SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[x] Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the Quarterly Period
Ended September 28, 2002
OR
[ ] Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the Transition Period
From to
Commission File Number 001-08634
Temple-Inland Inc.
(Exact name or registrant as specified in its charter)
Delaware 75-1903917
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1300 South MoPac Expressway, Austin, Texas 78746
(Address of principal executive offices) (Zip Code)
(512) 434-5800
(Registrant's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year,
if changed since last report.)
Indicate whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the registrant was required to file such
reports), and (2) has been subject to the filing requirements for
the past 90 days. Yes X No
Indicate whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes x No
Indicate the number of shares outstanding of each of the
issuer's classes of common stock, as of the latest practicable
date:
Number of common shares outstanding
Class as of September 28, 2002
Common Stock (par
value $1.00 per share) 53,717,073
Page 1 of 73 pages The Exhibit Index is page 49.
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SUMMARIZED STATEMENTS OF INCOME
PARENT COMPANY (TEMPLE-INLAND INC.)
Unaudited
Third Quarter First Nine
Months
2002 2001 2002 2001
(in millions)
NET REVENUES $ 874 $ 736 $ 2,542 $ 2,136
COSTS AND EXPENSES
Cost of sales 782 632 2,234 1,867
Selling and administrative 74 69 226 202
Other operating expense - (10) 6 (10)
----- ----- ----- -----
856 691 2,466 2,059
----- ----- ----- -----
MANUFACTURING INCOME 18 45 76 77
FINANCIAL SERVICES INCOME 44 43 108 134
----- ----- ----- -----
OPERATING INCOME 62 88 184 211
Interest expense (36) (23) (97) (76)
Other expense - - (11) -
----- ----- ----- -----
INCOME FROM CONTINUING
OPERATIONS BEFORE TAXES 26 65 76 135
Income taxes (11) (21) (30) (50)
----- ----- ----- -----
INCOME FROM CONTINUING
OPERATIONS 15 44 46 85
Discontinued operations - - (1) -
----- ----- ----- -----
INCOME BEFORE ACCOUNTING CHANGE 15 44 45 85
Effect of accounting change - - (11) (2)
----- ----- ----- -----
NET INCOME $ 15 $ 44 $ 34 $ 83
===== ===== ===== =====
See notes to consolidated financial statements.
3
SUMMARIZED BALANCE SHEETS
PARENT COMPANY (TEMPLE-INLAND INC.)
Unaudited
Third
Quarter Year End
2002 2001
(in millions)
ASSETS
Current Assets
Cash and cash equivalents $ 14 $ 3
Receivables, net of allowances of $13 in
2002 and $11 in 2001 401 288
Inventories:
Work in process and finished goods 67 53
Raw materials and supplies 293 205
----- -----
360 258
Prepaid expenses and other 80 73
----- -----
Total current assets 855 622
Investment in Temple-Inland Financial Services 1,150 1,142
Property and Equipment
Property and equipment 4,168 3,505
Less allowances for depreciation (2,057) (1,935)
----- -----
2,111 1,570
Timber and timberlands - less depletion 507 515
----- -----
Total property and equipment 2,618 2,085
Goodwill 177 62
Assets of Discontinued Operations 84 -
Other Assets 213 210
----- -----
Total Assets $ 5,097 $ 4,121
===== =====
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable $ 197 $ 128
Current portion of long-term debt 8 1
Other current liabilities 255 197
Liabilities of discontinued operations 33 21
----- -----
Total current liabilities 493 347
Long-Term Debt 1,961 1,339
Deferred Income Taxes 315 310
Postretirement Benefits 146 142
Other Long-Term liabilities 114 87
Shareholders' Equity 2,068 1,896
----- -----
Total Liabilities and Shareholders' Equity $ 5,097 $ 4,121
===== =====
See notes to consolidated financial statements.
4
SUMMARIZED STATEMENTS OF CASH FLOWS
PARENT COMPANY (TEMPLE-INLAND INC.)
Unaudited
First Nine
Months
2002 2001
(in millions)
CASH PROVIDED BY (USED FOR) OPERATIONS
Net income $ 34 $ 83
Adjustments:
Depreciation and depletion 164 136
Amortization of goodwill - 3
Depreciation of leased property 2 2
Unamortized financing fees 11 -
Other operating expense 6 (5)
Non-cash compensation 8 3
Deferred income taxes 25 21
Unremitted earnings from financial services (108) (123)
Dividends from financial services 100 80
Working capital changes, net (57) 16
Net assets of discontinued operations 16 -
Loss from discontinued operations 1 -
Cumulative effect of accounting change 11 2
Other 39 (12)
----- -----
252 206
===== =====
CASH PROVIDED BY (USED FOR) INVESTMENTS
Capital expenditures (81) (154)
Acquisition of Gaylord, net of cash acquired (569) -
Other acquisitions and joint ventures (40) (146)
Sale of non-strategic assets and operations 33 -
Other (3) 64
----- -----
(660) (236)
----- -----
CASH PROVIDED BY (USED FOR) FINANCING
Bridge financing facility 880 -
Payment of bridge financing facility (880) -
Payment of assumed Gaylord bank debt (285) -
Sale of common stock 215 -
Sale of Upper DECS 345 -
Sale of Senior Notes 496 -
Additions to debt 31 275
Payments of debt (310) (204)
Cash dividends paid to shareholders (50) (47)
Other (22) 5
----- -----
420 29
----- -----
Effect of exchange rate changes on cash (1) 1
----- -----
Net increase (decrease) in cash and cash
equivalents 11 -
Cash and cash equivalents at beginning of period 3 2
----- -----
Cash and cash equivalents at end of period $ 14 $ 2
===== =====
See notes to consolidated financial statements.
5
SUMMARIZED STATEMENTS OF INCOME
FINANCIAL SERVICES GROUP
Unaudited
First Nine
Third Quarter Months
2002 2001 2002 2001
(in millions)
INTEREST INCOME
Loans receivable and mortgage
loans held for sale $ 143 $ 190 $ 431 $ 633
Securities and other 54 45 141 154
----- ----- ----- -----
Total interest income 197 235 572 787
----- ----- ----- -----
INTEREST EXPENSE
Deposits 58 92 181 321
Borrowed funds 44 44 113 163
----- ----- ----- -----
Total interest expense 102 136 294 484
----- ----- ----- -----
NET INTEREST INCOME 95 99 278 303
Provision for loan losses (8) (8) (37) (39)
----- ----- ----- -----
NET INTEREST INCOME AFTER
PROVISION FOR LOAN LOSSES 87 91 241 264
NONINTEREST INCOME
Loan origination, marketing
and servicing fees, net 42 35 128 89
Real estate and other 55 51 156 160
----- ----- ----- -----
Total noninterest income 97 86 284 249
----- ----- ----- -----
NONINTEREST EXPENSE
Compensation and benefits 76 65 218 167
Real estate and other 64 69 192 212
Severance and asset write-offs - - 7 -
----- ----- ----- -----
Total noninterest expense 140 134 417 379
----- ----- ----- -----
INCOME BEFORE TAXES 44 43 108 134
Income taxes 7 (4) - (11)
----- ----- ----- -----
INCOME BEFORE ACCOUNTING CHANGE 51 39 108 123
Effect of accounting change - - - (1)
----- ----- ----- -----
NET INCOME $ 51 $ 39 $ 108 $ 122
===== ===== ===== =====
See notes to consolidated financial statements.
6
SUMMARIZED BALANCE SHEETS
FINANCIAL SERVICES GROUP
Unaudited
Third Year End
Quarter
2002 2001
(in millions)
ASSETS
Cash and cash equivalents $ 374 $ 587
Mortgage loans held for sale 975 958
Loans receivable, net of allowance
for losses of $141 in 2002 and $139 in 2001 9,744 9,847
Securities available-for-sale 2,112 2,599
Securities held-to-maturity 3,646 775
Mortgage servicing rights 119 156
Real estate 249 240
Goodwill 141 126
Accrued interest and other receivables 154 160
Property and equipment, net 159 166
Other assets 157 124
------ ------
TOTAL ASSETS $ 17,830 $ 15,738
====== ======
LIABILITIES
Deposits $ 9,241 $ 9,030
Federal Home Loan Bank advances 3,372 3,435
Securities sold under repurchase agreements 2,578 1,107
Other borrowings 223 214
Trade date securities 469 -
Other liabilities 490 504
Stock issued by subsidiaries 307 306
------ ------
TOTAL LIABILITIES 16,680 14,596
------ ------
SHAREHOLDER'S EQUITY 1,150 1,142
------ ------
TOTAL LIABILITIES AND SHAREHOLDER' EQUITY $ 17,830 $ 15,738
====== ======
See notes to consolidated financial statements.
7
SUMMARIZED STATEMENTS OF CASH FLOWS
FINANCIAL SERVICES GROUP
Unaudited
First Nine Months
2002 2001
(in millions)
CASH PROVIDED BY (USED FOR) OPERATIONS
Net income $ 108 $ 122
Adjustments:
Depreciation 18 17
Amortization of goodwill - 5
Depreciation of leased property 8 7
Amortization and accretion of financial instruments 38 23
Provision for loan losses 37 39
Deferred income taxes 2 (7)
Loans held for sale -
Originations (5,403) (4,347)
Sales 5,386 3,801
Collections on loans serviced for others, net (78) 74
Originated mortgage servicing rights (34) (64)
Cumulative effect of accounting change - 1
Other 17 72
------ ------
99 (257)
------ ------
CASH PROVIDED BY (USED FOR) INVESTMENTS
Maturities of securities available-for-sale 573 651
Purchases of securities available-for-sale (22) (47)
Maturities of securities held-to-maturity 191 -
Purchases of securities held-to-maturity (2,599) -
Loans originated or acquired, net of
principal collected 1 (357)
Capital expenditures (11) (18)
Acquisitions, net of cash acquired 358 (62)
Sales of loans 11 495
Sale of mortgage servicing rights 33 108
Other 3 46
------ ------
(1,462) 816
------ ------
CASH PROVIDED BY (USED FOR) FINANCING
Net increase (decrease) in deposits (272) (847)
Securities sold under repurchase agreements,
short-term FHLB advances and borrowings, net (685) 337
Additions to debt and long-term FHLB advances 2,335 33
Payments of debt and long-term FHLB advances (232) (20)
Dividends paid to parent company (100) (80)
Purchase of deposits 104 -
Other - (73)
------ ------
1,150 (650)
------ ------
Net increase (decrease) in cash and cash (213) (91)
Cash and cash equivalents at beginning of period 587 320
------ ------
Cash and cash equivalents at end of period $ 374 $ 229
====== ======
See notes to consolidated financial statements.
