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 June 28, 2003
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 of 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, including 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 by check mark 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 such filing
requirements for the past 90 days. Yes X No
Indicate by check mark 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 June 28, 2003
Common Stock (par
value $1.00 per share) 54,150,400
Page 1 of 56 The Exhibit Index is page 50.
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SUMMARIZED STATEMENTS OF INCOME
PARENT COMPANY (TEMPLE-INLAND INC.)
Unaudited
Second Quarter First Six Months
2003 2002 2003 2002
---- ---- ---- ----
(in millions)
NET REVENUES $ 877 $ 921 $ 1,724 $ 1,668
COSTS AND EXPENSES
Cost of sales 800 795 1,596 1,452
Selling and administrative 75 84 150 152
Other (income) expense 21 6 30 6
----- ----- ----- -----
896 885 1,776 1,610
----- ----- ----- -----
(19) 36 (52) 58
FINANCIAL SERVICES EARNINGS 42 37 81 64
----- ----- ----- -----
OPERATING INCOME 23 73 29 122
Interest expense (35) (36) (70) (61)
Other expense -- (11) -- (11)
----- ----- ----- -----
INCOME (LOSS) FROM CONTINUING
OPERATIONS BEFORE TAXES (12) 26 (41) 50
Income tax (expense) benefit 167 (10) 179 (19)
----- ----- ----- -----
INCOME FROM CONTINUING OPERATIONS 155 16 138 31
Discontinued operations 1 (1) 1 (1)
----- ----- ----- -----
INCOME BEFORE ACCOUNTING CHANGE 156 15 139 30
Effect of accounting change -- -- (1) (11)
----- ----- ----- -----
NET INCOME $ 156 $ 15 $ 138 $ 19
===== ===== ===== =====
See the notes to consolidated financial statements.
3
SUMMARIZED BALANCE SHEETS
PARENT COMPANY (TEMPLE-INLAND INC.)
Unaudited
Second
Quarter Year-End
2003 2002
---- ----
(in millions)
ASSETS
Current Assets
Cash and cash equivalents $ 17 $ 17
Receivables, net of allowances of $13 in 2003 398 352
and $13 in 2002
Inventories:
Work in process and finished goods 86 69
Raw materials and supplies 240 269
----- -----
Total inventories 326 338
----- -----
Prepaid expenses and other 66 50
----- -----
Total current assets 807 757
----- -----
Investment in Financial Services 1,161 1,178
Property and Equipment:
Land and buildings 641 638
Machinery and equipment 3,451 3,412
Construction in progress 87 92
Less allowances for depreciation (2,202) (2,101)
----- -----
1,977 2,041
Timber and timberlands - less depletion 499 508
----- -----
Total property and equipment 2,476 2,549
Goodwill 239 249
Assets of Discontinued Operations 25 78
Other Assets 153 146
----- -----
TOTAL ASSETS $ 4,861 $ 4,957
===== =====
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable $ 207 $ 188
Employee compensation and benefits 57 67
Accrued interest 29 30
Accrued property taxes 23 28
Other accrued expenses 131 133
Liabilities of discontinued operations 20 28
Current portion of long-term debt 6 8
----- -----
Total current liabilities 473 482
Long-Term Debt 1,813 1,883
Deferred Income Taxes 59 245
Postretirement Benefits 148 147
Pension Liability 163 142
Other Long-Term Liabilities 139 109
----- -----
Total Liabilities 2,795 3,008
Shareholders' Equity 2,066 1,949
----- -----
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 4,861 $ 4,957
===== =====
See the notes to consolidated financial statements.
4
SUMMARIZED STATEMENTS OF CASH FLOW
PARENT COMPANY (TEMPLE-INLAND INC.)
Unaudited
First Six Months
2003 2002
---- ----
(in millions)
CASH PROVIDED BY (USED FOR) OPERATIONS
Net income $ 138 $ 19
Adjustments:
Depreciation, depletion and amortization 117 108
Depreciation of leased property 1 1
Non-cash stock based compensation 16 4
Non-cash pension and postretirement expense 27 12
Cash contribution to pension and postretirement
plans (6) (6)
Other non-cash charges (credits) (135) 17
Deferred income taxes -- 12
Unremitted earnings from Financial Services (52) (57)
Dividends from Financial Services 70 75
Working capital changes, net (42) (48)
Net assets of discontinued operations (1) 9
Loss from discontinued operations (1) 1
Cumulative effect of accounting change 1 11
Other 9 20
----- -----
142 178
----- -----
CASH PROVIDED BY (USED FOR) INVESTING
Capital expenditures (58) (52)
Sales of non-strategic assets and operations 30 33
Acquisition of Gaylord, net of cash acquired -- (568)
Other acquisitions and joint ventures (5) (37)
Other -- (3)
----- -----
(33) (627)
----- -----
CASH PROVIDED BY (USED FOR) FINANCING
Payments of debt (74) (262)
Cash dividends paid to shareholders (37) (33)
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 DECSSM -- 345
Sale of Senior Notes -- 496
Other additions to debt 2 30
Other -- (21)
----- -----
(109) 485
----- -----
Net increase in cash -- 36
Cash at beginning of period 17 3
----- -----
Cash at end of period $ 17 $ 39
===== =====
See the notes to consolidated financial statements.
5
SUMMARIZED STATEMENTS OF INCOME
FINANCIAL SERVICES
Unaudited
Second Quarter First Six Months
2003 2002 2003 2002
---- ---- ---- ----
(in millions)
INTEREST INCOME
Loans and loans held for sale $ 131 $ 142 $ 264 $ 288
Securities available-for-sale 18 27 38 58
Securities held-to-maturity 37 17 76 27
Other earning assets 1 1 2 2
----- ----- ----- -----
Total interest income 187 187 380 375
INTEREST EXPENSE
Deposits 49 58 102 123
Borrowed funds 44 38 89 69
----- ----- ----- -----
Total interest expense 93 96 191 192
----- ----- ----- -----
NET INTEREST INCOME 94 91 189 183
Provision for loan losses (20) (15) (31) (29)
----- ----- ----- -----
NET INTEREST INCOME AFTER PROVISION FOR
LOAN LOSSES 74 76 158 154
----- ----- ----- -----
NONINTEREST INCOME
Loan servicing fees 7 11 16 22
Amortization and impairment of servicing
rights (23) (9) (41) (17)
Loan origination fees 51 24 94 54
Gain on sale of loans 37 14 60 27
Real estate operations 12 13 20 22
Insurance commissions and fees 12 13 22 24
Service charges on deposits 9 7 17 14
Operating lease income 3 3 5 6
Other 10 6 20 15
----- ----- ----- -----
Total noninterest income 118 82 213 167
----- ----- ----- -----
NONINTEREST EXPENSE
Compensation and benefits 91 67 174 143
Loan servicing and origination 4 1 7 2
Real estate operations, other than
compensation 8 8 15 15
Insurance operations, other than
compensation 4 3 7 7
Occupancy 8 8 16 17
Data processing 6 7 13 17
Other 29 27 58 56
----- ----- ----- -----
Total noninterest expense 150 121 290 257
----- ----- ----- -----
INCOME BEFORE TAXES 42 37 81 64
Income tax expense (15) (4) (29) (7)
----- ----- ----- -----
NET INCOME $ 27 $ 33 $ 52 $ 57
===== ===== ===== =====
See the notes to consolidated financial statements.
6
SUMMARIZED BALANCE SHEETS
FINANCIAL SERVICES
Unaudited
Second
Quarter Year-End
2003 2002
---- ----
(in millions)
ASSETS
Cash and cash equivalents $ 341 $ 438
Loans held for sale 1,051 1,088
Loans receivable, net of allowance for losses of
$117 in 2003 and $132 in 2002 9,594 9,668
Securities available-for-sale 1,621 1,926
Securities held-to-maturity 4,272 3,915
Real estate 247 249
Premises and equipment, net 158 157
Accounts, notes and accrued interest receivable 143 159
Goodwill 149 148
Mortgage servicing rights 81 105
Other assets 246 163
------ ------
TOTAL ASSETS $ 17,903 $ 18,016
====== ======
LIABILITIES AND SHAREHOLDER'S EQUITY
Deposits $ 9,150 $ 9,203
Federal Home Loan Bank advances 3,432 3,386
Securities sold under repurchase agreements 2,560 2,907
Obligations to settle trade date securities 573 369
Other liabilities 550 487
Other borrowings 172 181
Preferred stock issued by subsidiaries 305 305
------ ------
TOTAL LIABILITIES 16,742 16,838
------ ------
SHAREHOLDER'S EQUITY 1,161 1,178
------ ------
TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY $ 17,903 $ 18,016
====== ======
See the notes to consolidated financial statements.
7
SUMMARIZED STATEMENTS OF CASH FLOWS
FINANCIAL SERVICES
Unaudited
First Six Months
2003 2002
---- ----
(in millions)
CASH PROVIDED BY (USED FOR) OPERATIONS
Net income $ 52 $ 57
Adjustments:
Amortization and accretion 44 19
Depreciation 12 12
Depreciation of leased assets 4 5
Provision for loan losses 31 29
Deferred income taxes (9) (1)
Originations of loans held for sale (7,458) (3,750)
Sales of loans held for sale 7,495 4,082
Collections on loans serviced for others, net (31) (159)
Originated mortgage servicing rights (19) (28)
Other 55 19
----- -----
176 285
----- -----
CASH PROVIDED BY (USED FOR) INVESTING
Purchases of securities available-for-sale (4) (21)
Principal payments and maturities of securities
available-for-sale 312 420
Purchases of securities held-to-maturity (1,112) (1,115)
Principal payments and maturities of securities
held-to-maturity 960 56
Loans originated or acquired, net of collections (44) 154
Sale of mortgage servicing rights -- 34
Sale of loans 23 1
Acquisitions, net of cash acquired (1) (6)
Capital expenditures (11) (7)
Other 4 (1)
----- -----
127 (485)
----- -----
CASH PROVIDED BY (USED FOR) FINANCING
Net decrease in deposits (29) (592)
Securities sold under repurchase agreements and
short-term borrowings, net 58 (309)
Additions to debt and long-term FHLB advances 57 1,121
Payments of debt and long-term FHLB advances (425) (108)
Dividends paid to parent company (70) (75)
Other 9 4
----- -----
(400) 41
----- -----
Net decrease in cash and cash equivalents (97) (159)
Cash and cash equivalents at beginning of period 438 587
----- -----
Cash and cash equivalents at end of period $ 341 $ 428
===== =====
See the notes to consolidated financial statements.
