UNITED STATES
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 October 2, 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 Identification
incorporation or organization) 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 October 2, 2004
------ ---------------------
Common Stock (par value $1.00 55,991,644
per share)
Page 1 of 47 The Exhibit Index is page 41.
2
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 21
Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About 37
Market Risk
Item 4. Controls and Procedures 38
PART II. OTHER INFORMATION 38
Item 1. Legal Proceedings 38
Item 2. Unregistered Sales of Equity Securities and Use 38
of Proceeds
Item 3. Defaults Upon Senior Securities 38
Item 4. Submission of Matters to a Vote of Security 38
Holders
Item 5. Other Information 39
Item 6. Exhibits and Reports on Form 8-K 39
SIGNATURES 40
3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SUMMARIZED STATEMENTS OF INCOME
PARENT COMPANY (TEMPLE-INLAND INC.)
Unaudited
Third First Nine
Quarter Months
----------- -----------
2004 2003 2004 2003
---- ---- ---- ----
(In millions)
NET REVENUES $ 955 $ 878 $ 2,788 $ 2,602
COSTS AND EXPENSES
Cost of sales 804 799 2,408 2,398
Selling 25 28 76 85
General and administrative 41 40 128 130
Other operating (income) expense 4 15 28 45
----- ----- ----- -----
874 882 2,640 2,658
----- ----- ----- -----
81 (4) 148 (56)
FINANCIAL SERVICES EARNINGS 16 48 128 129
----- ----- ----- -----
OPERATING INCOME 97 44 276 73
Interest expense (31) (33) (97) (103)
Other non-operating expense - (8) (2) (8)
----- ----- ----- -----
INCOME (LOSS) FROM CONTINUING 66 3 177 (38)
OPERATIONS BEFORE TAXES
Income tax (expense) benefit (26) (6) (69) 173
----- ----- ----- -----
INCOME (LOSS) FROM CONTINUING 40 (3) 108 135
OPERATIONS
Discontinued operations 1 - 2 1
----- ----- ----- -----
INCOME (LOSS) BEFORE ACCOUNTING 41 (3) 110 136
CHANGE
Effect of accounting change - - - (1)
----- ----- ----- -----
NET INCOME (LOSS) $ 41 $ (3) $ 110 $ 135
===== ===== ===== =====
See the notes to consolidated financial statements.
4
SUMMARIZED BALANCE SHEETS
PARENT COMPANY (TEMPLE-INLAND INC.)
Unaudited
Third Quarter Year-End
2004 2003
---- ----
(In millions)
ASSETS
Current Assets
Cash and cash equivalents $ 15 $ 20
Receivables, net of allowances of $15 445 359
in 2004 and $14 in 2003
Inventories:
Work in process and finished goods 99 83
Raw materials and supplies 273 247
----- -----
Total inventories 372 330
Prepaid expenses and other 67 69
----- -----
Total current assets 899 778
Investment in financial services 1,129 1,123
Timber and timberlands 497 497
Property and equipment:
Land and buildings 592 600
Machinery and equipment 3,474 3,454
Construction in progress 47 59
Less allowances for depreciation (2,366) (2,259)
----- -----
Total property and equipment 1,747 1,854
Goodwill 235 237
Assets of discontinued operations 28 50
Other assets 111 99
----- -----
TOTAL ASSETS $ 4,646 $ 4,638
===== =====
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Accounts payable $ 211 $ 218
Employee compensation and benefits 73 72
Accrued interest 25 27
Accrued property taxes 30 23
Other accrued expenses 150 141
Liabilities of discontinued operations 23 22
Current portion of long-term debt 3 4
----- -----
Total current liabilities 515 507
Long-term debt 1,457 1,611
Deferred income taxes 80 25
Postretirement benefits 144 146
Pension liability 285 250
Other long-term liabilities 61 131
----- -----
Total Liabilities 2,542 2,670
Shareholders' Equity 2,104 1,968
----- -----
TOTAL LIABILITIES AND SHAREHOLDERS' $ 4,646 $ 4,638
EQUITY ===== =====
See the notes to consolidated financial statements.
5
SUMMARIZED STATEMENTS OF CASH FLOW
PARENT COMPANY (TEMPLE-INLAND INC.)
Unaudited
First Nine
Months
----------
2004 2003
---- ----
(In millions)
CASH PROVIDED BY (USED FOR) OPERATIONS
Net income $ 110 $ 135
Adjustments:
Depreciation and amortization 166 176
Non-cash stock based compensation 26 22
Non-cash pension and postretirement 45 41
expense
Cash contribution to pension and (13) (11)
postretirement plans
Other non-cash charges (credits) 14 (133)
Deferred income taxes 53 10
Net earnings of financial services (79) (83)
Dividends from financial services 70 120
Joint venture earnings (19) (2)
Dividends from joint ventures 10 4
Net assets of discontinued operations (9) (1)
Cumulative effect of accounting change - 1
Other 16 12
----- -----
390 291
Changes in:
Receivables (86) (48)
Inventories (44) 18
Prepaid expenses and other 3 (9)
Accounts payable and accrued expenses 8 12
----- -----
271 264
----- -----
CASH PROVIDED BY (USED FOR) INVESTING
Capital expenditures (117) (96)
Sales of non-strategic assets 63 36
Other acquisitions and joint ventures (3) (7)
----- -----
(57) (67)
----- -----
CASH PROVIDED BY (USED FOR) FINANCING
Payments of debt (155) (169)
Payments of other long-term liabilities (64) -
Cash dividends paid to shareholders (60) (55)
Proceeds from exercise of stock options 60 -
Additions to debt - 24
----- -----
(219) (200)
----- -----
(5) (3)
Effect of exchange rate changes on cash - -
----- -----
Net increase (decrease) in cash and cash (5) (3)
equivalents
Cash and cash equivalents at beginning of
period 20 17
----- -----
Cash and cash equivalents at end of period $ 15 $ 14
===== =====
See the notes to consolidated financial statements.
6
SUMMARIZED STATEMENTS OF INCOME
FINANCIAL SERVICES
Unaudited
Third Quarter First Nine Months
------------- -----------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions)
INTEREST INCOME
Loans and loans held for sale $ 122 $ 129 $ 354 $ 393
Securities available-for-sale 13 16 42 54
Securities held-to-maturity 40 33 129 109
Other earning assets 1 1 2 3
---- ---- ---- ----
Total interest income 176 179 527 559
INTEREST EXPENSE
Deposits 37 43 104 145
Borrowed funds 43 41 128 130
---- ---- ---- ----
Total interest expense 80 84 232 275
---- ---- ---- ----
NET INTEREST INCOME 96 95 295 284
(Provision) credit for loan losses 5 (13) 9 (44)
---- ---- ---- ----
NET INTEREST INCOME AFTER (PROVISION) 101 82 304 240
---- ---- ---- ----
NON-INTEREST INCOME
Loan servicing fees 8 8 24 24
Amortization and impairment of (21) (12) (34) (53)
Loan origination and sale of loans 34 71 117 225
Real estate operations 8 14 43 34
Insurance commissions and fees 12 12 36 33
Service charges on deposits 11 9 31 26
Operating lease income 2 3 8 8
Other 9 8 26 29
---- ---- ---- ----
Total non-interest income 63 113 251 326
---- ---- ---- ----
NON-INTEREST EXPENSE
Compensation and benefits 65 84 209 256
Loan servicing and origination 3 5 9 12
Real estate operations, other than 4 9 24 24
Insurance operations, other than 1 1 4 4
Occupancy 9 9 24 25
Data processing 5 7 14 20
Other 40 31 122 93
Charges related to asset impairments
and severance 21 1 21 3
---- ---- ---- ----
Total non-interest expense 148 147 427 437
---- ---- ---- ----
INCOME BEFORE TAXES 16 48 128 129
Income tax (expense) (7) (17) (49) (46)
---- ---- ---- ----
NET INCOME $ 9 $ 31 $ 79 $ 83
==== ==== ==== ====
See the notes to consolidated financial statements.
7
SUMMARIZED BALANCE SHEETS
FINANCIAL SERVICES
Unaudited
Third Quarter Year-End
2004 2003
--------- --------
(In millions)
ASSETS
Cash and cash equivalents $ 421 $ 379
Loans held for sale 535 551
Loans, net of allowance for losses of $96 in
2004 and $111 in 2003 9,690 9,026
Securities available-for-sale 1,170 1,374
Securities held-to-maturity 4,232 5,267
Real estate 241 295
Premises and equipment, net 174 164
Accounts, notes and accrued interest
receivable 133 138
Goodwill 152 147
Mortgage servicing rights - 89
Assets held for sale 67 -
Other assets 222 231
------ ------
TOTAL ASSETS $ 17,037 $ 17,661
====== ======
LIABILITIES AND SHAREHOLDER'S EQUITY
Deposits $ 8,991 $ 8,698
Federal Home Loan Bank advances 4,834 4,992
Securities sold under repurchase agreements 1,162 1,327
Obligations to settle trade date securities - 567
Other liabilities 418 410
Other borrowings 198 239
Preferred stock issued by subsidiaries 305 305
------ ------
TOTAL LIABILITIES 15,908 16,538
------ ------
SHAREHOLDER'S EQUITY 1,129 1,123
------ ------
TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY $ 17,037 $ 17,661
====== ======
See the notes to consolidated financial statements.
