International Paper Company — 2018 Form 10-K Summary
Business context and reporting period
International Paper is a global producer of fiber-based packaging, cellulose fibers and printing papers, operating in North America, Latin America, Europe, North Africa, India and Russia. Reportable segments are Industrial Packaging, Global Cellulose Fibers and Printing Papers; the company also holds a 50% equity interest in Ilim and a 20.5% interest in Graphic Packaging International Partners, LLC (GPIP).
The filing covers the fiscal year ended December 31, 2018. Fourth-quarter 2018 results are included below where relevant. The company employed approximately 53,000 people and operated 27 U.S. pulp, paper and packaging mills, 166 converting and packaging plants, and additional international facilities.
Financial performance and liquidity
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Net sales | $23.306 billion | $21.743 billion | +7.2% |
| Net earnings attributable to International Paper | $2.012 billion | $2.144 billion | -6.2% |
| Diluted EPS | $4.85 | $5.13 | -5.5% |
| Earnings from continuing operations attributable to shareholders | $1.667 billion | $2.110 billion | -21.0% |
| Adjusted operating earnings | $2.204 billion | $1.456 billion | +51.4% |
| Business segment operating profit | $2.877 billion | $2.069 billion | +39.0% |
| Cash provided by operations | $3.226 billion | $1.757 billion | +83.6% |
| Free cash flow | $1.654 billion | $1.970 billion | -16.0% |
| Capital expenditures | $1.572 billion | $1.391 billion | +13.0% |
Approximate calculated margins were 12.3% for business segment operating profit, 8.6% for net earnings attributable to shareholders and 7.2% for continuing-operations earnings. Free cash flow declined because higher operating cash generation was more than offset by higher capital spending; 2018 included no voluntary pension contribution, compared with $1.25 billion in 2017.
- Segment results: Industrial Packaging operating profit was $2.093 billion, up $546 million; Global Cellulose Fibers was $251 million, up $186 million; and Printing Papers was $533 million, up $76 million.
- Drivers: Higher pricing and mix contributed approximately $1.3 billion to operating profit, partially offset by higher operating costs, input costs and maintenance outage costs.
- Cash and liquidity: Cash and temporary investments were $589 million at year-end, compared with $1.018 billion in 2017. The company reported approximately $2.1 billion of credit facilities, with no borrowings under its principal bank facility or receivables securitization program.
- Debt: Corporate debt totaled approximately $10.7 billion, including $639 million of current maturities and $10.015 billion of long-term debt. Debt declined by approximately $500 million during 2018; the total debt-to-capital ratio was 59%, compared with 63% in 2017.
- Credit profile: Long-term ratings were BBB with a stable outlook from S&P and Baa2 with a stable outlook from Moody’s. The company was in compliance with its debt covenants.
- Shareholder returns: The company paid approximately $800 million in dividends and repurchased approximately $700 million of common stock. The quarterly dividend increased to $0.50 per share for the fourth quarter, and approximately $2.2 billion remained under the repurchase authorization at year-end.
Fourth-quarter 2018 performance
Fourth-quarter net sales were $5.951 billion, compared with $5.711 billion in the fourth quarter of 2017. Net earnings attributable to International Paper were $316 million, or $0.78 diluted EPS, compared with $1.460 billion, or $3.50 diluted EPS, in the prior-year quarter. Adjusted operating earnings were $670 million, or $1.65 per diluted share, compared with $530 million, or $1.27 per diluted share. Fourth-quarter operating results included $429 million of non-operating pension expense, primarily related to a pension settlement charge.
Material changes versus the prior comparable period
- On January 1, 2018, International Paper transferred its North American Consumer Packaging business to GPIP in exchange for a 20.5% ownership interest. The transaction generated a $488 million pretax gain, or $364 million after tax, and GPIP contributed $46 million of equity earnings in 2018.
- Equity earnings increased to $336 million from $177 million, including $290 million from Ilim and $46 million from GPIP. Cash dividends from equity investments totaled $153 million.
- 2017 net earnings benefited from a provisional $1.2 billion tax benefit related to the Tax Cuts and Jobs Act. In 2018, the company recorded a $445 million income tax provision and an additional $36 million Tax Act benefit.
