10-Q 1 tin3d200310q.txt TEMPLE-INLAND FORM 10-Q FOR 9/27/2003 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 September 27, 2003 OR [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Transition Period From to Commission File Number 001-08634 Temple-Inland Inc. (Exact name of registrant as specified in its charter) Delaware 75-1903917 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 1300 South MoPac Expressway, Austin, Texas 78746 (Address of principal executive offices, including Zip Code) (512) 434-5800 (Registrant's telephone number, including area code) Not Applicable (Former name, former address and former fiscal year, if changed since last report.) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: Number of common shares outstanding Class as of September 27, 2003 Common Stock (par value $1.00 per share) 54,268,508 Page 1 of 90 The Exhibit Index is page 50. 2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS SUMMARIZED STATEMENTS OF INCOME PARENT COMPANY (TEMPLE-INLAND INC.) Unaudited
Third Quarter First Nine Months ------------- ----------------- 2003 2002 2003 2002 ---- ---- ---- ---- (in millions) NET REVENUES $ 878 $ 874 $ 2,602 $ 2,542 COSTS AND EXPENSES Cost of sales 797 782 2,393 2,234 Selling and administrative 70 74 220 226 Other (income) expense 15 -- 45 6 ----- ----- ----- ----- 882 856 2,658 2,466 ----- ----- ----- ----- (4) 18 (56) 76 FINANCIAL SERVICES EARNINGS 48 44 129 108 ----- ----- ----- ----- OPERATING INCOME 44 62 73 184 Interest expense (33) (36) (103) (97) Other expense (8) -- (8) (11) ----- ----- ----- ----- INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE TAXES 3 26 (38) 76 Income tax (expense) benefit (6) (11) 173 (30) ----- ----- ----- ----- INCOME (LOSS) FROM CONTINUING OPERATIONS (3) 15 135 46 Discontinued operations -- -- 1 (1) ----- ----- ----- ----- INCOME (LOSS) BEFORE ACCOUNTING CHANGE (3) 15 136 45 Effect of accounting change -- -- (1) (11) ----- ----- ----- ----- NET INCOME (LOSS) $ (3) $ 15 $ 135 $ 34 ===== ===== ===== =====
See the notes to consolidated financial statements. 2 3 SUMMARIZED BALANCE SHEETS PARENT COMPANY (TEMPLE-INLAND INC.) Unaudited
Third Quarter Year-End 2003 2002 ---- ---- (in millions) ASSETS Current Assets Cash and cash equivalents $ 14 $ 17 Receivables, net of allowances of $14 in 2003 399 352 and $13 in 2002 Inventories: Work in process and finished goods 83 69 Raw materials and supplies 242 269 ----- ----- Total inventories 325 338 ----- ----- Prepaid expenses and other 56 50 ----- ----- Total current assets 794 757 ----- ----- Investment in Financial Services 1,139 1,178 Property and Equipment: Land and buildings 618 638 Machinery and equipment 3,518 3,412 Construction in progress 62 92 Less allowances for depreciation (2,249) (2,101) ----- ----- 1,949 2,041 Timber and timberlands - less depletion 494 508 ----- ----- Total property and equipment 2,443 2,549 Goodwill 239 249 Assets of Discontinued Operations 25 78 Other Assets 146 146 ----- ----- TOTAL ASSETS $ 4,786 $ 4,957 ===== ===== LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities Accounts payable $ 205 $ 188 Employee compensation and benefits 60 67 Accrued interest 26 30 Accrued property taxes 29 28 Other accrued expenses 131 133 Liabilities of discontinued operations 20 28 Current portion of long-term debt 4 8 ----- ----- Total current liabilities 475 482 Long-Term Debt 1,743 1,883 Deferred Income Taxes 67 245 Postretirement Benefits 146 147 Pension Liability 173 142 Other Long-Term Liabilities 136 109 ----- ----- Total Liabilities 2,740 3,008 Shareholders' Equity 2,046 1,949 ----- ----- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 4,786 $ 4,957 ===== =====
See the notes to consolidated financial statements. 3 4 SUMMARIZED STATEMENTS OF CASH FLOW PARENT COMPANY (TEMPLE-INLAND INC.) Unaudited
First Nine Months ----------------- 2003 2002 ---- ---- (in millions) CASH PROVIDED BY (USED FOR) OPERATIONS Net income $ 135 $ 34 Adjustments: Depreciation, depletion and amortization 174 164 Depreciation of leased property 2 2 Non-cash stock based compensation 22 1 Non-cash pension and postretirement expense 41 18 Cash contribution to pension and postretirement plans (11) (11) Other non-cash charges (credits) (133) 17 Deferred income taxes 10 25 Unremitted earnings from Financial Services (83) (108) Dividends from Financial Services 120 100 Working capital changes, net (27) (57) Net assets of discontinued operations (1) 16 Loss from discontinued operations (1) 1 Cumulative effect of accounting change 1 11 Other 15 39 ----- ----- 264 252 ----- ----- CASH PROVIDED BY (USED FOR) INVESTING Capital expenditures (96) (81) Sales of non-strategic assets and operations 36 33 Acquisition of Gaylord, net of cash acquired -- (569) Other acquisitions and joint ventures (7) (40) Other -- (3) ----- ----- (67) (660) ----- ----- CASH PROVIDED BY (USED FOR) FINANCING Payments of debt (169) (310) Cash dividends paid to shareholders (55) (50) Bridge financing facility -- 880 Payment of bridge financing facility -- (880) Payment of assumed Gaylord bank debt -- (285) Sale of common stock -- 215 Sale of Upper DECSSM -- 345 Sale of Senior Notes -- 496 Other additions to debt 24 31 Other -- (22) ----- ----- (200) 420 ----- ----- Effect of exchange rate changes on cash -- (1) Net increase (decrease) in cash (3) 11 Cash at beginning of period 17 3 ----- ----- Cash at end of period $ 14 $ 14 ===== =====
See the notes to consolidated financial statements. 4 5 SUMMARIZED STATEMENTS OF INCOME FINANCIAL SERVICES Unaudited
Third Quarter First Nine Months ------------- ----------------- 2003 2002 2003 2002 ---- ---- ---- ---- (in millions) INTEREST INCOME Loans and loans held for sale $ 129 $ 143 $ 393 $ 431 Securities available-for-sale 16 25 54 83 Securities held-to-maturity 33 28 109 55 Other earning assets 1 1 3 3 ----- ----- ----- ----- Total interest income 179 197 559 572 INTEREST EXPENSE Deposits 43 58 145 181 Borrowed funds 41 44 130 113 ----- ----- ----- ----- Total interest expense 84 102 275 294 ----- ----- ----- ----- NET INTEREST INCOME 95 95 284 278 Provision for loan losses (13) (8) (44) (37) ----- ----- ----- ----- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 82 87 240 241 ----- ----- ----- ----- NONINTEREST INCOME Loan servicing fees 8 10 24 32 Amortization and impairment of servicing rights (12) (20) (53) (37) Loan origination and marketing 71 53 225 134 Real estate operations 14 13 34 35 Insurance commissions and fees 12 14 33 38 Service charges on deposits 9 8 26 22 Operating lease income 3 2 8 8 Other 8 6 29 21 ----- ----- ----- ----- Total noninterest income 113 86 326 253 ----- ----- ----- ----- NONINTEREST EXPENSE Compensation and benefits 85 75 258 218 Loan servicing and origination 5 2 12 4 Real estate operations, other than compensation 9 9 24 24 Insurance operations, other than 3 5 10 11 compensation Occupancy 8 8 25 25 Data processing 7 6 20 24 Other 30 24 88 80 ----- ----- ----- ----- Total noninterest expense 147 129 437 386 ----- ----- ----- ----- INCOME BEFORE TAXES 48 44 129 108 Income tax (expense) benefit (17) 7 (46) -- ----- ----- ----- ----- NET INCOME $ 31 $ 51 $ 83 $ 108 ===== ===== ===== =====
See the notes to consolidated financial statements. 5 6 SUMMARIZED BALANCE SHEETS FINANCIAL SERVICES Unaudited
Third Quarter Year-End 2003 2002 ---- ---- (in millions) ASSETS Cash and cash equivalents $ 456 $ 438 Loans held for sale 621 1,088 Loans receivable, net of allowance for losses of $130 in 2003 and $132 in 2002 9,321 9,668 Securities available-for-sale 1,491 1,926 Securities held-to-maturity 4,805 3,915 Real estate 278 249 Premises and equipment, net 167 157 Accounts, notes and accrued interest receivable 132 159 Goodwill 148 148 Mortgage servicing rights 88 105 Other assets 245 163 ------ ------ TOTAL ASSETS $ 17,752 $ 18,016 ====== ====== LIABILITIES AND SHAREHOLDER'S EQUITY Deposits $ 8,945 $ 9,203 Federal Home Loan Bank advances 3,506 3,386 Securities sold under repurchase agreements 2,183 2,907 Obligations to settle trade date securities 963 369 Other liabilities 500 487 Other borrowings 211 181 Preferred stock issued by subsidiaries 305 305 ------ ------ TOTAL LIABILITIES 16,613 16,838 ------ ------ SHAREHOLDER'S EQUITY 1,139 1,178 ------ ------ TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY $ 17,752 $ 18,016 ====== ======
See the notes to consolidated financial statements. 6 7 SUMMARIZED STATEMENTS OF CASH FLOWS FINANCIAL SERVICES Unaudited
First Nine Months 2003 2002 ---- ---- (in millions) CASH PROVIDED BY (USED FOR) OPERATIONS Net income (loss) $ 83 $ 108 Adjustments: Amortization and accretion 70 38 Depreciation 18 18 Depreciation of leased assets 6 8 Provision for loan losses 44 37 Deferred income taxes (12) 2 Originations of loans held for sale (11,144) (5,403) Sales of loans held for sale 11,611 5,386 Collections on loans serviced for others, net (24) (78) Originated mortgage servicing rights (38) (34) Other (3) 17 ------ ------ 611 99 ------ ------ CASH PROVIDED BY (USED FOR) INVESTING Purchases of securities available-for-sale (17) (22) Principal payments and maturities of securities available-for-sale 452 573 Purchases of securities held-to-maturity (2,008) (2,599) Principal payments and maturities of securities held-to-maturity 1,706 191 Loans originated or acquired, net of collections 198 1 Sale of mortgage servicing rights -- 33 Sale of loans 41 11 Acquisitions, net of cash acquired (1) 358 Capital expenditures (25) (11) Other 10 3 ------ ------ 356 (1,462) ------ ------ CASH PROVIDED BY (USED FOR) FINANCING Net increase (decrease) in deposits (234) (272) Securities sold under repurchase agreements and short-term borrowings, net (241) (685) Additions to debt and long-term FHLB advances 282 2,335 Payments of debt and long-term FHLB advances (647) (232) Dividends paid to parent company (120) (100) Purchase of deposits -- 104 Other 11 -- ------ ------ (949) 1,150 ------ ------ Net increase (decrease) in cash and cash equivalents 18 (213) Cash and cash equivalents at beginning of period 438 587 ------ ------ Cash and cash equivalents at end of period $ 456 $ 374 ====== ======
See the notes to consolidated financial statements. 7 8 CONSOLIDATED STATEMENTS OF INCOME TEMPLE-INLAND INC. AND SUBSIDIARIES Unaudited
