10-Q 1 tin2d200310q.txt FORM 10-Q FOR THE PERIOD ENDED JUNE 28, 2003 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [x] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Quarterly Period Ended June 28, 2003 OR [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Transition Period From to Commission File Number 001-08634 Temple-Inland Inc. (Exact name of registrant as specified in its charter) Delaware 75-1903917 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 1300 South MoPac Expressway, Austin, Texas 78746 (Address of principal executive offices, including Zip Code) (512) 434-5800 (Registrant's telephone number, including area code) Not Applicable (Former name, former address and former fiscal year, if changed since last report.) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: Number of common shares outstanding Class as of June 28, 2003 Common Stock (par value $1.00 per share) 54,150,400 Page 1 of 56 The Exhibit Index is page 50. 2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS SUMMARIZED STATEMENTS OF INCOME PARENT COMPANY (TEMPLE-INLAND INC.) Unaudited
Second Quarter First Six Months 2003 2002 2003 2002 ---- ---- ---- ---- (in millions) NET REVENUES $ 877 $ 921 $ 1,724 $ 1,668 COSTS AND EXPENSES Cost of sales 800 795 1,596 1,452 Selling and administrative 75 84 150 152 Other (income) expense 21 6 30 6 ----- ----- ----- ----- 896 885 1,776 1,610 ----- ----- ----- ----- (19) 36 (52) 58 FINANCIAL SERVICES EARNINGS 42 37 81 64 ----- ----- ----- ----- OPERATING INCOME 23 73 29 122 Interest expense (35) (36) (70) (61) Other expense -- (11) -- (11) ----- ----- ----- ----- INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE TAXES (12) 26 (41) 50 Income tax (expense) benefit 167 (10) 179 (19) ----- ----- ----- ----- INCOME FROM CONTINUING OPERATIONS 155 16 138 31 Discontinued operations 1 (1) 1 (1) ----- ----- ----- ----- INCOME BEFORE ACCOUNTING CHANGE 156 15 139 30 Effect of accounting change -- -- (1) (11) ----- ----- ----- ----- NET INCOME $ 156 $ 15 $ 138 $ 19 ===== ===== ===== =====
See the notes to consolidated financial statements. 3 SUMMARIZED BALANCE SHEETS PARENT COMPANY (TEMPLE-INLAND INC.) Unaudited
Second Quarter Year-End 2003 2002 ---- ---- (in millions) ASSETS Current Assets Cash and cash equivalents $ 17 $ 17 Receivables, net of allowances of $13 in 2003 398 352 and $13 in 2002 Inventories: Work in process and finished goods 86 69 Raw materials and supplies 240 269 ----- ----- Total inventories 326 338 ----- ----- Prepaid expenses and other 66 50 ----- ----- Total current assets 807 757 ----- ----- Investment in Financial Services 1,161 1,178 Property and Equipment: Land and buildings 641 638 Machinery and equipment 3,451 3,412 Construction in progress 87 92 Less allowances for depreciation (2,202) (2,101) ----- ----- 1,977 2,041 Timber and timberlands - less depletion 499 508 ----- ----- Total property and equipment 2,476 2,549 Goodwill 239 249 Assets of Discontinued Operations 25 78 Other Assets 153 146 ----- ----- TOTAL ASSETS $ 4,861 $ 4,957 ===== ===== LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities Accounts payable $ 207 $ 188 Employee compensation and benefits 57 67 Accrued interest 29 30 Accrued property taxes 23 28 Other accrued expenses 131 133 Liabilities of discontinued operations 20 28 Current portion of long-term debt 6 8 ----- ----- Total current liabilities 473 482 Long-Term Debt 1,813 1,883 Deferred Income Taxes 59 245 Postretirement Benefits 148 147 Pension Liability 163 142 Other Long-Term Liabilities 139 109 ----- ----- Total Liabilities 2,795 3,008 Shareholders' Equity 2,066 1,949 ----- ----- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 4,861 $ 4,957 ===== =====
See the notes to consolidated financial statements. 4 SUMMARIZED STATEMENTS OF CASH FLOW PARENT COMPANY (TEMPLE-INLAND INC.) Unaudited
First Six Months 2003 2002 ---- ---- (in millions) CASH PROVIDED BY (USED FOR) OPERATIONS Net income $ 138 $ 19 Adjustments: Depreciation, depletion and amortization 117 108 Depreciation of leased property 1 1 Non-cash stock based compensation 16 4 Non-cash pension and postretirement expense 27 12 Cash contribution to pension and postretirement plans (6) (6) Other non-cash charges (credits) (135) 17 Deferred income taxes -- 12 Unremitted earnings from Financial Services (52) (57) Dividends from Financial Services 70 75 Working capital changes, net (42) (48) Net assets of discontinued operations (1) 9 Loss from discontinued operations (1) 1 Cumulative effect of accounting change 1 11 Other 9 20 ----- ----- 142 178 ----- ----- CASH PROVIDED BY (USED FOR) INVESTING Capital expenditures (58) (52) Sales of non-strategic assets and operations 30 33 Acquisition of Gaylord, net of cash acquired -- (568) Other acquisitions and joint ventures (5) (37) Other -- (3) ----- ----- (33) (627) ----- ----- CASH PROVIDED BY (USED FOR) FINANCING Payments of debt (74) (262) Cash dividends paid to shareholders (37) (33) Bridge financing facility -- 880 Payment of bridge financing facility -- (880) Payment of assumed Gaylord bank debt -- (285) Sale of common stock -- 215 Sale of Upper DECSSM -- 345 Sale of Senior Notes -- 496 Other additions to debt 2 30 Other -- (21) ----- ----- (109) 485 ----- ----- Net increase in cash -- 36 Cash at beginning of period 17 3 ----- ----- Cash at end of period $ 17 $ 39 ===== =====
See the notes to consolidated financial statements. 5 SUMMARIZED STATEMENTS OF INCOME FINANCIAL SERVICES Unaudited
Second Quarter First Six Months 2003 2002 2003 2002 ---- ---- ---- ---- (in millions) INTEREST INCOME Loans and loans held for sale $ 131 $ 142 $ 264 $ 288 Securities available-for-sale 18 27 38 58 Securities held-to-maturity 37 17 76 27 Other earning assets 1 1 2 2 ----- ----- ----- ----- Total interest income 187 187 380 375 INTEREST EXPENSE Deposits 49 58 102 123 Borrowed funds 44 38 89 69 ----- ----- ----- ----- Total interest expense 93 96 191 192 ----- ----- ----- ----- NET INTEREST INCOME 94 91 189 183 Provision for loan losses (20) (15) (31) (29) ----- ----- ----- ----- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 74 76 158 154 ----- ----- ----- ----- NONINTEREST INCOME Loan servicing fees 7 11 16 22 Amortization and impairment of servicing rights (23) (9) (41) (17) Loan origination fees 51 24 94 54 Gain on sale of loans 37 14 60 27 Real estate operations 12 13 20 22 Insurance commissions and fees 12 13 22 24 Service charges on deposits 9 7 17 14 Operating lease income 3 3 5 6 Other 10 6 20 15 ----- ----- ----- ----- Total noninterest income 118 82 213 167 ----- ----- ----- ----- NONINTEREST EXPENSE Compensation and benefits 91 67 174 143 Loan servicing and origination 4 1 7 2 Real estate operations, other than compensation 8 8 15 15 Insurance operations, other than compensation 4 3 7 7 Occupancy 8 8 16 17 Data processing 6 7 13 17 Other 29 27 58 56 ----- ----- ----- ----- Total noninterest expense 150 121 290 257 ----- ----- ----- ----- INCOME BEFORE TAXES 42 37 81 64 Income tax expense (15) (4) (29) (7) ----- ----- ----- ----- NET INCOME $ 27 $ 33 $ 52 $ 57 ===== ===== ===== =====
See the notes to consolidated financial statements. 6 SUMMARIZED BALANCE SHEETS FINANCIAL SERVICES Unaudited
Second Quarter Year-End 2003 2002 ---- ---- (in millions) ASSETS Cash and cash equivalents $ 341 $ 438 Loans held for sale 1,051 1,088 Loans receivable, net of allowance for losses of $117 in 2003 and $132 in 2002 9,594 9,668 Securities available-for-sale 1,621 1,926 Securities held-to-maturity 4,272 3,915 Real estate 247 249 Premises and equipment, net 158 157 Accounts, notes and accrued interest receivable 143 159 Goodwill 149 148 Mortgage servicing rights 81 105 Other assets 246 163 ------ ------ TOTAL ASSETS $ 17,903 $ 18,016 ====== ====== LIABILITIES AND SHAREHOLDER'S EQUITY Deposits $ 9,150 $ 9,203 Federal Home Loan Bank advances 3,432 3,386 Securities sold under repurchase agreements 2,560 2,907 Obligations to settle trade date securities 573 369 Other liabilities 550 487 Other borrowings 172 181 Preferred stock issued by subsidiaries 305 305 ------ ------ TOTAL LIABILITIES 16,742 16,838 ------ ------ SHAREHOLDER'S EQUITY 1,161 1,178 ------ ------ TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY $ 17,903 $ 18,016 ====== ======
See the notes to consolidated financial statements. 7 SUMMARIZED STATEMENTS OF CASH FLOWS FINANCIAL SERVICES Unaudited
First Six Months 2003 2002 ---- ---- (in millions) CASH PROVIDED BY (USED FOR) OPERATIONS Net income $ 52 $ 57 Adjustments: Amortization and accretion 44 19 Depreciation 12 12 Depreciation of leased assets 4 5 Provision for loan losses 31 29 Deferred income taxes (9) (1) Originations of loans held for sale (7,458) (3,750) Sales of loans held for sale 7,495 4,082 Collections on loans serviced for others, net (31) (159) Originated mortgage servicing rights (19) (28) Other 55 19 ----- ----- 176 285 ----- ----- CASH PROVIDED BY (USED FOR) INVESTING Purchases of securities available-for-sale (4) (21) Principal payments and maturities of securities available-for-sale 312 420 Purchases of securities held-to-maturity (1,112) (1,115) Principal payments and maturities of securities held-to-maturity 960 56 Loans originated or acquired, net of collections (44) 154 Sale of mortgage servicing rights -- 34 Sale of loans 23 1 Acquisitions, net of cash acquired (1) (6) Capital expenditures (11) (7) Other 4 (1) ----- ----- 127 (485) ----- ----- CASH PROVIDED BY (USED FOR) FINANCING Net decrease in deposits (29) (592) Securities sold under repurchase agreements and short-term borrowings, net 58 (309) Additions to debt and long-term FHLB advances 57 1,121 Payments of debt and long-term FHLB advances (425) (108) Dividends paid to parent company (70) (75) Other 9 4 ----- ----- (400) 41 ----- ----- Net decrease in cash and cash equivalents (97) (159) Cash and cash equivalents at beginning of period 438 587 ----- ----- Cash and cash equivalents at end of period $ 341 $ 428 ===== =====
See the notes to consolidated financial statements. 8 CONSOLIDATED STATEMENTS OF INCOME TEMPLE-INLAND INC. AND SUBSIDIARIES Unaudited
Second Quarter First Six Months 2003 2002 2003 2002 ---- ---- ---- ---- (in millions, except per share amounts) REVENUES Manufacturing $ 877 $ 921 $ 1,724 $ 1,668 Financial Services 305 269 593 542 ----- ----- ----- ----- 1,182 1,190 2,317 2,210 ----- ----- ----- ----- COSTS AND EXPENSES Manufacturing 896 885 1,776 1,610 Financial Services 263 232 512 478 ----- ----- ----- ----- 1,159 1,117 2,288 2,088 ----- ----- ----- ----- OPERATING INCOME 23 73 29 122 Parent company interest (35) (36) (70) (61) Other expense -- (11) -- (11) ----- ----- ----- ----- INCOME (LOSS) BEFORE TAXES (12) 26 (41) 50 Income tax (expense) benefit 167 (10) 179 (19) ----- ----- ----- ----- INCOME FROM CONTINUING OPERATIONS 155 16 138 31 Discontinued operations 1 (1) 1 (1) ----- ----- ----- ----- INCOME BEFORE ACCOUNTING CHANGE 156 15 139 30 Effect of accounting change -- -- (1) (11) ----- ----- ----- ----- NET INCOME $ 156 $ 15 $ 138 $ 19 ===== ===== ===== ===== EARNINGS (LOSS) PER SHARE Basic: Income from continuing operations $ 2.86 $ 0.31 $ 2.55 $ 0.61 Discontinued operations 0.01 (0.02) 0.01 (0.02) Effect of accounting change -- -- (0.01) (0.22) ----- ----- ----- ----- Net income $ 2.87 $ 0.29 $ 2.55 $ 0.37 ===== ===== ===== ===== Diluted: Income from continuing operations $ 2.86 $ 0.31 $ 2.55 $ 0.61 Discontinued operations 0.01 (0.02) 0.01 (0.02) Effect of accounting change -- -- (0.01) (0.22) ----- ----- ----- ----- Net income $ 2.87 $ 0.29 $ 2.55 $ 0.37 ===== ===== ===== ===== DIVIDENDS PAID PER SHARE OF COMMON STOCK $ 0.34 $ 0.32 $ 0.68 $ 0.64 ===== ===== ===== =====
See the notes to consolidated financial statements. 9 CONSOLIDATING BALANCE SHEETS TEMPLE-INLAND INC. AND SUBSIDIARIES Second Quarter 2003 Unaudited
