INTERNATIONAL PAPER CO quarterly report, Q3 FY2010

International Paper Company — Q3 2010 Form 10-Q Summary

Business context and reporting period

International Paper is a global producer and distributor of packaging, printing papers, consumer packaging, pulp and forest products. Reported segments include Industrial Packaging, Printing Papers, Consumer Packaging, Distribution, Forest Products and the 50%-owned Ilim joint venture. This unaudited filing covers the three and nine months ended September 30, 2010, compared primarily with the corresponding 2009 periods.

Key financial metrics

Metric	Q3 2010	Q3 2009	9M 2010	9M 2009
Net sales	$6.720 billion	$5.919 billion	$18.648 billion	$17.389 billion
Net earnings attributable to International Paper	$397 million	$371 million	$328 million	$764 million
Diluted EPS	$0.91	$0.87	$0.76	$1.79
Operating profit	$752 million	$940 million	$1.125 billion	$2.507 billion
Net earnings margin	5.9%	6.3%	1.8%	4.4%
Operating profit margin	11.2%	15.9%	6.0%	14.4%

Management reported third-quarter EPS before special items of $0.91, up from $0.37 in Q3 2009 and $0.42 in Q2 2010. The comparable GAAP diluted EPS was also $0.91 in Q3 2010 because the quarter had no material special items. The quarter included a $50 million after-tax-equivalent gain from land sales and a $16 million bad-debt recovery; excluding land-sale earnings, management cited EPS of $0.83.

Q3 results benefited from higher price realizations, increased volumes, improved mill and converting operations, lower downtime, restructuring benefits, lower interest expense and $22 million of Ilim equity earnings. These benefits were partly offset by higher raw-material and freight costs, operating costs, taxes and maintenance costs.

Cash flow, liquidity and capital structure

Cash provided by operations was $587 million in the first nine months of 2010, compared with $3.570 billion in the prior-year period.
Management-defined free cash flow was $1.148 billion, versus $1.908 billion in the first nine months of 2009. The 2010 calculation includes a $1.150 billion pension contribution and excludes $132 million of alternative-fuel-credit cash receipts.
Capital spending was $457 million through September 30, with full-year 2010 spending expected to be approximately $800 million.
Cash and temporary investments were $1.429 billion at September 30, down from $1.892 billion at December 31, 2009.
Total reported debt was approximately $8.740 billion, consisting of $312 million of current notes and maturities and $8.428 billion of long-term debt. Management reported approximately $8.7 billion of debt at fair value of $9.9 billion.
Debt was reduced by approximately $328 million net during the first nine months. Contractual debt maturities total $143 million in 2010, $296 million in 2011, $226 million in 2012, $136 million in 2013, $558 million in 2014, $784 million in 2015 and $6.597 billion thereafter.
Committed liquidity facilities totaled $2.5 billion, including a $1.5 billion bank facility expiring in November 2012 and up to $1.0 billion under a receivables securitization program extended to January 2011. Management stated that liquidity was adequate for expected 2010 needs.
Credit ratings were BBB with a stable outlook from S&P and Baa3 with a stable outlook from Moody’s.
The quarterly dividend was $0.125 per share, increased from $0.025 in 2009; nine-month dividends paid were $120 million.

Material changes versus comparable periods

Q3 sales increased 14% year over year, driven by price increases, volume growth and the SCA Packaging Asia acquisition. Nine-month sales increased 7%.
Q3 net earnings increased 7%, but nine-month earnings declined 58% because the 2009 period included substantial alternative fuel mixture credits and other favorable special items.
Q3 operating profit declined 20% year over year, primarily because Q3 2009 included approximately $497 million of special items, principally alternative fuel mixture credits. Excluding those items and other unusual charges, 2010 underlying segment performance improved materially.
Industrial Packaging Q3 operating profit was $332 million, Printing Papers $278 million, Consumer Packaging $71 million, Distribution $22 million and Forest Products $49 million.
The company completed the $206 million acquisition of SCA Packaging Asia on June 30, 2010, comprising 13 corrugated box plants and two specialty packaging facilities, primarily in China.
The company recorded $359 million of restructuring and other charges through nine months, including $315 million of Franklin, Virginia mill closure costs, $22 million of early debt-extinguishment costs and other items. Q3 restructuring charges were immaterial.
Q3 downtime fell to approximately 144,000 tons from approximately 715,000 tons in Q3 2009, which included substantial capacity-reduction downtime.

Guidance, outlook, risks and unusual items

Management expected fourth-quarter 2010 earnings and free cash flow to remain strong but seasonally lower. Paper and packaging volumes were expected to decline seasonally, prices to remain generally stable, recycled-fiber and certain chemical costs to rise, and maintenance outages to increase by approximately $30 million. xpedx distribution earnings were expected to decline seasonally, while Ilim's contribution was expected to approximate Q3 levels. Q4 earnings were expected to exclude the Q3 $50 million land-sale gain and $16 million bad-debt recovery.

Forest Products results included a $50 million gain from selling 163,000 acres for $199 million. Management stated that future land-sale earnings should be insignificant in any individual quarter.
The alternative fuel mixture credit expired December 31, 2009. Following an October 2010 IRS ruling, the company may elect a $1.01-per-gallon cellulosic biofuel credit for 2009 gallons, but may not claim both credits on the same gallons. The company may need to repay some or all of previously received $0.50-per-gallon credits and amend its 2009 tax return.
The company contributed $1.15 billion voluntarily to its pension plan during Q3. Pension obligations, funding requirements and future pension expense remain material risks.
Unrecognized tax benefits were $180 million at September 30, 2010, with accrued interest and penalties of $91 million. Management estimated that approximately $80 million could be reduced during the next 12 months through settlements or statute expirations.
An environmental CERCLA remediation matter could require costs significantly higher than amounts currently accrued because the EPA had not finalized the remedial action.
The Ilim shareholder agreement could, under specified deadlock circumstances, require the company to purchase the partners’ 50% interest for an estimated $425 million to $450 million. The parties stated they had no current intention to initiate the process.
Key disclosed risks include raw-material, energy and transportation costs; product pricing and demand; economic cyclicality; credit-rating downgrades; debt refinancing; pension funding; environmental compliance; litigation; manufacturing disruptions; foreign exchange; and joint-venture performance.

Important facts for investors to verify

Reconcile management’s non-GAAP EPS and free-cash-flow measures to GAAP results, particularly the treatment of pension contributions, land sales, bad-debt recoveries and alternative-fuel credits.
Assess recurring earnings power after removing 2009 alternative-fuel credits and 2010 land-sale and other unusual items.
Review the timing and funding sources for the $6.597 billion of debt maturities scheduled after 2015 and the company’s ability to preserve investment-grade ratings.
Monitor the potential IRS credit election, possible repayment exposure and related tax-return amendments.
Evaluate pension-plan funded status and the likelihood of additional discretionary contributions.
Review EPA remediation developments, other environmental matters and the company’s accrued liabilities.
Consider the potential financial and consolidation implications if the Ilim deadlock provisions are invoked.
Confirm the final purchase-price allocation and integration performance for SCA Packaging Asia, which was preliminary at the filing date.