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 July 3, 2004
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 MoPac Expressway South, 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 July 3, 2004
Common Stock (par
value $1.00 per share) 55,723,917
Page 1 of 127 The Exhibit Index is page 46.
2
TABLE OF CONTENTS
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Parent company financial statements 3
Financial services financial statements 6
Consolidated financial statements 9
Notes to consolidated financial statements 13
Item 2. Management's Discussion and Analysis of Financial 22
Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About 41
Market Risk
Item 4. Controls and Procedures 42
PART II. OTHER INFORMATION 42
Item 1. Legal Proceedings 42
Item 2. Changes in Securities, Use of Proceeds and Issuer 43
Purchases of Equity Securities
Item 3. Defaults Upon Senior Securities 43
Item 4. Submission of Matters to a Vote of Security 43
Holders
Item 5. Other Information 44
Item 6. Exhibits and Reports on Form 8-K 44
SIGNATURES 45
3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SUMMARIZED STATEMENTS OF INCOME
PARENT COMPANY (TEMPLE-INLAND INC.)
Unaudited
Second Quarter First Six Months
2004 2003 2004 2003
---- ---- ---- ----
(In millions)
NET REVENUES $ 940 $ 877 $ 1,833 $ 1,724
COSTS AND EXPENSES
Cost of sales 800 802 1,600 1,599
Selling 25 28 53 57
General and administrative 43 45 89 90
Other (income) expense 5 21 24 30
----- ----- ----- -----
873 896 1,766 1,776
----- ----- ----- -----
67 (19) 67 (52)
FINANCIAL SERVICES EARNINGS 59 42 112 81
----- ----- ----- -----
OPERATING INCOME 126 23 179 29
Interest expense (34) (35) (66) (70)
Other expense (2) -- (2) --
----- ----- ----- -----
INCOME (LOSS) FROM CONTINUING
BEFORE TAXES 90 (12) 111 (41)
Income tax (expense) benefit (35) 167 (43) 179
----- ----- ----- -----
INCOME FROM CONTINUING OPERATIONS 55 155 68 138
Discontinued operations 1 1 1 1
----- ----- ----- -----
INCOME BEFORE ACCOUNTING CHANGE 56 156 69 139
Effect of accounting change -- -- -- (1)
----- ----- ----- -----
NET INCOME $ 56 $ 156 $ 69 $ 138
===== ===== ===== =====
See the notes to consolidated financial statements.
4
SUMMARIZED BALANCE SHEETS
PARENT COMPANY (TEMPLE-INLAND INC.)
Unaudited
Second Year-
Quarter End
2004 2003
---- ----
(In millions)
ASSETS
Current Assets
Cash and cash equivalents $ 67 $ 20
Receivables, net of allowances of $15 in 2004
and $14 in 2003 437 359
Inventories:
Work in process and finished goods 90 83
Raw materials and supplies 241 247
----- -----
Total inventories 331 330
Prepaid expenses and other 63 69
----- -----
Total current assets 898 778
Investment in Financial Services 1,120 1,123
Timber and Timberlands 499 497
Property and Equipment:
Land and buildings 594 600
Machinery and equipment 3,443 3,454
Construction in progress 51 59
Less allowances for depreciation (2,331) (2,259)
----- -----
Total property and equipment 1,757 1,854
Goodwill 235 237
Assets of Discontinued Operations 28 50
Other Assets 113 99
----- -----
TOTAL ASSETS $ 4,650 $ 4,638
===== =====
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable $ 223 $ 218
Employee compensation and benefits 60 72
Accrued interest 25 27
Accrued property taxes 26 23
Other accrued expenses 133 141
Liabilities of discontinued operations 22 22
Current portion of long-term debt 3 4
----- -----
Total current liabilities 492 507
Long-Term Debt 1,557 1,611
Deferred Income Taxes 55 25
Postretirement Benefits 144 146
Pension Liability 274 250
Other Long-Term Liabilities 63 131
----- -----
Total Liabilities 2,585 2,670
Shareholders' Equity 2,065 1,968
----- -----
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 4,650 $ 4,638
===== =====
See the notes to consolidated financial statements.
5
SUMMARIZED STATEMENTS OF CASH FLOW
PARENT COMPANY (TEMPLE-INLAND INC.)
Unaudited
First Six
Months
------------
2004 2003
---- ----
(In millions)
CASH PROVIDED BY (USED FOR) OPERATIONS
Net income (loss) $ 69 $ 138
Adjustments:
Depreciation and amortization 111 118
Non-cash stock based compensation 19 16
Non-cash pension and postretirement expense 30 27
Cash contribution to pension and postretirement
plans (8) (6)
Other non-cash charges (credits) 14 (135)
Deferred income taxes 30 --
Net earnings of financial services (70) (52)
Dividends from financial services 70 70
Net assets of discontinued operations (9) (1)
Cumulative effect of accounting change -- 1
Other (5) 8
----- -----
251 184
Changes in:
Receivables (78) (46)
Inventories (2) 18
Prepaid expenses and other 6 (16)
Accounts payable and accrued expenses (14) 2
----- -----
163 142
----- -----
CASH PROVIDED BY (USED FOR) INVESTING
Capital expenditures (64) (58)
Sales of non-strategic assets 61 30
Other acquisitions and joint ventures (3) (5)
----- -----
(6) (33)
----- -----
CASH PROVIDED BY (USED FOR) FINANCING
Payments of debt (55) (74)
Payments of other long-term liabilities (64) --
Cash dividends paid to shareholders (40) (37)
Proceeds from exercise of stock options 49 --
Additions to debt -- 2
----- -----
(110) (109)
Effect of exchange rate changes on cash -- --
----- -----
Net increase (decrease) in cash and cash equivalents 47 --
Cash and cash equivalents at beginning of period 20 17
----- -----
Cash and cash equivalents at end of period $ 67 $ 17
===== =====
See the notes to consolidated financial statements.
6
SUMMARIZED STATEMENTS OF INCOME
FINANCIAL SERVICES
Unaudited
Second Quarter First Six Months
-------------- ----------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions)
INTEREST INCOME
Loans and loans held for sale $ 118 $ 131 $ 232 $ 264
Securities available-for-sale 14 18 29 37
Securities held-to-maturity 43 37 89 77
Other earning assets -- 1 1 2
---- ---- ---- ----
Total interest income 175 187 351 380
INTEREST EXPENSE
Deposits 33 49 67 102
Borrowed funds 43 44 85 89
---- ---- ---- ----
Total interest expense 76 93 152 191
---- ---- ---- ----
NET INTEREST INCOME 99 94 199 189
(Provision) credit for loan losses 4 (20) 4 (31)
---- ---- ---- ----
NET INTEREST INCOME AFTER (PROVISION)
CREDIT FOR LOAN LOSSES 103 74 203 158
---- ---- ---- ----
NONINTEREST INCOME
Loan servicing fees 8 7 16 16
Amortization and impairment of servicing
rights (6) (23) (13) (41)
Loan origination and sale of loans 46 88 83 154
Real estate operations 20 12 35 20
Insurance commissions and fees 13 12 24 22
Service charges on deposits 11 9 20 17
Operating lease income 3 3 6 5
Other 8 10 17 20
---- ---- ---- ----
Total noninterest income 103 118 188 213
---- ---- ---- ----
NONINTEREST EXPENSE
Compensation and benefits 74 91 144 174
Loan servicing and origination 4 4 6 7
Real estate operations, other than
compensation 12 8 20 15
Insurance operations, other than
compensation 2 1 3 3
Occupancy 7 8 15 16
Data processing 5 6 9 13
Other 43 32 82 62
---- ---- ---- ----
Total noninterest expense 147 150 279 290
---- ---- ---- ----
INCOME BEFORE TAXES 59 42 112 81
Income tax (expense) (22) (15) (42) (29)
---- ---- ---- ----
NET INCOME $ 37 $ 27 $ 70 $ 52
==== ==== ==== ====
See the notes to consolidated financial statements.
7
SUMMARIZED BALANCE SHEETS
FINANCIAL SERVICES
Unaudited
Second
Quarter Year-End
2004 2003
---- ----
(In millions)
ASSETS
Cash and cash equivalents $ 353 $ 379
Loans held for sale 566 551
Loans, net of allowance for losses of $100 in 2004 9,414 9,026
and $111 in 2003
Securities available-for-sale 1,241 1,374
Securities held-to-maturity 4,425 5,267
Real estate 252 295
Premises and equipment, net 172 164
Accounts, notes and accrued interest receivable 130 138
Goodwill 158 147
Mortgage servicing rights 90 89
Other assets 212 231
------ ------
TOTAL ASSETS $ 17,013 $ 17,661
====== ======
LIABILITIES AND SHAREHOLDER'S EQUITY
Deposits $ 8,813 $ 8,698
Federal Home Loan Bank advances 4,579 4,992
Securities sold under repurchase agreements 1,577 1,327
Obligations to settle trade date securities 3 567
Other liabilities 417 410
Other borrowings 199 239
Preferred stock issued by subsidiaries 305 305
------ ------
TOTAL LIABILITIES 15,893 16,538
------ ------
SHAREHOLDER'S EQUITY 1,120 1,123
------ ------
TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY $ 17,013 $ 17,661
====== ======
See the notes to consolidated financial statements.
