filings.toolsItem 2. [MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS](#ibb1a7aad2ffb4c63bc398e4ef405226b97)
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Item 2. [MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS](#ibb1a7aad2ffb4c63bc398e4ef405226b97)
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes included in "Financial Statements and Supplementary Data" of this Quarterly Report on Form 10-Q (this "Form 10-Q") and the Company's Annual Report on Form 10-K for the year ended December 31, 2021 (our "Annual Report"). In addition to historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates, and beliefs that involve significant risks and uncertainties. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to those differences include those discussed below and in our Annual Report, particularly under "Risk Factors" and "Forward-Looking Statements" of this Form 10-Q and our Annual Report.
EXECUTIVE SUMMARY
Net earnings (loss) attributable to the Company's common shareholders were $951 million ($2.64 per diluted share) in the third quarter of 2022, compared with $511 million ($1.38 per diluted share) in the second quarter of 2022 and $864 million ($2.20 per diluted share) in the third quarter of 2021. The Company generated Adjusted operating earnings attributable to its common shareholders (a non-GAAP measure defined below) of $364 million ($1.01 per diluted share) in the third quarter of 2022, compared with $459 million ($1.24 per diluted share) in the second quarter of 2022 and $431 million ($1.10 per diluted share) in the third quarter of 2021.
During the third quarter 2022, International Paper’s earnings were significantly impacted by a challenging macroeconomic environment, resulting in a sharp decline in demand related to our Industrial Packaging segment, and significant cost headwinds from higher energy and distribution costs. As we entered the third quarter 2022, we recognized there were considerable macroeconomic uncertainties ahead of us, however these trends significantly shifted roughly mid-way through the third quarter, creating stronger headwinds than expected. Demand for packaging continued to weaken in the third quarter 2022 across all channels and all end-use segments as consumers reduced their spending for goods, focusing more on non-discretionary products and services. In addition, we saw our customers, and the broader retail channel, continue to manage through elevated inventories which further impacted demand for packaging in the third quarter 2022. The large decline in volume also significantly impacted operating costs as we adjusted our system to align our production with customer demand. This resulted in approximately 400,000 tons of economic downtime across the system resulting in high unabsorbed fixed costs and a sub-optimized system. Despite these macroeconomic challenges, fluff pulp demand was stable, and our Global Cellulose business generated strong earnings growth to deliver cost-of-capital returns in the third quarter 2022. On capital allocation, we returned $434 million to shareowners in the third quarter 2022, including $269 million of share repurchases. We have returned approximately $1.6 billion of cash to shareowners so far this year. Additionally, in October 2022, our Board of Directors authorized an additional $1.5 billion of share repurchases, in addition to amounts previously authorized and available.
Comparing our performance in the third quarter 2022 to the second quarter 2022, price and mix improved, driven by continued price realization from prior period increases in both our North American Industrial Packaging and Global Cellulose Fibers businesses. Volume was lower in our North American Industrial Packaging business as a result of softer demand across all channels, while volume improved in our Global Cellulose Fibers business on improved supply chain velocity. Operations and costs were significantly higher in our North American Industrial Packaging business on the non-repeat of favorable one-time items from the second quarter 2022, along with significant economic downtime, higher distribution costs and other inflation driven cost increases. Operations and costs were relatively flat in our Global Cellulose Fibers business. Maintenance outages were sequentially lower in both business segments coming off of the heavy maintenance outage activity in the second quarter 2022. Input costs continued to be a significant headwind with sequentially unfavorable costs in both business segments, driven by higher energy and chemicals, partially offset by lower recovered fiber costs in our North American Industrial Packaging business.
Looking ahead to the fourth quarter 2022, as compared to the third quarter 2022, in our Industrial Packaging business, we expect price and mix to be lower due to the export market. Volume is expected to be lower on four fewer shipping days, partially offset by seasonally higher produce volume in our EMEA Packaging business. The traditional seasonal increase in volume from holiday demand is not expected to be as strong this year. Operations and costs are expected to be significantly higher due to unabsorbed fixed costs on lower volumes, higher seasonal energy costs, along with further inflation on materials and services. Maintenance outage expense is expected to be flat relative to the third quarter 2022. Input costs are expected to be lower driven by lower fiber and energy costs. In our Global Cellulose Fibers business, we expect price and mix to improve on price realization from prior period increases. Volume is expected to be lower on timing of shipments through the supply chain. Operations and costs are expected to be stable while maintenance outage expenses are expected to increase. Input costs are expected to increase, primarily related to energy costs at our converting operation in Poland.
The Russia-Ukraine conflict, including current and future sanctions, actions by the Russian government, and associated domestic and global economic and geopolitical conditions, have affected and 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 unable to predict the full impact of Russia’s ongoing invasion of Ukraine, sanctions that have been imposed to date or that may in the future be imposed, geopolitical instability and the possibility of broadened military conflict may have on us or our Ilim joint venture, including whether our Ilim joint venture may be able to continue to pay dividends to us. We continue to actively explore strategic options with respect to the Ilim joint venture, including a sale of our 50% equity interest in Ilim. While we may sell our equity interests in the Ilim joint venture, we cannot be certain if and when this may occur, or the impact that possible disruptions in the capital markets, negative macroeconomic conditions, or conditions associated with the Russia-Ukraine conflict, could have on the value of and our ability to sell our equity interest in the Ilim joint venture and the timing of any such sale.
