SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[x] Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the Quarterly Period
Ended September 27, 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 September 27, 2003
Common Stock (par
value $1.00 per share) 54,268,508
Page 1 of 90 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
Third Quarter First Nine Months
------------- -----------------
2003 2002 2003 2002
---- ---- ---- ----
(in millions)
NET REVENUES $ 878 $ 874 $ 2,602 $ 2,542
COSTS AND EXPENSES
Cost of sales 797 782 2,393 2,234
Selling and administrative 70 74 220 226
Other (income) expense 15 -- 45 6
----- ----- ----- -----
882 856 2,658 2,466
----- ----- ----- -----
(4) 18 (56) 76
FINANCIAL SERVICES EARNINGS 48 44 129 108
----- ----- ----- -----
OPERATING INCOME 44 62 73 184
Interest expense (33) (36) (103) (97)
Other expense (8) -- (8) (11)
----- ----- ----- -----
INCOME (LOSS) FROM CONTINUING
OPERATIONS BEFORE TAXES 3 26 (38) 76
Income tax (expense) benefit (6) (11) 173 (30)
----- ----- ----- -----
INCOME (LOSS) FROM CONTINUING
OPERATIONS (3) 15 135 46
Discontinued operations -- -- 1 (1)
----- ----- ----- -----
INCOME (LOSS) BEFORE ACCOUNTING
CHANGE (3) 15 136 45
Effect of accounting change -- -- (1) (11)
----- ----- ----- -----
NET INCOME (LOSS) $ (3) $ 15 $ 135 $ 34
===== ===== ===== =====
See the notes to consolidated financial statements.
2
3
SUMMARIZED BALANCE SHEETS
PARENT COMPANY (TEMPLE-INLAND INC.)
Unaudited
Third
Quarter Year-End
2003 2002
---- ----
(in millions)
ASSETS
Current Assets
Cash and cash equivalents $ 14 $ 17
Receivables, net of allowances of $14 in 2003 399 352
and $13 in 2002
Inventories:
Work in process and finished goods 83 69
Raw materials and supplies 242 269
----- -----
Total inventories 325 338
----- -----
Prepaid expenses and other 56 50
----- -----
Total current assets 794 757
----- -----
Investment in Financial Services 1,139 1,178
Property and Equipment:
Land and buildings 618 638
Machinery and equipment 3,518 3,412
Construction in progress 62 92
Less allowances for depreciation
(2,249) (2,101)
----- -----
1,949 2,041
Timber and timberlands - less depletion 494 508
----- -----
Total property and equipment 2,443 2,549
Goodwill 239 249
Assets of Discontinued Operations 25 78
Other Assets 146 146
----- -----
TOTAL ASSETS $ 4,786 $ 4,957
===== =====
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable $ 205 $ 188
Employee compensation and benefits 60 67
Accrued interest 26 30
Accrued property taxes 29 28
Other accrued expenses 131 133
Liabilities of discontinued operations 20 28
Current portion of long-term debt 4 8
----- -----
Total current liabilities 475 482
Long-Term Debt 1,743 1,883
Deferred Income Taxes 67 245
Postretirement Benefits 146 147
Pension Liability 173 142
Other Long-Term Liabilities 136 109
----- -----
Total Liabilities 2,740 3,008
Shareholders' Equity 2,046 1,949
----- -----
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 4,786 $ 4,957
===== =====
See the notes to consolidated financial statements.
3
4
SUMMARIZED STATEMENTS OF CASH FLOW
PARENT COMPANY (TEMPLE-INLAND INC.)
Unaudited
First Nine Months
-----------------
2003 2002
---- ----
(in millions)
CASH PROVIDED BY (USED FOR) OPERATIONS
Net income $ 135 $ 34
Adjustments:
Depreciation, depletion and amortization 174 164
Depreciation of leased property 2 2
Non-cash stock based compensation 22 1
Non-cash pension and postretirement expense 41 18
Cash contribution to pension and postretirement
plans (11) (11)
Other non-cash charges (credits) (133) 17
Deferred income taxes 10 25
Unremitted earnings from Financial Services (83) (108)
Dividends from Financial Services 120 100
Working capital changes, net (27) (57)
Net assets of discontinued operations (1) 16
Loss from discontinued operations (1) 1
Cumulative effect of accounting change 1 11
Other 15 39
----- -----
264 252
----- -----
CASH PROVIDED BY (USED FOR) INVESTING
Capital expenditures (96) (81)
Sales of non-strategic assets and operations 36 33
Acquisition of Gaylord, net of cash acquired -- (569)
Other acquisitions and joint ventures (7) (40)
Other -- (3)
----- -----
(67) (660)
----- -----
CASH PROVIDED BY (USED FOR) FINANCING
Payments of debt (169) (310)
Cash dividends paid to shareholders (55) (50)
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 24 31
Other -- (22)
----- -----
(200) 420
----- -----
Effect of exchange rate changes on cash -- (1)
Net increase (decrease) in cash (3) 11
Cash at beginning of period 17 3
----- -----
Cash at end of period $ 14 $ 14
===== =====
See the notes to consolidated financial statements.
4
5
SUMMARIZED STATEMENTS OF INCOME
FINANCIAL SERVICES
Unaudited
Third Quarter First Nine Months
------------- -----------------
2003 2002 2003 2002
---- ---- ---- ----
(in millions)
INTEREST INCOME
Loans and loans held for sale $ 129 $ 143 $ 393 $ 431
Securities available-for-sale 16 25 54 83
Securities held-to-maturity 33 28 109 55
Other earning assets 1 1 3 3
----- ----- ----- -----
Total interest income 179 197 559 572
INTEREST EXPENSE
Deposits 43 58 145 181
Borrowed funds 41 44 130 113
----- ----- ----- -----
Total interest expense 84 102 275 294
----- ----- ----- -----
NET INTEREST INCOME 95 95 284 278
Provision for loan losses (13) (8) (44) (37)
----- ----- ----- -----
NET INTEREST INCOME AFTER PROVISION FOR
LOAN LOSSES 82 87 240 241
----- ----- ----- -----
NONINTEREST INCOME
Loan servicing fees 8 10 24 32
Amortization and impairment of servicing
rights (12) (20) (53) (37)
Loan origination and marketing 71 53 225 134
Real estate operations 14 13 34 35
Insurance commissions and fees 12 14 33 38
Service charges on deposits 9 8 26 22
Operating lease income 3 2 8 8
Other 8 6 29 21
----- ----- ----- -----
Total noninterest income 113 86 326 253
----- ----- ----- -----
NONINTEREST EXPENSE
Compensation and benefits 85 75 258 218
Loan servicing and origination 5 2 12 4
Real estate operations, other than
compensation 9 9 24 24
Insurance operations, other than 3 5 10 11
compensation
Occupancy 8 8 25 25
Data processing 7 6 20 24
Other 30 24 88 80
----- ----- ----- -----
Total noninterest expense 147 129 437 386
----- ----- ----- -----
INCOME BEFORE TAXES 48 44 129 108
Income tax (expense) benefit (17) 7 (46) --
----- ----- ----- -----
NET INCOME $ 31 $ 51 $ 83 $ 108
===== ===== ===== =====
See the notes to consolidated financial statements.
5
6
SUMMARIZED BALANCE SHEETS
FINANCIAL SERVICES
Unaudited
Third
Quarter Year-End
2003 2002
---- ----
(in millions)
ASSETS
Cash and cash equivalents $ 456 $ 438
Loans held for sale 621 1,088
Loans receivable, net of allowance for losses of
$130 in 2003 and $132 in 2002 9,321 9,668
Securities available-for-sale 1,491 1,926
Securities held-to-maturity 4,805 3,915
Real estate 278 249
Premises and equipment, net 167 157
Accounts, notes and accrued interest receivable 132 159
Goodwill 148 148
Mortgage servicing rights 88 105
Other assets 245 163
------ ------
TOTAL ASSETS $ 17,752 $ 18,016
====== ======
LIABILITIES AND SHAREHOLDER'S EQUITY
Deposits $ 8,945 $ 9,203
Federal Home Loan Bank advances 3,506 3,386
Securities sold under repurchase agreements 2,183 2,907
Obligations to settle trade date securities 963 369
Other liabilities 500 487
Other borrowings 211 181
Preferred stock issued by subsidiaries 305 305
------ ------
TOTAL LIABILITIES 16,613 16,838
------ ------
SHAREHOLDER'S EQUITY 1,139 1,178
------ ------
TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY $ 17,752 $ 18,016
====== ======
See the notes to consolidated financial statements.
