UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
---------------
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1997 Commission File Number 1-8857
MAXXAM GROUP INC.
(Exact name of Registrant as Specified in its Charter)
DELAWARE 13-1310680
(State or other (I.R.S. Employer
jurisdiction Identification Number)
of incorporation or
organization)
5847 SAN FELIPE, SUITE 2600 77057
HOUSTON, TEXAS (Zip Code)
(Address of Principal
Executive Offices)
Registrant's telephone number, including area code: (713) 975-7600
---------------
Securities registered pursuant to Section 12(b) of the Act:
None.
Securities registered pursuant to Section 12(g) of the Act:
None.
---------------
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that the Registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days.
Yes /X/ No / /
All of the Registrant's voting stock is held by an affiliate of the
Registrant.
Number of shares of Common Stock outstanding at March 15, 1998: 100
REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION
(J)(1)(A) AND (B) OF FORM 10-K AND IS THEREFORE FILING THIS FORM WITH THE
REDUCED DISCLOSURE FORMAT.
DOCUMENTS INCORPORATED BY REFERENCE:
Not applicable.
TABLE OF CONTENTS
PART I
Item 1. Business 2
Item 2. Properties 13
Item 3. Legal Proceedings 13
Item 4. Submission of Matters to a Vote of Security Holders 15
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 15
Item 6. Selected Financial Data 15
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 15
Item 8. Financial Statements and Supplementary Data
Report of Independent Public Accountants 20
Consolidated Balance Sheet 21
Consolidated Statement of Operations 22
Consolidated Statement of Cash Flows 23
Notes to Consolidated Financial Statements 24
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 36
PART III
Items
10-13. Not applicable.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K 36
PART I
ITEM 1. BUSINESS
GENERAL
MAXXAM Group Inc. (the "Company" or "MGI") is a wholly owned
subsidiary of MAXXAM Group Holdings Inc. ("MGHI"), which in turn is a
wholly owned subsidiary of MAXXAM Inc. ("MAXXAM"). The Company engages in
forest products operations through its wholly owned subsidiaries, The
Pacific Lumber Company and its wholly owned subsidiaries (collectively
referred to herein as "Pacific Lumber," unless the context indicates
otherwise), and Britt Lumber Co., Inc. ("Britt"). Pacific Lumber's
principal wholly owned subsidiaries are Scotia Pacific Holding Company
("Scotia Pacific") and Salmon Creek Corporation ("Salmon Creek"). As used
herein, the terms "Company" or "MGI," "MGHI," "Pacific Lumber" or "MAXXAM"
refer to the respective companies and their subsidiaries, unless otherwise
noted or the context indicates otherwise.
Pacific Lumber, which has been in continuous operation for over
125 years, engages in several principal aspects of the lumber industry--the
growing and harvesting of redwood and Douglas-fir timber, the milling of
logs into lumber products and the manufacturing of lumber into a variety of
value-added finished products. Britt manufactures redwood fencing and
decking products from small diameter logs, a substantial portion of which
Britt acquires from Pacific Lumber (as Pacific Lumber cannot efficiently
process them in its own mills).
This Annual Report on Form 10-K contains statements which
constitute "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. These statements appear in a
number of places (see Item 1. "Business--Regulatory and Environmental
Factors and Headwaters Agreement," Item 3. "Legal Proceedings," and Item
7. "Management's Discussion and Analysis of Financial Condition and Results
of Operations--Background," "--Financial Condition and Investing and
Financing Activities" and "--Trends"). Such statements can be identified
by the use of forward-looking terminology such as "believes," "expects,"
"may," "estimates,""will," "should," "plans" or "anticipates" or the
negative thereof or other variations thereon or comparable terminology,
or by discussions of strategy. Readers are cautioned that any such forward-
looking statements are not guarantees of future performance and involve
significant risks and uncertainties, and that actual results may vary
materially from those in the forward-looking statements as a result of
various factors. These factors include the effectiveness of management's
strategies and decisions, general economic and business conditions,
developments in technology, new or modified statutory or regulatory
requirements and changing prices and market conditions. This report
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.
PACIFIC LUMBER OPERATIONS
Timberlands
Pacific Lumber owns and manages approximately 202,000 acres of
virtually contiguous commercial timberlands located in Humboldt County
along the northern California coast, an area which has very favorable soil
and climate conditions for growing timber. These timberlands contain
approximately three-quarters redwood and one-quarter Douglas-fir timber,
are located in close proximity to Pacific Lumber's four sawmills and
contain an extensive network of roads. Approximately 179,000 acres of
Pacific Lumber's timberlands are owned by Scotia Pacific (the "Scotia
Pacific Timberlands"), a special purpose Delaware corporation and wholly
owned subsidiary of Pacific Lumber. Pacific Lumber has the exclusive right
to harvest (the "Pacific Lumber Harvest Rights") approximately 8,000 acres
of the Scotia Pacific Timberlands consisting substantially of virgin old
growth redwood and virgin old growth Douglas-fir timber located on numerous
small parcels throughout the Scotia Pacific Timberlands. The timber on the
Scotia Pacific Timberlands which is not subject to the Pacific Lumber
Harvest Rights is referred to herein as the "Scotia Pacific Timber."
Substantially all of Scotia Pacific's assets are pledged as security for
Scotia Pacific's 7.95% Timber Collateralized Notes due 2015 (the "Timber
Notes"). Pacific Lumber harvests and purchases from Scotia Pacific all of
the logs harvested from the Scotia Pacific Timber. See "--Relationships
With Scotia Pacific and Britt" for a description of this and other
relationships among Pacific Lumber, Scotia Pacific and Britt.
The forest products industry grades lumber in various
classifications according to quality. The two broad categories within
which all grades fall, based on the absence or presence of knots, are
called "upper" and "common" grades, respectively. "Old growth" trees,
often defined as trees which have been growing for approximately 200 years
or longer, have a higher percentage of upper grade lumber than "young
growth" trees (those which have been growing for less than 200 years).
"Virgin" old growth trees are located in timber stands that have not
previously been harvested. "Residual" old growth trees are located in
timber stands which have been partially harvested in the past.
Pacific Lumber engages in extensive efforts to supplement the
natural regeneration of timber and increase the amount of timber on its
timberlands. Pacific Lumber is required to comply with California forestry
regulations regarding reforestation, which generally require that an area
be reforested to specified standards within an established period of time.
Pacific Lumber also actively engages in efforts to establish timberlands
from open areas such as pasture land. Regeneration of redwood timber
generally is accomplished through the natural growth of new redwood sprouts
from the stump remaining after a redwood tree is harvested. Such new
redwood sprouts grow quickly, thriving on existing mature root systems. In
addition, Pacific Lumber supplements natural redwood regeneration by
planting redwood seedlings. Douglas-fir timber grown on Pacific Lumber's
timberlands is regenerated almost entirely by planting seedlings. During
1997, Pacific Lumber planted an estimated 659,000 redwood and Douglas-fir
seedlings.
Harvesting Practices
The ability of Pacific Lumber to sell logs or lumber products
will depend, in part, upon its ability to obtain regulatory approval of
timber harvesting plans ("THPs"). THPs are required to be developed by
registered professional foresters and must be filed with, and approved by,
the California Department of Forestry ("CDF") prior to the harvesting of
timber. Each THP is designed to comply with applicable laws and
regulations. The CDF's evaluation of proposed THPs incorporates review and
analysis of such THPs by several California and federal agencies and public
comments received with respect to such THPs. An approved THP is applicable
to specific acreage and specifies the harvesting method and other
conditions relating to the harvesting of the timber covered by such THP.
See "--Regulatory and Environmental Factors and Headwaters Agreement"
for information regarding Pacific Lumber's obligation to develop a plan
establishing a long-term sustained yield level for its timberlands. That
section also contains information regarding threatened and endangered species
listings, a critical habitat designation and similar matters concerning
Pacific Lumber and its operations. The number of Pacific Lumber's approved
THPs and the amount of timber covered by such THPs varies significantly from
time to time, depending upon a variety of factors, including the timing of
agency review.
Pacific Lumber maintains a detailed geographical information
system covering its timberlands (the "GIS"). The GIS covers numerous
aspects of Pacific Lumber's properties, including timber type, tree class,
wildlife data, roads, rivers and streams. By carefully monitoring and
updating this data base and conducting field studies, Pacific Lumber's
foresters are better able to develop detailed THPs addressing the various
regulatory requirements. Pacific Lumber also utilizes a Global Positioning
System ("GPS") which allows precise location of geographic features through
satellite positioning.
Pacific Lumber employs a variety of well-accepted methods of
selecting trees for harvest. These methods, which are designed to achieve
optimal regeneration, are referred to as "silvicultural systems" in the
forestry profession. Silvicultural systems range from very light thinnings
aimed at enhancing the growth rate of retained trees to clear cutting which
results in the harvest of all trees in an area and replacement with a new
forest stand. In between are a number of varying levels of partial
harvests which can be employed.
Production Facilities
Pacific Lumber owns four highly mechanized sawmills and related
facilities located in Scotia, Fortuna and Carlotta, California. The
sawmills historically have been supplied almost entirely from timber
harvested from Pacific Lumber's timberlands. Since 1986, Pacific Lumber
has implemented numerous technological advances that have increased the
operating efficiency of its production facilities and the recovery of
finished products from its timber. Over the past three years, Pacific
Lumber's annual lumber production has averaged approximately 297 million
board feet, with approximately 309, 291 and 290 million board feet produced
in 1997, 1996 and 1995, respectively. The Fortuna sawmill produces
primarily common grade lumber. During 1997, the Fortuna mill produced
approximately 101 million board feet of lumber. The Carlotta sawmill
produces both common and upper grade redwood lumber. During 1997, the
Carlotta mill produced approximately 76 million board feet of lumber.
Sawmills "A" and "B" are both located in Scotia. Sawmill "A" processes
Douglas-fir logs and Sawmill "B" primarily processes large diameter redwood
logs. During 1997, Sawmills "A" and "B" produced 91 million and 41 million
board feet of lumber, respectively.
Pacific Lumber operates a finishing and remanufacturing plant in
Scotia which processes rough lumber into a variety of finished products
such as trim, fascia, siding and paneling. These finished products include
the redwood lumber industry's largest variety of customized trim and fascia
patterns. Remanufacturing enhances the value of some grades of lumber by
assembling knot-free pieces of narrower and shorter lumber into wider or
longer pieces in its state-of-the-art end and edge glue plants. The result
is a standard sized upper grade product which can be sold at a premium over
common grade products. Pacific Lumber has also installed a lumber
remanufacturing facility at its mill in Fortuna which processes low grade
redwood common lumber into value-added, higher grade redwood fence and
related products.
Pacific Lumber dries the majority of its upper grade lumber
before it is sold. Upper grades of redwood lumber are generally air-dried
for three to twelve months and then kiln-dried for seven to twenty-four
days to produce a dimensionally stable and high quality product which
generally commands higher prices than "green" lumber (which is lumber sold
before it has been dried). Upper grade Douglas-fir lumber is generally
kiln-dried immediately after it is cut. Pacific Lumber owns and operates
34 kilns, having an annual capacity of approximately 95 million board feet,
to dry its upper grades of lumber efficiently in order to produce a
quality, premium product. Pacific Lumber also maintains several large
enclosed storage sheds which hold approximately 27 million board feet of
lumber.
In addition, Pacific Lumber owns and operates a modern
25-megawatt cogeneration power plant which is fueled almost entirely by the
wood residue from Pacific Lumber's milling and finishing operations. This
power plant generates substantially all of the energy requirements of
Scotia, California, the town adjacent to Pacific Lumber's timberlands where
several of its manufacturing facilities are located. Pacific Lumber sells
surplus power to Pacific Gas and Electric Company. In 1997, the sale of
surplus power accounted for approximately 2% of Pacific Lumber's total
revenues.
Products
The following table sets forth the distribution of Pacific
Lumber's lumber production (on a net board foot basis) and revenues by
product line:
<TABLE>
<CAPTION>
Year Ended December 31, 1997 Year Ended December 31, 1996
----------------------------------------- -----------------------------------------
% of Total % of Total
Lumber % of Total Lumber % of Total
Production Lumber % of Total Production Lumber % of Total
Product Volume Revenues Revenues Volume Revenues Revenues
------------- ------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Upper grade redwood
lumber 12% 34% 29% 13% 33% 28%
Common grade redwood
lumber 55% 42% 35% 53% 42% 35%
------------- ------------- ------------- ------------- ------------- -------------
Total redwood
lumber 67% 76% 64% 66% 75% 63%
------------- ------------- ------------- ------------- ------------- -------------
Upper grade Douglas-
fir lumber 4% 6% 5% 3% 6% 5%
Common grade Douglas-
fir lumber 25% 16% 13% 27% 16% 13%
------------- ------------- ------------- ------------- ------------- -------------
Total Douglas-
fir lumber 29% 22% 18% 30% 22% 18%
------------- ------------- ------------- ------------- ------------- -------------
Other grades of
lumber 4% 2% 2% 4% 3% 2%
------------- ------------- ------------- ------------- ------------- -------------
Total
lumber 100% 100% 84% 100% 100% 83%
============= ============= ============= ============= ============= =============
Logs 7% 9%
============= =============
Hardwood chips 3% 2%
Softwood chips 4% 4%
------------- -------------
Total wood chips 7% 6%
============= =============
</TABLE>
Lumber. In 1997, Pacific Lumber sold approximately 312 million
board feet of lumber, which accounted for approximately 84% of Pacific
Lumber's total revenues. Lumber products vary greatly by the species and
quality of the timber from which it is produced. Lumber is sold not only
by grade (such as "upper" grade versus "common" grade), but also by board
size and the drying process associated with the lumber.
Redwood lumber is Pacific Lumber's largest product category.
Redwood is commercially grown only along the northern coast of California
and possesses certain unique characteristics that permit it to be sold at a
premium to many other wood products. Such characteristics include its
natural beauty, superior ability to retain paint and other finishes,
dimensional stability and innate resistance to decay, insects and
chemicals. Typical applications include exterior siding, trim and fascia
for both residential and commercial construction, outdoor furniture, decks,
planters, retaining walls and other specialty applications. Redwood also
has a variety of industrial applications because of its chemical resistance
and because it does not impart any taste or odor to liquids or solids.
Upper grade redwood lumber, which is derived primarily from large
diameter logs and is characterized by an absence of knots and other
defects, is used primarily in distinctive interior and exterior
applications. The overall supply of upper grade lumber has been
diminishing due to increasing environmental and regulatory restrictions and
other factors, and Pacific Lumber's supply of upper grade lumber has
decreased in some premium product categories. See Item 7. "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Background." Common grade redwood lumber, Pacific Lumber's largest volume
product, has many of the same aesthetic and structural qualities of redwood
uppers, but has some knots, sapwood and a coarser grain. Such lumber is
commonly used for construction purposes, including outdoor structures such
as decks, hot tubs and fencing.
Douglas-fir lumber is used primarily for new construction and
some decorative purposes and is widely recognized for its strength, hard
surface and attractive appearance. Douglas-fir is grown commercially along
the west coast of North America and in Chile and New Zealand. Upper grade
Douglas-fir lumber is derived primarily from old growth Douglas-fir timber
and is used principally in finished carpentry applications. Common grade
Douglas-fir lumber is used for a variety of general construction purposes
and is largely interchangeable with common grades of other whitewood
lumber.
Logs. Pacific Lumber currently sells certain logs that, due to
their size or quality, cannot be efficiently processed by its mills into
lumber. The majority of these logs are purchased by Britt. The balance
are purchased by surrounding mills which do not own sufficient timberlands
to support their mill operations. See "--Relationships with Scotia Pacific
and Britt" below. Except for the agreement with Britt described below,
Pacific Lumber does not have any significant contractual relationships with
third parties relating to the purchase of logs. Pacific Lumber has
historically not purchased significant quantities of logs from third
parties; however, Pacific Lumber may from time to time purchase logs from
third parties for processing in its mills or for resale to third parties
if, in the opinion of management, economic factors are advantageous to
Pacific Lumber.
Wood Chips. Pacific Lumber uses a whole-log chipper to produce
wood chips from hardwood trees which would otherwise be left as waste.
These chips are sold to third parties primarily for the production of
facsimile and other specialty papers. Pacific Lumber also produces
softwood chips from the wood residue from its milling operations. These
chips are sold to third parties for the production of wood pulp and paper
products.
Backlog and Seasonality
Pacific Lumber's backlog of sales orders at December 31, 1997 and
1996 was approximately $26.4 and approximately $21.3 million, respectively,
the substantial portion of which was delivered in the first quarter of the
next fiscal year. Pacific Lumber has historically experienced lower first
quarter sales due largely to the general decline in construction-related
activity during the winter months. As a result, Pacific Lumber's results
in any one quarter are not necessarily indicative of results to be expected
for the full year.
Other
The Company also derives revenues from a soil amendment operation
and a concrete block manufacturing operation.
Marketing
The housing, construction and remodeling markets are the primary
markets for Pacific Lumber's lumber products. Pacific Lumber's policy is
to maintain a wide distribution of its products both geographically and in
terms of the number of customers. Pacific Lumber sells its lumber products
throughout the country to a variety of accounts, the large majority of
which are wholesalers, followed by retailers, industrial users, exporters
and manufacturers. Upper grades of redwood and Douglas-fir lumber are sold
throughout the entire United States, as well as to export markets. Common
grades of redwood lumber are sold principally west of the Mississippi
River, with California accounting for approximately 66% of these sales in
1997. Common grades of Douglas-fir lumber are sold primarily in
California. In 1997, Pacific Lumber had three customers which accounted
for approximately 10%, 5% and 5%, respectively, of Pacific Lumber's total
revenues. Exports of lumber accounted for approximately 6% of Pacific
Lumber's total revenues in 1997. Pacific Lumber markets its products
through its own sales staff which focuses primarily on domestic sales.
Pacific Lumber actively follows trends in the housing,
construction and remodeling markets in order to maintain an appropriate
level of inventory and assortment of products. Due to its high quality
products, large inventory, competitive prices and long history, Pacific
Lumber believes it has a strong degree of customer loyalty.
Competition
Pacific Lumber's lumber is sold in highly competitive markets.
Competition is generally based upon a combination of price, service,
product availability and product quality. Pacific Lumber's products
compete not only with other wood products but with metals, masonry, plastic
and other construction materials made from non-renewable resources. The
level of demand for Pacific Lumber's products is dependent on such broad
factors as overall economic conditions, interest rates and demographic
trends. In addition, competitive considerations, such as total industry
production and competitors' pricing, as well as the price of other
construction products, affect the sales prices for Pacific Lumber's lumber
products. Pacific Lumber currently enjoys a competitive advantage in the
upper grade redwood lumber market due to the quality of its timber holdings
and relatively low cost production operations. Competition in the common
grade redwood and Douglas-fir lumber market is more intense, and Pacific
Lumber competes with numerous large and small lumber producers.
Employees
As of March 1, 1998, Pacific Lumber had approximately 1,550
employees, none of whom are covered by a collective bargaining agreement.
Relationships with Scotia Pacific and Britt
In March 1993, Pacific Lumber consummated its offering of $235
million of 10-1/2% Senior Notes due 2003 (the "Pacific Lumber Senior
Notes") and Scotia Pacific consummated its offering of $385 million of
Timber Notes. Upon the closing of such offerings, Pacific Lumber, Scotia
Pacific and Britt entered into a variety of agreements. Pacific Lumber and
Scotia Pacific entered into a Services Agreement (the "Services Agreement")
and an Additional Services Agreement (the "Additional Services Agreement").
Pursuant to the Services Agreement, Pacific Lumber provides operational,
management and related services with respect to the Scotia Pacific Timber
not performed by Scotia Pacific's own employees. Such services include the
furnishing of all equipment, personnel and expertise not within Scotia
Pacific's possession and reasonably necessary for the operation and
maintenance of the Scotia Pacific Timber. In particular, Pacific Lumber is
required to regenerate Scotia Pacific Timber, prevent and control loss of
Scotia Pacific Timber by fires, maintain a system of roads throughout the
Scotia Pacific Timberlands, take measures to control the spread of disease
and insect infestation affecting Scotia Pacific Timber and comply with
environmental laws and regulations. Pacific Lumber is also required (to
the extent necessary) to assist Scotia Pacific personnel in updating the
GIS and to prepare and file, on Scotia Pacific's behalf, all pleadings and
motions and otherwise diligently pursue appeals of any denial of any THP
and related matters. As compensation for these and the other services to
be provided by Pacific Lumber, Scotia Pacific pays a fee which is adjusted
on January 1 of each year based on a specified government index relating to
wood products. The fee was approximately $115,400 per month in 1997 and is
expected to be approximately $117,300 per month in 1998.
Pursuant to the Additional Services Agreement, Scotia Pacific
provides Pacific Lumber with a variety of services, including (a) assisting
Pacific Lumber to operate, maintain and harvest its own timber properties,
(b) updating and providing access to the GIS with respect to information
concerning Pacific Lumber's own timber properties, and (c) assisting
Pacific Lumber with its statutory and regulatory compliance. Pacific
Lumber pays Scotia Pacific a fee for such services equal to the actual cost
of providing such services, as determined in accordance with generally
accepted accounting principles.
Pacific Lumber and Scotia Pacific also entered into a Master
Purchase Agreement (the "Master Purchase Agreement"). The Master Purchase
Agreement governs all purchases of logs by Pacific Lumber from Scotia
Pacific. Each purchase of logs by Pacific Lumber from Scotia Pacific is
made pursuant to a separate log purchase agreement (which incorporates the
terms of the Master Purchase Agreement) for the Scotia Pacific Timber
covered by an approved THP. Such log purchase agreement provides for the
sale to Pacific Lumber of the logs harvested from the Scotia Pacific Timber
covered by such THP and generally constitutes an exclusive agreement with
respect to the timber covered thereby, subject to certain limited
exceptions. The Master Purchase Agreement generally contemplates that all
sales of logs by Scotia Pacific to Pacific Lumber will be at a price which
equals or exceeds the applicable stumpage price for such species and
category, as set forth in the most recent Harvest Value Schedule published
by the California State Board of Equalization (the "SBE Price"). The
Harvest Value Schedule is published by the California State Board of
Equalization at six month intervals for the purpose of computing yield
taxes imposed on the harvesting of timber. SBE Prices are based on average
actual log prices between unrelated parties over a recent twenty-four month
period. As Pacific Lumber purchases logs from Scotia Pacific pursuant to
the Master Purchase Agreement, Pacific Lumber is responsible, at its own
expense, for harvesting and removing the standing Scotia Pacific Timber
covered by approved THPs, and the purchase price is therefore based upon
"stumpage prices." Substantially all of Scotia Pacific's revenues are
derived from the sale of logs to Pacific Lumber under the Master Purchase
Agreement.
Pacific Lumber, Scotia Pacific and Salmon Creek also entered into
a Reciprocal Rights Agreement granting to each other certain reciprocal
rights of egress and ingress through their respective properties in
connection with the operation and maintenance of such properties and their
respective businesses. In addition, Pacific Lumber entered into an
Environmental Indemnification Agreement with Scotia Pacific pursuant to
which Pacific Lumber agreed to indemnify Scotia Pacific from and against
certain present and future liabilities arising with respect to hazardous
materials, hazardous materials contamination or disposal sites, or under
environmental laws with respect to the Scotia Pacific Timberlands. In
particular, Pacific Lumber is liable with respect to any contamination
which occurred on the Scotia Pacific Timberlands prior to the date of the
agreement.
Pacific Lumber entered into an agreement with Britt (the "Britt
Agreement") which governs the sale of logs by Pacific Lumber and Britt to
each other, the sale of hog fuel (wood residue) by Britt to Pacific Lumber
for use in Pacific Lumber's cogeneration plant, the sale of lumber by
Pacific Lumber and Britt to each other, and the provision by Pacific Lumber
of certain administrative services to Britt (including accounting,
purchasing, data processing, safety and human resources services). The
logs which Pacific Lumber sells to Britt and which are used in Britt's
manufacturing operations are sold at approximately 75% of applicable SBE
prices (to reflect the lower quality of these logs). Logs which either
Pacific Lumber or Britt purchases from third parties and which are then
sold to each other are transferred at the actual cost of such logs. Hog
fuel is sold at applicable market prices, and administrative services are
provided by Pacific Lumber based on Pacific Lumber's actual costs and an
allocable share of Pacific Lumber's overhead expenses consistent with past
practice.
BRITT LUMBER OPERATIONS
Business
Britt is located in Arcata, California, approximately 45 miles
north of Pacific Lumber's headquarters. Britt's primary business is the
processing of small diameter redwood logs into wood fencing products for
sale to retail and wholesale customers. Britt was incorporated in 1965 and
operated as an independent manufacturer of fence products until July 1990,
when it was purchased by a subsidiary of the Company. Britt purchases
small diameter (6 to 11 inch) redwood logs of varying lengths. Britt's
purchases are primarily from Pacific Lumber, although it does purchase a
variety of different diameter and different length logs from various other
timberland owners. Britt processes logs at its mill into a variety of
different fencing products, including "dog-eared" 1" x 6" fence stock in
six foot lengths, 4" x 4" fence posts in 6 through 12 foot lengths, and
other lumber products in 6 through 12 foot lengths. Britt's purchases of
logs from third parties are generally consummated pursuant to short-term
contracts of twelve months or less. See "--Pacific Lumber Operations--
Relationships with Scotia Pacific and Britt" for a description of Britt's
log purchases from Pacific Lumber.
Marketing
In 1997, Britt sold approximately 90 million board feet of lumber
products to approximately 84 different customers. Over one-half of its
1997 lumber sales were in California. The remainder of its 1997 sales were
in ten other western states. In 1997, Britt had four customers which
accounted for 29%, 18%, 10% and 8%, respectively, of Britt's total sales.
