shedding our highest cost supplier of fiber to the mills. Our teams across the mill and box plants also are driving significant reductions in distribution costs by doing things like reducing highest cost freight carriers renegotiating contract rates, increasing weights per load, reducing miles per load, and shedding warehouse and demurrage expense. Turning to slide seven, I'll share some perspective regarding how inventory destocking is progressing for our customers. Based on their feedback and our own analysis, we believe inventory destocking across the supply chain has accounted for a large portion of overall demand declines this year. It's also lasting longer than initial expectations due to the limited visibility across the entire supply chain of excess inventories built up during the pandemic. Feedback from some of our larger customers suggests that approximately 75% of them entered the third quarter at or below inventory levels, target inventory levels. The good news is that given feedback from our customers and looking at the data, we expect this destocking trend to be completed in the third quarter. On slide eight, some additional data supports our current view. We believe the majority of retailer inventory destocking was completed in the first quarter. However, manufacturers are still reducing inventories through the second quarter as a result of lower demand levels, improved supply chain velocity, and focus on working capital given higher interest rates. Despite the current environment, corrugated packaging plays a critical role in bringing essential products to consumers. IP is well positioned to grow with our customers over the long term 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 AU segments.

Turning to global cellulose fibers on slide nine.

Taking a look at the second quarter performance, price index was lowered due to price index movements and a higher level of commodity grades in the quarter in response to weaker fluff pulp shipments. As a reminder, approximately 85% of the products in this business are exported, as international paper serves major global and regional customers around the world. As we entered the year, fluff pulp volumes came under pressure. First, consumer demand for absorbent hygiene products was lower driven by inflationary pressures. And second, there was significant inventory destocking across the long supply chains. This destocking trend continued in the second quarter as supply chains became more efficient and reliable. As a result, customers were able to work down safety stocks that were built up in response to the supply chain disruptions during the pandemic. This resulted in approximately 143,000 tons of economic downtime across the system as we aligned our production with customer demand. The combined impact of lower volumes and a higher mix of commodity grades continued to negatively impact business earnings. Looking forward, based on feedback from our customers and order bookings, Majority of destocking should be completed in the third quarter, and we believe fluff demand will continue to grow over the long term. This is due to the essential role absorbent personal products play in meeting customer needs. Coming back to the second quarter, operations and costs improved sequentially as we benefited from lower distribution costs, and our business teams remain focused on driving down the high marginal costs going forward. Sequentially, option costs were also favorably impacted by seasonally lower energy consumption and higher residual energy sales. Plan maintenance outages were lowered by $34 million sequentially, and input costs were lowered by $17 million due to low energy and chemical costs.

Turning to slide 10, I'll take a moment to update you on our capital allocation actions.

We have a strong balance sheet, which is core to our capital allocation framework. Looking ahead, we have limited medium-term debt maturities, and our pension plan remains fully funded. Returning cash to shareholders is a meaningful part of our capital allocation framework. In the second quarter, we returned $200 million to shareholders. Going forward, we are committed to returning cash by maintaining our dividends. Investment excellence is essential to grow in earnings and cash generation. We invested $267 million in our businesses in the second 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. On slide 11, we'll take a look at the third quarter outlook.

I'll start with industrial packaging. We expect price and mix to decrease earnings by $95 million as a result of prior index movement in North America and lower average export prices based on declines to date. Volume is expected to increase earnings by $5 million due to improving demand in daily shipments in North America, offsetting one less shipping day. Operations and costs are expected to increase earnings by $95 million. More than half is due to lower cost of company paid benefits and our cost management initiatives. The balance is primarily due to lower unabsorbed fixed costs. Lower maintenance outage expense is expected to increase earnings by $28 million. And lastly, rising input costs are expected to decrease earnings by $15 million from higher average energy costs. Switching to global cellulose fibers, we expect price and mix to decrease earnings by $40 million as a result of prior index movements and declines in spot pricing to date. Volume is expected to increase earnings by $10 million as demand improves from lower inventory destocking. Operations and costs are expected to be stable relative to the second quarter. Lower maintenance outage expense is expected to increase earnings by $12 million. And lastly, declining input costs are expected to increase earnings by $10 million, mostly due to lower fiber and chemical costs.

Slide 12 will take a look at the full year outlook.

