International Paper Company (IP) Q4 2021 Earnings Report, Transcript and Summary

Good morning and thank you for standing by. Welcome to today's International Paper Fourth Quarter and Full Year 2021 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be opportunity to ask questions. [Operator Instructions] I’d now like to turn the conference over to Guillermo Gutierrez, Vice President of Investor Relations. Sir you may begin.

Thank you Angie. Good morning and thank you for joining International Paper's fourth quarter and full year 2021 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-US GAAP financial information. A reconciliation of those figures to US GAAP financial measures is available on our website. Our website contains copies of the fourth quarter 2021 earnings press release, and today's presentation slides. I would note that the Printing Papers business segment is now reflected as discontinued operations from 2019 to 2021. Lastly relative to the Ilim joint venture slide 2 provides context around the joint venture's financial information and statistical measures. I will now turn the call over to Mark Sutton.

Thank you, Guillermo and good morning everyone. Thank you for joining our call. We will begin our discussion on slide 3. In 2021, we served a strong customer demand in a really highly challenging operating environment due to the continued uncertainties associated with COVID-19. I'm really proud and appreciative of the commitment of our employees to continue to take care of each other and to take care of our customers. Our employees' health and safety is our most important responsibility. Looking at our performance International Paper grew earnings and revenue while managing through significant operational and supply chain constraints. For much of 2021, we operated with a sub-optimized system, which limited our ability to capture the full opportunity that comes with a strong demand backdrop. We made strong progress on price realization from prior increases to mitigate the impact of substantial cost pressure from inputs and distribution. While we anticipate the near-term operating environment to remain fluid, we expect to grow earnings meaningfully in 2022. We are building a better IP. We're a corrugated packaging focused company with less complexity and more focus. We've initiated meaningful actions to materially lower our cost structure and accelerate profitable growth. We have a strong balance sheet. We reduced debt by $2.5 billion in 2021, our pension plan is fully funded and we will invest to grow earnings and cash generation by building out capabilities and capacity in our US box system over the next few years. We are also well-positioned to return meaningful cash to shareholders. In 2021, we returned $1.6 billion to share owners including about $800 million in share repurchases. Turning to the full year results on slide 4. Revenue for International Paper increased by 10%, driven by strong price realization in our two business segments and operating earnings improved by 50%. The operating margins were impacted by input operating and distribution costs, which outpaced price realization. Looking at segment performance, earnings in our packaging segment decreased by about $100 million year-over-year with significant cost headwinds from fiber energy and distribution. While our earnings in our cellulose fibers business improved by about $200 million, driven by commercial improvements and price recovery. Equity earnings were $313 million driven by very strong performance from our Ilim joint venture, which delivered EBITDA of $1.1 billion in 2021. Free cash flow was $1.5 billion. I would note that free cash flow included about $500 million in tax payments related to the various monetization actions that we took in 2021 as well as payroll tax payments related to the CARES Act. Turning now to slide 5. Revenue in the fourth quarter increased by about $650 million or 15% compared to last year. We delivered EBITDA of $645 million. Margins decreased primarily due to higher operating maintenance and input costs. This was partially offset by price realization. And I would note that input costs were higher than anticipated. Free cash flow in the fourth quarter was impacted by about $300 million in tax payments again related to the various monetization actions that we took throughout 2021 and the impact of the CARES Act. I'll now turn it over to Tim who will cover business performance and our outlook. Tim?

