SCOTIA PACIFIC COMPANY LLC
SUPPLEMENT DATED MARCH 19, 1999
TO PROSPECTUS DATED DECEMBER 30, 1998
This Supplement (the "Supplement") supplements the Prospectus (the
"Prospectus") dated December 30, 1998 issued by Scotia Pacific Company LLC in
connection with its exchange offer relating to $160,700,000 original principal
amount of its 6.55% Series B Class A-1 Timber Collateralized Timber Notes due
2028, $243,200,000 original principal amount of its 7.11% Series B Class A-2
Timber Collateralized Timber Notes due 2028, and $463,348,000 original principal
amount of its 7.71% Series B Class A-3 Timber Collateralized Timber Notes due
2028.
The information contained in this Supplement reflects the consummation of
the Headwaters Agreement and certain other developments since the date of the
Prospectus. Any information in the Prospectus that is inconsistent with the
information set forth herein is superseded by this Supplement. Capitalized terms
not otherwise defined in this Supplement are used with the same meanings set
forth in the Prospectus.
EXTENSION OF THE EXCHANGE OFFER
The Exchange Offer has been extended until Thursday, March 25, 1999 at
5:00 p.m., New York City time. Commencing on March 18, 1999 and continuing until
consummation of the Exchange Offer, the Company is obligated to pay
Non-Registration Premiums at the rate of 1/2% per annum on the outstanding
balance of the Timber Notes. Eligible Holders whose Old Notes are accepted for
exchange will not have the right to receive accrued Non-Registration Premiums
thereon since such Premiums will be payable to the holders of the New Notes with
the first interest payment on the New Notes.
THIS SUPPLEMENT CONTAINS STATEMENTS WHICH CONSTITUTE "FORWARD-LOOKING
STATEMENTS." THESE STATEMENTS APPEAR IN A NUMBER OF PLACES. SUCH STATEMENTS CAN
BE IDENTIFIED BY THE USE OF FORWARD-LOOKING TERMINOLOGY SUCH AS "BELIEVES,"
"INTENDS," "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 NEW OR MODIFIED ENVIRONMENTAL OR OTHER REGULATORY
REQUIREMENTS, CHANGING PRICES AND MARKET CONDITIONS, THE EFFECTIVENESS OF
MANAGEMENT'S STRATEGIES AND DECISIONS AND THEIR IMPLEMENTATION, GENERAL ECONOMIC
AND BUSINESS CONDITIONS AND DEVELOPMENTS IN TECHNOLOGY. THIS SUPPLEMENT
IDENTIFIES 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.
CONTENTS OF SUPPLEMENT
PAGE
Extension of the Exchange Offer................................... S-1
Summary .......................................................... S-2
Risk Factors...................................................... S-5
The Company....................................................... S-7
Pacific Lumber.................................................... S-17
Amortization After Giving Effect to the Headwaters Transaction.... S-18
Escrow Agreement.................................................. S-19
Ratings........................................................... S-20
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SUMMARY
THE FOLLOWING IS A SUMMARY OF CERTAIN INFORMATION CONTAINED ELSEWHERE IN THIS
PROSPECTUS SUPPLEMENT. THIS SUMMARY IS NOT INTENDED TO BE A COMPLETE DESCRIPTION
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO THE MORE DETAILED INFORMATION
CONTAINED IN THIS PROSPECTUS SUPPLEMENT AND THE PROSPECTUS. HOLDERS ARE
ENCOURAGED TO READ THIS PROSPECTUS SUPPLEMENT AND THE PROSPECTUS IN THEIR
ENTIRETY. CAPITALIZED TERMS USED IN THIS SUMMARY HAVE THE MEANINGS ASSIGNED IN
THIS PROSPECTUS SUPPLEMENT AND THE PROSPECTUS.
RECENT DEVELOPMENTS
o As described in the Prospectus, in September 1996 Pacific Lumber and
MAXXAM entered into the Headwaters Agreement with the United States and
California. Following the public review and comment period relating to the
habitat conservation and sustained yield plans to be completed as a part
of the Headwaters Agreement, beginning in December 1998 certain
restrictions and requirements were proposed by various state and federal
agencies that were more stringent than were previously contemplated, and
extensive negotiations ensued among Pacific Lumber, the Company and the
governmental agencies.
o The Company's Board of Managers appointed a Special Committee of
independent managers to review the Headwaters Agreement. After
consideration of the Headwaters Agreement and the available alternatives,
the Special Committee recommended that the Company proceed with the
transactions. It was a condition to the Special Committee's recommendation
that the net proceeds from the sale of the Headwaters Timberlands and the
portion of the Grizzly Creek grove to be sold be held in escrow to support
the Timber Notes, and be released only under certain circumstances.
o On March 1, 1999, after receipt of certain clarifications relating to the
habitat conservation and sustained yield plans, the Company's Board of
Managers approved consummating the Headwaters Agreement, as a result of
which, (i) the Headwaters Timberlands were transferred to the United
States, (ii) Salmon Creek was paid $299,850,000 and the Company was paid
$150,000, (iii) the Elk River Timberlands will be transferred to the
Company, (iv) habitat conservation and sustained yield plans were approved
covering substantially all of the Company Timberlands, (v) California
agreed to purchase the Company's Owl Creek grove and a portion of Pacific
Lumber's Grizzly Creek grove, and (vi) the Company, Pacific Lumber and
Salmon Creek dismissed the Takings Litigation against the United States
and California. See "--Consummation of the Headwaters Agreement" below.
o Salmon Creek deposited approximately $285 million of the proceeds from the
sale of the Headwaters Timberlands into escrow pursuant to an Escrow
Agreement.
o The Timber Notes were placed on review by Moody's on November 24, 1998 and
by Standard & Poor's on February 18, 1999. The Company expects to meet
shortly with the rating agencies to review various matters related to the
ratings of the Timber Notes. Following these meetings, the Company expects
to make a determination as to what extent, and in what manner, funds held
under the Escrow Agreement will be applied to support the Timber Notes and
the circumstances under which such funds could be released to Pacific
Lumber or Salmon Creek in accordance with the Escrow Agreement.
CONSUMMATION OF THE HEADWATERS AGREEMENT
On March 1, 1999, the Company, Pacific Lumber and Salmon Creek consummated
the Headwaters Agreement with the United States and California.
As a result, among other things:
o The United States acquired the Headwaters and Elk Head Springs forest
groves through the transfer by Salmon Creek of approximately 4,900 acres
of timberlands, the transfer by Pacific Lumber of approximately 150 acres
of timberlands and timber rights on approximately 650 acres of
timberlands, the transfer by the Company of approximately 650 acres of
land subject to those timber rights, and the transfer of 1,770 acres of
the Elk River Timberlands not transferred to Pacific Lumber.
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o The United States and California paid $300 million, of which Salmon Creek
received $299,850,000 (prior to payment of approximately $125,000 of
related closing costs) and the Company received approximately $150,000
(see "Escrow Agreement" regarding an escrow account established with
respect to not less than $285 million of these proceeds to support the
Timber Notes).
o The Elk River Timberlands, consisting of approximately 7,700 acres (of a
total of approximately 9,470 acres for which the United States and
California paid third party owners approximately $78 million), were
transferred to Pacific Lumber (which paid approximately $25,000 of related
closing costs) and within 180 days will be transferred to the Company and
become subject to the Lien of the Deed of Trust securing the Timber Notes.
o A combined habitat conservation plan (the "Final HCP") and a sustained
yield plan (the "Final SYP") covering substantially all of the Company
Timberlands (other than the Additional Timber Property, as defined on page
8 below) and certain lands and timber owned by Pacific Lumber and Salmon
Creek (the Final HCP and the Final SYP, together and collectively, the
"Final Plans") were approved, providing for the issuance of federal and
state incidental take permits (the "Permits") covering 17 species that are
or could become listed as endangered or threatened and allowing harvest of
certain Company Timber that otherwise might not have been harvestable.
o California entered into an agreement for the future purchase of the Owl
Creek grove owned by the Company for up to $80 million (see "The Company;
Regulatory and Environmental Matters; The Headwaters Agreement--Owl Creek
and Grizzly Creek Agreements" for information
regarding the Owl Creek sales agreement).
o California entered into an agreement for the future purchase, for up to
$20 million, of a specified portion (to be determined by California) of
the Grizzly Creek grove, in which the timber is owned by Pacific Lumber
and the underlying land is owned by the Company (see "The
Company--Regulatory and Environmental Matters; The Headwaters
Agreement--Owl Creek and Grizzly Creek Agreements" for information
regarding the Grizzly Creek sales agreement; "The Company-- Regulatory and
Environmental Matters; The Headwaters Agreement--Implementing Agreements"
for information regarding a five-year prohibition on harvesting in the
Grizzly Creek grove; and "The Escrow Agreement" regarding possible escrow
of the proceeds of the sale of a portion of the Grizzly Creek grove).
o The Company, Pacific Lumber and Salmon Creek dismissed the Takings
Litigation, which were lawsuits pending against the United States and
California alleging that certain old growth timberlands had been "taken"
without constitutionally required "just compensation."
In addition to receiving the Elk River Timberlands, the Company anticipates
that the consummation of the Headwaters Agreement and the implementation of the
Final Plans have the potential to allow the Company to realize certain long-term
benefits, including (i) the sale by the Company to California, for up to
approximately $80 million, of the Owl Creek grove, which otherwise might not
have been harvestable; (ii) the opportunity, under the Permits and the Final
HCP, to harvest certain Company Timber that otherwise might not have been
harvestable; (iii) greater protection for the Company under the "no surprises"
provisions of the Final HCP with respect to the "take" of certain listed species
covered by the Final HCP, as well as certain other species that are not now, but
may in the future become, listed as threatened or endangered species; and, (iv)
an enhanced position in litigation and similar challenges to the Company's
operations. The Company also has received clarifications from representatives of
both federal and state governmental agencies that the adaptive management
provision of the Final HCP will be implemented by the agencies on a timely and
efficient basis, and in a manner that is both biologically and economically
sound. See "The Company--Regulatory and Environmental Matters; The Headwaters
Agreement --The Final Plans." In addition, although there can be no assurances,
the Company anticipates that, after a transition period, the implementation of
the Final Plans will streamline the process of preparing THPs and potentially
shorten the time required to obtain approval of THPs.
