Good morning, everyone. I'm Phil Ng, Jefferies Paper and Packaging analyst. We're excited to have the International Paper team with us today. Kicking things off, representing the company with me right here is Andy Silvernail, the CEO. Tim Nicholls, CFO, is in the audience as well as Mark and Michelle. Andy, I mean, exciting times, a lot to talk about. I guess just to kind of kick things off, I think we're all excited to hear how you unlock value. You gave us some framework how to think about the next few years, you know, bringing your business from, call it, 2 billion of EBITDA to perhaps 4 billion in the medium term.
What are some of the big buckets in terms of that unlock, and how do you get from A to B?
Yeah, so I think, thanks, Phil. First of all, it's good to be with everybody. I appreciate it very much. Before we get started, I think as everyone knows in the audience, we're involved with kind of the last stages of our acquisition of DS Smith, and just because of that, we're gonna have to be careful about a number of things that we talk about in terms of timing or things that can be interpreted as a forecast. We don't wanna find ourselves in trouble with the authorities and then extending the timeframe of the deal. So I just thought I'd say that upfront as we jump in.
So, Phil, you know, when I think about the unlock of value, you know, first and foremost, I ask myself, you know, "Is the potential there, you know, to do that?" So when you think about the ability to expand profitability in this business by a couple of billion dollars, that question of, is it actually there? Is it viable to go get? And for those of you who sat through the second quarter call or the 80/20 101 session that we did, I think it's self-evident that it is there, and we are the barrier to getting there. And what I mean by that is, if you look at the potential profitability, that we start with what we call material margin, so think of sales minus the cost, the input cost of a business.
You know, that's nearly $13 billion in our business, and over the last five years, our input costs, our material margin has actually grown by $1 billion, so it's increased by about $1 billion in the last four or five years. At the same time, our overhead costs, or I shouldn't say overhead costs, our operating costs, total operating costs, SG&A, and manufacturing overheads, have increased by $1.7 billion, and so obviously there's been inflation there. But I would argue it's really all of what is stuck, so to speak, in terms of profitability, is due to complexity. It's due to complexity of how we think about customers and products.
It's due to complexity with how we manage in a pretty heavily matrixed structure, and it is not aligned toward how value really flows to and from the customer. And so that's really where my focus is, how do you unlock that? And I kind of break down, you know, value creation into two pieces when I think about IP. The first piece is really around what I'll call a profit reset, which is, how do you get to a baseline level of profitability that's possible with the current portfolio that we have in the “medium term”? And I apologize, but I'm not gonna define medium term, back to my opening.
Sure.
And so when I look at that, and you look at, you know, roughly, you know, $19 billion of revenue on the current portfolio, that idea of getting to $4 billion of EBITDA, given those material margins and given the reality that we are in the way of it with the complexity, I think that's very possible. The second part is in the medium term to forever, which is, can you consistently grow value? Which we've been challenged with, right? We've been challenged with principally around two things. One is around organic growth, so actually, keeping pace with the market and eventually, actually growing above market in terms of revenue growth.
And then secondarily, that cost issue, which we talked a lot at our dinner last night about our lack of a continuous improvement culture. So for those of you who know me well, you know, I came out of business school 25 years ago, and really from then through my time through IDEX, I've spent the vast majority of my time in a Danaher-type culture, right? I joined Danaher out of business school, and the companies that I was part of had their lineage with leadership, including myself, from there. And so that really aggressive, continuous improvement culture around safety, quality, delivery, and cost is not something that's embedded in our culture, and it's something that needs to shift.
So as we think about those two tranches, getting to the profit reset, being significantly more profitable than we are today, and then ongoing, how do you drive, you know, value creation over time in terms of organic growth and in terms of a culture of productivity? Those are the two big buckets.
Okay, so lots to unpack, right? So on the cost side, there's a complexity element, which you talked about.
Right.
When do you think you're gonna be in a position to know what the game plan is to take costs and where you need to take costs out, and how do you kind of reduce complexity and unlock that cost piece, which could be pretty significant?
Yeah, we're pretty far down the path already, and part of the difficulty in articulating that as clearly as we want to, and you want us to, is the DS Smith deal, right? There are just simply some things we cannot talk about, and we can't. We just can't dig into at this stage because of the restrictions around that deal.
Okay.
And so, you know, our expectation is as we go into the fourth quarter, things will become more evident. So when we do our third quarter call, there will be some specific things that we'll talk about, and that we'll execute as we move into the fourth quarter. And then when we get the deal closed, we can be a lot more specific, and we expect that to be the end of this year, the first part of next year, given where we are in the regulatory process.
... And then, you reminded me, Andy, people that don't get the 80/20 part is there's a huge cost element, but you wouldn't be doing your job to create long-term value unless you reinvest it, right?