As we entered the year, we recognized there were macroeconomic uncertainties ahead of us and that our businesses were not immune to these risks. These macro trends have shifted, resulting in weaker than expected demand for our products and price reductions across our portfolio through the second quarter, including prior index changes that will be implemented over the remainder of the year. I would also remind you that we that when we provide an outlook, it includes only the impact from published price changes to date. We are now projecting full-year 2023 EBITDA for the company to be in the range of $2.1 billion to $2.3 billion. Despite the market headwinds, we are taking actions across the company to optimize our system by reducing high marginal costs and driving additional commercial and cost benefits from our Building a Better IP initiatives. Mark will share more about these opportunities in the next few slides. Free cash flow is expected to be between $500 and $600 million, which includes a one-time tax payment of $193 million in the first quarter related to our timber monetization settlement. For 2023, we are targeting capex of $1.1 to $1.2 billion with increased investments in our U.S. boxes. I'll turn it back over to Mark.

Thanks, Tim. I'm going to turn to slide 13 now, and I'd like to provide our quarterly update on our Building a Better IT Initiative. You can see the targets and the appropriate metrics on this slide, but as I mentioned earlier on the call, we're making solid progress and delivered $55 million in year-over-year incremental earnings improvement in the second quarter, for a total benefit of $120 million year-to-date. Given this strong momentum, we expect to exceed our original target again this year. These are issues and opportunities that are unique to IP that will shine through as we see the economic conditions improve. Our Lean Effectiveness Initiative contributed $116 million of the cost savings since we began our Building a Better IP program in 2020. Early on, by streamlining our corporate and staff functions to realign with our more simplified portfolio after the spinoff of our paper business, we more than offset 100% of those dis-synergies resulting from the spinoff. The majority of the benefits going forward will come and are coming from our strategy acceleration and process optimization initiatives, where our business teams have intense focus on creating significant value through commercial strategies and by leveraging advanced technologies and big data across our large system to improve productivity and lower costs. I'm excited about these opportunities, and in the next couple of slides, I'd like to share more examples of what our teams are working on and some of the early results. Turning to slide 14, we'll start with our industrial packaging business. As you can see on the slide, our teams across the business are pursuing multiple opportunities to improve margins and drive profitable growth. First, I'll mention that we're making good progress on reducing high marginal costs. Tim has previously referenced that input and distribution costs increased by more than $2 billion for IP over the period of the pandemic. Coming into the year, clawing back these high marginal costs was an area of intense focus for us. We're accomplishing this by doing things like optimizing mix and usage of fiber and energy, reducing labor costs and overtime, shifting to lower cost suppliers, driving lower distribution costs, and reducing discretionary spending and overhead expenses. As I've mentioned before, we're also investing in our box business to expand our capabilities and improve productivity for future growth. On the commercial front, we have opportunities to leverage these new investments as well as our market expertise to further improve our mix and capture additional value. As we look across our system of mills and box plants, we are seeing real potential to leverage advanced technology and data analytics. In fact, some of that work is helping us get to levels of marginal cost reduction in high economic downtime periods that we've never reached before. Over the past year, we've developed and piloted new tools and capabilities to increase efficiency and reduce cost across a broad number of categories. We're starting to see benefits in areas such as maintenance and reliability, distribution and logistics, as well as sourcing. And we anticipate significant benefits as we continue to deploy these new technologies across our manufacturing system. All of this gives me confidence in our ability to drive profitable growth over the long term. Turning to slide 15, I'll share some key opportunities in our global cellulose fibrous business. Over the past year, we have captured meaningful benefits from our commercial initiatives and believe that there are more opportunities to capture significant value in this business as we continue to execute our revised go-to-market strategy. For example, our commercial teams finalized our contract negotiations, which is contributing meaningful commercial benefits this year. In addition, we have earned a higher premium for fluff grades relative to commodity grades by capturing more value and aligning with those customers and segments and regions of the world who value our differentiated product and service offerings. The benefits of our commercial strategy are currently being masked by a very challenging and unprecedented business cycle. as well as our exposure to the commodity grades that are not our core focus. As Tim mentioned earlier, it began with major supply chain disruptions during the pandemic, followed by significant inventory destocking actions that continue to constrain demand today. This combination of elevated supply chain costs and lower volumes have had a substantial impact on business earnings. But we do not believe that these issues are structural. And as I said, we have more opportunities to capture significant value going forward. And we will continue to test this strategy over the business cycle. Fundamentally, I believe there's a good business within this business and that we can continue to grow earnings and cash flows over the cycle. We are focused on creating value for our customers by delivering products that meet their stringent performance and product safety standards while delivering innovation. Over time, we have an opportunity to improve our mix by reducing our exposure to commodity grades. We can further align with customers in end-use markets that allow us to maximize the value of this business while optimizing our overall cost structure. I'm going to turn to slide 16. As you can see, there are several key areas of opportunity we're working on to navigate the current economic environment. while driving profitable growth over the long term. Combined with our strong financial foundation, International Paper is well positioned for success. None of this would be accomplished or possible without our team of talented and engaged employees. I will close by expressing my appreciation for all the hard work of our International Paper employees and for our strong customer relationships. And with that, we're happy to move to the question and answer section. And similar to last quarter, our senior business leaders are joining me to provide you with their perspectives. So, operator, we're ready to move to the question and answer portion of the call.