8
CONSOLIDATED STATEMENTS OF INCOME
TEMPLE-INLAND INC. AND
SUBSIDIARIES
Unaudited
Third Quarter First Nine Months
2002 2001 2002 2001
(in millions, except per share amounts)
REVENUES
Manufacturing $ 874 $ 736 $ 2,542 $ 2,136
Financial Services 294 321 856 1,036
----- ----- ----- -----
1,168 1,057 3,398 3,172
----- ----- ----- -----
COSTS AND EXPENSES
Manufacturing 856 691 2,466 2,059
Financial Services 250 278 748 902
----- ----- ----- -----
1,106 969 3,214 2,961
----- ----- ----- -----
OPERATING INCOME 62 88 184 211
Parent company interest (36) (23) (97) (76)
Other income (expense), - - (11) -
----- ----- ----- -----
INCOME BEFORE TAXES 26 65 76 135
Income taxes (11) (21) (30) (50)
----- ----- ----- -----
INCOME FROM CONTINUING 15 44 46 85
Discontinued operations - - (1) -
----- ----- ----- -----
INCOME BEFORE ACCOUNTING CHANGE 15 44 45 85
Effect of accounting change - - (11) (2)
----- ----- ----- -----
NET INCOME $ 15 $ 44 $ 34 $ 83
===== ===== ===== =====
EARNINGS PER SHARE
Basic:
Income from continuing
operations $ 0.28 $ 0.90 $ 0.89 $ 1.72
Discontinued operations - - (0.02) -
Effect of accounting change - - (0.21) (0.04)
----- ----- ----- -----
Net income $ 0.28 $ 0.90 $ 0.66 $ 1.68
===== ===== ===== =====
Diluted:
Income from continuing
operations $ 0.28 $ 0.90 $ 0.89 $ 1.72
Discontinued operations - - (0.02) -
Effect of accounting change - - (0.21) (0.04)
----- ----- ----- -----
Net income $ 0.28 $ 0.90 $ 0.66 $ 1.68
===== ===== ===== =====
DIVIDENDS PAID PER SHARE OF
COMMON STOCK $ 0.32 $ 0.32 $ 0.96 $ 0.96
===== ===== ===== =====
See notes to consolidated financial statements.
9
CONSOLIDATING BALANCE SHEETS
TEMPLE-INLAND INC. AND SUBSIDIARIES
Third Quarter 2002
Unaudited
Parent Financial
Company Services Consolidated
(in millions)
ASSETS
Cash and cash equivalents $ 14 $ 374 $ 388
Mortgage loans held for sale - 975 975
Loans receivable, net - 9,744 9,744
Securities available-for-sale - 2,112 2,112
Securities held-to-maturity - 3,646 3,646
Trade receivables 401 - 401
Inventories 360 - 360
Property and equipment 2,618 159 2,777
Goodwill 177 141 318
Assets of discontinued operations 84 - 84
Other assets 293 679 940
Investment in Financial Services 1,150 - -
----- ------ ------
TOTAL ASSETS $ 5,097 $ 17,830 $ 21,745
===== ====== ======
LIABILITIES
Deposits $ - $ 9,241 $ 9,241
Securities sold under repurchase agreements - 2,578 2,578
Federal Home Loan Bank advances - 3,372 3,372
Trade date securities - 469 469
Other liabilities 607 490 1,074
Long-term debt 1,961 223 2,184
Deferred income taxes 315 - 306
Postretirement benefits 146 - 146
Stock issued by subsidiaries - 307 307
----- ------ ------
TOTAL LIABILITIES $ 3,029 $ 16,680 $ 19,677
----- ------ ------
SHAREHOLDERS' EQUITY
Preferred stock - par value $1 per share:
authorized 25,000,000 shares; none issued -
Common stock - par value $1 per share;
authorized 200,000,000 shares; issued 61,389,552 shares
including shares held in the treasury 61
Additional paid-in capital 367
Accumulated other comprehensive income (loss) (10)
Retained earnings 1,998
-----
2,416
Cost of shares held in the treasury: 7,672,479 shares (348)
-----
TOTAL SHAREHOLDERS' EQUITY 2,068
-----
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 21,745
======
See the notes to the consolidated financial statements.
10
CONSOLIDATING BALANCE SHEETS
TEMPLE-INLAND INC. AND SUBSIDIARIES
Year End 2001
Parent Financial
Company Services Consolidated
(in millions)
ASSETS
Cash and cash equivalents $ 3 $ 587 $ 590
Mortgage loans held for sale - 958 958
Loans receivable, net - 9,847 9,847
Securities available-for-sale - 2,599 2,599
Securities held-to-maturity - 775 775
Trade receivables 288 - 288
Inventories 258 - 258
Property and equipment 2,085 166 2,251
Goodwill 62 126 188
Other assets 283 680 933
Investment in Financial Services 1,142 - -
----- ------ ------
TOTAL ASSETS $ 4,121 $ 15,738 $ 18,687
===== ====== ======
LIABILITIES
Deposits $ - $ 9,030 $ 9,030
Federal Home Loan Bank advances - 3,435 3,435
Securities sold under repurchase agreements - 1,107 1,107
Other liabilities 434 504 914
Long-term debt 1,339 214 1,553
Deferred income taxes 310 - 304
Postretirement benefits 142 - 142
Stock issued by subsidiaries - 306 306
----- ------ ------
TOTAL LIABILITIES $ 2,225 $ 14,596 $ 16,791
----- ------ ------
SHAREHOLDERS' EQUITY
Preferred stock - par value $1 per share:
authorized 25,000,000 shares; none issued -
Common stock - par value $1 per share;
authorized 200,000,000 shares; issued 61,389,552 shares
including shares held in the treasury 61
Additional paid-in capital 367
Accumulated other comprehensive income (loss) (1)
Retained earnings 2,014
-----
2,441
Cost of shares held in the treasury: 12,030,402 shares (545)
-----
TOTAL SHAREHOLDERS' EQUITY 1,896
-----
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 18,687
======
See the notes to the consolidated financial statements.
11
CONSOLIDATED STATEMENT OF CASH FLOWS
TEMPLE-INLAND INC. AND SUBSIDIARIES
Unaudited
First Nine Months
2002 2001
(in millions)
CASH PROVIDED (USED FOR) OPERATIONS
Net income $ 34 $ 83
Adjustments:
Depreciation and depletion 182 153
Provision for loan losses 37 39
Amortization of goodwill - 8
Depreciation of leased property 10 9
Deferred income taxes 27 14
Deferred financing fees 11 -
Amortization and accretion of financial 38 23
Loans held for sale
Originations (5,403) (4,347)
Sales 5,386 3,801
Working capital changes, net (57) 16
Collections on loans serviced for others, (78) 74
Originated mortgage servicing rights (34) (64)
Net assets of discontinued operations 16 -
Loss from discontinued operations 1 -
Cumulative effect of accounting change 11 2
Other income (expense) 6 (5)
Other 64 63
----- -----
251 (131)
----- -----
CASH PROVIDED BY (USED FOR) INVESTMENTS
Capital expenditures for property and equipment (92) (172)
Maturities of securities available-for-sale 573 651
Maturities and redemptions of securities held-to-
maturity 191 -
Purchases of securities held-to-maturity (2,599) -
Purchases of securities available-for-sale (22) (47)
Loans originated or acquired, net of
principal collected 1 (357)
Acquisitions, net of cash acquired (251) (208)
Sales of loans 11 495
Sale of servicing rights 33 108
Other 33 110
----- -----
(2,122) 580
----- -----
CASH PROVIDED BY (USED FOR) FINANCING
Net increase (decrease) in deposits (272) (847)
Bridge financing facility 880 -
Payment of bridge financing facility (880) -
Payment of assumed Gaylord bank debt (285) -
Sale of common stock, Upper DECS and Senior Notes 1,056 -
Additions to debt 2,366 308
Payments of debt (542) (224)
Securities sold under repurchase agreements
and short-term borrowings, net (685) 337
Cash dividends paid to shareholders (50) (47)
Purchase of deposits 104 -
Other (22) (68)
----- -----
1,670 (541)
----- -----
Effect of exchange rate changes on cash (1) 1
----- -----
Net increase (decrease) in cash and cash equivalents (202) (91)
Cash and cash equivalents at beginning of period 590 322
----- -----
Cash and cash equivalents at end of period $ 388 $ 231
===== =====
See the notes to the consolidated financial statements.
12
TEMPLE-INLAND INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
NOTE A - BASIS OF PRESENTATION
The accompanying unaudited interim financial statements have been
prepared in accordance with generally accepted accounting
principles for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X.
Therefore, these statements do not include all of the information
and footnotes required by generally accepted accounting
principles for complete financial statements. However, in the
opinion of management, all adjustments (consisting of normal
accruals and the acquisition related accruals described in Note
F) considered necessary for a fair presentation have been
included. Interim operating results are not necessarily
indicative of the results that may be expected for the entire
year. For further information, refer to the financial statements
and footnotes included in the Annual Report on Form 10-K of
Temple-Inland Inc. (the "company") for the fiscal year ended
December 29, 2001.
The consolidated financial statements include the accounts of the
company and its manufacturing and financial services
subsidiaries. The consolidated net assets invested in financial
services activities are subject, in varying degrees, to
regulatory rules and restrictions including restrictions on the
payment of dividends to the company. Accordingly, included as an
integral part of the consolidated financial statements are
separate summarized financial statements for the company's
manufacturing and financial services groups.
The Parent Company (Temple-Inland Inc.) summarized financial
statements include the accounts of the company and its
manufacturing subsidiaries (the parent company). The net assets
invested in the Financial Services Group are reflected in the
summarized financial statements on the equity basis. Related
earnings, however, are presented before tax to be consistent with
the consolidated financial statements. These financial
statements should be read in conjunction with the Temple-Inland
Inc. consolidated financial statements and the Temple-Inland
Financial Services summarized financial statements.
All material intercompany amounts and transactions have been
eliminated. Certain amounts have been reclassified to conform to
current year's classifications.
13
NOTE B - EARNINGS PER SHARE
Denominators used in computing earnings per share are as follows:
Third Quarter First Nine
Months
2002 2001 2002 2001
(In millions)
Denominator for basic earnings per
share:
Weighted average common shares
outstanding 53.7 49.3 51.8 49.3
Dilutive effect of:
Equity purchase contracts - - - -
Stock options - - 0.1 -
----- ----- ----- -----
Denominator for diluted earnings
per share 53.7 49.3 51.9 49.3
===== ===== ===== =====
NOTE C - COMPREHENSIVE INCOME
Comprehensive income consists of:
Third Quarter First Nine
Months
2002 2001 2002 2001
(in millions)
Net income $ 15 $ 44 $ 34 $ 83
Other comprehensive income, net of
income taxes:
Effect of adopting SFAS No. 133-
Unrealized losses on held-to-
maturity securities re-designated
as available-for-sale securities - - - (16)
Unrealized losses on derivative
instruments classified as cash
flow hedges - - - (4)
----- ----- ----- -----
- - - (20)
Unrealized gains (losses) on:
Available-for-sale securities 1 5 - 32
Derivative instruments (2) 1 (2) 1
Currency translation adjustments (1) (3) (7) (1)
----- ----- ----- -----
Other comprehensive income (2) 3 (9) 12
----- ----- ----- -----
Comprehensive income $ 13 $ 47 $ 25 $ 95
===== ===== ===== =====
At third quarter-end 2002, the aggregate fair value of all
derivative instruments was a $9 million liability, consisting of
a $9 million liability for an interest rate swap and an
offsetting $1 million asset and a $1 million liability related to
linerboard and OCC derivatives. During the third quarter 2002,
neither the ineffective portion of these derivative instruments
charged to earnings nor the amounts reclassified from other
comprehensive income into earnings was material.