Adjusted operating earnings and Adjusted operating earnings per share are non-GAAP measures and are defined as net earnings (loss) attributable to International Paper (a GAAP measure) excluding discontinued operations, net special items and non-operating pension expense (income). Net earnings (loss) and Diluted earnings (loss) per share attributable to common shareholders are the most directly comparable GAAP measures. The Company calculates Adjusted operating earnings by excluding the after-tax effect of discontinued operations, non-operating pension expense (income) and items considered by management to be unusual or otherwise not reflective of on-going operations (net special items) from net earnings (loss) attributable to shareholders reported under GAAP. Adjusted operating earnings per share is calculated by dividing Adjusted operating earnings by diluted average shares of common stock outstanding. Management uses these measures to focus on on-going operations, and believes that these measures are useful to investors because such measures enable investors to perform meaningful comparisons of past and present consolidated operating results. The Company believes that using this information, along with the most directly comparable GAAP measures, provide for a more complete analysis of the results of operations.
The following are reconciliations of Net earnings (loss) attributable to shareholders to Adjusted operating earnings (loss) attributable to common shareholders on a total and per share basis. Additional detail is provided later in this Form 10-Q regarding the net special items expense (income) referenced in the charts below.
| Three Months Ended September 30, | Three Months Ended June 30, | ||||||||||||||||
| In millions | 2022 | 2021 | 2022 | ||||||||||||||
| Net earnings (loss) attributable to shareholders | $ | 951 | $ | 864 | $ | 511 | |||||||||||
| Less - Discontinued operations (gain) loss | — | (432) | — | ||||||||||||||
| Earnings (loss) from continuing operations attributable to shareholders | 951 | 432 | 511 | ||||||||||||||
| Add back - Non-operating pension expense (income) | (48) | (50) | (47) | ||||||||||||||
| Add back - Net special items expense (income) | 117 | 49 | 18 | ||||||||||||||
| Income tax effect - Non-operating pension and net special items expense (income) | (656) | — | (23) | ||||||||||||||
| Adjusted operating earnings (loss) attributable to shareholders | $ | 364 | $ | 431 | $ | 459 |
| Three Months Ended September 30, | Three Months Ended June 30, | ||||||||||||||||
| In millions | 2022 | 2021 | 2022 | ||||||||||||||
| Diluted earnings (loss) per share attributable to shareholders | $ | 2.64 | $ | 2.20 | $ | 1.38 | |||||||||||
| Less - Discontinued operations (gain) loss per share | — | (1.10) | — | ||||||||||||||
| Diluted earnings (loss) per share from continuing operations attributable to shareholders | 2.64 | 1.10 | 1.38 | ||||||||||||||
| Add back - Non-operating pension expense (income) per share | (0.13) | (0.12) | (0.13) | ||||||||||||||
| Add back - Net special items expense (income) per share | 0.32 | 0.12 | 0.05 | ||||||||||||||
| Income tax effect per share - Non-operating pension and net special items expense (income) | (1.82) | — | (0.06) | ||||||||||||||
| Adjusted operating earnings (loss) per share attributable to shareholders | $ | 1.01 | $ | 1.10 | $ | 1.24 |
Cash provided by operations totaled $1.4 billion and $1.9 billion for the first nine months of 2022 and 2021, respectively. The Company generated free cash flow of approximately $804 million and $1.6 billion in the first nine months of 2022 and 2021, respectively. Free cash flow is a non-GAAP measure and the most directly comparable GAAP measure is cash provided by operations. Management utilizes this measure in connection with managing our business and believes that free cash flow is useful to investors as a liquidity measure because it measures the amount of cash generated that is available, after reinvesting in
the business, to maintain a strong balance sheet, pay dividends, repurchase stock, service debt and make investments for future growth. It should not be inferred that the entire free cash flow amount is available for discretionary expenditures. By adjusting for certain items that are not indicative of the Company's ongoing performance, we believe that free cash flow also enables investors to perform meaningful comparisons between past and present periods.
The following is a reconciliation of cash provided by operations to free cash flow:
| Nine Months Ended September 30, | |||||||||||
| In millions | 2022 | 2021 | |||||||||
| Cash provided by operations | $ | 1,413 | $ | 1,923 | |||||||
| Adjustments: | |||||||||||
| Cash invested in capital projects, net of insurance recoveries | (609) | (348) | |||||||||
| Free Cash Flow | $ | 804 | $ | 1,575 |
The non-GAAP financial measures presented in this Form 10-Q as referenced above have limitations as analytical tools and should not be considered in isolation or as a substitute for an analysis of our results calculated in accordance with GAAP. In addition, because not all companies utilize identical calculations, the Company's presentation of non-GAAP measures in this Form 10-Q may not be comparable to similarly titled measures disclosed by other companies, including companies in the same industry as the Company.
For the third quarter of 2022, International Paper reported net sales of $5.4 billion, compared with $5.4 billion in the second quarter of 2022 and $4.9 billion in the third quarter of 2021.
Net earnings (loss) attributable to International Paper totaled $951 million, or $2.64 per diluted share, in the third quarter of 2022. This compared with $511 million, or $1.38 per diluted share, in the second quarter of 2022 and $864 million, or $2.20 per diluted share, in the third quarter of 2021.
Compared with the second quarter of 2022, earnings benefited from higher average sales prices net of an unfavorable mix ($114 million), lower mill maintenance outage costs ($48 million), lower corporate and other items ($9 million), lower net interest expense ($5 million), lower tax expense ($12 million) and lower non-operating pension expense ($1 million). These benefits
were offset by lower sales volumes ($20 million), higher operating costs ($176 million) and higher raw material and freight costs ($57 million). Equity earnings, net of taxes, relating to International Paper’s investments in Ilim and other investments were $30 million lower in the third quarter of 2022 than in the second quarter of 2022. Net special items in the third quarter of 2022 were a gain of $551 million compared with a gain of $17 million in the second quarter of 2022.
Compared with the third quarter of 2021, the third quarter of 2022 reflects higher average sales prices and a favorable mix ($473 million) and lower net interest expense ($12 million). These benefits were offset by lower sales volumes ($24 million), higher operating costs ($209 million), higher raw material and freight costs ($247 million), higher mill maintenance outage costs ($15 million), higher corporate and other costs ($2 million), higher tax expense ($24 million) and higher non-operating pension expense ($2 million). Equity earnings, net of taxes, relating to International Paper’s investments in Ilim and other investments were $31 million lower in the third quarter of 2022 than in the third quarter of 2021. Net special items in the third quarter of 2022 were a gain of $551 million compared with a loss of $37 million in the third quarter of 2021.