Thank you, Mark. Good morning, everyone. I'm on slide 6, which shows our year-over-year earnings bridge. Price and mix improved with strong price realization across all of our channels. Mix was also favorable driven by growth in higher-margin US packaging channels and lower export containerboard volume. Volume was essentially flat versus last year. Significant operational and supply chain constraints limited our ability to capture the full benefits of a really solid demand backdrop. Our North American packaging business operated with depleted inventories throughout much of 2021, which increased our costs across the system. Across the company, supply chain operating costs increased $170 million or about $0.35 per share, representing more than half of the increase in operations and cost in 2021. The second half of 2021 was especially challenging due to the slow supply chain velocity and very poor logistics reliability, putting additional cost pressure on our manufacturing systems. Maintenance outages increased as planned following deferrals we chose to make in 2020. Input costs rose sharply across just about every category. Cost increased throughout the year with $370 million of higher input costs just in the second half of 2021 resulting in significantly elevated input cost levels exiting 2021. Total corporate expenses decreased by $0.29 per share. Interest expense decreased by $0.21 per share benefiting from significant debt reduction. Tax expense was lower by $0.17 per share with an effective tax rate of 19% as compared to 25% in 2020. These benefits were partially offset by higher corporate costs following the recent spin-off as expected. And lastly equity earnings improved by $0.57 per share. Ilim equity earnings increased by $0.66 while equity earnings from Graphic Packaging decreased by $0.09. Moving to the quarter-over-quarter earnings bridge on slide 7. Fourth quarter operating earnings per share were $0.78 as compared to $1.10 in the third quarter. Price and mix improved by $0.22 per share with strong price realization in our North American packaging business, partially offset by mix associated with labor challenges in our US box system. Volume improved less than we anticipated, primarily due to the significant Omicron-related labor and supply chain constraints late in the fourth quarter, especially in the US box system. Many of our suppliers, customers and logistics providers, have also reported labor impacts due to the ongoing COVID resurgence. In our Global Cellulose Fibers business, fluff demand is solid. However, vessel delays worsened in the fourth quarter and limited our volume potential. Operations and costs were a headwind in the quarter. The cost impact in the fourth quarter from the tank failure at the Prattville mill was less than we anticipated due to timing. Additionally, we received $40 million of insurance proceeds for Prattville. Operating and distribution costs were impacted by poor reliability from logistics providers across every mode of transportation. Maintenance costs increased sequentially as planned. Input costs increased by $0.22 per share or about $110 million with energy, fiber and chemicals rising in the fourth quarter. Corporate expenses and taxes increased sequentially and interest expense decreased. Ilim equity earnings were lower sequentially partly due to supply chain limitations resulting from increased health measures on rail shipments to China. Turning to the segments and starting with Industrial Packaging on slide 8. In North America demand in the fourth quarter was solid across all our accounts including boxes, sheets and containerboard. However, Omicron intensified supply chain and labor constraints in the later part of the quarter which impacted box volume. The labor impact from Omicron across the value chain is substantial and continues into January, with labor constraints impacting our box plants, suppliers, customers and logistics providers. We're very proud of the IP team and their continued resilience and ability to adapt almost on a daily basis to deliver for our customers. We're experiencing very stretched supply chains and poor carrier reliability across just about every mode of transportation, which put significant strain on our shipments and cost pressure on our mills and box plants. Our mill-to-box plant velocity for containerboard is running three to four days longer than our normalized flow and in some lanes even longer. The lost production of Prattville in the fourth quarter further stressed our network and operating cost. Production at the other mills in our system was 100%. Looking at the fourth quarter performance, price and mix was strong, with very good progress on price realization of our August increase. This was partly offset by a weaker mix related to higher export shipments in the fourth quarter as expected. Volume improved by $20 million sequentially on strong seasonal demand in North America and EMEA, despite three fewer shipping days. As mentioned earlier, box shipments in North America were impacted by supply chain and labor constraints, especially in the latter part of the quarter due to the COVID Omicron variant. Operations and costs were a headwind. Operating and distribution costs in our mills and box plants increased. We operated with very lean containerboard inventories and higher distribution costs throughout most of the fourth quarter to compensate for lost production at Prattville mill. The cost impact of Prattville in the fourth quarter was about $40 million, and we did receive $40 million in insurance in late December. We are currently in the process of restarting the second Prattville machine and expect additional costs in the first quarter. Input costs increased by $90 million in the quarter. Energy accounted for $40 million of that total including $15 million in Europe, where energy prices rose to historically high levels. Wood and OCC accounted for another $35 million, despite modest relief in OCC cost in the latter part of the fourth quarter. Wood fiber costs rose sharply in the third and fourth quarters due to the challenging operating conditions, especially in Southern regions as well as inbound transportation constraints. We expect difficult operating conditions and elevated costs in the first quarter. Let me turn to Slide 9. Earlier in the month, we announced plans to build a new corrugated box plant in Eastern Pennsylvania. The new box plant will complement our Northeast box plant network and support the customers' growth across multiple customer sites. We expect the new plant to start early 2023 and deliver returns of about 20%. We plan to further invest in our US box system to build our needed capabilities and capacity. Investing in our US box system is one of the elements of building a better IP to accelerate profitable growth in our most attractive business. We have some regions where we are limited on box capacity. We have plans to increase capital investments at existing plants as well as invest in new box plants in the next few years. We will ensure we have the right capabilities and capacity to grow earnings and cash. Moving to Cellulose Fibers on Slide 10, I'll start with a few comments on our performance in 2021. We made progress on our commercial initiatives with price mix and volume, contributing about $450 million of improvement. Demand for fluff pulp was solid throughout the year. However, the operating and supply chain environment was extremely challenging, which affected shipments and costs. We also experienced distribution and input cost pressure of more than $200 million, with inputs rising in just about every category. For the full year 2021, our earnings improved about $230 million versus 2020 and we expect further improvement in 2022. Taking a look at the fourth quarter, demand for fluff pulp is strong globally and our backlogs are healthy. Looking at our sequential earnings, product mix impacted earnings by about $5 million. Volume decreased by $10 million due to shipment delays. Our shipments continue to be negatively impacted by port