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Although the Company believes that benefits may be realized as a result of
the consummation of the Headwaters Agreement, particularly in contrast to the
adverse environmental and regulatory climate that the Company believes would
likely have resulted if it had not agreed to consummate the Headwaters
Agreement, there nevertheless remain significant uncertainties regarding many
aspects of the Company's future operations in implementing the various aspects
of the Final Plans. In addition, significant regulatory restrictions and
requirements have been imposed upon the Company that were not contemplated when
the Timber Notes were structured and sold and therefore were not anticipated
when the assumptions used in structuring the Timber Notes were determined. In
response to uncertainties regarding the potential impact of the Headwaters
Agreement on the Timber Notes, Salmon Creek has deposited approximately $285
million (representing all of its cash proceeds from the sale of the Headwaters
Timberlands, net of costs associated with the negotiation and consummation of
the Headwaters Agreement) in an escrow account to be made available, while so
held, as necessary to support the Timber Notes, and to be released only under
certain circumstances. See "Escrow Agreement" below.
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RISK FACTORS
HOLDERS OF TIMBER NOTES SHOULD CAREFULLY CONSIDER THE FACTORS SET FORTH
UNDER "RISK FACTORS" BEGINNING AT PAGE 40 OF THE PROSPECTUS AND IN THE OTHER
SECTIONS OF THE PROSPECTUS REFERRED TO IN THE "RISK FACTORS" SECTION. THE
FOLLOWING ADDITIONAL RISK FACTORS SHOULD ALSO BE CONSIDERED IN LIGHT OF THE
CONSUMMATION OF THE HEADWATERS AGREEMENT AND OTHER DEVELOPMENTS SINCE THE DATE
OF THE PROSPECTUS.
RATING OF THE TIMBER NOTES
On November 24, 1998, Moody's announced that it had placed the Timber
Notes on review for possible downgrade of their assigned rating. Moody's
indicated that its rating action was prompted by the suspension by the CDF of
Pacific Lumber's 1998 TOL on November 10, 1998. On February 24, 1999, Moody's
announced that, given its continuing concerns about the status of Pacific
Lumber's 1999 TOL, as well as its concerns regarding the status of negotiations
on the Headwaters transactions and proposed changes in the Combined Plan, it was
maintaining its review of the Timber Notes for possible downgrade.
On February 17, 1999, Standard & Poor's Corp. announced that it had placed
the Timber Notes on CreditWatch with negative implications. Standard & Poor's
indicated the CreditWatch placement had been prompted by the potential
set-asides and harvesting restrictions being proposed under the Headwaters
Agreement. Standard & Poor's indicated that if the Headwaters Agreement was
consummated, it would review the final closing documents related to the
transaction to determine if further action was required.
The Company expects to meet shortly with the rating agencies to review
various matters related to the ratings of the Timber Notes. However, there can
be no assurance that the ratings on the Timber Notes will not be downgraded by
Moody's or Standard & Poor's or both notwithstanding application of funds now
held under the Escrow Agreement to support the Timber Notes. See "Ratings."
INSUFFICIENT SHORT-TERM CASH FLOW
The Company's and Pacific Lumber's results of operations have been and
continue to be adversely affected by the absence of a sufficient number of THPs.
The Company believes that it will not generate sufficient cash from operations
to pay interest on the Timber Notes on the July 20, 1999 payment date. As a
result, the Company expects to rely on funds borrowed under the Line of Credit
Agreement, capital contributions or funds made available under the Escrow
Agreement to meet its debt service obligations during 1999. The Company had
sufficient cash on hand to pay the interest due on the Timber Notes on the
January 20, 1999 Note Payment Date but did not have sufficient additional cash
to pay Minimum Principal Amortization or Scheduled Amortization. Nonetheless,
the Company paid $5.4 million of principal on the Timber Notes (the amount equal
to Scheduled Amortization) using funds provided as a capital contribution by
Pacific Lumber, which in turn received a $5.0 million capital contribution from
its indirect parent, MGI.
LONG-TERM CASH FLOW MAY BE SIGNIFICANTLY REDUCED
No assurance can be given that the Company will not continue to experience
the current reduced levels of available THPs, reduced harvest and log sale
levels and, consequently, reduced revenues and cash flows from operations to a
degree that would result in slower amortization of the Timber Notes than Minimum
Principal Amortization, without giving effect to use of the funds now held under
the Escrow Agreement.
The Company expects that the experience it will gain in implementing the
Final Plans will better enable it to analyze the impact of such restrictions on
its future harvesting operations, including its ability to harvest timber under
approved THPs. There can be no assurance that the Company will in the future
obtain THP approvals at a rate sufficient to permit timber harvests at the
levels permitted by the Final SYP, or even if it obtains such approvals, that it
will be able to harvest the full amount of timber covered by the approved THPs.
Cash flows from operations may continue to be adversely affected if the Company
does not experience improvements in the THP submission and approval process, or
if inclement weather conditions or seasonal operating or other restrictions
under the Final HCP hamper harvesting operations. Cash flows from operations
would also be adversely affected if additional
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judicial or regulatory restrictions are imposed on the Company's harvesting
activities, or the Final Plans are not implemented in accordance with the
clarifications received from the regulatory agencies.
CERTAIN STRUCTURING ASSUMPTIONS WOULD BE LESS FAVORABLE
The Timber Notes were originally structured based upon certain assumptions
regarding, among other things, harvest levels, timber prices, related yield
taxes, operating expenses and capital expenditures. For purposes of producing
the Structuring Cash Flows, which were used to derive the Minimum Principal
Amortization Schedules and to determine the amount of Timber Notes to be issued,
the amount of timber on the Initial Harvest Schedule was reduced by 10% over and
above the net reductions from historical harvest levels already reflected in the
Initial Harvest Schedule, to produce a hypothetical schedule of Company Timber
to be harvested. The prices related to the sale of harvested logs were derived
from the June 1998 SBE Prices (the SBE Prices applicable to the six month period
ended June 30, 1998), which were initially reduced by approximately 25% (on an
effective basis) and then escalated at a rate of 3-1/2% per year, commencing
January 1, 1999, to produce a hypothetical schedule of timber prices. These
harvest and price schedules were combined, together with certain assumptions
regarding the yield tax rate and commitment fees under the Line of Credit
Agreement (the rates in effect as of July 9, 1998 with no escalations) and other
operating expenses and capital expenditures (adjusted each decade to reflect
changes in assumed harvest levels between decades and escalated at a rate of 5%
per year, commencing January 1, 1999) to produce the Structuring Cash Flows, a
hypothetical schedule of cash flows attributable to the Company Timber.
The Company believes that, although the 10% reduction to the Initial
Harvest Schedule, the approximately 25% reduction from June 1998 SBE Prices and
the 5% annual escalation of operating expenses and capital expenditures used as
assumptions in generating the Structuring Cash Flows were intended to reflect
conservatism in structuring the transaction when the Old Notes were issued in
July 1998, subsequent events have resulted in certain changes that would, in the
Company's view, require different, and in certain instances less favorable,
assumptions in order to reflect a comparable degree of conservatism if the
Timber Notes were being structured and issued for the first time as of the date
of this Supplement. See "Amortization After Giving Effect to the Headwaters
Transaction."
BANKRUPTCY OR INSOLVENCY OF PACIFIC LUMBER OR SALMON CREEK
Pacific Lumber expects that in the near term its cash flows from
operations will be adversely affected by an inadequate supply of logs and a
slowdown in lumber production. Furthermore, Pacific Lumber does not expect to
receive any dividends from the Company in 1999, borrowings available under the
Pacific Lumber Credit Agreement will decrease significantly from the $27.5
million available as of December 31, 1998 due to a decline in receivables and
inventories required to secure the facility and, until such time as there are
adequate dividends from the Company or a determination is made that all or a
significant portion of the funds subject to the Escrow Agreement can be
released, Pacific Lumber expects that it will be dependent upon its parent to
meet some portion of its working capital and capital expenditure requirements.
If the Company's future cash flows are not sufficient to generate
distributable funds to Pacific Lumber, Pacific Lumber's ability to satisfy its
operating expenses and capital expenditure requirements will be materially
impaired. If such impairment were to occur and to result in the bankruptcy or
insolvency of Pacific Lumber or Salmon Creek, a creditor or bankruptcy trustee
of Pacific Lumber or Salmon Creek, as applicable, could attempt to gain access
to the funds held under the Escrow Agreement or otherwise to support the Timber
Notes, or to recover funds distributed or used for such purposes. The success of
any such attempt would depend on the facts and circumstances, including the
timing and nature of the transfer of such funds to support the Timber Notes, the
timing of such bankruptcy or insolvency, and the solvency and financial
condition of Pacific Lumber, Salmon Creek and the Company on the date of
transfer of such funds to support the Timber Notes.
In addition, if Pacific Lumber is unable to meet its operating expenses
and capital expenditure requirements, the Company's operations could be
adversely affected if Pacific Lumber's cash shortfalls affect its ability to
perform its obligations under the New Services Agreement or the New Purchase
Agreement. The Structuring Cash Flows, and the assumptions used to create the
Structuring Cash Flows, were not prepared with reference to (and do not take
account of) Pacific Lumber's operating and other expenses. Under the assumptions
underlying the Structuring Cash Flows, there would be no funds available for
distribution by the Company to Pacific Lumber. At the time such assumptions were
made in structuring the Timber Notes, the Company anticipated that its
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actual cash flows would be more favorable than those arising from such
assumptions, and that it would have excess funds available for distribution to
Pacific Lumber. While the Company continues to believe that it will have excess
funds available for distribution to Pacific Lumber, events subsequent to the
structuring of the Timber Notes indicate that the amount that will be so
available will be less than originally contemplated and there can be no
assurance that the timing and amount of distributions to Pacific Lumber from the
Company will be adequate to meet the needs of Pacific Lumber that are not
satisfied from other sources.
