10-Q 1 tin1stq200410q.txt FORM 10-Q FOR THE PERIOD ENDED APRIL 3, 2004 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 April 3, 2004 OR [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Transition Period From to Commission File Number 001-08634 Temple-Inland Inc. (Exact name of registrant as specified in its charter) Delaware 75-1903917 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 1300 MoPac Expressway South, Austin, Texas 78746 (Address of principal executive offices, including Zip Code) (512) 434-5800 (Registrant's telephone number, including area code) Not Applicable (Former name, former address and former fiscal year, if changed since last report.) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: Number of common shares outstanding Class as of April 3, 2004 Common Stock (par value $1.00 per share) 55,354,332 Page 1 of 48 The Exhibit Index is page 44. 2 TABLE OF CONTENTS Page PART I. FINANCIAL INFORMATION Item 1. Financial Statements Parent company financial statements 3 Financial services financial statements 6 Consolidated financial statements 9 Notes to consolidated financial statements 13 Item 2. Management's Discussion and Analysis of Financial 21 Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosures About 39 Market Risk Item 4. Controls and Procedures 40 PART II. OTHER INFORMATION Item 1. Legal Proceedings 40 Item 2. Changes in Securities, Use of Proceeds and 41 Issuer Purchases of Equity Securities Item 3. Defaults Upon Senior Securities 41 Item 4. Submission of Matters to a Vote of Security 41 Holders Item 5. Other Information 41 Item 6. Exhibits and Reports on Form 8-K 41 3 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS SUMMARIZED STATEMENTS OF INCOME PARENT COMPANY (TEMPLE-INLAND INC.) Unaudited First Quarter --------------- 2004 2003 ---- ---- (In millions) NET REVENUES $ 893 $ 847 COSTS AND EXPENSES Cost of sales 800 797 Selling 28 29 General and administrative 46 45 Other (income) expense 19 9 ----- ----- 893 880 ----- ----- -- (33) FINANCIAL SERVICES EARNINGS 53 39 ----- ----- OPERATING INCOME 53 6 Interest expense (32) (35) ----- ----- INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE TAXES 21 (29) Income tax (expense) benefit (8) 12 ----- ----- INCOME (LOSS) FROM CONTINUING OPERATIONS 13 (17) Discontinued operations -- -- ----- ----- INCOME (LOSS) BEFORE ACCOUNTING CHANGE 13 (17) Effect of accounting change -- (1) ----- ----- NET INCOME (LOSS) $ 13 (18) ===== ===== See the notes to consolidated financial statements. 4 SUMMARIZED BALANCE SHEETS PARENT COMPANY (TEMPLE-INLAND INC.) Unaudited First Year- Quarter End 2004 2003 ---- ---- (In millions) ASSETS Current Assets Cash and cash equivalents $ 31 $ 20 Receivables, net of allowances of $15 in 2004 and $14 in 2003 408 359 Inventories: Work in process and finished goods 84 83 Raw materials and supplies 241 247 ----- ----- Total inventories 325 330 Prepaid expenses and other 78 69 ----- ----- Total current assets 842 778 Investment in Financial Services 1,124 1,123 Timber and Timberlands 497 497 Property and Equipment: Land and buildings 604 600 Machinery and equipment 3,475 3,454 Construction in progress 39 59 Less allowances for depreciation (2,303) (2,259) ----- ----- Total property and equipment 1,815 1,854 Goodwill 237 237 Assets of Discontinued Operations 47 50 Other Assets 97 99 ----- ----- TOTAL ASSETS $ 4,659 $ 4,638 ===== ===== LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities Accounts payable $ 204 $ 218 Employee compensation and benefits 50 72 Accrued interest 26 27 Accrued property taxes 15 23 Other accrued expenses 159 141 Liabilities of discontinued operations 22 22 Current portion of long-term debt 2 4 ----- ----- Total current liabilities 478 507 Long-Term Debt 1,611 1,611 Deferred Income Taxes 28 25 Postretirement Benefits 146 146 Pension Liability 262 250 Other Long-Term Liabilities 130 131 ----- ----- Total Liabilities 2,655 2,670 Shareholders' Equity 2,004 1,968 ----- ----- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 4,659 $ 4,638 ===== ===== See the notes to consolidated financial statements. 5 SUMMARIZED STATEMENTS OF CASH FLOW PARENT COMPANY (TEMPLE-INLAND INC.) Unaudited First Quarter 2004 2003 ---- ---- (In millions) CASH PROVIDED BY (USED FOR) OPERATIONS Net income (loss) $ 13 $ (18) Adjustments: Depreciation and amortization 56 59 Non-cash stock based compensation 9 9 Non-cash pension and postretirement expense 15 14 Cash contribution to pension and postretirement plans (4) (3) Other non-cash charges 13 4 Deferred income taxes 3 (13) Net earnings of financial services (33) (25) Dividends from financial services 30 35 Net assets of discontinued operations (1) (5) Cumulative effect of accounting change -- 1 Other (2) 9 ---- ---- 99 67 Changes in: Receivables (48) (31) Inventories 4 25 Prepaid expenses and other (8) (17) Accounts payable and accrued expenses (27) (24) ---- ---- 20 20 ---- ---- CASH PROVIDED BY (USED FOR) INVESTING Capital expenditures (28) (29) Sales of non-strategic assets and operations 6 30 Other acquisitions and joint ventures -- (3) ---- ---- (22) (2) ---- ---- CASH PROVIDED BY (USED FOR) FINANCING Payments of debt (2) (6) Cash dividends paid to shareholders (20) (19) Proceeds from exercise of stock options 35 -- Additions to debt -- 1 ---- ---- 13 (24) ---- ---- Effect of exchange rate changes on cash -- (2) ---- ---- Net increase (decrease) in cash and cash equivalents 11 (8) Cash and cash equivalents at beginning of period 20 17 ---- ---- Cash and cash equivalents at end of period $ 31 $ 9 ==== ==== See the notes to consolidated financial statements. 6 SUMMARIZED STATEMENTS OF INCOME FINANCIAL SERVICES Unaudited First Quarter 2004 2003 ---- ---- (In millions) INTEREST INCOME Loans and loans held for sale $ 114 $ 133 Securities available-for-sale 15 19 Securities held-to-maturity 46 40 Other earning assets 1 1 ---- ---- Total interest income 176 193 INTEREST EXPENSE Deposits 34 53 Borrowed funds 42 45 ---- ---- Total interest expense 76 98 ---- ---- NET INTEREST INCOME 100 95 Provision for loan losses -- (11) ---- ---- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 100 84 NONINTEREST INCOME Loan servicing fees 8 9 Amortization and impairment of servicing rights (7) (18) Loan origination and sale of loans 37 66 Real estate operations 8 8 Insurance commissions and fees 11 10 Service charges on deposits 9 8 Operating lease income 3 2 Other 10 10 ---- ---- Total noninterest income 79 95 ---- ---- NONINTEREST EXPENSE Compensation and benefits 70 83 Loan servicing and origination 2 3 Real estate operations, other than compensation 2 7 Insurance operations, other than compensation 1 2 Occupancy 8 8 Data processing 4 7 Other 39 30 ---- ---- Total noninterest expense 126 140 ---- ---- INCOME BEFORE TAXES 53 39 Income tax expense (20) (14) ---- ---- NET INCOME $ 33 $ 25 ==== ==== See the notes to consolidated financial statements. 7 SUMMARIZED BALANCE SHEETS FINANCIAL SERVICES Unaudited First Quarter Year-End 2004 2003 ---- ---- (In millions) ASSETS Cash and cash equivalents $ 301 $ 379 Loans held for sale 610 551 Loans, net of allowance for losses of $113 in 2004 and $111 in 2003 9,139 9,026 Securities available-for-sale 1,323 1,374 Securities held-to-maturity 4,978 5,267 Real estate 295 295 Premises and equipment, net 168 164 Accounts, notes and accrued interest receivable 127 138 Goodwill 158 147 Mortgage servicing rights 85 89 Other assets 200 231 ------ ------ TOTAL ASSETS $ 17,384 $ 17,661 ====== ====== LIABILITIES AND SHAREHOLDER'S EQUITY Deposits $ 8,537 $ 8,698 Federal Home Loan Bank advances 5,349 4,992 Securities sold under repurchase agreements 1,363 1,327 Obligations to settle trade date securities -- 567 Other liabilities 468 410 Other borrowings 238 239 Preferred stock issued by subsidiaries 305 305 ------ ------ TOTAL LIABILITIES 16,260 16,538 ------ ------ SHAREHOLDER'S EQUITY 1,124 1,123 ------ ------ TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY $ 17,384 $ 17,661 ====== ====== See the notes to consolidated financial statements. 8 SUMMARIZED STATEMENTS OF CASH FLOWS FINANCIAL SERVICES Unaudited First Quarter 2004 2003 ---- ---- (In millions) CASH PROVIDED BY (USED FOR) OPERATIONS Net income $ 33 $ 25 Adjustments: Depreciation 6 6 Depreciation of leased assets 2 1 Amortization and impairment of servicing rights 7 17 Provision for loan losses -- 11 Amortization and accretion of financial instruments 4 3 Deferred income taxes 2 (1) ------ ------ 54 62 Changes in: Loans held for sale, originations (1,639) (3,200) Loans held for sale, sales 1,576 3,362 Collections on loans services for others, net 13 (24) Other 75 60 ------ ------ 79 260 ------ ------ CASH PROVIDED BY (USED FOR) INVESTING Securities available-for-sale Purchases (28) (4) Principal payments and maturities 77 161 Securities held-to-maturity Purchases (623) (553) Principal payments and maturities 340 371 Loans originated or acquired, net of collections (147) (239) Sale of loans 35 11 Acquisitions, net of cash acquired (10) (1) Capital expenditures (9) (5) Other (3) (12) ------ ------ (368) (271) ------ ------ CASH PROVIDED BY (USED FOR) FINANCING Net increase (decrease) in deposits (161) 150 Repurchase agreements and short-term borrowings, net 459 2 Additions to long-term FHLB advances and other borrowings 111 10 Payments of long-term FHLB advances and other rowings (177) (228) Dividends paid to parent company (30) (35) Other 9 1 ------ ------ 211 (100) ------ ------ Net decrease in cash and cash equivalents (78) (111) Cash and cash equivalents at beginning of period 379 438 ------ ------ Cash and cash equivalents at end of period $ 301 $ 327 ====== ====== See the notes to consolidated financial statements. 