Parent Financial Company Services Consolidated ------- --------- ------------ (in millions) ASSETS Cash and cash equivalents $ 17 $ 341 $ 358 Loans held for sale -- 1,051 1,051 Loans receivable, net -- 9,594 9,594 Securities available-for-sale -- 1,621 1,621 Securities held-to-maturity -- 4,272 4,272 Trade receivables, net 398 -- 398 Inventories 326 -- 326 Property and equipment, net 2,476 158 2,634 Goodwill 239 149 388 Other assets 244 717 918 Investment in Financial Services 1,161 -- -- ----- ------ ------ TOTAL ASSETS $ 4,861 $ 17,903 $ 21,560 ===== ====== ====== LIABILITIES AND SHAREHOLDERS' EQUITY Deposits $ -- $ 9,150 $ 9,150 Federal Home Loan Bank advances -- 3,432 3,432 Securities sold under repurchase -- 2,560 2,560 Obligations to settle trade date -- 573 573 Other liabilities 612 550 1,137 Long-term debt 1,813 172 1,985 Deferred income taxes 59 -- 41 Postretirement benefits 148 -- 148 Pension liability 163 -- 163 Preferred stock issued by subsidiaries -- 305 305 ----- ------ ------ TOTAL LIABILITIES $ 2,795 $ 16,742 $ 19,494 ----- ------ ------ SHAREHOLDERS' EQUITY Preferred stock - par value $1 per share: authorized 25,000,000 shares; none issued -- Common stock - par value $1 per share: authorized 200,000,000 shares; issued 61,389,552 shares including shares held in the treasury 61 Additional paid-in capital 370 Accumulated other comprehensive loss (138) Retained earnings 2,101 ------ 2,394 Cost of shares held in the treasury: 7,239,152 shares (328) ------ TOTAL SHAREHOLDERS' EQUITY 2,066 ------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 21,560 ======
See the notes to consolidated financial statements. 10 CONSOLIDATING BALANCE SHEETS TEMPLE-INLAND INC. AND SUBSIDIARIES Year-End 2002 Unaudited
Parent Financial Company Services Consolidated ------- --------- ------------ (in millions) ASSETS Cash and cash equivalents $ 17 $ 438 $ 455 Loans held for sale -- 1,088 1,088 Loans receivable, net -- 9,668 9,668 Securities available-for-sale -- 1,926 1,926 Securities held-to-maturity -- 3,915 3,915 Trade receivables 352 -- 352 Inventories 338 -- 338 Property and equipment, net 2,549 157 2,706 Goodwill 249 148 397 Other assets 274 676 915 Investment in Financial Services 1,178 -- -- ----- ------ ------ TOTAL ASSETS $ 4,957 $ 18,016 $ 21,760 ===== ====== ====== LIABILITIES AND SHAREHOLDERS' EQUITY Deposits $ -- $ 9,203 $ 9,203 Federal Home Loan Bank advances -- 3,386 3,386 Securities sold under repurchase -- 2,907 2,907 Obligations to settle trade date -- 369 369 Other liabilities 591 487 1,052 Long-term debt 1,883 181 2,064 Deferred income taxes 245 -- 236 Postretirement benefits 147 -- 147 Pension liability 142 -- 142 Preferred stock issued by subsidiaries -- 305 305 ----- ------ ------ TOTAL LIABILITIES $ 3,008 $ 16,838 $ 19,811 ----- ------ ------ SHAREHOLDERS' EQUITY Preferred stock - par value $1 per share: authorized 25,000,000 shares; none issued -- Common stock - par value $1 per share: authorized 200,000,000 shares; issued 61,389,552 shares including shares held in the treasury 61 Additional paid-in capital 368 Accumulated other comprehensive loss (136) Retained earnings 2,000 ------ 2,293 Cost of shares held in the treasury: 7,583,293 shares (344) ------ TOTAL SHAREHOLDERS' EQUITY 1,949 ------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 21,760 ======
See the notes to consolidated financial statements. 11 CONSOLIDATED STATEMENT OF CASH FLOWS TEMPLE-INLAND INC. AND SUBSIDIARIES Unaudited
First Six Months 2003 2002 ---- ---- (in millions) CASH PROVIDED BY (USED FOR) OPERATIONS Net income $ 138 $ 19 Adjustments: Depreciation, depletion and amortization 129 120 Depreciation on leased property 5 6 Provision for loan losses 31 29 Deferred taxes (9) 11 Other non-cash charges (135) 17 Amortization and accretion of financial instruments 44 19 Originations of loans held for sale (7,458) (3,750) Sales of loans held for sale 7,495 4,082 Working capital changes, net (42) (48) Collections on loans serviced for others, net (31) (159) Originated mortgage servicing rights (19) (28) Net assets of discontinued operations (1) 9 Loss from discontinued operations (1) 1 Cumulative effect of accounting change 1 11 Other 101 49 ----- ----- 248 388 ----- ----- CASH PROVIDED BY (USED FOR) INVESTING Capital expenditures (69) (59) Sale of non-strategic assets and operations 30 33 Purchases of securities available-for-sale (4) (21) Principal payments and maturities of securities available-for-sale 312 420 Purchases of securities held-to-maturity (1,112) (1,115) Principal payments and maturities and redemptions of securities held-to-maturity 960 56 Sale of mortgage servicing rights -- 34 Loans originated or acquired, net of principal collected (44) 154 Proceeds from sale of loans 23 1 Acquisitions, net of cash acquired (6) (611) Other 4 (4) ----- ----- 94 (1,112) ----- ----- CASH PROVIDED BY (USED FOR) FINANCING Net decrease in deposits (29) (592) Additions to debt 59 1,151 Payments of debt (499) (370) Repurchase agreements and short-term borrowings, net 58 (309) Cash dividends paid to shareholders (37) (33) Bridge financing facility -- 880 Payment of bridge financing facility -- (880) Payment of assumed Gaylord bank debt -- (285) Sale of common stock, Upper DECS(SM), and Senior Notes -- 1,056 Other 9 (17) ----- ----- (439) 601 ----- ----- Net decrease in cash and cash equivalents (97) (123) Cash and cash equivalents at beginning of period 455 590 ----- ----- Cash and cash equivalents at end of period $ 358 $ 467 ===== =====
See the notes to consolidated financial statements. 12 TEMPLE-INLAND INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS NOTE A - BASIS OF PRESENTATION The accompanying unaudited interim financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Therefore, these statements do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. However, in the opinion of management, all adjustments (consisting only of normal accruals) considered necessary for a fair presentation have been included. Interim operating results are not necessarily indicative of the results that may be expected for the entire year. For further information, refer to the financial statements and footnotes included in the Annual Report on Form 10-K of Temple-Inland Inc. (the "Company") for the fiscal year ended December 28, 2002. The consolidated financial statements include the accounts of the Company and its manufacturing and financial services subsidiaries. The consolidated net assets invested in financial services activities are subject, in varying degrees, to regulatory rules and restrictions including restrictions on the payment of dividends to the Company. Accordingly, included as an integral part of the consolidated financial statements are separate summarized financial statements for the Company's manufacturing and financial services subsidiaries. The Parent Company (Temple-Inland Inc.) summarized financial statements include the accounts of the Company and its manufacturing subsidiaries (the parent company). The net assets invested in Financial Services are reflected in the summarized financial statements using the equity method. Related earnings, however, are presented before tax to be consistent with the consolidated financial statements. These financial statements should be read in conjunction with the Company's consolidated financial statements and the Financial Services summarized financial statements. All material intercompany amounts and transactions have been eliminated. Certain amounts have been reclassified to conform to current year's classifications. 13 TEMPLE-INLAND INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS NOTE B - EARNINGS PER SHARE Denominators used in computing per share amounts follow: Second Quarter First Six Months 2003 2002 2003 2002 ---- ---- ---- ---- (in millions) Denominator for basic earnings per share: Weighted average common shares 54.1 52.3 54.0 50.9 outstanding Dilutive effect of: Equity purchase contracts -- -- -- -- Stock options -- 0.1 0.1 0.1 ---- ---- ---- ---- Denominator for diluted earnings per share 54.1 52.4 54.1 51.0 ==== ==== ==== ==== NOTE C - COMPREHENSIVE INCOME Comprehensive income consists of: Second Quarter First Six Months 2003 2002 2003 2002 ---- ---- ---- ---- (in millions) Net income $ 156 $ 15 $ 138 $ 19 Other comprehensive income (loss), net of taxes: Unrealized gains (losses) on: Available-for-sale securities (3) (1) 1 (1) Derivative instruments (1) (1) (1) -- Foreign currency translation adjustments 1 (7) (2) (6) ---- ---- ---- ---- Other comprehensive loss (3) (9) (2) (7) ---- ---- ---- ---- Comprehensive income $ 153 $ 6 $ 136 $ 12 ==== ==== ==== ==== At second quarter-end 2003, the aggregate fair value of all derivative instruments was a $10 million liability, consisting of a $10 million liability for an interest rate swap derivative and a $0.4 million liability related to linerboard and OCC derivatives. There was no ineffective portion of derivatives charged to earnings in second quarter 2003 or in first six months 2003 and amounts reclassified from other comprehensive income into earnings were not material. NOTE D - SEGMENT INFORMATION The Company has three reportable segments: Corrugated Packaging, Building Products, and Financial Services. The Company evaluates performance based, in part, on operating income before other (income) expense, unallocated general and administrative expenses, parent company interest, and income taxes. Other (income) expense includes gain or loss on sale of assets, asset impairments and expenses associated with consolidation and supply chain initiatives and facility closures. 14 TEMPLE-INLAND INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Unallocated General & Administrative and Other Corrugated Building Financial (Income) For second quarter 2003 Packaging Products Services Expense Total ----------------------- --------- -------- -------- -------------- ----- (in millions) Revenues from external customers $ 685 192 305 -- $ 1,182 Depreciation, depletion and amortization $ 42 16 9(e) 1 $ 68 Operating income $ 1 12 44 (34)(a) $ 23 Financial Services, net interest income $ -- -- 94 -- $ 94 Capital expenditures $ 21 7 6 1 $ 35 --------------------------------------------------------------------------------------------------- For first six months 2003 or at second quarter end 2003 ---------------------------- (in millions) Revenues from external customers $ 1,352 372 593 -- $ 2,317 Depreciation, depletion and amortization $ 83 32 16(e) 3 $ 134 Operating income $ (3) 3 83 (54)(b) $ 29 Financial Services, net interest income $ -- -- 189 -- $ 189 Total assets $ 2,442 1,116 17,903 99 $21,560 Capital expenditures $ 41 15 11 2 $ 69 Goodwill $ 239 -- 149 -- $ 388 --------------------------------------------------------------------------------------------------- For second quarter 2002 (in millions) Revenues from external customers $ 703 218 269 -- $ 1,190 Depreciation, depletion and amortization $ 42 16 7(e) 1 $ 66 Operating income $ 29 21 37 (14)(c) $ 73 Financial Services, net interest income $ -- -- 91 -- $ 91 Capital expenditures $ 13 11 5 2 $ 31 --------------------------------------------------------------------------------------------------- For first six months 2002 or at second quarter end 2002 ---------------------------- (in millions) Revenues from external customers $ 1,260 408 542 -- $ 2,210 Depreciation, depletion and amortization $ 77 30 17(e) 2 $ 126 Operating income $ 51 31 71 (31)(d) $ 122 Financial Services, net interest income $ -- -- 183 -- $ 183 Total assets $ 2,692 1,200 16,440 73 $20,405 Capital expenditures $ 30 20 7 2 $ 59 Goodwill $ 162 -- 136 -- $ 298 ---------------------------------------------------------------------------------------------------