REGULATORY RISK UPON FORECLOSURE
The Timber Notes are secured by, and are payable from the proceeds of, the
Mortgaged Property. The Company does not have any material assets other than the
Mortgaged Property. Accordingly, in the event such proceeds are insufficient to
pay amounts payable on the Timber Notes when due, the Trustee and, to the extent
permitted under the Indenture, the holders of the Timber Notes, will effectively
be limited to the exercise of remedies against the Mortgaged Property, including
foreclosure or exercise of power of sale under the Deed of Trust.
If the Trustee were to exercise foreclosure or power of sale remedies
under the Deed of Trust, there is a substantial likelihood that the Final HCP,
the Final SYP and the Permits would not be transferable to a purchaser of the
Mortgaged Property without further action by the relevant regulatory
authorities. Pursuant to the California Agreement (as defined on page 12),
entered into in connection with the issuance of the Final Plans and in
connection with forestry, endangered species and environmental laws, rules and
regulations, the restrictions and obligations set forth in the California
Agreement were recorded as covenants running with the land and binding on the
Company and any successor owner for 50 years. The California Agreement also
generally provides that transfers of land included in the Mortgaged Property are
to be conducted in accordance with the Implementation Agreement. The
Implementation Agreement requires, among other things, that dispositions of such
Covered Lands (as defined on page 12) require approval of the Agencies (as
defined on page 11) and amendment of the Permits. However, a transfer may be
processed as a so-called minor modification not requiring public notice and
comment periods if the transferee (a) has entered into an agreement acceptable
to the Agencies to reasonably assure that the lands will be managed so as not to
compromise the effectiveness of the Final HCP or (b) agrees to be bound by the
Final HCP as it applies to the Covered Lands and obtains incidental take permits
following normal permitting procedures. Minor modifications require the approval
of all of the parties to the Implementation Agreement (as defined on page 11).
Disposition of land within marbled murrelet conservation areas also requires
assurances that the marbled murrelet will be adequately protected for 50 years.
THE COMPANY
BACKGROUND
The Company is a special purpose Delaware limited liability company wholly
owned by Pacific Lumber and was organized by Pacific Lumber to facilitate the
offering of the Timber Notes. As of March 1, 1999, after giving effect to the
consummation of the Headwaters Agreement and the transfer to be made to the
Company of the Elk River Timberlands, the Company owned (i) approximately
206,000 acres of timberlands, including the timber and related timber harvesting
rights with respect to such acreage, (ii) the Company Timber Rights consisting
of the timber harvest rights on an additional approximately 12,200 acres of real
property, (iii) approximately 1,100 acres of timberlands subject to the Pacific
Lumber Timber Rights, and (iv) certain computer hardware and software and other
assets. Substantially all of the Company's assets serve as security for the
Timber Notes. The timberlands owned by the Company and the timberlands subject
to the Company Timber Rights are collectively referred to as the "Company
Timberlands." The timber located on the Company Timberlands which is not subject
to the Pacific Lumber Timber Rights is referred to as the "Company Timber."
The Company estimates that the amount of Company Timber (including timber
on the Elk River Timberlands and on the Additional Timber Property defined
below) consists of approximately 3.0 million Mbfe of timber by volume, and is
comprised of primarily young growth and old growth redwood and Douglas-fir
timber. In addition, substantial quantities of sub-merchantable trees exist on
the Company Timberlands which are not yet mature and have not been included in
the inventory of the Company Timber. The estimates of the volume of timber
comprising the Company Timber are based on a timber cruise performed in 1986 of
all of Pacific Lumber's
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properties at that time (including the Company Timber), as adjusted to reflect
acquisitions, dispositions and actual harvest levels since the cruise and
estimated growth rates of the Company Timber. Subsequent to the issuance of the
Timber Notes, as of March 1, 1999, the Company had expended approximately $19.2
million (using proceeds from the $25.0 million Prefunding Account established
under the Indenture) to purchase approximately 7,100 acres of timberlands (the
"Additional Timber Property"). The Additional Timber Property is not subject to
the Final SYP.
BUSINESS OF THE COMPANY
Substantially all of the Company's revenues have been and are expected to
continue to be derived from the sale of logs harvested from the Company Timber
by Pacific Lumber pursuant to the New Master Purchase Agreement. The Company
relies on Pacific Lumber to provide, pursuant to the New Services Agreement,
operational, management and related services not performed by its own employees
with respect to the Company Timberlands. As compensation for the services
provided by Pacific Lumber pursuant to the New Services Agreement, the Company
pays Pacific Lumber the Services Fee, and reimburses Pacific Lumber for the cost
of constructing, rehabilitating and maintaining roads, and performing
reforestation services, on the Company Timberlands.
Prior to harvesting Company Timber, the Company is required to file with
the CDF, and obtain its approval of, a THP for the area to be harvested. The
Company has experienced a significant decrease in the number of available THPs
for the conduct of harvesting on the Company Timberlands. See "--Recent
Operating Results" for a description of difficulties the Company has been
experiencing in the THP preparation, submission and approval process. Although
the Company anticipates that, after a transition period, the implementation of
the Final Plans will streamline the process of preparing THPs and potentially
shorten the time required to obtain approval of THPs, the Company expects the
effects of the existing reduction in the number of available THPs to adversely
affect its operations during at least the first half of 1999. See "--Recent
Operating Results --Log Sales to Pacific Lumber."
Under the New Master Purchase Agreement and related log purchase
agreements, Pacific Lumber is responsible, at its own expense, for harvesting
and removing Company Timber covered by approved THPs. In order to conduct its
own harvesting and logging operations in California, Pacific Lumber is required
to have a timber operator's license ("TOL") issued by the CDF. See "--Regulatory
and Environmental Matters; The Headwaters Agreement--TimbeR Operator's License"
for information regarding Pacific Lumber's loss of its 1998 conditional TOL in
November 1998, and the recent issuance of its conditional TOL for 1999.
REGULATORY AND ENVIRONMENTAL MATTERS; THE HEADWATERS AGREEMENT
BACKGROUND
Regulatory and environmental matters play a significant role in the
Company's operations, which are subject to a variety of California and federal
laws and regulations, dealing with timber harvesting practices, threatened and
endangered species and habitat for such species, and air and water quality.
While regulatory and environmental concerns have resulted in restrictions on the
geographic scope and timing of the Company's timber operations, increased
operational costs and engendered litigation and other challenges to the
Company's operations and THP filings, prior to 1998 they had not had a
significant adverse effect on the Company's financial position, results of
operations or liquidity; however, the Company's 1998 results of operations were
adversely affected by certain regulatory and environmental matters, including
during the second half of 1998 the absence of a sufficient number of available
THPs to enable the Company to conduct its operations at historic levels. See
"--Recent Operating Results."
In addition to the filing of THPs, California law requires timber owners
such as the Company to demonstrate that their operations will not decrease the
sustainable productivity of their timberlands. A timber company may comply with
this requirement by submitting a sustained yield plan ("SYP") to the CDF for
review and approval. An SYP contains a timber growth and yield assessment, which
evaluates and calculates the amount of timber and long-term production outlook
for a company's timberlands, a fish and wildlife assessment, which addresses the
condition and management of fisheries and wildlife in the area, and a watershed
analysis, which addresses the protection of aquatic resources.
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The Company is also subject to federal and state laws providing for the
protection and conservation of wildlife species which have been designated as
endangered or threatened, certain of which are found on the Company Timberlands.
These laws generally prohibit certain adverse impacts on such species (referred
to as a "take"), except for incidental takes pursuant to otherwise lawful
activities which do not jeopardize the continued existence of the affected
species and which are made in accordance with an approved HCP and related
incidental take permit. An HCP, among other things, analyzes the potential
impact of the incidental take of species and specifies measures to monitor,
minimize and mitigate such impact.
In September 1996, Pacific Lumber and MAXXAM entered into the Headwaters
Agreement with the United States and California that provided the framework for
the acquisition by the United States and California of the Headwaters
Timberlands. A substantial portion of the Headwaters Timberlands consists of
virgin old growth timberlands. Consummation of the Headwaters Agreement was
conditioned upon, among other things (i) federal and state funding, (ii) state
approval of an SYP covering the Company Timberlands, (iii) federal approval of
an HCP covering the Company Timberlands, (iv) the issuance of incidental take
permits with respect to threatened or endangered species on the Company
Timberlands, (v) acquisition of the Elk River Timberlands and (vi) tax closing
agreements satisfactory to MAXXAM and Pacific Lumber. The Headwaters Agreement
transactions were consummated on March 1, 1999.
EVENTS LEADING TO CONSUMMATION OF THE HEADWATERS AGREEMENT
In November 1997, President Clinton signed an appropriations bill which
authorized the expenditure of $250 million of federal funds toward consummation
of the Headwaters Agreement. In September 1998, California Governor Wilson
signed the California Headwaters Bill which, among other things, appropriated
$130 million toward consummation of the Headwaters Agreement, and authorized the
expenditure of up to $80 million toward the acquisition at fair market value of
the Owl Creek grove. The bill also provided that if any portion of the $80
million remained after purchase of the Owl Creek grove, it could be used to
purchase certain other timberlands. Other provisions of the California
Headwaters Bill authorized the expenditure of up to $20 million for the purchase
of a portion of the Grizzly Creek grove, in which the timber is owned by Pacific
Lumber.