6
7
SUMMARIZED STATEMENTS OF CASH FLOWS
FINANCIAL SERVICES
Unaudited
First Nine Months
2003 2002
---- ----
(in millions)
CASH PROVIDED BY (USED FOR) OPERATIONS
Net income (loss) $ 83 $ 108
Adjustments:
Amortization and accretion 70 38
Depreciation 18 18
Depreciation of leased assets 6 8
Provision for loan losses 44 37
Deferred income taxes (12) 2
Originations of loans held for sale (11,144) (5,403)
Sales of loans held for sale 11,611 5,386
Collections on loans serviced for others, net (24) (78)
Originated mortgage servicing rights (38) (34)
Other (3) 17
------ ------
611 99
------ ------
CASH PROVIDED BY (USED FOR) INVESTING
Purchases of securities available-for-sale (17) (22)
Principal payments and maturities of securities
available-for-sale 452 573
Purchases of securities held-to-maturity (2,008) (2,599)
Principal payments and maturities of securities
held-to-maturity 1,706 191
Loans originated or acquired, net of collections 198 1
Sale of mortgage servicing rights -- 33
Sale of loans 41 11
Acquisitions, net of cash acquired (1) 358
Capital expenditures (25) (11)
Other 10 3
------ ------
356 (1,462)
------ ------
CASH PROVIDED BY (USED FOR) FINANCING
Net increase (decrease) in deposits (234) (272)
Securities sold under repurchase agreements and
short-term borrowings, net (241) (685)
Additions to debt and long-term FHLB advances 282 2,335
Payments of debt and long-term FHLB advances (647) (232)
Dividends paid to parent company (120) (100)
Purchase of deposits -- 104
Other 11 --
------ ------
(949) 1,150
------ ------
Net increase (decrease) in cash and cash equivalents 18 (213)
Cash and cash equivalents at beginning of period 438 587
------ ------
Cash and cash equivalents at end of period $ 456 $ 374
====== ======
See the notes to consolidated financial statements.
7
8
CONSOLIDATED STATEMENTS OF INCOME
TEMPLE-INLAND INC. AND SUBSIDIARIES
Unaudited
Third Quarter First Nine Months
------------- -----------------
2003 2002 2003 2002
---- ---- ---- ----
(in millions, except per share amounts)
REVENUES
Manufacturing $ 878 $ 874 $ 2,602 $ 2,542
Financial Services 292 283 885 825
----- ----- ----- -----
1,170 1,157 3,487 3,367
----- ----- ----- -----
COSTS AND EXPENSES
Manufacturing 882 856 2,658 2,466
Financial Services 244 239 756 717
----- ----- ----- -----
1,126 1,095 3,414 3,183
----- ----- ----- -----
OPERATING INCOME 44 62 73 184
Parent company interest (33) (36) (103) (97)
Other expense (8) -- (8) (11)
----- ----- ----- -----
INCOME (LOSS) BEFORE TAXES 3 26 (38) 76
Income tax (expense) benefit (6) (11) 173 (30)
----- ----- ----- -----
INCOME (LOSS) FROM CONTINUING
OPERATIONS (3) 15 135 46
Discontinued operations -- -- 1 (1)
----- ----- ----- -----
INCOME (LOSS) BEFORE ACCOUNTING CHANGE (3) 15 136 45
Effect of accounting change -- -- (1) (11)
----- ----- ----- -----
NET INCOME (LOSS) $ (3) $ 15 $ 135 $ 34
===== ===== ===== =====
EARNINGS (LOSS) PER SHARE
Basic:
Income (loss) from continuing
operations $ (0.06) $ 0.28 $ 2.49 $ 0.89
Discontinued operations -- -- 0.01 (0.02)
Effect of accounting change -- -- (0.01) (0.21)
----- ----- ----- -----
Net income (loss) $ (0.06) $ 0.28 $ 2.49 $ 0.66
===== ===== ===== =====
Diluted:
Income (loss) from continuing
operations $ (0.06) $ 0.28 $ 2.49 $ 0.89
Discontinued operations -- -- 0.01 (0.02)
Effect of accounting change -- -- (0.01) (0.21)
----- ----- ----- -----
Net income (loss) $ (0.06) $ 0.28 $ 2.49 $ 0.66
===== ===== ===== =====
DIVIDENDS PAID PER SHARE OF
COMMON STOCK $ 0.34 $ 0.32 $ 1.02 $ 0.96
===== ===== ===== =====
See the notes to consolidated financial statements.
8
9
CONSOLIDATING BALANCE SHEETS
TEMPLE-INLAND INC. AND SUBSIDIARIES
Third Quarter 2003
Unaudited
Parent Financial
Company Services Consolidated
------- -------- ------------
(in millions)
ASSETS
Cash and cash equivalents $ 14 $ 456 $ 470
Loans held for sale -- 621 621
Loans receivable, net -- 9,321 9,321
Securities available-for-sale -- 1,491 1,491
Securities held-to-maturity -- 4,805 4,805
Trade receivables, net 399 -- 399
Inventories 325 -- 325
Property and equipment, net 2,443 167 2,610
Goodwill 239 148 387
Other assets 227 743 925
Investment in Financial Services 1,139 -- --
------ ------ ------
TOTAL ASSETS $ 4,786 $ 17,752 $ 21,354
====== ====== ======
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits $ -- $ 8,945 $ 8,945
Federal Home Loan Bank advances -- 3,506 3,506
Securities sold under repurchase
agreements -- 2,183 2,183
Obligations to settle trade date
securities -- 963 963
Other liabilities 611 500 1,087
Long-term debt 1,743 211 1,954
Deferred income taxes 67 -- 46
Postretirement benefits 146 -- 146
Pension liability 173 -- 173
Preferred stock issued by subsidiaries -- 305 305
------ ------ ------
TOTAL LIABILITIES $ 2,740 $ 16,613 $ 19,308
------ ------ ------
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 371
Accumulated other comprehensive loss (143)
Retained earnings 2,080
------
2,369
Cost of shares held in the treasury:
7,121,044 shares (323)
------
TOTAL SHAREHOLDERS' EQUITY 2,046
------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 21,354
======
See the notes to consolidated financial statements.
9
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
securities -- 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.
10
11
CONSOLIDATED STATEMENT OF CASH FLOWS
TEMPLE-INLAND INC. AND SUBSIDIARIES
Unaudited
First Nine Months
-----------------
2003 2002
---- ----
(in millions)
CASH PROVIDED BY (USED FOR) OPERATIONS
Net income (loss) $ 135 $ 34
Adjustments:
Depreciation, depletion and amortization 192 182
Depreciation on leased property 8 10
Provision for loan losses 44 37
Deferred taxes (2) 27
Other non-cash charges (133) 17
Amortization and accretion of financial
instruments 70 38
Originations of loans held for sale (11,144) (5,403)
Sales of loans held for sale 11,611 5,386
Working capital changes, net (27) (57)
Collections on loans serviced for others, net (24) (78)
Originated mortgage servicing rights (38) (34)
Net assets of discontinued operations (1) 16
Loss from discontinued operations (1) 1
Cumulative effect of accounting change 1 11
Other 64 64
------ ------
755 251
------ ------
CASH PROVIDED BY (USED FOR) INVESTING
Capital expenditures (121) (92)
Sale of non-strategic assets and operations 36 33
Purchases of securities available-for-sale (17) (22)
Principal payments and maturities of securities
available-for-sale 452 573
Purchases of securities held-to-maturity (2,008) (2,599)
Principal payments and maturities and redemptions
of securities held-to-maturity 1,706 191
Sale of mortgage servicing rights -- 33
Loans originated or acquired, net of principal
collected 198 1
Proceeds from sale of loans 41 11
Acquisitions, net of cash acquired (8) (251)
Other 10 --
------ ------
289 (2,122)
------ ------
CASH PROVIDED BY (USED FOR) FINANCING
Net increase (decrease) in deposits (234) (272)
Additions to debt 306 2,366
Payments of debt (816) (542)
Repurchase agreements and short-term borrowings,
net (241) (685)
Cash dividends paid to shareholders (55) (50)
Bridge financing facility -- 880
Payment of bridge financing facility -- (880)
Payment of assumed Gaylord bank debt -- (285)
Sale of common stock, Upper DECS, and
Senior Notes -- 1,056
Purchase of deposits -- 104
Other 11 (22)
------ ------
(1,029) 1,670
------ ------
Effect of exchange rate changes on cash -- (1)
------ ------
Net increase (decrease) in cash and cash equivalents 15 (202)
Cash and cash equivalents at beginning of period 455 590
------ ------
Cash and cash equivalents at end of period $ 470 $ 388
====== ======
See the notes to consolidated financial statements.
