10-Q 1 tin2nd01q.txt TIN FORM 10-Q FOR THE PERIOD ENDED 06/30/2001 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [x] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Quarterly Period Ended June 30, 2001 OR [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Transaction Period From to Commission File Number 001-08634 Temple-Inland Inc. (Exact name or registrant as specified in its charter) Delaware 75-1903917 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 1300 South MoPac Expressway, Austin, Texas 78746 (Address of principal executive offices) (Zip Code) (512) 434-8000 (Registrant's telephone number, including area code) Not Applicable (Former name, former address and former fiscal year, if changed since last report.) Indicate whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for the past 90 days. Yes X No Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: Number of common shares outstanding Class as of June 30, 2001 ----- ------------------- Common Stock (par value $1.00 per share) 49,266,384 Page 1 of 42 pages The Exhibit Index appears on page 32 of this report. 2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS SUMMARIZED STATEMENTS OF INCOME PARENT COMPANY (TEMPLE-INLAND INC.) Unaudited Second Quarter First Six Months 2001 2000 2001 2000 (in millions) NET REVENUES $ 719 $ 757 $ 1,400 $ 1,515 COSTS AND EXPENSES Cost of sales 623 612 1,235 1,221 Selling and administrative 68 66 133 134 ----- ----- ----- ----- 691 678 1,368 1,355 ----- ----- ----- ----- 28 79 32 160 FINANCIAL SERVICES EARNINGS 46 48 91 83 ----- ----- ----- ----- OPERATING INCOME 74 127 123 243 Interest expense (25) (27) (53) (52) ----- ----- ----- ----- INCOME BEFORE TAXES 49 100 70 191 Income taxes (20) (38) (29) (74) ----- ----- ----- ----- INCOME BEFORE ACCOUNTING CHANGE 29 62 41 117 Effect of accounting change - - (2) - ----- ----- ----- ----- NET INCOME $ 29 $ 62 $ 39 $ 117 ===== ===== ===== ===== See notes to consolidated financial statements. 3 SUMMARIZED BALANCE SHEETS PARENT COMPANY (TEMPLE-INLAND INC.) Unaudited Second Quarter End Year End 2001 2000 (in millions) ASSETS Current Assets Cash $ 1 $ 2 Receivables, net of allowances of $11 in 2001 and $10 in 2000 416 320 Inventories: Work in process and finished goods 64 61 Raw materials 201 192 ----- ----- 265 253 Prepaid expenses 24 25 ----- ----- Total current assets 706 600 Investment in Temple-Inland Financial Services 1,157 1,093 Property and Equipment Property and Equipment 3,511 3,346 Less allowances for depreciation (1,891) (1,822) ------ ------ 1,620 1,524 Timber and timberlands, net of depletion 493 503 ------ ------ Total property and equipment 2,113 2,027 Other Assets 267 227 ------ ------ Total Assets $ 4,243 $ 3,947 ====== ====== LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities Accounts payable $ 135 $ 112 Other current liabilities 205 191 ------ ------ Total current liabilities 340 303 Long-Term Debt 1,593 1,381 Other Long-Term Liabilities 457 430 Shareholders' Equity 1,853 1,833 ------ ------ Total Liabilities and Shareholders' Equity $ 4,243 $ 3,947 ====== ====== See notes to consolidated financial statements. 4 SUMMARIZED STATEMENTS OF CASH FLOW PARENT COMPANY (TEMPLE-INLAND INC.) Unaudited First Six Months 2001 2000 (in millions) CASH PROVIDED BY (USED FOR) OPERATIONS Net income $ 39 $ 117 Adjustments: Depreciation and depletion 90 100 Unremitted earnings from financial services (84) (64) Dividends from financial services 30 30 Working capital changes (35) (82) Cumulative effect of accounting change 2 - Other 27 46 ----- ----- 69 147 ----- ----- CASH PROVIDED BY (USED FOR) INVESTMENTS Capital expenditures for property and equipment (109) (102) Acquisitions, net of cash acquired (134) - Capital contributions to financial services - (10) Other ( 7) (6) ----- ----- (250) (118) ----- ----- CASH PROVIDED BY (USED FOR) FINANCING Additions to debt 412 126 Payments of debt (201) - Purchase of stock for treasury - (172) Cash dividends paid to shareholders (32) (34) Other 1 2 ----- ----- 180 (78) ----- ----- Net decrease in cash (1) (49) Cash at beginning of period 2 51 ----- ----- Cash at end of period $ 1 $ 2 ===== ===== See notes to consolidated financial statements. 5 SUMMARIZED STATEMENTS OF INCOME FINANCIAL SERVICES GROUP Unaudited Second Quarter First Six Months 2001 2000 2001 2000 (in millions) INTEREST INCOME Loans $ 213 $ 213 $ 446 $ 415 Securities and other 49 57 106 102 ---- ---- ---- ---- Total interest income 262 270 552 517 INTEREST EXPENSE Deposits 105 120 229 229 Borrowed funds 49 52 108 100 ---- ---- ---- ---- Total interest expense 154 172 337 329 NET INTEREST INCOME 108 98 215 188 Provision for loan losses (14) (10) (31) (25) ---- ---- ---- ---- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 94 88 184 163 NONINTEREST INCOME 81 73 163 135 NONINTEREST EXPENSE Compensation and benefits 53 41 102 80 Other 71 67 143 126 ---- ---- ---- ---- Total noninterest expense 124 108 245 206 INCOME BEFORE MINORITY INTEREST AND TAXES 51 53 102 92 Minority interest in income of consolidated subsidiaries (5) (5) (11) (9) ---- ---- ---- ---- INCOME BEFORE TAXES 46 48 91 83 Income taxes (4) (12) (7) (19) ---- ---- ---- ---- INCOME BEFORE ACCOUNTING CHANGE 42 36 84 64 Effect of accounting change - - (1) - ---- ---- ---- ---- NET INCOME $ 42 $ 36 $ 83 $ 64 ==== ==== ==== ==== See notes to consolidated financial statements. 6 SUMMARIZED BALANCE SHEETS FINANCIAL SERVICES GROUP Unaudited Second Quarter End Year End 2001 2000 (in millions) ASSETS Cash and cash equivalents $ 249 $ 320 Mortgage loans held for sale 493 232 Loans and leases receivable, net of allowance for losses of $135 in 2001 and $118 in 2000 10,306 10,411 Securities available-for-sale 3,080 2,415 Securities held-to-maturity - 864 Other assets 1,010 1,082 ------ ------ TOTAL ASSETS $ 15,138 $ 15,324 ====== ====== LIABILITIES Deposits $ 8,866 $ 9,828 Securities sold under repurchase agreements 505 595 Federal Home Loan Bank advances 3,437 2,869 Other borrowings 218 210 Other liabilities 649 423 Stock issued by subsidiaries 306 306 ------ ------ TOTAL LIABILITIES 13,981 14,231 SHAREHOLDERS' EQUITY 1,157 1,093 ------ ------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 15,138 $ 15,324 ====== ====== See notes to consolidated financial statements. 