Third Quarter First Nine Months ------------- ----------------- 2003 2002 2003 2002 ---- ---- ---- ---- (in millions, except per share amounts) REVENUES Manufacturing $ 878 $ 874 $ 2,602 $ 2,542 Financial Services 292 283 885 825 ----- ----- ----- ----- 1,170 1,157 3,487 3,367 ----- ----- ----- ----- COSTS AND EXPENSES Manufacturing 882 856 2,658 2,466 Financial Services 244 239 756 717 ----- ----- ----- ----- 1,126 1,095 3,414 3,183 ----- ----- ----- ----- OPERATING INCOME 44 62 73 184 Parent company interest (33) (36) (103) (97) Other expense (8) -- (8) (11) ----- ----- ----- ----- INCOME (LOSS) BEFORE TAXES 3 26 (38) 76 Income tax (expense) benefit (6) (11) 173 (30) ----- ----- ----- ----- INCOME (LOSS) FROM CONTINUING OPERATIONS (3) 15 135 46 Discontinued operations -- -- 1 (1) ----- ----- ----- ----- INCOME (LOSS) BEFORE ACCOUNTING CHANGE (3) 15 136 45 Effect of accounting change -- -- (1) (11) ----- ----- ----- ----- NET INCOME (LOSS) $ (3) $ 15 $ 135 $ 34 ===== ===== ===== ===== EARNINGS (LOSS) PER SHARE Basic: Income (loss) from continuing operations $ (0.06) $ 0.28 $ 2.49 $ 0.89 Discontinued operations -- -- 0.01 (0.02) Effect of accounting change -- -- (0.01) (0.21) ----- ----- ----- ----- Net income (loss) $ (0.06) $ 0.28 $ 2.49 $ 0.66 ===== ===== ===== ===== Diluted: Income (loss) from continuing operations $ (0.06) $ 0.28 $ 2.49 $ 0.89 Discontinued operations -- -- 0.01 (0.02) Effect of accounting change -- -- (0.01) (0.21) ----- ----- ----- ----- Net income (loss) $ (0.06) $ 0.28 $ 2.49 $ 0.66 ===== ===== ===== ===== DIVIDENDS PAID PER SHARE OF COMMON STOCK $ 0.34 $ 0.32 $ 1.02 $ 0.96 ===== ===== ===== =====
See the notes to consolidated financial statements. 8 9 CONSOLIDATING BALANCE SHEETS TEMPLE-INLAND INC. AND SUBSIDIARIES Third Quarter 2003 Unaudited
Parent Financial Company Services Consolidated ------- -------- ------------ (in millions) ASSETS Cash and cash equivalents $ 14 $ 456 $ 470 Loans held for sale -- 621 621 Loans receivable, net -- 9,321 9,321 Securities available-for-sale -- 1,491 1,491 Securities held-to-maturity -- 4,805 4,805 Trade receivables, net 399 -- 399 Inventories 325 -- 325 Property and equipment, net 2,443 167 2,610 Goodwill 239 148 387 Other assets 227 743 925 Investment in Financial Services 1,139 -- -- ------ ------ ------ TOTAL ASSETS $ 4,786 $ 17,752 $ 21,354 ====== ====== ====== LIABILITIES AND SHAREHOLDERS' EQUITY Deposits $ -- $ 8,945 $ 8,945 Federal Home Loan Bank advances -- 3,506 3,506 Securities sold under repurchase agreements -- 2,183 2,183 Obligations to settle trade date securities -- 963 963 Other liabilities 611 500 1,087 Long-term debt 1,743 211 1,954 Deferred income taxes 67 -- 46 Postretirement benefits 146 -- 146 Pension liability 173 -- 173 Preferred stock issued by subsidiaries -- 305 305 ------ ------ ------ TOTAL LIABILITIES $ 2,740 $ 16,613 $ 19,308 ------ ------ ------ SHAREHOLDERS' EQUITY Preferred stock - par value $1 per share: authorized 25,000,000 shares; none issued -- Common stock - par value $1 per share: authorized 200,000,000 shares; issued 61,389,552 shares including shares held in the treasury 61 Additional paid-in capital 371 Accumulated other comprehensive loss (143) Retained earnings 2,080 ------ 2,369 Cost of shares held in the treasury: 7,121,044 shares (323) ------ TOTAL SHAREHOLDERS' EQUITY 2,046 ------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 21,354 ======
See the notes to consolidated financial statements. 9 10 CONSOLIDATING BALANCE SHEETS TEMPLE-INLAND INC. AND SUBSIDIARIES Year-End 2002 Unaudited
Parent Financial Company Services Consolidated ------- -------- ------------ (in millions) ASSETS Cash and cash equivalents $ 17 $ 438 $ 455 Loans held for sale -- 1,088 1,088 Loans receivable, net -- 9,668 9,668 Securities available-for-sale -- 1,926 1,926 Securities held-to-maturity -- 3,915 3,915 Trade receivables 352 -- 352 Inventories 338 -- 338 Property and equipment, net 2,549 157 2,706 Goodwill 249 148 397 Other assets 274 676 915 Investment in Financial Services 1,178 -- -- ----- ------ ------ TOTAL ASSETS $ 4,957 $ 18,016 $ 21,760 LIABILITIES AND SHAREHOLDERS' EQUITY Deposits $ -- $ 9,203 $ 9,203 Federal Home Loan Bank advances -- 3,386 3,386 Securities sold under repurchase -- 2,907 2,907 Obligations to settle trade date securities -- 369 369 Other liabilities 591 487 1,052 Long-term debt 1,883 181 2,064 Deferred income taxes 245 -- 236 Postretirement benefits 147 -- 147 Pension liability 142 -- 142 Preferred stock issued by subsidiaries -- 305 305 ------ ------ ------ TOTAL LIABILITIES $ 3,008 $ 16,838 $ 19,811 ------ ------ ------ SHAREHOLDERS' EQUITY Preferred stock - par value $1 per share: authorized 25,000,000 shares; none issued -- Common stock - par value $1 per share: authorized 200,000,000 shares; issued 61,389,552 shares including shares held in the treasury 61 Additional paid-in capital 368 Accumulated other comprehensive loss (136) Retained earnings 2,000 ------ 2,293 Cost of shares held in the treasury: 7,583,293 shares (344) ------ TOTAL SHAREHOLDERS' EQUITY 1,949 ------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 21,760 ======
See the notes to consolidated financial statements. 10 11 CONSOLIDATED STATEMENT OF CASH FLOWS TEMPLE-INLAND INC. AND SUBSIDIARIES Unaudited
First Nine Months ----------------- 2003 2002 ---- ---- (in millions) CASH PROVIDED BY (USED FOR) OPERATIONS Net income (loss) $ 135 $ 34 Adjustments: Depreciation, depletion and amortization 192 182 Depreciation on leased property 8 10 Provision for loan losses 44 37 Deferred taxes (2) 27 Other non-cash charges (133) 17 Amortization and accretion of financial instruments 70 38 Originations of loans held for sale (11,144) (5,403) Sales of loans held for sale 11,611 5,386 Working capital changes, net (27) (57) Collections on loans serviced for others, net (24) (78) Originated mortgage servicing rights (38) (34) Net assets of discontinued operations (1) 16 Loss from discontinued operations (1) 1 Cumulative effect of accounting change 1 11 Other 64 64 ------ ------ 755 251 ------ ------ CASH PROVIDED BY (USED FOR) INVESTING Capital expenditures (121) (92) Sale of non-strategic assets and operations 36 33 Purchases of securities available-for-sale (17) (22) Principal payments and maturities of securities available-for-sale 452 573 Purchases of securities held-to-maturity (2,008) (2,599) Principal payments and maturities and redemptions of securities held-to-maturity 1,706 191 Sale of mortgage servicing rights -- 33 Loans originated or acquired, net of principal collected 198 1 Proceeds from sale of loans 41 11 Acquisitions, net of cash acquired (8) (251) Other 10 -- ------ ------ 289 (2,122) ------ ------ CASH PROVIDED BY (USED FOR) FINANCING Net increase (decrease) in deposits (234) (272) Additions to debt 306 2,366 Payments of debt (816) (542) Repurchase agreements and short-term borrowings, net (241) (685) Cash dividends paid to shareholders (55) (50) Bridge financing facility -- 880 Payment of bridge financing facility -- (880) Payment of assumed Gaylord bank debt -- (285) Sale of common stock, Upper DECS, and Senior Notes -- 1,056 Purchase of deposits -- 104 Other 11 (22) ------ ------ (1,029) 1,670 ------ ------ Effect of exchange rate changes on cash -- (1) ------ ------ Net increase (decrease) in cash and cash equivalents 15 (202) Cash and cash equivalents at beginning of period 455 590 ------ ------ Cash and cash equivalents at end of period $ 470 $ 388 ====== ======
See the notes to consolidated financial statements. 11 12 TEMPLE-INLAND INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS NOTE A - BASIS OF PRESENTATION The accompanying unaudited interim financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Therefore, these statements do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. However, in the opinion of management, all adjustments (consisting only of normal accruals) considered necessary for a fair presentation have been included. Interim operating results are not necessarily indicative of the results that may be expected for the entire year. For further information, refer to the financial statements and footnotes included in the Annual Report on Form 10-K of Temple-Inland Inc. (the "Company") for the fiscal year ended December 28, 2002. The consolidated financial statements include the accounts of the Company and its manufacturing and financial services subsidiaries. The consolidated net assets invested in financial services activities are subject, in varying degrees, to regulatory rules and restrictions including restrictions on the payment of dividends to the Company. Accordingly, included as an integral part of the consolidated financial statements are separate summarized financial statements for the Company's manufacturing and financial services subsidiaries. The Parent Company (Temple-Inland Inc.) summarized financial statements include the accounts of the Company and its manufacturing subsidiaries (the parent company). The net assets invested in Financial Services are reflected in the summarized financial statements using the equity method. Related earnings, however, are presented before tax to be consistent with the consolidated financial statements. These financial statements should be read in conjunction with the Company's consolidated financial statements and the Financial Services summarized financial statements. All material intercompany amounts and transactions have been eliminated. Certain amounts have been reclassified to conform to current year's classifications. 13 TEMPLE-INLAND INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE B - EARNINGS PER SHARE Denominators used in computing per share amounts follow:
Third First Nine Quarter Months ------------ ------------ 2003 2002 2003 2002 ---- ---- ---- ---- (in millions) Denominator for basic earnings per share: Weighted average common shares outstanding 54.2 53.7 54.1 51.8 Dilutive effect of: Equity purchase contracts -- -- -- -- Stock options 0.1 -- -- 0.1 ---- ---- ---- ---- Denominator for diluted earnings per share 54.3 53.7 54.1 51.9 ==== ==== ==== ====
NOTE C - COMPREHENSIVE INCOME (LOSS) Comprehensive income (loss) consists of:
Third First Nine Quarter Months ------------ ------------ 2003 2002 2003 2002 ---- ---- ---- ---- (in millions) Net income (loss) $ (3) $ 15 $ 135 $ 34 Other comprehensive income (loss), net of taxes: Unrealized gains (losses) on: Available-for-sale securities (2) 1 (1) -- Derivative instruments -- (2) (1) (2) Foreign currency translation adjustments (3) (1) (5) (7) ---- ---- ---- ---- Other comprehensive income (loss) (5) (2) (7) (9) ---- ---- ---- ---- Comprehensive income (loss) $ (8) $ 13 $ 128 $ 25 ==== ==== ==== ====