8
SUMMARIZED STATEMENTS OF CASH FLOWS
FINANCIAL SERVICES
Unaudited
First Nine Months
-----------------
2004 2003
---- ----
(In millions)
CASH PROVIDED BY (USED FOR) OPERATIONS
Net income $ 79 $ 83
Adjustments:
Depreciation of premises and equipment 18 18
Depreciation of leased assets 7 6
Amortization and impairment of servicing
rights 34 53
Non-cash charges related to mortgage
banking repositioning 17 -
Provision (credit) for loan losses (9) 44
Amortization and accretion of financial
instruments 14 17
Deferred income taxes (9) (12)
----- -----
151 209
Changes in:
Loans held for sale, originations of loans (5,464) (11,144)
Loans held for sale, sales of loans 5,479 11,611
Collections on loans services for others, net (5) (24)
Other (1) (41)
----- -----
160 611
----- -----
CASH PROVIDED BY (USED FOR) INVESTING
Securities available-for-sale:
Purchases (28) (17)
Principal payments and maturities 229 452
Securities held-to-maturity:
Purchases (896) (2,008)
Principal payments and maturities 1,349 1,706
Loans originated or acquired, net of (725) 198
collections
Sale of loans 36 41
Acquisitions, net of cash acquired (20) (1)
Capital expenditures (30) (25)
Sale of assets and other 56 10
----- -----
(29) 356
----- -----
CASH PROVIDED BY (USED FOR) FINANCING
Net increase (decrease) in deposits 293 (234)
Repurchase agreements and short-term
borrowings, net (85) (241)
Additions to long-term FHLB advances and
other borrowings 321 282
Payments of long-term FHLB advances and
other borrowings (562) (647)
Dividends paid to parent company (70) (120)
Other 14 11
----- -----
(89) (949)
----- -----
Net increase (decrease) in cash and cash
equivalents 42 18
Cash and cash equivalents at beginning of period 379 438
----- -----
Cash and cash equivalents at end of period $ 421 $ 456
===== =====
See the notes to consolidated financial statements.
9
CONSOLIDATED STATEMENTS OF INCOME
TEMPLE-INLAND INC. AND SUBSIDIARIES
Unaudited
Third Quarter First Nine Months
------------- -----------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions, except per share amounts)
REVENUES
Manufacturing $ 955 $ 878 $ 2,788 $ 2,602
Financial services 239 292 778 885
------ ------ ------ ------
1,194 1,170 3,566 3,487
------ ------ ------ ------
COSTS AND EXPENSES
Manufacturing 874 882 2,640 2,658
Financial services 223 244 650 756
------ ------ ------ ------
1,097 1,126 3,290 3,414
------ ------ ------ ------
OPERATING INCOME 97 44 276 73
Parent company interest (31) (33) (97) (103)
Other non-operating expense - (8) (2) (8)
------ ------ ------ ------
INCOME (LOSS) BEFORE TAXES 66 3 177 (38)
Income tax (expense) benefit (26) (6) (69) 173
------ ------ ------ ------
INCOME (LOSS) FROM CONTINUING
OPERATIONS 40 (3) 108 135
Discontinued operations 1 - 2 1
------ ------ ------ ------
INCOME (LOSS) BEFORE ACCOUNTING
CHANGE 41 (3) 110 136
Effect of accounting change - - - (1)
------ ------ ------ ------
NET INCOME (LOSS) $ 41 $ (3) $ 110 $ 135
====== ====== ====== ======
EARNINGS (LOSS) PER SHARE
Basic:
Income (loss) from continuing
operations $ 0.71 $(0.06) $ 1.95 $ 2.49
Discontinued operations 0.02 - 0.03 0.01
Effect of accounting change - - - (0.01)
------ ------ ------ ------
Net income (loss) $ 0.73 $(0.06) $ 1.98 $ 2.49
====== ====== ====== ======
Diluted:
Income (loss) from continuing
operations $ 0.71 $(0.06) $ 1.93 $ 2.49
Discontinued operations 0.02 - 0.03 0.01
Effect of accounting change - - - (0.01)
------ ------ ------ ------
Net income (loss) $ 0.73 $(0.06) $ 1.96 $ 2.49
====== ====== ====== ======
DIVIDENDS PAID PER SHARE OF COMMON
STOCK $ 0.36 $ 0.34 $ 1.08 $ 1.02
====== ====== ====== ======
See the notes to consolidated financial statements.
10
CONSOLIDATING BALANCE SHEETS
TEMPLE-INLAND INC. AND SUBSIDIARIES
Third Quarter 2004
Unaudited
Parent Financial
Company Services Consolidated
------- -------- ------------
(In millions)
ASSETS
Cash and cash equivalents $ 15 $ 421 $ 436
Loans held for sale - 535 535
Loans receivable - 9,690 9,690
Securities available-for-sale - 1,170 1,170
Securities held-to-maturity - 4,232 4,232
Trade receivables 445 - 445
Inventories 372 - 372
Timber and timberlands 497 - 497
Property and equipment 1,747 174 1,921
Goodwill 235 152 387
Other assets 206 663 821
Investment in financial
services 1,129 - -
------ ------- -------
TOTAL ASSETS $ 4,646 $ 17,037 $ 20,506
====== ======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits $ - $ 8,991 $ 8,991
Federal Home Loan Bank advances - 4,834 4,834
Securities sold under
repurchase agreements - 1,162 1,162
Other liabilities 576 418 975
Long-term debt 1,457 198 1,655
Deferred income taxes 80 - 51
Postretirement benefits 144 - 144
Pension liability 285 - 285
Preferred stock issued by
subsidiaries - 305 305
------ ------- -------
TOTAL LIABILITIES $ 2,542 $ 15,908 $ 18,402
------ ------- -------
SHAREHOLDERS' EQUITY
Preferred stock - par value $1 per -
share: authorized 25,000,000
shares; none issued
Common stock - par value $1 per 61
share: authorized 200,000,000
shares; issued 61,389,552 shares
including shares held in the
treasury
Additional paid-in capital 402
Accumulated other comprehensive loss (186)
Retained earnings 2,073
-------
2,350
Cost of shares held in the
treasury: 5,397,908 shares (246)
-------
TOTAL SHAREHOLDERS' EQUITY 2,104
-------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 20,506
=======
See the notes to consolidated financial statements.
11
CONSOLIDATING BALANCE SHEETS
TEMPLE-INLAND INC. AND SUBSIDIARIES
Year-End 2003
Unaudited
Parent Financial
Company Services Consolidated
------- -------- ------------
(In millions)
ASSETS
Cash and cash equivalents $ 20 $ 379 $ 399
Loans held for sale - 551 551
Loans receivable - 9,026 9,026
Securities available-for-sale - 1,374 1,374
Securities held-to-maturity - 5,267 5,267
Trade receivables 359 - 359
Inventories 330 - 330
Timber and timberlands 497 - 497
Property and equipment 1,854 164 2,018
Goodwill 237 147 384
Other assets 218 753 938
Investment in financial services 1,123 - -
------ ------- -------
TOTAL ASSETS $ 4,638 $ 17,661 $ 21,143
------ ------- -------
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits $ - $ 8,698 $ 8,698
Federal Home Loan Bank advances - 4,992 4,992
Securities sold under repurchase
agreements - 1,327 1,327
Obligations to settle trade date
securities - 567 567
Other liabilities 638 410 1,033
Long-term debt 1,611 239 1,850
Deferred income taxes 25 - 7
Postretirement benefits 146 - 146
Pension liability 250 - 250
Preferred stock issued by
subsidiaries - 305 305
------ ------- -------
TOTAL LIABILITIES $ 2,670 $ 16,538 $ 19,175
====== ======= =======
SHAREHOLDERS' EQUITY
Preferred stock - par value $1 per -
share: authorized 25,000,000
shares; none issued
Common stock - par value $1 per 61
share: authorized 200,000,000
shares; issued 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 Nine Months
-----------------
2004 2003
---- ----
(In millions)
CASH PROVIDED (USED FOR) OPERATIONS
Net income $ 110 $ 135
Adjustments:
Depreciation and amortization 191 200
Amortization and accretion of
financial instruments 48 70
Provision for loan losses (9) 44
Deferred income taxes 44 (2)
Other non-cash charges (credits) 31 (133)
Net assets of discontinued operations (9) (1)
Joint venture earnings (19) (2)
Dividends from joint ventures 10 4
Cumulative effect of accounting
change - 1
Other 73 23
----- -----
470 339
Changes in:
Receivables (86) (48)
Inventories (44) 18
Prepaid expenses and other 3 (9)
Accounts payable and accrued expenses 8 12
Loans held for sale, originations of
loans (5,464) (11,144)
Loans held for sale, sales of loans 5,479 11,611
Collections on loans services for
others, net (5) (24)
----- -----
361 755
----- -----
CASH PROVIDED BY (USED FOR) INVESTING
Capital expenditures (147) (121)
Sale of non-strategic assets 63 36
Securities available-for-sale, net 201 435
Securities held-to-maturity, net 453 (302)
Loans originated or acquired, net of
principal collected (725) 198
Proceeds from sale of loans 36 41
Acquisitions, net of cash acquired (20) (1)
Other 53 3
----- -----
(86) 289
----- -----
CASH PROVIDED BY (USED FOR) FINANCING
Deposits, net 293 (234)
Additions to long-term debt 321 306
Payments of long-term debt (717) (816)
Payments of other long-term liabilities (64) -
Repurchase agreements and short-term
borrowings, net (85) (241)
Cash dividends paid to shareholders (60) (55)
Proceeds from exercise of stock options 60 -
Other 14 11
----- -----
(238) (1,029)
----- -----
37 15
Effect of exchange rate changes on cash - -
----- -----
Net increase (decrease) in cash and cash
equivalents 37 15
Cash and cash equivalents at beginning of
period 399 455
----- -----
Cash and cash equivalents at end of period $ 436 $ 470
===== =====
See the notes to consolidated financial statements.
13
TEMPLE-INLAND INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Note A - Basis Of Presentation
We prepared these unaudited interim financial statements in
accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form
10-Q and Article 10 of Regulation S-X. As a result, they do not
include all of the information and footnotes required by
generally accepted accounting principles for complete financial
statements. However, in our opinion, all adjustments (consisting
only of normal accruals) considered necessary for a fair
presentation have been included. These interim operating results
are not necessarily indicative of the results that may be
expected for the entire year. For further information, refer to
the financial statements and footnotes included in our Annual
Report on Form 10-K for the fiscal year ended January 3, 2004.