Business segment operating profits are used by International Paper's management to measure the earnings performance of its businesses. Management uses this measure to focus on on-going operations, and believes that it is useful to investors because it enables them to perform meaningful comparisons of past and present operating results. International Paper believes that using this information, along with net earnings, provides a more complete analysis of the results of operations by quarter. Business segment operating profits are defined as earnings (loss) from continuing operations before income taxes and equity earnings, but including the impact of less than wholly owned subsidiaries, and excluding interest expense, net, corporate expenses, net, corporate net special items, business net special items and non-operating pension expense. Business segment operating profits is a measure reported to our management for purposes of making decisions about allocating resources to our business segments and assessing the performance of our business segments and is presented in our financial statement footnotes in accordance with ASC 280.
The Company currently operates in two segments: Industrial Packaging and Global Cellulose Fibers.
The following table presents a reconciliation of Net earnings (loss) attributable to International Paper Company to its Total business segment operating profit:
| Three Months Ended | |||||||||||||||||
| September 30, | June 30, | ||||||||||||||||
| In millions | 2022 | 2021 | 2022 | ||||||||||||||
| Net Earnings (Loss) from Continuing Operations Attributable to International Paper Company | $ | 951 | $ | 432 | $ | 511 | |||||||||||
| Add back (deduct): | |||||||||||||||||
| Income tax provision (benefit) | (575) | 59 | 96 | ||||||||||||||
| Equity (earnings) loss, net of taxes | (63) | (94) | (93) | ||||||||||||||
| Earnings (Loss) From Continuing Operations Before Income Taxes and Equity Earnings | 313 | 397 | 514 | ||||||||||||||
| Interest expense, net | 123 | 82 | 74 | ||||||||||||||
| Less than wholly owned subsidiaries included in operations | (1) | (1) | (1) | ||||||||||||||
| Corporate expenses, net | 15 | 13 | 27 | ||||||||||||||
| Corporate net special items | 62 | 49 | 18 | ||||||||||||||
| Non-operating pension expense (income) | (48) | (50) | (47) | ||||||||||||||
| Adjusted Operating Profit | $ | 464 | $ | 490 | $ | 585 | |||||||||||
| Business Segment Operating Profit (Loss): | |||||||||||||||||
| Industrial Packaging | $ | 369 | $ | 414 | $ | 560 | |||||||||||
| Global Cellulose Fibers | 95 | 76 | 25 | ||||||||||||||
| Total Business Segment Operating Profit | $ | 464 | $ | 490 | $ | 585 |
Business Segment Operating Profit
Total business segment operating profits were $464 million in the third quarter of 2022, $585 million in the second quarter of 2022 and $490 million in the third quarter of 2021.
Compared with the second quarter of 2022, operating profits benefited from higher average sales prices net of an unfavorable mix ($151 million) and lower mill outage costs ($63 million). These benefits were offset by lower sales volumes ($27 million), higher operating costs ($233 million) and higher raw material and freight costs ($75 million).
Compared with the third quarter of 2021, operating profits in the current quarter benefited from higher average sales prices and a favorable mix ($556 million). These benefits were offset by lower sales volumes ($28 million), higher operating costs ($246 million), higher raw material and freight costs ($290 million) and higher mill outage costs ($18 million).
Sales Volumes by Product (a)
Sales volumes of major products for the three months and nine months ended September 30, 2022 and 2021 were as follows:
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| In thousands of short tons (except as noted) | 2022 | 2021 | 2022 | 2021 | |||||||||||||||||||
| Industrial Packaging | |||||||||||||||||||||||
| Corrugated Packaging (b) | 2,522 | 2,689 | 7,759 | 8,106 | |||||||||||||||||||
| Containerboard | 677 | 710 | 2,096 | 2,118 | |||||||||||||||||||
| Recycling | 546 | 521 | 1,645 | 1,647 | |||||||||||||||||||
| Saturated Kraft | 51 | 45 | 146 | 140 | |||||||||||||||||||
| Gypsum/Release Kraft | 66 | 56 | 184 | 179 | |||||||||||||||||||
| EMEA Packaging (b) | 297 | 334 | 1,019 | 1,179 | |||||||||||||||||||
| Industrial Packaging | 4,159 | 4,355 | 12,849 | 13,369 | |||||||||||||||||||
| Global Cellulose Fibers (in thousands of metric tons) (c) | 750 | 748 | 2,182 | 2,246 |
(a)Sales volumes include third party and inter-segment sales and exclude sales of equity investees.
(b)Volumes for corrugated box sales reflect consumed tons sold (CTS). Board sales for these businesses reflect invoiced tons.
(c)Includes North American volumes and internal sales to mills.
Discontinued Operations
On October 1, 2021, the Company completed the previously announced spin-off of its Printing Papers business along with certain mixed-use coated paperboard and pulp businesses in North America, France and Russia into a standalone, publicly-traded company, Sylvamo. 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 spin-off and sale of Kwidzyn, the Company no longer has a Printing Papers business segment, and all historical results have been adjusted to reflect the Kwidzyn and the Printing Papers business and other businesses conveyed to Sylvamo as discontinued operations. See Note 9 - Divestitures and Impairments of Item 1. Financial Statements for further discussion.
Discontinued operations include the operating earnings of the businesses noted above. Discontinued operations also includes after-tax net special items income of $331 million and $338 million for the three months and nine months ended September 30, 2021, respectively.