(a) Includes other (income) expenses of $23 million, of which $1 million is related to the Mt. Jewett particleboard plant closure, which applies to Building Products, $23 million is related to consolidation and supply chain cost reduction initiatives of which $2 million was attributable to Financial Services, and other income of $1 million related to the collection of notes that were written off in 2002, which applies to Corrugated Packaging. (b) Includes other (income) expenses of $32 million, of which $6 million is related to box plant closures, which applies to Corrugated Packaging, $1 million is related to Mt.Jewett particleboard plant closure, $26 million is related to consolidation and supply chain cost reduction initiatives of which $2 million was attributable to Financial Services, and other income of $1 million related to the collection of notes that were written off in 2002, which applies to Corrugated Packaging. 15 TEMPLE-INLAND INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (c) Includes other expenses of $6 million related to the repurchase of notes sold with recourse, which applies to Corrugated Packaging. (d) Includes other expenses of $13 million, of which $7 million is related to severance and write-off of technology investments, which applies to Financial Services, and $6 million related to the repurchase of notes sold with recourse, which applies to Corrugated Packaging. (e) Includes depreciation and amortization of premises and equipment and leased assets. NOTE E - CONTINGENCIES There are pending against the Company and its subsidiaries lawsuits, claims and environmental matters arising in the regular course of business. The resolution of these matters is not expected to have a material adverse effect on the Company's operations or financial position. NOTE F - ACQUISITIONS The Company acquired effective control of Gaylord Container Corporation on February 28, 2002. The Company acquired a box plant in Puerto Rico during March 2002, two converting operations of Mack Packaging Group, Inc. during May 2002, and Fibre Innovations LLC during November 2002. The results of the acquired operations have been included in the Company's income statement since the dates of acquisition. The following parent company unaudited pro forma information assumes these acquisitions and related financing occurred at the beginning of 2002 (in millions except per share): Second Quarter First Six Months 2002 2002 ---- ---- (in millions, except per share) Net revenues $ 927 $ 1,811 Income from continuing operations $ 13 $ 19 Per diluted share Income from continuing operations $ 0.25 $ 0.37 NOTE G - DISCONTINUED OPERATIONS At second quarter-end 2003, discontinued operations consist of Gaylord's chemical business and accruals related to the 1999 sale of the bleached paperboard operations. At second quarter-end 2003, the assets and liabilities of discontinued operations includes $8 million of working capital, $16 million of property and equipment, and $19 million of environmental and other long- term accruals. Revenues from discontinued operations for second quarter 2003 were $3 million and for first six months 2003 were $12 million. 16 TEMPLE-INLAND INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS NOTE H - OTHER OPERATING (INCOME) EXPENSE Other operating (income) expense consists of: Second Quarter First Six Months 2003 2002 2003 2002 ---- ---- ---- ---- (in millions) Expenses associated with consolidation and supply chain initiatives $ 21 $ -- $ 24 $ -- Loss on closure of Mt. Jewett particleboard 1 -- 1 -- (Income) loss related to collection of notes that were written off in 2002 (1) 6 (1) 6 Loss on closure of box plants -- -- 6 -- ----- ----- ----- ----- Total $ 21 $ 6 $ 30 $ 6 ===== ===== ===== ===== Expenses related to initiatives to consolidate administrative functions and effect improvements in supply chain management consist principally of relocation costs and fees paid to third party consultants. During second quarter 2003, the Company permanently closed two box plants and paid $1 million in severance with another $1 million in severance to be paid in third quarter 2003. During second quarter 2003, the Company indefinitely shutdown the Mt. Jewett particleboard plant and incurred $1 million in severance, all of which was paid in second quarter 2003. A summary of the activity related to all facility closure accruals for second quarter 2003 follows: Beginning Cash End of of Period Additions Payments Period --------- --------- -------- ------ Involuntary employee terminations $ 2 $ 1 $ (2) $ 1 Contract termination penalties 6 -- -- 6 Environmental compliance 13 -- (1) 12 Demolition 12 -- -- 12 ----- ----- ----- ----- Total $ 33 $ 1 $ (3) $ 31 ===== ===== ===== ===== 17 TEMPLE-INLAND INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS NOTE I - INCOME TAX During second quarter 2003, the Internal Revenue Service concluded its examination of the Company's tax returns through 1996, including matters related to net operating losses and minimum tax credit carryforwards, which resulted from certain deductions following the 1988 acquisition of Guaranty Bank and for which no financial accounting benefit had been recognized. Also, the Company resolved certain state tax refund claims for the years 1991 through 1994. As a result, valuation allowances and tax accruals previously provided for these matters are no longer required. Accordingly, during second quarter 2003, the Company recorded a one-time benefit of $165 million, or $3.05 per diluted share. Of this one-time benefit, $26 million represents expected cash refunds of previously paid taxes plus related interest. The remainder is a non-cash benefit. NOTE J - NEW ACCOUNTING PRONOUNCEMENTS Stock-Based Compensation Beginning January 2003, the Company voluntarily adopted the prospective transition method of accounting for stock-based compensation contained in Statement of Financial Accounting Standards (SFAS) No. 148, Accounting for Stock-Based Compensation- Transition and Disclosure, an amendment of FASB Statement No. 123. The principal effect of adopting the prospective transition method is that the fair value of stock options granted in 2003 and thereafter are charged to expense over the option vesting period. As a result of the adoption of this prospective transition method, second quarter 2003 net income was decreased by $3 million or $0.04 per share. Prior to 2003, the Company used the intrinsic value method in accounting for its stock-based compensation. As a result, no stock-based compensation expense related to stock options is reflected in prior years' net income, as all stock options granted had an exercise price equal to the market value of the underlying common stock on the date of grant. Therefore, the cost related to stock-based compensation recognized in net income for second quarter 2003 and 2002 is less than would have been recognized if the fair value method had been applied to all stock options granted since 1995. The following table illustrates the effect on net income and earnings per share as if the fair value method had been applied to all stock options granted since 1995. 18 TEMPLE-INLAND INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Second Quarter First Six Months 2003 2002 2003 2002 ---- ---- ---- ---- (in millions) Net income, as reported $ 156 $ 15 $ 138 $ 19 Add: Stock-based compensation expense, net of related tax effects, included in the determination of reported net income 5 1 10 2 Deduct: Total stock-based compensation expense, net of related tax effects, determined under the fair value based method for all awards (8) (3) (15) (6) ----- ----- ----- ----- Pro forma net income $ 153 $ 13 $ 133 $ 15 ===== ===== ===== ===== Earnings per share: Basic, as reported $ 2.87 $ 0.29 $ 2.55 $ 0.37 Basic, pro forma $ 2.83 $ 0.25 $ 2.46 $ 0.29 Diluted, as reported $ 2.87 $ 0.29 $ 2.55 $ 0.37 Diluted, pro forma $ 2.83 $ 0.25 $ 2.46 $ 0.29 Liabilities and Equity Instruments Beginning third quarter 2003, the Company will be required to adopt SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This Statement establishes standards for classifying and measuring as liabilities certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity. The effect on earnings or financial position of adopting this statement is not expected to be material. Asset Retirement Obligations Beginning January 2003, the Company was required to adopt SFAS No. 143, Accounting for Asset Retirement Obligations. The Statement requires legal obligations associated with the retirement of long- lived assets to be recognized at their fair value at the time that the obligations are incurred. Upon initial recognition of a liability, that cost is capitalized as part of the related long- lived asset and allocated to expense over the useful life of the asset. The effect of adopting this statement was to increase property, plant and equipment by $3 million, recognize an asset retirement obligation liability of $4 million, and to increase first quarter net loss by $1 million or $0.01 per share for the cumulative effect of adoption. Other Pronouncements Beginning third quarter 2003, the Company will be required to apply FASB Interpretation No. 46, Consolidation of Variable Interest Entities to its variable interest entities created prior to February 1, 2003. The Company has not yet determined the effect on earnings or financial position of applying this interpretation, but expects the effects will not be material. 19 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Forward-Looking Statements Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties. The actual results achieved by the Company may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include general economic, market, or business conditions; the opportunities or lack thereof that may or may not be presented to and pursued; availability and price of raw materials used; competitive actions by other companies; changes in laws or regulations; the accuracy of certain judgments and estimates concerning the integration of acquired operations; the accuracy of certain judgments and estimates concerning the consolidation and supply chain initiatives; and other factors, many of which are beyond the control of the Company. Results of Operations Summary Consolidated revenues were $1.2 billion in second quarter 2003 and second quarter 2002. Income from continuing operations was $155 million in second quarter 2003 compared with $16 million in second quarter 2002. Income from continuing operations per share was $2.86 in second quarter 2003 compared with $0.31 in second quarter 2002. Business Segments The Company manages its operations through three business segments, Corrugated Packaging, Building Products, and Financial Services. Each of these business segments is affected by the factors of supply and demand and changes in domestic and global economic conditions. These conditions include changes in interest rates, new housing starts, home repair and remodeling activities, and the strength of the U.S. dollar, some or all of which may have varying degrees of impact on the business segments. As used herein, the term "parent company" refers to the financial statements of the Company and its manufacturing business segments, Corrugated Packaging and Building Products, with Financial Services reflected on the equity method. The Company evaluates performance based on operating income before other (income) expense, unallocated general and administrative expenses, parent company interest, and income taxes. Other (income) expense includes gain or loss on sale of assets, asset impairment and expenses associated with consolidation and supply chain initiatives and facility closure accruals. 