UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
---------------
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
Commission File Number 333-18723
MAXXAM GROUP HOLDINGS INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 76-0518669
(State or other jurisdiction (I.R.S. Employer
of incorporation or Identification Number)
organization)
5847 SAN FELIPE, SUITE 2600 77057
HOUSTON, TEXAS (Zip Code)
(Address of Principal
Executive Offices)
Registrant's telephone number, including area code: (713) 975-7600
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 / /
Number of shares of common stock outstanding at November 13, 1998: 1,000
Registrant meets the conditions set forth in General Instruction H(1)(a)
and (b) of Form 10-Q and is therefore filing this Form with the reduced
disclosure format.
---------------
<PAGE>
TABLE OF CONTENTS
PAGE
PART I. - FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheet at September 30, 1998
and December 31, 1997 3
Consolidated Statement of Operations for the three and
nine months ended September 30, 1998 and 1997 4
Consolidated Statement of Cash Flows for the nine months
ended September 30, 1998 and 1997 5
Condensed Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 13
PART II. - OTHER INFORMATION
Item 1. Legal Proceedings 18
Item 6. Exhibits and Reports on Form 8-K 20
Signatures S-1
Appendix A - Glossary of Defined Terms A-1
<PAGE>
MAXXAM GROUP HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS OF DOLLARS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------ ------------
(UNAUDITED)
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 125,965 $ 91,753
Marketable securities 19,052 51,324
Receivables:
Trade 11,840 19,269
Other 6,647 6,667
Inventories 53,865 61,355
Prepaid expenses and other current assets 8,622 13,080
------------ ------------
Total current assets 225,991 243,448
Timber and timberlands, net of accumulated
depletion of $176,975 and $169,167,
respectively 296,300 299,153
Property, plant and equipment, net of accumulated
depreciation of $83,492 and $76,420,
respectively 103,532 103,388
Note receivable from MAXXAM Inc. 132,798 125,000
Investment in Kaiser Aluminum Corporation 55,296 41,402
Deferred financing costs, net 26,525 25,739
Deferred income taxes 88,427 58,767
Restricted cash 23,743 28,434
Other assets 6,163 4,209
------------ ------------
$ 958,775 $ 929,540
============ ============
LIABILITIES AND STOCKHOLDER'S DEFICIT
Current liabilities:
Accounts payable $ 5,545 $ 3,535
Accrued interest 15,067 30,838
Accrued compensation and related benefits 9,744 12,544
Deferred income taxes 10,784 10,882
Other accrued liabilities 3,945 1,631
Long-term debt, current maturities 8,270 19,429
------------ ------------
Total current liabilities 53,355 78,859
Long-term debt, less current maturities 989,488 892,896
Other noncurrent liabilities 28,487 28,976
------------ ------------
Total liabilities 1,071,330 1,000,731
------------ ------------
Contingencies
Stockholder's deficit:
Common stock, $1.00 par value; 3,000 shares
authorized; 1,000 shares issued 1 1
Additional capital 123,167 123,167
Accumulated deficit (235,723) (194,359)
------------ ------------
Total stockholder's deficit (112,555) (71,191)
------------ ------------
$ 958,775 $ 929,540
============ ============
<FN>
The accompanying notes are an integral part of these financial statements.
</TABLE>
<PAGE>
MAXXAM GROUP HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- --------------------------
1998 1997 1998 1997
------------ ------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C>
Net sales:
Lumber and logs $ 58,795 $ 65,720 $ 165,086 $ 196,125
Other 7,037 7,091 16,172 20,349
------------ ------------ ------------ ------------
65,832 72,811 181,258 216,474
------------ ------------ ------------ ------------
Operating expenses:
Cost of goods sold 43,700 39,855 116,290 119,957
Selling, general and
administrative expenses 3,391 3,690 10,089 10,938
Depletion and depreciation 5,956 6,144 17,307 19,351
------------ ------------ ------------ ------------
53,047 49,689 143,686 150,246
------------ ------------ ------------ ------------
Operating income 12,785 23,122 37,572 66,228
Other income (expense):
Equity in earnings of Kaiser 3,764 1,973 13,894 1,973
Investment, interest and
other income 2,159 6,922 16,262 19,029
Interest expense (23,245) (23,821) (70,895) (71,164)
------------ ------------ ------------ ------------
Income (loss) before income taxes (4,537) 8,196 (3,167) 16,066
Credit (provision) for income
taxes 2,888 (2,376) 6,052 (5,534)
------------ ------------ ------------ ------------
Income (loss) before extraordinary
item (1,649) 5,820 2,885 10,532
Extraordinary item:
Loss on early extinguishment
of debt, net of income
tax benefit of $23,606 (41,749) -- (41,749) --
------------ ------------ ------------ ------------
Net income (loss) $ (43,398) $ 5,820 $ (38,864) $ 10,532
============ ============ ============ ============
<FN>
The accompanying notes are an integral part of these financial statements.
</TABLE>
<PAGE>
MAXXAM GROUP HOLDINGS INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------------
1998 1997
------------ ------------
(UNAUDITED)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ (38,864) $ 10,532
Adjustments to reconcile net income to net
cash provided by operating activities: --
Depletion and depreciation 17,307 19,351
Extraordinary loss on early
extinguishment of debt, net 41,749 --
Equity in undistributed earnings of
Kaiser Aluminum Corporation (13,894) (1,973)
Amortization of deferred financing
costs and discounts on long-term
debt 10,888 12,353
Net gain on asset dispositions (1,909) --
Net sales of marketable securities 32,720 3,260
Net gain on marketable securities (393) (4,807)
Deferral of interest payment on note
receivable from MAXXAM Inc. (7,798) --
Increase (decrease) in cash resulting from
changes in:
Receivables 1,587 2,717
Inventories, net of depletion 5,267 200
Prepaid expenses and other assets (2,235) (3,687)
Accounts payable 6,932 521
Accrued interest (15,771) (13,655)
Other liabilities (2,815) 3,824
Accrued and deferred income taxes (7,070) 4,060
Other -- 162
------------ ------------
Net cash provided by operating
activities 25,701 32,858
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (10,439) (9,692)
Net proceeds from sale of assets 6,565 96
Restricted cash withdrawals used to acquire
timberlands 1,767 --
------------ ------------
Net cash used for investing
activities (2,107) (9,596)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt 867,248 --
Premiums for early retirement of debt (45,470) --
Incurrence of deferred financing costs (21,374) --
Principal payments on long-term debt (790,210) (16,256)
Dividends paid (2,500) --
Restricted cash withdrawals, net 2,924 1,149
------------ ------------
Net cash provided by (used for)
financing activities 10,618 (15,107)
------------ ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 34,212 8,155
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 91,753 73,595
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 125,965 $ 81,750
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid, net of capitalized interest $ 77,927 $ 72,763
Income taxes paid 50 169
Tax allocation payments to MAXXAM Inc. 4 167
SUPPLEMENTAL INFORMATION ON NON-CASH INVESTING
AND FINANCING ACTIVITIES:
Timber and timberlands acquired subject to
long-term debt $ -- $ 7,014
<FN>
The accompanying notes are an integral part of these financial statements.
</TABLE>
<PAGE>
MAXXAM GROUP HOLDINGS INC. AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. GENERAL
The information contained in the following Condensed Notes to
Consolidated Financial Statements is condensed from that which would appear
in the annual consolidated financial statements; accordingly, the
consolidated financial statements included herein should be reviewed in
conjunction with the consolidated financial statements and related notes
thereto contained in the Form 10-K filed by the Company. Any capitalized
terms used but not defined in these Condensed Notes to the Consolidated
Financial Statements are defined in the "Glossary of Defined Terms"
contained in Appendix A. All references to the "Company" include MAXXAM
Group Holdings Inc. and its subsidiary companies unless otherwise indicated
or the context indicates otherwise. See Note 5 below regarding the
formation of Scotia LLC and the merger of Scotia Pacific into Scotia LLC.
