International Paper Co /New/ Q4 FY2022 Earnings Call

Good morning and thank you for standing by. Welcome to today's International Paper's Fourth Quarter 2022 Earnings Call. As a reminder, today's conference call is being recorded. I'd now like to turn today's conference over to Mark Nellessen, Vice President, Investor Relations.

Thank you, Paul. Good morning and thank you for joining International Paper's Fourth Quarter 2022 Earnings Call. Our speakers this morning are Mark Sutton, Chairman and Chief Executive Officer; and Tim Nicholls, Senior Vice President and Chief Financial Officer. There is important information at the beginning of our presentation on Slide 2, 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 fourth 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'll begin our discussion on Slide 3, where I will touch on our full year 2022 results. First of all, as I think about 2022, I'm very proud and appreciative of all the hard work our employees have done during the year. And for our strong customer relationships, as we've managed through a very dynamic and uncertain market environment. Looking at our performance, International Paper grew revenue and earnings driven by solid commercial and operational execution, while facing significant inflation and lower demand in the second half of the year. We also made solid progress in building a better IP. We delivered $250 million of earnings benefits from our initiatives, focused on lowering our cost structure and accelerating profitable growth. As a result, we exceeded our full-year target and have strong momentum going forward. We're also confident in the profitable growth opportunities across our Industrial Packaging business and have made strategic investments to support this growth. We will continue to invest to grow earnings and cash generation by building additional capabilities and capacity in our U.S. box system during the next few years. I'm also pleased with the significant progress we made towards achieving value-creating returns in our Global Cellulose Fibers business. We delivered $100 million of earnings growth in 2022, and we expect significant earnings improvement this year. This past year, we also returned $1.9 billion of cash to shareholders, and our balance sheet is very strong. This allows International Paper to navigate the uncertain macroeconomic environment from a position of strength. We believe it will give us the opportunity to continue to invest through the cycle to grow earnings and cash generation while also returning cash to our shareholders by maintaining our dividend and through opportunistic share repurchases. Turning to our full year key financials on Slide 4. Revenue increased by 9% year-over-year, driven by strong price realization in our two business segments. Operating earnings per share improved by 32%. Operating margins were impacted by lower volumes from weaker demand for packaging and elevated supply chain and input costs. Overall, EBIT improved by about $300 million year-over-year. In terms of segment performance, both our Industrial Packaging and Global Cellulose Fibers segments contributed to our earnings growth by about $100 million each as our profit improvement initiatives and price realization offset significant inflationary cost headwinds. Our corporate expenses were also lowered by about $100 million, primarily driven by our building a better IP initiatives and some favorable FX. For the year, we also generated $1.2 billion of free cash flow, which was above our prior outlook, driven by higher earnings and improved working capital in the fourth quarter. Turning to Slide 5, I would like to comment on the press release we issued last week regarding the progress we are making related to our Ilim joint venture. We have entered into an agreement to sell our 50% interest in Ilim SA to our JV partners for $484 million. This transaction reflects a total enterprise value for Ilim of approximately $3.5 billion and approximately 3.1x EBITDA and the EBITDA multiple for 2022 full-year results. The JV partners have also expressed interest in purchasing all of IP shares in JSC Ilim Group, which represents a 2.39% stake for $24 million. We also intend to divest all other residual and non-material interests associated with Ilim to our JV partners. The deal is subject to regulatory approvals in Russia. We are making good progress and will provide you with additional information when it becomes available. Upon finalizing this deal, IP will no longer have any investments in Russia. Turning now to Slide 6 and our fourth quarter results. Earnings and free cash flow for the quarter were above prior periods and came in better than the outlook we provided last quarter. Demand for our products played out as we expected. In Industrial Packaging, our U.S. box shipments were down about 6% year-over-year on a daily basis, similar to what we experienced in the latter part of the third quarter, after consumer priorities shifted towards non-discretionary goods and services. In addition, our customers and the broader retail channel continue to work through elevated inventories of their products, which constrained packaging demand in the quarter. Underlying demand for absorbent pulp was stable. On a positive note, we did see meaningful relief from lower input costs, and our fourth-quarter earnings also benefited from our building a better IP initiatives and some favorable one-time items in the quarter, which Tim will speak to later in the presentation. Finally, we generated solid free cash flow and returned $355 million to shareholders during the quarter. I will now turn the call over to Tim to cover our business segment performance as well as our outlook.