7 SUMMARIZED STATEMENTS OF CASH FLOWS FINANCIAL SERVICES GROUP Unaudited First Six Months 2001 2000 (in millions) CASH PROVIDED BY (USED FOR) OPERATIONS Net income $ 83 $ 64 Adjustments: Provision for loan losses 31 25 Amortization, depreciation and accretion 35 29 Mortgage loans held for sale (261) 78 Collections and remittances on loans serviced for others, net 196 (11) Cumulative effect of accounting change 1 - Other (15) 36 ----- ----- 70 221 ----- ----- CASH PROVIDED BY (USED FOR) INVESTMENTS Maturities of securities 386 255 Purchases of securities (46) (769) Loans originated or acquired, net of principal collected (443) (764) Sales of loans 390 135 Proceeds from sale of servicing rights 45 - Capital expenditures for property and equipment (13) (18) Acquisitions, net of cash acquired - (19) Other 29 12 ----- ----- 348 (1,168) ----- ----- CASH PROVIDED BY (USED FOR) FINANCING Net increase (decrease) in deposits (929) 575 Securities sold under repurchase agreements and short-term borrowings, net 483 580 Additions to debt 23 17 Payments of debt (19) (137) Capital contributions from Parent Company - 10 Dividends paid to Parent Company (30) (30) Other (17) 16 ----- ----- (489) 1,031 ----- ----- Net increase (decrease) in cash and cash equivalents (71) 84 Cash and cash equivalents at beginning of period 320 233 ----- ----- Cash and cash equivalents at end of period $ 249 $ 317 ===== ===== See notes to consolidated financial statements. 8 CONSOLIDATED STATEMENTS OF INCOME TEMPLE-INLAND INC. AND SUBSIDIARIES Unaudited Second Quarter First Six Months 2001 2000 2001 2000 (in millions) REVENUES Manufacturing $ 719 $ 757 $ 1,400 $ 1,515 Financial services 343 343 715 652 ----- ----- ----- ----- 1,062 1,100 2,115 2,167 COSTS AND EXPENSES Manufacturing 691 678 1,368 1,355 Financial services 297 295 624 569 ----- ----- ----- ----- 988 973 1,992 1,924 ----- ----- ----- ----- OPERATING INCOME 74 127 123 243 Parent company interest (25) (27) (53) (52) ----- ----- ----- ----- INCOME BEFORE TAXES 49 100 70 191 Income taxes (20) (38) (29) (74) ----- ----- ----- ----- INCOME BEFORE ACCOUNTING CHANGE 29 62 41 117 Effect of accounting change - - (2) - ----- ----- ----- ----- NET INCOME $ 29 $ 62 $ 39 $ 117 ===== ===== ===== ===== EARNINGS PER SHARE Basic: Income before accounting change $ 0.58 $ 1.20 $ 0.82 $ 2.24 Effect of accounting change - - (0.04) - ----- ----- ----- ----- Net income $ 0.58 $ 1.20 $ 0.78 $ 2.24 ===== ===== ===== ===== Diluted: Income before accounting change $ 0.58 $ 1.20 $ 0.82 $ 2.24 Effect of accounting change - - (0.04) - ----- ----- ----- ----- Net income $ 0.58 $ 1.20 $ 0.78 $ 2.24 ===== ===== ===== ===== Dividends paid per share of common stock $ 0.32 $ 0.32 $ 0.64 $ 0.64 ===== ===== ===== ===== See notes to consolidated financial statements. 9 CONSOLIDATING BALANCE SHEETS TEMPLE-INLAND INC. AND SUBSIDIRIES Second Quarter End 2001 Unaudited Parent Financial Company Services Consolidated (in millions) ASSETS Cash and cash equivalents $ 1 $ 249 $ 250 Mortgage loans held for sale - 493 493 Loans and leases receivable, net - 10,306 10,306 Securities available-for-sale - 3,080 3,080 Trade and other receivables 416 - 388 Inventories 265 - 265 Property and equipment 2,113 162 2,275 Other assets 291 848 1,107 Investment in Financial Services 1,157 - - ------ ------ ------ TOTAL ASSETS $ 4,243 $ 15,138 $ 18,164 ====== ====== ====== LIABILITIES Deposits $ - $ 8,866 $ 8,866 Federal Home Loan Bank advances - 3,437 3,437 Securities sold under repurchase agreements - 505 505 Other liabilities 364 649 963 Long-term debt 1,593 218 1,811 Deferred income taxes 289 - 279 Postretirement benefits 144 - 144 Stock issued by subsidiary - 306 306 ------ ------ ------ TOTAL LIABILITIES $ 2,390 $ 13,981 $ 16,311 ------ ------ ------ 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 365 Accumulated other comprehensive income (loss) 1 Retained earnings 1,975 ------ 2,402 Cost of shares held in the treasury: 12,123,168 shares (549) ------ TOTAL SHAREHOLDERS' EQUITY 1,853 ------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 18,164 ====== See the notes to the consolidated financial statements. 10 CONSOLIDATING BALANCE SHEETS TEMPLE-INLAND INC. AND SUBSIDIARIES Year End 2000 Parent Financial Company Services Consolidated (in millions) ASSETS Cash and cash equivalents $ 2 $ 320 $ 322 Mortgage loans held for sale - 232 232 Loans receivable, net - 10,411 10,411 Securities available-for-sale - 2,415 2,415 Securities held-to-maturity - 864 864 Trade and other receivables 320 - 309 Inventories 253 - 253 Property and equipment 2,027 157 2,184 Other assets 252 925 1,152 Investment in Financial Services 1,093 - - ------ ------ ------ TOTAL ASSETS $ 3,947 $ 15,324 $ 18,142 ====== ====== ====== LIABILITIES Deposits $ - $ 9,828 $ 9,828 Federal Home Loan Bank advances - 2,869 2,869 Securities sold under repurchase agreements - 595 595 Other liabilities 315 423 706 Long-term debt 1,381 210 1,591 Deferred income taxes 276 - 272 Postretirement benefits 142 - 142 Stock issued by subsidiary - 306 306 ------ ------ ------ TOTAL LIABILITIES $ 2,114 $ 14,231 $ 16,309 ------ ------ ------ 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 365 Accumulated other comprehensive income (loss) (8) Retained earnings 1,968 ------ 2,386 Cost of shares held in the treasury: 12,215,499 shares (553) ------ TOTAL SHAREHOLDERS' EQUITY 1,833 ------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 18,142 ====== See the notes to the consolidated financial statements. 11 CONSOLIDATED STATEMENT OF CASH FLOWS TEMPLE-INLAND INC. AND SUBSIDIARIES Unaudited First Six Months 2001 2000 (in millions) CASH PROVIDED (USED FOR) OPERATIONS Net income $ 39 $ 117 Adjustments: Provision for loan losses 31 25 Depreciation and depletion 101 112 Amortization of goodwill 5 4 Amortization and accretion on financial instruments 15 13 Mortgage loans held for sale (261) 78 Working capital changes (35) (82) Collections and remittances on loans serviced for others, net 196 (11) Cumulative effect of accounting change 2 - Other 16 82 ----- ----- 109 338 ----- ----- CASH PROVIDED BY (USED FOR) INVESTMENTS Capital expenditures for property and equipment (122) (120) Maturities of securities available-for-sale 386 148 Maturities of securities held-to-maturity - 107 Purchases of securities available-for-sale (46) (769) Loans originated or acquired, net of principal collected (443) (764) Proceeds from sale of servicing rights 45 - Sales of loans 390 135 Acquisitions, net of cash acquired (134) (19) Other 22 6 ----- ----- 98 (1,276) ----- ----- CASH PROVIDED BY (USED FOR) FINANCING Additions to debt 435 143 Payments of debt (220) (137) Net increase (decrease) in deposits (929) 575 Securities sold under repurchase agreements and short-term borrowings, net 483 580 Purchase of stock for treasury - (172) Cash dividends paid to shareholders (32) (34) Other (16) 18 ----- ----- (279) 973 ----- ----- Net increase (decrease) in cash and cash equivalents (72) 35 Cash and cash equivalents at beginning of period 322 284 ----- ----- Cash and cash equivalents at end of period $ 250 $ 319 ===== ===== See the notes to the consolidated financial statements. 