INTERNATIONAL PAPER CO quarterly report, Q3 FY2009

International Paper Company — Q3 2009 Form 10-Q

Business context and reporting period

International Paper manufactures and distributes paper, packaging, pulp and related products through Industrial Packaging, Printing Papers, Consumer Packaging, Distribution and Forest Products segments. This unaudited quarterly report covers the three and nine months ended September 30, 2009, with comparisons to the corresponding 2008 periods. The company also reports its 50% interest in Ilim Holding S.A. on a one-quarter lag.

Key financial metrics

Metric	Q3 2009	Q3 2008	9M 2009	9M 2008
Net sales	$5.919 billion	$6.808 billion	$17.389 billion	$18.283 billion
Net earnings attributable to International Paper	$371 million	$149 million	$764 million	$509 million
Diluted EPS	$0.87	$0.35	$1.79	$1.20
Operating profit	$940 million	$536 million	$2.507 billion	$1.261 billion
Cash provided by operations	Not separately provided	Not separately provided	$3.570 billion	$1.956 billion
Capital expenditures	Not separately provided	Not separately provided	$367 million	$732 million

Reported net earnings margin was approximately 6.3% in Q3 2009 versus 2.2% in Q3 2008. Operating profit margin was approximately 15.9% versus 7.9%, although both 2009 periods benefited materially from alternative fuel mixture credits and other special items.

Q3 sales declined approximately 13% year over year, while nine-month sales declined approximately 5%.
Q3 earnings attributable to International Paper increased approximately 149% year over year; nine-month earnings increased approximately 50%.
Q3 industry segment operating profit increased to $940 million from $536 million. Including alternative fuel mixture credits, Industrial Packaging generated $410 million, Printing Papers $363 million and Consumer Packaging $144 million.
Alternative fuel mixture credits contributed approximately $525 million before tax in Q3 and $1.5 billion before tax for the first nine months. Approximately $1.3 billion had been received in cash and $251 million remained recorded as a receivable at September 30.
Cash and temporary investments were $1.652 billion at September 30, up from $1.144 billion at December 31, 2008.
Total debt was approximately $9.6 billion at September 30, consisting of $369 million of current maturities and $9.253 billion of long-term debt, compared with approximately $12.1 billion at year-end 2008.
Shareholders’ equity increased to $5.645 billion from $4.169 billion at December 31, 2008; total equity was $5.884 billion.
Quarterly cash dividend was $0.025 per share, compared with $0.25 per share in Q3 2008. Nine-month dividends paid were $133 million versus $325 million in 2008.

Material changes versus comparable periods

Management reported improved operating performance despite weak economic conditions, citing lower operating costs, raw-material and freight costs, and mill outage costs. These benefits were partly offset by lower prices, weaker volumes, unfavorable product mix and increased market-related downtime.
Market-related downtime was approximately 555,000 tons in Q3 2009, compared with 55,000 tons in Q3 2008; total downtime was approximately 715,000 tons versus 360,000 tons.
Industrial Packaging sales decreased 4% year over year, but operating profit rose to $410 million from $95 million, substantially reflecting $221 million of alternative fuel mixture credits.
Printing Papers sales decreased 18% year over year. Operating profit increased to $363 million from $103 million, including $226 million of alternative fuel mixture credits and the absence of the $107 million Inverurie mill impairment recorded in Q3 2008.
Consumer Packaging sales decreased 5%, while operating profit improved to $144 million from a $2 million loss, including $78 million of alternative fuel mixture credits.
Distribution sales decreased 20% and operating profit declined to $21 million from $35 million, primarily because of weak demand and selling-price deflation.
Forest Products operating profit fell to $2 million from $305 million because the prior-year period included significant mineral-rights and forestland sales.
Interest expense, net rose to $169 million from $144 million in Q3 2008, reflecting debt issued primarily for the 2008 acquisition of Weyerhaeuser’s Containerboard, Packaging and Recycling business.
Equity earnings from Ilim were approximately breakeven in Q3 2009 versus $5 million in Q3 2008; the nine-month contribution was a $56 million loss versus $54 million of earnings.