congestion and vessel delays, which worsened in the fourth quarter. Keep in mind that we export about 90% of our volume in this business. Operations and costs decreased earnings by about $10 million, driven by higher distribution costs, lower energy sales and the non-repeat of nitrogen credit sales in the third quarter. These headwinds were partially offset by a favorable LIFO adjustment of $10 million in the fourth quarter. Planned maintenance outage costs increased sequentially and input costs increased primarily due to higher chemicals and energy costs. Turning to Ilim results on slide 11. The joint venture has delivered equity earnings of $66 million with an EBITDA margin of 39% in the fourth quarter. Volume and costs were impacted by distribution constraints related to COVID health measures on rail shipments to China. Ilim expects these conditions to continue into early February. For the full year, Ilim delivered outstanding earnings performance with adjusted EBITDA of $1.1 billion and an average margin of 40%. Ilim's strong operational performance and low cost system make it a powerful cash generator. We received dividends of $154 million in 2021 and expect to receive about $200 million of dividends in 2022. Turning to slide 12. I want to take a moment to update you on our capital allocation actions in 2021 and provide clarity on what you can expect from International Paper in 2022. Let's start with the balance sheet. We will maintain a strong balance sheet and investment -- credit -- an investment-grade credit rating. As we've said previously, we're comfortable taking our leverage below our target range of 2.5 times to 2.8 times debt-to-EBITDA on a Moody's basis. We reduced debt by $2.5 billion in 2021 and more than $4 billion over the last two years. Looking ahead, we have limited near-term maturities with about $900 million due over the next five years. Taking a look at pension, we're very pleased with the performance of our plan. Our qualified pension plan is fully funded with a surplus of about $600 million at year-end. We feel really good about the actions that we've taken to improve performance and derisk the plan. All-in, we closed 2021 with a leverage of 2.5 times on a Moody's basis. Returning cash to shareholders is a meaningful part of our capital allocation framework. In 2021, we returned $1.6 billion to shareholders through dividends and share repurchases. And over the past five years, we've returned $6 billion to shareholders or about 63% of free cash flow. Looking ahead we're committed to a competitive and sustainable dividend with a payout of 40% to 50% of free cash flow, which we will continue to review annually as earnings and cash flow grow. With regard to share repurchases, as of the end of 2021, we had $2.9 billion of available authorizations. We will continue to execute on these authorizations in a manner that balances the investment needs of the business and maximizes value for our shareholders. Investment excellence is essential to growing earnings and cash. CapEx in 2021 was $550 million, which was less than we planned due to the timing of equipment delivery and a challenging contract labor environment. Turning to 2022, we are targeting capital spending of $1.1 billion. The planned increase is primarily for strategic projects in our packaging business to build out capabilities and capacity in our box system to drive profitable growth. We also plan to increase funding for cost reduction projects with expected returns in excess of 25%. We will continue to assess disciplined and selective M&A opportunities to supplement our goal of accelerating profitable growth. You can expect M&A to focus primarily on bolt-on opportunities in our packaging businesses in North America and Europe. Any potential opportunity we pursue must create compelling value for our shareholders. If we turn to slide 13, before we get into the details of our outlook, let me frame up how we're thinking about this year. First and foremost, we're confident in our ability to grow earnings in 2022, and we project our full year EBITDA to be in the range of $3.1 billion to $3.4 billion. Having said that, we expect first quarter earnings to be impacted by a very challenging operating condition and related to the Omicron variant and our highest maintenance outage quarter. As we said earlier, Omicron intensified supply chain and labor constraints in December, which impacted volume and cost. That impact intensified in January as cases increased impacting our workforce, suppliers, customers and logistics providers. Our assumption is that conditions will begin to improve late in the first quarter as Omicron cases begin to subside. Looking at the full year, we expect a solid demand environment for corrugated packaging and pulp with demand growth normalizing as we recover from the near-term Omicron constraints. We're also making good progress on our Building a Better IP set of initiatives which ramp up as the year progresses. Lastly, we are positioned to optimize our mill and box plants from the various disruptions of 2021 which will further improve our operating and distribution costs. We understand the challenges of the first quarter and how we will navigate these near-term headwinds to ensure the company delivers on our full year outlook. So if we turn to Slide 14, we'll take a look at the first quarter. Given the heightened level of near-term noise the first quarter outlook we provide a range of those items where the timing of Omicron recovery presents greater uncertainty. So we'll start with Industrial Packaging. We expect price and mix to improve by $65 million on the realization of our August 2021 price increase. Volume is expected to decrease by $15 million to $35 million with a gradual recovery in the first quarter. Operations and costs are expected to decrease by $60 million to $75 million which includes additional costs related to Prattville. Staying with Industrial Packaging, maintenance outage expense is expected to increase by $118 million. The first quarter will be our highest outage quarter this year representing about 40% of total planned outage costs in 2022. First quarter maintenance expense includes the Riverdale printing papers machine. This cost will be fully recovered as part of the transfer price to Sylvamo over the course of the year. Lastly, input costs are expected to decrease by $30 million to $40 million. In Cellulose Fibers, we expect price and mix to be stable. We expect volume to decrease by $5 million due to ongoing vessel delays. Operations and costs are expected to decrease earnings by $45 million related to the higher seasonal cost and non-repeat of LIFO benefits in the fourth quarter. Maintenance outage expense is expected to increase by $11 million. The first quarter will be our highest maintenance outage quarter this year also representing about 40% of total planned outages in 2022. First quarter maintenance expense includes Georgetown printing business. This cost will be fully recovered as part of the transfer price to Sylvamo over the course of the year. Lastly, input costs are expected to increase by $5 million mostly due to higher energy costs. Moving to our full year outlook on Slide 15. We are projecting full year 2022 EBITDA for the company of $3.1 billion to $3.4 billion. I would note that our outlook only includes the impact from previously published price increases. Free cash flow is expected to be $1.3 billion to $1.5 billion. And as a reminder our 2021 free cash flow included about $300 million generated by the Printing Papers business which was part of International Paper through the third quarter. We are targeting CapEx of $1.1 billion with increased investments in our US box systems. Our free cash flow projection also includes about $100 million of cash used for the execution of our Build a Better IP set of initiatives, as well as $60 million of payroll taxes related to the CARES Act. Lastly the slide includes our outlook for corporate items and our expected tax rate of 25%. With that I'll turn it back over to Mark.