8
SUMMARIZED STATEMENTS OF CASH FLOWS
FINANCIAL SERVICES
Unaudited
First Six Months
----------------
2004 2003
---- ----
(In millions)
CASH PROVIDED BY (USED FOR) OPERATIONS
Net income $ 70 $ 52
Adjustments:
Depreciation of premises and equipment 12 12
Depreciation of leased assets 4 4
Amortization and impairment of servicing rights 13 41
Provision (credit) for loan losses (4) 31
Amortization and accretion of financial
instruments 9 9
Deferred income taxes 4 (9)
----- -----
108 140
Changes in:
Loans held for sale, originations of loans (3,932) (7,477)
Loans held for sale, sales of loans 3,902 7,495
Collections on loans services for others, net (1) (31)
Other 13 49
----- -----
90 176
----- -----
CASH PROVIDED BY (USED FOR) INVESTING
Securities available-for-sale:
Purchases (28) (4)
Principal payments and maturities 157 312
Securities held-to-maturity:
Purchases (666) (1,112)
Principal payments and maturities 933 960
Loans originated or acquired, net of collections (448) (44)
Sale of loans 35 23
Acquisitions, net of cash acquired (15) (1)
Capital expenditures (18) (11)
Other 42 4
----- -----
(8) 127
----- -----
CASH PROVIDED BY (USED FOR) FINANCING
Net increase (decrease) in deposits 116 (29)
Repurchase agreements and short-term borrowings, net (8) 58
Additions to long-term FHLB advances and other
borrowings 183 57
Payments of long-term FHLB advances and other
borrowings (341) (425)
Dividends paid to parent company (70) (70)
Other 12 9
----- -----
(108) (400)
----- -----
Net increase (decrease) in cash and cash equivalents (26) (97)
Cash and cash equivalents at beginning of period 379 438
----- -----
Cash and cash equivalents at end of period $ 353 $ 341
===== =====
See the notes to consolidated financial statements.
9
CONSOLIDATED STATEMENTS OF INCOME
TEMPLE-INLAND INC. AND SUBSIDIARIES
Unaudited
Second Quarter First Six Months
-------------- ----------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions, except per share amounts)
REVENUES
Manufacturing $ 940 $ 877 $ 1,833 $ 1,724
Financial Services 278 305 539 593
----- ----- ----- -----
1,218 1,182 2,372 2,317
----- ----- ----- -----
COSTS AND EXPENSES
Manufacturing 873 896 1,766 1,776
Financial Services 219 263 427 512
----- ----- ----- -----
1,092 1,159 2,193 2,288
----- ----- ----- -----
OPERATING INCOME 126 23 179 29
Parent company interest (34) (35) (66) (70)
Other expense (2) -- (2) --
----- ----- ----- -----
INCOME (LOSS) BEFORE TAXES 90 (12) 111 (41)
Income tax (expense) benefit (35) 167 (43) 179
----- ----- ----- -----
INCOME FROM CONTINUING OPERATIONS 55 155 68 138
Discontinued operations 1 1 1 1
----- ----- ----- -----
INCOME BEFORE ACCOUNTING CHANGE 56 156 69 139
Effect of accounting change -- -- -- (1)
----- ----- ----- -----
NET INCOME $ 56 $ 156 $ 69 $ 138
===== ===== ===== =====
EARNINGS (LOSS) PER SHARE
Basic:
Income from continuing operations $ 0.99 $ 2.86 $ 1.23 $ 2.55
Discontinued operations 0.01 0.01 0.01 0.01
Effect of accounting change -- -- -- (0.01)
----- ----- ----- -----
Net income $ 1.00 $ 2.87 $ 1.24 $ 2.55
===== ===== ===== =====
Diluted:
Income from continuing operations $ 0.98 $ 2.86 $ 1.22 $ 2.55
Discontinued operations 0.01 0.01 0.01 0.01
Effect of accounting change -- -- -- (0.01)
----- ----- ----- -----
Net income $ 0.99 $ 2.87 $ 1.23 $ 2.55
===== ===== ===== =====
DIVIDENDS PAID PER SHARE OF COMMON STOCK $ 0.36 $ 0.34 $ 0.72 $ 0.68
===== ===== ===== =====
See the notes to consolidated financial statements.
10
CONSOLIDATING BALANCE SHEETS
TEMPLE-INLAND INC. AND SUBSIDIARIES
Second Quarter 2004
Unaudited
Parent Financial
Company Services Consolidated
------- -------- ------------
(In millions)
ASSETS
Cash and cash equivalents $ 67 $ 353 $ 420
Loans held for sale -- 566 566
Loans receivable -- 9,414 9,414
Securities available-for-sale -- 1,241 1,241
Securities held-to-maturity -- 4,425 4,425
Trade receivables 437 -- 437
Inventories 331 -- 331
Timber and timberlands 499 -- 499
Property and equipment 1,757 172 1,929
Goodwill 235 158 393
Other assets 204 684 852
Investment in Financial Services 1,120 -- --
----- ------ ------
TOTAL ASSETS $ 4,650 $ 17,013 $ 20,507
===== ====== ======
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits $ -- $ 8,813 $ 8,813
Federal Home Loan Bank advances -- 4,579 4,579
Securities sold under repurchase
agreements -- 1,577 1,577
Obligations to settle trade date
securities -- 3 3
Other liabilities 555 417 952
Long-term debt 1,557 199 1,756
Deferred income taxes 55 -- 39
Postretirement benefits 144 -- 144
Pension liability 274 -- 274
Preferred stock issued by subsidiaries -- 305 305
----- ------ ------
TOTAL LIABILITIES $ 2,585 $ 15,893 $ 18,442
----- ------ ------
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 395
Accumulated other comprehensive loss (185)
Retained earnings 2,052
-----
2,323
Cost of shares held in the treasury:
5,665,635 shares (258)
-----
TOTAL SHAREHOLDERS' EQUITY 2,065
-----
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 20,507
======
See the notes to consolidated financial statements.
11
CONSOLIDATING BALANCE SHEETS
TEMPLE-INLAND INC. AND SUBSIDIARIES
Year-End 2003
Unaudited
Parent Financial
Company Services Consolidated
------- -------- ------------
(In millions)
ASSETS
Cash and cash equivalents $ 20 $ 379 $ 399
Loans held for sale -- 551 551
Loans receivable -- 9,026 9,026
Securities available-for-sale -- 1,374 1,374
Securities held-to-maturity -- 5,267 5,267
Trade receivables 359 -- 359
Inventories 330 -- 330
Timber and timberlands 497 -- 497
Property and equipment 1,854 164 2,018
Goodwill 237 147 384
Other assets 218 753 938
Investment in Financial Services 1,123 -- --
----- ------ ------
TOTAL ASSETS $ 4,638 $ 17,661 $ 21,143
===== ====== ======
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits $ -- $ 8,698 $ 8,698
Federal Home Loan Bank advances -- 4,992 4,992
Securities sold under repurchase
agreements -- 1,327 1,327
Obligations to settle trade date
securities -- 567 567
Other liabilities 638 410 1,033
Long-term debt 1,611 239 1,850
Deferred income taxes 25 -- 7
Postretirement benefits 146 -- 146
Pension liability 250 -- 250
Preferred stock issued by subsidiaries -- 305 305
----- ------ ------
TOTAL LIABILITIES $ 2,670 $ 16,538 $ 19,175
----- ------ ------
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 377
Accumulated other comprehensive loss (185)
Retained earnings 2,023
-----
2,276
-----
Cost of shares held in the treasury:
6,792,410 shares (308)
TOTAL SHAREHOLDERS' EQUITY 1,968
-----
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 21,143
======
See the notes to consolidated financial statements.
12
CONSOLIDATED STATEMENT OF CASH FLOWS
TEMPLE-INLAND INC. AND SUBSIDIARIES
Unaudited
First Six Months
----------------
2004 2003
---- ----
(In millions)
CASH PROVIDED (USED FOR) OPERATIONS
Net income (loss) $ 69 $ 138
Adjustments:
Depreciation and amortization 127 134
Amortization and accretion of financial
instruments 22 50
Provision for loan losses (4) 31
Deferred income taxes 34 (9)
Other non-cash charges (credits) 14 (135)
Net assets of discontinued operations (9) (1)
Cumulative effect of accounting change -- 1
Other 49 94
---- ----
302 303
---- ----
Changes in:
Receivables (78) (46)
Inventories (2) 18
Prepaid expenses and other 6 (16)
Accounts payable and accrued expenses (14) 2
Loans held for sale, originations of loans (3,932) (7,477)
Loans held for sale, sales of loans 3,902 7,495
Collections on loans services for others, net (1) (31)
---- ----
183 248
---- ----
CASH PROVIDED BY (USED FOR) INVESTING
Capital expenditures (82) (69)
Sale of non-strategic assets 61 30
Securities available-for-sale, net 129 308
Securities held-to-maturity, net 267 (152)
Loans originated or acquired, net of principal
collected (448) (44)
Proceeds from sale of loans 35 23
Acquisitions, net of cash acquired (18) (6)
Other 42 4
---- ----
(14) 94
---- ----
CASH PROVIDED BY (USED FOR) FINANCING
Deposits, net 116 (29)
Additions to long-term debt 183 59
Payments of long-term debt (396) (499)
Payments of other long-term liabilities (64) --
Repurchase agreements and short-term borrowings, net (8) 58
Cash dividends paid to shareholders (40) (37)
Proceeds from exercise of stock options 49 --
Other 12 9
---- ----
(148) (439)
---- ----
Effect of exchange rate changes on cash -- --
---- ----
Net increase (decrease) in cash and cash equivalents 21 (97)
Cash and cash equivalents at beginning of period 399 455
---- ----
Cash and cash equivalents at end of period $ 420 $ 358
==== ====
See the notes to consolidated financial statements.
