International Paper - Q1 2024

Transcript

Operator (participant)

Good morning, and thank you for standing by. Welcome to today's International Paper's first quarter 2024 earnings call. All lines have been placed on mute to prevent background noise. After the speaker's remarks, you will have an opportunity to ask questions. To ask a question, press one then zero on your telephone keypad. To withdraw a question, press one then zero. As a reminder, to ask a question, press one then zero. To withdraw a question, press one then zero. Again, that is, press one then zero on your telephone keypad. To withdraw a question, press one then zero. It is now my pleasure to turn the call over to Mark Nellessen, Vice President, Investor Relations. Sir, the floor is yours.

Mark Nellessen (VP of Investor Relations)

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

Mark Sutton (Chairman and CEO)

Thank you, Mark, and good morning, everyone. We will begin our discussion on slide four, where I will highlight our results. Starting off the year, our teams across International Paper executed well, with intense focus on taking care of our customers while accelerating our commercial and mill optimization strategies. We are also encouraged to see positive market momentum as we continue to see signs of demand recovery. Additionally, Sales Price Index has improved across our portfolio, and the majority of the benefits will flow through our contracts in future quarters. Our first quarter earnings were generally in line with our outlook and represent a trough based on seasonally low volumes, higher OCC costs, and the majority impact from the 2023 Sales Price Index declines.

Earnings were also unfavorably impacted by approximately $38 million from the January winter freeze and approximately $14 million from a significant fire that consumed our box plant in Ixtaczoquitlán, Mexico. Fortunately, no one was injured, and our teams remain focused on taking care of our employees and customers as we manage through this incident. Also in the quarter, our teams across International Paper made significant progress executing our strategic initiatives. We realized significant margin and mixed benefits from our Box Go-to-Market Strategy, well above our initial expectations for the first quarter. In addition, we continue to make investments to strengthen our packaging businesses. We also realized benefits from our optimization strategy in Global Cellulose Fibers and from the fixed cost reduction initiatives in our mill system. These strategic initiatives across our portfolio are focused on accelerating margin improvement and driving profitable growth.

In addition to this ongoing work, last week we announced a catalyst to create significant value for shareholders through a highly compelling combination with DS Smith. This additional catalyst is something we look forward to working on with the DS Smith team and continuing our conversations with investors regarding this opportunity. At this time, we do not have any additional information to share, so for today's call, including the Q&A session, we intend to focus specifically on International Paper's performance. I will now turn it over to Tim, who will provide more details about our first quarter performance and also our outlook. Tim?

Tim Nicholls (Senior VP and CFO)

Great. Thank you, Mark. Excuse me. Turning to our first quarter key financials on slide five. As Mark mentioned earlier, our first quarter earnings were generally in line with our outlook and represent a trough based on seasonally low volumes, higher OCC costs, and the majority impact from the 2023 sales price index declines. Operating earnings and margins were also negatively impacted by approximately $52 million or $0.10 per share from the January winter freeze and the Ixtac box plant fire. For the quarter, we generated $144 million of free cash flow. As a reminder, our free cash flow in the first quarter of last year included a $193 million final settlement with the IRS related to IP's timber monetization structure. Looking ahead, we expect significant earnings improvement based on positive market trends and benefits from our commercial and cost improvement initiatives.

Now I'll turn to slide six, and I'll provide more details about the quarter as we walk through the sequential earnings bridge. First quarter operating earnings per share was $0.17 as compared to $0.41 in the fourth quarter. As I mentioned earlier, the first quarter included $0.10 per share related to the January freeze and the Iztacc fire. Price and mix was higher by $0.14 per share, driven by significant margin and mix benefits from successfully executing our Box Go-to-Market Strategy and our GCF Optimization Strategy. This was partially offset by the majority of prior Sales Price Index declines from 2023. Volume was unfavorable by $0.08 per share, primarily due to seasonally low shipments across both segments, as well as some impact from the winter storm in January.

We continue to deploy our commercial strategies across the portfolio, focused on margin and mix improvement, which has impacted volumes in the near term as we transition based on our strategy. Operations and costs were unfavorable by $0.13 per share sequentially. This included approximately $0.07 per share from the January winter freeze and the Ixtaczoquitlán box plant fire. The remainder was primarily due to cost inflation, including the higher cost of employee benefits. The unfavorable impact to operating costs from seasonally lower volumes was offset by cost savings from our mill closure and machine shutdowns last year. Maintenance outages were higher by $16 million or $0.03 per share in the first quarter. An input cost unfavorably impacted earnings by $0.07 per share sequentially, largely due to increased costs for OCC, with the remainder from higher energy and chemicals.