14
NOTE D - SEGMENT INFORMATION
The company has three reportable segments: Paper, Building
Products and Financial Services.
Building Financial Corporate
(in millions) Paper Products Services and Other Total
For the third quarter 2002
Revenues from external customers $ 672 $ 202 $ 294 $ - $ 1,168
Depreciation, depletion and
amortization 38 16 9 3 66
Operating income 14 12 44 (8) 62
Financial Services, net
interest income - - 95 - 95
- -----------------------------------------------------------------------------------------
For the first nine months 2002 or
at third quarter end 2002
- ---------------------------------
Revenues from external customers $1,932 $ 610 $ 856 $ - $ 3,398
Depreciation depletion and
amortization 115 46 26 5 192
Operating Income 65 43 115 (39)184
Financial Services, net
interest income - - 278 - 278
Total assets 2,681 1,188 17,830 46 21,745
Goodwill 177 - 141 - 318
- -----------------------------------------------------------------------------------------
For the third quarter 2001
- --------------------------
Revenues from external customers $ 534 $ 202 $ 321 $ - $ 1,057
Depreciation, depletion and
amortization 30 17 6 1 54
Operating income 31 17 43 (3)88
Financial Services, net
interest income - - 99 - 99
- -----------------------------------------------------------------------------------------
For the first nine months 2001 or
at third quarter end 2001
- ---------------------------------
Revenues from external customers $1,575 $ 561 $1,036 $ - $3,172
Depreciation, depletion and
amortization 89 48 29 4 170
Operating income 80 17 134 (20)211
Financial Services, net
interest income - - 303 - 303
Total assets 1,738 1,160 14,948 40 17,886
Goodwill 53 - 124 - 177
- -----------------------------------------------------------------------------------------
Includes other expense of $13 million, of which $7 million
is related to the severance and write-off of technology
investments, which applies to the Financial Services Group, and
$6 million related to the repurchase of notes sold with recourse,
which applies to the Paper Group.
Includes other expense of $15 million, of which $11 million
applies to the Paper Group and $4 million to corporate, and other
income of $20 million, which applies to the Building Products
Group.
NOTE E - CONTINGENCIES
As previously disclosed, Gaylord Container Corporation and
Gaylord Chemical Corporation entered into a settlement agreement
with respect to claims arising out of an October 23, 1995 rail
tank car explosion in Bogalusa, Louisiana. The settlement
agreement was extended during the second quarter 2002, and a
hearing for preliminary approval of the settlement is expected to
be scheduled by year-end 2002.
As previously disclosed, the paper group is involved in a
contract dispute with Southern California Edison related to the
group's co-generation facility in Ontario, California. The paper
15
group has collected all amounts due to it under its power
purchase contract with Southern California Edison. The parties,
however, remain in litigation concerning, among other things,
termination of their contract and the rights of the paper group
to sell its excess generating capacity to third parties.
On July 22, 2002, a delivery driver for a chemical supply company
overfilled a storage tank for caustic soda at a Gaylord Container
Corporation converting facility in Tipton, Indiana. The excess
caustic soda drained through an overflow pipe into the city sewer
system, resulting in a temporary shutdown of the city wastewater
treatment plant and killing approximately 2,000 fish in a local
creek. Gaylord has removed the fish, assisted in restoring
operations at the wastewater treatment plant, and taken other
corrective actions to assure no ongoing effect to human health or
the environment. The incident is being investigated by the U.S.
Environmental Protection Agency and the Indiana Department of
Natural Resources, with the cooperation of the company. At this
time, the company is not able to predict whether Gaylord will be
subject to any monetary sanctions arising out of this incident or
the amount of any such monetary sanctions.
As previously disclosed, the plaintiffs in the Winoff antitrust
litigation, in which the company's subsidiaries, Inland
Paperboard and Packaging, Inc. and Gaylord, and eight other
containerboard producers are defendants, moved to certify a class
of all persons in the United States who purchased corrugated
containers directly from any of the defendants during the period
at issue. The trial court granted plaintiffs' motion on
September 4, 2001, but modified the proposed class to exclude
those purchasers whose prices were "not tied to the price of
linerboard." The United States Court of Appeals for the Third
Circuit accepted review of the decision to certify the class and
recently upheld the trial court's ruling. Decisions regarding
whether to appeal this ruling further have not yet been made.
The case is currently set for trial in April 2004. The company
believes that the plaintiffs' allegations have no merit and
intends to continue to defend against the suit vigorously. The
company does not believe that the outcome of this litigation
would have a material adverse effect on its financial position,
results of operations, or cash flow.
There are also pending against the company and its subsidiaries
lawsuits, claims and environmental matters arising in the regular
course of business. In addition, the Internal Revenue Service is
currently examining the company's consolidated income tax returns
for the years 1993 through 1996.
All litigation has an element of uncertainty and the final
outcome of any legal proceeding cannot be predicted with any
degree of certainty. With these limitations in mind, management
believes recoveries and claims, if any, by plaintiffs or
claimants resulting from the foregoing litigation will not have a
material adverse effect on the company's operations or financial
position.
16
NOTE F - ACQUISITIONS
On February 28, 2002, the company completed tender offers for
Gaylord Container Corporation's common stock and senior and
senior subordinated notes. On April 5, 2002, the company
acquired the remainder of Gaylord's outstanding common stock.
The results of Gaylord's operations have been included in the
company's income statement since the beginning of March 2002.
The cash purchase price to acquire Gaylord was $598 million
including $44 million in termination and change in control
payments and $17 million in advisory and professional fees.
Proceeds from a $900 million Credit Agreement (the bridge
financing facility) were used to fund the cash purchase and to
pay off the assumed bank debt of $285 million. The company paid
$12 million in fees to the lending institutions for this
facility, which was funded from the bridge financing facility.
The bridge financing facility was repaid during May 2002 using
proceeds from sales of the company's securities described in Note
H.
The purchase price will be allocated to the assets acquired and
liabilities assumed based on their estimated fair values at the
date of acquisition. The allocation of the purchase price will
be based upon independent appraisals and other valuations and
will reflect finalized management intentions. It is expected
that the final allocations will be completed by first quarter-end
2003. The final allocations will probably differ from those
currently assumed. Changes, if any, to the fair value of property
and equipment will impact the amount of depreciation to be reported.
Goodwill from this acquisition is allocated to the paper group.
It is anticipated that all of the goodwill will be deductible for
income tax purposes.
On September 20, 2002, the company permanently closed the
Antioch, California recycle linerboard mill obtained in the
acquisition of Gaylord. During second quarter 2002, the company
established accruals for the estimated costs to be incurred in
connection with this closure. The allocation of the purchase
price includes these accruals, aggregating $30 million, which
consists of $3 million for involuntary employee terminations, $7
million for contract termination penalties, $8 million for
environmental compliance and $12 million for demolition. It is
expected that any differences between these estimates and the
ultimate amount incurred will be reflected as an adjustment of
goodwill. As a result, these costs will not affect current
operating income.
The preliminary allocations of the purchase price were updated
during the third quarter 2002 to reflect current appraisal
information. As a result, adjustments were made during the third
quarter 2002 to increase goodwill $13 million resulting in a
third quarter-end balance of goodwill related to the acquisition
of Gaylord of $130 million. The offset was to adjust the carrying
value of the acquired assets and liabilities including a $10
million decrease of property and equipment. These changes and
other refinements in valuations of property and equipment
17
resulted in a $5 million decrease in depreciation expense for the
third quarter 2002.
During March 2002, the company acquired a box plant in Puerto
Rico for $10 million cash. During May 2002, the company acquired
the two converting operations of Mack Packaging Group, Inc. for
$24 million including $20 million cash and $4 million related to
the present value of a minimum earn out arrangement. The purchase
prices were allocated to the acquired assets and liabilities
based on their fair values with $2 million assigned to goodwill,
all of which is allocated to the paper group.
The following unaudited pro forma information assumes these three
acquisitions and related financing occurred at the beginning of
2002 and 2001 (in millions except per share):
Three Months Nine Months
Ended September Ended September
2002 2001 2002 2001
Parent company revenues $ 874 $ 966 $ 2,685 $ 2,800
Income from continuing
operations $ 15 $ 31 $ 35 $ 70
Per diluted share
Income from continuing
operations $ 0.28 $ 0.58 $ 0.67 $ 1.30
Adjustments made to derive this pro forma information include
those related to the effects of the purchase price allocations
described above, the reclassification of the discontinued
operations described in Note G, and the effects of financing
transactions described in Note H. The pro forma information does
not reflect the effects of planned capacity rationalization, cost
savings or other synergies that may be realized. These pro forma
results are not necessarily indicative of what actually would
have occurred if the acquisitions had been completed on those
dates and are not intended to be indicative of future results.
During February 2002, the financial services group acquired an
insurance agency for $6 million cash and a potential earn-out
payment of $2 million based on revenue growth. The purchase
price was allocated to acquired assets and liabilities based on
their fair values with $4 million allocated to goodwill.
During September 2002, the financial services group acquired $374
million in deposits and a five-branch network in Northern
California for a purchase price of $9 million. The purchase
price was allocated to the acquired assets and liabilities based
on their estimated fair values with $12 million allocated to
goodwill. Pro forma results of operations assuming these
acquisitions took place at the beginning of 2002 would not be
materially different from those reported.
18
NOTE G - DISCONTINUED OPERATIONS
In conjunction with the acquisition of Gaylord, the company
announced that it intended to sell several non-strategic assets
and operations obtained in the Gaylord acquisition including the
retail bag business, the multi-wall bag business and kraft paper
mill and the chemical business. The retail bag business was sold
during May 2002. During October 2002, the company signed a
letter of intent to sell the multi-wall bag business and the
kraft paper mill. The sale is expected to close by year-end
2002. The assets and liabilities of the discontinued operations
have been adjusted to their estimated realizable values and are
identified in the balance sheet as discontinued operations.
Through first quarter 2003, differences between estimated net
realizable value and their actual value will be reflected as an
adjustment to goodwill. The operating results and cash flows of
these operations are classified as discontinued operations and
are excluded from income from continuing operations and business
segment information for the paper group.