9 CONSOLIDATED STATEMENTS OF INCOME TEMPLE-INLAND INC. AND SUBSIDIARIES Unaudited First Quarter 2004 2003 ---- ---- (In millions, except per share amounts) REVENUES Manufacturing $ 893 $ 847 Financial Services 255 288 ------ ------ 1,148 1,135 ------ ------ COSTS AND EXPENSES Manufacturing 893 880 Financial Services 202 249 ------ ------ 1,095 1,129 ------ ------ OPERATING INCOME 53 6 Parent company interest (32) (35) ------ ------ INCOME (LOSS) BEFORE TAXES 21 (29) Income tax (expense) benefit (8) 12 ------ ------ INCOME (LOSS) FROM CONTINUING OPERATIONS 13 (17) Discontinued operations -- -- ------ ------ INCOME (LOSS) BEFORE ACCOUNTING CHANGE 13 (17) Effect of accounting change -- (1) ------ ------ NET INCOME (LOSS) $ 13 $ (18) ====== ====== EARNINGS (LOSS) PER SHARE Basic: Income (loss) from continuing operations $ 0.24 $ (0.31) Discontinued operations -- -- Effect of accounting change -- (0.01) ------ ------ Net income (loss) $ 0.24 $ (0.32) ====== ====== Diluted: Income (loss) from continuing operations $ 0.24 $ (0.31) Discontinued operations -- -- Effect of accounting change -- (0.01) ------ ------ Net income (loss) $ 0.24 $ (0.32) ====== ====== DIVIDENDS PAID PER SHARE OF COMMON STOCK $ 0.36 $ 0.34 ====== ====== See the notes to consolidated financial statements. 10 CONSOLIDATING BALANCE SHEETS TEMPLE-INLAND INC. AND SUBSIDIARIES First Quarter 2004 Unaudited Parent Financial Company Services Consolidated ------- -------- ------------ (In millions) ASSETS Cash and cash equivalents $ 31 $ 301 $ 332 Loans held for sale -- 610 610 Loans receivable -- 9,139 9,139 Securities available-for-sale -- 1,323 1,323 Securities held-to-maturity -- 4,978 4,978 Trade receivables, net 408 -- 408 Inventories 325 -- 325 Timber and timberlands 497 -- 497 Property and equipment 1,815 168 1,983 Goodwill 237 158 395 Other assets 222 707 874 Investment in Financial Services 1,124 -- -- ------ ------ ------ TOTAL ASSETS $ 4,659 $ 17,384 $ 20,864 ====== ====== ====== LIABILITIES AND SHAREHOLDERS' EQUITY Deposits $ -- $ 8,537 $ 8,537 Federal Home Loan Bank advances -- 5,349 5,349 Securities sold under repurchase agreements -- 1,363 1,363 Obligations to settle trade date securities -- -- -- Other liabilities 608 468 1,038 Long-term debt 1,611 238 1,849 Deferred income taxes 28 -- 11 Postretirement benefits 146 -- 146 Pension liability 262 -- 262 Preferred stock issued by subsidiaries -- 305 305 ------ ------ ------ TOTAL LIABILITIES $ 2,655 $ 16,260 $ 18,860 ------ ------ ------ 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 388 Accumulated other comprehensive loss (187) Retained earnings 2,016 ------ 2,278 Cost of shares held in the treasury: 6,035,220 shares (274) ------ TOTAL SHAREHOLDERS' EQUITY 2,004 ------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 20,864 ====== See the notes to consolidated financial statements. 11 CONSOLIDATING BALANCE SHEETS TEMPLE-INLAND INC. AND SUBSIDIARIES Year-End 2003 Unaudited Parent Financial Company Services Consolidated ------- -------- ------------ (In millions) ASSETS Cash and cash equivalents $ 20 $ 379 $ 399 Loans held for sale -- 551 551 Loans receivable -- 9,026 9,026 Securities available-for-sale -- 1,374 1,374 Securities held-to-maturity -- 5,267 5,267 Trade receivables 359 -- 359 Inventories 330 -- 330 Timber and timberlands 497 -- 497 Property and equipment 1,854 164 2,007 Goodwill 237 147 384 Other assets 218 753 949 Investment in Financial Services 1,123 -- -- ------ ------ ------ TOTAL ASSETS $ 4,638 $ 17,661 $ 21,143 ====== ====== ====== LIABILITIES AND SHAREHOLDERS' EQUITY Deposits $ -- $ 8,698 $ 8,698 Federal Home Loan Bank advances -- 4,992 4,992 Securities sold under repurchase agreements -- 1,327 1,327 Obligations to settle trade date securities -- 567 567 Other liabilities 638 410 1,033 Long-term debt 1,611 239 1,850 Deferred income taxes 25 -- 7 Postretirement benefits 146 -- 146 Pension liability 250 -- 250 Preferred stock issued by subsidiaries -- 305 305 ------ ------ ------ TOTAL LIABILITIES $ 2,670 $ 16,538 $ 19,175 ------ ------ ------ SHAREHOLDERS' EQUITY Preferred stock - par value $1 per share: authorized 25,000,000 shares; none issued -- Common stock - par value $1 per share: authorized 200,000,000 shares; issued 61 61,389,552 shares including shares held in the treasury Additional paid-in capital 377 Accumulated other comprehensive loss (185) Retained earnings 2,023 ------ 2,276 Cost of shares held in the treasury: 6,792,410 shares (308) ------ TOTAL SHAREHOLDERS' EQUITY 1,968 ------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 21,143 ====== See the notes to consolidated financial statements. 12 CONSOLIDATED STATEMENT OF CASH FLOWS TEMPLE-INLAND INC. AND SUBSIDIARIES Unaudited First Quarter 2004 2003 ---- ---- (In millions) CASH PROVIDED (USED FOR) OPERATIONS Net income (loss) $ 13 $ (18) Adjustments: Depreciation and amortization 64 66 Amortization and accretion of financial instruments 11 20 Provision for loan losses -- 11 Deferred income taxes 5 (13) Other non-cash charges 13 4 Net assets of discontinued operations (1) (5) Cumulative effect of accounting change -- 1 Other 93 88 ----- ----- 198 154 Changes in: Receivables (48) (31) Inventories 4 25 Prepaid expenses and other (8) (17) Accounts payable and accrued expenses (27) (24) Loans held for sale, originations (1,639) (3,200) Loans held for sale, sales 1,576 3,362 Collections on loans services for others, net 13 (24) ----- ----- 69 245 ----- ----- CASH PROVIDED BY (USED FOR) INVESTING Capital expenditures (37) (34) Sale of non-strategic assets and operations 8 40 Securities available-for-sale, net 49 157 Securities held-to-maturity, net (283) (182) Loans originated or acquired, net of principal collected (147) (239) Proceeds from sale of loans 35 11 Acquisitions, net of cash acquired (10) (4) Other (5) (22) ----- ----- (390) (273) ----- ----- CASH PROVIDED BY (USED FOR) FINANCING Deposits, net (161) 150 Additions to long-term debt 111 11 Payments of long-term debt (179) (234) Repurchase agreements and short-term borrowings, net 459 2 Cash dividends paid to shareholders (20) (19) Proceeds from exercise of stock options 35 -- Other 9 1 ----- ----- 254 (89) ----- ----- Effect of exchange rate changes on cash -- (2) ----- ----- Net decrease in cash and cash equivalents (67) (119) Cash and cash equivalents at beginning of period 399 455 ----- ----- Cash and cash equivalents at end of period $ 332 $ 336 ===== ===== 13 TEMPLE-INLAND INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS NOTE A - BASIS OF PRESENTATION We prepared these unaudited interim financial statements in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. As a result, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. However, in our opinion, all adjustments (consisting only of normal accruals) considered necessary for a fair presentation have been included. These interim operating results are not necessarily indicative of the results that may be expected for the entire year. For further information, refer to the financial statements and footnotes included in our Annual Report on Form 10-K for the fiscal year ended January 3, 2004. The consolidated financial statements include the accounts of Temple-Inland Inc. and its manufacturing and financial services subsidiaries. A significant portion of our consolidated net assets invested in financial services is subject, in varying degrees, to regulatory rules and restrictions including restrictions on the ability of financial services to pay dividends to us. Accordingly, included as an integral part of the consolidated financial statements are separate summarized financial statements for our parent company and for our financial services segment. The parent company summarized financial statements include the accounts of Temple-Inland and its manufacturing segments. The net assets invested in financial services are reflected using the equity method. Related earnings, however, are presented before tax to be consistent with the consolidated financial statements. We have eliminated all material intercompany amounts and transactions. We have reclassified certain prior period amounts to conform to current year's classifications. 