International Paper Company — Q3 2010 Form 10-Q Summary
Business context and reporting period
International Paper is a global producer and distributor of packaging, printing papers, consumer packaging, pulp and forest products. Reported segments include Industrial Packaging, Printing Papers, Consumer Packaging, Distribution, Forest Products and the 50%-owned Ilim joint venture. This unaudited filing covers the three and nine months ended September 30, 2010, compared primarily with the corresponding 2009 periods.
Key financial metrics
| Metric | Q3 2010 | Q3 2009 | 9M 2010 | 9M 2009 |
|---|---|---|---|---|
| Net sales | $6.720 billion | $5.919 billion | $18.648 billion | $17.389 billion |
| Net earnings attributable to International Paper | $397 million | $371 million | $328 million | $764 million |
| Diluted EPS | $0.91 | $0.87 | $0.76 | $1.79 |
| Operating profit | $752 million | $940 million | $1.125 billion | $2.507 billion |
| Net earnings margin | 5.9% | 6.3% | 1.8% | 4.4% |
| Operating profit margin | 11.2% | 15.9% | 6.0% | 14.4% |
Management reported third-quarter EPS before special items of $0.91, up from $0.37 in Q3 2009 and $0.42 in Q2 2010. The comparable GAAP diluted EPS was also $0.91 in Q3 2010 because the quarter had no material special items. The quarter included a $50 million after-tax-equivalent gain from land sales and a $16 million bad-debt recovery; excluding land-sale earnings, management cited EPS of $0.83.
Q3 results benefited from higher price realizations, increased volumes, improved mill and converting operations, lower downtime, restructuring benefits, lower interest expense and $22 million of Ilim equity earnings. These benefits were partly offset by higher raw-material and freight costs, operating costs, taxes and maintenance costs.
Cash flow, liquidity and capital structure
- Cash provided by operations was $587 million in the first nine months of 2010, compared with $3.570 billion in the prior-year period.
- Management-defined free cash flow was $1.148 billion, versus $1.908 billion in the first nine months of 2009. The 2010 calculation includes a $1.150 billion pension contribution and excludes $132 million of alternative-fuel-credit cash receipts.
- Capital spending was $457 million through September 30, with full-year 2010 spending expected to be approximately $800 million.
- Cash and temporary investments were $1.429 billion at September 30, down from $1.892 billion at December 31, 2009.
- Total reported debt was approximately $8.740 billion, consisting of $312 million of current notes and maturities and $8.428 billion of long-term debt. Management reported approximately $8.7 billion of debt at fair value of $9.9 billion.
- Debt was reduced by approximately $328 million net during the first nine months. Contractual debt maturities total $143 million in 2010, $296 million in 2011, $226 million in 2012, $136 million in 2013, $558 million in 2014, $784 million in 2015 and $6.597 billion thereafter.
- Committed liquidity facilities totaled $2.5 billion, including a $1.5 billion bank facility expiring in November 2012 and up to $1.0 billion under a receivables securitization program extended to January 2011. Management stated that liquidity was adequate for expected 2010 needs.
- Credit ratings were BBB with a stable outlook from S&P and Baa3 with a stable outlook from Moody’s.
- The quarterly dividend was $0.125 per share, increased from $0.025 in 2009; nine-month dividends paid were $120 million.
Material changes versus comparable periods
- Q3 sales increased 14% year over year, driven by price increases, volume growth and the SCA Packaging Asia acquisition. Nine-month sales increased 7%.
- Q3 net earnings increased 7%, but nine-month earnings declined 58% because the 2009 period included substantial alternative fuel mixture credits and other favorable special items.
- Q3 operating profit declined 20% year over year, primarily because Q3 2009 included approximately $497 million of special items, principally alternative fuel mixture credits. Excluding those items and other unusual charges, 2010 underlying segment performance improved materially.
- Industrial Packaging Q3 operating profit was $332 million, Printing Papers $278 million, Consumer Packaging $71 million, Distribution $22 million and Forest Products $49 million.
- The company completed the $206 million acquisition of SCA Packaging Asia on June 30, 2010, comprising 13 corrugated box plants and two specialty packaging facilities, primarily in China.
- The company recorded $359 million of restructuring and other charges through nine months, including $315 million of Franklin, Virginia mill closure costs, $22 million of early debt-extinguishment costs and other items. Q3 restructuring charges were immaterial.
- Q3 downtime fell to approximately 144,000 tons from approximately 715,000 tons in Q3 2009, which included substantial capacity-reduction downtime.
Guidance, outlook, risks and unusual items
Management expected fourth-quarter 2010 earnings and free cash flow to remain strong but seasonally lower. Paper and packaging volumes were expected to decline seasonally, prices to remain generally stable, recycled-fiber and certain chemical costs to rise, and maintenance outages to increase by approximately $30 million. xpedx distribution earnings were expected to decline seasonally, while Ilim's contribution was expected to approximate Q3 levels. Q4 earnings were expected to exclude the Q3 $50 million land-sale gain and $16 million bad-debt recovery.
- Forest Products results included a $50 million gain from selling 163,000 acres for $199 million. Management stated that future land-sale earnings should be insignificant in any individual quarter.
- The alternative fuel mixture credit expired December 31, 2009. Following an October 2010 IRS ruling, the company may elect a $1.01-per-gallon cellulosic biofuel credit for 2009 gallons, but may not claim both credits on the same gallons. The company may need to repay some or all of previously received $0.50-per-gallon credits and amend its 2009 tax return.
- The company contributed $1.15 billion voluntarily to its pension plan during Q3. Pension obligations, funding requirements and future pension expense remain material risks.
- Unrecognized tax benefits were $180 million at September 30, 2010, with accrued interest and penalties of $91 million. Management estimated that approximately $80 million could be reduced during the next 12 months through settlements or statute expirations.
- An environmental CERCLA remediation matter could require costs significantly higher than amounts currently accrued because the EPA had not finalized the remedial action.
- The Ilim shareholder agreement could, under specified deadlock circumstances, require the company to purchase the partners’ 50% interest for an estimated $425 million to $450 million. The parties stated they had no current intention to initiate the process.
- Key disclosed risks include raw-material, energy and transportation costs; product pricing and demand; economic cyclicality; credit-rating downgrades; debt refinancing; pension funding; environmental compliance; litigation; manufacturing disruptions; foreign exchange; and joint-venture performance.
Important facts for investors to verify
- Reconcile management’s non-GAAP EPS and free-cash-flow measures to GAAP results, particularly the treatment of pension contributions, land sales, bad-debt recoveries and alternative-fuel credits.
- Assess recurring earnings power after removing 2009 alternative-fuel credits and 2010 land-sale and other unusual items.
- Review the timing and funding sources for the $6.597 billion of debt maturities scheduled after 2015 and the company’s ability to preserve investment-grade ratings.
- Monitor the potential IRS credit election, possible repayment exposure and related tax-return amendments.
- Evaluate pension-plan funded status and the likelihood of additional discretionary contributions.
- Review EPA remediation developments, other environmental matters and the company’s accrued liabilities.
- Consider the potential financial and consolidation implications if the Ilim deadlock provisions are invoked.
- Confirm the final purchase-price allocation and integration performance for SCA Packaging Asia, which was preliminary at the filing date.