8
CONSOLIDATED STATEMENTS OF INCOME
TEMPLE-INLAND INC. AND SUBSIDIARIES
Unaudited
Second Quarter First Six Months
2003 2002 2003 2002
---- ---- ---- ----
(in millions, except per share amounts)
REVENUES
Manufacturing $ 877 $ 921 $ 1,724 $ 1,668
Financial Services 305 269 593 542
----- ----- ----- -----
1,182 1,190 2,317 2,210
----- ----- ----- -----
COSTS AND EXPENSES
Manufacturing 896 885 1,776 1,610
Financial Services 263 232 512 478
----- ----- ----- -----
1,159 1,117 2,288 2,088
----- ----- ----- -----
OPERATING INCOME 23 73 29 122
Parent company interest (35) (36) (70) (61)
Other expense -- (11) -- (11)
----- ----- ----- -----
INCOME (LOSS) BEFORE TAXES (12) 26 (41) 50
Income tax (expense) benefit 167 (10) 179 (19)
----- ----- ----- -----
INCOME FROM CONTINUING OPERATIONS 155 16 138 31
Discontinued operations 1 (1) 1 (1)
----- ----- ----- -----
INCOME BEFORE ACCOUNTING CHANGE 156 15 139 30
Effect of accounting change -- -- (1) (11)
----- ----- ----- -----
NET INCOME $ 156 $ 15 $ 138 $ 19
===== ===== ===== =====
EARNINGS (LOSS) PER SHARE
Basic:
Income from continuing operations $ 2.86 $ 0.31 $ 2.55 $ 0.61
Discontinued operations 0.01 (0.02) 0.01 (0.02)
Effect of accounting change -- -- (0.01) (0.22)
----- ----- ----- -----
Net income $ 2.87 $ 0.29 $ 2.55 $ 0.37
===== ===== ===== =====
Diluted:
Income from continuing operations $ 2.86 $ 0.31 $ 2.55 $ 0.61
Discontinued operations 0.01 (0.02) 0.01 (0.02)
Effect of accounting change -- -- (0.01) (0.22)
----- ----- ----- -----
Net income $ 2.87 $ 0.29 $ 2.55 $ 0.37
===== ===== ===== =====
DIVIDENDS PAID PER SHARE OF COMMON
STOCK $ 0.34 $ 0.32 $ 0.68 $ 0.64
===== ===== ===== =====
See the notes to consolidated financial statements.
9
CONSOLIDATING BALANCE SHEETS
TEMPLE-INLAND INC. AND SUBSIDIARIES
Second Quarter 2003
Unaudited
Parent Financial
Company Services Consolidated
------- --------- ------------
(in millions)
ASSETS
Cash and cash equivalents $ 17 $ 341 $ 358
Loans held for sale -- 1,051 1,051
Loans receivable, net -- 9,594 9,594
Securities available-for-sale -- 1,621 1,621
Securities held-to-maturity -- 4,272 4,272
Trade receivables, net 398 -- 398
Inventories 326 -- 326
Property and equipment, net 2,476 158 2,634
Goodwill 239 149 388
Other assets 244 717 918
Investment in Financial Services 1,161 -- --
----- ------ ------
TOTAL ASSETS $ 4,861 $ 17,903 $ 21,560
===== ====== ======
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits $ -- $ 9,150 $ 9,150
Federal Home Loan Bank advances -- 3,432 3,432
Securities sold under repurchase -- 2,560 2,560
Obligations to settle trade date -- 573 573
Other liabilities 612 550 1,137
Long-term debt 1,813 172 1,985
Deferred income taxes 59 -- 41
Postretirement benefits 148 -- 148
Pension liability 163 -- 163
Preferred stock issued by subsidiaries -- 305 305
----- ------ ------
TOTAL LIABILITIES $ 2,795 $ 16,742 $ 19,494
----- ------ ------
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 370
Accumulated other comprehensive loss (138)
Retained earnings 2,101
------
2,394
Cost of shares held in the treasury:
7,239,152 shares (328)
------
TOTAL SHAREHOLDERS' EQUITY 2,066
------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 21,560
======
See the notes to consolidated financial statements.
10
CONSOLIDATING BALANCE SHEETS
TEMPLE-INLAND INC. AND SUBSIDIARIES
Year-End 2002
Unaudited
Parent Financial
Company Services Consolidated
------- --------- ------------
(in millions)
ASSETS
Cash and cash equivalents $ 17 $ 438 $ 455
Loans held for sale -- 1,088 1,088
Loans receivable, net -- 9,668 9,668
Securities available-for-sale -- 1,926 1,926
Securities held-to-maturity -- 3,915 3,915
Trade receivables 352 -- 352
Inventories 338 -- 338
Property and equipment, net 2,549 157 2,706
Goodwill 249 148 397
Other assets 274 676 915
Investment in Financial Services 1,178 -- --
----- ------ ------
TOTAL ASSETS $ 4,957 $ 18,016 $ 21,760
===== ====== ======
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits $ -- $ 9,203 $ 9,203
Federal Home Loan Bank advances -- 3,386 3,386
Securities sold under repurchase -- 2,907 2,907
Obligations to settle trade date -- 369 369
Other liabilities 591 487 1,052
Long-term debt 1,883 181 2,064
Deferred income taxes 245 -- 236
Postretirement benefits 147 -- 147
Pension liability 142 -- 142
Preferred stock issued by subsidiaries -- 305 305
----- ------ ------
TOTAL LIABILITIES $ 3,008 $ 16,838 $ 19,811
----- ------ ------
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 368
Accumulated other comprehensive loss (136)
Retained earnings 2,000
------
2,293
Cost of shares held in the treasury:
7,583,293 shares (344)
------
TOTAL SHAREHOLDERS' EQUITY 1,949
------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 21,760
======
See the notes to consolidated financial statements.
11
CONSOLIDATED STATEMENT OF CASH FLOWS
TEMPLE-INLAND INC. AND SUBSIDIARIES
Unaudited
First Six Months
2003 2002
---- ----
(in millions)
CASH PROVIDED BY (USED FOR) OPERATIONS
Net income $ 138 $ 19
Adjustments:
Depreciation, depletion and amortization 129 120
Depreciation on leased property 5 6
Provision for loan losses 31 29
Deferred taxes (9) 11
Other non-cash charges (135) 17
Amortization and accretion of financial
instruments 44 19
Originations of loans held for sale (7,458) (3,750)
Sales of loans held for sale 7,495 4,082
Working capital changes, net (42) (48)
Collections on loans serviced for others, net (31) (159)
Originated mortgage servicing rights (19) (28)
Net assets of discontinued operations (1) 9
Loss from discontinued operations (1) 1
Cumulative effect of accounting change 1 11
Other 101 49
----- -----
248 388
----- -----
CASH PROVIDED BY (USED FOR) INVESTING
Capital expenditures (69) (59)
Sale of non-strategic assets and operations 30 33
Purchases of securities available-for-sale (4) (21)
Principal payments and maturities of securities
available-for-sale 312 420
Purchases of securities held-to-maturity (1,112) (1,115)
Principal payments and maturities and redemptions
of securities held-to-maturity 960 56
Sale of mortgage servicing rights -- 34
Loans originated or acquired, net of principal
collected (44) 154
Proceeds from sale of loans 23 1
Acquisitions, net of cash acquired (6) (611)
Other 4 (4)
----- -----
94 (1,112)
----- -----
CASH PROVIDED BY (USED FOR) FINANCING
Net decrease in deposits (29) (592)
Additions to debt 59 1,151
Payments of debt (499) (370)
Repurchase agreements and short-term borrowings, net 58 (309)
Cash dividends paid to shareholders (37) (33)
Bridge financing facility -- 880
Payment of bridge financing facility -- (880)
Payment of assumed Gaylord bank debt -- (285)
Sale of common stock, Upper DECS(SM), and Senior Notes -- 1,056
Other 9 (17)
----- -----
(439) 601
----- -----
Net decrease in cash and cash equivalents (97) (123)
Cash and cash equivalents at beginning of period 455 590
----- -----
Cash and cash equivalents at end of period $ 358 $ 467
===== =====
See the notes to consolidated financial statements.
12
TEMPLE-INLAND INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED 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 only of normal
accruals) 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 28, 2002.
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 subsidiaries.
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 Financial Services are reflected in the summarized
financial statements using the equity method. 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 Company's consolidated
financial statements and the 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
TEMPLE-INLAND INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE B - EARNINGS PER SHARE
Denominators used in computing per share amounts follow:
Second Quarter First Six Months
2003 2002 2003 2002
---- ---- ---- ----
(in millions)
Denominator for basic earnings per
share:
Weighted average common shares 54.1 52.3 54.0 50.9
outstanding
Dilutive effect of:
Equity purchase contracts -- -- -- --
Stock options -- 0.1 0.1 0.1
---- ---- ---- ----
Denominator for diluted earnings
per share 54.1 52.4 54.1 51.0
==== ==== ==== ====
NOTE C - COMPREHENSIVE INCOME
Comprehensive income consists of:
Second Quarter First Six Months
2003 2002 2003 2002
---- ---- ---- ----
(in millions)
Net income $ 156 $ 15 $ 138 $ 19
Other comprehensive income (loss),
net of taxes:
Unrealized gains (losses) on:
Available-for-sale securities (3) (1) 1 (1)
Derivative instruments (1) (1) (1) --
Foreign currency translation
adjustments 1 (7) (2) (6)
---- ---- ---- ----
Other comprehensive loss (3) (9) (2) (7)
---- ---- ---- ----
Comprehensive income $ 153 $ 6 $ 136 $ 12
==== ==== ==== ====
At second quarter-end 2003, the aggregate fair value of all
derivative instruments was a $10 million liability, consisting of
a $10 million liability for an interest rate swap derivative and
a $0.4 million liability related to linerboard and OCC
derivatives. There was no ineffective portion of derivatives
charged to earnings in second quarter 2003 or in first six months
2003 and amounts reclassified from other comprehensive income
into earnings were not material.
NOTE D - SEGMENT INFORMATION
The Company has three reportable segments: Corrugated
Packaging, Building Products, and Financial Services. The Company
evaluates performance based, in part, on operating income before
other (income) expense, unallocated general and administrative
expenses, parent company interest, and income taxes. Other
(income) expense includes gain or loss on sale of assets, asset
impairments and expenses associated with consolidation and supply
chain initiatives and facility closures.