Great. Thank you, Mark, and good morning, everyone. I'm on Slide 7, which shows our year-over-year earnings bridge. Price and mix improved significantly with strong price realization across all channels and benefits from our commercial initiatives. Volume was lower in 2022 as consumers shifted priorities towards non-discretionary goods and services while dealing with high inflation following a period of demand pull forward during the pandemic. Operating costs were negatively impacted by high inflation on materials and services and significantly higher supply chain costs across all of our businesses, as well as lower volumes in our Industrial Packaging business. This was partially offset by improved mill performance and reliability. Maintenance outages increased as planned, impacted by high inflation on equipment, parts, and contracted services. Input costs rose sharply across just about every category, with more than half of the increase directly related to higher energy and fuel costs. Total corporate expenses and other items decreased by $0.33 per share as follows. Corporate expenses declined by $0.19 per share and benefited from our building a better IP initiatives as well as some FX. Interest expense was lower by $0.14 per share, benefiting from significant debt reduction in the prior year. Tax expense was $0.20 higher per share, with a normalized effective tax rate of 24% as compared to 19% in 2021. Lastly, share repurchases impacted earnings by $0.20 per share year-over-year. Moving to the fourth quarter sequential earnings bridge on Slide 8. Fourth-quarter operating earnings per share were $0.87 as compared to $0.83 in the third quarter. Price and mix improved by $0.06 per share from better mix in our Industrial Packaging business and additional price realization in our Global Cellulose Fibers business. Volume was lower in Industrial Packaging as a result of softer demand across all channels, and Global Cellulose Fibers demand was stable. However, volume was lower sequentially due to higher pull-through of shipments in the third quarter as supply chain velocity began to improve. Operations and costs were impacted by the lower volume resulting in higher economic downtime and unabsorbed fixed costs as well as seasonality. Some of the downtime in our Global Cellulose Fibers business was caused by winter storm Elliott and also some isolated reliability issues. Ops and costs also benefited from favorable one-time items in the quarter related to lower employee benefit costs, workers' compensation expenses, and medical claims. These favorable one-time items added about $71 million or $0.15 per share, which is not expected to repeat in the first quarter. Maintenance outages were higher in the fourth quarter as planned. As Mark mentioned earlier, we saw a significant relief from input costs, which were $144 million or $0.31 per share lower in the fourth quarter, driven by lower energy and OCC costs. Corporate and other items include benefits from lower interest expense, favorable FX, and other corporate items, partially offset by sequentially higher tax expense. Turning to the segments, and I'll start with Industrial Packaging on Slide 9. Price and mix improved in the quarter, primarily from commercial mix initiatives focused on margin improvement. The recent publication changes did not have a material impact on the fourth quarter. As Mark mentioned earlier, demand for packaging was in line with our expectations. Fourth-quarter volumes remained at lower levels due to constrained consumer demand and ongoing retailer inventory destocking. Sequentially, volume was also impacted by four fewer shipping days. However, in this dynamic demand environment, International Paper is well positioned due to our diverse portfolio of products and services and our strategic relationships with a large number of national and local customers across a broad range of attractive end-use segments. Overall, our mill system ran well and we managed through winter storm Elliott effectively. The lower demand environment impacted operations and costs in the quarter as we adjusted our system to align our production with our customer demand. These actions resulted in approximately 530,000 tons of economic downtime across the system, resulting in higher unabsorbed fixed costs. Operations and costs were also seasonally higher. However, this segment benefited from approximately $57 million of favorable one-time items I mentioned earlier. Input costs were significantly lower and improved earnings by $139 million sequentially. About half of the benefit was from lower energy costs in North America and Europe, and the remainder was primarily from lower OCC costs. Overall, we continue to face elevated supply chain costs as well as the impact from high inflation on materials and services during the past couple of years. In a lower demand environment, when we aren't running at full capacity, we believe there is a large opportunity to further optimize our system and take out high marginal costs. This remains a key lever in 2023. Turning to Cellulose Fibers on Slide 10. Taking a look at the fourth-quarter performance. Price and mix improved by $17 million due to the previously announced price increases. Volume was lower sequentially due to higher pull-through of shipments in the third quarter as supply chain velocity began to improve. Operations and costs were negatively impacted by disruptions from winter storm Elliott and some reliability incidents at two of our mills. These were partially offset by approximately $14 million of favorable one-time items I mentioned earlier. Planned maintenance outages were higher by $39 million sequentially, coming off of the third quarter which represented the lowest outage quarter of the year. In addition, input costs were lower by $5 million. As we look forward, feedback from our customers indicates they are seeing in-transit inventory pull through at a faster pace due to improvements in supply chain velocity from last port congestion and improved vessel reliability. Combined with seasonal demand decline related to the Chinese New Year, we expect some customer inventory destocking to impact demand through the first quarter. With that said, fluff pulp inventories remain below historical levels, and we believe fluff demand will continue to grow. This is due to the essential role that absorbent personal care products play in meeting consumer needs. Turning to Slide 11. Our Global Cellulose Fibers business continues to make significant progress, growing earnings and executing on our strategy to deliver value-creating returns over the business cycle. The business increased earnings by approximately $100 million in 2022 and was near cost of capital returns in the second half of the year, despite significant supply chain cost headwinds. Our team successfully deployed a commercial strategy focused on building strategic relationships with key global and regional customers and aligning with the most attractive regions and segments. We are focused on creating value for our customers by delivering products that meet their stringent product safety standards and deliver innovative value. In addition, we are driving structural margin improvement by ensuring we get paid for the value we provide. In the fourth quarter, we made solid progress in our fluff pulp contract