The consolidated financial statements include the accounts
of Temple-Inland Inc. and its manufacturing and financial
services subsidiaries. Substantially all of our consolidated net
assets invested in financial services are subject to regulatory
rules and restrictions including restrictions on the ability of
our financial services subsidiaries 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
subsidiaries.
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.
Note B - Earnings Per Share
Denominators used in computing per share amounts were:
Third Quarter First Nine Months
------------- -----------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions)
Denominator for basic earnings per share:
Weighted average common 55.9 54.2 55.5 54.1
shares outstanding
Dilutive effect of:
Equity purchase
contracts 0.2 - 0.1 -
Stock options 0.6 0.1 0.5 -
----- ----- ----- -----
Denominator for diluted
earnings per share 56.7 54.3 56.1 54.1
===== ===== ===== =====
We will settle the equity purchase contracts in May 2005.
At that time, we will issue common stock in exchange for $345
million cash. The actual number of shares we will issue will be
based on the average market price of our stock with a floor of
$52, in which case we would issue 6.6 million shares, and a
ceiling of $63, in which case we would issue 5.5 million shares.
14
TEMPLE-INLAND INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Note C - Comprehensive Income (Loss)
Comprehensive income (loss) consists of:
Third Quarter First Nine Months
-------------- -----------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions)
Net income (loss) $ 41 $ (3) $ 110 $ 135
Other comprehensive income
(loss), net of taxes:
Unrealized gains (losses) on:
Available-for-sale
securities - (2) (3) (1)
Derivative instruments (1) - 3 (1)
Foreign currency translation
adjustments - (3) (1) (5)
----- ----- ----- -----
Other comprehensive income (loss) (1) (5) (1) (7)
----- ----- ----- -----
Comprehensive income (loss) $ 40 $ (8) $ 109 $ 128
===== ===== ===== =====
At third quarter-end 2004, the aggregate fair value of all
of our derivative instruments was a $4 million liability
consisting of $6 million of liabilities for our interest rate
swap derivatives and a $2 million asset for our linerboard and
OCC derivatives. Of the interest rate swap derivative
liabilities, $3 million is related to a hedged transaction and $3
million is related to a non-hedged transaction. The ineffective
portion of the interest rate swap derivative designated as a
hedged transaction resulted in a $1 million reduction in interest
expense in first nine months 2004. During second quarter 2004,
a portion of the interest rate swap derivative was reclassified as
a non-hedged transaction, which resulted in the reclassification
of $4 million from other comprehensive income to interest expense.
During third quarter 2004, the loss charged to other non-operating
expense for the non-hedged transaction was less than $1 million.
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 operating (income) expense
and unallocated expenses, principally general and administrative
expenses. We do not allocate parent company interest to the
business segments. Other operating (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 - CONTINUED
Corrugated Forest Financial
For Third Quarter 2004 Packaging Products Services Unallocated Total
---------------------- ---------- -------- --------- ----------- -----
(In millions)
Revenues from external
customers $ 689 $ 266 $ 239 $ - $ 1,194
Depreciation and
amortization 40 13 9 2 64
Operating income (loss) 42 68 37 (50) 97
Financial services, net
interest income - - 96 - 96
Capital expenditures 36 15 12 2 65
---------------------------------------------------------------------------------------
For First Nine Months 2004 or at
Third Quarter-End 2004
--------------------------------
(In millions)
Revenues from external
customers $ 2,049 $ 739 $ 778 $ - $ 3,566
Depreciation and
amortization 119 41 25 6 191
Operating income (loss) 78 165 149 (116) 276
Financial services, net
interest income - - 295 - 295
Total assets 2,370 1,010 17,037 89 20,506
Capital expenditures 77 34 30 6 147
Goodwill 235 - 152 - 387
---------------------------------------------------------------------------------------
For Third Quarter 2003
----------------------
(In millions)
Revenues from external
customers $ 667 $ 211 $ 292 $ - $ 1,170
Depreciation and
amortization 40 16 8 2 66
Operating income (loss) 7 24 49 (36) 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 and
amortization 123 48 24 5 200
Operating income (loss) 16 32 132 (107) 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
---------------------------------------------------------------------------------------
Includes other expenses for third quarter 2004 of $25
million, which consists of a $4 million charge associated with
converting and production facility closures, a $1 million charge
related to consolidation and supply chain initiatives, a $21
million charge associated with the repositioning of mortgage
origination and servicing activities and $1 million of income
related to the collection of notes previously written-off. Of
these amounts, $3 million applies to corrugated packaging, $ 21
million applies to financial services, and $1 million is
unallocated.
Includes other expenses for first nine months 2004 of $49
million, which consists of a $21 million charge associated with
converting and production facility closures, a $7 million charge
related to consolidation and supply chain initiatives, a $21
million charge associated with the repositioning of mortgage
origination and servicing activities, $1 million of income
related to the collection of notes previously written-off, and $1
million of other. Of these amounts, $9 million applies to
corrugated packaging, $12 million applies to forest products, $21
applies to financial services and $7 million is unallocated.
16
TEMPLE-INLAND INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Includes other expenses for third quarter 2003 of $16
million, which consists of a $3 million charge associated with
converting and production facility closures and a $13 million
charge related to consolidation and supply chain initiatives. Of
these amounts, $4 million applies to corrugated packaging, $1
million applies to forest products, $1 million applies to
financial services, and $10 million is unallocated.
Includes other expenses for first nine months 2003 of $48
million, which consists of a $10 million charge associated with
converting and production facility closures, a $39 million charge
related to consolidation and supply chain initiatives, and other
income of $1 million related to the collection of notes
previously written-off. Of these amounts, $9 million applies to
corrugated packaging, $2 million applies to forest products, $3
million applies to financial services, and $34 million is
unallocated.
As a result of the consolidation of our administrative
functions and adoption of a shared services concept, beginning
first quarter 2004, we changed the way we allocate cost to the
business segments. The effect of this change was to increase
segment operating income and to increase unallocated expenses by
a like amount. Third quarter and first nine months 2003 amounts
have been reclassified to reflect this change as follows:
Originally As
Reported Reclassifications Reclassified
---------- ----------------- ------------
(In millions)
Third Quarter 2003
Corrugated packaging $ - $ 7 $ 7
Forest products 22 2 24
Financial services 49 - 49
----- ----- -----
Segment operating income 71 9 80
Unallocated expenses (27) (9) (36)
----- ----- -----
Operating income $ 44 $ - $ 44
===== ===== =====
First Nine Months 2003
Corrugated packaging $ (3) $ 19 $ 16
Forest products 25 7 32
Financial services 132 - 132
----- ----- -----
Segment operating income 154 26 180
Unallocated expenses (81) (26) (107)
----- ----- -----
Operating income $ 73 $ - $ 73
===== ===== =====
Note E - Employee Benefit Plans
The components of net periodic benefit cost of our defined
benefit pension plans are:
Third Quarter First Nine Months
------------- -----------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions)
Service costs $ 6 $ 6 $ 18 $ 17
Interest cost on projected
benefit obligation 18 17 54 49
Expected return on plan
assets (17) (16) (51) (47)
Amortization of prior - - - 2
service costs
Amortization of net loss 6 5 18 10
---- ---- ---- ----
Net periodic benefit cost $ 13 $ 12 $ 39 $ 31
==== ==== ==== ====
17
TEMPLE-INLAND INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
The components of net periodic benefit cost of our
postretirement benefit plans are:
Third Quarter First Nine Months
------------- -----------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions)
Service costs $ 1 $ 1 $ 3 $ 3
Interest cost on projected
benefit obligation 2 3 6 8
Expected return on plan
assets - - - -
Amortization of prior service
costs (1) (1) (3) (3)
Amortization of net loss - 1 - 2
---- ---- ---- ----
Net periodic benefit cost $ 2 $ 4 $ 6 $ 10
==== ==== ==== ====
Note F - Stock-Based Compensation
Prior to 2003, we used the intrinsic value method in
accounting for stock-based compensation. As a result, no stock-
based compensation expense related to stock options granted prior
to 2003 is reflected in net income, as all stock options granted
had an exercise price equal to the market value of the underlying
common stock on the date of grant. Therefore, the cost related
to stock-based compensation recognized in net income for third
quarter and first nine months 2004 and 2003 is less than would
have been recognized if the fair value method had been applied to
all stock options granted since 1995. The following table
illustrates the effect on net income and earnings per share as if
the fair value method had been applied to all stock options
granted since 1995.
Third Quarter First Nine Months
------------- -----------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions)
Net income (loss), as reported $ 41 $ (3) $ 110 $ 135
Add: Stock-based compensation
expense, net of related tax
effects,included in the
determination of reported
net income 6 8 16 18
Deduct: Total stock-based
compensation expense, net
of related tax effects,
determined under the fair
value based method for all
awards (8) (11) (23) (26)
----- ----- ----- -----
Pro forma net income (loss) $ 39 $ (6) $ 103 $ 127
===== ===== ===== =====
Earnings (loss) per share:
Basic, as reported $ 0.73 $ (0.06) $ 1.96 $ 2.49
Basic, pro forma $ 0.70 $ (0.11) $ 1.86 $ 2.35
Diluted, as reported $ 0.73 $ (0.06) $ 1.96 $ 2.49
Diluted, pro forma $ 0.69 $ (0.11) $ 1.84 $ 2.35
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 third quarter-end 2004, discontinued operations consist
of the chemical business obtained in the 2002 acquisition of
Gaylord Container Corporation and accruals related to the 1999
sale of our bleached paperboard operations. At third quarter-end
18
TEMPLE-INLAND INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
2004, the assets and liabilities of the discontinued operations
include $5 million of working capital, $18 million of property
and equipment, and $18 million of environmental and other long-
term accruals. Revenues from discontinued operations for third
quarter 2004 were $4 million and for first nine months 2004 were
$12 million. Net income from discontinued operations includes a
$2 million gain from the early settlement of a note received in
connection with the 2003 sale of the retail bag business obtained
in the acquisition of Gaylord and a $1 million charge related to
the settlement of certain liabilities related to the retail bag
business.