20 A summary of the results of operations by business segment follows: Second Quarter First Six Months 2003 2002 2003 2002 ---- ---- ---- ---- (in millions, except per share) Revenues Corrugated Packaging $ 685 $ 703 $ 1,352 $ 1,260 Building Products 192 218 372 408 Financial Services 305 269 593 542 ------ ----- ----- ----- Total revenues $ 1,182 $ 1,190 $ 2,317 $ 2,210 ===== ===== ===== ===== Segment Operating Income Corrugated Packaging $ 1 $ 29 $ (3) $ 51 Building Products 12 21 3 31 Financial Services 44 37 83 71 ----- ----- ----- ----- Total segment operating income 57 87 83 153 Unallocated general and administrative expenses (11) (8) (22) (18) Other income (expense)(a)(b) (23) (17) (32) (24) Parent company interest (35) (36) (70) (61) ----- ----- ----- ----- Income (loss) before taxes (12) 26 (41) 50 Income tax (expense) benefit, including a one-time tax benefit of $165 million in 2003 167 (10) 179 (19) ----- ----- ----- ----- Income from continuing operations 155 16 138 31 Discontinued operations 1 (1) 1 (1) Effect of accounting change -- -- (1) (11) ----- ----- ----- ----- Net income $ 156 $ 15 $ 138 $ 19 ===== ===== ===== ===== Diluted earnings per share Income from continuing operationS $ 2.86 $ 0.31 $ 2.55 $ 0.61 Discontinued operations 0.01 (0.02) 0.01 (0.02) Effect of accounting change -- -- (0.01) (0.22) ----- ----- ----- ----- Net income $ 2.87 $ 0.29 $ 2.55 $ 0.37 ===== ===== ===== ===== Average diluted shares outstanding 54.1 52.4 54.1 51.0 (a) Other income (expense) includes (i) for second quarter 2003, expenses of $1 million related to the Mt. Jewett particleboard plant closure, which applies to Building Products, $23 million related to consolidation and supply chain initiatives, of which $2 million was attributable to Financial Services, and income of $1 million related to the collection of notes written off in 2002, which applies to Corrugated Packaging, and (ii) for second quarter 2002, a $6 million charge related to the repurchase of notes sold with recourse, which applies to Corrugated Packaging, and an $11 million write off of unamortized financing fees in connection with the early repayment of a bridge financing facility. (b) Other income (expense) includes (i) for first six months 2003, expenses of $6 million related to box plant closures and $1 million of income related to the collection of notes written off in 2002, which applies to Corrugated Packaging, $1 million related to the Mt. Jewett particleboard plant closure, which applies to Building Products, and $26 million related to consolidation and supply chain initiatives, of which $2 million was attributable to Financial Services, and (ii) for first six months 2002, a $7 million charge for severance and write-off of technology investments, which applies to Financial Services, a $6 million charge related to the repurchase of notes sold with recourse, which applies to Corrugated Packaging, and an $11 million write off of unamortized financing fees in connection with the early repayment of a bridge financing facility. 21 For second quarter 2003 and 2002 Corrugated Packaging Corrugated Packaging revenues were $685 million in second quarter 2003 compared with $703 million in second quarter 2002. Revenues from sales of corrugated packaging represented 90 percent of segment revenues for second quarter 2003 and second quarter 2002. The remaining revenues are derived from sales of linerboard. The change in revenues was principally due to changes in average prices and shipments: Second Quarter 2003 versus Second Quarter 2002 Increase (Decrease) in ---------------------------------------------- Average Prices Shipments(a) -------------- ------------ Corrugated packaging -- (3%) Linerboard 1% 12% (a) 2002 shipments have been adjusted for the effect of acquisitions. Compared with first quarter 2003, Corrugated Packaging revenues were up $18 million. Average corrugated packaging prices were down two percent while shipments were up four percent. Average linerboard prices were down six percent while shipments were up 19 percent. Corrugated packaging markets continue to be adversely affected by the weak manufacturing economy. Linerboard markets continue to be adversely affected by both the weak manufacturing economy and increased offshore capacity, partially offset by a weaker U.S. dollar. Costs, which include production, selling, distribution, and administrative costs, were $684 million in second quarter 2003 compared with $674 million in second quarter 2002. The change in costs in 2003 was principally due to: - higher energy costs, up $13 million, - higher pension costs, up $7 million, and - lower OCC costs due to lower prices and a decrease in OCC purchases, down $11 million. Average OCC prices were $95 per ton during second quarter 2003 compared with $102 per ton during second quarter 2002. It is likely that OCC costs will continue to fluctuate during 2003. Mill production was: - 819,000 tons in second quarter 2003, - 857,000 tons in second quarter 2002, and - 763,000 tons in first quarter 2003. Mill production data is not comparable due to the effect of the Antioch shutdown completed during September 2002. 22 The percentage of mill production used by Corrugated Packaging operations was: - 82 percent in second quarter 2003, - 84 percent in second quarter 2002, and - 84 percent in first quarter 2003. The remainder was sold in the domestic and export markets. Excluding routine maintenance, production downtime was: - 18,000 tons in second quarter 2003 due to mix and operational reasons, - 108,000 tons in second quarter 2002 due to market, mix and operational reasons, and - 46,000 tons in first quarter 2003 due to mix and operational reasons. Production downtime may occur in future quarters. Market conditions continue to be weak for lightweight gypsum facing paper. As a result, the Company's Premier Boxboard joint venture continues to produce both gypsum facing paper and corrugating medium. The Company purchased 47,000 tons of corrugating medium from the joint venture in second quarter 2003. It is uncertain when market conditions for lightweight gypsum facing paper will improve. The Company is continuing its efforts to enhance return on investment within Corrugated Packaging. These efforts include reviewing operations that are unable to meet return objectives and determining appropriate courses of action including the possible consolidation and rationalization of converting facilities. During second quarter 2003, the Company affected the previously announced closure of its box plants in Hattiesburg, Mississippi and Elizabethton, Tennessee and paid $1 million in previously accrued severance to affected employees. It is expected that the remaining severance of $1 million will be paid during third quarter 2003. These losses and costs are included in other operating (income) expense and excluded from segment operating income. Corrugated Packaging had operating income of $1 million in second quarter 2003 compared with $29 million in second quarter 2002. Building Products Building Products revenues were $192 million in second quarter 2003 compared with $218 million in second quarter 2002. The change in revenues in 2003 was principally due to changes in average prices and shipments as follows: 23 Second Quarter 2003 versus Second Quarter 2002 Increase (Decrease) in ---------------------------------------------- Average Prices Shipments ---------------- --------- Lumber (9%) 7% Particleboard (4%) (21%) Gypsum (3%) (12%) MDF (4%) (33%) Other revenues include sales of high-value timberlands. These sales contributed $5 million in operating income in second quarter 2003 compared with $5 million in second quarter 2002 and $1 million in first quarter 2003. Compared with first quarter 2003, revenues were up $12 million. Average prices were up five percent for lumber, three percent for particleboard, and seven percent for gypsum, while average prices were down two percent for MDF. Shipments were up nine percent for lumber, while shipments were down ten percent for particleboard, nine percent for gypsum and 11 percent for MDF. Costs, which include production, selling, distribution, and administrative costs, were $180 million in second quarter 2003 compared with $197 million in second quarter 2002. The change in costs in 2003 was principally due to lower production volumes partially offset by higher energy costs, up $2 million. Production averaged from a low of 59 percent to a high of 80 percent of capacity in the various product lines. Production was curtailed to varying degrees in all product lines in second quarter 2003 to match customer demand. The Company's joint venture operations also experienced production curtailments in second quarter 2003. Production may be curtailed in future quarters to match customer demand. The Company's Del-Tin Fiber LLC MDF joint venture in El Dorado, Arkansas continues to experience production and cost issues, though some improvement was made in second quarter 2003. In January 2003, Deltic Timber Corporation, the partner in this venture, announced its intention to exit this business upon the earliest, reasonable opportunity provided by the market. It is uncertain what effects Deltic Timber's decision will have on the joint venture or its operations. The venture had a net loss of $2 million in second quarter 2003 compared with a net loss of $6 million in second quarter 2002, of which the Company's share was $1 million and $3 million, respectively. In second quarter 2003, the Company and Deltic Timber Corporation each contributed $2 million in cash to the venture. The Company is continuing its efforts to enhance return on investment within Building Products. These efforts include reviewing operations that are unable to meet return objectives and determining appropriate courses of action including the 24 possible rationalization of production facilities. In addition, the Company is continuing to address market issues at its Mt. Jewett, Pennsylvania particleboard plant and market and production issues at its MDF facilities, including the Del-Tin Fiber MDF joint venture. During second quarter 2003, the Company expensed and paid $1 million in severance in connection with the indefinite shutdown of its Mt. Jewett particleboard plant. These costs are included in other operating (income) expense and excluded from segment operating income. Building Products had income of $12 million in second quarter 2003 compared with $21 million in second quarter 2002. Financial Services Operations Financial Services revenues, consisting of interest and non- interest income, were $305 million in second quarter 2003 compared with $269 million in second quarter 2002. Selected financial information for Financial Services follows: First Second Quarter Quarter 2003 2002 2003 ---- ---- ---- (in millions) Net interest income $ 94 $ 91 $ 95 Provision for loan losses (20) (15) (11) Noninterest income 118 82 95 Noninterest expense (148) (121) (140) ----- ----- ----- Segment operating income 44 37 39 Severance (2) -- -- ----- ----- ----- Operating income $ 42 $ 37 $ 39 ===== ===== ===== Net interest income was $94 million in second quarter 2003 compared with $91 million in second quarter 2002. The change was principally due to: - an increase in average earning assets, principally securities, up 14 percent, - partially offset by a decline in the net interest spread resulting from the lower interest rate environment combined with an asset sensitive position. In general, increases in interest rates increase Financial Services' net interest income. However, Financial Services' net interest income is not as sensitive to changes in interest rates at second quarter end 2003 as it was at year end 2002 principally ue to: - a change in the mix of earning assets achieved by increasing single-family mortgage loans and securities with interest rates that adjust annually after an initial 25 fixed rate for the first three to five years and decreasing commercial real estate loans, the interest rates on which generally reset every 30 to 90 days, and - a shift in deposits decreasing certificates of deposit and increasing money market accounts. If interest rates rise for the remainder of 2003, then it is likely that net interest income would be positively affected. If interest rates decline during the remainder of 2003 it is likely that net interest income will be adversely affected. The provision for loan losses was $20 million in second quarter 2003 compared with $15 million in second quarter 2002. The provision for second quarter 2003 related principally to commercial real estate loans and asset-based commercial and business loans. The provision for second quarter 2002 related principally to commercial and business loans, primarily in the asset-based lending and leasing portfolios, and residential loans in the senior housing portfolio. Noninterest income includes revenues from mortgage banking, real estate, and insurance activities. Noninterest income was $118 million in second quarter 2003 compared with $82 million in second quarter 2002. The change in noninterest income in 2003 was principally due to: - an increase in mortgage banking loan originations and related gain on sale of loans, up $50 million, - partially offset by higher amortization and impairment of mortgage servicing rights, up $14 million, associated with increased runoff of the servicing portfolio. Noninterest expense was $148 million in second quarter 2003 compared with $121 million in second quarter 2002. The change in noninterest expense in 2003 was principally due to higher costs associated with the mortgage banking operations, primarily salary, commissions, benefits, and loan servicing and origination expenses, up $24 million as a result of the increased loan production activity. See Mortgage Banking Activities for further information regarding mortgage-banking operations. Earning Assets Earning assets include cash equivalents, mortgage loans held for sale, securities, and loans. At second quarter-end 2003, cash equivalents, mortgage loans held for sale, securities, and residential housing loans constituted 80 percent of total earning assets compared with 71 percent at second quarter-end 2002. The increased percentage in 2003 is a result of efforts to change the earning asset mix by increasing residential earning assets. 