negotiations, which will provide additional commercial benefits going forward. We are committed to building on this momentum and expect to deliver significant earnings growth in 2023. On Slide 12, I'd like to update you on building a better IP set of initiatives. We're making solid progress and delivered $75 million of earnings in the fourth quarter for a total of $250 million in 2022, which exceeded our target for the year. About half of the benefits today are from our lean effectiveness initiatives by rapidly streamlining our corporate and staff functions to realign with our more simplified portfolio; we have offset 100% of the dissynergies from the printing paper spin-off. Although most of these benefits have been achieved, we will continue to pursue additional opportunities. Another significant driver of full-year results was strategy acceleration as we delivered profitable growth through commercial and investment excellence. Going forward, we continue to focus on getting our Global Cellulose Fibers business to deliver value-creating returns, and we are also focused on profitably growing our Industrial Packaging business by improving margins and investing for organic growth. Finally, the process optimization initiative has the potential to reduce costs across areas such as maintenance and reliability, distribution and logistics, and sourcing as we leverage advanced technology and data analytics. We believe these initiatives will deliver benefits going forward as we finish implementing new capabilities across our business. Turning to Slide 13. I want to take a moment to update you on our capital allocation actions. As Mark mentioned earlier, we have a very strong balance sheet which we will preserve because we believe it is core to our capital allocation framework. Our 2022 year-end leverage was 2.1x on a Moody's basis, which is below our target range of 2.5 to 2.8x. Looking ahead, we have limited medium-term debt maturities with about $1.6 billion due during the next 10 years. Finally, even in this environment, our pension plan remains fully funded. Returning cash to shareholders is a meaningful part of our capital allocation framework. In the fourth quarter, we returned $355 million to shareholders, including $191 million through share repurchases, which represents 5.4 million shares or about 1.5% of shares outstanding. As a result, we've returned approximately $1.9 million of cash to shareholders in 2022. In October, our Board of Directors authorized an additional $1.5 billion of share repurchases. At year-end, our total authorization was approximately $3.2 billion. Going forward, we are committed to returning cash through maintaining our dividend and through opportunistic share repurchases. Investment excellence is essential to growing earnings and cash. We invested $931 million in our businesses in 2022, which includes funding for cost reduction projects with attractive returns and for strategic projects to build out capabilities and capacity in our box system. As an example of this, the successful start-up of our new corrugated box plant in Eastern Pennsylvania, which has an expected return on investment of 20%. Going forward, we plan to make additional investments across our box system to support long-term profitable growth. We will continue to be disciplined and selective when assessing M&A opportunities that may supplement our goal of accelerating profitable growth. You can expect M&A to focus primarily on bolt-on opportunities in our packaging businesses in North America and Europe. Any potential opportunity we pursue must create compelling long-term value for our shareholders. So turning to Slide 14, we'll look at our first quarter outlook. I'll start with Industrial Packaging. We expect price and mix to decrease earnings by $65 million as a result of prior index movement in North America and lower average export prices based on declines in the fourth quarter. Volume is expected to increase earnings by $20 million due to four more days sequentially in North America, partially offset by the normal seasonal decline in daily shipments in North America. Operations and costs are expected to decrease earnings by $65 million due to the non-repeat of favorable one-time items in the fourth quarter. In addition, we expect seasonally higher energy consumption and some additional inflation on materials and services. Operations and costs will also benefit from lower unabsorbed fixed costs due to higher volumes and more planned maintenance outages. Maintenance outage expenses are expected to increase by $91 million. The first quarter will be our highest outage quarter this year representing approximately 40% of planned outage costs in 2023. Lastly, input costs are expected to decrease by $70 million from lower average costs for energy, fuel, and fiber. Switching to Global Cellulose Fibers, we expect price and mix to improve by $1 million on the realization of prior increases. Volume is expected to decrease earnings by $15 million based on seasonally lower demand and customer inventory destocking in response to increased supply chain velocity. Operations and costs are expected to decrease by $30 million due to the non-repeat of favorable one-time items in the fourth quarter. In addition, operations and costs will be impacted by higher unabsorbed fixed costs due to lower volumes, as well as seasonally higher energy consumption and some additional inflation on materials and services. Maintenance strategy expenses are expected to increase by $13 million, which is largely associated with the Georgetown mill printing paper out. This cost will be fully recovered as part of the transfer price to Sylvamo over the course of the year. Again, the first quarter will be our highest maintenance outage quarter this year, representing almost 40% of total planned outages in 2023. Lastly, input costs are expected to decrease by $15 million, mostly due to lower energy and fiber. Moving to our full year outlook on Slide 15. We are projecting full year 2023 EBITDA for the company of approximately $2.8 billion. As I mentioned earlier in this presentation, we believe we have significant opportunities to reduce high marginal costs across our system and capture more benefits from our building a better IP set of initiatives. This includes meaningful earnings growth in our Global Cellulose Fibers business as a result of our commercial strategy execution. I would also note that our outlook includes only the impact from previously published price changes. Free cash flow is expected to be between $900 million and $1.1 billion, which includes a one-time tax payment of $190 million related to our timber monetization settlement. In addition to free cash flow, we expect to receive approximately $500 million of cash proceeds from the Ilim sale. Regarding this transaction, for reporting purposes, the Ilim JV has been classified as discontinued operations. In the fourth quarter, we took an impairment charge that was treated as a non-cash special item. For 2023, we are targeting capital spending of between $1 billion and $1.2 billion with increased investments in our U.S. box system to build additional capabilities and support profitable growth with our customers. We will also focus on high-cost reduction projects across our system. And with that, I'll turn it back over to Mark.