At third quarter-end 2003, the aggregate fair value of all derivative instruments was a $9 million liability, consisting of an $8 million liability for an interest rate swap derivative and a $1 million liability related to linerboard and OCC derivatives. There was no ineffective portion of derivatives charged to earnings in third quarter 2003 or in first nine months 2003 and amounts reclassified from other comprehensive income into earnings were not material. NOTE D - SEGMENT INFORMATION The Company has three reportable segments: Corrugated Packaging, Building Products, and Financial Services. The Company evaluates performance based, in part, on operating income before other (income) expense, unallocated general and administrative expenses, parent company interest, and income taxes. Other (income) expense includes gain or loss on sale of assets, asset impairments and expenses associated with consolidation and supply chain initiatives and facility closures. 14 TEMPLE-INLAND INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Unallocated General and Administrative and Other Corrugated Building Financial (Income) For third quarter 2003 Packaging Products Services Expense Total ---------------------- --------- -------- -------- -------------- --------- (in millions) Revenues from external customers $ 667 211 292 -- $ 1,170 Depreciation, depletion and amortization $ 40 16 8 2 $ 66 Operating income (loss) $ -- 22 49 (27) $ 44 Financial Services, net interest income $ -- -- 95 -- $ 95 Capital expenditures $ 27 8 14 3 $ 52 ---------------------------------------------------------------------------------------------- For first nine months 2003 or at third quarter end 2003 ---------------------- (in millions) Revenues from external customers $ 2,019 583 885 -- $ 3,487 Depreciation, depletion and amortization $ 123 48 24 5 $ 200 Operating income (loss) $ (3) 25 132 (81) $ 73 Financial Services, net interest income $ -- -- 284 -- $ 284 Total assets $ 2,427 1,104 17,752 71 $21,354 Capital expenditures $ 68 23 25 5 $ 121 Goodwill $ 239 -- 148 -- $ 387 ---------------------------------------------------------------------------------------------- For third quarter 2002 ---------------------- (in millions) Revenues from external $ 672 202 283 -- $ 1,157 Depreciation, depletion and amortization $ 38 16 9 3 $ 66 Operating income (loss) $ 14 12 44 (8) $ 62 Financial Services, net interest income $ -- -- 95 -- $ 95 Capital expenditures $ 19 7 4 3 $ 33 ---------------------------------------------------------------------------------------------- For first nine months 2002 or at third quarter end 2002 --------------------- (in millions) Revenues from external $ 1,932 610 825 -- $ 3,367 Depreciation, depletion and amortization $ 115 46 26 5 $ 192 Operating income (loss) $ 65 43 115 (39) $ 184 Financial Services, net interest income $ -- -- 278 -- $ 278 Total assets $ 2,681 1,188 17,830 46 $21,745 Capital expenditures $ 49 27 11 5 $ 92 Goodwill $ 177 -- 141 -- $ 318 ---------------------------------------------------------------------------------------------- Includes other (income) expenses for third quarter 2003 of $16 million, which consists of $3 million related to converting and production facility closures and $13 million related to consolidation and supply chain initiatives. Of these amounts, $1 million applies to Building Products, $4 million to Corrugated Packaging, and $1 million to Financial Services. Includes other (income) expense for first nine months 2003 of $48 million, which consists of $10 million related to converting and production facility closures, $39 million related to consolidation and supply chain initiatives and other income of $1 million related to the collection of notes previously written- off. Of these amounts, $13 million applies to Building Products, $11 million to Corrugated Packaging and $3 million to Financial Services. 15 TEMPLE-INLAND INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) Includes other expenses of $13 million, of which $7 million is related to severance and write-off of technology investments, which applies to Financial Services, and $6 million related to the repurchase of notes sold with recourse, which applies to Corrugated Packaging. Includes depreciation and amortization of premises, equipment and leased assets.
NOTE E - CONTINGENCIES There are pending against the Company and its subsidiaries lawsuits, claims and environmental matters arising in the regular course of business. The resolution of these matters is not expected to have a material adverse effect on the Company's operations or financial position. NOTE F - ACQUISITIONS The Company acquired effective control of Gaylord Container Corporation on February 28, 2002. The Company acquired a box plant in Puerto Rico during March 2002, two converting operations of Mack Packaging Group, Inc. during May 2002, and Fibre Innovations LLC during November 2002. The results of the acquired operations have been included in the Company's income statement since the dates of acquisition. The following parent company unaudited pro forma information assumes these acquisitions and related financing occurred at the beginning of 2002 (in millions except per share): First Nine Months 2002 ---------------------- (in millions, except per share) Net revenues $ 2,865 Income from continuing operations $ 35 Per diluted share Income from continuing operations $ 0.67 NOTE G - DISCONTINUED OPERATIONS At third quarter-end 2003, discontinued operations consist of Gaylord's chemical business and accruals related to the 1999 sale of the bleached paperboard operations. At third quarter-end 2003, the assets and liabilities of discontinued operations includes $10 million of working capital, $16 million of property and equipment, and $20 million of environmental and other long- term accruals. Revenues from discontinued operations for third quarter 2003 were $3 million and for first nine months 2003 were $15 million. 16 TEMPLE-INLAND INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) NOTE H - OTHER OPERATING (INCOME) EXPENSE Other operating (income) expense consists of:
Third Quarter First Nine Months -------------- ----------------- 2003 2002 2003 2002 ---- ---- ---- ---- (in millions) Expenses associated with consolidation and supply chain initiatives $ 12 $ -- $ 36 $ -- Loss on closure of production and converting facilities 3 -- 10 -- (Income) loss related to collection of notes that were written off in 2002 -- -- (1) 6 ---- ---- ---- ---- Total $ 15 $ -- $ 45 $ 6 ==== ==== ==== ====
Expenses related to initiatives to relocate the Corrugated Packaging operations, consolidate administrative functions, and effect improvements in supply chain management consist principally of relocation costs and fees paid to third party consultants. Losses on closure of production and converting facilities consist principally of severance and asset impairments. In September 2003, the Company announced the indefinite shutdown of its Clarion, Pennsylvania medium density fiberboard plant. In connection with this shutdown the Company incurred and paid $1 million in involuntary employee termination liabilities. During third quarter 2003, the Company paid $1 million in severance related to the previously announced closure of three box plants. In addition, the Company incurred and paid $1 million in severance related to workforce reductions at its Rome, Georgia mill. A summary of the activity related to all facility closure accruals for third quarter 2003 follow:
Beginning End of of Period Additions Cash Payments Period --------- --------- ------------- ------ Involuntary employee terminations $ 1 $ 2 $ (3) $ -- Contract termination penalties 6 -- -- 6 Environmental compliance 12 -- -- 12 Demolition 12 -- (1) 11 ---- ---- ---- ---- Total $ 31 $ 2 $ (4) $ 29 ==== ==== ==== ====
NOTE I - INCOME TAX In second quarter 2003, the Internal Revenue Service concluded its examination of the Company's tax returns through 17 TEMPLE-INLAND INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) 1996, including matters related to net operating losses and minimum tax credit carryforwards, which resulted from certain deductions following the 1988 acquisition of Guaranty Bank and for which no financial accounting benefit had been recognized. Also, the Company resolved certain state tax refund claims for the years 1991 through 1994. As a result, valuation allowances and tax accruals previously provided for these matters are no longer required. Accordingly, during second quarter 2003, the Company recorded a one-time benefit of $165 million, or $3.05 per diluted share. Of this one-time benefit, $26 million represents expected cash refunds of previously paid taxes plus related interest, of which $21 million was received in third quarter 2003. The remainder is a non-cash benefit. During third quarter 2003, the Company lowered the estimated effective tax rate for the year 2003 from 35 percent to 20 percent due to changes in estimates of income and expenses. As a result, during third quarter 2003 the Company reduced its previously recorded tax benefits for the first six months 2003 by $6 million. NOTE J - FINANCING TRANSACTIONS During third quarter 2003, the Company redeemed its $150 million 8.25% debentures due 2022. The Company paid a $6 million call premium and wrote off $2 million of unamortized financing costs all of which are included in other expense. The redemption of the debentures was funded from borrowings under the Company's accounts receivable securitization program. NOTE K - NEW ACCOUNTING PRONOUNCEMENTS Stock-Based Compensation Beginning January 2003, the Company voluntarily adopted the prospective transition method of accounting for stock-based compensation contained in Statement of Financial Accounting Standards (SFAS) No. 148, Accounting for Stock-Based Compensation- Transition and Disclosure, an amendment of FASB Statement No. 123. The principal effect of adopting the prospective transition method is that the fair value of stock options granted in 2003 and thereafter is charged to expense over the option vesting period. As a result of the adoption of this prospective transition method, third quarter 2003 net income was decreased by $3 million or $0.05 per share. Prior to 2003, the Company used the intrinsic value method in accounting for its stock-based compensation. As a result, no stock-based compensation expense related to stock options is reflected in prior years' net income, as all stock options granted had an exercise price equal to the market value of the underlying common stock on the date of grant. Therefore, the cost 18 TEMPLE-INLAND INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) related to stock-based compensation recognized in net income for third quarter 2003 and 2002 is less than would have been recognized if the fair value method had been applied to all stock options granted since 1995. The following table illustrates the effect on net income and earnings per share as if the fair value method had been applied to all stock options granted since 1995.