12 TEMPLE-INLAND INC. AND SUBSIDIARIES NOTES TO FINANCIAL STATEMENTS NOTE A - BASIS OF PRESENTATION The accompanying unaudited interim financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Therefore, these statements do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. However, in the opinion of management, all adjustments (consisting 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, or incorporated into, the Annual Report on Form 10-K of Temple-Inland Inc. (the "Company") for the fiscal year ended December 30, 2000. 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. Accordingly, included as an integral part of the consolidated financial statements are separate summarized financial statements for the company's manufacturing and financial services groups. The Parent Company (Temple-Inland Inc.) summarized financial statements include the accounts of the company and its manufacturing subsidiaries (the parent company). The net assets invested in Temple- Inland Financial Services Group is reflected in the summarized financial statements on the equity basis. Related earnings, however, are presented before tax to be consistent with the consolidated financial statements. These financial statements should be read in conjunction with the Temple-Inland Inc. consolidated financial statements and the Temple-Inland Financial Services summarized financial statements. All material intercompany amounts and transactions have been eliminated. Certain amounts have been reclassified to conform to current year's classifications. 13 Note B - EARNINGS PER SHARE Denominators used in computing earnings per share are as follows: Second Quarter First Six Months 2001 2000 2001 2000 (in millions) Denominator for basic earnings per share - weighted average shares outstanding 49.3 51.7 49.3 52.3 Dilutive effect of stock options - - - - ---- ---- ---- ---- Denominator for diluted earnings per share 49.3 51.7 49.3 52.3 ==== ==== ==== ==== NOTE C - COMPREHENSIVE INCOME Comprehensive income consists of: Second Quarter First Six Months 2001 2000 2001 2000 (in millions) Net income $ 29 $ 62 $ 39 $ 117 Other comprehensive income, Net of income taxes: Effect of adopting FAS No. 133- Unrealized losses on held-to- maturity securities re-designated as available-for-sale securities - - (16) - Unrealized losses on derivative instruments classified as cash flow hedges - - (4) - Unrealized gains (losses) on: Available-for-sale securities (6) - 27 (4) Derivative instruments (1) - - - Foreign currency translation adjustments 2 (2) 2 (1) ---- ---- ---- ---- Other comprehensive income (5) (2) 9 (5) ---- ---- ---- ---- Comprehensive income $ 24 $ 60 $ 48 $ 112 ==== ==== ==== ==== For the first six months of 2001, accumulated comprehensive income included $4 million of unrealized after-tax losses on open commodity derivative instruments classified as cash flow hedges. It is expected that $3 million of these unrealized after-tax losses will be recognized over the next 12 months as the hedged transactions are completed. 14 NOTE D - SEGMENT INFORMATION The company has three reportable segments: Paper, Building Products and Financial Services. Building Financial Corporate (in millions) Paper Products Services And Other Total For the second quarter 2001 --------------------------- Revenues from external customers $ 529 $ 190 $ 343 $ - $ 1,062 Operating income (a) 28 9 46 (9) 74 Financial Services, net interest income - - 108 - 108 Depreciation, depletion and amortization (a) 31 15 7 2 55 --------------------------------------------------------------------------- For the first six months 2001 ----------------------------- Revenues from external customers $1,041 $ 359 $ 715 $ - $ 2,115 Operating income (a) 49 - 91 (17) 123 Financial Services, net interest income - - 215 - 215 Depreciation, depletion and amortization (a) 59 30 14 3 106 --------------------------------------------------------------------------- For the second quarter 2000 --------------------------- Revenues from external customers $ 533 $ 224 $ 343 $ - $ 1,100 Operating income 57 30 48 (8) 127 Financial Services, net interest income - - 98 - 98 Depreciation, depletion and amortization 34 14 9 2 59 --------------------------------------------------------------------------- For the first six months 2000 ----------------------------- Revenues from external customers $1,053 $ 462 $ 652 $ - $ 2,167 Operating income 109 67 83 (16) 243 Financial Services, net interest income - - 188 - 188 Depreciation, depletion and amortization 67 31 15 3 116 --------------------------------------------------------------------------- (a) Second quarter 2001 includes a $6 million reduction in depreciation expense resulting from a change in the estimated useful lives of certain production equipment, of which $5 million applies to the paper segment and $1 million applies to the building products segment. Reduction in depreciation expense for the first six months 2001 was $13 million, of which $10 million applies to the paper segment and $3 million applies to the building products segment. NOTE E - CONTINGENCIES There are pending against the company and its subsidiaries lawsuits, claims and environmental matters arising in the regular course of business. In addition, the Internal Revenue Service is currently examining the company's consolidated income tax returns for the years 1993 through 1996. The paper group is a party to a long-term power purchase agreement with Southern California Edison (Edison). Under this agreement, the 15 paper group sold to Edison a portion of its peak electrical generating capacity from a co-generation facility operated in connection with its Ontario mill. During April 2001, the paper group notified Edison that the long-term power purchase agreement was terminated because of Edison's material breach of the agreement. Edison has contested the right of the paper group to terminate the power purchase agreement. The parties are currently in litigation to determine, among other matters, whether the agreement has been terminated and whether the paper group may continue to have access through the