The California Headwaters Bill contained 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 analysis 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 analysis process within five years (on a watershed
by watershed basis), imposing minimum and maximum "no-cut" buffers upon the
completion of the watershed analysis process and designating the Company's Owl
Creek grove as a marbled murrelet conservation area. The California Headwaters
Bill also provided that the SYP should be subject to the foregoing provisions.
In July 1998, Pacific Lumber and the Company released the Combined Plan
for the purpose of public review and comment. The Combined Plan provided for,
among other things, certain measures designed to protect habitat for the marbled
murrelet and the northern spotted owl, and required Pacific Lumber to undertake
a specified watershed analysis process designed to result in site specific
protective zones for fish and other wildlife being established on the Company
Timberlands.
Beginning in December 1998, following the conclusion of the public review
and comment period, federal and state regulatory agencies began to propose
changes to the Combined Plan. These proposals, together with the California
Headwaters Bill, sought to impose more stringent restrictions and requirements,
reducing the amount of Company Timber that could be harvested as compared to the
amount contemplated by the Combined Plan. Certain of the agencies' proposals had
been previously considered and rejected by Pacific Lumber and the Company in the
course of negotiations concerning the Pre-Permit Agreement and the Combined Plan
as, among other things, being unduly restrictive on timber harvesting operations
on the Company Timberlands. As a result, on December 17, 1998, Pacific Lumber
announced that its negotiations with the regulatory agencies regarding these
proposed revisions had not produced agreement on a Multi-Species HCP, as Pacific
Lumber and the Company could not agree to certain of the proposed revisions and
continue to operate effectively. Negotiations continued through December without
the parties reaching an agreement, and on December 31, 1998, Pacific Lumber
announced that it could not concur with the terms of the then-current regulatory
proposals until the Final Plans were received, reviewed and
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analyzed. On January 22, 1999, the federal and state agencies published their
final EIR/EIS, which included a revised Multi-Species HCP containing many of the
restrictions to which Pacific Lumber had objected and certain other new
restrictions not agreed to by Pacific Lumber and the Company.
On February 5, 1999, the Board of Managers of the Company appointed its
independent managers to serve as members of a Special Committee (the "Special
Committee") to review and evaluate, and (if requested by the Board of Managers)
to make a recommendation and report to the Board of Managers with respect to,
the Headwaters Agreement. The Special Committee retained separate legal counsel
to assist it in its review. In addition, the Company retained a nationally
recognized investment banking firm to assist it in its evaluation of the
financial aspects of the Headwaters Agreement. Over the course of the succeeding
three-week period, the Special Committee, the full Board of Managers and their
financial and legal advisors met on numerous occasions to consider the
Headwaters Agreement.
On February 16, 1999, the Company and Pacific Lumber filed with the CDF
certain information regarding the final EIR/EIS and estimates of sustained
yield, harvest and economic impacts based on various scenarios giving effect to
the new proposed restrictions (the "CDF Filing"). The CDF Filing included
computer-modeled estimates indicating a range of possible average annual net
softwood harvest levels for the first decade of operations under the proposed
restrictions. Pacific Lumber stated in the CDF Filing that, based on its
estimates, minimum average annual harvest levels of 210 million board feet of
softwoods during the first decade were needed in order to generate income and
cash flows to meet interest and capital expenditure obligations; to provide a
minimum basis upon which to plan, adjust, budget and conduct future operations
so as to meet financial obligations and avoid additional layoffs, mill closings
and customer supply disruptions; and to satisfy other obligations to employees,
customers and creditors. On February 25, 1999, the CDF delivered a letter to
Pacific Lumber that in effect interpreted the final EIR/EIS and Final HCP to
limit the Company's projected average annual harvest levels during the first
decade to approximately 137 million board feet of softwoods. On February 26,
1999, Pacific Lumber announced that it could not proceed to consummate the
Headwaters Agreement based on these projected harvest levels and other factors.
On March 1, 1999, the CDF delivered a superseding letter to Pacific Lumber
approving the Final SYP and stating that, based upon further analysis and
information, the Company's projected base average annual harvest level during
the first decade, consistent with the Final HCP, could be approximately 179
million board feet of softwoods (not including timber harvestable from the
Additional Timber Property). Further, on the same date, the Company received
written clarification from the federal and state wildlife agencies that, among
other things, the adaptive management provision in the Final HCP would be
implemented on a timely and efficient basis, and in a manner that would be both
biologically and economically sound. See "--The Final Plans."
On March 1, 1999, the Special Committee recommended, after considering the
Headwaters Agreement and the alternatives available to the Company, that the
Company consummate the Headwaters Agreement. It was a condition of the Special
Committee's recommendation that the net proceeds from the sale of the Headwaters
Timberlands and the portion of the Grizzly Creek grove to be sold be deposited
in a restricted account or in a trust arrangement, be made available, while so
held, as necessary to support the Timber Notes, and be released only under
certain circumstances (see "Escrow Agreement"). After consideration of the
Special Committee's recommendation and all other relevant factors, the Board of
Managers voted unanimously to consummate the transactions contemplated by the
Headwaters Agreement.
The factors considered by the Board included the anticipated adverse
regulatory and environmental climate had the Headwaters Agreement not been
consummated, the March 1, 1999 clarifications from the regulatory agencies
referred to above, the funds to be available under the Escrow Agreement to
support the Timber Notes and potential increases in timber harvest levels. Under
the Final Plans, the Company's projected harvest level is approximately 179
million board feet per year for the first decade. The Company also anticipates
harvesting an additional approximately 6 million board feet of timber per year
from the Additional Timber Property. In addition, under applicable California
regulations, timber owners can harvest relatively minor amounts of timber in
excess of their projected average harvest levels for a given decade (not in
excess of ten percent of such amount) without amending the applicable SYP.
Assuming the Company can adjust operationally to the restrictions and conditions
imposed under the Final Plans, the Company believes, although there can be no
assurance, that it can achieve harvest levels under the Final Plans that will
allow it to meet its obligations under the Timber Notes without giving effect to
the use of funds now held under the Escrow Agreement.
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THE FINAL PLANS
As part of the consummation of the Headwaters Agreement, the Company and
Pacific Lumber reached agreement with various federal and state regulatory
agencies with respect to the Final Plans. The Final Plans include the Final HCP
and the Final SYP. The Final HCP provides for the issuance by state and federal
regulatory agencies of the Permits with respect to certain threatened,
endangered and other species, found on the Company Timberlands over a term of 50
years. The Permits issued under the Final HCP allow incidental takes of 17
different species covered by the Final HCP, including the coho salmon, the
marbled murrelet, the northern spotted owl and the steelhead trout.
The Final HCP has modified certain provisions of the Combined Plan
proposed in July 1998 and includes other provisions contemplated by the
California Headwaters Bill. Among other things, it no longer covers 19 of the
species which were included in the Combined Plan. The Final HCP also increased
the size of the marbled murrelet conservation areas, and has also adopted the
wider interim streamside "no cut" buffers contemplated by the California
Headwaters Bill. Pending completion of the watershed analysis, the Final HCP
also provides for "no cut" buffers adjacent to certain intermittent watercourses
on the Company Timberlands that flow only in response to significant
precipitation. The Company has not completed its analysis of the location of all
of the intermittent streams on its property. The areas set aside for streamside
buffers may be adjusted up or down, subject to certain minimum and maximum
buffers, based upon the watershed analysis process, which the Final HCP requires
be completed within five years of its effective date. The watershed analysis
will also be reassessed every five years.
The Final HCP also imposes certain restrictions on the use of roads on the
Covered Lands (as defined below) by Pacific Lumber and the Company during
several months of the year and during periods of wet weather, except for certain
limited situations. These restrictions may restrict operations on the Company
Timberlands so that many harvesting activities could generally only be carried
out from June through October of any particular harvest year, and then only if
wet weather conditions do not exist. However, the Company anticipates that some
harvesting will be able to be conducted during the other months. The Final HCP
also requires the Company and Pacific Lumber to stormproof 75 miles of roads on
the Covered Lands on an annual basis, and also to build and repair certain
roads. The Final HCP requires the stormproofing to be done between May 2 and
October 14 of each year, while the road building and repair is to be
accomplished between June 2 and October 14 of each year. The stormproofing and
road building and repair is also required to be suspended if certain wet weather
conditions exist.
The Final HCP contains an adaptive management provision, which various
regulatory agencies have clarified will be implemented on a timely and efficient
basis, and in a manner which will be both biologically and economically sound.
This provision allows Pacific Lumber or the Company to propose changes that are
consistent with the California Agreement (as defined below) to any of the Final
HCP prescriptions based on, among other things, certain economic considerations.
The regulatory agencies have also clarified that in applying this adaptive
management provision, to the extent the changes proposed by Pacific Lumber do
not result in the jeopardy of a particular species, the regulatory agencies will
consider the practicality of the suggested changes, including the cost to
Pacific Lumber and economic feasibility and viability.
IMPLEMENTING AGREEMENTS
In connection with consummation of the Headwaters Agreement, the Company,
Pacific Lumber and Salmon Creek (collectively, the "Companies") entered into
several implementing agreements, including an Implementation Agreement with
Regard to Habitat Conservation Plan (the "Implementation Agreement") among the
Companies and NMFS, USFWS, CDFG and the CDF (the "Agencies") to effectuate the
Final HCP. Pursuant to the Implementation Agreement, NMFS, USFWS and CDFG found
that the Final HCP met all applicable regulatory requirements and authorized the
issuance of the Permits. Each new THP on the Covered Lands to be submitted by
the Company is required to incorporate the provisions of the Final HCP. Timber
harvesting and certain other specified activities detrimental to the marbled
murrelet are prohibited for the life of the Permits in all of the marbled
murrelet conservation areas. Such activities are prohibited in the Grizzly Creek
grove for an initial five-year period to allow an opportunity for a portion of
the grove to be purchased. Timber harvesting and certain other specified
activities may take place in the Grizzly Creek grove after the initial five-year
period unless USFWS or CDFG, in conjunction with analysis from a scientific
panel, make certain determinations under the ESA and CESA regarding
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the effect on the marbled murrelet of these activities. If USFWS or CDFG make
such a determination, the Grizzly Creek grove is required to be managed as a
marbled murrelet conservation area.
