International Paper (IP) 10-Q2022 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13 (a) of the Exchange

 

The accompanying unaudited condensed financial statements have been prepared in conformity with accounting principles generally accepted in the United States and in accordance with the instructions to Form 10-Q and, in the opinion of management, include all adjustments that are necessary for the fair presentation of International Paper Company’s ("International Paper's", "the Company’s" or "our") financial position, results of operations, and cash flows for the interim periods presented. Except as disclosed herein, such adjustments are of a normal, recurring nature. Results for the first three months of the year may not necessarily be indicative of full year results. It is suggested that these condensed financial statements be read in conjunction with the audited financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021, which have previously been filed with the Securities and Exchange Commission.

On October 1, 2021, the Company completed the previously announced spin-off of its Printing Papers segment along with certain mixed-use coated paperboard and pulp businesses in North America, France and Russia into a standalone, publicly-traded company, Sylvamo Corporation. The transaction was implemented through the distribution of shares of the standalone company to International Paper's shareholders (the "Distribution"). As a result of the Distribution, Sylvamo Corporation is an independent public company that trades on the New York Stock Exchange under the symbol "SLVM".

The Russia-Ukraine conflict, including escalating sanctions, possible actions by the Russian government, and associated domestic and global economic and geopolitical conditions, could materially and adversely affect our Ilim joint venture and could otherwise adversely affect our business, financial condition, results of operations and cash flows. We are currently unable to predict the impact the Russian invasion of Ukraine, sanctions imposed to date or that may be imposed in the future, geopolitical instability and the possibility of broadened military conflict may have on us or our Ilim joint venture, including on our receipt of dividends from our Ilim joint venture. Moreover, we have announced our intention to explore strategic options with respect to Ilim S.A., including a sale of our 50% equity interest in Ilim S.A. In addition, we have disclosed our intent to monetize our remaining equity stake in Sylvamo Corporation (which has certain operations in Russia, and announced in March 2022 that it began the suspension of operations in Russia and that it was continuing to assess various options for its operations in that country). While we may sell our equity interests in the Ilim joint venture and/or Sylvamo in the future, we cannot be certain if and when this may occur, or the impact that possible disruptions in the capital markets, or conditions associated with the Russia-Ukraine conflict, could have on the value of and our ability to sell our equity interests in the Ilim joint venture and/or Sylvamo and the timing of any such sales.

In March 2020, the FASB issued ASU 2020-04, "Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting." This guidance provides companies with optional guidance to ease the potential accounting burden associated with transitioning away from reference rates that are expected to be discontinued. This guidance is effective upon issuance and generally can be applied through December 31, 2022. The Company will apply the amendments in this update to account for contract modifications due to changes in reference rates once those occur. We do not expect these amendments to have a material impact on our consolidated financial statements and related disclosures.

In November 2021, the FASB issued ASU 2021-10, "Government Assistance (Topic 832): Disclosures by Business Entities about Government Assistance." This guidance requires a business entity to provide certain disclosures around assistance received from governments. This guidance is effective for annual reporting periods beginning after December 15, 2021. The Company is currently evaluating the provisions of the guidance.

A geographic disaggregation of revenues across our company segmentation in the following tables provides information to assist in evaluating the nature, timing and uncertainty of revenue and cash flows and how they may be impacted by economic factors.

A contract asset is created when the Company recognizes revenue on its customized products prior to having an unconditional right to payment from the customer, which generally does not occur until title and risk of loss passes to the customer.

The difference between the opening and closing balances of the Company's contract assets and contract liabilities primarily results from the difference between the price and quantity at comparable points in time for goods for which we have an unconditional right to payment or receive prepayment from the customer, respectively.