Britt markets its products through its own salesmen to a variety of
customers, including distribution centers, industrial remanufacturers,
wholesalers and retailers.
Britt's backlog of sales orders at December 31, 1997 and 1996 was
approximately $5.4 million and $4.2 million, respectively, the substantial
portion of which was delivered in the first quarter of the next fiscal
year.
Facilities and Employees
Britt's manufacturing operations are conducted on 12 acres of
land, 10 acres of which are leased on a long-term fixed-price basis from an
unrelated third party. Production is conducted in a 46,000 square foot
mill. An 18-acre log sorting and storage yard is located one quarter of a
mile away. The mill was constructed in 1980, and capital expenditures to
enhance its output and efficiency are made periodically. Britt's (single
shift) mill capacity, assuming 40 production hours per week, is estimated
at 37.4 million board feet of fencing products per year. As of March 1,
1998, Britt employed approximately 125 people, none of whom are covered by
a collective bargaining agreement.
Competition
Management estimates that Britt accounted for approximately one-
third of the total redwood fence market in 1997. Britt competes primarily
with the northern California mills of Louisiana Pacific, Georgia Pacific,
Eel River and Redwood Empire.
REGULATORY AND ENVIRONMENTAL FACTORS AND HEADWATERS AGREEMENT
This section contains statements which constitute "forward-
looking statements" within the meaning of the Private Securities Litigation
Reform Act of 1995. See Item 1. "Business--General" and "Status of Multi-
Species HCP, SYP and Headwaters Agreement" in this section for cautionary
information with respect to such forward-looking statements.
General
Pacific Lumber's business is subject to a variety of California
and federal laws and regulations dealing with timber harvesting, threatened
and endangered species and habitat for such species, and air and water
quality. Compliance with such laws and regulations plays a significant
role in Pacific Lumber's business. The California Forest Practice Act (the
"Forest Practice Act") and related regulations adopted by the California
Board of Forestry (the "BOF") set forth detailed requirements for the
conduct of timber harvesting operations in California. These requirements
include the obligation of timber companies to prepare, and obtain
regulatory approval of, detailed THPs (timber harvesting plans) containing
information with respect to areas proposed to be harvested (see "--
Harvesting Practices" above). As described further below, California law
has also required large timber companies submitting THPs to demonstrate
that their proposed timber operations will not decrease the sustainable
productivity of their timberlands. A timber company may comply with this
requirement by submitting for review and approval by the CDF a long-term
sustained yield plan ("SYP") establishing a long-term sustained yield
harvest level for their timberlands. The federal Endangered Species Act
(the "ESA") and California Endangered Species Act (the "CESA") provide in
general for the protection and conservation of specifically listed wildlife
and plants which have been declared to be endangered or threatened. The
operations of Pacific Lumber are also subject to the California
Environmental Quality Act ("CEQA"), which provides for protection of the
state's air and water quality and wildlife, and the California Water
Quality Act and Federal Clean Water Act, which require that Pacific Lumber
conduct its operations so as to reasonably protect the water quality of
nearby rivers and streams.
While compliance with such laws, regulations and judicial and
administrative interpretations, together with the cost of litigation
incurred in connection with certain timber harvesting operations, have
increased the costs of Pacific Lumber, they have not had a significant
adverse effect on its financial position, results of operations or
liquidity. However, these laws and related administrative actions and
legal challenges have severely restricted the ability of Pacific Lumber to
harvest virgin old growth timber on its timberlands, and to a lesser
extent, residual old growth timber. As a result, Pacific Lumber, Scotia
Pacific and Salmon Creek in April 1996 filed two actions (the "Takings
Litigation") alleging that certain portions of their timberlands had been
"taken" by California and the United States and seeking just compensation.
See Item 3. "Legal Proceedings--Takings Litigation."
Headwaters Agreement
On September 28, 1996, Pacific Lumber (on behalf of itself, its
subsidiaries and affiliates) and MAXXAM (collectively, the "Pacific Lumber
Parties") entered into an agreement with the United States and California
("Headwaters Agreement") which provides the framework for the acquisition
by the United States and California of approximately 5,600 acres of Pacific
Lumber's timberlands. These timberlands are commonly referred to as the
Headwaters Forest and the Elk Head Springs Forest (collectively, the
"Headwaters Timberlands"). A substantial portion of the Headwaters
Timberlands consists of virgin old growth timberlands. Approximately 4,900
of these acres are owned by Salmon Creek, with the remaining acreage being
owned by Scotia Pacific (Pacific Lumber having harvesting rights on
approximately 300 of such acres). The Headwaters Timberlands would be
transferred in exchange for (a) property and other consideration from the
United States and California having an aggregate fair market value of $300
million, and (b) approximately 7,755 acres of adjacent timberlands (the
"Elk River Timberlands") to be acquired from a third party. As part of the
Headwaters Agreement, the Pacific Lumber Parties agreed to not enter the
Headwaters Forest or the Elk Head Springs Forest to conduct any logging or
salvage operations.
Closing of the Headwaters Agreement is subject to various
conditions, including (a) the United States and California furnishing the
requisite consideration, (b) approval of an SYP for Pacific Lumber's
timberlands, in form and substance satisfactory to Pacific Lumber, (c)
approval of a habitat conservation plan covering multiple species ("Multi-
Species HCP") and issuance of a related incidental take permit (the
"Permit") covering Pacific Lumber's timberlands, each in form and substance
satisfactory to Pacific Lumber, (d) the issuance by the Internal Revenue
Service and the California Franchise Tax Board of tax closing agreements in
form and substance sought by and satisfactory to the Pacific Lumber
Parties, (e) acquisition of the Elk River Timberlands, (f) the absence of a
judicial decision in any litigation brought by third parties that any party
reasonably believes will significantly delay or impair the transactions
described in the Headwaters Agreement, and (g) the dismissal of the Takings
Litigation.
In November 1997, President Clinton signed an appropriations bill
which contains authorization for the expenditure of $250 million of federal
funds toward consummation of the Headwaters Agreement (the "Interior
Appropriations Bill"). The federal funding is to remain available until
March 1, 1999 and is subject to, among other things, contribution by the
State of California of its $130 million portion of funding for the
Headwaters Agreement. Although California has not enacted legislation
providing funds for its portion of the acquisition contemplated by the
Headwaters Agreement, representatives of the State of California continue
to indicate that they are considering various methods of furnishing the
required consideration. In August 1997, Pacific Lumber submitted drafts of
the Multi-Species HCP and the SYP to the appropriate government agencies
for review. On February 27, 1998, Pacific Lumber, MAXXAM and various
government agencies entered into a Pre-Permit Application Agreement in
Principle (the "HCP/SYP Agreement") regarding certain understandings that
they had reached regarding the Multi-Species HCP, the Permit and the SYP.
The parties have been discussing the tax closing agreements but, to date,
have not been able to reach agreement. The parties to the Headwaters
Agreement are working diligently to satisfy the other closing conditions.
Terms of the HCP/SYP Agreement
The Company believes that execution of the HCP/SYP Agreement
mentioned above is an important milestone toward completion of the
Headwaters Agreement. The HCP/SYP Agreement provides that the Permit and
Multi-Species HCP would have a term of 50 years. Subject to certain rights
of Pacific Lumber to seek an amendment to the Permit and Multi-Species HCP,
the HCP/SYP Agreement provides that for the term of the Permit, only
management activities designed to enhance habitat could be conducted by
Pacific Lumber in twelve forest groves not being sold to the United States
and California. These groves aggregate approximately 8,000 acres and
consist of substantial quantities of virgin and residual old growth redwood
and Douglas-fir timber. These limitations are designed primarily to
protect habitat for the marbled murrelet, a coastal seabird which has been
listed as endangered under the CESA and threatened under the ESA. The
HCP/SYP Agreement also requires Pacific Lumber to initiate a specified
watershed assessment process, which Pacific Lumber has begun. This process
is intended to result in appropriate protective zones for fish and other
wildlife being established adjacent to the streams on Pacific Lumber's
timberlands. Until the watershed assessment process is complete, Pacific
Lumber must incorporate certain interim stream protective measures into its
THPs, including amending its pending (but not yet approved) THPs. These
interim stream protection measures are more stringent than the measures
currently required by existing state regulations.
Effect of the HCP/SYP Agreement
In addition to being an important milestone toward completion of
the Headwaters Agreement, the Company also believes that the HCP/SYP
Agreement would be a positive development in respect of the environmental
challenges that it has faced over the last several years. For instance,
various groups and individuals have filed objections with the CDF and the
BOF regarding these agencies' actions and rulings with respect to certain
of Pacific Lumber's THPs. In addition, lawsuits are pending or threatened
which seek to prevent Pacific Lumber from implementing certain of its
approved THPs. While challenges with respect to Pacific Lumber's young
growth timber have historically been limited, a lawsuit was recently filed
under the ESA which relates to a significant number of THPs covering young
growth timber of Pacific Lumber. See Item 3. "Legal Proceedings--Timber
Harvesting Litigation." While the Company expects these environmentally
focused objections and lawsuits to continue, it believes that the HCP/SYP
Agreement will enhance its position in connection with these challenges.
The Company also believes that the Multi-Species HCP would expedite the
preparation and facilitate approval of its THPs.
A related environmental challenge which Pacific Lumber has faced
is the listing of threatened or endangered species which are found on
Pacific Lumber's timberlands. Several species, including the northern
spotted owl, the marbled murrelet and the coho salmon, have been listed as
endangered or threatened under the ESA and/or the CESA. Other species such
as the steelhead trout could be listed in the future. Pacific Lumber has
developed federal and state northern spotted owl management plans which
permit harvesting activities to be conducted so long as Pacific Lumber
adheres to certain measures designed to protect the northern spotted owl.
The potential impact of the listings of the marbled murrelet and
the coho salmon is more uncertain. The marbled murrelet has been listed as
endangered under the CESA and as threatened under the ESA. Approximately
33,000 acres of Pacific Lumber's timberlands have been designated as
critical habitat for the marbled murrelet. Pacific Lumber incorporates
mitigation measures into its THPs as necessary to protect and maintain
habitat for the marbled murrelet on its timberlands and conducts certain
pre-harvest marbled murrelet surveys. These surveys delay the review and
approval process with respect to certain of the THPs filed by Pacific
Lumber. They have also indicated that Pacific Lumber has certain
timberlands which are occupied murrelet habitat. As discussed in "--Terms
of the HCP/SYP Agreement" above, the HCP/SYP Agreement contains provisions
regarding protection of the marbled murrelet.
The coho salmon was listed in April 1997 as threatened under the
ESA in northern California, including Pacific Lumber's timberlands. The
State of California and other persons, including Pacific Lumber, are
working with NMFS and other government agencies to determine what
mitigation measures will be instituted to protect the coho salmon. As
discussed above, the HCP/SYP Agreement contains provisions regarding
establishment of protective measures for the coho salmon and other fish and
wildlife species. Pacific Lumber is also attempting to include in the
Multi-Species HCP a resolution of the potential effect of limits by the
Environmental Protection Agency ("EPA") on sedimentation, temperature and
other factors (i.e. non-point source total maximum daily loadings; "TMDL").
The EPA is in the process of establishing limits on TMDL under the Federal
Clean Water Act for seventeen northern California rivers and certain of
their tributaries, including rivers within Pacific Lumber's timberlands.
The TMDL limits will be aimed at protecting water quality.
As a result of the HCP/SYP Agreement, Pacific Lumber will revise
and resubmit the Multi-Species HCP. If the Multi-Species HCP is approved,
Pacific Lumber would be issued the Permit, which would allow limited
incidental "take" of listed species so long as there was no "jeopardy" to
the species. The Multi-Species HCP would also identify measures to be
instituted in order to minimize and mitigate the anticipated level of take
to the greatest extent possible. The Multi-Species HCP will be designed to
protect habitat for and accommodate species currently listed under the ESA
and CESA such as the marbled murrelet and coho salmon, as well as to
consider candidate and future-listed species and their potential habitat
needs. This forward-looking feature of the Multi-Species HCP is designed
to both protect future-listed species and their habitat, and to provide
more certainty and protection to Pacific Lumber against further
restrictions on harvesting as a result of future listings or unforeseen
circumstances. This additional protection and certainty against future
listings and unforeseen circumstances is referred to as the "no surprises"
policy of the United States Fish and Wildlife Service ("USFWS"), which must
review and approve the Multi-Species HCP.
The HCP/SYP Agreement also contains certain provisions relating
to the SYP. Pacific Lumber will submit a revised SYP, which will assume
that the transactions contemplated by the Headwaters Agreement (including
acquisition of the Elk River Timberlands) will be consummated and that the
Multi-Species HCP will be approved. Subject to further study, the Company
expects Pacific Lumber to propose a long-term sustained yield harvest level
("LTSY") which is somewhat less than Pacific Lumber's recent harvest
levels. In order to mitigate the anticipated impact of the SYP, Pacific
Lumber has acquired approximately 11,000 acres of timberlands since January
1, 1996 and expects to continue to acquire such additional timberlands as
will enable it to maintain recent harvest levels. However, there can be no
assurance that Pacific Lumber would be able to continue such acquisitions,
which would be limited by Pacific Lumber's financial resources and the
availability of acceptable properties. If the SYP is approved, Pacific
Lumber will have complied with certain BOF regulations requiring that
timber companies project timber growth and harvest on their timberlands
over a 100-year planning period and establish an LTSY harvest level.
The SYP must demonstrate that the average annual harvest over any rolling
ten-year period will not exceed the LTSY harvest level and that Pacific
Lumber's projected timber inventory is capable of sustaining the LTSY harvest
level in the last decade of the 100-year planning period. The HCP/SYP
Agreement provides that upon submission of certain timber growth estimates
by Pacific Lumber, CDF will find the SYP sufficient for public review.
An approved SYP is expected to be valid for ten years, although it would
be subject to review after five years. Thereafter, revised SYPs will be
prepared every decade that address the LTSY harvest level based upon
reassessment of changes in the resource base and other factors.
Status of the Multi-Species HCP, the SYP and the Headwaters
Agreement
The final terms of the SYP, the Multi-Species HCP and the Permit
are subject to additional negotiation and agreement among the parties. At
such time as the parties reach agreement on the form of the Multi-Species
HCP and the Permit, these documents, along with federal and state
environmental impact statements, will be made available for public review
and comment. After the government agencies complete the public review
process and approve a final environmental impact statement, the agencies
will decide whether to approve a Multi-Species HCP and a Permit. A similar
process will occur with respect to the SYP. While the Company believes
that the HCP/SYP Agreement represents an important milestone toward
completion of the Headwaters Agreement and the parties are working
diligently to complete the Multi-Species HCP and the SYP as well as the
other closing conditions contained in the Headwaters Agreement, there can
be no assurance that the Headwaters Agreement will be consummated or that
an SYP, Multi-Species HCP or Permit acceptable to Pacific Lumber will be
approved.
In the event that a Multi-Species HCP is not approved, Pacific
Lumber will not enjoy the benefits of expedited preparation and facilitated
review of its THPs. Furthermore, if a Multi-Species HCP acceptable to
Pacific Lumber is not approved, it is impossible for the Company to
determine the potential adverse effect of the listings of the marbled
murrelet and coho salmon or the TMDL limits on the Company's financial
position, results of operations or liquidity until such time as the various
regulatory and legal issues are resolved; however, if Pacific Lumber is
unable to harvest, or is severely limited in harvesting, on significant
amounts of its timberlands, such effect could be materially adverse to the
Company. If the Headwaters Agreement is not consummated and Pacific Lumber
is unable to harvest or is severely limited in harvesting on various of its
timberlands, it intends to continue and/or expand its Takings Litigation
seeking just compensation from the appropriate governmental agencies on the
grounds that such restrictions constitute an uncompensated governmental
taking of private property for public use.
Potential Future Developments
Laws, regulations and related judicial decisions and
administrative interpretations dealing with Pacific Lumber's operations are
subject to change and new laws and regulations are frequently introduced
concerning the California timber industry. From time to time, bills are
introduced in the California legislature and the U.S. Congress which relate
to the business of Pacific Lumber, including the protection and acquisition
of old growth and other timberlands, endangered species, environmental
protection, air and water quality and the restriction, regulation and
administration of timber harvesting practices. It is impossible to predict
the content of any such bills, the likelihood of any of the bills passing
or the impact of any of these bills on the future liquidity, financial
position or operating results of the Company. Furthermore, any bills which
are passed are subject to executive veto and court challenge. In addition
to existing and possible new or modified statutory enactments, regulatory
requirements and administrative and legal actions, the California timber
industry remains subject to potential California or local ballot
initiatives and evolving federal and California case law which could affect
timber harvesting practices. It is impossible, however, to assess the
effect of such matters on the Company's financial position, operating
results or liquidity.
ITEM 2. PROPERTIES
A description of the Company's properties is included under Item
1 above.
ITEM 3. LEGAL PROCEEDINGS
This section contains statements which constitute "forward-
looking statements" within the meaning of the Private Securities Litigation
Reform Act of 1995. See Item 1. "Business--General" for cautionary
information with respect to such forward-looking statements.
TIMBER HARVESTING LITIGATION
On January 26, 1998, an action entitled Coho Salmon, et al. v.
Pacific Lumber, et al. (No. 98-0283) (the "Coho lawsuit") was filed against
Pacific Lumber, Scotia Pacific and Salmon Creek in the United States
District Court for the Northern District of California. This action
alleges, among other things, violations of the ESA and claims that
defendants' logging operations in five watersheds have contributed to the
"take" of the coho salmon. This action relates to a significant number of
the Company's approved or pending THPs. Plaintiffs seek, among other
things, to enjoin timber harvesting on the THPs and acreage identified.
The THPs which are the subject of the Coho lawsuit are at various stages of
the THP cycle. Approximately one-third of the THPs have been submitted to
the CDF, but have not yet been approved and will have to be amended
pursuant to the HCP/SYP Agreement discussed above under Item 1. "--
Regulatory and Environmental Factors and Headwaters Agreement." Pacific
Lumber estimates that as of February 15, 1998, approximately 28 million
board feet of standing timber remained to be harvested under the approved
THPs. While the Company believes that completion of the HCP/SYP Agreement
is a positive development in respect of the Coho lawsuit, the Company is
unable to predict the outcome of this case or its ultimate impact on the
Company.
On December 30, 1997, the CDF issued a statement of issues in
connection with an administrative action entitled In the Matter of the
Statement of Issues Against: The Pacific Lumber Company, Timber Operator
License A-5326 (No. LT 97-8). This administrative action sought to deny
Pacific Lumber's application for a timber operator's license ("TOL") based
on various violations of the rules and regulations of the Forest Practice
Act. On the same date, Pacific Lumber entered into a Stipulation with the
CDF and received a conditional TOL for 1998. The 1998 TOL and Stipulation
are conditioned on, among other things, Pacific Lumber (a) complying with
existing requirements governing timber harvesting, as well as additional
obligations concerning, primarily, wet weather operations and minimizing
the flow of sediment into water courses on properties of Pacific Lumber,
and (b) complying with additional self-monitoring and inspection
obligations. Compliance with the obligations set forth in the Stipulation
will restrict Pacific Lumber's ability to harvest timber and transport logs
during periods of wet weather and could impair Pacific Lumber's ability to
maintain adequate log inventories during these periods. Pacific Lumber has
instituted additional policies and procedures to assure that it complies
with the Stipulation. Should Pacific Lumber's TOL nevertheless be revoked,
Pacific Lumber could engage independent contractors to complete these
activities on its behalf (independent contractors currently account for
approximately 60% of the harvesting activities on Pacific Lumber's
timberlands). Pacific Lumber therefore does not believe that loss of its
TOL would have a significant adverse effect on its operations or financial
performance.
TAKINGS LITIGATION
On April 22, 1996, Salmon Creek filed a lawsuit entitled Salmon
Creek Corporation v. California State Board of Forestry, et al. (No.
96CS01057) in the Superior Court of Sacramento County. This action seeks
to overturn the BOF's decision denying approval of a THP relating to
approximately 8 acres of virgin old growth timber in the Headwaters Forest.
Salmon Creek seeks a court order requiring approval of the THP so that it
may harvest timber in order to construct a road in accordance with the THP.
Salmon Creek also seeks constitutional "just compensation" damages to the
extent that its old growth timber within and surrounding the THP has been
"taken" without compensation by reason of this regulatory denial and
previous actions of governmental authorities. In addition, on May 7, 1996,
Pacific Lumber, Scotia Pacific and Salmon Creek filed a lawsuit entitled
The Pacific Lumber Company, et al. v. The United States of America (No. 96-
257L) in the United States Court of Federal Claims. The suit alleges that
the federal government has "taken" without compensation over 3,800 acres of
Pacific Lumber's old growth timberlands through its application of the ESA.
Pacific Lumber and Salmon Creek seek constitutional "just compensation"
damages for the taking of these timberlands by the federal government's
actions. The court in each of these actions has granted the parties'
agreed motions to stay the actions pursuant to the Headwaters Agreement.
These actions would be dismissed if the Headwaters Agreement is
consummated. See Item 1. "Business--Regulatory and Environmental Factors
and Headwaters Agreement" for description of the Headwaters Agreement.
ZERO COUPON NOTE LITIGATION
In April 1989, an action was filed against the Company, MAXXAM,
MAXXAM Properties Inc., a wholly owned subsidiary of the Company ("MPI"),
and certain of MAXXAM's directors in the Court of Chancery of the State of
Delaware, entitled Progressive United Corporation v. MAXXAM Inc., et al.
(No. 10785). Plaintiff purports to bring this action as a stockholder of
MAXXAM derivatively on behalf of MAXXAM and MPI. In May 1989, a second
action containing substantially similar allegations was filed in the Court
of Chancery of the State of Delaware, entitled Wolf v. Hurwitz, et al. and
the two cases were consolidated (under case No. 10785; collectively, the
"Zero Coupon Note actions"). The Zero Coupon Note actions relate to a Put
and Call Agreement entered into between MPI and Mr. Charles Hurwitz
(Chairman of the Board of the Company, MAXXAM and MPI), as well as a
predecessor agreement (the "Prior Agreement"). Among other things, the Put
and Call Agreement provided that Mr. Hurwitz had the option (the "Call") to
purchase from MPI certain notes (or MAXXAM's common stock into which they
were converted) for $10.3 million. In July 1989, Mr. Hurwitz exercised the
Call and acquired 990,400 shares of MAXXAM's common stock. The Zero Coupon
Note actions generally allege that in entering into the Prior Agreement Mr.
Hurwitz usurped a corporate opportunity belonging to MAXXAM, that the Put
and Call Agreement constituted a waste of corporate assets of MAXXAM and
MPI, and that the defendant directors breached their fiduciary duties in
connection with these matters. Plaintiffs seek to have the Put and Call
Agreement declared null and void, among other remedies. On February 3, 1998,
the Court dismissed this action.
USAT MATTER
In January 1995, an action entitled U.S., ex rel., Martel v.
Hurwitz, et al. (No. C950322) (the "Martel action") was filed against
MAXXAM, the Company and others and is pending in the U.S. District Court
for the Southern District of Texas. This action is purportedly brought by
plaintiff on behalf of the U.S. government; however, the U.S. government
has declined to participate in the suit. The suit alleges that defendants
made false statements and claims in violation of the Federal False Claims
Act in connection with their operation of United Savings Association of
Texas ("USAT"). Plaintiff alleges, among other things, that defendants
used the federally insured assets of USAT to acquire junk bonds from
Michael Milken and Drexel, Burnham, Lambert Inc. ("Drexel"). Plaintiffs
allege that in exchange Mr. Milken and Drexel arranged financing for
defendants' various business ventures, including the acquisition of Pacific
Lumber by MAXXAM. Plaintiff alleges that as a result of USAT's insolvency
defendants should be required to pay $1.6 billion (subject to trebling) to
cover USAT's losses. Plaintiff seeks, among other things, that the Court
impose a constructive trust upon the fruits of the alleged improper use of
USAT funds. On February 6, 1998, defendants' motion to dismiss was taken
under submission by the Court.
OTHER LITIGATION
The Company is involved in other claims, lawsuits and other
proceedings. While uncertainties are inherent in the final outcome of such
matters and it is presently impossible to determine the actual costs that
ultimately may be incurred, management believes that the resolution of such
uncertainties and the incurrence of such costs should not have a material
adverse effect on the Company's financial position, results of operations
or liquidity.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
All of the Company's common stock is owned by MGHI. Accordingly,
the Company's common stock is not traded on any stock exchange and has no
established public trading market. The Company declared and paid cash
dividends on its common stock of $3.0 million, $3.9 million and $4.8
million in 1997, 1996 and 1995, respectively. As of December 31, 1997,
approximately $4.1 million of dividends could be paid by the Company. See
Item 7. "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Financial Condition and Investing and Financing
Activities" and Note 4 to the Consolidated Financial Statements appearing
in Item 8.
The Company's 11-1/4% Senior Secured Notes due 2003 (the "MGI
Senior Notes") and the Company's 12-1/4% Senior Secured Discount Notes due
2003 (the "MGI Discount Notes," which, together with the MGI Senior Notes,
are referred to collectively as the "MGI Notes") are secured by a pledge of
27,938,250 shares of common stock of Kaiser Aluminum Corporation ("Kaiser")
owned by MGHI. See Item 7. "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Financial Condition and
Investing and Financing Activities" and Note 4 to the Consolidated
Financial Statements appearing in Item 8.
ITEM 6. SELECTED FINANCIAL DATA
Not applicable.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
BACKGROUND
This section contains statements which constitute "forward-
looking statements" within the meaning of the Private Securities Litigation
Reform Act of 1995. See Item 1. "Business--General" for cautionary
information with respect to such forward-looking statements.
The Company engages in forest products operations principally
through its subsidiaries, Pacific Lumber and Britt. The Company's business
is seasonal in that the forest products business generally experiences
lower first quarter sales due largely to the general decline in
construction-related activity during the winter months. The following
should be read in conjunction with the Company's Consolidated Financial
Statements and the Notes thereto appearing in Item 8.