Third Quarter First Nine Months ------------- ----------------- 2003 2002 2003 2002 ---- ---- ---- ---- (in millions) Net income (loss), as reported $ (3) $ 15 $ 135 $ 34 Add: Stock-based compensation expense, net of related tax effects, included in the determination of reported net income 8 -- 18 2 Deduct: Total stock-based compensation expense, net of related tax effects, determined under the fair value based method for all awards (11) (2) (26) (8) ---- ---- ---- ---- Pro forma net income (loss) $ (6) $ 13 $ 127 $ 28 ==== ==== ==== ==== Earnings per share: Basic, as reported $(0.06) $ 0.28 $ 2.49 $ 0.66 Basic, pro forma $(0.11) $ 0.25 $ 2.35 $ 0.54 Diluted, as reported $(0.06) $ 0.28 $ 2.49 $ 0.66 Diluted, pro forma $(0.11) $ 0.25 $ 2.35 $ 0.54
Asset Retirement Obligations Beginning January 2003, the Company was required to adopt SFAS No. 143, Accounting for Asset Retirement Obligations. The statement requires legal obligations associated with the retirement of long-lived assets to be recognized at their fair value at the time that the obligations are incurred. Upon initial recognition of a liability, that cost is capitalized as part of the related long-lived asset and allocated to expense over the useful life of the asset. The effect of adopting this statement was to increase property, plant and equipment by $3 million, recognize an asset retirement obligation liability of $4 million, and to increase first quarter net loss by $1 million or $0.01 per share for the cumulative effect of adoption. Liabilities and Equity Instruments During third quarter 2003, the Company was required to adopt SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This statement establishes standards for classifying and measuring as liabilities certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity. The effect on earnings and financial position of adopting this statement was not material. 19 TEMPLE-INLAND INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) Other Pronouncements During fourth quarter 2003, the Company will be required to begin applying FASB Interpretation No. 46, Consolidation of Variable Interest Entities to its variable interest entities created prior to February 1, 2003. It is anticipated that the effect on earnings and financial position of applying this interpretation will not be material. 20 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Forward-Looking Statements Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties. The actual results achieved by the Company may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include general economic, market, or business conditions; the opportunities or lack thereof that may or may not be presented to and pursued; availability and price of raw materials used; competitive actions by other companies; changes in laws or regulations; the accuracy of certain judgments and estimates concerning the integration of acquired operations; the accuracy of certain judgments and estimates concerning the consolidation and supply chain initiatives; and other factors, many of which are beyond the control of the Company. Results of Operations Business Segments The Company manages its operations through three business segments, Corrugated Packaging, Building Products, and Financial Services. Each of these business segments is affected by the factors of supply and demand and changes in domestic and global economic conditions. These conditions include changes in interest rates, new housing starts, home repair and remodeling activities, and the strength of the U.S. dollar, some or all of which may have varying degrees of impact on the business segments. As used herein, the term "parent company" refers to the financial statements of the Company and its manufacturing business segments, Corrugated Packaging and Building Products, with Financial Services reflected on the equity method. The Company evaluates performance based, in part, on operating income before other (income) expense, unallocated general and administrative expenses, parent company interest, and income taxes. Other (income) expense includes gain or loss on sale of assets, asset impairment and expenses associated with consolidation and supply chain initiatives and facility closure accruals. 21 Summary A summary of the results of operations by business segment follows:
Third Quarter First Nine Months ------------- ----------------- 2003 2002 2003 2002 ---- ---- ---- ---- (in millions, except per share) Revenues Corrugated Packaging $ 667 $ 672 $ 2,019 $ 1,932 Building Products 211 202 583 610 Financial Services 292 283 885 825 ----- ----- ----- ----- Total revenues $ 1,170 $ 1,157 $ 3,487 $ 3,367 ===== ===== ===== ===== Segment Operating Income Corrugated Packaging $ -- $ 14 $ (3) $ 65 Building Products 22 12 25 43 Financial Services 49 44 132 115 ----- ----- ----- ----- Total segment operating income 71 70 154 223 Unallocated general and administrative expenses (11) (8) (33) (26) Parent company interest (33) (36) (103) (97) Other income (expense) (24) -- (56) (24) ----- ----- ----- ----- Income (loss) before taxes 3 26 (38) 76 Income tax (expense) benefit (6) (11) 173 (30) ----- ----- ----- ----- Income (loss) from continuing operations (3) 15 135 46 Discontinued operations -- -- 1 (1) Effect of accounting change -- -- (1) (11) ----- ----- ----- ----- Net income (loss) $ (3) $ 15 $ 135 $ 34 ===== ===== ===== ===== Diluted earnings per share Income (loss) from continuing operations $ (0.06) $ 0.28 $ 2.49 $ 0.89 Discontinued operations -- -- 0.01 (0.02) Effect of accounting change -- -- (0.01) (0.21) ----- ----- ----- ----- Net income (loss) $ (0.06) $ 0.28 $ 2.49 $ 0.66 ===== ===== ===== ===== Average diluted shares outstanding 54.3 53.7 54.1 51.9 Other income (expense) for third quarter 2003 includes, $3 million related to converting and production facility closures, $13 million related to consolidation and supply chain initiatives and $8 million related to the early redemption of debentures. Of these amounts, $1 million applies to Building Products, $2 million to Corrugated Packaging, and $1 million to Financial Services. Other income (expense) for first nine months 2003 includes $10 million related to converting and production facility closures, $39 million related to consolidation and supply chain initiatives and $8 million related to the early redemption of debentures and other income of $1 million related to the collection of notes previously written-off. Of these amounts, $3 million applies to Building Products, $11 million to Corrugated Packaging and $3 million to Financial Services. Other income (expense) for first nine months 2002 includes $7 million related to severance and write-off of technology investments, $6 million related to the repurchase of notes sold with recourse and $11 million related to the early repayment of a bridge financing facility and other borrowings. Of these amounts, $6 million applies to Corrugated Packaging and $7 million to Financial Services. 22 Includes for third quarter 2003, a $6 million reduction in previously recorded tax benefits for first six months 2003 related to a decrease in the effective tax rate for the year 2003 and, for first nine months 2003, a one-time tax benefit of $165 million.
For third quarter 2003 and 2002 Corrugated Packaging Corrugated Packaging revenues were $667 million in third quarter 2003 compared with $672 million in third quarter 2002. Revenues from sales of corrugated packaging represented 93 percent of segment revenues for third quarter 2003 and 94 percent for third quarter 2002. The remaining revenues are derived from sales of linerboard. The change in revenues was principally due to changes in average prices and shipments: Third Quarter 2003 versus Third Quarter 2002 Increase (Decrease) in ------------------------------- Average Prices Shipments -------------- --------- Corrugated packaging (1%) -- Linerboard (1%) 18% Compared with second quarter 2003, revenues were down $18 million. Average corrugated packaging prices were down one percent while shipments were down two percent. Average linerboard prices were down two percent while shipments were up three percent. Corrugated packaging markets continue to be adversely affected by the weak manufacturing economy. Linerboard markets continue to be adversely affected by both the weak manufacturing economy and increased offshore capacity, partially offset by a weaker U.S. dollar. Costs, which include production, selling, distribution, and administrative costs, were $667 million in third quarter 2003 compared with $658 million in third quarter 2002. Significant changes within the principal components of costs in 2003 include: - higher energy costs, up $9 million, - higher pension costs, up $6 million, and - lower OCC costs due to lower prices and a decrease in OCC purchases, down $16 million. Average OCC prices were $90 per ton during third quarter 2003 compared with $122 per ton during third quarter 2002. It is likely that OCC costs will continue to fluctuate during 2003. Mill production was: - 808,000 tons in third quarter 2003, - 864,000 tons in third quarter 2002, and - 819,000 tons in second quarter 2003. 23 Mill production data is not comparable due to the effect of the shutdown of the Antioch, California mill completed during September 2002. The percentage of mill production used by Corrugated Packaging operations was: - 81 percent in third quarter 2003, - 85 percent in third quarter 2002, and - 82 percent in second quarter 2003. The remainder was sold in the domestic and export markets. Excluding routine maintenance, production downtime was minimal in third quarter 2003 and second quarter 2003 and 94,000 tons in third quarter 2002 due to market and operational reasons. Production downtime may occur in future quarters. Market conditions continue to be weak for lightweight gypsum facing paper. As a result, the Company's Premier Boxboard joint venture continues to produce both gypsum facing paper and corrugating medium. The Company purchased 45,000 tons of corrugating medium from the joint venture in third quarter 2003. It is uncertain when market conditions for lightweight gypsum facing paper will improve. The Company is continuing its efforts to enhance return on investment within Corrugated Packaging. These efforts include reviewing operations that are unable to meet return objectives and determining appropriate courses of action including the possible consolidation and closure of converting facilities. During third quarter 2003, the Company paid $1 million of severance to employees affected by the previously announced closure of its converting facilities in Hattiesburg, Mississippi, Elizabethton, Tennessee, and Tijuana, Mexico. In addition, the Company incurred and paid $1 million in severance related to workforce reductions at its Rome, Georgia mill. These costs are included in other operating (income) expense and excluded from segment operating income. Fourth quarter earnings for corrugated packaging will likely be adversely affected by the annual maintenance outages at the Bogalusa, Louisiana and Rome, Georgia linerboard mills and a 14 week fourth quarter with seven additional days of fixed costs and, due to holiday schedules, only one additional day of sales revenue from the converting operations. Corrugated Packaging operated at break even in third quarter 2003 compared with operating income of $14 million in third quarter 2002. 24 Building Products Building Products revenues were $211 million in third quarter 2003 compared with $202 million in third quarter 2002. The change in revenues in 2003 was principally due to changes in average prices and shipments as follows: Third Quarter 2003 versus Third Quarter 2002 Increase (Decrease) in ------------------------------- Average Prices Shipments -------------- --------- Lumber 10% 12% Particleboard (4%) (9%) Gypsum 3% (4%) MDF (7%) (30%) Other revenues include sales of high-value and non-strategic timberlands. These sales contributed $2 million in operating income in third quarter 2003 compared with $1 million in third quarter 2002 and $5 million in second quarter 2003. Compared with second quarter 2003, revenues were up $19 million. Average prices were up eight percent for lumber and three percent for gypsum, while average prices were down one percent for particleboard and flat for MDF. Shipments were up five percent for lumber, six percent for particleboard and 13 percent for gypsum, while average shipments were down 11 percent for MDF. Costs, which include production, selling, distribution, and administrative costs, were $189 million in third quarter 2003 compared with $190 million in third quarter 2002. Production averaged from a low of 52 percent to a high of 93 percent of capacity in the various product lines. Production average was negatively affected by the indefinite shutdowns of the Clarion, Pennsylvania MDF facility during third quarter 2003 and the Mt. Jewett, Pennsylvania particleboard facility during second quarter 2003, neither of which had any third quarter production. Production was curtailed to varying degrees in all product lines in third quarter 2003 to match customer demand. The Company's joint venture operations also experienced production curtailments in third quarter 2003. Production may be curtailed in future quarters to match customer demand. The Company's Del-Tin Fiber LLC MDF joint venture in El Dorado, Arkansas continues to experience production and cost issues. In January 2003, Deltic Timber Corporation, the partner in this venture, announced its intention to exit this business upon the earliest, reasonable opportunity provided by the market. It is uncertain what effects Deltic Timber's decision will have on