Yeah.
You made the point in your first earnings call, we have earned our performance because-
Yeah, we have.
invested, right? So I think there's a view that there's just a CapEx element, there's that, how are you gonna do that? But there's also obviously a P&L impact in terms of maintenance, reliability-
Sure.
- maybe from a capability on the sales force side of things. Just help us unpack where are some of the areas that you think, IP's underinvested, and, where you guys-
Yeah
... are planning to attack that going forward.
Sure. Well, I think, Phil, first what I'd say is, we have no intention of coming back to you, our investors, and asking you to fund it, right? We're not gonna say, "And therefore, we're going to lower our, you know, our expected profitability to fund these investments." My view of when you think about 80/20, what is it? It is around understanding where profit pools are long-term, where returns can be driven long-term, and moving people and investment towards those things very aggressively. One of my favorite sayings of all time is, "If nothing changes, nothing changes, and so fundamentally, you have to aggressively move resources, people and money, towards those things that you want to inflect, and we'll do that, and the idea behind it is we will fund that.
We'll both improve profitability and fund expense and capital through those changes. In my point of view, there are a number. I'm gonna put the big inflection points into three big buckets. Two are commercial, one is a-- Sorry, one is commercial, second is a hybrid, and the third is pure cost. And let me start with the cost side because ultimately, right, we have to reset our cost structure. You know, that growth of $1.7 billion in total operating costs, you know, over the last few years is unacceptable, and we have control over that.
And so our ability to understand where we are over-capacitated, where our matrix organization doesn't function for us, it doesn't drive value for us, and resetting that is step one, right? That's how you fund all of that, and that's how you start the journey toward a profit reset. The second one that is a hybrid is starting to think about investments around driving capability, both to drive productivity, but then driving capability long term. And I'll give you an example. So if you think about economic downtime, so economic downtime is a fancy word for, "We have too much cost." That's what it is. And the ability to eliminate that economic downtime and move that volume to assets that are far more capable has three benefits.
The first one I already talked about, which is to kind of taking out structural cost. The second one is actually with the assets that have the potential to be at full performance. The assets that we have run really well when you're kind of + 90% utilization, right? They run very well. That's what they're designed for. They're actually designed for that, whether it's a mill or a box plant, they're designed to run in those utilization ranges. Kinda like a guitar string, if it's too tight, it breaks, and if it's too loose, it goes dung, right? And so as you move volume and you find that tightness, those assets start to perform much better, right? Which drives reliability into the field, and that's why I say it's a hybrid.
It's just to drive reliability of supply into towards customers, and then the third piece is that culture of continuous improvement, so as you free up capital and you're able to really drive capital spending into continuous improvement, so what's very different about IP versus my time at IDEX is the nature of the capital cycle, right? We're dealing with half-decade capital cycles, generally, so from start to finish, where I was dealing with kind of two- and three-year capital cycles before, and why that's important is that that engine of productivity has to be fed consistently with investment. It absolutely has to be, specifically around maintenance investment and around overall productivity, and so that's those three parts, and that's kind of a hybrid piece that I was talking about.
The third one is really around commercial excellence, and I think around commercial excellence, I'll break that into an A and a B. The first one is getting coverage, right? So getting the right kind of coverage in the right geographies, which we're not covered appropriately. We have work to do. We need to expand our sales capability in terms of coverage and in terms of the type of coverage, meaning, as we segment different types of customers, they need and deserve different types of coverage. And that, the same thing on sales and on service capability. That's really important. The other one is really around pricing intelligence. So our industry is not very good at pricing, bottom line.
You know, for as big as we are and as important as pricing is in our industry, if you look at us compared to, say, other businesses that are similar, so I'll use the chemical industry as an example, and even to some degree, I don't wanna compare us to it, but just because they're so good at actually the intelligence of pricing, the airline industry, around the intelligence of pricing, we need to get much better at understanding that. And why is that so important? It's so important because in my old world, in a really highly engineered, highly differentiated product, when you were the market leader, you got 10%, 20%, 30% price premiums, you know, versus you know, the middle-tier players.
That's just not the way it works in this world. You're at a 3%-5% premium if you're high-performing and you're established. But that 3%-5% is a huge difference between being really profitable and having great returns and being okay... and we need to continue to invest in the tools and the intelligence to price to value in the marketplace.
Okay. On that note, on price, you pinned on price to value, maybe three to five points, and then we had a good conversation last time about pricing umbrellas. In the past, maybe the industry would, at times, get a little too greedy, and that would solicit more capacity. And then you talked a little bit about price to real costs rather than the mills. Can you kinda unpack all those elements from a pricing standpoint?