And finally, corporate items unfavorably impacted earnings by $0.07 per share sequentially, primarily due to FX and reserve adjustments that were favorable in the fourth quarter. Turning to the segments and starting with Industrial Packaging on slide seven, price and mix was higher due to significant benefits from our Box Go-to-Market Strategy, which contributed approximately $110 million of earnings benefit from improved margins and mix. This was partially offset by the majority of prior Sales Price Index declines from 2023, which negatively impacted earnings by approximately $53 million. With that said, the February index publication of a $40 per ton increase will flow through our contracts primarily over the next couple of quarters. In addition, the commercial benefits from our Box Go-to-Market Strategy exceeded our expectations for the first quarter, and the commercial teams remain focused on pursuing additional opportunities going forward.

Volume was lower as first quarter represents our seasonally lowest shipment quarter of the year and was also adversely impacted by the January freeze. Also, our Box Go-to-Market Strategy is about making choices that will likely impact our volume in the near term but will allow us to improve our margins and mix over the long term. Although we expect to trail the industry for the next few quarters when measuring unit volume growth, we fully expect the volume impacts to be temporary as we continue to transition toward our target mix of customers and invest in the business to maximize profitability. Operations and costs included a $34 million unfavorable impact from the January winter freeze and the Ixtaczoquitlán box plant fire in March. The remainder was primarily due to cost inflation, including items such as labor, materials, contracted maintenance services, and higher cost of employee benefits.

There was also lower fixed cost absorption from seasonally lower volumes. However, this was partially offset by $22 million of fixed cost savings from the Orange mill closure. Outside of the January freeze, our mill system ran very well in the first quarter. Planned maintenance outages were higher by $26 million sequentially, and input costs were higher primarily due to higher OCC costs. On slide eight, we thought it would be helpful to update you on segment trends for our North American packaging business like we did last quarter. We continue to see stable to improving demand across all end-use segments. Let me highlight some of the trends based on customer feedback. E-commerce continues to be very resilient, up mid-single digits on a year-over-year basis in the first quarter and significantly above pre-COVID levels. Food and beverage has been relatively stable overall.

The overall fresh food segment continues to benefit from solid performance across the food service channel, as well as consumer shifts toward make-at-home meals in lieu of processed food and its convenience. The processed food segment is beginning to show signs of improvement as some producers and retailers are running promotions to improve sales volumes. The produce segment was about flat in the first quarter with a drag from wet weather in the Western U.S. However, this segment is expected to recover in the second quarter. The protein segment is improving following a period of supply reductions in beef and poultry. Poultry remains a preferred choice by consumers based on value. The beverage segment remains under pressure as budget-conscious consumers have reduced consumption of specialty beverages and bottled beer, which tend to be more packaging-intensive.

In summary, based on these trends, we believe industry box demand will grow approximately 2%-3% in 2024. We understand the critical role corrugated packaging plays in bringing essential products to consumers, and we believe that IP is well-positioned to grow with our customers over the long term. Moving to Global Cellulose Fibers on slide nine, price and mix was higher due to price index movement and the GCF Optimization Strategy driving benefits from higher absorbent pulp mix and the reduction of commodity grades. Volume sequentially was relatively flat overall as improved demand for absorbent pulp was offset by lower sales of commodity grades as we continue to focus on strategically aligning our business with the most attractive customers and segments.

Operations and costs were unfavorable sequentially due to the January freeze and cost inflation, including labor, materials, contracted services, and higher cost of employee benefits and some timing of spend. Most of this was offset by $12 million of lower fixed costs resulting from the two pulp machine closures at our mills in Riegelwood, North Carolina, and Pensacola, Florida. Planned maintenance outages were lower in the first quarter by $10 million and also included a $24 million outage related to the Georgetown white paper machine that unfavorably impacted earnings in the first quarter but is expected to be recovered throughout the rest of the year through an existing supply agreement with Sylvamo. Finally, input costs were higher by $7 million, primarily due to higher energy costs during the January freeze. On slide 10, we'll take a look at our second quarter outlook. I'll start with industrial packaging.

We expect price and mix to improve earnings by $65 million sequentially. This is the result of the prior index movement in North America, higher export prices to date, as well as continued progress with our Box Go-to-Market Strategy. Volume is expected to increase earnings by $55 million, primarily due to seasonally higher daily demand with one more shipping day. Operations and costs are expected to decrease earnings by $70 million. This includes proactive maintenance spending beyond our full-scale mill annual outage program. As we anticipate continued demand recovery and increased equipment utilization, this spending is focused on improving productivity and efficiencies across our mills and box plant network. We will continue to experience additional inflation and higher S&A, including additional commercial resources to support our Box Go-to-Market Strategy. Higher maintenance outage expense is expected to decrease earnings by $4 million.