Under the Implementation Agreement, the Companies are required to expend
such funds as may be necessary to fulfill each of their obligations under the
Final HCP and to post $2 million security to help secure certain of their
obligations under the Final HCP, which amount is subject to an annual inflation
index and is increased by the amount of any liquidated damages the Companies are
required to pay to California in the prior year pursuant to the California
Agreement. The Companies are also required to fund an independent third party to
monitor compliance with the Final HCP. In addition, the Companies are required
to use reasonable efforts to furnish such additional information as the Agencies
may request regarding the Final HCP. The Agencies also have the right to inspect
the Covered Lands and the records relating the Final HCP.
The Implementation Agreement permits the Companies to add up to 25,000
acres to the Final HCP so long as various conditions are satisfied, including
that the acreage to be added must be situated within one mile of the main
contiguous portion of the Covered Lands, which are defined in the Implementation
Agreement generally to include all timberlands owned by the Companies on the
date of the Implementation Agreement.
The Implementation Agreement provides that the Companies may relinquish
the Permits; provided that in the event of a relinquishment or revocation of the
Permits, the Companies must fully mitigate for the take of species that has
occurred prior to the relinquishment or revocation. The extent of the full
mitigation that would be required depends on a variety of circumstances. If it
is determined that the Companies must so mitigate for the prior take of species,
the Companies are required to execute a binding covenant running with the land,
in form and content satisfactory to the Agencies, setting forth such commitment.
The Companies also entered into a separate agreement regarding enforcement
of the California Headwaters Bill (the "California Agreement") with the
California Resources Agency, CDFG, the CDF and the California Wildlife
Conservation Board ("CWCB"). The California Agreement, among other things,
provides that the Companies shall not undertake any timber harvesting
detrimental to the marbled murrelet in conservation areas totaling approximately
7,700 acres for 50 years from the effective date of the California Agreement.
Pursuant to the requirements of the California Agreement, and in connection with
forestry, endangered species and environmental laws, rules and regulations, the
terms and conditions of the California Agreement were recorded at closing as
terms and conditions against the Covered Lands, to bind the Company and its
successors and assigns for a term of 50 years. The California Agreement further
provides for various remedies in the event of a breach of the agreement, the
Final HCP, the Implementation Agreement, the State Permit, the California
Headwaters Bill or any THP, including the issuance of written stop orders with
respect to specified harmful activities, and liquidated damages for various
breaches.
The California Agreement also provides that the Companies are liable to
the state for the reasonable costs of mitigation or similar work performed by
California as a "self-help" remedy in certain circumstances. The Companies are
also required to reimburse California for monitoring for compliance with the
agreement and to allow for inspection of timber harvesting activities. The
Companies are also required to post $2 million security under the California
Agreement (which is the same $2 million required, as described above, under the
Implementation Agreement). The California Agreement generally provides that
transfers of land are to be conducted in accordance with the Implementation
Agreement. The California Agreement also provides that it may not be amended
unless, among other things, certain California academic officials and a panel of
scientists have found the proposed amendment to be consistent with the ESA, the
Final HCP and the California Headwaters Bill.
OWL CREEK AND GRIZZLY CREEK AGREEMENTS
The California Headwaters Bill appropriated up to $80 million toward the
purchase of the Owl Creek grove from the Company, and up to an additional $20
million toward the purchase of a portion of the Grizzly Creek grove, as
specified by California, from Pacific Lumber. In connection with the
consummation of the Headwaters Agreement, California entered into agreements
with respect to the future purchase of the Owl Creek grove (the "Owl Creek
Agreement") and a portion of the Grizzly Creek grove (the "Grizzly Creek
Agreement").
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Under the Owl Creek Agreement, the Company agreed to sell the Owl Creek
grove to the state of California for consideration consisting of the lesser of
the appraised fair market value or $79.65 million. The state may pay the
consideration for the Owl Creek grove to the Company in cash or, at the state's
option, 25% in cash and the balance in three equal annual installments without
interest. Should the Company disagree with the methodology of the appraisal or
its application, or if the fair market value determined under the appraisal is
less than $79.65 million, the Company would have the right to terminate the Owl
Creek Agreement. California must purchase the Owl Creek grove by the later of
the state's fiscal year immediately following the fiscal year in which the state
purchases the Grizzly Creek property, or June 30, 2001. Consummation of the
purchase transaction under the Owl Creek Agreement is also subject to typical
real estate title and other closing conditions. The California Headwaters Bill
provides that the appraisal methodology, at the Company's option, may assume the
issuance of all necessary permits and approvals with respect to the Owl Creek
grove, including the Permits.
With respect to the potential Grizzly Creek transfer, Pacific Lumber and
the CWCB agreed that Pacific Lumber would transfer a portion of the Grizzly
Creek grove to the state of California at a purchase price not to exceed $19.85
million. Within thirty days of the effective date of the Grizzly Creek
Agreement, Pacific Lumber is to furnish a list of licensed appraisers to the
state for its consideration. The state is then to select an appraiser from this
list to determine the fair market value of the property, as specified by
California, with Pacific Lumber having the right to terminate the agreement if
it reasonably disagrees with the methodology employed with respect to the
appraisal or in the application of such methodology. The Grizzly Creek Agreement
contains customary representations and warranties, and provides that California
must purchase a portion of the Grizzly Creek grove by no later than October 31,
2000. Also pursuant to the terms of the Grizzly Creek Agreement, Pacific Lumber
granted the state of California a five-year option to purchase, at fair market
value, additional property within the Grizzly Creek grove. The Company owns the
land, but not the timber, on a portion of the Grizzly Creek property and would
receive a small portion of the proceeds from the sale based on the fair market
value of its land. Consummation of the purchase transaction under the Grizzly
Creek Agreement is also subject to typical real estate title and other closing
conditions. The net proceeds of the sale of the portion of the Grizzly Creek
grove to be sold will also be placed in escrow (on the same basis as the net
proceeds of the sale of the Headwaters Timberlands) unless, at the time of
receipt of such proceeds, funds are no longer on deposit under the Escrow
Agreement.
TIMBER OPERATOR'S LICENSE
On February 26, 1999, the CDF issued Pacific Lumber a conditional TOL for
calendar year 1999. The 1999 TOL requires, among other things, that harvesting
under the Company's approved THPs by Pacific Lumber, the Company and their
contractors will be governed by limitations that require non-emergency road use
activities to cease under certain wet weather conditions. These road use
restrictions are substantially similar to those applicable under the Final Plans
and the 1998 TOL. The 1999 TOL also provides that Pacific Lumber shall enhance
its compliance program by, among other things, providing training for its
logging personnel, increasing the size of its compliance team and retaining an
outside consulting firm to audit its compliance procedures and make
recommendations for improvement. Pacific Lumber has completed most of these
items. The 1999 TOL, among other things, also contains a requirement that
Pacific Lumber pay a conservation organization designated by the CDF three times
the value of any timber felled by Pacific Lumber or any other licensed timber
operator in any no-cut zone on the Company Timberlands. The 1999 TOL also
advises Pacific Lumber that should the 1999 TOL be revoked, the issuance of a
new conditional license, absent compelling circumstances, would be unlikely.
Pacific Lumber does not believe that the restriction imposed by the 1999 TOL
will have a material adverse effect on its, or the Company's, business or
financial performance. See page 18 of the Prospectus under the heading
"Summary--Pacific Lumber."
CERTAIN LEGAL PROCEEDINGS
With the consummation of the Headwaters Agreement, the Company, Pacific
Lumber and Salmon Creek made the necessary filings to dismiss with prejudice the
pending Takings Litigation. The Company believes that the consummation of the
Headwaters Agreement will enhance the Company's position with respect to the
COHO LAWSUIT, EPIC LAWSUIT and other similar lawsuits in the future. The
Companies are seeking to dismiss the EPIC LAWSUIT as moot based on the
consummation of the Headwaters Agreement, the implementation of the Final HCP
and the conclusion of the consultation requirements. On March 15, 1999, the
Court affirmed its preliminary injunction until it reaches a decision on the
merits of the EPIC LAWSUIT. However, subsequent to this ruling, the Court heard
the
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defendants' motion for summary judgment on the merits of the case, and issued an
order for the plaintiffs to show cause why the lawsuit should not be dismissed
as moot since the consultation requirement appears to have been concluded.
However, the Company is unable to predict the outcome of this case or the COHO
LAWSUIT, the timing of such, or their ultimate impact, if any, on the Company's
financial condition or results of operations, or the ability to harvest timber
under the Company's THPs.
On or about January 29, 1999, the Company received a letter from two
private environmental advocacy groups of their 60-day notice of intent to sue
the Company, Pacific Lumber, several of the federal and state agencies and
others under the ESA. The letter alleges various violations of the ESA, and
challenges, among other things, the validity and legality of the Permits issued
in conjunction with the Final Plans. The Company does not know when or if a
lawsuit will be filed by the groups regarding these matters, or if a lawsuit is
filed, the ultimate impact of such lawsuit on the Final Plans or the Company's
financial condition or results of operations.
RECENT OPERATING RESULTS
SELECTED 1998 AND 1997 OPERATING AND FINANCIAL INFORMATION
The following summary of unaudited historical financial data for each of
the years in the two year period ended December 31, 1998 should be read in
conjunction with the information contained in "Management's Discussion and
Analysis of Financial Condition and Results of Operations" below.