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

And our first question will come from Wells Fargo Securities in the line of Gabe Hajde.

I had a specific question about energy use. When I examine the sequential math and how you performed in the quarter, I would say that in the corrugated or Industrial Packaging segment, at least half of the results were due to one-time events and the other half was likely from lower natural gas prices. Can you confirm this? Additionally, has there been any change in Industrial Packaging's approach to managing risk across the organization due to geopolitical tensions and their potential effects on commodity inputs?

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

Okay. Based on Tim's comments, it seems that the implied EBITDA for the first quarter is around $540 million, indicating a significant increase needed to meet your full-year forecast. I'd like you to clarify what was meant by the significant improvement in Global Cellulose Fibers. I also understand that some maintenance costs are somewhat front-loaded, which provides us with some visibility. However, it appears that much of the anticipated improvement in the latter half of the year relies on your ability to operate more efficiently and reduce costs that have gradually been introduced into the system. You mentioned that you were not fully satisfied with the performance. Could you elaborate on the key elements that will contribute to reaching your full-year target?

Gabe, it's Tim. I think you summarized it quite well. We are experiencing an increase in maintenance outages in the first quarter, which will lead to a decrease in performance compared to the average across the second to fourth quarters. However, we expect to see improved profitability from the contract negotiations completed in the fourth quarter. Furthermore, with our efforts to enhance our intellectual property and our expectations for this year, we will be able to offset some marginal costs. Over the past two years, costs have consistently risen across every category, with supply chain costs proving to be particularly persistent. Nonetheless, we believe there will be opportunities from both a rate and fuel perspective. The key opportunity lies in our operations, as we aim to return to a more normalized scheduling of transportation, which will help us eliminate premium freight and reduce the high marginal costs of supply chain and logistics involved in delivering products to our customers.

Next, we go to Bank of America in the line of George Staphos.

Congratulations on the quarter. Much better than we were looking for. One thing first point of clarification for Cellulose Fibers, did you say price and mix in the quarter would be a plus 5-0 or plus 1-5? I couldn't quite tell.

Sorry about that, plus 1-5.

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

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

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

Order of magnitude, yes, it's close...

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

Make sense. Two final questions, and then I’ll pass it over. The first is about GCF, and the second pertains to the industrial packaging business. For GCF, Tim and Mark, you indicated that inventories are low at your customers' levels, but you also mentioned the possibility of destocking in the first quarter. Can you clarify those two points? As for the industrial sector, with the addition of the Pennsylvania box plant and your focus on other potential converting investments, what are the implications? How are you addressing the impact on your overall box business, and how do you maintain high retention levels while adjusting your converting footprint in regions like Pennsylvania and New Jersey?