14 TEMPLE-INLAND INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS NOTE B - EARNINGS PER SHARE Denominators used in computing per share amounts were: First Quarter 2004 2003 ---- ---- (In millions) Denominators for earnings (loss) per share: Weighted average shares outstanding - basic 55.1 54.0 Dilutive effect of equity purchase contracts -- -- Dilutive effect of stock awards 0.5 -- ----- ----- Weighted average shares outstanding - diluted 55.6 54.0 ===== ===== NOTE C - COMPREHENSIVE INCOME (LOSS) Comprehensive income (loss) consists of: First Quarter 2004 2003 ---- ---- (In millions) Net income (loss) $ 13 $ (18) Other comprehensive income (loss), net of taxes: Unrealized gains (losses) on: Available-for-sale securities (2) 4 Derivative instruments -- -- Foreign currency translation adjustments -- (3) ---- ---- Other comprehensive income (loss) (2) 1 ---- ---- Comprehensive income (loss) $ 11 $ (17) ==== ==== At first quarter-end 2004, the aggregate fair value of our interest rate swap derivative was an $8 million liability. The ineffective portion of derivatives charged to earnings and amounts reclassified from other comprehensive income into earnings were not material. NOTE D - SEGMENT INFORMATION We have three reportable segments: corrugated packaging, forest products, and financial services. We evaluate performance based on operating income before other (income) expense and unallocated expenses, principally general and administrative expenses. We do not allocate parent company interest to the business segments. Other (income) expense includes gain or loss on sale of assets, asset impairments and expenses associated with consolidation initiatives and facility closures. 15 TEMPLE-INLAND INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Unallocated Expenses and For First Quarter or at Corrugated Forest Financial Other Income Quarter-End 2004 Packaging Products Services (Expense) Total ----------------------- ---------- -------- --------- ------------ ----- (In millions) Revenues from external customers $ 673 $ 220 $ 255 $ -- $ 1,148 Depreciation and amortization 39 15 8 2 64 Operating income 10 32 53 (42) 53 Financial services, net interest income -- -- 100 -- 100 Total assets 2,327 1,034 17,384 119 20,864 Capital expenditures 18 8 9 2 37 Goodwill 237 -- 158 -- 395 ------------------------------------------------------------------------------------ For First Quarter or at Quarter-End 2003 ----------------------- (In millions) Revenues from external customers $ 667 $ 180 $ 288 $ -- $ 1,135 Depreciation and amortization 41 16 7 2 66 Operating income 2 (7) 39 (28) 6 Financial services, net interest income -- -- 95 -- 95 Total assets 2,444 1,126 18,069 79 21,718 Capital expenditures 20 8 5 1 34 Goodwill 243 -- 149 -- 392 ------------------------------------------------------------------------------------ Includes other (income) expense for first quarter 2004 of $19 million, which consists of a $12 million asset impairment, a $2 million charge associated with converting facility closures and a $5 million charge related to consolidation and supply chain initiatives. Of these amounts, $2 million applies to corrugated packaging, $12 million applies to forest products, and $5 million is unallocated. Includes other (income) expenses for first quarter 2003 of $9 million, which consists of a $6 million charge related to converting facility closures, which applies to corrugated packaging, and a $3 million charge related to consolidation and supply chain cost reduction initiatives. As a result of the consolidation of our administrative functions and adoption of a shared services concept, beginning first quarter 2004, we changed the way we allocate cost to the business segments. The effect of this change was to increase segment operating income and to increase unallocated expenses by a like amount. First quarter 2003 amounts have been reclassified to reflect this change as follows: Originally As Reported Reclassification Reclassified -------- ---------------- ------------ (In millions) Corrugated packaging $ (4) $ 6 $ 2 Forest products (9) 2 (7) Financial services 39 -- 39 ---- ---- ---- Segment operating income 26 8 34 Unallocated expenses (20) (8) (28) ---- ---- ---- Operating income $ 6 $ -- $ 6 ==== ==== ====
NOTE E - EMPLOYEE BENEFIT PLANS The components of net periodic benefit cost of our defined benefit and postretirement plans for first quarter are: 16 TEMPLE-INLAND INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Pension Postretirement Benefits Benefits ------------ -------------- 2004 2003 2004 2003 ---- ---- ---- ---- (In millions) Service costs $ 6 $ 6 $ 1 $ 1 Interest cost on projected benefit obligation 18 17 2 3 Expected return on plan assets (17) (16) -- -- Amortization of prior service costs -- 1 (1) (1) Amortization of net (gain) loss 6 3 -- -- ---- ---- ---- ---- Net periodic benefit cost $ 13 $ 11 $ 2 $ 3 ==== ==== ==== ====
The Medicare Prescription Drug, Improvement and Modernization Act of 2003 was enacted in December 2003. This act expands Medicare to include, for the first time, coverage for prescription drugs. Our postretirement benefit plans provide for medical coverage, including a prescription drug subsidy, for certain participants. Due to the absence of detailed regulations necessary to implement the act, we have not completed the analysis to determine the effects of the act on our postretirement benefit plans, though it is likely that the effects will ultimately reduce our cost for these plans. In addition, the FASB has not issued specific authoritative guidance on accounting for the subsidy. In first quarter 2004, the FASB issued FASB Staff Position, No. 106-1, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003. This staff position allows companies to defer recognizing the effects of the act until authoritative guidance on the accounting for the prescription drug subsidy is issued or until certain other events occur. We elected to defer recognition. As a result, our reported postretirement benefit obligation and the 2004 net periodic benefit cost do not reflect the effects of the act and authoritative accounting guidance, when issued, could require us to change these amounts. NOTE F - STOCK-BASED COMPENSATION Prior to 2003, we used the intrinsic value method in accounting for stock-based compensation. As a result, no stock- based compensation expense related to stock options granted prior to 2003 is reflected in net income, as all stock options granted had an exercise price equal to the market value of the underlying common stock on the date of grant. Therefore, the cost related to stock-based compensation recognized in net income (loss) for first quarter 2004 and 2003 is less than would have been recognized if the fair value method had been applied to all stock options granted since 1995. The following table illustrates the effect on net income (loss) and earnings (loss) per share as if the fair value method had been applied to all stock options granted since 1995. 17 TEMPLE-INLAND INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
First Quarter --------------------- 2004 2003 ---- ---- (In millions) Net income (loss), as reported $ 13 $ (18) Add: Stock-based compensation expense, net of related tax effects, included in the determination of reported net income 6 5 Deduct: Total stock-based compensation expense, net of related tax effects, determined under the fair value based method for all awards (8) (7) ----- ----- Pro forma net income (loss) $ 11 $ (20) ===== ===== Earnings (loss) per share: Basic, as reported $ 0.24 $(0.32) Basic, pro forma $ 0.20 $(0.37) Diluted, as reported $ 0.24 $(0.32) Diluted, pro forma $ 0.20 $(0.37)