interconnection services provided by Edison. The paper group continues to provide power to Edison. The company does not believe that the resolution of these matters will have a material adverse effect on its consolidated operations or financial position. NOTE F - ACQUISITIONS AND DISPOSITIONS During May 2001, the parent company completed the acquisition of Elgin Corrugated Box Company for $14 million cash, subject to final adjustments. The purchase price was allocated to the acquired assets and liabilities based on their fair values with $5 million allocated to goodwill. During May 2001, the parent company completed the acquisition of the corrugated packaging operations of Chesapeake Corporation for $120 million cash, subject to final adjustments. These operations consist of 10 corrugated container plants in seven states. The purchase price was allocated to the acquired assets and liabilities based on their fair values with $28 million allocated to goodwill. The operating results of these packaging operations are included in the accompanying summarized financial statements from the acquisition date. The unaudited pro forma results of operations, assuming the acquisitions had been effected as of the beginning of the applicable fiscal year, would not have been materially different from those reported. During June 2001, the parent company entered into a definitive agreement to sell 78,000 acres of non-strategic timberland in Georgia and Alabama. It is anticipated that this sale will close by year-end 2001 and will result in an after-tax gain in the range of $13 million. In July 2001, the parent company sold its box plant in Chile. It is anticipated that this sale will result in an after-tax gain in the range of $4 million. 16 NOTE G - NEW ACCOUNTING PRONOUNCMENTS AND CHANGES IN ESTIMATES Derivatives Beginning January 2001, the company adopted Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended. The cumulative effect of adopting this statement was to reduce first quarter 2001 net income by $2 million or $0.04 per diluted share and other comprehensive income, a component of shareholders' equity, by $4 million. As permitted by this statement, the company also changed the designation of its portfolio of held-to-maturity securities, which are carried at unamortized cost, to available-for-sale, which are carried at fair value. As a result, the $864 million carrying value of these securities was adjusted to their fair value with a corresponding after-tax reduction of $16 million in other comprehensive income. Depreciation Beginning January 2001, the parent company began computing depreciation of certain production equipment using revised estimated useful lives. These revisions ranged from a reduction of several years to a lengthening of up to five years. Second quarter 2001 net income was increased $4 million, or $0.07 per diluted share, as a result of this change. First six months 2001 net income was increased $8 million, or $0.15 per diluted share, as a result of this change. 17 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results of Operations For the quarter and for the first six months ended June 2001 and 2000. Summary Second quarter 2001 revenues were $1.1 billion and net income was $29 million or $0.58 per diluted share compared with $62 million or $1.20 per diluted share for second quarter 2000. Second quarter 2001 net income includes a $4 million or $0.07 per diluted share reduction in depreciation expense resulting from a change in estimated useful lives of certain production equipment. The first six months 2001 revenues were $2.1 billion and net income was $39 million or $0.78 per diluted share compared with $117 million or $2.24 per diluted share for the first six months 2000. The first six months 2001 net income includes an $8 million or $0.15 per diluted share reduction in depreciation expense and a charge of $2.0 million or $0.04 per diluted share as a result of adopting Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities. Business Segments The Company manages its operations through three business segments: Paper, Building Products, and Financial Services. A summary of the results of operations by business segment follows. Second Quarter First Six Months 2001 2000 2001 2000 (in millions) Revenues Paper $ 529 $ 533 $ 1,041 $ 1,053 Building Products 190 224 359 462 Financial Services 343 343 715 652 ----- ----- ----- ----- Total revenues $ 1,062 $ 1,100 $ 2,115 $ 2,167 ===== ===== ===== ===== Income Paper $ 28 $ 57 $ 49 $ 109 Building Products 9 30 - 67 Financial Services 46 48 91 83 ----- ----- ----- ----- Segment operating income (1) 83 135 140 259 Corporate and other (9) (8) (17) (16) Parent company interest (25) (27) (53) (52) ----- ----- ----- ----- Income before taxes 49 100 70 191 Income taxes 20 38 29 74 ----- ----- ----- ----- Income before accounting change 29 62 41 117 Effect of accounting change - - (2) - ----- ----- ----- ----- Net income $ 29 $ 62 $ 39 $ 117 ===== ===== ===== ===== (1) Segment operating income for second quarter 2001 and first six months 2001 includes a $6 million and a $13 million reduction in depreciation expense resulting from a change in the estimated useful lives of certain production equipment. For the second quarter 2001 $5 million applies to Paper and $1 million to Building Products. For the first six months 2001 $10 million applies to Paper and $3 million to Building Products. 18 Each of these business segments is affected by the factors of supply and demand and changes in domestic and global economic conditions, including changes in interest rates, new housing starts, home repair and remodeling activities, and the strength of the U.S. dollar. Unless otherwise noted, increases or decreases refer to second quarter 2001 amounts compared with second quarter 2000 amounts and first six months 2001 amounts compared with first six months 2000 amounts. Second quarter and first six months 2000 amounts have been reclassified to conform to current year classifications. For the second quarter 2001 Paper The Paper Group's revenues were $529 million, down less than one percent. Average box prices were up 2 percent and box shipments were 552,000 tons, down approximately 2 percent. Average linerboard prices were down 6 percent while outside linerboard shipments were down 22 percent. Compared with the first quarter 2001, revenues were up 3 percent. Box prices were down less than 1 percent. Box shipments were up slightly for seasonal reasons. Linerboard prices were down 4 percent