Accounting measurements at interim dates inherently involve greater
reliance on estimates than at year end. The results of operations for the
interim periods presented are not necessarily indicative of the results to
be expected for the entire year.
The consolidated financial statements included herein are
unaudited; however, they include all adjustments of a normal recurring
nature which, in the opinion of management, are necessary to present fairly
the consolidated financial position of the Company at September 30, 1998,
the consolidated results of operations for the three and nine months ended
September 30, 1998 and 1997 and consolidated cash flows for the nine months
ended September 30, 1998 and 1997. The Company is a wholly owned
subsidiary of MAXXAM.
SFAS No. 130 was issued in June 1997 and was adopted by the
Company as of January 1, 1998. SFAS No. 130 requires the presentation of
an additional income measure (termed "comprehensive income") which adjusts
traditional net income for certain items that previously were only
reflected as direct charges to equity (such as minimum pension
liabilities). As the amount of the adjustments to arrive at comprehensive
income is not significant, there is not a significant difference between
"traditional" net income and comprehensive income for the three and nine
months ended September 30, 1998 and 1997.
SFAS No. 133, issued in June 1998, requires companies to
recognize all derivative instruments as assets or liabilities in the
balance sheet and to measure those instruments at fair value. Kaiser, the
Company's equity investee, has hedging programs which use various
derivative products to "lock-in" a price (or range of prices) for products
sold or used so that earnings and cash flows are subject to reduced risk of
volatility. Under SFAS No. 133, Kaiser will be required to "mark-to-
market" its hedging positions at the end of each period in advance of the
period of recognition for the transactions to which the hedge relates.
Pursuant to SFAS No. 130, Kaiser will reflect changes in the fair value of
its open hedging positions as an increase or reduction in stockholders'
equity through comprehensive income. Under SFAS No. 130, the impact of the
changes in the fair value of financial instruments will be reversed from
comprehensive income (net of any fluctuations in other "open" positions)
and will be reflected in traditional net income upon occurrence of the
transaction to which the hedge relates. Under the equity method of
accounting which the Company follows in accounting for its investment in
Kaiser, the Company will reflect its equity share of Kaiser's adjustments
to stockholder's equity through comprehensive income.
2. INVENTORIES
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------ ------------
<S> <C> <C>
Lumber $ 41,161 $ 49,734
Logs 12,704 11,621
------------ ------------
$ 53,865 $ 61,355
============ ============
</TABLE>
3. RESTRICTED CASH
Restricted cash at September 30, 1998 represents the amount held
by the trustee under the Timber Notes Indenture to enable Scotia LLC to
acquire timberlands. Restricted cash at December 31, 1997 represents the
amount held by the trustee in the Liquidity Account for the benefit of
holders of the Old Timber Notes under the indenture governing the Old
Timber Notes.
4. INVESTMENT IN KAISER
Subsequent to its formation, the Company received, as a capital
contribution from MAXXAM, 27,938,250 Pledged Kaiser Shares. Kaiser is an
integrated producer and marketer of alumina, primary aluminum and
fabricated aluminum products. Kaiser's common stock is publicly traded on
the New York Stock Exchange under the trading symbol "KLU." The Pledged
Kaiser Shares represent a 35.3% equity interest in Kaiser at September 30,
1998. The Company follows the equity method of accounting for its
investment in Kaiser.
The Company and MAXXAM are entities under common control;
accordingly, the Company has recorded its investment in Kaiser at MAXXAM's
historical cost. During the first quarter of 1993, losses exhausted
Kaiser's equity with respect to its common stockholders. The Company
recorded its equity share of such losses in January 1993 up to the amount
of its investment in the Pledged Kaiser Shares. From January 1993 until
August 1997, cumulative losses with respect to the results of operations
attributable to Kaiser's common stockholders exceeded cumulative earnings.
However, this was no longer the case when equity attributable to Kaiser's
common stockholders increased upon conversion of the PRIDES into Kaiser
common stock. As a result, the Company recorded a $33.4 million adjustment
to reduce the stockholder's deficit reflecting the Company's 35.4% equity
interest in the impact of the PRIDES conversion on the common stockholders.
In addition, the Company began recording its equity in Kaiser's results of
operations.
The market value for the Pledged Kaiser Shares based on the price
per share quoted at the close of business on November 13, 1998 was $214.8
million. There can be no assurance that such value would be realized
should the Company dispose of its investment in the Pledged Kaiser Shares.
The following table contains summarized financial information of Kaiser (in
thousands). For more information regarding Kaiser's financial condition
and operations, reference is made to Kaiser's Annual Report on Form 10-K
for the fiscal year ended December 31, 1997 and Quarterly Report on Form
10-Q for the quarter ended September 30, 1998, both filed with the SEC.
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------ -------------
<S> <C> <C>
Current assets $ 1,034,400 $ 1,045,600
Property, plant and equipment, net 1,156,100 1,171,800
Other assets 793,300 796,500
------------ -------------
Total assets $ 2,983,800 $ 3,013,900
============ =============
Current liabilities $ 546,800 $ 594,100
Long-term debt, less current maturities 962,500 962,900
Other liabilities 1,194,900 1,212,200
Minority interests 121,500 127,700
Stockholders' equity 158,100 117,000
------------ -------------
Total liabilities and
stockholders' equity $ 2,983,800 $ 3,013,900
============ =============
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- --------------------------
1998 1997 1998 1997
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net sales $ 541,600 $ 634,100 $ 1,753,400 $ 1,778,600
Costs and expenses (510,800) (579,600) (1,622,500) (1,637,800)
Restructuring of operations -- -- -- (19,700)
Other expenses (26,400) (25,400) (83,200) (81,600)
------------ ------------ ------------ ------------
Income before income taxes and
minority interests 4,400 29,100 47,700 39,500
Credit (provision) for income
taxes 6,700 (11,000) (8,500) (2,400)
Minority interests (300) (600) 300 (3,300)
------------ ------------ ------------ ------------
Net income 10,800 17,500 39,500 33,800
Dividends on preferred stock -- (1,300) -- (5,500)
------------ ------------ ------------ ------------
Net income available to common
stockholders $ 10,800 $ 16,200 $ 39,500 $ 28,300
============ ============ ============ ============
Equity in earnings of Kaiser $ 3,764 $ 1,973 $ 13,894 $ 1,973
============ ============ ============ ============
</TABLE>
5. LONG-TERM DEBT
Long-term debt consists of the following (in thousands):
<TABLE>
<CAPTION>
September 30, DECEMBER 31,
1998 1997
------------ ------------
<S> <C> <C>
7.95% Scotia Pacific Timber Collateralized Notes
due July 20, 2015 $ -- $ 319,965
7.43% Scotia LLC Timber Collateralized Notes due
July 20, 2028 867,248 --
10-1/2% Pacific Lumber Senior Notes due March 1,
2003 -- 235,000
Pacific Lumber Credit Agreement -- 9,445
11-1/4% MGI Senior Secured Notes due August 1,
2003 -- 100,000
12-1/4% MGI Senior Secured Discount Notes due
August 1, 2003, net of discount -- 117,325
12% MGHI Senior Secured Notes due August 1, 2003 130,000 130,000
Other 510 590
------------ ------------
997,758 912,325
Less: current maturities (8,270) (19,429)
------------ ------------
$ 989,488 $ 892,896
============ ============
</TABLE>
On July 20, 1998, Scotia LLC, a recently formed limited liability
company wholly owned by Pacific Lumber, issued the Timber Notes which
consist of $867.2 million aggregate principal amount of Class A-1, Class
A-2 and Class A-3 timber collateralized notes which mature on July 20, 2028
and have an overall effective interest rate of 7.43% per annum. Net
proceeds from the offering of the Timber Notes were used primarily to
prepay the Old Timber Notes and to redeem the Pacific Lumber Senior Notes
and the MGI Notes effective August 19, 1998. The Company recognized an
extraordinary loss of $41.8 million, net of the related income tax benefit
of $23.6 million, in the quarter ended September 30, 1998 for the early
extinguishment of the Old Timber Notes, Pacific Lumber Senior Notes and MGI
Notes. Concurrently with the issuance of the Timber Notes, (i) Scotia
Pacific was merged into Scotia LLC, (ii) Pacific Lumber and Salmon Creek
transferred to Scotia LLC approximately 13,500 acres of timberlands and the
timber and timber harvesting rights with respect to an additional 19,700
acres of timberlands, and (iii) Scotia LLC transferred to Pacific Lumber
the timber and timber harvesting rights related to approximately 1,400
acres of timberlands.