26 Securities, which include mortgage-backed and other securities, were $5.9 billion at second quarter-end 2003 compared with $4.8 billion at second quarter-end 2002. The increase was primarily a result of purchasing mortgage-backed securities as part of the efforts to increase residential housing assets. Loans were $9.7 billion at second quarter-end 2003 compared with $9.7 billion at second quarter-end 2002 and $10.0 billion at first quarter-end 2003. The following table summarizes the composition of the loan portfolio: First Quarter- Second Quarter-End End 2003 2002 2003 (in millions) Single-family mortgage $ 2,892 $ 1,997 $ 2,743 Single-family mortgage warehouse 502 298 463 Single-family construction 1,065 913 1,028 Multifamily and senior housing 1,865 2,011 1,892 ----- ----- ----- Total residential housing 6,324 5,219 6,126 Commercial real estate 1,393 2,419 1,765 Commercial and business 1,812 1,882 1,886 Consumer and other 182 223 191 ----- ----- ----- Total loans 9,711 9,743 9,968 Less allowance for loan losses (117) (135) (122) ----- ----- ----- Loans receivable, net $ 9,594 $ 9,608 $ 9,846 ===== ===== ===== Single-family mortgages are made to owners to finance the purchase of a home. Single-family mortgage warehouse provides funding to mortgage lenders to support the flow of loans from origination to sale. Single-family construction finances the development and construction of single-family homes, condominiums, and town homes, including the acquisition and development of home lots. Multifamily and senior housing loans are for the development, construction, and lease up of apartment projects and housing for independent, assisted, and memory- impaired residents. Commercial real estate loans provide funding for the development, construction, and lease up principally of office, retail, and industrial projects. Commercial and business loans finance business operations and principally include asset-based, syndicated and middle market loans, and direct financing leases on equipment. Consumer and other loans principally include loans secured by junior liens on single-family homes not related to their purchase. Although the size of the total loan portfolio has remained relatively flat over the past year, the composition of the portfolio has changed due to efforts to increase residential housing assets. As a result, residential housing loans represent 65 percent of the loan portfolio at second quarter-end 2003 compared with 54 percent at second quarter-end 2002 and 61 percent at first quarter-end 2003. 27 Asset Quality Several key measures are used to evaluate and monitor asset quality. These measures include the level of loan delinquencies, nonperforming loans, assets, and allowance coverage.
First Second Quarter- Quarter- End End 2003 2002 2003 ---- ---- ---- (in millions) Accruing loans past due 30 - 89 days $ 48 $ 81 $ 95 Accruing loans past due 90 days or more -- -- 15 ---- ---- ---- Accruing loans past due 30 days or more $ 48 $ 81 $ 110 ==== ==== ==== Nonaccrual loans $ 69 $ 179 $ 128 Restructured loans 10 -- -- ---- ---- ---- Nonperforming loans 79 179 128 Foreclosed property 12 7 4 Restructured operating leases 42 -- 42 ---- ---- ---- Nonperforming assets $ 133 $ 186 $ 174 ==== ==== ==== Allowance for loan losses $ 117 $ 135 $ 122 Nonperforming loan ratio 0.81% 1.84% 1.28% Nonperforming asset ratio 1.37% 1.91% 1.74% Allowance for loan losses/total loans 1.21% 1.39% 1.22% Allowance for loan losses/nonperforming loans 148.84% 75.48% 95.52%
The change at second quarter-end 2003 compared with second quarter-end 2002 in the level of nonaccrual loans was principally due to $61 million in upgrades of several loans in the senior housing portfolio, $36 million in payoffs and paydowns of senior housing and commercial loans, and $ 21 million in charge-offs of previously reserved loans. These decreases were partially offset by new nonaccrual loans, principally commercial and business loans. The restructured operating leases added in 2003 relate to the restructuring of two previous leveraged, direct financing leases on cargo aircraft totaling $33 million. Due to a reduction in the lease payments in the restructuring, the leases were reclassified as operating leases. As a result, $27 million in leverage was removed, and the assets were written down to estimated fair market value. The restructured operating leases will be classified as nonperforming until such time as the lessee has evidenced the ability to perform under the terms of the restructured leases. Both the asset-based lending and leasing portfolios, which together represent 35 percent of commercial and business loans, will likely continue to be adversely affected by the weak economy. 28 Allowance for Loan Losses The allowance for loan losses is comprised of specific allowances, general allowances, and an unallocated allowance. Management evaluates the allowance for loan losses to ensure the level is adequate to absorb losses inherent in the loan portfolio. The allowance is increased by charges to income and decreased by charge-offs, net of recoveries. Changes in the allowance for loan losses were: First Second Quarter Quarter 2003 2002 2003 (in millions) Balance at beginning of period $ 122 $ 136 $ 132 Charge-offs: Total residential housing -- (12) -- Commercial real estate (7) -- -- Commercial and business (21) (5) (21) Consumer and other (1) -- -- ---- ---- ---- Total charge-offs (29) (17) (21) ---- ---- ---- Recoveries: Total residential housing 4 1 -- Commercial real estate -- -- -- Commercial and business -- -- -- Consumer and other -- -- -- ---- ---- ---- Total recoveries 4 1 -- ---- ---- ---- Net charge-offs (25) (16) (21) Provision for loan losses 20 15 11 ---- ---- ---- Balance at end of period $ 117 $ 135 $ 122 ==== ==== ==== Net charge-offs (annualized) as a percentage of average loans outstanding 1.00% 0.65% 0.86% Second quarter 2003 charge-offs related principally to several loans in the asset-based lending portfolio and a commercial real estate loan secured by an office building. Second quarter 2002 charge-offs related principally to the two senior housing loans and two commercial loans. First quarter 2003 charge offs related principally to the two restructured aircraft leases and two asset based commercial loans. Mortgage Banking Activities Mortgage loan originations were $4.3 billion in second quarter 2003 compared with $1.7 billion in second quarter 2002. The high level of mortgage loan originations during second quarter 2003 was due to continued refinance activity resulting from the low interest rate environment. Higher interest rates in second quarter 2002 resulted in a significant reduction in mortgage refinancing activity, contributing to the lower level of originations. 29 In second quarter 2003, the savings bank retained $469 million in loans originated by the mortgage banking operations, compared with $126 million in second quarter 2002. The change in loans originated for the savings bank in second quarter 2003 was the result of continued efforts to increase the level of adjustable-rate single-family mortgage assets. In second quarter 2003, the mortgage banking operations sold $3.8 billion in loans to secondary markets by delivering loans to third parties or by delivering loans into mortgage-backed securities that were purchased by third parties. Of the loans sold in second quarter 2003, the only retained interest was mortgage servicing rights of $17 million relating to $1.7 billion of loans. The following table provides information regarding the mortgage servicing portfolio: Second Quarter First End Quarter End 2003 2002 2003 ---- ---- ---- (in millions) Outstanding balance of loans serviced for: Third parties $ 8.4 $ 9.6 $ 8.2 Savings bank 1.9 0.8 2.0 ------ ------ ------ Total mortgage servicing portfolio $ 10.3 $ 10.4 $ 10.2 ====== ====== ====== Annualized runoff rate 53% 24% 42% The change in the balance of loans serviced was principally due to significant repayments on loans, partially offset by new loan originations for which servicing was retained. The change in the runoff rate was due to the lower interest rate environment in 2003. As a result of the high runoff rates, amortization and impairment of mortgage servicing rights increased in second quarter 2003. The following table provides information regarding charges for amortization and impairment of mortgage servicing rights: Second Quarter First Quarter 2003 2002 2003 ---- ---- ---- (in millions) Amortization $ 18 $ 8 $ 16 Impairment 5 1 2 ------- ------- ------- $ 23 $ 9 $ 18 ======= ======= ======= In 2003 and 2002, the mortgage banking operations were significantly affected by the refinancing activity associated with the declining interest rate environment. In July 2003, interest rates increased somewhat. If interest rates remain 30 constant or increase, the level of mortgage originations and the level of mortgage servicing rights amortization and impairment will likely decline. However, if interest rates again decline in 2003, the level of mortgage originations and the level of mortgage servicing rights amortization and impairment will likely remain high. Unallocated General and Administrative Expenses, Interest and Other (Income) Expense Unallocated general and administrative expenses were $11 million in second quarter 2003 compared with $8 million in second quarter 2002. The change in 2003 was principally due to an increase in pension and stock-based compensation costs. Parent company interest expense was $35 million in second quarter 2003 compared with $36 million in second quarter 2002. During second quarter 2002, the parent company effected a number of transactions that lengthened debt maturities and reduced reliance on short-term borrowings. The average interest on borrowings was 7.1 percent in second quarter 2003 compared with 6.2 percent in second quarter 2002. In addition, long-term debt was reduced by $196 million. Other operating (income) expense for second quarter 2003 includes $23 million in expenses related to initiatives to consolidate administrative functions and effect improvements in supply chain management, of which $2 million was attributable to Financial Services. These expenses consist principally of relocation and severance expenses and fees paid to third party consultants. The Company expects to incur in the remainder of 2003 an additional $10 million to $15 million in relocation, severance, benefits, and other expenses related to these initiatives. The Company expects the benefits from these initiatives to begin to be realized in 2004. Pension Expense Non-cash pension expenses were $11 million in second quarter 2003 compared with $2 million in second quarter 2002. The change in 2003 was principally due to previously disclosed changes in the assumed discount rate, a decrease in the expected rate of return on plan assets to 8.5 percent, and an increase in the recognition of the accumulated decline in the fair value of plan assets. Income Taxes During second quarter 2003, the Internal Revenue Service concluded its examination of the Company's tax returns through 1996, including matters related to net operating losses and minimum tax credit carryforwards, which resulted from certain deductions following the 1988 acquisition of Guaranty Bank and 