the joint venture or its operations. The venture had net losses of $4 million in each of third quarter 2003 and third quarter 2002, of which the Company's share was $2 million for 25 each period. In third quarter 2003, the Company and Deltic Timber Corporation each contributed $2 million in cash to the venture. The Company is continuing its efforts to enhance return on investment within Building Products. These efforts include reviewing operations that are unable to meet return objectives and determining appropriate courses of action including the possible closure of production facilities. The Company is continuing to address market and production issues at its MDF facilities, including the Del-Tin Fiber MDF joint venture. During third quarter 2003, the Company announced the indefinite shutdown of its Clarion, Pennsylvania medium density fiberboard plant. In addition, the Company announced the indefinite shutdown of its Mt. Jewett, Pennsylvania particleboard plant in second quarter 2003 due to market issues. In connection with these shutdowns, the Company incurred and paid $1 million in involuntary employee termination liabilities. These costs are included in other operating (income) expense and excluded from segment operating income. Building Products had income of $22 million in third quarter 2003 compared with $12 million in third quarter 2002. Financial Services Financial Services revenues, consisting of interest and non- interest income, were $292 million in third quarter 2003 compared with $283 million in third quarter 2002. Operations Selected financial information for Financial Services follows: Second Third Quarter Quarter ------------- ------- 2003 2002 2003 ---- ---- ---- (in millions) Net interest income $ 95 $ 95 $ 94 Provision for loan losses (13) (8) (20) Noninterest income 113 86 118 Noninterest expense (146) (129) (148) ---- ---- ---- Segment operating income 49 44 44 Severance (1) -- (2) ---- ---- ---- Operating income $ 48 $ 44 $ 42 ==== ==== ==== Net interest income in third quarter 2003 was similar to third quarter 2002 and second quarter 2003; however, the following changes in the components of net interest income occurred: - average earning assets, principally securities, increased five percent compared with third quarter 2002, but 26 - the net interest spread declined due to the lower interest rate environment combined with an asset sensitive position. In general, increases in interest rates increase Financial Services' net interest income. However, Financial Services' net interest income is not as sensitive to changes in interest rates at third quarter-end 2003 as it was at year-end 2002 principally due to: - a change in the mix of earning assets achieved by increasing single-family mortgage loans and securities, the interest rates on which generally are fixed for the first three to five years and then reset annually thereafter, and decreasing commercial real estate loans, the interest rates on which generally reset every 30 to 90 days, and - a shift in deposits achieved by decreasing certificates of deposits and increasing money market accounts. If interest rates rise for the remainder of 2003, then it is likely that net interest income would be positively affected. If interest rates again decline, it is likely that net interest income will be adversely affected. The provision for loan losses was $13 million in third quarter 2003 compared with $8 million in third quarter 2002. The provision for third quarter 2003 related principally to commercial real estate loans and asset-based commercial and business loans. The provision for third quarter 2002 related principally to asset-based commercial and business loans and senior housing residential loans. Noninterest income includes revenues from mortgage banking, real estate, and insurance activities. Noninterest income was $113 million in third quarter 2003 compared with $86 million in third quarter 2002. The change in noninterest income in 2003 was principally due to: - an increase in mortgage banking loan originations and related gain on sale of loans, up $18 million, - an increase in mortgage servicing rights amortization, up $6 million, and - a reversal of mortgage servicing rights valuation allowance in third quarter 2003 of $7 million compared with an increase in the mortgage servicing rights valuation allowance of $7 million in third quarter 2002. Noninterest expense was $146 million in third quarter 2003 compared with $129 million in third quarter 2002. The change in noninterest expense in 2003 was principally due to higher costs associated with the mortgage banking operations, primarily employee compensation and other origination expenses associated with higher origination volume. 27 See Mortgage Banking Activities for further information regarding mortgage-banking operations. Earning Assets Earning assets include cash equivalents, mortgage loans held for sale, securities, and loans. At third quarter-end 2003, cash equivalents, mortgage loans held for sale, securities, and residential housing loans constituted 81 percent of total earning assets compared with 74 percent at third quarter-end 2002. The increased percentage in 2003 is a result of efforts to change the earning asset mix by increasing residential earning assets. Securities, which include mortgage-backed and other securities, were $6.3 billion at third quarter-end 2003 compared with $5.8 billion at third quarter-end 2002. The increase was primarily a result of purchasing mortgage-backed securities as part of the efforts to increase residential housing assets. Loans were $9.5 billion at third quarter-end 2003 compared with $9.9 billion at third quarter-end 2002 and $9.7 billion at second quarter-end 2003. The following table summarizes the composition of the loan portfolio:
Second Third Quarter-End Quarter-End ----------------- 2003 2002 2003 ---- ---- ---- (in millions) Single-family mortgage $ 3,089 $ 2,100 $ 2,892 Single-family mortgage warehouse 395 454 502 Single-family construction 1,054 1,090 1,065 Multifamily and senior housing 1,831 1,891 1,865 ----- ----- ----- Total residential housing 6,369 5,535 6,324 Commercial real estate 1,175 2,310 1,393 Commercial and business 1,142 1,076 1,178 Asset based lending & leasing 595 749 634 Consumer and other 170 215 182 ----- ----- ----- Total loans 9,451 9,885 9,711 Less allowance for loan losses (130) (141) (117) ----- ----- ----- Loans receivable, net $ 9,321 $ 9,744 $ 9,594 ===== ===== =====
The size of the total loan portfolio decreased $434 million over the past year, and the composition of the portfolio has changed due to efforts to increase residential housing assets. As a result, residential housing loans represent 67 percent of the loan portfolio at third quarter-end 2003 compared with 56 percent at third quarter-end 2002 and 65 percent at second quarter-end 2003. 28 Asset Quality Several key measures are used to evaluate and monitor asset quality. These measures include the level of loan delinquencies, nonperforming loans, assets, and allowance coverage.
Second Third Quarter-End Quarter-End ----------------- 2003 2002 2003 ---- ---- ---- (in millions) Accruing loans past due 30 - 89 days $ 63 $ 116 $ 48 Accruing loans past due 90 days or more 1 9 -- ------ ----- ------ Accruing loans past due 30 days or more $ 64 $ 125 $ 48 ====== ===== ====== Nonaccrual loans $ 76 $ 109 $ 69 Nonaccrual restructured loans 10 -- 10 ------ ----- ------ Nonperforming loans 86 109 79 Foreclosed property 12 8 12 Restructured operating leases 41 -- 42 ------ ----- ------ Nonperforming assets $ 139 $ 117 $ 133 ====== ===== ====== Restructured loans - performing $ 3 $ -- $ -- Allowance for loan losses $ 130 $ 141 $ 117 Nonperforming loan ratio 0.91% 1.11% 0.81% Nonperforming asset ratio 1.46% 1.19% 1.37% Allowance for loan losses/total loans 1.38% 1.42% 1.21% Allowance for loan losses/nonperforming loans 152% 129% 149%
The change in the level of nonaccrual loans at third quarter- end 2003 compared with third quarter-end 2002 was principally due to $21 million in payoffs and paydowns of senior housing and asset-based lending loans, a $10 million commercial office building foreclosure, and $34 million in charge-offs of previously reserved loans. These decreases were partially offset by new nonaccrual loans, principally asset-based lending, senior housing, and commercial and business loans. The restructured operating leases added in 2003 relate to the restructuring of two leveraged, direct financing leases on cargo aircraft totaling $33 million. Due to a reduction in the lease payments in the restructuring, the leases were reclassified as operating leases. As a result, $27 million in leverage was removed, and the assets were written down to estimated fair market value. The restructured operating leases will be classified as nonperforming until such time as the lessee has evidenced the ability to continue to perform under the terms of the restructured leases. Both the asset-based lending and leasing portfolios and commercial real estate loan portfolio will likely continue to be adversely affected by the weak economy. 29 Allowance for Loan Losses The allowance for loan losses is comprised of: - reserves for impaired loans in accordance with SFAS No. 114, - reserves allocated to defined groups of loans that are not considered individually impaired under SFAS No. 114, and - other reserves for unidentified incurred losses inherent in the portfolio that are not allocated to defined groups of loans. Management evaluates the allowance for loan losses at each period end to ensure the level is adequate to absorb losses inherent in the loan portfolio. The allowance is increased by charges to income and decreased by charge-offs, net of recoveries. Changes in the allowance for loan losses were:
Second Third Quarter Quarter --------------- 2003 2002 2003 ---- ---- ---- (in millions) Balance at beginning of period $ 117 $ 135 $ 122 Charge-offs: Total residential housing -- -- -- Commercial real estate (1) -- (7) Commercial and business -- -- (4) Asset based lending and leasing (1) (5) (17) Consumer and other (1) (1) (1) ----- ----- ----- Total charge-offs (3) (6) (29) ----- ----- ----- Recoveries: Total residential housing -- 4 4 Commercial real estate -- -- -- Commercial and business -- -- -- Asset based lending and leasing 3 -- -- Consumer and other -- -- -- ----- ----- ----- Total recoveries 3 4 4 ----- ----- ----- Net charge-offs -- (2) (25) Provision for loan losses 13 8 20 ----- ----- ----- Balance at end of period $ 130 $ 141 $ 117 ===== ===== ===== Annualized net charge-offs as a percentage of average loans outstanding -- 0.1% 1.0%
Third quarter 2003 recoveries related principally to two loans in the asset-based lending portfolio. Third quarter 2002 charge-offs related principally to two asset-based lending and leasing credits, offset principally by one recovery related to a previously charged off senior housing loan. Second quarter 2003 charge-offs related principally to several asset-based commercial and business loans and a commercial real estate loan secured by an office building. 30 Mortgage Banking Activities Mortgage loan originations were $3.7 billion in third quarter 2003 compared with $2.9 billion in third quarter 2002. The high level of mortgage loan originations during third quarter 2003 was due to continued high refinance activity resulting from the low interest rate environment. In third quarter 2003, the savings bank retained $600 million in loans originated by the mortgage banking operations, compared with $327 million in third quarter 2002. The change in loans originated for the savings bank in third quarter 2003 was the result of continued efforts to increase the level of adjustable-rate single-family mortgage assets in the loan portfolio. In third quarter 2003, the mortgage banking operations sold $3.5 billion in loans to secondary markets by delivering loans to third parties or by delivering loans into mortgage-backed securities that were purchased by third parties. Of the loans sold in third quarter 2003, the only retained interest was mortgage servicing rights of $19 million relating to $1.7 billion of loans. The following table provides information regarding the mortgage servicing portfolio:
Second Quarter- Third Quarter-End End ----------------- 2003 2002 2003 ---- ---- ---- (in millions) Outstanding balance of loans serviced for: Third parties $ 8.5 $ 9.4 $ 8.4 Savings bank 2.5 1.0 1.9 ----- ----- ----- Total mortgage servicing portfolio $ 11.0 $ 10.4 $ 10.3 Annualized runoff rate 55% 36% 53%
The decrease in the balance of loans serviced for third parties at third quarter-end 2003 compared with third quarter-end 2002 was principally due to significant repayments on loans, partially offset by new loan originations for which servicing was retained. The increased runoff rate was due to the lower interest rate environment in 2003. As a result of the high runoff rates, amortization of mortgage servicing rights increased in third quarter 2003; however, because interest rates increased near the end of third quarter 2003, and prepayments slowed, the value of the mortgage servicing rights increased, and $7 million in impairment valuation allowance was reversed. The following table provides information regarding charges for amortization and impairment of mortgage servicing rights: 31
Second Third Quarter Quarter ---------------- 2003 2002 2003 ---- ---- ---- (in millions) Amortization $ 19 $ 13 $ 19 Impairment (recovery) (7) 7 5 ----- ----- ----- $ 12 $ 20 $ 24 ===== ===== ===== Valuation allowance at end of period $ 15 $ 12 $ 22