13
TEMPLE-INLAND INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - BASIS OF PRESENTATION
We prepared these unaudited interim financial statements 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. As a result, they do not
include all of the information and footnotes required by
generally accepted accounting principles for complete financial
statements. However, in our opinion, all adjustments (consisting
only of normal accruals) considered necessary for a fair
presentation have been included. These 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 our Annual
Report on Form 10-K for the fiscal year ended January 3, 2004.
The consolidated financial statements include the accounts
of Temple-Inland Inc. and its manufacturing and financial
services subsidiaries. Substantially all of our consolidated net
assets invested in financial services are subject to regulatory
rules and restrictions including restrictions on the ability of
financial services to pay dividends to us. Accordingly, included
as an integral part of the consolidated financial statements are
separate summarized financial statements for our parent company
and for our financial services segment.
The parent company summarized financial statements include
the accounts of Temple-Inland and its manufacturing segments.
The net assets invested in financial services are reflected using
the equity method. Related earnings, however, are presented
before tax to be consistent with the consolidated financial
statements.
We have eliminated all material intercompany amounts and
transactions. We have reclassified certain prior period amounts
to conform to current year's classifications.
14
TEMPLE-INLAND INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE B - EARNINGS PER SHARE
Denominators used in computing per share amounts were:
Second Quarter First Six Months
-------------- ----------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions)
Denominator for basic earnings per share:
Weighted average common shares
outstanding 55.6 54.1 55.3 54.0
Dilutive effect of:
Equity purchase contracts -- -- -- --
Stock options 0.6 -- 0.6 0.1
----- ----- ----- -----
Denominator for diluted earnings per
share 56.2 54.1 55.9 54.1
===== ===== ===== =====
NOTE C - COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) consists of:
Second Quarter First Six Months
-------------- ----------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions)
Net income $ 56 $ 156 $ 69 $ 138
Other comprehensive income (loss),
net of taxes:
Unrealized gains (losses) on:
Available-for-sale securities (1) (3) (3) 1
Derivative instruments 4 (1) 4 (1)
Foreign currency translation
adjustments (1) 1 (1) (2)
----- ----- ----- -----
Other comprehensive income (loss) 2 (3) -- (2)
----- ----- ----- -----
Comprehensive income $ 58 $ 153 $ 69 $ 136
===== ===== ===== =====
At second quarter-end 2004, the aggregate fair value of all
of our derivative instruments was a $3 million liability
consisting of a $5 million liability for our interest rate swap
derivative and a $2 million asset for our linerboard and OCC
derivatives. The ineffective portion of the interest rate swap
derivative resulted in a $1 million reduction in interest expense
in second quarter and first six months 2004. During second
quarter 2004, $4 million was reclassified from other
comprehensive income into interest expense because it is probable
that a portion of the forecasted transaction will not occur.
NOTE D - SEGMENT INFORMATION
We have three reportable segments: corrugated packaging,
forest products, and financial services. We evaluate performance
based on operating income before other (income) expense and
unallocated expenses, principally general and administrative
expenses. We do not allocate parent company interest to the
business segments. Other (income) expense includes gain or loss
on sale of assets, asset impairments and expenses associated with
consolidation initiatives and facility closures.
15
TEMPLE-INLAND INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Unallocated
Expenses and
Corrugated Forest Financial Other Income
For Second Quarter 2004 Packaging Products Services (Expense) Total
----------------------- ---------- -------- --------- ------------ -----
(In millions)
Revenues from external
customers $ 687 $ 253 $ 278 $ -- $ 1,218
Depreciation and
amortization 40 13 8 2 63
Operating income 26 65 59 (24) 126
Financial services,
net interest income -- -- 99 -- 99
Capital expenditures 23 11 9 2 45
-------------------------------------------------------------------------------------
For First Six Months 2004
or at Second Quarter-End 2004
-----------------------------
(In millions)
Revenues from external
customers $ 1,360 $ 473 $ 539 $ -- $ 2,372
Depreciation and
amortization 79 28 16 4 127
Operating income 36 97 112 (66) 179
Financial services,
net interest income -- -- 199 -- 199
Total assets 2,307 1,021 17,013 166 20,507
Capital expenditures 41 19 18 4 82
Goodwill 235 -- 158 -- 393
-------------------------------------------------------------------------------------
For Second Quarter 2003
-----------------------
(In millions)
Revenues from external
customers $ 685 $ 192 $ 305 $ -- $ 1,182
Depreciation and
amortization 42 16 9 1 68
Operating income 7 15 44 (43)(c) 23
Financial services,
net interest income -- -- 94 -- 94
Capital expenditures 21 7 6 1 35
-------------------------------------------------------------------------------------
For First Six Months 2003
or at Second Quarter-End 2003
-----------------------------
(In millions)
Revenues from external
customers $ 1,352 $ 372 $ 593 $ -- $ 2,317
Depreciation and
amortization 83 32 16 3 134
Operating income 9 8 83 (71) 29
Financial services,
net interest income -- -- 189 -- 189
Total assets 2,442 1,116 17,888 99 21,545
Capital expenditures 41 15 11 2 69
Goodwill 239 -- 149 -- 388
-------------------------------------------------------------------------------------
Includes other (income) expense for second quarter 2004 of
$5 million, which consists of a $3 million charge associated with
converting and production facility closures, a $1 million charge
related to consolidation and supply chain initiatives, and $1
million of other. Of these amounts, $4 million applies to
corrugated packaging and $1 million is unallocated.
Includes other (income) expense for first six months 2004 of
$24 million, which consists of a $17 million charge associated
with converting and production facility closures, a $6 million
charge related to consolidation and supply chain initiatives, and
$1 million of other. Of these amounts, $6 million applies to
corrugated packaging, $12 million applies to forest products, and
$6 million is unallocated.
Includes other (income) expense for second quarter 2003 of
$23 million, which consists of a $1 million charge associated
with a production facility closure, a $23 million charge related
16
TEMPLE-INLAND INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
to consolidation and supply chain initiatives, and other income
of $1 million related to the collection of notes previously
written off. Of these amounts, $1 million applies to forest
products, $2 million applies to financial services, $21 million
is unallocated, and the $1 million of other income applies to
corrugated packaging.
Includes other (income) expense for first six months 2003 of
$32 million, which consists of a $7 million charge associated
with converting and production facility closures, a $26 million
charge 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, $5 million applies to
corrugated packaging, $1 million applies to forest products, $2
million applies to financial services and $24 million is
unallocated.
As a result of the consolidation of our administrative
functions and adoption of a shared services concept, beginning
first quarter 2004, we changed the way we allocate cost to the
business segments. The effect of this change was to increase
segment operating income and to increase unallocated expenses by
a like amount. Second quarter and first six months 2003 amounts
have been reclassified to reflect this change as follows:
Originally As
Reported Reclassification Reclassified
-------- ---------------- ------------
(In millions)
Second Quarter 2003
Corrugated packaging $ 1 $ 6 $ 7
Forest products 12 3 15
Financial services 44 -- 44
----- ----- -----
Segment operating
income 57 9 66
Unallocated expenses (34) (9) (43)
----- ----- -----
Operating income $ 23 $ -- $ 23
===== ===== =====
First Six Months 2003
Corrugated packaging $ (3) $ 12 $ 9
Forest products 3 5 8
Financial services 83 -- 83
----- ----- -----
Segment operating
income 83 17 100
Unallocated expenses (54) (17) (71)
----- ----- -----
Operating income $ 29 $ -- $ 29
===== ===== =====
NOTE E - EMPLOYEE BENEFIT PLANS
The components of net periodic benefit cost of our defined
benefit pension plans are:
First Six
Second Quarter Months
-------------- ------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions)
Service costs $ 6 $ 5 $ 12 $ 11
Interest cost on projected benefit
obligation 18 15 36 33
Expected return on plan assets (17) (15) (34) (32)
Amortization of prior service costs -- 1 -- 1
Amortization of net (gain) loss 6 2 12 8
---- ---- ---- ----
Net periodic benefit cost $ 13 $ 8 $ 26 $ 21
==== ==== ==== ====
17
TEMPLE-INLAND INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The components of net periodic benefit cost of our
postretirement benefit plans are:
First Six
Second Quarter Months
-------------- ------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions)
Service costs $ 1 $ 1 $ 2 $ 2
Interest cost on projected benefit
obligation 2 2 4 5
Expected return on plan assets -- -- -- --
Amortization of prior service costs (1) (1) (2) (2)
Amortization of net (gain) loss -- 1 -- 1
---- ---- ---- ----
Net periodic benefit cost $ 2 $ 3 $ 4 $ 6
==== ==== ==== ====
The Medicare Prescription Drug, Improvement and
Modernization Act of 2003 was enacted in December 2003. This act
expands Medicare to include, for the first time, coverage for
prescription drugs. Our postretirement benefit plans provide for
medical coverage, including a prescription drug subsidy, for
certain participants. Due to the absence of detailed guidance
necessary to implement the act, we are unable to precisely
determine its effects on our postretirement benefit plans.
However, based on our current understanding and analysis, it is
likely that the effects will not significantly reduce our net
periodic benefit costs. In second quarter 2004, we adopted FASB
Staff Position, No. 106-2, Accounting and Disclosure Requirements
Related to the Medicare Prescription Drug, Improvement and
Modernization Act of 2003. This staff position permits us to
defer recognizing the effects of the act when we conclude they
are not significant until our next annual plan measurement date,
September 2004. At that time the effects will be considered and
will likely reduce our net periodic benefit cost in 2005 and
beyond but not by a significant amount.