NOTE G - CONTINGENCIES We are involved in various legal proceedings that arise from time to time in the ordinary course of doing business. We believe that the possibility of a material liability from any of these proceedings is remote and we do not believe that the outcome of any of these proceedings should have a material adverse effect on our financial position, results of operations, or cash flow. NOTE H - ASSETS HELD FOR SALE Assets held for sale include assets of discontinued operations and other assets held for sale. At first quarter-end 2004, discontinued operations consist of the chemical business obtained in the Gaylord acquisition and accruals related to the 1999 sale of our bleached paperboard operations. At first quarter-end 2004, the assets and liabilities of the discontinued operations includes $7 million of working capital, $17 million of property and equipment, and $18 million of environmental and other long-term accruals. Revenues from discontinued operations for first quarter 2004 were $4 million. 18 TEMPLE-INLAND INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS In conjunction with our previously announced plan, during first quarter 2004, we entered into an agreement to sell certain assets used in our specialty packaging operations for $19 million cash subject to working capital adjustments. The sale closed in April 2004. The anticipated proceeds approximate the current carrying value of these assets. During second quarter 2004 we expect to incur, $1 million in severance and $0.2 million in other exit costs most of which will be paid during second quarter 2004. NOTE I - OTHER OPERATING (INCOME) EXPENSE First Quarter 2004 2003 ---- ---- (In millions) Expenses associated with consolidation of administrative functions $ 5 $ 3 Closure of production and converting facilities 14 6 ---- ---- Total $ 19 $ 9 ==== ==== Expenses associated with the consolidation of administrative functions consist principally of severance most of which was paid during first quarter 2004. In conjunction with our previously announced plans, we closed one converting facility in March 2004, a second converting facility in April 2004, and we intend to close a third converting facility by the end of second quarter 2004. As a result, we paid $1 million in severance during first quarter 2004 and expect to incur additional severance and exit costs in second quarter 2004. Asset impairments were recognized in fourth quarter 2003 in conjunction with our initial announcement of these plans. During first quarter 2004, we revised our strategic alternatives for the intended use of our Clarion MDF facility to now include a possible sale of this facility during 2004. As a result, during first quarter 2004, we recognized a $12 million impairment charge related to the Clarion MDF facility based on the probability that we will not be able to recover our entire investment in this facility. A summary of the activity within production and converting facility exit costs and consolidation of administrative functions accruals for first quarter 2004 follow: 19 TEMPLE-INLAND INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Beginning Cash End of of Period Additions Payments Period --------- --------- -------- ------ (In millions) Involuntary employee terminations $ 9 $ 2 $ (8) $ 3 Contract termination penalties 6 -- -- 6 Environmental compliance 11 -- -- 11 Demolition 11 -- -- 11 ---- ---- ---- ---- Total $ 37 $ 2 $ (8) $ 31 ==== ==== ==== ====
NOTE J - ACQUISITIONS During first quarter 2004, financial services acquired an insurance agency for $14 million cash. The purchase price was allocated to acquired assets and liabilities based upon their fair values with $11 million allocated to goodwill. The unaudited pro forma results of operations, assuming the acquisition had been effected at the beginning of the year, would not have been materially different from those reported. NOTE K - ACCOUNTING PRONOUNCEMENTS During first quarter 2004, we were required to adopt the following accounting pronouncements: FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities an interpretation of ARB No. 51. This interpretation provides guidance for determining whether an entity is a variable interest entity and which beneficiary of the variable interest entity, if any, should consolidate the variable interest entity. There was no effect on earnings or financial position of adopting this interpretation. Disclosures required by this interpretation follow: * In 1999 we entered into an agreement to lease a particleboard and medium density fiberboard facility in Mt. Jewett, PA. The lease is for 20 years and includes fixed price purchase options in 2014 and at the end of the lease. The options prices were intended to approximate the estimated fair value of the facility at those dates and do not represent a guarantee of the facilities residual value. After exhaustive efforts, we were unable to determine whether the lease is with a variable interest entity or if there is a primary beneficiary because the unrelated third party lessors will not provide the necessary financial information. The lease is accounted for as an operating lease and our financial interest is limited to our obligation to make the remaining $191 million of contractual lease payments, $10 million per year. 20 TEMPLE-INLAND INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS * In 1999 we invested $2 million in the form of equity and subordinated debt in a residential land development partnership that meets the definition of a variable interest entity. However, we have determined that we are not the primary beneficiary of the entity and, therefore, are not required to consolidate this entity. At year-end 2003, this partnership had total assets of $88 million and total liabilities of $89 million. Our maximum exposure to loss is the carrying amount of our subordinated debt and equity investments in this partnership, currently $2 million. Securities and Exchange Commission Staff Accounting Bulletin No.105, Application of Accounting Principles to Loan Commitments. This bulletin applies to loan commitments issued after March 2004 and accounted for as derivative instruments and it precludes the recognition of an asset at the inception of the loan commitment. The effect of adopting this bulletin was not significant. 21 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Forward-Looking Statements Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties. Our actual results may differ significantly from the results discussed in the forward- looking statements. Factors that might cause such differences include general economic, market, or business conditions; the opportunities or lack thereof that may or may not be presented to and pursued by us; availability and price of raw materials we use; competitive actions by others; changes in laws or regulations; the accuracy of our judgments and estimates concerning the integration of acquired operations and the consolidation and supply chain initiatives; and other factors, many of which are beyond our control. Results of Operations for First Quarter Ended March 2004 and 2003 Summary A summary of our consolidated results for first quarter follows: First Quarter 2004 2003 ---- ---- (In millions, except per share) Consolidated revenues $ 1,148 $ 1,135 Income (loss) from continuing operations 13 (17) Income (loss) from continuing operations, per diluted share 0.24 (0.31) Average diluted shares outstanding 55.6 54.0 Significant items affecting 2004 income from continuing operations included: * higher corrugated packaging shipments and lower mill and converting costs more than offset lower corrugated packaging prices and higher OCC costs; * higher pricing and shipments within forest products; * improvements in financial services operating income, principally due to higher spreads, lower loan loss provisions, and reduced costs; and * charges and expenses of $19 million related to under- performing assets and the consolidation of administrative functions. 22 Business Segments We manage our operations through three business segments: * Corrugated packaging, * Forest products, and * Financial services. Our operations are affected to varying degrees by supply and demand factors and economic conditions including changes in interest rates, new housing starts, home repair and remodeling activities, and the strength of the U.S. dollar. Given the commodity nature of our manufactured products, we have little control over market pricing or market demand. A summary of the results of operations by business segment follows:
First Quarter ---------------- 2004 2003 ---- ---- (In millions) Revenues Corrugated packaging $ 673 $ 667 Forest products 220 180 Financial services 255 288 ------ ------ Total revenues $ 1,148 $ 1,135 ====== ====== Segment Operating Income Corrugated packaging $ 10 $ 2 Forest products 32 (7) Financial services 53 39 ------ ------ Total segment operating income 95 34 Unallocated expenses (23) (19) Other income (expense) (19) (9) Parent company interest (32) (35) ------ ------ Income (loss) before taxes 21 (29) Income tax (expense) benefit (8) 12 ------ ------ Income (loss) from continuing operations 13 (17) Discontinued operations -- -- Effect of accounting change -- (1) ------ ------ Net income (loss) $ 13 $ (18) ====== ====== As a result of the consolidation of our administrative functions and adoption of a shared services concept, beginning first quarter 2004, we changed the way we allocate cost to the business segments. The effect of this change was to increase segment operating income and to increase unallocated expenses by a like amount. First quarter 2003 amounts have been reclassified to reflect this change as follows: Originally As Reported Reclassification Reclassified -------- ---------------- ------------ (In millions) Corrugated packaging $ (4) $ 6 $ 2 Forest products (9) 2 (7) Financial services 39 -- 39 ----- ----- ----- Segment operating income 26 8 34 Unallocated expenses (20) (8) (28) ----- ----- ----- Operating income $ 6 $ -- $ 6 ===== ===== ===== 23 Other (income) expense for first quarter 2004 consists of a $12 million asset impairment, a $2 million charge associated with converting facility closures, and a $5 million charge related to consolidation and supply chain initiatives. Of these amounts, $2 million applies to corrugated packaging, $12 million applies to forest products, and $5 million is unallocated. Other (income) expenses for first quarter 2003 consists of a $6 million charge related to converting facility closures, which applies to corrugated packaging, and a $3 million charge related to consolidation and supply chain cost reduction initiatives.