Liquidity, debt and cash flow

Operating cash flow of $3.570 billion included approximately $1.3 billion of alternative fuel mixture credit receipts and $205 million from the sale of European accounts receivable.
The company used $2.678 billion in financing activities during the first nine months, including $4.911 billion of debt reductions, partly offset by $2.490 billion of debt issuance.
During Q3, the company issued $1 billion of 7.5% senior notes due 2021 and used the proceeds to repay approximately $942 million of existing notes. It also repaid approximately $1.1 billion of CBPR-related debt during the quarter.
Committed liquidity facilities totaled approximately $2.5 billion, including a $1.5 billion bank credit agreement expiring in March 2011 and $1 billion of receivables-based financing scheduled to expire in January 2010.
Long-term credit ratings were BBB with negative outlook from Standard & Poor’s and Baa3 with negative outlook from Moody’s. Short-term ratings were A-3 and P-3, respectively.
Management expected existing cash, operating cash flow and committed facilities to fund 2009 capital expenditures, debt service, working capital and dividends. Full-year 2009 capital spending was expected to be approximately $600 million.

Guidance, outlook, risks and unusual items

Management expected Q4 2009 earnings to be significantly below Q3. Expected headwinds included seasonal demand declines in North America, lower box prices, higher maintenance costs, increased natural gas, wood and freight costs, and substantial shutdown-related charges.
Paper pricing was expected to remain stable, pulp prices to improve and box prices to decline. Demand in other global markets was expected to be stable to modestly higher.
On October 22, 2009, the company announced closures of its Franklin, Virginia paper mill and containerboard mills in Pineville, Louisiana and Albany, Oregon, plus the permanent shutdown of Valliant, Oklahoma’s No. 3 machine. The actions were expected to reduce annual capacity by 2.1 million tons and affect approximately 1,600 employees.
The company estimated approximately $1.1 billion of noncash asset write-offs and accelerated depreciation and approximately $60 million of cash severance charges, primarily in Q4 2009 and Q1 2010, plus additional closure costs.
Q3 restructuring and other charges totaled $151 million before tax, including $102 million for early debt extinguishment, $39 million for overhead-reduction severance, and costs related to the planned Etienne mill closure.
The alternative fuel mixture credit was scheduled to expire December 31, 2009. Claims are subject to review and possible adjustment by the Internal Revenue Service, creating a material tax-related risk to future cash flow and earnings.
The company had accrued minimum estimated costs for a CERCLA environmental remediation matter but stated that final costs could be significantly higher after the EPA selected a remediation alternative.
Other risks include weak demand and pricing, raw-material, energy and freight costs, credit-rating downgrades, pension funding, environmental and legal matters, manufacturing disruptions, tax-law changes and risks associated with the Ilim joint venture.
The company estimated that approximately $80 million of unrecognized tax benefits could be reduced over the next twelve months as settlements and statute expirations occur. It also reported $258 million of unrecognized tax benefits and $76 million of accrued interest and penalties at Q3 end.

Most important facts for investors to verify

How much of 2009 earnings and operating cash flow was attributable to alternative fuel mixture credits, whether additional claims were collectible, and the effect of the credit’s expiration.
The timing and ultimate size of the announced mill shutdown charges, capacity reductions, severance costs and related cash savings.
Debt maturities, refinancing needs and the January 2010 expiration of the $1 billion receivables-based financing.
Underlying operating margins excluding tax credits, restructuring charges, integration costs, impairments and other special items.
Demand, pricing and market-related downtime trends across Industrial Packaging, Printing Papers and Consumer Packaging.
Potential exposure from the CERCLA remediation matter, tax audits and settlements, pension obligations, litigation and the Ilim shareholder agreement.
Whether the negative outlook on the company’s investment-grade credit ratings changes borrowing costs or access to liquidity.