11
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 - (Continued)
NOTE B - EARNINGS PER SHARE
Denominators used in computing per share amounts follow:
Third First Nine
Quarter Months
------------ ------------
2003 2002 2003 2002
---- ---- ---- ----
(in millions)
Denominator for basic earnings per
share:
Weighted average common shares
outstanding 54.2 53.7 54.1 51.8
Dilutive effect of:
Equity purchase contracts -- -- -- --
Stock options 0.1 -- -- 0.1
---- ---- ---- ----
Denominator for diluted earnings
per share 54.3 53.7 54.1 51.9
==== ==== ==== ====
NOTE C - COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) consists of:
Third First Nine
Quarter Months
------------ ------------
2003 2002 2003 2002
---- ---- ---- ----
(in millions)
Net income (loss) $ (3) $ 15 $ 135 $ 34
Other comprehensive income (loss),
net of taxes:
Unrealized gains (losses) on:
Available-for-sale securities (2) 1 (1) --
Derivative instruments -- (2) (1) (2)
Foreign currency translation
adjustments (3) (1) (5) (7)
---- ---- ---- ----
Other comprehensive income (loss) (5) (2) (7) (9)
---- ---- ---- ----
Comprehensive income (loss) $ (8) $ 13 $ 128 $ 25
==== ==== ==== ====
At third quarter-end 2003, the aggregate fair value of all
derivative instruments was a $9 million liability, consisting of
an $8 million liability for an interest rate swap derivative and
a $1 million liability related to linerboard and OCC derivatives.
There was no ineffective portion of derivatives charged to
earnings in third quarter 2003 or in first nine 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 - (Continued)
Unallocated
General and
Administrative
and Other
Corrugated Building Financial (Income)
For third quarter 2003 Packaging Products Services Expense Total
---------------------- --------- -------- -------- -------------- ---------
(in millions)
Revenues from external
customers $ 667 211 292 -- $ 1,170
Depreciation, depletion
and amortization $ 40 16 8 2 $ 66
Operating income (loss) $ -- 22 49 (27) $ 44
Financial Services,
net interest income $ -- -- 95 -- $ 95
Capital expenditures $ 27 8 14 3 $ 52
----------------------------------------------------------------------------------------------
For first nine months
2003 or at third
quarter end 2003
----------------------
(in millions)
Revenues from external
customers $ 2,019 583 885 -- $ 3,487
Depreciation, depletion
and amortization $ 123 48 24 5 $ 200
Operating income (loss) $ (3) 25 132 (81) $ 73
Financial Services,
net interest income $ -- -- 284 -- $ 284
Total assets $ 2,427 1,104 17,752 71 $21,354
Capital expenditures $ 68 23 25 5 $ 121
Goodwill $ 239 -- 148 -- $ 387
----------------------------------------------------------------------------------------------
For third quarter 2002
----------------------
(in millions)
Revenues from external $ 672 202 283 -- $ 1,157
Depreciation, depletion
and amortization $ 38 16 9 3 $ 66
Operating income (loss) $ 14 12 44 (8) $ 62
Financial Services,
net interest income $ -- -- 95 -- $ 95
Capital expenditures $ 19 7 4 3 $ 33
----------------------------------------------------------------------------------------------
For first nine months
2002 or at third
quarter end 2002
---------------------
(in millions)
Revenues from external $ 1,932 610 825 -- $ 3,367
Depreciation, depletion
and amortization $ 115 46 26 5 $ 192
Operating income (loss) $ 65 43 115 (39) $ 184
Financial Services,
net interest income $ -- -- 278 -- $ 278
Total assets $ 2,681 1,188 17,830 46 $21,745
Capital expenditures $ 49 27 11 5 $ 92
Goodwill $ 177 -- 141 -- $ 318
----------------------------------------------------------------------------------------------
Includes other (income) expenses for third quarter 2003 of
$16 million, which consists of $3 million related to converting
and production facility closures and $13 million related to
consolidation and supply chain initiatives. Of these amounts, $1
million applies to Building Products, $4 million to Corrugated
Packaging, and $1 million to Financial Services.
Includes other (income) expense for first nine months 2003
of $48 million, which consists of $10 million related to
converting and production facility closures, $39 million related
to consolidation and supply chain initiatives and other income of
$1 million related to the collection of notes previously written-
off. Of these amounts, $13 million applies to Building Products,
$11 million to Corrugated Packaging and $3 million to Financial
Services.
15
TEMPLE-INLAND INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
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.
Includes depreciation and amortization of premises,
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):
First Nine Months 2002
----------------------
(in millions, except per share)
Net revenues $ 2,865
Income from continuing operations $ 35
Per diluted share
Income from continuing operations $ 0.67
NOTE G - DISCONTINUED OPERATIONS
At third quarter-end 2003, discontinued operations consist
of Gaylord's chemical business and accruals related to the 1999
sale of the bleached paperboard operations. At third quarter-end
2003, the assets and liabilities of discontinued operations
includes $10 million of working capital, $16 million of property
and equipment, and $20 million of environmental and other long-
term accruals. Revenues from discontinued operations for third
quarter 2003 were $3 million and for first nine months 2003 were
$15 million.
16
TEMPLE-INLAND INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
NOTE H - OTHER OPERATING (INCOME) EXPENSE
Other operating (income) expense consists of:
Third Quarter First Nine Months
-------------- -----------------
2003 2002 2003 2002
---- ---- ---- ----
(in millions)
Expenses associated with
consolidation and supply
chain initiatives $ 12 $ -- $ 36 $ --
Loss on closure of production
and converting facilities 3 -- 10 --
(Income) loss related to
collection of notes that
were written off in 2002 -- -- (1) 6
---- ---- ---- ----
Total $ 15 $ -- $ 45 $ 6
==== ==== ==== ====
Expenses related to initiatives to relocate the Corrugated
Packaging operations, consolidate administrative functions, and
effect improvements in supply chain management consist
principally of relocation costs and fees paid to third party
consultants. Losses on closure of production and converting
facilities consist principally of severance and asset
impairments.
In September 2003, the Company announced the indefinite
shutdown of its Clarion, Pennsylvania medium density fiberboard
plant. In connection with this shutdown the Company incurred and
paid $1 million in involuntary employee termination liabilities.
During third quarter 2003, the Company paid $1 million in
severance related to the previously announced closure of three
box plants. In addition, the Company incurred and paid $1 million
in severance related to workforce reductions at its Rome, Georgia
mill.
A summary of the activity related to all facility closure
accruals for third quarter 2003 follow:
Beginning End of
of Period Additions Cash Payments Period
--------- --------- ------------- ------
Involuntary employee
terminations $ 1 $ 2 $ (3) $ --
Contract termination
penalties 6 -- -- 6
Environmental
compliance 12 -- -- 12
Demolition 12 -- (1) 11
---- ---- ---- ----
Total $ 31 $ 2 $ (4) $ 29
==== ==== ==== ====
NOTE I - INCOME TAX
In second quarter 2003, the Internal Revenue Service
concluded its examination of the Company's tax returns through
17
TEMPLE-INLAND INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
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, of which $21 million was received in third quarter
2003. The remainder is a non-cash benefit.
During third quarter 2003, the Company lowered the estimated
effective tax rate for the year 2003 from 35 percent to 20
percent due to changes in estimates of income and expenses. As a
result, during third quarter 2003 the Company reduced its
previously recorded tax benefits for the first six months 2003 by
$6 million.
NOTE J - FINANCING TRANSACTIONS
During third quarter 2003, the Company redeemed its $150
million 8.25% debentures due 2022. The Company paid a $6 million
call premium and wrote off $2 million of unamortized financing
costs all of which are included in other expense. The redemption
of the debentures was funded from borrowings under the Company's
accounts receivable securitization program.
NOTE K - 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 is charged to expense over the option vesting
period. As a result of the adoption of this prospective
transition method, third quarter 2003 net income was decreased by
$3 million or $0.05 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
18
TEMPLE-INLAND INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
related to stock-based compensation recognized in net income for
third 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.