Corrugated Packaging A summary of our corrugated packaging results follows: First Quarter 2004 2003 ---- ---- (In millions) Revenues $ 673 $ 667 Segment operating income 10 2 Corrugated packaging prices declined during the quarter. Corrugated packaging shipments, however, continued to improve and inventory levels continued to decline. As a result of improved demand, lower inventories and a generally improving U.S. economy, we announced a $50 per ton increase in the price of linerboard effective March 2004 and a similar increase in corrugated packaging prices effective April 2004. In addition, we recently announced another $50 per ton increase in the price of linerboard effective June 2004. First Quarter 2004 versus First Quarter 2003 Increase (Decrease) ------------------------- Corrugated packaging Average prices (5)% Shipments per workday 5% Industry shipments, average week(a) 3% Linerboard Average prices (6)% Shipments, tons (10)% (a) Source: Fibre Box Association As discussed later, mill production was up significantly during the quarter. However, linerboard shipments were down because the increased production was used in our converting facilities. Compared with fourth quarter 2003, average corrugated packaging prices were down one percent while shipments per workday were up 0.5 percent. Compared with fourth quarter 2003, average linerboard prices were flat while shipments were down 26 percent. 24 In addition to reductions in mill and converting costs, other factors affecting operating income include fluctuations in the following costs and expenses: First Quarter 2004 versus First Quarter 2003 Increase (Decrease) ------------------------- (In millions) OCC recycled fiber $ 8 Energy, principally natural gas (3) Depreciation (2) Pension and postretirement 2 Our OCC costs averaged $103 per ton during first quarter 2004 and $82 per ton during first quarter 2003. Our OCC and energy costs fluctuate based on the market prices we pay for these commodities. Information about our mills and converting facilities follows: First Quarter 2004 2003 ---- ---- Number of converting facilities (at quarter-end 73 77 Mill capacity, in thousand tons 827 827 Mill production, in thousand tons 832 763 Percent mill production used internally 87% 84% Production downtime, excluding routine -- 46 maintenance, in thousand tons We purchased 28,000 tons in first quarter 2004 and 26,000 tons in first quarter 2003 of corrugated medium produced by our Premier Boxboard Limited LLC joint venture. We continue our efforts to enhance return on investment. This includes reviewing operations that are unable to meet return objectives and determining appropriate courses of action, including possibly consolidating and closing converting facilities. In conjunction with our previously announced plans: * We closed one of our Dallas, Texas converting facilities in March 2004, and closed our Raleigh, North Carolina converting facility in April 2004. In April 2004, we announced that we would close one of our Louisville, Kentucky converting facilities by the end of second quarter 2004. As a result, we paid $1 million in severance cost during first quarter 2004, and we expect to incur additional severance and other exit costs during second quarter 2004. Asset impairments were recognized in fourth quarter 2003 in conjunction with the initial announcement of these plans. 25 * In April 2004, we sold certain assets used in our specialty packaging operations for $19 million cash subject to working capital adjustments. The anticipated proceeds approximate the current carrying value of these assets. During second quarter 2004, we expect to incur $1 million in severance and other exit costs, most of which will be paid during second quarter 2004. The accounting effects of these items are included in other operating expenses and are excluded from segment operating income. Forest Products A summary of our forest products results follows: First Quarter 2004 2003 ---- ---- (In millions) Revenues $ 220 $ 180 Segment operating income (loss) 32 (7) Product prices and shipments continued to improve due in part to the strong housing and remodeling markets. First Quarter 2004 versus First Quarter 2003 Increase (Decrease) ------------------------- Average Prices Shipments ------- --------- Lumber 18% 19% Particleboard 13% 3% Gypsum 26% 6% MDF 2% (11%) Compared with fourth quarter 2003, average prices were up nine percent for particleboard, up six percent for gypsum, and up four percent for MDF, while average prices were down two percent for lumber. Shipments were up six percent for lumber, four percent for particleboard, two percent for MDF and flat for gypsum. First quarter 2004 comparisons of shipments for MDF and particleboard are affected by the indefinite closures of our Clarion MDF facility in third quarter 2003 and our Mt. Jewett particleboard facility in second quarter 2003. Other factors affecting operating income include fluctuations in the following costs and expenses: 26 First Quarter 2004 versus First Quarter 2003 Increase (Decrease) ------------------------- (In millions) Energy, principally natural gas $ (2) Our energy costs fluctuate based on the market prices we pay for these commodities. Information about our converting and manufacturing facilities follows: First Quarter 2004 2003 ---- ---- Number of converting and manufacturing facilities (at quarter-end) 19 19 Average operating rates for all product lines: High 92% 76% Low 57% 66% Average operating rates for first quarter 2004 include the effects of the indefinite closures of our Clarion MDF facility in third quarter 2003 and our Mt. Jewett particleboard facility in second quarter 2003. Excluding these effects, the average operating rates for all product lines during the first quarter 2004 would range from a high of 95 percent to a low of 76 percent. We sold 430 acres of high-value land in first quarter 2004 and 253 acres in first quarter 2003. These sales increased segment operating income by $3 million in first quarter 2004 and $1 million in first quarter 2003. We continue our efforts to enhance return on investment. This includes reviewing operations that are unable to meet return objectives and determining appropriate courses of action. In addition, we are continuing to address market and production cost issues at our MDF facilities, including the Del-Tin Fiber joint venture. During first quarter 2004, we revised our strategic alternatives for the intended use of our Clarion MDF facility to now include a possible sale of this facility during 2004. As a result, during first quarter 2004, we recognized a $12 million impairment charge related to the Clarion MDF facility based on the probability that we will not be able to recover our entire investment in this facility. The accounting effect of this item is included in other operating expenses and is excluded from segment operating income. 27 Financial Services A summary of our financial services results follows: First Quarter 2004 2003 ---- ---- (In millions) Net interest income $ 100 $ 95 Segment operating income 53 39 Information concerning our interest rate spread follows:
First Quarter ----------------------------------- 2004 2003 --------------- ---------------- Average Yield/ Average Yield/ Balance Rate Balance Rate ------- ------ ------- ------ (Dollars in millions) Earning assets $16,222 4.34% $16,845 4.59% Interest-bearing liabilities 15,136 2.01% 15,544 2.52% ---- ---- Interest rate spread 2.33% 2.07% ==== ====
Near year-end 2003 a sizable portion of our certificates of deposit liabilities that were issued in previous years, and that carried rates substantially above 2003 rates, matured. We remain in an asset sensitive position, which means that increases in interest rates generally increase our net interest income and decreases in interest rates generally decrease our net interest income. Since first quarter 2003, we have reduced our asset sensitivity, primarily by increasing our residential housing assets with loans that have fixed interest rates for the first three to five years, and by shifting our deposit base to include more demand deposits and less certificates of deposits. The following tables summarize the composition of earning assets and deposits:
First Quarter-End Year-End ----------------- -------- 2004 2003 2003 ---- ---- ---- (Dollars in millions) Residential housing assets (loans and securities) $ 13,326 $ 13,014 $ 13,492 Other earning assets 2,964 3,960 3,010 ------ ------ ------ Total earning assets $ 16,290 $ 16,974 $ 16,502 ====== ====== ====== Residential housing assets as a percentage of total earning assets 82% 77% 82% Demand deposit and savings accounts $ 5,237 $ 4,332 $ 5,115 Certificates of deposit 3,300 4,998 3,583 ------ ------ ------ Total deposits $ 8,537 $ 9,330 $ 8,698 ====== ====== ======
Other factors affecting operating income include fluctuations in the following noninterest income and expenses: 28 First Quarter 2004 versus First Quarter 2003 Increase (Decrease) ------------------------- (In millions) Noninterest income: Gains on mortgage loan sales $ (29) Servicing rights amortization and impairment (11) The decrease in gains on mortgage loan sales in first quarter 2004 was due to the decline in mortgage loan production activity in first quarter 2004. The decrease in servicing rights amortization and impairment in first quarter 2004 was due to the decrease in prepayments. As mortgage interest rates rise, mortgage loan production activity and servicing rights amortization and impairment generally decline and as mortgage interest rates decline, mortgage loan production activity and servicing rights amortization and impairment generally increase. Information regarding mortgage loan production activity follows:
For First Quarter 2004 2003 ---- ---- (Dollars in millions) Loans originated for sale to third parties $ 1,257 $ 2,625 Gains on loan sales as a percent of originations 2.26% 2.06% Value of mortgage servicing rights retained $ 4 $ 6
Information regarding the mortgage loans we service for others and our mortgage servicing rights follows:
At First Quarter-End or For First Quarter -------------------- 2004 2003 ---- ---- (Dollars in millions) Outstanding balance of loans serviced for third parties $ 7,938 $ 7,821 Annualized prepayment rate 28% 42% Carrying amount of mortgage servicing rights as a percent of principal balance serviced 1.07% 1.19%
Factors affecting noninterest expense follows: 29 First Quarter 2004 versus First Quarter 2003 Increase (Decrease) ------------------------- (In millions) Noninterest expense: Compensation and benefits $ (13) Real estate operations (5) A significant portion of our compensation cost is directly related to our mortgage banking operations' production volume. In first quarter 2004, compensation costs declined in conjunction with the decline in production volume. A substantial portion of our mortgage banking operations' production-related costs are directly variable with production activities. However, other mortgage banking production-related operating costs are fixed or only partially variable. Asset Quality and Allowance for Loan Losses The following table summarizes various asset quality measures:
First Quarter-End Year-End ----------------- -------- 2004 2003 2003 ---- ---- ---- (Dollars in millions) Non-performing loans $ 102 $ 128 $ 65 Restructured operating lease assets 39 42 40 Foreclosed real estate 27 4 26 ----- ----- ----- Non-performing assets $ 168 $ 174 $ 131 ===== ===== ===== Non-performing loans as a percentage of total loans 1.10% 1.28% 0.71% Non-performing assets ratio 1.80% 1.74% 1.42% Allowance for loan losses as a percent of: Non-performing loans 111% 96% 172% Total loans 1.22% 1.22% 1.22%
The increase in non-performing loans at first quarter-end 2004 from year-end 2003 principally related to a $33 million commercial real estate loan collateralized by a two-building office complex in which the sole tenant filed bankruptcy. At year-end 2003 and continuing through first quarter-end 2004 we were negotiating with the borrower and carried the loan at the estimated collateral value. The following table summarizes changes in the allowance for loan losses: 30 First Quarter 2004 2003 ---- ---- (Dollars in millions) Balance at beginning of period $ 111 $ 132 Net charge-offs (recoveries) 2 (21) Provision for loan losses -- 11 ----- ----- Balance at end of period $ 113 $ 122 ===== ===== Net charge-offs as a percentage of average loans outstanding (0.10%) 0.86% In first quarter 2004, we received a recovery of $2 million on a previously charged-off asset-based loan. In first quarter 2004, we increased our allowance for loan losses for several deteriorating credit loans, but those increases were offset by improvement in the credit quality of other loans. Charge-offs in first quarter 2003 related principally to three asset-based loan and leasing transactions. Unallocated Expenses, Other (Income) Expense and Interest Unallocated general and administrative expenses were $23 million in first quarter 2004 and $19 million in first quarter 2003. The change in first quarter 2004 was principally due to an increase in stock based compensation. Other operating (income) expense items are not allocated to business segments. In addition to the items previously discussed within the segments, the remainder of unallocated other operating (income) expense includes expenses related to initiatives to consolidate administrative functions and effect improvements in supply chain management of $5 million in first quarter 2004 and $3 million in first quarter 2003. Our parent company interest expense was $32 million in first quarter 2004 and $35 million in first quarter 2003. The change in 2004 was due to a reduction in long-term debt to $1,611 million in first quarter 2004 from $1,879 million in first quarter 2003. Income Taxes Our effective tax rate was 39 percent in first quarter 2004 and 42 percent in first quarter 2003. Differences between the effective tax rate and the statutory rate are due to state income taxes, nondeductible items, foreign operating losses, and other items for which no financial benefit is recognized until realized. Average Shares Outstanding Our average diluted shares outstanding were 55.6 million in first quarter 2004 and 54.0 million in first quarter 2003. The change in 2004 was principally due to employee exercises of stock 31 options and the issuance of restricted stock units during first quarter 2004. Capital Resources and Liquidity for the First Quarter 2004 A significant portion of our consolidated net assets invested in financial services is subject, in varying degrees, to regulatory rules and regulations including restrictions on the ability of financial services to pay dividends to the parent company. Accordingly, the parent company and the financial services capital resources and liquidity are discussed separately. Parent Company Operating Activities Cash provided by operations was $20 million in first quarter 2004 and first quarter 2003. Depreciation and other non-cash charges and credits were $96 million in first quarter 2004 and $86 million in first quarter 2003. Dividends received from financial services were $30 million in first quarter 2004 and $35 million in first quarter 2003. Our working capital needs increased $79 million in first quarter 2004 and $47 million in first quarter 2003. The change was principally due to an increase in receivables. Working capital is always subject to the timing of payments on payables and collections on receivables. Investing Activities Our investing activities used $22 million in first quarter 2004 and $2 million in first quarter 2003. The change was principally due to a decrease in proceeds from sales of non- strategic assets and operations. Capital expenditures were $28 million in first quarter 2004, 50 percent of depreciation, and $29 million in first quarter 2003, 49 percent of depreciation. We made no capital contributions to financial services in first quarter 2004 or first quarter 2003. Financing Activities Our financing activities provided $13 million in first quarter 2004, but used $24 million in first quarter 2003. The change was principally due to employee exercises of stock options. Debt was reduced by $2 million in first quarter 2004. We paid cash dividends to our shareholders of $20 million, or $0.36 per share, in first quarter 2004 and $19 million, or $0.34 per share, in first quarter 2003. In February 2004, the Board of Directors increased the quarterly cash dividend to $0.36 per share. 