At third quarter-end 2002, the carrying value of discontinued
operations includes $50 million of property and equipment and $1
million of working capital. Revenues from discontinued operations
for third quarter 2002 and first nine months 2002 were $37
million and $106 million. The discontinued operations broke-even
for third quarter 2002 and incurred a loss of $1 million for
first nine months 2002.
NOTE H - FINANCING TRANSACTIONS
During May 2002, the company sold 4.1 million shares of common
stock at $52 per share, and issued $345 million of Upper DECS
units and $500 million of 7.875% Senior Notes due 2012. Total
proceeds from these offerings were $1,060 million, before
expenses of $28 million. The net proceeds from these offerings
were used to repay the bridge financing facility and other
borrowings. As a result of the early repayment of these
borrowings, approximately $11 million of unamortized debt
financing fees was charged to other expense.
The Upper DECS units consist of $345 million of 6.42% Senior
Notes due in 2007 and contracts to purchase common stock. The
interest rate on the Upper DECS senior notes will be reset during
February 2005. The purchase contracts represent an obligation to
purchase by May 2005, shares of common stock based on an
aggregate purchase price of $345 million. The actual number of
shares that will be issued on the stock purchase date will be
determined by a settlement rate that is based on the average
market price of the company's common stock for 20 days preceding
the stock purchase date. The average price per share will not be
less than $52, in which case 6.635 million shares would be
issued, and will not be higher than $63.44, in which case 5.438
million shares would be issued. If a holder elects to purchase
shares prior to May 2005, the number of shares that would be
19
issued will be based on a fixed price of $63.44 per share (the
settlement rate resulting in the fewest number of shares issued to
the holder) regardless of the actual market price of the shares at
that time. Accordingly, if the purchase contracts had been
settled at third quarter-end 2002, the settlement rate would have
resulted in the issuance of 5.438 million shares of common stock.
The purchase contracts also provide for contract adjustment
payments at an annual rate of 1.08 percent. The present value of
the contract adjustment payments was recorded as a liability at
the time the Upper DECS were sold.
The $500 million of 7.875% Senior Notes due 2012 were sold at
99.289 percent of par. The notes bear interest at an annual
effective rate of 7.98 percent.
NOTE I - OTHER OPERATING EXPENSE
Other operating expense for the first nine months ended 2002
includes a $6 million charge related to promissory notes
previously sold with recourse. In connection with the 1998 sale
of the company's Argentine box plant, the company received $11
million in promissory notes repayable in U.S. dollars, which were
subsequently sold with recourse to a financial institution.
During May 2002, the borrower notified the financial institution
that Argentine legislation enacted as a result of that country's
currency crisis requires the borrower to repay these promissory
notes in Argentine pesos at a specified exchange rate, which is
less favorable to the company than the current exchange rate.
During June 2002, the company purchased these notes from the
financial institution at their unpaid principal balance of $6
million. Based on current exchange rates these notes and related
prepaid interest totaling $7 million have a U.S. dollar value of
$1 million. The difference of $6 million was charged to other
operating expense in second quarter 2002.
NOTE J - ACCOUNTING PRONOUNCEMENTS
Goodwill
Beginning January 2002, the company adopted Statement of
Financial Accounting Standards (FAS) No. 142, Goodwill and Other
Intangible Assets. Under this statement, amortization of
goodwill and other indefinitely lived intangible assets is
precluded but is periodically measured for impairment.
The cumulative effect of adopting this statement was to reduce
first nine months 2002 net income by $11 million, or $0.22 per
diluted share, for an $18 million goodwill impairment associated
with the paper group's pre-2001 specialty packaging acquisitions.
Under this statement, impairment is measured based upon the
present value of future operating cash flows while under the
prior methodology impairment was measured based upon undiscounted
future cash flows.
At third quarter-end 2002, the company has $324 million of
indefinitely lived intangible assets, which are not subject to
amortization, including $318 million of goodwill and $6 million
20
of trademarks. Based upon the most recent preliminary allocation
of the Gaylord purchase price, the company has now assigned $130
million to goodwill. The actual allocations will probably differ
from those assumed and could give rise to intangible assets with
finite or indefinite useful lives other than goodwill. Any
intangible assets with finite useful lives will be amortized. At
third quarter-end 2002, the company has $12 million of core
deposit intangible assets, which are being amortized at the rate
of $2 million per year and $3 million of other finite lived
intangible assets, which are being amortized over a five year
period.
The effects of not amortizing goodwill and trademarks in periods
prior to the adoption of this statement follows (in millions,
except per share):
Third Quarter First Nine Months
2002 2001 2002 2001
Income from continuing
operations
As reported $ 15 $ 44 $ 46 $ 85
Goodwill and trademark
Amortization, net of tax - 2 - 6
---- ---- ---- ----
As adjusted $ 15 $ 46 $ 46 $ 91
==== ==== ==== ====
Per diluted share
As reported $0.28 $0.90 $0.89 $1.72
Goodwill and trademark
Amortization, net of tax - 0.04 - 0.12
---- ---- ---- ----
As adjusted $0.28 $0.94 $0.89 $1.84
==== ==== ==== ====
Impairment or Disposal of Long-Lived Assets
Beginning first quarter 2002, the company adopted FAS No. 144,
Accounting for the Impairment or Disposal of Long-Lived Assets.
The effect on earnings or financial position of adopting this
statement is not material.
Rescission of FAS No. 4
Beginning second quarter 2002, the company adopted FAS No. 145,
Rescission of FASB Statements No. 4, 44, and 64, Amendment of
FASB Statement No. 13 and Technical Corrections. The principal
effect of adopting this statement was that the charge-off of the
unamortized debt financing fees commensurate with the early
repayment of the bridge financing facility and other borrowings
was not classified as an extraordinary item in the determination
of income from continuing operations.
Accounting for Stock Options
Beginning with options granted in first quarter 2003, the company
will adopt the fair value based method of accounting for employee
stock options as set forth in FAS No. 123, Accounting for Stock
Based Compensation. Under this method, the fair value of options
granted is charged to expense over the option vesting period. If
21
options are granted in 2003 at a similar level with 2002, the
expected effect on earnings or financial position of adopting
this method would not be material.
Accounting for Costs Associated with Exit or Disposal Activities
Beginning with the first quarter 2003, the company will be
required to adopt FAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities. Under this statement,
liabilities for costs associated with an exit or disposal
activity, including restructurings, are to be recognized when the
liability is incurred and can be measured at estimated fair
value. The company believes that the effect on earnings or
financial position of adopting this statement will not be
material.
Accounting for Acquisitions of Certain Financial Institutions
Beginning with acquisitions of certain financial institutions
effected after October 1, 2002, the company will be required to
apply the provisions of FAS No. 147, Acquisitions of Certain
Financial Institutions-an amendment of FAS Statements No. 72 and
144 and FASB Interpretations No. 9. The principal effect of this
statement is the clarification of what constitutes the
acquisition of a business and that such acquisitions should be
accounted for in accordance with the provisions of FAS 141,
Business Combinations, and FAS 142, Goodwill and Other Intangible
Assets. It also includes within the scope of FAS 144, Accounting
for the Impairment or Disposal of Long-Lived Assets, intangible
assets customarily recognized in acquisitions of financial
institutions. The company believes that the effect on earnings
or financial positions of adopting this statement will not be
material.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Results of Operations
Temple-Inland manages its operations through three business
segments: paper, building products and financial services. Each
of these business segments is affected by the factors of supply
and demand and changes in domestic and global economic
conditions, aspects of which have varying degrees of impact on
the business segments. As used herein the term "parent company"
refers to the financial statements of Temple-Inland and its
manufacturing business segments, paper and building products,
with financial services reflected on the equity method.
Temple-Inland acquired effective control of Gaylord
Container Corporation and began consolidating the results of
Gaylord at the beginning of March 2002. Temple-Inland also
acquired a box plant in Puerto Rico during March 2002 and certain
assets of Mack Packaging Group, Inc. during May 2002. Also
during May 2002, Temple-Inland sold 4.1 million shares of common
stock and issued $345 million of Upper DECS units and $500
million of Senior Notes. These transactions significantly
22
increased the assets and operations of Temple-Inland and its
paper group and changed the capital structure of Temple-Inland.
As a result, third quarter 2002 financial information is not
readily comparable to prior periods.
A summary of the results of operations by business segment
follows.
Third Quarter First Nine Months
2002 2001 2002 2001
(in millions, except per share amounts)
Revenues
Paper $ 672 $ 534 $1,932 $ 1,575
Building Products 202 202 610 561
Financial Services 294 321 856 1,036
---- ---- ---- ----
Total revenues $1,168 $ 1,057 $3,398 $ 3,172
==== ==== ==== ====
Income
Paper $ 14 $ 31 $ 65 $ 80
Building Products 12 17 43 17
Financial Services 44 43 115 134
---- ---- ---- ----
Segment operating income 70 91 223 231
Corporate and other (8) (8) (26) (25)
Other income (expense) - 5 (24) 5
Parent company interest (36) (23) (97) (76)
---- ---- ---- ----
Income from continuing
operations before taxes 26 65 76 135
Income taxes (11) (21) (30) (50)
---- ---- ---- ----
Income from continuing
operations 15 44 46 85
Discontinued operations - - (1) -
Effect of accounting change - - (11) (2)
---- ---- ---- ----
Net income $ 15 $ 44 $ 34 $ 83
==== ==== ==== ====
Per diluted share
Income from continuing operations $ 0.28 $ 0.90 $ 0.89 $ 1.72
Discontinued operations - - (0.02) -
Effect of accounting change - - (0.21) (0.04)
---- ---- ---- ----
Net income $ 0.28 $ 0.90 $ 0.66 $ 1.68
==== ==== ==== ====
Average diluted shares outstanding 53.7 49.3 51.9 49.3
==== ==== ==== ====
Unless otherwise noted, increases or decreases refer to
third quarter 2002 amounts compared with third quarter 2001
amounts and first nine months 2002 amounts compared with first
nine months 2001 amounts. Third quarter and first nine months
2001 amounts have been reclassified to conform to current year
classifications.
For the quarter ended September 2002
Paper
Operating income was $14 million, down $17 million. Effects
of the weak economy on corrugated container and linerboard
23
pricing and shipments, an increase in the cost of old corrugated
containers (OCC) and mill operating issues more than offset the
benefits from the inclusion of the acquired operations. Due to
the integration of the acquired operations, the incremental
effects on revenues and operating income associated with
acquisitions cannot be readily determined.
Revenues were $672 million, up 26 percent. This increase
was primarily due to the inclusion of the acquired operations,
offset in part by lower prices and shipments. Average corrugated
container prices were down 4 percent and box shipments were down
3 percent compared with pro forma shipments (including Gaylord)
for the third quarter 2001. Corrugated container prices and
shipments were adversely affected by the weak economy. Average
linerboard prices were down 8 percent and linerboard shipments
were down 25 percent. Linerboard markets continue to be adversely
affected by the weak economy and increased offshore capacity.
