Temple-Inland 10-K 2008
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Commission File Number 001-08634
1300 MoPac Expressway South, 3rd Floor
Austin, Texas 78746
Registrants telephone number, including area code: (512) 434-5800
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Exchange Act of 1934. Yes o No þ
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 þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ Accelerated filer o Non-accelerated filer o Smaller reporting company o
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No þ
The aggregate market value of the Common Stock held by non-affiliates of the registrant, based on the closing sales price of the Common Stock on the New York Stock Exchange on June 29, 2007, was approximately $5,098,255,000. For purposes of this computation, all officers, directors, and five percent beneficial owners of the registrant (as indicated in Item 12) are deemed to be affiliates. Such determination should not be deemed an admission that such directors, officers, or five percent beneficial owners are, in fact, affiliates of the registrant.
As of February 22, 2008, there were 106,274,170 shares of Common Stock outstanding.
Portions of the Companys definitive proxy statement to be prepared in connection with the 2008 Annual Meeting of Shareholders are incorporated by reference into Part III of this report.
Temple-Inland Inc. is a Delaware corporation that was organized in 1983. We manufacture corrugated packaging and building products, which we report as separate operating segments. The following chart presents our corporate structure at year-end 2007. It does not contain all our subsidiaries, many of which are dormant or immaterial entities. A list of our subsidiaries is filed as an exhibit to this Annual Report on Form 10-K. All subsidiaries shown are 100 percent owned by their immediate parent company listed in the chart, unless indicated otherwise.
Our principal executive offices are located at 1300 MoPac Expressway South, 3rd Floor, Austin, Texas 78746. Our telephone number is (512) 434-5800.
Financial information about our principal operating segments and revenues by geographic areas are shown in our notes to financial statements contained in Item 8, and revenues and unit sales by product line are contained in Item 7 of this Annual Report on Form 10-K.
On February 25, 2007, our board of directors unanimously authorized a transformation plan that included the spin-off of our real estate business and our financial services business. The spin-offs were completed on December 28, 2007 through distributions to our stockholders of all of the shares of common stock of Forestar Real Estate Group Inc., which holds all of the assets and liabilities formerly associated with our real estate business, and Guaranty Financial Group Inc., which holds all of the assets and liabilities formerly associated with our financial services business. Our consolidated financial statements contained in this Annual Report on Form 10-K have been reclassified for all periods presented to report Forestar and Guaranty as discontinued operations.
As part of the transformation plan, we also sold our strategic timberland on October 31, 2007 for approximately $2.38 billion. The total consideration consisted almost entirely of notes due in 2027, which are
secured by irrevocable standby letters of credit. In December 2007, we pledged the notes as collateral for nonrecourse loans. The net cash proceeds from the nonrecourse loans, after current taxes and transaction costs, were approximately $1.8 billion. We used these proceeds to pay a special dividend to our shareholders of $10.25 per share and reduce debt by approximately $700 million.
Corrugated Packaging. Our corrugated packaging segment provided 77.5 percent of our 2007 consolidated net revenues. Our vertically integrated corrugated packaging operation includes:
We manufacture containerboard and convert it into a complete line of corrugated packaging. We sold eight percent of the containerboard we produced in 2007 in the domestic and export markets. We converted the remaining internal production, in combination with containerboard we purchased from other producers, into corrugated containers at our converting facilities. While we have the capacity to convert more containerboard than we produce, we routinely buy and sell various grades of containerboard depending on our product mix.
Our nationwide network of converting facilities produces a wide range of products from commodity brown boxes to intricate die cut containers that can be printed with multi-color graphics. Even though the corrugated packaging business is characterized by commodity pricing, each order for each customer is a custom order. Our corrugated packaging is sold to a variety of customers in the food, paper, glass containers, chemical, appliance, and plastics industries, among others. We also manufacture bulk containers constructed of multi-wall corrugated board for extra strength, which are used for bulk shipments of various materials.
We serve over 9,500 corrugated packaging customers with 17,000 shipping destinations. We have no single customer to which sales equal ten percent or more of consolidated revenues or the loss of which would have a material adverse effect on our corrugated packaging segment.
Sales of corrugated packaging track changing population patterns and other demographics. Historically, there has been a correlation between the demand for corrugated packaging and orders for nondurable goods.
We also own a 50 percent interest in Premier Boxboard Limited LLC, a joint venture that produces light-weight gypsum facing paper and corrugating medium at a mill in Newport, Indiana.
Building Products. Our building products segment provided 20.5 percent of our 2007 consolidated net revenues. We manufacture a wide range of building products, including:
We sell building products throughout the continental United States, with the majority of sales occurring in the southern United States. We have no single customer to which sales equal ten percent or more of consolidated revenues or the loss of which would have a material adverse effect on our building products segment. Most of our products are sold by account managers and representatives to distributors, retailers, and original equipment manufacturers. Sales of building products are heavily dependent upon the level of residential housing expenditures, including the repair and remodeling market.
We also own a 50 percent interest in Del-Tin Fiber LLC, a joint venture that produces MDF at a facility in El Dorado, Arkansas.
Wood fiber, in various forms, is the principal raw material we use in manufacturing our products. In October 2007, in conjunction with our transformation plan, we sold our 1.5 million acres of strategic timberland and entered into long-term fiber supply agreements with the purchaser. During 2007, owned timberland supplied approximately 41 percent of our virgin wood fiber requirements. The balance of our virgin wood fiber requirements was purchased from numerous landowners and other timber owners, as well as other producers of wood by-products. In 2008, we currently expect that we will purchase at market prices approximately 50 percent of our wood fiber requirements under our long-term fiber supply agreements, the most significant of which were entered into in connection with our timberland sale. The remainder of our virgin wood fiber requirements will be purchased at market prices from numerous landowners and other timber owners, as well as other producers of wood by-products.
Linerboard and corrugating medium are the principal materials used to make corrugated boxes. Our mills at Rome, Georgia and Bogalusa, Louisiana, only manufacture linerboard. Our Ontario, California; Maysville, Kentucky; and Orange, Texas, mills are traditionally linerboard mills, but can also manufacture corrugating medium. Our New Johnsonville, Tennessee, mill only manufactures corrugating medium. The principal raw material used by the Rome, Georgia; Orange, Texas; and Bogalusa, Louisiana, mills is virgin wood fiber, but each mill is also able to use recycled fiber for up to 15 percent of its wood fiber requirements. The Ontario, California, and Maysville, Kentucky, mills use only recycled fiber. The mill at New Johnsonville, Tennessee, uses a combination of virgin wood and recycled fiber.
In 2007, recycled fiber represented approximately 36 percent of the total wood fiber needs of our containerboard operations. We purchase recycled fiber at market prices on the open market from numerous suppliers. We generally produce more linerboard and less corrugating medium than is used by our converting facilities. The deficit of corrugating medium is filled through open market purchases and/or trades, and we sell any excess linerboard in the open market.
We obtain gypsum for our wallboard operations in Fletcher, Oklahoma, from one outside source through a long-term purchase contract at market prices. At our gypsum wallboard plants in West Memphis, Arkansas, and Cumberland City, Tennessee, synthetic gypsum is used as a raw material. Synthetic gypsum is a by-product of coal-burning electrical power plants. We have a long-term supply agreement for synthetic gypsum produced at a Tennessee Valley Authority electrical plant located adjacent to our Cumberland City plant. Synthetic gypsum acquired pursuant to this agreement supplies all the synthetic gypsum required by our Cumberland City and West Memphis plants. In 2007, our gypsum wallboard plant in McQueeney, Texas, primarily used gypsum obtained from its own quarry and gypsum acquired from the same source that supplies the Fletcher, Oklahoma, plant. In 2008, we expect the McQueeney plant will use synthetic gypsum and gypsum from our quarry.
