International Paper Company — 2017 Third-Quarter Form 10-Q
Business context and reporting period
International Paper is a global producer of industrial packaging, cellulose fibers, printing papers and consumer packaging. This unaudited Form 10-Q covers the three and nine months ended September 30, 2017. Results include the Weyerhaeuser pulp business acquired in December 2016, which is reported in the Global Cellulose Fibers segment.
Key financial metrics
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Net sales | $5,913 million | $5,266 million | $17,196 million | $15,698 million |
| Net earnings attributable to International Paper | $395 million | $312 million | $684 million | $686 million |
| Diluted EPS | $0.95 | $0.75 | $1.64 | $1.65 |
| Net margin | 6.7% | 5.9% | 4.0% | 4.4% |
| Cash provided by operations | Not separately provided | Not separately provided | $569 million | $1,566 million |
| Capital expenditures | Not separately provided | Not separately provided | $935 million | $903 million |
| Company-defined free cash flow | Not separately provided | Not separately provided | $1,238 million | $1,413 million |
Q3 business segment operating profit was $707 million versus $613 million in the prior-year quarter. Management reported adjusted operating earnings of $449 million, or $1.08 per diluted share, compared with $380 million, or $0.91 per share, in Q3 2016. These are non-GAAP measures and exclude special items and non-operating pension expense.
- Q3 sales increased approximately 12% year over year; nine-month sales increased approximately 10%.
- Q3 earnings attributable to shareholders increased approximately 27%, while nine-month earnings were broadly flat because of the $354 million pre-tax Kleen Products antitrust settlement recorded in 2017 and other items.
- Q3 reported effective tax rate was 30.5%; the adjusted rate excluding special-item and pension effects was 28.0%.
- Cash and temporary investments were $998 million at September 30, 2017, compared with $1,033 million at December 31, 2016.
- Debt totaled approximately $12.3 billion, consisting of current maturities and long-term debt; the balance sheet also included $6.3 billion of nonrecourse financial liabilities of special purpose entities. Commercial paper borrowings were $445 million at a 1.39% weighted-average interest rate.
- Credit facilities totaled $2.1 billion, including a $1.5 billion committed facility expiring in December 2021 and up to $600 million of receivables-based uncommitted financing.
- The quarterly common dividend was $0.4625 per share; nine-month dividends paid were $573 million.
Material changes versus comparable periods
- Industrial Packaging Q3 sales rose to $3,734 million from $3,491 million, and operating profit rose to $469 million from $423 million. Higher prices and lower outage costs more than offset higher recycled-fiber, freight and operating costs.
- Global Cellulose Fibers sales increased to $654 million from $242 million, primarily because of the Weyerhaeuser pulp acquisition. Operating profit improved to $49 million from a $38 million loss.
- Printing Papers sales were broadly stable at $1,039 million versus $1,019 million, but operating profit declined to $135 million from $167 million, reflecting weaker pricing and unfavorable mix despite lower outage costs.
- Consumer Packaging sales declined slightly to $491 million from $494 million, and operating profit declined to $54 million from $61 million.
- Operating cash flow declined by $997 million year over year, principally because of the $1.25 billion pension contribution, the Kleen settlement payment and unfavorable working-capital changes.
- Debt increased as the Company issued $1.0 billion of 4.35% senior unsecured notes due 2048 to help fund the $1.25 billion voluntary pension contribution. Approximately $382 million of 7.95% notes were repaid after quarter-end.
Guidance, outlook, risks and unusual items
Management expected strong fourth-quarter results and cash generation. Expected benefits included continued price realization in Industrial Packaging and Global Cellulose Fibers, lower recycled-containerboard costs, improved manufacturing performance after hurricane-related disruptions and stronger seasonal demand in several businesses. Offsets included one fewer shipping day, higher wood and chemical costs, scheduled maintenance outages and continued hurricane-related input-cost pressure.
- Hurricanes Harvey and Irma caused approximately $30 million of Q3 costs, including about $20 million in North American Industrial Packaging and approximately $5 million in Global Cellulose Fibers.
- The Company recorded a $354 million pre-tax, $219 million after-tax Kleen Products antitrust settlement charge during the first nine months. Other 2017 special items included acquisition and integration costs, a $9 million Foodservice Asia impairment, a $10 million Brazil intangible-asset charge and a $6 million bargain purchase gain.
- A group annuity transaction closed October 3, 2017, transferring approximately $1.3 billion of pension obligations to Prudential. Management expected a non-cash pension settlement charge of approximately $400 million before tax in Q4 2017.
- On October 23, 2017, International Paper agreed to contribute its North American Consumer Packaging business to Graphic Packaging in a transaction valued at $1.8 billion. International Paper is expected to receive a 20.5% interest valued at $1.14 billion and use $660 million of cash proceeds from new borrowing to repay debt. Closing was expected in early 2018 and remained subject to regulatory and other conditions.
- Environmental remediation liabilities were approximately $130 million. The Harris County Superfund matter could result in additional material losses, although the amount was not estimable at filing.
- The Company continued to defend the Ashley Furniture and Tennessee containerboard antitrust lawsuits and other litigation. A Texas contract case had a jury verdict of approximately $125 million, but the Company expected any eventual loss to be immaterial and planned to appeal.
- Key risks include leverage and interest rates, cyclical product demand and pricing, raw-material and energy costs, mill disruptions, environmental obligations, pension funding, litigation, joint-venture performance and execution or regulatory approval of the Graphic Packaging transaction.
Most important facts for investors to verify
- Whether the Graphic Packaging transaction closed on schedule, received required approvals and produced the expected debt reduction and strategic benefits.
- The actual Q4 2017 pension settlement charge and the continuing funded status of the pension plans.
- Underlying operating performance excluding the Kleen settlement, pension items, acquisition costs and other special items.
- Whether operating cash flow recovered after the large pension contribution, settlement payment and working-capital use.
- Progress on reducing debt, the cost and availability of liquidity facilities, and maintenance of investment-grade ratings.
- Exposure and potential additional costs from Harris County, Kalamazoo River and other environmental matters, as well as pending antitrust and contract litigation.
- Realization of Weyerhaeuser pulp acquisition synergies and sensitivity to recycled fiber, wood, energy, chemical and freight prices.