Details of these charges were as follows:
| Three Months Ended | Nine Months | ||||||||||||||||||||||
| September 30, | September 30, | ||||||||||||||||||||||
| 2021 | 2021 | ||||||||||||||||||||||
| In millions | Before Tax | After Tax | Before Tax | After Tax | |||||||||||||||||||
| Gain on sale of Kwidzyn, Poland mill | $ | (360) | $ | (350) | $ | (360) | $ | (350) | |||||||||||||||
| Gain on sale of La Mirada, CA distribution center | (86) | (65) | (86) | (65) | |||||||||||||||||||
| Printing Papers spin-off | 52 | 47 | 101 | 87 | |||||||||||||||||||
| Foreign value-added tax credit (including interest) | 15 | 10 | (55) | (37) | |||||||||||||||||||
| Foreign and state taxes related to Printing Papers spin-off | — | 27 | — | 27 | |||||||||||||||||||
| Total | $ | (379) | $ | (331) | $ | (400) | $ | (338) |
Income Taxes
An income tax benefit of $575 million was recorded for the third quarter of 2022 and the reported effective income tax rate was (184)%. Excluding a benefit of $668 million related to the tax effects of net special items and expense of $12 million related to the tax effects of non-operating pension expense, the effective income tax rate was 21% for the quarter. The effective tax rate for the third quarter of 2022 was lower than the prior quarter primarily due to the tax-free exchange of a portion of the Company’s shares of Sylvamo Corporation, the settlement of the timber monetization restructuring tax matter with the Internal Revenue Service and a reduction in the forecasted annual effective tax rate including additional tax credits available through the Inflation Reduction Act.
An income tax provision of $96 million was recorded for the second quarter of 2022 and the reported effective income tax rate was 19%. Excluding a benefit of $35 million related to the tax effects of net special items and expense of $12 million related to the tax effects of non-operating pension expense, the effective income tax rate was 25% for the quarter. The effective tax rate for the second quarter of 2022 was lower than the first quarter of 2022 due to the tax-free exchange of a portion of the Company’s shares of Sylvamo Corporation.
An income tax provision of $59 million was recorded for the third quarter of 2021 and the reported effective income tax rate was 15%. Excluding a benefit of $12 million related to the tax effects of net special items and expense of $12 million related to the tax effects of non-operating pension expense, the effective income tax rate was 15% for the quarter. The tax rate in the third quarter of 2021 was lower than the prior two quarters in 2021 primarily as a result of tax benefits recognized after the finalization of the 2020 U.S. federal income tax return, and the impact of lower tax expense associated with the sale of our Kwidzyn, Poland mill.
Interest Expense
Net interest expense was $123 million in the third quarter of 2022, compared with $74 million in the second quarter of 2022 and $82 million in the third quarter of 2021. The third quarter of 2022 includes $55 million of interest expense related to the previously announced settlement of the timber monetization restructuring tax matter.
Effects of Net Special Items Expense (Income) and Non-Operating Pension Expense
Details of net special items expense (income) and non-operating pension expense (income) for the three months ended are as follows:
| Three Months Ended | ||||||||||||||||||||||||||||||||||||||
| September 30, | June 30, | |||||||||||||||||||||||||||||||||||||
| 2022 | 2021 | 2022 | ||||||||||||||||||||||||||||||||||||
| In millions | Before Tax | After Tax | Before Tax | After Tax | Before Tax | After Tax | ||||||||||||||||||||||||||||||||
| Corporate | ||||||||||||||||||||||||||||||||||||||
| Debt extinguishment costs | $ | 93 | $ | 70 | $ | 35 | $ | 26 | $ | — | $ | — | ||||||||||||||||||||||||||
| Timber monetization settlement interest | 55 | 41 | — | — | — | — | ||||||||||||||||||||||||||||||||
| Environmental remediation reserve adjustment | — | — | 5 | 4 | 15 | 11 | ||||||||||||||||||||||||||||||||
| Sylvamo investment | (16) | (12) | — | — | (3) | (2) | ||||||||||||||||||||||||||||||||
| Legal settlement | (15) | (11) | — | — | — | — | ||||||||||||||||||||||||||||||||
| Other | — | — | 9 | 7 | 6 | 5 | ||||||||||||||||||||||||||||||||
| Corporate Total | 117 | 88 | 49 | 37 | 18 | 14 | ||||||||||||||||||||||||||||||||
| Total net special items expense (income) | 117 | 88 | 49 | 37 | 18 | 14 | ||||||||||||||||||||||||||||||||
| Non-operating pension expense (income) | (48) | (36) | (50) | (38) | (47) | (35) | ||||||||||||||||||||||||||||||||
| Total net special items and non-operating pension expense (income) | $ | 69 | $ | 52 | $ | (1) | $ | (1) | $ | (29) | $ | (21) |
Net special items expense (income) include the following tax expenses (benefits):
| Three Months Ended | ||||||||||||||||||||
| September 30, | June 30, | |||||||||||||||||||
| In millions | 2022 | 2021 | 2022 | |||||||||||||||||
| Tax benefit related to the timber monetization settlement | $ | (604) | $ | — | $ | — | ||||||||||||||
| Tax benefit related to tax-free exchange of Sylvamo shares | (35) | — | (31) | |||||||||||||||||
| Total | $ | (639) | $ | — | $ | (31) |
Details of net special items expense (income) and non-operating pension expense (income) for the nine months ended are as follows:
| Nine Months Ended | ||||||||||||||||||||||||||
| September 30, | ||||||||||||||||||||||||||
| 2022 | 2021 | |||||||||||||||||||||||||
| In millions | Before Tax | After Tax | Before Tax | After Tax | ||||||||||||||||||||||
| Business Segments | ||||||||||||||||||||||||||
| EMEA Packaging business optimization | $ | — | $ | — | $ | 12 | $ | 10 | (a) | |||||||||||||||||
| EMEA Packaging impairment - Turkey | — | — | (6) | — | (a) | |||||||||||||||||||||
| Business Segments Total | — | — | 6 | 10 | ||||||||||||||||||||||
| Corporate | ||||||||||||||||||||||||||
| Debt extinguishment costs | 93 | 70 | 223 | 168 | ||||||||||||||||||||||
| Timber monetization settlement interest | 55 | 41 | — | — | ||||||||||||||||||||||
| Environmental remediation reserve adjustment | 15 | 11 | 10 | 7 | ||||||||||||||||||||||
| Real estate - office impairment | — | — | 21 | 16 | ||||||||||||||||||||||
| Sylvamo investment | (65) | (49) | — | — | ||||||||||||||||||||||
| Legal settlement | (15) | (11) | — | — | ||||||||||||||||||||||
| Gain on sale of equity investment in Graphic Packaging | — | — | (204) | (154) | ||||||||||||||||||||||
| Other | 6 | 5 | 20 | 15 | ||||||||||||||||||||||
| Corporate Total | 89 | 67 | 70 | 52 | ||||||||||||||||||||||
| Total net special items expense (income) | 89 | 67 | 76 | 62 | ||||||||||||||||||||||
| Non-operating pension expense (income) | (144) | (108) | (153) | (115) | ||||||||||||||||||||||
| Total net special items and non-operating pension expense (income) | $ | (55) | $ | (41) | $ | (77) | $ | (53) |
(a) Recorded in the Industrial Packaging segment.