Third Quarter First Nine Months
------------- -----------------
2003 2002 2003 2002
---- ---- ---- ----
(in millions)
Net income (loss), as reported $ (3) $ 15 $ 135 $ 34
Add: Stock-based compensation
expense, net of related tax
effects, included in the
determination of reported net
income 8 -- 18 2
Deduct: Total stock-based
compensation expense, net of
related tax effects, determined
under the fair value based method
for all awards (11) (2) (26) (8)
---- ---- ---- ----
Pro forma net income (loss) $ (6) $ 13 $ 127 $ 28
==== ==== ==== ====
Earnings per share:
Basic, as reported $(0.06) $ 0.28 $ 2.49 $ 0.66
Basic, pro forma $(0.11) $ 0.25 $ 2.35 $ 0.54
Diluted, as reported $(0.06) $ 0.28 $ 2.49 $ 0.66
Diluted, pro forma $(0.11) $ 0.25 $ 2.35 $ 0.54
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.
Liabilities and Equity Instruments
During third quarter 2003, the Company was 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 and financial position of adopting
this statement was not material.
19
TEMPLE-INLAND INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Other Pronouncements
During fourth quarter 2003, the Company will be required to
begin applying FASB Interpretation No. 46, Consolidation of
Variable Interest Entities to its variable interest entities
created prior to February 1, 2003. It is anticipated that the
effect on earnings and financial position of applying this
interpretation will not be material.
20
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
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, 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 impairment and expenses associated with
consolidation and supply chain initiatives and facility closure
accruals.
21
Summary
A summary of the results of operations by business segment
follows:
Third Quarter First Nine Months
------------- -----------------
2003 2002 2003 2002
---- ---- ---- ----
(in millions, except per share)
Revenues
Corrugated Packaging $ 667 $ 672 $ 2,019 $ 1,932
Building Products 211 202 583 610
Financial Services 292 283 885 825
----- ----- ----- -----
Total revenues $ 1,170 $ 1,157 $ 3,487 $ 3,367
===== ===== ===== =====
Segment Operating Income
Corrugated Packaging $ -- $ 14 $ (3) $ 65
Building Products 22 12 25 43
Financial Services 49 44 132 115
----- ----- ----- -----
Total segment operating income 71 70 154 223
Unallocated general and
administrative expenses (11) (8) (33) (26)
Parent company interest (33) (36) (103) (97)
Other income (expense) (24) -- (56) (24)
----- ----- ----- -----
Income (loss) before taxes 3 26 (38) 76
Income tax (expense) benefit (6) (11) 173 (30)
----- ----- ----- -----
Income (loss) from continuing
operations (3) 15 135 46
Discontinued operations -- -- 1 (1)
Effect of accounting change -- -- (1) (11)
----- ----- ----- -----
Net income (loss) $ (3) $ 15 $ 135 $ 34
===== ===== ===== =====
Diluted earnings per share
Income (loss) from continuing
operations $ (0.06) $ 0.28 $ 2.49 $ 0.89
Discontinued operations -- -- 0.01 (0.02)
Effect of accounting change -- -- (0.01) (0.21)
----- ----- ----- -----
Net income (loss) $ (0.06) $ 0.28 $ 2.49 $ 0.66
===== ===== ===== =====
Average diluted shares
outstanding 54.3 53.7 54.1 51.9
Other income (expense) for third quarter 2003 includes, $3
million related to converting and production facility closures,
$13 million related to consolidation and supply chain initiatives
and $8 million related to the early redemption of debentures. Of
these amounts, $1 million applies to Building Products, $2
million to Corrugated Packaging, and $1 million to Financial
Services.
Other income (expense) for first nine months 2003 includes
$10 million related to converting and production facility
closures, $39 million related to consolidation and supply chain
initiatives and $8 million related to the early redemption of
debentures and other income of $1 million related to the
collection of notes previously written-off. Of these amounts, $3
million applies to Building Products, $11 million to Corrugated
Packaging and $3 million to Financial Services.
Other income (expense) for first nine months 2002 includes $7
million related to severance and write-off of technology
investments, $6 million related to the repurchase of notes
sold with recourse and $11 million related to the early
repayment of a bridge financing facility and other
borrowings. Of these amounts, $6 million applies to
Corrugated Packaging and $7 million to Financial Services.
22
Includes for third quarter 2003, a $6 million reduction in
previously recorded tax benefits for first six months 2003
related to a decrease in the effective tax rate for the year 2003
and, for first nine months 2003, a one-time tax benefit of $165
million.
For third quarter 2003 and 2002
Corrugated Packaging
Corrugated Packaging revenues were $667 million in third
quarter 2003 compared with $672 million in third quarter 2002.
Revenues from sales of corrugated packaging represented 93
percent of segment revenues for third quarter 2003 and 94 percent
for third 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:
Third Quarter 2003 versus Third Quarter 2002
Increase (Decrease) in
-------------------------------
Average Prices Shipments
-------------- ---------
Corrugated packaging (1%) --
Linerboard (1%) 18%
Compared with second quarter 2003, revenues were down $18
million. Average corrugated packaging prices were down one
percent while shipments were down two percent. Average linerboard
prices were down two percent while shipments were up three
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 $667 million in third quarter 2003
compared with $658 million in third quarter 2002. Significant
changes within the principal components of costs in 2003 include:
- higher energy costs, up $9 million,
- higher pension costs, up $6 million, and
- lower OCC costs due to lower prices and a decrease in OCC
purchases, down $16 million.
Average OCC prices were $90 per ton during third quarter 2003
compared with $122 per ton during third quarter 2002. It is
likely that OCC costs will continue to fluctuate during 2003.
Mill production was:
- 808,000 tons in third quarter 2003,
- 864,000 tons in third quarter 2002, and
- 819,000 tons in second quarter 2003.
23
Mill production data is not comparable due to the effect of the
shutdown of the Antioch, California mill completed during
September 2002.
The percentage of mill production used by Corrugated
Packaging operations was:
- 81 percent in third quarter 2003,
- 85 percent in third quarter 2002, and
- 82 percent in second quarter 2003.
The remainder was sold in the domestic and export markets.
Excluding routine maintenance, production downtime was
minimal in third quarter 2003 and second quarter 2003 and 94,000
tons in third quarter 2002 due to market 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 45,000 tons of
corrugating medium from the joint venture in third 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 closure of converting facilities.
During third quarter 2003, the Company paid $1 million of
severance to employees affected by the previously announced
closure of its converting facilities in Hattiesburg, Mississippi,
Elizabethton, Tennessee, and Tijuana, Mexico. In addition, the
Company incurred and paid $1 million in severance related to
workforce reductions at its Rome, Georgia mill. These costs are
included in other operating (income) expense and excluded from
segment operating income.
Fourth quarter earnings for corrugated packaging will likely
be adversely affected by the annual maintenance outages at the
Bogalusa, Louisiana and Rome, Georgia linerboard mills and a 14
week fourth quarter with seven additional days of fixed costs
and, due to holiday schedules, only one additional day of sales
revenue from the converting operations.
Corrugated Packaging operated at break even in third quarter
2003 compared with operating income of $14 million in third
quarter 2002.
24
Building Products
Building Products revenues were $211 million in third
quarter 2003 compared with $202 million in third quarter 2002.
The change in revenues in 2003 was principally due to changes in
average prices and shipments as follows:
Third Quarter 2003 versus Third Quarter 2002
Increase (Decrease) in
-------------------------------
Average Prices Shipments
-------------- ---------
Lumber 10% 12%
Particleboard (4%) (9%)
Gypsum 3% (4%)
MDF (7%) (30%)
Other revenues include sales of high-value and non-strategic
timberlands. These sales contributed $2 million in operating
income in third quarter 2003 compared with $1 million in third
quarter 2002 and $5 million in second quarter 2003.
Compared with second quarter 2003, revenues were up $19
million. Average prices were up eight percent for lumber and
three percent for gypsum, while average prices were down one
percent for particleboard and flat for MDF. Shipments were up
five percent for lumber, six percent for particleboard and 13
percent for gypsum, while average shipments were down 11 percent
for MDF.
Costs, which include production, selling, distribution, and
administrative costs, were $189 million in third quarter 2003
compared with $190 million in third quarter 2002.