SCOTIA PACIFIC COMPANY LLC
SELECTED OPERATING AND FINANCIAL INFORMATION
(DOLLARS IN MILLIONS EXCEPT DELIVERIES AND AVERAGE SALES PRICES)
YEAR ENDED DECEMBER 31,
------------------------
1998 1997
---------- ----------
Log deliveries (Mbfe) .............................. 115,700 182,300
========== ==========
Average sales price per Mbfe ....................... $ 694 $ 693
========== ==========
Log sales to Pacific Lumber ........................ $ 80.3 $ 126.4
---------- ----------
Operating expenses:
General and administrative expenses ............. 9.1 8.3
Depletion and depreciation ...................... 11.3 16.8
---------- ----------
20.4 25.1
---------- ----------
Operating income ................................... 59.9 101.3
Other income (expense):
Interest and other income ....................... 2.5 2.8
Interest expense ................................ (43.9) (27.3)
---------- ----------
Income before income taxes ......................... 18.5 76.8
Provision in lieu of income taxes .................. (7.6) (31.2)
---------- ----------
Income before extraordinary item ................... 10.9 45.6
Extraordinary item:
Loss on early extinguishment of debt ............ (35.4) --
---------- ----------
Net income (loss) .................................. $ (24.5) $ 45.6
========== ==========
Results from operations for 1998 reflect interest expense on the Old
Timber Notes until July 19, 1998 and on the Timber Notes thereafter. Had the
Timber Notes been outstanding for the full year, the Company would have incurred
interest expense of $65.3 million and would have had a loss before income taxes
in 1998 of $4.5 million. Cash flows available for debt service (after capital
expenditures) would have been slightly more than that needed to pay interest on
the Timber Notes.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
SEASONALITY. Logging operations on the Company's timberlands are highly
seasonal and have historically been significantly higher in the months of April
through November than in the months of December through March. Management
expects that the Company's revenues and cash flows will continue to be markedly
seasonal. The Company's seasonality is expected to become more pronounced than
it has historically been because of the harvesting, road use, wet weather and
other restrictions imposed by the Final HCP. As a result, a substantial majority
of the future harvesting on the Company Timberlands can be expected to be
concentrated during the period from June through October of each year. Some of
these restrictions may be modified under the adaptive management provision
contained in the Final HCP, and as a result of the watershed analysis process to
be performed over the five-year period beginning March 1, 1999. See
"--Regulatory and Environmental Matters; The Headwaters Agreement--The Final
Plans." However, the Company can give no assurances that such modifications to
the Final HCP will be achieved, and that the Company will not continue to
experience such seasonal restrictions on its operations for the remainder of the
term of the Timber Notes.
LOG SALES TO PACIFIC LUMBER. The Company's revenues from log sales
declined from $126.4 million for the year ended December 31, 1997 to $80.3
million for the year ended December 31, 1998 as a result of the decrease in the
volume of log deliveries for such periods from 182,300 Mbfe to 115,700 Mbfe,
respectively. The well-above-normal rainfall during the first half of 1998 and
additional restrictions on wet weather operations pursuant to the terms of the
1998 TOL, together with logging restrictions during the nesting seasons for both
the northern spotted owl and the marbled murrelet, were the principal factors
that impeded logging operations on the Company Timberlands during the first half
of 1998. Revenues for the second half of 1998 were primarily affected by a
reduction in the volume of logs harvested as a result of the factors discussed
below.
The reduced level of logging activities on the Company Timberlands during
the second half of 1998 was due in substantial part to the absence of a
sufficient number of THPs available for harvest to enable the conduct of
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 second half of 1998 as well as regulatory and judicial
restrictions imposed upon harvesting activities in areas covered by previously
approved THPs. The reduced number of approved THPs was, and continues to be,
attributable to several factors, including a significantly reduced level of THPs
submitted by the Company to the CDF during 1998 and the first two months of 1999
due to (a) the extensive amount of time devoted by the Company'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, responding to
comments on the Combined Plan, and assessing and responding to federal and state
proposals and changes concerning the Combined Plan and incorporated into the
Final Plans, (iii) responding to comments received by the Company from various
federal and state governmental agencies with respect to its filed THPs in light
of the new and more stringent requirements that Pacific Lumber agreed to observe
pursuant to the Pre-Permit Agreement and (iv) assisting Pacific Lumber (in
accordance with the New Additional Services Agreement) with responding to newly
filed litigation involving certain of the Company's approved THPs 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
the Company's THPs prior to submission to the CDF. The Company 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 emerged in applying the
new requirements embodied in the Pre-Permit Agreement to the Company's THPs,
certain of which requirements imposed new forestry practices that applied solely
to operations on the Company Timberlands. As a result of the factors discussed
above, the Company's inventory of approved THPs was severely diminished at March
1, 1999, which limited, and continues to limit, its ability to conduct
harvesting operations on the Company Timberlands.
With the consummation of the Headwaters Agreement, Pacific Lumber has
completed its work in connection with preparation of the Final Plans; however,
significant additional work will be required in connection with its
implementation. The remainder of 1999 will be a transition year for the Company
with respect to the filing and approval of its THPs. Certain of the THPs which
were approved by the CDF prior to March 1, 1999 were grandfathered under the
Final Plans, and are harvestable subject to the harvesting restrictions
prescribed under the THPs and satisfaction of certain agreed conditions. The
remaining THPs which were in the process of being
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reviewed but were not yet approved by the CDF at the time of the consummation of
the Final Plans each require varying degrees of revisions in order to comply
with the requirements of the Final Plans. The rate of submissions of THPs and
the review and approval of THPs during the next quarter may be slower than the
Company has historically experienced as the Company and the CDF develop
procedures for implementing the Final Plans. Accordingly, the Company believes
that its rate of new THP submissions will not increase until some time in the
second or third quarter of 1999. Nevertheless, the Company anticipates that
after a transition period, the implementation of the Final Plans will streamline
the process of preparing THPs and potentially shorten the time required to
obtain approval of THPs. However, there can be no assurance that the Company
will not continue to experience difficulties in submitting and receiving
approvals of its THPs similar to those difficulties it has been experiencing.
OPERATING INCOME AND INCOME BEFORE INCOME TAXES. Operating income was
$59.9 million and $101.3 million for the years ended December 31, 1998 and 1997,
respectively. Income before income taxes was $18.5 million and $76.7 million for
the years ended December 31, 1998 and 1997, respectively. The decline in
operating income and income before income taxes is principally due to the
decrease in log sales discussed above, offset by a decline in depletion expense
attributed to the decrease in harvest volumes between periods. General and
administrative expenses were higher for the year ended December 31, 1998
compared to 1997 primarily due to increased fees for professional services
relating to THP preparation and road maintenance costs provided for under the
New Services Agreement, but were partially offset by lower yield taxes which
vary directly with the volume of log harvest. In addition to the impact from
lower operating income, income before income taxes also declined between periods
due to the higher interest expense resulting from the increase in debt from the
Timber Notes.
LIQUIDITY AND CAPITAL RESOURCES. The Company had sufficient cash on hand
to pay the interest due on the Timber Notes on the January 20, 1999 payment
date, but did not have sufficient additional cash to pay Minimum Principal
Amortization or Scheduled Amortization. Nonetheless, the Company paid $5.4
million of principal on the Timber Notes (the amount equal to Scheduled
Amortization) using funds provided as a capital contribution by Pacific Lumber,
which in turn received a $5.0 million capital contribution from its indirect
parent, MGI.
The Company believes that it will not generate sufficient cash from
operations to pay interest on the Timber Notes on the July 20, 1999 payment
date. However, the Company expects that funds sufficient to meet debt service
obligations on the Timber Notes during 1999 will either be made available from
funds borrowed under the Line of Credit Agreement, through capital contributions
from Pacific Lumber or a direct or indirect parent corporation, or from the use
of funds now held under the Escrow Agreement.
With respect to long-term liquidity, the Company believes that, without
giving effect to any use of the funds now held under the Escrow Agreement, its
existing cash and funds available under the Line of Credit Agreement, together
with its ability to generate sufficient levels of cash flows from operations
over the long term, should provide sufficient funds to meet its long-term
working capital, capital expenditures and required debt service obligations. If
the Company generates excess funds after the payment of operating expenses,
capital expenditures, interest, Premiums and required principal payments, it may
at its option either pay dividends, retain these funds for internal purposes or
make voluntary principal payments. The Company has prepared preliminary
estimates of its cash flows from operations and its ability to pay interest and
principal over the term of the Timber Notes based on the current expectations of
harvest levels under the Final Plans but excluding the effect of any use of
funds now held under the Escrow Agreement. These estimates indicate that: (i)
through the January 20, 2014 Note Payment Date, the required amortization of the
Timber Notes would be at the principal payments shown in the Minimum Principal
Amortization Schedules for all but the three Note Payment Dates ending with the
January 20, 2001 Note Payment Date, but would be below the principal payments
shown in the Scheduled Amortization Schedules, and (ii) required amortization
would result in the Timber Notes being fully amortized prior to the July 20,
2028 final maturity date. These estimates also indicate that, after the January
20, 2014 Note Payment Date (which is the Scheduled Maturity Date for the Class
A-2 and the Class A-3 Timber Notes), the required amortization of the Timber
Notes would exceed the principal payments shown on the Minimum Principal
Amortization Schedules. However, there can be no assurance that the Company will
be able to achieve these results. Cash flows from operations may continue to be
adversely affected if the Company does not experience improvements in the THP
submission and approval process, or if inclement weather conditions or seasonal
operating restrictions under the Final HCP hamper harvesting operations. Cash
flows from operations would also be adversely affected if additional judicial or
regulatory
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restrictions are imposed on the Company's harvesting activities, or if the Final
Plans are not implemented in accordance with the Company's current expectations.
PRELIMINARY 1999 INFORMATION
As a result of road use and other restrictions on logging operations
during wet weather and the diminished inventory of available THPs, the Company's
timber harvest during January and February 1999 continued to be at the low
levels experienced during the same period in 1998.