Thank you, Tim for all the details and for walking us through the key earnings drivers. As we look ahead, I am very confident in our ability to grow our earnings in 2022. We anticipate a solid demand growth environment. We're positioned to operate with a fully optimized mill and box plant system as we exit the first quarter and our team is laser-focused on delivering $200 million to $225 million from our Build a Better IP initiative. We have a clear plan and we have a team in place to make it happen. With that operator, we're ready to take your questions.

Thank you. [Operator Instructions] Your first question comes from the line of Gabe Hajde with Wells Fargo. Please state your question.

Good morning, Mark and Tim. I hope you and your family are well. I had a question. I know it's probably an oversimplification. But when I think about your North American corrugated business, we don't yet know obviously industry data, but US box shipment is down 3.3%. Can you talk about how much of that is missed opportunity and perhaps the market itself is still growing versus maybe some customers that are having to go to competing suppliers. And relatedly, to the extent I guess you can comment and that's true, what you may have to do to kind of re-earn that business. I suspect it's better on-time delivery the service et cetera. But just if you could expand on that a little bit?

Yes I think that's a great question Gabe. The results we posted in the fourth quarter, so I don't know what the market will be, but half of our sort of gap to what we think the market was like just given our participation rate in all the segments was really due to the -- our inability to service demand that was there related to the gyrations caused by the lack of containerboard from Prattville. And so, just practically speaking, what that means is we've got to source that board from another mill and it just so happens some of those other mills are in the most rail congested shipping lines. So getting it to the box plants in time to meet the order expectation by the customer was compromised. It's a different version of the same thing we struggled with after the winter storm and freeze earlier in the year, which took a number of -- took 150,000 tons offline for us just based on the geography of our plants. And the other half of what we think we missed relative to where the market might be is really just our own impact in our company and in our supply chain partners with labor around Omicron. Now, the good news, if there is good news in all of that is as we look at our key targeted customers and the customers we have large positions with, it doesn't appear that we're losing any share. What we have not been able to do and it's been consistent really since the second quarter, third -- the second quarter, when we were coming out of these production disruptions, we have not been able to enjoy some of the incremental growth. Everybody in the industry has been running relatively full out. So finding replacement packaging, if you don't have incremental capacity coming online, I think has been a challenge for a lot of customers. So, lack of ability to take advantage of incremental growth, so far has been where the damage has been limited to. And we're ready to be able to be in a position post the first quarter, when Prattville is fully back online, a big chunk of these outages are behind us. And our system can be optimized again, where we're shipping from the correct mill to the correct set of box plants, our costs will go down as well. And we should be in very good shape to take advantage of what the market has.

All right. Thank you for that, Mark. So I guess it's fair to say that, Q1 is kind of a trough for the company overall. And then obviously second half will be much stronger. And then I guess, my other question was, where will we see benefits from Build a Better IP? Is that going to show up in operations? As you presented, I guess in your earnings bridges that's sort of what I'm more curious. And then, the cadence of that over the course of this year and again don't take this the wrong way, but it doesn't feel like there's a whole lot showing up in Q1.

Yes. And we'll report out in Q1, when we get to the end of the quarter. So, it will show up mostly in cost. Now we do have -- as we go into next year, we do have growth initiatives that we believe will begin ramping up. But early on, it's going to be in a couple of places. One, just rebalancing for the stranded costs that we have from Sylvamo. We shared a slide I believe last quarter that showed that we have just under $100 million of costs that we will overcome as we go through this year. And then the other place where there's significant opportunity that we will see ramp up as we go through the year and these are things that we've been working on for 12-plus months is around process optimization. And a lot of that has to do with how we source inputs in our global sourcing organization. There's some supply chain impact. And in our Industrial Packaging business, there's actually a lot of advanced technology projects that are being deployed for allowing us to operate slightly differently and make better operating decisions real-time in the moment. And so we had targeted the $200 million to $225 million for this year gross which will overcome and then some the $100 million that we have in stranded cost. And we'll be -- as we go to the first quarter we'll start sharing quarterly updates and we'll do that throughout the year.

Thank you gentlemen. Good luck.