Thank you. If you would like to ask a question, simply press 1 then 0 on your telephone keypad. To withdraw your question, press 1 then 0. We will pause a moment to compile the Q&A roster. We do ask that you limit yourself to one question and one follow-up question.

Your first question will come from Mike Roxland with Truist Securities.

Go ahead.

Thank you. Thank you, Mark, Tim, and Mark for taking my questions. Congrats on a good quarter. Can you walk us through some of the moving parts regarding the updated EBITDA outlook versus your prior target Any way, kind of size, how much of that reduction is driven by industrial packaging versus global cellulose fibers? How much is driven by a change in pricing versus maybe the weaker demand environment? We're just trying to gauge how much, you know, that type of breakdown.

Yeah. Hey, Mike. It's Tim. I think, you know, obviously prices has published down more than what we updated the last quarter. So the bulk of it is price. It's both price on the index and then as I referenced in the speaker comments, export pricing and spot pricing in the pulp business. There is some impact from volume because of the destocking has taken a little bit longer, but the bulk of it is price. And, you know, on a proportional basis, GCF has had more frequent and higher levels of price reductions on the index than what we anticipated or what had been published when we updated last quarter.

Got it. Thank you, Tim. And then just quickly, just in terms of some of the initiatives that you pursued in global cellulose fibers, I believe looking at your prior forecast, I don't think you anticipated that an additional 100-plus ton decline in fluff pull pricing. Obviously, it did better than we expected in that segment. So I'm wondering, I know Mark highlighted some of the things that you're working on, but was there anything in particular that occurred in GCF during the quarter that allowed you to achieve that level of EBITDA despite the fact that prices notably declined?

Mike, I'm going to ask Clay Ellis to talk a little bit about how they're running in the business despite the soft demand and Some of those improvements are really just in the operational side of it. Running well in a reduced demand environment. Clay, if you could share a couple of things about the second quarter. How did you overcome some of the price headwinds? Great question, Mike. Thank you. This is Clay Ellis. I think you mentioned coming into the second quarter what we thought about. demand and price and amount of EDT that we took. We came into or exited the first quarter believing that we would see most of the inventory and destocking issues subside through the quarter. We did not see that as we expected. We've begun to see some improvement, June being better than May, July being better. than June and August is also looking better. So it's improving, but it's certainly what we're seeing now we hope to see earlier in the second quarter. The things that we're focused on maximizing cash generation, managing our machine downtime. You may have seen we've idled our Pensacola mill to consolidate some EDT there, allow the other mills to run. a little bit more of a normal rate, that's overall better for our cost. Supply chain, aggressive supply chain cost and driving out costs there, as Tim mentioned, minimizing our fiber costs, maximizing green energy sales and carbon credit sales, and then also increasing our pulp byproduct sales and production. So pulling all of the levers to manage our cash costs and our marginal costs. in the businesses. But we see improving through the third quarter in the stocking. We certainly in the second half, we see of the year to get out of that. In the meantime, we're doing everything that we can on cost. And then also looking, as Tim and Mark mentioned, around our business, our mix, and mitigating some of our exposure to commodity grades.

Thank you very much for that.

Your next question will come from the line of Mark Weintraub with Seaport Research. Go ahead.

Thank you. So the slide on page seven, very interesting slide. I'm curious how you came about to put that together. Is that just conversations with customers? Do you do some sort of survey on that? And then are you seeing any sign in the metrics be it shipments, be it bookings, where this hopeful end to the destocking is translating into changing business as you look at what you registered in July and maybe thoughts on August?