We believe the sources outlined above will be sufficient to supply our raw material needs for the foreseeable future. We hedge very little of our raw material costs. The wood fiber market is difficult to predict and there can be no assurance of the future direction of prices for virgin wood or recycled fiber. Future increases in wood fiber prices could adversely affect our results of operations.
Electricity and steam requirements at our manufacturing facilities are either supplied by a local utility or generated internally through the use of a variety of fuels, including natural gas, fuel oil, coal, petroleum coke, tire derived fuel, wood bark, and other waste products resulting from the manufacturing process. By utilizing these waste products and other wood by-products as a biomass fuel to generate electricity and steam, we were able to generate approximately 84 percent of our energy requirements in 2007 at our mills in Rome, Georgia; Bogalusa, Louisiana; and Orange, Texas. In some cases where natural gas or fuel oil is used, our facilities possess a dual capacity enabling the use of either fuel as a source of energy.
The natural gas needed to run our natural gas fueled power boilers, package boilers, and turbines is acquired pursuant to a multiple vendor solicitation process that provides for the purchase of gas, primarily on a firm basis with a few operations on an interruptible basis, at rates favorable to spot market rates. It is likely that prices of natural gas will continue to fluctuate in the future. We hedge very little of our energy costs.
We have approximately 12,000 employees, of which approximately 5,000 are covered by collective bargaining agreements. These agreements generally run for a term of three to six years and have varying expiration dates. The following table summarizes certain information about our principal collective bargaining agreements:
We have additional collective bargaining agreements with employees at various other manufacturing facilities. These agreements each cover a relatively small number of employees and are negotiated on an individual basis at each such facility.
We consider our relations with our employees to be good.
We are committed to protecting the health and welfare of our employees, the public, and the environment and strive to maintain compliance with all state and federal environmental regulations in a manner that is also
cost effective. When we construct new facilities or modernize existing facilities, we generally use state of the art technology for air and water emissions. This forward-looking approach is intended to minimize the effect that changing regulations have on capital expenditures for environmental compliance.
Our operations are subject to federal, state, and local provisions regulating discharges into the environment and otherwise related to the protection of the environment. Compliance with these provisions, primarily the Federal Clean Air Act, Clean Water Act, Comprehensive Environmental Response, Compensation and Liability Act of 1980 (or CERCLA), as amended by the Superfund Amendments and Reauthorization Act of 1986 (or SARA), and Resource Conservation and Recovery Act (or RCRA), requires us to invest substantial funds to modify facilities to assure compliance with applicable environmental regulations. Capital expenditures directly related to environmental compliance totaled $12 million in 2007. This amount does not include capital expenditures for environmental control facilities made as a part of major mill modernizations and expansions or capital expenditures made for another purpose that have an indirect benefit on environmental compliance.
Future expenditures for environmental control facilities will depend on new laws and regulations and other changes in legal requirements and agency interpretations thereof, as well as technological advances. We expect the prominence of environmental regulation and compliance to continue for the foreseeable future. Given these uncertainties, we currently estimate that capital expenditures for environmental purposes, excluding expenditures related to the Maximum Achievable Control Technology (or MACT) programs and landfill closures discussed below, will be $9 million in 2008, $16 million in 2009, and $9 million in 2010. The estimated expenditures could be significantly higher if more stringent laws and regulations are implemented.
The U.S. Environmental Protection Agency (or EPA) has issued extensive regulations governing air and water emissions from the forest products industry. Compliance with these MACT regulations will be required as they become enacted.
On September 13, 2004, EPA published the Boiler MACT, regulations affecting industrial boilers and process heaters burning all fuel types with the exception of small gas-fired units. On July 30, 2007, the U.S. Court of Appeals for the D.C. Circuit remanded and vacated the Boiler MACT. In order to accurately gauge our liability regarding future related regulations, we continue to monitor and are actively engaged in the process the EPA is undertaking to develop new standards for industrial boilers and process heaters.
The Plywood and Composite Wood Panel (or PCWP) MACT standards were published July 30, 2004. Compliance with PCWP MACT was required by October 1, 2008. On June 19, 2007, the U.S. Court of Appeals for the D.C. Circuit rejected the PCWP MACT low risk option and the one-year compliance extension previously granted by EPA. As a result, the PCWP MACT compliance date reverted back to the October 1, 2007 deadline contained in the standards published in 2004. We have 12 building products facilities affected by the regulation. In a limited number of cases, one year extension requests were submitted to state regulatory agencies to allow for installation of appropriate PCWP MACT pollution control equipment. All of our extension requests were granted and we anticipate full compliance. Capital expenditures to comply with PCWP MACT are estimated at $6 million, of which we spent $2 million in 2007.
We use company-owned landfills for disposal of non-hazardous waste at three containerboard mills and two building products facilities. We also have two additional sites that we are remediating. Based on third-party cost estimates, we expect to spend, on an undiscounted basis, $27 million over the next 25 years to ensure proper closure of these landfills and remediation of these two additional sites for which we have established a reserve.
At one of these sites, we continue to work with environmental consultants and the Louisiana Department of Environmental Quality (DEQ) to remediate the source of contaminated water discovered in a manhole adjacent to our facility in Bogalusa, Louisiana. Phase II of the investigation process, which involved drilling more and deeper test wells in the affected area, is complete. Our investigation report, including a final remediation plan, was approved by the Louisiana DEQ in December 2007. We have incurred $2 million in costs to date and estimate that we will incur additional remediation expenses of about $10 million, for which we have established a reserve.
In addition to these capital expenditures, we spend a significant amount on ongoing maintenance costs to continue compliance with environmental regulations. We do not believe, however, that these capital expenditures or maintenance costs will have a material adverse effect on our earnings. In addition, expenditures for environmental compliance should not have a material effect on our competitive position because our competitors are also subject to these regulations.
Our facilities are periodically inspected by environmental authorities. We are required to file with these authorities periodic reports on the discharge of pollutants. Occasionally, one or more of these facilities may operate in violation of applicable pollution control standards, which could subject the company to fines or penalties. We believe that any fines or penalties that may be imposed as a result of these violations will not have a material adverse effect on our earnings or competitive position. No assurance can be given, however, that any fines levied in the future for any such violations will not be material.
Under CERCLA, liability for the cleanup of a Superfund site may be imposed on waste generators, site owners and operators, and others regardless of fault or the legality of the original waste disposal activity. While joint and several liability is authorized under CERCLA, as a practical matter, the cost of cleanup is generally allocated among the many waste generators. We are named as a potentially responsible party in five proceedings relating to the cleanup of hazardous waste sites under CERCLA and similar state laws, excluding sites for which our records disclose no involvement or for which our potential liability has been finally determined. In all but one of these sites, we are either designated as a de minimus potentially responsible party or believe our financial exposure is insignificant. We have conducted investigations of all five sites, and currently estimate that the remediation costs to be allocated to us are about $2 million and should not have a material effect on our earnings or competitive position. There can be no assurance that we will not be named as a potentially responsible party at additional Superfund sites in the future or that the costs associated with the remediation of those sites would not be material.
We operate in highly competitive industries. The commodity nature of our manufactured products gives us little control over market pricing or market demand for our products. The level of competition in a given product or market may be affected by economic factors, including interest rates, housing starts, home repair and remodeling activities, and the strength of the dollar, as well as other market factors including supply and demand for these products, geographic location, and the operating efficiencies of competitors. Our competitive position is influenced by varying factors depending on the characteristics of the products involved. The primary factors are product quality and performance, price, service, and product innovation.