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

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

The next from Seaport Research Partners, the line of Mark Weintraub.

I have two quick questions. Firstly, regarding the cellulose fibers, with the modifications you're implementing, do you believe that pricing beyond 2023 will be less influenced by the fluctuations we observe in PPW? Are these prices likely to be more stable, or will we still see significant movement in alignment with open market transactions?

Yes, it's Tim. I don't want to make any forecasts or predictions, but we believe that the business is taking steps to ensure it gets compensated for the value it provides. There is a mix across the different channels and segments we serve. The contract negotiations we mentioned for the fourth quarter were necessary corrections for the business, which took some time to address. While I'm not making a prediction, we believe that our actions align with our approach to being compensated for value. You can interpret that as we progress through 2023 and 2024.

Okay. I hope this leads to reduced volatility. Is that a fair interpretation of the intent of the contracts?

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

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

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

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

Then next, we go to Truist Securities in the line of Mike Roxland.

Tim and Mark, congratulations on a strong quarter. Last quarter, you mentioned that you have an internal algorithm to determine how and where to schedule downtime. One of the factors in this algorithm is natural gas. With domestic natural gas prices having decreased significantly along with the decline in OCC, how have you adjusted your downtime plans, if at all? I'm trying to understand if you've been able to more effectively manage downtime and if that had any positive impact in the quarter.

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

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

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

Then next, we go to RBC Capital Markets in the line of Matthew McKellar.

First, I just wanted to ask about the sale of your stake in Ilim. Can you discuss the timeline for closing that transaction? It seems based on your guidance that you aim to finalize it this year. Is there any additional information on that? Additionally, what are the key hurdles you anticipate in securing regulatory approval?

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

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

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

The next from Deutsche Bank, I'm sorry, from KeyBanc, Adam Josephson.

I have a couple of questions regarding the assumptions behind your full year guidance. First, Tim, you mentioned that you expect underlying box demand to remain somewhat flat from the fourth quarter to the first quarter. Could you elaborate on your expectations for demand thereafter? Considering the destocking you mentioned affecting the fourth quarter, it seems logical to expect some improvement in demand at some point during 2023. So, I'm curious about your expectations beyond the first quarter and for full-year shipments in 2023 compared to 2022, if you're able to share that information.

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

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

Yes, I think that's reasonable.

Okay. My last question is about the implied first-quarter guidance, which I believe is around $530 million. Maintenance costs will be higher by about $120 million compared to the last three quarters. If I take the $530 million and increase it to $650 million with all else being equal, I estimate that leads to about $2.5 billion for the year. It seems there is additional improvement in your guidance, likely due to higher realized pulp prices or similar factors. So, even though prices in Industrial Packaging are expected to be lower from the first quarter to the second quarter and beyond, I want to clarify the changing variables from the first quarter onward.

It all sounds reasonable.

Got it. And just one last question from me: what is your perspective, Tim or Mark, on how customer destocking has affected box demand? Do you think you are 90% of the way there? 70%? What feedback are you receiving from your customers regarding their inventory levels and expectations?

I think we're hearing there is a range, but a large portion of the destocking happened in the fourth quarter. There are a couple of segments that may still be experiencing it. However, in some cases, we've had orders increase in certain segments to help replenish inventory. Based on what we're hearing qualitatively and what we're seeing in the order book, it seems the destocking trend in the demand chain has largely played out. The main uncertainty is how consumers will behave in the first half of the year regarding their disposable income, inflation, and the relief they are getting on fuel prices, and whether they will return to the goods economy. Most likely, any predictions will be inaccurate, and the rebound could happen faster or take longer than expected, but that's the information we have.

Our last question will come from Citi in line of Anthony Pettinari.

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

Anthony, it's Tim. We said approximately $2.8 billion. It could be a little bit higher or a little bit lower; it's just a dynamic environment and we think it will be around that $2.8 billion level.

Okay. And then you talked about lower fiber costs in the 1Q outlook slide. I was wondering if that's just a function of seasonality or if you're seeing real deflation or maybe price declines there. And then I was just wondering if you're seeing any uptick in OCC? And if you could just kind of comment on Southern Virginia fiber costs, understanding those are kind of local markets.

No, I think we're expecting a modest decline in OCC and virgin fiber. Transportation costs have impacted both, but our inventories are in good shape. We believe there’s a possibility to slightly reduce virgin wood costs as well.

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

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

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