Net special items include the following tax expenses (benefits):
| Nine Months Ended | ||||||||||||||
| September 30, | ||||||||||||||
| In millions | 2022 | 2021 | ||||||||||||
| Tax benefit related to the timber monetization settlement | $ | (604) | $ | — | ||||||||||
| Tax benefit related to tax-free exchange of Sylvamo shares | (66) | — | ||||||||||||
| Total | $ | (670) | $ | — |
BUSINESS SEGMENT OPERATING RESULTS
The following tables present net sales and business segment operating profit (loss) which is the Company's measure of segment profitability.
Industrial Packaging
| Total Industrial Packaging | 2022 | 2021 | |||||||||||||||||||||||||||||||||
| In millions | 3rd Quarter | 2nd Quarter | Nine Months | 3rd Quarter | 2nd Quarter | Nine Months | |||||||||||||||||||||||||||||
| Sales | $ | 4,385 | $ | 4,491 | $ | 13,282 | $ | 4,111 | $ | 4,030 | $ | 12,071 | |||||||||||||||||||||||
| Operating Profit (Loss) | $ | 369 | $ | 560 | $ | 1,326 | $ | 414 | $ | 389 | $ | 1,224 |
Industrial Packaging net sales for the third quarter of 2022 were 2% lower compared with the second quarter of 2022 and 7% higher compared with the third quarter of 2021. Operating profit was 34% lower in the third quarter of 2022 compared with the second quarter of 2022 and 11% lower compared with the third quarter of 2021.
| North American Industrial Packaging | 2022 | 2021 | |||||||||||||||||||||||||||||||||
| In millions | 3rd Quarter | 2nd Quarter | Nine Months | 3rd Quarter | 2nd Quarter | Nine Months | |||||||||||||||||||||||||||||
| Sales (a) | $ | 4,055 | $ | 4,126 | $ | 12,206 | $ | 3,814 | $ | 3,663 | $ | 11,037 | |||||||||||||||||||||||
| Operating Profit (Loss) | $ | 387 | $ | 550 | $ | 1,337 | $ | 418 | $ | 377 | $ | 1,190 |
(a)Includes intra-segment sales of $25 million and $34 million for the three months ended September 30, 2022 and 2021, respectively; $48 million and $27 million for the three months ended June 30, 2022 and 2021, respectively; and $102 million and $87 million for the nine months ended September 30, 2022 and 2021, respectively.
North American Industrial Packaging sales volumes in the third quarter of 2022 were lower compared to the second quarter of 2022 for corrugated boxes in all segments driven by the macroeconomic environment reflecting lower consumer spending on goods and retailer inventory destocking. Export and domestic containerboard volumes were also lower. Total maintenance and economic downtime was about 391,000 short tons higher in the third quarter of 2022 compared with the second quarter of 2022, due to economic downtime. Average sales margins were higher reflecting higher average sales prices for boxes and containerboard. Operating costs were higher driven by economic downtime and inflation. Distribution costs increased. Planned maintenance downtime costs were $37 million lower in the third quarter of 2022 compared with the second quarter of 2022. Input costs were higher as higher energy costs were partially offset by lower recovered fiber costs. Second quarter 2022 results were impacted by some favorable one-time items that did not repeat in the third quarter.
Compared with the third quarter of 2021, sales volumes in the third quarter of 2022 were lower for corrugated boxes and domestic containerboard but increased for export containerboard. Sales volumes for corrugated boxes were lower reflecting inflation impacts on consumer spending. Total maintenance and economic downtime was about 450,000 short tons higher in the third quarter of 2022, primarily due to economic downtime. Average sales prices for boxes and containerboard were higher reflecting previous price increases. Operating costs increased, driven by economic downtime and inflation. Distribution costs increased. Planned maintenance downtime costs were $21 million higher in the third quarter of 2022 compared with the third quarter of 2021. Input costs were significantly higher driven by energy, chemicals and freight, partially offset by lower recovered fiber costs.