The corrugated packaging industry is highly competitive with over 1,350 box plants in the United States. Our box plants accounted for approximately 12.5 percent of total industry shipments in 2007, making us the third largest producer of corrugated packaging in the United States. Although corrugated packaging is dominant in the national distribution process, our products also compete with various other packaging materials, including products made of paper, plastics, wood, and metals.
In building products markets, we compete with many companies that are substantially larger and have greater resources in the manufacturing of building products.
The names, ages, and titles of our executive officers are:
Doyle R. Simons became Chairman of the Board and Chief Executive Officer on December 29, 2007. He was previously named Executive Vice President in February 2005 following his service as Chief Administrative Officer since November 2003. Since joining the Company in 1992, Mr. Simons has served as Vice President, Administration from November 2000 to November 2003 and Director of Investor Relations from 1994 through 2000.
J. Patrick Maley III became President and Chief Operating Officer on December 29, 2007. He was previously named Executive Vice President Paper in November 2004 following his appointment as Group Vice President in May 2003. Prior to joining the Company, Mr. Maley served in various capacities from 1992 to 2003 at International Paper.
Bart J. Doney became Group Vice President in February 2000. Mr. Doney has served as an officer of our corrugated packaging segment since 1990.
Jack C. Sweeny became Group Vice President in May 1996. Since November 1982, Mr. Sweeny has served in various capacities in our building products segment.
Dennis J. Vesci became Group Vice President in August 2005. Mr. Vesci has served as an officer of our corrugated packaging segment since 1998.
Grant F. Adamson became Chief Governance Officer in May 2006. Mr. Adamson joined the Company in 1991 and has served in various capacities including Assistant General Counsel.
J. Bradley Johnston became Chief Administrative Officer in February 2005. Prior to that, Mr. Johnston served as General Counsel from August 2002 through May 2006 and in various capacities in our former financial services segment since 1993.
Randall D. Levy became Chief Financial Officer in May 1999. Mr. Levy joined the Company in 1989 serving in various capacities in our former financial services segment before being named Chief Financial Officer.
Scott Smith became Chief Information Officer in February 2000. Prior to that, Mr. Smith served in various capacities within our former financial services segment since 1988.
Leslie K. ONeal was named Vice President in August 2002 and became Secretary in February 2000 after serving as Assistant Secretary since 1995. Ms. ONeal also serves as Assistant General Counsel, a position she has held since 1985.
Carolyn C. Sloan was named Vice President, Internal Audit, in August 2005. Ms. Sloan joined the Company in 2001 as Director, Internal Audit.
C. Morris Davis became General Counsel in May 2006. Mr. Davis joined Temple-Inland after 39 years with the law firm of McGinnis, Lochridge & Kilgore in Austin, where he served seven years as the firms managing partner.
Troy L. Hester was named Principal Accounting Officer in August 2006. Mr. Hester has been with Temple-Inland since 1999 and has served in various capacities including Controller-Financial Services, Vice President Accounting Center, and was named Corporate Controller in May 2006.
David W. Turpin has served as Treasurer since joining the Company in June 1991.
The Board of Directors annually elects officers to serve until their successors have been elected and have qualified or as otherwise provided in our Bylaws.
From our Internet website, http://www.templeinland.com, you may obtain additional information about us including:
We will also provide printed copies of any of these documents to any shareholder upon request. In addition, the materials we file with the SEC may be read and copied at the SECs Public Reference Room at 100 F Street, NE, Washington, DC 20549. Information about the operation of the Public Reference Room is available by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site (http://www.sec.gov) that contains reports, proxy and information statements, and other information that is filed electronically with the SEC.
The business segments in which we operate are highly competitive and 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. No single company is dominant in any of our industries.
Our corrugated packaging competitors include large, vertically-integrated paperboard and packaging products companies and numerous smaller companies. Because these products are globally traded commodities, the industries in which we compete are particularly sensitive to price fluctuations as well as other factors, including innovation, design, quality, and service, with varying emphasis on these factors depending on the product line. To the extent that one or more of our competitors become more successful with respect to any key competitive factor, our business could be materially adversely affected. Although corrugated packaging is dominant in the national distribution process, our products also compete with various other packaging materials, including products made of paper, plastics, wood, and various types of metal.
In the building products markets, we compete with many companies that are substantially larger and have greater resources in the manufacturing of building products.
Virgin wood fiber and recycled fiber are the principal raw materials we use to manufacture corrugated packaging and certain of our building products. We purchase virgin wood fiber in highly competitive, price sensitive markets. The price for wood fiber has historically fluctuated on a cyclical basis and has often depended on a variety of factors over which we have no control, including environmental and conservation regulations, natural disasters, the price and level of imported timber and the continuation of any applicable tariffs, and weather. In addition, the increase in demand for old corrugated containers, especially from China, may cause a significant increase in the cost of recycled fiber used in the manufacture of recycled containerboard and related products. Such costs are likely to continue to fluctuate. While we have not experienced any significant difficulty in obtaining virgin wood fiber and recycled fiber in economic proximity to our facilities, this may not continue to be the case for any or all of our facilities.
Our profitability is also sensitive to changes in the prices of energy and transportation. While we have attempted to contain energy costs through internal generation and in some instances the use of by-products from our manufacturing processes as fuel, no assurance can be given that such efforts will be successful in the future or that energy prices will not rise to levels that would have a material adverse effect on our results of operations. We hedge very little of our energy needs.
The corrugated packaging and building products industries are cyclical in nature and experience periods of overcapacity.
The operating results of our corrugated packaging and building products segments reflect each such industrys general cyclical pattern. While the cycles of each industry do not historically coincide, demand and prices in each tend to drop substantially in an economic downturn. The building products industry is further influenced by the residential construction and remodeling markets. Further, each industry periodically experiences substantial overcapacity. Both industries are capital intensive, which leads to high fixed costs and generally results in continued production as long as prices are sufficient to cover marginal costs. These conditions have contributed to substantial price competition and volatility in these industries, even when demand is strong. Any increased production by our competitors could depress prices for our products. From time to time, we have closed certain of our facilities or have taken downtime based on prevailing market demand for our products and may continue to do so, reducing our total production levels. Certain of our competitors have also temporarily closed or reduced production at their facilities, but can reopen and/or increase production capacity at any time, which could exacerbate the overcapacity in these industries and depress prices.
Our manufacturing activities are subject to environmental regulations and liabilities that could have a negative effect on our operating results.
Our manufacturing operations are subject to federal, state, and local provisions regulating the discharge of materials into the environment and otherwise related to the protection of the environment. Compliance with these provisions has required us to invest substantial funds to modify facilities to ensure compliance with applicable environmental regulations. In other sections of this Annual Report on Form 10-K, we provide
certain estimates of expenditures we expect to make for environmental compliance in the next few years. However, we could incur additional significant expenditures due to changes in law or the discovery of new information, and such expenditures could have a material adverse effect on our financial condition, cash flows, and results of operations.
Downward changes in demand for housing in the market regions where we operate could decrease profitability in our building products segment.
The residential homebuilding industry is sensitive to changes in economic conditions, including interest rates and availability of financing. Adverse changes in these conditions generally, or in the market regions where we operate, could decrease demand for new homes in these areas. Decline in housing demand could have a negative effect on the pricing and demand for many of our building products, particularly lumber and gypsum wallboard, which could result in a decrease in our revenues and earnings.
If certain internal restructuring transactions and the distributions of Forestar and Guaranty are determined to be taxable for U.S. federal income tax purposes, we and our stockholders that are subject to U.S. federal income tax could incur significant U.S. federal income tax liabilities.