Production averaged from a low of 52 percent to a high of 93
percent of capacity in the various product lines. Production
average was negatively affected by the indefinite shutdowns of
the Clarion, Pennsylvania MDF facility during third quarter 2003
and the Mt. Jewett, Pennsylvania particleboard facility during
second quarter 2003, neither of which had any third quarter
production. Production was curtailed to varying degrees in all
product lines in third quarter 2003 to match customer demand. The
Company's joint venture operations also experienced production
curtailments in third 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. 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 net
losses of $4 million in each of third quarter 2003 and third
quarter 2002, of which the Company's share was $2 million for
25
each period. In third 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
possible closure of production facilities. The Company is
continuing to address market and production issues at its MDF
facilities, including the Del-Tin Fiber MDF joint venture. During
third quarter 2003, the Company announced the indefinite shutdown
of its Clarion, Pennsylvania medium density fiberboard plant. In
addition, the Company announced the indefinite shutdown of its
Mt. Jewett, Pennsylvania particleboard plant in second quarter
2003 due to market issues. In connection with these shutdowns,
the Company incurred and paid $1 million in involuntary employee
termination liabilities. These costs are included in other
operating (income) expense and excluded from segment operating
income.
Building Products had income of $22 million in third quarter
2003 compared with $12 million in third quarter 2002.
Financial Services
Financial Services revenues, consisting of interest and non-
interest income, were $292 million in third quarter 2003 compared
with $283 million in third quarter 2002.
Operations
Selected financial information for Financial Services
follows:
Second
Third Quarter Quarter
------------- -------
2003 2002 2003
---- ---- ----
(in millions)
Net interest income $ 95 $ 95 $ 94
Provision for loan losses (13) (8) (20)
Noninterest income 113 86 118
Noninterest expense (146) (129) (148)
---- ---- ----
Segment operating income 49 44 44
Severance (1) -- (2)
---- ---- ----
Operating income $ 48 $ 44 $ 42
==== ==== ====
Net interest income in third quarter 2003 was similar to
third quarter 2002 and second quarter 2003; however, the
following changes in the components of net interest income
occurred:
- average earning assets, principally securities,
increased five percent compared with third quarter
2002, but
26
- the net interest spread declined due to 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 third quarter-end 2003 as it was at year-end 2002 principally
due to:
- a change in the mix of earning assets achieved by
increasing single-family mortgage loans and securities,
the interest rates on which generally are fixed for the
first three to five years and then reset annually
thereafter, and decreasing commercial real estate loans,
the interest rates on which generally reset every 30
to 90 days, and
- a shift in deposits achieved by decreasing certificates
of deposits 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 again decline, it is likely that net interest
income will be adversely affected.
The provision for loan losses was $13 million in third
quarter 2003 compared with $8 million in third quarter 2002. The
provision for third quarter 2003 related principally to
commercial real estate loans and asset-based commercial and
business loans. The provision for third quarter 2002 related
principally to asset-based commercial and business loans and
senior housing residential loans.
Noninterest income includes revenues from mortgage banking,
real estate, and insurance activities. Noninterest income was
$113 million in third quarter 2003 compared with $86 million in
third 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 $18 million,
- an increase in mortgage servicing rights amortization,
up $6 million, and
- a reversal of mortgage servicing rights valuation
allowance in third quarter 2003 of $7 million compared
with an increase in the mortgage servicing rights
valuation allowance of $7 million in third quarter 2002.
Noninterest expense was $146 million in third quarter 2003
compared with $129 million in third quarter 2002. The change in
noninterest expense in 2003 was principally due to higher costs
associated with the mortgage banking operations, primarily
employee compensation and other origination expenses associated
with higher origination volume.
27
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 third quarter-end 2003, cash
equivalents, mortgage loans held for sale, securities, and
residential housing loans constituted 81 percent of total earning
assets compared with 74 percent at third quarter-end 2002. The
increased percentage in 2003 is a result of efforts to change the
earning asset mix by increasing residential earning assets.
Securities, which include mortgage-backed and other
securities, were $6.3 billion at third quarter-end 2003 compared
with $5.8 billion at third 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 $9.5 billion at third quarter-end 2003 compared
with $9.9 billion at third quarter-end 2002 and $9.7 billion at
second quarter-end 2003. The following table summarizes the
composition of the loan portfolio:
Second
Third Quarter-End Quarter-End
-----------------
2003 2002 2003
---- ---- ----
(in millions)
Single-family mortgage $ 3,089 $ 2,100 $ 2,892
Single-family mortgage warehouse 395 454 502
Single-family construction 1,054 1,090 1,065
Multifamily and senior housing 1,831 1,891 1,865
----- ----- -----
Total residential housing 6,369 5,535 6,324
Commercial real estate 1,175 2,310 1,393
Commercial and business 1,142 1,076 1,178
Asset based lending & leasing 595 749 634
Consumer and other 170 215 182
----- ----- -----
Total loans 9,451 9,885 9,711
Less allowance for loan losses (130) (141) (117)
----- ----- -----
Loans receivable, net $ 9,321 $ 9,744 $ 9,594
===== ===== =====
The size of the total loan portfolio decreased $434 million
over the past year, and the composition of the portfolio has
changed due to efforts to increase residential housing assets. As
a result, residential housing loans represent 67 percent of the
loan portfolio at third quarter-end 2003 compared with 56 percent
at third quarter-end 2002 and 65 percent at second quarter-end
2003.
28
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.
Second
Third Quarter-End Quarter-End
-----------------
2003 2002 2003
---- ---- ----
(in millions)
Accruing loans past due 30 - 89 days $ 63 $ 116 $ 48
Accruing loans past due 90 days or more 1 9 --
------ ----- ------
Accruing loans past due 30 days or more $ 64 $ 125 $ 48
====== ===== ======
Nonaccrual loans $ 76 $ 109 $ 69
Nonaccrual restructured loans 10 -- 10
------ ----- ------
Nonperforming loans 86 109 79
Foreclosed property 12 8 12
Restructured operating leases 41 -- 42
------ ----- ------
Nonperforming assets $ 139 $ 117 $ 133
====== ===== ======
Restructured loans - performing $ 3 $ -- $ --
Allowance for loan losses $ 130 $ 141 $ 117
Nonperforming loan ratio 0.91% 1.11% 0.81%
Nonperforming asset ratio 1.46% 1.19% 1.37%
Allowance for loan losses/total loans 1.38% 1.42% 1.21%
Allowance for loan losses/nonperforming loans 152% 129% 149%
The change in the level of nonaccrual loans at third quarter-
end 2003 compared with third quarter-end 2002 was principally due
to $21 million in payoffs and paydowns of senior housing and
asset-based lending loans, a $10 million commercial office
building foreclosure, and $34 million in charge-offs of
previously reserved loans. These decreases were partially offset
by new nonaccrual loans, principally asset-based lending, senior
housing, and commercial and business loans. The restructured
operating leases added in 2003 relate to the restructuring of two
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
continue to perform under the terms of the restructured leases.
Both the asset-based lending and leasing portfolios and
commercial real estate loan portfolio will likely continue to be
adversely affected by the weak economy.
29
Allowance for Loan Losses
The allowance for loan losses is comprised of:
- reserves for impaired loans in accordance with SFAS
No. 114,
- reserves allocated to defined groups of loans that
are not considered individually impaired under SFAS
No. 114, and
- other reserves for unidentified incurred losses
inherent in the portfolio that are not allocated to
defined groups of loans.
Management evaluates the allowance for loan losses at each period
end 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:
Second
Third Quarter Quarter
---------------
2003 2002 2003
---- ---- ----
(in millions)
Balance at beginning of period $ 117 $ 135 $ 122
Charge-offs:
Total residential housing -- -- --
Commercial real estate (1) -- (7)
Commercial and business -- -- (4)
Asset based lending and leasing (1) (5) (17)
Consumer and other (1) (1) (1)
----- ----- -----
Total charge-offs (3) (6) (29)
----- ----- -----
Recoveries:
Total residential housing -- 4 4
Commercial real estate -- -- --
Commercial and business -- -- --
Asset based lending and leasing 3 -- --
Consumer and other -- -- --
----- ----- -----
Total recoveries 3 4 4
----- ----- -----
Net charge-offs -- (2) (25)
Provision for loan losses 13 8 20
----- ----- -----
Balance at end of period $ 130 $ 141 $ 117
===== ===== =====
Annualized net charge-offs as a
percentage of average loans
outstanding -- 0.1% 1.0%
Third quarter 2003 recoveries related principally to two
loans in the asset-based lending portfolio. Third quarter 2002
charge-offs related principally to two asset-based lending and
leasing credits, offset principally by one recovery related to a
previously charged off senior housing loan. Second quarter 2003
charge-offs related principally to several asset-based commercial
and business loans and a commercial real estate loan secured by
an office building.