Mark, this is Mark. That's a great question. There is a qualitative piece to that slide, and there's a quantitative piece that's internal and some of the other metrics we use. I'll ask Tom Hammack to kind of give you perspective on what that slide kind of represents in terms of how we feel demand has been evolving and different spots in the supply chain that have been a bit hard for anybody and everybody to call in terms of where inventory actually resides along the value chain. So, Tom, if you could share a bit on that.

Sure. Great. Morning, Mark. This is Tom Hemmick. We take a subset of customers, and that subset We talk to them about how they see their demand patterns, but also what their inventory levels are for not only boxes, but finished goods. That's what you see flowing through here. We have a representative sample, but it's not 60% of the customer base. It's leaders in the segments that we look at. I think when you talk about destocking, it's pretty consistent. flowing through our system like we expected. I think what you can see, going back to Q4, is that consistency is based on the customer feedback. Both pieces are matching up very well. We finished Q2 about where we expected, so we was up 2% sequentially in terms of shipments per day. And we're seeing an improvement into July of mid-single digits. So I think that's very reflective of kind of this curve of destocking or overstocking going away over time.

Super. And so that's sequential. And so the comps are getting easier too, I believe. So is it fair to say that on a year-over-year basis, it's even better than the mid-single digits?

Well, the mid-single digits is a positive from quarter to quarter. That's sequential. I think that ties out to about flat to minus 2% growth in the third quarter, or really more July. So, you know, we've flown through more strongly through the second quarter. That's continuing now, and I think that is a pretty good representation of how our customers are viewing it.

Right. Thank you. That – I misstated. Thank you for getting that. And then just in terms of in pulp, you idle to consolidate downtime. And obviously, you took huge amounts of downtime in container board during the second quarter. And even with things ramping up, it does seem like there's a big gap between your capacity to produce and demand. Are you looking at idling to consolidate downtime in the container board business? Or have you done anything there yet?

That's a really good question, Mark. We kind of anticipated that question. What you see is a perfect example of the specific back patterns in two different parts of international paper. What Clay described is the best cost position for GCF was to take the Pensacola mill down and then maximize production at the other mills. Those mills are 100% virgin fiber, so the marginal cost actions you have to take at the other mills to load them up And the fact that you can sell green energy when you're running full at those mills led us to one set of decisions. So far, in container board, because the marginal cost profile of the other container board mills, the ones you wouldn't idle permanently or completely, involve a Huge mix of, you know, we're 65-35 urging to recycle. So you ramp up recycled fiber. You have physical logistics challenges based on where the other mills are. So far, we believe the way we've been doing it for IP, for our container board system, has resulted in the lowest marginal cost. There is a question mark, though, about the duration of this type of mismatch between our capacity and our order book. And as we learn more about that, and we now believe we've seen the bottom of the demand decline in destocking, we will then evaluate what does the upturn look like, and then if there's a different decision to be made and marginal costs have changed through the year where it's not as expensive to load up those other mills, you would see us make a different decision. And so that's how we try to operate it. And you can see an example of two different methods in two different parts of the same company that have different marginal cost attributes based on the products we're making.

Very clear and helpful. Thank you.

Your next question comes from the line of George Staffos with Bank of America. Go ahead. Thanks very much, everybody.

Thanks for the details and great operating performance in the quarter. Mark and Tom, a question for you. So to the extent that we have data, and it's really not a perfect analog for what you'd be seeing in the box market, nonetheless, scanner data, retail takeaway remains relatively weak. And obviously a lot of what drives the box market is consumer non-durables. It's the center of the store. So what are your customers telling you in terms of what is happening at retail and sell-through and takeaway relative to hopefully what's an uptick now in their purchase patterns from you and through the supply chain loading the center of the store?

Sure, George. This is Tom. We look at scanner data as well, but we also look at, we try and push it down to what is box-intensive, so what uses boxes. Our analysis would suggest that the retail channel in that space is somewhere between minus 2% year-over-year and plus 1%. The difficulty, obviously, is taking the revenue line, which is what you normally get, and then, okay, what is inflation for this set of goods? But if you take a broader That's about where it comes out. I would say that when you look at the perishability of the segments, so think of a segment that, you know, produce. That's been the most resilient. That's been our strongest segment, exit in Q3 relative to the past. But the ones that are struggling are exactly what you said, non-durables and durables. And I think it's because the shelf life is so long. and now obviously they're going to have to pull it down further. But I don't think that the health of the consumer, beyond the goods recession that we've talked about, will negatively impact box demand in a material way.