In 2003 and 2002, the mortgage banking operations were significantly affected by the refinancing activity associated with the declining interest rate environment. If interest rates remain constant or increase, the level of mortgage originations, mortgage servicing rights amortization, and the impairment valuation allowance will likely decline. However, if interest rates again decline in 2003, the level of mortgage originations and the level of mortgage servicing rights amortization and impairment will likely increase. In third quarter 2003, interest rates increased somewhat. Accordingly, the level of mortgage loan originations declined substantially near the end of third quarter 2003 and has remained at lower levels in October 2003. As a result of the decline in mortgage originations, it is likely that loan origination and marketing income and variable production costs, including commission costs, will be lower during fourth quarter 2003. Unallocated General and Administrative Expenses, Interest and Other (Income) Expense Unallocated general and administrative expenses were $11 million in third quarter 2003 compared with $8 million in third quarter 2002. The change in 2003 was principally due to an increase in pension and stock-based compensation costs. Parent company interest expense was $33 million in third quarter 2003 compared with $36 million in third quarter 2002. The average interest rate on borrowings was 6.9 percent in third quarter 2003 compared with 7.0 percent in third quarter 2002. Long-term debt was reduced by $70 million during third quarter 2003. In addition, the Company used borrowings under its accounts receivable securitization program to redeem its $150 million 8.25% debentures due 2022. As a result, the Company paid a $6 million call premium and wrote off $2 million of unamortized financing costs, all of which are included in other expense. The Company's accounts receivable securitization program currently bears interest at a rate of 1.1 percent per annum. Other operating (income) expense for third quarter 2003 includes $13 million in expenses related to initiatives to relocate the Corrugated Packaging operations, consolidate administrative functions and effect improvements in supply chain 32 management. These expenses consist principally of relocation and severance expenses and fees paid to third party consultants. In the remainder of 2003, the Company expects to incur an additional $5 million to $10 million in relocation, severance, benefits, and other expenses related to these initiatives. The Company expects the benefits from these initiatives to begin to be realized in 2004. Pension Expense Non-cash pension expenses were $11 million in third quarter 2003 compared with $2 million in third quarter 2002. The change in 2003 was principally due to previously disclosed changes in the assumed discount rate, a decrease in the expected rate of return on plan assets to 8.5 percent, and an increase in the recognition of the accumulated decline in the fair value of plan assets. Income Taxes The effective tax rate includes federal and state income taxes and the effects of non-deductible items. During third quarter 2003, the Company lowered the estimated effective tax rate from 35 percent to 20 percent due to changes in the estimates of income and expenses for the year 2003. As a result, during third quarter 2003 the Company reduced, by $6 million, its previously recorded tax benefits for the first six months 2003. Average Shares Outstanding Average shares outstanding were 54.3 million in third quarter 2003 compared with 53.7 million in third quarter 2002. The dilutive effect of stock options and equity purchase contracts was not significant in any of the periods presented. For first nine months 2003 and 2002 Corrugated Packaging The Company acquired effective control of Gaylord Container Corporation and began consolidating the results of Gaylord in March 2002. The Company also acquired a box plant in Puerto Rico in March 2002, the converting facilities of Mack Packaging Group in May 2002, and Fibre Innovations LLC in November 2002. As a result, the 2003 financial information for Corrugated Packaging is not comparable to prior periods. Corrugated Packaging revenues were $2,019 million for first nine months 2003 compared with $1,932 million for first nine months 2002. Revenues from sales of corrugated packaging represented 93 percent of segment revenues for first nine months 2003 and 94 percent of revenues for first nine months 2002. The remaining revenues are derived from sales of linerboard. The 33 change in revenues was principally due to changes in average prices and shipments: First Nine Months 2003 versus First Nine Months 2002 Increase (Decrease) in --------------------------------- Average Prices Shipments(a) -------------- ------------ Corrugated packaging (1%) 2% Linerboard 1% 15% (a) 2002 shipments have been adjusted for the effect of acquisitions. Costs, which include production, selling, distribution, and administrative costs, were $2,022 million for first nine months 2003 compared with $1,867 million for first nine months 2002. The change in costs in 2003 was principally due to: - the inclusion of the acquired operations, - higher energy costs, up $43 million, - higher pension costs, up $20 million, and - lower OCC costs due to lower prices and a decrease in OCC purchases, down $24 million. Average OCC prices were $89 per ton for first nine months 2003 compared with $101 per ton for first nine months 2002. Mill production was: - 2,390,000 tons for first nine months 2003 and - 2,335,000 tons for first nine months 2002. Mill production data is not comparable due to the effect of the consolidation of Gaylord, which began on March 1, 2002, and Antioch shutdown completed September 2002. The percentage of mill production used by Corrugated Packaging operations was: - 82 percent for first nine months 2003 and - 84 percent for first nine months 2002. The remainder was sold in the domestic and export markets. Excluding routine maintenance, production downtime was minimal for first nine months 2003 and 301,000 tons for first nine months 2002 due to market, mix and operational reasons. Production downtime may occur in future quarters. Market conditions continue to be weak for lightweight gypsum facing paper. As a result, the Company's Premier Boxboard joint venture continues to produce both gypsum facing paper and corrugating medium. The Company purchased 118,000 tons of corrugating medium from the joint venture during first nine months 2003, compared with 134,000 tons in first nine months 2002. 34 Corrugated Packaging had a $3 million operating loss for first nine months 2003 compared with income of $65 million for first nine months 2002. Building Products Building Products revenues were $583 million for first nine months 2003 compared with $610 million for first nine months 2002. The change in revenues in 2003 was principally due to lower average prices and shipments in most product lines as follows: First Nine Months 2003 versus First Nine Months 2002 Increase (Decrease) in -------------------------------- Average Prices Shipments -------------- --------- Lumber (3%) 11% Particleboard (5%) (11%) Gypsum (1%) (7%) MDF (3%) (24%) Other revenues include sales of high-value timberlands. These sales contributed $8 million in operating income for first nine months 2003 compared with $11 million for first nine months 2002. Costs, which include production, selling, distribution, and administrative costs, were $558 million for first nine months 2003 compared with $567 million for first nine months 2002. The change in costs in 2003 was principally due to lower production volumes partially offset by: - higher energy costs, up $6 million, and - higher pension costs, up $3 million. Production averaged from a low of 45 percent to a high of 95 percent of capacity in the various product lines. Production was curtailed to varying degrees in all product lines for first nine months 2003 to match customer demand. The Company's joint venture operations also experienced production curtailments in first nine months 2003. Building Products had operating income of $25 million for first nine months 2003 compared with $43 million for first nine months 2002. Financial Services Financial Services revenues, consisting of interest and non- interest income, were $885 million for first nine months 2003 compared with $825 million for first nine months 2002. Operations Selected financial information for Financial Services follows: 35
First Nine Months ----------------- 2003 2002 ---- ---- (in millions) Net interest income $ 284 $ 278 Provision for loan losses (44) (37) Noninterest income 326 253 Noninterest expense (434) (379) ----- ----- Segment operating income 132 115 Severance and asset write-offs (3) (7) ----- ----- Operating income $ 129 $ 108 ===== =====
Net interest income was $284 million for first nine months 2003 compared with $278 million for first nine months 2002. The change was principally due to: - average earning assets, principally securities,increased 11 percent compared with first nine months 2002, but - the net interest spread declined due to the lower interest rate environment combined with an asset sensitive position. The provision for loan losses was $44 million for first nine months 2003 compared with $37 million for first nine months 2002. The provision for first nine months 2003 related principally to commercial real estate loans, the restructured aircraft leases, and asset-based commercial and business loans. The provision for first nine months 2002 related principally to senior housing residential and commercial and business loans. Noninterest income includes revenues from mortgage banking and real estate and insurance activities. Noninterest income was $326 million for first nine months 2003 compared with $253 million for first nine months 2002. The change in noninterest income in 2003 was principally due to: - an increase in mortgage banking loan originations and related gain on sale of loans, up $91 million, - an increase in mortgage servicing rights amortization, up $16 million, and - no net change in the mortgage servicing rights valuation allowance in first nine months 2003 compared with an increase in the mortgage servicing rights valuation allowance of $5 million in first nine months 2002. Noninterest expense was $434 million for first nine months 2003 compared with $379 million for first nine months 2002. The change in noninterest expense in 2003 was principally due to higher costs associated with the mortgage banking operations, primarily employee compensation and other origination expenses associated with higher origination volume. See Mortgage Banking Activities for further information regarding mortgage-banking operations. 36 Allowance for Loan Losses Changes in the allowance for loan losses were:
First Nine Months ----------------- 2003 2002 ---- ---- (in millions) Balance at beginning of period $ 132 $ 139 Charge-offs: Total residential housing -- (11) Commercial real estate (8) -- Commercial and business (5) (5) Asset based lending and leasing (38) (24) Consumer and other (2) (1) ----- ----- Total charge-offs (53) (41) ----- ----- Recoveries: Total residential housing 4 5 Commercial real estate -- -- Commercial and business -- -- Asset based lending and leasing 3 1 Consumer and other -- -- ----- ----- Total recoveries 7 6 ----- ----- Net charge-offs (46) (35) Provision for loan losses 44 37 ----- ----- Balance at end of period $ 130 $ 141 ===== ===== Net charge-offs (annualized) as a percentage of average loans outstanding 0.62% 0.49%
Charge-offs for first nine months 2003 related principally to a commercial real estate loan secured by an office building, two commercial and business loans, two restructured aircraft leases, and several asset-based lending loans. Charge-offs for first nine months 2002 related principally to two senior housing loans, one commercial and business loan, and several asset-based lending and leasing credits. Mortgage Banking Activities Mortgage loan originations were $11.1 billion for first nine months 2003 compared with $6.7 billion for first nine months 2002. The high level of mortgage loan originations for first nine months 2003 was due to continued refinance activity resulting from the low interest rate environment. For first nine months 2003, the savings bank retained $1.6 billion in loans originated by the mortgage banking operations, compared with $637 million for first nine months 2002. The significant increase in loans originated for the savings bank for first nine months 2003 was the result of continued efforts to increase the level of adjustable-rate single-family mortgage assets in the loan portfolio. 