Under the Timber Notes Indenture, the business activities of
Scotia LLC are generally limited to the ownership and operation of its
timber and timberlands. The Timber Notes are senior secured obligations of
Scotia LLC and are not obligations of, or guaranteed by, Pacific Lumber or
any other person. The Timber Notes are secured by a lien on (i) Scotia
LLC's timber and timberlands (representing $245.1 million of the Company's
consolidated balance at September 30, 1998), and (ii) substantially all of
Scotia LLC's other property. Interest on the Timber Notes is further
secured by the Timber Notes Line of Credit. The Timber Notes Indenture
permits Scotia LLC to have outstanding up to $75.0 million of non-recourse
indebtedness to acquire additional timberlands and to issue additional
timber notes provided certain conditions are met (including repayment or
redemption of the $160.7 million of Class A-1 Timber Notes).
The Timber Notes are structured to link, to the extent of cash
available, the deemed depletion of Scotia LLC's timber (through the harvest
and sale of logs) to the required amortization of the Timber Notes. The
required amount of amortization on any Timber Notes payment date is
determined by various mathematical formulas set forth in the Timber Notes
Indenture. The minimum amount of principal which Scotia LLC must pay (on a
cumulative basis and subject to available cash) through any Timber Notes
payment date in order to avoid an Event of Default is referred to as
Minimum Principal Amortization. If the Timber Notes were amortized in
accordance with Minimum Principal Amortization, the final installment of
principal would be paid on July 20, 2028. The minimum amount of principal
which Scotia LLC must pay (on a cumulative basis) through any Timber Notes
payment date in order to avoid payment of prepayment or deficiency premiums
is referred to as Scheduled Amortization. If all payments of principal are
made in accordance with Scheduled Amortization, the payment date on which
Scotia LLC will pay the final installment of principal is January 20, 2014.
Such final installment would include a single bullet principal payment of
$463.3 million related to the Class A-3 Timber Notes.
Principal and interest on the Timber Notes are payable semi-
annually on January 20 and July 20. The Timber Notes are redeemable at the
option of Scotia LLC at any time. The redemption price of the Timber Notes
is equal to the sum of the principal amount, accrued interest and a
prepayment premium calculated based upon the yield of like-term Treasury
securities plus 50 basis points.
The indenture for the MGHI Notes provided that in the event the
27,938,250 shares of Kaiser common stock which it owns were released from
the pledge securing the MGI Notes, the Company would pledge 16,055,000 of
such shares. In connection with the redemption of the MGI Notes and the
issuance of the Timber Notes, the Company agreed to amend the indenture for
the MGHI Notes to, among other things, pledge all of the 27,938,250 shares
of Kaiser common stock released from the MGI Notes.
6. Contingencies
Pacific Lumber's business is subject to a variety of California
and federal laws and regulations dealing with timber harvesting, threatened
and endangered species and habitat for such species, and air and water
quality. Compliance with such laws and regulations plays a significant
role in Pacific Lumber's business. While compliance with such laws,
regulations and judicial and administrative interpretations and related
litigation have increased the costs of Pacific Lumber, they have not
historically had a significant adverse effect on Pacific Lumber's financial
position, results of operations or liquidity, although Pacific Lumber's
recent results of operations have been adversely affected by the absence of
a sufficient number of available THPs to enable it to conduct its
operations at historic levels. These laws and related administrative
actions and legal challenges have also severely restricted the ability of
Pacific Lumber to harvest virgin old growth timber and, to a lesser extent,
residual old growth timber on its timberlands. On August 12, 1998, the
EPIC lawsuit was filed by two environmental groups against Pacific Lumber,
Scotia Pacific and Salmon Creek under which the environmental groups allege
that certain violations of the ESA have resulted from logging activities on
Pacific Lumber's timberlands and seek to prevent the defendants from
carrying out any harvesting activities until certain purported intra-agency
wildlife consultation requirements under the ESA are satisfied in
connection with the Combined Plan (see below). Pacific Lumber is uncertain
what impact the EPIC lawsuit will have upon its operations and financial
results but it is possible that other approved timber harvesting activities
on Pacific Lumber's timberlands could be severely restricted (and revenues
potentially significantly adversely affected) until such time as the
consultation requirements are satisfied. Pacific Lumber is vigorously
defending this matter and is devoting resources toward facilitating
completion of the consultation requirements as soon as practicable.
On September 28, 1996, the Pacific Lumber Parties entered into
the Headwaters Agreement with the United States and California which
provides the framework for the acquisition by the United States and
California of the Headwaters Timberlands. A substantial portion of the
Headwaters Timberlands contains virgin old growth timber. Approximately
4,900 of these acres are owned by Salmon Creek, with the remaining acreage
being owned by Scotia LLC (Pacific Lumber owning the timber and related
timber harvesting rights on this acreage). The Headwaters Timberlands
would be transferred in exchange for (a) cash or other consideration from
the United States and California having an aggregate fair market value of
$300 million, and (b) approximately 7,700 acres of timberlands to be
acquired from a third party. As part of the Headwaters Agreement, the
Pacific Lumber Parties agreed to not enter the Headwaters Timberlands to
conduct any logging or salvage operations. Closing of the Headwaters
Agreement is subject to various conditions, including obtaining federal and
California funding, approval of an SYP, approval of a Multi-Species HCP and
issuance of the Permits, acquisition of the third party timberlands and the
issuance of certain tax agreements satisfactory to the Pacific Lumber
Parties.
In November 1997, President Clinton signed an appropriations bill
which authorizes the expenditure of $250 million of federal funds towards
consummation of the Headwaters Agreement. These funds remain available
until March 1, 1999, and their availability is subject to, among other
things, contribution by California of its $130 million portion of funding
for the Headwaters Agreement. In September 1998, California Governor
Wilson signed the California Headwaters Bill, which among other things,
appropriated California's $130 million portion of the funding required to
consummate the Headwaters Agreement. The state funds remain available
until June 30, 1999. The bill also contains an additional appropriation
available from July 1, 1999 until June 30, 2000 authorizing the expenditure
of up to $80 million toward acquisition at fair market value of the Owl
Creek grove from Scotia LLC. If any portion of the $80 million remains
after purchase of the Owl Creek grove, it may be used to purchase certain
other timberlands. An additional $20 million was appropriated under the
bill toward purchase of a forest grove referred to as "Grizzly Creek" from
Pacific Lumber at fair market value. The Combined Plan (see below) would
have allowed the harvesting over time of either the Owl Creek grove or
Grizzly Creek grove. The Scheduled Amortization schedule for the Timber
Notes assumed that the Owl Creek grove would be harvested over time;
however, a provision of the California Headwaters Bill designates the Owl
Creek grove as a conservation area for the marbled murrelet, which would
have the effect of restricting the activities which could be conducted in
the grove. The Company estimates that the Owl Creek grove constitutes
approximately 2% of the aggregate Mbfe contained in the timber owned by
Scotia LLC. It is uncertain whether the Owl Creek grove will ultimately be
sold to the state of California. Furthermore, Scotia LLC could arrange to
exchange the Owl Creek grove for other timberlands pursuant to the
substitute collateral provisions of the Timber Notes Indenture. Were the
Owl Creek grove to be sold to the state of California, Scotia LLC would be
required to recognize Deemed Production (as defined in the Timber Notes
Indenture) with respect to the Mbfe contained within the grove, which could
result in significant prepayments (and related prepayment premiums) which
might be offset by a reduction in the required amortization in later years
attributable to not having any actual harvest from the Owl Creek grove.