14
TEMPLE-INLAND INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Unallocated
General &
Administrative
and Other
Corrugated Building Financial (Income)
For second quarter 2003 Packaging Products Services Expense Total
- ----------------------- --------- -------- -------- -------------- -----
(in millions)
Revenues from external customers $ 685 192 305 -- $ 1,182
Depreciation, depletion and
amortization $ 42 16 9(e) 1 $ 68
Operating income $ 1 12 44 (34)(a) $ 23
Financial Services, net
interest income $ -- -- 94 -- $ 94
Capital expenditures $ 21 7 6 1 $ 35
- ---------------------------------------------------------------------------------------------------
For first six months 2003 or
at second quarter end 2003
- ----------------------------
(in millions)
Revenues from external customers $ 1,352 372 593 -- $ 2,317
Depreciation, depletion and
amortization $ 83 32 16(e) 3 $ 134
Operating income $ (3) 3 83 (54)(b) $ 29
Financial Services, net
interest income $ -- -- 189 -- $ 189
Total assets $ 2,442 1,116 17,903 99 $21,560
Capital expenditures $ 41 15 11 2 $ 69
Goodwill $ 239 -- 149 -- $ 388
- ---------------------------------------------------------------------------------------------------
For second quarter 2002
(in millions)
Revenues from external customers $ 703 218 269 -- $ 1,190
Depreciation, depletion and
amortization $ 42 16 7(e) 1 $ 66
Operating income $ 29 21 37 (14)(c) $ 73
Financial Services, net
interest income $ -- -- 91 -- $ 91
Capital expenditures $ 13 11 5 2 $ 31
- ---------------------------------------------------------------------------------------------------
For first six months 2002 or
at second quarter end 2002
- ----------------------------
(in millions)
Revenues from external customers $ 1,260 408 542 -- $ 2,210
Depreciation, depletion and
amortization $ 77 30 17(e) 2 $ 126
Operating income $ 51 31 71 (31)(d) $ 122
Financial Services, net
interest income $ -- -- 183 -- $ 183
Total assets $ 2,692 1,200 16,440 73 $20,405
Capital expenditures $ 30 20 7 2 $ 59
Goodwill $ 162 -- 136 -- $ 298
- ---------------------------------------------------------------------------------------------------
(a) Includes other (income) expenses of $23 million, of which $1
million is related to the Mt. Jewett particleboard plant closure,
which applies to Building Products, $23 million is related to
consolidation and supply chain cost reduction initiatives of
which $2 million was attributable to Financial Services, and
other income of $1 million related to the collection of notes
that were written off in 2002, which applies to Corrugated
Packaging.
(b) Includes other (income) expenses of $32 million, of which $6
million is related to box plant closures, which applies to
Corrugated Packaging, $1 million is related to Mt.Jewett
particleboard plant closure, $26 million is related to
consolidation and supply chain cost reduction initiatives of
which $2 million was attributable to Financial Services, and
other income of $1 million related to the collection of notes
that were written off in 2002, which applies to Corrugated
Packaging.
15
TEMPLE-INLAND INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(c) Includes other expenses of $6 million related to the
repurchase of notes sold with recourse, which applies to
Corrugated Packaging.
(d) Includes other expenses of $13 million, of which $7 million
is related to severance and write-off of technology investments,
which applies to Financial Services, and $6 million related to
the repurchase of notes sold with recourse, which applies to
Corrugated Packaging.
(e) Includes depreciation and amortization of premises and
equipment and leased assets.
NOTE E - CONTINGENCIES
There are pending against the Company and its subsidiaries
lawsuits, claims and environmental matters arising in the regular
course of business. The resolution of these matters is not
expected to have a material adverse effect on the Company's
operations or financial position.
NOTE F - ACQUISITIONS
The Company acquired effective control of Gaylord Container
Corporation on February 28, 2002. The Company acquired a box
plant in Puerto Rico during March 2002, two converting operations
of Mack Packaging Group, Inc. during May 2002, and Fibre
Innovations LLC during November 2002. The results of the acquired
operations have been included in the Company's income statement
since the dates of acquisition.
The following parent company unaudited pro forma information
assumes these acquisitions and related financing occurred at the
beginning of 2002 (in millions except per share):
Second Quarter First Six Months
2002 2002
---- ----
(in millions, except per share)
Net revenues $ 927 $ 1,811
Income from continuing operations $ 13 $ 19
Per diluted share
Income from continuing operations $ 0.25 $ 0.37
NOTE G - DISCONTINUED OPERATIONS
At second quarter-end 2003, discontinued operations consist
of Gaylord's chemical business and accruals related to the 1999
sale of the bleached paperboard operations. At second quarter-end
2003, the assets and liabilities of discontinued operations
includes $8 million of working capital, $16 million of property
and equipment, and $19 million of environmental and other long-
term accruals. Revenues from discontinued operations for second
quarter 2003 were $3 million and for first six months 2003 were
$12 million.
16
TEMPLE-INLAND INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE H - OTHER OPERATING (INCOME) EXPENSE
Other operating (income) expense consists of:
Second Quarter First Six Months
2003 2002 2003 2002
---- ---- ---- ----
(in millions)
Expenses associated with
consolidation and supply
chain initiatives $ 21 $ -- $ 24 $ --
Loss on closure of Mt. Jewett
particleboard 1 -- 1 --
(Income) loss related to
collection of notes that
were written off in 2002 (1) 6 (1) 6
Loss on closure of box plants -- -- 6 --
----- ----- ----- -----
Total $ 21 $ 6 $ 30 $ 6
===== ===== ===== =====
Expenses related to initiatives to consolidate
administrative functions and effect improvements in supply chain
management consist principally of relocation costs and fees paid
to third party consultants.
During second quarter 2003, the Company permanently closed
two box plants and paid $1 million in severance with another $1
million in severance to be paid in third quarter 2003. During
second quarter 2003, the Company indefinitely shutdown the Mt.
Jewett particleboard plant and incurred $1 million in severance,
all of which was paid in second quarter 2003.
A summary of the activity related to all facility closure
accruals for second quarter 2003 follows:
Beginning Cash End of
of Period Additions Payments Period
--------- --------- -------- ------
Involuntary employee
terminations $ 2 $ 1 $ (2) $ 1
Contract termination
penalties 6 -- -- 6
Environmental
compliance 13 -- (1) 12
Demolition 12 -- -- 12
----- ----- ----- -----
Total $ 33 $ 1 $ (3) $ 31
===== ===== ===== =====
17
TEMPLE-INLAND INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE I - INCOME TAX
During second quarter 2003, the Internal Revenue Service
concluded its examination of the Company's tax returns through
1996, including matters related to net operating losses and
minimum tax credit carryforwards, which resulted from certain
deductions following the 1988 acquisition of Guaranty Bank and
for which no financial accounting benefit had been recognized.
Also, the Company resolved certain state tax refund claims for
the years 1991 through 1994. As a result, valuation allowances
and tax accruals previously provided for these matters are no
longer required. Accordingly, during second quarter 2003, the
Company recorded a one-time benefit of $165 million, or $3.05 per
diluted share. Of this one-time benefit, $26 million represents
expected cash refunds of previously paid taxes plus related
interest. The remainder is a non-cash benefit.
NOTE J - NEW ACCOUNTING PRONOUNCEMENTS
Stock-Based Compensation
Beginning January 2003, the Company voluntarily adopted the
prospective transition method of accounting for stock-based
compensation contained in Statement of Financial Accounting
Standards (SFAS) No. 148, Accounting for Stock-Based Compensation-
Transition and Disclosure, an amendment of FASB Statement No.
123. The principal effect of adopting the prospective transition
method is that the fair value of stock options granted in 2003
and thereafter are charged to expense over the option vesting
period. As a result of the adoption of this prospective
transition method, second quarter 2003 net income was decreased
by $3 million or $0.04 per share.
Prior to 2003, the Company used the intrinsic value method
in accounting for its stock-based compensation. As a result, no
stock-based compensation expense related to stock options is
reflected in prior years' net income, as all stock options
granted had an exercise price equal to the market value of the
underlying common stock on the date of grant. Therefore, the cost
related to stock-based compensation recognized in net income for
second quarter 2003 and 2002 is less than would have been
recognized if the fair value method had been applied to all stock
options granted since 1995. The following table illustrates the
effect on net income and earnings per share as if the fair value
method had been applied to all stock options granted since 1995.
18
TEMPLE-INLAND INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Second Quarter First Six Months
2003 2002 2003 2002
---- ---- ---- ----
(in millions)
Net income, as reported $ 156 $ 15 $ 138 $ 19
Add: Stock-based compensation
expense, net of related tax
effects, included in the
determination of reported net
income 5 1 10 2
Deduct: Total stock-based
compensation expense, net of
related tax effects, determined
under the fair value based method
for all awards (8) (3) (15) (6)
----- ----- ----- -----
Pro forma net income $ 153 $ 13 $ 133 $ 15
===== ===== ===== =====
Earnings per share:
Basic, as reported $ 2.87 $ 0.29 $ 2.55 $ 0.37
Basic, pro forma $ 2.83 $ 0.25 $ 2.46 $ 0.29
Diluted, as reported $ 2.87 $ 0.29 $ 2.55 $ 0.37
Diluted, pro forma $ 2.83 $ 0.25 $ 2.46 $ 0.29
Liabilities and Equity Instruments
Beginning third quarter 2003, the Company will be required
to adopt SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity.
This Statement establishes standards for classifying and
measuring as liabilities certain financial instruments that
embody obligations of the issuer and have characteristics of both
liabilities and equity. The effect on earnings or financial
position of adopting this statement is not expected to be
material.
Asset Retirement Obligations
Beginning January 2003, the Company was required to adopt SFAS
No. 143, Accounting for Asset Retirement Obligations. The Statement
requires legal obligations associated with the retirement of long-
lived assets to be recognized at their fair value at the time that
the obligations are incurred. Upon initial recognition of a
liability, that cost is capitalized as part of the related long-
lived asset and allocated to expense over the useful life of the
asset. The effect of adopting this statement was to increase
property, plant and equipment by $3 million, recognize an asset
retirement obligation liability of $4 million, and to increase
first quarter net loss by $1 million or $0.01 per share for the
cumulative effect of adoption.
Other Pronouncements
Beginning third quarter 2003, the Company will be required
to apply FASB Interpretation No. 46, Consolidation of Variable
Interest Entities to its variable interest entities created prior
to February 1, 2003. The Company has not yet determined the
effect on earnings or financial position of applying this
interpretation, but expects the effects will not be material.
