International Paper Company 2014 Q3 Form 10-Q Summary
Business context and reporting period
International Paper reported for the quarter and nine months ended September 30, 2014. Its principal reportable businesses were Industrial Packaging, Printing Papers and Consumer Packaging, with a 50% equity interest in Ilim Holding S.A. Results were recast to present the xpedx distribution business as discontinued operations following its July 1, 2014 spinoff and merger with Unisource Worldwide to form Veritiv Corporation.
Key financial metrics
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Net sales | $6.051 billion | $5.975 billion | $17.674 billion | $17.635 billion |
| Earnings from continuing operations attributable to International Paper | $339 million | $387 million | $425 million | $909 million |
| Net earnings attributable to International Paper | $355 million | $382 million | $421 million | $959 million |
| Diluted EPS | $0.83 | $0.85 | $0.97 | $2.14 |
| Industry segment operating profit | $781 million | $665 million | $1.480 billion | $1.777 billion |
| Cash provided by operations | Not separately provided | Not separately provided | $1.933 billion | $1.991 billion |
| Free cash flow | Not separately provided | Not separately provided | $1.325 billion | $1.233 billion |
Q3 operating profit margin was approximately 12.9%, compared with 11.1% in the prior-year quarter. Net margin attributable to International Paper was approximately 5.9%, compared with 6.4%. For the first nine months, operating profit margin was approximately 8.4%, compared with 10.1%, while net margin was approximately 2.4%, compared with 5.4%.
- Q3 segment operating profit was $527 million for Industrial Packaging, $177 million for Printing Papers and $77 million for Consumer Packaging.
- Q3 continuing-operations earnings declined primarily because of an $81 million year-over-year reduction in Ilim equity earnings, higher tax expense and higher raw material and freight costs. These were partly offset by higher price realizations, lower maintenance outage costs and lower non-operating pension expense.
- Q3 diluted EPS included $0.04 per share from discontinued operations. Operating EPS, a non-GAAP measure, was $0.95 versus $1.01 in Q3 2013 and $0.93 in Q2 2014.
- Cash and temporary investments were $1.718 billion at September 30, 2014, versus $1.802 billion at December 31, 2013.
- Total debt was approximately $9.7 billion, consisting primarily of $8.988 billion of long-term debt and $724 million of current maturities and notes payable. The filing reports approximately $10.7 billion of fair value.
- Liquidity facilities totaled $2.0 billion, including a $1.5 billion committed bank facility expiring in August 2019 and up to $500 million of receivables-based financing. No borrowings were outstanding under these facilities at quarter-end.
- The company held investment-grade ratings of BBB stable from S&P and Baa2 stable from Moody’s.
- Capital spending was $961 million through nine months, and full-year 2014 capital spending was expected to be approximately $1.4 billion. Pension contributions were $353 million.
- Common-stock repurchases and restricted-stock tax withholding totaled $891 million through nine months; dividends paid totaled $451 million, or $1.05 per share.
Material changes versus the prior comparable period
- Sales increased modestly year over year, but nine-month earnings fell substantially because 2014 included significant Courtland mill shutdown costs, early debt extinguishment costs and other special items.
- Q3 2014 restructuring and other charges were $24 million before tax, compared with $59 million in Q3 2013. The nine-month 2014 total was $830 million, compared with $87 million in the prior-year period.
- The company issued $1.6 billion of senior unsecured notes at 3.65% due 2024 and 4.80% due 2044, using proceeds partly to repay approximately $957 million of higher-rate notes. Early debt retirement costs included $262 million of cash premiums in the second quarter.
- Free cash flow increased to $1.325 billion from $1.233 billion despite higher capital spending and substantially higher pension contributions.
- Industrial Packaging Q3 operating profit rose 6% year over year, Printing Papers rose 90%, and Consumer Packaging rose 5%; these comparisons include varying special items and should not be viewed as purely operational changes.
- The xpedx spinoff removed approximately $2.604 billion of nine-month 2014 sales from continuing operations, compared with $4.196 billion in the prior-year period, and generated a $385 million payment to International Paper during Q3. A further $25 million working-capital and net-debt adjustment was received in Q4.
- International Paper acquired the remaining 25% of Orsa IP for approximately $127 million, including $9 million paid from escrow during Q3. It owned 91.5% of Olmuksan at September 30 and was pursuing the remaining public shares.
Guidance, outlook, risks and unusual items
Management expected relatively stable fourth-quarter volumes overall, with lower North American Industrial Packaging volumes because of three fewer shipping days, seasonal weakness in certain paper markets and continued export pricing pressure. Input costs were expected to be broadly stable, although lower recovered fiber and energy costs could be offset by higher wood costs. Maintenance outage costs were expected to increase from Q3 levels.
- Management expected continued operational improvement at Ilim, but identified uncertainty from foreign-currency movements on Ilim’s U.S.-dollar-denominated debt. Ilim produced a Q3 after-tax foreign-exchange loss of $82 million, resulting in a $70 million equity loss for the quarter, despite a $56 million dividend received.
- Key operating exposures include cyclicality, product pricing, demand, raw material, energy and freight costs, foreign exchange, interest rates, global economic conditions and manufacturing disruptions.
- The company recorded approximately $95 million of probable environmental liabilities at September 30, including a $50 million reserve for the Cass Lake site. Potential additional costs at Cass Lake, the Kalamazoo River Superfund site and the San Jacinto River site could not be reasonably estimated.
- Trial activity was ongoing in the San Jacinto River matters, and additional claims were scheduled for 2015. The company stated that material loss was not probable for the Harris County penalty action but could not estimate a maximum loss.
- The company reached an agreement in principle in October 2014 to settle U.S. gypsum-board antitrust cases for an immaterial amount, subject to a definitive agreement and court approval. Canadian antitrust proceedings remained preliminary.
- The company settled a Brazil tax matter for $22 million, or $11 million after tax, under a tax amnesty program. Q3 also included a $20 million gain from resolution of an India legal contingency and a $32 million charge related to the Brazil tax amnesty in Printing Papers.
- Beginning January 1, 2019, participation and credited service under certain U.S. pension plans will be frozen. The related February 2014 remeasurement increased the projected benefit obligation by approximately $170 million, or $103 million after tax.
- Beginning January 1, 2017, the amended Ilim shareholder agreement permits specified deadlock procedures. In certain circumstances, International Paper may elect to purchase its partners’ 50% interest, but no purchase obligation exists and any transaction would require regulatory approval.
Important facts for investors to verify
- Reconcile reported GAAP EPS with management’s non-GAAP operating EPS and quantify the effect of Courtland, debt refinancing, pension, tax, legal and foreign-exchange items.
- Assess whether the Q3 improvement in segment operating profit is sustainable after normalizing for unusually low maintenance outage costs and special items.
- Monitor debt maturities, refinancing needs, interest expense and the effect of maintaining investment-grade credit ratings.
- Evaluate the cash-flow impact of pension contributions, capital spending, dividends, share repurchases and future restructuring payments.
- Track Ilim’s operating performance, currency exposure and any potential change in ownership or consolidation.
- Review environmental, antitrust, tax and other litigation developments, particularly the Kalamazoo River and San Jacinto River matters.
- Confirm the final economics of the Veritiv spinoff, including the subsequent $25 million working-capital and net-debt adjustment.