37 For first nine months 2003, the mortgage banking operations sold $10.0 billion in loans to secondary markets by delivering loans to third parties or by delivering loans into mortgage- backed securities that were purchased by third parties. Of the loans sold during first nine months 2003, the only retained interest was mortgage servicing rights of $38 million relating to $3.5 billion of loans. The outstanding balance of loans in the mortgage servicing portfolio decreased at an annualized rate of 50 percent during first nine months 2003 compared with an annualized rate of 29 percent during first nine months 2002. The increased runoff rate was due to the lower interest rate environment in 2003. As a result of the high runoff rates, amortization of mortgage servicing rights increased for first nine months 2003. However, because interest rates increased near the end of first nine months 2003 and prepayments slowed, the value of the mortgage servicing rights increased and $7 million in impairment valuation allowance was reversed. The following table provides information regarding charges for amortization and impairment of recorded mortgage servicing rights: First Nine Months ----------------- 2003 2002 ---- ---- (in millions) Amortization $ 53 $ 31 Impairment -- 6 ----- ----- $ 53 $ 37 ===== ===== Unallocated General and Administrative Expenses, Interest and Other (Income) Expense Unallocated general and administrative expenses were $33 million for first nine months 2003 compared with $26 million for first nine months 2002. The change in 2003 was principally due to an increase in pension and stock-based compensation costs. Parent company interest expense was $103 million for first nine months 2003 compared with $97 million for first nine months 2002. The change was principally due the full effect of interest expense on debt related to the acquisition of Gaylord. Long-term debt was reduced by $145 million in first nine months 2003. The average interest rate on borrowings was 7.0 percent for first nine months 2003 compared with 6.2 percent for first nine months 2002. Other operating expenses for first nine months 2003 include $39 million in expenses related to initiatives to relocate the Corrugated Packaging operations, consolidate administrative functions and effect improvements in supply chain management. 38 These expenses consist principally of relocation and severance expenses and fees paid to third party consultants. Pension Expense Non-cash pension expenses were $32 million for first nine months 2003 compared with $7 million for first nine months 2002. Income Taxes In second quarter 2003, the Internal Revenue Service concluded its examination of the Company's tax returns through 1996, including matters related to net operating losses and minimum tax credit carryforwards, which resulted from certain deductions following the 1988 acquisition of Guaranty Bank and for which no financial accounting benefit had been recognized. Also, the Company resolved certain state tax refund claims for the years 1991 through 1994. As a result, valuation allowances and tax accruals previously provided for these matters are no longer required. Accordingly, during second quarter 2003, the Company recorded a one-time benefit of $165 million, or $3.05 per diluted share. Of this one-time benefit, approximately $26 million represents expected cash refunds of previously paid taxes plus related interest, of which $21 million was received in third quarter 2003. The remainder is a non-cash benefit. Excluding the second quarter 2003 one-time tax benefit described above, the effective tax rate for 2003 is expected to be 20 percent based on current estimates of income and expenses for the year 2003. Average Shares Outstanding Average shares outstanding were 54.1 million for first nine months 2003 compared with 51.9 million for first nine months 2002. The change in 2003 was principally due to the May 2002 sale of 4.1 million shares of common stock. The dilutive effect of stock options and equity purchase contracts was not significant in any of the periods presented. Capital Resources and Liquidity The consolidated net assets invested in Financial Services are subject, in varying degrees, to regulatory rules and regulations including restrictions on the payment of dividends to the parent company. Accordingly, parent company and Financial Services capital resources and liquidity are discussed separately. 39 For first nine months 2003 Parent Company Operating Activities Cash provided by operations was $264 million. Income for first nine months 2003 included $106 million of depreciation and other non-cash charges and credits. Dividends received from Financial Services were $120 million. Working capital needs increased $27 million, principally due to a seasonal increase in receivables. Investing Activities Investing activities used $67 million. Capital expenditures were $96 million. Capital expenditures are expected to approximate $150 million in 2003 or about 63 percent of expected annual depreciation and depletion for 2003. Proceeds from the sale of non-strategic assets acquired in connection with the acquisition of Gaylord were $36 million. Financing Activities Financing activities used $200 million. Debt and other borrowings were reduced by $145 million. Cash dividends paid to shareholders were $55 million or $1.02 per share. Liquidity and Off Balance Sheet Financing Arrangements The parent company's sources of short-term funding are its operating cash flows, which include dividends received from Financial Services, and its existing credit arrangements. The parent company operates in cyclical industries, and its operating cash flows vary accordingly. The dividends received from the savings bank are subject to regulatory approval and restrictions. At third quarter-end 2003, the parent company had $555 million in unused borrowing capacity under its revolving credit agreements and $180 million under its accounts receivable securitization program, which matures in April 2006. During September 2003, the accounts receivable securitization program was increased from $200 million to $250 million. At third quarter- end 2003, the parent company was in compliance with all of the terms and conditions of its credit agreements and accounts receivable securitization program. During fourth quarter 2003, $20 million in revolving credit agreements expire, all of which are unused at third quarter-end 2003; however, any borrowings outstanding at the end of the revolving period would not mature until two years after the revolving period ends. During third quarter 2003, $83 million of tax exempt bonds were converted from variable interest rate modes to fixed rate 40 interest modes, and remarketed to investors at par. The bonds, which have a weighted average remaining term of 12.4 years, were issued with a weighted average interest rate of 5.82 percent. In addition, the Company, redeemed all of the 8.25% Debentures payable 2022. The principal amount of $150 million and the call premium of $6 million were funded by draws on the accounts receivable securitization program. On October 1, 2003, the Company repaid at maturity a $61 million term loan with funds provided from the accounts receivable securitization program. Financial Services The principal sources of cash for Financial Services are operating cash flows, deposits, and borrowings. Financial Services uses these funds to invest in earning assets, generally loans and securities. Operating Activities Cash provided by operations was $611 million. Income for first nine months 2003 included $70 million of amortization and other non-cash charges. Investing Activities Cash provided by investing activities was $356 million. Principal payments and maturities of securities, net of purchases, provided $133 million and loan originations, net of collections, provided $198 million. Financing Activities Cash used for financing activities was $949 million. Borrowings decreased $840 million, principally due to repayments of FHLB advances and a decrease in deposits. In addition, $120 million in dividends were paid to the parent company. Cash Equivalents Cash equivalents were $456 million at third quarter-end 2003 compared with $438 million at year end 2002. Other Financial Services' short-term funding needs are met through operating cash flows, attracting new retail deposits, increased borrowings, and converting assets to cash through sales or reverse repurchase agreements. Assets that can be converted to cash include short-term investments, mortgage loans held for sale, and securities. At third quarter-end 2003, Financial Services had available liquidity of $2.6 billion. The manner in 41 which Financial Services meets its funding needs can affect its asset sensitive position. For example, increased term borrowings at fixed rates would increase asset sensitivity. At third quarter-end 2003, commitments to originate single- family residential mortgage loans totaled $0.9 billion and commitments to sell single-family residential mortgage loans totaled $0.9 billion. At third quarter-end 2003, the savings bank exceeded all applicable regulatory capital requirements. The parent company expects to maintain the savings bank capital at a level that exceeds the minimum required for designation as "well capitalized." As a result, the Company could make capital contributions to the savings bank, if necessary. During third quarter 2003, the Company made no capital contributions to the savings bank. Selected consolidated financial and regulatory capital data for the savings bank follows:
Third Quarter- Year-End End 2003 2002 -------- ------ (dollars in millions) Balance sheet data Total assets $ 17,323 $ 17,634 Total deposits 8,945 9,203 Shareholder's equity 984 1,025
Savings Regulatory For Categorization Bank Minimum as "Well Capitalized" ------- ---------- --------------------- Regulatory capital ratios: Tangible capital 6.36% 2.00% N/A Leverage capital 6.36% 4.00% 5.00% Tier 1 risk-based capital 9.74% 4.00% 6.00% Total risk-based capital 11.19% 8.00% 10.00%
Energy and the Effects of Inflation Energy costs, principally natural gas, were $63 million in third quarter 2003 compared with $53 million in third quarter 2002 and $69 million in second quarter 2003. It is likely that energy costs will continue to fluctuate during 2003. Litigation and Related Matters There are pending against the Company and its subsidiaries lawsuits, claims and environmental matters arising in the regular course of business. The resolution of these matters is not expected to have a material adverse effect on the Company's operations or financial position. For further information on pending legal proceedings, see Part II, Item 1. 42 Accounting Policies New Accounting Standards Adopted Stock-Based Compensation Beginning January 2003, the Company voluntarily adopted the prospective transition method of accounting for stock-based compensation contained in SFAS No. 148, Accounting for Stock- Based Compensation-Transition and Disclosure, an amendment of FASB Statement No. 123. The principal effect of adopting the prospective transition method is that the fair value of stock options granted in 2003 and thereafter are charged to expense over the option vesting period. As a result of the adoption of this prospective transition method, third quarter 2003 net income was decreased by $3 million or $0.05 per share. Prior to 2003, the Company used the intrinsic value method in accounting for its stock-based compensation. As a result, no stock-based compensation expense is reflected in prior years' net income, as all stock options granted had an exercise price equal to the market value of the underlying common stock on the date of grant. Therefore, the cost related to stock-based compensation recognized in net income for first quarter 2003 and 2002 is less than would have been recognized if the fair value method had been applied to all stock options granted since 1995. Asset Retirement Obligations Beginning January 2003, the Company was required to adopt SFAS No. 143, Accounting for Asset Retirement Obligations. The statement requires legal obligations associated with the retirement of long-lived assets to be recognized at their fair value at the time that the obligations are incurred. Upon initial recognition of a liability, that cost is capitalized as part of the related long-lived asset and allocated to expense over the useful life of the asset. The effect of adopting this statement was to increase property, plant and equipment by $3 million, recognize an asset retirement obligation liability of $4 million, and to increase first quarter net loss by $1 million or $0.01 per share for the cumulative effect of adoption. Liabilities and Equity Instruments During third quarter 2003, the Company was required to adopt SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. This statement establishes standards for classifying and measuring as liabilities certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity. The effect on earnings or financial position of adopting this statement was not material. Other Pronouncements During fourth quarter 2003, the Company will be required to begin applying FASB Interpretation No. 46, Consolidation of 43 Variable Interest Entities to its variable interest entities created prior to February 1, 2003. It is anticipated that the effect on earnings or financial position of applying this interpretation will not be material. Critical Accounting Policies In third quarter 2003, there were no significant changes in critical accounting policies from those disclosed in the Company's Form 10-K for the year 2002. Statistical and other data
First Nine Third Quarter Months ------------- ------------- 2003 2002 2003 2002 ---- ---- ---- ---- (in millions) Revenues Corrugated Packaging Corrugated packaging $ 617 $ 629 $ 1,877 $ 1,809 Linerboard 50 43 142 123 ----- ----- ----- ----- Total Corrugated Packaging $ 667 $ 672 $ 2,019 $ 1,932 ===== ===== ===== ===== Building Products Lumber $ 73 $ 59 $ 193 $ 177 Particleboard 38 43 113 133 Medium density fiberboard 21 32 70 91 Gypsum wallboard 19 19 53 58 Fiberboard 20 18 51 52 Other 40 31 103 99 ----- ----- ----- ----- Total Building Products $ 211 $ 202 $ 583 $ 610 ===== ===== ===== ===== Unit sales Corrugated Packaging Corrugated packaging, thousands of tons 793 795 2,382 2,263 Linerboard, thousands of tons 150 127 421 367 ----- ----- ----- ----- Total, thousands of tons 943 922 2,803 2,630 ===== ===== ===== ===== Building Products Lumber, mbf 227 203 641 578 Particleboard, msf 149 164 444 501 Medium density fiberboard, msf 51 73 172 225 Gypsum wallboard, msf 165 171 472 510 Fiberboard, msf 123 106 312 312 Revenues and unit sales do not include joint venture operations.