A summary of the changes in equity for the three months March 31, 2022 and 2021 is provided below:

The following table presents changes in accumulated other comprehensive income (AOCI) for the three months ended March 31, 2022 and 2021:

The following table presents details of the reclassifications out of AOCI for the three months ended March 31, 2022 and 2021:

Basic earnings per share is computed by dividing earnings by the weighted average number of common shares outstanding. Diluted earnings per share is computed assuming that all potentially dilutive securities were converted into common shares. There are no adjustments required to be made to net income for purposes of computing basic and diluted earnings per share. A reconciliation of the amounts included in the computation of basic earnings (loss) per share and diluted earnings (loss) per share is as follows:

The following table summarizes the final fair value assigned to assets and liabilities acquired as of April 1, 2021:

Temporary investments with an original maturity of three months or less and money market funds with greater than three month maturities but with the right to redeem without notices are treated as cash equivalents and are stated at cost. Temporary investments totaled $889 million and $1.1 billion at March 31, 2022 and December 31, 2021, respectively.

Restricted Cash

A reconciliation of cash and temporary investments and restricted cash in the condensed consolidated balance sheet to cash and temporary investments and restricted cash in the condensed consolidated statement of cash flows for the three months ended March 31, 2022 is below. The Company had no restricted cash at March 31, 2021.

Inventories

Current Investments

As a result of the 2021 spin-off of Sylvamo Corporation, the Company retained 19.9% of the shares of Sylvamo. The intent is to monetize its investment and to provide additional proceeds to the Company. The Company is accounting for its ownership interest in Sylvamo at fair value as an investment in equity securities. The investment was valued at $291 million and $245 million at March 31, 2022 and December 31, 2021, respectively, and is recorded in Current investments in the accompanying condensed consolidated balance sheet.

Interest payments made during the three months ended March 31, 2022 and 2021 were $56 million and $111 million, respectively.

The Company had recorded liabilities of $107 million related to asset retirement obligations at March 31, 2022 and December 31, 2021.

International Paper leases various real estate, including certain operating facilities, warehouses, office space and land. The Company also leases material handling equipment, vehicles, and certain other equipment. The Company's leases have a remaining lease term of up to 31 years. Total lease costs were $60 million for both of the three months ended March 31, 2022 and 2021.

The Company accounts for the following investments under the equity method of accounting.

The Company has a 50% equity interest in Ilim S.A. (Ilim), which has subsidiaries whose primary operations are in Russia. The Company recorded equity earnings, net of taxes, of $93 million and $49 million for the three months ended March 31, 2022 and 2021, respectively. Foreign exchange losses included in equity earnings for the three months ended March 31, 2022 were $15 million, primarily on the remeasurement of U.S. dollar denominated payables. JSC Ilim Group had no U.S. dollar-denominated debt outstanding as of March 31, 2022. Equity earnings (losses) for the three months ended March 31, 2021 included after-tax foreign exchange losses of $2 million primarily on the remeasurement of U.S. dollar-denominated debt. The Company received cash dividends from the joint venture of $204 million during the first three months of 2022. At March 31, 2022 and December 31, 2021, the Company's investment in Ilim, which is recorded in Long-Term Investments in the condensed consolidated balance sheets, was $413 million and $557 million, respectively, which was $125 million and $121 million, respectively, more than the Company's proportionate share of the joint venture's underlying net assets. The differences primarily relate to currency translation adjustments and the basis difference between the fair value of our investment at acquisition and the underlying net assets. Prior to the spin-off of the Printing Papers segment on October 1, 2021, the Company was party to a joint marketing agreement with JSC Ilim Group, a subsidiary of Ilim, under which the Company purchased, marketed and sold paper produced by JSC Ilim Group. Purchases under this agreement were $41 million for the three months ended March 31, 2021. The joint marketing agreement was conveyed to Sylvamo Corporation as part of the spin-off transaction on October 1, 2021.

Summarized financial information for Ilim is presented in the following tables:

Balance Sheet

The Company's remaining equity method investments are not material.

The following table presents changes in goodwill balances as allocated to each business segment for the three-months ended March 31, 2022:

International Paper made income tax payments, net of refunds, of $20 million and $17 million for the three months ended March 31, 2022 and 2021, respectively.

The Company currently estimates, that as a result of ongoing discussions, pending tax settlements and expirations of statutes of limitations, the amount of unrecognized tax benefits could be reduced by approximately $13 million during the next 12 months.