During first nine months 2004 we sold certain assets used in
our specialty packaging operations, our Clarion MDF facility, and
other non-strategic assets for $72 million of which $61 million
was cash and $11 million was a note due in 2009. At third
quarter-end 2004, the carrying value of other assets held for
sale was $1 million compared with $23 million at year-end 2003.
Impairment charges related to and gains or losses recognized upon
sale of these assets are included in other operating (income)
expense.
During third quarter 2004, we announced our intentions to
reposition our financial services mortgage origination activities
and sell our third-party mortgage servicing portfolio. At third
quarter-end 2004, the carrying value of those assets held for
sale was $67 million, including $64 million of third-party
mortgage servicing rights.
Note I - Other Operating (Income) Expense
Third Quarter First Nine Months
------------- -----------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions)
Expenses associated with consolidation
of administrative functions $ 1 $ 12 $ 7 $ 36
Loss on closure of production
and converting facilities 4 3 21 10
Collection of notes that were
previously written-off (1) - (1) (1)
Other - - 1 -
---- ---- ---- ----
Total $ 4 $ 15 $ 28 $ 45
==== ==== ==== ====
Expenses associated with the consolidation of administrative
functions consist principally of severance, most of which was
paid during 2003. During third quarter 2004, we revised our
estimates of contractual relocation expense and reduced our
accrual for these expenses by $2 million.
In conjunction with our previously announced plans, we closed
one converting facility in first quarter 2004, one converting
facility in second quarter 2004, and three converting facilities in
third quarter 2004. With respect to the loss on closure of
production and converting facilities, we recognized asset
impairments and gains (losses) upon disposition of assets of $14
million during first nine months 2004, of which $12 million related
to the closure of our Clarion MDF facility, and $7 million in
severance and other costs. We expect to incur additional severance
and exit costs in fourth quarter 2004.
A summary of the activity within our accruals for exit costs
during third quarter 2004 follows:
Beginning of Cash End of
Period Additions Payments Period
------ --------- -------- ------
(In millions)
Involuntary employee termination
and severance $ 3 $ 2 $ (3) $ 2
Contract termination penalties 6 - - 6
Environmental compliance 11 - (1) 10
Demolition 10 - (1) 9
---- ---- ---- ----
Total $ 30 $ 2 $ (5) $ 27
==== ==== ==== ====
19
TEMPLE-INLAND INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
During third quarter 2004, we announced our intentions to
reposition our financial services mortgage origination activities
and sell our third-party mortgage servicing portfolio. These
actions will affect approximately 1,500 employees and will reduce
our costs and our exposure to changing market conditions. At
third quarter-end 2004, the carrying value of these assets held
for sale was $67 million, including $64 million of mortgage
servicing rights. In connection with these actions, we
recognized $17 million in asset and goodwill impairments and
incurred $4 million in retention, severance and other exit costs,
most of which will be paid in fourth quarter 2004. These
impairment charges and exit costs are included in financial
services non-interest expense. During fourth quarter 2004, we
entered into a letter of intent to sell our servicing rights. We
anticipate closing this sale by year-end 2004. As these actions
are finalized it is likely that additional impairments, severance
and other exit costs will be incurred, and such amounts could be
significant.
Note J - Acquisitions And Other Items
During first quarter 2004, financial services acquired an
insurance agency for $15 million cash. The purchase price was
allocated to acquired assets and liabilities based upon their
fair values with $10 million allocated to goodwill. During third
quarter 2004, financial services acquired two branches and $150
million in deposits for a $5 million premium of which $3 million
was allocated to goodwill and the remainder was allocated to
other intangible assets. The unaudited pro forma results of
operations, assuming the acquisition had been effected at the
beginning of the year, would not have been materially different
from those reported.
During second quarter 2004, we recognized a $2 million
charge, which is included in other non-operating expense, related
to our early retirement of $44 million of debt.
Note K - Accounting Pronouncements
During first quarter 2004, we were required to adopt the
following accounting pronouncements:
FASB Interpretation No. 46 (revised December 2003),
Consolidation of Variable Interest Entities an Interpretation of
ARB No. 51. This interpretation provides guidance for
determining whether an entity is a variable interest entity and
which beneficiary of the variable interest entity, if any, should
consolidate the variable interest entity. There was no effect on
earnings or financial position of adopting this interpretation.
Disclosures required by this interpretation follow:
* In 1999 we entered into an agreement to lease particleboard
and medium density fiberboard facilities in Mt. Jewett, PA. The
lease is for 20 years and includes fixed price purchase options
in 2014 and at the end of the lease. The option prices were
intended to approximate the estimated fair values of the
facilities at those dates and do not represent a guarantee of the
facilities' residual values. After exhaustive efforts, we were
unable to determine whether the lease is with a variable interest
entity or if there is a primary beneficiary because the unrelated
third-party lessors will not provide the necessary financial
information. The lease is accounted for as an operating lease
and at year-end 2003 our financial interest was limited to our
obligation to make the remaining $191 million of contractual
lease payments, $10 million per year.
* In 1999 we invested $2 million in the form of equity and
subordinated debt in a residential land development partnership
that meets the definition of a variable interest entity.
However, we have determined that we are not the primary
beneficiary of the entity and, therefore, are not required to
consolidate this entity. At year-end 2003, this partnership had
total assets of $88 million and total liabilities of $89 million.
20
TEMPLE-INLAND INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Our maximum exposure to loss is the carrying amount of our
subordinated debt and equity investments in this partnership,
currently $2 million.
* At third quarter-end 2004, $192 million of financial
services' real estate construction loans (and $121 million of
unfunded commitments to lend) are to single-asset entities that
meet the definition of a variable interest entity. All of these
loans are secured by financial guarantees or tri-party takeout
commitment from substantive third parties. We have determined
that we are not the primary beneficiary of any of these entities.
Our maximum exposure to loss is the committed loan amount.
Securities and Exchange Commission Staff Accounting Bulletin
No.105, Application of Accounting Principles to Loan Commitments.
This bulletin applies to loan commitments issued after March 2004
and accounted for as derivative instruments, and it precludes the
recognition of an asset at the inception of the loan commitment.
The effect of adopting this bulletin was not significant.
FASB Staff Position, No. FAS 106-2, Accounting and
Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003. The effect of
adopting this staff position was not significant.
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 Third Quarter and First Nine Months
2004 and 2003
Summary
A summary of our consolidated results for third quarter and
first nine months follows:
Third Quarter First Nine Months
------------- -----------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions, except per share)
Consolidated revenues $ 1,194 $ 1,170 $ 3,566 $ 3,487
Income (loss) from
continuing operations 40 (3) 108 135
Income (loss) from
continuing operations, per
diluted share 0.71 (0.06) 1.93 2.49
Average diluted shares
outstanding 56.7 54.3 56.1 54.1
Significant items affecting third quarter 2004 compared with
third quarter 2003 income from continuing operations included:
* charges and expenses of $25 million, principally related to
the repositioning of the mortgage origination and servicing
activities, and the closure of three converting facilities;
* higher corrugated packaging shipments and prices and lower
converting costs, partially offset by higher energy and recycled
fiber costs;
* higher pricing and shipments for lumber, gypsum, and medium
density fiberboard; and
* lower financial services operating income, principally due
to a $15 million increase in the mortgage servicing valuation
allowance, partially offset by lower loan loss provisions.
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.
22
A summary of the results of operations by business segment
follows:
Third Quarter First Nine Months
------------- -----------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions)
Revenues
Corrugated packaging $ 689 $ 667 $ 2,049 $ 2,019
Forest products 266 211 739 583
Financial services 239 292 778 885
----- ----- ------ ------
Total revenues $1,194 $1,170 $ 3,566 $ 3,487
===== ===== ====== ======
Segment Operating Income
Corrugated packaging $ 42 $ 7 $ 78 $ 16
Forest products 68 24 165 32
Financial services 37 49 149 132
----- ----- ------ ------
Total segment operating income 147 80 392 180
Unallocated expenses (25) (20) (67) (59)
Other income (expense) (25) (24) (51) (56)
Parent company interest (31) (33) (97) (103)
----- ----- ------ ------
Income (loss) before taxes 66 3 177 (38)
Income tax (expense) benefit (26) (6) (69) 173
----- ----- ------ ------
Income (loss) from continuing
operations 40 (3) 108 135
Discontinued operations 1 - 2 1
Effect of accounting change - - - (1)
----- ----- ------ ------
Net income (loss) $ 41 $ (3) $ 110 $ 135
===== ===== ====== ======
Includes the effect of a reclassification of $6 million
related to first quarter 2004. The reclassification had no
effect on operating income.
As a result of the consolidation of our administrative
functions and adoption of a shared services concept, beginning
first quarter 2004, we changed the way we allocate cost to the
business segments. The effect of this change was to increase
segment operating income and to increase unallocated expenses by
a like amount. Third quarter and first nine months 2003 amounts
have been reclassified to reflect this change as follows:
Originally As
Reported Reclassifications Reclassified
---------- ----------------- ------------
(In millions)
Third Quarter 2003
Corrugated packaging $ - $ 7 $ 7
Forest products 22 2 24
Financial services 49 - 49
----- ----- -----
Segment operating income 71 9 80
Unallocated expenses (27) (9) (36)
----- ----- -----
Operating income $ 44 $ - $ 44
===== ===== =====
First Nine Months 2003
Corrugated packaging $ (3) $ 19 $ 16
Forest products 25 7 32
Financial services 132 - 132
----- ----- -----
Segment operating income 154 26 180
Unallocated expenses (81) (26) (107)
----- ----- -----
Operating income $ 73 $ - $ 73
===== ===== =====
Other income (expense) for third quarter 2004 consists of a
$4 million charge associated with converting and production
facility closures, a $1 million charge related to consolidation
and supply chain initiatives, a $21 million charge associated
with the repositioning of the mortgage origination and servicing
activities, and income of $1 million related to the collection of
notes previously written-off. Of these amounts, $3 million
applies to corrugated packaging, $21 million applies to
financial services, and $1 million is unallocated. Other income
(expense) for third quarter 2003 consists of a $3 million charge
related to a production facility closure, a $13 million charge
related to consolidation and supply chain initiatives, and $8
million related to the early redemption of debentures. Of these
23
amounts $4 million applies to corrugated packaging, $1 million
applies to forest products, $1 million applies to financial
services, and $18 million is unallocated.