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
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 the Company 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; availability and price of
raw materials used; competitive actions by other companies;
changes in laws or regulations; the accuracy of certain judgments
and estimates concerning the integration of acquired operations;
the accuracy of certain judgments and estimates concerning the
consolidation and supply chain initiatives; and other factors,
many of which are beyond the control of the Company.
Results of Operations
Summary
Consolidated revenues were $1.2 billion in second quarter
2003 and second quarter 2002. Income from continuing operations
was $155 million in second quarter 2003 compared with $16 million
in second quarter 2002. Income from continuing operations per
share was $2.86 in second quarter 2003 compared with $0.31 in
second quarter 2002.
Business Segments
The Company manages its operations through three business
segments, Corrugated Packaging, 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. These conditions include changes in interest
rates, new housing starts, home repair and remodeling activities,
and the strength of the U.S. dollar, some or all of which may
have varying degrees of impact on the business segments. As used
herein, the term "parent company" refers to the financial
statements of the Company and its manufacturing business
segments, Corrugated Packaging and Building Products, with
Financial Services reflected on the equity method.
The Company evaluates performance based on operating income
before other (income) expense, unallocated general and
administrative expenses, parent company interest, and income taxes.
Other (income) expense includes gain or loss on sale of assets,
asset impairment and expenses associated with consolidation and
supply chain initiatives and facility closure accruals.
20
A summary of the results of operations by business segment
follows:
Second Quarter First Six Months
2003 2002 2003 2002
---- ---- ---- ----
(in millions, except per share)
Revenues
Corrugated Packaging $ 685 $ 703 $ 1,352 $ 1,260
Building Products 192 218 372 408
Financial Services 305 269 593 542
------ ----- ----- -----
Total revenues $ 1,182 $ 1,190 $ 2,317 $ 2,210
===== ===== ===== =====
Segment Operating Income
Corrugated Packaging $ 1 $ 29 $ (3) $ 51
Building Products 12 21 3 31
Financial Services 44 37 83 71
----- ----- ----- -----
Total segment operating
income 57 87 83 153
Unallocated general and
administrative expenses (11) (8) (22) (18)
Other income (expense)(a)(b) (23) (17) (32) (24)
Parent company interest (35) (36) (70) (61)
----- ----- ----- -----
Income (loss) before taxes (12) 26 (41) 50
Income tax (expense) benefit,
including a one-time tax
benefit of $165 million
in 2003 167 (10) 179 (19)
----- ----- ----- -----
Income from continuing
operations 155 16 138 31
Discontinued operations 1 (1) 1 (1)
Effect of accounting change -- -- (1) (11)
----- ----- ----- -----
Net income $ 156 $ 15 $ 138 $ 19
===== ===== ===== =====
Diluted earnings per share
Income from continuing
operationS $ 2.86 $ 0.31 $ 2.55 $ 0.61
Discontinued operations 0.01 (0.02) 0.01 (0.02)
Effect of accounting change -- -- (0.01) (0.22)
----- ----- ----- -----
Net income $ 2.87 $ 0.29 $ 2.55 $ 0.37
===== ===== ===== =====
Average diluted shares
outstanding 54.1 52.4 54.1 51.0
(a) Other income (expense) includes (i) for second quarter 2003,
expenses of $1 million related to the Mt. Jewett particleboard
plant closure, which applies to Building Products, $23 million
related to consolidation and supply chain initiatives, of which
$2 million was attributable to Financial Services, and income of
$1 million related to the collection of notes written off in
2002, which applies to Corrugated Packaging, and (ii) for second
quarter 2002, a $6 million charge related to the repurchase of
notes sold with recourse, which applies to Corrugated Packaging,
and an $11 million write off of unamortized financing fees in
connection with the early repayment of a bridge financing
facility.
(b) Other income (expense) includes (i) for first six months
2003, expenses of $6 million related to box plant closures and $1
million of income related to the collection of notes written off
in 2002, which applies to Corrugated Packaging, $1 million
related to the Mt. Jewett particleboard plant closure, which
applies to Building Products, and $26 million related to
consolidation and supply chain initiatives, of which $2 million
was attributable to Financial Services, and (ii) for first six
months 2002, a $7 million charge for severance and write-off of
technology investments, which applies to Financial Services, a $6
million charge related to the repurchase of notes sold with
recourse, which applies to Corrugated Packaging, and an $11
million write off of unamortized financing fees in connection
with the early repayment of a bridge financing facility.
21
For second quarter 2003 and 2002
Corrugated Packaging
Corrugated Packaging revenues were $685 million in second
quarter 2003 compared with $703 million in second quarter 2002.
Revenues from sales of corrugated packaging represented 90
percent of segment revenues for second quarter 2003 and second
quarter 2002. The remaining revenues are derived from sales of
linerboard. The change in revenues was principally due to changes
in average prices and shipments:
Second Quarter 2003 versus Second Quarter 2002
Increase (Decrease) in
----------------------------------------------
Average Prices Shipments(a)
-------------- ------------
Corrugated packaging -- (3%)
Linerboard 1% 12%
(a) 2002 shipments have been adjusted for the effect of
acquisitions.
Compared with first quarter 2003, Corrugated Packaging
revenues were up $18 million. Average corrugated packaging prices
were down two percent while shipments were up four percent. Average
linerboard prices were down six percent while shipments were up 19
percent. Corrugated packaging markets continue to be adversely
affected by the weak manufacturing economy. Linerboard markets
continue to be adversely affected by both the weak manufacturing
economy and increased offshore capacity, partially offset by a
weaker U.S. dollar.
Costs, which include production, selling, distribution, and
administrative costs, were $684 million in second quarter 2003
compared with $674 million in second quarter 2002. The change in
costs in 2003 was principally due to:
- higher energy costs, up $13 million,
- higher pension costs, up $7 million, and
- lower OCC costs due to lower prices and a decrease in OCC
purchases, down $11 million.
Average OCC prices were $95 per ton during second quarter 2003
compared with $102 per ton during second quarter 2002. It is
likely that OCC costs will continue to fluctuate during 2003.
Mill production was:
- 819,000 tons in second quarter 2003,
- 857,000 tons in second quarter 2002, and
- 763,000 tons in first quarter 2003.
Mill production data is not comparable due to the effect of the
Antioch shutdown completed during September 2002.
22
The percentage of mill production used by Corrugated
Packaging operations was:
- 82 percent in second quarter 2003,
- 84 percent in second quarter 2002, and
- 84 percent in first quarter 2003.
The remainder was sold in the domestic and export markets.
Excluding routine maintenance, production downtime was:
- 18,000 tons in second quarter 2003 due to mix and
operational reasons,
- 108,000 tons in second quarter 2002 due to market, mix and
operational reasons, and
- 46,000 tons in first quarter 2003 due to mix and operational
reasons.
Production downtime may occur in future quarters.
Market conditions continue to be weak for lightweight gypsum
facing paper. As a result, the Company's Premier Boxboard joint
venture continues to produce both gypsum facing paper and
corrugating medium. The Company purchased 47,000 tons of
corrugating medium from the joint venture in second quarter 2003.
It is uncertain when market conditions for lightweight gypsum
facing paper will improve.
The Company is continuing its efforts to enhance return on
investment within Corrugated Packaging. These efforts include
reviewing operations that are unable to meet return objectives
and determining appropriate courses of action including the
possible consolidation and rationalization of converting
facilities. During second quarter 2003, the Company affected the
previously announced closure of its box plants in Hattiesburg,
Mississippi and Elizabethton, Tennessee and paid $1 million in
previously accrued severance to affected employees. It is
expected that the remaining severance of $1 million will be paid
during third quarter 2003. These losses and costs are included in
other operating (income) expense and excluded from segment
operating income.
Corrugated Packaging had operating income of $1 million in
second quarter 2003 compared with $29 million in second quarter
2002.
Building Products
Building Products revenues were $192 million in second
quarter 2003 compared with $218 million in second quarter 2002.
The change in revenues in 2003 was principally due to changes in
average prices and shipments as follows:
23
Second Quarter 2003 versus Second Quarter 2002
Increase (Decrease) in
----------------------------------------------
Average Prices Shipments
---------------- ---------
Lumber (9%) 7%
Particleboard (4%) (21%)
Gypsum (3%) (12%)
MDF (4%) (33%)
Other revenues include sales of high-value timberlands.
These sales contributed $5 million in operating income in second
quarter 2003 compared with $5 million in second quarter 2002 and
$1 million in first quarter 2003.
Compared with first quarter 2003, revenues were up $12
million. Average prices were up five percent for lumber, three
percent for particleboard, and seven percent for gypsum, while
average prices were down two percent for MDF. Shipments were up
nine percent for lumber, while shipments were down ten percent
for particleboard, nine percent for gypsum and 11 percent for
MDF.
Costs, which include production, selling, distribution, and
administrative costs, were $180 million in second quarter 2003
compared with $197 million in second quarter 2002. The change in
costs in 2003 was principally due to lower production volumes
partially offset by higher energy costs, up $2 million.
Production averaged from a low of 59 percent to a high of 80
percent of capacity in the various product lines. Production was
curtailed to varying degrees in all product lines in second
quarter 2003 to match customer demand. The Company's joint
venture operations also experienced production curtailments in
second quarter 2003. Production may be curtailed in future
quarters to match customer demand.
The Company's Del-Tin Fiber LLC MDF joint venture in El
Dorado, Arkansas continues to experience production and cost
issues, though some improvement was made in second quarter 2003.
In January 2003, Deltic Timber Corporation, the partner in this
venture, announced its intention to exit this business upon the
earliest, reasonable opportunity provided by the market. It is
uncertain what effects Deltic Timber's decision will have on the
joint venture or its operations. The venture had a net loss of $2
million in second quarter 2003 compared with a net loss of $6
million in second quarter 2002, of which the Company's share was
$1 million and $3 million, respectively. In second quarter 2003,
the Company and Deltic Timber Corporation each contributed $2
million in cash to the venture.
The Company is continuing its efforts to enhance return on
investment within Building Products. These efforts include
reviewing operations that are unable to meet return objectives
and determining appropriate courses of action including the
24
possible rationalization of production facilities. In addition,
the Company is continuing to address market issues at its Mt.
Jewett, Pennsylvania particleboard plant and market and
production issues at its MDF facilities, including the Del-Tin
Fiber MDF joint venture. During second quarter 2003, the Company
expensed and paid $1 million in severance in connection with the
indefinite shutdown of its Mt. Jewett particleboard plant. These
costs are included in other operating (income) expense and
excluded from segment operating income.
Building Products had income of $12 million in second
quarter 2003 compared with $21 million in second quarter 2002.