In connection with sales of businesses, property, equipment, forestlands and other assets, International Paper commonly makes representations and warranties relating to such businesses or assets, and may agree to indemnify buyers with respect to tax and environmental liabilities, breaches of representations and warranties, and other matters. Where liabilities for such matters are determined to be probable and reasonably estimable, accrued liabilities are recorded at the time of sale as a cost of the transaction.

The Company has been named as a potentially responsible party (PRP) in environmental remediation actions under various federal and state laws, including the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA). Many of these proceedings involve the cleanup of hazardous substances at large commercial landfills that received waste from many different sources. While joint and several liability is authorized under CERCLA and equivalent state laws, as a practical matter, liability for CERCLA cleanups is typically allocated among the many PRPs. There are other remediation costs typically associated with the cleanup of hazardous substances at the Company’s current, closed or formerly-owned facilities, and recorded as liabilities in the balance sheet.

Remediation costs are recorded in the consolidated financial statements when they become probable and reasonably estimable. International Paper has estimated the probable liability associated with these environmental remediation matters, including those described herein, to be approximately $182 million ($190 million undiscounted) in the aggregate as of March 31, 2022. Other than as described below, completion of required environmental remedial actions is not expected to have a material effect on our consolidated financial statements.

In October 2017, the EPA issued a Record of Decision (ROD) selecting the final remedy for the site: removal and relocation of the waste material from both the northern and southern impoundments. The EPA did not specify the methods or practices needed to perform this work. The EPA’s selected remedy was accompanied by a cost estimate of approximately $115 million ($105 million for the northern impoundment, and $10 million for the southern impoundment). Subsequent to the issuance of the ROD, there have been numerous meetings between the EPA and the PRPs, and the Company continues to work with the EPA and MIMC/WMI to develop the remedial design.

To this end, in April 2018, the PRPs entered into an Administrative Order on Consent (AOC) with the EPA, agreeing to work together to develop the remedial design for the northern impoundment. That remedial design work is ongoing. The AOC does not include any agreement to perform waste removal or other construction activity at the site. Rather, it involves adaptive management techniques and a pre-design investigation, the objectives of which include filling data gaps (including but not limited to post-Hurricane Harvey technical data generated prior to the ROD and not incorporated into the selected remedy), refining areas and volumes of materials to be addressed, determining if an excavation remedy is able to be implemented in a manner protective of human health and the environment, and investigating potential impacts of remediation activities to infrastructure in the vicinity.

We have submitted the Final Design Package for the southern impoundment to the EPA, and the EPA approved this plan May 7, 2021. The EPA issued a Unilateral Administrative Order for Remedial Action of the southern impoundment on August 5, 2021.

With respect to the northern impoundment, although several key technical issues have been resolved, we still face significant challenges remediating this area in a cost-efficient manner and without a release to the environment and therefore our discussions with the EPA on the best approach to remediation will continue. Because of ongoing questions regarding cost effectiveness, timing and gathering other technical data, additional losses in excess of our recorded liability are possible. We are currently unable to reasonably estimate any further adjustment to our recorded liability or any loss or range of loss in excess of such liability; however, we believe it is unlikely any adjustment would be material.

We have been named as a defendant in various asbestos-related personal injury litigation, in both state and federal court, primarily in relation to the prior operations of certain companies previously acquired by the Company. As of March 31, 2022, the Company's total recorded liability with respect to pending and future asbestos-related claims was $101 million, net of estimated insurance recoveries. While it is reasonably possible that the Company may incur losses in excess of its recorded liability with respect to asbestos-related matters, we are unable to estimate any loss or range in excess of such liability, and do not believe additional material losses are probable.

In March 2017, the Italian Competition Authority (ICA) commenced an investigation into the Italian packaging industry to determine whether producers of corrugated sheets and boxes violated the applicable European competition law. In April 2019, the ICA concluded its investigation and issued initial findings alleging that over 30 producers, including our Italian packaging subsidiary (IP Italy), improperly coordinated the production and sale of corrugated sheets and boxes. On August 6, 2019, the ICA issued its decision and assessed IP Italy a fine of €29 million (approximately $32 million at current exchange rates) which was recorded in the third quarter of 2019. We appealed the ICA decision and our appeal was denied on May 25, 2021. However, we continue to believe we have numerous and strong bases to challenge the ICA decision, and we have further appealed the decision to the Italian Council of State.