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

Thank you. Just on the Global Fibers side, I wanted to clarify I think you indicated you expected earnings to be higher in 2022 than in 2021. And you've also indicated when you're providing your outlook for 2022 that you weren't including any price increases that haven't been published. So, I just want to confirm that that statement also didn't include the latest round of increases that you've announced on fluff pulp. And then to fill it in given obviously based on the guidance Q1 is starting pretty deep in the hole. What is it that's going to drive this superior or this improved earnings in 2022 over 2021 because it would seem to be something beyond at least the types of published prices that we tend to see?

So, Mark you're correct on the first two points. Those price increases are not in the commentary or not considered in the full year outlook. And I think what we're looking at in the first quarter we outlined -- Tim outlined additional maintenance. So, in past years, a lot of that was done in the second quarter. So, what we got is a strong demand environment. We got the full year benefit of the prior published price increases which I'm sure you're modeling correctly. We have the $200 million to $225 million of initiatives that are part of our reimagined Building a Better IP. And very, very importantly which we haven't had really since the second quarter of last year we should enter the second quarter of this year with our mill our containerboard mill system and our containerboard box system back in balance. So, that means not paying premium freight because we're shipping off of our contractual rates we're shipping from the wrong geography. All of the things we've been struggling with that have disproportionately probably added cost to our company beyond just the general inflation in the market goes away. So, a well-organized back to our normal supply chain configuration for three quarters of the year we feel really good about being able to put the first quarter in perspective. And again what Tim walked you through was a range because we are trying our best to be realistic about how long the disruptions related to Omicron last for us and our supply chain partners. I hope we're wrong and I hope it goes back to full staffing and all that sooner. But we're just trying to be as transparent as we can. But we believe we're going to be set up, especially because the company would be optimized again for the remainder of the year.

Thank you. And so that would be true on the Cellulose because I guess the question was really just to make sure I heard right that you expected global cellulose to be higher and so it's also better positioning? I guess I was trying to understand whether some of the commercial initiatives that you've talked about are also an important part of the Global Cellulose Fibers improvement you're expecting in 2022.

So, Mark almost all of the improvement in Global Cellulose Fibers in 2021 and into 2022 has been the commercial changes we're making and continue to make to the business. Without going into a lot of detail, the business is mostly absorbent pulp and of the absorbent pulp, there are three types of channels, sort of, what might be called spot or month-to-month there is long-term volume-based contractual and then there are some other configurations. Each of those has a different pace of changing commercial terms how fast prices go through. We'll have the full year of this pricing environment. We're making changes. You can see it in some of the data around fluff pulp versus others. And when we get to the second half of the year I mean typically we've had one quarter which is a low maintenance outage quarter where the business produces 20%-plus margins and cost of capital returns. We should see that in the entire second half of the year. And then as we go into 2023 we should start to see that for three out of four quarters. And then we're going to have a business where I said we would get it which is value-creating throughout a full year. And a big portion of that is driven by the commercial changes. After or not after but as we get through the commercial changes we'll begin to make some of the investments necessary to structurally reduce the cost to make the product primarily in the legacy IP mills where our cost structure is reflective of those mills being converted mills and not built for purpose. So it's moving in the right direction. The commercial changes we're making are working and the business will be profitable this year. It will be better than last year and it will be around the cost of capital for the final two quarters of the year.

Great. I will get back in queue for another question if there is time. Thank you.

Thanks, Mark.

Your next question comes from the line of George Staphos with Bank of America. Please state your question.

Thanks very much. Hi, everyone. Good morning. Thanks for the details. Congratulations on all the efforts and progress this year. I guess, my first question is kind of joined at the hip around the box business. Mark, can you talk a little bit about what kind of shipments or bookings you're seeing early in the quarter or at least from a market standpoint if not for IP? And then when we look at Pennsylvania and the investments that you're making there you talked about 20% returns when you're done with the project. Do you have similar abilities with other box plant projects to get that kind of return? And then I had a quick follow-on.

Yes. So the January is very difficult to get any visibility to because what we've got is a fair amount of demand and orders, but the inability to get it made or get it shipped or for our customers to accept it. So I don't know how to give you a real focus on January. What we are hearing though is that our end customer demand is not dissipating at all. So I think what's going to happen is demand will be -- shipments will be choppy in January and probably most of February. If this virus curve tracks like it looks like it's tracking I think there'll be a tremendous amount of inventory replenishment activity starting in March and the quarter -- it will come out in the quarter. But January is very choppy just because of the hitting this ability for us to get -- most of it is labor related for us to get boxes made. If we have them made getting them shipped and for our customers especially some of the large customers to be able to accept the shipments because they're running at a reduced rate. The second part of your question, can you repeat it George?

Yes, Mark just on – yes, no worries at all. The Pennsylvania box plant and the returns that you're targeting there, can you replicate that kind of return with other box plant investments that you have in your investment horizon over the next couple of years? And sort of my follow-on question and I'll hand it over here. There does seem to be a fair amount of box plant capacity coming into the Pennsylvania-Delaware region. Does that give you any pause relative to your investment? And when we think about the European business where the returns have been probably below expectations the last couple of years how do you see that improving and fitting strategically within IP? Thanks and good luck in the quarter.