Included in that total is a $19 million outage related to the Riverdale white paper machine that will be recovered throughout the year through an existing supply agreement with Sylvamo. Lastly, input costs are expected to be stable overall as higher OCC costs are expected to be offset by lower energy costs. Switching to Global Cellulose Fibers, we expect price and mix to increase earnings by $15 million as a result of prior index movements. Volume is expected to remain flat as we reduce exposure to commodity grades and grow with absorbent pulp. Operations and costs are expected to increase earnings by $20 million, primarily due to lower fixed costs resulting from the pulp machine closures in our Riegelwood and Pensacola mills, the non-repeat of the January freeze, and timing of spending. Lower maintenance outage expense is expected to increase earnings in the second quarter by $19 million.

This sequential improvement reflects the $24 million Georgetown paper outage that occurred in the first quarter, which we expect to recover throughout the rest of the year. And lastly, input costs are expected to be stable. With that, I'll turn it back over to Mark.

Mark Sutton (Chairman and CEO)

Thanks, Jim. I'll turn to slide 11 and give you some additional perspective on our progress we're making on our business strategies. Our teams across International Paper are advancing our strategies and capturing significant value. In the packaging business, which is on the left-hand side of this slide, our box go-to-market strategy is focused on enhancing our capabilities and strong value propositions to improve margins and mix. We are making choices that create value for our customers while maximizing the profitability of our packaging business.

Earlier, Tim called out approximately $110 million of price and mix benefits realized in the first quarter, and we expect additional opportunities as we go through the year. In addition, we continue to make investments across our box network to improve our capabilities to serve customer needs and increase productivity. These projects have attractive financial returns and position our packaging businesses for profitable growth in the future. In our Global Cellulose Fibers business, we also realize benefits from our optimization strategy by aligning our resources with the most attractive customers and segments and reducing exposure to commodity grades. This shows up as margin and mix improvements in the first quarter. Across the enterprise, we also optimized our mill system and realized $34 million of fixed cost savings in the first quarter.

These strategic initiatives across our portfolio are focused on accelerating margin improvement and driving profitable growth and will remain a high priority for our teams at IP. Moving to slide 12, and given our CEO transition, I'd like to take a moment to express my personal gratitude for my journey with International Paper. It has been a privilege to be part of the IP family for my entire career. Forty years really goes by fast when you work with outstanding people at a great company. While I enjoyed all the various roles and opportunities, I'm truly humbled and honored to have served as IP's leader for the past decade. During this time, we have become a more focused company, and our financial foundation is strong, as are the principles and core values that guide our actions and decisions about how we operate.

Our team knows our mission matters, that we improve people's lives by using renewable resources to make products people depend on every day. We understand how important it is to help our customers solve problems and achieve their goals, and we're laser-focused on the things that are improving the company and making IP a very well-positioned company for the future. I'm incredibly proud of our employees. I have seen them demonstrate time and time again their resilience and agility to overcome challenges. This was particularly evident during the global pandemic when our team showed up for work every day to get the job done. Their dedication ensured people around the world had access to a variety of essential goods. To everyone on the IP team in all our operations and offices around the globe for what you do each day and for making a difference, thank you.

To our shareholders, thank you for your continued confidence and investment in International Paper. It has been a remarkable journey for me being part of IP's 126-year legacy. I'm proud of how far our company has come, and I'm looking forward to seeing how far International Paper will go. With that, we're ready to move to Q&A.

Operator (participant)

Thank you. If you would like to ask a question, simply press one then zero on your telephone keypad. To withdraw a question, press one then zero. We will pause a moment to compile the Q&A roster. We do ask that you limit yourself to one question and one follow-up question. As a reminder, today's Q&A is intended to focus specifically on International Paper's performance. One moment, please, for your first question. Your first question comes from the line of Matthew McKellar from RBC Capital Markets. Please go ahead.

Matthew McKellar (VP of Paper and Forest Products)

Hi. Good morning. Thanks for taking my questions. I was wondering if you could start with just reconciling the benefits from the changes in your go-to-market strategy in the box business versus what you were expecting to start the year? And then it sounds like you're expecting some incremental benefits that will flow through in Q2 and beyond. I was wondering if you could help us just quantify that?

Mark Sutton (Chairman and CEO)

So, Matthew, I think you're asking we had outlooked closer to maybe $70 million, and we overachieved that. Tom Hamic, I think, can walk you through a lot of moving parts on that, but I think he can walk you through how we basically overachieved our outlook.