30
Mortgage Banking Activities
Mortgage loan originations were $3.7 billion in third
quarter 2003 compared with $2.9 billion in third quarter 2002.
The high level of mortgage loan originations during third quarter
2003 was due to continued high refinance activity resulting from
the low interest rate environment.
In third quarter 2003, the savings bank retained $600
million in loans originated by the mortgage banking operations,
compared with $327 million in third quarter 2002. The change in
loans originated for the savings bank in third quarter 2003 was
the result of continued efforts to increase the level of
adjustable-rate single-family mortgage assets in the loan
portfolio.
In third quarter 2003, the mortgage banking operations sold
$3.5 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 third quarter 2003, the only retained interest was
mortgage servicing rights of $19 million relating to $1.7 billion
of loans. The following table provides information regarding the
mortgage servicing portfolio:
Second
Quarter-
Third Quarter-End End
-----------------
2003 2002 2003
---- ---- ----
(in millions)
Outstanding balance of loans
serviced for:
Third parties $ 8.5 $ 9.4 $ 8.4
Savings bank 2.5 1.0 1.9
----- ----- -----
Total mortgage servicing
portfolio $ 11.0 $ 10.4 $ 10.3
Annualized runoff rate 55% 36% 53%
The decrease in the balance of loans serviced for third
parties at third quarter-end 2003 compared with third quarter-end
2002 was principally due to significant repayments on loans,
partially offset by new loan originations for which servicing was
retained.
The increased runoff rate was due to the lower interest rate
environment in 2003. As a result of the high runoff rates,
amortization of mortgage servicing rights increased in third
quarter 2003; however, because interest rates increased near the
end of third quarter 2003, and prepayments slowed, the value of
the mortgage servicing rights increased, and $7 million in
impairment valuation allowance was reversed. The following table
provides information regarding charges for amortization and
impairment of mortgage servicing rights:
31
Second
Third Quarter Quarter
----------------
2003 2002 2003
---- ---- ----
(in millions)
Amortization $ 19 $ 13 $ 19
Impairment (recovery) (7) 7 5
----- ----- -----
$ 12 $ 20 $ 24
===== ===== =====
Valuation allowance at end of
period $ 15 $ 12 $ 22
In 2003 and 2002, the mortgage banking operations were
significantly affected by the refinancing activity associated
with the declining interest rate environment. If interest rates
remain constant or increase, the level of mortgage originations,
mortgage servicing rights amortization, and the impairment
valuation allowance 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 increase. In third quarter 2003, interest
rates increased somewhat. Accordingly, the level of mortgage loan
originations declined substantially near the end of third quarter
2003 and has remained at lower levels in October 2003. As a
result of the decline in mortgage originations, it is likely that
loan origination and marketing income and variable production
costs, including commission costs, will be lower during fourth
quarter 2003.
Unallocated General and Administrative Expenses, Interest and
Other (Income) Expense
Unallocated general and administrative expenses were $11
million in third quarter 2003 compared with $8 million in third
quarter 2002. The change in 2003 was principally due to an
increase in pension and stock-based compensation costs.
Parent company interest expense was $33 million in third
quarter 2003 compared with $36 million in third quarter 2002. The
average interest rate on borrowings was 6.9 percent in third
quarter 2003 compared with 7.0 percent in third quarter 2002.
Long-term debt was reduced by $70 million during third quarter
2003. In addition, the Company used borrowings under its
accounts receivable securitization program to redeem its $150
million 8.25% debentures due 2022. As a result, the Company paid
a $6 million call premium and wrote off $2 million of unamortized
financing costs, all of which are included in other expense. The
Company's accounts receivable securitization program currently
bears interest at a rate of 1.1 percent per annum.
Other operating (income) expense for third quarter 2003
includes $13 million in expenses related to initiatives to
relocate the Corrugated Packaging operations, consolidate
administrative functions and effect improvements in supply chain
32
management. These expenses consist principally of relocation and
severance expenses and fees paid to third party consultants. In
the remainder of 2003, the Company expects to incur an additional
$5 million to $10 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 third quarter
2003 compared with $2 million in third 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
The effective tax rate includes federal and state income
taxes and the effects of non-deductible items. During third
quarter 2003, the Company lowered the estimated effective tax
rate from 35 percent to 20 percent due to changes in the
estimates of income and expenses for the year 2003. As a result,
during third quarter 2003 the Company reduced, by $6 million, its
previously recorded tax benefits for the first six months 2003.
Average Shares Outstanding
Average shares outstanding were 54.3 million in third
quarter 2003 compared with 53.7 million in third quarter 2002.
The dilutive effect of stock options and equity purchase
contracts was not significant in any of the periods presented.
For first nine 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 $2,019 million for first
nine months 2003 compared with $1,932 million for first nine
months 2002. Revenues from sales of corrugated packaging
represented 93 percent of segment revenues for first nine months
2003 and 94 percent of revenues for first nine months 2002. The
remaining revenues are derived from sales of linerboard. The
33
change in revenues was principally due to changes in average
prices and shipments:
First Nine Months 2003 versus First Nine Months 2002
Increase (Decrease) in
---------------------------------
Average Prices Shipments(a)
-------------- ------------
Corrugated packaging (1%) 2%
Linerboard 1% 15%
(a) 2002 shipments have been adjusted for the effect of
acquisitions.
Costs, which include production, selling, distribution, and
administrative costs, were $2,022 million for first nine months
2003 compared with $1,867 million for first nine months 2002. The
change in costs in 2003 was principally due to:
- the inclusion of the acquired operations,
- higher energy costs, up $43 million,
- higher pension costs, up $20 million, and
- lower OCC costs due to lower prices and a decrease in
OCC purchases, down $24 million.
Average OCC prices were $89 per ton for first nine months 2003
compared with $101 per ton for first nine months 2002.
Mill production was:
- 2,390,000 tons for first nine months 2003 and
- 2,335,000 tons for first nine months 2002.
Mill production data is not comparable due to the effect of the
consolidation of Gaylord, which began on March 1, 2002, and
Antioch shutdown completed September 2002.
The percentage of mill production used by Corrugated
Packaging operations was:
- 82 percent for first nine months 2003 and
- 84 percent for first nine months 2002.
The remainder was sold in the domestic and export markets.
Excluding routine maintenance, production downtime was
minimal for first nine months 2003 and 301,000 tons for first
nine 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 118,000 tons of
corrugating medium from the joint venture during first nine
months 2003, compared with 134,000 tons in first nine months
2002.
34
Corrugated Packaging had a $3 million operating loss for
first nine months 2003 compared with income of $65 million for
first nine months 2002.
Building Products
Building Products revenues were $583 million for first nine
months 2003 compared with $610 million for first nine months
2002. The change in revenues in 2003 was principally due to lower
average prices and shipments in most product lines as follows:
First Nine Months 2003 versus First Nine Months 2002
Increase (Decrease) in
--------------------------------
Average Prices Shipments
-------------- ---------
Lumber (3%) 11%
Particleboard (5%) (11%)
Gypsum (1%) (7%)
MDF (3%) (24%)
Other revenues include sales of high-value timberlands. These
sales contributed $8 million in operating income for first nine
months 2003 compared with $11 million for first nine months 2002.
Costs, which include production, selling, distribution, and
administrative costs, were $558 million for first nine months
2003 compared with $567 million for first nine months 2002. The
change in costs in 2003 was principally due to lower production
volumes partially offset by:
- higher energy costs, up $6 million, and
- higher pension costs, up $3 million.
Production averaged from a low of 45 percent to a high of 95
percent of capacity in the various product lines. Production was
curtailed to varying degrees in all product lines for first nine
months 2003 to match customer demand. The Company's joint venture
operations also experienced production curtailments in first nine
months 2003.
Building Products had operating income of $25 million for
first nine months 2003 compared with $43 million for first nine
months 2002.
Financial Services
Financial Services revenues, consisting of interest and non-
interest income, were $885 million for first nine months 2003
compared with $825 million for first nine months 2002.
Operations
Selected financial information for Financial Services
follows:
35
First Nine Months
-----------------
2003 2002
---- ----
(in millions)
Net interest income $ 284 $ 278
Provision for loan losses (44) (37)
Noninterest income 326 253
Noninterest expense (434) (379)
----- -----
Segment operating income 132 115
Severance and asset write-offs (3) (7)
----- -----
Operating income $ 129 $ 108
===== =====
Net interest income was $284 million for first nine months
2003 compared with $278 million for first nine months 2002. The
change was principally due to:
- average earning assets, principally securities,increased
11 percent compared with first nine months 2002, but
- the net interest spread declined due to the lower interest
rate environment combined with an asset sensitive position.