32 Liquidity Our sources of short-term funding are our operating cash flows, which include dividends received from financial services, and borrowings under our existing credit arrangements and accounts receivable securitization program. We operate in cyclical industries, and our operating cash flows vary accordingly. The dividends we receive from financial services are dependent on its level of earnings and capital needs and are subject to regulatory approval and restrictions. At first quarter-end 2004, we had $562 million in unused borrowing capacity under our credit agreements and $240 million under our accounts receivable securitization program, which matures in May 2007. At quarter-end 2004, we complied with all the terms and conditions of our credit agreements and of our accounts receivable securitization program. In April 2004, we issued a redemption notice for all of the outstanding notes of all three series of the 9.38% to 9.88% senior subordinated and senior notes issued by Gaylord. The redemption dates are in May and June 2004. The principal amount held by third parties of $44 million and the related redemption premium of $2 million will be funded by draws under our existing credit agreements or our accounts receivable securitization program or with available cash. In addition, timber rights obligations totaling $61 million are due in second quarter and third quarter 2004 and will be funded by draws under our existing credit agreements or our asset securitization program or with available cash. Financial Services Operating Activities Cash provided by operations was $79 million in first quarter 2004 and $260 million in first quarter 2003. The change was principally because we originated more loans held for sale than we sold during first quarter 2004 as a result of increasing origination volume near the end of the quarter. Loans held for sale are always subject to the timing of loan originations and loan sales. Investing Activities Our investing activities used $368 million in first quarter 2004 and $271 million in first quarter 2003. The change was principally because we settled the purchases of forward-dated securities purchased in 2003. 33 Financing Activities Our financing activities provided $211 million in first quarter 2004 and used $100 million in first quarter 2003. The change was principally because of increased borrowings to fund our securities settlements. In first quarter 2004, financial services paid a $30 million dividend to the parent company. Liquidity Our sources of short-term funding are our operating cash flows, new deposits, borrowings under our existing agreements and, if necessary, sales of assets. Assets that can be readily converted to cash or against which we can readily borrow include short-term investments, loans, mortgage loans held for sale, and securities. At first quarter-end 2004, we had available liquidity of $2.4 billion. Off-Balance Sheet Arrangements We enter into commitments to extend credit for loans, leases, and letters of credit in the normal course of our business. We generally require collateral upon funding of these commitments and they carry substantially the same risk as loans. These commitments normally include provisions allowing us to exit the commitment under certain circumstances. At first quarter-end 2004, our unfunded commitments consist of: (In millions) Single-family mortgage loans $ 1,230 Other loans 4,987 Letters of credit 307 ------ Total $ 6,524 ====== Regulatory Limitations At first quarter-end 2004, Guaranty met or exceeded all applicable regulatory capital requirements. We expect to maintain Guaranty's capital at a level that exceeds the minimum required for designation as "well capitalized" under the capital adequacy regulations of the Office of Thrift Supervision (OTS). From time to time, we may make capital contributions to or receive dividends from Guaranty. Selected financial and regulatory capital data for Guaranty and its consolidated mortgage banking and insurance subsidiaries follow: 34 First Quarter-End Year-End 2004 2003 ----------- --------- (In millions) Balance sheet data: Total assets $ 16,974 $ 17,247 Total deposits 8,537 8,698 Shareholder's equity 1,004 999 For Categorization Regulatory as "Well Actual Minimum Capitalized" ------ ------- ------------ Regulatory capital ratios: Tangible capital 6.35% 2.00% N/A Leverage capital 6.35% 4.00% 5.00% Risk-based capital 11.08% 8.00% 10.00% Pension and Postretirement Matters The Medicare Prescription Drug, Improvement and Modernization Act of 2003 was enacted in December 2003. Due to the absence of detailed regulations necessary to implement the act, we have not completed the analysis to determine the effects of the act on our postretirement benefit plans, though it is likely that the effects will ultimately reduce our cost for these plans. In first quarter 2004, the FASB issued FASB Staff Position, No. 106-1, Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003. This staff position allows companies to defer recognizing the effects of the act until authoritative guidance on the accounting for the prescription drug subsidy is issued or until certain other events occur. We elected to defer recognition. As a result, our reported postretirement benefit obligation and the 2004 net periodic benefit cost do not reflect the effects of the act and authoritative accounting guidance when issued could require us to change these amounts. Energy and the Effects of Inflation Energy costs were $70 million in first quarter 2004 compared with $75 million in first quarter 2003. Our energy costs fluctuate based on the market prices we pay for these commodities and on the amount and mix of the types of fuel we may use. We hedge very little of our energy needs. It is likely that these costs will continue to fluctuate during 2004. Accounting Policies Critical Accounting Estimates In first quarter 2004, there were no significant changes in our critical accounting estimates from those we identified in our Form 10-K for the year 2003. 35 New Accounting Pronouncements Adopted In first quarter 2004, we were required to adopt the following accounting pronouncements: * FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities an interpretation of ARB No. 51. This interpretation provides guidance for determining whether an entity is a variable interest entity and which beneficiary of the variable interest entity, if any, should consolidate the variable interest entity (the primary beneficiary). * Securities and Exchange Commission Staff Accounting Bulletin No.105, Application of Accounting Principles to Loan Commitments. This bulletin applies to loan commitments issued after March 2004 and accounted for as derivative instruments and it precludes the recognition of an asset at the inception of the loan commitment. The effect of adopting these pronouncements was not significant. Litigation and Related Matters We are involved in various legal proceedings that arise from time to time in the ordinary course of business. We believe that the possibility of a material liability from any of these proceedings is remote, and we do not believe that the outcome of any of these proceedings should have a material adverse effect on our financial position, results of operations, or cash flow. Since we filed our Annual Report on Form 10-K for the period ended January 3, 2004, there have been no material developments in pending legal proceedings except as noted below: Gaylord Chemical Litigation This litigation involves the Louisiana class action and approximately 4,000 individual actions consolidated in Hinds County, Mississippi, all of which relate to the October 23, 1995, explosion of a rail tank car of nitrogen tetroxide at the Bogalusa, Louisiana plant of Gaylord Chemical Corporation, a wholly-owned, independently-operated subsidiary of Gaylord Container Corporation. As previously reported, on December 9, 2003, Gaylord and Gaylord Chemical agreed in principle to settle all claims, including claims for compensatory and punitive damages, arising from this accident. In exchange for payments by certain insurance carriers and assignment of our insurance coverage rights against the non-settling carriers, Gaylord and Gaylord Chemical received full releases and/or dismissals of all claims for damages, including punitive damages. Neither Gaylord nor Gaylord Chemical contributed to the settlement. The settlement 36 is subject to a fairness hearing and final court approval. The final fairness hearing is currently scheduled for August 6, 2004. Environmental As previously reported, the Ontario Ministry of Environment filed an enforcement action alleging that air emissions from the MDF plant at Pembroke, Ontario, Canada adversely affect surrounding property owners. In April 2004, we agreed to a final settlement in this action that will require payment of fines in the amount of approximately $300,000. 37 STATISTICAL AND OTHER DATA Parent Company The following table presents revenues and unit sales for our manufacturing segments:
First Quarter ---------------- 2004 2003 ---- ---- (Dollars in millions) Revenues Corrugated Packaging Corrugated packaging $ 637 $ 625 Linerboard 36 42 ----- ----- Total $ 673 $ 667 ===== ===== Forest Products Pine lumber $ 79 $ 56 Particleboard 44 39 Medium density fiberboard 25 26 Gypsum wallboard 23 18 Fiberboard 17 14 Other 32 27 ----- ----- Total $ 220 $ 180 ===== ===== Unit sales Corrugated Packaging Corrugated packaging, thousands of tons 841 780 Linerboard, thousands of tons 112 124 ----- ----- Total, thousands of tons 953 904 ===== ===== Forest Products Pine lumber, mbf 236 198 Particleboard, msf 160 155 Medium density fiberboard, msf 57 64 Gypsum wallboard, msf 171 161 Fiberboard, msf 97 87 Revenues and unit sales do not include joint venture operations.
