Business Context and Reporting Period
International Paper Company filed an unaudited Form 10-Q for the three months ended March 31, 2010. The company operates through Industrial Packaging, Printing Papers, Consumer Packaging, Distribution and Forest Products, and holds a 50% interest in Ilim Holding S.A., which is reported on a one-quarter lag.
Financial Performance and Position
| Metric | Q1 2010 | Q1 2009 |
|---|---|---|
| Net sales | $5.807 billion | $5.668 billion |
| Net earnings attributable to International Paper | $(162) million | $257 million |
| Diluted EPS | $(0.38) | $0.61 |
| Operating profit | $20 million | $779 million |
| Cash provided by operations | $159 million | $794 million |
| Free cash flow | $39 million | $521 million |
| Cash and temporary investments | $1.749 billion | $1.892 billion at December 31, 2009 |
| Long-term debt | $8.597 billion | $8.729 billion at December 31, 2009 |
| Current liabilities | $4.083 billion | $4.012 billion at December 31, 2009 |
Net sales increased approximately 2.5% year over year, but the company reported a loss before taxes and equity earnings of $175 million versus income of $518 million in the prior-year quarter. The approximate GAAP net margin was negative 2.8%, compared with 4.5% in Q1 2009. Operating profit margin was approximately 0.3%, compared with 13.7% in Q1 2009.
Capital spending was $120 million, and full-year 2010 capital spending was expected to be approximately $800 million. Financing activities included a net debt reduction of $82 million, including repayment of approximately $120 million of notes. Contractual debt maturities totaled $320 million in 2010, $565 million in 2011, $224 million in 2012, $134 million in 2013, $561 million in 2014, $446 million in 2015 and $6.7 billion thereafter.
Liquidity included $2.5 billion of committed bank credit agreements, comprising a $1.5 billion revolving facility expiring in November 2012 and up to $1.0 billion of receivables-securitization capacity. Management stated that cash balances, operating cash flow and existing facilities were expected to fund 2010 capital expenditures, debt service, working capital and dividends.
Material Changes Versus Prior Comparable Period
- Operating results declined sharply despite higher sales. Q1 2010 operating profit was $20 million versus $779 million in Q1 2009.
- The prior-year quarter benefited from approximately $540 million of alternative fuel mixture credits, including approximately $330 million after tax. The credit expired December 31, 2009.
- Q1 2010 included $215 million of pretax restructuring and other charges, or $132 million after tax. The largest item was $204 million for closure costs at the Franklin, Virginia, paper mill and associated operations, including $190 million of accelerated depreciation.
- Input costs increased approximately $144 million versus Q4 2009, driven by wood, recycled fiber and natural gas. Weather and fiber shortages also caused inefficient mill operations.
- Compared with Q1 2009, results benefited from higher volumes, lower lack-of-order downtime, lower operating costs and lower net interest expense, but were adversely affected by lower price realizations, higher raw-material and freight costs, higher mill outage costs and higher special items.
- Segment operating profit declined in Industrial Packaging to $41 million from $360 million, in Printing Papers to a loss of $78 million from $312 million, and in Consumer Packaging to $28 million from $112 million. Distribution improved to $21 million from a $7 million loss.
- Cash from operations fell by $635 million year over year, principally because the 2009 period included alternative fuel credit receipts and because working capital consumed cash in 2010.
- The quarterly dividend was $0.025 per share, versus $0.25 in Q1 2009. In April 2010, the company announced an increase to $0.125 per share effective with the dividend payable June 15, 2010.
Guidance, Outlook, Risks and Unusual Items
Management described Q1 as difficult but consistent with original expectations and stated that performance improved as March progressed. It expected Q2 earnings to increase significantly as price increases took effect, input costs trended lower and demand improved. Management expected Q2 input costs to average near Q1 levels but decline during the quarter.
- Q2 would include more than $20 million of additional mill maintenance outage expense, with approximately two-thirds of planned annual outages expected to be completed by quarter-end.
- North American and European paper demand was expected to remain stable, while demand in Brazil and Asia was expected to increase. North American packaging demand was expected to improve and European packaging demand to remain stable.
- Ilim was expected to return to profitability, although higher input costs were expected to offset part of the benefit from higher selling prices.
- The company signed an agreement to acquire SCA’s Asian packaging business for $200 million in cash, subject to adjustments and regulatory approval in China, with closing expected in Q2 2010.
- Material risks include volatility in raw-material, energy and transportation costs; cyclicality and pricing pressure; manufacturing disruptions and maintenance outages; debt refinancing and credit-rating downgrades; pension and postretirement obligations; environmental compliance and litigation; foreign exchange exposure; and risks related to joint ventures.
- The company had investment-grade ratings of BBB with a stable outlook from S&P and Baa3 with a negative outlook from Moody’s at quarter-end. Moody’s revised its outlook to stable on April 1, 2010.
- An environmental remediation matter could ultimately require costs significantly above the minimum amount accrued. The company also disclosed various legal, environmental, tax, labor and other proceedings, but stated that their combined outcome was not expected to have a material adverse effect.
- Unrecognized tax benefits declined to $192 million, with accrued interest and penalties of $86 million. Management estimated that approximately $30 million of unrecognized tax benefits could be reduced during the following 12 months.
Important Facts for Investors to Verify
- Whether announced price increases and lower fiber and energy costs offset maintenance outages and other input-cost pressures in Q2.
- The cash and earnings effects of the Franklin mill closure and other restructuring actions, including the large accelerated-depreciation charge.
- The sustainability of the stated Q2 earnings improvement and the timing and cost of the planned SCA Asian packaging acquisition.
- Debt maturities, refinancing capacity, credit-rating developments and availability under the $2.5 billion committed liquidity facilities.
- The sensitivity of free cash flow to working capital, maintenance spending, pension funding and dividend increases.
- Potential exposure from environmental remediation, tax settlements, litigation and the company’s variable-interest-entity arrangements.
- The comparability of Q1 2010 with Q1 2009, particularly the absence of the prior-year alternative fuel mixture credits.