International Paper Co (IP) 2016 Q1 法說會逐字稿

Good morning. My name is Brandy and I will be your conference operator today. At this time, I would like to welcome everyone to the International Paper first-quarter 2016 earnings call.

(Operator Instructions)

Thank you. I would now like to turn the call over to Mr. Jay Royalty, Vice President of Investor Relations, to begin.

Thanks, Brandy, and good morning, everyone, and thank you for joining International Paper's first quarter 2016 earnings conference call. Our key speakers this morning are Mark Sutton, Chairman and Chief Executive Officer, and Carol Roberts, Senior Vice President and Chief Financial Officer.

During this call, we'll make forward-looking statements that are subject to risks and uncertainties which are outlined on slide 2 of our presentation. We will also present certain non-US GAAP financial information. A reconciliation of those figures to US GAAP financial measures are available on our website. Our website also contains copies of the first quarter 2016 earnings press release and today's presentation slides.

Lastly, relative to the Ilim JV, slide 4 provides context around the joint venture's financial information and statistical measures. With that, I'll now turn the call over to Mark Sutton.

Thank you, Jay, and good morning, everyone. Thank you for joining our call.

I'm going to start on slide 5. International Paper delivered a solid first quarter, driven by continued strong performance in our North American Industrial Packaging business, along with improved results in our Global Papers business. Demand across our businesses was at or slightly better than expectations. Our operations performed well and input costs were favorable.

The Riegelwood conversion to fluff pulp was completed several days ago and we have commenced startup and qualifications. The Ilim JV had another strong quarter of results. And we announced a couple of important strategic moves, both of which will benefit IP's returns and are really all about making our best business, our Industrial Packaging business, even better.

We reached a definitive agreement to sell our Asia Industrial Packaging business, which is expected to close in the second quarter. We also reached an agreement to acquire a state-of-the-art newsprint mill in Spain from Holmen Paper, which we plan to convert to high performance recycled linerboard to strengthen our value proposition to our customers and enhance the results for our European Industrial Packaging business. We plan to use all of that containerboard inside of our converting system.

Turning to slide 6. Just like to give you a little more color on our financial performance. IP's revenue declined year-over-year. It's primarily due to the sale of the Sun joint venture in China, which took place in the fourth quarter of 2015. We also incurred costs of about $45 million, exclusive of outage expenses, associated with the Riegelwood conversion, and this was a significant drag to earnings in the quarter. Margins would have been about 100 basis points better, absent this impact. Our free cash flow of $311 million was on par with last year's first quarter.

At this point, what I'd like to do is turn it over to Carol and she'll walk us through the performance of our individual businesses and the second quarter outlook. Then I'll return to wrap it up and we'll open it up for your questions. Carol?

Thanks, Mark, and good morning, everyone. As Mark mentioned, IP delivered a solid first quarter at $0.80 EPS, with favorable operations and input costs offset by lower prices, seasonally lower volume, and heavy maintenance outages, including the Riegelwood conversion. The positive swing at Ilim is FX related, primarily due to the strengthening of the ruble as it relates to the JV's US dollar denominated net debt.

Turning to the businesses on slide 8. Industrial Packaging, as Mark said, had a strong quarter. We had favorable operations and lower input costs, but they were mostly offset by lower export and box pricing, seasonally lower box volume, as expected, and higher planned maintenance outage expense. Export volume did rebound from a weak fourth quarter.

The North American business took 212 tons of economic downtime to balance our supply with our demand and adjust our needs to match a more efficient supply chain. Input costs were positively impacted by lower cost of OCC and diesel fuel.

Turning to slide 9. IP's North American box demand came in generally as expected, with year-over-year volume up 1.3% for the first quarter, which was in line with the industry. The quarter finished strong in March and that momentum has continued through April.

As you can see in the table, which highlights several of IP's key customer segments, we see several encouraging trends. We continue to see strong growth in online retail, which has become more meaningful for overall demand. The large processed food segment is beginning to show some positive signs, as the major companies are making moves to adjust to changing consumer preferences.

The agricultural segment, to which IP is a major supplier, is enjoying the most favorable weather conditions the regions have seen in a few years, and this points to solid growth for 2016. And the outlook for the important protein segment is improving. So net-net, a fairly favorable outlook for the business.

Turning to Europe, as Mark mentioned, we recently announced a strategic move to acquire a unique asset that can be converted to very effectively complement our corrugated packaging network in the region. This transaction will create significant value from both a customer offering and a financial standpoint, as it will enable IP to produce high performance, light weight recycled containerboard in region. We will acquire the mill, along with associated recycling operations and Holmen's ownership position, in an on-site co-generation facility.

Upon closing of the deal, we will initiate plans for the conversion of the state-of-the-art newsprint machine to a first quartile test liner machine, which we expect to complete in late 2017. Once reconfigured, the machine will produce 420,000 short tons of recycled containerboard, which will enable IP to integrate a majority of our test liner needs. The total investment for the acquisition and conversion is expected to be approximately $160 million, with an expected IRR of more than 15%.