Okay, that's very interesting. So the fact that you've got such a large shelf life, and also, I guess, for that matter, the supply chain opening up, that allows customers to really take down their inventories on the stuff that can stay the longest on the shelf because they probably have the most of that. And they're saying consumer isn't going into a shell from what you're seeing on the retail side. Would that be a fair summary of what you're saying?

I think that's exactly right. I mean, I think about the classic motor oil in the department store. That's not going to time out. But during the pandemic, you can see people stocking that type of thing up. And so I think you've got multiple places where people stock.

Understood. My other question, and recognizing this is a bit tricky and you're not guiding on 24, but here comes the question. So, you know, we know building a better IP, which you're doing very well on, congratulations. We'll add, I think you said from the slide, another 150 to 125 next year. If we look at what the price index changes that have occurred to date, making no further assumptions one way or another going forward, what would the impact of that be into 24 in terms of EBITDA? We know what your guidance is. We know what building a better IP does. What is the effect of prior price changes on EBITDA for next year? And what is the What do you have in the back pocket in terms of all the operating efficiencies, all the optimization that you've done, as well as you look out to 24? Thank you, guys, and good luck in the quarter.

Hey, George, it's Tim. You're right, that's a tricky question, but I'll give it a shot.

But who better to answer it than you, Tim?

Yeah, thanks, George. So, you know, we look at the price carryover impact, but I hesitate to quantify it. for a lot of reasons, but one in particular is just, you know, we're sorting through mix, and mix is going to change, and so the price impact won't be the same on a different mix than the one that we had as the prices changed. In terms of initiatives, I think you heard characterized on the call all of the things that we're working on in the moment, but there are also strategic initiatives that we're working on that are going to drive better results on the commercial side and also on the call side. So, you know, we typically give our outlook when we do the fourth quarter call at the beginning of the year and I think we'll stick to that. But we feel pretty good about what's going on in the company in the way of self-help that will mitigate that carryover that we're going to see as we go into 24. Okay.

We appreciate it. We'll turn it over. Thank you, guys.

Your next question will come from Cleve Ruckert with UBS. Go ahead.

Great. Thanks very much for taking the questions. Good morning, everybody. I just want to follow up on George's question. It was kind of asked a little bit differently earlier as well, but just sort of thinking about a bigger picture the next couple of years, what really needs to happen to drive the earnings recovery in that you've been looking for? I mean, I think the last couple of quarters we've talked about this cyclicality, and you've said a couple of times you feel like you've got the capacity in the system that you need versus the volume expectations. I mean, it sounds like that's still the case, but are we talking about a pricing recovery? Is volume kind of enough to get you there? I mean, what are kind of the drivers that you're going to be evaluating in the second half here?

Hi, this is Mark. That's a really good question. Unfortunately, it's not one thing. I think what we need to see the earnings recovery is the kind of structure between price and cost, which obviously has a volume component to it that drives our margin structure back. north of 20%. So what we do to track that is we look at, in the case of packaging, we used to be there a lot of the time. In the case of this GCF business, we were working our way to that kind of margin structure that yields returns that are well above at least 200 basis points above cost of capital. And so what we do is we break that down into just a simple EBITDA per ton for everybody to focus on. And there are components of that number that are purely commercial, who we sell to and at what price, that are somewhat macro related, i.e. the amount of volume available in the market that we can compete for. And then there's the wealth of areas to work on in the cost area. And what's changed for IP is The demand that really ramped up and pulled forward was accompanied by a number of price increases that it took us longer to get them through based on the customer mix we had and contractual responsibilities. But the inflationary impact of our cost structure didn't wait for that. So we had a classic margin squeeze that we have to undo now. So that's really what's got to happen. Obviously, a lot of it is a a market that is not declining at the rate it started to decline, for all the reasons we talked about, maybe not the end consumer, but the destocking effect and all of that, that started about this time last year or in August of last year in earnest. And it's hard to get out from under that quickly when you've got sticky inflation that has flowed through to labor costs and all of those things in your supply chain. So I think that's what's got to happen in most of those efforts. We don't control the overall demand, but we are confident in both product lines facing a long-term growth profile. What we do control is who we sell to and at what price and how we operate our manufacturing facilities to be first quartile-type cost producer of these types of products. And so we've got efforts and focus on all back to the levels of earnings and returns and then grow from there.

