INTERNATIONAL PAPER CO annual report, FY2016

International Paper Company — FY2016 Form 10-K Summary

Business context and reporting period

International Paper is a global producer of fiber-based packaging, pulp and paper products, operating in North America, Latin America, Europe, North Africa, Asia and Russia. The filing covers the fiscal year ended December 31, 2016, including fourth-quarter results. Reportable businesses were Industrial Packaging, Global Cellulose Fibers, Printing Papers and Consumer Packaging, plus the 50% equity-method investment in Ilim Holding S.A.

Following the December 2016 acquisition of Weyerhaeuser’s pulp business, Global Cellulose Fibers became a separate segment and prior-period segment information was reclassified accordingly.

Financial performance and key metrics

Metric	2016	2015	Change
Net sales	$21.079 billion	$22.365 billion	Down 6%
Net earnings attributable to International Paper	$904 million	$938 million	Down 4%
Diluted EPS	$2.18	$2.23	Down $0.05
Adjusted operating earnings	$1.392 billion	$1.534 billion	Down 9%
Adjusted operating EPS	$3.35	$3.65	Down $0.30
Cash provided by operations	$2.478 billion	$2.580 billion	Down $102 million
Free cash flow	$1.880 billion	$1.843 billion	Up $37 million
Capital spending	$1.348 billion	$1.487 billion	Down $139 million

Fourth-quarter diluted EPS was $0.53, compared with $0.43 in the fourth quarter of 2015 and $0.75 in the third quarter of 2016. Fourth-quarter adjusted operating EPS was $0.73, compared with $0.87 in the prior-year quarter and $0.91 in the preceding quarter. Fourth-quarter free cash flow was $467 million.

Segment operating profit: Industrial Packaging $1.651 billion, Global Cellulose Fibers loss of $180 million, Printing Papers $540 million and Consumer Packaging $191 million.
Equity earnings: Ilim contributed $199 million in 2016, compared with a $131 million loss in 2015, including a $25 million after-tax foreign-exchange gain in 2016.
Balance sheet: Cash and temporary investments were $1.033 billion; total assets were $33.345 billion; shareholders’ equity was $4.341 billion.
Debt: Total outstanding debt was approximately $11.3 billion, including $11.075 billion of long-term debt and $239 million of current maturities and notes payable. The total debt-to-capital ratio was 72% under the selected financial summary definition.
Liquidity: Available credit facilities totaled approximately $2.1 billion, with no borrowings under the committed bank facility or receivables securitization program at year-end. The company reported compliance with its debt covenants.
Shareholder returns: The quarterly dividend increased from $0.44 to $0.46 per share for the fourth quarter. The company paid $733 million of dividends and repurchased approximately $100 million of shares under its repurchase program during 2016.

Material changes versus the prior comparable period

Sales declined primarily because of lower price realizations and unfavorable mix, particularly in North American Industrial Packaging, partly offset by higher volumes.
Industrial Packaging operating profit fell $202 million as price and mix pressure, higher operating costs and special items outweighed volume and cost benefits.
Global Cellulose Fibers declined from $68 million of operating profit to a $180 million loss. Results reflected lower pulp pricing and mix, higher operating and maintenance costs, the Riegelwood conversion and acquisition-related charges.
Printing Papers operating profit improved $75 million to $540 million, supported by better pricing and mix, lower operating and outage costs, and lower input costs.
Consumer Packaging improved from a $25 million operating loss to $191 million of operating profit, primarily due to lower operating, outage and input costs and reduced special items. The segment’s sales declined following the exit from certain businesses, including the prior-year sale of the Asian coated paperboard joint venture.
Net special items declined substantially to $182 million before tax from $559 million in 2015. The 2016 items included $70 million related to the sale and restructuring of Asian corrugated packaging, $31 million of acquired pulp-business costs, $29 million of early debt extinguishment costs and $19 million of acquired-inventory fair-value amortization.
Non-operating pension expense rose to $610 million from $258 million, including a $439 million non-cash settlement charge related to a $1.2 billion lump-sum pension payout program.
Net debt increased as the company issued $3.8 billion of debt and retired $1.9 billion, primarily funding the Weyerhaeuser pulp acquisition.

Acquisitions, outlook and management commentary

On December 1, 2016, International Paper acquired Weyerhaeuser’s pulp business for approximately $2.2 billion in cash. The acquired business contributed $111 million of 2016 sales and a $21 million operating loss before taxes and equity earnings from the acquisition date.
In June 2016, the company acquired the Madrid, Spain newsprint mill and related assets for approximately $59 million. It plans to convert the mill to recycled containerboard production during the second half of 2017, with expected capacity of approximately 419,000 tons.
Management expects 2017 capital expenditures of approximately $1.5 billion and anticipates strong cash generation, continued cost reductions, debt reduction and shareholder returns.
For the first quarter of 2017, management expected higher volumes in several businesses and higher Industrial Packaging pricing, but also higher natural gas, wood and recycled-fiber costs, heavier maintenance outages and lower seasonal Ilim results.
Management expected approximately a 33% effective tax rate in 2017 and approximately $310 million of U.S. defined-benefit pension expense, versus $809 million in 2016.

Risks, contingencies and unusual items

On January 22, 2017, structural damage occurred at the Pensacola, Florida mill, including its largest pulp digester and power house. Partial operations resumed, but full containerboard production was not expected to resume during the first quarter. The company estimated total financial impact above $50 million, with significant insurance coverage expected; timing of costs and recoveries remained uncertain.
The company is exposed to cyclical demand, product-price volatility, competition, input-cost inflation, energy and transportation costs, foreign-exchange movements and economic or political conditions in Brazil, Russia, Europe and other markets.
Environmental remediation liabilities were estimated at approximately $134 million at year-end. Boiler MACT, climate-related regulation and other environmental requirements could require additional spending.
Pension obligations were underfunded by approximately $3.4 billion at year-end. Although no required U.S. qualified-plan contribution was expected in 2017, future voluntary or required contributions could be material.
Potentially material legal and regulatory matters include Kalamazoo River and other environmental proceedings, containerboard antitrust litigation, and a $110 million Brazilian tax assessment. The company stated that material losses were not considered probable for these matters, but several outcomes could not yet be estimated.
Approximately $11.3 billion of company debt and substantial nonrecourse financial liabilities remain important liquidity considerations. A credit-rating downgrade could increase borrowing costs, restrict market access or require collateral postings.
The filing identifies approximately $3.5 billion of 2017 contractual obligations, including debt maturities, leases and purchase obligations, and approximately $11.6 billion thereafter. Fiber supply agreements represent a significant portion of purchase commitments.

Important facts for investors to verify

Reconcile GAAP earnings and cash flow with management’s non-GAAP adjusted operating earnings and free cash flow measures.
Track integration, synergies and full-year earnings contribution from the Weyerhaeuser pulp acquisition.
Assess the operational and insurance impact of the Pensacola mill incident and the timing of the digester repair.
Monitor Industrial Packaging pricing, recycled-fiber, wood and energy costs, and the planned Madrid mill conversion.
Review debt maturities, covenant headroom, credit ratings and the company’s stated 2017 debt-reduction priorities.
Evaluate pension funding exposure, settlement-related charges and sensitivity to discount rates and asset returns.
Follow environmental, antitrust and tax proceedings whose ultimate outcomes or loss ranges were not determinable at filing.
Note that Deloitte & Touche issued unqualified opinions on the consolidated financial statements and internal control over financial reporting; controls over the recently acquired Holmen and Weyerhaeuser pulp operations were excluded from management’s year-end assessment.