Tom Hamic (EVP and President of North American Packaging Solutions)

Sure. Thanks, Mark. And good morning, Matthew. I would say we exceeded the price component for two reasons. First of all, at the local level, we had better-than-expected improvement as we were starting Q4. So these are customers that are really the decisions are made in the field. Most of our forecast and thinking about the improvement was focused on very large customers that are across the country. We exceeded the expectations there, but the big mover was our investment in the commercial teams in the field, training, execution, driving benefit for our customers, and frankly, getting a fair price that maybe we didn't in the past. I can say that the volume gap to market was almost exactly where we expected it. So these trade-offs are playing out the way we expected, but the margin improvement is more significant.

Matthew McKellar (VP of Paper and Forest Products)

Great. Thanks for the color there. And then I realize it's a pretty marginal change, but could you talk about what you're seeing in the market, either in Q2 so far or more generally, that led you to revise your expected North American industry box shipment growth to 2%-3% in 2024 from 3% previously?

Tom Hamic (EVP and President of North American Packaging Solutions)

Sure, Matthew. This is Tom again. I would say that the second quarter is going to be close to +2% for the industry. So that's an improvement from 4% to 1% to 2%. We expect that improvement to continue. I would say 2% is probably in line with a fairly tough economic second half. And obviously, when you're forecasting, the toughest things to predict are when you have a turn. And we are going to have a turn. Our customers do not have enough inventory. And at some point, they're going to have to reinvest in that base as the economy improves. And so our forecast, if you go down to 2%, that suggests no improvement at all and probably a fairly tough retail sales environment. I think of it closer to 3%, and I would not take 4% off the table.

A minor adjustment to be conservative is what I would say.

Matthew McKellar (VP of Paper and Forest Products)

Great. Thanks for the color there. That's all from me, Mark. Congratulations on the retirement. I'll turn it back.

Mark Sutton (Chairman and CEO)

Thank you, Matthew. Thank you, Matthew.

Operator (participant)

Your next question comes from the line of Mark Weintraub from Seaport Research Partners. Please go ahead.

Matthew McKellar (VP of Paper and Forest Products)

Thank you. First question, just wanted to understand the operations and costs in the packaging business. I think you talked at being a negative $70 million Q/Q v. 1Q. And I think, though, at the same time, we should have about $50 million positive because we don't have the fire and we don't have the winter freeze issues. So that seems to me like a $120 million negative swing. So I was hoping to get kind of more specifics as to why that number would be so large.

Mark Sutton (Chairman and CEO)

Mark, hi. This is Mark. That's a great question. I think it's two parts. It's the value chain starting with containerboard and all the way through box. Our prepared remarks talked about generically preparing for what we believe will be higher utilization, as well as some of the spending is maintenance cost, but it really is in the box business to improve productivity and throughput. It's just not at the capital cost level. So what I would like to do is ask Jay Royalty to talk a little bit about the containerboard part of the value chain, and then Tom to add some comments on the converting and box side. So, Jay?

Jay Royalty (Senior VP of Containerboard and Recycling)

Thanks, Mark. Good morning, Mark. Thanks for the question. I think speaking to the containerboard side of the equation, there's a couple of things going on to keep in mind. One is the inflationary situation. So if you step back and think about what's happened the last couple of years and how to think about that in the context of where we are, the cost to deliver the same value to customers has really increased dramatically over the last couple of years. And we see that again as we step into 2024, and we saw it. We saw a meaningful impact in our 1Q numbers. We'll see and this is related to all of this inflation. And we'll see another step in 2Q. And then you can really think about that kind of leveling out from there.

And why that is the case is a lot of this inflation is labor-related. And you think about labor flowing through all of these different things, but it's also front-end loaded as these contracts reset at really the beginning of the year. And so labor and benefits, maintenance services, operating supplies and materials, warehousing costs, and even some kind of benign overhead expenses like insurance and property taxes, we all see those meaningfully up as we come into 2024. And so that's one thing that's impacting the numbers in 1Q and then again in 2Q. The other thing and Tim spoke to it in terms of the proactive maintenance spending. If you think about how we've been operating for the last several quarters in light of the lower demand environment, we have been modulating our spending in reaction to that.

But as you heard us talk about, we're seeing more and more evidence of the recovery really across all the channels. And we need to be ready for that. We're in the early stages, but it's going to continue to ramp, and we need to be ahead of that. So Tom will talk about the box side. On the mill side, I would characterize it as a very modest step up, but given our size and scale, the numbers are not insignificant. But it's really about trying to get ahead of that. And these are things like ongoing maintenance and repairs to support productivity, efficiency, reliability across all facets of the mill, the pulp areas, the power areas, and the paper as well. So it's really about increasing that cadence. And then depending on how the demand plays out from here, we'll modulate that accordingly.