Financial Services
Operations
Financial Services revenues, consisting of interest and non-
interest income, were $305 million in second quarter 2003
compared with $269 million in second quarter 2002.
Selected financial information for Financial Services
follows:
First
Second Quarter Quarter
2003 2002 2003
---- ---- ----
(in millions)
Net interest income $ 94 $ 91 $ 95
Provision for loan losses (20) (15) (11)
Noninterest income 118 82 95
Noninterest expense (148) (121) (140)
----- ----- -----
Segment operating income 44 37 39
Severance (2) -- --
----- ----- -----
Operating income $ 42 $ 37 $ 39
===== ===== =====
Net interest income was $94 million in second quarter 2003
compared with $91 million in second quarter 2002. The change was
principally due to:
- an increase in average earning assets, principally
securities, up 14 percent,
- partially offset by a decline in the net interest spread
resulting from the lower interest rate environment
combined with an asset sensitive position.
In general, increases in interest rates increase Financial
Services' net interest income. However, Financial Services' net
interest income is not as sensitive to changes in interest rates at
second quarter end 2003 as it was at year end 2002 principally
ue to:
- a change in the mix of earning assets achieved by
increasing single-family mortgage loans and securities
with interest rates that adjust annually after an initial
25
fixed rate for the first three to five years and
decreasing commercial real estate loans, the interest
rates on which generally reset every 30 to 90 days, and
- a shift in deposits decreasing certificates of deposit and
increasing money market accounts.
If interest rates rise for the remainder of 2003, then it is
likely that net interest income would be positively affected. If
interest rates decline during the remainder of 2003 it is likely
that net interest income will be adversely affected.
The provision for loan losses was $20 million in second
quarter 2003 compared with $15 million in second quarter 2002.
The provision for second quarter 2003 related principally to
commercial real estate loans and asset-based commercial and
business loans. The provision for second quarter 2002 related
principally to commercial and business loans, primarily in the
asset-based lending and leasing portfolios, and residential loans
in the senior housing portfolio.
Noninterest income includes revenues from mortgage banking,
real estate, and insurance activities. Noninterest income was
$118 million in second quarter 2003 compared with $82 million in
second quarter 2002. The change in noninterest income in 2003 was
principally due to:
- an increase in mortgage banking loan originations and
related gain on sale of loans, up $50 million,
- partially offset by higher amortization and impairment of
mortgage servicing rights, up $14 million, associated with
increased runoff of the servicing portfolio.
Noninterest expense was $148 million in second quarter 2003
compared with $121 million in second quarter 2002. The change in
noninterest expense in 2003 was principally due to higher costs
associated with the mortgage banking operations, primarily
salary, commissions, benefits, and loan servicing and origination
expenses, up $24 million as a result of the increased loan
production activity.
See Mortgage Banking Activities for further information
regarding mortgage-banking operations.
Earning Assets
Earning assets include cash equivalents, mortgage loans held
for sale, securities, and loans. At second quarter-end 2003, cash
equivalents, mortgage loans held for sale, securities, and
residential housing loans constituted 80 percent of total earning
assets compared with 71 percent at second quarter-end 2002. The
increased percentage in 2003 is a result of efforts to change the
earning asset mix by increasing residential earning assets.
26
Securities, which include mortgage-backed and other
securities, were $5.9 billion at second quarter-end 2003 compared
with $4.8 billion at second quarter-end 2002. The increase was
primarily a result of purchasing mortgage-backed securities as
part of the efforts to increase residential housing assets.
Loans were $9.7 billion at second quarter-end 2003 compared
with $9.7 billion at second quarter-end 2002 and $10.0 billion at
first quarter-end 2003. The following table summarizes the
composition of the loan portfolio:
First
Quarter-
Second Quarter-End End
2003 2002 2003
(in millions)
Single-family mortgage $ 2,892 $ 1,997 $ 2,743
Single-family mortgage warehouse 502 298 463
Single-family construction 1,065 913 1,028
Multifamily and senior housing 1,865 2,011 1,892
----- ----- -----
Total residential housing 6,324 5,219 6,126
Commercial real estate 1,393 2,419 1,765
Commercial and business 1,812 1,882 1,886
Consumer and other 182 223 191
----- ----- -----
Total loans 9,711 9,743 9,968
Less allowance for loan losses (117) (135) (122)
----- ----- -----
Loans receivable, net $ 9,594 $ 9,608 $ 9,846
===== ===== =====
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.
Commercial real estate loans provide funding for the
development, construction, and lease up principally of office,
retail, and industrial projects. Commercial and business loans
finance business operations and principally include asset-based,
syndicated and middle market loans, and direct financing leases
on equipment. Consumer and other loans principally include loans
secured by junior liens on single-family homes not related to
their purchase.
Although the size of the total loan portfolio has remained
relatively flat over the past year, the composition of the
portfolio has changed due to efforts to increase residential
housing assets. As a result, residential housing loans represent
65 percent of the loan portfolio at second quarter-end 2003
compared with 54 percent at second quarter-end 2002 and 61
percent at first quarter-end 2003.
27
Asset Quality
Several key measures are used to evaluate and monitor asset
quality. These measures include the level of loan delinquencies,
nonperforming loans, assets, and allowance coverage.
First
Second Quarter- Quarter-
End End
2003 2002 2003
---- ---- ----
(in millions)
Accruing loans past due 30 - 89 days $ 48 $ 81 $ 95
Accruing loans past due 90 days or more -- -- 15
---- ---- ----
Accruing loans past due 30 days or more $ 48 $ 81 $ 110
==== ==== ====
Nonaccrual loans $ 69 $ 179 $ 128
Restructured loans 10 -- --
---- ---- ----
Nonperforming loans 79 179 128
Foreclosed property 12 7 4
Restructured operating leases 42 -- 42
---- ---- ----
Nonperforming assets $ 133 $ 186 $ 174
==== ==== ====
Allowance for loan losses $ 117 $ 135 $ 122
Nonperforming loan ratio 0.81% 1.84% 1.28%
Nonperforming asset ratio 1.37% 1.91% 1.74%
Allowance for loan losses/total loans 1.21% 1.39% 1.22%
Allowance for loan losses/nonperforming
loans 148.84% 75.48% 95.52%
The change at second quarter-end 2003 compared with second
quarter-end 2002 in the level of nonaccrual loans was principally
due to $61 million in upgrades of several loans in the senior
housing portfolio, $36 million in payoffs and paydowns of senior
housing and commercial loans, and $ 21 million in charge-offs of
previously reserved loans. These decreases were partially
offset by new nonaccrual loans, principally commercial and
business loans. The restructured operating leases added in 2003
relate to the restructuring of two previous leveraged, direct
financing leases on cargo aircraft totaling $33 million. Due to a
reduction in the lease payments in the restructuring, the leases
were reclassified as operating leases. As a result, $27 million
in leverage was removed, and the assets were written down to
estimated fair market value. The restructured operating leases
will be classified as nonperforming until such time as the lessee
has evidenced the ability to perform under the terms of the
restructured leases.
Both the asset-based lending and leasing portfolios, which
together represent 35 percent of commercial and business loans,
will likely continue to be adversely affected by the weak economy.
28
Allowance for Loan Losses
The allowance for loan losses is comprised of specific
allowances, general allowances, and an unallocated allowance.
Management evaluates the allowance for loan losses to ensure the
level is adequate to absorb losses inherent in the loan
portfolio. The allowance is increased by charges to income and
decreased by charge-offs, net of recoveries.
Changes in the allowance for loan losses were:
First
Second Quarter Quarter
2003 2002 2003
(in millions)
Balance at beginning of period $ 122 $ 136 $ 132
Charge-offs:
Total residential housing -- (12) --
Commercial real estate (7) -- --
Commercial and business (21) (5) (21)
Consumer and other (1) -- --
---- ---- ----
Total charge-offs (29) (17) (21)
---- ---- ----
Recoveries:
Total residential housing 4 1 --
Commercial real estate -- -- --
Commercial and business -- -- --
Consumer and other -- -- --
---- ---- ----
Total recoveries 4 1 --
---- ---- ----
Net charge-offs (25) (16) (21)
Provision for loan losses 20 15 11
---- ---- ----
Balance at end of period $ 117 $ 135 $ 122
==== ==== ====
Net charge-offs (annualized) as a
percentage of average loans
outstanding 1.00% 0.65% 0.86%
Second quarter 2003 charge-offs related principally to
several loans in the asset-based lending portfolio and a
commercial real estate loan secured by an office building. Second
quarter 2002 charge-offs related principally to the two senior
housing loans and two commercial loans. First quarter 2003 charge
offs related principally to the two restructured aircraft leases
and two asset based commercial loans.
Mortgage Banking Activities
Mortgage loan originations were $4.3 billion in second
quarter 2003 compared with $1.7 billion in second quarter 2002.
The high level of mortgage loan originations during second
quarter 2003 was due to continued refinance activity resulting
from the low interest rate environment. Higher interest rates in
second quarter 2002 resulted in a significant reduction in
mortgage refinancing activity, contributing to the lower level of
originations.
29
In second quarter 2003, the savings bank retained $469
million in loans originated by the mortgage banking operations,
compared with $126 million in second quarter 2002. The change in
loans originated for the savings bank in second quarter 2003 was
the result of continued efforts to increase the level of
adjustable-rate single-family mortgage assets.
In second quarter 2003, the mortgage banking operations sold
$3.8 billion in loans to secondary markets by delivering loans to
third parties or by delivering loans into mortgage-backed
securities that were purchased by third parties. Of the loans
sold in second quarter 2003, the only retained interest was
mortgage servicing rights of $17 million relating to $1.7 billion
of loans. The following table provides information regarding the
mortgage servicing portfolio:
Second Quarter First
End Quarter End
2003 2002 2003
---- ---- ----
(in millions)
Outstanding balance of loans
serviced for:
Third parties $ 8.4 $ 9.6 $ 8.2
Savings bank 1.9 0.8 2.0
------ ------ ------
Total mortgage servicing
portfolio $ 10.3 $ 10.4 $ 10.2
====== ====== ======
Annualized runoff rate 53% 24% 42%
The change in the balance of loans serviced was principally
due to significant repayments on loans, partially offset by new
loan originations for which servicing was retained.