and linerboard shipments were relatively unchanged. Domestic box and linerboard prices and shipments continue to be negatively affected by the slowing economy. Export linerboard prices and shipments continue to be negatively affected by the increase in offshore capacity and a strong U.S. dollar. Production, distribution and administrative costs were $501 million, up 5 percent due to higher energy costs partially offset by declines in the cost of old corrugated containers (OCC) and the positive effect from lower depreciation expense. Energy costs were up $10 million due primarily to the higher cost of natural gas. The costs of OCC, which accounts for 38 percent of the Paper Group's fiber requirements, was down $16 million. OCC was $67 per ton at quarter end, down 52 percent. As a result of the lengthening of the estimated useful lives of certain production equipment, depreciation was reduced by $5 million. Compared with the first quarter 2001, production, distribution and administrative costs were up about 2 percent. The mills operated at 88 percent of capacity. Mill production was 541,000 tons, down 14 percent or 88,000 tons. The box plants used 83 percent of the mill containerboard production. The remainder of the mill production was sold in the domestic and export markets. The decrease in production was due to curtailments, including the temporary closure of the Ontario, California mill during June 2001 and the conversion of the Newport, Indiana medium mill during July 2000 to the production of gypsum facing paper. Production was curtailed by 76,000 tons due to market, maintenance and operational reasons compared with second quarter 2000 curtailments of 52,000 tons and first quarter 2001 curtailments of 98,000 tons. The Paper Group may curtail production in future quarters for these reasons. During the quarter the Paper Group purchased 41,412 tons of medium from its 19 Newport joint venture. The agreement requiring the Paper Group to purchase medium from the Newport venture expired during June 2001. Operating income was $28 million, down 51 percent due to the factors discussed above. During May 2001, the Paper Group completed the acquisitions of the corrugated packaging operations of Chesapeake Corporation and Elgin Corrugated Box Company for $134 million cash, subject to final adjustment. The corrugated packaging operations of Chesapeake Corporation include 10 corrugated container plants in seven states and will increase the Paper Group's integration level and customer base. The acquired operations did not contribute significantly to the Paper Group's second quarter 2001 operating income. The Paper Group is continuing its efforts to enhance return on investment, including reviewing operations that are unable to meet return objectives and determining appropriate courses of action. In July 2001, the Paper Group sold its box plant in Chile. It is anticipated that this sale will result in an after-tax gain in the range of $4 million. Building Products The Building Products Group's revenues were $190 million, down 15 percent. Higher lumber prices, up 4 percent, were more than offset by lower prices for particleboard, down 16 percent, and gypsum, down 57 percent. MDF prices were up slightly. Shipments of lumber were up 5 percent while shipments of particleboard were down 17 percent and gypsum down 12 percent. MDF shipments were up 10 percent. Compared with the first quarter 2001, revenues were up 12 percent. Average prices for all products except gypsum were up. Lumber prices were up 19 percent. Shipments for most products were up. Product pricing and volumes continued to be negatively affected by the slowing domestic economy. Gypsum prices continued to drop in the quarter due to overcapacity. Several plant closings and production curtailments in the industry were announced during the quarter. Production, distribution and administrative costs were $181 million, down 7 percent due to lower volumes and the positive effect from lower depreciation expense. Weaker demand and production lost at the Mt. Jewett particleboard facility following the explosion at that facility affected production volumes. The Mt. Jewett facility resumed full production late in the second quarter 2001. As a result of the lengthening of the estimated useful lives of certain production equipment, depreciation was reduced by $1 million. Energy costs were up $1 million due primarily to the higher cost of natural gas. Compared with the first quarter 2001, production, distribution and administrative costs were up about 2 percent. Production was curtailed to varying degrees in most product lines due to market and operational reasons. Production averaged from a low of 67 percent to a high of 95 percent of capacity in the various product lines. The Building Products Group may curtail production in future quarters for these reasons. 20 Operating income was $9 million, down 70 percent due to the factors discussed above. The Building Products Group is continuing its efforts to enhance return on investment, including reviewing operations that are unable to meet return objectives and determining appropriate courses of action. As part of this effort, the Building Products Group has performed a review of its 600,000 acres of timberland in Georgia and Alabama and identified approximately 110,000 acres of non-strategic fee and leased timberlands. In July 2001, the Building Products Group entered into a definitive agreement to sell 78,000 acres of this non-strategic fee and leased timberlands for approximately $56 million. It is anticipated that this sale will close before year-end 2001 and will result in an after-tax gain in the range of $13 million. The Building Products Group has also identified approximately 160,000 acres of timberland in Georgia that will be converted over time to higher value use than the production of fiber. Financial Services The Financial Services Group's revenues, consisting of interest and non-interest income, were $343 million, equal to last year's revenues for the same period, while operating income was $46 million, down 4 percent. Compared with first quarter 2001, revenues were down 8 percent while operating income was up 2 percent. Net interest income was $108 million, up 10 percent due to a 9 basis point increase in the net interest spread and a 7 percent increase in average earning assets. The provision for loan losses was $14 million, up 40 percent. The increase in the provision was the result of growth and a change in the mix of the loan portfolio and a decline in asset quality, primarily relating to several construction and development loans in the senior housing industry and certain large commercial and business loans. Non-interest income, which consists primarily of income from real estate and insurance activities, loan related fees and service charges on deposits, was $81 million, up 11 percent. The increase was due to increases in mortgage origination and insurance activities and a focus on fee-based products. This was offset by an additional $2 million loss on the sale of mortgage servicing rights consummated in the first quarter due to an adjustment of the selling price to reflect higher than anticipated prepayments. Non-interest expense was $124 million, up 15 percent. The increase was due to commission related activity, an acquisition in the asset based lending operation and increased activity in the leasing operation. 