Thanks, George. Yes, the box plant question we do have other opportunities. There could be somewhere between three to five box plants geographically placed with the same set of economics of a market area where we are low on capacity and a customer list that wants to buy more from us and it's fully integrated with our mill system. That gives you a return in the 17% to 22%. So we think we've got several more 20% opportunities for new box plants and we've got many opportunities as I mentioned on our last call and at the last conference I spoke at that we have to put additional equipment inside of existing plants that have the physical room and space and are in the right market geographies. So when Tim talked about capital, expenditures moving up, most of that is for converting capability and capacity throughout the US box system. On the Europe question, the Europe returns are moving up. I think again, we got to look at the moment of extraordinarily high energy cost. Natural gas is at all-time highs. We don't think that will stay that way. We've got the normal lag in recovery of containerboard prices going up against box prices. That usually takes a couple of quarters. When you look at normalized energy, when you look at the value of integration from these small acquisitions we've made, the business is at a value-creating return level in the not-too-distant future. So with one large mill and it being 100% on purchased power because it's recycled, that natural gas phenomenon, if you're following it in Europe is a huge blow to the profitability. But it's a moment in time. It's not a – we don't believe it's a permanent issue.

Thank you very much.

Thanks, George.

Your next question comes from the line of Anthony Pettinari with Citi.

Good morning. In containerboard, can you talk a little bit more about your inventory levels? It seems like from industry data, mill inventories are somewhat elevated versus history. But some of your competitors have flagged box plant inventories as quite lean. Just wondering with all the moving pieces in Prattville, how you think about your inventories and kind of getting back into balance?

Yes, it's a great question, Anthony. I think the inventory – this is the IP perspective and it may be what others are saying as well, the absolute number is less important right now versus where it is and how fast or slow the supply chain is moving. So we have struggled with having not enough inventory, regardless of what the absolute number might be to really take advantage of sourcing our box plants with board through most of 2021. It started back in February, March and we never really were able to catch up because demand kept accelerating. So we think we've got inventory as we enter 2022 in a much better position. It's not all in the right place. Our experience is also that our box plants still don't have everything they need. The paper is made, it's sitting at a mill in a warehouse and we're waiting for railcars to get switched to a specific mill. We have several mills below a certain rail line that kind of joins up in Birmingham. South and East of that is the biggest choke point in the country right now. So moving our containerboard into our box network has been just a random occurrence almost every day. So our inventories are better but I measure it as can we fund the box plants with the board they need at the moment that they need it. And we're still not where we want to be on that.

Okay. That's very helpful. And then maybe just a question for Tim. On Ilim, the ruble has plunged I think to multiyear lows. And obviously, there's some geopolitical uncertainty there. How does that impact, how does the Ilim ruble impact what Ilim might report in 1Q? And then is there any operational impact or potential future operational impact if tensions worsen, or just any thoughts there?

Yes. It's really hard to speculate on that scenario or what might happen or how the US government might respond. I think the good news is from a currency standpoint, there is very little exposure from currency movement to the debt position. They hold a lot of debt in rubles. And so they're somewhat insulated from maybe what we would have seen in prior periods. And we also referenced in the speaker comments about the dividend and that dividend is paid out of the entity in Switzerland, where they manage all of their export sales. And currently, it's viewed that there is sufficient cash in that entity to be able to pay the dividend, unless there's some other type of restrictions. So we feel pretty good about Ilim, their position and especially, how they're running the business. But from a financial standpoint, they seem to be in pretty good shape.

Okay. That’s helpful. I’ll turn it over.

Your next question comes from the line of Paul Quinn with RBC Capital Markets. Please state your question.

Yeah. Thanks so much. Good morning. Just a question on Global Cellulose Fibers. I see some price increases in the marketplace and I understand your guidance doesn't reflect those recent price increases. But just overall, on pricing the spread between fluff and NBSK is at a historical high. If I look back at the last seven years, I mean that spread is less than $40. We're currently at $240. What has caused that? And do you think that's going to hold going forward?

Yes. Hey, Paul it's Tim. I think there's a lot of moving pieces but certainly our approach to how we're interacting with customers is part of the strategy that we've talked about commercially. And so we feel good about the steps commercially that the team has taken up to this point. Supply chain could also be providing a little bit of help, just given how much disruption there is and we'll have to see how it plays out as supply chains normalize. But I think the way the team is executing and how they're thinking about their opportunities in the market, relative to segments and geographies is producing the results that we wanted.

All right. That’s all I had. Best of luck

Thank you.

Your next question comes from the line of Mark Wilde with BMO. Please state your question.

Thanks. Good morning, Mark. Good morning, Tim. I wondered if you guys could just help reconcile some numbers. I mean if we look at the Pulp and Paper Week open market prices for containerboard they're kind of $800 to $875. If we then look at kind of the data that is out there on estimated mill cash costs, I'm trying to get from those numbers to your segment results because it just -- it seems like there's an enormous gap there.