Tom Hamic (EVP and President of North American Packaging Solutions)

Hey, Mark. This is Tom Hamic. I think Jay and Mark laid it out very well. I would say the one difference with the box business, because we are increasing maintenance spending, is that it's very targeted to places where either we've struggled with reliability or we have an opportunity to grow. So as you look across the country, it's not that we're spreading the maintenance dollars. We're really reacting to the marketplace and the strength of demand. And then we're targeting maintenance spending to improve reliability for those customers while at the same time, we're improving our margins. So this real focus on reliability and delivering on time is going to pay off.

Matthew McKellar (VP of Paper and Forest Products)

Okay. Thank you. So would you say that what we're going to see in the second quarter is back to what you think to be your normal type of, given where the world is today, your normal levels of maintenance-type spending, etc., etc.? Or are we spending even a bit extra now to make up for maybe having spent a little bit before? Or is there even further increases that we might, though it didn't sound like there'd be further increases going forward? But maybe just clarify, are we just kind of at normalized spend levels in the second quarter and we were just a bit below previously? Is that the way to think about it?

Tom Hamic (EVP and President of North American Packaging Solutions)

Hey, Mark. This is Tom Hamic again. I think there's a large part of it that is adjusting. But I think the key is what I talked about earlier, is we've got to respond to the market, and we can't wait for the market to then respond. And so there's a bit of this that is getting ready, as Jay talked about, for what we see as an expansion in box demand going forward. And one of the really positive things about maintenance expense in the box plants is what we've seen is a very short payback. So we're seeing the results. We're tracking the results. And I feel very good. It really is our fastest way to react to customer needs. And so I feel very confident what we're spending is going to pay off.

Mark Sutton (Chairman and CEO)

So, Mark, I think what Jay described on the mill side is true in packaging. It's also true in cellulose fibers. Modulating our spending over the last, let's say, 4-5 quarters as we were running both businesses at less than target output, which would be somewhere in the 94%-95% output, it's been much lower than that, as you know, based on the demand environment. And so we stretched those dollars over a longer period of time because we didn't need our plants to run at maximum output. So now we're preparing to be running more toward our target output. The only thing I would call out that's maybe a little bit of an abnormality in the mill system is it just so happens timing of some of these projects that are related to power generation.

So in some of our integrated mills, we have major preventive maintenance shutdowns in some of the turbine generators that generate our steam and electricity. Those aren't done every year. They're sequenced, but you have to get them done in a certain window. There's a few extra turbine generator major scheduled maintenance roles, jobs in this period of time that we would normally have. So if you take that out, then I think the rest of it is preparing to be at a more I don't like to call it run full, but a more targeted run environment.

Matthew McKellar (VP of Paper and Forest Products)

Got it. Thanks, guys. Thank you, Mark, for your clear explanation there and for your clarity over the years you've been working. Congrats on retirement.

Mark Sutton (Chairman and CEO)

Thank you, Mark.

Operator (participant)

As a reminder, if you'd like to ask a question, please press one, then zero. Next, we'll go to the line of Charlie Muir-Sands from BNP Paribas. Please go ahead.

Matthew McKellar (VP of Paper and Forest Products)

Yes. Good morning. Thank you very much for taking my questions. I just want to stay with two, please. Firstly, just in terms of the market prices and the recognition of the $40 per ton increase that you put through in March, followed by no further change in April, is it your expectation that relative to the higher numbers that you and others announced at the start of the year that we won't see any further recognition unless there's further price increases made? And then the second question, just related to the corporate expenses, $24 million in the first quarter compared with $60 million-$80 million guided for the year, have you got any view on how Q2 might shape up specifically and whether for the full year, you might now be perhaps looking towards the upper end of that range given the large number in Q1? Thanks.

Mark Sutton (Chairman and CEO)

Charlie, this is Mark Sutton. Thank you for your questions. I'll take the first one, and our CFO, Tim Nicholls, will take the second one on the corporate expenses. On the pricing, we don't comment on forward-looking pricing. IP had an announcement of $70. $40 was recognized. There's lots of reasons for that in the way that the index discovers price through the analytics. So I think we would just stop there and say that's what we have. That'll flow through in the next few quarters. But we really don't forecast or talk about forward pricing that hasn't kind of published in an index. Tim, you want to take the corporate expense question?

Tim Nicholls (Senior VP and CFO)

Yeah. Great. Hi, Charlie. So we don't break it out quarter by quarter. What we keep at corporate, there's a lot of things that can have some volatility to them. We still feel good about the $60 million-$80 million for the year. But we capture things like FX movements, and there's some unallocated subs and things like that. So there's a lot of moving parts running through. And generally, you can estimate it for a full year. It can bounce around quarter by quarter.

