International Paper Company — Q2 2020 Form 10-Q Summary
Business context and reporting period
International Paper filed its unaudited Form 10-Q for the quarter and six months ended June 30, 2020. The company operates through Industrial Packaging, Global Cellulose Fibers and Printing Papers. Its facilities generally remained operational as forest products were treated as essential industries during the COVID-19 pandemic.
COVID-19 materially reduced demand for printing papers and created risks for pulp, containerboard and corrugated box demand if economic conditions deteriorated. Demand for corrugated packaging and fluff pulp was comparatively resilient during the quarter.
Financial performance and key metrics
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net sales | $4.866 billion | $5.667 billion | $10.218 billion | $11.310 billion |
| Net earnings attributable to International Paper | $266 million | $292 million | $125 million | $716 million |
| Diluted EPS | $0.67 | $0.73 | $0.32 | $1.78 |
| Cash provided by operations | Not separately provided | Not separately provided | $1.539 billion | $1.800 billion |
| Free cash flow | Not separately provided | Not separately provided | $1.001 billion | $1.172 billion |
- Q2 sales declined 14% year over year; six-month sales declined 10%.
- Q2 net earnings margin was approximately 5.5%, compared with 5.2% in Q2 2019. Six-month net earnings margin was approximately 1.2%, compared with 6.3% in the prior-year period.
- Adjusted operating earnings, a non-GAAP measure, were $305 million, or $0.77 per diluted share, compared with $460 million, or $1.15 per share, in Q2 2019 and $226 million, or $0.57 per share, in Q1 2020.
- Business segment operating profit was $428 million, down from $629 million in Q2 2019 and $512 million in Q1 2020.
- Industrial Packaging operating profit was $449 million, Global Cellulose Fibers reported a $10 million loss, and Printing Papers reported an $11 million loss.
- Equity earnings were $72 million in Q2, including $63 million from Ilim and $11 million from Graphic Packaging International Partners. Ilim earnings included a $34 million after-tax foreign-exchange gain.
Cash flow, balance sheet, debt and liquidity
- Cash and temporary investments increased to $847 million at June 30, 2020, from $511 million at December 31, 2019.
- Operating cash flow was $1.539 billion, while capital expenditures were $538 million, producing reported free cash flow of $1.001 billion.
- Financing activities used $817 million of cash, including $917 million of debt reductions, $403 million of dividends and $41 million of share repurchases and restricted-stock tax withholding, partly offset by $579 million of debt issuance.
- Long-term debt was $9.432 billion, and notes payable and current maturities were $33 million. The company reported approximately $9.5 billion of debt at fair value of approximately $11.2 billion.
- The company had no borrowings under its $1.0 billion commercial paper program, $750 million 364-day revolving facility, $1.5 billion five-year credit agreement or $550 million receivables securitization facility.
- Total available credit agreements were $2.8 billion, subject to facility terms and eligible receivables. The company was in compliance with its debt covenants, including minimum net worth and debt-to-capital requirements.
- Full-year 2020 capital spending was expected to be approximately $800 million, about $200 million below the initial plan. The share repurchase program was indefinitely suspended beginning in April 2020.
- Contractual debt maturities, excluding timber monetization structures, included $253 million in 2021, $227 million in 2022, $360 million in 2023, $806 million in 2024 and $7.8 billion thereafter.
Material changes versus prior comparable periods
- Printing Papers was the principal area of deterioration: Q2 sales fell to $583 million from $1.088 billion, and operating profit fell to a $11 million loss from $114 million of profit. Printing paper volumes declined 42% year over year.
- Industrial Packaging sales declined 6% and operating profit declined 13% year over year, although corrugated packaging demand was relatively resilient.
- Global Cellulose Fibers sales declined 8% and operating profit fell from break-even to a $10 million loss, primarily reflecting lower prices despite stronger volumes and lower maintenance costs.
- Six-month earnings declined sharply because of lower operating performance and significant special items, including a $353 million pre-tax charge related to the planned sale of the Brazilian Industrial Packaging business.
- The company recorded $26 million of debt extinguishment costs during the first half, including $18 million in Q2, and a $43 million pre-tax asbestos-liability reserve adjustment in Q2.
- The Brazilian Industrial Packaging business was classified as held for sale. Total assets held for sale were $112 million and liabilities held for sale were $368 million at June 30, 2020. Closing was expected in the second half of 2020, subject to conditions and regulatory approvals.
- The company sold part of its Graphic Packaging investment for $250 million in Q1 and recognized a $33 million pre-tax gain. Its ownership interest was 18.9% at June 30, 2020.
- Dividends paid increased to $403 million from $398 million in the prior-year six-month period, while share repurchases fell substantially from $460 million to $41 million.
Guidance, outlook, risks and unusual items
Management expected Q3 2020 Industrial Packaging volume to be broadly stable, but anticipated lower price and mix, higher maintenance and certain operating costs, and lower recovered-fiber costs. Global Cellulose Fibers price and mix were expected to improve, while volumes were expected to decline seasonally and maintenance and input costs to increase. Printing Papers volumes were expected to show initial recovery, but price and mix were expected to decline and maintenance costs to increase. Ilim equity earnings were expected to decline because the Q2 foreign-exchange gain was not expected to repeat.
- COVID-19 remained the most significant uncertainty. Management could not fully quantify its effect on 2020 results and warned of potential material adverse effects on demand, operations, supply chains, cash flows, asset values, pension assets and access to capital markets.
- Environmental remediation liabilities were approximately $189 million, including reserves for the Kalamazoo River and San Jacinto River Waste Pits sites. Additional losses could be material in certain matters, although management did not expect pending matters to have a material effect on consolidated liquidity.
- The company faced Brazilian tax assessments totaling approximately $110 million of tax and $350 million of interest, penalties and fees as of June 30, 2020. The company is appealing and believes its position is supportable.
- The company had significant variable-interest-entity obligations: approximately $4.2 billion of third-party loans were due in the fourth quarter of 2020 unless extended or refinanced. Management believed refinancing was likely and stated it could dispose of related installment notes if necessary.
- The company expected to meet capital expenditures, debt service, working capital and dividend requirements through cash balances, operating cash flow and existing credit facilities, but acknowledged that prolonged economic disruption could reduce liquidity and market access.
Investor verification checklist
- Verify the duration and severity of COVID-19 effects on printing paper demand and whether weakness spreads to packaging and pulp.
- Monitor completion and proceeds of the Brazilian Industrial Packaging divestiture and any additional impairment or foreign-exchange adjustments.
- Assess refinancing or extension of the approximately $4.2 billion of variable-interest-entity obligations due in late 2020.
- Compare actual Q3 pricing, volumes, maintenance costs and Ilim earnings with management’s stated expectations.
- Track debt reduction, covenant headroom, credit ratings and the adequacy of the $2.8 billion committed liquidity facilities.
- Review environmental, asbestos and Brazilian tax litigation for changes beyond recorded reserves.
- Distinguish GAAP earnings from adjusted operating earnings and evaluate the recurring nature of special items and the $34 million Ilim foreign-exchange gain.