Revenues were down 4 percent compared with second quarter
2002 primarily due to a 3 percent decrease in box shipments.
Average corrugated container prices were flat. Linerboard prices
were up 2 percent and shipments were down 4 percent. A $25 per
ton increase in linerboard prices was implemented in third
quarter 2002. An increase in box prices began to be implemented
in September 2002.
Costs, which include production, distribution and
administrative costs and expenses, were $658 million, up 31
percent primarily due to the inclusion of the acquired
operations. Other factors increasing costs included higher OCC
costs, up $12 million, higher pension costs, up $4 million, and
mill maintenance expense, up $4 million. Factors decreasing
costs included lower energy costs, down $1 million, less goodwill
amortization, down $1 million, and lower expenses associated with
the specialty packaging operations. The cost of OCC, which
accounted for 41 percent of the paper group's fiber requirements
in the quarter, was up 74 percent. OCC prices, however, began to
decline in August 2002 and this downward trend has continued.
Average OCC prices were $122 per ton in third quarter 2002, $70
per ton in third quarter 2001 and $102 per ton in second quarter
2002. Costs were down 2 percent compared with second quarter
2002 primarily due to decreases in depreciation and
administrative expenses. Depreciation expense was down $5
million due to adjustments and refinements in the valuations of
the property and equipment obtained in the Gaylord acquisition.
Administrative expense was down $2 million from second quarter
2002 resulting from the elimination of the majority of Gaylord's
corporate staff during second quarter 2002.
The mills operated at 89 percent of rated capacity. Mill
production was 864,000 tons. Of the mill production, 85 percent
was used by the corrugated packaging operations; the remainder
was sold in the domestic and export markets. Production was
curtailed by 111,000 tons due to market, maintenance and
operational reasons compared with third quarter 2001 curtailments
of 71,000 tons and second quarter 2002 curtailments of 108,000
24
tons. The paper group may curtail more production in future
quarters for these reasons. The paper group anticipates taking
the annual maintenance outage at the Bogalusa linerboard mill
during December 2002.
Market conditions continue to be weak for gypsum facing
paper. As a result, the paper group's Premier Boxboard Limited
LLC joint venture continues to produce some corrugating medium,
of which the paper group purchased 52,000 tons during the
quarter. It is uncertain when market conditions for lightweight
gypsum facing paper will improve to levels that eliminate the
venture's need to produce corrugating medium.
On September 20, 2002, the paper group permanently closed
the 425,000 ton per year capacity recycled linerboard mill in
Antioch, California, obtained in the Gaylord acquisition.
During October 2002, the company signed a letter of intent
to sell the non-strategic multi-wall bag business and the kraft
paper mill obtained in the Gaylord acquisition for approximately
$40 million. The sale is expected to close by year-end 2002.
Anticipated proceeds from this sale, coupled with proceeds from
previous sales of other non-strategic assets and operations
obtained in the Gaylord acquisition, are expected to approximate
$100 million, the majority of which is expected to be collected
by year-end 2002.
Building Products
Operating income was $12 million, down $5 million.
Improvements in gypsum pricing and shipments were more than
offset by declines in lumber and particleboard prices and sales
of high-value land.
Building products' revenues were flat at $202 million.
Average prices for lumber were down 12 percent and particleboard
prices were down 13 percent. Average prices for MDF were up
slightly and gypsum prices were up 23 percent. Shipments for all
products were up with lumber shipments up 2 percent,
particleboard up 7 percent, MDF up 22 percent and gypsum up 4
percent. The ongoing initiative to sell high-value land
contributed $1 million in operating income for the quarter, down
$7 million.
Compared with second quarter 2002, revenues were down 7
percent. Average prices for lumber were down 10 percent, MDF
prices were up 4 percent and gypsum prices were down 3 percent.
Average prices for particleboard were down slightly. Lumber
shipments were flat, particleboard shipments were down 7 percent,
and MDF shipments were down 14 percent. Gypsum shipments were up
3 percent. Industry over-capacity continues to hamper lumber, MDF
and particleboard product pricing and volumes. The contribution
to operating income of sales of high-value lands was $1 million,
down $4 million.
25
Costs, which include production, distribution and
administrative costs and expenses, were $190 million, up 3
percent. Increased production volumes were partially offset by
lower energy costs, down $3 million. Compared with second quarter
2002, costs were down 4 percent primarily due to lower production
volumes.
Production in the various product lines was curtailed to
varying degrees during third quarter 2002 to match customer
demand. Production in the various product lines averaged from a
low of 77 percent to a high of 82 percent of capacity. The
building products group's joint venture operations also
experienced production curtailments during third quarter 2002.
The building products group and its joint venture operations may
curtail more production in future quarters for this reason.
The Del-Tin Fiber LLC MDF joint venture in El Dorado,
Arkansas, continues to experience production and cost issues.
Deltic Timber Corporation, the partner in this venture, announced
its intentions to evaluate strategic alternatives for its one-
half interest in the venture. It is uncertain what effects this
will have on the joint venture or its operations. The building
products group has $14 million invested in this venture and has
agreed to provide up to $55 million of venture production and
other support obligations.
Financial Services
Operations
Operating income was $44 million, up $1 million. The $11
million increase in noninterest income was partially offset by a
$4 million decrease in net interest income and a $6 million
increase in noninterest expense. Revenues, consisting of
interest and noninterest income, were $294 million, down 9
percent. The reduction in revenues was due to lower interest
income, down $38 million, partially offset by an $11 million
increase in non-interest income.
During the third quarter, the financial services group
acquired $374 million in deposits and a five-branch network in
Northern California for a purchase price of $9 million. In
connection with this acquisition, the financial services group
recognized $12 million of goodwill.
Changes in operating income are discussed below.
(in millions) Third Quarter
2002 2001
Net interest income $ 95 $ 99
Provision for loan losses (8) (8)
Noninterest income 97 86
Noninterest expense (140) (134)
----- -----
Operating income $ 44 $ 43
===== =====
26
Net interest income was $95 million, down $4 million.
Interest income was down $38 million and interest expense was
down $34 million due primarily to the lower interest rate
environment. If the downward trend in interest rates continues,
it is likely that net interest income will continue to be
adversely affected. In addition, the mix of interest income and
interest expense changed. Interest income from loans currently
represents 73 percent of total interest income compared with 81
percent and interest income from securities currently represents
27 percent of total interest income compared with 19 percent.
Interest expense from deposits currently represents 57 percent of
total interest expense compared with 68 percent and interest
expense from borrowings currently represents 43 percent of total
interest expense compared with 32 percent.
The provision for loan losses was $8 million. The provision
was largely the result of continued weakness in the economy.
Both the senior housing and commercial and business portfolios
continue to show some weaknesses. The commercial and business
loans are primarily asset-based and equipment leasing
relationships.
Noninterest income, which consists primarily of income from
mortgage banking, real estate and insurance activities, loan
related fees, service charges on deposits, and alternative
investment sales, was $97 million, up 13 percent. The increase
was due to increased mortgage originations, resulting in a $20
million increase in related income, and continued focus on fee-
based products, resulting in a $2 million increase in service
charges on deposits, and a $2 million increase in annuity sales
income. The increase in mortgage originations resulted from
continued high levels of refinance activities. These increases
were partially offset by a $12 million decline in income from
mortgage loan servicing activities and a $2 million decline in
income from real estate operations. The decline in income from
mortgage loan servicing activities was the result of a
significant increase in amortization of mortgage servicing rights
and a $7 million increase in the impairment reserve for mortgage
servicing rights due to the high levels of refinance activity.
Noninterest expense was $140 million, up 4 percent. The
increase was due to increased single-family mortgage production
resulting in a $19 million increase in mortgage-related salary,
commissions, benefits and other expense. This increase was
partially offset by a $2 million decrease in non-mortgage related
salary and benefits, a $2 million decrease in professional
services, a $1 million decrease in marketing expense, a $5
million decrease in other general and administrative expense and
a $2 million decrease in goodwill amortization.
Compared with second quarter 2002, operating income was up
$7 million, due principally to a $4 million increase in net
interest income, a $7 million decrease in provision for loan
losses and a $3 million increase in noninterest income; partially
offset by a $7 million increase in noninterest expense.
27
Earning Assets
Earning assets include cash equivalents, mortgage loans held
for sale, securities and loans. At third quarter-end 2002, cash
equivalents, mortgage loans held for sale, securities and
residential loans comprised 74 percent of total earning assets,
compared with 68 percent at third quarter-end 2001 and 71 percent
at second quarter-end 2002.
Securities, which include mortgage-backed and other
securities, were $5.8 billion, up 104 percent and up 19 percent
compared with second quarter-end 2002. This growth is the result
of an increased focus on single-family mortgage assets.
Loans were $9.9 billion compared with $10.2 billion at third
quarter-end 2001 and $9.7 billion at second quarter-end 2002.
The decrease in the loan portfolio from third quarter-end 2001 is
primarily due to declines in the single-family mortgage, multi-
family and senior housing, and commercial real estate portfolios;
partially offset by increases in the single-family mortgage
warehouse and commercial and business portfolios. The increase
in the loan portfolio from second quarter-end 2002 is primarily
due to increases in the single-family mortgage, mortgage
warehouse and construction portfolios; partially offset by
declines in the multi-family and senior housing, commercial real
estate and commercial and business portfolios.
A summary of loans by major category follows:
Third Second
Quarter Quarter
(in millions) 2002 2001 2002
Single-family mortgage $ 2,100 $ 2,233 $ 1,997
Single-family mortgage warehouse 454 389 298
Single-family construction 1,090 1,070 988
Multifamily and senior housing 1,891 2,008 1,936
----------------------------
Total $ 5,535 $ 5,700 $ 5,219
Commercial real estate 2,310 2,653 2,419
Commercial and business 1,825 1,646 1,882
Consumer and other 215 247 223
----------------------------
9,885 10,246 9,743
Less allowance for loan losses (141) (135) (135)
----------------------------
$ 9,744 $10,111 $ 9,608
============================
Single-family mortgages are made to owners to finance the
purchase of a home. Single-family mortgage warehouse provides
funding to mortgage lenders to support the flow of loans from
origination to sale. Single-family construction finances the
development and construction of single-family homes, condominiums
and town homes, including the acquisition and development of home
lots. Multifamily and senior housing loans are for the
development, construction and lease up of apartment projects and
housing for independent, assisted and memory-impaired residents.
28
The commercial real estate portfolio provides funding for
the development, construction and lease up primarily of office,
retail and industrial projects and is geographically diversified
among 23 states and 38 market areas. The commercial and business
portfolio finances business operations and is primarily comprised
of asset-based and middle-market loans and direct financing
leases on equipment. The consumer and other portfolio is
primarily composed of loans secured by second liens on single-
family homes.