Matthew McKellar (VP of Paper and Forest Products)

All right. Thanks.

Operator (participant)

Your next question comes from the line of Mike Roxland from Truist Securities. Please go ahead.

Matthew McKellar (VP of Paper and Forest Products)

Thank you, Mark, Andy, Tim, and Mark for taking my questions. Mark, I just want to echo what everybody else has said. A good congrats on your retirement and all the years on the road.

Mark Sutton (Chairman and CEO)

Thanks, Mike.

Matthew McKellar (VP of Paper and Forest Products)

Just wanted to get a sense. Going through this commercial reorg, margin improvement, industrial packaging, what type of EBITDA margin are you looking to achieve and over what time frame? And can you help us frame how this should play out over the next year at mill?

Mark Sutton (Chairman and CEO)

I think the number we've always thrown out there was EBITDA margin that led us to a really strong ROIC, several hundred basis points above our cost of capital. At yesterday's revenue line, that used to be in the 20%s. But I think for us, that's an aspirational target to get back into that area. But even at today's revenue, an 18% margin generates very strong ROICs similar to what a 21% margin used to generate. So I think that's the sort of milepost we're working toward now is getting up into those high teens, 18-ish%, on our way to 20%. And if you kind of take that to an ROIC, you've got a really strong kind of mid-teens ROIC in the packaging business. And then you put some growth on top of that, and I think the value creation can be pretty powerful.

Matthew McKellar (VP of Paper and Forest Products)

Based on where you stand today, Mark, that 18% margin, when do you see that occurring? Is that something that occurs next year, next two years? And how do you see that unfolding in the near term?

Mark Sutton (Chairman and CEO)

I think the answer to that question is going to depend a lot on what Tom Hamic talked about, and that is this steady improvement in demand, the consumer, and when this turn occurs. Obviously, those margins would be indicative of a healthy economy, which leads to a healthy box market. So we would think it's several quarters before we're sitting at that point. But we should see a step change in improvement in the margins as we go through quarter by quarter by quarter. I'd like to say a point in time in 2025, but it's really going to depend on the demand environment. But it's not that far in the future.

Matthew McKellar (VP of Paper and Forest Products)

Got it. Just one quick follow-up. I think at a recent conference, you mentioned about a change in your customer mix pre-COVID versus post-COVID and the different margin profiles you're now contending with. So can you provide more color about the changing in your customer mix pre-COVID versus post-COVID and any regional impacts that that mix has had as well?

Yeah. That's a good question, Mike. At that conference, what I was discussing was during COVID, on some of our large contractual-type customers that are in certain types of venue segments, their growth rate was so astounding. We had an obligation, if you will, to support their demand either as a percentage of their buy or some other metrics inside of our contracts. They grew at an outsized rate to some of the other segments and some of the smaller customers. As it absorbed basically all of our capacity, we had to leave certain customers and certain segments where we didn't have those contractual obligations because we just had no more room in our converting system. That's what I was trying to describe. These are not bad customers. They're all great customers. It's not ever the customer's fault.

They grew very fast, and we met their demand. But it cost us in margin because some of the customers that we didn't have room for were actually more profitable. They were regional and local-type customers. So the mix ended up shifting more toward very large, what we would call national accounts as a percentage of our total business. And what we're doing now is, in those large national accounts, improving the economics now that the contracts are open post-COVID. Some of them were two-year. Some of them were three-year contracts. And where we can, we're improving the economics. And that's what Tom has been describing. That was a large portion of the $110 million in the first quarter.

Where we're not able to work with our customer to improve the economics, and they may have a better alternative, we will lose that amount of volume, free up that capacity, and retarget the original segments and customers that we disappointed a few years ago. The good news is we've been suppliers to most of these people for very long periods of time. While it was painful, we're getting opportunities to go back into these customers that we served for so many years. A real external shock created demand profiles that were very abnormal. We did our best to meet all our obligations, ended up in a spot, especially with post-COVID inflation and demand declines and contractual limits, a spot economically we didn't like. What we're doing is getting back to the most profitable mix that we can have.

If you think about converting, Mike, it's basically hours of time you have on your converting machinery to add value to containerboard in the form of making a package. So maximizing the profitability per hour of converting time you have to offer to the market is always the challenge and the equation, the value creation algorithm that the box business uses. That just got skewed for us, not necessarily because we wanted it to, but because we did what we thought was the right thing to do for our customers during that period of time based on the commercial contracts we signed pre-COVID.

Got it. Thank you very much. Great clarity. Good luck in retirement, Mark.