Entering the fourth quarter of 2022, sales volumes are expected to be lower compared to the third quarter of 2022 including the impact of four less shipping days. Average sales margins are expected to be lower. Operating costs are expected to be higher. Planned maintenance downtime costs are expected to be slightly lower in the fourth quarter of 2022 compared with the third quarter of 2022. Input costs are expected to be lower.
| EMEA Industrial Packaging | 2022 | 2021 | |||||||||||||||||||||||||||||||||
| In millions | 3rd Quarter | 2nd Quarter | Nine Months | 3rd Quarter | 2nd Quarter | Nine Months | |||||||||||||||||||||||||||||
| Sales | $ | 355 | $ | 413 | $ | 1,178 | $ | 331 | $ | 394 | $ | 1,121 | |||||||||||||||||||||||
| Operating Profit (Loss) | $ | (18) | $ | 10 | $ | (11) | $ | (4) | $ | 12 | $ | 34 |
EMEA Industrial Packaging sales volumes for corrugated boxes in the third quarter of 2022 were lower compared with the second quarter of 2022 reflecting seasonally lower volumes in Morocco. Average sales margins for corrugated boxes and containerboard were stable. Operating costs were stable. Distribution costs were higher. There were no planned maintenance outages in either the third quarter of 2022 or the second quarter of 2022. Input costs were significantly higher, reflecting significantly higher energy costs.
Compared with the third quarter of 2021, sales volumes in the third quarter of 2022 were lower reflecting softening demand in the Eurozone. Average sales margins for corrugated boxes were higher driven by higher sales prices in the Eurozone. Operating costs were higher mostly due to inflation. Distribution costs were higher. Planned maintenance downtime costs were $2 million lower in the third quarter of 2022 compared with the third quarter of 2021. Input costs were significantly higher driven by energy.
Looking ahead to the fourth quarter of 2022, sales volumes for corrugated boxes are expected to be higher driven by seasonally higher volumes in Morocco. Operating costs are expected to be flat. Planned maintenance downtime costs are expected to be $4 million higher in the fourth quarter of 2022. Input costs are expected to increase.
Global Cellulose Fibers
| Total Global Cellulose Fibers | 2022 | 2021 | |||||||||||||||||||||||||||||||||
| In millions | 3rd Quarter | 2nd Quarter | Nine Months | 3rd Quarter | 2nd Quarter | Nine Months | |||||||||||||||||||||||||||||
| Sales | $ | 887 | $ | 788 | $ | 2,385 | $ | 740 | $ | 680 | $ | 2,015 | |||||||||||||||||||||||
| Operating Profit (Loss) | $ | 95 | $ | 25 | $ | 71 | $ | 76 | $ | 1 | $ | (4) |
Global Cellulose Fibers net sales in the third quarter of 2022 were 13% higher compared with the second quarter of 2022 and 20% higher than in the third quarter of 2021. Operating profit was 280% higher in the third quarter of 2022 compared with the second quarter of 2022 and 25% higher compared with the third quarter of 2021.
Sales volumes in the third quarter of 2022 compared with the second quarter of 2022 were higher reflecting a favorable demand/supply environment for fluff pulp and some improvement in supply chain conditions. Total maintenance and economic downtime was about 10,000 short tons lower in the third quarter of 2022 compared with the second quarter of 2022 due to maintenance downtime. Average sales margins improved significantly, reflecting higher average sales price for both fluff pulp and market pulp. Operating costs were higher due to inflation. Distribution costs also increased. Planned maintenance downtime costs in the third quarter of 2022 were $26 million lower compared with the second quarter of 2022. Input costs were higher, primarily for wood and chemicals. Second quarter 2022 results were impacted by some favorable one-time items that did not repeat in the third quarter.
Compared with the third quarter of 2021, sales volumes in the third quarter of 2022 were flat as higher sales volumes for fluff pulp were mostly offset by lower sales volumes for market pulp reflecting continued logistics challenges. Total maintenance and economic downtime was about 2,000 short tons higher in the third quarter of 2022, due to maintenance downtime. Average sales prices were higher for both fluff and market pulp. Operating costs were higher due to continued logistics challenges and inflation. Distribution costs were also higher. Planned maintenance downtime costs in the third quarter of 2022 were $1 million lower compared with the third quarter of 2021. Input costs were higher primarily for energy, chemicals, wood and freight.
Entering the fourth quarter of 2022, sales volumes are expected to be lower. Average sales margins are expected to be higher. Planned maintenance downtime costs in the fourth quarter of 2022 are expected to be $34 million higher compared with the third quarter of 2022. Operating costs are expected to be lower. Input costs are expected to be higher.
Equity Earnings, Net of Taxes – Ilim
International Paper accounts for its 50% equity interest in Ilim using the equity method of accounting. Ilim is a separate reportable industry segment with primary operations in Russia. During the first quarter of 2022, the Company announced its intention to explore strategic options, including a sale of its 50% ownership in Ilim. The Company recorded equity earnings, net
of taxes, of $64 million in the third quarter of 2022, compared with $95 million in the second quarter of 2022 and $95 million in the third quarter of 2021.
Compared with the second quarter of 2022, sales volumes in the third quarter of 2022 were 3% higher led by hardwood pulp shipments to China and other export markets, and shipments of containerboard in Russia, but were partially offset by lower shipments of containerboard to other export markets. Softwood pulp shipments to China and in Russia were higher but were offset by lower shipments of softwood pulp to other export markets. Average sales prices for containerboard decreased in all markets. Average sales prices for softwood pulp and hardwood pulp were sequentially higher in China and Russia. Costs primarily for wood increased while fuel and energy costs were lower. Distribution costs decreased. Planned mill maintenance outage costs were lower.
Compared with the third quarter of 2021, sales volumes in the third quarter of 2022 were 8% higher overall, driven by shipments of softwood pulp, hardwood pulp and containerboard to China and Russia. Shipments to other export markets declined sharply for softwood pulp and containerboard. Average sales margins for softwood pulp and hardwood pulp increased reflecting higher average sales prices in China and Russia. Average sales prices for containerboard decreased in Russia and in China. Costs of wood, chemicals and labor increased due to inflation. Transportation costs were also higher, partially driven by inflation and the change of shipping routes due to restrictions. Planned mill maintenance outage costs were lower.