The provision for loan losses was $44 million for first nine
months 2003 compared with $37 million for first nine months 2002.
The provision for first nine months 2003 related principally to
commercial real estate loans, the restructured aircraft leases,
and asset-based commercial and business loans. The provision for
first nine months 2002 related principally to senior housing
residential and commercial and business loans.
Noninterest income includes revenues from mortgage banking
and real estate and insurance activities. Noninterest income was
$326 million for first nine months 2003 compared with $253
million for first nine 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 $91 million,
- an increase in mortgage servicing rights amortization,
up $16 million, and
- no net change in the mortgage servicing rights valuation
allowance in first nine months 2003 compared with an
increase in the mortgage servicing rights valuation
allowance of $5 million in first nine months 2002.
Noninterest expense was $434 million for first nine months
2003 compared with $379 million for first nine months 2002. The
change in noninterest expense in 2003 was principally due to
higher costs associated with the mortgage banking operations,
primarily employee compensation and other origination expenses
associated with higher origination volume.
See Mortgage Banking Activities for further information
regarding mortgage-banking operations.
36
Allowance for Loan Losses
Changes in the allowance for loan losses were:
First Nine Months
-----------------
2003 2002
---- ----
(in millions)
Balance at beginning of period $ 132 $ 139
Charge-offs:
Total residential housing -- (11)
Commercial real estate (8) --
Commercial and business (5) (5)
Asset based lending and leasing (38) (24)
Consumer and other (2) (1)
----- -----
Total charge-offs (53) (41)
----- -----
Recoveries:
Total residential housing 4 5
Commercial real estate -- --
Commercial and business -- --
Asset based lending and leasing 3 1
Consumer and other -- --
----- -----
Total recoveries 7 6
----- -----
Net charge-offs (46) (35)
Provision for loan losses 44 37
----- -----
Balance at end of period $ 130 $ 141
===== =====
Net charge-offs (annualized) as
a percentage of average loans
outstanding 0.62% 0.49%
Charge-offs for first nine months 2003 related principally
to a commercial real estate loan secured by an office building,
two commercial and business loans, two restructured aircraft
leases, and several asset-based lending loans. Charge-offs for
first nine months 2002 related principally to two senior housing
loans, one commercial and business loan, and several asset-based
lending and leasing credits.
Mortgage Banking Activities
Mortgage loan originations were $11.1 billion for first nine
months 2003 compared with $6.7 billion for first nine months
2002. The high level of mortgage loan originations for first nine
months 2003 was due to continued refinance activity resulting
from the low interest rate environment.
For first nine months 2003, the savings bank retained $1.6
billion in loans originated by the mortgage banking operations,
compared with $637 million for first nine months 2002. The
significant increase in loans originated for the savings bank for
first nine months 2003 was the result of continued efforts to
increase the level of adjustable-rate single-family mortgage
assets in the loan portfolio.
37
For first nine months 2003, the mortgage banking operations
sold $10.0 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 during first nine months 2003, the only retained
interest was mortgage servicing rights of $38 million relating to
$3.5 billion of loans.
The outstanding balance of loans in the mortgage servicing
portfolio decreased at an annualized rate of 50 percent during
first nine months 2003 compared with an annualized rate of 29
percent during first nine months 2002. The increased runoff rate
was due to the lower interest rate environment in 2003. As a
result of the high runoff rates, amortization of mortgage
servicing rights increased for first nine months 2003. However,
because interest rates increased near the end of first nine
months 2003 and prepayments slowed, the value of the mortgage
servicing rights increased and $7 million in impairment valuation
allowance was reversed. The following table provides information
regarding charges for amortization and impairment of recorded
mortgage servicing rights:
First Nine Months
-----------------
2003 2002
---- ----
(in millions)
Amortization $ 53 $ 31
Impairment -- 6
----- -----
$ 53 $ 37
===== =====
Unallocated General and Administrative Expenses, Interest and
Other (Income) Expense
Unallocated general and administrative expenses were $33
million for first nine months 2003 compared with $26 million for
first nine months 2002. The change in 2003 was principally due to
an increase in pension and stock-based compensation costs.
Parent company interest expense was $103 million for first
nine months 2003 compared with $97 million for first nine months
2002. The change was principally due the full effect of interest
expense on debt related to the acquisition of Gaylord. Long-term
debt was reduced by $145 million in first nine months 2003. The
average interest rate on borrowings was 7.0 percent for first
nine months 2003 compared with 6.2 percent for first nine months
2002.
Other operating expenses for first nine months 2003 include
$39 million in expenses related to initiatives to relocate the
Corrugated Packaging operations, consolidate administrative
functions and effect improvements in supply chain management.
38
These expenses consist principally of relocation and severance
expenses and fees paid to third party consultants.
Pension Expense
Non-cash pension expenses were $32 million for first nine
months 2003 compared with $7 million for first nine months 2002.
Income Taxes
In 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, approximately $26
million represents expected cash refunds of previously paid taxes
plus related interest, of which $21 million was received in third
quarter 2003. The remainder is a non-cash benefit.
Excluding the second quarter 2003 one-time tax benefit
described above, the effective tax rate for 2003 is expected to
be 20 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 nine
months 2003 compared with 51.9 million for first nine 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.
39
For first nine months 2003
Parent Company
Operating Activities
Cash provided by operations was $264 million. Income for
first nine months 2003 included $106 million of depreciation and
other non-cash charges and credits. Dividends received from
Financial Services were $120 million. Working capital needs
increased $27 million, principally due to a seasonal increase in
receivables.
Investing Activities
Investing activities used $67 million. Capital expenditures
were $96 million. Capital expenditures are expected to
approximate $150 million in 2003 or about 63 percent of expected
annual depreciation and depletion for 2003. Proceeds from the
sale of non-strategic assets acquired in connection with the
acquisition of Gaylord were $36 million.
Financing Activities
Financing activities used $200 million. Debt and other
borrowings were reduced by $145 million. Cash dividends paid to
shareholders were $55 million or $1.02 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 third quarter-end 2003, the parent company had $555
million in unused borrowing capacity under its revolving credit
agreements and $180 million under its accounts receivable
securitization program, which matures in April 2006. During
September 2003, the accounts receivable securitization program
was increased from $200 million to $250 million. At third 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. During fourth quarter 2003,
$20 million in revolving credit agreements expire, all of which
are unused at third 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.
During third quarter 2003, $83 million of tax exempt bonds
were converted from variable interest rate modes to fixed rate
40
interest modes, and remarketed to investors at par. The bonds,
which have a weighted average remaining term of 12.4 years, were
issued with a weighted average interest rate of 5.82 percent. In
addition, the Company, redeemed all of the 8.25% Debentures
payable 2022. The principal amount of $150 million and the call
premium of $6 million were funded by draws on the accounts
receivable securitization program.
On October 1, 2003, the Company repaid at maturity a $61
million term loan with funds provided from the 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 $611 million. Income for
first nine months 2003 included $70 million of amortization and
other non-cash charges.
Investing Activities
Cash provided by investing activities was $356 million.
Principal payments and maturities of securities, net of
purchases, provided $133 million and loan originations, net of
collections, provided $198 million.
Financing Activities
Cash used for financing activities was $949 million.
Borrowings decreased $840 million, principally due to repayments
of FHLB advances and a decrease in deposits. In addition, $120
million in dividends were paid to the parent company.
Cash Equivalents
Cash equivalents were $456 million at third 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 third quarter-end 2003, Financial
Services had available liquidity of $2.6 billion. The manner in
41
which Financial Services meets its funding needs can affect its
asset sensitive position. For example, increased term borrowings
at fixed rates would increase asset sensitivity.
At third quarter-end 2003, commitments to originate single-
family residential mortgage loans totaled $0.9 billion and
commitments to sell single-family residential mortgage loans
totaled $0.9 billion.
At third 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 could make capital
contributions to the savings bank, if necessary. During third
quarter 2003, the Company made no capital contributions to the
savings bank.