Asset Quality and Allowance for Loan Losses
Several key measures are used to evaluate and monitor the
asset quality of the financial services group. These measures
include the level of loan delinquencies, nonperforming loans and
nonperforming assets.
(dollars in millions) Third Second
Quarter Quarter
2002 2001 2002
Accruing loans past due 30 - 89 days $ 116 $ 155 $ 81
Accruing loans past due 90 days or more 9 18 -
----- ----- -----
Accruing loans past due 30 days or more $ 125 $ 173 $ 81
===== ===== =====
Nonaccrual loans $ 109 $ 140 $ 179
Restructured loans - - -
----- ----- -----
Nonperforming loans 109 140 179
Foreclosed property 8 2 7
----- ----- -----
Nonperforming asses $ 117 $ 142 $ 186
===== ===== =====
Allowance for loan losses $ 141 $ 135 $ 135
Net charge-offs $ 2 $ 8 $ 16
Nonperforming loan ratio 1.11% 1.37% 1.84%
Nonperforming asset ratio 1.19% 1.39% 1.91%
Allowance for loan losses/total loans 1.42% 1.32% 1.39%
Allowance for loan losses/nonperforming
loans 128.71% 96.22% 75.48%
Annualized year to date net charge
offs/average loans 0.49% 0.30% 0.68%
The decrease in the level of nonaccrual loans was primarily
due to payoffs and upgrades of certain large loans in the senior
housing portfolio.
The allowance for loan losses is comprised of specific
allowances (assessed for loans that have known credit
weaknesses), general allowances and an unallocated allowance. At
third quarter-end 2002, the unallocated allowance for loan losses
was $42 million, up $7 million. Compared with second quarter-end
2002, the unallocated allowance for loan losses was up $10
million, due primarily to the potential impact on borrowers of
continued uncertain economic conditions.
Third quarter 2002 charge-offs were $6 million, offset by
recoveries of $4 million. The charge-offs related primarily to
certain loans in the commercial and business portfolio and the
29
recoveries related primarily to certain loans in the senior
housing portfolio.
Mortgage Banking Activities
Mortgage loan originations were $2,893 million, up $1,213
million. The increase was due to the mortgage origination operations
acquired during the third quarter 2001 and the high level of refinance
activity resulting from the lower interest rate environment. The
mortgage bank delivers its loans originated for sale into securities
or sells them to third parties in whole loan form. The only
interest retained, if any, on loans originated for sale is
mortgage servicing rights. During third quarter 2002, the
allocated value of loans delivered into securities and loans sold
in whole loan form was $2,542 million. The financial services
group recognized gains from these activities of $26 million, up
$9 million. The financial services group serviced 106,067
mortgage loans with an aggregate principal balance of $10.4
billion at third quarter-end 2002, compared with 123,287 mortgage
loans with an aggregate principal balance of $10.8 billion at
third quarter-end 2001.
Corporate and Parent Company Interest
Parent company interest expense was $36 million, up $13
million due to an increase in debt and an increase in interest
rates incurred. Long-term debt was up $629 million, primarily
due to the acquisition of Gaylord offset in part by a reduction
in other borrowings. In addition, the parent company effected a
number of financing transactions during second quarter 2002 that
lengthened debt maturities and reduced reliance on short-term
borrowings. As a result, the average interest rate incurred on
debt increased. The average interest rate incurred was 6.97
percent at third quarter-end 2002 compared with 5.93 percent at
third quarter-end 2001 and 6.19 percent at second quarter-end
2002.
Income Taxes
The effective tax rate was 42 percent compared with 39
percent in the first and second quarter 2002. This reflects the
effect of adjusting the estimated annual effective tax rate from
39 percent to 40 percent based on current expectations of income
and expenses for the year 2002. The effective tax rate for the
third quarter 2001 was 32 percent due to the one-time tax benefit
of $8 million related to the sale of the box plant in Chile.
Without that one-time benefit the effective tax rate for the
third quarter 2001 would have been 41.5 percent.
Average Shares Outstanding
As reported average diluted shares outstanding were 53.7
million, up 9 percent due to the May 2002 sale of 4.1 million
shares of common stock.
30
For the nine months ended September 2002
Paper
Operating income was $65 million, down $15 million. The
benefits from the inclusion of the acquired operations and lower
energy prices were partially offset by the effects of the weak
economy on corrugated container and linerboard pricing and
shipments and an increase in the cost of OCC. Due to the
integration of the acquired operations, the incremental effects
on revenues and operating income associated with acquisitions
cannot be readily determined.
Revenues were $1,932 million, up 23 percent, primarily due
to the inclusion of the acquired operations. Adjusted to include
the acquired operations, average corrugated container prices and
shipments were down 3 percent. Corrugated container prices and
shipments were adversely affected by the weak economy. Adjusted
to include the acquired operations, average linerboard prices
were down 10 percent and linerboard shipments were down 9 percent.
Linerboard markets continue to be adversely affected by the weak
economy and increased offshore capacity.
Costs, which include production, distribution and
administrative costs and expenses, were $1,867 million, up 25
percent primarily due to the inclusion of the acquired
operations. Other factors increasing cost included higher OCC
costs, up $19 million, and higher pension costs, up $12 million.
Factors decreasing cost included lower energy costs, down $31
million, less goodwill amortization, down $3 million, and lower
expenses associated with the specialty packaging operations.
The mills operated at 88 percent of capacity. Mill
production was 2,342,000 tons. Of the mill production, 84
percent was used by the corrugated packaging operations; the
remainder was sold in the domestic and export markets.
Production was curtailed by 327,000 tons due to market,
maintenance and operational reasons compared with first nine
months 2001 curtailments of 362,000 tons.
The paper group's Premier Boxboard Limited LLC joint venture
continues to produce corrugating medium, of which the paper group
purchased 134,000 tons during the first nine months 2002 compared
with 128,000 tons during the first nine months 2001.
Building Products
Operating income was $43 million, up $26 million.
Improvements in shipments for all products, higher MDF and gypsum
pricing, and improvements at the company owned MDF facilities
contributed to the increase in operating income. Operating
income continued to benefit from the ongoing initiatives to sell
high-value lands.
Revenues were $610 million, up 9 percent. Average prices
were down 7 percent for lumber and 13 percent for particleboard.
31
Average prices were up 3 percent for MDF and 35 percent for
gypsum. Shipments for all products were up with lumber shipments
up 8 percent, particleboard up 10 percent, MDF up 9 percent and
gypsum up 11 percent. The ongoing initiative to sell high-value
land contributed $14 million in operating income for the first
nine months 2002, up $1 million.
Costs, which include production, distribution and
administrative costs and expenses, were $567 million, up 4
percent. Higher pension costs, up $3 million and increased
production volume offset lower energy costs, down $7 million.
Production was curtailed to varying degrees in all product
lines to match customer demand. Production in the various
product lines averaged from a low of 75 percent to a high of 96
percent of capacity. The building products group's joint venture
operations also experienced production curtailments during the
first nine months 2002. The building products group and its joint
venture operations may curtail production in the future for these
and other reasons.
Financial Services
Operating income was $108 million, down $26 million. The
$25 million decrease in net interest income and the $38 million
increase in noninterest expense were partially offset by a $35
million increase in noninterest income and a $2 million decrease
in the provision for loan losses. Revenues, consisting of
interest and noninterest income, were $856 million, down 17
percent. The reduction in revenues was due to lower interest
income, down $215 million, partially offset by a $35 million
increase in noninterest income.
Changes in operating income are discussed below.
(in millions) First Nine Months
2002 2001
Net interest income $ 278 $ 303
Provision for loan losses (37) (39)
Noninterest income 284 249
Noninterest expense (417) (379)
----- -----
Operating income $ 108 $ 134
===== =====
Net interest income was $278 million, down $25 million.
Interest income was down $215 million and interest expense was
down $190 million due primarily to the lower interest rate
environment. If the downward trend in interest rates continues,
it is likely that net interest income will continue to be
adversely affected. In addition, the mix of interest income
changed and interest expense changed. Interest income from loans
currently represents 75 percent of total interest income compared
with 80 percent and interest income from securities currently
represents 25 percent of total interest income compared with 20
percent. Interest expense from deposits currently represents 62
32
percent of total interest expense compared with 66 percent and
interest expense from borrowings currently represents 38 percent
of total interest expense compared with 34 percent.
The provision for loan losses was $37 million, down $2
million. The provision for the first nine months of 2002 largely
related to certain senior housing and commercial and business
loans and continued weakness in the overall economy. The
commercial and business loans are primarily asset-based and
equipment leasing relationships.
Noninterest income, which consists primarily of income from
mortgage banking, real estate and insurance activities, loan
related fees, service charges on deposits, and alternative
investment sales, was $284 million, up 14 percent. The increase
was due to increased mortgage originations, resulting in a $56
million increase in related income, and continued focus on fee-
based products, resulting in a $6 million increase in service
charges on deposits. The increase in mortgage originations
resulted from the acquisition of mortgage production operations
in the last half of 2001 and continued high levels of refinance
activities. These increases were partially offset by a $22
million decline in income from real estate operations and a $16
million decline in income from mortgage loan servicing
activities. The decline in income from real estate operations is
primarily the result of the slower economy during 2002 resulting
in a reduction in real estate sales. The decline in income from
mortgage loan servicing activities was the result of the sale of
servicing on $8.6 billion in mortgage loans during 2001, reducing
service fee income, a significant increase in amortization of
mortgage loan servicing rights and a $6 million charge for
impairment of mortgage loan servicing rights in 2002 due to the
high levels of refinance activity.
Noninterest expense was $417 million, up 10 percent. The
increase was due to continued refinance activities and the
acquisition of mortgage production operations in the last half of
2001, resulting in a $64 million increase in mortgage-related
salary, commissions, benefits and other expense. This increase
was partially offset by a $14 million decrease in expenses
associated with real estate operations; a $4 million decrease in
professional services, a $2 million decrease in marketing expense
and a $6 million decrease in goodwill amortization.
Mortgage Banking Activities
Mortgage loan originations were $6,657 million, up $2,310
million. The increase was due to the mortgage origination
operations acquired during the third quarter 2001 and the high
level of refinance activity resulting from the lower interest rate
environment. The mortgage bank delivers its loans originated for
sale into securities or sells them to third parties in whole loan
form. The only interest retained, if any, on loans originated for
sale is mortgage servicing rights. During the first nine months of
2002, the allocated value of loans delivered into securities and
loans sold in whole loan form was $6,597 million. The financial services
33
group recognized gains from these activities of $68 million, up
$31 million.
Corporate and Parent Company Interest
Parent company interest expense was $97 million, up $21
million due to an increase in long-term debt and an increase in
average interest rates incurred due to the shift to longer-term
debt maturities and reduced reliance on variable rate debt.