Old growth trees constitute Pacific Lumber's principal source of
upper grade redwood lumber, Pacific Lumber's most valuable product. Due to
restrictions on Pacific Lumber's ability to harvest old growth timber on
its property, Pacific Lumber's supply of upper grade lumber has decreased
in some premium product categories. Furthermore, logging costs have
increased, primarily due to the harvest of smaller diameter logs and, to a
lesser extent, compliance with environmental regulations relating to the
harvesting of timber and litigation costs incurred in connection with
certain timber harvesting plans ("THPs") filed by Pacific Lumber. Pacific
Lumber has been able to lessen the impact of these factors by instituting a
number of measures at its sawmills during the past several years designed
to enhance the efficiency of its operations, such as expansion of its
manufactured lumber facilities and other improvements in lumber recovery
and installation of a lumber remanufacturing facility at its Fortuna lumber
mill. However, unless Pacific Lumber is able to sustain the harvest level
of old growth trees, Pacific Lumber expects that its production of premium
upper grade lumber products will decline and that its manufactured lumber
products will constitute a higher percentage of its shipments of upper
grade lumber products. See also "--Trends" and Item 1. "Business--
Regulatory and Environmental Factors and Headwaters Agreement."
RESULTS OF OPERATIONS
The following table presents selected operational and financial
information for the years ended December 31, 1997, 1996 and 1995.
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------
1997 1996 1995
------------- ------------- -------------
(In millions of dollars,
except shipments and prices)
<S> <C> <C> <C>
Shipments:
Lumber: (1)
Redwood upper grades 52.4 49.7 46.5
Redwood common grades 244.2 229.6 216.7
Douglas-fir upper grades 11.5 10.6 7.4
Douglas-fir common grades 75.3 74.9 64.6
Other 14.5 17.2 11.4
------------- ------------- -------------
Total lumber 397.9 382.0 346.6
============= ============= =============
Logs (2) 11.9 20.1 12.6
============= ============= =============
Wood chips (3) 237.8 208.9 214.0
============= ============= =============
Average sales price:
Lumber: (4)
Redwood upper grades $ 1,443 $ 1,380 $ 1,495
Redwood common grades 531 511 477
Douglas-fir upper grades 1,203 1,154 1,301
Douglas-fir common grades 455 439 392
Logs (4) 414 477 440
Wood chips (5) 73 76 102
Net sales:
Lumber, net of discount $ 256.1 $ 234.1 $ 211.3
Logs 4.9 9.6 5.6
Wood chips 17.4 15.8 21.7
Cogeneration power 4.5 3.3 2.5
Other 4.3 1.8 1.5
------------- ------------- -------------
Total net sales $ 287.2 $ 264.6 $ 242.6
============= ============= =============
Operating income $ 83.8 $ 72.0 $ 73.2
============= ============= =============
Operating cash flow (6) $ 111.0 $ 100.2 $ 99.6
============= ============= =============
Income before income taxes $ 18.6 $ 4.9 $ 4.7
============= ============= =============
Net income $ 12.6 $ 5.6 $ 3.5
============= ============= =============
Capital Expenditures $ 22.9 $ 15.2 $ 10.5
============= ============= =============
<FN>
- ---------------
(1) Lumber shipments are expressed in millions of board feet.
(2) Log shipments are expressed in millions of feet, net Scribner scale.
(3) Wood chip shipments are expressed in thousands of bone dry units of
2,400 pounds.
(4) Dollars per thousand board feet.
(5) Dollars per bone dry unit.
(6) Operating income before depletion and depreciation, also referred to
as "EBITDA."
</TABLE>
Net sales
Net sales for 1997 increased over 1996 due to higher average
realized prices and an increase in shipments for most categories of redwood
and Douglas-fir lumber. Net sales for 1996 increased compared to 1995
principally due to higher lumber shipments in all categories and higher
average realized prices for common grade lumber. Partially offsetting
these improvements were lower average realized prices for upper grade
redwood lumber and wood chips. Shipments of fencing and other value-added
common lumber products from the Company's new remanufacturing facility were
a contributing factor in the improved redwood common lumber realizations.
Operating income
Operating income for 1997 increased over 1996, principally due to
the increase in net sales discussed above. Operating income, after
excluding from 1995 the benefit from a $1.5 million insurance settlement,
increased in 1996 due to the increase in net sales discussed above.
Increases in costs of goods sold reflect both the impact of additional
manufacturing costs attributable to the increased shipments of manufactured
lumber products, higher shipments of lower margin lumber and the increasing
cost of regulatory compliance for the Company's timber harvesting
operations.
Income before income taxes
Income before taxes for 1997 increased over 1996 principally due
to higher operating income discussed above and due to an increase in net
gains on marketable securities in 1997. Income before income taxes for
1996 was basically flat as compared to 1995.
Credit in lieu of income taxes
The credit in lieu of income taxes for 1996 includes a benefit of
$2.3 million relating to the refund of taxes previously paid in connection
with a settlement of certain federal income tax matters in 1996.
FINANCIAL CONDITION AND INVESTING AND FINANCING ACTIVITIES
This section contains statements which constitute "forward-
looking statements" within the meaning of the Private Securities Litigation
Reform Act of 1995. See Item 1. "Business--General" for cautionary
information with respect to such forward-looking statements.
The Company conducts its operations primarily through its
subsidiaries, Pacific Lumber and Britt. Substantially all of the Company's
consolidated assets are owned by Pacific Lumber and a significant portion
of Pacific Lumber's consolidated assets are owned by Scotia Pacific.
Moreover, Pacific Lumber is dependent upon Scotia Pacific for most of its
log requirements. The holders of the Timber Notes ($320.0 million
outstanding as of December 31, 1997) have priority over the claims of
creditors of Pacific Lumber with respect to the assets and cash flows of
Scotia Pacific, and the holders of the $235.0 million of 10-1/2% Pacific
Lumber Senior Notes (the "Pacific Lumber Senior Notes") have priority over
the claims of creditors of the Company with respect to the assets and cash
flows of Pacific Lumber. In the event Scotia Pacific's cash flows are not
sufficient to generate distributable funds to Pacific Lumber, Pacific
Lumber would effectively be precluded from distributing funds to the
Company, and the Company's ability to pay interest on the MGI Notes and its
other indebtedness would also be materially impaired. The Company is
dependent upon its existing cash resources and dividends from Pacific
Lumber and Britt to meet its financial and debt service obligations as they
become due. The Company expects that Pacific Lumber will provide a major
portion of its future operating cash flow.
The indentures governing the MGI Notes, the Pacific Lumber Senior
Notes, the Timber Notes (the "Timber Note Indenture") and Pacific Lumber's
revolving credit agreement (the "Pacific Lumber Credit Agreement") contain
various covenants which, among other things, limit the ability to incur
additional indebtedness and liens, to engage in transactions with
affiliates, to pay dividends and to make investments. Under the terms of
the Timber Note Indenture, Scotia Pacific will generally have available
cash for distribution to Pacific Lumber when Scotia Pacific's cash flow
from operations exceeds the amounts required by the Timber Note Indenture
to be reserved for the payment of current debt service (including interest,
principal and premiums) on the Timber Notes, capital expenditures and
certain other operating expenses. Pacific Lumber can pay dividends in an
amount that is generally equal to 50% of Pacific Lumber's consolidated net
income plus depletion and cash dividends received from Scotia Pacific,
exclusive of the net income and depletion of Scotia Pacific as long as any
Timber Notes are outstanding.
Dividends paid are as follows:
<TABLE>
<CAPTION>
Dividends Paid for
Years Ended December 31,
----------------------------------------
1997 1996 1995
------------- ------------- -------------
(In millions of dollars)
<S> <C> <C> <C>
Scotia Pacific $ 60.8 $ 76.9 $ 59.0
============= ============= =============
Pacific Lumber $ 23.0 $ 20.5 $ 22.0
Britt 4.0 6.0 6.0
------------- ------------- -------------
$ 27.0 $ 26.5 $ 28.0
============= ============= =============
MGI $ 3.0 $ 3.9 $ 4.8
============= ============= =============
</TABLE>
On October 9, 1997, the Pacific Lumber Credit Agreement was
amended to, among other things, extend the date on which it expires to May
31, 2000. The Pacific Lumber Credit Agreement provides for borrowings of
up to $60.0 million, of which $20.0 million may be used for standby
letters of credit and $30.0 million is restricted to acquisition of
timberlands. Borrowings made pursuant to the portion of the credit
facility restricted to timberland acquisitions are secured by the purchased
timberlands. As of December 31, 1997, $9.4 million of borrowings were
outstanding and letters of credit outstanding amounted to $15.1 million.
As of December 31, 1997, $35.5 million of borrowings was available under
the Pacific Lumber Credit Agreement, of which $4.9 million was available
for letters of credit and $20.6 million was restricted to timberland
acquisitions.
As of December 31, 1997, the Company had working capital of
$161.7 million and long-term debt of $734.5 million (net of current
maturities and restricted cash deposited in a liquidity account for the
benefit of the holders of the Timber Notes) as compared to $131.4 million
and $729.8 million, respectively, at December 31, 1996. The change in
long-term debt was primarily due to $9.4 million of borrowings under the
Pacific Lumber Credit Agreement and $13.2 million in accretion of discount
on the MGI Discount Notes offset by $16.2 million in principal payments on
the Timber Notes.
Recent capital expenditures were made to improve production
efficiency, reduce operating costs and acquire additional timberlands. The
Company's consolidated capital expenditures were $22.9 million, $15.2
million and $10.5 million for the years ended December 31, 1997, 1996 and
1995, respectively. Capital expenditures, excluding expenditures for
timberlands, are estimated to be between $10.0 million and $20.0 million
per year for the 1998 - 2000 period. Pacific Lumber expects to purchase
additional timberlands from time to time as appropriate opportunities arise
to maintain recent harvest levels. However, there can be no assurance that
Pacific Lumber would be able to continue such operations which would be
limited by its financial resources and the availability of acceptable
properties.
As of December 31, 1997, the Company had cash and marketable
securities of approximately $141.2 million, $38.8 million of which
represents cash and marketable securities held by subsidiaries. The
Company anticipates that cash from operations, together with existing cash,
marketable securities and available sources of financing, will be
sufficient to fund its working capital and capital expenditure requirements
for the next year. With respect to their long-term liquidity, the Company
believes that its existing cash and cash equivalents, together with its
ability to generate sufficient levels of cash from operations and its
ability to obtain both short- and long-term financing, should provide
sufficient funds to meet its working capital and capital expenditure
requirements. However, due to its highly leveraged condition, the Company
is more sensitive than less leveraged companies to factors affecting its
operations, including governmental regulation and litigation affecting its
timber harvesting practices (see "--Trends" below), increased competition
from other lumber producers or alternative building products and general
economic conditions.
TRENDS
This section contains statements which constitute "forward-
looking statements" within the meaning of the Private Securities Litigation
Reform Act of 1995. See Item 1. "Business--General" for cautionary
information with respect to such forward-looking statements.
The Company's forest products operations are primarily conducted
by Pacific Lumber. Pacific Lumber's operations are subject to a variety of
California and federal laws and regulations dealing with timber harvesting,
threatened and endangered species and habitat for such species, and air and
water quality. Moreover, these laws and regulations are modified from time
to time and are subject to judicial and administrative interpretation.
Compliance with such laws, regulations and judicial and administrative
interpretations, together with the cost of litigation incurred in
connection with certain timber harvesting operations of Pacific Lumber,
have increased the cost of logging operations. Pacific Lumber is subject
to certain pending matters which could have a material adverse effect on
the Company's consolidated financial position, results of operations or
liquidity. There can be no assurance that these pending matters or future
governmental regulations, legislation or judicial or administrative
decisions would not have a material and adverse effect on the Company. See
Item 1. "Business--Regulatory and Environmental Factors and Headwaters
Agreement," Item 3. "Legal Proceedings--Timber Harvesting Litigation" and
Note 9 to the Consolidated Financial Statements for further information
regarding regulatory and legal proceedings affecting the Company's
operations.
Judicial or regulatory actions adverse to Pacific Lumber,
increased regulatory delays and inclement weather in northern California,
independently or collectively, could impair Pacific Lumber's ability to
maintain adequate log inventories and force Pacific Lumber to temporarily
idle or curtail operations at certain lumber mills from time to time.
There can be no assurance that the above described pending matters or
future governmental regulations, legislation or judicial or administrative
decisions would not have a material adverse effect on Pacific Lumber.
YEAR 2000
Internal assessments undertaken for the Company have determined
that the Company's software and related technologies will be affected to a
small extent by the year 2000 date change. Spending is expected to be less
than $100,000. System modification costs will be expensed as incurred.
Costs associated with new systems will be capitalized and amortized over
the estimated useful life of the product.
RECENT ACCOUNTING PRONOUNCEMENTS
During June 1997, two new accounting standards were issued that
will affect future financial reporting. Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("SFAS No. 130"),
requires the presentation of an additional income measure (termed
"comprehensive income"), which adjusts traditional net income for certain
items that previously were only reflected as direct charges to equity,
(such as minimum pension liabilities). Statement of Financial Accounting
Standards No. 131, "Disclosures About Segments of an Enterprise and Related
Information" ("SFAS No. 131"), requires that segment reporting for public
reporting purposes be conformed to the segment reporting used by management
for internal purposes. SFAS No. 131 also adds a requirement for the
presentation of certain segment data on a quarterly basis starting in 1999.
SFAS No. 130 and SFAS No. 131 must both be adopted in the Company's first
quarter ending March 31, 1998 and year-end 1998 reporting, respectively, if
applicable. Early adoption is acceptable but not required. Management is
evaluating the impact of these two standards on the Company's future
financial reporting.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholder and Board of Directors of MAXXAM Group Inc.:
We have audited the accompanying consolidated balance sheets of
MAXXAM Group Inc. (a Delaware corporation and a wholly owned subsidiary of
MAXXAM Group Holdings Inc.) and subsidiaries as of December 31, 1997 and
1996, and the related consolidated statements of operations and cash flows
for each of the three years in the period ended December 31, 1997. These
financial statements and the schedule referred to below are the
responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the financial position of
MAXXAM Group Inc. and subsidiaries as of December 31, 1997 and 1996, and
the results of their operations and their cash flows for each of the three
years in the period ended December 31, 1997, in conformity with generally
accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the
basic consolidated financial statements taken as a whole. The schedule
listed in Item 14(a)(2) of this Form 10-K is presented for purposes of
complying with the Securities and Exchange Commission's rules and is not
part of the basic consolidated financial statements. This schedule has
been subjected to the auditing procedures applied in the audits of the
basic consolidated financial statements and, in our opinion, fairly states
in all material respects the financial data required to be set forth
therein in relation to the basic consolidated financial statements taken as
a whole.
ARTHUR ANDERSEN LLP
San Francisco, California
January 30, 1998
(Except for the matter discussed in the fourth paragraph of Note 9 as to
which the date is February 27, 1998.)
MAXXAM GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
December 31,
--------------------------
1997 1996
------------ ------------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 89,840 $ 72,418
Marketable securities 51,324 31,423
Receivables:
Trade 19,269 18,850
Other 2,157 2,542
Inventories 58,078 69,307
Prepaid expenses and other current assets 13,080 5,474
------------ ------------
Total current assets 233,748 200,014
Timber and timberlands, net of accumulated
depletion of $236,824 and $221,063,
respectively 321,206 324,986
Property, plant and equipment, net of accumulated
depreciation of $85,468 and $76,753,
respectively 102,761 102,029
Deferred financing costs, net 21,513 24,249
Deferred income taxes 49,623 55,047
Restricted cash 28,434 29,967
Other assets 4,209 6,455
------------ ------------
$ 761,494 $ 742,747
============ ============
LIABILITIES AND STOCKHOLDER'S DEFICIT
Current liabilities:
Accounts payable $ 3,535 $ 3,928
Accrued interest 24,338 24,899
Accrued compensation and related benefits 12,544 10,033
Deferred income taxes 9,671 10,173
Other accrued liabilities 2,564 3,335
Long-term debt, current maturities 19,429 16,258
------------ ------------
Total current liabilities 72,081 68,626
Long-term debt, less current maturities 762,896 759,769
Other noncurrent liabilities 28,976 26,387
------------ ------------
Total liabilities 863,953 854,782
------------ ------------
Contingencies
Stockholder's deficit:
Common stock, $.08-1/3 par value; 1,000
shares authorized, 100 shares issued - -
Additional capital 81,287 81,287
Accumulated deficit (183,746) (193,322)
------------ ------------
Total stockholder's deficit (102,459) (112,035)
------------ ------------
$ 761,494 $ 742,747
============ ============
<FN>
The accompanying notes are an integral part of these financial statements.
</TABLE>
MAXXAM GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Net sales:
Lumber and logs $ 260,993 $ 243,726 $ 216,898
Other 26,182 20,858 25,694
------------ ------------ ------------
287,175 264,584 242,592
------------ ------------ ------------
Operating expenses:
Cost of goods sold 162,020 148,522 127,124
Selling, general and administrative
expenses 14,205 15,853 15,884
Depletion and depreciation 27,108 28,176 26,405
------------ ------------ ------------
203,333 192,551 169,413
------------ ------------ ------------
Operating income 83,842 72,033 73,179
Other income (expense):
Investment, interest and other
income 13,444 10,942 9,393
Interest expense (78,674) (78,045) (77,824)
------------ ------------ ------------
Income before income taxes 18,612 4,930 4,748
Credit (provision) in lieu of income
taxes (6,036) 680 (1,211)
------------ ------------ ------------
Net income $ 12,576 $ 5,610 $ 3,537
============ ============ ============
<FN>
The accompanying notes are an integral part of these financial statements.
</TABLE>
MAXXAM GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 12,576 $ 5,610 $ 3,537
Adjustments to reconcile net income
to net cash provided by
operating activities:
Depletion and depreciation 27,108 28,176 26,405
Amortization of deferred
financing costs and
discounts on
long-term debt 15,888 14,714 13,328
Net sales (purchases) of
marketable securities (11,330) 10,298 (19,533)
Net gains on marketable
securities (8,571) (5,153) (4,175)
Increase (decrease) in cash
resulting from changes in:
Receivables (28) 1,284 5,778
Inventories, net of depletion 9,657 6,011 (7,695)
Prepaid, expenses and other
current assets (5,360) 714 (3,384)
Accounts payable (54) (238) 463
Accrued interest (561) (455) (411)
Accrued and deferred income
taxes 5,618 (925) 2,303
Other liabilities 3,280 (4,288) 7,734
Other 96 5 1,020
------------ ------------ ------------
Net cash provided by
operating activities 48,319 55,753 25,370
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (13,467) (15,200) (9,852)
Payment of note receivable from
affiliate - - 2,500
Net proceeds from sale of assets 336 122 18
------------ ------------ ------------
Net cash used for
investing activities (13,131) (15,078) (7,334)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Redemptions, repurchases of and
principal payments on long-term
debt (16,299) (14,153) (14,300)
Dividends paid (3,000) (3,900) (4,800)
Restricted cash withdrawals, net 1,533 1,400 1,035
Incurrence of financing costs - - (150)
------------ ------------ ------------
Net cash used for
financing activities (17,766) (16,653) (18,215)
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 17,422 24,022 (179)
CASH AND CASH EQUIVALENTS AT BEGINNING OF
YEAR 72,418 48,396 48,575
------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 89,840 $ 72,418 $ 48,396
============ ============ ============
<FN>
The accompanying notes are an integral part of these financial statements.
</TABLE>
MAXXAM GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of
MAXXAM Group Inc. ("MGI") and its subsidiaries, collectively referred to
herein as the "Company." MGI is a wholly owned subsidiary of MAXXAM Group
Holdings Inc. ("MGHI") which is a wholly owned subsidiary of MAXXAM Inc.
("MAXXAM"). Intercompany balances and transactions have been eliminated.
Certain reclassifications have been made to prior years' financial
statements to be consistent with the current year's presentation.
The Company is engaged in forest products operations conducted
through its wholly owned subsidiaries, The Pacific Lumber Company ("Pacific
Lumber") and Britt Lumber Co., Inc. ("Britt"). Pacific Lumber's principal
wholly owned subsidiaries are Scotia Pacific Holding Company ("Scotia
Pacific") and Salmon Creek Corporation ("Salmon Creek"). Pacific Lumber is
engaged in several principal aspects of the lumber industry, including the
growing and harvesting of redwood and Douglas-fir timber, the milling of
logs into lumber and the manufacture of lumber into a variety of finished
products. Britt manufactures redwood and cedar fencing and decking products
from small diameter logs, a substantial portion of which are obtained from
Pacific Lumber. Housing, construction and remodeling are the principal
markets for the Company's lumber products. Export sales generally
constitute approximately 5% of sales. A significant portion of forest
product sales are made to third parties located west of the Mississippi
River.
USE OF ESTIMATES AND ASSUMPTIONS
The preparation of financial statements in accordance with
generally accepted accounting principles requires the use of estimates and
assumptions that affect (i) the reported amounts of assets and liabilities,
(ii) the disclosure of contingent assets and liabilities known to exist as
of the date the financial statements are published and (iii) the reported
amount of revenues and expenses recognized during each period presented.
The Company reviews all significant estimates affecting its consolidated
financial statements on a recurring basis and records the effect of any
necessary adjustments prior to their publication. Adjustments made with
respect to the use of estimates often relate to improved information not
previously available. Uncertainties with respect to such estimates and
assumptions are inherent in the preparation of the Company's consolidated
financial statements; accordingly, it is possible that the subsequent
resolution of any one of the contingent matters described in Note 8 could
differ materially from current estimates. The results of an adverse
resolution of such uncertainties could have a material effect on the
Company's consolidated financial position, results of operations or
liquidity.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash Equivalents
Cash equivalents consist of highly liquid money market
instruments with original maturities of three months or less.
Marketable Securities
Marketable securities are carried at fair value. The cost of the
securities sold is determined using the first-in, first-out method.
Included in investment, interest and other income for each of the three
years ended December 31, 1997 were: 1997 - net unrealized holding gains of
$2,851,000 and net realized gains of $5,720,000; 1996 - net unrealized
holding losses of $902,000 and net realized gains of $5,287,000; and 1995 -
net unrealized holding gains of $1,666,000 and net realized gains of
$2,509,000.
Inventories
Inventories are stated at the lower of cost or market. Cost is
primarily determined using the last-in, first-out ("LIFO") method.
Timber and Timberlands
Timber and timberlands are stated at cost, net of accumulated
depletion. Depletion is computed utilizing the unit-of-production method
based upon estimates of timber values and quantities.
Property, Plant and Equipment
Property, plant and equipment, including capitalized interest, is
stated at cost, net of accumulated depreciation. Depreciation is computed
utilizing the straight-line method at rates based upon the estimated useful
lives of the various classes of assets.
Deferred Financing Costs
Costs incurred to obtain financing are deferred and amortized
over the estimated term of the related borrowing.
Restricted Cash and Concentrations of Credit Risk
Restricted cash represents the amount deposited into an account
(the "Liquidity Account") held by the Trustee under the Indenture governing
the 7.95% Timber Collateralized Notes due 2015 (the "Timber Notes") of
Scotia Pacific. See Note 4. The Liquidity Account is not available,
except under certain limited circumstances, for Scotia Pacific's working
capital purposes; however, it is available to pay the Rated Amortization
(as defined in Note 4) and interest on the Timber Notes if and to the
extent that cash flows are insufficient to make such payments. The
required Liquidity Account balance will generally decline as principal
payments are made on the Timber Notes. Investment, interest and other
income for the years ended December 31, 1997, 1996 and 1995 includes
interest of approximately $2,336,000, $2,457,000 and $2,560,000,
respectively, attributable to an investment rate agreement (at 7.95% per
annum) with the financial institution which holds the Liquidity Account.
At December 31, 1997 and 1996, cash and cash equivalents include
$17,784,000 and $17,600,000, respectively, (the "Payment Account") which is
reserved for debt service payments on the Timber Notes (see Note 4). The
Payment Account and the Liquidity Account are each held by a different
financial institution. In the event of nonperformance by such financial
institutions, the Company's exposure to credit loss is represented by the
amounts deposited plus any unpaid accrued interest thereon. The Company
mitigates its concentrations of credit risk with respect to these
restricted cash deposits by maintaining them at high credit quality
financial institutions and monitoring the credit ratings of these
institutions.
Fair Value of Financial Instruments
The carrying amounts of cash equivalents and restricted cash
approximate fair value. Marketable securities are carried at fair value
which is determined based on quoted market prices. As of December 31, 1997
and 1996, the estimated fair value of long-term debt, including current
maturities, was $816,014,000 and $747,991,000, respectively. The estimated
fair value of long-term debt is determined based on the quoted market
prices for the Timber Notes, Pacific Lumber's 10-1/2% Senior Notes due 2003
(the "Pacific Lumber Senior Notes"), the Company's 11-1/4% Senior Secured
Notes due 2003 (the "MGI Senior Notes") and the Company's 12-1/4% Senior
Secured Discount Notes due 2003 (the "MGI Discount Notes" and together with
the MGI Senior Notes, the "MGI Notes"), and on the current rates offered
for borrowings similar to the other debt. Some of the Company's publicly
traded debt issues are thinly traded financial instruments; accordingly,
their market prices at any balance sheet date may not be representative of
the prices which would be derived from a more active market.