Okay. That's pretty clear. Sort of a little bit of a vague question for me to ask, but thanks for the clarity and the insight into your thought process. And then maybe just one quick follow-up, just sort of sticking with the volumes in the packaging business. I think you said sequentially on the bridge, it's sort of a $5 million tailwind into the the third quarter and, you know, we're sort of starting to be able to figure out what's implied for the fourth quarter. But are we just – am I correct in assuming that your expectations on volume growth in the second half are relatively low? I mean, in this flat to up slightly kind of environment that we're talking about for July?

Are you talking about box volumes or overall?

Yeah, well, in the packaging, definitely.

Well, I'll ask Tom to comment on the box side, and Jay Royalty is also here to talk about what we're seeing on container board and our other channels, the open market and the export channel. So, Tom, if you want to start.

Yeah, I think we're going to see through the third quarter and into the fourth quarter getting back to normal. I think this de-stocking is a big effect, and so we expect the demand to normalize, and you'll see a much better

half relative year-over-year and I think somebody pointed out that the year-over-year comps get easier but even with that we see continued strengthening through the balance of the year this is Jay royalty so you know commenting on the the open market domestic channel and the export channel I would say that you know relative to the domestic channel you know it's Both of these have been a big drag on us from a demand standpoint thus far this year, but we are seeing improvement in both of those channels. From a domestic standpoint, we did see some modest improvement in the second quarter, and based on our order books, we're continuing to see, we're encouraged about the improvements in the third quarter. If you think about those type of customers and their orientation, they're less oriented to food customers. And so from a destocking standpoint, I think they've been hit harder. And as that unwinds, we'll have the opportunity for more pickup. So we're encouraged there. From an export standpoint, the first half of the year has been incredibly weak. As I mentioned last quarter, we started to see some stabilization in inventory levels and some improvement in order patterns, particularly related to Latin America. We saw that flow through in the second quarter. The encouraging thing is we're seeing improvement across all three regions, Asia, EMBA, and Latin America as we go into the third quarter. And if you look at our run rate based on our current order bookings out through August, we're seeing about a 200,000 ton pickup in the run rate of the second half versus the first half. And that's evidenced in our order pattern. And we've got room to grow from there. So I think in both cases, we're encouraged about what we're seeing at this time and how that can flow through for the second half.

That's very clear. Thank you so much for all the color. Appreciate it.

Your next question comes from the line of Anthony Pettinari with Citigroup. Go ahead.

Good morning.

I just had a question on the updated free cash flow guidance. And specifically, you know, with regards to the dividend, you know, you talked about, you know, the commitment to maintain the dividend and targeting 40 to 50 percent of, I think, free cash flow over time. You know, with the dividend payment, I think, coming in above the midpoint of the free cash flow guide, just how do we think about, you know, levers that you can pull or sort of capital allocation priorities or ways that you can kind of balance that? you know, this year and going forward and how that, you know, maybe changes the approach a little bit.

This is Mark. I'll start on that. Just on the dividend question, it's a very fair question. It's one we get if you just look at the numbers and the math. You know, the long-term plan is 40% to 50% of free cash flow. We know that occasionally that will be tested, and this is kind of a really odd set of cyclical dynamics that are really testing it. But we're very confident in the medium and long-term cash flow potential, the generation potential of the company. And if the dividend is at the upper, upper end of a range for a short period of time, we're comfortable with that. We know we can grow back into it with future cash flows. So as Tim said in his prepared remarks, we're committed to the dividend. That's what that means. It's not just a formulaic. commitment for international paper. We believe in talking with our shareholders, especially the people who hold our shares for a long period of time, the dividend is very important to them. So that's why we're committed to it, not just when it's easy and it fits into a metric, but we're committed to it in good times and we're committed to it in stress times. And as far as the levers to pull and what happened with the guidance and what we could do that we're not doing, I'll ask Tim to comment a little bit on that. But just so I'm clear on how we think about the dividend, we don't get nervous when we're at the upper end, just like we don't look at arbitrarily doing something when we're on the lower end. That might be also a cyclical dynamic. It's something that we believe we can handle over time and that will grow very nicely back into a more normal range. Tim, if you would add a few comments on the second part of his question.