The Company is involved in various other inquiries, administrative proceedings and litigation relating to environmental and safety matters, personal injury, product liability, labor and employment, contracts, sales of property, intellectual property, tax, and other matters, some of which allege substantial monetary damages. Assessments of lawsuits and claims can involve a series of complex judgments about future events, can rely heavily on estimates and assumptions, and are otherwise subject to significant uncertainties. As a result, there can be no certainty that the Company will not ultimately incur charges in excess of presently recorded liabilities. The Company believes that loss contingencies arising from pending matters including the matters described herein, will not have a material effect on the consolidated financial position or liquidity of the Company. However, in light of the inherent uncertainties involved in pending or threatened legal matters, some of which are beyond the Company's control, and the large or indeterminate damages sought in some of these matters, a future adverse ruling, settlement,

unfavorable development, or increase in accruals with respect to these matters could result in future charges that could be material to the Company's results of operations or cash flows in any particular reporting period.

Variable Interest Entities

As of March 31, 2022, the fair value of the Timber Notes and Extension Loans for the 2007 Financing Entities was $2.3 billion and $2.1 billion, respectively. The Timber Notes and Extension Loans are classified as Level 2 within the fair value hierarchy, which is further defined in Note 17 in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021.

The Timber Notes of $2.3 billion and the Extension Loans of $2.1 billion both mature in 2027 and are shown in Long-term nonrecourse financial assets of variable interest entities and Long-term nonrecourse financial liabilities of variable interest entities, respectively, on the accompanying balance sheet.

Activity between the Company and the 2007 Financing Entities was as follows:

As of March 31, 2022, the Company's remaining deferred tax liability associated with the 2015 Financing Entities was $813 million. The 2015 timber monetization restructuring is currently under examination by the Internal Revenue Service. An unfavorable resolution in such current examination, future administrative procedures, or future tax litigation could result in material, accelerated cash tax payments as a result of all or a portion of deferred tax liability becoming payable.

Activity between the Company and the 2015 Financing Entities for the three months ended March 31, 2021 was as follows:

The borrowing capacity of the Company's commercial paper program is $1.0 billion supported by its $1.5 billion credit agreement. Under the terms of the program, individual maturities on borrowings may vary, but not exceed one year from the date of issue. Interest bearing notes may be issued either as fixed or floating rate notes. As of March 31, 2022, the Company had no borrowings outstanding under the program.

At March 31, 2022, International Paper’s credit facilities totaled $2.1 billion. The Agreements generally provide for interest rates at a floating rate index plus a pre-determined margin dependent upon International Paper’s credit rating. The Agreements include a $1.5 billion contractually committed bank facility with a maturity date of June 2026. The liquidity facilities also include up to $550 million of uncommitted financings based on eligible receivables balances under a receivables securitization program with the expiration date in April 2022. The receivables securitization program was renewed on April 27, 2022 with up to $500 million of uncommitted financings based on eligible receivables balances with the expiration date in April 2024. At March 31, 2022, there were no borrowings outstanding under either the bank facility or receivables securitization program.

The Company’s financial covenants require the maintenance of a minimum net worth, as defined in our debt agreements, of $9 billion and a total debt-to-capital ratio of less than 60%. Net worth is defined as the sum of common stock, paid-in capital and retained earnings, less treasury stock plus any cumulative goodwill impairment charges. The calculation also excludes accumulated other comprehensive income/loss and both the current and long-term Nonrecourse Financial Liabilities of Variable Interest Entities. The total debt-to-capital ratio is defined as total debt divided by the sum of total debt plus net worth. As of March 31, 2022, we were in compliance with our debt covenants.

At March 31, 2022, the fair value of International Paper’s $5.7 billion of debt was approximately $6.3 billion. The fair value of the Company’s long-term debt is estimated based on the quoted market prices for the same or similar issues. International Paper’s long-term debt is classified as Level 2 within the fair value hierarchy, which is further defined in Note 17 in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021.