The California Headwaters Bill contains provisions requiring the
inclusion of additional environmentally focused provisions in the final
version of the Multi-Species HCP, including establishing wider interim
streamside "no-cut" buffers (while the watershed assessment process
referred to below is being completed) than provided for in the Combined
Plan, obligating Pacific Lumber and the government agencies to establish a
schedule that results in completion of the watershed assessment process
within five years (on a watershed by watershed basis), imposing minimum and
maximum "no-cut" buffers upon the watershed assessment process and
designating the Company's Owl Creek grove as a marbled murrelet
conservation area. The California Headwaters Bill also provides that the
SYP shall be subject to the foregoing provisions.
With respect to the SYP, Pacific Lumber has proposed an LTSY
which is approximately 10% less than Pacific Lumber's average timber
harvest over the last three calendar years. If the SYP is approved by the
CDF, Pacific Lumber will have complied with certain BOF regulations
requiring timber companies to project timber growth and harvest on their
timberlands over a 100-year planning period and establish an LTSY harvest
level. The SYP must demonstrate that the average annual harvest over any
rolling ten-year period will not exceed the LTSY harvest level and that
Pacific Lumber's projected timber inventory is capable of sustaining the
LTSY harvest level in the last decade of the 100-year planning period. The
SYP is expected to be valid for ten years, although it would be subject to
review after five years. Thereafter, revised SYPs would be prepared every
decade that address the LTSY harvest level based upon reassessment of
changes in the resource base and other factors.
In July 1998, the proposed Combined Plan was made available to
the public for review and comment. The proposed Multi-Species HCP and
related Permits would have a term of 50 years, and would, among other
things, limit the activities which could be conducted by Pacific Lumber in
various forest groves to those which would not be detrimental to marbled
murrelet habitat. Under the Multi-Species HCP and the California
Headwaters Bill, these groves aggregate approximately 8,500 acres and
consist of substantial quantities of virgin and residual old growth redwood
and Douglas-fir timber. The Combined Plan and the draft EIR/EIS were
released and made available for public review and comment in July 1998 and
early October 1998, respectively. The public review and comment periods
for the Combined Plan and the draft EIR/EIS close on November 16, 1998.
The Company believes that submission of the proposed Combined
Plan and the draft EIR/EIS for public review and comment and passage of the
California Headwaters Bill are favorable developments that enhance the
prospects for consummation of the Headwaters Agreement and the issuance of
the Permits. However, certain provisions of the California Headwaters Bill,
including its provisions relating to the watershed assessment process, are
required to be included in the final version of the Combined Plan. In
addition, discussions are expected to occur with the regulatory agencies
following the conclusion of the public review and comment periods referred
to above, which discussions are expected to result in proposed amendments
to the Combined Plan. The provisions of the California Headwaters Bill
impose, and the potential proposed amendments could impose, more stringent
harvesting requirements and reduce the amount of timber that Pacific Lumber
will be permitted to harvest as contemplated by the SYP in its current
form. Inasmuch as approval of the Multi-Species HCP and the SYP are
conditions to the consummation of the Headwaters Agreement and certain
modifications proposed by the regulatory agencies may not be acceptable to
Pacific Lumber, any such proposed modifications could also affect the
consummation of the Headwaters Agreement. Accordingly, while the parties
are working diligently to complete the closing conditions contained in the
Headwaters Agreement, there can be no assurance that the Multi-Species HCP
and the SYP will be approved, that the Permits will be issued or that the
Headwaters Agreement will be consummated. If the Headwaters Agreement is
not consummated and Pacific Lumber is unable to harvest or is severely
limited in harvesting on various of its timberlands, it intends to continue
and/or expand its takings litigation seeking just compensation from the
appropriate government agencies on the grounds that such restrictions
constitute an uncompensated governmental taking of private property for
public use.
Several species, including the northern spotted owl, the marbled
murrelet and the coho salmon, have been listed as endangered or threatened
under the ESA and/or the CESA. Pacific Lumber has developed federal and
state ("no-take") northern spotted owl management plans which permit
harvesting activities to be conducted so long as Pacific Lumber adheres to
certain measures designed to protect the northern spotted owl. The
potential impact of the listings of the marbled murrelet and the coho
salmon is more uncertain. If the Multi-Species HCP is approved, Pacific
Lumber would be issued the Permits, which would allow limited incidental
"take" of listed species so long as there was no "jeopardy" to the
continued existence of such species, and the Multi-Species HCP would
identify the measures to be instituted in order to minimize and mitigate
the anticipated level of take to the greatest extent practicable. The
Multi-Species HCP would not only provide for Pacific Lumber's compliance
with habitat requirements for currently listed species, it should also
provide greater certainty and protection for Pacific Lumber with regard to
identified species that may be listed in the future.
Lawsuits are pending or threatened which seek to prevent Pacific
Lumber from implementing certain of its approved THPs or other operations.
While challenges with respect to Pacific Lumber's young growth timber have
historically been limited, on January 26, 1998, the Coho lawsuit was filed
against Pacific Lumber, Scotia Pacific and Salmon Creek. This action
alleges, among other things, violations of the ESA and claims that
defendants' logging operations in five watersheds have contributed to the
"take" of the coho salmon. The plaintiffs seek, among other things, to
enjoin timber harvesting on the THPs and acreage identified, and to require
Pacific Lumber to restore coho habitat allegedly harmed by adverse
cumulative effects of past (approved) timber harvesting. Pacific Lumber
has also received notice of additional threatened actions with respect to
the coho salmon. Pacific Lumber is unable to predict the outcome of this
case or its ultimate impact on its financial condition or results of
operations or the ability to harvest timber on its THPs. While Pacific
Lumber expects environmentally focused objections and lawsuits to continue,
it believes that the Combined Plan should enhance its position in
connection with these challenges. Pacific Lumber also believes that the
Combined Plan should expedite the preparation and facilitate approval of
its THPs, although there can be no assurance that Pacific Lumber will not
face difficulties in the THP submission and approval process as it
implements the Combined Plan.
In the event that the final Combined Plan is not approved, or is
not acceptable to Pacific Lumber, Pacific Lumber will not enjoy the
benefits of a more streamlined THP preparation and review process.
Furthermore, it is impossible for the Company to determine the potential
adverse effect of (i) the listings of the marbled murrelet and coho salmon
if the Combined Plan is not approved or is not acceptable to Pacific
Lumber, or (ii) the EPA's potential regulations regarding water quality on
the Company's financial position, results of operations or liquidity until
such time as the various regulatory and legal issues are resolved; however,
if Pacific Lumber is unable to harvest, or is severely limited in
harvesting, on significant amounts of its timberlands, such effect could be
materially adverse to the Company.
On November 9, 1998, the CDF notified Pacific Lumber that it had
suspended Pacific Lumber's 1998 TOL. As a result, Pacific Lumber has ceased
all operations under its TOL. Pacific Lumber is making the necessary
arrangements for independent contract loggers to be substituted as the
licensed timber operator on those THPs where Pacific Lumber's logging crews
were working prior to the suspension (independent contractors historically
account for approximately 60% of the harvesting activities on Pacific Lumber's
timberlands). Pacific Lumber believes that it will be able to engage
independent contractors to complete harvesting activities on all of the THPs
that Pacific Lumber was operating on, as well as any other THPs on which
harvesting activities will be conducted, during the balance of 1998 and
during calendar year 1999, if necessary. Accordingly, Pacific Lumber does not
believe that the revocation of its TOL will have a significant adverse
effect on its business or financial performance. Pacific Lumber has
determined not to appeal the suspension of its TOL, will apply for a new
TOL from the CDF, and expects to engage in discussions with the CDF
concerning a new TOL in the near future. The CDF has indicated to Pacific
Lumber that it is considering a denial of Pacific Lumber's TOL for
calendar year 1999 and that any agreements for the issuance of a conditional
TOL for 1999 must contain sufficient provisions to the CDF's satisfaction
to ensure that Pacific Lumber complies with the California Forest Practice
Act.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following should be read in conjunction with the response to
Part I, Item 1 of this Report and Items 7 and 8 of the Form 10-K. Any
capitalized terms used but not defined in this Item are defined in the
"Glossary of Defined Terms" contained in Appendix A.