Other income (expense) for first nine months 2004 consists
of a $21 million charge associated with converting and production
facility closures, a $7 million charge related to consolidation
and supply chain initiatives, a $21 million charge associated
with the repositioning of the mortgage origination and servicing
activities, $1 million of income related to collection of notes
previously written-off, $1 million of other, and a $2 million
premium related to the early redemption of debt. Of these
amounts, $9 million applies to corrugated packaging, $12 million
to forest products, $21 million to financial services, and $9 is
unallocated. Other income (expense) for first nine months 2003
consists of a $10 million charge associated with converting and
production facility closures, a $39 million charge related to
consolidation and supply chain initiatives, an $8 million premium
related to the early redemption of debt, and income of $1 million
related to the collection of notes previously written-off. Of
these amounts, $9 million applies to corrugated packaging, $2
million to forest products, $3 million to financial services, and
$42 million is unallocated.
Includes a one-time tax benefit of $165 million in first
nine months 2003.
Corrugated Packaging
A summary of our corrugated packaging results follows:
Third Quarter First Nine Months
------------- -----------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions)
Revenues $ 689 $ 667 $ 2,049 $ 2,019
Segment operating income 42 7 78 16
Corrugated packaging shipments and pricing continued to
improve. We announced a $50 per ton increase in the price of
linerboard effective March 2004 and a similar increase in
corrugated packaging prices effective April 2004. We announced
another $50 per ton increase in the price of linerboard effective
June 2004 and a similar increase in corrugated packaging prices
effective July 2004.
Third Quarter First Nine Months
2004 versus Third 2004 versus First
Quarter 2003 Nine Months 2003
----------------- -----------------
Increase (Decrease)
Corrugated packaging
Average prices 3 % (2)%
Shipments per workday, tons 6 % 7 %
Industry shipments,
average week (msf) 3 % 4 %
Linerboard
Average prices 22 % 5 %
Shipments to third parties, tons (62)% (43)%
Source: Fibre Box Association
The increase in corrugated packaging shipments was generated
with seven fewer converting facilities at third quarter-end 2004
compared with third quarter-end 2003.
Compared with second quarter 2004, average corrugated
packaging prices were up four percent and shipments per workday
were down three percent.
Linerboard sales and shipments to third parties were down
because more of our production was used in our converting
facilities. Compared with second quarter 2004, average
linerboard prices were up 12 percent while shipments were down 19
percent.
24
In addition to reductions in converting costs due to the
closure of converting facilities, other factors affecting
operating income include fluctuations in the following costs and
expenses:
Third Quarter First Nine Months
2004 versus Third 2004 versus First
Quarter 2003 Nine Months 2003
----------------- -----------------
Increase (Decrease)
(In millions)
Recycled fiber $ 6 $ 22
Energy, principally natural gas 3 -
Depreciation - (4)
Pension and postretirement 2 5
Our recycled fiber costs averaged $115 per ton during third
quarter 2004 compared with $90 per ton during third quarter 2003.
Our recycled fiber costs averaged $112 per ton during first nine
months 2004 compared with $89 per ton during first nine months
2003. Our recycled fiber and energy costs fluctuate based on the
market prices we pay for these commodities.
Information about our mills and converting facilities
follows:
Third Quarter First Nine Months
------------- -----------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions)
Number of converting facilities
(at quarter-end) 72 79 72 79
Mill capacity, in thousand tons 826 824 2,467 2,455
Mill production, in thousand tons 853 808 2,533 2,390
Percent mill production used internally 93 % 81 % 91 % 82 %
Corrugating medium purchases from
our Premier Boxboard Limited LLC
joint venture, in thousand tons 23 45 78 118
We continue our efforts to improve return on investment.
These include reviewing operations that are unable to meet return
objectives and determining appropriate courses of action. In
conjunction with our previously announced plans, we closed our
Dallas, Texas converting facility in March 2004 and our Raleigh,
North Carolina converting facility in April 2004. We closed a
converting facility in Rock Hill, Tennessee, in July 2004 and
converting facilities in Louisville, Kentucky, and Mishawaka,
Indiana, in September 2004. As a result, we paid $2 million in
severance cost during third quarter 2004, and we expect to incur
additional severance and other exit costs during fourth quarter
2004. We also recognized asset impairments, net of adjustments
of less than $1 million during third quarter 2004 and $1 million
during first nine months 2004 related to these closures. We sold
certain assets used in our specialty packaging operations and
other non-strategic assets for $27 million cash during second
quarter 2004 and recognized a gain of $1 million. As a result of
the sale of the specialty packaging assets, during second quarter
2004, we incurred $1 million in severance and other exit costs,
most of which was paid during second quarter 2004. The
accounting effects of these items are included in other operating
expense and are excluded from segment operating income.
Forest Products
A summary of our forest products results follows:
Third Quarter First Nine Months
------------- -----------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions)
Revenues $ 266 $ 211 $ 739 $ 583
Segment operating income 68 24 165 32
25
Product prices and shipments continued to improve due in
part to the strong housing and remodeling markets.
Third Quarter First Nine Months
2004 versus Third 2004 versus First
Quarter 2003 Nine Months 2003
----------------- -----------------
Increase (Decrease)
Average Average
Prices Shipments Prices Shipments
------- --------- ------- ---------
Lumber 18 % 4 % 21 % 10 %
Particleboard 41 % (5)% 27 % 4 %
Gypsum 30 % 23 % 28 % 21 %
MDF 24 % 12 % 13 % 6 %
Comparisons of shipments for MDF and particleboard are
affected by the indefinite closures of our Clarion MDF facility
in third quarter 2003 and sale of this facility in second quarter
2004 and by the indefinite closure of our Mt. Jewett
particleboard facility in second quarter 2003.
Compared with second quarter 2004, average prices were up 10
percent for particleboard, eight percent for MDF, and five percent
for gypsum, while average prices were down one percent for lumber.
Shipments were up one percent for lumber and three percent for
gypsum, while shipments were down 13 percent for particleboard
and 16 percent for MDF.
Information about our converting and manufacturing
facilities follows:
Third Quarter First Nine Months
------------- -----------------
2004 2003 2004 2003
---- ---- ---- ----
Number of converting and
manufacturing facilities (at
quarter-end) 17 18 17 18
Average operating rates for
all product lines:
High 106 % 93 % 95 % 95 %
Low 60 % 52 % 60 % 45 %
Average operating rates include the effects of the
indefinite closure of our Clarion MDF facility in third quarter
2003 and sale of this facility in second quarter 2004 and by the
indefinite closure of our Mt. Jewett particleboard facility in
second quarter 2003. Excluding these effects, the average
operating rates for all product lines during third quarter 2004
would range from a high of 106 percent to a low of 88 percent and
during first nine months 2004 would range from a high of 95
percent to a low of 84 percent.
Other factors affecting operating income include
fluctuations in the following costs and expenses:
Third Quarter First Nine Months
2004 versus Third 2004 versus First
Quarter2003 Nine Months 2003
----------------- -----------------
Increase (Decrease)
(In millions)
Energy, principally natural gas $ 3 $ 3
Depreciation (3) (7)
Information regarding sales of our high value land follows:
Third Quarter First Nine Months
------------- -----------------
2004 2003 2004 2003
---- ---- ---- ----
Acres sold 469 347 1,811 1,650
Profit included in segment
operating income (in millions) $ 3 $ 2 $ 12 $ 8
We continue our efforts to enhance return on investment.
These include reviewing operations, including our MDF facilities,
that are unable to meet return objectives and determining
appropriate courses of action. During second quarter 2004, we
26
sold our Clarion MDF facility and recognized a gain on
disposition of less than $1 million and incurred an insignificant
amount of severance and related exit costs most of which was paid
during second quarter 2004. During first quarter 2004, we
recognized an asset impairment of $12 million related to this
facility. The accounting effect of this item is included in
other operating expense and is excluded from segment operating
income.
Financial Services
A summary of our financial services results follows:
Third Quarter First Nine Months
------------- -----------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions)
Net interest income $ 96 $ 95 $ 295 $ 284
Segment operating income 37 49 149 132
Improvements in our net interest income and lower loan loss
provisions were more than offset by an increase in the mortgage
servicing valuation allowance due to the recent reduction in long-
term interest rates and the decision to sell the third-party
servicing portfolio.
Compared with third quarter 2003, our interest rate spread
improved, partially due to a repricing of maturing certificates
of deposit at lower market rates. In addition, we have changed
the composition of our asset and deposit base primarily by
increasing our residential housing loans, which have fixed
interest rates for the first three to five years and adjustable
rates thereafter, and by increasing demand deposits and money
market accounts and decreasing certificates of deposit. Given
this current position, if interest rates remain relatively
stable, it is likely that our net interest income will remain
near its current level. However, if interest rates change
significantly, it is likely that our net interest income will
decline. Although our interest rate spread was higher in third
quarter 2004 than in third quarter 2003, our net interest income
was approximately the same because we have lower earning assets
in 2004 than in 2003, primarily because our single-family
mortgage-backed security portfolio has declined in size as a
result of prepayments of the underlying mortgage loans in these
securities.