If you turn to slide 11, in addition to the attractive age and technology of the machine, as well as the mill's configuration, the location of the mill in relation to the majority of our box network is very attractive. The grades of high performance test liner that we intend to produce on this machine have the greatest application for our broad base of industrial customers, and most of these are served out of our box plants in Spain, France and Northern Italy, as shown on the highlighted area of the map. So once again, we're excited about the prospects of this move and what it can do for our customers and International Paper.

Turning to slide 12, let me talk about Consumer Packaging, where we saw a seasonally slower quarter combined with some price pressures, a less favorable mix, and heavier outage expense, resulted in lower earnings for the business in the first quarter. Most of the pricing pressure was felt in the commodity plate segment. The timing of volume and higher value mix in the food service business was slower to materialize than we had expected, as well. Additionally, the sale and exit of the Coated Bristols business negatively impacted results in the quarter.

Moving to slide 13 and talking about our Printing Paper segment. The slide shows the sequential bridge for the entire segment, which does include our Pulp business. As was mentioned earlier, the cost impact of the Riegelwood conversion, along with a sub optimized operation at Riegelwood as the conversion of PM18 was underway, significantly impacted segment results for the first quarter by approximately $45 million in total.

We will continue to see cost impact from the conversion in the second quarter, along with startup and qualification costs that will continue to impact results in the second quarter and the second half of 2016. This is consistent with the outlook we provided last quarter and is fully captured in the outlook that I'll share with you shortly.

Slide 14 shows the results of the Global Paper segment, excluding Pulp and the impact of the conversion. Volume was seasonally weaker, as we expected, largely in Brazil, while demand in North America was solid. Good operations and lower input costs contributed favorably to the results, as did lower planned maintenance outage expense.

Prices were lower in North America, but higher in Europe, Russia and Brazil, as we began to see the benefit of the implementation of previously announced price increases. And price increases are announced in North America and are being implemented in the second quarter.

Let me give a little more color on Riegelwood. As Mark said, we are pleased that the conversion has been completed on time and on budget in the month of April, and startup and qualification of the machine has commenced. Production of softwood market pulp is underway, and then we'll move to the qualification of fluff pulp. We expect to begin fluff trials in the third quarter.

The current pricing environment for softwood market pulp, which is used for paper towel and tissue products, is under pressure in the near term. As we ramp up and produce SBSK on the new machine through the rest of 2016, these current conditions will adversely affect earnings. This will improve as we qualify fluff pulp on the new machine and optimize production across our system.

Turning now to the Ilim JV. The JV had another very strong quarter, with operational EBITDA of $176 million, as strong manufacturing performance partially offset lower pulp prices and seasonally lower volume. Over the course of the first quarter, the ruble strengthened slightly against the dollar, which resulted in a favorable non-cash FX gain on the JV's $600 million of US denominated net debt, and that impacted our first quarter earnings favorably by $0.03 per share. Lower pulp prices and seasonally higher wood costs, along with planned maintenance outages at the Bratsk and [Korioshlin] mills, are expected to negatively impact second quarter results.

Before I turn it back over to Mark, let me give you the second quarter outlook. Earnings will increase, due to seasonally higher volume in North American box and Brazil papers. The additional box volume is expected to favorably impact North American Industrial Packaging earnings by roughly $40 million. The impact of seasonally stronger demand in Brazil is expected to positively impact earnings by $10 million.

Moving on to pricing in North America. The expected impact of lower pulp prices and a less favorable mix associated with the ramp-up of Riegelwood on softwood pulp in the second quarter is about a negative $20 million. This is net of the benefits of the previously announced price increases in uncoated free sheet in North America.

Pricing for North American Industrial Packaging will be impacted by lower export pricing, along with the flow-through of the January PPW index change that will move through to boxes. Combined, this is expected to negatively impact earnings in the range of $25 million to $30 million.

Prices are expected to improve in Brazil papers, as the previously announced price increases are implemented. This will favorably impact earnings by about $10 million.

Operational costs in North American Industrial Packaging are expected to improve as a result of seasonally stronger demand and utilization, along with other cost reduction and improvement initiatives. This will be a benefit of roughly $30 million. Operational costs across the other businesses are expected to remain favorable and input costs are expected to remain generally favorable, as well, although we do expect some slight pressure in Europe.

Maintenance outage expenses will continue to be heavy in the second quarter, but are expected to decrease by a total of $22 million, as shown on the slide, mainly due to the lower outage costs at Riegelwood. And relative to the Ilim JV, the items you see on the chart are expected to negatively impact IP equity earnings by approximately $10 million to $15 million.

And additionally, we are assuming stable FX coming out of the quarter. As you know, we don't attempt to forecast currency. So the outlook assumes a non-repeat of the $0.03 gain from the first quarter. So with that overview, let me turn it back over to Mark.

Thanks, Carol. So let me wrap things up before we take your questions. I feel really good about our execution and results from the first quarter, and I'm encouraged that demand feels more favorable across the primary markets that we serve.

Our focus remains on execution, and we saw benefit from our efforts in the first quarter in terms of good operational performance and lower cost. The conversion at Riegelwood went well, was on time and on budget, and our team is now ramping up and qualifying the new capabilities. All of this will enable International Paper to continue to generate strong free cash flow, which we will allocate to create additional value.