NOTE F - STOCK-BASED COMPENSATION
Prior to 2003, we used the intrinsic value method in
accounting for stock-based compensation. As a result, no stock-
based compensation expense related to stock options granted prior
to 2003 is reflected in net income, as all stock options granted
had an exercise price equal to the market value of the underlying
common stock on the date of grant. Therefore, the cost related to
stock-based compensation recognized in net income for second
quarter and first six months 2004 and 2003 is less than would
have been recognized if the fair value method had been applied to
all stock options granted since 1995. The following table
illustrates the effect on net income and earnings per share as if
the fair value method had been applied to all stock options
granted since 1995.
18
TEMPLE-INLAND INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
First Six
Second Quarter Months
-------------- ------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions)
Net income, as reported $ 56 $ 156 $ 69 $ 138
Add: Stock-based compensation
expense, net of related tax
effects, included in the
determination of reported net
income 4 5 13 10
Deduct: Total stock-based
compensation expense, net of
related tax effects, determined
under the fair value based method
for all awards (7) (8) (18) (15)
---- ---- ---- ----
Pro forma net income $ 53 $ 153 $ 64 $ 133
==== ==== ==== ====
Earnings per share:
Basic, as reported $ 1.00 $ 2.87 $ 1.24 $ 2.55
Basic, pro forma $ 0.95 $ 2.83 $ 1.18 $ 2.46
Diluted, as reported $ 0.99 $ 2.87 $ 1.23 $ 2.55
Diluted, pro forma $ 0.94 $ 2.83 $ 1.18 $ 2.46
NOTE G - CONTINGENCIES
We are involved in various legal proceedings that arise from
time to time in the ordinary course of doing business. We
believe that the possibility of a material liability from any of
these proceedings is remote and we do not believe that the
outcome of any of these proceedings should have a material
adverse effect on our financial position, results of operations,
or cash flow.
NOTE H - ASSETS HELD FOR SALE
Assets held for sale include assets of discontinued
operations and other assets held for sale.
At second quarter-end 2004, discontinued operations consist
of the chemical business obtained in the 2002 acquisition of
Gaylord Container Corporation and accruals related to the 1999
sale of our bleached paperboard operations. At second quarter-
end 2004, the assets and liabilities of the discontinued
operations include $6 million of working capital, $18 million of
property and equipment, and $18 million of environmental and
other long-term accruals. Revenues from discontinued operations
for second quarter 2004 were $4 million and for first six months
2004 were $8 million.
During first six months 2004 we sold certain assets used in
our specialty packaging operations, our Clarion MDF facility and
other non-strategic assets for $72 million of which $61 million
was cash and $11 million was a note due in 2009. At second
quarter-end 2004, the carrying value of other assets held for
sale was $1 million compared with $23 million at year-end 2003.
19
TEMPLE-INLAND INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Impairment charges related to and gains or losses recognized upon
sale of these assets are included in other operating (income)
expense.
NOTE I - OTHER OPERATING (INCOME) EXPENSE
Second Quarter First Six Months
-------------- ----------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions)
Expenses associated with
consolidation of
administrative functions $ 1 $ 21 $ 6 $ 24
Loss on closure of production
and converting facilities 3 1 17 7
Collection of notes that were
previously written off -- (1) -- (1)
Other 1 -- 1 --
---- ---- ---- ----
Total $ 5 $ 21 $ 24 $ 30
==== ==== ==== ====
Expenses associated with the consolidation of administrative
functions consist principally of severance, most of which was
paid during 2003. During second quarter 2004, we revised our
estimates of contractual relocation expense and reduced our
accrual for these expenses by $2 million.
In conjunction with our previously announced plans, we
closed one converting facility in first quarter 2004, one
converting facility in second quarter 2004 and we intend to close
three more converting facilities in third quarter 2004. In
addition, during first six months 2004, we recognized a $12
million impairment charge related to our Clarion MDF facility,
which we sold during second quarter 2004 for a nominal gain.
Also during second quarter 2004, we sold certain assets used in
our specialty packaging operation. As a result, we incurred $4
million in severance and other exit costs during first six months
2004 and expect to incur additional severance and exit costs in
third quarter 2004. We also recognized asset impairments and
gains (losses) upon disposition of assets of $13 million during
first six months 2004 related to these closures.
A summary of the activity within our accruals for exit costs
during second quarter 2004 follow:
20
TEMPLE-INLAND INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Beginning Cash End of
of Period Additions Payments Period
--------- --------- -------- ------
(In millions)
Involuntary
employee
termination
severance $ 3 $ 3 $ 3 $ 3
Contract
termination
penalties 6 -- -- 6
Environmental
compliance 11 -- -- 11
Demolition 11 -- 1 10
---- ---- ---- ----
Total $ 31 $ 3 $ 4 $ 30
==== ==== ==== ====
NOTE J - ACQUISITIONS AND OTHER ITEMS
During first quarter 2004, financial services acquired an
insurance agency for $15 million cash. The purchase price was
allocated to acquired assets and liabilities based upon their
fair values with $10 million allocated to goodwill. The
unaudited pro forma results of operations, assuming the
acquisition had been effected at the beginning of the year, would
not have been materially different from those reported.
During second quarter 2004, we recognized a $2 million
charge, which is included in other expense, related to our early
retirement of $44 million of debt.
NOTE K - ACCOUNTING PRONOUNCEMENTS
During first quarter 2004, we were required to adopt the
following accounting pronouncements:
FASB Interpretation No. 46 (revised December 2003),
Consolidation of Variable Interest Entities an Interpretation of
ARB No. 51. This interpretation provides guidance for
determining whether an entity is a variable interest entity and
which beneficiary of the variable interest entity, if any, should
consolidate the variable interest entity. There was no effect on
earnings or financial position of adopting this interpretation.
Disclosures required by this interpretation follow:
* In 1999 we entered into an agreement to lease particleboard
and medium density fiberboard facilities in Mt. Jewett, PA. The
lease is for 20 years and includes fixed price purchase options
in 2014 and at the end of the lease. The option prices were
intended to approximate the estimated fair values of the
facilities at those dates and do not represent a guarantee of the
facilities' residual values. After exhaustive efforts, we were
unable to determine whether the lease is with a variable interest
entity or if there is a primary beneficiary because the unrelated
third party lessors will not provide the necessary financial
21
TEMPLE-INLAND INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
information. The lease is accounted for as an operating lease
and at year-end 2003 our financial interest was limited to our
obligation to make the remaining $191 million of contractual
lease payments, $10 million per year.
* In 1999 we invested $2 million in the form of equity and
subordinated debt in a residential land development partnership
that meets the definition of a variable interest entity.
However, we have determined that we are not the primary
beneficiary of the entity and, therefore, are not required to
consolidate this entity. At year-end 2003, this partnership had
total assets of $88 million and total liabilities of $89 million.
Our maximum exposure to loss is the carrying amount of our
subordinated debt and equity investments in this partnership,
currently $2 million.
Securities and Exchange Commission Staff Accounting Bulletin
No.105, Application of Accounting Principles to Loan Commitments.
This bulletin applies to loan commitments issued after March 2004
and accounted for as derivative instruments and it precludes the
recognition of an asset at the inception of the loan commitment.
The effect of adopting this bulletin was not significant.
FASB Staff Position, No. FAS 106-2, Accounting and
Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003. The effect of
adopting this staff position was not significant. See Note E for
additional information.
22
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. Our actual results may
differ significantly from the results discussed in the forward-
looking statements. Factors that might cause such differences
include general economic, market, or business conditions; the
opportunities or lack thereof that may or may not be presented to
and pursued by us; availability and price of raw materials we
use; competitive actions by others; changes in laws or
regulations; the accuracy of our judgments and estimates
concerning the integration of acquired operations and the
consolidation and supply chain initiatives; and other factors,
many of which are beyond our control.
Results of Operations for Second Quarter and First Six Months
Ended June 2004 and 2003
Summary
A summary of our consolidated results for second quarter and
first six months follows:
Second Quarter First Six Months
-------------- ----------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions, except per share)
Consolidated revenues $ 1,218 $ 1,182 $ 2,372 $ 2,317
Income (loss) from continuing
operations 55 155 68 138
Income (loss) from continuing
operations, per diluted share 0.98 2.86 1.22 2.55
Average diluted shares
outstanding 56.2 54.1 55.9 54.1
Significant items affecting second quarter 2004 compared
with second quarter 2003 income from continuing operations
included:
* a one-time tax benefit of $165 million, $3.05 per diluted
share, that was recorded in second quarter 2003;
* higher corrugated packaging shipments and lower mill and
converting costs, partially offset by lower prices;
* higher pricing and shipments within forest products;
* improvements in financial services operating income,
principally due to higher spreads and lower loan loss provisions,
partially offset by lower mortgage origination activity; and
23
* charges and expenses of $7 million related to under-
performing and non-strategic assets and the consolidation of
administrative functions and early retirement of debt.
Business Segments
We manage our operations through three business segments:
* Corrugated packaging,
* Forest products, and
* Financial services.
Our operations are affected to varying degrees by supply and
demand factors and economic conditions including changes in
interest rates, new housing starts, home repair and remodeling
activities, and the strength of the U.S. dollar. Given the
commodity nature of our manufactured products, we have little
control over market pricing or market demand.