31 for which no financial accounting benefit had been recognized. Also, the Company resolved certain state tax refund claims for the years 1991 through 1994. As a result, valuation allowances and tax accruals previously provided for these matters are no longer required. Accordingly, during second quarter 2003, the Company recorded a one-time benefit of $165 million, or $3.05 per diluted share. Of this one-time benefit, approximately $26 million represents expected cash refunds of previously paid taxes plus related interest. The remainder is a non-cash benefit. Excluding this one-time benefit, the effective tax rate for 2003 is expected to be 35 percent based on current estimates of income and expenses for the year 2003. The effective tax rate includes federal and state income taxes and the effects of non-deductible items. Average Shares Outstanding Average shares outstanding were 54.1 million in second quarter 2003 compared with 52.4 million in second quarter 2002. The change in 2003 was principally due to the May 2002 sale of 4.1 million shares of common stock. The dilutive effect of stock options and equity purchase contracts was not significant in any of the periods presented. For first six months 2003 and 2002 Corrugated Packaging The Company acquired effective control of Gaylord Container Corporation and began consolidating the results of Gaylord in March 2002. The Company also acquired a box plant in Puerto Rico in March 2002, the converting facilities of Mack Packaging Group in May 2002, and Fibre Innovations LLC in November 2002. As a result, the 2003 financial information for Corrugated Packaging is not comparable to prior periods. Corrugated Packaging revenues were $1,352 million for first six months 2003 compared with $1,260 million for first six months 2002. Revenues from sales of corrugated packaging represented 91 percent of segment revenues for first six months 2003 and 90 percent of revenues for first six months 2002. The remaining revenues are derived from sales of linerboard. The change in revenues was principally due to changes in average prices and shipments: First Six Months 2003 versus First Six Months 2002 Increase (Decrease) in -------------------------------------------------- Average Prices Shipments(a) -------------- ------------ Corrugated packaging (1%) (3%) Linerboard 1% 13% (a) 2002 shipments have been adjusted for the effect of acquisitions. 32 Costs, which include production, distribution, and administrative costs, were $1,355 million for first six months 2003 compared with $1,209 million for first six months 2002. The change in costs in 2003 was principally due to: - the inclusion of the acquired operations, - higher energy costs, up $35 million, - higher pension costs, up $14 million, and - lower OCC costs due to a decrease in OCC purchases, down $8 million. Average OCC prices were $88 per ton for first six months 2003 compared with $87 per ton for first six months 2002. Mill production was: - 1,582,000 tons for first six months 2003 and - 1,472,000 tons for first six months 2002. Mill production data is not comparable due to the effect of the Gaylord acquisition, completed on March 1, 2002, and Antioch shutdown completed September 2002. The percentage of mill production used by Corrugated Packaging operations was: - 83 percent for first six months 2003 and - 84 percent for first six months 2002. The remainder was sold in the domestic and export markets. Excluding routine maintenance, production downtime was: - 64,000 tons for first six months 2003 due to mix and operational reasons and - 211,000 tons for first six months 2002 due to market, mix and operational reasons. Production downtime may occur in future quarters. Market conditions continue to be weak for lightweight gypsum facing paper. As a result, the Company's Premier Boxboard joint venture continues to produce both gypsum facing paper and corrugating medium. The Company purchased 73,000 tons of corrugating medium from the joint venture during first six months 2003. Corrugated Packaging had a $3 million operating loss for first six months 2003 compared with income of $51 million for first six months 2002. Building Products Building Products revenues were $372 million for first six months 2003 compared with $408 million for first six months 2002. 33 The change in revenues in 2003 was principally due to lower average prices and shipments in most product lines as follows: First Six Months 2003 versus First Six Months 2002 Increase (Decrease) in --------------------------------------------------- Average Prices Shipments -------------- --------- Lumber (9%) 10% Particleboard (6%) (12%) Gypsum (3%) (9%) MDF (2%) (20%) Other revenues include sales of high-value timberlands. These sales contributed $6 million in operating income for first six months 2003 compared with $9 million for first six months 2002. Costs, which include production, distribution, and administrative costs, were $369 million for first six months 2003 compared with $377 million for first six months 2002. The change in costs in 2003 was principally due to lower production volumes partially offset by: - higher energy costs, up $5 million, and - higher pension costs, up $2 million. Production averaged from a low of 62 percent to a high of 77 percent of capacity in the various product lines. Production was curtailed to varying degrees in all product lines for first six months 2003 to match customer demand. The Company's joint venture operations also experienced production curtailments in second quarter 2003. Building Products had operating income of $3 million for first six months 2003 compared with $31 million for first six months 2002. Financial Services Operations Financial Services revenues, consisting of interest and non- interest income, were $593 million for first six months 2003 compared with $542 million for first six months 2002. Selected financial information for Financial Services follows: 34 First Six Months 2003 2002 ---- ---- (in millions) Net interest income $ 189 $ 183 Provision for loan losses (31) (29) Noninterest income 213 167 Noninterest expense (288) (250) ----- ----- Segment operating income 83 71 Severance and asset write-offs (2) (7) ----- ----- Operating income $ 81 $ 64 ===== ===== Net interest income was $189 million for first six months 2003 compared with $183 million for first six months 2002. The change was principally due to: - an increase in average earning assets, principally securities, up 15 percent, - partially offset by a decline in the net interest spread resulting from the lower interest rate environment combined with an asset sensitive position. The provision for loan losses was $31 million for first six months 2003 compared with $29 million for first six months 2002. The provision for first six months 2003 related principally to commercial real estate loans, the restructured aircraft leases, and commercial and business loans primarily in the asset-based lending portfolio. The provision for first six months 2002 related principally to commercial and business loans, primarily in the asset-based lending and leasing portfolios, and residential loans in the senior housing portfolio. Noninterest income includes revenues from mortgage banking and real estate and insurance activities. Noninterest income was $213 million for first six months 2003 compared with $167 million for first six months 2002. The change in noninterest income in 2003 was principally due to: - an increase in mortgage banking loan originations, and related gain on sale of loans, up $73 million, - partially offset by higher amortization and impairment of mortgage servicing rights, up $24 million. Noninterest expense was $288 million for first six months 2003 compared with $250 million for first six months 2002. The change in noninterest expense in 2003 was principally due to higher costs associated with the mortgage banking operations, primarily salary, commissions, benefits, and loan servicing and origination expenses, up $38 million as a result of the increased loan production activity. See Mortgage Banking Activities for further information regarding mortgage-banking operations. 35 Changes in the allowance for loan losses were: First Six Months 2003 2002 ---- ---- (in millions) Balance at beginning of period $ 132 $ 139 Charge-offs: Total residential housing -- (12) Commercial real estate (7) -- Commercial and business (42) (23) Consumer and other (1) -- ------ ------ Total charge-offs (50) (35) ------ ------ Recoveries: Total residential housing 4 1 Commercial real estate -- -- Commercial and business -- 1 Consumer and other -- -- ----- ------ Total recoveries 4 2 ------ ------ Net charge-offs (46) (33) Provision for loan losses 31 29 ------ ------ Balance at end of period $ 117 $ 135 ====== ====== Net charge-offs (annualized) as a percentage of average loans outstanding 0.93% 0.68% Charge-offs for first six months 2003 related principally to two restructured aircraft leases, a commercial real estate loan secured by an office building, and several asset-based commercial loans. Charge-offs for first six months 2002 related principally to senior housing loans and asset-based commercial and business loans. Mortgage Banking Activities Mortgage loan originations were $7.5 billion for first six months 2003 compared with $3.8 billion for first six months 2002. The high level of mortgage loan originations for first six months 2003 was due to continued refinance activity resulting from the low interest rate environment. Higher interest rates for first six months 2002 resulted in a significant reduction in mortgage refinancing activity, contributing to the lower level of originations. For first six months 2003, the savings bank retained $1 billion in loans originated by the mortgage banking operations, compared with $310 million for first six months 2002. The significant increase in loans originated for the savings bank for first six months 2003 was the result of continued efforts to increase the level of adjustabl-rate single-family mortgage assets. For first six months 2003, the mortgage banking operations sold $6.6 billion in loans to secondary markets by delivering 36 loans to third parties or by delivering loans into mortgage- backed securities that were purchased by third parties. Of the loans sold during first six months 2003, the only retained interest was mortgage servicing rights of $23 million relating to $2.3 billion of loans. The outstanding balance of loans in the mortgage servicing portfolio decreased at an annualized rate of 48 percent during first six months 2003 compared with an annualized rate of 23 percent during first six months 2002. The change in the runoff rate was due to the lower interest rate environment in 2003. As a result of the high runoff rates, amortization and impairment of mortgage servicing rights increased for first six months 2003. The following table provides information regarding charges for amortization and impairment of mortgage servicing rights: First Six Months 2003 2002 (in millions) Amortization $ 34 $ 19 Impairment 7 (2) ----- ----- $ 41 $ 17 ===== ===== Unallocated General and Administrative Expenses, Interest and Other (Income) Expense Unallocated general and administrative expenses were $22 million for first six months 2003 compared with $18 million for first six months 2002. The change in 2003 was principally due to an increase in pension and stock-based compensation costs. Parent company interest expense was $70 million for first six months 2003 compared with $61 million for first six months 2002. The change was principally due to reduced reliance on short- term borrowings and to the full effect of interest expense on debt related to the acquisition of Gaylord. For first six months 2002, the parent company effected a number of transactions that lengthened debt maturities and reduced reliance on short-term borrowings. The average interest rate on borrowings was 7.0 percent for first six months 2003 compared with 5.7 percent for first six months 2002. Other operating expenses for first six months 2003 include $24 million in expenses related to initiatives to consolidate administrative functions and effect improvements in supply chain management, of which $2 million was incurred by Financial Services. These expenses consist principally of relocation and severance expenses and fees paid to third party consultants. 