Yeah.
and how you're thinking about it, perhaps a little differently than the old IP?
Yeah, so as I, as I've studied this both in my diligence and since I joined the company the first of May, you know, one of the questions I had was: how much of the market volatility is driven by self-inflicted wounds, and how much of it is, where you can bring discipline to that? And I think part of the self-inflicted wounds is it. As things cycle in and out, how dramatically we respond, I'm not gonna speak about the rest of the industry, but how dramatically we tend to respond to things, drives a lot of behaviors internally, and I think drives a lot of market behaviors. What do I mean by that? When things are good and pricing is high, the industry tends to get pretty darn greedy.
And what do I mean by that? We get greedy, and we extend, and we ride price for as long as we possibly can, which really starts to invite what I'll call relatively undisciplined capital. And if you think of it from a perspective of you know where it's attractive to come in or not, my best estimate is in the mid-teens it's probably relatively unattractive for somebody who's a marginal producer to enter the marketplace. When you start talking about things that are you know in the twenties the risk just the risk that you have right?
The margin of safety that's out there tends to attract, you know, kind of crazy behaviors, even though you know that the downside of that, right, is one where the cash returns over time don't pay off, and so I think really being disciplined around that and not getting too excited when things are tough and not getting too excited when things are good, and really understanding it's the long term is what matters, and creating value over the long term, and bringing that discipline in the marketplace, even if that means you're making some tough choices, like, we're making some tough choices right now around price and volume because we have been undisciplined and because we have been pricing below reasonable returns, and so I think that's really important.
Now, to get that right and to drive really good returns over time, that balance between pricing to value, so pricing to market, not pricing to cost, and this, our industry, from what I can tell, is a cost-based pricing industry, right? That's how we think about it, and that, that's completely wrong from my perspective. You have to be able to compete, you know, kind of at that intersection of customers and competitors, and then you've got to drive the heck out of productivity. That's how you drive long-term returns.
Okay, and I think the perception out there in terms of thinking about the corrugated containerboard producers that have delivered higher returns and margins consistently, you know, we often point to higher vertical integration, a mix in smaller regional customers, which I think is important. But I think in your 80/20 presentation, you talked about how, you know, the profit pools you're looking to attack, and it's actually not necessarily that profile, but kind of-
Yeah
... help us think through which profit pools that you're looking at and why that's gonna unlock value.
Yeah, look, I think there's a bit of a... It's a fallacy, a bit of a fallacy, that the only place that money is made in this industry is in the small, local customers. I think that's a fallacy, and what do I mean by that? When you look at the national accounts or the larger customers, when you look at those businesses, if you behave in a way like we have, which is a very complex, relatively undisciplined cost structure, yes, it's very hard to compete and win and make sustainable returns, you know, when you're playing in the very large pieces of the market.
If you are disciplined, and you do have the right cost structure, it can be very attractive, and you can offer a superior solution to those customers. But that requires you to drive like heck to be the low-cost producer, not the low-price player. Just to be very clear, that's not what I mean, but to be the low-cost producer. And when you sub-segment the market between what I'll call, you know, national and local or regional accounts, they both have very attractive profit pools, but you have to approach them differently. How you go about doing business is different, and one of the mistakes that we have made is we have treated them, in many ways, the same in terms of the cost structure and in terms of the intensity of how we service them.
And when you do that, you basically are managing to the mean, and when you manage to the mean, you're kind of not good for anybody. And so that segmentation and organizing yourself around those customer segments, and that's really what 80/20 is all about, is gonna be a big key to: can we access those profit pools?
Super. I think probably a lot of investors in this room, if there's any, pushback that we've gotten on our bullishness on the IP call is, you know, How does DS Smith fit in the equation-
Yeah
... going forward? You know, IP has had a mixed track record being international. Why is it important it being international? And then you're obviously looking to lead a transformational change in culture and how you're running business in the U.S.. How does, you know, executing all that, is there any risk around integrating DS Smith and doing what you're trying to accomplish in the U.S.? So help us kind of think through that.
Yeah. Well, look, I would be disingenuous if I said there was no risk. Right, that would be, it'd be crazy to say. And ideally, right, if we could do this deal a year or two from now, that would be better, but we can't, right? That's not reality. And from the perspective, a strategic perspective and from a financial perspective, this is a very good deal, right? It is structurally, a very good business in that marketplace in Europe, and we become a clear leader in the European marketplace. But that's really an investment decision around the European theater. And the reason I say that is that there's very little overlap.
