INTERNATIONAL PAPER CO quarterly report, Q2 FY2010

International Paper Company — 2Q 2010 Form 10-Q Summary

Business Context and Reporting Period

International Paper filed an unaudited Form 10-Q for the quarter and six months ended June 30, 2010. The company operates in Industrial Packaging, Printing Papers, Consumer Packaging, Distribution and Forest Products, with a 50% equity investment in Ilim Holding S.A. Results for Ilim are reported with a one-quarter lag.

Financial Performance and Key Metrics

Metric	Three Months Ended June 30, 2010	Three Months Ended June 30, 2009	Six Months Ended June 30, 2010	Six Months Ended June 30, 2009
Net sales	$6.121 billion	$5.802 billion	$11.928 billion	$11.470 billion
Net earnings attributable to International Paper	$93 million	$136 million	$(69) million	$393 million
Diluted EPS	$0.21	$0.32	$(0.16)	$0.93
Operating profit	$353 million	$788 million	$373 million	$1.567 billion
Cash provided by operations	Not separately provided	Not separately provided	$800 million	$2.189 billion
Free cash flow	Not separately provided	Not separately provided	$395 million	$1.097 billion

Second-quarter sales increased approximately 5.5% year over year. Reported diluted EPS was $0.21, while management reported earnings per share before special items of $0.42, compared with $0.20 in the prior-year quarter and $0.04 in the first quarter of 2010.

Second-quarter operating profit was $353 million, or approximately 5.8% of sales, compared with $788 million, or approximately 13.6% of sales, in the prior-year period. The comparison was materially affected by approximately $482 million of alternative fuel mixture credits recognized in the second quarter of 2009. Excluding those credits and other specified items, management stated that underlying operating profit improved year over year.

Six-month cash flow was substantially lower than in 2009, principally because the prior-year period included significant alternative fuel mixture credit proceeds and related earnings. Working capital used $336 million of cash in the first six months of 2010, compared with a $269 million source in the comparable 2009 period.

Balance Sheet, Debt and Liquidity

Cash and temporary investments were $1.871 billion at June 30, 2010, compared with $1.892 billion at December 31, 2009.
Total debt reported on the balance sheet was approximately $8.931 billion, comprising $357 million of current debt and $8.574 billion of long-term debt. The company reported approximately $8.9 billion of total debt at fair value of approximately $10 billion.
Debt maturities were $284 million in 2010, $232 million in 2011, $233 million in 2012, $136 million in 2013, $558 million in 2014, $784 million in 2015 and $6.704 billion thereafter.
Contractually committed credit agreements 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 expiring in January 2011.
Management expected cash balances, operating cash flow and existing credit facilities to fund 2010 capital expenditures, debt service, working capital and dividends.
Capital spending was $273 million in the first six months, with full-year 2010 capital spending expected to be approximately $800 million.
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

Revenue increased, supported by price increases, higher volumes in most businesses and stronger operating performance.
Reported earnings declined because the 2009 period benefited from approximately $1.0 billion of alternative fuel mixture credits for the first six months, including approximately $482 million in the second quarter.
Second-quarter 2010 raw material and freight costs were $133 million higher than in the prior-year quarter, while a $22 million bad-debt provision was recorded for a large envelope company.
Operating profit improved sequentially from $20 million in the first quarter of 2010 to $353 million in the second quarter, reflecting price realization, volume gains and lower operating costs.
Industrial Packaging sales rose to $2.440 billion from $2.270 billion, but operating profit fell to $192 million from $382 million because the prior-year quarter included substantial alternative fuel credits.
Printing Papers sales rose to $1.445 billion from $1.360 billion. Operating profit was $47 million versus $279 million, with the 2010 result burdened by Franklin mill closure charges and the 2009 result benefiting from alternative fuel credits.
Consumer Packaging sales rose to $845 million from $770 million, while operating profit declined to $48 million from $114 million for the same special-item reasons.
Distribution operating profit increased to $26 million from $10 million, and Forest Products operating profit increased to $40 million from $3 million, primarily due to land and mineral rights sales.

Guidance, Outlook, Risks and Unusual Items

Management expected third-quarter 2010 earnings to increase meaningfully from second-quarter levels. The outlook assumed continued, but slower, demand growth; further realization of announced paper, coated paperboard and corrugated packaging price increases; lower maintenance outages; stable but elevated input costs; favorable wood costs; uncertain recycled fiber costs; and higher compensation and other costs.

Second-quarter 2010 restructuring and other charges totaled $144 million before tax and $88 million after tax. The largest component was $111 million for closure costs at the Franklin, Virginia mill, including $46 million of accelerated depreciation and $36 million of environmental closure costs.
First-half restructuring and other charges totaled $359 million before tax. The company also recorded a $46 million after-tax tax adjustment in the first quarter.
The company completed its $206 million acquisition of SCA Packaging Asia on June 30, 2010, including $172 million in cash and $34 million of assumed debt. The business included 13 corrugated box plants and two specialty packaging facilities.
International Paper agreed to expand its Sun Paper joint venture in China through a proposed $300 million coated-board machine, including approximately $55 million of International Paper cash, subject to government approval.
On July 22, 2010, the company announced an agreement to sell 163,000 acres for approximately $200 million, with at least $160 million payable at closing. The transaction was expected to close in the third quarter.
The company made a voluntary $500 million qualified pension plan contribution on July 27, 2010.
Environmental remediation costs at a CERCLA site could be significantly higher than amounts currently accrued because the EPA had not finalized the required remedial action.
The company estimated that approximately $15 million of unrecognized tax benefits could be reduced during the following 12 months.
International Paper disclosed potential exposure under the Ilim shareholder agreement requiring a possible purchase of its partner’s 50% interest for approximately $425 million to $450 million if specified deadlock procedures are initiated. The parties stated that they had no current intention to initiate those procedures.
Key risks include raw material, energy and freight costs; cyclicality and product demand; competition; credit downgrades and refinancing requirements; pension funding; environmental compliance; litigation; manufacturing disruptions; currency movements; and joint-venture risks.

Most Important Facts for Investors to Verify

Reconcile management’s non-GAAP $0.42 second-quarter EPS before special items to GAAP diluted EPS of $0.21 and assess the recurring earnings base after exclusions.
Adjust year-over-year comparisons for the approximately $482 million of alternative fuel mixture credits recognized in the second quarter of 2009.
Monitor cash conversion, working-capital requirements and the decline in first-half operating cash flow to $800 million from $2.189 billion.
Assess debt maturities, the January 2011 receivables facility renewal and continued access to the $2.5 billion committed liquidity capacity.
Evaluate the financial and operational effects of the Franklin mill closure, the SCA Packaging Asia acquisition and the proposed China joint-venture expansion.
Review the $500 million pension contribution, future pension funding needs and the company’s ability to fund capital spending and dividends while reducing debt.
Track environmental remediation exposure, tax settlements, the Ilim shareholder agreement and other legal or contingent liabilities.