21 Asset Quality Several key measures are used to evaluate and monitor the asset quality of the Financial Services Group. These measures include the level of loan delinquencies, nonperforming loans and nonperforming assets. Second First Quarter Quarter 2001 2000 2001 (in millions of dollars) Accruing loan past due 30 - 89 days $ 164 $ 81 $ 199 Accruing loan past due 90 days or more 27 4 4 ---- ---- ---- Accruing loans past due 30 days or more $ 191 $ 85 $ 203 ==== ==== ==== Nonaccrual loans $ 134 $ 75 $ 152 Restructured loans - - - ---- ---- ---- Nonperforming loans 134 75 152 Foreclosed property 2 7 2 ---- ---- ---- Nonperforming assets $ 136 $ 82 $ 154 ==== ==== ==== Allowance for loan losses $ 135 $ 129 $ 136 Net charge-offs 16 9 1 Nonperforming loan ratio 1.29% 0.76% 1.43% Nonperforming asset ratio 1.30% 0.82% 1.45% Allowance for loan losses/total loans 1.29% 1.29% 1.27% Allowance for loan losses/ nonperforming loans 100.54% 170.89% 89.2% Net loans charged off/average loans 0.30% 0.18% 0.02% The increase in the level of nonaccrual loans was primarily due to certain large loans in the construction and development and commercial and business portfolios. The loans in the construction and development portfolio are primarily in the senior housing industry and the commercial and business loans are primarily asset-based transactions. These loans are well collateralized and are being actively monitored. The lower annualized net charge-off ratio for the first quarter of 2001 was the result of a recovery of $2 million on a previously charged off loan. Operating income was $46 million, down 4 percent due to the factors discussed above. Corporate, Interest, and Other Parent Company interest expense was down $2 million. Lower interest rates more than offset higher debt outstanding. 22 Income Taxes The effective tax rate was 41 percent compared with 43 percent in the first quarter 2001. This reflects the effect of adjusting the estimated annual effective tax rate from 43 percent to 41.5 percent based on current expectations of income and expenses for the year 2001. Average Shares Outstanding Average diluted shares outstanding were 49.3 million, down five percent due to the effects of the share repurchase programs authorized during the fourth quarter 1999 and the third quarter 2000. The 1999 share repurchase program was completed during August 2000. For the first six months 2001 Paper The Paper Group revenues were $1.041 billion, down 1 percent. Average domestic box prices were up 5 percent while box shipments were 1,100 thousand tons, down 3 percent. Average linerboard prices were up slightly while outside linerboard shipments were down 30 percent. Production, distribution, and administrative costs were $992 million, up 5 percent due to higher energy costs partially offset by declines in OCC costs and the positive effect from lower depreciation expense. Energy costs were up $32 million due primarily to the higher cost of natural gas. OCC cost was down $25 million. As a result of the lengthening of the estimated useful lives of certain production equipment, depreciation was reduced by $10 million. The mills operated at 86 percent of capacity. Mill production was 1.060 million tons, down 17 percent or 220,000 tons. The box plants used 82 percent of the mill containerboard production. The remainder of the mill production was sold in the domestic and export markets. Production was curtailed by 174,000 tons due to market, maintenance, and operational reasons compared with curtailments in the first six months of 2000 of 95,000 tons. The Paper Group may curtail production in the future for these reasons. Operating income was $49 million, down 55 percent due to the factors discussed above. Building Products The Building Products Group's revenues were $359 million, down 22 percent. Average prices for all products except MDF were down with lumber prices down 8 percent, gypsum down 55 percent, particleboard down 15 percent and fiber products prices down 7 percent. MDF prices were up slightly. Shipments for all products except MDF were down with lumber and fiber products shipments each down 2 percent and particleboard and gypsum each down 16 percent. MDF shipments were up 7 percent. Production, distribution, and administrative costs were $359 million, down 9 percent due to lower volumes and the positive effect from lower depreciation expense offset by higher energy costs. As a result 23 of the lengthening of the estimated useful lives of certain production equipment, depreciation was reduced by $3 million. Energy costs were up $4 million due primarily to the higher cost of natural gas. Production was curtailed to varying degrees in most product lines due to market and operational reasons. Production averaged from a low of 65 percent to a high of 81 percent of capacity in the various product lines. The Building Products Group may curtail production in the future for these reasons. Operating income was at break-even level, down $67 million due to the factors discussed above. Financial Services The Financial Services Group's revenues were $715 million up 10 percent. Net interest income was $215 million; up 14 percent due to a 15 basis point increase in the net interest spread and a 9 percent increase in average earning assets. The provision for loan losses was $31 million, up 24 percent. The increase in the provision was the result of growth, a change in the mix of the loan portfolio, and a decline in asset quality, primarily relating to several construction and development loans in the senior housing industry and certain large commercial and business