International Paper Company: FY2011 Form 10-K Summary
Business context and reporting period
International Paper is a global paper, packaging and merchant distribution company operating across North America, Europe, Latin America, Russia, Asia and North Africa. Reportable segments were Industrial Packaging, Printing Papers, Consumer Packaging, Distribution and the 50% Ilim Holding joint venture. Forest Products ceased to be a separate reportable segment beginning January 1, 2011.
The filing covers the fiscal year ended December 31, 2011, including fourth-quarter results. The Form 10-K was filed February 27, 2012. Temple-Inland was acquired on February 13, 2012 and therefore was not included in 2011 reported operating results.
Key financial metrics
| Metric | 2011 | 2010 | Change |
|---|---|---|---|
| Net sales | $26.034 billion | $25.179 billion | Up 3% |
| Net earnings attributable to International Paper | $1.341 billion | $644 million | Up $697 million |
| Diluted EPS | $3.07 | $1.48 | Up $1.59 |
| Continuing-operations diluted EPS | $2.96 | $1.48 | Up $1.48 |
| Cash flow from operations | $2.675 billion | $1.631 billion | Up $1.044 billion |
| Free cash flow | $1.727 billion | $1.749 billion | Essentially stable |
| Capital expenditures | $1.159 billion | $775 million | Up $384 million |
| Interest expense, net | $541 million | $608 million | Down $67 million |
| Cash and temporary investments | $3.994 billion | $2.073 billion | Up $1.921 billion |
| Total debt, including current maturities | $9.908 billion | $8.671 billion | Up $1.237 billion |
| Shareholders’ equity | $6.620 billion | $6.834 billion | Down $214 million |
Reported gross margin was $7.074 billion, or approximately 27.2% of sales, compared with $6.697 billion, or approximately 26.6%, in 2010. The company reported a 200-basis-point North American margin expansion according to management. The effective tax rate was 21% on a reported basis and approximately 32% excluding special items.
At December 31, 2011, the current ratio was 2.2 and total debt-to-capital was 60% under the five-year summary definition. Under the company’s debt-covenant calculation, total debt-to-capital was 43% and net worth was $13.3 billion. The company had approximately $2.5 billion of committed credit facilities, with no borrowings outstanding under those facilities at year-end.
Fourth-quarter 2011 results
| Metric | Q4 2011 | Q4 2010 | Q3 2011 |
|---|---|---|---|
| Net sales | $6.367 billion | $6.531 billion | $6.632 billion |
| Gross margin | $1.705 billion | $1.761 billion | $1.839 billion |
| Diluted EPS | $0.59 | $0.73 | $1.19 |
| EPS before special items | $0.66 | $0.68 | $0.92 |
| Cash flow from operations | $637 million | $1.044 billion | $876 million |
| Free cash flow | $328 million | $601 million | $561 million |
Management attributed the fourth-quarter decline to normal North American seasonality, pricing pressure in market pulp and North American paper and packaging exports, and a significant unfavorable currency effect at Ilim. These factors were partly offset by stronger paper demand in Brazil, Russia and Europe, improved EMEA packaging margins, and lower fiber and energy costs.
Segment performance and material changes
- Industrial Packaging: Sales were $10.430 billion and operating profit was $1.147 billion, up from $826 million. Higher price realizations and operating performance more than offset lower volumes, downtime and higher recycled-fiber and freight costs.
- Printing Papers: Sales were $6.215 billion and operating profit was $872 million, up from $481 million. Price increases, lower operating costs and mix improvements outweighed higher raw-material and freight costs. Results included a $24 million gain related to repurposing the Franklin, Virginia mill and an $11 million Inverurie impairment.
- Consumer Packaging: Sales were $3.710 billion and operating profit was $163 million, down from $207 million. Results included $201 million of Shorewood impairment and sale-related charges; excluding those charges, underlying earnings improved materially.
- Distribution: Sales were $6.630 billion and operating profit was $34 million, down from $78 million. Results included $52 million of xpedx reorganization expenses.