We've also made some key decisions that will improve IP's portfolio and make it stronger and further improve returns on invested capital, namely, our decisions in Asia and Madrid. And you'll see more of this as we move forward, where it makes sense for International Paper and our stakeholders.

We have winning strategies in the right markets and our focus is clear, as you're seeing in the moves we are making. We're focused on producing products where we have a distinct advantage, with good access to fiber and low cost manufacturing. We're concentrating our efforts on the markets and product lines that give IP the greatest potential to generate meaningful earnings and attractive returns.

So with that, I'll turn it back over to the operator and we'll be happy to take your questions.

(Operator Instructions)

Your first question comes from the line of Adam Josephson of KeyBanc Capital Markets.

Thanks. Good morning, everyone. Mark and Carol, two-part question for my first question. Do you still expect D&A expenses of $1.3 billion this year, just given that they fell a bit below what I was expecting this quarter? And relatedly, your EBITDA was down 14% in the first quarter. Do you still think you can be close to flat this year, or if not, what do you think reasonable expectations are along those lines for EBITDA? Thank you.

Adam, this is Carol and I'll take the first one, on the D&A. Yes, we do still expect to be in the range of $1.3 billion. What happens is there's some variability to it. When you have mills down for outages, you stop your depreciation for that period of time. So it's really just some lumpiness in it. But overall, $1.3 billion is still a good number for the year.

Adam, on EBITDA, your question about how we feel around the flat year-over-year. It's obviously got some stretch in it, with some of the pricing headwinds that have occurred. But at the same time, as I mentioned in my comments, we feel really good about our execution and our ability to make improvement in our businesses, both commercially and operationally. So I think we're very much still in the range of being able to accomplish that.

We've got a lot of the year left and we've got some real positive trends on our commercial front, and we're operating very, very well. So we are all about focused on hitting that EBITDA that we talked about.

Thanks, Mark. And just one on containerboard exports. Can you just comment -- forgive me if I missed this -- on what your export volumes were sequentially and year-over-year.

Obviously, the trade press has talked about export prices falling to cash costs for some of the higher cost mills in the US. I'm just hoping you can address this issue. And thanks very much.

Hello, Adam, it's Tim. Demand actually is holding up reasonably well. In the fourth quarter, I think we called out our volume was down. We called out some reasons around that that were situational and we thought temporary. And in the first quarter, we saw a rebound in export volumes.

We were still a little bit lower in total than we were in the first quarter last year. Part of that -- in fact, a big part of it -- is really Turkey and the dumping tariff that has been imposed and just simply how we're thinking about our participation in the market. It's still a very key market for us, but not every account there is equal. And so we made some decisions in terms of how we were going to position ourselves in the first quarter and going forward.

I'd say demand is good. Price gets written about a lot. It doesn't feel like our experience is quite as negative as all the things that is written about it. But there's no doubt there's some competitive situations out there and there is a little bit of price pressure. That will probably continue as we go through the second quarter.

Thanks very much, Tim. Appreciate it.

Sure.

Your next question comes from Dr. Mark Wilde of BMO Capital Markets.

Good morning.

Good morning.

Mark, I wondered if you guys, maybe you and Tim, could just help us a little bit as we think about these PPW adjustments back in February and how they roll through first quarter, second quarter and into the second half.

Mark, I'll let Tim take that.

Good morning, Mark. Carol spotted you a number. It was fairly minimal in the first quarter. We're dealing customer by customer and contract by contract and they don't all work exactly the same way.

And given the timing of the PPW adjustment in the first quarter, not very much of that flowed through in the quarter. It will ramp up in the second quarter, and Carol pointed out a combination of PPW and export being between $25 million and $30 million. The bulk of that, we think, is because of the price adjustment with the index.

And we'll talk to you about third and fourth quarter as we go through the year, as we continue to work through all of the customer contracts. But you'll see a fairly significant step-up first to second.

Okay. And Tim, as we think about trying to model out the third and fourth quarter, would it be fair to assume some additional bleed-through carrying into third and fourth quarter?

Possibly. It's hard to say, Mark. I'd rather us do the work and get through it and then talk to you about what we think it will be in the third quarter as we finish the second quarter, the same way we did going into this quarter.

Okay. All right. That's fair. And just staying on the containerboard and Industrial Packaging business, you've taken about 440,000 tons of economic downtime over the last six months.

I wondered if you can talk about how you're taking that. Are you slowing back? Are you actually idling machines for a week or two here or there? And is there a point where you need to consider a longer term move on the supply side?

Well, we'll see. I think the power of what we're doing, it just shows the power of the system and the flexibility that we've built. And some of the investments that we're making, it's all around building capability and flexibility in the system. We know that when you're stretching the system in terms of utilization rate, things don't always work out the way you want them to. And we've built a tremendous amount of flexibility in a very strong system.

So I can't say what it will be going forward. What I can say is we look over a multi-period, multiple periods, out months at a time, not just within a quarter, and we target where we think we need to be in terms of how we run the system, and then we adjust that almost day to day to day and week to week, based on a variety of factors.