Selected consolidated financial and regulatory capital data
for the savings bank follows:
Third
Quarter- Year-End
End 2003 2002
-------- ------
(dollars in millions)
Balance sheet data
Total assets $ 17,323 $ 17,634
Total deposits 8,945 9,203
Shareholder's equity 984 1,025
Savings Regulatory For Categorization
Bank Minimum as "Well Capitalized"
------- ---------- ---------------------
Regulatory capital ratios:
Tangible capital 6.36% 2.00% N/A
Leverage capital 6.36% 4.00% 5.00%
Tier 1 risk-based capital 9.74% 4.00% 6.00%
Total risk-based capital 11.19% 8.00% 10.00%
Energy and the Effects of Inflation
Energy costs, principally natural gas, were $63 million in
third quarter 2003 compared with $53 million in third quarter
2002 and $69 million in second 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.
42
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, third quarter 2003 net income
was decreased by $3 million or $0.05 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.
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.
Liabilities and Equity Instruments
During third quarter 2003, the Company was 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 was not material.
Other Pronouncements
During fourth quarter 2003, the Company will be required to
begin applying FASB Interpretation No. 46, Consolidation of
43
Variable Interest Entities to its variable interest entities
created prior to February 1, 2003. It is anticipated that the
effect on earnings or financial position of applying this
interpretation will not be material.
Critical Accounting Policies
In third 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.
Statistical and other data
First Nine
Third Quarter Months
------------- -------------
2003 2002 2003 2002
---- ---- ---- ----
(in millions)
Revenues
Corrugated Packaging
Corrugated packaging $ 617 $ 629 $ 1,877 $ 1,809
Linerboard 50 43 142 123
----- ----- ----- -----
Total Corrugated Packaging $ 667 $ 672 $ 2,019 $ 1,932
===== ===== ===== =====
Building Products
Lumber $ 73 $ 59 $ 193 $ 177
Particleboard 38 43 113 133
Medium density fiberboard 21 32 70 91
Gypsum wallboard 19 19 53 58
Fiberboard 20 18 51 52
Other 40 31 103 99
----- ----- ----- -----
Total Building Products $ 211 $ 202 $ 583 $ 610
===== ===== ===== =====
Unit sales
Corrugated Packaging
Corrugated packaging, thousands
of tons 793 795 2,382 2,263
Linerboard, thousands of tons 150 127 421 367
----- ----- ----- -----
Total, thousands of tons 943 922 2,803 2,630
===== ===== ===== =====
Building Products
Lumber, mbf 227 203 641 578
Particleboard, msf 149 164 444 501
Medium density fiberboard, msf 51 73 172 225
Gypsum wallboard, msf 165 171 472 510
Fiberboard, msf 123 106 312 312
Revenues and unit sales do not include joint venture
operations.
Note: Data for Corrugated Packaging for first nine months 2003 is
not comparable due to the effect of acquisitions completed in
2002.
44
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 of immediate, parallel and sustained shifts in
interest rates for the subsequent 12-month period at third
quarter-end 2003, with comparative information at year-end 2002.
The estimated effect takes into account the effects of changing
prepayment speeds, repricing characteristics and average balances
over the next 12 months. The simultaneous nature of these
effects may result in non-symmetrical pre-tax impacts on income
across shifts in interest rates or comparisons across reporting
periods.
Increase (decrease) in Income Before Taxes
(In millions)
Third Quarter
End 2003 Year-end 2002
------------- -------------
Change in
Interest Parent Financial Parent Financial
Rates Company Services Company Services
--------- ------- --------- ------- ---------
+2% $ (4) $ 33 $ (3) $ 40
+1% $ (2) $ 38 $ (2) $ 34
0 $ -- $ -- $ -- $ --
-1% $ 2 $ (21) $ 2 $ (29)
Due to the current low levels of interest rates, the two
percent decrease in interest rates is not presented.
The Parent Company's long-term debt is sensitive to changes
in interest rates. Interest rate changes would impact the Parent
Company's long-term debt due to differences in market interest
rates and the rates at inception of the debt agreements. The
analysis used to calculate the effect of changes in interest
rates was based on actual debt balances at quarter end, reduced
for contractual payments, which were assumed to be replaced with
variable rate debt.
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. In an asset sensitive position, earnings will
45
generally be positively affected in a rising rate environment,
but generally be negatively affected in a falling rate
environment.
Overall, Financial Services' interest rate sensitivity
decreased at third quarter-end 2003 compared with year-end 2002,
primarily because of changes in the earning asset mix, changes in
the deposit base, and interest rate increases in third quarter
2003. The commercial real estate portfolio, which tends to
reprice frequently, decreased $700 million, while the mortgage
loan portfolio, which generally reprice after three to five
years, increased $600 million. Additionally, approximately $600
million of deposits have shifted from certificates of deposit to
money market deposit accounts, which generally reprice more
frequently. However, because of current market pricing of these
accounts, the sensitivity amounts for third quarter-end 2003
anticipate only limited repricing sensitivity of these accounts
in the -1% and +1% scenarios.
The fair value of mortgage servicing rights (estimated at
$88 million at third quarter-end 2003) is also affected by
changes in interest rates, primarily long-term fixed mortgage
rates. The Company estimates that a one percent decline in long-
term fixed mortgage rates from current levels would decrease the
fair value of the mortgage servicing rights by approximately $24
million.
Foreign Currency Risk
In third 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 third 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,
46
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.
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. There have
been no material developments in this matter since the Company
filed its Quarterly Report on Form 10-Q for second quarter 2003,
with the exception that the court's order approving the fairness
of the settlement agreement has become final and there are now 12
opt-out cases, which the Company continues to defend vigorously.
The Company continues to believe 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. There have been no material
developments in this matter since the Company filed its Quarterly
Report on Form 10-Q for second quarter 2003 other than the trial
of the Louisiana class action is currently in process and is
expected to be submitted to the jury in mid-November.
47
The Company continues to believe 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
Inland was served with an administrative complaint filed by
the U.S. Environmental Protection Agency under the Clean Water
Act alleging that its box plant in Crawfordsville, Indiana
exceeded its permit limits for suspended solids and BOD and that
it failed to make timely reports of its sampling results and
failed to follow proper sampling protocols at various times
between 1999 and 2002. The served complaint appears to call for
a penalty that could exceed $100,000. The permit exceedences
were recognized by the city at the time, which imposed a
surcharge on the plant. Inland intends to engage in negotiations
to determine whether the penalty can be reduced based on the
city's surcharges and other defenses.
On October 15, 2003, a release of what is suspected to have
been nitrogen dioxide and nitrogen oxide took place at Gaylord's
linerboard mill lift station and sewer system in Bogalusa,
Louisiana. Based upon the Company's investigation, the total
amount of released nitrogen oxide and nitrogen dioxide is
believed to be no more than twenty pounds. The gaseous release
dispersed in the atmosphere and was not observed beyond the fence-
line. The mill followed appropriate protocols for handling this
type event, notifying the Louisiana Department of Environmental
Quality, the U.S. Environmental Protection Agency and local law
enforcement officials. The environmental agencies and the
Company are currently investigating the incident. Although the
investigations are not complete, the Company believes the
likelihood of a material loss from this incident to be remote and
does not believe that the outcome should have a material adverse
effect on its financial position, results of operations, or cash
flow.
The Ontario Ministry of Environment filed an enforcement
action alleging that air emissions from the MDF plant at
Pembroke, Ontario, Canada adversely impact surrounding property
owners. Trial of the matter is currently ongoing and is expected
to continue with sporadic testimony and trial dates through the
first quarter of 2004. Fines and penalties assessed in the
matter could exceed $100,000, but are not expected to have a
material adverse effect on the Company's financial position,
results of operations, or cash flow.
Item 2. Changes in Securities and Use of Proceeds.
None.
48
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
None
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
10.1 - Employment Agreement with J. Patrick Maley,
effective June 1, 2003.
10.2 - Separation Agreement and Release of Claims with
Dale E. Stahl, dated August 15, 2003.
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.
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 July 23, 2003, reporting
under Item 9 and 12 a press release issued by the Company
announcing earnings for the period ended June 28, 2003.
2. Current Report on Form 8-K dated July 25, 2003, reporting
under Item 5 a press release issued by the Company announcing
the resignation of Dale Stahl as an executive officer of the
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: November 10, 2003 By /s/ Louis R. Brill
----------------------------
Louis R. Brill
Chief Accounting Officer
50
INDEX TO EXHIBITS
Exhibit No. Description Page No.
----------- ----------- --------
10.1 Employment Agreement with J. 51
Patrick Maley, effective June 1,
2003
10.2 Separation Agreement and Release 80
of Claims with Dale E. Stahl,
dated August 15, 2003
31.1 Certification of Chief Executive 85
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 87
Officer 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 89
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 90
Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-
Oxley Act of 2002