2. INVENTORIES
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
---------------------------
1997 1996
------------- -------------
<S> <C> <C>
Lumber $ 43,731 $ 49,829
Logs 14,347 19,478
------------- -------------
$ 58,078 $ 69,307
============= =============
</TABLE>
3. PROPERTY, PLANT AND EQUIPMENT
The major classes of property, plant and equipment are as follows
(dollar amounts in thousands):
<TABLE>
<CAPTION>
Estimated December 31,
--------------------------
Useful Lives 1997 1996
------------- ------------ ------------
<S> <C> <C> <C>
Logging roads, land and improvements 15 years $ 16,685 $ 11,541
Buildings 33 years 36,637 34,877
Machinery and equipment 3 - 15 years 134,823 132,364
Construction in progress 84 -
------------ ------------
188,229 178,782
Less: accumulated depreciation (85,468) (76,753)
------------ ------------
$ 102,761 $ 102,029
============ ============
</TABLE>
Depreciation expense for the years ended December 31, 1997, 1996
and 1995 was $9,774,000, $ 9,382,000 and $9,663,000, respectively.
4. LONG-TERM DEBT
Long-term debt consists of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
--------------------------
1997 1996
------------ ------------
<S> <C> <C>
7.95% Scotia Pacific Timber Collateralized
Notes due through July 20, 2015 $ 319,965 $ 336,130
10-1/2% Pacific Lumber Senior Notes due March
1, 2003 235,000 235,000
Pacific Lumber Credit Agreement 9,445 -
11-1/4% MGI Senior Secured Notes due August 1,
2003 100,000 100,000
12-1/4% MGI Senior Secured Discount Notes due
August 1, 2003, net of discount 117,325 104,173
Other 590 724
------------ ------------
782,325 776,027
Less: current maturities (19,429) (16,258)
------------ ------------
$ 762,896 $ 759,769
============ ============
</TABLE>
The indenture governing the Timber Notes (the "Timber Note
Indenture") prohibits Scotia Pacific from incurring any additional
indebtedness for borrowed money and generally limits the business
activities of Scotia Pacific to the ownership and operation of its timber
and timberlands. The Timber Notes are senior secured obligations of Scotia
Pacific and are not obligations of, or guaranteed by, Pacific Lumber or any
other person. The Timber Notes are secured by a lien on (i) Scotia
Pacific's timber and timberlands (representing $154,288,000 of the
Company's consolidated balance at December 31, 1997), (ii) Scotia Pacific's
contract rights and certain other assets, (iii) the funds deposited in the
Payment Account and the Liquidity Account, and (iv) substantially all of
Scotia Pacific's other property and equipment.
The Timber Notes are structured to link, to the extent of
available cash, the deemed depletion of Scotia Pacific's timber (through
the harvest and sale of logs) to the required amortization of the Timber
Notes. The required amount of amortization due on any Timber Note payment
date is determined by various mathematical formulas set forth in the Timber
Note Indenture. The minimum amount of principal which Scotia Pacific must
pay (on a cumulative basis) through any Timber Note payment date in order
to avoid an Event of Default (as defined) is referred to as rated
amortization ("Rated Amortization"). If all payments of principal are made
in accordance with Rated Amortization, the payment date on which Scotia
Pacific will pay the final installment of principal is July 20, 2015. The
amount of principal which Scotia Pacific must pay through each Timber Note
payment date in order to avoid prepayment or deficiency premiums is
referred to as scheduled amortization ("Scheduled Amortization"). If all
payments of principal are made in accordance with Scheduled Amortization,
the payment date on which Scotia Pacific will pay the final installment of
principal is July 20, 2009.
Substantially all of the Company's consolidated assets are owned
by Pacific Lumber and a significant portion of Pacific Lumber's assets are
owned by Scotia Pacific. The Company expects that Pacific Lumber will
provide a major portion of the Company's future operating cash flow.
Pacific Lumber is dependent upon Scotia Pacific for a significant portion
of its operating cash flow. The holders of the Timber Notes have priority
over the claims of creditors of Pacific Lumber with respect to the assets
and cash flows of Scotia Pacific, and the holders of the Pacific Lumber
Senior Notes have priority over the claims and creditors of the Company
with respect to the assets and cash flows of Pacific Lumber. Under the
terms of the Timber Note Indenture, Scotia Pacific will generally have
available cash for distribution to Pacific Lumber when Scotia Pacific's
cash flow from operations exceeds the amounts required by the Timber Note
Indenture to be reserved for the payment of current debt service (including
interest, principal and premiums) on the Timber Notes, capital expenditures
and certain other operating expenses.
Principal and interest on the Timber Notes are payable semi-
annually on January 20 and July 20. On January 20, 1998,
Scotia Pacific paid $10,773,000 of principal on the Timber Notes. The
Timber Notes are redeemable at the option of Scotia Pacific, in whole but
not in part, at any time. The redemption price of the Timber Notes is
equal to the sum of the principal amount, accrued interest and a prepayment
premium calculated based upon the yield of like-term Treasury securities
plus 50 basis points.
Interest on the Pacific Lumber Senior Notes is payable semi-
annually on March 1 and September 1. The Pacific Lumber Senior Notes are
redeemable at the option of Pacific Lumber, in whole or in part, on or
after March 1, 1998 at a price of 103% of the principal amount plus accrued
interest. The redemption price is reduced annually until March 1, 2000,
after which time the Pacific Lumber Senior Notes are redeemable at par.
The Pacific Lumber Senior Notes are unsecured and are senior indebtedness
of Pacific Lumber; however, they are effectively subordinated to the Timber
Notes. The indenture governing the Pacific Lumber Senior Notes contains
various covenants which, among other things, limit Pacific Lumber's ability
to incur additional indebtedness and liens, to engage in transactions with
affiliates, to make investments and to pay dividends.
On October 9, 1997, Pacific Lumber amended its revolving credit
agreement with a bank (the "Pacific Lumber Credit Agreement") to extend the
date on which it expires to May 31, 2000. Borrowings under the Pacific
Lumber Credit Agreement are secured by Pacific Lumber's trade receivables
and inventories, with interest currently computed at the bank's reference
rate plus 1-1/4% or the bank's offshore rate plus 2-1/4%. The Pacific
Lumber Credit Agreement provides for borrowings of up to $60,000,000, of
which $20,000,000 may be used for standby letters of credit and $30,000,000
is restricted to timberland acquisitions. Borrowings made pursuant to the
portion of the credit facility restricted to timberland acquisitions would
also be secured by the purchased timberlands. As of December 31, 1997,
$35,484,000 of borrowings was available under the Pacific Lumber Credit
Agreement, of which $4,929,000 was available for letters of credit and
$20,554,000 was restricted to timberland acquisitions. As of December 31,
1997, $9,445,000 borrowings were outstanding and letters of credit
outstanding amounted to $15,071,000. The Pacific Lumber Credit Agreement
contains covenants substantially similar to those contained in the
indenture governing the Pacific Lumber Senior Notes.
As of December 31, 1997, under the most restrictive covenants
contained in the indentures governing the Pacific Lumber Senior Notes, the
Timber Notes and the Pacific Lumber Credit Agreement, Pacific Lumber could
pay approximately $15,900,000 of dividends.
On August 4, 1993, the Company issued $100,000,000 aggregate
principal amount of the MGI Senior Notes and $126,720,000 aggregate
principal amount (approximately $70,000,000 net of original issue discount)
of the MGI Discount Notes. The MGI Notes are secured by the Company's
pledge of 100% of the common stock of Pacific Lumber, Britt and MAXXAM
Properties Inc. ("MPI"), a wholly owned subsidiary of the Company, and by
MGHI's pledge of 27,938,250 shares of Kaiser Aluminum Corporation
("Kaiser") common stock. The indenture governing the MGI Notes, among
other things, restricts the ability of the Company to incur additional
indebtedness and liens, engage in transactions with affiliates, pay
dividends and make investments. As of December 31, 1997, under the most
restrictive of these covenants, approximately $4,100,000 of dividends could
be paid by the Company. The MGI Notes are senior indebtedness of the
Company; however, they are effectively subordinated to the liabilities of
the Company's subsidiaries, which include the Timber Notes and the Pacific
Lumber Senior Notes. The MGI Discount Notes are net of discount of
$8,395,000 and $21,547,000 at December 31, 1997 and 1996, respectively.
The MGI Senior Notes pay interest semi-annually on February 1 and
August 1 of each year. The MGI Discount Notes will not pay any interest
until February 1, 1999, at which time semi-annual interest payments will
become due on each February 1 and August 1 thereafter.
Maturities
Scheduled maturities of long-term debt for the five years
following December 31, 1997, using the Scheduled Amortization for the
Timber Notes, are: $19,429,000 in 1998, $24,107,000 in 1999, $26,426,000
in 2000, $27,189,000 in 2001, $27,213,000 in 2002 and $666,356,000
thereafter. Maturities for 1998 through 2002 are principally attributable
to the Timber Notes.
Restricted Net Assets of Subsidiaries
At December 31, 1997, certain debt instruments restricted the
ability of Pacific Lumber to transfer assets, make loans and advances and
pay dividends to the Company. As of December 31, 1997, all of the assets
of Pacific Lumber and its subsidiaries are subject to such restrictions.
5. CREDIT (PROVISION) IN LIEU OF INCOME TAXES
Income taxes are determined using an asset and liability approach
which requires the recognition of deferred income tax assets and
liabilities for the expected future tax consequences of events that have
been recognized in the Company's financial statements or tax returns.
Under this method, deferred income tax assets and liabilities are
determined based on the temporary differences between the financial
statement and tax bases of assets and liabilities using enacted tax rates.
The Company and its subsidiaries are members of MAXXAM's consolidated
return group for federal income tax purposes.
Pursuant to a tax allocation agreement between MAXXAM, Pacific
Lumber, Scotia Pacific and Salmon Creek (the "PL Tax Allocation
Agreement"), Pacific Lumber is liable to MAXXAM for the federal
consolidated income tax liability of Pacific Lumber, Scotia Pacific and
certain other subsidiaries of Pacific Lumber (but excluding Salmon Creek)
(collectively, the "PL Subgroup") computed as if the PL Subgroup was a
separate affiliated group of corporations which was never connected with
MAXXAM. The PL Tax Allocation Agreement further provides that Salmon Creek
is liable to MAXXAM for its federal income tax liability computed on a
separate company basis as if it was never connected with MAXXAM. The
remaining subsidiaries of MGI are each liable to MAXXAM for their
respective income tax liabilities computed on a separate company basis as
if they were never connected with MAXXAM, pursuant to their respective tax
allocation agreements.
MGI's tax allocation agreement with MAXXAM, (the "Tax Allocation
Agreement"), provides that the Company's federal income tax liability is
computed as if MGI files a consolidated tax return with all of its
subsidiaries except Salmon Creek, and that such corporations were never
connected with MAXXAM (the "MGI Consolidated Tax Liability"). The federal
income tax liability of MGI is the difference between (i) the MGI
Consolidated Tax Liability and (ii) the sum of the separate tax liabilities
for the Company's subsidiaries (computed as discussed above), but excluding
Salmon Creek. To the extent that the MGI Consolidated Tax Liability is
less than the aggregate amounts in (ii), MAXXAM is obligated to pay the
amount of such difference to MGI.
The credit (provision) in lieu of income taxes on income before
income taxes consists of the following (in thousands):
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Current:
Federal (provision) in lieu of
income taxes $ (423) $ (159) $ (167)
State and local (provision) (139) (9) (35)
------------ ------------ ------------
(562) (168) (202)
------------ ------------ ------------
Deferred:
Federal credit (provision) in lieu
of income taxes (5,523) 363 (33)
State and local credit (provision) 49 485 (976)
------------ ------------ ------------
(5,474) 848 (1,009)
------------ ------------ ------------
$ (6,036) $ 680 $ (1,211)
============ ============ ============
</TABLE>
A reconciliation between the credit (provision) in lieu of income
taxes and the amount computed by applying the federal statutory income tax
rate to income before income taxes is as follows (in thousands):
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Income before income taxes $ 18,612 $ 4,930 $ 4,748
============ ============ ============
Amount of federal income tax based upon
the statutory rate $ (6,514) $ (1,726) $ (1,662)
Revision of prior years' tax estimates
and other changes in valuation
allowances 982 3,372 907
Expenses for which no federal tax
benefit is available (178) (493) -
State and local taxes, net of federal
tax effect (59) (573) (657)
Other (267) 100 201
------------ ------------ ------------
$ (6,036) $ 680 $ (1,211)
============ ============ ============
</TABLE>
Revision of prior years' tax estimates and other changes in
valuation allowances as shown in the table above include amounts for the
reversal of reserves which the Company no longer believes are necessary,
other changes in prior year tax estimates and changes in valuation
allowances with respect to deferred income tax assets. Generally, the
reversal of reserves relates to the expiration of the relevant statute of
limitations with respect to certain income tax returns or the resolution of
specific income tax matters with the relevant tax authorities. For the
years ended December 31, 1996 and 1995, the reversal of reserves which the
Company believes are no longer necessary resulted in a credit to the income
tax provision of $3,203,000 and $127,000, respectively. There was no
reversal of reserves for the year ended December 31, 1997.
The components of the Company's net deferred income tax assets
(liabilities) are as follows (in thousands):
<TABLE>
<CAPTION>
December 31,
--------------------------
1997 1996
------------ ------------
<S> <C> <C>
Deferred income tax assets:
Loss and credit carryforwards $ 68,140 $ 79,411
Timber and timberlands 25,800 28,992
Other liabilities and other 32,316 22,934
Valuation allowances (49,828) (51,049)
------------ ------------
Total deferred income tax assets, net 76,428 80,288
------------ ------------
Deferred income tax liabilities:
Property, plant and equipment (17,455) (17,458)
Inventories (12,750) (15,091)
Other (6,271) (2,865)
------------ ------------
Total deferred income tax liabilities (36,476) (35,414)
------------ ------------
Net deferred income tax assets $ 39,952 $ 44,874
============ ============
</TABLE>
The valuation allowances listed above relate to loss and credit
carryforwards. As of December 31, 1997, approximately $25,800,000 of the
net deferred income tax assets listed above relate to the excess of the tax
basis over financial statement basis with respect to timber and
timberlands. The Company believes that it is more likely than not that
this net deferred income tax asset will be realized, based primarily upon
the estimated value of its timber and timberlands which is well in excess
of its tax basis. Also included in net deferred income tax assets as of
December 31, 1997 is $18,312,000 which relates to the benefit of loss and
credit carryforwards, net of valuation allowances. The Company evaluated
all appropriate factors to determine the proper valuation allowances for
loss and credit carryforwards. These factors included any limitations
concerning use of the carryforwards, the year the carryforwards expire and
the levels of taxable income necessary for utilization. The Company has
concluded that it will more likely than not generate sufficient taxable
income to realize the benefit attributable to the loss and credit
carryforwards for which valuation allowances were not provided.
Included in the net deferred income tax assets listed above are
$35,683,000 and $41,206,000 at December 31, 1997 and 1996, respectively,
which are recorded pursuant to the tax allocation agreements with MAXXAM.
The following table presents the estimated tax attributes for
federal income tax purposes for the Company and its subsidiaries as of
December 31, 1997, under the terms of the respective tax allocation
agreements (in thousands). The utilization of certain of these attributes
is subject to limitations.
<TABLE>
<CAPTION>
Expiring
Through
-------------
<S> <C> <C>
Regular Tax Attribute Carryforwards:
Net operating losses $ 186,814 2012
Net capital losses 4,201 1998
Minimum tax credit 802 Indefinite
Alternative Minimum Tax Attribute
Carryforwards:
Net operating losses $ 159,334 2012
Net capital losses 4,201 1998
</TABLE>
6. EMPLOYEE BENEFIT PLANS
RETIREMENT PLAN
Pacific Lumber has a defined benefit plan which covers all
employees of Pacific Lumber. Under the plan, employees are eligible for
benefits at age 65, or earlier, if certain provisions are met. The
benefits are determined under a career average formula based on each year
of service with Pacific Lumber and the employee's compensation for that
year. Pacific Lumber's funding policy is to contribute annually an amount
at least equal to the minimum cash contribution required by The Employee
Retirement Income Security Act of 1974, as amended.
A summary of the components of net periodic pension cost is as
follows (in thousands):
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Service cost - benefits earned during
the year $ 1,937 $ 1,903 $ 1,483
Interest cost on projected benefit
obligation 1,892 1,682 1,693
Actual gain on plan assets (3,988) (2,762) (3,900)
Net amortization and deferral 2,451 1,448 2,460
------------ ------------ ------------
Net periodic pension cost $ 2,292 $ 2,271 $ 1,736
============ ============ ============
</TABLE>
The following table sets forth the funded status and amounts
recognized in the Consolidated Balance Sheet (in thousands):
<TABLE>
<CAPTION>
December 31,
--------------------------
1997 1996
------------ ------------
<S> <C> <C>
Actuarial present value of accumulated plan
benefits:
Vested benefit obligation $ 22,181 $ 18,506
Non-vested benefit obligation 2,176 1,371
------------ ------------
Total accumulated benefit obligation $ 24,357 $ 19,877
============ ============
Projected benefit obligation $ 28,940 $ 23,582
Plan assets at fair value, primarily equity and
debt securities (25,872) (21,800)
------------ ------------
Projected benefit obligation in excess of plan
assets 3,068 1,782
Unrecognized net transition asset 12 18
Unrecognized net gain 4,226 2,855
Unrecognized prior service cost (950) (39)
------------ ------------
Accrued pension liability $ 6,356 $ 4,616
============ ============
</TABLE>
The assumptions used in accounting for the defined benefit plan
were as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------------- ------------- -------------
<S> <C> <C> <C>
Rate of increase in compensation levels 5.0% 5.0% 5.0%
Discount rate 7.25% 7.5% 7.25%
Expected long-term rate of return on
assets 8.0% 8.0% 8.0%
</TABLE>
POSTRETIREMENT MEDICAL BENEFITS
Pacific Lumber has an unfunded benefit plan for certain
postretirement medical benefits which covers substantially all employees of
Pacific Lumber. Participants of the plan are eligible for certain health
care benefits upon termination of employment and retirement and
commencement of pension benefits. Participants make contributions for a
portion of the cost of their health care benefits. The expected costs of
postretirement medical benefits are accrued over the period the employees
provide services to the date of their full eligibility for such benefits.
A summary of the components of net periodic postretirement
medical benefit cost is as follows (in thousands):
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Service cost - medical benefits earned
during the year $ 287 $ 332 $ 228
Interest cost on accumulated postretirement
medical benefit obligation 362 415 317
Net amortization and deferral (42) - (53)
------------ ------------ ------------
Net periodic postretirement medical benefit
cost $ 607 $ 747 $ 492
------------ ------------ ------------
</TABLE>
The postretirement medical benefit liability recognized in the
Company's Consolidated Balance Sheet is as follows (in thousands):
<TABLE>
<CAPTION>
December 31,
--------------------------
1997 1996
------------ ------------
<S> <C> <C>
Retirees $ 710 $ 1,182
Actives eligible for benefits 893 905
Actives not eligible for benefits 3,434 3,818
------------ ------------
Accumulated postretirement medical benefit
obligation 5,037 5,905
1,003 (86)
Unrecognized net gain (loss) ------------ ------------
Postretirement medical benefit liability $ 6,040 $ 5,819
============ ============
</TABLE>
The annual assumed rate of increase in the per capita cost of
covered benefits (i.e., health care cost trend rate) is 10.0% for 1998 and
is assumed to decrease gradually to 5.5% in 2009 and remain at that level
thereafter. Each one percentage point increase in the assumed health care
cost trend rate would increase the accumulated postretirement medical
benefit obligation as of December 31, 1997 by approximately $655,000 and
the aggregate of the service and interest cost components of net periodic
postretirement medical benefit cost by approximately $112,000.
The discount rates used in determining the accumulated
postretirement medical benefit obligation were 7.25% and 7.5% at December
31, 1997 and 1996, respectively.
EMPLOYEE SAVINGS PLAN
Pacific Lumber's employees are eligible to participate in a
defined contribution savings plan sponsored by MAXXAM. This plan is
designed to enhance the existing retirement programs of participating
employees. Employees may elect to defer up to 16% of their base
compensation to the plan. For those participants who have elected to defer
a portion of their compensation to the plan, Pacific Lumber's contributions
consist of a matching contribution of up to 4% of the base compensation of
participants. The cost to the Company of this plan was $1,516,000,
$1,388,000 and $1,281,000 for the years ended December 31, 1997, 1996 and
1995, respectively.
WORKERS' COMPENSATION BENEFITS
Pacific Lumber is self-insured for workers' compensation
benefits, whereas Britt is insured for workers' compensation benefits.
Included in accrued compensation and related benefits and other noncurrent
liabilities are accruals for workers' compensation claims amounting to
$10,800,000 and $8,000,000 at December 31, 1997 and 1996, respectively.
Workers' compensation expenses amounted to $4,660,000, $2,564,000 and
$3,579,000 for the years ended December 31, 1997, 1996 and 1995,
respectively.
7. RELATED PARTY TRANSACTIONS
MAXXAM provides the Company and certain of the Company's
subsidiaries with accounting and data processing services. In addition,
MAXXAM provides the Company with office space and various office personnel,
insurance, legal, operating, financial and certain other services.
MAXXAM's expenses incurred on behalf of the Company are reimbursed by the
Company through payments consisting of (i) an allocation of the lease
expense for the office space utilized by or on behalf of the Company and
(ii) a reimbursement of actual out-of-pocket expenses incurred by MAXXAM,
including, but not limited to, labor costs of MAXXAM personnel rendering
services to the Company. Charges by MAXXAM for such services were
$2,160,000, $2,423,000 and $1,994,000 for the years ended December 31,
1997, 1996 and 1995, respectively. The Company believes that the services
being rendered are on terms not less favorable to the Company than those
which would be obtainable from unaffiliated third parties.
8. STOCKHOLDER'S DEFICIT
Changes in stockholder's deficit were (in thousands):
<TABLE>
<CAPTION>
Common
Stock
($.08-1/3 Additional Accumulated
Par) Capital Deficit Total
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Balance, January 1, 1995 $ - $ 81,287 $ (193,769) $ (112,482)
Net income - - 3,537 3,537
Dividends - - (4,800) (4,800)
------------ ------------ ------------ ------------
Balance, December 31, 1995 - 81,287 (195,032) (113,745)
Net income - - 5,610 5,610
Dividends - - (3,900) (3,900)
------------ ------------ ------------ ------------
Balance, December 31, 1996 - 81,287 (193,322) (112,035)
Net income - - 12,576 12,576
Dividends - - (3,000) (3,000)
------------ ------------ ------------ ------------
Balance, December 31, 1997 $ - $ 81,287 $ (183,746) $ (102,459)
============ ============ ============ ============
</TABLE>
9. CONTINGENCIES
Pacific Lumber's business is subject to a variety of California
and federal laws and regulations dealing with timber harvesting, threatened
and endangered species and habitat for such species, and air and water
quality. Compliance with such laws and regulations plays a significant
role in Pacific Lumber's business. While compliance with such laws,
regulations and judicial and administrative interpretations, together with
the cost of litigation incurred in connection with certain timber
harvesting operations, have increased the costs of Pacific Lumber, they
have not had a significant adverse effect on its financial position,
results of operations or liquidity. However, these laws and related
administrative actions and legal challenges have severely restricted the
ability of Pacific Lumber to harvest virgin old growth timber on its
timberlands, and to a lesser extent, residual old growth timber.
On September 28, 1996, Pacific Lumber (on behalf of itself, its
subsidiaries and affiliates) and MAXXAM (collectively, the "Pacific Lumber
Parties") entered into an agreement with the United States and California
("Headwaters Agreement") which provides the framework for the acquisition
by the United States and California of approximately 5,600 acres of Pacific
Lumber's timberlands. These timberlands are commonly referred to as the
Headwaters Forest and the Elk Head Springs Forest (collectively, the
"Headwaters Timberlands"). A substantial portion of the Headwaters
Timberlands consists of virgin old growth timberlands. Approximately 4,900
of these acres are owned by Salmon Creek, with the remaining acreage being
owned by Scotia Pacific (Pacific Lumber having harvesting rights on
approximately 300 of such acres). The Headwaters Timberlands would be
transferred in exchange for (a) property and other consideration from the
United States and California having an aggregate fair market value of $300
million, and (b) approximately 7,755 acres of adjacent timberlands (the
"Elk River Timberlands") to be acquired from a third party. As part of the
Headwaters Agreement, the Pacific Lumber Parties agreed to not enter the
Headwaters Forest or the Elk Head Springs Forest to conduct any logging or
salvage operations.
Closing of the Headwaters Agreement is subject to various
conditions, including federal and California funding, approval of a
sustained yield plan ("SYP"), approval of a habitat conservation plan
covering multiple species ("Multi-Species HCP") and issuance of a related
incidental take permit (the "Permit") and the issuance of certain tax
agreements satisfactory to the Pacific Lumber Parties.
In November 1997, President Clinton signed an appropriations bill
which contains authorization for the expenditure of $250 million of federal
funds toward consummation of the Headwaters Agreement. On February 27,
1998, Pacific Lumber, MAXXAM and various government agencies entered into a
Pre-Permit Application Agreement in Principle (the "HCP/SYP Agreement")
regarding certain understandings that they had reached regarding the Multi-
Species HCP, the Permit and the SYP. The HCP/SYP Agreement provides that
the Permit and Multi-Species HCP would have a term of 50 years, and would
limit the activities to those which would enhance habitat. These groves
could be conducted by Pacific Lumber in twelve forest groves to those
which would enhance habitat. These groves aggregate approximately 8,000
acres and consist of substantial quantities of virgin and residual old
growth redwood and Douglas-fir timber.