The change in the runoff rate was due to the lower interest
rate environment in 2003. As a result of the high runoff rates,
amortization and impairment of mortgage servicing rights increased
in second quarter 2003. The following table provides information
regarding charges for amortization and impairment of mortgage
servicing rights:
Second Quarter First
Quarter
2003 2002 2003
---- ---- ----
(in millions)
Amortization $ 18 $ 8 $ 16
Impairment 5 1 2
------- ------- -------
$ 23 $ 9 $ 18
======= ======= =======
In 2003 and 2002, the mortgage banking operations were
significantly affected by the refinancing activity associated
with the declining interest rate environment. In July 2003,
interest rates increased somewhat. If interest rates remain
30
constant or increase, the level of mortgage originations and the
level of mortgage servicing rights amortization and impairment
will likely decline. However, if interest rates again decline in
2003, the level of mortgage originations and the level of
mortgage servicing rights amortization and impairment will likely
remain high.
Unallocated General and Administrative Expenses, Interest and
Other (Income) Expense
Unallocated general and administrative expenses were $11
million in second quarter 2003 compared with $8 million in second
quarter 2002. The change in 2003 was principally due to an
increase in pension and stock-based compensation costs.
Parent company interest expense was $35 million in second
quarter 2003 compared with $36 million in second quarter 2002.
During second quarter 2002, the parent company effected a number
of transactions that lengthened debt maturities and reduced
reliance on short-term borrowings. The average interest on
borrowings was 7.1 percent in second quarter 2003 compared with
6.2 percent in second quarter 2002. In addition, long-term debt
was reduced by $196 million.
Other operating (income) expense for second quarter 2003
includes $23 million in expenses related to initiatives to
consolidate administrative functions and effect improvements in
supply chain management, of which $2 million was attributable to
Financial Services. These expenses consist principally of
relocation and severance expenses and fees paid to third party
consultants. The Company expects to incur in the remainder of
2003 an additional $10 million to $15 million in relocation,
severance, benefits, and other expenses related to these
initiatives. The Company expects the benefits from these
initiatives to begin to be realized in 2004.
Pension Expense
Non-cash pension expenses were $11 million in second quarter
2003 compared with $2 million in second quarter 2002. The change
in 2003 was principally due to previously disclosed changes in
the assumed discount rate, a decrease in the expected rate of
return on plan assets to 8.5 percent, and an increase in the
recognition of the accumulated decline in the fair value of plan
assets.
Income Taxes
During second quarter 2003, the Internal Revenue Service
concluded its examination of the Company's tax returns through
1996, including matters related to net operating losses and
minimum tax credit carryforwards, which resulted from certain
deductions following the 1988 acquisition of Guaranty Bank and
31
for which no financial accounting benefit had been recognized.
Also, the Company resolved certain state tax refund claims for
the years 1991 through 1994. As a result, valuation allowances
and tax accruals previously provided for these matters are no
longer required. Accordingly, during second quarter 2003, the
Company recorded a one-time benefit of $165 million, or $3.05 per
diluted share. Of this one-time benefit, approximately $26
million represents expected cash refunds of previously paid taxes
plus related interest. The remainder is a non-cash benefit.
Excluding this one-time benefit, the effective tax rate for
2003 is expected to be 35 percent based on current estimates of
income and expenses for the year 2003. The effective tax rate
includes federal and state income taxes and the effects of
non-deductible items.
Average Shares Outstanding
Average shares outstanding were 54.1 million in second
quarter 2003 compared with 52.4 million in second quarter 2002.
The change in 2003 was principally due to the May 2002 sale of
4.1 million shares of common stock. The dilutive effect of stock
options and equity purchase contracts was not significant in any
of the periods presented.
For first six months 2003 and 2002
Corrugated Packaging
The Company acquired effective control of Gaylord Container
Corporation and began consolidating the results of Gaylord in
March 2002. The Company also acquired a box plant in Puerto Rico
in March 2002, the converting facilities of Mack Packaging Group
in May 2002, and Fibre Innovations LLC in November 2002. As a
result, the 2003 financial information for Corrugated Packaging
is not comparable to prior periods.
Corrugated Packaging revenues were $1,352 million for first
six months 2003 compared with $1,260 million for first six months
2002. Revenues from sales of corrugated packaging represented 91
percent of segment revenues for first six months 2003 and 90
percent of revenues for first six months 2002. The remaining
revenues are derived from sales of linerboard. The change in
revenues was principally due to changes in average prices and
shipments:
First Six Months 2003 versus First Six Months 2002
Increase (Decrease) in
--------------------------------------------------
Average Prices Shipments(a)
-------------- ------------
Corrugated packaging (1%) (3%)
Linerboard 1% 13%
(a) 2002 shipments have been adjusted for the effect of
acquisitions.
32
Costs, which include production, distribution, and
administrative costs, were $1,355 million for first six months
2003 compared with $1,209 million for first six months 2002. The
change in costs in 2003 was principally due to:
- the inclusion of the acquired operations,
- higher energy costs, up $35 million,
- higher pension costs, up $14 million, and
- lower OCC costs due to a decrease in OCC purchases, down $8
million.
Average OCC prices were $88 per ton for first six months 2003
compared with $87 per ton for first six months 2002.
Mill production was:
- 1,582,000 tons for first six months 2003 and
- 1,472,000 tons for first six months 2002.
Mill production data is not comparable due to the effect of the
Gaylord acquisition, completed on March 1, 2002, and Antioch
shutdown completed September 2002.
The percentage of mill production used by Corrugated
Packaging operations was:
- 83 percent for first six months 2003 and
- 84 percent for first six months 2002.
The remainder was sold in the domestic and export markets.
Excluding routine maintenance, production downtime was:
- 64,000 tons for first six months 2003 due to mix and
operational reasons and
- 211,000 tons for first six months 2002 due to market, mix
and operational reasons.
Production downtime may occur in future quarters.
Market conditions continue to be weak for lightweight gypsum
facing paper. As a result, the Company's Premier Boxboard joint
venture continues to produce both gypsum facing paper and
corrugating medium. The Company purchased 73,000 tons of
corrugating medium from the joint venture during first six months
2003.
Corrugated Packaging had a $3 million operating loss for
first six months 2003 compared with income of $51 million for
first six months 2002.
Building Products
Building Products revenues were $372 million for first six
months 2003 compared with $408 million for first six months 2002.
33
The change in revenues in 2003 was principally due to lower
average prices and shipments in most product lines as follows:
First Six Months 2003 versus First Six Months 2002
Increase (Decrease) in
---------------------------------------------------
Average Prices Shipments
-------------- ---------
Lumber (9%) 10%
Particleboard (6%) (12%)
Gypsum (3%) (9%)
MDF (2%) (20%)
Other revenues include sales of high-value timberlands. These
sales contributed $6 million in operating income for first six
months 2003 compared with $9 million for first six months 2002.
Costs, which include production, distribution, and
administrative costs, were $369 million for first six months 2003
compared with $377 million for first six months 2002. The change
in costs in 2003 was principally due to lower production volumes
partially offset by:
- higher energy costs, up $5 million, and
- higher pension costs, up $2 million.
Production averaged from a low of 62 percent to a high of 77
percent of capacity in the various product lines. Production was
curtailed to varying degrees in all product lines for first six
months 2003 to match customer demand. The Company's joint venture
operations also experienced production curtailments in second
quarter 2003.
Building Products had operating income of $3 million for
first six months 2003 compared with $31 million for first six
months 2002.
Financial Services
Operations
Financial Services revenues, consisting of interest and non-
interest income, were $593 million for first six months 2003
compared with $542 million for first six months 2002.
Selected financial information for Financial Services
follows:
34
First Six Months
2003 2002
---- ----
(in millions)
Net interest income $ 189 $ 183
Provision for loan losses (31) (29)
Noninterest income 213 167
Noninterest expense (288) (250)
----- -----
Segment operating income 83 71
Severance and asset write-offs (2) (7)
----- -----
Operating income $ 81 $ 64
===== =====
Net interest income was $189 million for first six months
2003 compared with $183 million for first six months 2002. The
change was principally due to:
- an increase in average earning assets, principally
securities, up 15 percent,
- partially offset by a decline in the net interest spread
resulting from the lower interest rate environment
combined with an asset sensitive position.
The provision for loan losses was $31 million for first six
months 2003 compared with $29 million for first six months 2002.
The provision for first six months 2003 related principally to
commercial real estate loans, the restructured aircraft leases,
and commercial and business loans primarily in the asset-based
lending portfolio. The provision for first six months 2002
related principally to commercial and business loans, primarily
in the asset-based lending and leasing portfolios, and
residential loans in the senior housing portfolio.
Noninterest income includes revenues from mortgage banking
and real estate and insurance activities. Noninterest income was
$213 million for first six months 2003 compared with $167 million
for first six months 2002. The change in noninterest income in
2003 was principally due to:
- an increase in mortgage banking loan originations, and
related gain on sale of loans, up $73 million,
- partially offset by higher amortization and impairment of
mortgage servicing rights, up $24 million.
Noninterest expense was $288 million for first six months
2003 compared with $250 million for first six months 2002. The
change in noninterest expense in 2003 was principally due to
higher costs associated with the mortgage banking operations,
primarily salary, commissions, benefits, and loan servicing and
origination expenses, up $38 million as a result of the increased
loan production activity.
See Mortgage Banking Activities for further information regarding
mortgage-banking operations.
35
Changes in the allowance for loan losses were:
First Six Months
2003 2002
---- ----
(in millions)
Balance at beginning of period $ 132 $ 139
Charge-offs:
Total residential housing -- (12)
Commercial real estate (7) --
Commercial and business (42) (23)
Consumer and other (1) --
------ ------
Total charge-offs (50) (35)
------ ------
Recoveries:
Total residential housing 4 1
Commercial real estate -- --
Commercial and business -- 1
Consumer and other -- --
----- ------
Total recoveries 4 2
------ ------
Net charge-offs (46) (33)
Provision for loan losses 31 29
------ ------
Balance at end of period $ 117 $ 135
====== ======
Net charge-offs (annualized) as a
percentage of average loans
outstanding 0.93% 0.68%
Charge-offs for first six months 2003 related principally to
two restructured aircraft leases, a commercial real estate loan
secured by an office building, and several asset-based commercial
loans. Charge-offs for first six months 2002 related principally
to senior housing loans and asset-based commercial and business
loans.
Mortgage Banking Activities
Mortgage loan originations were $7.5 billion for first six
months 2003 compared with $3.8 billion for first six months 2002.
The high level of mortgage loan originations for first six months
2003 was due to continued refinance activity resulting from the
low interest rate environment. Higher interest rates for first
six months 2002 resulted in a significant reduction in mortgage
refinancing activity, contributing to the lower level of
originations.