One thing that happened in the fourth quarter, really late third, and continues to be a factor is just how efficiently the supply chain network is running right now. And so what it's meant for us at a moment in time is we just need less inventory, and so we've adjusted our production accordingly to match that.

We'll have to monitor that over time. Things don't stay the same. They have a tendency to move around. So we'll have to see how supply chain performs through the rest of the year.

Mark, if I could just add to Tim's comment. One of the things we've learned as our system has been optimized and it's gotten as large as it's gotten, is we clearly create more value in our containerboard and box system when there is a bit of flexibility in the system and we create less value when we try to run everything to its limits.

And I mean commercial value, in our ability to respond to customers, run an efficient box network, and also actual cost value in properly maintaining the equipment before the expensive failures occur. And so that few percent on maintenance and that few percent on economic flexibility, economic downtime, really ends up creating the best opportunity for us to generate the highest margin. So it's something that we don't look to solve to zero; because I think if it was zero, we would have a very difficult commercial proposition for our customers.

All right. That's really helpful, Mark. Good luck in the second quarter and through the balance of the year. I'll turn it over.

Thank you.

Your next question comes from Steve Chercover of D.A. Davidson.

Thank you and good morning, everyone.

Good morning, Steve.

First question. Hello, Carol. I wanted to ask about the announcement of a new fluff pulp mill in Arkansas at a cost of $1.3 billion. Will that seriously upset the supply/demand dynamic, and what does it say about the value of fluff pulp assets, perhaps?

Steve, we saw that. We have a little bit of knowledge about the background there. It's hard to predict what that facility's going to do and when.

I think fluff pulp is a highly technical product. You have to have a customer list and a track record. So it will be an open question about whether or not a mill that, in theory, can make the product actually ends up with a large book of business in that.

And there are different degrees of absorbent products that are loosely lumped into fluff. What we concentrate on is the higher end, high performance products that are medical device type of products.

So can't speculate on what that particular company's going to try to do. But obviously, there's a lot to being successful in fluff pulp over the long term, primarily because of the branded nature of the consumer product that it goes into. And we've been at it for a while and have a premium customer list that wants us to continue to provide them new material.

Did you want to take the bait on the value of fluff pulp assets in general?

I must not have, because I didn't. (Laughter) No, I think my comments on all fluff's not created equal and their types of products should characterize the value of fluff pulp is a highly valuable product, given the technical nature of it and the consumer branded equity that's behind those products that it goes into.

Great. Thank you, Mark. And then a quick one for Carol. We know that the average shares outstanding was 414 million. Was the ending share count significantly different? Did you maybe ramp up the repo as your confidence grew through the quarter?

I think we'll show that the repo in the quarter was $100 million. And I'm looking at my colleagues here on the final share count, but I think you can factor in the $100 million purchase and that's what we did in the quarter, Steve. So it's continuing to move down and our intent is to continue to be opportunistic with our buyback.

Thank you very much. I appreciate it.

Your next question comes from the line of Philip Ng of Jefferies.

Hello, guys. Post Riegelwood, I would imagine a very large chunk of your business is more on the food service side, which is holding up okay, I would imagine, especially on the cup side. But with the PBW cut on SBS, is it about 40% of your business that gets impacted? And then how should we think about the lag in terms of it flowing through your P&L?

Hello, Philip. This is Mike Amick. The number's going to be roughly 30% to 35% of our business could potentially be impacted by that in 2016. And we primarily see this being a second half phenomenon.

And how would you guys characterize supply/demand in the bleachboard market? Certainly, Riegelwood should help. But I guess one of your competitors did bring back an idled mill, and then you've got some of that potential capacity making its way into the US market from the European. How do you guys think about supply/demand medium to longer term? Thanks.

Philip, this is Mike again. I would characterize the demand as okay. I don't know that I'd use the term really strong. But through the quarter, we've seen improving backlogs and order backlogs by almost 50% as we moved through the quarter. So I think -- I know right now, sitting where are in the first part of April, we're about where we were this time last year.

Okay. And just one last one from me. Mark, you talked about how demand in the quarter for containerboard firmed up with ag picking up and e-commerce certainly seeing a lift, as well. Can you remind us how you're thinking about box shipments for the full year now, in light of some of the strength you've seen in 1Q?

I'll let Tim take that.

Last quarter, we said we thought it would be for the full year for total market, 1% to 1.5%. I don't think our view has changed that much.

I would say that we did see the quarter strengthen as we went through the first quarter, and March was very strong for us. April continues to be very strong for us. Right now, month to date, we're in the up 2% range.

Some of these segments that have been weighing against us over the past few quarters are starting to turn, hopefully, and we'll see if it holds up. But we feel pretty good right now.

I think Tim's point, Philip, about every organization has a mix, a customer mix, and we like what we've seen in some of the trends of the mix that's particularly heavy for International Paper. So that should lead us to tracking a lot more consistent with what the overall market's doing versus maybe our past experience. So we feel good about that.

And the mix dynamic with protein potentially picking up in the back half, with the beef cycle turning, that should be a positive for you guys, as well. Are we thinking about that right?