In addition to being an important milestone toward completion of
the Headwaters Agreement, the Company also believes that the HCP/SYP
Agreement is a positive development in respect of the environmental
challenges that it has faced over the last several years. Several species,
including the northern spotted owl, the marbled murrelet and the coho
salmon, have been listed as endangered or threatened under the federal
Endangered Species Act ("ESA") and/or the California Endangered Species Act
("CESA"). Pacific Lumber has developed federal and state northern spotted
owl management plans which permit harvesting activities to be conducted so
long as Pacific Lumber adheres to certain measures designed to protect the
northern spotted owl. The potential impact of the listings of the marbled
murrelet and the coho salmon is more uncertain. If the Multi-Species HCP
is approved, Pacific Lumber would be issued the Permit, which would allow
limited incidental "take" of listed species so long as there was no
"jeopardy" to the species and the Multi-Species HCP would identify the
measures to be instituted in order to minimize and mitigate the anticipated
level of take to the greatest extent possible. The Multi-Species HCP would
be designed to protect currently listed species as well as to consider
candidate and future-listed species. Pacific Lumber is also attempting to
include in the Multi-Species HCP a resolution of the potential effect of
limits by the Environmental Protection Agency ("EPA") on sedimentation,
temperature and other factors for seventeen northern California rivers and
certain of their tributaries, including rivers within Pacific Lumber's
timberlands. These limitations will be aimed at protecting water
quality.
Lawsuits are pending or threatened which seek to prevent Pacific
Lumber from implementing certain of its approved timber harvesting plans
("THPs"). While challenges with respect to Pacific Lumber's young growth
timber have historically been limited, a lawsuit was recently filed under
the ESA which relates to a significant number of THPs covering young growth
timber of Pacific Lumber. While the Company expects these environmentally
focused objections and lawsuits to continue, it believes that the HCP/SYP
Agreement will enhance its position in connection with these challenges.
The Company also believes that the Multi-Species HCP would expedite the
preparation and facilitate approval of its THPs.
The HCP/SYP Agreement also contains certain provisions relating
to the SYP. Subject to further study, the Company expects Pacific Lumber
to propose a long-term sustained yield harvest level ("LTSY") which is
somewhat less than Pacific Lumber's recent harvest levels. If the SYP is
approved, Pacific Lumber will have complied with certain BOF regulations
requiring that timber companies project timber growth and harvest on their
timberlands over a 100-year planning period and establish an LTSY harvest
level. The SYP must demonstrate that the average annual harvest over any
rolling ten-year period will not exceed the LTSY harvest level and that
Pacific Lumber's projected timber inventory is capable of
sustaining the LTSY harvest level in the last decade of the 100-year
planning period. An approved SYP is expected to be valid for ten years,
although it would be subject to review after five years. Thereafter,
revised SYPs will be prepared every decade that address the LTSY harvest
level based upon reassessment of changes in the resource base and other
factors.
The final terms of the SYP, the Multi-Species HCP and the Permit
are subject to additional negotiation and agreement among the parties as
well as public review and comment. While the parties are working
diligently to complete the Multi-Species HCP and the SYP as well as the
other closing conditions contained in the Headwaters Agreement, there can
be no assurance that the Headwaters Agreement will be consummated or that
an SYP, Multi-Species HCP or Permit acceptable to Pacific Lumber will be
approved.
In the event that a Multi-Species HCP is not approved, Pacific
Lumber will not enjoy the benefits of expedited preparation and facilitated
review of its THPs. Furthermore, if a Multi-Species HCP acceptable to
Pacific Lumber is not approved, it is impossible for the Company to
determine the potential adverse effect of the listings of the marbled
murrelet and coho salmon or the EPA's limitations on the Company's
financial position, results of operations or liquidity until such time as
the various regulatory and legal issues are resolved; however, if Pacific
Lumber is unable to harvest, or is severely limited in harvesting,
on significant amounts of its timberlands, such effect could be materially
adverse to the Company.
10. SUPPLEMENTAL CASH FLOW AND OTHER INFORMATION
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------
1997 1996 1995
------------- ------------ ------------
(In thousands)
<S> <C> <C> <C>
Supplemental information on non-cash
investing and financing activities:
Net margin payments for marketable
securities $ - $ - $ 6,648
Timber and timberlands acquired
subject to long-term debt 9,445 - 615
Supplemental disclosure of cash flow
information:
Interest paid, net of capitalized
interest $ 63,644 $ 63,785 $ 64,907
Income taxes paid (refunded) 166 (2,900) (5,190)
Tax allocation payments to MAXXAM 418 188 -
</TABLE>
Items Related to 1992 Earthquake
In 1995 Pacific Lumber recorded reductions in cost of sales of
$1,527,000 resulting from business interruption insurance reimbursements
for higher operating costs and the related loss of revenues resulting from
the April 1992 earthquake.
11. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Summary quarterly financial information for the years ended
December 31, 1997 and 1996 is as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended
------------------------------------------------------
March 31 June 30 September 30 December 31
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
1997:
Net sales $ 66,815 $ 76,848 $ 72,811 $ 70,701
Operating income 18,687 24,125 22,813 18,217
Net income 15 5,351 4,064 3,146
1996:
Net sales $ 59,804 $ 71,303 $ 68,473 $ 65,004
Operating income 16,417 19,010 17,184 19,422
Net income (loss) 124 3,909 (35) 1,612
</TABLE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None.
PART III
Not applicable.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(A) INDEX TO FINANCIAL STATEMENTS PAGE
1. FINANCIAL STATEMENTS (INCLUDED UNDER ITEM 8):
Report of Independent Public Accountants 20
Consolidated balance sheet at December 31, 1997 and
1996 21
Consolidated statement of operations for the years
ended December 31, 1997, 1996 and 1995 22
Consolidated statement of cash flows for the years
ended December 31, 1997, 1996 and 1995 23
Notes to consolidated financial statements 24
2. FINANCIAL STATEMENT SCHEDULES:
Schedule I - Condensed financial information of
Registrant at December 31, 1997 and 1996 and
for the years ended December 31, 1997, 1996
and 1995 37
The consolidated financial statements and notes
thereto of Kaiser Aluminum Corporation and The
Pacific Lumber Company are incorporated herein
by reference and included as Exhibits 99.1
and 99.2 hereto, respectively.
All other schedules are inapplicable or the required
information is included in the consolidated financial
statements or the notes thereto.
(B) REPORTS ON FORM 8-K
There were no reports on Form 8-K during the fourth quarter of
1997.
(C) EXHIBITS
Reference is made to the Index of Exhibits immediately preceding
the exhibits hereto (beginning on page 42), which index is incorporated
herein by reference.
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
MAXXAM GROUP INC.
BALANCE SHEET (UNCONSOLIDATED)
(IN THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
December 31,
--------------------------
1997 1996
------------ ------------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 51,058 $ 45,611
Marketable securities 51,324 31,423
Other current assets 1,398 102
------------ ------------
Total current assets 103,780 77,136
Deferred income taxes 23,986 21,947
Deferred financing costs and other assets 3,615 4,260
------------ ------------
$ 131,381 $ 103,343
============ ============
LIABILITIES AND STOCKHOLDER'S DEFICIT
Current liabilities:
Accounts payable and other accrued
liabilities $ 1,240 $ 866
Accrued interest 4,688 4,688
------------ ------------
Total current liabilities 5,928 5,554
Long-term debt 217,325 204,173
Advances from and investments in subsidiaries 9,802 5,351
Other liabilities 785 300
------------ ------------
Total liabilities 233,840 215,378
------------ ------------
Stockholder's deficit:
Common stock, $.08-1/3 par value; 1,000
shares authorized; 100 shares issued - -
Additional capital 81,287 81,287
Accumulated deficit (183,746) (193,322)
------------ ------------
Total stockholder's deficit (102,459) (112,035)
------------ ------------
$ 131,381 $ 103,343
============ ============
<FN>
The accompanying notes are an integral part of these financial statements.
</TABLE>
MAXXAM GROUP INC.
STATEMENT OF OPERATIONS (UNCONSOLIDATED)
(IN THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Investment, interest and other income $ 6,813 $ 1,961 $ 1,341
Interest expense (25,047) (23,573) (22,341)
General and administrative expenses (866) (826) (370)
Equity in earnings of subsidiaries 24,112 16,514 16,170
------------ ------------ ------------
Income before income taxes 5,012 (5,924) (5,200)
Credit in lieu of income taxes 7,564 11,534 8,737
------------ ------------ ------------
Net income $ 12,576 $ 5,610 $ 3,537
============ ============ ============
<FN>
The accompanying notes are an integral part of these financial statements.
</TABLE>
MAXXAM GROUP INC.
STATEMENT OF CASH FLOWS (UNCONSOLIDATED)
(IN THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 12,576 $ 5,610 $ 3,537
Adjustments to reconcile net income
to net cash provided by
(used for) operating
activities:
Amortization of deferred
financing costs and
discounts on long-term
debt 13,797 12,320 11,059
Equity in earnings of
subsidiaries (24,112) (16,514) (16,170)
Net sales (purchases) of
marketable securities (11,370) 10,246 (20,011)
Net gains on marketable
securities (8,531) (5,101) (3,697)
Increase (decrease) in cash
resulting from changes in:
Receivables 352 (3,505) 171
Accrued and deferred income
taxes (2,752) (1,519) (5,237)
Accounts payable and other
accrued liabilities (72) 4,104 298
Accrued interest - - 32
Other - - (16)
------------ ------------ ------------
Net cash provided by (used
for) operating
activities (20,112) 5,641 (30,034)
------------ ------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net advances from subsidiaries 28,559 22,008 33,112
------------ ------------ ------------
Net cash provided by
investing activities 28,559 22,008 33,112
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividends paid (3,000) (3,900) (4,800)
Redemptions of long-term debt - - (630)
------------ ------------ ------------
Net cash used for
financing activities (3,000) (3,900) (5,430)
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 5,447 23,749 (2,352)
CASH AND CASH EQUIVALENTS AT BEGINNING OF
YEAR 45,611 21,862 24,214
------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 51,058 $ 45,611 $ 21,862
============ ============ ============
<FN>
The accompanying notes are an integral part of these financial statements.
</TABLE>
MAXXAM GROUP INC.
NOTES TO FINANCIAL STATEMENTS
A. DEFERRED INCOME TAXES
The deferred income tax assets and liabilities reported in the
accompanying unconsolidated balance sheet are determined by computing such
amounts on a consolidated basis, as if MGI files a consolidated tax return
with all of its subsidiaries except Salmon Creek, and that such
corporations were never connected with MAXXAM, and then reducing such
consolidated amounts by the amounts recorded by the Company's subsidiaries,
but excluding Salmon Creek, pursuant to their respective tax allocation
agreements with MAXXAM. The Company's net deferred income tax assets
relate primarily to loss and credit carryforwards and to the excess of the
tax basis over financial statement basis with respect to timber and
timberlands. The Company has concluded that it is more likely than not
that these net deferred income tax assets will be realized based in part
upon the estimated values of the underlying assets which are in excess of
their tax basis.
B. LONG-TERM DEBT
The MGI Notes are secured by the Company's pledge of 100% of the
common stock of Pacific Lumber, Britt and MPI and by MGHI's pledge of
27,938,250 shares of Kaiser's common stock.
Long-term debt consists of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
---------------------------
1997 1996
------------- -------------
<S> <C> <C>
11-1/4% MGI Senior Secured Notes due August 1, 2003 $ 100,000 $ 100,000
12-1/4% MGI Senior Secured Discount Notes due
August 1, 2003, net of discount 117,325 104,173
------------- -------------
$ 217,325 $ 204,173
============= =============
</TABLE>
C. SUPPLEMENTAL CASH FLOW INFORMATION
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------
1997 1996 1995
------------- ------------- -------------
(In thousands)
<S> <C> <C> <C>
Supplemental information on non-cash
investing and financing activities:
Net margin payments for marketable
securities $ - $ - $ 6,648
Supplemental disclosure of cash flow
information:
Interest paid $ 11,250 $ 11,253 $ 11,250
Tax allocation refunds from MAXXAM 4,812 7,127 3,500
Income taxes refunded - 3,121 -
</TABLE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the
Securities Exchange Act of 1934, the Registrant has duly caused this report
to be signed on its behalf by the undersigned, thereunto duly authorized.
MAXXAM GROUP INC.
Date: March 26, 1998 By: /S/ PAUL N. SCHWARTZ
Paul N. Schwartz
Vice President, Chief Financial
Officer and Director
Date: March 26, 1998 By: /S/ GARY L. CLARK
Gary L. Clark
Vice President
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on behalf
of the Registrant and in the capacities and on the dates indicated.
Date: March 26, 1998 By: /S/ CHARLES E. HURWITZ
Charles E. Hurwitz
Chairman of the Board, President,
Chief Executive Officer and
Director
Date: March 26, 1998 By: /S/ PAUL N. SCHWARTZ
Paul N. Schwartz
Vice President, Chief Financial
Officer and Director
(Principal Financial Officer)
Date: March 26, 1998 By: /S/ JOHN A. CAMPBELL
John A. Campbell
Vice President and Director
Date: March 26, 1998 By: /S/ JOHN T. LA DUC
John T. La Duc
Vice President and Director
Date: March 26, 1998 By: /S/ WILLIAM S. RIEGEL
William S. Riegel
Vice President and Director
Date: March 26, 1998 By: /S/ GARY L. CLARK
Gary L. Clark
Vice President
(Principal Accounting Officer)
INDEX OF EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
<S> <C>
3.1 Certificate of Incorporation of MAXXAM Group Inc. (the
"Company" or "MGI") (incorporated herein by reference
to Exhibit 3.1E to the Company's definitive proxy
statement dated October 24, 1984)
3.2 Certificate of Amendment of Certificate of
Incorporation of the Company dated as of September 28,
1988 (incorporated herein by reference to Exhibit 3(b)
to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1988)
3.3 Certificate of Amendment of Certificate of
Incorporation of the Company dated as of June 1, 1989
(incorporated herein by reference to Exhibit 3(c) to
the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 1989)
3.4 By-laws of the Company (incorporated herein by
reference to Exhibit 3.2 to the Company's Current
Report on Form 8-K dated July 10, 1986)
4.1 Indenture between the Company and Shawmut Bank, N.A.,
Trustee, regarding the Company's 12-3/4% Senior Secured
Discount Notes due 2003 and 11-1/4% Senior Secured
Notes due 2003 (incorporated herein by reference to
Exhibit 4.1 to the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 1993)
4.2 Indenture between The Pacific Lumber Company ("Pacific
Lumber") and State Street Bank and Trust Company
("State Street"), regarding Pacific Lumber's 10-1/2%
Senior Notes due 2003 (incorporated herein by reference
to Exhibit 4.1 to the Annual Report on Form 10-K of
Pacific Lumber for the fiscal year ended December 31,
1993, File No. 1-9204)
4.3 Indenture between Scotia Pacific Holding Company
("Scotia Pacific") and State Street, as Trustee,
regarding Scotia Pacific's 7.95% Timber Collateralized
Notes due 2015 (incorporated herein by reference to
Exhibit 4.1 to Scotia Pacific's Annual Report on Form
10-K for the fiscal year ended December 31, 1993, File
No. 55538; the "Scotia Pacific 1993 Form 10-K")
4.4 Deed of Trust, Security Agreement, Financing Statement,
Fixture Filing and Assignment among Scotia Pacific,
State Street, as Trustee, and State Street, as
Collateral Agent (incorporated herein by reference to
Exhibit 4.2 to the Scotia Pacific 1993 Form 10-K)
4.5 Amended and Restated Credit Agreement dated as of
November 10, 1995 between Pacific Lumber and Bank of
America National Trust and Savings Association (the
"Pacific Lumber Credit Agreement;" incorporated herein
by reference to Exhibit 4.1 to the Quarterly Report on
Form 10-Q of Pacific Lumber for the quarter ended
September 30, 1995; File No. 1-9204)
4.6 First Amendment, dated February 10, 1997, to the
Pacific Lumber Credit Agreement (incorporated herein by
reference to Exhibit 4.4 to the Annual Report on Form
10-K of The Pacific Lumber Company for the fiscal year
ended December 31, 1996; File No. 1-9204)
4.7 Form of Deed of Trust, Assignment of Rents, Grant of
Easement and Fixture Filing (incorporated herein by
reference to Exhibit 4.2 to the Quarterly Report on
Form 10-Q of Pacific Lumber for the quarter ended
September 30, 1995; File No. 1-9204)
4.8 Second Amendment, dated October 9, 1997, to the Pacific
Lumber Credit Agreement (incorporated herein by
reference to Exhibit 4.1 to the Quarterly Report on
Form 10-Q of the Pacific Lumber Company for the quarter
ended September 30, 1997; File No. 1-9204)
Note: Pursuant to Regulation Section 229.601, Item 601
(b)(4)(iii) of Regulation S-K, upon request of the
Securities and Exchange Commission, the Company hereby
agrees to furnish a copy of any unfiled instrument
which defines the rights of holders of long-term debt
of the Company and its consolidated subsidiaries (and
for any of its unconsolidated subsidiaries for which
financial statements are required to be filed) wherein
the total amount of securities authorized thereunder
does not exceed 10 percent of the total consolidated
assets of the Company
10.1 Tax Allocation Agreement between the Company and MAXXAM
Inc. dated August 4, 1993 (incorporated herein by
reference to Exhibit 10.6 to the Amendment No. 3 to the
Registration Statement on Form S-2 of the Company,
Registration No. 33-64042; the "MGI Registration
Statement")
10.2 Tax Allocation Agreement dated as of May 21, 1988 among
MAXXAM Inc., the Company, Pacific Lumber and the
corporations signatory thereto (incorporated herein by
reference to Exhibit 10.8 to Pacific Lumber's Annual
Report on Form 10-K for the fiscal year ended December
31, 1988, File No. 1-9204)
10.3 Tax Allocation Agreement among Pacific Lumber, Scotia
Pacific, Salmon Creek Corporation and MAXXAM Inc. dated
March 23, 1993 (incorporated herein by reference to
Exhibit 10.1 to Amendment No. 3 to the Form S-1
Registration Statement of Scotia Pacific, Registration
No. 33-55538)
10.4 Tax Allocation Agreement between MAXXAM Inc. and Britt
Lumber Co., Inc., dated as of July 3, 1990
(incorporated herein by reference to Exhibit 10.4 to
the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 1993)
10.5 Agreement dated December 20, 1985 between Pacific
Lumber and General Electric Company (incorporated
herein by reference to Exhibit 10(m) to Pacific
Lumber's Registration Statement on Form S-1,
Registration No. 33-5549; the "1985 GE Agreement")
10.6 Amendment No. 1 to Agreement between Pacific Lumber and
General Electric Company dated July 29, 1986 relating
to the 1985 GE Agreement (incorporated herein by
reference to Exhibit 10.4 to Pacific Lumber's Annual
Report on Form 10-K for the fiscal year ended December
31, 1988, File No. 1-9204)
10.7 Power Purchase Agreement dated January 17, 1986 between
Pacific Lumber and Pacific Gas and Electric Company
(incorporated herein by reference to Exhibit 10(n) to
Pacific Lumber's Registration Statement on Form S-1,
Registration No. 33-5549)
10.8 Master Purchase Agreement between Pacific Lumber and
Scotia Pacific (incorporated herein by reference to
Exhibit 10.1 to the Scotia Pacific 1993 Form 10-K)
10.9 Services Agreement between Pacific Lumber and Scotia
Pacific (incorporated herein by reference to Exhibit
10.2 to the Scotia Pacific 1993 Form 10-K)
10.10 Additional Services Agreement between Pacific Lumber
and Scotia Pacific (incorporated herein by reference to
Exhibit 10.3 to the Scotia Pacific 1993 Form 10-K)
10.11 Reciprocal Rights Agreement among Pacific Lumber,
Scotia Pacific and Salmon Creek Corporation
(incorporated herein by reference to Exhibit 10.4 to
the Scotia Pacific 1993 Form 10-K)
10.12 Environmental Indemnification Agreement between Pacific
Lumber and Scotia Pacific (incorporated herein by
reference to Exhibit 10.5 to the Scotia Pacific 1993
Form 10-K)
10.13 Purchase and Services Agreement between Pacific Lumber
and Britt Lumber Co., Inc. (incorporated herein by
reference to Exhibit 10.17 to Amendment No. 2 to the
Form S-2 Registration Statement of Pacific Lumber;
Registration Statement No. 33-56332)
10.14 Put and Call Agreement dated November 16, 1987 between
Charles E. Hurwitz and MPI (incorporated herein by
reference to Exhibit C to Schedule 13D dated November
24, 1987, filed by the Company with respect to MAXXAM
Inc.'s common stock; the "Put and Call Agreement")
10.15 Amendment to Put and Call Agreement, dated May 18, 1988
(incorporated herein by reference to Exhibit D to the
Final Amendment to Schedule 13D dated May 20, 1988,
filed by the Company relating to MAXXAM Inc.'s common
stock)
10.16 Amendment to Put and Call Agreement, dated as of
February 17, 1989 (incorporated herein by reference to
Exhibit 10.35 to MAXXAM Inc.'s Annual Report on Form
10-K for the fiscal year ended December 31, 1988, File
No. 1-3924)
10.22 Undertaking, dated August 4, 1993, executed by MAXXAM
in favor of the Company (incorporated herein by
reference to Exhibit 10.24 to the Company's Annual
Report on Form 10-K for the fiscal year ended December
31, 1994)
10.23 Agreement (the "Headwaters Agreement") dated September
28, 1996 among MAXXAM Inc., The Pacific Lumber Company
(on behalf of itself, its subsidiaries and its
affiliates), the United States of America and the State
of California (incorporated herein by reference to
Exhibit 10.1 to MAXXAM Inc.'s Form 8-K dated September
28, 1996; File No. 1-3924)
10.24 Pre-Permit Application Agreement in Principle dated
February 27, 1998 relating to the Headwaters Agreement
(incorporated herein by reference to Exhibit 10.16 to
the Annual Report on Form 10-K of Pacific Lumber for
the fiscal year ended December 31, 1997, File No. 1-
9204)
*10.25 Pre-Permit Application Agreement in Principle dated
February 27, 1998 relating to the Headwaters Agreement.
*27 Financial Data Schedule
*99.1 The consolidated financial statements and notes thereto
of Kaiser Aluminum Corporation for the fiscal year
ended December 31, 1997
*99.2 The consolidated financial statements and notes thereto
of The Pacific Lumber Company for the fiscal year ended
December 31, 1997
<FN>
- ---------------
* Included with this filing.
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Company's consolidated balance sheet and consolidated statement of operations
and is qualified in its entirety by reference to such consolidated financial
statements together with the related footnotes thereto.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<EXCHANGE-RATE> 1
<CASH> 89,840
<SECURITIES> 51,324
<RECEIVABLES> 19,269
<ALLOWANCES> 0
<INVENTORY> 58,078
<CURRENT-ASSETS> 233,748
<PP&E> 188,229
<DEPRECIATION> 85,468
<TOTAL-ASSETS> 761,494
<CURRENT-LIABILITIES> 72,081
<BONDS> 782,325
0
0
<COMMON> 0
<OTHER-SE> (102,459)
<TOTAL-LIABILITY-AND-EQUITY> 761,494
<SALES> 287,175
<TOTAL-REVENUES> 287,175
<CGS> 162,020
<TOTAL-COSTS> 162,020
<OTHER-EXPENSES> 41,313
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 78,674
<INCOME-PRETAX> 18,612
<INCOME-TAX> 6,036
<INCOME-CONTINUING> 12,576
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 12,576
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANEIS
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders and the Board of Directors of Kaiser Aluminum
Corporaiton:
We have audited the accompanying consolidated balance sheets of
Kaiser Aluminum Corporation (a Delaware corporation) and
subsidiaries as of December 31, 1997 and 1996, and the related
statements of consolidated income (loss) and cash flows for each of
the three years in the period ended December 31, 1997. These
financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements. An audit also
includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Kaiser
Aluminum Corporation and subsidiaries as of December 31, 1997 and
1996, and the results of their operations and their cash flows for
each of the three years in the period ended December 31, 1997, in
conformity with generally accepted accounting principles.
HOUSTON, TEXAS
February 16, 1998
KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES
C O N S O L I D A T E D B A L A N C E S H E E T S
<TABLE>
<CAPTION>
December 31,
------------------------------
(In millions of dollars, except share amounts) 1997 1996
------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 15.8 $ 81.3
Receivables:
Trade, less allowance for doubtful receivables of
$5.8 in 1997 and $4.7 in 1996 232.9 177.9
Other 107.3 74.5
Inventories 568.3 562.2
Prepaid expenses and other current assets 121.3 127.8
-------------- --------------
Total current assets 1,045.6 1,023.7
Investments in and advances to unconsolidated affiliates 148.6 168.4
Property, plant, and equipment - net 1,171.8 1,168.7
Deferred income taxes 330.6 264.5
Other assets 317.3 308.7
-------------- --------------
Total $ 3,013.9 $ 2,934.0
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 176.2 $ 189.7
Accrued interest 37.6 35.6
Accrued salaries, wages, and related expenses 97.9 95.4
Accrued postretirement medical benefit obligation -
current portion 45.3 50.1
Other accrued liabilities 145.6 132.7
Payable to affiliates 82.7 97.0
Long-term debt - current portion 8.8 8.9
-------------- --------------
Total current liabilities 594.1 609.4
Long-term liabilities 491.9 458.1
Accrued postretirement medical benefit obligation 720.3 722.5
Long-term debt 962.9 953.0
Minority interests 127.7 121.7
Commitments and contingencies
Stockholders' equity:
Preferred stock, par value $.05, authorized 20,000,000
shares;
PRIDES Convertible, par value $.05, issued and
outstanding, 8,673,850 in 1996. - .4
Common stock, par value $.01, authorized 100,000,000
shares; issued and outstanding, 78,980,881 and
71,646,789 in 1997 and 1996 .8 .7
Additional capital 533.8 531.1
Accumulated deficit (417.6) (460.1)
Additional minimum pension liability - (2.8)
-------------- --------------
Total stockholders' equity 117.0 69.3
-------------- --------------
Total $ 3,013.9 $ 2,934.0
============== ==============
</TABLE>
The accompanying notes to consolidated financial statements are an
integral part of these statements.
KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES
S T A T E M E N T S O F C O N S O L I D A T E D I N C O M E
( L O S S )
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------
(In millions of dollars, except share amounts) 1997 1996 1995
----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net sales $ 2,373.2 $ 2,190.5 $ 2,237.8
-------------- -------------- --------------
Costs and expenses:
Cost of products sold 1,962.6 1,869.1 1,798.4
Depreciation 91.1 96.0 94.3
Selling, administrative, research and development, and
general 131.8 127.6 134.5
Restructuring of operations 19.7 - -
-------------- -------------- --------------
Total costs and expenses 2,205.2 2,092.7 2,027.2
-------------- -------------- --------------
Operating income 168.0 97.8 210.6
Other income (expense):
Interest expense (110.7) (93.4) (93.9)
Other - net 3.0 (2.7) (14.1)
-------------- -------------- --------------
Income before income taxes and minority interests 60.3 1.7 102.6
(Provision) credit for income taxes (8.8) 9.3 (37.2)
Minority interests (3.5) (2.8) (5.1)
-------------- -------------- --------------
Net income 48.0 8.2 60.3
Dividends on preferred stock (5.5) (8.4) (17.6)
-------------- -------------- --------------
Net income (loss) available to common shareholders $ 42.5 $ (0.2) $ 42.7
============== ============== ==============
Earnings per common share:
Basic $ .57 $ .00 $ .69
============== ============== ==============
Diluted $ .57 $ .00 $ .69
============== ============== ==============
Weighted average common shares outstanding (000):
Basic 74,221 71,644 62,000
============== ============== ==============
Diluted 74,382 71,644 62,264
============== ============== ==============
</TABLE>
The accompanying notes to consolidated financial statements are an
integral part of these statements.
KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES
S T A T E M E N T S O F C O N S O L I D A T E D C A S H F L O W S
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------
(In millions of dollars) 1997 1996 1995
-----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 48.0 $ 8.2 $ 60.3
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 91.1 96.0 94.3
Restructuring of operations 19.7 - -
Non-cash benefit for income taxes (12.5) - -
Amortization of excess investment over 11.4 11.6 11.4
equity in unconsolidated affiliates
Amortization of deferred financing costs 6.1 5.6 5.4
and net discount on long-term debt
Undistributed equity in (income) losses
of unconsolidated affiliates, net 7.8 3.0 (19.2)
of distributions
Minority interests 3.5 2.8 5.1
(Increase) decrease in receivables (85.9) 51.8 (109.7)
Increase in inventories (9.3) (36.5) (57.7)
Decrease (increase) in prepaid expenses 1.6 (39.5) 82.9
and other assets
(Decrease) increase in accounts payable (13.5) 5.2 32.4
Increase (decrease) in accrued interest 2.0 3.6 (.6)
(Decrease) increase in payable to (19.6) (62.9) 10.6
affiliates and accrued liabilities
Decrease in accrued and deferred income (17.4) (36.5) (7.4)
taxes
Other 12.0 9.5 10.9
-------------- -------------- --------------
Net cash provided by operating 45.0 21.9 118.7
activities -------------- -------------- --------------
Cash flows from investing activities:
Additions to property, plant, and equipment (128.5) (161.5) (88.4)
Other 19.9 17.2 8.6
-------------- -------------- --------------
Net cash used for investing (108.6) (144.3) (79.8)
activities -------------- -------------- --------------
Cash flows from financing activities:
Borrowings (repayments) under revolving credit - (13.1) 6.4
facility, net
Borrowings of long-term debt 19.0 225.9 -
Repayments of long-term debt (8.8) (9.0) (11.8)
Incurrence of financing costs (.9) (6.2) (.8)
Dividends paid (4.2) (10.5) (20.8)
Capital stock issued .4 - 1.2
Increase in restricted cash, net (5.3) - -
Redemption of minority interests' preference stock (2.1) (5.3) (8.8)
-------------- -------------- --------------
Net cash (used for) provided by (1.9) 181.8 (34.6)
financing activities -------------- -------------- --------------
Net (decrease) increase in Cash and cash equivalents (65.5) 59.4 4.3
during the year
Cash and cash equivalents at beginning of year 81.3 21.9 17.6
-------------- -------------- --------------
Cash and cash equivalents at end of year $ 15.8 $ 81.3 $ 21.9
============== ============== ==============
Supplemental disclosure of cash flow information:
Interest paid, net of capitalized interest $ 102.7 $ 84.2 $ 88.8
Income taxes paid 24.4 22.7 35.7
Tax allocation payments to MAXXAM Inc. 11.8 1.1 -
</TABLE>
The accompanying notes to consolidated financial statements are an
integral part of these statements.
KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In millions of dollars, except share amounts)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the statements of Kaiser
Aluminum Corporation ("Kaiser" or the "Company") and its majority owned
subsidiaries. The Company is a subsidiary of MAXXAM Inc. ("MAXXAM") and
conducts its operations through its wholly owned subsidiary, Kaiser
Aluminum & Chemical Corporation ("KACC"). KACC operates in all principal
aspects of the aluminum industry-the mining of bauxite (the major aluminum
bearing ore), the refining of bauxite into alumina (the intermediate material),
the production of primary aluminum, and the manufacture of fabricated and
semi-fabricated aluminum products. Kaiser's production levels of alumina
and primary aluminum exceed its internal processing needs, which allows it
to be a major seller of alumina and primary aluminum to domestic and
international third parties (see Note 11).
The preparation of financial statements in accordance with generally
accepted accounting principles requires the use of estimates and assumptions
that affect the reported amounts of assets and liabilities, disclosure of
contingent assets and liabilities known to exist as of the date the financial
statements are published, and the reported amounts of revenues and expenses
during the reporting period. Uncertainties, with respect to such estimates and
assumptions, are inherent in the preparation of the Company's consolidated
financial statements; accordingly, it is possible that the actual results
could differ from these estimates and assumptions, which could have a material
effect on the reported amounts of the Company's consolidated financial position
and results of operation.
Investments in 50%-or-less-owned entities are accounted for primarily by
the equity method. Intercompany balances and transactions are eliminated.
Certain reclassifications of prior-year information were made to conform to
the current presentation.
CASH AND CASH EQUIVALENTS
The Company considers only those short-term, highly liquid investments with
original maturities of 90 days or less to be cash equivalents.
INVENTORIES
Substantially all product inventories are stated at last-in, first-out
("LIFO") cost, not in excess of market value. Replacement cost is not in
excess of LIFO cost. Other inventories, principally operating supplies
and repair and maintenance parts, are stated at the lower of average cost
or market. Inventory costs consist of material, labor, and manufacturing
overhead, including depreciation. Inventories consist of the following:
<TABLE>
<CAPTION>
December 31,
------------------------------
1997 1996
- -------------------------------------------------------------------------------------
<S> <C> <C>
Finished fabricated products $ 103.9 $ 113.5
Primary aluminum and work in process 226.6 200.3
Bauxite and alumina 108.4 110.2
Operating supplies and repair and maintenance parts 129.4 138.2
-------------- --------------
$ 568.3 $ 562.2
============== ==============
</TABLE>
DEPRECIATION
Depreciation is computed principally by the straight-line method at rates
based on the estimated useful lives of the various classes of assets.
The principal estimated useful lives of land improvements, buildings, and
machinery and equipment are 8 to 25 years, 15 to 45 years, and 10 to 22 years,
respectively.
STOCK-BASED COMPENSATION
The Company applies the intrinsic value method to account for a stock-based
compensation plan whereby compensation cost is recognized only to the extent
that the quoted market price of the stock at the measurement date exceeds
the amount an employee must pay to acquire the stock. No compensation cost has
been recognized for this plan as the stock options granted in 1997 were
at the market price. No stock options were granted in 1996 or 1995. (See
Note 7).
OTHER INCOME (EXPENSE)
Other expense in 1997, 1996, and 1995 includes $8.8, $3.1, and $17.8 of
pre-tax charges related principally to establishing additional: (i)
litigation reserves for asbestos claims, net of estimated aggregate
insurance recoveries, and (ii) environmental reserves for potential soil and
ground water remediation matters, each pertaining to operations which were
discontinued prior to the acquisition of the Company by MAXXAM in 1988.
DEFERRED FINANCING COSTS
Costs incurred to obtain debt financing are deferred and amortized over the
estimated term of the related borrowing. Such amortization is included in
interest expense.
FOREIGN CURRENCY
The Company uses the United States dollar as the functional currency for
its foreign operations.
DERIVATIVE FINANCIAL INSTRUMENTS
Hedging transactions using derivative financial instruments are primarily
designed to mitigate KACC's exposure to changes in prices for certain of the
products which KACC sells and consumes and, to a lesser extent, to mitigate
KACC's exposure to changes in foreign currency exchange rates. KACC does not
utilize derivative financial instruments for trading or other speculative
purposes. KACC's derivative activities are initiated within guidelines
established by management and approved by KACC's and the Company's boards
of directors. Hedging transactions are executed centrally on behalf of all
of KACC's business segments to minimize transaction costs, monitor consolidated
net exposures and allow for increased responsiveness to changes in market
factors.
Most of KACC's hedging activities involve the use of option contracts
(which establish a maximum and/or minimum amount to be paid or received)
and forward sales contracts (which effectively fix or lock-in the amount
KACC will pay or receive). Option contracts typically require the
payment of an up-front premium in return for the right to receive the
amount (if any) by which the price at the settlement date exceeds the
strike price. Any interim fluctuations in prices prior to the settlement
date are deferred until the settlement date of the underlying hedged
transaction, at which point they are reflected in net sales or cost of sales (as
applicable) together with the related premium cost. Forward sales
contracts do not require an up-front payment and are settled by
the receipt or payment of the amount by which the price at the settlement
date varies from the contract price. No accounting recognition is
accorded to interim fluctuations in prices of forward sales contracts.
KACC has established margin accounts and credit limits with certain
counterparties related to open forward sales and option contracts.
When unrealized gains or losses are in excess of such credit limits, KACC
is entitled to receive advances from the counterparties on open positions
or is required to make margin deposits to counterparties, as the case may be.
At December 31, 1997, KACC had neither received nor made any margin deposits.
At December 31, 1996, KACC had received $13.0 of margin advances
from counterparties. Management considers credit risk related to possible
failure of the counterparties to perform their obligations pursuant to the
derivative contracts to be minimal.
Deferred gains or losses as of December 31, 1997, are included in Prepaid
expenses and other current assets and Other accrued liabilities (See Note 10).
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company estimates the fair value of its outstanding indebtedness to be
$1,020.0 and $1,007.0 at December 31, 1997, and 1996, respectively, based on
quoted market prices for KACC's 9-7/8% Senior Notes due 2002 (the "9-7/8%
Notes"), 12-3/4% Senior Subordinated Notes due 2003 (the "12-3/4% Notes"), and
10-7/8% Senior Notes due 2006 (the "10-7/8% Notes"), and the discounted
future cash flows for all other indebtedness, using the current rate for
debt of similar maturities and terms. The Company believes that the
carrying amount of other financial instruments is a reasonable estimate of
their fair value, unless otherwise noted.
EARNINGS (LOSS) PER SHARE
In the fourth quarter of 1997 the Company adopted Statement of Financial
Accounting standards No. 128, Earnings Per Share ("SFAS No. 128") which,
among other things, requires the presentation of "Basic" and "Diluted"
earnings per share in lieu of "Primary" and "Fully Diluted" earnings per share.
Basic differs from Primary earnings per share in that it only includes the
weighted average impact of outstanding shares of the Company's Common Stock
(i.e., it excludes common stock equivalents and the dilutive effect of stock
options, etc.). Diluted earnings per share is substantially similar to
Fully diluted earnings per share as previously reported. In accordance with
the provision of SFAS No. 128, all earnings per share data for prior periods has
been restated to conform to the new computation and presentation guidelines of
SFAS No. 128. However, such restatement did not have a significant impact
on earnings per share amounts previously reported for any recent prior period.
Basic - Earnings (loss) per share is computed by deducting preferred stock
dividends from net income (loss) in order to determine net income (loss)
available to common share holders. This amount is then divided by the
weighted average number of common shares outstanding during the period,
including the weighted average impact of the shares of common stock issued
during the year from the date(s) of issuance.
Diluted - Diluted earnings per share for the years ended December 31, 1997,
and 1995 include the dilutive effect of outstanding stock options (161,000
and 264,000 shares, respectively). The impact of outstanding stock options
was excluded from the computation for the year ended December 31, 1996, as
its effect would have been antidilutive. The Company's 8.255% PRIDES,
Convertible Preferred Stock ("PRIDES") have not been treated "as if"
converted for purposes of the Diluted computation in any period presented
as such treatment would have been antidilutive. The Company's Mandatory
Conversion Premium Dividend Preferred Stock was not treated "as if"
converted in the Diluted computation for the year ended December 31,
1995, because such treatment would have been antidilutive.
2. INVESTMENTS IN AND ADVANCES TO UNCONSOLIDATED AFFILIATES
Summary combined financial information is provided below for unconsolidated
aluminum investments, most of which supply and process raw materials. The
investees are Queensland Alumina Limited ("QAL") (28.3% owned), Anglesey
Aluminium Limited ("Anglesey") (49.0% owned), and Kaiser Jamaica Bauxite
Company (49.0% owned). The equity in earnings (losses) before income taxes
of such operations is treated as a reduction (increase) in cost of products
sold. At December 31, 1997, and 1996, KACC's net receivables from these
affiliates were not material.
The summary combined financial information for the year ended December 31,
1997, also contains the balances and results of AKW L.P. (50% owned), an
aluminum wheels joint venture formed with a third party during May 1997.
(See Note 4)
SUMMARY OF COMBINED FINANCIAL POSITION
<TABLE>
<CAPTION>
December 31,
------------------------------
1997 1996
- -------------------------------------------------------------------------------------
<S> <C> <C>
Current assets $ 393.0 $ 450.3
Long-term assets (primarily property, plant, and 395.0 364.7
equipment, net) -------------- --------------
Total assets $ 788.0 $ 815.0
============== ==============
Current liabilities $ 117.1 $ 116.9
Long-term liabilities (primarily long-term debt) 400.8 386.7
Stockholders' equity 270.1 311.4
-------------- --------------
Total liabilities and stockholders' equity $ 788.0 $ 815.0
============== ==============
</TABLE>
SUMMARY OF COMBINED OPERATIONS
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------
1997 1996 1995
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net sales $ 644.1 $ 660.5 $ 685.9
Costs and expenses (637.8) (631.5) (618.7)
Provision for income taxes (8.2) (8.7) (18.7)
-------------- -------------- --------------
Net income (loss) $ (1.9) $ 20.3 $ 48.5
============== ============== ==============
Company's equity in income (loss) $ 2.9 $ 8.8 $ 19.2
============== ============== ==============
Dividends received $ 10.7 $ 11.8 $ -
============== ============== ==============
</TABLE>
The Company's equity in income (loss) differs from the summary net income
(loss) due to various percentage ownerships in the entities and equity
method accounting adjustments. At December 31, 1997, KACC's investment in
its unconsolidated affiliates exceeded its equity in their net assets by
approximately $28.8 which amount will be fully amortized over the next
three years.
The Company and its affiliates have interrelated operations. KACC provides
some of its affiliates with services such as financing, management, and
engineering. Significant activities with affiliates include the acquisition
and processing of bauxite, alumina, and primary aluminum. Purchases from
these affiliates were $245.2, $281.6, and $284.4 in the years ended
December 31, 1997, 1996, and 1995, respectively.
3. PROPERTY, PLANT, AND EQUIPMENT
The major classes of property, plant, and equipment are as follows:
<TABLE>
<CAPTION>
December 31,
------------------------------
1997 1996
- -------------------------------------------------------------------------------------
<S> <C> <C>
Land and improvements $ 163.9 $ 157.5
Buildings 228.3 216.0
Machinery and equipment 1,529.1 1,441.1
Construction in progress 51.2 84.7
-------------- --------------
1,972.5 1,899.3
Accumulated depreciation (800.7) (730.6)
-------------- --------------
Property, plant, and equipment, net $ 1,171.8 $ 1,168.7
============== ==============
</TABLE>
During June 1997, Kaiser Bellwood Corporation, a newly formed, wholly owned
subsidiary of KACC, completed the acquisition of Reynolds Metals Company's
Richmond, Virginia, extrusion plant and its existing inventories for a
total purchase price of $41.6, consisting of cash payments of $38.4 and
the assumption of approximately $3.2 of employee related and other
liabilities. Upon completion of the transaction, Kaiser Bellwood
Corporation became a subsidiary guarantor under the indentures in respect
of the 9-7/8% Notes, 10-7/8% Notes, and the 12-3/4% Notes. (See Note 5).
4. RESTRUCTURING OF OPERATIONS
The Company has previously disclosed that it set a goal of achieving significant
cost reductions and other profit improvements, measured against 1996 results,
with the full effect planned to be realized in 1998 and beyond. The initiative
is based on the Company's conclusion that the level of performance of its
existing facilities and businesses would not achieve the level of profits the
Company considers satisfactory based upon historic long-term average prices
for primary aluminum and alumina. During the second quarter of 1997, the
Company recorded a $19.7 restructuring charge to reflect actions taken and
plans initiated to achieve the reduced production costs, decreased corporate
selling, general and administrative expenses, and enhanced product mix
intended to achieve this goal. The significant components of the
restructuring charge are enumerated below.
ERIE PLANT DISPOSITION
During the second quarter of 1997, the Company formed a joint venture with
a third party related to the assets and liabilities associated with the
wheel manufacturing operations at its Erie, Pennsylvania, fabrication
plant. Management subsequently decided to close the remainder of the
Erie plant in order to consolidate its aluminum forgings operations at
two other facilities for increased efficiency. As a result of the joint
venture formation and plant closure, the Company recognized a net pre-tax
loss of approximately $1.4.
OTHER ASSET DISPOSITIONS
As a part of the Company's profit enhancement and cost reduction initiative,
management made decisions regarding product rationalization and geographical
optimization, which led management to decide to dispose of certain assets
which had nominal operating contribution. These strategic decisions
resulted in the Company recognizing a pre-tax charge of approximately $15.6
associated with such asset dispositions.
EMPLOYEE AND OTHER COSTS
As a part of the Company's profit enhancement and cost reduction
initiative, management concluded that certain corporate and other staff
functions could be consolidated or eliminated resulting in a second quarter
pre-tax charge of approximately $2.7 for the benefit and other costs.
5. LONG-TERM DEBT
Long-term debt and its maturity schedule are as follows:
<TABLE>
<CAPTION>
December 31,
2003 ----------------------
and 1997 1996
1998 1999 2000 2001 2002 After Total Total
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Credit Agreement - -
9-7/8% Senior Notes due 2002, $ 224.2 $ - $ 224.2 $ 224.0
net
10-7/8% Senior Notes due 2006, 225.8 225.8 225.9
net
12-3/4% Senior Subordinated 400.0 400.0 400.0
Notes due 2003
Alpart CARIFA Loans - (fixed
and variable rates) 60.0 60.0 60.0
due 2007, 2008
Other borrowings (fixed and $ 8.8 $ .4 $ .3 $ .3 .3 51.6 61.7 52.0
variable rates) ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Total $ 8.8 $ .4 $ .3 $ .3 $ 224.5 $ 737.4 971.7 961.9
========== ========== ========== ========== ========== ==========
Less current portion 8.8 8.9
---------- ----------
Long-term debt $ 962.9 $ 953.0
========== ==========
</TABLE>
CREDIT AGREEMENT
In February 1994, the Company and KACC entered into a credit agreement (as
amended, the "Credit Agreement") which provides a $325.0 five-year secured,
revolving line of credit. KACC is able to borrow under the facility by
means of revolving credit advances and letters of credit (up to $125.0)
in an aggregate amount equal to the lesser of $325.0 or a borrowing base
relating to eligible accounts receivable and eligible inventory. As of
December 31, 1997, $273.4 (of which $73.4 could have been used for
letters of credit) was available to KACC under the Credit Agreement. The
Credit Agreement is unconditionally guaranteed by the Company and by certain
significant subsidiaries of KACC. Interest on any outstanding balances will
bear a premium (which varies based on the results of a financial test) over
either a base rate or LIBOR, at the Company's option.
In January 1998, the term of the Credit Agreement was extended from
February 1999 to August 2001.
LOAN COVENANTS AND RESTRICTIONS
The Credit Agreement requires KACC to comply with certain financial
covenants and places restrictions on the Company's and KACC's
ability to, among other things, incur debt and liens, make investments, pay
dividends, undertake transactions with affiliates, make capital expenditures,
and enter into unrelated lines of business. The Credit Agreement is secured
by, among other things, (i) mortgages on KACC's major domestic plants
(excluding KACC's Gramercy alumina plant and Nevada Micromill(TM) facility);
(ii) subject to certain exceptions, liens on the accounts receivable,
inventory, equipment, domestic patents and trademarks, and substantially
all other personal property of KACC and certain of its subsidiaries;
(iii) a pledge of all the stock of KACC owned by Kaiser; and (iv) pledges
of all of the stock of a number of KACC's wholly owned domestic subsidiaries,
pledges of a portion of the stock of certain foreign subsidiaries, and
pledges of a portion of the stock of certain partially owned foreign
affiliates.
The obligations of KACC with respect to its 9-7/8% Notes, its 10-7/8% Notes
and its 12-3/4% Notes are guaranteed, jointly and severally, by certain
subsidiaries of KACC. The indentures governing the 9-7/8% Notes, the
10-7/8% Notes and the 12-3/4% Notes (collectively, the "Indentures")
restrict, among other things, KACC's ability to incur debt, undertake
transactions with affiliates, and pay dividends. Further, the Indentures
provide that KACC must offer to purchase the 9-7/8% Notes, the 10-7/8%
Notes and the 12-3/4% Notes, respectively, upon the occurrence of a Change
of Control (as defined therein), and the Credit Agreement provides that
the occurrence of a Change in Control (as defined therein) shall constitute
an Event of Default thereunder.
Under the most restrictive of the covenants in the Credit Agreement,
neither the Company nor KACC currently is permitted to pay dividends on its
common stock.
In December 1991, Alpart entered into a loan agreement with the Caribbean
Basin Projects Financing Authority ("CARIFA"). Alpart's obligations under
the loan agreement are secured by a $64.2 letter of credit guaranteed by
the partners in Alpart (of which $22.5 is guaranteed by the Company's
minority partner in Alpart). Alpart has also agreed to indemnify
bondholders of CARIFA for certain tax payments that could result from
events, as defined, that adversely affect the tax treatment of the interest
income on the bonds.
RESTRICTED NET ASSETS OF SUBSIDIARIES
Certain debt instruments restrict the ability of KACC to transfer assets,
make loans and advances, and pay dividends to the Company. The restricted
net assets of KACC totaled $121.9 and $56.1 at December 31, 1997 and 1996,
respectively.
CAPITALIZED INTEREST
Interest capitalized in 1997, 1996, and 1995 was $6.6, $4.9, and $2.8,
respectively.
6. INCOME TAXES
Income (loss) before income taxes and minority interests by geographic area
is as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------
1997 1996 1995
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Domestic $ (112.6) $ (45.8) $ (55.9)
Foreign 172.9 47.5 158.5
-------------- -------------- --------------
Total $ 60.3 $ 1.7 $ 102.6
============== ============== ==============
</TABLE>
Income taxes are classified as either domestic or foreign, based on whether
payment is made or due to the United States or a foreign country. Certain
income classified as foreign is also subject to domestic income taxes.
The (provision) credit for income taxes on income (loss) before income
taxes and minority interests consists of:
<TABLE>
<CAPTION>
Federal Foreign State Total
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1997 Current $ (2.0) $ (28.7) $ (.2) $ (30.9)
Deferred 30.5 (7.0) (1.4) 22.1
-------------- -------------- -------------- --------------
Total $ 28.5 $ (35.7) $ (1.6) $ (8.8)
============== ============== ============== ==============
1996 Current $ (1.6) $ (21.8) $ (.1) $ (23.5)
Deferred 8.6 7.6 16.6 32.8
-------------- -------------- -------------- --------------
Total $ 7.0 $ (14.2) $ 16.5 $ 9.3
============== ============== ============== ==============
1995 Current $ (4.3) $ (40.2) $ (.1) $ (44.6)
Deferred 15.2 (4.9) (2.9) 7.4
-------------- -------------- -------------- --------------
Total $ 10.9 $ (45.1) $ (3.0) $ (37.2)
============== ============== ============== ==============
</TABLE>
A reconciliation between the (provision) credit for income taxes and the
amount computed by applying the federal statutory income tax rate to income
before income taxes and minority interests is as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------
1997 1996 1995
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Amount of federal income tax provision based on $ (21.1) $ (.6) $ (35.9)
the statutory rate
Revision of prior years' tax estimates and other 12.5 10.0 1.5
changes in valuation allowances
Percentage depletion 4.2 3.9 4.2
Foreign taxes, net of federal tax benefit (3.1) (5.5) (5.4)
Other (1.3) 1.5 (1.6)
-------------- -------------- --------------
(Provision) credit for income taxes $ (8.8) $ 9.3 $ (37.2)
============== ============== ==============
</TABLE>
Included in revision of prior years' tax estimates and other changes in
valuation allowances for 1997 and 1996 shown above are $12.5 and $9.8
related to the resolution of certain income tax matters in the second
quarter of 1997 and fourth quarter of 1996,
respectively.