Mark Sutton (Chairman and CEO)

Thanks.

Operator (participant)

Your final question for today comes from the line of Gabe Hajde from Wells Fargo. Please go ahead.

Matthew McKellar (VP of Paper and Forest Products)

Mark, I'll echo everyone's comments. I think we told you also last call, congratulations. Hope you get to enjoy the time.

Mark Sutton (Chairman and CEO)

Thanks, Gabe.

I'm going to try to come back to this maintenance and investment question. I looked at average maintenance outage expense pre-pandemic, and it averaged about $250 million. During the pandemic and over the past 4 years, including 2024, I think it's averaging about $380 million. So $130 million more maintenance expense that we're investing. And now we're talking about some additional costs running through the P&L. I don't know if you quantified it for us, but it seems like it's maybe at least $100 million in the second quarter. Correct me if I'm wrong. So maybe just help us with dimensionalizing some of these costs, where maintenance would go next year sort of in an ordinary environment, and what sort of return are you expecting on the capital or the extra costs that are flowing through the P&L?

Tim Nicholls (Senior VP and CFO)

Gabe, let me start just at a high level. So the $250 you talked about, you could probably put a 40% inflation number across that spend. Typically, maintenance is half materials and half labor. Some of the labor is in annual outages, and it's labor that we don't provide. It's specialty work. So we hire that labor during those two-week outages. And so that $250 automatically jumps up in the neighborhood of 40% more. Now, the numbers you quoted at $380-$400, that's more like 50% more. Some of that is additional targeted spending, and a lot of that's in the box business. It shows up as maintenance spending, not capital expense because box plant projects tend to be small enough in many cases where we don't need a new machine. We just upgrade an existing machine. That flows through the P&L as an expense.

A lot of the mill projects are so expensive and large, and OEM equipment is of a scale that it ends up flowing through our CapEx in that $1 billion of CapEx. So the way we think about it, and I'll ask Jay and Tom maybe to give you some particulars, we look at the cash investment in our business, whether it's a maintenance expense or whether it flows through capital, as the investment in protecting today's cash flows via reliability and generating tomorrow's cash flows in the box business via new capacity and capability and in the mill business by lowering our cost and changing grade structures and those types of things. But the 40%-ish inflation in that neighborhood is the part that I think a lot of people miss. And while inflation isn't going up as much, there's no deflation in any of that stuff.

There's some deflation, a few energy inputs, and all that. There's no deflation in what drives maintenance cost. It's just going up less fast than it was. So Jay and Tom, if you want to add a little bit of color for that.

Jay Royalty (Senior VP of Containerboard and Recycling)

No, I think the inflation comments are right on. It's a very extraordinary period that we're in versus the last decade or a couple of decades. And so certainly a step change in that regard. I think the other thing to keep in mind, Gabe, is we have been intentionally spending at lower levels for the last several quarters to match the lower demand environment. And as we see the early stages of recovery and making sure that we're ready to ramp with that as it comes, we're stepping up. So that's the other piece, I think, to keep in mind in terms of these comparisons. Tom, I don't know what you.

Tom Hamic (EVP and President of North American Packaging Solutions)

Sure. And I think Mark summed it up well. I would say the increase, if there is an increase in the box spending, that is focused on reliability. If there's any change in our focus, I would say that in the past, we were comfortable running overtime, so, say, two Saturdays a month in a box plant. But that lets you get the orders made, but it doesn't satisfy the reliability. So we've become very focused on on-time delivery and quality. And there is a significant amount of this maintenance spending that we're targeting toward that shift. And frankly, it supports our margin structure going forward.

Mark Sutton (Chairman and CEO)

Okay. Thank you. Thank you for that, Tom.

Tom Hamic (EVP and President of North American Packaging Solutions)

You guys did outperform if I go back to the bridge on a sequential basis. You talked about flattish pricing, and it was +57. So it's clearly showing up. We didn't see Build a Better IP in this presentation formally talked about. Is it incorrect to annualize that 110 number? Is there a reason why it's more pronounced here in the first quarter? Or just, again, any way to think about that? Because I mean, that in and of itself was, I think, a big part of Build a Better IP. And it's showing up in pretty big numbers now here.

Mark Sutton (Chairman and CEO)

Gabe, this is Mark. I think you broke up on the first part of your question, but I think we get the gist of it. On the 110, yeah, it's a fair assessment to say you can annualize that number. And a portion of that is definitely inside of the Build a Better IP. But I didn't hear the very first we didn't hear the very first part of your question when you were referencing the bridge, one of the bridges?

Tim Nicholls (Senior VP and CFO)

The sequential price bridge, you guys outperformed, I think, by $57 million. So it was just.