Hey, Anthony. Just a couple of points that I think are important. First of all, as we referenced, the $500 million to $600 million includes the settlement payment for timber monetization, which was almost $200 million in the first quarter. And so that's a one-time item and not to repeat. The other item is we're going to invest more capital this year than we have since before the pandemic. And at the beginning of the year, we put out a range of one to one, two, really with the, you know, normally we're tighter than that, but just given supply chain delays and difficulties, we had struggled to invest as much as we wanted the past couple of years. And so, you know, anticipating that it could be that way again, it was kind of the one billion and things freed up. it could be as high as 1.2. Well, things have freed up, and so we tighten the range. We're later in the year, of course, but we tighten the range, and the way projects are being deployed, you know, it could push that upper limit on 1.2. So I think that's important relative to the free cash flow. On the go-forward basis, it's back to what we were talking about earlier in terms of initiatives. A big portion of the initiatives we're working on are costs. And so we think we're getting traction on that, and we think there's a lot more to call back. Working capital is something we focus on pretty intently. And then capital, if we need to. We have, and I think we've demonstrated this over the years, we have an ability to flex our capital spend in moments, and certainly that would be a consideration as well. So, hopefully that helps.

Yeah, I think, Tim, that was exactly what I was hoping you would cover is we have the levers, we can pull them if and when we want to, but I'll just finish that point that Tim made about the investments. A lot of the investments that we're doing now, unlike in the past, are in our box business, in our converting operations. And so you ask why am I confident about future cash flows? It's because those investments we're making today will produce a lot of those future cash flows in 24, 25, and 26. And so it's not a lot of the spending on normal maintenance and normal protection of current cash flows. A fair amount of it is about future cash flows. And that's what's different about the quality of the capital investment number that Tim cited versus maybe in the past where we were doing some things that needed to be done but didn't have a real connection to a lot of future cash flows.

Okay, that's very helpful. That's very helpful, caller. I appreciate that. And then I guess just a question, maybe somewhat related, but in terms of the competitive landscape in container board and corrugated, you know, we've obviously seen a number of capacity additions this year, which I think most of which are up and running. And I guess without speaking about any specific competitor or company, is it possible to talk about sort of the impact of this capacity, maybe relative to your expectations? I mean, has it been more disruptive, less disruptive, sort of as expected? Is the impact sort of already maybe absorbed in the market? Is it something that is going to be felt more in the second half? I'm just wondering if you could just generally talk about how this new capacity has been absorbed in the market and how you kind of see the overall competitive landscape here.

Hey, Anthony. It's Jay Royalty. Yeah, it's a great question. I think, you know, from our vantage point, we continue to, you know, wonder where these tons are going because we're not seeing a lot of evidence of it in our space, in our customer space. You know, I'll take you back to... At the end of the day, our customers buy boxes, and that requires a complex set of needs and a complex offering. If you think about some of these new entrants, they're coming in with a singular and a limited set of offerings in terms of one mil, limited grades, that cannot fulfill all their needs. When we think about our relationships with our customers, we're bringing a more robust offering multiple grades, redundancy in our supply chain and our manufacturing system to help them fulfill all of those needs, and we structure our relationships accordingly. So, you know, that's what they're up against in terms of competing with a company like International Paper.

Okay, that's helpful. I'll turn it over. Your next question will come from the line of Gabe Haji with Wells Fargo. Go ahead.

Mark, Tim, good morning. I apologize in advance for the long-winded question here, but I'm looking back at 21, 22, where there was a cumulative, I think, in the industrial packaging business, $2.8 billion of price realized. And If I take the 24 million year over year in the second quarter, plus the 95, I think that you talked about on a sequential basis. I know it doesn't work exactly this way, but on a year over year, we're sort of implying down 125 million ish. Has something changed? Like when I think about the 80% of the business is vertically integrated of your corrugated converted, maybe 80% of that is, is RISI linked. You guys have talked about commercial initiatives. Has anything changed with respect to that lag in the pass-through and maybe it's shorter or longer than it used to be? And I guess, relatedly, will we be at sort of, based on what RSEI cuts have transpired, at run rate negative price in Q3? And I'll take one stab at it. And if I were to summarize what you guys have said thus far, If we make an assumption about what the negative price roll through for next year might look like based on what you see in terms of maybe an improvement in volumes and improvement in operating rates and cost out, that industrial packaging segment EBIT would be flattish with 2023.