The components of the Company's net deferred income tax assets are as
follows:
<TABLE>
<CAPTION>
December 31,
------------------------------
1997 1996
- ----------------------------------------------------- ------------------------------
<S> <C> <C>
Deferred income tax assets:
Postretirement benefits other than pensions $ 288.9 $ 290.5
Loss and credit carryforwards 99.3 135.1
Other liabilities 169.3 157.6
Other 102.0 86.7
Valuation allowances (113.3) (127.2)
-------------- --------------
Total deferred income tax assets-net 546.2 542.7
-------------- --------------
Deferred income tax liabilities:
Property, plant, and equipment (139.7) (160.9)
Other (54.8) (72.6)
-------------- --------------
Total deferred income tax liabilities (194.5) (233.5)
-------------- --------------
Net deferred income tax assets $ 351.7 $ 309.2
============== ==============
</TABLE>
The principal component of the Company's net deferred income tax assets is
the tax benefit, net of certain valuation allowances, associated with the
accrued liability for postretirement benefits other than pensions. The
future tax deductions with respect to the turnaround of this accrual will
occur over a 30-to-40-year period. If such deductions create or increase
a net operating loss in any year subsequent to 1997, the Company has the
ability to carry forward such loss for 20 taxable years. For these reasons,
the Company believes that a long-term view of profitability is appropriate
and has concluded that this net deferred income tax asset will more likely
than not be realized.
A substantial portion of the valuation allowances provided by the Company
relates to loss and credit carryforwards. To determine
the proper amount of valuation allowances with respect to these
carryforwards, the Company evaluated all appropriate factors,
including any limitations concerning their use and the year the
carryforwards expire, as well as the levels of taxable income
necessary for utilization. With regard to future levels of income, the
Company believes, based on the cyclical nature of its
business, its history of operating earnings, and its expectations for
future years, that it will more likely than not generate
sufficient taxable income to realize the benefit attributable to the loss
and credit carryforwards for which valuation allowances
were not provided.
As of December 31, 1997 and 1996, $53.7 and $69.7, respectively, of the net
deferred income tax assets listed above are included on the Consolidated
Balance Sheets in the caption entitled Prepaid expenses and other current
assets. Certain other portions of the deferred income tax liabilities
listed above are included on the Consolidated Balance Sheets in the
captions entitled Other accrued liabilities and Long-term liabilities.
The Company and its domestic subsidiaries file consolidated federal income
tax returns. During the period from October 28, 1988 through June 30, 1993,
the Company and its domestic subsidiaries were included in the consolidated
federal income tax returns of MAXXAM. During 1997 MAXXAM reached a
settlement with the Internal Revenue Service regarding all remaining
years where the Company and its subsidiaries were included in the MAXXAM
consolidated federal income tax returns. As a result of this settlement,
KACC paid $11.8 to MAXXAM in respect of its liabilities pursuant to its tax
allocation agreement with MAXXAM. Payments or refunds for periods prior to
July 1, 1993, related to other jurisdictions could still be required pursuant
to the Company's and KACC's respective tax allocation agreements with MAXXAM.
In accordance with the Credit Agreement, any such payments to MAXXAM by KACC
would require lender approval, except in certain specific circumstances.
The tax allocation agreements of the Company and KACC with MAXXAM terminated
pursuant to their terms, effective for taxable periods beginning after June
30, 1993.
At December 31, 1997, the Company had certain tax attributes available to
offset regular federal income tax requirements, subject to certain
limitations, including net operating loss and general business credit
carryforwards of $33.2 and $10.4, respectively, which expire periodically
through 2011, foreign tax credit ("FTC") carryforwards of $50.0, which
expire periodically through 2002, and alternative minimum tax ("AMT")
credit carryforwards of $21.6, which have an indefinite life. The Company
also has AMT net operating loss and FTC carryforwards of $17.6 and $74.7,
respectively, available, subject to certain limitations, to offset future
alternative minimum taxable income, which expire periodically through 2011
and 2002, respectively.
7. EMPLOYEE BENEFIT AND INCENTIVE PLANS
RETIREMENT PLANS
Retirement plans are non-contributory for salaried and hourly employees and
generally provide for benefits based on a formula which considers length
of service and earnings during years of service. The Company's funding
policies meet or exceed all regulatory requirements.
The funded status of the employee pension benefit plans and the
corresponding amounts that are included in the Company's Consolidated
Balance Sheets are as follows:
<TABLE>
<CAPTION>
Plans with Accumulated
Benefits Exceeding
Assets(1)
December 31,
-----------------------------
1997 1996
- ----------------------------------------------------------- ------------- - -------------
<S> <C> <C>
Accumulated benefit obligation:
Vested employees $ 785.4 $ 737.7
Nonvested employees 41.2 38.5
------------- -------------
Accumulated benefit obligation 826.6 776.2
Additional amounts related to projected salary increases 46.4 40.0
------------- -------------
Projected benefit obligation 873.0 816.2
Plan assets (principally common stocks and fixed income
obligations) at fair value (756.9) (662.0)
------------- -------------
Plan assets less than projected benefit obligation 116.1 154.2
Unrecognized net gains (losses) .3 (13.6)
Unrecognized net obligations (.3) (.4)
Unrecognized prior-service cost (22.2) (26.9)
Adjustment required to recognize minimum liability 5.4 13.7
------------- -------------
Accrued pension obligation included in the Consolidated
Balance Sheets (principally in Long-term liabilities) $ 99.3 $ 127.0
============= =============
</TABLE>
(1) Includes accrued pension obligations of approximately $6.3 and $.3 in
1997 and 1996, respectively, related to plans with assets exceeding
accumulated benefits.
As required by Statement of Financial Accounting Standards No. 87,
Employers' Accounting for Pensions, the Company recorded after-tax credits
to equity of $2.8 and $11.0 at December 31, 1997 and 1996, respectively, to
reduce the deficit of the minimum liability over the unrecognized net
obligation and prior-service cost. These amounts were recorded net of the
related income tax provision of $1.3 and $6.5 as of December 31, 1997 and
1996, respectively, which approximated the federal and state statutory
rates.
The components of net periodic pension cost are:
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------
1997 1996 1995
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Service cost - benefits earned during the period $ 13.4 $ 12.9 $ 10.0
Interest cost on projected benefit obligation 61.6 60.0 59.8
Return on assets:
Actual gain (129.9) (89.8) (112.2)
Deferred gain 68.1 34.8 64.6
Net amortization and deferral 6.0 5.5 4.2
-------------- -------------- --------------
Net periodic pension cost $ 19.2 $ 23.4 $ 26.4
============== ============== ==============
</TABLE>
Assumptions used to value obligations at year-end, and to determine the net
periodic pension cost in the subsequent year are:
<TABLE>
<CAPTION>
1997 1996 1995
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Discount rate 7.25% 7.75% 7.5%
Expected long-term rate of return on assets 9.5% 9.5% 9.5%
Rate of increase in compensation levels 5.0% 5.0% 5.0%
</TABLE>
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
The Company and its subsidiaries provide postretirement health care and
life insurance benefits to eligible retired employees and their dependents.
Substantially all employees may become eligible for those benefits if they
reach retirement age while still working for the Company or its subsidiaries.
The Company has not funded the liability for these benefits, which are
expected to be paid out of cash generated by operations. The Company
reserves the right, subject to applicable collective bargaining agreements,
to amend or terminate these benefits.
The Company's accrued postretirement benefit obligation is composed of the
following:
<TABLE>
<CAPTION>
December 31,
------------------------------
1997 1996
- ------------------------------------------------------------------------------------------
<S> <C> <C>
Accumulated postretirement benefit obligation:
Retirees $ 446.7 $ 498.7
Active employees eligible for postretirement benefits 35.1 36.7
Active employees not eligible for postretirement 62.7 67.4
benefits -------------- --------------
Accumulated postretirement benefit obligation 544.5 602.8
Unrecognized net gains 135.0 71.3
Unrecognized gains related to prior-service costs 86.1 98.5
-------------- --------------
Accrued postretirement benefit obligation $ 765.6 $ 772.6
============== ==============
</TABLE>
The components of net periodic postretirement benefit cost are:
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------------------
1997 1996 1995
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Service cost $ 6.1 $ 3.8 $ 4.5
Interest cost 43.9 46.9 52.3
Amortization of prior service cost (12.4) (12.4) (8.9)
-------------- -------------- --------------
Net periodic postretirement benefit cost $ 37.6 $ 38.3 $ 47.9
============== ============== ==============
</TABLE>
In 1997 annual assumed rates of increase in the per capita cost of covered
benefits (i.e., health care cost trend rate) for non-HMO are 7.5% and 5.5%
for retirees under 65 and over 65, respectively, and 4.0% for HMO at all
ages. Non-HMO rates are assumed to decrease gradually to 5.35% in 2007
and remain at that level thereafter. The health care cost trend rate has
a significant effect on the amounts reported. A one percentage point
increase in the assumed health care cost trend rate would increase the
accumulated postretirement benefit obligation as of December 31, 1997, by
approximately $53.0 and the aggregate of the service and interest cost
components of net periodic postretirement benefit cost for 1997 by
approximately $6.0. The weighted average discount rate used to
determine the accumulated postretirement benefit obligation at December
31, 1997 and 1996, was 7.25% and 7.75%, respectively.
POSTEMPLOYMENT BENEFITS
The Company provides certain benefits to former or inactive employees after
employment but before retirement.
INCENTIVE PLANS
The Company has an unfunded incentive compensation program, which provides
incentive compensation based on performance against annual plans and over
rolling three-year periods. In addition, the Company has a "nonqualified"
stock option plan and KACC has a defined contribution plan for salaried
employees. The Company's expense for all of these plans was $8.3, $(2.1)
and $11.9 for the years ended December 31, 1997, 1996 and 1995, respectively.
The Company has a total of 5,500,000 shares of Common Stock reserved for
grant under its incentive compensation programs. At December 31, 1997,
3,536,653 shares of Common Stock remained available for grant after
consideration of the 3,000,000 share increase in available shares,
approved by shareholders in May 1997, and current year share grants
and stock option activity. Stock options granted pursuant to the Company's
nonqualified stock option program are granted at the prevailing market price,
generally vest at a rate of 20 - 33% per year, and have a ten year term.
Information concerning nonqualified stock option plan activity is shown
below. The weighted average price per share for each year is shown
parenthetically.
<TABLE>
<CAPTION>
1997 1996 1995
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Outstanding at beginning of year ($10.33, $10.32 and 890,395 926,085 1,119,680
$9.85)
Granted ($10.06) 15,092 - -
Exercised ($8.33, $8.99, and $7.32) (48,410) (8,275) (155,500)
Expired or forfeited ($10.12, $10.45, and $8.88) (37,325) (27,415) (38,095)
-------------- -------------- --------------
Outstanding at end of year ($10.45, $10.33, and 819,752 890,395 926,085
$10.32) ============== ============== ==============
Exercisable at end of year ($10.53, $10.47, and 601,115 436,195 211,755
$10.73) ============== ============== ==============
</TABLE>
In accordance with Statement of Financial Accounting Standards No. 123,
Accounting for Stock Based Compensation ("SFAS No. 123"),
the Company is required to calculate pro forma compensation cost for all
stock options granted subsequent to December 31, 1994. No stock options
were granted during 1995 and 1996. However, as shown in the table above,
15,092 options were granted in 1997 which would be subject to the pro forma
calculation requirements. For SFAS No. 123 purposes, the fair value of the
1997 stock option grant was estimated using the Black-Scholes option pricing
model. The estimated fair value of the 1997 stock options grants of $.1
would result in increased pro forma compensation expense and therefore
reduced net income.
8. STOCKHOLDER'S EQUITY AND MINORITY INTERESTS
Changes in stockholders' equity and minority interests were:
<TABLE>
<CAPTION>
Minority Interests Stockholders' Equity
--------------------- -------------------------------------------------------
Additional
Redeemable Accu Minimum
Preference Preferred Common Additional mulated Pension
Stock Other Stock Stock Capital Deficit Liability
- --------------------------------------------------- ---------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1994 $ 29.1 $ 87.1 $ .6 $ .6 $ 527.8 $ (502.6) $ (9.1)
Net income 60.3
Redeemable preference
stock:
Accretion 3.9
Stock redemption (8.7)
Stock repurchase 5.4
Conversions (1,222
preference shares
into cash) (.1)
Common stock issued upon
redemption and
conversion of
preferred stock (.2) .1 1.1
Dividends on preferred
stock (17.6)
Minority interests 6.0
Incentive plans
accretion 1.4
Additional minimum (4.7)
pension liability ---------- ------- ---------- ------- ---------- ---------- ----------
BALANCE, DECEMBER 31, 1995 29.7 93.0 .4 .7 530.3 (459.9) (13.8)
Net income 8.2
Redeemable preference
stock:
Accretion 3.1
Stock redemption (5.3)
Common stock issued upon
redemption and
conversion of
preferred stock .1
Dividends on preferred
stock (8.4)
Minority interests 1.2
Incentive plan accretion .7
Reduction of minimum
pension liability 11.0
---------- ------- ---------- ------- ---------- ---------- ----------
BALANCE, DECEMBER 31, 1996 27.5 94.2 .4 .7 531.1 (460.1) (2.8)
Net income 48.0
Redeemable preference
stock:
Accretion 2.3
Stock redemption (2.1)
Common stock issued upon
redemption and
conversion of
preferred stock (.4) .1 1.7
Stock options exercised .4
Dividends on preferred
stock (5.5)
Minority interests 5.8
Incentive plan accretion .6
Reduction of minimum
pension liability 2.8
---------- ------- ---------- ------- ---------- ---------- ----------
BALANCE, DECEMBER 31, 1997 $ 27.7 $ 100.0 $ - $ .8 $ 533.8 $ (417.6) $ -
========== ======= ========== ======= ========== ========== ==========
</TABLE>
REDEEMABLE PREFERENCE STOCK
In 1985, KACC issued its Cumulative (1985 Series A) Preference Stock and
its Cumulative (1985 Series B) Preference Stock (together, the "Redeemable
Preference Stock") each of which has a par value of $1 per share and a
liquidation and redemption value of $50 per share plus accrued dividends,
if any. No additional Redeemable Preference Stock is expected to be issued.
Holders of the Redeemable Preference Stock are entitled to an annual cash
dividend of $5 per share, or an amount based on a formula tied to
KACC's pre-tax income from aluminum operations, when and as declared by the
Board of Directors.
The carrying values of the Redeemable Preference Stock are increased each
year to recognize accretion between the fair value (at which the Redeemable
Preference Stock was originally issued) and the redemption value. Changes
in Redeemable Preference Stock are shown below.
<TABLE>
<CAPTION>
1997 1996 1995
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Shares:
Beginning of year 634,684 737,363 912,167
Redeemed (39,631) (102,679) (174,804)
------------- -------------- --------------
End of year 595,053 634,684 737,363
============= ============== ==============
</TABLE>
Redemption fund agreements require KACC to make annual payments by March 31
of the subsequent year based on a formula tied to consolidated net income
until the redemption funds are sufficient to redeem all of the Redeemable
Preference Stock. On an annual basis, the minimum payment is $4.3 and the
maximum payment is $7.3. KACC also has certain additional repurchase
requirements which are, among other things, based upon profitability tests.
The Redeemable Preference Stock is entitled to the same voting rights as
KACC common stock and to certain additional voting rights under certain
circumstances, including the right to elect, along with other KACC
preference stockholders, two directors whenever accrued dividends have
not been paid on two annual dividend payment dates or when accrued
dividends in an amount equivalent to six full quarterly dividends are
in arrears. The Redeemable Preference Stock restricts the ability of
KACC to redeem or pay dividends on common stock if KACC is in default
on any dividends payable on Redeemable Preference Stock.
PREFERENCE STOCK
KACC has four series of $100 par value Cumulative Convertible Preference
Stock ("$100 Preference Stock") with annual dividend requirements of
between 4-1/8% and 4-3/4%. KACC has the option to redeem the $100
Preference Stock at par value plus accrued dividends. KACC does not
intend to issue any additional shares of the $100 Preference Stock.
The $100 Preference Stock can be exchanged for per share cash amounts
between $69 - $80. KACC records the $100 Preference Stock
at their exchange amounts for financial statement presentation and the
Company includes such amounts in minority interests. At December 31,
1997, and 1996, outstanding shares of $100 Preference Stock were 20,543
and 21,630, respectively.
PREFERRED STOCK
PRIDES Convertible - during August 1997, the remaining 8,673,850
outstanding shares of PRIDES were converted into 7,227,848 shares
of Common Stock pursuant to the terms of the PRIDES Certificate of
Designations. Further, in accordance with the PRIDES Certificate of
Designations, no dividends were paid or payable for the period June 30,
1997, to, but not including, the date of conversion. However, in
accordance with generally accepted accounting principles, the $1.3 of
accrued dividends attributable to the period June 30, 1997, to, but not
including, the conversion date is treated as an increase in Additional
capital at the date of conversion and must still be reflected as a
reduction of Net income available to common shareholders.
Series A Convertible - In September 1995, the Company redeemed all
1,938,295 shares of its Series A Mandatory Conversion Premium
Dividend Preferred Stock, which resulted in the simultaneous redemption of
all of its $.65 Depositary Shares in exchange for (i) 13,126,521 shares of
the Company's Common Stock and (ii) $2.8 in cash in satisfaction of all
accrued and unpaid dividends and fractional shares of Common Stock that
would have otherwise been issuable.
PLEDGED SHARES
From time to time MAXXAM or certain of its subsidiaries which own the
Company's Common Stock may use such stock as collateral
under various financing arrangements. At December 31, 1997, 27,938,250
shares of the Company's Common Stock (the "Pledged Shares") beneficially
owned by MAXXAM Group Holdings Inc. ("MGHI"), a wholly owned subsidiary of
MAXXAM, were pledged as security for debt of MAXXAM Group Inc. ("MGI"), a
wholly owned subsidiary of MGHI, consisting of $100.0 aggregate principal
amount of 11-1/4% Senior Secured Notes due 2003 and $125.7 aggregate
principal amount of 12-1/4% Senior Secured Discount Notes due 2003
(collectively the "MGI Secured Debt"). Additionally, up to 16,055,000 of
the Pledged Shares are to be pledged by MGHI as security for $130.0
principal amount of 12% Senior Secured Notes due 2003 issued in December
1996 by MGHI, if any of the Pledged Shares are released as security for
the MGI Secured Debt by reason of an early retirement of such indebtedness
(other than by a refinancing).
9. COMMITMENTS AND CONTINGENCIES
COMMITMENTS
KACC has a variety of financial commitments, including purchase agreements,
tolling arrangements, forward foreign exchange and forward sales contracts
(see Note 10), letters of credit, and guarantees. Such purchase agreements
and tolling arrangements include long-term agreements for the purchase and
tolling of bauxite into alumina in Australia by QAL. These obligations
expire in 2008. Under the agreements, KACC is unconditionally obligated
to pay its proportional share of debt, operating costs, and certain other
costs of QAL. The aggregate minimum amount of required future principal
payments at December 31, 1997, is $97.6, of which approximately $12.0 is
due in each of 2000 and 2001 with the balance being due thereafter.
KACC's share of payments, including operating costs and certain other
expenses under the agreements, has ranged between $100.0 - $120.0 over
the past three years. KACC also has agreements to supply alumina to and
to purchase aluminum from Anglesey.
Minimum rental commitments under operating leases at December 31, 1997, are
as follows: years ending December 31, 1998 - $26.5; 1999 - $32.0; 2000 -
$28.8; 2001 - $28.1; 2002 - $26.4; thereafter - $134.3. The future minimum
rentals receivable under noncancelable subleases was $62.5 at December 31, 1997.
Rental expenses were $30.4, $29.6, and $29.0, for the years ended December
31, 1997, 1996, and 1995, respectively.
ENVIRONMENTAL CONTINGENCIES
The Company and KACC are subject to a number of environmental laws, to
fines or penalties assessed for alleged breaches of the environmental laws,
and to claims and litigation based upon such laws. KACC currently is
subject to a number of lawsuits under the Comprehensive Environmental
Response, Compensation and Liability Act of 1980, as amended by the
Superfund Amendments Reauthorization Act of 1986 ("CERCLA"), and, along
with certain other entities, has been named as a potentially responsible
party for remedial costs at certain third-party sites listed on the National
Priorities List under CERCLA.
Based on the Company's evaluation of these and other environmental matters,
the Company has established environmental accruals, primarily related to
potential solid waste disposal and soil and groundwater remediation matters.
The following table presents the changes in such accruals, which are
primarily included in Long-term liabilities, for the years ended December
31, 1997, 1996, and 1995:
<TABLE>
<CAPTION>
1997 1996 1995
- --------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance at beginning of period $ 33.3 $ 38.9 $ 40.1
Additional amounts 2.0 3.2 3.3
Less expenditures (5.6) (8.8) (4.5)
-------------- -------------- --------------
Balance at end of period $ 29.7 $ 33.3 $ 38.9
============== ============== ==============
</TABLE>
These environmental accruals represent the Company's estimate of costs
reasonably expected to be incurred based on presently enacted laws and
regulations, currently available facts, existingb technology, and the
Company's assessment of the likely remediation action to be taken. The
Company expects that these remediation actions will be taken over the next
several years and estimates that annual expenditures to be charged to these
environmental accruals will be approximately $3.0 to $8.0 for the years
1998 through 2002 and an aggregate of approximately $8.0 thereafter.
As additional facts are developed and definitive remediation plans and
necessary regulatory approvals for implementation of remediation are
established or alternative technologies are developed, changes in these and
other factors may result in actual costs exceeding the current environmental
accruals. The Company believes that it is reasonably possible that costs
associated with these environmental matters may exceed current accruals by
amounts that could range, in the aggregate, up to an estimated
$18.0. As the resolution of these matters is subject to further regulatory
review and approval, no specific assurance can be given as to when the
factors upon which a substantial portion of this estimate is based can be
expected to be resolved. However, the Company is currently working to
resolve certain of these matters.
The Company believes that KACC has insurance coverage available to recover
certain incurred and future environmental costs and is actively pursuing
claims in this regard. However, no accruals have been made for any such
insurance recoveries and no assurances can be given that the Company will be
successful in its attempt to recover incurred or future costs.
While uncertainties are inherent in the final outcome of these
environmental matters, and it is presently impossible to determine
the actual costs that ultimately may be incurred, management currently
believes that the resolution of such uncertainties should not have a
material adverse effect on the Company's consolidated financial
position, results of operations, or liquidity.
ASBESTOS CONTINGENCIES
KACC is a defendant in a number of lawsuits, some of which involve claims
of multiple persons, in which the plaintiffs allege that certain of their
injuries were caused by, among other things, exposure to asbestos during,
and as a result of, their employment or association with KACC or exposure
to products containing asbestos produced or sold by KACC. The lawsuits
generally relate to products KACC has not manufactured for at least 20 years.
The following table presents the changes in number of such claims pending
for the years ended December 31, 1997, 1996, and 1995.
<TABLE>
<CAPTION>
1997 1996 1995
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Number of claims at beginning of period 71,100 59,700 25,200
Claims received 15,600 21,100 41,700
Claims settled or dismissed (9,300) (9,700) (7,200)
-------------- -------------- --------------
Number of claims at end of period 77,400 71,100 59,700
============== ============== ==============
</TABLE>
Based on past experience and reasonably anticipated future activity, the
Company has established an accrual for estimated asbestos-related costs
for claims filed and estimated to be filed through 2008. There are
inherent uncertainties involved in estimating asbestos-related costs,
and the Company's actual costs could exceed these estimates. The
Company's accrual was calculated based on the current and anticipated
number of asbestos-related claims, the prior timing and amounts of
asbestos-related payments, and the advice of Wharton Levin Ehrmantraut
Klein & Nash, P.A. with respect to the current state of the law
related to asbestos claims. Accordingly, an estimated asbestos-related
cost accrual of $158.8, before consideration of insurance
recoveries, is included primarily in Long-term liabilities at December 31,
1997. While the Company does not presently believe there is a reasonable
basis for estimating such costs beyond 2008 and, accordingly, no accrual
has been recorded for such costs which may be incurred beyond 2008, there
is a reasonable possibility that such costs may continue beyond 2008, and
such costs may be substantial. The Company estimates that annual future
cash payments in connection with such litigation will be approximately
$13.0 to $20.0 for each of the years 1998 through 2002, and an aggregate of
approximately $80.0 thereafter.
The Company believes that KACC has insurance coverage available to recover
a substantial portion of its asbestos-related costs. Claims for recovery
from some of KACC's insurance carriers are currently subject to pending
litigation and other carriers have raised certain defenses, which have
resulted in delays in recovering costs from the insurance carriers. The
timing and amount of ultimate recoveries from these insurance carriers
are dependent upon the resolution of these disputes. The Company believes,
based on prior insurance-related recoveries in respect of asbestos-related
claims, existing insurance policies, and the advice of Thelen, Marrin,
Johnson & Bridges LLP with respect to applicable insurance coverage law
relating to the terms and conditions of those policies, that substantial
recoveries from the insurance carriers are probable. Accordingly, an
estimated aggregate insurance recovery of $134.0, determined on the same
basis as the asbestos-related cost accrual, is recorded primarily in Other
assets at December 31, 1997.
Subsequent to December 31, 1997, KACC reached agreements settling
approximately 25,000 of the pending asbestos-related claims.
Also, subsequent to year-end 1997, KACC reached agreements on asbestos
related coverage matters with two insurance carriers under which the
Company will collect a total of approximately $17.5 during the first
quarter of 1998. The insurance recoveries will reduce the approximately
$134.0 of asbestos related receivable accrued at December 31, 1997. As
the amounts related to the claim settlements and insurance recoveries were
consistent with the Company's year-end 1997 accrual assumptions, these
events are not expected to have a material impact on the Company's financial
position, results of operations or liquidity.
Management continues to monitor claims activity, the status of lawsuits
(including settlement initiatives), legislative progress, and costs
incurred in order to ascertain whether an adjustment to the existing
accruals should be made to the extent that historical experience may
differ significantly from the Company's underlying assumptions. While
uncertainties are inherent in the final outcome of these asbestos matters
and it is presently impossible to determine the actual costs that ultimately
may be incurred and insurance recoveries that will be received, management
currently believes that, based on the factors discussed in the preceding
paragraphs, the resolution of asbestos-related uncertainties and
the incurrence of asbestos-related costs net of related insurance
recoveries should not have a material adverse effect on the Company's
consolidated financial position, results of operations, or liquidity.