Yes, I think so. Protein hopefully has stabilized and we'll see how it plays out the rest of the year. Processed food, actually for us, the mix of customers that we have, trended pretty favorably during the first quarter and looks like it's holding up in the second quarter. I'm not going to go into specifics, but we saw individual names being up 2%, 3%, 4%-plus in the quarter and it got stronger as we went through the quarter.

So it's ag. California's getting rain, that's a good thing. So we're well positioned in that part of the market.

And then everybody talks e-commerce, but it's really distribution. We've got a mix of customers across the e-commerce space, as well as distribution, and it's showing pretty good strength across the board.

Okay. Thanks a lot. Appreciate the color.

Your next question comes from Mark Weintraub of Buckingham Research.

Thank you. One quick follow-up on the DD&A question from before. I saw that the Consumer Packaging business was down quite a bit. Was that all Riegelwood?

And I noticed that the pulp hadn't gone up. Does that go up once the conversion's taken place?

Yes, Mark. What we did is we moved that mill, Riegelwood, which was a shared mill between the two segments, both the Coated Paperboard segment and the Paper segment, and that's now moved all the way over into NAPP. So it's less coated paperboard, hence the change there.

And with the mill down most of the quarter for the conversion and their actual annual outage, that's what you saw. So that will now show up in the NAPP segment.

Okay. So the Consumer Packaging runs at this $25 million a quarter now in North America, instead of the $45 million it had been for DD&A?

Yes.

Okay. And then on uncoated free sheet, is it fair to say that you are not reflecting a lot of impact from the price increase which is just currently underway in the second quarter, and so success on that, if it comes through, would largely show up in the third quarter and maybe if you could modify a little bit?

Well, Mark, you're accurate in your statement. It will be -- we started to see a little bit -- we'll start to see a little bit in the second quarter, but it will primarily be a second half event. And yes, primarily split between the third and latter part of third quarter, maybe a little in the fourth.

Okay. Thank you.

Your next question comes from the line of George Staphos of Bank of America.

Hello, everyone. Good morning. Congratulations on the performance, especially in Industrial. Had a couple questions.

First of all, in Industrial, can you update us on your thoughts as to how you might be able to increase your vertical integration? Are you seeing opportunities for investment, either organically or through M&A, to be able to accelerate that, if that's still a goal?

And the related point on containerboard, do you have a need for any similar moves like you did with Holmen, and what are the implications of that investment relative to your supply chain in North America? And I had a quick follow-on, if possible.

Yes, on your first question, George, it's Tim here, on integration, I would say we like all of the channels that we're in. We operate in multiple channels. Obviously, the Integrated channel is the largest and it's very important to us.

It's going to come down to how we win accounts in the marketplace and align ourselves with customers within segments. So there's no stated specific goal that we have to reach a certain integration level.

Acquisitions, we don't comment on speculation but we look at a lot of things. And so we'll continue to do that and if one makes sense, then we'll be talking to everyone about what it is and why we think it makes sense.

In terms of Holmen, I don't expect a big impact from one region to another at all. But the related question around are there things like that, I think that's what you see us doing with some of these investments that we're making.

We've talked about increasing capacity and adding flexibility. It's not that all capacity is the same. What we're doing is we're adding capability around certain products that we think are growing through our segments and that we think we need, and we're building that capability. So it's similar to Holmen. It's just different. We've got 16 mills where we can look at the product mix that we need and make investments accordingly.

Okay, Tim. I'll turn it over, since I had my two, and I'll try to come back. Thank you.

Thanks, George.

Your next question comes from Lars Kjellberg of Credit Suisse.

Hello. Just a question actually on the Holmen transaction. When I'm looking at your Industrial Packaging business in Europe, the problems seem to be that you have very low margins in your box business. This doesn't necessarily fix that problem. So how do we -- are you thinking about addressing that business in itself, because just adding upstream integration doesn't necessarily fix what seems to be a low margin business.

Lars, hello. This is Mark. The way, building on Tim's comment about channels, the way we look at our European corrugated business, it's a very focused business. We look at it as one of our channels to market. We move very high quality, high performance craft liner through that system. If you look at the geography, we're southern focused around fresh foods.

And so our view of that business is as part of our integrated channel to market. And the integration of high performance recycled liner coupled with our US produced high performance craft liner makes that whole value proposition better.

It allows us to improve our customer mix and, as you know from the European theater, the recycled board that's available is geographically available. So you have to have what you need, where you need it, in a reliable way to build out your offering for your customers. And that's what this does to improve that business.

So what we focus on in our European corrugated business is very good for the Company. And when you take it back and look at the way we think about Industrial Packaging globally, it's a really good business for IP.

Just a follow-up on that. There's a tremendous amount of conversions that hits the market tail end 2017, early 2018. We're talking about almost 2 million tons. Is that a consideration at all for you as a non-integrated system today? Is this the right time to do it?

Well, that phenomenon, Lars, has been sort of a fixture in the European market. There's been a couple of million tons overhang.

The problem with that statement is it's on average. And again, recycled, high performance liner, it's not all created equal. There are three to four grade levels, including medium.

And so what has to happen is a converter like International Paper has to have what we need where we need it. So if it's in the north of Europe, it's theoretical. Even if it's an overhang, it doesn't really affect. So what you have to look at is regional capacity.