So, Gabe, I appreciate the preface of the long question. I usually take notes on these questions, and I gave up halfway through. Big picture, what was different about the last price changes in the market and for IP that was different from what you would consider more normal is the rate of price movement, meaning three in a 12-month period. That type of thing was different for us. Some of our commercial arrangements had been constructed anticipating more like one price increase a year with maybe two, but limits on how fast you can go through. So in some cases, we were still getting price increases this year. Some customers bet the last price increase was early last year and it started declining in the fall. That was atypical in terms of a set of conditions. So the flow through and the realization schedule looked a little different for IP than it has in the past. The balance of your question about going forward, I couldn't keep up with all of it. I would ask maybe just following up with Mark and IR to try to kind of model out what you were talking about in terms of the flow through, and I think you used the term when we go price negative, but I'm not sure I followed all of that. That's the one critical thing to think about is the rate of increases and the type of mix we have with a portion of our customer base, which, you know, that same customer base is more resilient right now, which is one of the reasons we're performing pretty well in the market on an absolute basis is because those types of customers tend to be market leaders. With that comes some additional challenges on abnormal commercial times like rapid price increases and and those kind of things.

Okay, thank you. And appreciating that it's tough to talk about it live mic like this, but saw an article yesterday talking about some of the differences or vagaries of how paper businesses are performing in Russia. Again, today saying you can comment. Could anything change with respect to the process there and if things go sort of as planned Can you give us an update in terms of timing as to when the cash might come in? Thank you.

It's really, really hard to give you an update on the timing. As we said, we lack one approval from the competition authorities, and that's a multi-point, multi-part approval. We've got all of those parts. And so I think with what's been going on in Russia, that's unrelated to, you know, foreign companies exiting and all that, that things had happened with the – with the government and the military issues, I think it's a bit of a distraction factor for getting these kinds of jobs completed. I will say, though, the IP ILM transaction is on the larger end of things that have occurred. So it gets higher levels of scrutiny and the people doing the approvals are at a higher level and they've obviously been really busy with other things not related to this. So I wish I could give you a better timing. Our partners who are the Potential buyers are working it constantly. They're working their normal contacts with the government, trying to get it to the finish line. If I gave you a prediction, it would just be an educated guess, which, as we know, is not worth much. Tim, if you want to add something to that.

I think Mark's right. The timing on the approval is impossible to gauge. Once approval...

were to be obtained, the flow through on closing the transaction or receiving the cash is very quick.

Your final question today comes from the line of Matthew McKellar with RBC. One moment while we open your line. Go ahead, please.

Hi, thanks. Good morning. I'd like to ask about your global cellulose fibers business. So recognizing you talked about your focus on customers who value the attributes of your fluff pulp, but maybe thinking about the market more broadly, can you talk about any impact you've seen over the past few quarters from certain consumers substituting lower-cost grades, and then maybe whether you're seeing any changes in that substitution behavior with fluff pulp pricing coming off peak? Thanks.

That's a good question. Clay and his team are all over really understanding this whole substitution phenomenon. Clay, if you comment on what we know about that and how it affects and doesn't affect us. Yeah, sure. Hello, Matt. This is Clay Ellis. Yeah, I think it's a good question. You know, there's always been some level of substitution in local markets and areas of China. I think in the supply chain disruption in 22 really drove more of that. I mean, these are customers in some geographies and segments and these were customers that were very tail end of the supply chain and couldn't actually get the product and And so I think that drove a higher rate of substitution. These are segments and some geographies where brands and high-quality product performance are not as critical. I think about an example that might be like Pet Pads in parts of China. These are not our core customer base in this part of the market. We think we'll ebb and flow with substitution over time in their economics. you know, allow a little less regard to quality and product performance and the specs as, you know, the broader fluff market. So, again, we think it's a very small segment of the fluff market. Clearly, it went up in the first half of the year. We saw that increase, but also nearing the end of the second quarter, as you mentioned, as prices changed and spot market prices changed, we also saw a lot of that come back out. So, again, we think it's there. We understand it. We know where it is and how it's done. We don't think it's likely to grow, you know, very broadly. But it's not a new phenomenon, but clearly it increased due to the supply chain, and it's been stickier due to the price differential in their economics.

Great. Thanks very much. That's all from me. I'll turn it back.

Thank you, and I'll now turn the call back over to Mark Sutton for closing remarks.

Thank you, Operator. I want to thank everyone for your time today and for your continued interest in international paper. We outlined some exciting initiatives that are focused on the future of the company and the catalyst for some of our future earnings growth, so I look forward to updating you on our progress during our next call. Have a great day.

And once again, we'd like to thank you for your participating in today's International Paper Second Quarter 2023 Earnings Call. You may now disconnect.