Information concerning our interest rate spread follows:
Third Quarter First Nine Months
--------------------------------- -----------------------------------
2004 2003 2004 2003
--------------- ---------------- ---------------- -----------------
Average Yield/ Average Yield/ Average Yield/ Average Yield/
Balance Rate Balance Rate Balance Rate Balance Rate
------- ----- ------- ----- ------- ----- ------- -----
(Dollars in millions)
Earning assets $ 15,799 4.46% $ 17,075 4.19% $ 16,073 4.37% $ 16,973 4.39%
Interest-bearing
liabilities 14,956 2.14% 15,430 2.16% 15,180 2.04% 15,559 2.35%
---- ---- ---- ----
Interest rate spread
spread 2.32% 2.03% 2.33% 2.04%
The following tables summarize the composition of earning
assets and deposits:
Third Quarter End
-----------------
2004 2003
---- ----
(Dollars in millions)
Residential housing assets (loans and
securities) $ 13,079 $ 13,279
Other earning assets 2,899 3,286
------ ------
Total earning assets $ 15,978 $ 16,565
====== ======
Residential housing assets as a percentage
of total earning assets 82 % 80 %
Demand deposit and savings accounts $ 5,165 $ 4,962
Certificates of deposit 3,826 3,965
------ ------
Total deposits $ 8,991 $ 8,927
====== ======
27
The decrease in earning assets was primarily due to a
decrease in single-family mortgage-backed securities resulting
from reduced purchases coupled with prepayments related to
refinancing activity and a decrease in commercial real estate
loans resulting from repayment. We expect the trend of
repayments of commercial real estate loans to continue for
several months. As a result of the repositioning of our mortgage
activities discussed below, we anticipate a substantial decrease
during fourth quarter 2004 in our mortgage loans held for sale
and in deposits related to third-party servicing escrow accounts.
During third quarter 2004, we acquired two branches and $150
million in deposits for a $5 million premium, of which $3 million
was allocated to goodwill and the remainder was allocated to
other intangible assets.
During third quarter 2004, we announced our intentions to
reposition our mortgage origination activities and sell our third-
party mortgage servicing portfolio in order to reduce our costs
and our exposure to changing market conditions, including a slow
down in refinancing activity. While we will still originate
mortgage loans for our own portfolio and, to a lesser extent, for
sale to others, we intend to limit our product offerings and
reposition our retail origination activities. We will continue
to originate loans through brokers and correspondent networks and
in certain other retail channels, including the retail branches
of our bank. These actions will affect over 1,500 employees and
approximately 110 of our mortgage origination outlets. We expect
the repositioning and sales to be substantially completed by year-
end 2004. These actions will substantially reduce our future non-
interest income derived from loan originations and sale of loans
and loan servicing fees and the related servicing rights
amortization and impairment. In addition, these actions will
substantially reduce future non-interest expenses, principally
compensation and benefits and occupancy costs. As a result of
these actions, during third quarter 2004, we recognized $17
million in asset and goodwill impairments and incurred $4 million
in retention, severance and other exit costs. As these actions
are finalized it is likely that additional impairments, severance
and other exit costs will be incurred, and such amounts could be
significant. The accounting effects of these actions are
included in non-interest expense and are excluded from segment
operating income. Other factors affecting operating income
include fluctuations in the following non-interest income and
expenses:
Third Quarter First Nine Months
2004 versus Third 2004 versus First
Quarter2003 Nine Months 2003
----------------- -----------------
Increase (Decrease)
(In millions)
Non-interest income:
Loan origination and sale of loans $ (37) $ (108)
Servicing rights amortization
and impairment 9 (19)
The decrease in loan origination and sale of loans was due
to the decline in mortgage loan origination activity as
refinancing activity slowed considerably. The increase in
servicing rights amortization and impairment in the third quarter
was due to the recent decline in long-term interest rates and the
decision to sell the third-party mortgage servicing portfolio.
The mortgage servicing impairment valuation allowance was
increased by $15 million in third quarter 2004 and by $12 million
in first nine months 2004 compared with a decrease of $7 million
in third quarter 2003 and an increase of less than $1 million in
first nine months 2003. As mortgage interest rates rise,
mortgage loan origination activity and servicing rights
amortization and impairment generally decline and as mortgage
interest rates decline, mortgage loan origination activity and
servicing rights amortization and impairment generally increase.
Information regarding mortgage loan origination activity
follows:
Third Quarter First Nine Months
------------- -----------------
2004 2003 2004 2003
---- ---- ---- ----
(In millions)
Loans originated for sale to
third parties $ 1,162 $ 3,516 $ 4,115 $ 9,988
Value of mortgage servicing
rights retained $ 3 $ 19 $ 18 $ 38
28
Factors affecting non-interest expense follow:
Third Quarter First Nine Months
2004 versus Third 2004 versus First
Quarter2003 Nine Months 2003
----------------- -----------------
Increase (Decrease)
(In millions)
Non-interest expense:
Compensation and benefits $ (19) $ (47)
Real estate operations (5) -
A significant portion of our compensation cost is directly
related to our mortgage loan origination volume. In third
quarter and first nine months 2004, compensation costs declined
in conjunction with the decline in mortgage loan origination
volume. A portion of our mortgage loan origination-related costs
is directly variable with origination volume. However, other
mortgage loan origination-related operating costs are fixed or
only partially variable. In connection with the repositioning of
our mortgage origination activities, we are carrying the assets
related to these activities at fair value less cost to sell. At
third quarter-end 2004, the carrying value of these assets was $3
million. We anticipate selling or closing these retail
origination outlets by year end.
Information regarding the mortgage loans we service for
others and our mortgage servicing rights follows:
Third Quarter First Nine Months
---------------- -----------------
2004 2003 2004 2003
---- ---- ---- ----
(Dollars in millions)
Outstanding balance of loans
serviced for third parties (at
quarter-end) $ 7,827 $ 8,149 $ 7,827 $ 8,149
Annualized prepayment rate 26 % 55 % 31 % 50 %
Carrying amount of mortgage
servicing rights as a percent of
balance serviced (at quarter-end) 0.82 % 1.08 % 0.82 % 1.08 %
As previously announced, we have decided to sell our third-
party mortgage servicing rights. As a result, our mortgage
servicing rights are carried at fair value less estimated cost to
sell. At third quarter-end 2004, the carrying value of our
mortgage servicing rights was $64 million, net of a $31 million
valuation allowance, which includes $8 million for estimated
costs to sell. During fourth quarter 2004, we entered into a
letter of intent to sell our servicing rights. We anticipate
closing this sale by year-end 2004.
Asset Quality and Allowance for Loan Losses
The following table summarizes various asset quality
measures:
Third Quarter-End Year-End
----------------- --------
2004 2003 2003
---- ---- ----
(Dollars in millions)
Non-performing loans $ 56 $ 86 $ 65
Restructured operating lease assets 37 41 40
Foreclosed real estate 17 12 26
---- ---- ----
Non-performing assets $ 110 $ 139 $ 131
==== ==== ====
Non-performing loans as a percentage
of total loans 0.58 % 0.91 % 0.71 %
Non-performing assets ratio 1.12 % 1.46 % 1.42 %
Allowance for loan losses as a
percent of:
Non-performing loans 170 % 152 % 172 %
Total loans 0.98 % 1.38 % 1.22 %
We have contracts to sell one of our foreclosed real estate
assets for an amount approximating its $10 million carrying
value.
29
The following table summarizes changes in the allowance for
loan losses:
Third Quarter First Nine Months
------------- -----------------
2004 2003 2004 2003
---- ---- ---- ----
(Dollars in millions)
Balance at beginning of period $ 100 $ 117 $ 111 $ 132
Net charge-offs 1 - (6) (46)
Provision (credit) for loan losses (5) 13 (9) 44
----- ---- ---- -----
Balance at end of period $ 96 $ 130 $ 96 $ 130
===== ==== ==== =====
Net charge-offs as a percentage of
average loans outstanding (0.01%) - % 0.09 % 0.62 %
Third quarter 2004 and first nine months 2004 provision for
loan loss was a credit to earnings due to repayments on loans for
which we had previously provided loan loss reserves, recoveries
of previously charged-off loans and general improvement in
overall loan quality. While several loans required additional
loan loss reserves and we charged off a portion of several loans
that were foreclosed upon, our loan losses in 2004 have been
substantially less than in 2003. Third quarter and first nine
months 2003 charge-offs and loan loss provisions were principally
related to asset-based loans.
Unallocated Expenses, Other (Income) Expense and Interest
The change in unallocated expenses in first nine months 2004
was principally due to an increase in stock-based compensation
and expenses related to our assessment of internal controls over
financial reporting mandated by the Sarbanes-Oxley Act.
Other operating (income) expense items are not allocated to
business segments. In addition to the items previously discussed
within the segments, the remainder of unallocated other operating
(income) expense includes expenses related to initiatives to
consolidate administrative functions and effect improvements in
supply chain management of $1 million in third quarter 2004 and
$12 million in third quarter 2003 and $7 million in first nine
months 2004 and $36 million in first nine months 2003. During
third quarter 2004, we revised our estimates of contractual
relocation expense and reduced our accrual for these expenses by
$2 million.
The change in parent company interest expense in third
quarter and first nine months 2004 was due to a reduction in long-
term debt and lower interest rates.
Other non-operating expense consists of a charge related to
our early retirement of debt.
Income Taxes
Our effective tax rate was 39 percent in third quarter 2004
and first nine months 2004, the likely effective tax rate for the
year 2004. Our effective tax rate was 200 percent in third
quarter 2003 and, excluding the one-time tax benefit discussed
below, was 21 percent in first nine months 2003. Differences
between the effective tax rate and the statutory rate are due to
state income taxes, nondeductible items, foreign operating
losses, and other items for which no financial benefit is
recognized until realized.