Other Income (Expense)
Other expenses include the write-off of $11 million of
unamortized financing fees related to the early repayment of the
bridge financing facility and other borrowings. It also includes
a $6 million charge related to the purchase of promissory notes
previously sold with recourse, which applies to the paper group,
and a $7 million charge related to severance and technology write-
offs, which applies to the financial services group.
Income Taxes
The effective tax rate is 40 percent and is based on current
expectations of income and expenses for the year 2002. The
effective tax rate includes federal and state income taxes and
the effects of non-deductible items. The effective tax rate for
the first nine months 2001 was 37 percent and includes a one-time
tax benefit of 4 percent related to the sale of the box plant in
Chile.
Average Shares Outstanding
Average diluted shares outstanding were 51.9 million, up 5
percent due to the May 2002 sale of 4.1 million shares of common
stock.
Accounting Change
The cumulative effect of adopting FAS No. 142, Goodwill and
Other Intangible Assets, was to reduce net income by $11 million,
net of a deferred tax benefit of $7 million.
Capital Resources and Liquidity
For the nine months ended September 2002
The consolidated net assets invested in financial services
are subject, in varying degrees, to regulatory rules and
regulations including restrictions on the payment of dividends to
the parent company. Accordingly, parent company and financial
services capital resources and liquidity are discussed
separately.
34
Parent Company
Operating Activities
Cash provided by operations was $252 million.
A $100 million dividend from the financial services group,
resulting from an increase in the financial services group
dividend pay out ratio, coupled with an increase in non-cash
expenses more than offset increased working capital needs of $57
million and lower net income of $34 million.
Investing Activities
Investing activities used $660 million.
Capital expenditures were $81 million and depreciation was
$164 million. Capital expenditures are expected to approximate
$130 million for the year 2002. Depreciation is expected to
approximate $225 million for the year 2002.
Cash paid for acquisitions and joint venture investments was
$609 million including $569 million to acquire Gaylord and $33
million to acquire a box plant in Puerto Rico and the converting
facilities of Mack Packaging Group, Inc.
Cash received from the dispositions of Gaylord non-strategic
assets and operations was $58 million, including $25 million
related to working capital items.
Financing Activities
Financing activities provided $420 million.
Cash proceeds from the offerings of common stock, Upper DECS
units and senior notes were $1,060 million before expenses of $28
million. These proceeds were used to repay the $880 million
bridge financing facility and, coupled with the increase in cash
from operations, used to repay $310 million in other borrowings
and increase short-term investments.
The 4.1 million shares of common stock were sold for $52 per
share. The Upper DECS units consist of $345 million of 6.42%
senior notes due in 2007 and contracts to purchase common stock.
The interest rate on the Upper DECS senior notes will be reset
during February 2005. The purchase contracts represent an
obligation to purchase by May 2005, shares of common stock based
on an aggregate purchase price of $345 million. The purchase
contracts also provide for contract adjustment payments at an
annual rate of 1.08 percent. The actual number of shares that
will be issued on the stock purchase date will be determined by a
settlement rate that is based on the average market price of the
company's common stock for 20 days preceding the stock purchase
date. The average price per share will not be less than $52, in
which case 6.635 million shares would be issued, and will not be
higher than $63.44, in which case 5.438 million shares would be
35
issued. If a holder elects to purchase shares prior to May 2005,
the number of shares that would be issued will be based on a
fixed price of $63.44 per share (the settlement rate resulting
in the fewest number of shares issued to the holder) regardless
of the actual market price of the shares at that time.
Accordingly, if the purchase contracts had been settled at third
quarter-end 2002, the settlement rate would have resulted in the
issuance of 5.438 million shares of common stock.
The $500 million of 7.875% senior notes due 2012 were sold
at 99.289 percent of par. The notes bear interest at an
effective rate of 7.98 percent.
The bridge financing facility initially provided $880
million of which $525 was used to acquire Gaylord, $285 million
was used to repay Gaylord's assumed bank debt, $16 million was
used for financing fees and the remainder was used for other
acquisition related purposes.
Cash dividends paid were $50 million or $.32 per share.
Liquidity and Off Balance Sheet Financing Arrangements
The parent company's sources of short-term funding are its
operating cash flows, which include dividends received from
financial services, its existing credit arrangements, and its
accounts receivable securitization program. The dividends
received from financial services are subject to regulatory
approval and restrictions.
At third quarter-end 2002, the parent company had $455
million in committed credit agreements and a $200 million
accounts receivable securitization program. Unused capacity was
$391 million under the committed credit agreements and $197
million under the accounts receivable securitization program.
The credit agreements contain terms and conditions customary for
such agreements, including minimum levels of interest coverage
and limitations on leverage. At third quarter-end 2002, the
parent company has complied with all of the terms and conditions
of its credit agreements and the accounts receivable
securitization program. None of the current credit agreements or
the accounts receivable securitization program are restricted as
to availability based on the ratings of the parent company's long-
term-debt ratings. Approximately $32 million in joint venture and
subsidiary debt guarantees and funding obligations include rating
triggers, which if activated would result in acceleration. The
long-term debt of the parent company is currently rated
BBB/Stable by one rating agency and Baa3/Negative outlook by
another rating agency.
At third quarter-end 2002, the parent company's contractual
cash payment obligations by year for total debt follows (in
millions): 2002 - $32; 2003 - $80; 2004 - $105; 2005 - $142; 2006
- - $102; 2007 - $413; and 2008 and thereafter - $1,095.
36
During October 2002, the parent company increased its
committed credit agreements to $615 million by entering into a
new $400 million credit facility, canceling credit agreements
scheduled to mature in 2002, and renegotiated some of its
committed credit lines. Under the terms of the new $400 million
credit facility, $200 million expires in 2005, with a provision
to extend for one further year up to the full $200 million with
the consent of the lending banks. The other $200 million expires
in 2007. A $100 million bank term loan due in 2005 was pre-paid
simultaneously with the closing of the new $400 million credit
facility. Funding for this pre-payment came from the accounts
receivable securitization program. In addition, during the
quarter the maturity date of the accounts receivable
securitization program was extended until August 29, 2003. Upon
closing of the new credit agreement, the parent company's unused
borrowing capacity under its committed credit agreements became
$551 million with an additional $97 million of unused capacity
available under the accounts receivable securitization program.
Financial Services
The principal sources of cash for financial services are
operating cash flows, deposits and borrowings. The financial
services group uses these funds to invest in earning assets,
generally loans and securities.
Operating Activities
Cash provided by operations was $99 million.
Cash was provided by net income of $108 million,
depreciation, amortization and accretion of $64 million and
provision for loan losses of $37 million; partially offset by a
$78 million decrease in escrowed cash related to mortgage loans
serviced for others and $34 million of originated mortgage
servicing rights.
Investing Activities
Cash used in investment activities was $1,462 million.
Cash paid for securities purchases, net of maturities, were
$1,857 million. In addition, there were $469 million of mortgage-
backed securities purchased that will be settled during fourth
quarter 2002. Acquisitions of banking operations, predominately
deposit relationships, provided cash of $358 million, net of cash
used in the acquisition of insurance operations.
Financing Activities
Cash provided by financing activities was $1,150 million.
Deposits decreased $168 million, net of a deposit purchase
of $104 million, while borrowings increased $1,418 million. The
37
decrease in deposits was primarily due to competitive markets.
In addition, during fourth quarter 2002, it is expected that $470
million in amortizing fixed-rate debt commitments will be used in
connection with the settlement of mortgage-backed securities
purchased during the third quarter 2002.
Dividends paid to the parent company totaled $100 million.
Other
The financial services group's short-term funding needs are
met through operating cash flows, attracting new retail deposits,
increased borrowings and converting assets to cash through sales
or reverse repurchase agreements. Assets that can be converted
to cash include short-term investments, mortgage loans held for
sale and securities. At third quarter-end 2002, financial
services had available liquidity of $1.8 billion. In addition,
at third quarter-end 2002, commitments to originate single-family
residential mortgage loans totaled $2.8 billion and commitments
to sell single-family residential mortgage loans totaled $1.6
billion.
At third quarter-end 2002, the savings bank exceeded all
applicable regulatory capital requirements. The parent company
expects to maintain the savings bank's capital at a level that
exceeds the minimum required for designation as "well
capitalized." From time to time, the parent company may make
capital contributions to the savings bank or receive dividends
from the savings bank. During the first nine months of 2002, the
parent company made no contributions to the savings bank and
received $100 million in dividends from the savings bank.
Selected financial and regulatory capital data for the
savings bank follows:
Third Quarter-end Year-end
(dollars in millions) 2002 2001
Balance sheet data
Total assets $17,288 $15,251
Total deposits 9,504 9,369
Shareholder's equity 951 954
Savings Regulatory For Categorization as
Bank Minimum "Well Capitalized"
Regulatory capital ratios:
Tangible capital 6.9% 2.0% N/A
Leverage capital 6.9% 4.0% 5.0%
Risk-based capital 10.8% 8.0% 10.0%
Accounting Pronouncements
Beginning January 2002, the company adopted FAS No. 142,
Goodwill and Other Intangible Assets. Under this Statement,
38
amortization of goodwill is precluded and goodwill is
periodically measured for impairment. The cumulative effect of
adopting this statement was to reduce first quarter 2002 net
income by $11 million or $0.22 per diluted share for an $18
million goodwill impairment associated with the paper group's
specialty packaging acquisitions. The effect of not amortizing
goodwill in third quarter 2001 would have been to increase
operating income by $3 million and net income by $2 million or
$0.04 per diluted share. The effect of not amortizing goodwill
in the first nine months 2001 would have been to increase
operating income by $5 million and net income by $4 million or
$0.08 per diluted share.
Beginning with the first quarter 2003, the company will be
required to adopt FAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities. Under this statement,
liabilities for costs associated with an exit or disposal
activity, including restructurings, are to be recognized when the
liability is incurred and can be measured at estimated fair
value. The company believes that the effect on earnings or
financial position of adopting this statement will not be
material.
Beginning with acquisitions of certain financial
institutions effected after October 1, 2002, the company will be
required to apply the provisions of FAS No. 147, Acquisitions of
Certain Financial Institutions-an amendment of FAS Statements No.
72 and 144 and FASB Interpretations No. 9. The principal effect
of this statement is the clarification of what constitutes the
acquisition of a business and that such acquisitions should be
accounted for in accordance with the provisions of FAS 141,
Business Combinations, and FAS 142, Goodwill and Other Intangible
Assets. It also includes within the scope of FAS 144, Accounting
for the Impairment or Disposal of Long-Lived Assets, intangible
assets customarily recognized in acquisitions of financial
institutions. The company believes that the effect on earnings
or financial positions of adopting this statement will not be
material.