37 Pension Expense Non-cash pension expenses were $22 million for first six months 2003 compared with $4 million for first six months 2002. Income Taxes Excluding the second quarter 2003 one-time tax benefit, the effective tax rate for 2003 is expected to be 35 percent based on current estimates of income and expenses for the year 2003. Average Shares Outstanding Average shares outstanding were 54.1 million for first six months 2003 compared with 51.0 million for first six months 2002. The change in 2003 was principally due to the May 2002 sale of 4.1 million shares of common stock. The dilutive effect of stock options and equity purchase contracts was not significant in any of the periods presented. Capital Resources and Liquidity The consolidated net assets invested in Financial Services are subject, in varying degrees, to regulatory rules and regulations including restrictions on the payment of dividends to the parent company. Accordingly, parent company and Financial Services capital resources and liquidity are discussed separately. For first six months 2003 Parent Company Operating Activities Cash provided by operations was $142 million. Income for first six months 2003 included $26 million of depreciation and other non-cash charges and credits. Dividends received from Financial Services were $70 million. Working capital needs increased $42 million, principally due to a $46 million seasonal increase in receivables. Investing Activities Investing activities used $33 million. Proceeds from the sale of non-strategic assets acquired in connection with the acquisition of Gaylord were $30 million. Capital expenditures were $58 million. Capital expenditures are expected to approximate $160 million in 2003 or about 67 percent of the $240 million of expected depreciation in 2003. 38 Financing Activities Financing activities used $109 million. Debt and other borrowings were reduced $74 million. Cash dividends paid to shareholders were $37 million or $0.68 per share. Liquidity and Off Balance Sheet Financing Arrangements The parent company's sources of short-term funding are its operating cash flows, which include dividends received from Financial Services, and its existing credit arrangements. The parent company operates in cyclical industries, and its operating cash flows vary accordingly. The dividends received from the savings bank are subject to regulatory approval and restrictions. At second quarter-end 2003, the parent company had $520 million in unused borrowing capacity under its revolving credit agreements and $196 million under its accounts receivable securitization program, which matures in April 2006. At second quarter-end 2003, the parent company was in compliance with all of the terms and conditions of its credit agreements and accounts receivable securitization program. In 2003, $45 million in revolving credit agreements expire, all of which are unused at second quarter-end 2003; however, any borrowings outstanding at the end of the revolving period would not mature until two years after the revolving period ends. The long-term debt of the parent company is currently rated BBB and Baa3 by the rating agencies, with one rating agency maintaining a negative outlook. Subsequent to second quarter 2003 the Company, through the trustee, issued a call notice for all of the 8.25% Debentures payable 2022. The call date is August 15, 2003. The principal amount of $150 million and the call premium of $6 million will be funded by draws on the revolving credit facilities or with funding from its accounts receivable securitization program. In addition, a subsidiary of the Company has a $61 million term loan maturing October 1, 2003. The Company plans to repay this loan with funds provided from its revolving credit facilities or its accounts receivable securitization program. Financial Services The principal sources of cash for Financial Services are operating cash flows, deposits, and borrowings. Financial Services uses these funds to invest in earning assets, generally loans and securities. Operating Activities Cash provided by operations was $176 million. Income for first six months 2003 included $82 million of amortization and other non-cash charges. 39 Investing Activities Cash provided by investing activities was $127 million. Principal payments and maturities of securities, net of purchases, provided $156 million and loan originations, net of collections, used $44 million. Financing Activities Cash used for financing activities was $400 million. Borrowings decreased $310 million, principally due to repayments of FHLB advances and a decrease in deposits. In addition, $70 million in dividends were paid to the parent company. Cash Equivalents Cash equivalents were $341 million at second quarter-end 2003 compared with $438 million at year end 2002. Other Financial Services' short-term funding needs are met through operating cash flows, attracting new retail deposits, increased borrowings, and converting assets to cash through sales or reverse repurchase agreements. Assets that can be converted to cash include short-term investments, mortgage loans held for sale, and securities. At second quarter-end 2003, Financial Services had available liquidity of $2.2 billion. In addition, at second quarter-end 2003 commitments to originate single-family residential mortgage loans totaled $2.4 billion and commitments to sell single-family residential mortgage loans totaled $1.9 billion. At second quarter-end 2003, the savings bank exceeded all applicable regulatory capital requirements. The parent company expects to maintain the savings bank capital at a level that exceeds the minimum required for designation as "well capitalized." As a result, the Company may make capital contributions to the savings bank. During second quarter 2003, the Company made no capital contributions to the savings bank. Selected consolidated financial and regulatory capital data for the savings bank follows: Second Year-End Quarter- 2002 End 2003 (dollars in millions) Balance sheet data Total assets $ 17,517 $ 17,634 Total deposits 9,150 9,203 Shareholder's equity 1,007 1,025 40 Savings Regulatory For Categorization as Bank Minimum "Well Capitalized" Regulatory capital ratios: Tangible capital 6.4% 2.0% N/A Leverage capital 6.4% 4.0% 5.0% Tier 1 risk-based capital 9.6% 4.0% 6.0% Total risk-based capital 10.9% 8.0% 10.0% Energy and the Effects of Inflation Energy costs, principally natural gas, were $69 million in second quarter 2003 compared with $55 million in second quarter 2002. Energy costs, which remain at historically high levels, were down slightly in second quarter 2003 as compared with first quarter 2003. It is likely that energy costs will continue to fluctuate during 2003. Litigation and Related Matters There are pending against the Company and its subsidiaries lawsuits, claims and environmental matters arising in the regular course of business. The resolution of these matters is not expected to have a material adverse effect on the Company's operations or financial position. For further information on pending legal proceedings, see Part II. Item 1. Accounting Policies New Accounting Standards Adopted Stock-Based Compensation Beginning January 2003, the Company voluntarily adopted the prospective transition method of accounting for stock-based compensation contained in SFAS No. 148, Accounting for Stock- Based Compensation-Transition and Disclosure, an amendment of FASB Statement No. 123. The principal effect of adopting the prospective transition method is that the fair value of stock options granted in 2003 and thereafter are charged to expense over the option vesting period. As a result of the adoption of this prospective transition method, second quarter 2003 net income was decreased by $3 million or $0.04 per share. Prior to 2003, the Company used the intrinsic value method in accounting for its stock-based compensation. As a result, no stock-based compensation expense is reflected in prior years' net income, as all stock options granted had an exercise price equal to the market value of the underlying common stock on the date of grant. Therefore, the cost related to stock-based compensation recognized in net income for first quarter 2003 and 2002 is less than would have been recognized if the fair value method had been applied to all stock options granted since 1995. 41 Liabilities and Equity Instruments Beginning third quarter 2003, the Company will adopt SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This Statement establishes standards for classifying and measuring as liabilities certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity. The effect on earnings or financial position of adopting this statement is not expected to be material. Asset Retirement Obligations Beginning January 2003, the Company was required to adopt SFAS No. 143, Accounting for Asset Retirement Obligations. The Statement requires legal obligations associated with the retirement of long-lived assets to be recognized at their fair value at the time that the obligations are incurred. Upon initial recognition of a liability, that cost is capitalized as part of the related long-lived asset and allocated to expense over the useful life of the asset. The effect of adopting this statement was to increase property, plant and equipment by $3 million, recognize an asset retirement obligation liability of $4 million, and to increase first quarter net loss by $1 million or $0.01 per share for the cumulative effect of adoption. Other Pronouncements Beginning third quarter 2003, the Company will be required to apply FASB Interpretation No. 46, Consolidation of Variable Interest Entities to its variable interest entities created prior to February 1, 2003. The Company has not yet determined the effect on earnings or financial position of applying this interpretation but expects the effects will not be material. Critical Accounting Policies In second quarter 2003, there were no significant changes in critical accounting policies from those disclosed in the Company's Form 10-K for the year 2002. 42 Statistical and other data Second First Six Quarter Months 2003 2002 2003 2002 ---- ---- ---- ---- (in millions) Revenues(a) Corrugated Packaging Corrugated packaging $ 619 $ 636 $ 1,226 $ 1,135 Linerboard 66 67 126 125 ---- ---- ----- ----- Total Corrugated Packaging $ 685 $ 703 $ 1,352 $ 1,260 ==== ==== ===== ===== Building Products Pine lumber $ 64 66 $ 120 $ 118 Particleboard 36 47 75 90 Medium density fiberboard 23 33 49 59 Gypsum wallboard 16 20 34 39 Fiberboard 17 18 31 34 Other 36 34 63 68 ---- ---- ----- ----- Total Building Products $ 192 218 $ 372 $ 408 ==== ==== ===== ===== Unit sales(a) Corrugated Packaging Corrugated packaging, thousands of tons 809 833 1,589 1,468 Linerboard, thousands of tons 147 131 271 240 ---- ---- ----- ----- Total, thousands of tons 956 964 1,860 1,708 ==== ==== ===== ===== Building Products Pine lumber, mbf 216 202 414 375 Particleboard, msf 140 177 295 337 Medium density fiberboard, msf 57 85 121 152 Gypsum wallboard, msf 146 166 307 339 Fiberboard, msf 102 109 189 206 (a) Revenues and unit sales do not include joint venture operations. Note: Data for Corrugated Packaging for first six months 2003 is not comparable due to the effect of acquisitions completed in 2002. 