This section contains statements which constitute "forward-
looking statements" within the meaning of the Private Securities Litigation
Reform Act of 1995. These statements appear in several places in this Form
10-Q. Such statements can be identified by the use of forward-looking
terminology such as "believes," "expects," "may," "estimates," "will,"
"should," "plans" or "anticipates" or the negative thereof or other
variations thereon or comparable terminology, or by discussions of
strategy. Readers are cautioned that any such forward-looking statements
are not guarantees of future performance and involve significant risks and
uncertainties, and that actual results may vary materially from those in
the forward-looking statements as a result of various factors. These
factors include the effectiveness of management's strategies and decisions,
general economic and business conditions, developments in technology, new
or modified statutory or regulatory requirements and changing prices and
market conditions. This Form 10-Q and the Form 10-K identify other factors
that could cause such differences. No assurance can be given that these
are all of the factors that could cause actual results to vary materially
from the forward-looking statements.
RESULTS OF OPERATIONS
The Company engages in forest products operations principally
through its subsidiaries, Pacific Lumber and Britt. The Company's business
is seasonal in that the forest products business generally experiences
lower first quarter sales due largely to the general decline in
construction-related activity during the winter months. Accordingly, the
Company's results for any one quarter are not necessarily indicative of
results to be expected for the full year. The following table presents
selected operational and financial information for the three and nine
months ended September 30, 1998 and 1997.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- --------------------------
1998 1997 1998 1997
------------ ------------ ------------ ------------
(In millions of dollars, except shipments and prices)
<S> <C> <C> <C> <C>
Shipments:
Lumber: (1)
Redwood upper
grades 11.1 12.7 33.2 39.0
Redwood common
grades 63.6 53.9 177.1 178.7
Douglas-fir upper
grades 1.6 3.3 5.1 8.3
Douglas-fir common
grades 11.6 22.5 32.9 59.0
Other .7 4.6 6.4 13.4
------------ ------------ ------------ ------------
Total lumber 88.6 97.0 254.7 298.4
============ ============ ============ ============
Logs (2) 1.8 4.0 3.1 10.6
============ ============ ============ ============
Wood chips (3) 58.8 63.6 139.6 185.9
============ ============ ============ ============
Average sales price:
Lumber: (4)
Redwood upper
grades $ 1,453 $ 1,537 $ 1,486 $ 1.427
Redwood common
grades 560 546 540 533
Douglas-fir upper
grades 1,264 1,243 1,275 1,205
Douglas-fir common
grades 376 443 353 473
Logs (4) 478 426 452 412
Wood chips (5) 74 73 72 75
Net sales:
Lumber, net of discount $ 57.9 $ 64.1 $ 163.7 $ 191.8
Logs .9 1.7 1.4 4.4
Wood chips 4.3 4.7 10.0 13.9
Cogeneration power 1.4 1.2 3.2 3.4
Other 1.4 1.1 3.0 3.0
------------ ------------ ------------ ------------
Total net sales $ 65.9 $ 72.8 $ 181.3 $ 216.5
============ ============ ============ ============
Operating income $ 12.8 $ 23.1 $ 37.6 $ 66.2
============ ============ ============ ============
Operating cash flow (6) $ 18.7 $ 29.2 $ 54.9 $ 85.6
============ ============ ============ ============
Income (loss) before income
taxes $ (4.5) $ 8.2 $ (3.2) $ 16.1
============ ============ ============ ============
Net income (loss)(7) $ (43.4) $ 5.8 $ (38.9) $ 10.5
============ ============ ============ ============
Capital expenditures $ 4.4 $ 4.3 $ 10.4 $ 16.7
============ ============ ============ ============
<FN>
- ---------------
(1) Lumber shipments are expressed in millions of board feet.
(2) Log shipments are expressed in millions of feet, net Scribner scale.
(3) Wood chip shipments are expressed in thousands of bone dry units of
2,400 pounds.
(4) Dollars per thousand board feet.
(5) Dollars per bone dry unit.
(6) Operating income before depletion and depreciation, also referred to
as "EBITDA."
(7) The net loss for the three and nine months ended September 30, 1998
includes an extraordinary loss of $41.7 million, net of tax, for the
early extinguishment of debt.
</TABLE>
Recent Operating Results
Net sales declined from $72.8 million and $216.5 million for the
three and nine months ended September 30, 1997, respectively, to $65.9
million and $181.3 million for the comparable periods of 1998,
respectively, primarily due to lower shipments of lumber, logs and wood
chips. The decline in shipments which occurred during the first six months
of the 1998 period was principally due to well-above-normal rainfall which
reduced demand for lumber products and severely limited the availability of
rail transportation. The increased rainfall, combined with additional
restrictions on Pacific Lumber's wet weather operations pursuant to the
terms of the Stipulation and the applicability of logging restrictions
during the nesting seasons for both the northern spotted owl and the
marbled murrelet, also impeded Pacific Lumber's ability to transport logs
to its mills and hindered logging operations, thereby reducing the volume
of logs available for the production of lumber products. Revenues for the
three months ended September 30, 1998 were primarily affected by a
reduction in the volume of logs harvested and converted into lumber
products. Pacific Lumber's reduced harvest level during the third quarter
of 1998 was due in substantial part to the absence of a sufficient number
of available THPs to enable it to conduct its operations at levels
consistent with those in the comparable period of 1997. The diminished
supply of available THPs was attributable to a reduced volume of approved
THPs during the third quarter of 1998 as well as regulatory and judicial
restrictions imposed upon harvesting activities in areas covered by
previously approved THPs. See Note 6 to Condensed Consolidated Financial
Statements. These difficulties in harvesting and transporting logs affected
the types of logs available for the mills and Pacific Lumber's ability to
produce a desirable mix of lumber products which in turn adversely affected
sales.
The reduced number of approved THPs was, and continues to be,
attributable to several factors, including a significantly reduced level of
THPs submitted by Pacific Lumber to the CDF during the first nine months of
1998 due to (a) the extensive amount of time devoted by Pacific Lumber's
foresters, wildlife and fisheries biologists and other personnel to (i)
amending a significant number of previously submitted THPs to incorporate
various new requirements which Pacific Lumber agreed to as part of the Pre-
Permit Agreement, (ii) preparing the Combined Plan and all the related
data, (iii) responding to comments received from various federal and state
governmental agencies with respect to its filed THPs in light of the new
and more stringent requirements that agreed to observe pursuant to the Pre-
Permit Agreement and (iv) assisting with responding to newly filed
litigation involving certain of Pacific Lumber's approved THPs (see Part
II. Item 1. "Legal Proceedings") and (b) implementation of a provision
contained in the Pre-Permit Agreement which requires, for the first time, a
licensed geologist to review virtually all of Pacific Lumber's THPs prior
to submission to the CDF. Pacific Lumber has also experienced an unexpected
significantly slower rate of review and approval with respect to its filed
THPs due, in large part, to the issues that have emerged in applying the
requirements embodied in the Pre-Permit Agreement to Pacific Lumber's THPs,
certain of which requirements impose new forestry practices that apply
solely to Pacific Lumber's operations. As a result of the factors discussed
above, Pacific Lumber had a severely diminished inventory of approved THPs
at November 1, 1998 which is limiting Pacific Lumber's ability to conduct
harvesting operations. Pacific Lumber believes that its harvesting levels
during the fourth quarter of 1998 will be significantly below that of the
fourth quarter of 1997 which would in turn have an adverse impact on lumber
production and shipments.