We entered into certain internal restructuring transactions in preparation for the spin-offs of Forestar and Guaranty. These transactions are complex and could cause us to incur significant tax liabilities. We received a private letter ruling from the IRS and opinions of tax counsel regarding the tax-free nature of these transactions and the distributions. The ruling and opinions rely on certain facts, assumptions, representations, and undertakings, from us regarding the past and future conduct of our businesses and other matters. If any of these are incorrect or not otherwise satisfied, then we and our stockholders may not be able to rely on the ruling or opinions and could be subject to significant tax liabilities. Notwithstanding the ruling and opinions, the IRS could determine on audit that the distributions or the internal restructuring transactions should be treated as taxable transactions if it determines that any of these facts, assumptions, representations, or undertakings are not correct or have been violated, or if the distributions should become taxable for other reasons, including as a result of significant changes in stock ownership after the distribution.
If the sale of our strategic timberland did not qualify for installment method reporting for U.S. federal income tax purposes, we could incur significant U.S. federal income tax liabilities the payment of which we believe to be deferred.
We sold our strategic timberland in a manner intended for U.S. federal income tax purposes to defer recognition of a substantial portion of the gain on the sale. Under the installment method, we will not be required to pay U.S. federal income taxes on the deferred gain until we are required to recognize the gain. We received opinions of tax counsel regarding the timberland sale and the deferred gain. The opinions rely on certain facts, assumptions, representations, and undertakings from us regarding the past and future conduct of our businesses and other matters. If any of these are incorrect or not otherwise satisfied, then we may not be able to rely on the opinions. Notwithstanding the opinions, the IRS could determine on audit that the gain does not qualify for deferral if it determines that any of these facts, assumptions, representations, or undertakings are not correct or have been violated or that the transaction otherwise does not qualify for the installment method.
We have interest rate risk in connection with our financial assets and nonrecourse financial liabilities of special purpose entities.
In October 2007, we received $2.38 billion in notes due in 2027 from the sale of our timberland, which we later contributed to two wholly-owned, bankruptcy-remote special purpose entities. In December 2007, the special purpose entities pledged the notes as collateral for $2.14 billion nonrecourse loans payable in 2027. Both the notes and the borrowings require quarterly interest payments based on variable interest rates that reset quarterly. Because of the differences in references rates, margins, and reset dates, there could be periods in which the interest paid on the nonrecourse financial liabilities is significantly more than the interested received on the financial assets.
We own and operate manufacturing facilities throughout the United States, four converting plants in Mexico, and one in Puerto Rico. We believe our manufacturing facilities are suitable for their purposes and adequate for our business. Additional information about selected facilities by business segment follows:
Additionally, we own a graphics resource center in Indianapolis, Indiana, that has a 100 preprint press. We lease 37 warehouses located throughout much of the United States.
We occupy approximately 190,000 square feet of leased office space in Austin, Texas. We own and occupy a 150,000 square feet office building in Diboll, Texas.
At year-end 2007, property and equipment having a net book value of $2 million were subject to liens in connection with $14 million of debt.
We are involved in various legal proceedings that arise from time to time in the ordinary course of doing business. We believe that adequate reserves have been established for any probable losses and that the outcome of any of these proceedings should not have a material adverse effect on our financial position or long-term results of operations or cash flows. It is possible, however, that charges related to these matters could be significant to results of operations or cash flows in any single accounting period. A summary of our more significant legal matters is set forth below.
On May 14, 1999, we and eight other linerboard manufacturers were named as defendants in a consolidated class action complaint that alleged a civil violation of Section 1 of the Sherman Act. In addition, complaints containing allegations similar to those in the class action were filed by certain opt-out plaintiffs. Over the last several years, we have paid a total of $13 million to settle the class action and a majority of the opt-out claims. In December 2007, we agreed to participate in binding arbitration in an effort to resolve most of the remaining claims. As a result of the arbitration, we paid $48 million on the claims submitted to arbitration and to settle all remaining opt-out claims in the federal litigation.
One related Kansas state court claim for approximately $26 million in statutory damages, which could be trebled under applicable state law, is still pending against us.
On October 15, 2003, a release of nitrogen dioxide and nitrogen oxide took place at our linerboard mill in Bogalusa, Louisiana. The mill followed appropriate protocols for handling this type of event, notifying the Louisiana Department of Environmental Quality, the U.S. Environmental Protection Agency, and local law enforcement officials. The federal and state environmental agencies have analyzed the reports we prepared and have not indicated that they will take any action against us.
To date, we have been served with 11 lawsuits seeking damages for various personal injuries allegedly caused by either exposure to the released gas or fears of exposure. These 11 lawsuits have been consolidated under Louisiana state rules for purpose of discovery and are set for trial in third quarter 2008. We are vigorously defending against these allegations.
We are a defendant in various lawsuits involving alleged workplace exposure to asbestos. These cases involve exposure to asbestos in premises owned or operated by us. We do not manufacture any products that contain asbestos and all our cases in this area are limited to workplace exposure claims. Historically, our aggregate annual settlements related to asbestos claims have been approximately $1 million. The number of claims has remained relatively constant in the past few years despite the fact that the majority of the claims relate to a facility we sold at the end of 1999.
We are also defending two cases in California state court alleging violations of that states on-duty meal break laws. In 2007, we settled three additional meal break cases.
We did not submit any matter to a vote of our shareholders in fourth quarter 2007.
Our Common Stock is traded on the New York Stock Exchange. The high and low sales prices for our Common Stock and dividends paid in each fiscal quarter in the two most recent fiscal years were:
Our stock transfer records indicated that as of February 22, 2008, there were approximately 4,750 holders of record of our Common Stock.
As indicated above, we paid quarterly dividends during each of the two most recent years in the amounts shown. In addition to our regular quarterly dividend, we paid a special dividend of $10.25 per share in December 2007 as part of our transformation plan. On February 1, 2008, the Board of Directors declared a quarterly dividend on our Common Stock of $0.10 per share payable on March 14, 2008, to shareholders of record on February 29, 2008. The Board periodically reviews the dividend policy, and the declaration of dividends will necessarily depend upon our earnings and financial requirements and other factors within the discretion of the Board.
We composed an index of our peers consisting of AbitibiBowater Inc., Caraustar Industries, Inc., Domtar Corporation, International Paper Company, MeadWestvaco Corporation, Packaging Corporation of America, Smurfit-Stone Container Corporation, and Weyerhaeuser Corporation (Peer Index). During the five preceding years, our cumulative total stockholder return compared to the Standard & Poors 500 Stock Index and to the Peer Index was as shown in the following table:
Assumes $100 invested on the last trading day in fiscal year 2002
*Total return assumes reinvestment of dividends
See Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters for disclosure regarding securities authorized for issuance under equity compensation plans.
Managements Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements within the meaning of the federal securities laws. These forward-looking statements are identified by their use of terms and phrases such as believe, anticipate, could, estimate, likely, intend, may, plan, expect, and similar expressions, including references to assumptions. These statements reflect managements current views with respect to future events and are subject to risk and uncertainties. We note that a variety of factors and uncertainties could cause our actual results to differ significantly from the results discussed in the forward-looking statements. Factors and uncertainties that might cause such differences include, but are not limited to:
Our actual results, performance, or achievement probably will differ from those expressed in, or implied by, these forward-looking statements, and accordingly, we can give no assurances that any of the events anticipated by the forward-looking statements will transpire or occur, or if any of them do so, what impact they will have on our results of operations or financial condition. In view of these uncertainties, you are cautioned not to place undue reliance on these forward-looking statements. Except as required by law, we expressly disclaim any obligation to publicly revise any forward-looking statements contained in this report to reflect the occurrence of events after the date of this report.
Return on investment (ROI) is an important internal measure for us because it is a key component of our evaluation of overall performance and the performance of our business segments. Studies have shown that
there is a direct correlation between shareholder value and ROI and that shareholder value is created when ROI exceeds the cost of capital. ROI allows us to evaluate our performance on a consistent basis as the amount we earn relative to the amount invested in our business segments. A significant portion of senior managements compensation is based on achieving ROI targets.
