INTERNATIONAL PAPER CO quarterly report, Q3 FY2011

International Paper Company — Form 10-Q Summary

Business Context and Reporting Period

This unaudited Form 10-Q covers the three and nine months ended September 30, 2011, filed November 7, 2011. International Paper operated through Industrial Packaging, Printing Papers, Consumer Packaging and Distribution, with a 50% equity investment in Ilim Holding S.A. Forest Products was no longer reported as a separate segment beginning in 2011.

Key Financial Metrics

Metric	Q3 2011	Q3 2010	9M 2011	9M 2010
Net sales	$6.632 billion	$6.720 billion	$19.667 billion	$18.648 billion
Net earnings attributable to International Paper	$518 million	$397 million	$1.084 billion	$328 million
Diluted EPS	$1.19	$0.91	$2.48	$0.76
Operating profit	$571 million	$752 million	$1.639 billion	$1.125 billion
Cash provided by operations	Not separately provided	Not separately provided	$2.038 billion	$587 million
Free cash flow	$561 million	Not provided	$1.399 billion	$1.148 billion

Calculated Q3 net margin was approximately 7.8%, compared with 5.9% in the prior-year quarter. Operating profit margin was approximately 8.6%, compared with 11.2% in Q3 2010. The Q3 earnings increase included a $116 million net special-item gain, primarily associated with the Shorewood transaction and related tax effects.

At September 30, 2011, cash and temporary investments were $2.722 billion, compared with $2.073 billion at December 31, 2010. Total current assets were $9.935 billion and current liabilities were $4.747 billion. Long-term debt was $7.801 billion, while notes payable and current maturities of long-term debt were $644 million. The filing states that approximately $8.4 billion of debt had a fair value of approximately $9.3 billion.

Committed credit agreements totaled $2.5 billion, including a $1.5 billion bank facility expiring in August 2016 and up to $1.0 billion of receivables-backed commercial paper financing. Long-term credit ratings were BBB with a stable outlook from S&P and Baa3 with a stable outlook from Moody’s.

Material Changes Versus Comparable Periods

Q3 sales decreased 1% year over year, while nine-month sales increased 5%.
Q3 attributable earnings increased 30% year over year, and nine-month earnings more than tripled, reflecting improved operating performance, lower interest expense, higher Ilim equity earnings and favorable tax effects.
Q3 operating profit declined 24% year over year, primarily because of higher raw-material and freight costs, lower volumes, higher outage costs and the absence of prior-year Forest Products land-sale earnings. Excluding special items, Q3 earnings per share was $0.92, compared with $0.91 in Q3 2010.
Q3 Ilim equity earnings increased to $51 million from $22 million in the prior-year quarter. Nine-month Ilim equity earnings were $152 million, compared with $24 million.
Cash provided by operations rose to $2.038 billion from $587 million, helped by higher earnings, lower working-capital use and the absence of the $1.15 billion pension contribution made in 2010.
Capital spending increased to $725 million from $457 million for the first nine months. Management expected full-year 2011 capital spending of approximately $1.2 billion to $1.3 billion.
Debt reduction was lower than in the prior-year period: financing activities included a net $112 million debt reduction in the first nine months of 2011 versus $328 million in 2010.
The quarterly dividend increased to $0.2625 per share in Q2 2011. Nine-month dividends paid were $312 million, versus $120 million in the prior-year period.

Outlook, Commentary, Risks and Unusual Items

Management expected Q4 2011 earnings to decrease meaningfully from Q3 levels because of normal seasonality, four fewer North American shipment days, heavier North American maintenance outages and a significant negative currency impact at Ilim. Prices were generally expected to remain stable, although global market pulp weakness and further export containerboard price erosion were anticipated. Input costs were expected to remain elevated, although recovered-fiber prices were expected to decline partially offset by higher wood costs.

Management expected full-year capital expenditures of approximately $1.2 billion to $1.3 billion and believed existing cash, operating cash flow and credit facilities would be sufficient to fund 2011 capital expenditures, debt service, working capital and dividends.

International Paper agreed to acquire Temple-Inland for $32.00 per share in cash and assumed debt of approximately $600 million, for an estimated total transaction value of $4.3 billion. Closing was expected in Q4 2011 or Q1 2012, subject to shareholder and regulatory approvals; committed financing had been secured.
After quarter-end, the company completed the acquisition of a 75% interest in Andhra Pradesh Paper Mills in India for approximately $388 million in cash, including a $57 million non-compete payment. A pending SEBI matter could require additional non-compete payments; approximately $23 million was held in escrow.
The company signed an agreement to sell Shorewood and expected the transaction to be substantially completed by year-end 2011 while retaining an approximately 40% minority interest outside the United States. Shorewood assets and liabilities classified as held for sale were $228 million and $48 million, respectively.
Q3 restructuring and other charges were $49 million before tax and $32 million after tax, including xpedx restructuring, APPM acquisition costs, Temple-Inland transaction costs and Shorewood sale costs.
Environmental remediation liabilities were estimated at approximately $95 million, with an additional $48 million recorded for other remediation matters. The Cass Lake, Minnesota site reserve was increased to $51 million; a more expensive cleanup alternative could result in material additional costs.
The company faced containerboard antitrust lawsuits seeking class certification, treble damages and costs. Management considered the allegations without merit, but stated that potential costs could not yet be reasonably estimated.
The company had significant tax uncertainty related to alternative-fuel and cellulosic bio-fuel credits. Unrecognized tax benefits and related interest and penalties totaled approximately $992 million at September 30, 2011, although management estimated approximately $50 million could be reduced within 12 months.
A downgrade of a bank supporting $1.6 billion of Timber Notes required replacement of the related letters of credit within 60 days. Management expected the replacement to be completed on time.
The Ilim shareholder agreement could, under specified circumstances, require International Paper to purchase the partners’ 50% interest for an estimated $800 million to $850 million. The parties stated they had no current intention to initiate the deadlock procedures.

Most Important Facts for Investors to Verify

Whether Temple-Inland received all required approvals, closed on schedule and generated the expected synergies without materially increasing leverage.
The final purchase-price allocation, financing and operating contribution of the APPM acquisition, including the pending Indian non-compete-payment appeal.
Q4 and full-year effects of maintenance outages, pulp and containerboard pricing, raw-material costs and Ilim currency exposure.
The sustainability of the reported cash generation after excluding working-capital benefits, tax-related items and the absence of 2010’s large pension contribution.
The final disposition of Shorewood, including proceeds, retained ownership and any further impairment or restructuring charges.
Potential cash requirements from environmental remediation, antitrust litigation, tax-credit disputes, derivative collateral requirements and debt maturities.
The company’s reported debt obligations and liquidity after the Temple-Inland acquisition, including approximately $5.1 billion of debt obligations offset for accounting purposes through financing entities but still remaining legal obligations.