And we've been a large open market buyer for a long period of time and we will still buy some. That's how we look at it, regional board for the conversion that you need and the market segments that you're focused on, not the average of containerboard supply and demand for all of Europe, which is a very diverse market, especially for the recycled liner.

Very good. Thank you. I'll turn it over.

Your next question comes from Mark Connelly of CLSA.

Thanks. Just two quick things. Can you give us an update on the timing of the 250,000 tons of new containerboard capacity that you're adding here? We've talked about it as a gradual ramp. I'm just wondering if you can give us some sign posts and tell us when that would be up and running.

And second, it looks like you've cut your containerboard maintenance numbers. Is that a change in scope or just improved efficiency?

Hello, Mark. It's Tim. On the first question, the capacity, there's really no difference than what we said at the time we announced it. We said it was going to be a 2016 - 2017 set of actions. So I don't know if it's half, half. But you'll see some of it come through this year and you'll see a little bit more come through in the first half of next year.

And then on maintenance, maintenance varies mill by mill and period to period. So there's a plan. There's a schedule that goes out years. And you look at it, piece of equipment by piece of equipment and it just happens that you will hit periods when the things that need to be tended to in an annual outage costs more because of the nature of the work in a given period than in others.

And I would add to that, Mark -- this is Carol -- is while you do see the reduction from the last time we forecasted the second quarter down is we know as a Company that we've got headwinds, and so what we've been trying to do, of course, is you've got to find other levers to pull.

So we're, as Tim said, he's looking at his system very hard to make sure he's doing what he needs to do, and if there's an opportunity to trim some things up to get more money to the bottom line, that's what we're attempting to do. And we'll continue to disclose that each quarter so you can follow and track those changes.

That's really helpful.

Mark, this is Mark Sutton. Just the question, the first question you asked, just to tie it back to an earlier question around how we run our system, that incremental capacity capability that's coming from these investments, as Tim mentioned, is really about making some products differently than we've made before, making our system more flexible, meaning we can make similar products at the same mill or a different mill, so we can improve our supply chain.

So the issue of capacity coming online is only when and if we need it for the demand environment. It's really the driver is really making more of this and less of that for the boxes that we need to make going forward. And as an outcome of improving those facilities, we have more capacity if we need more capacity.

So that's the way to think about that, as opposed to this is coming on at this date and this is coming on at that date. It's coming on as a new product, a new basis weight, a new design. And net capacity comes on if we have the orders for it and doesn't come on if we don't have the orders for it.

Okay. That's helpful. Thank you.

Your next question comes from Scott Gaffner of Barclays.

This is actually John Dunigan filling in for Scott Gaffner. Good morning and congrats on a strong quarter.

Thank you.

Most of my questions, unfortunately, have been asked, but I did just have a couple. In particular, I wanted to ask about what you are seeing in the OCC prices and how the lower inputs have had an impact on your first quarter and then what you're expecting in terms of an outlook going forward for that and how it could affect IP?

I think our forecast is that we could see some modest pressure in OCC pricing as we go through the second quarter. We don't expect it, at this point, to be a major factor. And yes, in the first quarter inputs were a bit of a tailwind for us, which we're operating in a certain environment and trying to take advantage of the environment that we have.

Okay. And some of your peers had discussed some of the freight benefits that they've been enjoying, particularly getting some discounts and even building up on some inventory to meet some just in time demand. Could you just touch upon what IP's seeing in terms of those costs and how you guys are maybe taking advantage, particularly in your Industrial and Packaging sector?

Well, I think part of what you've seen, just in what we've seen in terms of our supply chain network is rail and truck availability has improved dramatically in the last part of last year, early this year, compared to where we were, say, a year ago. So that's obviously having an impact on the discussions you have with carriers about rate structures. It's still a very challenged environment, in some cases, in terms of those discussions, but we think we are having some measure of traction as we have those discussions.

The bigger impact in the moment is just what it means to how we think about our stocking positions across 200-plus facilities, and it's meaning at the moment that we need less inventory and we can run a much more efficient supply chain. So there's benefit in that. I think what we worry about is how it changes over time and will there be a snap back of utilization rates around carriers later this year.

And you generally think in the near term here that you can still enjoy the benefits, with possibly a snap back late this year or maybe early next year?

I don't know when it's going to happen or if it will happen. I just know that things don't stay static. People take actions. And so we don't count on anything lasting.

I think it goes back to the power of the system. We have tremendous flexibility, and we're trying to create more flexibility through these investments so that we can pull back when we need to and we can recover quickly when we need to.

Understood. Thank you very much.

Your next question comes from Debbie Jones of Deutsche Bank.

Hello. Good morning.

Good morning, Debbie.

I was wondering if you could talk about the change you made to your management incentive plan in early February. It looks like you switched it up based on 50% operating cash flows to 50% EBITDA, with ROIC being the remainder. Is there anything we should read into that about your cash operating expenses in the coming years?

Hello, Debbie. This is Mark. No, I think what we're attempting to do there is cash flow is still front and center. What we've got is that particular annual plan is focused on the majority of our employees who are running our operations, that's the level and type of job.