Mark, I don't know what numbers you're looking at. I think the issue that we have is our margins in North American Industrial Packaging have been compressed and there's two main reasons for that. Because of the way we've operated since essentially March, we have moved off of our most cost-effective supply chain approach. So we have hundreds of millions of dollars of incremental costs related to running a sub-optimized system. Sub-optimized means making the containerboard and shipping it to the wrong places because we don't have another alternative because other capacity was down. Given the size of our system, given the fact that we make containerboard in the Southeast and ship it to California and all of those things, we have not been able to realize as much of our price realization to the bottom line as we normally would. And so that's been a big portion of margin compression for us. And then when you look at the overall full breadth of our customer and segment mix we have varying degrees of sizes of customers timing of realization. So for example, Tim called out we're still getting $65 million of realization in the first quarter of 2022. That's not for every customer. That's for a group of customers that it takes longer. So I think that's really what you're seeing, if you're probing on margins, which I know you talk about a lot and we work on a lot. That's really the biggest issue. I think when we get to the second quarter and we're back to where we can optimize our network it really works well like a flywheel for us. And then we get margins north of 20% again and it's in the zone of what we would expect. It's been very hard for us to achieve the margin structure that I think most people would expect us to be in when we have operated with the initial 150,000 tons that came offline with the weather events at the beginning of the year and then coupled with the challenges we had through the rest of trying to make sure we put the customers first in many cases. And one way to not have had all of these issues is just to cut off a bunch of business and reset everything which is the wrong thing to do for the long-term. But the good news is most of that is behind us Prattville's coming up as we speak and we should be ready to optimize and regear the company back to the 20 -- the margins north of 20% again, which we would expect to have at this point in this business.

And I guess Mark, kind of, two just follow-ons to this. The first one is I'm just curious about whether there's maybe the need to rethink some of the bigger volume contracts and how those work for you. And then I'd also like to get a sense when you talk about this 20% return on the Philly area box plant, does that assume market level of transfer price and the 20% return is just the return you can generate at the box plant, or are you assuming some of that is a mill-related benefit?

Hey Mark, it's Tim. It has a mill-related benefit in it. We look at this business especially here in North America as being an integrated business. So we're deploying capital in our mill system for the benefit of our converting business. And the value proposition is across the whole supply chain. So we look at integrated returns for the investments that we make.

Okay. Last one Tim. I just -- we went through this whole exercise about 15 or 20 years ago with box USA and it just seemed like there were a lot of systems benefits that were priced into that deal. And I'm not sure that we ever saw them. Have you gone back and looked at some of these other prior transactions and to see what worked and what has not worked?

We do that on a regular basis and constantly trying to learn and make sure that we are seeing if there were opportunities that we missed in one instance that we correct that going forward. So I think we have a fairly robust process of -- and we're fairly critical of ourselves as we should be internally to make process improvements about how we do it. Box USA specifically I haven't looked at in a very long time.

Okay. All right, I’ll turn it over. Thanks.

Your next question comes from the line of Kyle White with Deutsche Bank. Please state your question.

Hey good morning. Thanks for taking the question. On the outlook that you provided, are you able to give a sense of what the midpoint of that guidance range assumes for box shipment growth in 2022? And then what are you assuming from the supply chain and labor challenges in terms of any moderation throughout the year?

Yeah. On the box growth, I think what we said in the speaker notes without quantifying but we can talk about historical numbers, we see if we get through this variant that we start normalizing on the demand function to pre-COVID. So we were consistently experiencing 1.5% to 2% growth. How that unfolds over the course of the year is a little bit of a question mark, but that's the expectation at the moment. I'm sorry what was the first part of your question?

He wants to know the supply chain and labor cost issues, what are we assuming for that for the rest of the year?

Yeah. Just at a high level, we think we begin normalizing as we get through the first quarter and then we'll have to see how it plays out going to the second quarter. I mean the disruption from Omicron it came on so suddenly and so severely, I think a lot of people were surprised by how quickly it began impacting almost every aspect of the supply chain. And so it started late November early December accelerated. Hopefully we're peaking here in the next few weeks. But I would say that geographically it's not uniform because of the way it's spread. It's going to peak in different places at different times and then fall off.

Got it. That's helpful. And then on Prattville it sounds like the Paper Machine one is starting up as we speak. But just curious if you could give us an exact time line of when you expect that machine to restart? And what are the additional costs from that disruption included in the 1Q outlook?

Yeah, what we're expecting in the first quarter is that there will be roughly $25 million of additional costs related to the inefficiency of the machine coming back up. And then we won't have the mill fully restored until we get through the outage in the second quarter and then we would expect the mill to be back up and fiber balanced and running at its optimum cost structure.

Got it. Thank you. I’ll turn it over.

Your next question comes from the line of Adam Josephson with KeyBanc. Please state your question.