A summary of the results of operations by business segment
follows:
Second Quarter First Six Months
-------------- ----------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions)
Revenues
Corrugated packaging $ 687 $ 685 $ 1,360 $1,352
Forest products 253 192 473 372
Financial services 278 305 539 593
----- ----- ----- -----
Total revenues $ 1,218 $ 1,182 $ 2,372 $2,317
===== ===== ===== =====
Segment Operating Income
Corrugated packaging $ 26 $ 7 $ 36 $ 9
Forest products 65 15 97 8
Financial services 59 44 112 83
----- ----- ----- -----
Total segment operating
income 150 66 245 100
Unallocated expenses (19) (20) (42) (39)
Other expense (7) (23) (26) (32)
Parent company interest (34) (35) (66) (70)
----- ----- ----- -----
Income (loss) before taxes 90 (12) 111 (41)
Income tax (expense) benefit (35) 167 (43) 179
----- ----- ----- -----
Income from continuing operations 55 155 68 138
Discontinued operations 1 1 1 1
Effect of accounting change -- -- -- (1)
----- ----- ----- -----
Net income $ 56 $ 156 $ 69 $ 138
===== ===== ===== =====
Includes the effect of a reclassification of $6 million
related to first quarter 2004. The reclassification had no effect
on operating income.
As a result of the consolidation of our administrative
functions and adoption of a shared services concept, beginning
first quarter 2004, we changed the way we allocate cost to the
business segments. The effect of this change was to increase
segment operating income and to increase unallocated expenses by
a like amount. Second quarter and first six months 2003 amounts
have been reclassified to reflect this change as follows:
24
Originally As
Reported Reclassification Reclassified
-------- ---------------- ------------
(In millions)
Second Quarter 2003
Corrugated packaging $ 1 $ 6 $ 7
Forest products 12 3 15
Financial services 44 -- 44
----- ----- -----
Segment operating
income 57 9 66
Unallocated expenses (34) (9) (43)
----- ----- -----
Operating income $ 23 $ -- $ 23
===== ===== =====
First Six Months 2003
Corrugated packaging $ (3) $ 12 $ 9
Forest products 3 5 8
Financial services 83 -- 83
----- ----- -----
Segment operating
income 83 17 100
Unallocated expenses (54) (17) (71)
----- ----- -----
Operating income $ 29 $ -- $ 29
===== ===== =====
Other (income) expense for second quarter 2004 consists of a
$3 million charge associated with converting and production
facility closures, a $1 million charge related to consolidation
and supply chain initiatives, $1 million of other, and a $2
million charge related to the early retirement of debt. Of these
amounts, $4 million applies to corrugated packaging and $3
million is unallocated. Other (income) expense for second quarter
2003 consists of a $1 million charge related to a production
facility closure, a $23 million charge 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 $1 million applies to forest products, $2 million
applies to financial services, $21 million is unallocated, and
$1 million of other income applies to corrugated packaging.
Other (income) expense for first six months 2004 consists of
a $17 million charge associated with converting and production
facility closures, a $6 million charge related to consolidation
and supply chain initiatives, $1 million of other, and a $2
million premium related to the early redemption of debt. Of
these amounts, $6 million applies to corrugated packaging, $12
million to forest products, and $8 million is unallocated. Other
(income) expense for first six months 2003 consists of $7 million
associated with converting and production facility closures, a
$26 million charge related to consolidation and supply chain
initiatives, and other income of $1 million relate to the
collection of notes previously written off. Of these amounts, $5
million applies to corrugated packaging, $1 million applies to
forest products, $2 million applies to financial services and $24
million is unallocated.
Includes a one-time tax benefit of $165 million in second
quarter 2003 and first six months 2003.
Corrugated Packaging
A summary of our corrugated packaging results follows:
Second Quarter First Six Months
-------------- ----------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions)
Revenues $ 687 $ 685 $ 1,360 $ 1,352
Segment operating income 26 7 36 9
Corrugated packaging shipments continued to improve and
inventory levels continued to decline.We announced a $50 per ton
increase in the price of linerboard effective March 2004 and a
similar increase in corrugated packaging prices effective April
2004. We announced another $50 per ton increase in the price of
25
linerboard effective June 2004 and a similar increase in
corrugated packaging prices effective July 2004.
Second Quarter First Six
2004 versus Months 2004
Second Quarter versus First
2003 Six Months 2003
-------------- ---------------
Increase (Decrease)
Corrugated packaging
Average prices (3)% (4)%
Shipments per workday, tons 8% 6%
Industry shipments, average
week(msf) 4% 4%
Linerboard
Average prices 7% (1)%
Shipments, tons (52)% (32)%
Source: Fibre Box Association
Compared with first quarter 2004, average corrugated
packaging prices were up one percent and shipments per workday
were up seven percent. Compared with first quarter 2004, average
linerboard prices were up 13 percent while shipments were down 38
percent.
Linerboard sales and shipments to third parties were down
because more of our production was used in our converting
facilities.
In addition to reductions in mill and converting costs,
other factors affecting operating income include fluctuations in
the following costs and expenses:
Second Quarter First Six
2004 versus Months 2004
Second Quarter versus First
2003 Six Months 2003
-------------- ---------------
Increase (Decrease)
OCC recycled fiber $ 7 $ 25
Energy, principally natural gas (1) (3)
Depreciation (2) (4)
Pension and postretirement 1 3
Our OCC costs averaged $116 per ton during second quarter
2004 compared to $95 per ton during second quarter 2003. Our OCC
costs averaged $110 per ton during first six months 2004 compared
to $72 per ton during first six months 2003. Our OCC and energy
costs fluctuate based on the market prices we pay for these
commodities.
26
Information about our mills and converting facilities
follows:
Second Quarter First Six Months
-------------- ----------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions)
Number of converting facilities (at
quarter-end) 72 75 72 75
Mill capacity, in thousand tons 827 827 1,654 1,654
Mill production, in thousand tons 849 819 1,680 1,582
Percent mill production used
internally 92% 82% 89% 83%
Production downtime, excluding
routine maintenance, in thousand
tons -- 18 -- 64
Corrugated medium purchases from our
Premier Boxboard Limited LLC joint
venture, in thousand tons 27 47 55 73
We continue our efforts to improve return on investment.
These include reviewing operations that are unable to meet return
objectives and determining appropriate courses of action,
including possibly consolidating and closing additional
converting facilities. In conjunction with our previously
announced plans:
* We closed our Dallas, Texas converting facility in March
2004 and our Raleigh, North Carolina converting facility in April
2004. We announced that we would close one of our Louisville,
Kentucky converting facilities, our Mishawaka, Indiana converting
facility, and our Rock Hill, Tennessee sheet plant by the end of
third quarter 2004. As a result, we paid $2 million in severance
cost during second quarter 2004, and we expect to incur
additional severance and other exit costs during third quarter
2004. We also recognized asset impairments of $1 million during
second quarter 2004 and $2 million during first six months 2004
related to these closures.
* We sold certain assets used in our specialty packaging
operations and other non-strategic assets for $27 million cash
during second quarter 2004 and recognized a gain of $1 million.
As a result of the sale of the specialty packaging assets, during
second quarter 2004, we incurred $1 million in severance and
other exit costs, most of which was paid during second quarter
2004.
The accounting effects of these items are included in other
operating expense and are excluded from segment operating income.
27
Forest Products
A summary of our forest products results follows:
Second First Six
Quarter Months
------------ -------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions)
Revenues $ 253 $ 192 $ 473 $ 372
Segment operating income (loss) 65 15 97 8
Product prices and shipments continued to improve due in
part to the strong housing and remodeling markets.
Second Quarter First Six Months
2004 versus Second 2004 versus First
Quarter 2003 Six Months 2003
------------------ -----------------
Increase (Decrease)
Average Average
Prices Shipments Prices Shipments
------- --------- ------- ---------
Lumber 28% 8% 23% 14%
Particleboard 27% 16% 21% 9%
Gypsum 28% 35% 28% 20%
MDF 14% 19% 8% 3%
Compared with first quarter 2004, average prices were up 14
percent for lumber, 16 percent for particleboard, eight percent
for gypsum, and ten percent for MDF. Shipments were down one
percent for lumber, but up one percent for particleboard, 19
percent for MDF and 15 percent for gypsum. Comparisons of
shipments for MDF and particleboard are affected by the
indefinite closures of our Clarion MDF facility in third quarter
2003 and sale of this facility in second quarter 2004 and by the
indefinite closure of our Mt. Jewett particleboard facility in
second quarter 2003.
Information about our converting and manufacturing
facilities follows:
Second First Six
Quarter Months
------------ -------------
2004 2003 2004 2003
---- ---- ---- ----
Number of converting and manufacturing 18 19 18 19
facilities (at quarter-end)
Average operating rates for all
product lines:
High 102% 80% 91% 77%
Low 61% 59% 59% 62%
Average operating rates include the effects of the
indefinite closure of our Clarion MDF facility in third quarter
2003 and sale of this facility in second quarter 2004 and by the
indefinite closure of our Mt. Jewett particleboard facility in
second quarter 2003. Excluding these effects, the average
operating rates for all product lines during the second quarter
2004 would range from a high of 102 percent to a low of 88
28
percent and during first six months 2004 would range from a high
of 96 percent to a low of 82 percent.
Information regarding sales of our high value land follows:
Second Quarter First Six Months
-------------- ----------------
2004 2003 2004 2003
---- ---- ---- ----
Acres sold 912 1,050 1,342 1,303
Profit included in segment
operating income (in
millions) $ 6 $ 5 $ 9 $ 6
We continue our efforts to enhance return on investment.