Note: Data for Corrugated Packaging for first nine months 2003 is not comparable due to the effect of acquisitions completed in 2002. 44 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Interest Rate Risk The Company's current level of interest rate risk with respect to financial instruments is primarily due to an asset sensitive position within Financial Services and, to a lesser degree, variable rate debt at the parent company. The following table illustrates the estimated effect on pre- tax income of immediate, parallel and sustained shifts in interest rates for the subsequent 12-month period at third quarter-end 2003, with comparative information at year-end 2002. The estimated effect takes into account the effects of changing prepayment speeds, repricing characteristics and average balances over the next 12 months. The simultaneous nature of these effects may result in non-symmetrical pre-tax impacts on income across shifts in interest rates or comparisons across reporting periods. Increase (decrease) in Income Before Taxes (In millions) Third Quarter End 2003 Year-end 2002 ------------- ------------- Change in Interest Parent Financial Parent Financial Rates Company Services Company Services --------- ------- --------- ------- --------- +2% $ (4) $ 33 $ (3) $ 40 +1% $ (2) $ 38 $ (2) $ 34 0 $ -- $ -- $ -- $ -- -1% $ 2 $ (21) $ 2 $ (29) Due to the current low levels of interest rates, the two percent decrease in interest rates is not presented. The Parent Company's long-term debt is sensitive to changes in interest rates. Interest rate changes would impact the Parent Company's long-term debt due to differences in market interest rates and the rates at inception of the debt agreements. The analysis used to calculate the effect of changes in interest rates was based on actual debt balances at quarter end, reduced for contractual payments, which were assumed to be replaced with variable rate debt. Financial Services is subject to interest rate risk from financial instruments to the extent that the interest-earning assets and interest-bearing liabilities repay or reprice at different times or in differing amounts or both. Financial Services is currently in an asset sensitive position whereby the rate and paydown characteristics of its assets are more responsive to changes in market interest rates than are its liabilities. In an asset sensitive position, earnings will 45 generally be positively affected in a rising rate environment, but generally be negatively affected in a falling rate environment. Overall, Financial Services' interest rate sensitivity decreased at third quarter-end 2003 compared with year-end 2002, primarily because of changes in the earning asset mix, changes in the deposit base, and interest rate increases in third quarter 2003. The commercial real estate portfolio, which tends to reprice frequently, decreased $700 million, while the mortgage loan portfolio, which generally reprice after three to five years, increased $600 million. Additionally, approximately $600 million of deposits have shifted from certificates of deposit to money market deposit accounts, which generally reprice more frequently. However, because of current market pricing of these accounts, the sensitivity amounts for third quarter-end 2003 anticipate only limited repricing sensitivity of these accounts in the -1% and +1% scenarios. The fair value of mortgage servicing rights (estimated at $88 million at third quarter-end 2003) is also affected by changes in interest rates, primarily long-term fixed mortgage rates. The Company estimates that a one percent decline in long- term fixed mortgage rates from current levels would decrease the fair value of the mortgage servicing rights by approximately $24 million. Foreign Currency Risk In third quarter 2003, there were no significant changes in foreign currency risk from that disclosed in the Company's Form 10-K for the year 2002. Commodity Price Risk In third quarter 2003, there were no significant changes in commodity price risk from that disclosed in the Company's Form 10-K for the year 2002. ITEM 4. CONTROLS AND PROCEDURES (a)Evaluation of disclosure controls and procedures The Company's chief executive officer and its chief financial officer, based on their evaluation of the Company's disclosure controls and procedures (as defined in Exchange Act Rule 13a- 15(e)) as of end of the period covered by this Quarterly Report on Form 10-Q, have concluded that the Company's disclosure controls and procedures are adequate and effective to ensure that the information required to be disclosed by us in the reports we file or submit under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), is recorded, processed, summarized, 46 and reported within the time periods specified in the Securities and Exchange Commission's ("SEC") rules and forms. (b) Changes in internal control over financial reporting. There were no changes in the Company's internal control over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. PART II. OTHER INFORMATION Item 1. Legal Proceedings. The information set forth in Note E to Notes to Consolidated Financial Statements in Part I of this report is incorporated by reference thereto. Antitrust Action As has been previously disclosed, on May 14, 1999, Inland Paperboard and Packaging, Inc. ("Inland") and Gaylord were named as defendants in a Consolidated Class Action Complaint that alleged a civil violation of Section 1 of the Sherman Act. The suit, captioned Winoff Industries, Inc. v. Stone Container Corporation, MDL No. 1261 (E.D. Pa.), names Inland, Gaylord, and eight other linerboard manufacturers as defendants. There have been no material developments in this matter since the Company filed its Quarterly Report on Form 10-Q for second quarter 2003, with the exception that the court's order approving the fairness of the settlement agreement has become final and there are now 12 opt-out cases, which the Company continues to defend vigorously. The Company continues to believe the likelihood of a material loss from these actions to be remote and does not believe that the outcome of these actions should have a material adverse effect on its financial position, results of operations, or cash flow. Gaylord Chemical Corporation As has been previously disclosed, on October 23, 1995, a rail tank car of nitrogen tetroxide exploded at the Bogalusa, Louisiana plant of Gaylord Chemical Corporation, a wholly-owned, independently-operated subsidiary of Gaylord Container Corporation. Following the explosion, more than 160 lawsuits were filed against Gaylord, Gaylord Chemical, and third parties alleging personal injury, property damage, economic loss, related injuries and fear of injuries. There have been no material developments in this matter since the Company filed its Quarterly Report on Form 10-Q for second quarter 2003 other than the trial of the Louisiana class action is currently in process and is expected to be submitted to the jury in mid-November. 47 The Company continues to believe the likelihood of a material loss from these actions to be remote and does not believe that the outcome of these actions should have a material adverse effect on its financial position, results of operations, or cash flow. Other Inland was served with an administrative complaint filed by the U.S. Environmental Protection Agency under the Clean Water Act alleging that its box plant in Crawfordsville, Indiana exceeded its permit limits for suspended solids and BOD and that it failed to make timely reports of its sampling results and failed to follow proper sampling protocols at various times between 1999 and 2002. The served complaint appears to call for a penalty that could exceed $100,000. The permit exceedences were recognized by the city at the time, which imposed a surcharge on the plant. Inland intends to engage in negotiations to determine whether the penalty can be reduced based on the city's surcharges and other defenses. On October 15, 2003, a release of what is suspected to have been nitrogen dioxide and nitrogen oxide took place at Gaylord's linerboard mill lift station and sewer system in Bogalusa, Louisiana. Based upon the Company's investigation, the total amount of released nitrogen oxide and nitrogen dioxide is believed to be no more than twenty pounds. The gaseous release dispersed in the atmosphere and was not observed beyond the fence- line. The mill followed appropriate protocols for handling this type event, notifying the Louisiana Department of Environmental Quality, the U.S. Environmental Protection Agency and local law enforcement officials. The environmental agencies and the Company are currently investigating the incident. Although the investigations are not complete, the Company believes the likelihood of a material loss from this incident to be remote and does not believe that the outcome should have a material adverse effect on its financial position, results of operations, or cash flow. The Ontario Ministry of Environment filed an enforcement action alleging that air emissions from the MDF plant at Pembroke, Ontario, Canada adversely impact surrounding property owners. Trial of the matter is currently ongoing and is expected to continue with sporadic testimony and trial dates through the first quarter of 2004. Fines and penalties assessed in the matter could exceed $100,000, but are not expected to have a material adverse effect on the Company's financial position, results of operations, or cash flow. Item 2. Changes in Securities and Use of Proceeds. None. 48 Item 3. Defaults Upon Senior Securities. None. Item 4. Submission of Matters to a Vote of Security Holders. None Item 5. Other Information. None. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits. 10.1 - Employment Agreement with J. Patrick Maley, effective June 1, 2003. 10.2 - Separation Agreement and Release of Claims with Dale E. Stahl, dated August 15, 2003. 31.1 - Certification of Chief Executive Officer pursuant to Exchange Act Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 - Certification of Chief Financial Officer pursuant to Exchange Act Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 - Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 32.2 - Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (b) Reports on Form 8-K During the quarter ended June 28, 2003, the Company filed the following Current Reports on Form 8-K: 1. Current Report on Form 8-K dated July 23, 2003, reporting under Item 9 and 12 a press release issued by the Company announcing earnings for the period ended June 28, 2003. 2. Current Report on Form 8-K dated July 25, 2003, reporting under Item 5 a press release issued by the Company announcing the resignation of Dale Stahl as an executive officer of the 49 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. TEMPLE-INLAND INC. (Registrant) Dated: November 10, 2003 By /s/ Louis R. Brill ---------------------------- Louis R. Brill Chief Accounting Officer 50 INDEX TO EXHIBITS Exhibit No. Description Page No. ----------- ----------- -------- 10.1 Employment Agreement with J. 51 Patrick Maley, effective June 1, 2003 10.2 Separation Agreement and Release 80 of Claims with Dale E. Stahl, dated August 15, 2003 31.1 Certification of Chief Executive 85 Officer pursuant to Exchange Act Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of Chief Financial 87 Officer pursuant to Exchange Act Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification of Chief Executive 89 Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes- Oxley Act of 2002 32.2 Certification of Chief Financial 90 Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes- Oxley Act of 2002