As a multinational company, International Paper is exposed to market risks, such as changes in interest rates, currency exchange rates and commodity prices.

The notional amounts of qualifying and non-qualifying financial instruments used in hedging transactions were as follows:

During the next 12 months, the amount of the March 31, 2022 AOCI balance, after tax, that is expected to be reclassified to earnings is a loss of $1 million.

The amounts of gains and losses recognized in the statement of operations on qualifying and non-qualifying financial instruments used in hedging transactions were as follows:

The Company has not changed its valuation techniques for measuring the fair value of any financial assets or liabilities during the year. Transfers between levels, if any, are recognized at the end of the reporting period.

The following table provides a summary of the impact of our derivative instruments in the balance sheet:

The above contracts are subject to enforceable master netting arrangements that provide rights of offset with each counterparty when amounts are payable on the same date in the same currency or in the case of certain specified defaults. Management has made an accounting policy election to not offset the fair value of recognized derivative assets and derivative liabilities in the balance sheet. The amounts owed to the counterparties and owed to the Company are considered immaterial with respect to each counterparty and in the aggregate with all counterparties.

International Paper sponsors and maintains the Retirement Plan of International Paper Company (the Pension Plan), a tax-qualified defined benefit pension plan that provides retirement benefits to substantially all hourly and union employees who work at a participating business unit. The plan was frozen as of January 1, 2019 for salaried participants.

The Pension Plan provides defined pension benefits based on years of credited service and either final average earnings (salaried employees and hourly employees receiving salaried benefits), hourly job rates or specified benefit rates (hourly and union employees).

The components of net periodic pension (income) expense other than the Service cost component are included in Non-operating pension (income) expense in the Condensed Consolidated Statement of Operations.

The Company’s funding policy for our pension plans is to contribute amounts sufficient to meet legal funding requirements, plus any additional amounts that the Company may determine to be appropriate considering the funded status of the plan, tax deductibility, the cash flows generated by the Company, and other factors. The Company made no voluntary cash contributions to the qualified pension plan in the first three months of 2022 or 2021. The nonqualified defined benefit plans are funded to the extent of benefit payments, which totaled $5 million for the three months ended March 31, 2022.

International Paper has an Incentive Compensation Plan (ICP) which is administered by the Management Development and Compensation Committee of the Board of Directors (the Committee). The ICP authorizes the grants of restricted stock, restricted or deferred stock units, performance awards payable in cash or stock upon the attainment of specified performance goals, dividend equivalents, stock options, stock appreciation rights, other stock-based awards and cash-based awards at the discretion of the Committee. As of March 31, 2022, 7.2 million shares were available for grant under the ICP.

At March 31, 2022, $188 million, net of estimated forfeitures, of compensation cost related to unvested restricted performance shares, executive continuity awards and restricted stock attributable to future service had not yet been recognized. This amount will be recognized in expense over a weighted-average period of 2.2 years.

During the first three months of 2022, the Company granted 1.9 million performance units at an average grant date fair value of $50.32.

International Paper’s business segments, Industrial Packaging and Global Cellulose Fibers, are consistent with the internal structure used to manage these businesses. All segments are differentiated on a common product, common customer basis consistent with the business segmentation generally used in the Forest Products industry. On October 1, 2021, the Company completed the previously announced spin-off of its Printing Papers business into a new, publicly-traded company, Sylvamo Corporation, listed on the New York Stock Exchange. Additionally, on August 6, 2021, the Company completed the sale of its Kwidzyn, Poland mill which included the pulp and paper mill in Kwidzyn and supporting functions. As a result of the Sylvamo Corporation spin-off and the sale of Kwidzyn, the Company no longer has a Printing Papers segment, and all prior year amounts have been adjusted to reflect the Sylvamo Corporation and Kwidzyn businesses as a discontinued operation.