And we all talk in EBITDA in the Company. That's what our plans are based on. That's what people are measured on. And we've had a little bit of slippage in our EBITDA progress over the last couple years. So it's just an attempt to refocus.

In the overall scheme of things, obviously cash from ops starts with good, strong EBITDA and then you go to the cash flow, free cash flow. And our capital allocation strategy's clearly understood commitment to the dividend. So no message other than focusing the people who are actually on that plan to look at ways we can improve our EBITDA and break through the flat nature of it over the last couple of years. So that's one plan for one year for a certain group of employees.

Can I just ask, do you still expect no pension contribution in 2016 and 2017?

Debbie, what I would say is we have no required pension contributions for 2016 and 2017. How we go forward, we'll obviously navigate that as we move forward.

Okay. And my last question, I just wanted to ask, we talk a lot about the substitution potential from craft liner to recycled liner and whether or not there's room to go, given the sustainably low OCC prices. And you see this from both vantage points, having exposure to both markets. I was wondering if you could comment on this, and then also how this might impact your longer term capacity plans.

Hello, Debbie, it's Tim. We see in certain regions, in certain areas, there's either more or less competition from a certain type of product range. I think the way we think about it is we're looking with our customers at best fit and best use for the packaging they need, and it includes a variety of substrates, some virgin, some recycled, fit for use.

But it also includes capability, geography, service levels. And so we're selling them more than just is it recycled or is it virgin. We're selling them a total product. And we've got the breadth of products to do it like no other. So there's always going to be competition. It's a very competitive market, but we feel good about the value propositions we have.

And then the question about the capacity plans in the future, just thinking about the tonnage that you're adding in the coming years.

Yes, I don't want to speculate on what we will do or won't do. We've got low OCC input cost at the moment. It's a moment in time. We think there's probably a different trend over time and we'll make decisions.

It's like I talked about these capacity additions, we're not just adding generic tons. We're adding products and grades and basis weights for where we see growth in our channels and the types of products that we need to support that growth.

And then we run it accordingly, as we've said, to what our demand is. So we constantly look at what are those products, what do they need to be, where should we add them. And it will be an ongoing evaluation.

Okay. Thanks very much. Good luck in the quarter.

Your next question comes from Chris Manuel of Wells Fargo Securities.

Good morning and congratulations to a great start to the year.

Thanks, Chris.

Two topics I wanted to touch on. First, a little bit more around -- you're probably tired of talking about it -- but some of the dynamics here with North American containerboard, and the second topic being Ilim. With respect to the first topic, I hear how you've answered Debbie and Mark's and a few others' questions around things.

But if I look to downtime you took in 4Q and 1Q, one quarter doesn't make a trend, but it's now been two in a row that it's been solidly north of 200,000 tons. If we annualize that, that's larger than a machine, close to a mill, 900-ish thousand tons on an annual basis of downtime, market downtime.

You also referenced you had some inventories coming down. So maybe you could help us, give us a sense as to when I look at inventory -- or I'm sorry, industry inventories -- they haven't really moved much the last few months, but maybe yours has. Could you give us a sense, maybe either in tons or in weeks supply or however you think about it, your inventories have changed 3Q to 4Q to 1Q?

I would say we run a very tight supply chain year round and we make adjustments as we go. So no, I'm not going to break out tons or weeks of supply. I'm just going to say that we're constantly looking out four, five months in advance, targeting where we think we need based on our demand signal, and then we make adjustments as we run the system.

So the downtime that we took in the fourth quarter and first quarter, a very large component of that goes back to supply chain efficiencies and just not needing as much inventory through our chain. That could change over time. And maybe we're taking a little bit of risk on the downside in terms of how it might change and what we might do to be able to do to respond it. But we just like to run a very tight supply chain, and we'll continue to do so.

So if I read into that a little, it sounds like your inventory levels over the last couple quarters have come down a good chunk then and they're not flat.

No, they're not flat. And a lot of things go into targeting inventory levels. We run hundreds and hundreds, if not thousands of grades, 200 locations. And so we're looking product by product, basis weights, grades, locations and stocking levels across all of those, and then we're adjusting the system quarterly. And if it just takes less time to get product from mills to box plant because the velocity has increased, then we obviously don't need as much inventory in the system.

Okay. Thank you. And with respect to Ilim, I've read several places it looks like you're going to do a pretty sizable expansion there. Could you maybe give us a little color as to what's happening in timing and things of that nature, and as well as while that's going on, what we would probably expect out of -- would dividends stop for a while or how might that work?

So Chris, on the Ilim, I think, release that you're referencing, they put out a five-year plan and it was a capital plan to improve the business. A big portion of that is inclusive of their normal maintenance and regulatory CapEx. That's about $325 million annually. So the incremental that was in that announcement over that five-year period was about $700 million.

And it's planned only as the projects are developed and as they have the right returns to improve the current business that they have and to improve the quality of the product and, if necessary, to make more product at a second facility. And the plan for that would be to organize the funding the same way the prior development of Ilim was done, which is on the Ilim balance sheet, and we don't see any effect on the dividend changing or going down or anything like that.