In evaluating overall performance, we define ROI as total segment operating income, less general and administrative expenses and share-based compensation not allocated to segments; divided by total assets, less certain assets and certain current liabilities. As a result of our transformation in 2007, we modified the return portion of this calculation. The ROI for all prior years has been recalculated to reflect this change. We do not believe there is a comparable GAAP financial measure to our definition of ROI. The reconciliation of our ROI calculation to amounts reported under GAAP is included in a later section of Managements Discussion and Analysis of Financial Condition and Results of Operations.
Despite its importance to us, ROI is a non-GAAP financial measure that has no standardized definition and as a result may not be comparable with other companies measures using the same or similar terms. Also there may be limits in the usefulness of ROI to investors. As a result, we encourage you to read our consolidated financial statements in their entirety and not to rely on any single financial measure.
In preparing our financial statements, we follow generally accepted accounting principles, which in many cases require us to make assumptions, estimates, and judgments that affect the amounts reported. Our significant accounting policies are included in Note 1 to the Consolidated Financial Statements. Many of these principles are relatively straightforward. There are, however, a few accounting policies that are critical because they are important in determining our financial condition and results, and they are difficult for us to apply. They include asset impairments, contingency reserves, and pension accounting. The difficulty in applying these policies arises from the assumptions, estimates and judgments that we have to make currently about matters that are inherently uncertain, such as future economic conditions, operating results and valuations, as well as our intentions. As the difficulty increases, the level of precision decreases, meaning actual results can, and probably will, be different from those currently estimated. We base our assumptions, estimates, and judgments on a combination of historical experiences and other factors that we believe are reasonable. We have discussed the selection and disclosure of these critical accounting estimates with our Audit Committee.
New Accounting Pronouncements and Change in Measurement Date of our Defined Benefit and Postretirement Plans
In the last three years, we adopted a number of new accounting pronouncements, including in 2007, FASB Staff Position No. AUG AIR-1, Accounting for Planned Major Maintenance Activities; FIN 48, Accounting for Uncertainty in Income Taxes; and a fiscal year-end measurement date for valuing plan assets and obligations for our defined benefit and postretirement benefit plans as required by SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans. In addition, there are four new accounting pronouncements that we will be required to adopt in 2008 and 2009, none of which we expect to have a significant effect on our financial position, results of operations or cash flows. Please read Note 1 to the Consolidated Financial Statements for additional information.
On December 28, 2007, we completed our transformation plan that was approved by our board of directors in February 2007. A summary of the significant elements of the transformation plan follows:
The transformation plan significantly changed our capital structure and operations. At year-end 2007, Temple-Inland is a manufacturing company focused on corrugated packaging and building products.
Results of Operations for the Years 2007, 2006, and 2005
Our two key objectives are:
We will accomplish our key objectives through execution of our strategic initiatives. Our key strategic initiatives in corrugated packaging are:
Our key strategic initiatives in building products are:
In 2007, consistent with our key strategic initiatives:
A summary of our consolidated results from continuing operations follows:
In 2007, significant items affecting income from continuing operations included:
In 2006, significant items affecting income from continuing operations included:
In 2005, significant items affecting income from continuing operations included:
As a result of the transformation plan, at year-end 2007, we have two ongoing business segments: corrugated packaging and building products. Timber and timberland, which managed our timber resources, is no longer an active segment as a result of the sale of our timberlands in fourth quarter 2007. Our financial information has been reclassified to reflect the spun-off entities, Forestar and Guaranty, as discontinued operations.
Our operations are affected to varying degrees by supply and demand factors and economic conditions including changes in 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.
We manufacture linerboard and corrugating medium that we convert into corrugated packaging and sell in the open market. Our corrugated packaging segment revenues are principally derived from the sale of corrugated packaging products and, to a lesser degree, from the sale of linerboard in the domestic and export markets. We also own a 50 percent interest in Premier Boxboard Limited LLC, a joint venture that produces light-weight gypsum facing paper and corrugating medium at a mill in Newport, Indiana.
A summary of our corrugated packaging results follows:
Hurricanes Katrina and Rita adversely affected 2005 segment operating results by about $10 million principally related to mill production downtime and re-start expenses at our Bogalusa, Louisiana and Orange, Texas linerboard mills.
Fluctuations in product pricing, which includes freight and is net of discounts, and shipments are set forth below:
In 2007, corrugated packaging prices and linerboard prices moved higher as a result of price increases implemented in 2006 and 2007. In 2006, corrugated packaging and linerboard prices moved higher reflecting price increases implemented in late 2005 and in 2006.
Linerboard shipments to third parties were slightly lower than in 2006. Linerboard shipments and sales to third parties increased in 2006 due to increased mill production.
Costs and expenses were up one percent in 2007 compared with 2006 and up one percent in 2006 compared with 2005. In 2007, higher raw material costs were partially offset by lower pension and postretirement costs, $8 million in business interruption and other insurance proceeds primarily related to an equipment outage and other operational issues at our mills that occurred in 2006, and cost reductions attributable to the sale of Performance Sheets. Increased mill reliability and efficiency resulted in lower maintenance costs and improved raw material yield and energy usage. In 2006, higher wood fiber and freight costs were partially offset by lower recycled fiber, energy, and healthcare costs.
Fluctuations in our significant cost and expense components included:
The costs of our wood and recycled fiber, energy, and freight fluctuate based on the market prices we pay for these commodities. It is likely that these costs will continue to fluctuate in 2008. The decrease in depreciation was principally due to the continued use of fully depreciated assets and the sale of Performance Sheets in August 2006.
Information about our converting facilities and mills follows:
We manufacture lumber, gypsum wallboard, particleboard, medium density fiberboard (MDF), and fiberboard. Our building products segment revenues are principally derived from sales of these products. We also own a 50 percent interest in Del-Tin Fiber LLC, a joint venture that produces MDF at a facility in El Dorado, Arkansas.
In 2006, we purchased our partners 50 percent interest in Standard Gypsum LP, a joint venture that produced gypsum wallboard. Results of operations have been consolidated since the date of purchase.
A summary of our building products results follows:
Fluctuation in product pricing, which includes freight and is net of discounts, and shipments are set forth below:
Demand for most products was down due to challenging market conditions in the housing industry. We expect this trend to continue in 2008.
Segment operating income also includes our share of income from our gypsum wallboard joint venture (in 2005) and MDF joint venture of $1 million in 2007, $3 million in 2006, and $28 million in 2005. The operating results from the joint ventures generally fluctuate in relation to the price and shipment changes noted above.
Costs and expenses were down 11 percent in 2007 compared with 2006, and up 16 percent in 2006 compared with 2005. The lower costs in 2007 were primarily driven by lower volumes. The increase in cost in 2006 is primarily attributable to the acquisition of Standard Gypsum LP in January 2006, partially offset by lower wood fiber costs and cost reductions attributable to the sale of our Pembroke MDF facility in June 2005.
Fluctuations in our significant cost and expense components included:
The cost of our fiber, energy, freight, and chemicals fluctuates based on the market prices we pay for these commodities. It is likely that these costs will continue to fluctuate in 2008.
Information about our converting and manufacturing facilities follows:
Markets for our building products continue to be challenging. Production in our converting operations is being reduced to match demand for our products. In December 2007, we permanently ceased production at our Mt. Jewett particleboard manufacturing plant.
Timber and timberland, which managed our timber resources, is no longer an active segment as a result of the sale of timber and timberland in October 2007.