For first six months 2003, the savings bank retained $1
billion in loans originated by the mortgage banking operations,
compared with $310 million for first six months 2002. The
significant increase in loans originated for the savings bank for
first six months 2003 was the result of continued efforts to
increase the level of adjustabl-rate single-family mortgage
assets.
For first six months 2003, the mortgage banking operations
sold $6.6 billion in loans to secondary markets by delivering
36
loans to third parties or by delivering loans into mortgage-
backed securities that were purchased by third parties. Of the
loans sold during first six months 2003, the only retained
interest was mortgage servicing rights of $23 million relating to
$2.3 billion of loans.
The outstanding balance of loans in the mortgage servicing
portfolio decreased at an annualized rate of 48 percent during
first six months 2003 compared with an annualized rate of 23
percent during first six months 2002.
The change in the runoff rate was due to the lower interest
rate environment in 2003. As a result of the high runoff rates,
amortization and impairment of mortgage servicing rights increased
for first six months 2003. The following table provides
information regarding charges for amortization and impairment
of mortgage servicing rights:
First Six Months
2003 2002
(in millions)
Amortization $ 34 $ 19
Impairment 7 (2)
----- -----
$ 41 $ 17
===== =====
Unallocated General and Administrative Expenses, Interest and
Other (Income) Expense
Unallocated general and administrative expenses were $22
million for first six months 2003 compared with $18 million for
first six months 2002. The change in 2003 was principally due to
an increase in pension and stock-based compensation costs.
Parent company interest expense was $70 million for first
six months 2003 compared with $61 million for first six months
2002. The change was principally due to reduced reliance on short-
term borrowings and to the full effect of interest expense on debt
related to the acquisition of Gaylord. For first six months 2002,
the parent company effected a number of transactions that
lengthened debt maturities and reduced reliance on short-term
borrowings. The average interest rate on borrowings was 7.0
percent for first six months 2003 compared with 5.7 percent for
first six months 2002.
Other operating expenses for first six months 2003 include
$24 million in expenses related to initiatives to consolidate
administrative functions and effect improvements in supply chain
management, of which $2 million was incurred by Financial
Services. These expenses consist principally of relocation and
severance expenses and fees paid to third party consultants.
37
Pension Expense
Non-cash pension expenses were $22 million for first six
months 2003 compared with $4 million for first six months 2002.
Income Taxes
Excluding the second quarter 2003 one-time tax benefit, the
effective tax rate for 2003 is expected to be 35 percent based
on current estimates of income and expenses for the year 2003.
Average Shares Outstanding
Average shares outstanding were 54.1 million for first six
months 2003 compared with 51.0 million for first six months 2002.
The change in 2003 was principally due to the May 2002 sale of
4.1 million shares of common stock. The dilutive effect of stock
options and equity purchase contracts was not significant in any
of the periods presented.
Capital Resources and Liquidity
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.
For first six months 2003
Parent Company
Operating Activities
Cash provided by operations was $142 million. Income for
first six months 2003 included $26 million of depreciation and
other non-cash charges and credits. Dividends received from
Financial Services were $70 million. Working capital needs
increased $42 million, principally due to a $46 million seasonal
increase in receivables.
Investing Activities
Investing activities used $33 million. Proceeds from the
sale of non-strategic assets acquired in connection with the
acquisition of Gaylord were $30 million.
Capital expenditures were $58 million. Capital expenditures
are expected to approximate $160 million in 2003 or about 67
percent of the $240 million of expected depreciation in 2003.
38
Financing Activities
Financing activities used $109 million. Debt and other
borrowings were reduced $74 million. Cash dividends paid to
shareholders were $37 million or $0.68 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, and its existing credit arrangements. The
parent company operates in cyclical industries, and its operating
cash flows vary accordingly. The dividends received from the
savings bank are subject to regulatory approval and restrictions.
At second quarter-end 2003, the parent company had $520
million in unused borrowing capacity under its revolving credit
agreements and $196 million under its accounts receivable
securitization program, which matures in April 2006. At second
quarter-end 2003, the parent company was in compliance with all
of the terms and conditions of its credit agreements and accounts
receivable securitization program. In 2003, $45 million in
revolving credit agreements expire, all of which are unused at
second quarter-end 2003; however, any borrowings outstanding at
the end of the revolving period would not mature until two years
after the revolving period ends. The long-term debt of the parent
company is currently rated BBB and Baa3 by the rating agencies,
with one rating agency maintaining a negative outlook.
Subsequent to second quarter 2003 the Company, through the
trustee, issued a call notice for all of the 8.25% Debentures
payable 2022. The call date is August 15, 2003. The principal
amount of $150 million and the call premium of $6 million will
be funded by draws on the revolving credit facilities or with
funding from its accounts receivable securitization program.
In addition, a subsidiary of the Company has a $61 million
term loan maturing October 1, 2003. The Company plans to repay
this loan with funds provided from its revolving credit
facilities or its accounts receivable securitization program.
Financial Services
The principal sources of cash for Financial Services are
operating cash flows, deposits, and borrowings. Financial
Services uses these funds to invest in earning assets, generally
loans and securities.
Operating Activities
Cash provided by operations was $176 million. Income for
first six months 2003 included $82 million of amortization and
other non-cash charges.
39
Investing Activities
Cash provided by investing activities was $127 million.
Principal payments and maturities of securities, net of
purchases, provided $156 million and loan originations, net of
collections, used $44 million.
Financing Activities
Cash used for financing activities was $400 million.
Borrowings decreased $310 million, principally due to repayments
of FHLB advances and a decrease in deposits. In addition,
$70 million in dividends were paid to the parent company.
Cash Equivalents
Cash equivalents were $341 million at second quarter-end
2003 compared with $438 million at year end 2002.
Other
Financial Services' 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 second quarter-end 2003, Financial
Services had available liquidity of $2.2 billion. In addition, at
second quarter-end 2003 commitments to originate single-family
residential mortgage loans totaled $2.4 billion and commitments
to sell single-family residential mortgage loans totaled $1.9
billion.
At second quarter-end 2003, the savings bank exceeded all
applicable regulatory capital requirements. The parent company
expects to maintain the savings bank capital at a level that
exceeds the minimum required for designation as "well
capitalized." As a result, the Company may make capital
contributions to the savings bank. During second quarter 2003,
the Company made no capital contributions to the savings bank.
Selected consolidated financial and regulatory capital
data for the savings bank follows:
Second Year-End
Quarter- 2002
End 2003
(dollars in millions)
Balance sheet data
Total assets $ 17,517 $ 17,634
Total deposits 9,150 9,203
Shareholder's equity 1,007 1,025
40
Savings Regulatory For Categorization as
Bank Minimum "Well Capitalized"
Regulatory capital ratios:
Tangible capital 6.4% 2.0% N/A
Leverage capital 6.4% 4.0% 5.0%
Tier 1 risk-based capital 9.6% 4.0% 6.0%
Total risk-based capital 10.9% 8.0% 10.0%
Energy and the Effects of Inflation
Energy costs, principally natural gas, were $69 million in
second quarter 2003 compared with $55 million in second quarter
2002. Energy costs, which remain at historically high levels,
were down slightly in second quarter 2003 as compared with first
quarter 2003. It is likely that energy costs will continue to
fluctuate during 2003.
Litigation and Related Matters
There are pending against the Company and its subsidiaries
lawsuits, claims and environmental matters arising in the regular
course of business. The resolution of these matters is not
expected to have a material adverse effect on the Company's
operations or financial position. For further information on
pending legal proceedings, see Part II. Item 1.
Accounting Policies
New Accounting Standards Adopted
Stock-Based Compensation
Beginning January 2003, the Company voluntarily adopted the
prospective transition method of accounting for stock-based
compensation contained in SFAS No. 148, Accounting for Stock-
Based Compensation-Transition and Disclosure, an amendment of
FASB Statement No. 123. The principal effect of adopting the
prospective transition method is that the fair value of stock
options granted in 2003 and thereafter are charged to expense
over the option vesting period. As a result of the adoption of
this prospective transition method, second quarter 2003 net
income was decreased by $3 million or $0.04 per share.
Prior to 2003, the Company used the intrinsic value method
in accounting for its stock-based compensation. As a result, no
stock-based compensation expense is reflected in prior years' net
income, as all stock options granted had an exercise price equal
to the market value of the underlying common stock on the date of
grant. Therefore, the cost related to stock-based compensation
recognized in net income for first quarter 2003 and 2002 is less
than would have been recognized if the fair value method had been
applied to all stock options granted since 1995.
41
Liabilities and Equity Instruments
Beginning third quarter 2003, the Company will adopt SFAS
No. 150, Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity. This Statement
establishes standards for classifying and measuring as
liabilities certain financial instruments that embody obligations
of the issuer and have characteristics of both liabilities and
equity. The effect on earnings or financial position of adopting
this statement is not expected to be material.
Asset Retirement Obligations
Beginning January 2003, the Company was required to adopt
SFAS No. 143, Accounting for Asset Retirement Obligations. The
Statement requires legal obligations associated with the
retirement of long-lived assets to be recognized at their fair
value at the time that the obligations are incurred. Upon
initial recognition of a liability, that cost is capitalized as
part of the related long-lived asset and allocated to expense
over the useful life of the asset. The effect of adopting this
statement was to increase property, plant and equipment by $3
million, recognize an asset retirement obligation liability of
$4 million, and to increase first quarter net loss by $1 million
or $0.01 per share for the cumulative effect of adoption.
Other Pronouncements
Beginning third quarter 2003, the Company will be required
to apply FASB Interpretation No. 46, Consolidation of Variable
Interest Entities to its variable interest entities created prior
to February 1, 2003. The Company has not yet determined the
effect on earnings or financial position of applying this
interpretation but expects the effects will not be material.
Critical Accounting Policies
In second quarter 2003, there were no significant changes in
critical accounting policies from those disclosed in the
Company's Form 10-K for the year 2002.
42
Statistical and other data
Second First Six
Quarter Months
2003 2002 2003 2002
---- ---- ---- ----
(in millions)
Revenues(a)
Corrugated Packaging
Corrugated packaging $ 619 $ 636 $ 1,226 $ 1,135
Linerboard 66 67 126 125
---- ---- ----- -----
Total Corrugated Packaging $ 685 $ 703 $ 1,352 $ 1,260
==== ==== ===== =====
Building Products
Pine lumber $ 64 66 $ 120 $ 118
Particleboard 36 47 75 90
Medium density fiberboard 23 33 49 59
Gypsum wallboard 16 20 34 39
Fiberboard 17 18 31 34
Other 36 34 63 68
---- ---- ----- -----
Total Building Products $ 192 218 $ 372 $ 408
==== ==== ===== =====
Unit sales(a)
Corrugated Packaging
Corrugated packaging, thousands of
tons 809 833 1,589 1,468
Linerboard, thousands of tons 147 131 271 240
---- ---- ----- -----
Total, thousands of tons 956 964 1,860 1,708
==== ==== ===== =====
Building Products
Pine lumber, mbf 216 202 414 375
Particleboard, msf 140 177 295 337
Medium density fiberboard, msf 57 85 121 152
Gypsum wallboard, msf 146 166 307 339
Fiberboard, msf 102 109 189 206
(a) Revenues and unit sales do not include joint venture
operations.