Mark Sutton (Chairman and CEO)

Yes.

Tim Nicholls (Senior VP and CFO)

Yes.

Mark Sutton (Chairman and CEO)

Yes. That's the part we didn't hear. Yes, that's correct. And that's the right way to think about it. Thanks, Gabe.

Operator (participant)

You have one last question. That question comes from the line of Phil Ng from Jefferies. Please go ahead.

Phil Ng (Managing Director)

Hey, guys. Well, I'm glad I got to get on this call because I wanted to thank you, Mark, for all the help over the years. Really appreciate it.

Mark Sutton (Chairman and CEO)

Thanks, Phil.

I guess first off, you're certainly seeing a lot of inflation, and you guys are putting real dollars here to be positioned to capitalize on a better demand environment. So my question is really, do you think you're getting paid for these investments? So is there another opportunity we should be mindful of in and out to this in the future? And as you implement these latest box price increases, are there levers here where you could potentially drive more than the $40 linerboard increase that went through in February, especially as you kind of move forward with this go-to-market strategy of yours?

Tom Hamic (EVP and President of North American Packaging Solutions)

Yeah. Yeah, Phil, this is Tom Hamic. I think we can comfortably separate the two. So the improvement you saw in Q1, as Mark said, is sustainable. The $40, I expect to be like it always is. I mean, if you think back to previous price increases, you should feel confident that it's going to flow through the same way. But I would see those a bit as separate. In terms of continuing the margin expansion, there's a lot that gives me confidence. Piece one is we're investing significantly in our commercial capability. And that's a shift. We've always focused on commercial, but not as much as we are going forward. And I think the other piece is where we really understand segments. And we are very close to those segments in the value proposition. We are very successful in terms of market growth and in terms of margin structure.

And so our job is to take that capability, and this is what we're doing in Build a Better, I mean, in go-to-market, is expanding that to other segments. So there's no know-how in the company. This is really the change process of driving that across the entire business.

Phil Ng (Managing Director)

Gotcha. Okay. That's helpful color. I guess my next question is just really on the operations front. I know during the COVID years, you had some operational headwinds that perhaps limited your ability to kind of grow with the market. You're obviously going through a stretch here with the go-to-market strategy. But when we kind of think going forward, are you set up properly now to kind of grow with the market on the operations front in terms of production? And then some of the investments you've made on the box side, give us an update there. Are you starting to see that take hold and be well-received in the marketplace? And as you kind of pivot to maybe a better mix in customers, give us a little perspective on is there a target percentage in terms of regional customers versus national in some medium to longer-term timeframe?

Tom Hamic (EVP and President of North American Packaging Solutions)

Sure. That's a great question. I'll take a couple of pieces of it. I think in terms of the investments, if you look at the first quarter, we still have a bit of a weight of new employees. And that's why we're very focused on retention. But new employees are not as productive as experienced employees. However, when we look at the productivity across our machines, even though we have a few extra people in place, it's not significant to the financials, but a few extra people, we are seeing productivity improvement for the first time in a long time. And so I feel like those investments are at a very good payback rate. And it's not insignificant. These are 2%-3% improvements in throughput.

I think the most positive shift we've made in terms of our capital process and our maintenance expense is we have spent a lot of time, put a lot of people in place to make sure that the local decisions are primary. What's happening in that market? Why? Tie that back to the national piece and make sure that we're reacting to the market. Because I talked to not all 120 plants are in the same position. You've got to be very targeted in where you spend the money, which is what we're doing. And then to your last question, I would expect that as a percentage of our business, the local business will grow over the next couple of years. It's improving faster right now than the national business.

We know that when you have the capability to match the local demand, it is much more profitable than the national. So I don't see some huge swing where we're abandoning national accounts. But I do see a rebalancing similar to what Mark talked about in the segment discussion.

Phil Ng (Managing Director)

Okay. Appreciate the color. Thank you.

Operator (participant)

Thank you.

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

Mark Sutton (Chairman and CEO)

Thank you, Greg. I'd like to wrap up today's call by sharing my conviction that International Paper is well-positioned for the future. Andy Silvernail steps into the CEO role next week on May 1st. I'm very confident that his leadership experience and proven track record, combined with the industry expertise of our senior leadership team, will amplify the company's success going forward. When I provided updates along the way about the CEO succession process, I said the board was looking for the right leader for the company's next chapter. I am confident that Andy is that leader. Andy and his team will look forward to sharing updates with you starting on next quarter's call. Thank you for your time today and for your continued interest in International Paper.

Operator (participant)

Once again, we'd like to thank you for participating in today's International Paper's first quarter 2024 earnings call. You may now disconnect.