loans. Non-interest income, which consists primarily of income from real estate and insurance activities, loan related fees and service charges on deposits, was $163 million, up 21 percent. The increase was due to increases in mortgage origination, real estate and insurance activities and a focus on fee based products. This was offset by a $2 million loss on the sale of an auto loan portfolio and a $7 million loss on the sale of servicing rights on $9 billion in mortgage loans. The servicing rights were sold to mitigate impairment risk in the declining rate environment. Non-interest expense was $245 million, up 19 percent. The increase was due to commission related activity, acquisitions in the asset based lending and leasing operations and increased real estate activity. Operating income was $91 million, up 10 percent due to the factors discussed above. Corporate, Interest, and Other Parent Company interest expense was up $1 million due to higher debt outstanding partially offset by lower interest rates. Income Taxes The effective tax rate was 41.5 percent compared with 39 percent. The effective tax rate is based on current expectations of income and expenses for the year 2001. The estimated annual effective tax rate 24 includes federal and state income taxes and the effects of non- deductible goodwill amortization and other items. Accounting Change The cumulative effect of adopting Statement of Financial Accounting Standards No. 133, Accounting for Derivative and Hedging Activities, as amended, was to reduce net income by $2 million, net of a deferred tax benefit of $1 million. Average Shares Outstanding Average diluted shares outstanding were 49.3 million, down 6 percent due to the effects of the share repurchase programs authorized during the fourth quarter 1999 and the third quarter 2000. The 1999 share repurchase program was completed during August 2000. Capital Resources and Liquidity For the first six months ended June 2001 The consolidated net assets invested in the Financial Services Group are subject, in varying degrees, to regulatory rules and regulations. Accordingly, Parent Company and Financial Services capital resources and liquidity are discussed separately. Parent Company Operating Activities Cash from operations was $69 million, down 53 percent due to lower earnings partially offset by a decrease in working capital needs. A $30 million dividend was received from the Financial Services Group. Investing Activities Capital expenditures were $109 million and are expected to approximate $190 million for the year 2001. The cost of acquiring the corrugated packaging operations of Chesapeake Corporation and Elgin Corrugated Box Company was $134 million. Financing Activities Dividends paid were $32 million or $.32 per share per quarter. Debt increased $211 million from year-end levels of which $102 was related to acquisitions. In addition, $200 million of 9.0% term notes were repaid using $100 million of short-term borrowings and $100 million from an existing three-year revolving credit agreement. There were no repurchases of shares under the August 2000 Board of Directors authorization to repurchase 2.5 million shares. To date a total of .75 million shares have been repurchased under this authorization. Other The Parent Company has sufficient liquidity and capital resources to meet its anticipated needs. 25 Financial Services The principal sources of cash for the Financial Services Group are operating cash flows, deposits, and borrowings. The Financial Services Group uses these funds to invest in earning assets, generally loans and securities. Operating Activities Cash from operations was $70 million, down 68 percent. Increases in earnings and in cash for mortgage loans serviced were more than offset by an increase in mortgage loans held for sale. Investing Activities Cash provided by investment activities was $348 million. Maturities of securities, net of purchases provided $340 million. Originations and purchases of loans and leases, net of sales used $53 million. Proceeds from the sale of mortgage servicing rights provided $45 million while capital expenditures used $13 million. Financing Activities Cash used for financing activities was $489 million. Deposits decreased $929 million while borrowings increased $487 million. The decrease in deposits was due to the competitive markets and a decision to pursue other funding sources such as Federal Home Loan Bank advances. A total of $30 million in dividends was paid to the parent company. Other The Financial Services Group has sufficient liquidity and capital resources to meet its anticipated needs. At quarter-end, 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." From time to time, the parent company may make capital contributions to the savings bank or receive dividends from the savings bank. During the first six months of 2001, the parent company made no contributions to the savings bank and received $30 million in dividends from the savings bank. Selected financial and regulatory capital data for the savings bank follows: Second Quarter Year End End 2001 2000 (in millions of dollars) Balance sheet data Total assets $14,658 $14,885 Total deposits 9,314 10,088 Shareholder's equity 985 931 Savings Bank Regulatory Minimum Regulatory capital ratios Tangible capital 8.4% 2.0% Leverage capital 8.4% 4.0% Risk-based capital 10.9% 8.0% 26 Energy and Related Matters Energy costs were approximately $11 million higher compared with second quarter 2000 and $10 million lower compared with first quarter 2001. The company continues to explore alternative arrangements and fuel sources in an effort to contain energy costs. The energy situation in California has been well publicized. The paper group is a party to a long-term power purchase agreement with Southern California Edison (Edison). Under this agreement, the paper group sold to Edison a portion of its peak electrical generating capacity from a co-generation facility operated in connection with its Ontario mill. During the fourth quarter 2000 and the first quarter 2001, the Ontario mill generated and delivered electricity to Edison but had not been paid. During April 2001, the paper group notified Edison that the long-term power purchase agreement was terminated because of Edison's material breach of the agreement. During the second quarter 2001, the Ontario mill continued to generate and deliver electricity to Edison and has received some partial payments from Edison. At second quarter-end 2001, approximately $5 million is