A summary of our timber and timberland results follows:
In 2005, we sold about 7,000 acres of timber and timberland to a joint venture in which our former real estate segment owned a 50 percent interest and an unrelated public company owned the other 50 percent. This acreage was sold pursuant to the terms of a long-standing option agreement, which was about to expire. The joint venture intended to hold the land for future development and sale. We recognized about half of the $10 million gain in income in 2005 and recognized the remainder in 2007 when we spun-off our real estate segment. As a result of Hurricane Rita, we recorded a $7 million loss due to damage to our timberland in 2005, which is not included in segment operating income.
Information about our timber harvest follows:
Unallocated income and expenses represent expenses managed on a company-wide basis and include corporate general and administrative expense, share-based compensation, other operating and non-operating income (expense), and interest income and expense.
The decrease in general and administrative expense in 2007 was principally due to a decrease in incentive compensation. Incentive compensation fluctuates based on changes in ROI.
Our share-based compensation fluctuates because a significant portion of our share-based awards are cash based and are affected by changes in the market price of our common stock. Based on our current expectations, it is likely that share-based compensation expense for 2008 will be in the range of $20 million to $30 million.
Other operating income (expense) not allocated to business segments consists of:
We continue our efforts to enhance return on investment by lowering costs, improving operating efficiencies, and increasing asset utilization. As a result, we continue to review operations that are unable to meet return objectives and determine appropriate courses of action, including possibly consolidating and closing facilities and selling under-performing assets. In 2007, we permanently ceased production at our particleboard plant in Mt. Jewett, Pennsylvania and recognized a $64 million charge, primarily related to the present value of remaining lease payments under our long-term operating lease of the plant and impairment of the related equipment.
Also, in December 2007, we resolved most of the remaining claims regarding an alleged violation of Section 1 of the Sherman Act and recognized a charge of $46 million. We are also defending two cases in California state court alleging violations of that states on-duty meal break laws. In 2007, we settled three additional meal break cases.
In 2006, the U.S. and Canada entered into the Softwood Lumber Agreement, which provided for the refund to domestic lumber producers of a portion of duties previously collected by the U.S. government. Our portion of this refund was $42 million.
Other non-operating income (expense) includes $40 million of expenses associated with the early repayment of debt in 2007 and a gain of $89 million related to the settlement of tax litigation in 2006.
Net interest income on financial assets and nonrecourse financial liabilities of special purpose entities relates to interest income on the $2.38 billion of notes received from the sale of our timberland in October 2007 and interest expense on the $2.14 billion of borrowings secured by a pledge of the notes receivable in December 2007. The notes receivable were contributed to and the borrowings were made by two wholly-owned, bankruptcy-remote special purpose entities, which we consolidate for financial reporting purposes. The borrowings are nonrecourse to us.
The change in interest expense in 2007 was due to lower average levels of debt outstanding compared with 2006. At year-end 2007, we had $0.9 billion of debt with fixed interest rates that averaged 7.08 percent. This compares with $1.4 billion of debt with fixed interest rates that averaged 7.02 percent and $0.2 billion of debt with variable interest rates that averaged 5.88 percent at year-end 2006.
Our effective tax rate, which is income tax expense (benefit) as a percentage of income from continuing operations before taxes, was 39 percent in 2007, 26 percent in 2006, and (64) percent in 2005. These rates reflect in 2007, non-deductible transformation related expenses, one-time tax benefit of $3 million related to changes to the State of Texas margin tax and a $4 million benefit from the resolution of state tax matters; in 2006, one-time benefits resulting from settlement of tax litigation with the U.S. Government and the new State of Texas margin tax; and in 2005, a one-time benefit related to the sale of a foreign subsidiary.
We anticipate that our effective tax rate in 2008 will approximate 40 percent.
On December 28, 2007, we spun off to our shareholders in tax free distributions, our real estate segment and financial services segment, which included certain real estate and minerals activities in our timber and timberland segment.
As a result, we report the results of operations of these segments as discontinued operations. Expenses allocated to these discontinued operations included interest expense of $7 million in 2007, $4 million in 2006, and none in 2005 and share-based compensation expense of $7 million in 2007, $8 million in 2006, and $5 million in 2005.
In addition, on August 31, 2007 we sold our previously acquired chemical operations. We received cash proceeds of $1 million and recognized a pre-tax loss of $6 million on the sale.
A summary of earnings from our discontinued operations follows:
Average shares outstanding and average diluted shares outstanding decreased in 2007, 2006, and 2005 due to the effects of share repurchases in 2006 and 2005.
Capital Resources and Liquidity
Sources and Uses of Cash
Cash from operations was $296 million in 2007, $780 million in 2006, and $508 million in 2005.
We operate in cyclical industries and our operating cash flows vary accordingly. Our principal operating cash requirements are for compensation, wood and recycled fiber, energy, interest, and taxes. We experienced improved pricing and shipments for most of our products in 2006 and 2005, but experienced deterioration in pricing and volume for our building products in 2007 due to challenging conditions in the housing market. Working capital is subject to cyclical operating needs, the timing of collection of receivables and the payment of payables and expenses and, to a lesser extent, to seasonal fluctuations in our operations.
We issued 1,009,246 net shares of common stock in 2007; 1,736,335 net shares of common stock in 2006; and 1,833,688 net shares in 2005 to employees exercising options. In addition, in 2005, we issued 10,875,739 shares of our common stock and received $345 million in cash in conjunction with the final settlement of our Upper DECS(sm) equity purchase contracts.
We paid cash dividends to shareholders of $11.37 per share in 2007 including a special dividend of $10.25 per share, $1.00 per share in 2006, and $0.90 per share in 2005. On February 1, 2008, our Board of Directors declared a regular quarterly dividend of $0.10 per share payable on March 14, 2008.
From February 2005 through year-end 2007, our Board of Directors approved repurchase programs aggregating 29.0 million shares. As of year-end 2007, we had repurchased 22.4 million shares under these programs. In 2007, we initiated no share purchases, but we settled $24 million of share purchases that were initiated in fourth quarter 2006. As of year-end 2007, there are 6.6 million shares remaining under current repurchase authorizations.
Capital expenditures and timberland reforestation were 111 percent of depreciation and amortization in 2007, 91 percent in 2006, and 101 percent in 2005. Most of the 2007 expenditures relate to initiatives to increase reliability and efficiency at our linerboard mills and increase asset utilization in our converting facilities. Capital expenditures are expected to approximate $195 million in 2008, or about 97 percent of expected 2008 depreciation and amortization.
In 2007, we reduced our outstanding debt by $742 million, principally with proceeds from the transactions related to our transformation plan. In 2006, we used $150 million of our credit facilities to fund
the purchase of the remaining 50 percent interest in Standard Gypsum LP. Following the purchase, we paid off $56 million of the ventures long-term debt, of which $28 million was related to the purchased interest. In 2005, market conditions provided the opportunity to lengthen our debt maturity profile in a cost effective manner. As a result, we issued $250 million of debt due in 2016 and $250 million of debt due in 2018. The proceeds were used to refinance debt due in 2006 and 2007.
Liquidity and Contractual Obligations
At year-end 2007 our contractual obligations consist of:
Our sources of short-term funding are our operating cash flows and borrowings under our credit agreements and accounts receivable securitization facility. Our contractual obligations due in 2008 will likely be repaid from our operating cash flow or from our unused borrowing capacity. At year-end 2007, we had $1.067 billion in unused borrowing capacity under our committed credit agreements and accounts receivable securitization facility:
Our committed credit agreements include a $750 million revolving credit facility that expires in 2011. The remainder of the committed agreements expire between 2008 and 2010.