The Company had an inventory of approved THPs for the harvesting of
approximately 41,000 Mbfe of timber as of March 1, 1999, subject to satisfaction
of certain agreed conditions. The Company anticipates that, upon expiration of
the restricted period of road use imposed under the Final HCP, and given
favorable weather conditions, the Company should be able to resume more normal
harvesting activities in June 1999. However, the Company expects that its
experience in implementing the Final Plans will make it better able to analyze
the impact of such restrictions on its future harvesting operations, including
its ability in the near term to harvest timber under approved THPs.
PACIFIC LUMBER
RECENT OPERATING RESULTS
Pacific Lumber's operating results for the year ended December 31, 1998
were also adversely affected by the factors described under "The Company--Recent
Operating Results" above, and its 1999 results will be adversely affected by the
decrease in log and lumber inventories. Pacific Lumber has terminated or laid
off over 200 employees in 1999, and more layoffs will be required. In addition,
Pacific Lumber has partially curtailed operations at all of its mills. Pacific
Lumber expects that such curtailments will continue for several months until
such time as log inventories are adequate to achieve normal lumber production
levels. Lumber shipments in 1999 are expected to be adversely affected by this
slowdown in production.
LIQUIDITY AND CAPITAL RESOURCES
Pacific Lumber expects that near term cash flows from operations will be
adversely affected by the inadequate supply of logs and the slowdown in lumber
production. Furthermore, Pacific Lumber does not expect to receive any dividends
from the Company in 1999, and borrowings available under the Pacific Lumber
Credit Agreement will decrease significantly from the $27.5 million available as
of December 31, 1998 due to a decline in receivables and inventories required to
secure the facility. As a result of the consummation of the Headwaters
Agreement, Salmon Creek, Pacific Lumber's wholly owned subsidiary, received
$299,850,000 in cash (before deducting closing costs). Approximately
$285,000,000 of these proceeds have been deposited in an escrow account pursuant
to the Escrow Agreement to support the Timber Notes, and are not available for
distribution to Pacific Lumber unless and until they are released from escrow in
accordance with the terms of the Escrow Agreement.
See "Escrow Agreement."
Pacific Lumber anticipates that cash flows from operations together with
funds available under the Pacific Lumber Credit Agreement (but excluding any
possible funds which may be released under the Escrow Agreement) will not be
adequate to meet its working capital and capital expenditure requirements for
1999 and it anticipates that contributions will be made by its indirect parent,
MGI, to meet such shortfalls. With respect to long-term liquidity, Pacific
Lumber expects that, until such time as there are adequate dividends from the
Company or a determination is made that all or a significant portion of the
funds now held under the Escrow Agreement can be released, it will be dependent
upon its parent to meet some portion of its working capital and capital
expenditure requirements.
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AMORTIZATION AFTER GIVING EFFECT TO THE HEADWATERS TRANSACTION
Provisions of the Final Plans impose significant harvesting and operating
restrictions and are expected to reduce the amount of Company Timber that may be
harvested, particularly in the first year or two of operations under the Final
Plans while the Company makes the operational and logistical adjustments
necessary to operate effectively under the Final Plans. The Company also
anticipates that it will experience higher operating costs as a result of the
Final Plans, and will sell a somewhat higher proportion of smaller diameter and
lower quality logs, resulting in a lower per board foot average purchase price,
than the Company had anticipated under its original Combined Plan.
The Company now expects that, through the January 20, 2001 Note Payment
Date, the actual rate of amortization of the Timber Notes will generally be
slower than that indicated on the Minimum Principal Amortization Schedules
without giving effect to any use of the funds now held under the Escrow
Agreement. The Company believes, although there can be no assurance, that, after
the January 20, 2001 Note Payment Date, without giving effect to any use of the
funds now held under the Escrow Agreement, it will generate sufficient cash from
operations to pay interest and Minimum Principal Amortization on the Timber
Notes, and will further generate excess funds which the Company could use to
make voluntary principal payments on the Timber Notes, retain for its own use or
distribute as dividends to its parent, Pacific Lumber. If the Owl Creek grove is
sold as currently contemplated under the Owl Creek Agreement, the Company will
not be required to make significant additional principal payments on the Timber
Notes, and the funds received in connection with any such sale would generally
be available to the Company to make voluntary principal payments on the Timber
Notes, to be retained for its own use, or to be distributed as a dividend to
Pacific Lumber.
The assumptions made in the Structuring Cash Flows were made solely for
purposes of generating the Structuring Cash Flows and structuring the
transaction. Accordingly, they were not updated in connection with the offering
of the New Notes (and the Company does not intend to update them for any other
purpose).
The Company has performed a preliminary analysis of the provisions of the
Final Plans in order to compare those provisions to the assumptions made in
connection with the preparation of the Initial Harvest Schedule and the other
Scheduled Assumptions (set forth on pages 68 through 70 of the Prospectus), and
to assess the estimated impacts on the Company's anticipated future harvest
levels and cash flows. The following summarizes that analysis and comparison:
(i) based on the restrictions in the Final Plans and the Company's current
estimates, the Company currently believes, although there can be no assurance,
that it could reasonably expect to harvest and sell, for each of the periods set
forth in the following table, the average amount of timber per year set forth in
such table under the column "Preliminary Analysis of Final Plans" (the
comparable average amounts of timber per year assumed in the Scheduled
Assumptions to be harvested and sold in each such year is set forth in the
following table under the column "Scheduled Assumptions"):
PRELIMINARY ANALYSIS SCHEDULED
OF FINAL PLANS ASSUMPTIONS
-------------------- ------------
July 1998 through December 2007 (9.5 years) . 138,500 Mbfe 162,274 Mbfe
January 2008 through December 2017 (10 years) 117,100 Mbfe 132,131 Mbfe
January 2018 through June 2028 (10.5 years) . 79,500 Mbfe 87,692 Mbfe
(ii) operating expenses in the initial year are currently assumed to be $12.0
million (of which less than 10% is assumed to vary with harvest) rather than
$6.9 million (of which $3.5 million was assumed to vary with harvest) to reflect
the additional personnel, road maintenance and other expenses required primarily
to comply with the Final HCP, (iii) capital expenditures in the initial year are
currently assumed to be $8.9 million (of which less than 10% is assumed to vary
with harvest) rather than $7.7 million (of which $5.6 million was assumed to
vary with harvest) primarily to reflect the increase in the annual requirement
to storm proof roads under the Final HCP to 75 miles per year from the
previously expected 50 miles per year, and (iv) the composition of harvested old
growth redwood and Douglas fir has been adjusted to reflect the somewhat higher
percentage of smaller diameter and lower quality logs currently expected under
the Final Plans, with the result that the average realized price per Mbfe would
be lower
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than that assumed in the Scheduled Assumptions by approximately 2.9% in the
period from July 1998 through December 2007 and by less than 1% thereafter.
In preparing its preliminary analysis, the Company assumed that in each
year after 2000 it would achieve harvests from the Covered Lands at the level
permitted under the Final SYP without amendment, as well as harvests from the
Additional Timber Property. As discussed above, the Company faces a number of
uncertainties in operating under the Final Plans, including uncertainties in
predicting the effects of significant regulatory restrictions and requirements
imposed pursuant to the Final Plans. No assurance can be given that the Company
will obtain approved THPs authorizing it to harvest at the level permitted under
the Final SYP, or even if such approved THPs are obtained, that the Company will
be able to harvest at such levels under the operating conditions applicable
under the Final Plans.
Applying the Scheduled Assumptions for purposes of estimating payment and
weighted average life scenarios, but substituting the updated assumptions
discussed above (and without giving effect to any potential utilization of funds
now held under the Escrow Agreement), the Company has estimated that: (i) the
weighted average life and final maturities of the Class A-1 Notes would be 6.8
and 11.5 years, respectively, compared to 5.0 and 8.5 years, respectively, based
on the Scheduled Assumptions utilized in July 1998; (ii) the weighted average
life and final maturity of the Class A-2 Notes, assuming no refinancing in 2014,
would be 15.7 and 18.5 years, respectively, compared to 12.4 and 15.5 years,
respectively, based on the Scheduled Assumptions; and (iii) the weighted average
life and final maturity of the Class A-3 Notes, assuming no refinancing in 2014,
would be 24 and 28.5 years, respectively, rather than 18.7 and 21.5 years,
respectively, based on the Scheduled Assumptions. A substantial portion of the
change in weighted average life and final maturity is attributable to the
decrease in assumed harvest levels and the increase in assumed operating
expenses.
THE ASSUMPTIONS AND ESTIMATES SET FORTH ABOVE ARE NOT INTENDED TO BE
PROJECTIONS OR FORECASTS, BUT, RATHER, SIMPLY REFLECT THE RESULTS OF
MATHEMATICAL CALCULATIONS UTILIZING THE ASSUMPTIONS AND METHODOLOGIES DESCRIBED
ABOVE. THESE ASSUMPTIONS DO NOT REPRESENT A COMPLETE LIST OF FACTORS WHICH MAY
AFFECT THE REVENUES, COSTS AND CAPITAL EXPENDITURES OF THE COMPANY OR THE
AMORTIZATION OF THE TIMBER NOTES, BUT RATHER INDICATE THOSE FACTORS WHICH ARE
LIKELY TO SIGNIFICANTLY AFFECT THE PERFORMANCE OF THE COMPANY IN FUTURE YEARS.