- Special items declined to $214 million pretax from $496 million in 2017. Significant 2018 items included a $122 million Brazil Packaging impairment, $47 million of EMEA Packaging optimization charges, $32 million of abandoned-property removal costs, $10 million of debt extinguishment costs and a $31 million gain on the sale of an investment.
- The company completed an annuity transaction transferring approximately $1.6 billion of pension obligations covering approximately 23,000 retirees. This resulted in a $424 million pretax, non-cash pension settlement charge.
- Capital spending increased to $1.572 billion, including substantial Industrial Packaging investments and completion of the Madrid, Spain mill conversion to recycled containerboard.
- The company adopted ASC 606 using the modified retrospective method, increasing opening retained earnings by $73 million. Reported 2018 revenue was $32 million higher than it would have been without adoption.
Guidance, outlook, risks and unusual items
Management expected 2019 capital spending of approximately $1.4 billion, including approximately $400 million of strategic investments, and anticipated meaningful growth in cash generation. Management expected about $200 million of cash dividends from Ilim in 2019, continued healthy North American box demand, solid fluff-pulp demand and improving benefits from the Madrid mill. The company also intended to strengthen the balance sheet and return cash through dividends and share repurchases.
Near-term first-quarter 2019 expectations were cautious: seasonal volume declines, customer destocking, lower export demand, lower pulp pricing and mix pressure, higher seasonal energy and operating costs, and significantly higher maintenance outage expense. Management expected first-half 2019 to contain approximately 80% of planned 2019 maintenance outage expense.
- Key operating risks include cyclicality, product pricing and demand, competition, raw-material and energy costs, freight costs, labor availability and manufacturing disruptions.
- International exposure creates currency, political, economic, trade and regulatory risks, particularly in Russia, Brazil, Poland, India and Turkey.
- Pension obligations remained underfunded by approximately $1.8 billion on a projected-benefit-obligation basis. No required U.S. qualified-plan contribution was expected in 2019, but future voluntary or required contributions could be material.
- Potential contingent exposures include approximately $128 million of recorded environmental remediation liabilities, unresolved future costs at the Kalamazoo River and Harris County sites, and various legal and tax matters.
- A Brazilian tax dispute involves assessments of approximately $150 million of tax and $380 million of interest and penalties as of December 31, 2018; the company intends to appeal and believes its position is supportable.
- A Texas contract lawsuit had a judgment of approximately $137 million, which the company appealed. Management expected any eventual loss to be immaterial, but the outcome was unresolved.
- Downgrades of banks supporting letters of credit could create replacement costs or accelerate up to $538 million of deferred income taxes. The company also had substantial nonrecourse financing entities and related letter-of-credit requirements.
- Environmental and climate-change regulations were not materially affecting results at filing, but future compliance costs, permitting delays and higher energy or transportation costs could be material.
Management concluded that disclosure controls and internal control over financial reporting were effective as of December 31, 2018. Deloitte & Touche issued unqualified opinions on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- Reconcile GAAP earnings and EPS with adjusted operating earnings, particularly the effects of pension settlement charges, special items, discontinued operations and the 2017 Tax Act benefit.
- Assess the sustainability of the 2018 pricing and mix gains against expected destocking, export weakness, maintenance outages and higher operating costs.
- Review corporate debt maturities, credit facilities, covenant definitions and the approximately $10.7 billion debt burden, including variable-rate exposure.
- Monitor the Brazil Packaging strategic review, the $122 million impairment and any subsequent disposition or restructuring.
- Evaluate the performance and valuation of the Ilim and GPIP equity investments and the expected dividend contributions.
- Review pension funded status, actuarial assumptions and the expected decline in 2019 pension expense after the 2018 annuity transaction.
- Track environmental reserves, the Kalamazoo River and Harris County matters, the Brazilian tax dispute and other unresolved litigation.
- Confirm the effect of ASC 606 adoption and the expected balance-sheet impact of ASC 842 lease adoption, which management estimated would add approximately $500 million of assets and liabilities.