43 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Interest Rate Risk The Company's current level of interest rate risk with respect to financial instruments is primarily due to an asset sensitive position within Financial Services and, to a lesser degree, variable rate debt at the parent company. The following table illustrates the estimated effect on pre- tax income from financial instruments of immediate, parallel and sustained shifts in interest rates for the subsequent 12-month period at second quarter-end 2003, with comparative information at year-end 2002. The estimated effect takes into account the effects of changing prepayment speeds and average balances over the next 12 months. Increase (decrease) in Income Before Taxes (In millions) Second Quarter End Year-end 2002 2003 Change in Parent Financial Parent Financial Interest Company Services Company Services Rates -------- ------- -------- ------- -------- +2% $(5) $ 24 $ (3) $ 40 +1% $(2) $ 28 $ (2) $ 34 0 $-- $ -- $ -- $ -- -1% $ 2 $(17) $ 2 $(29) Due to the current low levels of interest rates, the 2 percent decrease in interest rates is not presented. Financial Services is subject to interest rate risk from financial instruments to the extent that the interest-earning assets and interest-bearing liabilities repay or reprice at different times or in differing amounts or both. Financial Services is currently in an asset sensitive position whereby the rate and paydown characteristics of its assets are more responsive to changes in market interest rates than are its liabilities. Postured in this way, earnings will generally be positively affected in a rising rate environment, but generally be negatively affected in a falling rate environment. The change at second quarter end 2003 in sensitivity to changes in interest rates from year-end 2002 is due primarily to efforts to change the earning asset mix as well as changes in the deposit base. The commercial real estate portfolio, which tends to reprice frequently, decreased $500 million, while the mortgage loan portfolio increased by over $400 million, principally with loans that reprice after three to five years. Additionally, approximately $500 million of deposits have 44 shifted from certificates of deposit to money market deposit accounts, which reprice more frequently. Additionally, the fair value of mortgage servicing rights (estimated at $90 million at second quarter-end 2003) is also affected by changes in interest rates, primarily long-term fixed mortgage rates. The Company estimates that a 1 percent decline in long-term fixed mortgage rates from current levels would decrease the fair value of the mortgage servicing rights by approximately $21 million. Foreign Currency Risk In second quarter 2003, there were no significant changes in foreign currency risk from that disclosed in the Company's Form 10-K for the year 2002. Commodity Price Risk In second quarter 2003, there were no significant changes in commodity price risk from that disclosed in the Company's Form 10-K for the year 2002. ITEM 4. CONTROLS AND PROCEDURES (a)Evaluation of disclosure controls and procedures The Company's chief executive officer and its chief financial officer, based on their evaluation of the Company's disclosure controls and procedures (as defined in Exchange Act Rule 13a- 15(e)) as of end of the period covered by this Quarterly Report on Form 10-Q, have concluded that the Company's disclosure controls and procedures are adequate and effective to ensure that the information required to be disclosed by us in the reports we file or submit under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission's ("SEC") rules and forms. (b) Changes in internal control over financial reporting. There were no changes in the Company's internal control over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. PART II. OTHER INFORMATION Item 1. Legal Proceedings. The information set forth in Note E to Notes to Consolidated Financial Statements in Part I of this report is incorporated by reference thereto. 45 Antitrust Action As has been previously disclosed, on May 14, 1999, Inland Paperboard and Packaging, Inc. ("Inland") and Gaylord were named as defendants in a Consolidated Class Action Complaint that alleged a civil violation of Section 1 of the Sherman Act. The suit, captioned Winoff Industries, Inc. v. Stone Container Corporation, MDL No. 1261 (E.D. Pa.), names Inland, Gaylord, and eight other linerboard manufacturers as defendants. The complaint alleges that the defendants, during the period from October 1, 1993, through November 30, 1995, conspired to limit the supply of linerboard, and that the purpose and effect of the alleged conspiracy was artificially to increase prices of corrugated containers. The plaintiffs moved to certify a class of all persons in the United States who purchased corrugated containers directly from any defendant during the above period, and seek treble damages and attorneys' fees on behalf of the purported class. The trial court granted plaintiffs' motion on September 4, 2001, but modified the proposed class to exclude those purchasers whose prices were "not tied to the price of linerboard." The United States Court of Appeals for the Third Circuit accepted review of the decision to certify the class and upheld the trial court's ruling. Defendants appealed this decision to the United States Supreme Court, which denied their petition for a writ of certiorari. The case is currently set for trial in April 2004. Inland and Gaylord executed a settlement agreement on April 11, 2003, with the representatives of the class. On April 14, 2003, the trial court entered an order preliminarily approving the terms of the settlement. Gaylord and Inland paid a total of $8 million into escrow on April 17, 2003, to fulfill the terms of the settlement, which amount was within the amount previously accrued by the Company in connection with this matter. No objections to the settlement were filed with the court by the June 9, 2003, deadline. A final hearing on the fairness of the settlement to the classes is scheduled for August 11, 2003. The settlement will not become final until appeals, if any, to a final order approving the settlement terms have been exhausted. June 9, 2003, was also the deadline for potential class members to "opt-out" of the class action lawsuit. By this deadline, 140 companies and their named subsidiaries had advised the court of their opt-out election. Eleven individual complaints brought by over 100 of these opt-out plaintiffs have since been filed against the defendants in this action. As a result of the opt-outs, the Company received a refund of $800,000 from the original settlement amount. The Company is presently evaluating these complaints and continues to participate in a joint defense and cost sharing arrangement with other major industry participants, which also covers the opt-out litigation. 46 The Company believes the likelihood of a material loss from these actions to be remote and does not believe that the outcome of these actions should have a material adverse effect on its financial position, results of operations, or cash flow. Gaylord Chemical Corporation As has been previously disclosed, on October 23, 1995, a rail tank car of nitrogen tetroxide exploded at the Bogalusa, Louisiana plant of Gaylord Chemical Corporation, a wholly-owned, independently-operated subsidiary of Gaylord Container Corporation. Following the explosion, more than 160 lawsuits were filed against Gaylord, Gaylord Chemical, and third parties alleging personal injury, property damage, economic loss, related injuries and fear of injuries. Plaintiffs sought compensatory and punitive damages. On May 4, 2001, Gaylord and Gaylord Chemical agreed in principle to settle all claims arising out of the October 23, 1995 explosion. In exchange for payments by its primary insurance carrier and the first five excess layers of coverage and assignment of Gaylord's insurance coverage action against the remaining carriers, Gaylord and Gaylord Chemical will receive full releases and/or dismissals of all claims for damages, including punitive damages. Neither Gaylord nor Gaylord Chemical contributed to the settlement. The settlement agreement was fully executed on September 14, 2001, and all settlement funds were deposited in escrow. On December 24, 2002, counsel for the Louisiana class action plaintiffs advised Gaylord Chemical that they would not be able to deliver all the releases of the Gaylord entities that were promised as part of the September 2001 settlement agreement. As a result of this failure to tender the committed releases, the motion for preliminary approval of the settlement did not proceed as scheduled, and the parties engaged in negotiations over revised terms of settlement. On February 18, 2003, the Court granted the settling defendants' motion to retrieve the settlement proceeds from the escrow account and to lift the stay of proceedings in the Louisiana action. Gaylord, Gaylord Chemical, and their insurance carriers were reinstated as defendants in the Louisiana class-wide trial set to begin September 3, 2003. The Company believes the likelihood of a material loss from these actions to be remote and does not believe that the outcome of these actions should have a material adverse effect on its financial position, results of operations, or cash flow. Other The Company previously reported that the Georgia Department of Natural Resources, Environmental Protection Division on April 3, 2003, sent Inland a Notice of Violation alleging that Inland's 47 linerboard mill in Rome, Georgia, had experienced 502 excess sulfur dioxide emissions in the fourth quarter of 2002 due to the burning of coal with a level of sulfur that was too high. The Company timely filed its response to the State on May 1, 2003. The Company has entered into an agreement to settle this matter for the payment of penalties in an amount less than $25,000. Item 2. Changes in Securities and Use of Proceeds. None. Item 3. Defaults Upon Senior Securities. None. Item 4. Submission of Matters to a Vote of Security Holders. The Company held its annual meeting of stockholders on May 2, 2003, at which a quorum was present. The table below sets forth the number of votes cast for, against or withheld, as well as the number of abstentions and broker non-votes for each matter voted upon at that meeting. Abstentions Against and Broker Matter For or Non-votes Withheld --------- -------- ---------- 1. Election of four directors (a) Robert Cizik 47,708,064 914,389 -- (b) James T. Hackett 47,794,743 827,710 -- (c) Arthur Temple III 47,358,863 1,263,590 -- (d) Larry E. Temple 47,778,612 843,841 -- 2. Ratification of adoption of the Company's 2003 Stock Incentive Plan 40,856,478 7,347,821 418,154 Plan. 3. Ratification of appointment of Ernst & Young LLP. 47,586,904 729,025 306,524 Item 5. Other Information. None. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits. 31.1 - Certification of Chief Executive Officer pursuant to Exchange Act Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 - Certification of Chief Financial Officer pursuant to Exchange Act Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 48 32.1 - Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 - Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (b) Reports on Form 8-K During the quarter ended June 28, 2003, the Company filed the following Current Reports on Form 8-K: 1. Current Report on Form 8-K dated April 15, 2003, reporting under Item 9 the indefinite shut down of the Company's Mt. Jewett, Pennsylvania, particleboard plant. 2. Current Report on Form 8-K dated April 22, 2003, reporting under Item 9 a press release issued by the Company announcing earnings for the period ended March 29, 2003. 3. Current Report on Form 8-K dated April 23, 2003, reporting under Item 9 presentation materials used in a conference call discussing earnings for the period ended March 29, 2003. 4. Current Report on Form 8-K dated June 26, 2003, as amended, reporting under Item 5 the conclusion of certain tax matters. 49 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. TEMPLE-INLAND INC. (Registrant) Dated: August 11, 2003 By /s/ Louis R. Brill ------------------------- Louis R. Brill Chief Accounting Officer 50 INDEX TO EXHIBITS Exhibit No. Description Page No. ----------- ----------- -------- 31.1 Certification of Chief Executive Officer 51 pursuant to Exchange Act Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of Chief Financial Officer 53 pursuant to Exchange Act Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification of Chief Executive Officer 55 pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 Certification of Chief Financial Officer 56 pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002