These include reviewing operations, including our MDF facilities,
that are unable to meet return objectives and determining
appropriate courses of action. During second quarter 2004, we
sold our Clarion MDF facility and recognized a gain on
disposition of less than $1 million and incurred an insignificant
amount of severance and related exit costs most of which was paid
during second quarter 2004. During first quarter 2004, we
recognized an asset impairment of $12 million related to this
facility. The accounting effect of this item is included in
other operating expense and is excluded from segment operating
income.
Financial Services
A summary of our financial services results follows:
Second Quarter First Six Months
-------------- ----------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions)
Net interest income $ 99 $ 94 $ 199 $ 189
Segment operating income 59 44 112 83
Income continued to improve due in part to our
asset/liability position and lower loan loss provisions as a
result of asset allocations and general improvements in credit
quality. Since second quarter 2003, we have changed our asset
portfolio, primarily by increasing our residential housing loans,
which have fixed interest rates for the first three to five years
and adjustable rates thereafter. We have also changed our
deposit base by increasing demand deposits and money market
accounts and decreasing certificates of deposit. Given this
current position, if interest rates remain relatively stable, it
is likely that our net interest income will remain near its
current level. However, if interest rates change significantly,
it is likely that our net interest income will decline.
29
Information concerning our interest rate spread follows:
Second Quarter First Six Months
----------------------------------- --------------------------------
2004 2003 2004 2003
--------------- ---------------- --------------- ----------------
Average Yield/ Average Yield/ Average Yield/ Average Yield/
Balance Rate Balance Rate Balance Rate Balance Rate
------- ------ ------- ------ ------- ------ ------- ------
(Dollars in millions)
Earning assets $16,201 4.32% $16,996 4.39% $16,212 4.33% $16,921 4.49%
Interest-bearing
liabilities 15,451 1.97% 15,703 2.36% 15,294 1.99% 15,624 2.44%
---- ---- ---- ----
Interest rate spread 2.35% 2.03% 2.34% 2.05%
The following tables summarize the composition of earning
assets and deposits:
Second Quarter-End
------------------
2004 2003
---- ----
(Dollars in millions)
Residential housing assets (loans and securities) $ 12,962 $ 13,269
Other earning assets 2,964 3,515
------ ------
Total earning assets $ 15,926 $ 16,784
====== ======
Residential housing assets as a percentage of
total earning assets 81% 79%
Demand deposit and savings accounts $ 5,185 $ 4,422
Certificates of deposit 3,628 4,713
------ ------
Total deposits $ 8,813 $ 9,135
====== ======
The decrease in our earning assets was due primarily to a
decrease in mortgage loans held for sale and mortgage warehouse
loans, as higher mortgage rates resulted in a reduction in the
volume of mortgages being refinanced. It is likely that our
earning assets will continue to decrease during 2004.
Other factors affecting operating income include
fluctuations in the following noninterest income and expenses:
Second Quarter First Six Months
2004 versus Second 2004 versus First
Quarter 2003 Six Months 2003
------------------ -----------------
Increase (Decrease)
(In millions)
Noninterest income:
Loan origination and sale of loans $ (42) $ (71)
Servicing rights amortization and
impairment (17) (28)
The decrease in loan origination and sale of loans was due
to the decline in mortgage loan origination activity as
refinancing activity slowed considerably. The decrease in
servicing rights amortization and impairment was due to the
decrease in prepayments. The mortgage servicing impairment
30
valuation allowance was reduced by $3 million in second quarter
2004 and first six months 2004 compared with increases of $5
million in second quarter 2003 and $7 million in first six months
2003. As mortgage interest rates rise, mortgage loan origination
activity and servicing rights amortization and impairment
generally decline and as mortgage interest rates decline,
mortgage loan origination activity and servicing rights
amortization and impairment generally increase.
Information regarding mortgage loan origination activity
follows:
Second Quarter First Six Months
-------------- ----------------
2004 2003 2004 2003
---- ---- ---- ----
(Dollars in millions)
Loans originated for sale to third
parties $ 1,697 $ 3,794 $ 2,954 $ 6,420
Value of mortgage servicing rights
retained $ 11 $ 13 $ 15 $ 19
Factors affecting noninterest expense follow:
Second Quarter First Six Months
2004 versus Second 2004 versus First
Quarter 2003 Six Months 2003
------------------ -----------------
Increase (Decrease)
(In millions)
Noninterest expense:
Compensation and benefits $ (17) $ (30)
Real estate operations 4 5
A significant portion of our compensation cost is directly
related to our mortgage loan origination volume. In second
quarter and first six months 2004, compensation costs declined in
conjunction with the decline in mortgage loan origination volume.
A portion of our mortgage loan origination-related costs is
directly variable with origination volume. However, other
mortgage loan origination-related operating costs are fixed or
only partially variable.
Information regarding the mortgage loans we service for
others and our mortgage servicing rights follows:
31
Second Quarter First Six Months
-------------- ----------------
2004 2003 2004 2003
---- ---- ---- ----
(Dollars in millions)
Outstanding balance of loans $ 8,128 $ 7,722 $8,128 $ 7,722
serviced for third parties (at
quarter-end)
Annualized prepayment rate 38% 53% 33% 47%
Carrying amount of mortgage
servicing rights as a percent of
balance serviced (at quarter-end) 1.11% 1.05% 1.11% 1.05%
We recently announced plans to reposition our mortgage
origination activities, which will reduce costs and our exposure
to changing market conditions, including a slow-down in refinance
activity. While we will still originate mortgage loans for our
own portfolio and, to a lesser extent, for sale to others, we
intend to limit our product offerings and reposition our retail
origination activities. We will continue to originate loans
through broker and correspondent networks and in certain other
retail channels, including the retail branches of Guaranty Bank.
However, we will likely sell or close many of our retail
origination outlets that are not located in bank branches. We
expect this repositioning will be substantially completed by year-
end 2004. As a result, it is likely that we will recognize during
third and fourth quarter 2004, asset impairments and incur
severance and other exit costs that could be significant. It is
also likely that mortgage loans held for sale, which is included
in earning assets, will decline significantly and that our loan-
servicing portfolio will decline as we reduce loans serviced for
others. On an ongoing basis, these actions are not expected to
have a significant effect on our earnings.
Asset Quality and Allowance for Loan Losses
The following table summarizes various asset quality
measures:
32
Second Quarter-
End Year-End
2004 2003 2003
---- ---- ----
(Dollars in millions)
Non-performing loans $ 72 $ 79 $ 65
Restructured operating lease assets 38 42 40
Foreclosed real estate 25 12 26
----- ----- -----
Non-performing assets $ 135 $ 133 $ 131
===== ===== =====
Non-performing loans as a percentage of
total loans 0.76% 0.81% 0.71%
Non-performing assets ratio 1.41% 1.37% 1.42%
Allowance for loan losses as a percent of:
Non-performing loans 139% 149% 172%
Total loans 1.05% 1.21% 1.22%
In second quarter 2004, we foreclosed on a $33 million
commercial real estate loan and sold the office complex mortgaged
as collateral. Currently, we have contracts to sell two of our
foreclosed real estate assets for an amount approximating their
$19 million carrying value.
The following table summarizes changes in the allowance for
loan losses:
Second Quarter First Six Months
-------------- ----------------
2004 2003 2004 2003
---- ---- ---- ----
(Dollars in millions)
Balance at beginning of period $ 113 $ 122 $ 111 $ 132
Net charge-offs (9) (25) (7) (46)
Provision (credit) for loan
losses (4) 20 (4) 31
---- ---- ---- ----
Balance at end of period $ 100 $ 117 $ 100 $ 117
==== ==== ==== ====
Net charge-offs as a percentage
of average loans outstanding 0.35% 1.00% 0.13% 0.93%
Second quarter 2004 and first six months 2004 provision for
loan loss was a credit to earnings due to the general improvement
in overall loan quality. While several loans required additional
loan loss reserves, these were more than offset by principal
repayments on loans for which we had previously provided loan
loss reserves and recoveries of previously charged-off loans.
Second quarter and first six months 2004 charge-offs relate to
the foreclosure previously discussed and other loans offset by
$3 million in recoveries of previously charged-off asset-based
loans. Second quarter and first six months 2003 charge-offs and
loan loss provisions were principally related to asset-base
loans.
Unallocated Expenses, Other (Income) Expense and Interest
The change in unallocated expenses in first six months 2004
was principally due to an increase in stock based compensation.
33
Other operating (income) expense items are not allocated to
business segments. In addition to the items previously discussed
within the segments, the remainder of unallocated other operating
(income) expense includes expenses related to initiatives to
consolidate administrative functions and effect improvements in
supply chain management of $1 million in second quarter 2004 and
$21 million in second quarter 2003 and $6 million in first six
months 2004 and $24 million in first six months 2003. During
second quarter 2004, we revised our estimates of relocation
expense and reduced our accrual for these expenses by $2 million.
The change in parent company interest expense in second
quarter and first six months 2004 was due to a reduction in long-
term debt.
Other expense consists of a charge related to our early
retirement of debt.
Income Taxes
Our effective tax rate was 39 percent in second quarter 2004
and first six months 2004, the likely effective tax rate for the
year 2004. Excluding the one-time tax benefit discussed below,
our effective tax benefit was 17 percent in second quarter 2003
and 34 percent in first six months 2003. Differences between the
effective tax rate and the statutory rate are due to state income
taxes, nondeductible items, foreign operating losses, and other
items for which no financial benefit is recognized until
realized.