During second quarter 2003, the Internal Revenue Service
concluded its examination of our tax returns through 1996,
including matters related to net operating losses and minimum tax
credit carryforwards, which resulted from certain deductions
following our 1988 acquisition of Guaranty Bank and for which no
financial accounting benefit had been recognized. Also, we
resolved certain state tax refund claims for the years 1991
through 1994. As a result, valuation allowances and tax accruals
previously provided for these matters were no longer required.
Accordingly, during second quarter 2003, we recorded a one-time
benefit of $165 million, or $3.05 per diluted share. Of this one-
time benefit, approximately $26 million represents cash refunds
of previously paid taxes plus related interest. The remainder
was a non-cash benefit.
Average Shares Outstanding
The change in average shares outstanding in third quarter
2004 and first nine months 2004 was principally due to employee
exercises of stock options.
30
Capital Resources and Liquidity for First Nine Months 2004
Substantially all of our consolidated net assets invested in
financial services are subject to regulatory rules and
regulations including restrictions on the ability of financial
services to pay dividends to the parent company. Accordingly,
the parent company and the financial services capital resources
and liquidity are discussed separately.
Parent Company
Operating Activities
Cash provided by operations was $271 million in first nine
months 2004 and $264 million in first nine months 2003.
Depreciation and other non-cash charges and credits were $251
million in first nine months 2004 and $106 million in first nine
months 2003. Dividends received from financial services were $70
million in first nine months 2004 and $120 million in first nine
months 2003. No dividends were received during third quarter
2004.
Our working capital needs increased $119 million in first
nine months 2004 and $27 million in first nine months 2003. The
change was principally due to an increase in receivables and
inventories. Working capital is always subject to the timing of
collections on receivables and payments on payables and to a
lesser extent to seasonal fluctuations in our operations.
Investing Activities
Our investing activities used $57 million in first nine
months 2004 and $67 million in first nine months 2003. Capital
expenditures were $117 million in first nine months 2004, 70
percent of depreciation, and $96 million in first nine months
2003, 55 percent of depreciation. Cash proceeds from sales of
non-strategic assets were $63 million in first nine months 2004
and $36 million in first nine months 2003.
We made no capital contributions to financial services in
first nine months 2004 or first nine months 2003.
Financing Activities
Our financing activities used $219 million in first nine
months 2004 and $200 million in first nine months 2003. Debt was
reduced by $155 million in first nine months 2004. In June 2004,
we redeemed all of the outstanding 9.38% to 9.88% senior
subordinated and senior notes issued by Gaylord Container
Corporation. The principal amount held by third parties was $44
million and the redemption premium was $2 million. During third
quarter 2004, we repaid $100 million in 7.25% notes that became
due. Also during second quarter 2004, we paid $64 million of
other long-term liabilities, principally timber rights purchase
obligations. We issued 1,143,579 shares of our common stock to
employees exercising options having an aggregate exercise price
of $60 million during first nine months 2004.
We paid cash dividends to our shareholders of $60 million,
or $1.08 per share, in first nine months 2004 and $55 million, or
$1.02 per share, in first nine months 2003.
Liquidity
Our sources of short-term funding are our operating cash
flows, which include dividends received from financial services,
and borrowings under our existing credit arrangements and
accounts receivable securitization program. We operate in
cyclical industries, and our operating cash flows vary
accordingly. The dividends we receive from financial services
are dependent on its level of earnings and capital needs and are
subject to regulatory approval and restrictions.
At third quarter-end 2004, we had cash and short-term
investments of $15 million. Also, we had $562 million in unused
borrowing capacity under our credit agreements and $249 million
under our accounts receivable securitization program, which
matures in May 2007. At third quarter-end 2004, we complied with
all the terms and conditions of our credit agreements and of our
accounts receivable securitization program.
As we did earlier in 2004, from time to time we may
refinance existing debt obligations or use available cash flow to
retire existing debt obligations before they come due.
31
Financial Services
Operating Activities
Cash provided by operations was $160 million in first nine
months 2004 and $611 million in first nine months 2003. The
change was principally because in 2004 we have sold approximately
the same amount of mortgage loans as we originated, whereas in
2003 we sold substantially more than we originated, reducing our
available loans held for sale. Changes in loans held for sale
are always subject to the timing of loan originations and loan
sales, however, we anticipate our loans held for sale and related
cash flows will decrease substantially as a result of our
announced intentions to reposition our mortgage origination
activities.
Investing Activities
Our investing activities used $29 million in first nine
months 2004 and provided $356 million in first nine months 2003.
The change was principally because we received less principal
payments on mortgage-backed securities as mortgage prepayments
decreased in 2004. Assets held for sale approximate $67 million
at third quarter-end 2004. It is likely these assets will be
sold during fourth quarter 2004.
Financing Activities
Our financing activities used $89 million in first nine
months 2004 and $949 million in first nine months 2003. The
change was principally because we repaid fewer borrowings and
because we accepted more deposits.
Financial services paid dividends to the parent company of
$70 million in first nine months 2004 and $120 million in first
nine months 2003. No dividends were paid during third quarter
2004.
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 third quarter-end 2004, we had available
liquidity of $2.9 billion, an increase over second quarter 2004
as a result of obtaining improved collateral credit for some of
our assets. As a result of our planned sale of mortgage
servicing rights, we anticipate transferring deposits we hold for
mortgage borrowers and third-party mortgage investors to the
purchaser of our mortgage servicing rights. These deposits
totaled $184 million at third quarter end 2004.
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. Our unfunded
commitments consist of:
Third
Quarter-End Year-End
2004 2003
---- ----
(In millions)
Single-family mortgage loans $ 725 $ 509
Unused lines of credit 1,790 1,696
Other loans 3,447 3,141
Letters of credit 381 290
----- -----
Total $ 6,343 $ 5,636
===== =====
As a result of our decision to reposition our mortgage
origination activities and sell our third-party mortgage
servicing portfolio, it is likely that our unfunded single-family
mortgage loans commitments will decrease significantly.
32
Regulatory Matters
At third 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:
Third
Quarter-End Year-End
2004 2003
---- ----
(In millions)
Balance sheet data:
Total assets $ 16,669 $ 17,247
Total deposits 8,991 8,698
Shareholder's equity 1,007 999
Regulatory For Categorization as
Actual Minimum "Well Capitalized"
------ ------- ------------------
Regulatory capital ratios:
Tangible capital 6.63 % 2.00 % N/A
Leverage capital 6.63 % 4.00 % 5.00 %
Risk-based capital 10.93 % 8.00 % 10.00 %
An internal investigation, which is still ongoing, has
revealed that our mortgage origination operation failed to file
certain regulatory reports on a timely basis and may have
violated applicable laws or regulations. We have taken a number
of actions as a result of this investigation, including improving
compliance controls in the mortgage origination process. We
reported these events to the OTS, including the results of our
internal investigation and our remediation activities to date.
The OTS is authorized to pursue supervisory actions, including
the assessment of monetary penalties, to correct violations of
certain regulations. We do not expect that monetary penalties or
corrective actions, if any, imposed as a result of these
circumstances will have a material impact on our financial
position or results of operations. To date we have incurred $5
million of expenses, principally third-party consultants, to
assist in the investigation and remedial actions. These expenses
are included in non-operating expenses and are included in
segment operating income. We have not incurred any material
financial loss as a result of this matter and have no reason to
believe that our investigation, when completed, will result in
any material loss.
Pension and Postretirement Matters
Based on preliminary estimates, we expect to incur in the
range of $50 million in non-cash pension expense for the year
2005; about the same as expected for the year 2004, and that our
minimum pension liability will increase by $8 million to about
$258 million. Also based on these preliminary estimates, we do
not expect our cash funding requirements to be significantly
different from this year, in the range of $2 million or less.
The Medicare Prescription Drug, Improvement and
Modernization Act of 2003 was enacted in December 2003. This act
expands Medicare to include, for the first time, coverage for
prescription drugs. Our postretirement benefit plans provide for
medical coverage, including a prescription drug subsidy, for
certain participants. Due to the absence of detailed guidance
necessary to implement the act, we are unable to precisely
determine its effects on our postretirement benefit plans.
However, based on our current understanding and analysis, it is
likely that the effects will not significantly reduce our cost
for these plans. In second quarter 2004, we adopted FASB Staff
Position, No. 106-2, Accounting and Disclosure Requirements
Related to the Medicare Prescription Drug, Improvement and
Modernization Act of 2003. This staff position permits us to
defer recognizing the effects of the act when we conclude they
are not significant until our next annual plan measurement date.
Based on preliminary estimates, we expect the effect of the act
will be to reduce our 2005 postretirement expense by
approximately $1 million and reduce our year-end 2004
postretirement liability by approximately $8 million.
33
Energy and the Effects of Inflation
Energy costs were $211 million in first nine months 2004
compared with $208 million in first nine months 2003. Our energy
costs fluctuate based on the market prices we pay for these
commodities and on the amount and mix of the types of fuel we may
use. We hedge very little of our energy needs. It is likely
that these costs will continue to fluctuate during 2004.
Accounting Policies
Critical Accounting Estimates
In third quarter 2004, there were no significant changes in
our critical accounting estimates from those we identified in our
Form 10-K for the year 2003.
New Accounting Pronouncements Adopted
In second quarter 2004, we adopted FASB Staff Position, No.
106-2, Accounting and Disclosure Requirements Related to the
Medicare Prescription Drug, Improvement and Modernization Act of
2003. This staff position provides guidance on accounting for
the effects of this act on post retirement benefit plans that
provide prescription drug benefits.
In first quarter 2004, we were required to adopt the
following accounting pronouncements:
* FASB Interpretation No. 46 (revised December 2003),
Consolidation of Variable Interest Entities an interpretation of
ARB No. 51. This interpretation provides guidance for
determining whether an entity is a variable interest entity and
which beneficiary of the variable interest entity, if any, should
consolidate the variable interest entity (the primary
beneficiary).
* Securities and Exchange Commission Staff Accounting Bulletin
No.105, Application of Accounting Principles to Loan Commitments.