Pacific Lumber has released a draft of the Combined Plan for
public review and comment, and therefore believes that it has completed
most of its work in connection with preparation of the Combined Plan;
however, additional work will be required as a result of completion of the
public review and comment process for the Combined Plan and as a result of
the California Headwaters Bill. Pacific Lumber has also retained several
geologists, and believes it has made progress with the various state and
federal government agencies in resolving issues regarding the application
of the requirements of the Pre-Permit Agreement to Pacific Lumber's filed
THPs. Accordingly, Pacific Lumber believes that it will be able to increase
its rate of THP submissions during the first half of 1999. In addition, if
the Combined Plan and the Permits are approved, Pacific Lumber expects to
experience a more streamlined THP process, which should result in an
increased volume of approved THPs. However, there can be no assurance that
Pacific Lumber will not continue to experience difficulties in submitting
and receiving approvals of its THPs similar to those difficulties it has
been experiencing.
Pacific Lumber expects that its cash flow from operations,
together with other available sources of funds, will be sufficient to fund
its working capital, capital expenditures and required debt service
obligations for the next year. However, cash flows from operations may be
adversely affected if Pacific Lumber continues to experience difficulties
in the THP submission and approval process, additional judicial or
regulatory restrictions are imposed on Pacific Lumber's harvesting
activities, inclement weather conditions hamper harvesting operations or
the final Combined Plan is not approved or is not acceptable to Pacific
Lumber.
See "--Financial Condition and Investing and Financing
Activities."
Net sales
Net sales decreased from $72.8 million to $65.9 million for the
quarters ended September 30, 1997 and 1998, respectively, due to lower
shipments of redwood upper grade lumber and Douglas-fir upper and common
grade lumber. Third quarter lumber shipments were lower primarily as a
result of the factors described above. Lumber shipments also were
adversely affected by a general oversupply in the market for Douglas-fir
common grade lumber. Net sales declined from $216.5 million in the first
nine months of 1997 to $181.3 million for the first nine months of 1998
primarily due to lower shipments of lumber, logs and wood chips which was
the result of the factors described above.
Operating income
Operating income for the three and nine months ended September
30, 1998 decreased from the comparable prior year periods primarily due to
the decrease in net sales discussed above. In addition, cost of sales for
the three months ended September 30, 1998 increased by 10% over the
comparable prior year period due to an increase in logging costs. This
impact was partially offset by a decrease in depletion expense as a result
of the decline in volumes discussed above for the three and nine months
ended September 30, 1998 from the comparable prior year periods, and a
decrease in logging costs for the nine months ended September 30, 1998 from
the comparable prior year period.
Income (loss) before income taxes and minority interests
Income before income taxes for the three and nine months ended
September 30, 1998 decreased from the comparable 1997 periods, primarily
due to the decrease in operating income discussed above. Results for both
1998 periods were also affected by a decrease in investment income from
marketable securities, but were favorably affected by an increase in equity
in earnings from Kaiser.
FINANCIAL CONDITION AND INVESTING AND FINANCING ACTIVITIES
This section contains statements which constitute "forward-
looking statements" within the meaning of the Private Securities Litigation
Reform Act of 1995. See above for cautionary information with respect to
such forward-looking statements.
As discussed further in Note 5 to the Consolidated Financial
Statements, on July 20, 1998, Scotia LLC issued $867.2 million aggregate
principal amount of Timber Notes. Proceeds from the offering of the Timber
Notes were used primarily to prepay the Old Timber Notes and to redeem the
Pacific Lumber Senior Notes and the MGI Notes effective August 19, 1998.
The Pacific Lumber Credit Agreement and the indenture governing
the Timber Notes contain various covenants which, among other things, limit
the ability of Pacific Lumber and Scotia LLC to incur additional
indebtedness and liens, to engage in transactions with affiliates, to pay
dividends and to make investments. As of September 30, 1998, under the
most restrictive of these covenants, approximately $2.1 million of
dividends could be paid by Pacific Lumber to its parent.
As of September 30, 1998, $34.1 million of borrowings was
available under the Pacific Lumber Credit Agreement, of which $5.6 million
was available for letters of credit and $20.6 million was restricted to
timberland acquisitions. As of September 30, 1998, no borrowings were
outstanding and letters of credit outstanding amounted to $14.4 million.
At November 13, 1998, Pacific Lumber had borrowings outstanding of $5.0
million. The Pacific Lumber Credit Agreement expires on November 30, 1998;
however, Pacific Lumber and the existing bank have executed a term sheet
setting forth the basic terms of a new three-year credit facility. The new
facility would allow borrowings up to $60 million, all of which may be used
for revolving borrowings, $20 million of which may be used for standby
letters of credit and $30 million of which may be used for timberland
acquisitions. Borrowings would be secured by all of Pacific Lumber's
domestic accounts receivable and inventory. Borrowings for timberland
acquisitions would also be secured by the acquired timberlands and prior
to maturity of the facility would have to be repaid annually from 50%
of Pacific Lumber's cash flow (as defined). The remaining 50% of cash flow
would be available for dividends. Upon maturity of the facility, all
outstanding borrowings under the credit facility would convert to a term
loan repayable over four years.
The indenture governing the MGHI Notes, among other things,
restricts the ability of the Company to incur additional indebtedness and
liens, engage in transactions with affiliates, pay dividends and make
investments. During the nine months ended September 30, 1998, $2.5 million
of dividends were paid by the Company.
As of September 30, 1998, the Company had consolidated long-term
debt of $989.5 million (net of current maturities) as compared to $892.9
million at December 31, 1997. The increase in long-term debt was primarily
due to the issuance of the Timber Notes, offset by the payment of the Old
Timber Notes and the redemption of the Pacific Lumber Senior Notes and MGI
Notes (see Note 5 to the Consolidated Financial Statements). In addition
to principal payments, proceeds from the issuance of the Timber Notes were
used to pay redemption premiums and financing costs, and provided $25.0
million for timberland acquisitions. The Company anticipates that cash
flow from operations, together with existing cash, cash equivalents,
marketable securities and available sources of financing, will be
sufficient to fund its working capital and capital expenditure requirements
for the next year. However, cash flows from operations may be adversely
affected if Pacific Lumber continues to experience difficulties in the THP
submission and approval process, additional judicial or regulatory
restrictions are imposed on Pacific Lumber's harvesting activities,
inclement weather conditions hamper harvesting operations or the final
Combined Plan is not approved or is not acceptable to Pacific Lumber. With
respect to its long-term liquidity, the Company believes that its existing
cash and cash equivalents, together with its ability to generate sufficient
levels of cash from operations and its ability to obtain both short- and
long-term financing, should provide sufficient funds to meet its working
capital and capital expenditure requirements. However, due to its highly
leveraged condition, the Company is more sensitive than less leveraged
companies to factors affecting its operations, including governmental
regulation and litigation affecting timber harvesting practices (see "--
Trends" below), increased competition from other lumber producers or
alternative building products and general economic conditions.
TRENDS
This section contains statements which constitute "forward-
looking statements" within the meaning of the Private Securities Litigation
Reform Act of 1995. See above for cautionary information with respect to
such forward-looking statements.
The Company's forest products operations are conducted by Pacific
Lumber and Britt. Pacific Lumber's operations are subject to a variety of
California and federal laws and regulations dealing with timber harvesting,
threatened and endangered species and habitat for such species, and air and
water quality. Moreover, these laws and regulations are modified from time
to time and are subject to judicial and administrative interpretation.
