INTERNATIONAL PAPER CO quarterly report, Q3 FY2018

International Paper Company — Form 10-Q Summary

Business context and reporting period

International Paper manufactures and sells fiber-based packaging, pulp and paper products through Industrial Packaging, Global Cellulose Fibers and Printing Papers. This unaudited Form 10-Q covers the three and nine months ended September 30, 2018, compared primarily with the corresponding 2017 periods.

Financial performance and position

Metric	Q3 2018	Q3 2017	9M 2018	9M 2017
Net sales	$5.901 billion	$5.517 billion	$17.355 billion	$16.032 billion
Earnings from continuing operations	$562 million	$366 million	$1.354 billion	$642 million
Net earnings attributable to International Paper	$562 million	$395 million	$1.696 billion	$684 million
Diluted EPS	$1.37	$0.95	$4.08	$1.64
Cash provided by operations	Not separately provided	Not separately provided	$2.405 billion	$569 million
Free cash flow	Not separately provided	Not separately provided	$1.119 billion	$1.238 billion

Q3 net profit margin was approximately 9.5%, compared with approximately 7.2% in Q3 2017. Nine-month net profit margin was approximately 9.8%, compared with approximately 4.3% in the prior-year period. Management reported Q3 adjusted operating earnings of $641 million, or $1.56 per diluted share, compared with $420 million, or $1.01 per diluted share, in Q3 2017. These are non-GAAP measures that exclude special items, non-operating pension expense and discontinued operations.

Q3 business segment operating profit was $738 million, up from $674 million; nine-month segment operating profit was $1.947 billion, up from $1.245 billion.
Q3 segment operating profit was $472 million in Industrial Packaging, $83 million in Global Cellulose Fibers and $183 million in Printing Papers.
Cash and temporary investments were $1.026 billion at September 30, 2018, versus $1.018 billion at December 31, 2017.
Total debt was approximately $11.3 billion, including $10.7 billion of long-term debt and $555 million of current maturities and notes payable. Commercial paper borrowings were $400 million under a $1.0 billion program.
The company reported $2.1 billion of credit agreements, including a $1.5 billion committed bank facility; there were no borrowings under the bank facility or receivables securitization program.
Capital spending was $1.286 billion through nine months. Full-year 2018 capital spending was expected to be approximately $1.6 billion.
Dividends paid through nine months were $588 million, or $1.4250 per share. Share repurchases and restricted-stock tax withholding totaled $532 million.

Material changes versus comparable periods

Q3 sales increased 7% year over year, primarily from higher prices and favorable mix, with higher volumes also contributing. Nine-month sales increased 8%.
Q3 earnings from continuing operations increased 54% year over year, while diluted EPS increased from $0.88 to $1.37 on a continuing-operations basis.
Higher average selling prices and favorable mix contributed approximately $270 million to the Q3 year-over-year earnings comparison. Higher operating, raw-material, freight and maintenance costs partially offset the benefit.
Equity earnings increased to $92 million in Q3 from $45 million, including $74 million from Ilim and $19 million from Graphic Packaging International.
Operating cash flow increased substantially because the 2017 period included a $1.25 billion voluntary pension contribution and a $354 million litigation settlement payment. Free cash flow declined to $1.119 billion from $1.238 billion because of higher capital spending and the absence of those 2017 adjustments.
The North American Consumer Packaging business was transferred on January 1, 2018 in exchange for a 20.5% interest in Graphic Packaging International. The transaction produced a $385 million after-tax gain in the first quarter, partially reduced by a $21 million after-tax adjustment in the second quarter. Historical results of the transferred business are presented as discontinued operations.
The company adopted ASC 606 on January 1, 2018 using the modified retrospective method, increasing opening retained earnings by $73 million. The nine-month adoption effect increased reported net earnings by $6 million and created $383 million of short-term contract assets at September 30.

Guidance, outlook, risks and unusual items

Management stated that the company was positioned for strong fourth-quarter results, but did not provide formal consolidated revenue or earnings guidance. Expected drivers included further price realization, seasonally higher volumes, lower maintenance outages and stable or improving operations. Risks included higher wood, energy, chemical, recovered-fiber, freight and distribution costs; trade tensions affecting pulp shipments to China; softer European demand; and continuing Madrid mill start-up costs.

Hurricane Florence reduced Q3 results by approximately $36 million, including $28 million in Global Cellulose Fibers and $8 million from volume effects. A further approximately $14 million of fourth-quarter infrastructure repair and distribution costs was expected.
A $122 million pre-tax, $81 million after-tax impairment was recorded for Brazil Packaging assets following a change in the business outlook. The company announced that it was exploring strategic options for the business.
Q3 special items included the Brazil Packaging impairment, abandoned-property removal, Riverdale mill conversion costs and an environmental remediation reserve adjustment, totaling $142 million before tax and $96 million after tax.
The company recorded a $36 million favorable third-quarter tax adjustment related to the Tax Cuts and Jobs Act. Tax accounting remained provisional, with additional adjustments possible in the fourth quarter.
The company entered into a pension annuity transaction that closed October 2, 2018, transferring approximately $1.6 billion of projected benefit obligations. Management expected a non-cash pension settlement charge of approximately $425 million before tax in Q4 2018.
Environmental remediation liabilities totaled approximately $131 million at September 30. The Harris County matter could result in additional material losses, although the amount could not be estimated; the Kalamazoo River court allocated the company 15% of approximately $50 million of past costs, plus interest, subject to appeal.
The company is defending antitrust litigation involving containerboard pricing and other lawsuits, including the Signature matter involving an approximately $137 million judgment that is under appeal. Management stated that it expected any eventual loss in the Signature matter to be immaterial, but could not estimate a reasonably possible range.
Other significant risks include leverage and interest rates, cyclical product demand, raw-material and transportation costs, foreign exchange, pension funding, environmental compliance, litigation, facility disruptions, joint-venture risks and execution of acquisitions, divestitures and restructuring initiatives.

Important facts for investors to verify

Reconcile GAAP earnings and EPS with management’s adjusted operating earnings and special-item exclusions.
Assess the sustainability of price increases and whether higher input, freight, distribution and maintenance costs erode margins.
Monitor the strategic review and potential additional impairment or disposition of Brazil Packaging.
Quantify the after-tax impact and accounting treatment of the expected Q4 pension settlement charge.
Track completion of provisional Tax Cuts and Jobs Act accounting and any fourth-quarter tax adjustments.
Review debt maturities, commercial paper usage, credit ratings and available liquidity relative to the planned $1.6 billion capital program and shareholder returns.
Evaluate potential exposure from environmental proceedings, antitrust claims, the Signature appeal and other contingencies.
Consider the effect of the Graphic Packaging and Ilim investments, including equity earnings, dividends, currency movements and any potential Ilim deadlock-related purchase obligation.