This bulletin applies to loan commitments issued after March 2004
and accounted for as derivative instruments and it precludes the
recognition of an asset at the inception of the loan commitment.
The effect of adopting these pronouncements was not
significant.
Litigation and Related Matters
We are involved in various legal proceedings that arise from
time to time in the ordinary course of business. We believe that
the possibility of a material liability from any of these
proceedings is remote, and we do not believe that the outcome of
any of these proceedings should have a material adverse effect on
our financial position, results of operations, or cash flow.
Since we filed our Quarterly Report on Form 10-Q for the
period ended July 3, 2004, there have been no material
developments in pending legal proceedings, except as follows:
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 our 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. We assisted the environmental agencies in investigating
the incident and no citations or penalties were issued. In October
2004, a class action lawsuit was filed against Gaylord by local
residents seeking damages related to this incident. We believe the
likelihood of a material loss from this litigation is remote and do
not believe that the outcome should have a material adverse effect
on our financial position, results of operations, or cash flow.
On July 22, 2002, a delivery driver for a chemical supply
company overfilled a storage tank for caustic soda at a Gaylord
converting facility in Tipton, Indiana. The excess caustic soda
drained through an overflow pipe into the city sewer system,
34
resulting in a temporary shutdown of the city wastewater
treatment plant and killing approximately 2,000 fish in a local
creek. Gaylord removed the fish, assisted in restoring
operations at the wastewater treatment plant, and took other
corrective actions to assure no ongoing effect to human health or
the environment. We continue to assist the environmental agencies
in investigating the incident. At this time, we are not able to
predict whether Gaylord will be subject to any monetary sanctions
arising out of this incident or the amount of any such monetary
sanctions.
35
STATISTICAL AND OTHER DATA
Parent Company
The following table presents revenues and unit sales for our
manufacturing segments:
Third Quarter First Nine Months
---------------- -----------------
2004 2003 2004 2003
---- ---- ---- ----
(Dollars in millions)
Revenues
Corrugated Packaging
Corrugated packaging $ 667 $ 617 $1,965 $1,877
Linerboard 22 50 84 142
---- ---- ----- -----
Total $ 689 $ 667 $2,049 $2,019
==== ==== ===== =====
Forest Products
Pine lumber $ 90 $ 73 $ 258 $ 193
Particleboard 48 38 143 113
Medium density fiberboard 28 21 84 70
Gypsum wallboard 30 19 81 53
Fiberboard 23 20 62 51
Other 47 40 111 103
---- ---- ---- -----
Total $ 266 $ 211 $ 739 $ 583
==== ==== ==== =====
Unit sales
Corrugated Packaging
Corrugated packaging, thousands of tons 842 793 2,556 2,382
Linerboard, thousands of tons 57 150 240 421
---- ---- ---- -----
Total, thousands of tons 899 943 2,796 2,803
==== ==== ==== =====
Forest Products
Pine lumber, mbf 237 227 707 641
Particleboard, msf 141 149 463 444
Medium density fiberboard, msf 57 51 182 172
Gypsum wallboard, msf 203 165 571 472
Fiberboard, msf 121 123 331 312
Revenues and unit sales do not include joint venture
operations.
36
Financial Services
The following table summarizes the composition of our loan
portfolio:
Third Quarter-End Year-End
----------------- --------
2004 2003 2003
---- ---- ----
(In millions)
Single-family mortgage $ 3,627 $ 3,082 $ 3,255
Single-family mortgage warehouse 544 395 387
Single-family construction 1,280 1,054 889
Multifamily and senior housing 1,691 1,831 1,769
----- ----- -----
Total residential housing 7,142 6,362 6,300
Commercial real estate 623 1,175 1,015
Commercial and business 694 622 585
Energy lending 690 520 562
Asset-based lending and leasing 441 595 499
Consumer and other 196 177 176
----- ----- -----
Total loans 9,786 9,451 9,137
Less allowance for loan losses (96) (130) (111)
----- ----- -----
Loans receivable, net $ 9,690 $ 9,321 $ 9,026
===== ===== =====
37
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
Interest Rate Risk
Our current level of interest rate risk is primarily due to
the lending and funding activities of our financial services
segment. The following table illustrates the estimated effect on
our pre-tax income of immediate, parallel and sustained shifts in
interest rates for the next 12-months at third 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
--------------------------------------------
Third Quarter-End 2004 Year-End 2003
---------------------- -----------------
Parent Financial Parent Financial
Company Services Company Services
------- -------- ------- --------
(In millions)
Change in
Interest Rates
--------------
+2% $ 1 $ (5) $ (2) $ 8
+1% - 17 (1) 28
-1% - (27) 1 (20)
We did not present a two percent interest rate decrease
because of the current low interest rate environment. The
analysis assumes that debt reductions from contractual payments
will be replaced with short-term variable rate debt; however,
that may not be the financing alternative we choose to follow.
Our parent company's interest rate risk is related to our
long-term debt and our interest rate swap. Since our parent
company debt is primarily fixed rate, interest rate changes are
not expected to affect earnings significantly. However, interest
rate changes will affect the value of the interest rate swap
derivative transaction but we would not expect that would be
significant.
Our financial services segment is subject to interest rate
risk to the extent interest-earning assets and interest-bearing
liabilities repay or reprice at different times or in differing
amounts or both. Our financial services segment's interest rate
sensitivity has changed from year-end 2003, due principally to
increases in market interest rates that have occurred since then.
The rise in interest rates has resulted in an improved spread
relationship between the yields on our earning assets and costs
of funding sources, principally because our projected mortgage
yields are benefiting from slower prepayments and our deposit
rates have lagged the increase in market rates. We believe a
further modest increase in interest rates would result in
improved income, but to a lesser extent than in the past.
However, we expect that would not be the case if interest rates
increase significantly because we believe our deposit rates would
become more responsive to changes in rates.
The table above does not reflect the effect of changes in
interest rates on the fair value of our mortgage servicing rights
(estimated at $72 million, exclusive of selling costs at third
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 $18 million.
However, during fourth quarter 2004, we entered into a letter of
intent to sell our servicing rights. We anticipate closing this
sale by year-end 2004.
Foreign Currency Risk
In third 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 third 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.
38
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures
The Company's chief executive officer and its chief
financial officer, based on their evaluation of the Company's
disclosure controls and procedures (as defined in Exchange Act
Rule 13a-15(e)) as of the end of the period covered by this
Quarterly Report on Form 10-Q, have concluded that the Company's
disclosure controls and procedures are adequate and effective to
ensure that the information required to be disclosed by us in the
reports we file or submit under the Securities Exchange Act of
1934, as amended, is recorded, processed, summarized, and
reported within the time periods specified in the Securities and
Exchange Commission's rules and forms.
(b) Changes in internal control over financial reporting.
There were no changes in the Company's internal control over
financial reporting during the period covered by this report that
have materially affected, or are reasonably likely to materially
affect, the Company's internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
The information set forth in Note G of the Notes to
Consolidated Financial Statements in Part I of this report is
incorporated by reference thereto.
Since we filed our Quarterly Report on Form 10-Q for the
period ended July 3, 2004, there have been no material
developments in pending legal proceedings, except as set forth
below:
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 our 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. We assisted the environmental agencies in investigating
the incident and no citations or penalties were issued. In October
2004, a class action lawsuit was filed against Gaylord by local
residents seeking damages related to this incident. We believe the
likelihood of a material loss from this litigation is remote and do
not believe that the outcome should have a material adverse effect
on our financial position, results of operations, or cash flow.
On July 22, 2002, a delivery driver for a chemical supply
company overfilled a storage tank for caustic soda at a Gaylord
converting facility in Tipton, Indiana. The excess caustic soda
drained through an overflow pipe into the city sewer system,
resulting in a temporary shutdown of the city wastewater
treatment plant and killing approximately 2,000 fish in a local
creek. Gaylord removed the fish, assisted in restoring
operations at the wastewater treatment plant, and took other
corrective actions to assure no ongoing effect to human health or
the environment. We continue to assist the environmental agencies
in investigating the incident. At this time, we are not able to
predict whether Gaylord will be subject to any monetary sanctions
arising out of this incident or the amount of any such monetary
sanctions.
Item 2. Unregistered Sales of Equity Securities and Use of
Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
39
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
31.1 - Certification of Chief Executive Officer pursuant to
Exchange Act Rule 13a-14(a), as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 - Certification of Chief Financial Officer pursuant to
Exchange Act Rule 13a-14(a), as adopted pursuant to
Section302 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 October 2, 2004, the Company filed
the following Current Reports on Form 8-K:
1. Current Report on Form 8-K dated July 27, 2004, reporting
under Items 9 and 12 a press release issued by the Company
announcing earnings for the period ended July 3, 2004.
2. Current Report on Form 8-K dated July 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 July 27, 2004, discussing the
Company's earnings for the quarter ended July 3, 2004.
3. Current Report on Form 8-K dated August 4, 2004, reporting
under Item 5 a press release issued by the Company announcing
plans to reposition mortgage activities within its wholly-owned
subsidiary, Guaranty Residential Lending, Inc.
4. Current Report on Form 8-K dated September 20, 2004,
reporting under Item 8.01 a press release issued by the Company
announcing that its wholly-owned subsidiary, Guaranty Residential
Lending, Inc., plans to sell its third party mortgage servicing
portfolio.
5. Current Report on Form 8-K dated September 23, 2004,
furnishing under Item 7.01 the presentation materials of Kenneth
M. Jastrow, II, Chief Executive Officer of the Company, used in
Mr. Jastrow's address on September 23, 2004, to the Global Paper
and Forest Products Conference sponsored by UBS Warburg.
40
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, 2004 By /s/ Louis R. Brill
---------------------------
Louis R. Brill
Chief Accounting Officer
41
INDEX TO EXHIBITS
Exhibit No. Description Page No.
----------- -------------------------------- --------
31.1 Certification of Chief Executive 42
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 44
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 46
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 47
Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-
Oxley Act of 2002