During second quarter 2003, the Internal Revenue Service
concluded its examination of our tax returns through 1996,
including matters related to net operating losses and minimum tax
credit carryforwards, which resulted from certain deductions
following our 1988 acquisition of Guaranty Bank and for which no
financial accounting benefit had been recognized. Also, we
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 were no longer required.
Accordingly, during second quarter 2003, we recorded a one-time
benefit of $165 million, or $3.05 per diluted share. Of this one-
time benefit, approximately $26 million represents cash refunds
of previously paid taxes plus related interest. The remainder was
a non-cash benefit.
Average Shares Outstanding
The change in average shares outstanding in second quarter
2004 and first six months 2004 was principally due to employee
exercises of stock options.
34
Capital Resources and Liquidity for the First Six Months 2004
Substantially all of our consolidated net assets invested in
financial services are subject to regulatory rules and
regulations including restrictions on the ability of financial
services to pay dividends to the parent company. Accordingly,
the parent company and the financial services capital resources
and liquidity are discussed separately.
Parent Company
Operating Activities
Cash provided by operations was $163 million in first six
months 2004 and $142 million in first six months 2003.
Depreciation and other non-cash charges and credits were $174
million in first six months 2004 and $26 million in first six
months 2003. Dividends received from financial services were $70
million in first six months 2004 and first six months 2003.
Our working capital needs increased $88 million in first six
months 2004 and $42 million in first six months 2003. The change
was principally due to an increase in receivables. Working
capital is always subject to the timing of payments on payables
and collections on receivables.
Investing Activities
Our investing activities used $6 million in first six months
2004 and $33 million in first six months 2003. Capital
expenditures were $64 million in first six months 2004, 58
percent of depreciation, and $58 million in first six months
2003, 49 percent of depreciation. Cash proceeds from sales of
non-strategic assets were $61 million in first six months 2004
and $30 million in first six months 2003.
We made no capital contributions to financial services in
first six months 2004 or first six months 2003.
Financing Activities
Our financing activities used $110 million in first six
months 2004 and $109 million in first six months 2003. Debt was
reduced by $55 million in first six months 2004. In June 2004,
we redeemed all of the outstanding 9.38% to 9.88% senior
subordinated and senior notes issued by Gaylord Container
Corporation. The principal amount held by third parties was $44
million and the redemption premium was $2 million. Also during
second quarter 2004, we paid $64 million of other long-term
liabilities, principally timber rights purchase obligations. We
issued 938,529 shares of our common stock to employees exercising
options having an aggregate exercise price of $49 million.
35
We paid cash dividends to our shareholders of $40 million,
or $0.36 per share, in first six months 2004 and $37 million, or
$0.34 per share, in first six months 2003.
Liquidity
Our sources of short-term funding are our operating cash
flows, which include dividends received from financial services,
and borrowings under our existing credit arrangements and
accounts receivable securitization program. We operate in
cyclical industries, and our operating cash flows vary
accordingly. The dividends we receive from financial services
are dependent on its level of earnings and capital needs and are
subject to regulatory approval and restrictions.
At second quarter-end 2004, we had cash and short-term
investments of $67 million. Also, we had $562 million in unused
borrowing capacity under our credit agreements and $249 million
under our accounts receivable securitization program, which
matures in May 2007. At second quarter-end 2004, we complied
with all the terms and conditions of our credit agreements and of
our accounts receivable securitization program.
During third quarter 2004, $100 million of 7.25% notes will
be due and will be repaid by draws under our existing credit
agreements or our accounts receivable securitization program or
with available cash.
As we did during second quarter 2004, from time to time we
may continue to refinance existing debt obligations or use
available cash flow to retire existing debt obligations before
they come due.
Financial Services
Operating Activities
Cash provided by operations was $90 million in first six
months 2004 and $176 million in first six months 2003. The
change was principally because we originated more loans held for
sale than we sold during first six months 2004. Changes in
loans held for sale are always subject to the timing of loan
originations and loan sales.
Investing Activities
Our investing activities used $8 million in first six months
2004 and provided $127 million in first six months 2003. The
change was principally because we received less principal
payments on mortgage-backed securities as mortgage prepayments
decreased in 2004.
36
Financing Activities
Our financing activities used $108 million in first six
months 2004 and used $400 million in first six months 2003. The
change was principally because we repaid fewer borrowings.
In first six months 2004 and 2003, financial services paid
$70 million in dividends to the parent company.
Liquidity
Our sources of short-term funding are our operating cash
flows, new deposits, borrowings under our existing agreements
and, if necessary, sales of assets. Assets that can be readily
converted to cash or against which we can readily borrow include
short-term investments, loans, mortgage loans held for sale, and
securities. At second quarter-end 2004, we had available
liquidity of $2.3 billion.
Off-Balance Sheet Arrangements
We enter into commitments to extend credit for loans,
leases, and letters of credit in the normal course of our
business. We generally require collateral upon funding of these
commitments and they carry substantially the same risk as loans.
These commitments normally include provisions allowing us to exit
the commitment under certain circumstances. At second quarter-
end 2004, our unfunded commitments consist of:
(In millions)
Single-family mortgage loans $ 740
Other loans 5,042
Letters of credit 356
------
Total $ 6,138
======
Regulatory Matters
At second quarter-end 2004, Guaranty met or exceeded all
applicable regulatory capital requirements. We expect to
maintain Guaranty's capital at a level that exceeds the minimum
required for designation as "well capitalized" under the capital
adequacy regulations of the Office of Thrift Supervision (OTS).
From time to time, we may make capital contributions to or
receive dividends from Guaranty.
Selected financial and regulatory capital data for Guaranty
and its consolidated mortgage banking and insurance subsidiaries
follow:
37
Second
Quarter-End Year-End
2004 2003
----------- --------
(In millions)
Balance sheet data:
Total assets $ 16,644 $ 17,247
Total deposits 8,813 8,698
Shareholder's equity 998 999
For
Categorization
Regulatory as "Well
Actual Minimum Capitalized"
------ ---------- --------------
Regulatory capital ratios:
Tangible capital 6.57% 2.00% N/A
Leverage capital 6.57% 4.00% 5.00%
Risk-based capital 10.98% 8.00% 10.00%
An internal investigation, which is still ongoing, has
revealed that our mortgage origination operation failed to file
certain regulatory reports on a timely basis and may have
violated applicable laws or regulations. We have taken a number
of actions as a result of this investigation, including improving
compliance controls in the mortgage origination process. We
reported these events to the OTS, including the results of our
internal investigation and our remediation activities to date.
The OTS is authorized to pursue supervisory actions, including
the assessment of monetary penalties, to correct violations of
certain regulations. We do not expect that monetary penalties or
corrective actions, if any, imposed as a result of these
circumstances will have a material impact on our financial
position or results of operations.
We have not incurred any material financial loss as a result
of this matter and have no reason to believe that our
investigation, when completed, will result in any material loss.
Pension and Postretirement Matters
The Medicare Prescription Drug, Improvement and
Modernization Act of 2003 was enacted in December 2003. This act
expands Medicare to include, for the first time, coverage for
prescription drugs. Our postretirement benefit plans provide for
medical coverage, including a prescription drug subsidy, for
certain participants. Due to the absence of detailed guidance
necessary to implement the act, we are unable to precisely
determine its effects on our postretirement benefit plans.
However, based on our current understanding and analysis, it is
likely that the effects will not significantly reduce our cost
for these plans. In second quarter 2004, we adopted FASB Staff
Position, No. 106-2, Accounting and Disclosure Requirements
Related to the Medicare Prescription Drug, Improvement and
Modernization Act of 2003. This staff position permits us to
defer recognizing the effects of the act when we conclude they
are not significant until our next annual plan measurement date,
September 2004. At that time the effects will be considered and
38
will likely reduce our net periodic benefit cost in 2005 and
beyond but not by a significant amount.
Energy and the Effects of Inflation
Energy costs were $141 million in first six months 2004
compared with $145 million in first six months 2003. Our energy
costs fluctuate based on the market prices we pay for these
commodities and on the amount and mix of the types of fuel we may
use. We hedge very little of our energy needs. It is likely
that these costs will continue to fluctuate during 2004.
Accounting Policies
Critical Accounting Estimates
In second quarter 2004, there were no significant changes in
our critical accounting estimates from those we identified in our
Form 10-K for the year 2003.
New Accounting Pronouncements Adopted
In second quarter 2004, we adopted FASB Staff Position, No.
106-2, Accounting and Disclosure Requirements Related to the
Medicare Prescription Drug, Improvement and Modernization Act of
2003. This staff position provides guidance on accounting for the
effects of this act on post retirement benefit plans that provide
prescription drug benefits.
In first quarter 2004, we were required to adopt the
following accounting pronouncements:
* FASB Interpretation No. 46 (revised December 2003),
Consolidation of Variable Interest Entities an interpretation
of ARB No. 51. This interpretation provides guidance for
determining whether an entity is a variable interest entity
and which beneficiary of the variable interest entity, if any,
should consolidate the variable interest entity (the primary
beneficiary).
* Securities and Exchange Commission Staff Accounting Bulletin
No.105, Application of Accounting Principles to Loan Commitments.
This bulletin applies to loan commitments issued after March 2004
and accounted for as derivative instruments and it precludes the
recognition of an asset at the inception of the loan commitment.
The effect of adopting these pronouncements was not significant.