38 The following table summarizes the composition of our loan portfolio:
First Quarter Year-End -------------- 2004 2003 2003 ---- ---- --------- (In millions) Single-family mortgage $ 3,351 $ 2,743 $ 3,255 Single-family mortgage warehouse 345 463 387 Single-family construction 964 1,028 889 Multifamily and senior housing 1,756 1,892 1,769 ----- ----- ----- Total residential housing 6,416 6,126 6,300 Commercial real estate 974 1,766 1,015 Commercial and business 601 662 585 Energy lending 618 529 562 Asset-based lending and leasing 467 695 499 Consumer and other 176 190 176 ----- ----- ----- Total loans 9,252 9,968 9,137 Less allowance for loan losses (113) (122) (111) ----- ----- ----- Loans receivable, net $ 9,139 $ 9,846 $ 9,026 ===== ===== =====
39 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Interest Rate Risk Our current level of interest rate risk is primarily due to an asset sensitive position in our financial services segment. The following table illustrates the estimated effect on our pre- tax income of immediate, parallel and sustained shifts in interest rates for the next 12-months at first quarter end 2004, with comparative year-end 2003 information. This estimate considers the effect of changing prepayment speeds, repricing characteristics and average balances over the next 12 months. Increase (Decrease) in Income Before Taxes ------------------------------------------ First Quarter 2004 Year-End 2003 -------------------- -------------------- Parent Financial Parent Financial Company Services Company Services ------- --------- ------- --------- (In millions) Change in Interest Rates -------------- +2% $ (2) $ 14 $ (2) $ 8 +1% (1) 34 (1) 28 -1% 1 (26) 1 (20) We did not present a two percent interest rate decrease because of the current low interest rate environment. The analysis assumes that debt reductions from contractual payments will be replaced with short-term variable rate debt; however, that may not be the financing alternative we choose to follow. Our financial services segment is subject to interest rate risk to the extent interest-earning assets and interest-bearing liabilities repay or reprice at different times or in differing amounts or both. Our financial services segment is in an asset sensitive position where the rate and prepayment characteristics of its assets are more responsive to changes in market interest rates than its liabilities. In an asset sensitive position, earnings will generally be positively affected in a rising rate environment, but generally will be negatively affected in a falling rate environment. Our financial services segment's interest rate sensitivity increased in first quarter 2004, principally because of changes in our deposit base. In first quarter 2004, we issued certificates of deposit that increased the average duration of our deposit base. Also, because of current market pricing for certificates of deposit, we anticipate that in a rising rate environment, certain certificate of deposit rates will not increase as much as the rate changes shown in the table above. Additionally, changes in interest rates affect the fair value of our mortgage servicing rights (estimated at $92 million 40 at first quarter-end 2004). We estimate a one percent decline in long-term fixed mortgage rates from current levels would decrease the fair value of the mortgage servicing rights by $21 million. Foreign Currency Risk In first quarter 2004, there were no significant changes in foreign currency risk from that disclosed in our Annual Report on Form 10-K for the year 2003. Commodity Price Risk In first quarter 2004, there were no significant changes in commodity price risk from that disclosed in our Annual Report on Form 10-K for the year 2003. ITEM 4. CONTROLS AND PROCEDURES (a)Evaluation of disclosure controls and procedures The Company's chief executive officer and its chief financial officer, based on their evaluation of the Company's disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) as of end of the period covered by this Quarterly Report on Form 10-Q, have concluded that the Company's disclosure controls and procedures are adequate and effective to ensure that the information required to be disclosed by us in the reports we file or submit under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission's ("SEC") rules and forms. (b) Changes in internal control over financial reporting. There were no changes in the Company's internal control over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. PART II. OTHER INFORMATION Item 1. Legal Proceedings. The information set forth in Note G to Notes to Consolidated Financial Statements in Part I of this report is incorporated by reference thereto. Since we filed our Annual Report on Form 10-K for the period ended January 3, 2004, there have been no material developments in pending legal proceedings except as noted below: 41 Gaylord Chemical Litigation This litigation involves the Louisiana class action and approximately 4,000 individual actions consolidated in Hinds County, Mississippi, all of which relate to the October 23, 1995, explosion of a rail tank car of nitrogen tetroxide at the Bogalusa, Louisiana plant of Gaylord Chemical Corporation, a wholly-owned, independently-operated subsidiary of Gaylord Container Corporation. As previously reported, on December 9, 2003, Gaylord and Gaylord Chemical agreed in principle to settle all claims, including claims for compensatory and punitive damages, arising from this accident. In exchange for payments by certain insurance carriers and assignment of our insurance coverage rights against the non-settling carriers, Gaylord and Gaylord Chemical received full releases and/or dismissals of all claims for damages, including punitive damages. Neither Gaylord nor Gaylord Chemical contributed to the settlement. The settlement is subject to a fairness hearing and final court approval. The final fairness hearing is currently scheduled for August 6, 2004. Environmental As previously reported, the Ontario Ministry of Environment filed an enforcement action alleging that air emissions from the MDF plant at Pembroke, Ontario, Canada adversely affect surrounding property owners. In April 2004, we agreed to a final settlement in this action that will require payment of fines in the amount of approximately $300,000. Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities. None. Item 3. Defaults Upon Senior Securities. None. Item 4. Submission of Matters to a Vote of Security Holders. None. Item 5. Other Information. None. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits. 31.1 - Certification of Chief Executive Officer pursuant to Exchange Act Rule 13a-14(a), as adopted 42 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 April 3, 2004, the Company filed the following Current Reports on Form 8-K: 1. Current Report on Form 8-K dated February 2, 2004, reporting under Items 9 and 12 a press release issued by the Company announcing earnings for the period ended January 3, 2004. 2. Current Report on Form 8-K dated February 2, 2004, reporting under Item 9 presentation materials of Kenneth M. Jastrow, II, Chief Executive Officer of Temple-Inland Inc., used in Mr. Jastrow's conference call on February 2, 2004, discussing the Company's earnings for the quarter and year ended January 3, 2004. 3. Current Report on Form 8-K dated April 26, 2004, reporting under Items 9 and 12 a press release issued by the Company announcing earnings for the period ended April 3, 2004. 4. Current Report on Form 8-K dated April 27, 2004, reporting under Item 9 presentation materials of Kenneth M. Jastrow, II, Chief Executive Officer of Temple-Inland Inc., used in Mr. Jastrow's conference call on April 27, 2004, discussing the Company's earnings for the quarter ended April 3, 2004. 43 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: May 11, 2004 By /s/ Louis R. Brill Louis R. Brill Chief Accounting Officer 44 INDEX TO EXHIBITS Exhibit No. Description Page No. 31.1 Certification of Chief Executive 45 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 46 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 47 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 48 Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes- Oxley Act of 2002