Our accounts receivable securitization facility expires in 2010. Under this facility, a wholly-owned, bankruptcy-remote subsidiary purchases, on an on-going basis, substantially all of our trade receivables. As we need funds, the subsidiary draws under its revolving credit agreement, pledges the trade receivables as collateral, and remits the proceeds to us. In the event of liquidation of the subsidiary, its creditors would be entitled to satisfy their claims from the subsidiarys pledged receivables prior to distributions back to us. We included this subsidiary in our consolidated financial statements.
Our debt agreements, accounts receivable securitization facility, and credit agreements contain terms, conditions, and financial covenants customary for such agreements including minimum levels of interest coverage and limitations on leverage. At year-end 2007, we had complied with the terms, conditions, and financial covenants of these agreements. None of our credit agreements or the accounts receivable securitization facility are restricted as to availability based on the ratings of our long-term debt. Under the terms of our Senior Notes due 2016 and Senior Notes due 2018, the interest rate on the notes automatically adjusts if our long-term debt rating is decreased below investment grade by Moodys Investor Services, Inc. (Moodys) or Standard and Poors Rating Services, a division of McGraw-Hill, Inc. (S&P). The interest rate on these notes was increased 25 basis points during third quarter 2007 following a change in our long-term debt rating by Moodys. In addition, as required by our operating lease agreements for our particleboard and MDF facilities in Mt. Jewett, Pennsylvania, we provided an $11 million letter of credit to support a portion of our obligations due to this change in our long-term debt rating. Our long-term debt is currently rated BBB- by S&P and Ba1 by Moodys. At year-end 2007, property and equipment having a book value of $2 million were subject to liens in connection with $14 million of debt.
Operating leases represent pre-tax obligations and include $146 million for the lease of particleboard and MDF facilities in Mt. Jewett, Pennsylvania, which expire in 2019. The rest of our operating lease obligations are for facilities and equipment. As a result of an impairment charge in 2007, $60 million present value of our operating lease obligations is included on our balance sheet, of which $3 million is in current liabilities and $57 million is in other long-term liabilities.
In 2007, we received $2.38 billion in notes from the sale of timberland, which we contributed to two wholly-owned, bankruptcy-remote special purpose entities. The notes are secured by irrevocable letters of credit and are due in 2027. The special purpose entities pledged the notes and irrevocable letters of credit to secure $2.14 billion nonrecourse loans payable in 2027. In the event of liquidation of the special purpose entities, these creditors would be entitled to satisfy their claims from the pledged notes and irrevocable letters of credit prior to distributions back to us. We include these special purpose entities in our consolidated financial statements.
In the 1990s, we entered into two sale-lease back transactions of production facilities with municipalities. We entered into these transactions to mitigate property and similar taxes associated with these facilities. The municipalities purchased these facilities from us for $188 million, our carrying value, and we leased the facilities back from the municipalities under lease agreements, which expire in 2022 and 2025. Concurrently, we purchased $188 million of interest-bearing bonds issued by these municipalities. The bond terms are identical to the lease terms, are secured by payments under the capital lease obligations, and the municipalities are obligated only to the extent the underlying lease payments are made by us. The interest rate implicit in the leases is the same as the interest rate on the bonds. As a result, the present value of the capital lease obligations is $188 million, the same as the principal amount of the bonds. Since there is no legal right of offset, the $188 million of bonds are included in other assets and the $188 million present value of the capital lease obligations are included in other long-term liabilities. There is no net effect from these transactions as we are in substance both the obligor on, and the holder of, the bonds.
Purchase obligations are market priced obligations principally for pulpwood, timber, and gypsum used in our manufacturing and converting processes and for major committed capital expenditures.
We have other long-term liabilities, principally liabilities for pension and postretirement benefits, unrecognized tax benefits, and deferred income taxes that are not included in the table because they do not have scheduled maturities.
At year-end 2007, the liability for pension benefits was $119 million and the liability for postretirement benefits was $137 million. We expect our 2008 voluntary, discretionary contributions to our defined benefit pension plan to approximate 2008 service cost, which is estimated to be about $30 million. In addition, we have amended our supplemental defined benefit pension plan to allow for lump-sum settlements at the time of retirement. We offered a one-time window for our current retirees to take a lump-sum distribution in January 2008. We expect these lump-sum payments to aggregate $42 million in 2008. We also estimate that we will be required to pay in the range of $17 million to $20 million per year over the next five years to fund payments to participants of our supplemental defined benefit plan and retiree health care claims. Please read Pension, Postretirement Medical and Health Care Matters for additional information.
At year-end 2007, our net deferred income tax liability was $663 million, including $286 million of alternative minimum tax credits related to the 2007 sale of our timberland. We do not expect any significant changes in our deferred tax liability in 2008. We expect our cash tax rate in 2008 to be below 20 percent compared with 15 percent in 2007. The cash tax rate is impacted by utilization of our alternative minimum tax credits and deductions for 2008 payments associated with our 2007 transformation.
We have interest rate derivative instruments outstanding at year-end 2007. These interest rate instruments expire in 2008. They are non-exchange traded and are valued using either third-party resources or models. At year-end 2007, the aggregate fair value of our interest rate instruments was a $1 million liability.
From time to time, we enter into off-balance sheet arrangements to facilitate our operating activities. At year-end 2007, our off-balance sheet unfunded arrangements, excluding contractual interest payments, operating leases, and purchase and other obligations included in the table of contractual obligations, consisted of:
We participate in two joint ventures engaged in manufacturing and selling paper and building products. Our partner in each of these ventures is a publicly-held company unrelated to us. At year-end 2007, these ventures had $85 million in long-term debt and $6 million of debt included in current maturities, along with various letters of credit. We guaranteed $70 million of the joint ventures debt service obligations and letters of credit. Our joint venture partners also provided guarantees and letters of credit. Generally we would be called upon to fund the guarantees due to the lack of specific performance by the joint ventures, such as non-payment of debt.
Performance bonds and recourse obligations are primarily for workers compensation and general liability claims.
Our non-cash defined benefit pension expense was $35 million in 2007, $46 million in 2006, and $49 million in 2005. For the year 2008, we expect our non-cash defined benefit pension expense to be about $37 million. We also expect a one-time expense of $15 million related to lump sum settlements of supplemental benefits.
For accounting purposes, we measure the projected benefit obligation of our defined benefit plans and value the plan assets as of year-end 2007 to determine the funded status. The funded status is included on our balance sheet. At year-end 2007, the funded status of our defined benefit plans was a liability of $119 million compared with a liability of $231 million at year-end 2006. The change was principally due to an increase in the discount rate, a better than expected return on plan assets, and an increase in plan assets due in part to the $60 million of voluntary, discretionary contributions we made in 2007. Unrecognized actuarial losses, which
are included in accumulated other comprehensive income and principally represent the delayed recognition of changes in the assumed discount rate and differences between expected and actual returns, were $166 million at year-end 2007 and $253 million at year-end 2006. These losses will be recognized over the average remaining service period of our current employees, which is about nine years. We expect about $5 million of these losses will be recognized in 2008, compared with $14 million recognized in 2007.
We did not have any ERISA cash-funding requirement in 2007, and we expect our cash-funding requirement to be minimal in 2008. We made voluntary, discretionary contributions of $60 million to the defined benefit plan in 2007. We expect our 2008 voluntary, discretionary contributions to our defined benefit plan to approximate 2008 service cost, which is estimated to be about $30 million. Passage of the Pension Protection Act of 2006, which requires a minimum level of annual funding, is not expected to affect significantly our annual cash contributions.
The benefits payable from our defined benefit plan are a series of fixed monthly retirement payments. On an annual basis an actuarial assessment of the estimated amount and timing of these retirement payments is performed. The actuarial estimate is subject to variability due to changes in key assumptions regarding future wage inflation, participant mortality and other actuarial risks. Prior to the date of retirement, our obligation is to accumulate funds in our qualified plan sufficient to meet these related benefit payments. The weighted average timeframe of the retirement payments is generally in the 10-15 year range.