So we think there's some good opportunities for improving Ilim. And it goes to that comment I made on my closing statement around making products that are needed in the market, mainly into consumer-oriented end uses, and making them in the right place in the world for your advantage, fiber, cost structure, and workforce. And this is a perfect example of that.

And Chris, I'll just add on. We actually are going to get a dividend payment, I'm looking at my colleagues who are on the Board, is the Ilim joint venture last week approved the dividend payment for 2016.

So we'll receive between $50 million, $55 million this year and another recommitment to the dividend flow out of the business, given that it's generating significant cash. And also if you look at their debt balance, their debt has actually come down, as well. So the financial condition of that business is great and we're counting on dividends out of that business as part of the value creation equation for International Paper.

Okay. Thank you very much. Good luck.

Thank you, Chris.

Your next question comes from Chip Dillon of Vertical Research.

Yes and good morning.

Good morning, Chip.

I just wanted to make sure I understood. You gave a lot of moving parts earlier in the call. And I know you said that the price impact of mainly pulp would be about, on the North American Paper business, would be somewhere around $20 million. But then I think you said that there's a benefit in Brazil of about $10 million. So I guess for that segment, looking at just pricing, the difference would be just $10 million, is that right, negative?

Yes, those are two discrete items that we called out. So that would be the right way to look at it, Chip.

Okay. And just so I understand, on the slides, it looks like the total benefit from less maintenance in the second quarter, I think adds up to $42 million, but then you called out some other $30 million swing from operations. Could you just clarify that, please?

Yes, Chip, I think what I called out was $22 million on total outage expense from first to second.

Okay.

So I'm not sure where the number that you said. What we did call out is Riegelwood was a big driver, but if you add it all up, if you go all the way across the line there and add it all up, it's a $22 million improvement first to second.

Got you.

The second part of your question -- I'm not sure I -- the second part of your question then still has application.

The operations, I think you said there were some $30 million benefit from just operations that you referred to.

Yes, and you know, the second quarter's always a better operations quarter than the first. It's not as cold. Just have a lot behind you. It's generally a good operational quarter, for lots of reasons. And we anticipate that to happen.

Okay. And then just as a follow-up, you mentioned, I think this is very apropos, given the opportunity in Madrid, and you say you have a lot of exposure in the fruit, vegetable area. My understanding is that most or all of the fruits and vegetables need to be packaged in virgin-based craft liner because of the condensation issue.

And has technology changed to allow certain types of recycled board to be introduced there? Is there any kind of a change that has taken place or is taking place? And then is that, in part, behind your move in Madrid?

No, the move in Madrid is really to complement what we do with craft liner. And your assessment is accurate. There's been lots of attempts to make products with mixed substrates in that field.

It really, really is driven by the supply chain. There are probably some short supply chains that can bear different products. But the humidity from the harvest all the way through the supply chain to the market is what drives the performance characteristics of fresh food packaging for needing craft liner or craft-like performance characteristics.

The industrial business, the high end industrial business that complements your mix and your plant -- because obviously, agriculture is seasonal and you want to run your plant and run a successful business over the year -- that's where the high performance, light weight recycled comes in. And it allows us to perform better in some of the best industrial segments versus using board that is not that high performance, that you've got to use more of it and things of that nature. You end up not being competitive in the industrial segments that you really want to be in.

That makes a lot of sense. Thanks very much.

Your final question comes from the line of Danny Moran of Macquarie.

Hello. Good morning. Thanks for taking my questions. I just want to clarify something on your heat map that you provided in your earnings presentation. Do you anticipate continued higher year-over-year export shipments in 2Q and for the year? And then do you also expect further price erosion to the export markets?

Hello, Danny. I'm assuming you're talking about container board. We feel pretty good about the demand signal that we've gotten from the markets. Margins take a hit. Demand seems to be holding up, which says to us there's a need for the type of product that we're supplying to the export markets.

And we've been a strategic supplier to those markets for decades. So we have long-term relationships that we stick with quarter to quarter, year in, year out.

We feel pretty good about our backlogs for the second quarter. The market's very competitive. I don't want to forecast price, but I'll just leave it that it's competitive and the types of erosion that we've seen probably continue into the quarter. So we'll manage it accordingly. But we still make decent money on export and we like it a lot, on average, through the cycle.

Okay. That's helpful. Thanks. And then one last one from me. With all the moving parts in your North American Industrial Packaging business, with economic downtime and some capacity creep, on a net basis do you expect to produce more or less boxes this year?

Well, I'm not going to forecast what we'll produce. We've said that over time our goal is that we position ourselves with the right segments and with the right customers and we would expect to perform in line with market, as our choices around customer mix grow over time.

And we've seen a little bit of both here over the past year. Last year, we were underperforming because of some of that exposure. And in the first quarter of this year, we were right on top of it. So to us, it's about customer choices and how we align ourselves in the right spots.

Got it. Okay. Thanks and good luck for the rest of the year.

Thank you. I will now turn the --

Thanks, everyone.

Thank you. I will now turn the call back over to Jay Royalty for any closing comments.

Sorry, Brandy. I jumped the gun a little. That's all the time we have today, folks. Thanks for joining. And as always, Michelle and I are available after the call. Have a great day.

Thank you. That does conclude today's conference call. You may now disconnect.