Compliance with such laws, regulations and judicial and administrative
interpretations, and related litigation have increased the cost of logging
operations. There can be no assurance that certain pending regulatory and
environmental matters or future governmental regulations, legislation or
judicial or administrative decisions, or adverse weather conditions, would
not have a material adverse effect on the Company's financial position,
results of operations or liquidity. See Part II. Item 1. "Legal
Proceedings" and Note 6 to the Condensed Consolidated Financial Statements
for further information regarding regulatory and legal proceedings
affecting the Company's operations.
YEAR 2000
The Company has established a team to address the potential
impacts of the year 2000 on each of its critical business functions. The
team has substantially completed its assessment of the Company's critical
information technology and embedded technology, including its geographic
information system and equipment and systems used in operating its sawmills
and cogeneration plant, and is now in the process of making the required
modifications for these systems to be year 2000 compliant. The
modification costs are expected to be immaterial, costing less than
$100,000. The required modifications are expected to be completed by mid-
year 1999 and in most cases testing of the modifications will also be
completed by such time. Systems modification costs are being expensed as
incurred. Costs associated with new systems are being capitalized and will
be amortized over the life of the product.
In addition to addressing the Company's internal systems, the
team is in the process of identifying key vendors that could be impacted by
year 2000 issues, and surveys are being conducted. The Company expects to
evaluate the responses to the surveys over the next several months and will
make direct contact with parties which are deemed to be critical.
Kaiser, the Company's equity investee, has implemented a company-
wide program to coordinate the year 2000 efforts of its individual business
units and to track their progress. The intent of the program is to make
sure that critical items are identified on a sufficiently timely basis to
assure that the necessary resources can be committed to address any
material risk areas that could prevent its systems and assets from being
able to meet Kaiser's business needs and objectives. Spending related to
this program, which began in 1997 and is expected to continue through 1999,
is estimated to be in the $10-15 million range. Kaiser has established an
internal goal of having all necessary system changes in place and tested by
mid-year 1999. Kaiser plans to commit the necessary resources to meet this
deadline. In addition to addressing Kaiser's internal systems, the
company-wide program involves identification of key vendor and customer
relationships that could be impacted by year 2000 issues.
While the Company believes that its program is sufficient to
identify the critical issues and associated costs necessary to address
possible year 2000 problems in a timely manner, there can be no assurances
that the program, or underlying steps implemented, will be successful in
resolving all such issues prior to the year 2000. If the steps taken by
the Company (or critical third parties) are not made in a timely manner, or
are not successful in identifying and remedying all significant year 2000
issues, business interruptions or delays could occur. However, based on
the information the Company has gathered to date and its expectations of
its ability to remedy problems encountered, the Company believes that it
will not experience significant business interruptions that would have a
material impact on its results or financial condition.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Reference is made to Item 3 of the Form 10-K for information
concerning material legal proceedings with respect to the Company. The
following material developments have occurred with respect to such legal
proceeding subsequent to the filing of the Form 10-K.
On August 12, 1998, the EPIC lawsuit was filed against Pacific
Lumber, Scotia Pacific and Salmon Creek in the United States District Court
for the Northern District of California. The action relates to a number of
Pacific Lumber's THPs. The plaintiffs allege that certain procedural
violations of the ESA have resulted from defendants' logging activities on
Pacific Lumber's timberlands and seek to prevent the defendants from
carrying out any harvesting activities until certain purported intra-agency
wildlife consultation requirements under the ESA are satisfied in
connection with the Combined Plan. See Note 6 to the Condensed Consolidated
Financial Statements. On September 3, 1998, the Court granted plaintiffs'
motion for preliminary injunction covering three THPs (consisting
principally of old growth Douglas fir timber). Following evidentiary
hearings, which concluded on October 22, 1998, the Court requested
additional briefing which was filed on November 9, 1998. The preliminary
injunction remains in effect pending the Court's review of the evidence and
the additional briefs. Pacific Lumber is uncertain what impact this matter
will have upon its operations and financial results, but were the Court to
reaffirm the preliminary injunction after consideration of the evidence and
additional briefs, it is possible that other approved timber harvesting
activities on Pacific Lumber's timberlands could be severely restricted
(and revenues potentially significantly adversely affected) until such time
as the consultation requirements are satisfied. Pacific Lumber is
vigorously defending this matter and is devoting resources toward
facilitating completion of the consultation requirements as soon as
practicable.
With respect to the Coho lawsuit described in the Form 10-K, on
July 31, 1998, plaintiffs amended their complaint to include certain
additional THPs and are seeking to require defendants to restore coho habitat
allegedly harmed by adverse cumulative effects of past (approved) timber
harvesting. On November 2, 1998, the Court heard arguments and took under
submission defendants' motion for summary judgment challenging plaintiff's
standing to bring this action. Pacific Lumber has also received notice of
additional threatened actions with respect to the coho salmon.
Pacific Lumber is also subject to certain other pending THP cases
which would not be expected to have a material adverse effect upon Pacific
Lumber; however, due to the diminished supply of THPs currently held by
Pacific Lumber, the issuance of injunctive or similar relief in certain of
these cases could exacerbate the difficulties that Pacific Lumber has been
experiencing with respect to the conduct of harvesting operations. See
Part I. Item 2. "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Results of Operations--Recent
Operating Results."
On May 27, 1998, an action entitled Mateel Environmental Justice
Foundation v. Pacific Lumber, et al. (No. DR980301) was brought and is now
pending in the Superior Court of Humboldt County against MGI, Scotia
Pacific, Pacific Lumber and Salmon Creek. This action alleges, among other
things, violations of California's unfair competition law of the business
and professions code based on citations and violations (primarily water
quality related) issued against certain defendants since 1994 in connection
with a substantial number of THPs. The plaintiff seeks, among other
things, an injunction prohibiting alleged unlawful actions and requiring
corrective action, disgorgement of profits, appointment of a receiver to
ensure compliance with the law and any judgment, and financial security
with respect to future THPs to ensure full compliance with the California
Forest Practice Act. The Company does not believe that this matter will
have a material adverse effect upon its business or financial condition.
On November 9, 1998, the CDF notified Pacific Lumber that it
had suspended Pacific Lumber's 1998 TOL. As provided in the Stipulation,
Pacific Lumber has ceased all operations under its TOL. Pacific Lumber is
making the necessary arrangements for independent contract loggers to be
substituted as the licensed timber operator on those THPs where Pacific
Lumber's logging crews were working prior to the suspension (independent
contractors historically account for approximately 60% of the harvesting
activities on Pacific Lumber's timberlands). Pacific Lumber believes that
it will be able to engage independent contractors to complete harvesting
activities on all of the THPs that Pacific Lumber was operating on, as well
as any other THPs on which harvesting activities will be conducted, during
the balance of 1998 and during calendar year 1999, if necessary. Accordingly,
Pacific Lumber does not believe that the revocation of its TOL will have a
significant adverse effect on its business or financial performance.
Pacific Lumber has determined not to appeal the suspension of its TOL, will
apply for a new TOL from the CDF, and expects to engage in discussions with
the CDF concerning a new TOL in the near future. The CDF has indicated to
Pacific Lumber that it is considering a denial of Pacific Lumber's TOL for
calendar year 1999 and that any agreements for the issuance of a
conditional TOL for 1999 must contain sufficient provisions to the CDF's
satisfaction to ensure that Pacific Lumber complies with the California
Forest Practice Act.
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. EXHIBITS:
*27 Financial Data Schedule
* Included with this filing.
B. REPORTS ON FORM 8-K:
None.
<PAGE>
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, who have signed this report
on behalf of the Registrant and as the principal financial officer and as
the principal accounting officer of the Registrant, respectively.
MAXXAM GROUP HOLDINGS INC.