due the paper group under this agreement. Edison has contested the right of the paper group to terminate the power purchase agreement. The parties are currently in litigation to determine, among other matters, whether the agreement has been terminated and whether the paper group may continue to have access through the interconnection services provided by Edison. In addition, as the owner of a co-generation facility in California, the company is subject to the additional risks associated with any state or federal regulatory actions that may be taken in an effort to address the California energy situation. The company presently believes that any ultimate liability from these legal or regulatory proceedings or rulings would not have a material adverse effect on the business or financial condition of the company. Forward-Looking Statements Statements that are not historical are forward-looking statements that involve risks and uncertainties. The actual results achieved may differ significantly from those discussed. These differences can be caused by such matters as general economic, market, or business conditions and their effect on the prices of the company's products; opportunities or lack thereof that may or may not be pursued; availability and price of raw materials; competition; changes in laws or regulations; energy costs and regulatory actions that may be taken in an effort to alleviate the energy situation in California; and other factors, many of which are beyond the control of the Company. 27 Statistical and other data (a) Second Quarter First Six Months 2001 2000 2001 2000 Net revenues (in millions) Paper $ 529 $ 533 $ 1,041 $ 1,053 ===== ===== ===== ===== Building products: Pine lumber $ 62 $ 57 $ 110 $ 122 Particleboard 46 63 93 125 Medium density fiberboard 29 25 55 50 Gypsum wallboard 12 28 25 60 Fiberboard 19 19 32 38 Other 22 32 44 67 ----- ----- ----- ----- Total building products $ 190 $ 224 $ 359 $ 462 ===== ===== ===== ===== Unit sales Paper (in thousand tons) (b) 646 685 1,287 1,398 Building products: Pine lumber - mbf 176 167 338 345 Particleboard - msf (3/4" basis) 148 178 302 359 Medium density fiberboard - msf (3/4" basis) 75 68 146 137 Gypsum wallboard - msf 153 174 294 352 Fiberboard - msf (1/2" basis) 120 106 199 203 (a) Net revenues and shipments do not include joint venture operations (b) Includes boxes sold and open market sales of linerboard 28 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Interest Rate Risk: The company is subject to interest rate risk from the utilization of financial instruments such as adjustable-rate debt and other borrowings as well as the lending and deposit gathering activities of the Financial Services Group. 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 second quarter-end of 2001, with comparative information at year- end 2000: Increase (Decrease) Income Before Taxes (in millions) Second Quarter-End Year-End Change in Interest Rates 2001 2000 +2% $ (12) $ (7) +1% (2) (1) 0% - - -1% (1) (1) -2% (5) (13) The change in exposure to interest rate risk from year-end 2000 is primarily due to shorter durations of the Financial Services Group's funding sources. The operations of the Financial Services Group's savings bank are subject to interest rate risk to the extent that interest-earning assets and interest-bearing liabilities mature or reprice at different times or in differing amounts. Because approximately 91 percent of the savings bank's assets at second quarter-end 2001 have adjustable rates, this risk is significantly mitigated. However, the savings bank is also subject to prepayment risk inherent in a portion of its single-family adjustable-rate mortgage-backed assets. A substantial portion of the savings bank's investments in adjustable- rate mortgage-backed assets have annual and lifetime caps that subject the savings bank to interest rate risk should rates rise above certain levels. From time to time, to optimize net interest income while maintaining acceptable levels of interest rate and liquidity risk, the savings bank may enter into various interest rate contracts to better match assets and liabilities. Additionally, the fair value of the Financial Services Group's mortgage servicing rights (estimated at $152 million at second quarter-end 2001) is also affected by changes in interest rates. The company estimates that a one percent decline in interest rates from quarter-end levels would decrease the fair value of the mortgage servicing rights by approximately $27 million. During the first quarter 2001, the Financial Services Group sold servicing rights on $9 billion of mortgage loans in order to mitigate this risk. At 29 second quarter-end 2001, the Financial Services Group serviced $11 billion of mortgage loans compared with $19.5 billion at year-end 2000. Foreign Currency Risk: The company's exposure to foreign currency fluctuations on its financial instruments is not material because most of these instruments are denominated in U.S. dollars. Commodity Price Risk: From time to time the company uses commodity derivative instruments to mitigate its exposure to changes in product pricing and manufacturing costs. These instruments cover a small portion of the company's volume and range in duration from three months to three years. Based on the fair value of these instruments at second quarter-end 2001, the potential loss in fair value resulting from a hypothetical 10 percent change in the underlying commodity prices would not be significant. 30 PART II. OTHER INFORMATION Item 1. Legal Proceedings. The information set forth in Note E to Notes to Consolidated Financial Statements in Part I of this report is incorporated by reference thereto. Item 2. Changes in Securities and Use of Proceeds. None. Item 3. Defaults Upon Senior Securities. None. Item 4. Submission of Matters to a Vote of Security Holders. None. Item 5. Other Information. None. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits. Regulation S-K Exhibit Number 10.1* Temple-Inland Inc. Supplemental Executive Retirement Plan. * Management contract or compensatory plan or arrangement. (b) Reports on Form 8-K. During the three months ended June 30, 2001, the Company did not file a current report on Form 8-K. 31 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 14, 2001 By /s/ Louis R. Brill Louis R. Brill Vice President and Chief Accounting Officer 32 Index to Exhibits Regulation S-K Page Exhibit Number Description No. 10.1 Temple-Inland Inc. Supplemental Executive 33 Retirement Plan.