When we talk about cross-border deals, or we talk about international deals, the fact that they are in Europe is the only thing that's really of interest there. How the businesses operate, there's very little overlap, and there will be very little overlap between the businesses, besides a handful of places that will drive a bunch of cost benefits. So how we purchase chemicals, us being long paper, them being short paper, are examples. The overhead structure, the combined overhead structure that exists in Europe. Those things are things that are shared and we can go get from being together. The reality is, is that what this is, is really three different integrations, and we have to treat it that way, and I think by treating it that way, we can de-risk the transaction very substantially.
And by the way, I think the capital structure, and I think the price paid, de-risk the transaction substantially already. But the three different integrations, how we're thinking of that, is in the U.S., they have two small mills and eight box plants. It's pretty darn small. That really gets absorbed into our North American packaging footprint. And it's a relatively small integration. It does not worry me substantially. On the corporate side, we have. What we've said is, we're gonna make this very simple. We're gonna close the books, and we're gonna be compliant, and that's it. We are gonna close the books, and we are gonna be compliant. We are not gonna do systems integrations. We're not gonna do policies and procedures integrations. We're not gonna do all that administrivia and bureaucracy that tend to go with large deals.
There's really no point in that. It's not to say that there won't be benefits at some point in the future of, of finding those things, but they are nowhere near coming to the top of the list. The top of the list is what's happening in Europe. And what's happening in Europe is effectively DS Smith acquiring our European footprint, right? We are really strong in the Iberian Peninsula. We're very, very strong there. And they are strong throughout the rest of Europe. The way we can actually think about our box plant network, the way we can think about how we link our mills to our box plant network, the way we can leverage their strengths commercially. DS Smith is very good commercially, much better than we are.
And what we can do to help bring operating discipline in terms of manufacturing to them, I think of that. So completely different teams of people. Tim Nicholls, our CFO, is gonna lead the overall integration. We have a very strong finance team, and so that's gonna become the bulk of his time. That's gonna become his eighty, so to speak. And so making sure that we do no harm with the core of DS Smith, making sure we go get the $514 million plus of integration benefits, and that's kind of the start. And the fact that the price we paid in the capital structure puts it in a pretty good position to de-risk it.
Okay. You're going through. I mean, I think everyone in this room appreciates that you're trying to unlock long-term value, but call it the next few quarters. There's an adjustment period, whether it's-
Sure
... your go-to-market strategy from a pricing standpoint, or there's gonna be some volume leakage, and then you're stepping up costs, in terms of improving, the performance of business over the long term.
Yeah.
On the commercial front, can you remind us where you are kinda in that negotiation process for some of these below-market contracts?
Yeah.
And when you expect that is fleshed out, and you could see your volumes stabilize a little?
Yeah. So, the vast majority of things that we're going to negotiate have been negotiated.
Okay.
Now what it is is a matter of kind of when they flow through. Our expectation is, you know, kind of the bottom of that was last quarter and over the next two quarters, and we believe that by the end of next year we start to get to some kind of equilibrium, right? So it should get sequentially better as we get into the second quarter of next year. That's kinda how I would think about that first, second quarter of next year, and then hopefully by the end of next year, we're starting to get to some level of parity. That's really the goal. What gives me any level of confidence around that?
So if we kind of freeze the economic outlook, right? So I'm just saying, let's just kind of freeze that, 'cause I don't control that, and that's gonna go up and down. We know when expected volume is going to fall off from things that have been negotiated, and so we can look at that pipeline. I'm personally spending a lot of time looking at the pipeline, trying to understand how the pipeline flows, customers in, customers out, customers that we think are out, but actually are coming back to us, which we're seeing a little bit of that, which is good, and so that's what gives me confidence that we can get there.
That being said, and we talked about this, you know, last night, ultimately, right, for the investment thesis to work past the reset, we have to inflect from being a net share loser, right, to getting to parity, to winning, right? If I just kinda think about that over time, and that's what we're focused in on. That's why when you think about commercial excellence around having the right kind of coverage, having the right kind of service and support, having the right kind of pricing models, those sorts of things are gonna be really key as I think about multiple years forward.
I guess we have time for one last one. The investments you're making, just to make sure you have the right coverage, the sales force, when do you think you're gonna have that in place? I'm not asking you when-
Yeah
... you're gonna see results, but in terms of hiring the people, having the infrastructure, kind of walk us through the next few steps.
I think it's kinda twelve to eighteen months to have it structurally right, and why does it take that long? Look, you gotta hire people. You're hiring people who aren't necessarily in the industry. So there's a training cycle. There's a pipeline cycle, right? So if someone comes in, you know, if you think of their training, their onboarding, their development, that early stages, then you're building their pipeline to ultimately that turn into new volume. I think that's kind of an eighteen-month outlook.
Okay. Well, Andy, I think, that's all the time we have. Really appreciate all the great insights.
You bet.
Thanks so much.
Thanks, everybody.
All right.
Take care.