- Ilim joint venture: Equity earnings were $153 million, compared with $55 million in 2010. The improvement reflected higher volumes and prices for much of the reporting period, partly offset by a $14 million after-tax foreign-exchange loss.
Management reported diluted EPS before special items of $3.10 for 2011 versus $2.05 in 2010. The reported 2011 result included $63 million of net special-item charges after tax, compared with $246 million of charges in 2010. Key 2011 unusual items included $102 million of restructuring and other charges before tax, a $218 million pretax loss on sales and impairments of businesses, and a $49 million after-tax gain from previously discontinued operations.
Liquidity, debt and capital allocation
- Operating cash flow increased to $2.675 billion, while free cash flow remained approximately $1.7 billion despite the higher capital program and a $300 million voluntary pension contribution.
- Debt issuance totaled $1.766 billion and debt reductions totaled $517 million. The company issued $900 million of 4.75% notes due 2022 and $600 million of 6% notes due 2041 in November 2011, primarily to prepare for Temple-Inland.
- Temple-Inland was acquired for approximately $4.5 billion, including assumed debt of approximately $700 million. February 2012 financing included $1.2 billion and $200 million term loans used with cash to fund the acquisition.
- 2012 capital expenditures were targeted at approximately $1.5 billion, including spending at legacy Temple-Inland facilities. Management expected strong 2012 free cash flow and intended to balance debt reduction, pension funding, dividends, capital investment and acquisitions.
- The quarterly dividend increased during 2011 to $0.2625 per share beginning in the second quarter; total 2011 dividends were $0.975 per share.
Guidance, outlook, risks and contingencies
- Management expected modestly higher North American first-quarter 2012 volumes, particularly in packaging, but anticipated lower export price realizations, seasonally weaker Brazilian demand, higher North American wood and chemical costs, and lower xpedx earnings due to seasonality.
- The company estimated a 2012 effective tax rate of approximately 33% to 35% excluding unforeseen developments.
- U.S. defined-benefit pension plans were underfunded by approximately $2.4 billion at year-end. Management estimated 2012 U.S. pension expense of approximately $315 million, versus $195 million in 2011, although no required 2012 cash contribution was then expected.
- Environmental regulation was a significant uncertainty. The company spent $60 million on environmental capital projects in 2011, expected approximately $90 million in 2012, and preliminarily estimated environmental-control expenditures of approximately $105 million in 2013 and $260 million in 2014. Boiler MACT, pulp-and-paper NESHAP, air-quality rules and climate regulation could materially change these estimates.
- Pending matters included environmental remediation, the Kalamazoo River and San Jacinto River matters, containerboard antitrust litigation, tax examinations and an appeal concerning additional non-compete payments related to the APPM acquisition. The filing states that several litigation exposures cannot yet be reasonably estimated.
- Temple-Inland integration and required divestiture of three containerboard mills with approximately 970,000 tons of capacity were material post-year-end contingencies. The company identified risks related to achieving synergies, retaining customers and employees, obtaining approvals and absorbing undisclosed liabilities.
- The company had approximately $5.2 billion of debt obligations associated with non-consolidated variable-interest entities that were offset in the balance sheet against related interests. These obligations remain International Paper debt obligations despite the accounting offset.
Important facts for investors to verify
- Reconcile reported earnings with the company’s non-GAAP EPS before special items and assess the sustainability of 2011 price and margin improvements.
- Review Temple-Inland’s post-acquisition purchase-price allocation, incremental debt, integration costs, required mill divestitures and realized synergies in subsequent filings.
- Monitor debt reduction, covenant headroom, credit ratings and refinancing needs following the acquisition financing.
- Evaluate the funding trajectory of the approximately $2.4 billion pension deficit and the expected increase in 2012 pension expense.
- Track environmental compliance spending and potential liabilities from Boiler MACT, NESHAP, climate rules and remediation sites.
- Assess litigation, tax-audit and APPM non-compete contingencies, for which final outcomes or amounts were not clear in the filing.
- Consider Ilim’s one-quarter reporting lag and exposure to Russian pulp prices, currency movements and joint-venture capital requirements.