Litigation and Related Matters
We are involved in various legal proceedings that arise from
time to time in the ordinary course of business. We believe that
the possibility of a material liability from any of these
proceedings is remote, and we do not believe that the outcome of
39
any of these proceedings should have a material adverse effect on
our financial position, results of operations, or cash flow.
Since we filed our Quarterly Report on Form 10-Q for the
period ended April 3, 2004, there have been no material
developments in pending legal proceedings, except as set forth in
Part II, Item 1 hereof.
STATISTICAL AND OTHER DATA
Parent Company
The following table presents revenues and unit sales for our
manufacturing segments:
Second Quarter First Six Months
-------------- ----------------
2004 2003 2004 2003
---- ---- ---- ----
(Dollars in millions)
Revenues
Corrugated Packaging
Corrugated packaging $ 661 $ 635 $ 1,298 $ 1,260
Linerboard 26 50 62 92
----- ----- ------ ------
Total $ 687 $ 685 $ 1,360 $ 1,352
===== ===== ====== ======
Forest Products
Pine lumber $ 89 $ 64 $ 168 $ 120
Particleboard 51 36 95 75
Medium density fiberboard 31 23 56 49
Gypsum wallboard 28 16 51 34
Fiberboard 22 17 39 31
Other 32 36 64 63
----- ----- ------ ------
Total $ 253 192 473 372
===== ===== ====== ======
Unit sales
Corrugated Packaging
Corrugated packaging, thousands
of tons 874 809 1,715 1,589
Linerboard, thousands of tons 70 147 182 271
----- ----- ------ ------
Total, thousands of tons 944 956 1,897 1,860
===== ===== ====== ======
Forest Products
Pine lumber, mbf 234 216 470 414
Particleboard, msf 162 140 322 295
Medium density fiberboard, msf 68 57 125 121
Gypsum wallboard, msf 197 146 368 307
Fiberboard, msf 113 102 210 189
Revenues and unit sales do not include joint venture
operations.
40
The following table summarizes the composition of our
loan portfolio:
Second Quarter-
End Year-End
2004 2003 2003
---- ---- ----
(In millions)
Single-family mortgage $ 3,497 $ 2,892 $ 3,255
Single-family mortgage warehouse 375 502 387
Single-family construction 1,128 1,065 889
Multifamily and senior housing 1,730 1,865 1,769
------ ------ ------
Total residential housing 6,730 6,324 6,300
Commercial real estate 826 1,393 1,015
Commercial and business 653 623 585
Energy lending 640 634 562
Asset-based lending and leasing 472 555 499
Consumer and other 193 182 176
------ ------ ------
Total loans 9,514 9,711 9,137
Less allowance for loan losses (100) (117) (111)
------ ------ ------
Loans receivable, net $ 9,414 $ 9,594 $ 9,026
====== ====== ======
41
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
Interest Rate Risk
Our current level of interest rate risk is primarily due to
the lending and funding activities of our financial services
segment. The following table illustrates the estimated effect
on our pre-tax income of immediate, parallel and sustained
shifts in interest rates for the next 12-months at second
quarter-end 2004, with comparative year-end 2003 information.
This estimate considers the effect of changing prepayment
speeds, repricing characteristics and average balances over the
next 12 months.
Increase (Decrease) in Income Before Taxes
------------------------------------------
Second Quarter-End 2004 Year-End 2003
----------------------- -----------------
Parent Financial Parent Financial
Company Services Company Services
------- --------- ------- ---------
(In millions)
Change in
Interest Rates
--------------
+2% $ 1 $ (8) $ (2) $ 8
+1% -- 11 (1) 28
-1% -- (29) 1 (20)
We did not present a two percent interest rate decrease
because of the current low interest rate environment. The
analysis assumes that debt reductions from contractual payments
will be replaced with short-term variable rate debt; however,
that may not be the financing alternative we choose to follow.
Our parent company's interest rate risk is related to our
long-term debt and our interest rate swap. Since our parent
company debt is primarily fixed rate, interest rate changes are
not expected to significantly affect earnings. However,
interest rate changes will affect the value of the interest rate
swap.
Our financial services segment is subject to interest rate
risk to the extent interest-earning assets and interest-bearing
liabilities repay or reprice at different times or in differing
amounts or both. Our financial services segment's interest rate
sensitivity has changed from year-end 2003, due principally to
increases in market interest rates that have occurred since
then. The rise in interest rates has resulted in an improved
spread relationship between the yields on our earning assets and
costs of funding sources, principally because our projected
mortgage yields are benefiting from slower prepayments and our
deposit rates have lagged the increase in market rates. We
believe a further modest increase in interest rates would result
in improved income, but to a lesser extent than in the past.
However, we expect that would not be the case if interest rates
increase significantly because we believe our deposit rates
would become more responsive to changes in rates.
42
The table above does not reflect the effect of changes in
interest rates on the fair value of our mortgage servicing
rights (estimated at $100 million at second quarter-end 2004).
We estimate a one percent decline in long-term fixed mortgage
rates from current levels would decrease the fair value of the
mortgage servicing rights by $21 million.
Foreign Currency Risk
In second quarter 2004, there were no significant changes
in foreign currency risk from that disclosed in our Annual
Report on Form 10-K for the year 2003.
Commodity Price Risk
In second quarter 2004, there were no significant changes
in commodity price risk from that disclosed in our Annual Report
on Form 10-K for the year 2003.
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 the 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, is recorded, processed, summarized, and
reported within the time periods specified in the Securities and
Exchange Commission's 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 G of the Notes to
Consolidated Financial Statements in Part I of this report is
incorporated by reference thereto.
Since we filed our Quarterly Report on Form 10-Q for the
period ended April 3, 2004, there have been no material
43
developments in pending legal proceedings, except as set forth
below:
As previously reported, on December 9, 2003, Gaylord and its
wholly-owned subsidiary, Gaylord Chemical Corporation, agreed in
principle to settle all claims, including claims for compensatory
and punitive damages, arising from an explosion of a rail tank
car in 1995. In exchange for payments by certain insurance
carriers and assignment of our insurance coverage rights against
the non-settling carriers, Gaylord and Gaylord Chemical received
full releases and/or dismissals of all claims for damages,
including punitive damages. Neither Gaylord nor Gaylord Chemical
contributed to the settlement. The settlement was subject to a
fairness hearing and final court approval. The fairness hearing
was held on August 6, 2004, at which time the court gave its
final approval of the settlement.
As reported in our Annual Report on Form 10-K for the period
ended January 3, 2004, in October 2003, Inland was served with an
Administrative Complaint filed by the U. S. Environmental
Protection Agency under the Clean Water Act alleging that our box
plant in Crawfordsville, Indiana exceeded its permit limits for
suspended solids and biochemical oxygen demand. In addition, the
Complaint alleged the plant failed to make timely reports of its
sampling results and failed to follow proper sampling protocol at
various times between 1999 and 2002. The permit exceedences were
acknowledged by the City of Crawfordsville at the time, and the
City imposed a surcharge, which was paid by the plant. Inland
has successfully negotiated a settlement of this matter with the
EPA, pursuant to which Inland will pay an agreed fine of $65,000.
Item 2. Changes in Securities, Use of Proceeds and Issuer
Purchases of Equity Securities.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
The Company held its annual meeting of stockholders on
May 7, 2004, at which a quorum was present. The table below sets
forth the number of votes cast for, against or withheld, as well
as the number of abstentions and broker non-votes for each matter
voted upon at that meeting.
44
Against Abstentions
or and Broker
Matter For Withheld Non-votes
------ ---------- --------- -----------
1. Election of five directors
(a) Donald M. Carlton 49,085,308 1,017,303 --
(b) E. Linn Draper, Jr. 49,424,206 678,405 --
(c) Jeffrey M. Heller 49,428,298 674,313 --
(d) Kenneth M. Jastrow, II 49,027,956 1,074,655 --
(e) James A. Johnston 49,334,254 768,357 --
2. Ratification of appointment
of Ernst & Young LLP. 49,231,721 595,806 275,084
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
10.1 - Change in Control Agreement dated May 7, 2004,
between the Company and Doyle R. Simons.
10.2 - Change in Control Agreement dated May 7, 2004,
between the Company and J. Patrick Maley, III.
10.3 - Change in Control Agreement dated May 7, 2004,
between the Company and J. Bradley Johnston.
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 July 3, 2004, the Company
filed the following Current Reports on Form 8-K:
1. Current Report on Form 8-K dated April 26, 2004, reporting
under Items 9 and 12 a press release issued by the Company
announcing earnings for the period ended April 3, 2004.
2. Current Report on Form 8-K dated April 27, 2004, reporting
under Item 9 presentation materials of Kenneth M. Jastrow, II,
Chief Executive Officer of Temple-Inland Inc., used in Mr.
Jastrow's conference call on April 27, 2004, discussing the
Company's earnings for the quarter ended April 3, 2004.
45
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
TEMPLE-INLAND INC.
(Registrant)
Dated: August 12, 2004 By /s/ Louis R. Brill
---------------------------
Louis R. Brill
Chief Accounting Officer
46
INDEX TO EXHIBITS
Exhibit No. Description Page No.
10.1 Change in Control Agreement dated 47
May 7, 2004, between the Company
and Doyle R. Simons
10.2 Change in Control Agreement dated 72
May 7, 2004, between the Company
and J. Patrick Maley, III
10.3 Change in Control Agreement dated 97
May 7, 2004, between the Company
and J. Bradley Johnston
31.1 Certification of Chief Executive 122
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 124
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 126
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 127
Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-
Oxley Act of 2002