THE COMPANY DOES NOT INTEND TO UPDATE OR REVISE THE INFORMATION PRESENTED
ABOVE TO REFLECT THE RESULTS OF ANY CHANGES OCCURRING AFTER THE DATE OF THIS
SUPPLEMENT, INCLUDING ANY CHANGES RELATING TO ANY POTENTIAL FUTURE USE OF FUNDS
DEPOSITED PURSUANT TO THE ESCROW AGREEMENT. IT IS HIGHLY LIKELY THAT ACTUAL
EXPERIENCE WILL VARY FROM THE ASSUMPTIONS AND POSSIBLE CASH FLOW AND
AMORTIZATION DISCUSSED ABOVE. IN PARTICULAR, IF ACTUAL HARVEST LEVELS OR PRICES
ARE LOWER THAN THOSE ASSUMED, OR ACTUAL OPERATING EXPENSES OR CAPITAL
EXPENDITURES ARE HIGHER THAN THOSE ASSUMED, THE WEIGHTED AVERAGE LIVES AND FINAL
MATURITIES COULD BE LONGER OR, IN CERTAIN CASES, THERE COULD BE AN EVENT OF
DEFAULT.
ESCROW AGREEMENT
As a result of the sale of the Headwaters Timberlands on March 1, 1999,
Salmon Creek received proceeds of $299,850,000 in cash, prior to payment of
closing costs and expenses. In accordance with the recommendation of the Special
Committee of the Board of Managers of the Company described above under "The
Company--Regulatory and Environmental Matters; The Headwaters Agreement" and
pursuant to an Escrow Agreement among Salmon Creek, Pacific Lumber and an escrow
agent (the "Escrow Agent"), Salmon Creek has deposited approximately $285
million of such proceeds into a restricted account (the "Escrowed Funds"), which
Escrowed Funds will be made available, while so held in escrow, as necessary to
support the Timber Notes with the balance of approximately $15 million to be
retained to defray expenses in connection with negotiation and consummation of
the Headwaters Agreement. In the event that the expenses in connection with the
negotiation and consummation of the Headwaters Agreement are less than $15
million, the remaining unused portion of the $15 million estimated expense
amount is to be added to the Escrowed Funds. For purposes of this calculation,
expenses include the amount of any security posted within 90 days after the
consummation of the Headwaters Agreement pursuant to the Implementation
Agreement, the California Agreement or any other contemporaneous agreements. The
net proceeds of the sale of the portion of the Grizzly Creek grove to be sold
will also be placed in escrow (on the same basis as
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the net proceeds of the sale of the Headwaters Timberlands) unless, at the time
of receipt of such proceeds, funds are no longer on deposit under the Escrow
Agreement.
Under the Escrow Agreement, the Escrowed Funds will be released by the
Escrow Agent only in accordance with resolutions duly adopted by the Board of
Managers of the Company and, unless the resolutions authorize the payment of
funds exclusively to, or to the order of, the Trustee or the Collateral Agent
under the Indenture, only if one or more of the following conditions is
satisfied: (a) the resolutions authorizing the release of the Escrowed Funds are
adopted by a majority of the Board of Managers of the Company (including the
affirmative vote of the two independent managers); (b) a Rating Agency
Confirmation (as defined in the Indenture) has been received that gives effect
to the release or disposition of funds directed by the resolutions; or (c) the
Company has received an opinion from a nationally recognized investment banking
firm to the effect that, based on the revised harvest schedule and the other
assumptions provided to such firm, the funds that would be available to the
Company based on such harvest schedule, assumptions and otherwise under the
Indenture after giving effect to the release or disposition of funds directed by
such resolutions would be adequate (i) to pay Scheduled Amortization (as defined
in the Indenture) on the Class A-1 and Class A-2 Timber Notes and (ii) to
amortize the Class A-3 Timber Notes on a schedule consistent with the original
harvest schedule as of July 9, 1998 (assuming that the Class A-3 Timber Notes
are not refinanced on January 20, 2014).
The Escrow Agreement provides that the Escrowed Funds are to be invested,
as Salmon Creek shall instruct, in various specified types of investment grade
securities or as approved by a majority vote of the Board of Managers of the
Company (including the affirmative vote of the two independent managers). Income
received from such investments will be added to the Escrowed Funds. The Escrow
Agreement also contains typical provisions exculpating the Escrow Agent and
providing that its duties are ministerial in nature.
RATINGS
The Timber Notes were given the following ratings at the time of their
issuance:
RATING FOR
----------------------------------------
RATING AGENCY CLASS A-1 CLASS A-2 CLASS A-3
------------- --------- --------- ---------
Moody's......................... A1 A3 Baa2
S&P............................. A A BBB
THE RATINGS ON THE TIMBER NOTES ADDRESS ONLY THE PAYMENT OF INTEREST WHEN
DUE AND THE PAYMENT OF ALL PRINCIPAL BY JULY 20, 2028 (THE "FINAL MATURITY
DATE") AND DO NOT ADDRESS PAYMENT OF PRINCIPAL AT ANY FASTER RATE OR THE PAYMENT
OF ANY PREMIUM OR INTEREST ON PREMIUM. A SECURITY RATING IS NOT A RECOMMENDATION
TO BUY, SELL OR HOLD SECURITIES, AND SUCH RATINGS MAY BE SUBJECT TO REVISION OR
WITHDRAWAL AT ANY TIME.
On November 24, 1998, Moody's announced that it has placed the Timber
Notes on review for possible downgrade of their assigned rating. Moody's
indicated that its rating action was prompted by the suspension by the CDF of
Pacific Lumber's 1998 TOL on November 10, 1998. On February 24, 1999, Moody's
announced that, given its continuing concerns about the status of Pacific
Lumber's TOL, as well as its concerns regarding the status of negotiations on
the Headwaters transactions and proposed changes to the Combined Plan, it was
maintaining its review of the Timber Notes for possible downgrade. A copy of
Moody's announcement is attached to this Supplement as Exhibit A.
On February 18, 1999, Standard & Poor's Corp. announced that it had placed
the Timber Notes on CreditWatch with negative implications. Standard & Poor's
indicated the CreditWatch placement had been prompted by the potential
set-asides and harvesting restrictions being proposed under the Headwaters
Agreement. Standard & Poor's indicated that if the Headwaters Agreement was
consummated, it would review the final closing documents related to the
transaction to determine if further action was required. A copy of the Standard
and Poor's announcement is attached to this Supplement as Exhibit B.
The Company intends to begin meeting with the Rating Agencies in the near
future regarding various matters related to the ratings of the Timber Notes.
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<PAGE>
EXHIBIT A
New York -- Feb 24 -- Moody's today released the following comment:
New York New York
Maureen Coen Everett Rutan
Managing Director Vice President - Senior Analyst
Structured Finance Group Structured Finance Group
Moody's Investors Service Moody's Investors Service
JOURNALISTS: (212) 553-0376 JOURNALISTS: (212) 553-0376
SUBSCRIBERS: (212) 553-1653 SUBSCRIBERS: (212) 553-1653
MOODY'S MAINTAINS REVIEW ON SCOTIA PACIFIC TIMBER
COLLATERALIZED NOTES
$867 MILLION OF ASSET BACKED NOTES AFFECTED
New York, <Rating Date Pending> -- On November 24, Moody's placed the
three classes of Timber Collateralized Notes issued by Scotia Pacific Company
LLC (Scotia) on review for possible downgrade. The securities affected are:
$160.700 MM 6.55% Class A-1 Timber Collateralized Notes rated A1
$243.200 MM 7.11% Class A-2 Timber Collateralized Notes rated A3
$463.348 MM 7.71% Class A-3 Timber Collateralized Notes rated Baa2
Moody's rating action was prompted by the fact that on November 10 the
California Department of Forestry and Fire Protection (CDF) suspended the timber
operator's license of The Pacific Lumber Company (Palco) for continued
violations of forest practice rules. The impact of the license suspension has
been minimized by Palco's use of contract loggers to maintain production.
Furthermore, Palco's 1999 timber license is expected to be issued in the near
future.
Moody's is also concerned with the status of the negotiations between Scotia,
Palco and state and federal regulatory authorities over the sale of the
Headwaters forest and approval of the Habitat Conservation Plan and
Sustained Yield Plan (HCP/SYP). While the Headwaters forest is not owned
by Scotia, and its sale does not directly benefit investors, the sale is
contingent on acceptance of the HCP/SYP, which requires Scotia's consent. A
variety of changes in the HCP/SYP, which were not envisioned when the
transaction was structured last year, may result from these negotiations.
These changes may reduce the expected timber harvest from the Scotia
properties, and therefore reduce the cash flow available to service the debt.
Inability to reach an agreement on the HCP/SYP and the Headwaters sale would
increase the uncertainty regarding future allowable timber harvests, which would
not be governed by comprehensive conservation and forestry plans.
Moody's is maintaining its review of the Scotia notes for possible
downgrade until the results of the Headwaters negotiations and their effect on
the credit quality of the Scotia notes become clear. The availability of federal
funding for the Headwaters sale expires March 1. Moody's is monitoring the
process closely, and will continue to keep investors informed.
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EXHIBIT B
New York -- Feb 17 -- Standard and Poor's Corp. today released the following
comment:
* * *
Standard & Poor's today placed its ratings on Scotia Pacific Company LLC's
timber collateralized notes on CreditWatch with negative implications (see list
below).
The CreditWatch placement reflects the potential for the transaction to be
adversely impacted by the "Headwaters Agreement," which is in its final stages
of negotiation between the government and Maxxam and its subsidiary the Pacific
Lumber Co. While consummation of the agreement is uncertain, harvesting
restrictions and set-asides proposed by federal and California state regulators,
not originally contemplated, would cause a decrease in original harvest
assumptions. This could impact the required principal amortization and could
potentially negatively impact collateral values and/or cashflows.
As Maxxam and Pacific Lumber continue to negotiate and assess its options,
Standard & Poor's will review the final agreement to determine the impact, if
any, on the transaction.
OUTSTANDING RATINGS PLACED ON CREDIT
WATCH WITH NEGATIVE IMPLICATIONS
RATING
Class A-1 $160.700 million timber collateralized notes A
Class A-2 $243.200 million timber collateralized notes A
Class A-3 $463.348 million timber collateralized notes BBB
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