The benefit obligation, which is the present value of the estimated retirement payments, conceptually is very similar to the fair value of a portfolio of long-term bonds. The funded status of our benefit obligation that is matched by long-term bonds of similar duration should remain relatively unchanged even if long-term interest rates change.
In the last two months of 2007, we transitioned to a more matched position between our assets and liabilities in our qualified defined benefit plan. This action is expected to reduce the volatility of our defined benefit expense and our funding requirements. As a result, our expected long-term rate of return for 2008 expense is 6.875 percent compared with the 2007 rate of 8 percent. The lower expected long-term rate of return reflects the higher allocation of invested funds in fixed income securities that better match our defined benefit obligation.
For accounting purposes we measure the postretirement medical plans projected benefit obligation as of year-end 2007 to determine the funded status. At year-end 2007, the funded status of these plans was a liability of $137 million compared with $135 million at year-end 2006.
About 26 percent of our employees participated in a consumer driven health plan in 2007 compared with 29 percent in 2006. In 2007, the total cost of providing health benefits was about $88 million of which we incurred $57 million and our employees incurred $31 million. In 2006, the total cost of providing health benefits was about $97 million of which we incurred $67 million and our employees incurred $30 million.
Energy costs decreased $22 million in 2007, increased $8 million in 2006, and increased $43 million in 2005. The decrease in 2007 is primarily attributable to reduced production because of the decreased demand for our building products as a result of the declines in the housing industry. The increase in energy costs for 2006 is primarily attributable to the acquisition of Standard Gypsum LP in January 2006. Our energy costs fluctuate based on the market prices we pay. We hedge very little of our energy needs. It is likely that these costs will continue to fluctuate in 2008.
Inflationary increases in compensation and certain input costs such as fiber, energy and freight have had a negative impact on our operating results. However, we have managed to partially offset the impact of inflation through increased productivity. Our fixed assets are, and our timber and timberland were, carried at historical costs. If carried at current replacement costs, depreciation expense and the cost of timber cut or timberland sold would have been significantly higher than what we reported.
Our operations are subject to federal, state, and local provisions regulating discharges into the environment and otherwise related to the protection of the environment. Compliance with these provisions requires us to invest substantial funds to modify facilities to assure compliance with applicable environmental regulations. A more detailed discussion regarding our compliance with environmental regulation can be found in Business Environmental Regulation.
We are involved in various legal proceedings that arise from time to time in the ordinary course of doing business. In our opinion, the possibility of a material loss from any of these proceedings is considered to be remote, and we do not expect that the effect of these proceedings will be material to our financial position, results of operations, or cash flow. It is possible, however, that charges related to these matters could be significant to results of operations or cash flows in any one accounting period. A more detailed discussion regarding our most significant litigation matters can be found in Legal Proceedings.
Calculation of Non-GAAP Financial Measures
Statistical and Other Data
Revenues and unit sales, excluding joint venture operations, follows:
Our current level of interest rate risk is primarily due to our variable-rate, long-term debt and financial assets and nonrecourse financial liabilities of special purpose entities. 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 year-end 2007, with comparative year-end 2006 information. These estimates assume 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.
Interest rate changes impact earnings due to the resulting increase or decrease in the cost of our variable-rate, long-term debt. The interest rate sensitivity change from year-end 2006 is due to a decrease in variable-rate debt. Additionally, changes in interest rates will affect the value of our interest rate swap agreements (currently $50 million notional amount). We believe that any changes in the value of these agreements would not be significant.
We do not have significant exposure to foreign currency fluctuations on our financial instruments because most of these instruments are denominated in U.S. dollars.
From time to time we use commodity derivative instruments to mitigate our exposure to changes in product pricing and manufacturing costs. These instruments cover a small portion of our volume and range in duration from three months to three years. Considering the fair value of these instruments at year-end 2007, we believe the potential loss in fair value resulting from a hypothetical ten percent change in the underlying commodity prices would not be significant.
The management of Temple-Inland is responsible for establishing and maintaining adequate internal control over financial reporting. Management has designed our internal control over financial reporting to provide reasonable assurance that our published financial statements are fairly presented, in all material respects, in conformity with generally accepted accounting principles.
Management is required by paragraph (c) of Rule 13a-15 of the Securities Exchange Act of 1934, as amended, to assess the effectiveness of our internal control over financial reporting as of each year end. In making this assessment, management used the Internal Control Integrated Framework issued in July 1994 by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
Management conducted the required assessment of the effectiveness of our internal control over financial reporting as of year end. Based upon this assessment, management believes that our internal control over financial reporting is effective as of year-end 2007.
Ernst & Young LLP, the independent registered public accounting firm that audited our financial statements included in this Form 10-K, has also audited our internal control over financial reporting. Their attestation report follows this report of management.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We have audited Temple-Inland Incs internal control over financial reporting as of December 29, 2007 based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Temple-Inland Inc.s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting including in the accompanying Managements Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the effectiveness of the Companys internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Temple-Inland Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 29, 2007 based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Temple-Inland Inc. and subsidiaries as of December 29, 2007 and December 30, 2006 and the related consolidated statements of income, shareholders equity, and cash flows for each of the three years in the period ended December 29, 2007 and our report dated February 25, 2008 expressed an unqualified opinion thereon.
Ernst & Young LLP
February 25, 2008
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We have audited the accompanying consolidated balance sheets of Temple-Inland Inc. and subsidiaries as of December 29, 2007 and December 30, 2006, and the related consolidated statements of income, shareholders equity, and cash flows for each of the three years in the period ended December 29, 2007. These financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Temple-Inland Inc. and subsidiaries at December 29, 2007 and December 30, 2006, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 29, 2007, in conformity with U.S. generally accepted accounting principles.
As discussed in Note 1 to the Consolidated Financial Statements, in 2006, the Company changed its method of accounting for the funded status of defined pension and other postretirement benefit plans, and in 2007 the Company changed the measurement date for measuring the funded status of defined pension and other postretirement benefit plans. Additionally, during 2007 the Company changed its method of accounting for and disclosure of uncertainties associated with certain aspects of measurement and recognition of income taxes.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Temple-Inland Inc.s internal control over financial reporting as of December 29, 2007, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 25, 2008 expressed an unqualified opinion thereon.
Ernst & Young LLP
February 25, 2008
TEMPLE-INLAND INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
Please read the notes to consolidated financial statements.
TEMPLE-INLAND INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Please read the notes to consolidated financial statements.
TEMPLE-INLAND INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Please read the notes to consolidated financial statements.
TEMPLE-INLAND INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
Please read the notes to consolidated financial statements.
TEMPLE-INLAND INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On December 28, 2007, we completed our transformation plan that was approved by our board of directors in February 2007. A summary of the significant elements of the transformation plan follows:
The transformation plan significantly changed our capital structure and operations. At year-end 2007, Temple-Inland is a manufacturing company focused on corrugated packaging and building products.
Our consolidated financial statements include the accounts of Temple-Inland Inc., its subsidiaries and special purpose and variable interest entities of which we are the primary beneficiary. We account for our investment in other entities in which we have significant influence over operations and financial policies using the equity method.
We prepare our financial statements in accordance with generally accepted accounting principles, which require us to make estimates and assumptions about future events. Actual results can, and probably will, differ from those we currently estimate. We eliminate all material intercompany accounts and transactions.
Our fiscal year ends on the Saturday closest to December 31, which from time to time means that a fiscal year will include 53 weeks instead of 52 weeks. All of the periods presented had 52 weeks. Fiscal year 2007 ended on December 29, 2007, fiscal ye