Looking forward to the fourth quarter of 2022, sales volumes are expected to be lower due to continued logistics challenges impacting export shipments. Average sales margins are projected to decrease, primarily for containerboard. Input costs for wood are expected to be seasonally higher, but transportation costs are expected to decline. Repair and maintenance costs are projected to be higher.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operations totaled $1.4 billion for the first nine months of 2022, compared with $1.9 billion for the comparable 2021 nine-month period.
Investments in capital projects, net of insurance recoveries, totaled $609 million in the first nine months of 2022, compared to $348 million in the first nine months of 2021. Full-year 2022 capital spending is currently expected to be approximately $900 million to $1.0 billion, or 86% to 95% of depreciation and amortization.
Financing activities for the first nine months of 2022 included a $202 million net decrease in debt versus a $379 million net increase in debt during the comparable 2021 nine-month period.
See Note 17 - Debt of Item 1. Financial Statements for a discussion of various debt-related actions taken by the Company during the third quarter of 2022, including the tender offer completed by the Company.
Amounts related to early debt extinguishment during the three and nine months ended September 30, 2022 and 2021 were as follows:
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||||
| In millions | 2022 | 2021 | 2022 | 2021 | |||||||||||||||||||
| Early debt reductions (a) | $ | 498 | $ | 200 | $ | 503 | $ | 1,097 | |||||||||||||||
| Pre-tax early debt extinguishment (gain) loss, net | 93 | 35 | 93 | 223 |
(a)Reductions related to notes with interest rates ranging from 6.40% to 8.70% with original maturities from 2023 to 2039 and 3.55% with original maturities of 2029 for the three month ended September 30, 2022 and 2021, respectively, and from 4.35% to 8.70% with original maturities from 2023 to 2048 and from 3.00% to 5.15% with original maturities from 2027 to 2048 for the nine months ended September 30, 2022 and 2021, respectively.
At September 30, 2022, contractual obligations for future payments of debt maturities (including finance lease liabilities disclosed in Note 11 - Leases and excluding the timber monetization structure disclosed in Note 16 - Variable Interest Entities) by calendar year were as follows: $356 million in 2022; $352 million in 2023; $149 million in 2024; $192 million in 2025; $74 million in 2026; and $4.3 billion thereafter.
Maintaining an investment-grade credit rating is an important element of International Paper’s financing strategy. At September 30, 2022, the Company held long-term credit ratings of BBB (stable outlook) and Baa2 (stable outlook) by S&P and Moody’s, respectively. In addition, the Company held short-term credit ratings of A2 and P2 by S&P and Moody's, respectively, for borrowings under the Company's commercial paper program.
At September 30, 2022, International Paper’s credit agreements totaled $2.0 billion, which is comprised of the $1.5 billion contractually committed bank credit agreement and up to $500 million under the receivables securitization program. Management believes these credit agreements are adequate to cover expected operating cash flow variability during the current economic cycle. The credit agreements generally provide for interest rates at a floating rate index plus a pre-determined margin dependent upon International Paper’s credit rating. At September 30, 2022, the Company had no borrowings outstanding under the $1.5 billion credit agreement or the $500 million receivables securitization program. The Company’s credit agreements are not subject to any restrictive covenants other than the financial covenants as disclosed in Note 17 - Debt, and the borrowings under the receivables securitization program being limited by eligible receivables. The Company was in compliance with all its debt covenants at September 30, 2022 and was well below the thresholds stipulated under the covenants as defined in the credit agreements. Further the financial covenants do not restrict any borrowings under the credit agreements.
In addition to the $2.0 billion capacity under the Company's credit agreements, International Paper has a commercial paper program with a borrowing capacity of $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 September 30, 2022, the Company had $260 million outstanding under the program with remaining capacity available of $740 million. As of September 30, 2022, the remaining credit agreement capacity was $1.2 billion.
International Paper expects to be able to meet projected capital expenditures, service existing debt, meet working capital and dividend requirements and make common stock and/or debt repurchases for the next 12 months and for the foreseeable future thereafter with current cash balances and cash from operations, supplemented as required by its existing credit facilities. The Company will continue to rely on debt and capital markets for the majority of any necessary long-term funding not provided by operating cash flows. Funding decisions will be guided by our capital structure planning objectives. The primary goals of the Company’s capital structure planning are to maximize financial flexibility and maintain appropriate levels of liquidity to meet our needs while managing balance sheet debt and interest expense, and we have repurchased, and may continue to repurchase, our common stock (under our existing share repurchase program) and debt (including in open market purchases) to the extent consistent with this capital structure planning. The majority of International Paper’s debt is accessed through global public capital markets where we have a wide base of investors.
During the first nine months of 2022, International Paper used 1.5 million shares of treasury stock for various incentive plans. International Paper also acquired 24.4 million shares of treasury stock, including restricted stock tax withholdings. Repurchases of common stock and payments of restricted stock withholding taxes totaled $1.09 billion, including $1.07 billion related to shares repurchased under the Company's repurchase program. On October 11, 2022, the Company’s Board of Directors authorized the Company to acquire up to an additional $1.5 billion of the Company’s common stock. This new authorization is in addition to $1.85 billion remaining as of September 30, 2022 from a previous repurchase authorization. Thus, our current share repurchase program, which does not have an expiration date, has approximately $3.35 billion aggregate amount of shares of common stock remaining authorized for purchase.
During the first nine months of 2021, International Paper used approximately 1.8 million shares of treasury stock for various incentive plans. International Paper also acquired 7.7 million shares of treasury stock, including restricted stock tax withholding. Repurchases of common stock and payments of restricted stock withholding taxes totaled $425 million, including $398 million related to shares repurchased under the Company's repurchase program.
Cash dividend payments related to common stock totaled $509 million and $602 million for the first nine months of 2022 and 2021, respectively. Dividends were $1.3875 per share and $1.5375 per share for the first nine months in 2022 and 2021, respectively.