Mark and Tim, good morning, and thanks for taking my questions. I hope you’re well. Tim, one on guidance for you, my obligatory guidance question. So, since the pandemic started you've refrained from providing annual guidance, understandably so. And I know you have a number of portfolio changes which may increase your desire to give a full year number. Otherwise we might be all over the place. But, it seems like the uncertainty is greater than it's ever been in terms of the virus inflation the state of the global economy. You just talked about Russia earlier, demand same. I mean so, I guess what -- how much confidence do you really have in this full year EBITDA range that you've provided? And did you consider just not doing it because of all of these uncertainties that seem to only be getting more pronounced, not less?

Yeah. That's a great question, Adam. I mean just a few thoughts for consideration. When we stopped we stopped because no one knew what the pandemic was going to bring. I would argue there was more uncertainty at that moment in time back in 2020 than there is currently. But -- and in 2021 as well. I think if we look at what Omicron has done globally, we see where it started and ramped quickly peaked and then fell off. And so, we used that as a base case for a set of expectations here. There's always going to be things that crop up like you mentioned that is difficult for us to really calibrate on in the moment. But what we have confidence in is what we've been working on for the past 12 to 18 months and how we believe those initiatives are going to come through this year. So, there's the things that we can manage and control, and then there's the impacts externally that we'll just have to deal with. But in terms of how the business we expect to perform, what we're going to see in terms of initiatives falling through to the bottom line, we're very confident in.

Adam, if I could add to Tim's comments and you mentioned it in the way you phrased the question, one of the reasons we're more confident than we have been is because the portfolio is narrowed. And we now know that the Packaging business and for that matter the Cellulose Fibers business both have performed very well in the environment of a pandemic. And we know what they perform like if we weren't in a pandemic because so much of our packaging goes into essential materials like food. If there's another difficult year with a pandemic, we think the packaging business because of who it provides packaging for, is going to perform very well. We performed very well in the first part of the pandemic. We got our system out of whack in the second year of the pandemic but still grew our earnings and our revenue. And whatever 2022 holds pandemic related, we believe, because of what we make, we're going to have really good opportunities to perform. We think we have the ability depending on where cost go to capture pricing to be able to offset some of that. And what we're not -- what we're going to have in 2022 that we didn't have in 2021 is a more balanced operating system. So, that's about as confident as we can be without knowing the future.

Sure. No, I understand that Mark. And just one more for you Mark. On the supply/demand, someone asked you this earlier, but all we can see is what the industry data is with respect to inventories operating rate shipments. And appreciating how messed up the supply chain is what are your thoughts about what "underlying supply/demand" is such that we can perhaps seize through whatever distortions you think exist in the industry data that would be supportive of rising prices?

It's -- I just think what I would do if I were you as an analyst, I would try to look at the historical absolutes weeks of supply, whatever number you want to choose. And then I would look -- I would map that against supply chain. There's a few metrics out there around velocity and recognize that operating rates, absolute inventory, supply chain velocity and the pure supply-demand balance. So, against a backdrop of firm demand and companies that knowing IP's case, have cut corners a bit on maintenance because of availability of equipment and just the demand environment last year, we'll be taking facilities down for maintenance which takes supply offline, I would look at that holistically and I would shy away from looking at an absolute inventory number and comparing it to normal times. I just think that leads to the wrong conclusion.

Got it. I really appreciate, Mark.

Thank you, Adam.

Our last question comes from the line of Phil Ng with Jefferies. Please state your question.

Hey, guys. Thanks for squeezing me in. Tim, certainly, a big step up in CapEx this year, but should we expect that to stay pretty elevated in 2023 with some of the box plant opportunity you referred to? And how should we think about normalized CapEx with your slimmed down portfolio now?

I think normalized. So with the new portfolio, we're at about $1.1 billion of depreciation. And so we're in line with that for 2022. I think we should be close to that in future years. There may be times when we're slightly above, but it will be above for very distinguishable strategic opportunities that we can highlight.

Okay. Got you. And then Tim you talked about this a little bit about the financial impact on the ruble and how you guys are positioned. But any color on even some of the political unrest in that region and COVID shutdown in China? Have you seen any choppiness in order activity in your operations whether it's Ilim or any impact on your Cellulose Fibers segment?

No, not really. It's mostly supply chain related due to COVID and all of the disruptions that we've seen as we've gone through the past year. Yes, we haven't noticed anything outside of that at this point.

All right. Thanks a lot guys.

Yes.

I would now like to turn the floor back to CEO, Mark Sutton for any additional or closing remarks.

Thank you. What I'd like to do is just reiterate that we're confident in our ability to execute for the remainder of 2022. We've got a solid demand environment. We've got the full year benefit of the pricing that we've already implemented flowing through for the full year. We highlighted the $200-plus million of benefits associated with building a better IP. We will have very importantly the biggest part of our company optimized again for the majority of 2022 that being our mill and box plant system. And very importantly, our balance sheet's in the best shape that we've been in a very long time. All the capital allocation levers are available to us and we plan to invest smartly in our US box system over the next few years to grow profitably. So, thank you for your interest in International Paper. We look forward to talking to you next quarter.

Thank you for participating in International Paper's fourth quarter and full year 2021 earnings conference call. You may now disconnect.