Pension Matter Expected to Affect Fourth Quarter 2002 and the
Year 2003
Based on preliminary estimates the company expects to record
a non-cash after-tax charge to shareholders' equity during fourth
quarter 2002 in the range of $120 million due to changes in the
funded status of its defined benefit pension plans. The actual
amounts will be determined upon completion of the annual
actuarial valuations. Decreases in the values of pension plan
assets due to lower investment returns coupled with an increase
in the present value of future pension benefits due to lower
interest rates have resulted in company's defined benefit pension
plans being under funded from an accounting perspective. The
company's pension plans were over funded by $38 million in 2001
and are expected to be under funded in the range of $230 million
as of September 2002, the annual valuation date. Under current
accounting rules, the company must record a minimum pension
39
liability equal to the excess of accumulated benefit obligations
over the fair value of plan assets. The approximate $120
million after-tax effect of recognizing the minimum pension
liability will be charged against other comprehensive income,
a component of shareholders' equity. This charge will not affect
2002 net income or cash flow nor does the company expect it to
result in any debt covenant violations.
For the year 2002, the company expects to incur $9 million
in non-cash pension expense. For the year 2003, the company
expects to incur in the range of $40 million in non-cash pension
expense. The increase in pension expenses is primarily due to the
change in the funded status, a planned decrease in the assumed
expected rate of return on plan assets from 9.0 percent to 8.5
percent and an increase in the recognition of the accumulated
decline in the fair value of plan assets.
For the years 2002 and 2003, the company expects the defined
benefit plan cash funding requirements to be in the range of $2
million or less per year.
Forward-Looking Statements
Management's Discussion and Analysis of Financial Condition
and Results of Operations contains forward-looking statements
that involve risks and uncertainties. The actual results
achieved by Temple-Inland may differ significantly from the
results discussed in the forward-looking statements. Factors
that might cause such differences include general economic,
market, or business conditions; the opportunities or lack thereof
that may or may not be presented to and pursued by Temple-Inland
and its subsidiaries; availability and price of raw materials
used by Temple-Inland and its subsidiaries; competitive actions
by other companies; changes in laws or regulations; the accuracy
of certain judgments and estimates concerning the integration of
Gaylord Container Corporation into the operations of Temple-
Inland; and other factors, many of which are beyond the control
of Temple-Inland and its subsidiaries.
40
Statistical and other data
Third Quarter First Nine Months
2002 2001 2002 2001
Revenues (in millions)
Paper
Corrugated packaging $ 606 $ 464 $ 1,743 $ 1,376
Linerboard 43 39 123 110
Other 23 31 66 89
----- ---- ----- -----
Total Paper $ 672 $ 534 $ 1,932 $ 1,575
===== ==== ===== =====
Building Products
Pine lumber $ 59 $ 65 $ 177 $ 175
Particleboard 43 45 133 138
Medium density fiberboard 32 24 91 79
Gypsum wallboard 19 16 58 41
Fiberboard 18 17 52 49
Other 31 35 99 79
----- ---- ----- -----
Total Building Products $ 202 $ 202 $ 610 $ 561
===== ==== ===== =====
Financial Services
Savings bank $ 205 $ 271 $ 597 $ 572
Mortgage banking 51 31 154 54
Real estate 24 29 65 61
Insurance brokerage 14 12 40 28
----- ---- ----- -----
Total Financial Services $ 294 $ 321 $ 856 $ 1,036
===== ==== ===== =====
Unit sales
Paper (in thousand tons)
Corrugated packaging 795 568 2,262 1,668
Linerboard 127 109 368 296
----- ---- ----- -----
Total 922 677 2,630 1,964
===== ==== ===== =====
Building Products
Pine lumber - mbf 203 199 578 537
Particleboard - msf 164 153 501 455
Medium density fiberboard - msf 73 60 225 206
Gypsum wallboard - msf 171 165 510 459
Fiberboard - msf 106 102 312 301
Financial Services
Segment operating income
Savings bank $ 44 $ 41 $ 102 $ 123
Mortgage banking (3) (1) 7 -
Real estate - - (3) 2
Insurance brokerage 3 3 9 9
----- ---- ----- -----
Total Financial Services $ 44 $ 43 $ 115 $ 134
===== ==== ===== =====
Operating Ratios
Return on average assets 1.18% 1.04% 0.90% 1.06%
Return on average equity 17.87% 13.53% 12.90% 14.27%
(a) Revenues and unit sales do not include joint venture
operations
Note: Data for the paper group for 2002 is not comparable due to
the effect of acquisitions completed in 2002.
41
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
Interest Rate Risk
Temple-Inland's current level of interest rate risk is
primarily due to an asset sensitive position within the financial
services group and, to a lesser degree, variable rate debt at the
parent company.
The following table illustrates the estimated effect on pre-
tax income of immediate, parallel and sustained shifts in
interest rates for the subsequent 12-month period at third
quarter-end 2002, with comparative information at year-end 2001.
This estimate considers the effects of changing prepayment speeds
and average balances over the next 12 months.
Increase (decrease) in Income Before Taxes
(In millions)
Third Quarter 2002 Year-end 2001
Change in Parent Financial Parent Financial
Interest Company Services Company Services
Rates
+2% $(4) $ 40 $(11) $ 13
+1% $(2) $ 32 $ (6) $ 14
0 $ - $ - $ - $ -
-1% $ 2 $(34) $ 6 $(12)
Due to the current low interest rate environment, a 2
percent decrease in interest rates is not presented.
The parent company's change in interest rate risk from year-
end 2001 is primarily due to a decrease in variable rate debt.
During the second quarter 2002, the parent company effected a
number of financing transactions that reduced reliance on short-
term borrowings.
The financial services group is subject to interest rate
risk to the extent that its interest-earning assets and interest-
bearing liabilities repay or reprice at different times or in
differing amounts or both. The financial services group is
currently in an asset sensitive position whereby the rate and
prepayment characteristics of its assets are more responsive to
changes in market interest rates than are its liabilities.
Postured in this way, earnings will generally be positively
affected in a rising rate environment, but generally be
negatively affected in a falling rate environment. The effect of
lower interest rates during the first nine months 2002 resulted
in faster prepayments on seasoned mortgage loans and mortgage-
backed securities and increased sensitivity to further changes in
interest rates.
Additionally, the fair value of the financial services
group's mortgage servicing rights (estimated at $129 million at
third quarter-end 2002) is also affected by changes in interest
42
rates. Temple-Inland estimates that a 1 percent decline in
interest rates from current levels would decrease the fair value
of the mortgage servicing rights by approximately $25 million.
Foreign Currency Risk
Temple-Inland's exposure to foreign currency fluctuations on
its financial instruments is not material because most of these
instruments are denominated in U.S. dollars.
Commodity Price Risk
From time to time Temple-Inland uses commodity derivative
instruments to mitigate its exposure to changes in product
pricing and manufacturing costs. These instruments cover a small
portion of Temple-Inland's manufacturing volume and range in
duration from three months to three years. Based on the fair
value of these instruments at third quarter-end 2002, the
potential loss in fair value resulting from a hypothetical 10
percent change in the underlying commodity prices would not be
significant.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
The Company's chief executive officer and its chief financial
officer, based on their evaluation of the Company's disclosure
controls and procedures (as defined in Exchange Act Rule 13a-
14(c)) as of a date within 90 days prior to the filing of this
Quarterly Report on Form 10-Q, have concluded that the Company's
disclosure controls and procedures are adequate and effective for
the information required to be disclosed by us in the reports we
file or submit under the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), is recorded, processed, summarized,
and reported within the time periods specified in the Securities
and Exchange Commission's ("SEC") rules and forms.
(b) Changes in internal controls.
There were no significant changes in the Company's internal
controls or in other factors that could significantly affect the
Company's internal controls subsequent to the date of their
evaluation described above.
43
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
The information set forth in Note E to Notes to
Consolidated Financial Statements in Part I of this
report is incorporated by reference thereto.
Item 2. Changes in Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
3.1 - Amended and Restated Bylaws of Temple-Inland
Inc. as adopted by the Board of Directors on May 2,
2002
99.1 - Certification of Chief Executive Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
99.2 - Certification of Chief Financial Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
During the quarter ended September 28, 2002, the
company filed the following Current Reports on Form 8-
K:
1. Current Report on Form 8-K dated August 12, 2002, reporting
under Item 9 the submission to the Securities and Exchange
Commission by each of the chief executive officer and chief
financial officer of Temple-Inland Inc. of sworn statements in
accordance with Order No. 4-460 of the Securities and Exchange
Commission
2. Current Report on Form 8-K dated September 26, 2002,
reporting under Item 9 an address by Kenneth M. Jastrow, II,
Chief Executive Officer of Temple-Inland Inc., to the Global
Paper and Forest Products Conference sponsored by UBS Warburg.
44
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
TEMPLE-INLAND INC.
(Registrant)
Dated: November 12, 2002 By /S/ Louis R. Brill
------------------------
Louis R. Brill
Chief Accounting Officer
45
CERTIFICATIONS
I, Kenneth M. Jastrow, II, Chief Executive Officer of Temple-
Inland Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Temple-
Inland Inc.;
2. Based on my knowledge, this quarterly report does not
contain any untrue statement of a material fact or omit to state
a material fact necessary to make the statements made, in light
of the circumstances under which such statements were made, not
misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly
present in all material respects the financial condition, results
of operations and cash flows of the registrant as of, and for,
the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure controls
and procedures (as defined in Exchange Act Rules 13a-14 and 15d-
14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including
its consolidated subsidiaries, is made known to us by others
within those entities, particularly during the period in which
this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
46
6. The registrant's other certifying officers and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors that
could significantly affect internal controls subsequent to the
date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material
weaknesses.
Date: November 12, 2002 /s/ Kenneth M. Jastrow, II
-----------------------------
Kenneth M. Jastrow, II
Chief Executive Officer
47
CERTIFICATIONS
I, Randall D. Levy, Chief Financial Officer of Temple-Inland
Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Temple-
Inland Inc.;
2. Based on my knowledge, this quarterly report does not
contain any untrue statement of a material fact or omit to state
a material fact necessary to make the statements made, in light
of the circumstances under which such statements were made, not
misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly
present in all material respects the financial condition, results
of operations and cash flows of the registrant as of, and for,
the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure controls
and procedures (as defined in Exchange Act Rules 13a-14 and 15d-
14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including
its consolidated subsidiaries, is made known to us by others
within those entities, particularly during the period in which
this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
48
6. The registrant's other certifying officers and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors that
could significantly affect internal controls subsequent to the
date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material
weaknesses.
Date: November 12, 2002 /s/ Randall D. Levy
--------------------------
Randall D. Levy
Chief Financial Officer
49
INDEX TO EXHIBITS
Exhibit No. Description Page No.
3.1 Amended and Restated Bylaws of 50
Temple-Inland Inc. as adopted by
the Board of Directors on May 2,
2002
99.1 Certification of Chief Executive 72
Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-
Oxley Act of 2002
99.2 Certification of Chief Financial 73
Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-
Oxley Act of 2002