Our pension plan is currently sufficiently funded and we do not anticipate any required contributions for the next 12 months.
Variable Interest Entities
Information concerning variable interest entities is set forth in Note 15 in the Company's Annual Report on Form 10-K for the year ended December 31, 2021. In connection with the 2006 International Paper installment sale of forestlands, we received $4.8 billion of installment notes. The restructured variable interest entities held installment notes of $4.8 billion and third-party loans of $4.2 billion which both matured in August 2021. We settled the third-party loans at their maturity with the proceeds from the installment notes. On September 2, 2022, the Company and the Internal Revenue Service agreed to settle the previously disclosed timber monetization restructuring tax matter. Under this agreement, the Company will fully resolve the matter and pay $252 million in U.S. federal income taxes. As a result, interest will also be charged upon closing of the audit. The amount of interest expense recognized through September 30, 2022 is $52 million. As of September 30, 2022, $89 million
in U.S. federal income taxes and $28 million in interest expense have been paid as a result of the settlement agreement. The remaining $163 million U.S. federal income tax liability and $24 million accrued interest liability are recorded as current liabilities in the balance sheet. The reversal of the Company’s remaining deferred tax liability associated with the 2015 Financing Entities of $604 million was recognized as a one-time tax benefit in the third quarter of 2022.
Ilim S.A. Shareholders’ Agreement
We continue to actively explore strategic options with respect to the Ilim joint venture, including a sale of our 50% equity interest in Ilim. While we may sell our equity interests in the Ilim joint venture 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 the timing of any such sales.
CRITICAL ACCOUNTING POLICIES AND SIGNIFICANT ACCOUNTING ESTIMATES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires International Paper to establish accounting policies and to make estimates that affect both the amounts and timing of the recording of assets, liabilities, revenues and expenses. Some of these estimates require judgments about matters that are inherently uncertain.
Accounting policies whose application may have a significant effect on the reported results of operations and financial position of International Paper, and that can require judgments by management that affect their application, include accounting for contingencies, impairment or disposal of long-lived assets, goodwill and other intangible assets, pensions and income taxes.
As of September 30, 2022, our EMEA packaging reporting unit had a goodwill balance of $76 million. Our 2021 annual goodwill impairment test for the EMEA Packaging reporting unit indicated that the fair value exceeded the carrying amount by 28%. Certain macroeconomic conditions continue to be challenging, including assessing the impacts from inflation and the geopolitical environment. We will continue to evaluate these macroeconomic conditions and their overall longer-term impact on the business and on the reporting unit’s fair value.
The Company has included in its Annual Report a discussion of these critical accounting policies, which are important to the portrayal of the Company’s financial condition and results of operations and require management’s judgments. The Company has not made any changes in these critical accounting policies during the first nine months of 2022.
FORWARD-LOOKING STATEMENTS
Certain statements in this Quarterly Report on Form 10-Q that are not historical in nature may be considered “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as “expects,” “anticipates,” “believes,” “estimates” and similar expressions identify forward-looking statements. These statements are not guarantees of future performance and reflect management’s current views and are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied in these statements. Factors which could cause actual results to differ include but are not limited to: (i) risks with respect to climate change and global, regional, and local weather conditions, as well as risks related to our ability to meet targets and goals with respect to climate change and the emission of GHGs and other environmental, social and governance matters; (ii) the impact of the conflict involving Russia and Ukraine, including in connection with related escalated sanctions imposed by the United States, the European Union, G7 and other countries and possible actions by the Russian government, and the impact of such developments on domestic and global economic and geopolitical conditions in general and on us and our Ilim joint venture, which could be materially and adversely affected by such developments, and our inability to predict the full impact of the Russian invasion of Ukraine, current or future sanctions, geopolitical instability and the possibility of broadened military conflict on our Ilim joint venture and on our receipt of dividends from our Ilim joint venture; (iii ) the level of our indebtedness and changes in interest rates; (iv) the impact of global and domestic economic conditions and industry conditions, including with respect to commercial activity, inflationary pressures and changes in the cost or availability of raw materials, energy sources and transportation sources, supply chain shortages and disruptions, the availability of labor, particularly in light of current labor market conditions which are exceptionally tight, competition we face, cyclicality and changes in consumer preferences, demand and pricing for our products, and conditions impacting the credit, capital and financial markets; (v) domestic and global geopolitical conditions, changes in currency exchange rates, trade protectionist policies, downgrades in our credit ratings, and/or the credit ratings of banks issuing certain letters of credit, issued by recognized credit rating organizations; (vi) the amount of our future pension funding obligations, and pension and healthcare costs; (vii) unanticipated expenditures or other adverse developments related to compliance with existing and new environmental, tax, labor and employment, privacy, anti-bribery and anti-corruption, and
other U.S. and non-U.S. governmental laws and regulations; (viii) any material disruption at any of our manufacturing facilities or other adverse impact on our operations due to severe weather, natural disasters, climate change or other causes; (ix) risks inherent in conducting business through joint ventures; (x) our ability to achieve the benefits expected from, and other risks associated with, acquisitions, joint ventures, divestitures, spinoffs and other corporate transactions, (xi) cybersecurity and information technology risks; (xii) loss contingencies and pending, threatened or future litigation, including with respect to environmental related matters; (xiii) our exposure to claims under our agreements with Sylvamo Corporation; (xiv) our failure to realize the anticipated benefits of the spin-off of Sylvamo Corporation and the qualification of such spin-off as a tax-free transaction for U.S. federal income tax purposes; and (xv) our ability to attract and retain qualified personnel. These and other factors that could cause or contribute to actual results differing materially from such forward-looking statements can be found in our press releases and SEC filings. In addition, other risks and uncertainties not presently known to the Company or that we currently believe to be immaterial could affect the accuracy of any forward-looking statements. The Company undertakes no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.
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