Business segment operating profits are used by International Paper's management to measure the earnings performance of its businesses. Management believes that this measure allows a better understanding of trends in costs, operating efficiencies, prices and volumes. Business segment operating profits are defined as earnings (loss) from continuing operations before income taxes and equity earnings, but including the impact of noncontrolling interests, and excluding interest expense, net, corporate expenses, net, corporate net special items, business net special items and non-operating pension expense.

Net earnings (loss) attributable to International Paper common shareholders were $360 million ($0.95 per diluted share) in the first quarter of 2022, compared with $107 million ($0.28 per diluted share) in the fourth quarter of 2021 and $349 million ($0.88 per diluted share) in the first quarter of 2021. International Paper generated Adjusted operating earnings attributable to International Paper common shareholders (a non-GAAP measure defined below) of $288 million ($0.76 per diluted share) in the first quarter of 2022, compared with $301 million ($0.78 per diluted share) in the fourth quarter of 2021 and $198 million ($0.50 per diluted share) in the first quarter of 2021.

International Paper delivered first quarter earnings that were better than our outlook, driven by strong price realization and solid operations, overcoming significantly higher input costs. We also delivered another quarter of strong cash generation. Constraints associated with the Covid-19 Omicron variant impacted volume in our Industrial Packaging business in the early part of the first quarter 2022. Shipments recovered, as expected throughout the first quarter, with demand stabilizing at elevated levels as we exited the quarter. Our mills and converting system performed well, as we managed through continued logistics constraints which negatively impacted operating costs. We successfully executed our highest maintenance outage quarter of 2022 and expect to complete about 70% of full-year planned maintenance outages by the end of the second quarter. We achieved $40 million of earnings through our Building a Better IP initiatives, which are focused on materially lowering our cost structure and accelerating profitable growth. Regarding capital allocation, in the first quarter we returned $580 million to shareholders, including dividends and approximately $400 million of share repurchases. During the first quarter 2022, we announced that we are actively exploring options, including a sale of our 50% equity investment in Ilim Group. We are working with urgency to complete this work. We have engaged advisors and had discussions with interested parties, which are ongoing.

Comparing our performance in the first quarter 2022 to the fourth quarter 2021, price and mix improved significantly, driven by price realization of our August 2021 price increase in our North American Industrial Packaging business, as well as price realization from prior increases in our Global Cellulose Fibers business. Volumes were slightly lower compared to the fourth quarter 2021, as expected, due to seasonally lower demand and Omicron variant impacts early in the quarter in our North American Industrial Packaging business along with on-going shipping constraints in our Global Cellulose Fibers business. In our North American Industrial Packaging business, operations and costs improved sequentially. Our mills and converting system performed well and made good progress normalizing containerboard inventories across our packaging system. In our Global Cellulose Fibers business, volume and operating costs were negatively impacted by on-going logistics constraints. Maintenance outages were sequentially higher in both business segments as we completed the highest maintenance outage quarter of 2022. Input costs were significantly higher sequentially in both business segments due to higher energy, chemicals and distribution costs. These higher costs were partially offset by moderately lower recovered fiber costs.

Looking ahead to the second quarter 2022, as compared to the first quarter 2022, in our Industrial Packaging business, we expect higher price and mix on the flow-through of prior price increases in North America. Volume is expected to improve on seasonally stronger demand. Operations and costs are expected to be slightly higher on the non-repeat of the Prattville insurance proceeds. Maintenance outage expense is expected to decrease as we step down from our highest maintenance quarter of 2022. Input costs are expected to increase on higher energy, chemicals and distribution costs. In our Global Cellulose Fibers business, we expect price and mix to improve on price realization of prior price increases. Volume is expected to be slightly lower. Operations and costs are expected to increase on continued logistics constraints. Maintenance outage expenses are expected to decrease, and input costs are expected to increase, again driven by higher energy, chemicals and distribution costs.

The Russia-Ukraine conflict, including escalating sanctions, possible actions by the Russian government, and associated domestic and global economic and geopolitical conditions, could materially and adversely affect our Ilim joint venture and could otherwise adversely affect our business, financial condition, results of operations and cash flows. We are currently unable to predict the impact the Russian invasion of Ukraine, sanctions imposed to date or that may be imposed in the future,