International Paper Company — 2012 First-Quarter Form 10-Q
Business context and reporting period
Unaudited results cover the three months ended March 31, 2012, compared with the three months ended March 31, 2011. International Paper operates Industrial Packaging, Printing Papers, Consumer Packaging and Distribution businesses and holds a 50% equity interest in Ilim Holding S.A. The Temple-Inland acquisition closed on February 13, 2012; its packaging operations are included from the acquisition date.
The Company retrospectively eliminated the one-quarter reporting lag for Ilim, increasing previously reported first-quarter 2011 equity earnings and net earnings attributable to International Paper by $12 million, or $0.03 per diluted share.
Key financial metrics
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Net sales | $6,655 million | $6,387 million | Up 4% |
| Operating profit | $462 million | $585 million | Down 21% |
| Operating margin | 6.9% | 9.2% | Down 2.3 percentage points |
| Earnings from continuing operations attributable to International Paper | $183 million | $305 million | Down 40% |
| Net earnings attributable to International Paper | $188 million | $354 million | Down 47% |
| Diluted EPS | $0.43 | $0.81 | Down $0.38 |
| Cash provided by continuing operations | $633 million | $514 million | Up 23% |
| Free cash flow | $357 million | $419 million | Down 15% |
Net earnings margin declined to approximately 2.8% from 5.5%. Diluted EPS from continuing operations was $0.42 versus $0.70. Management reported diluted EPS before special items of $0.57, compared with $0.77 in the prior-year quarter.
- Segment sales: Industrial Packaging $3,115 million; Printing Papers $1,560 million; Consumer Packaging $810 million; Distribution $1,475 million.
- Segment operating profit: Industrial Packaging $215 million; Printing Papers $146 million; Consumer Packaging $103 million; Distribution a $2 million loss.
- Cash and temporary investments were $1,288 million at March 31, 2012, versus $3,994 million at December 31, 2011, primarily reflecting the Temple-Inland acquisition.
- Total debt was approximately $11.6 billion, including $738 million of current maturities and $10.9 billion of long-term debt. The fair value of debt was approximately $13.2 billion.
- Credit facilities totaled $2.75 billion; no borrowings were outstanding under the bank facility or receivables securitization programs at quarter-end. Long-term ratings were BBB and Baa3, both with stable outlooks.
- Capital spending was $285 million in the quarter. Full-year 2012 capital spending was expected to be approximately $1.5 billion.
- The quarterly common dividend increased to $0.2625 per share from $0.1875 in the prior-year quarter.
Material changes versus the prior comparable period
- Sales increased primarily because of the Temple-Inland acquisition, but earnings declined because lower global pulp, paper and packaging price realizations more than offset higher volumes, lower raw-material and freight costs, and acquired earnings.
- Operating profit decreased by $123 million. Management identified lower price realizations as the largest negative factor, with additional pressure from product mix, operating costs and mill outages.
- Interest expense increased to $168 million from $136 million, reflecting acquisition-related debt.
- Corporate costs increased to $69 million from $44 million, principally because of higher pension costs. U.S. pension expense increased to $83 million from $45 million.
- Industrial Packaging operating profit declined despite acquisition benefits, reflecting $43 million of Temple-Inland integration costs and a $20 million inventory fair-value write-up.
- Printing Papers operating profit declined to $146 million from $201 million, primarily because of lower price realizations and weaker margins.
- Consumer Packaging operating profit increased slightly to $103 million from $100 million, despite lower sales, while Distribution declined to a $2 million loss from $5 million of profit.
- Operating cash flow from continuing operations increased, but free cash flow declined because capital spending rose by $104 million and acquisition-related and other adjustments affected the free-cash-flow calculation.
Guidance, outlook, risks and unusual items
Management expected seasonally stronger second-quarter demand, especially for North American packaging and Brazilian paper, with a full quarter of Temple-Inland earnings and additional synergy capture. Expected benefits included announced price increases for paper, containerboard, fluff pulp and market pulp. Offsetting factors included higher recycled-fiber, chemical and freight costs, scheduled maintenance outages and the expected absence of a favorable Ilim foreign-exchange impact recorded in the first quarter.
- Temple-Inland integration and realization of expected synergies remain key execution risks. The purchase-price allocation was preliminary and could change materially; it was expected to be finalized in the fourth quarter of 2012.
- The Department of Justice required divestiture of three containerboard mills with approximately 970,000 tons of capacity. The assets held for sale totaled $187 million, with a required divestiture deadline of June 11, 2012, subject to possible extensions.
- The acquired Temple-Inland Building Products business was classified as discontinued operations and held for sale. Related assets totaled $481 million and liabilities $52 million at March 31, 2012.
- Restructuring and other charges were $34 million before tax, including $19 million for xpedx restructuring and $16 million of early debt-extinguishment costs. Net gains on business sales and impairments were $7 million.
- Environmental remediation liabilities were approximately $96 million in the aggregate, including a $51 million reserve for the Cass Lake, Minnesota site. Several environmental, antitrust, tax and acquired-company litigation matters remained unresolved, and potential losses for certain matters could not be estimated.
- A Brazilian tax dispute had a potential loss of approximately $34 million. The Company also disclosed possible penalties and litigation related to the Temple-Inland Bogalusa environmental incident, with exposure not reasonably estimable.
- The Company estimated a possible reduction of approximately $45 million in unrecognized tax benefits during the next 12 months.
- An Ilim shareholder agreement could, under specified circumstances, require International Paper to purchase its partner’s 50% interest for an estimated $900 million to $950 million; management stated that neither party currently intended to initiate the process.
- Key ongoing risks include leverage and interest rates, cyclical pricing and demand, raw-material and energy costs, foreign exchange, pension funding, environmental compliance, litigation, manufacturing disruptions, credit ratings and the ability to complete required divestitures.
Facts investors should verify
- Progress, final purchase-price allocation, integration costs and realized synergies from the Temple-Inland acquisition.
- Completion and proceeds of the DOJ-required mill divestitures and the sale of the Building Products business.
- Debt reduction plans, refinancing needs, covenant capacity and the effect of higher interest rates on the $11.6 billion debt balance.
- Whether announced price increases offset higher maintenance, freight, recycled-fiber, chemical and energy costs.
- Developments in environmental, antitrust, Bogalusa, Brazilian tax and Temple-Inland-related litigation matters.
- Actual second-quarter demand, pricing, Ilim earnings and foreign-exchange results relative to management’s outlook.
- Progress toward the expected $1.5 billion full-year capital-spending plan and preservation of free cash flow and dividend capacity.