Note: Data for Corrugated Packaging for first six months 2003 is
not comparable due to the effect of acquisitions completed in
2002.
43
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
Interest Rate Risk
The Company's current level of interest rate risk with
respect to financial instruments is primarily due to an asset
sensitive position within Financial Services and, to a lesser
degree, variable rate debt at the parent company.
The following table illustrates the estimated effect on pre-
tax income from financial instruments of immediate, parallel and
sustained shifts in interest rates for the subsequent 12-month
period at second quarter-end 2003, with comparative information
at year-end 2002. The estimated effect takes into account the
effects of changing prepayment speeds and average balances over
the next 12 months.
Increase (decrease) in Income Before Taxes
(In millions)
Second Quarter End Year-end 2002
2003
Change in Parent Financial Parent Financial
Interest Company Services Company Services
Rates
-------- ------- -------- ------- --------
+2% $(5) $ 24 $ (3) $ 40
+1% $(2) $ 28 $ (2) $ 34
0 $-- $ -- $ -- $ --
-1% $ 2 $(17) $ 2 $(29)
Due to the current low levels of interest rates, the 2
percent decrease in interest rates is not presented.
Financial Services is subject to interest rate risk from
financial instruments to the extent that the interest-earning
assets and interest-bearing liabilities repay or reprice at
different times or in differing amounts or both. Financial
Services is currently in an asset sensitive position whereby
the rate and paydown 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 change at second quarter end 2003 in sensitivity to
changes in interest rates from year-end 2002 is due primarily
to efforts to change the earning asset mix as well as changes
in the deposit base. The commercial real estate portfolio,
which tends to reprice frequently, decreased $500 million, while
the mortgage loan portfolio increased by over $400 million,
principally with loans that reprice after three to five years.
Additionally, approximately $500 million of deposits have
44
shifted from certificates of deposit to money market deposit
accounts, which reprice more frequently.
Additionally, the fair value of mortgage servicing rights
(estimated at $90 million at second quarter-end 2003) is also
affected by changes in interest rates, primarily long-term fixed
mortgage rates. The Company estimates that a 1 percent decline in
long-term fixed mortgage rates from current levels would decrease
the fair value of the mortgage servicing rights by approximately
$21 million.
Foreign Currency Risk
In second quarter 2003, there were no significant changes
in foreign currency risk from that disclosed in the Company's
Form 10-K for the year 2002.
Commodity Price Risk
In second quarter 2003, there were no significant changes
in commodity price risk from that disclosed in the Company's
Form 10-K for the year 2002.
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-
15(e)) as of end of the period covered by this Quarterly Report
on Form 10-Q, have concluded that the Company's disclosure
controls and procedures are adequate and effective to ensure that
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 control over financial reporting.
There were no changes in the Company's internal control over
financial reporting during the period covered by this report that
have materially affected, or are reasonably likely to materially
affect, the Company's internal control over financial reporting.
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.
45
Antitrust Action
As has been previously disclosed, on May 14, 1999, Inland
Paperboard and Packaging, Inc. ("Inland") and Gaylord were named
as defendants in a Consolidated Class Action Complaint that
alleged a civil violation of Section 1 of the Sherman Act. The
suit, captioned Winoff Industries, Inc. v. Stone Container
Corporation, MDL No. 1261 (E.D. Pa.), names Inland, Gaylord, and
eight other linerboard manufacturers as defendants. The complaint
alleges that the defendants, during the period from October 1,
1993, through November 30, 1995, conspired to limit the supply of
linerboard, and that the purpose and effect of the alleged
conspiracy was artificially to increase prices of corrugated
containers. The plaintiffs moved to certify a class of all
persons in the United States who purchased corrugated containers
directly from any defendant during the above period, and seek
treble damages and attorneys' fees on behalf of the purported
class. 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 upheld the trial
court's ruling. Defendants appealed this decision to the United
States Supreme Court, which denied their petition for a writ of
certiorari. The case is currently set for trial in April 2004.
Inland and Gaylord executed a settlement agreement on April
11, 2003, with the representatives of the class. On April 14,
2003, the trial court entered an order preliminarily approving
the terms of the settlement. Gaylord and Inland paid a total of
$8 million into escrow on April 17, 2003, to fulfill the terms of
the settlement, which amount was within the amount previously
accrued by the Company in connection with this matter. No
objections to the settlement were filed with the court by the
June 9, 2003, deadline. A final hearing on the fairness of the
settlement to the classes is scheduled for August 11, 2003. The
settlement will not become final until appeals, if any, to a
final order approving the settlement terms have been exhausted.
June 9, 2003, was also the deadline for potential class
members to "opt-out" of the class action lawsuit. By this
deadline, 140 companies and their named subsidiaries had advised
the court of their opt-out election. Eleven individual
complaints brought by over 100 of these opt-out plaintiffs have
since been filed against the defendants in this action. As a
result of the opt-outs, the Company received a refund of $800,000
from the original settlement amount. The Company is presently
evaluating these complaints and continues to participate in a
joint defense and cost sharing arrangement with other major
industry participants, which also covers the opt-out litigation.
46
The Company believes the likelihood of a material loss from
these actions to be remote and does not believe that the outcome
of these actions should have a material adverse effect on its
financial position, results of operations, or cash flow.
Gaylord Chemical Corporation
As has been previously disclosed, on October 23, 1995, a
rail tank car of nitrogen tetroxide exploded at the Bogalusa,
Louisiana plant of Gaylord Chemical Corporation, a wholly-owned,
independently-operated subsidiary of Gaylord Container
Corporation. Following the explosion, more than 160 lawsuits were
filed against Gaylord, Gaylord Chemical, and third parties
alleging personal injury, property damage, economic loss, related
injuries and fear of injuries. Plaintiffs sought compensatory and
punitive damages.
On May 4, 2001, Gaylord and Gaylord Chemical agreed in
principle to settle all claims arising out of the October 23,
1995 explosion. In exchange for payments by its primary insurance
carrier and the first five excess layers of coverage and
assignment of Gaylord's insurance coverage action against the
remaining carriers, Gaylord and Gaylord Chemical will receive
full releases and/or dismissals of all claims for damages,
including punitive damages. Neither Gaylord nor Gaylord Chemical
contributed to the settlement. The settlement agreement was fully
executed on September 14, 2001, and all settlement funds were
deposited in escrow.
On December 24, 2002, counsel for the Louisiana class action
plaintiffs advised Gaylord Chemical that they would not be able
to deliver all the releases of the Gaylord entities that were
promised as part of the September 2001 settlement agreement. As a
result of this failure to tender the committed releases, the
motion for preliminary approval of the settlement did not proceed
as scheduled, and the parties engaged in negotiations over
revised terms of settlement. On February 18, 2003, the Court
granted the settling defendants' motion to retrieve the
settlement proceeds from the escrow account and to lift the stay
of proceedings in the Louisiana action. Gaylord, Gaylord
Chemical, and their insurance carriers were reinstated as
defendants in the Louisiana class-wide trial set to begin
September 3, 2003.
The Company believes the likelihood of a material loss from
these actions to be remote and does not believe that the outcome
of these actions should have a material adverse effect on its
financial position, results of operations, or cash flow.
Other
The Company previously reported that the Georgia Department
of Natural Resources, Environmental Protection Division on April
3, 2003, sent Inland a Notice of Violation alleging that Inland's
47
linerboard mill in Rome, Georgia, had experienced 502 excess
sulfur dioxide emissions in the fourth quarter of 2002 due to the
burning of coal with a level of sulfur that was too high. The
Company timely filed its response to the State on May 1, 2003.
The Company has entered into an agreement to settle this matter
for the payment of penalties in an amount less than $25,000.
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.
The Company held its annual meeting of stockholders on
May 2, 2003, at which a quorum was present. The table below sets
forth the number of votes cast for, against or withheld, as well
as the number of abstentions and broker non-votes for each matter
voted upon at that meeting.
Abstentions
Against and Broker
Matter For or Non-votes
Withheld
--------- -------- ----------
1. Election of four directors
(a) Robert Cizik 47,708,064 914,389 --
(b) James T. Hackett 47,794,743 827,710 --
(c) Arthur Temple III 47,358,863 1,263,590 --
(d) Larry E. Temple 47,778,612 843,841 --
2. Ratification of adoption of
the Company's 2003 Stock
Incentive Plan 40,856,478 7,347,821 418,154
Plan.
3. Ratification of appointment
of Ernst & Young LLP. 47,586,904 729,025 306,524
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
31.1 - Certification of Chief Executive Officer
pursuant to Exchange Act Rule 13a-14(a), as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
31.2 - Certification of Chief Financial Officer
pursuant to Exchange Act Rule 13a-14(a), as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
48
32.1 - 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
32.2 - 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 June 28, 2003, the
Company filed the following Current Reports on
Form 8-K:
1. Current Report on Form 8-K dated April 15, 2003, reporting
under Item 9 the indefinite shut down of the Company's Mt.
Jewett, Pennsylvania, particleboard plant.
2. Current Report on Form 8-K dated April 22, 2003, reporting
under Item 9 a press release issued by the Company announcing
earnings for the period ended March 29, 2003.
3. Current Report on Form 8-K dated April 23, 2003, reporting
under Item 9 presentation materials used in a conference call
discussing earnings for the period ended March 29, 2003.
4. Current Report on Form 8-K dated June 26, 2003, as amended,
reporting under Item 5 the conclusion of certain tax matters.
49
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: August 11, 2003 By /s/ Louis R. Brill
-------------------------
Louis R. Brill
Chief Accounting Officer
50
INDEX TO EXHIBITS
Exhibit No. Description Page No.
- ----------- ----------- --------
31.1 Certification of Chief Executive Officer 51
pursuant to Exchange Act Rule 13a-14(a),
as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer 53
pursuant to Exchange Act Rule 13a-14(a),
as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer 55
pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer 56
pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002