Date: November 13, 1998 By: /s/ Paul N. Schwartz
Paul N. Schwartz
Vice President, Chief
Financial Officer
(Principal Financial Officer)
Date: November 13, 1998 By: /s/ Elizabeth D. Brumley
Elizabeth D. Brumley
Assistant Controller
(Principal Accounting Officer)
<PAGE>
APPENDIX A
GLOSSARY OF DEFINED TERMS
BOF: California Board of Forestry
Britt: Britt Lumber Co., Inc., an indirect, wholly owned subsidiary of MGI
CDF: California Department of Forestry and Fire Protection
California Headwaters Bill: The bill enacted August 31, 1998 by the
California Legislature which, among other things appropriates California's
$130 million portion of funding required to consummate the Headwaters
Agreement, appropriates up to an additional $80 million to acquire the Owl
Creek grove and contains environmentally focused provisions regarding
streamside buffers, the watershed assessment process and designation of the
Owl Creek grove as a marbled murrelet conservation area
CESA: California Endangered Species Act
Coho lawsuit: An action entitled Coho Salmon, et al. v. Pacific Lumber, et
al. (No. 98-0283) filed January 26, 1998 in the United States District
Court for the Northern District of California
Combined Plan: The combined SYP and Multi-Species HCP released by Pacific
Lumber and Scotia LLC for public review and comment in July 1998
Company: MAXXAM Group Holdings Inc., a wholly owned subsidiary of MAXXAM
EIR/EIS: An environmental impact statement/report analyzing the Combined Plan
and the Headwaters Agreement released by Pacific Lumber
EPA: Environmental Protection Agency
EPIC lawsuit: An action entitled Environmental Protection Information
Center, Inc., Sierra Club v. Pacific Lumber, Scotia Pacific and Salmon
Creek (No. C98-3129) filed August 12, 1998 in the United States District
Court for the Northern District of California
ESA: The federal Endangered Species Act
Event of Default: Event of Default under the Timber Notes as defined in
the Timber Notes Indenture.
Form 10-K: The Company's Annual Report on Form 10-K filed with the
Securities and Exchange Commission for the fiscal year ended December 31,
1997
HCP: Habitat Conservation Plan
Headwaters Agreement: The September 28, 1996 agreement among the Pacific
Lumber Parties, the United States and California which provides the
framework for the acquisition by the United States and California of the
Headwaters Timberlands
Headwaters Timberlands: Approximately 5,600 acres of Pacific Lumber's
timberlands consisting of two forest groves commonly referred to as the
Headwaters Forest and the Elk Head Springs Forest
Kaiser: Kaiser Aluminum Corporation, an equity investee of the Company
engaged in aluminum operations
Liquidity Account: A liquidity account maintained by Scotia Pacific with
respect to the Old Timber Notes
LTSY: Long-term sustained yield
Mbfe: A concept used in structuring the Timber Notes; under this concept,
one thousand board feet, net Scribner scale, of old growth redwood timber
equates to one Mbfe
MAXXAM: MAXXAM Inc., including its subsidiaries unless otherwise noted or
the context indicates otherwise
MGHI Notes: 12% MGHI Senior Secured Notes due August 1, 2003
MGI: MAXXAM Group Inc., a wholly owned subsidiary of the Company
MGI Discount Notes: 12-1/4% MGI Senior Secured Discount Notes due August
1, 2003
MGI Notes: MGI Discount Notes and MGI Senior Notes
MGI Senior Notes: 11-1/4% MGI Senior Secured Notes due August 1, 2003
Minimum Principal Amortization: The minimum amount of principal on the
Timber Notes which Scotia LLC must pay (on a cumulative basis and subject
to available cash) through any Timber Notes payment date in order to avoid
an Event of Default (as defined in the Timber Notes Indenture)
Multi-Species HCP: The HCP covering multiple species contemplated by the
Headwaters Agreement
Old Timber Notes: The 7.95% Scotia Pacific Timber Collateralized Notes due
July 20, 2015
Owl Creek grove: A 900-acre grove of primarily old growth timber owned by
Scotia LLC
Pacific Lumber: The Pacific Lumber Company, an indirect, wholly owned
subsidiary of MGI
Pacific Lumber Credit Agreement: The revolving credit agreement between
Pacific Lumber and a bank which provides for borrowings of up to $60.0
million of which $20.0 million may be used for standby letters of credit
and $30.0 million is restricted to timberland acquisitions
Pacific Lumber Parties: Pacific Lumber, including its subsidiaries and
affiliates, and MAXXAM
Pacific Lumber Senior Notes: 10-1/2% Pacific Lumber Senior Notes due March
1, 2003
Permits: The incidental take permits related to the Multi-Species HCP to
be approved pursuant to the Headwaters Agreement
Pledged Kaiser Shares: The 27,938,250 shares of common stock of Kaiser
pledged as security for the MGI Notes
Pre-Permit Agreement: A February 27, 1998 Pre-Permit Application
Agreement in Principle entered into by Pacific Lumber, MAXXAM and various
government agencies regarding certain understandings that they had reached
regarding the Multi-Species HCP, the Permits and the SYP
PRIDES: 8,855,550 8.255% Preferred Redeemable Increased Dividend Equity
Securities issued by Kaiser during the first quarter of 1994; all
outstanding shares were converted into 7,227,848 shares of Kaiser common
stock in August 1997
Salmon Creek: Salmon Creek Corporation, a wholly owned subsidiary of
Pacific Lumber
Scheduled Amortization: The minimum amount of principal on the Timber
Notes which Scotia LLC must pay (on a cumulative basis) through any Timber
Notes payment date in order to avoid payment of prepayment or deficiency
premiums
Scotia LLC: Scotia Pacific Company LLC, a limited liability company,
wholly owned by Pacific Lumber
Scotia Pacific: Scotia Pacific Holding Company, a wholly owned subsidiary
of Pacific Lumber, which was merged into Scotia LLC on July 20, 1998
SEC: Securities and Exchange Commission
SFAS No. 130: Statement of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income"
SFAS No. 133: Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities"
Stipulation: Stipulation entered into between the CDF and Pacific Lumber
in December 1997 in connection with the administrative action entitled: In
the Matter of the Statement of Issues Against: The Pacific Lumber Company,
Timber Operator License A-5326 (No. LT 97-8) with respect to Pacific
Lumber's TOL
SYP: The sustained yield plan establishing LTSY harvest levels for Pacific
Lumber's timberlands
THP: Timber harvesting plan required to be filed with and approved by the
CDF prior to the harvesting of timber
Timber Notes Indenture: The indenture dated July 20, 1998 governing the
Timber Notes
Timber Notes: The Scotia LLC 6.55% Class A-1, 7.11% Class A-2 and 7.71%
Class A-3 Timber Collateralized Notes due July 20, 2028
Timber Notes Line of Credit: A line of credit agreement provided as
security for the payment of interest on the Timber Notes, which line of
credit secures the payment of one year's interest on the Timber Notes
TOL: Timber operator's license allowing the holder to conduct timber
harvesting operations
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Company's consolidated balance sheet and consolidated statement of operations
and is qualified in its entirety by reference to such consolidated financial
statements together with the related footnotes thereto.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-1-1998
<PERIOD-END> SEP-30-1998
<EXCHANGE-RATE> 1
<CASH> 125,965
<SECURITIES> 19,052
<RECEIVABLES> 18,487
<ALLOWANCES> 0
<INVENTORY> 53,865
<CURRENT-ASSETS> 225,991
<PP&E> 187,024
<DEPRECIATION> 83,492
<TOTAL-ASSETS> 958,775
<CURRENT-LIABILITIES> 53,355
<BONDS> 989,488
0
0
<COMMON> 1
<OTHER-SE> (112,556)
<TOTAL-LIABILITY-AND-EQUITY> 958,775
<SALES> 181,258
<TOTAL-REVENUES> 181,258
<CGS> 116,290
<TOTAL-COSTS> 116,290
<OTHER-EXPENSES> 27,396
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 70,895
<INCOME-PRETAX> (3,167)
<INCOME-TAX> (6,052)
<INCOME-CONTINUING> 2,885
<DISCONTINUED> 0
<EXTRAORDINARY> (41,749)
<CHANGES> 0
<NET-INCOME> (38,864)
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