OTHER CONTINGENCIES
The Company or KACC is involved in various other claims, lawsuits, and
other proceedings relating to a wide variety of matters. While
uncertainties are inherent in the final outcome of such matters, and it
is presently impossible to determine the actual costs that ultimately may
be incurred, management currently believes that the resolution of such
uncertainties and the incurrence of such costs should not have a material
adverse effect on the Company's consolidated financial position, results of
operations, or liquidity.
10. DERIVATIVE FINANCIAL INSTRUMENTS AND RELATED HEDGING PROGRAMS
At December 31, 1997, the net unrealized loss on KACC's position in
aluminum forward sales and option contracts, (based on an average price of
$1,643 per ton ($.75 per pound) of primary aluminum), natural gas and
fuel oil forward purchase and option contracts, and forward foreign
exchange contracts, was approximately $21.0. Any gains or losses on
the derivative contracts utilized in KACC's hedging activities are
offset by losses or gains, respectively, on the transactions being hedged.
ALUMINA AND ALUMINUM
The Company's earnings are sensitive to changes in the prices of alumina,
primary aluminum and fabricated aluminum products, and also depend to a
significant degree upon the volume and mix of all products sold. Primary
aluminum prices have historically been subject to significant cyclical price
fluctuations. Alumina prices as well as fabricated aluminum product prices
(which vary considerably among products) are significantly influenced by
changes in the price of primary aluminum but generally lag behind
primary aluminum price changes by up to three months. Since 1993, the
Average Midwest United States transaction price for primary
aluminum has ranged from approximately $.50 to $1.00 per pound.
From time to time in the ordinary course of business, KACC enters into
hedging transactions to provide price risk management in respect of the
net exposure of earnings resulting from (i) anticipated sales of alumina,
primary aluminum and fabricated aluminum products, less (ii) expected
purchases of certain items, such as aluminum scrap, rolling ingot, and
bauxite, whose prices fluctuate with the price of primary aluminum.
Forward sales contracts are used by KACC to effectively fix the price
that KACC will receive for its shipments. KACC also uses option
contracts (i) to establish a minimum price for its product shipments, (ii)
to establish a "collar" or range of price for KACC's anticipated sales,
and/or (iii) to permit KACC to realize possible upside price movements.
As of December 31, 1997, KACC had sold forward, at fixed prices,
approximately 109,850 and 24,000 tons of primary aluminum with respect
to 1998 and 1999, respectively. KACC had also purchased put options to
establish a minimum price for approximately 52,000 tons with respect to
1998 and as of December 31, 1997, had entered into option contracts that
established a price range for an additional 243,600 and 124,500 tons with
respect to 1998 and 1999, respectively. Additionally, at December
31, 1997, KACC also held fixed price purchase contracts for 134,850 tons of
primary aluminum with respect to 1998.
As of December 31, 1997, KACC had sold forward virtually all of the alumina
available to it in excess of its projected internal smelting requirements
for 1998 and 1999 at prices indexed to future prices of primary aluminum.
ENERGY
KACC is exposed to energy price risk from fluctuating prices for fuel oil
and natural gas consumed in the production process. Accordingly, KACC from
time to time in the ordinary course of business enters into hedging
transactions with major suppliers of energy and energy related financial
instruments. As of December 31, 1997, KACC had a combination of fixed price
purchase and option contracts for the purchase of approximately 41,000
MMBtu of natural gas per day during 1998. At December 31, 1997, KACC
also held a combination of fixed price purchase and option contracts for an
average of 232,000 and 25,000 barrels of fuel oil per month for 1998 and
1999, respectively.
FOREIGN CURRENCY
KACC enters into forward exchange contracts to hedge material cash
commitments to foreign subsidiaries or affiliates. At December 31, 1997,
KACC had net forward foreign exchange contracts totaling approximately
$136.6 for the purchase of 180.0 Australian dollars from January 1998
through February 1999, in respect of its commitments for 1998 and 1999
expenditures denominated in Australian dollars.
11. SEGMENT AND GEOGRAPHICAL AREA INFORMATION
The Company's operations are located in many foreign countries, including
Australia, Canada, Ghana, Jamaica, and the United Kingdom. Foreign
operations in general may be more vulnerable than domestic operations
due to a variety of political and other risks. Sales and transfers
among geographic areas are made on a basis intended to reflect the
market value of products.
The aggregate foreign currency gain included in determining net income was
immaterial for the years ended December 31, 1997, 1996, and 1995.
No single customer accounted for sales in excess of 10% of total revenue in
1997, 1996 or 1995.
Export sales were less than 10% of total revenue during the years ended
December 31, 1997, 1996, and 1995.
Geographical area information relative to operations is summarized as
follows:
<TABLE>
<CAPTION>
Year Ended Other
December 31, Domestic Caribbean Africa Foreign Eliminations Total
- ------------------------------------------------------------------------------------------------------------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Net sales to unaffiliated customers 1997 $ 1,720.3 $ 204.6 $ 234.2 $ 214.1 $ 2,373.2
1996 1,610.0 201.8 198.3 180.4 2,190.5
1995 1,589.5 191.7 239.4 217.2 2,237.8
Sales and transfers among 1997 $ 121.7 $ 197.3 $ (319.0)
geographic areas 1996 116.9 206.0 (322.9)
1995 79.6 191.5 (271.1)
Equity in income (losses) of 1997 $ 4.8 $ (1.9) $ 2.9
unconsolidated affiliates 1996 .3 8.5 8.8
1995 (.2) 19.4 19.2
Operating income 1997 $ 18.9 $ 11.6 $ 72.2 $ 65.3 $ 168.0
1996 4.4 1.6 27.8 64.0 97.8
1995 32.0 9.8 83.5 85.3 210.6
Investment in and advances to 1997 $ 15.8 $ 23.9 $ 108.9 $ 148.6
unconsolidated affiliates 1996 .5 25.3 142.6 168.4
Identifiable assets 1997 $ 2,274.9 $ 391.2 $ 179.6 $ 168.2 $ 3,013.9
1996 2,136.7 391.2 194.7 211.4 2,934.0
</TABLE>
Financial information by industry segment at December 31, 1997 and 1996,
and for the years ended December 31, 1997, 1996, and
1995, is as follows:
<TABLE>
<CAPTION>
Year Ended Bauxite & Aluminum
December 31, Alumina Processing Corporate Total
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net sales to unaffiliated customers 1997 $ 483.3 $ 1,889.9 $ 2,373.2
1996 508.0 1,682.5 2,190.5
1995 514.2 1,723.6 2,237.8
Intersegment sales 1997 $ 193.2 $ 193.2
1996 181.6 181.6
1995 159.7 159.7
Equity in income (losses) of 1997 $ (7.0) $ 9.9 $ - $ 2.9
unconsolidated affiliates 1996 1.7 6.7 .4 8.8
1995 3.6 15.8 (.2) 19.2
Operating income (loss) 1997 $ 20.0 $ 222.6 $ (74.6) $ 168.0
1996 1.1 156.5 (59.8) 97.8
1995 54.0 238.9 (82.3) 210.6
Depreciation 1997 $ 29.3 $ 58.7 $ 3.1 $ 91.1
1996 31.2 61.7 3.1 96.0
1995 31.1 60.4 2.8 94.3
Capital expenditures 1997 $ 27.8 $ 99.0 $ 1.7 $ 128.5
1996 29.9 126.9 4.7 161.5
1995 27.3 53.0 8.1 88.4
Investment in and advances to 1997 $ 88.6 59.5 .5 148.6
unconsolidated affiliates 1996 121.3 46.6 .5 168.4
Identifiable assets 1997 $ 735.9 $ 1,510.9 $ 767.1 $ 3,013.9
1996 784.6 1,408.5 740.9 2,934.0
</TABLE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholder of
The Pacific Lumber Company:
We have audited the accompanying consolidated balance
sheets of The Pacific Lumber Company (a Delaware corporation) and
subsidiaries as of December 31, 1997 and 1996, and the related
consolidated statements of operations and cash flows for each of
the three years in the period ended December 31, 1997. These
financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally
accepted auditing standards. Those standards require that we
plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements
referred to above present fairly, in all material respects, the
financial position of The Pacific Lumber Company and subsidiaries
as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in
the period ended December 31, 1997, in conformity with generally
accepted accounting principles.
ARTHUR ANDERSEN LLP
San Francisco, California
January 30, 1998
(Except for the matter discussed in the fourth paragraph of Note 9
as to which the date is February 27, 1998.)
THE PACIFIC LUMBER COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
December 31,
--------------------------
1997 1996
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 31,768 $ 26,027
Receivables:
Trade 19,216 18,080
Other 2,123 2,514
Inventories 56,079 65,690
Prepaid expenses and other current assets 12,898 5,329
------------ ------------
Total current assets 122,084 117,640
Timber and timberlands, net of accumulated
depletion of $236,824 and $221,063,
respectively 321,206 324,986
Property, plant and equipment, net of accumulated
depreciation of $82,070 and $73,772,
respectively 96,292 95,515
Deferred financing costs, net 17,912 20,003
Deferred income taxes 27,018 34,639
Restricted cash 28,434 29,967
Other assets 4,186 6,424
------------ ------------
$ 617,132 $ 629,174
============ ============
LIABILITIES AND STOCKHOLDER'S DEFICIT
Current liabilities:
Accounts payable $ 3,538 $ 3,765
Accrued compensation and related benefits 12,365 9,673
Accrued interest 19,650 20,211
Deferred income taxes 9,671 10,173
Other accrued liabilities 1,042 2,325
Long-term debt, current maturities 19,429 16,258
------------ ------------
Total current liabilities 65,695 62,405
Long-term debt, less current maturities 545,571 555,596
Other noncurrent liabilities 27,991 25,887
------------ ------------
Total liabilities 639,257 643,888
------------ ------------
Contingencies
Stockholder's deficit:
Common stock, $.01 par value, 100 shares
authorized and issued - -
Additional capital 157,520 157,520
Accumulated deficit (179,645) (172,234)
------------ ------------
Total stockholder's deficit (22,125) (14,714)
------------ ------------
$ 617,132 $ 629,174
============ ============
<FN>
The accompanying notes are an integral part of these financial statements.
</TABLE>
THE PACIFIC LUMBER COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Net sales:
Lumber and logs $ 235,588 $ 225,017 $ 197,320
Other 25,789 19,832 24,619
------------ ------------ ------------
261,377 244,849 221,939
------------ ------------ ------------
Operating expenses:
Cost of goods sold 147,372 136,335 116,445
Selling, general and administrative
expenses 12,915 14,570 14,992
Depletion and depreciation 26,525 27,644 25,927
------------ ------------ ------------
186,812 178,549 157,364
------------ ------------ ------------
Operating income 74,565 66,300 64,575
Other income (expense):
Investment, interest and other
income 2,516 4,209 3,928
Interest expense (53,613) (54,456) (55,462)
------------ ------------ ------------
Income before income taxes 23,468 16,053 13,041
Provision in lieu of income taxes (7,879) (6,107) (6,480)
------------ ------------ ------------
Net income $ 15,589 $ 9,946 $ 6,561
============ ============ ============
<FN>
The accompanying notes are an integral part of these financial
statements.
</TABLE>
THE PACIFIC LUMBER COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 15,589 $ 9,946 $ 6,561
Adjustments to reconcile net income
to net cash provided by
operating activities:
Depletion and depreciation 26,525 27,644 25,927
Amortization of deferred
financing costs 2,091 2,394 2,269
Net loss on asset dispositions 67 6 419
Increase (decrease) in cash
resulting from changes in:
Receivables (740) 803 5,913
Inventories, net of
depletion 8,039 7,304 (7,301)
Prepaid expenses and other
current assets (5,331) 682 (3,273)
Accounts payable (548) (164) 589
Accrued interest (561) (455) (443)
Accrued and deferred income
taxes 7,425 7,135 7,572
Other liabilities 3,513 (8,046) 7,406
Other - (12) 423
------------ ------------ ------------
Net cash provided by
operating activities 56,069 47,237 46,062
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net proceeds from sale of assets 226 115 13
Capital expenditures (12,788) (14,552) (9,140)
------------ ------------ ------------
Net cash used for investing
activities (12,562) (14,437) (9,127)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividends paid (23,000) (20,500) (22,000)
Redemptions, repurchase of and
principal payments on long-term
debt (16,299) (14,153) (13,670)
Incurrence of financing costs - - (150)
Decrease in restricted cash 1,533 1,400 1,035
------------ ------------ ------------
Net cash used for financing
activities (37,766) (33,253) (34,785)
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 5,741 (453) 2,150
CASH AND CASH EQUIVALENTS AT BEGINNING OF
YEAR 26,027 26,480 24,330
------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 31,768 $ 26,027 $ 26,480
============ ============ ============
<FN>
The accompanying notes are an integral part of these financial statements.
</TABLE>
THE PACIFIC LUMBER COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of The
Pacific Lumber Company and its wholly owned
subsidiaries, collectively referred to herein as the "Company."
The Company is an indirect wholly owned subsidiary of MAXXAM
Group Inc. ("MGI"). MGI is a wholly owned subsidiary of MAXXAM
Group Holdings Inc. ("MGHI") which is a wholly owned subsidiary
of MAXXAM Inc. ("MAXXAM"). Pacific Lumber's principal wholly
owned subsidiaries are Scotia Pacific Holding Company ("Scotia
Pacific") and Salmon Creek Corporation ("Salmon Creek"). Intercompany
balances and transactions have been eliminated. Certain reclassifications
have been made to prior years' financial statements to be consistent with
the current year's presentation.
The Company grows and harvests redwood and Douglas-fir timber,
mills logs into lumber and manufactures lumber into a variety of finished
products. Housing, construction and remodeling are the principal markets
for the Company's lumber products. Export sales approximate 6% of the
Company's sales. A significant portion of the Company's sales are made to
third parties located west of the Mississippi River.
USE OF ESTIMATES AND ASSUMPTIONS
The preparation of financial statements in accordance with
generally accepted accounting principles requires the use of estimates and
assumptions that affect (i) the reported amounts of assets and liabilities,
(ii) the disclosure of contingent assets and liabilities known to exist as
of the date the financial statements are published and (iii) the reported
amount of revenues and expenses recognized during each period presented.
The Company reviews all significant estimates affecting its consolidated
financial statements on a recurring basis and records the effect of any
necessary adjustments prior to their publication. Adjustments made with
respect to the use of estimates often relate to improved information not
previously available. Uncertainties with respect to such estimates and
assumptions are inherent in the preparation of the Company's consolidated
financial statements; accordingly, it is possible that the subsequent
resolution of any one of the contingent matters described in Note 8 could
differ materially from current estimates. The results of an adverse
resolution of such uncertainties could have a material effect on the
Company's consolidated financial position, results of operations or
liquidity.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash Equivalents
Cash equivalents consist of highly liquid money market
instruments with original maturities of three months or less.
Marketable Securities
Marketable securities are carried at fair value. The cost of the
securities sold is determined using the first-in, first-out method.
Included in investment, interest and other income for the years ending
1997, 1996 and 1995 were net realized gains of $40,000, $52,000 and
$478,000, respectively.
Inventories
Inventories are stated at the lower of cost or market value.
Cost is determined using the last-in, first-out ("LIFO") method.
Timber and Timberlands
Timber and timberlands are stated at cost, net of accumulated
depletion. Depletion is computed utilizing the unit-of-production method
based upon estimates of timber values and quantities.
Property, Plant and Equipment
Property, plant and equipment, including capitalized interest, is
stated at cost, net of accumulated depreciation. Depreciation is computed
utilizing the straight-line method at rates based upon the estimated useful
lives of the various classes of assets.
Deferred Financing Costs
Costs incurred to obtain financing are deferred and amortized
over the estimated term of the related borrowing.
Restricted Cash and Concentrations of Credit Risk
Restricted cash represents the amount deposited into an account
(the "Liquidity Account") held by the Trustee under the Indenture governing
the 7.95% Timber Collateralized Notes due 2015 (the "Timber Notes") of
Scotia Pacific. See Note 4. The Liquidity Account is not available, except
under certain limited circumstances, for Scotia Pacific's working capital
purposes; however, it is available to pay the Rated Amortization (as
defined in Note 4) and interest on the Timber Notes if and to the extent
that cash flows are insufficient to make such payments. The required
Liquidity Account balance will generally decline as principal payments are
made on the Timber Notes. Investment, interest and other income for the
years ended December 31, 1997, 1996 and 1995 includes interest of
approximately $2,336,000, $2,457,000 and $2,560,000, respectively,
attributable to an investment rate agreement (at 7.95% per annum) with the
financial institution which holds the Liquidity Account.
At December 31, 1997 and 1996, cash and cash equivalents include
$17,784,000 and $17,600,000, respectively, (the "Payment Account") which is
reserved for debt service payments on the Timber Notes (see Note 4). The
Payment Account and the Liquidity Account are each held by a different
financial institution. In the event of nonperformance by such financial
institutions, the Company's exposure to credit loss is represented by the
amounts deposited plus any unpaid accrued interest thereon. The Company
mitigates its concentrations of credit risk with respect to these
restricted cash deposits by maintaining them at high credit quality
financial institutions and monitoring the credit ratings of these
institutions.
Fair Value of Financial Instruments
The carrying amounts of cash equivalents and restricted cash
approximate fair value. Marketable securities are carried at fair value
which is determined based on quoted market prices. As of December 31, 1997
and 1996, the estimated fair value of long-term debt, including current
maturities, was $584,423,000 and $579,102,000, respectively. The estimated
fair value of long-term debt is determined based on the quoted market
prices for the Timber Notes and the Company's 10-1/2% Senior Notes due 2003
(the "Senior Notes"), and on the current rates offered for borrowings
similar to the Company's other debt. Some of the Company's publicly traded
debt issues are thinly traded financial instruments; accordingly, their
market prices at any balance sheet date may not be representative of the
prices which would be derived from a more active market.
2. INVENTORIES
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
---------------------------
1997 1996
------------- -------------
<S> <C> <C>
Lumber $ 41,737 $ 46,882
Logs 14,342 18,808
------------- -------------
$ 56,079 $ 65,690
============= =============
</TABLE>
3. PROPERTY, PLANT AND EQUIPMENT
The major classes of property, plant and equipment are as follows
(dollar amounts in thousands):
<TABLE>
<CAPTION>
Estimated December 31,
--------------------------
Useful Lives 1997 1996
------------- ------------ ------------
<S> <C> <C> <C>
Machinery and equipment 5 - 15 years $ 126,079 $ 123,909
Buildings 33 years 36,217 34,285
Logging roads 15 years 16,066 11,093
------------ ------------
178,362 169,287
Less: accumulated depreciation (82,070) (73,772)
------------ ------------
$ 96,292 $ 95,515
============ ============
</TABLE>
Depreciation expense for the years ended December 31, 1997, 1996
and 1995 was $9,191,000, $8,850,000 and $9,185,000, respectively.
4. LONG-TERM DEBT
Long-term debt consists of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
--------------------------
1997 1996
------------ ------------
<S> <C> <C>
7.95% Scotia Pacific Timber Collateralized
Notes due through July 20, 2015 $ 319,965 $ 336,130
10-1/2% Pacific Lumber Senior Notes due March
1, 2003 235,000 235,000
Revolving Credit Agreement 9,445 -
Other 590 724
------------ ------------
565,000 571,854
Less: current maturities (19,429) (16,258)
------------ ------------
$ 545,571 $ 555,596
============ ============
</TABLE>
The indenture governing the Timber Notes (the "Timber Note
Indenture") prohibits Scotia Pacific from incurring any additional
indebtedness for borrowed money and generally limits the business
activities of Scotia Pacific to the ownership and operation of its timber
and timberlands. The Timber Notes are senior secured obligations of Scotia
Pacific and are not obligations of, or guaranteed by, the Company or any
other person. The Timber Notes are secured by a lien on (i) Scotia
Pacific's timber and timberlands (representing $154,288,000 of the
Company's consolidated balance at December 31, 1997), (ii) Scotia Pacific's
contract rights and certain other assets, (iii) the funds deposited in the
Payment Account and the Liquidity Account, and (iv) substantially all of
Scotia Pacific's other property and equipment.
The Timber Notes are structured to link, to the extent of
available cash, the deemed depletion of Scotia Pacific's timber (through
the harvest and sale of logs) to the required amortization of the Timber
Notes. The required amount of amortization due on any Timber Note payment
date is determined by various mathematical formulas set forth in the Timber
Note Indenture. The minimum amount of principal which Scotia Pacific must
pay (on a cumulative basis) through any Timber Note payment date in order
to avoid an Event of Default (as defined) is referred to as rated
amortization ("Rated Amortization"). If all payments of principal are made
in accordance with Rated Amortization, the payment date on which Scotia
Pacific will pay the final installment of principal is July 20, 2015. The
amount of principal which Scotia Pacific must pay through each Timber Note
payment date in order to avoid prepayment or deficiency premiums is
referred to as scheduled amortization ("Scheduled Amortization"). If all
payments of principal are made in accordance with Scheduled Amortization,
the payment date on which Scotia Pacific will pay the final installment of
principal is July 20, 2009.
Principal and interest on the Timber Notes are payable semi-
annually on January 20 and July 20. On January 20, 1998, Scotia Pacific
paid $10,773,000 of principal on the Timber Notes. The Timber Notes are
redeemable at the option of Scotia Pacific, in whole but not in part, at
any time. The redemption price of the Timber Notes is equal to the sum of
the principal amount, accrued interest and a prepayment premium calculated
based upon the yield of like-term Treasury securities plus 50 basis points.
Interest on the Senior Notes is payable semi-annually on March 1
and September 1. The Senior Notes are redeemable at the option of the
Company, in whole or in part, on or after March 1, 1998, at a price of 103%
of the principal amount plus accrued interest. The redemption price is
reduced annually until March 1, 2000, after which time the Senior Notes are
redeemable at par. The Senior Notes are unsecured and are senior
indebtedness of the Company; however, they are effectively subordinated to
the Timber Notes. The indenture governing the Senior Notes contains
various covenants which, among other things, limit the Company's ability to
incur additional indebtedness and liens, to engage in transactions with
affiliates, to make investments and to pay dividends.
On October 9, 1997, the Company amended its revolving credit
agreement with a bank (the "Revolving Credit Agreement") to extend the date
on which it expires to May 31, 2000. Borrowings under the Revolving Credit
Agreement are secured by the Company's trade receivables and inventories,
with interest currently computed at the bank's reference rate plus 1-1/4%
or the bank's offshore rate plus 2-1/4%. The Revolving Credit Agreement
provides for borrowings of up to $60,000,000, of which $20,000,000 may be
used for standby letters of credit and $30,000,000 is restricted to
timberland acquisitions. Borrowings made pursuant to the portion of the
credit facility restricted to timberland acquisitions would also be secured
by the purchased timberlands. As of December 31, 1997, $35,484,000 of
borrowings was available under the Revolving Credit Agreement, of which
$4,929,000 was available for letters of credit and $20,554,000 was
restricted to timberland acquisitions. $9,445,000 of borrowings were
outstanding as of December 31, 1997, and letters of credit outstanding
amounted to $15,071,000. The Revolving Credit Agreement contains covenants
substantially similar to those contained in the indenture governing the
Senior Notes.
As of December 31, 1997, under the most restrictive covenants
contained in the indentures governing the Senior Notes, the Timber Notes
and the Revolving Credit Agreement, the Company could pay approximately
$15,900,000 of dividends.
Scheduled maturities of long-term debt outstanding at December
31, 1997, using the Scheduled Amortization for the Timber Notes, are as
follows: years ending December 31, 1998 - $19,429,000; 1999 - $24,107,000;
2000 - $26,426,000; 2001 - $27,189,000; 2002 - $27,213,000; thereafter -
$440,636,000.
5. PROVISION IN LIEU OF INCOME TAXES
Income taxes are determined using an asset and liability approach
which requires the recognition of deferred income tax assets and
liabilities for the expected future tax consequences of events that have
been recognized in the Company's financial statements or tax returns.
Under this method, deferred income tax assets and liabilities are
determined based on the temporary differences between the financial
statement and tax bases of assets and liabilities using enacted tax rates.
The Company and its subsidiaries are members of MAXXAM's
consolidated return group for federal income tax purposes. The Company's
tax allocation agreement with MAXXAM (the "Tax Allocation Agreement")
provides that the Company, excluding its wholly owned subsidiaries
("Pacific Lumber"), is liable to MAXXAM for the federal consolidated income
tax liability of Pacific Lumber, Scotia Pacific and certain other
subsidiaries of Pacific Lumber (but excluding Salmon Creek) (collectively,
the "PL Subgroup") computed as if the PL Subgroup was a separate affiliated
group of corporations which was never connected with MAXXAM. The Tax
Allocation Agreement further provides that Salmon Creek is liable to MAXXAM
for its federal income tax liability computed as if Salmon Creek was a
separate corporation which was never affiliated with MAXXAM.
The provision in lieu of income taxes on income before income
taxes and extraordinary item consists of the following (in thousands):
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------
1997 1996 1995
------------- ------------- -------------
<S> <C> <C> <C>
Current:
Federal provision in lieu of
income taxes $ 369 $ 189 $ 239
State and local 391 28 61
------------- ------------- -------------
760 217 300
------------- ------------- -------------
Deferred:
Federal provision in lieu of
income taxes 6,851 5,613 4,755
State and local 268 277 1,425
------------- ------------- -------------
7,119 5,890 6,180
------------- ------------- -------------
$ 7,879 $ 6,107 $ 6,480
============= ============= =============
</TABLE>
A reconciliation between the provision in lieu of income taxes
and the amount computed by applying the federal statutory income tax rate
to income before income taxes is as follows (in thousands):
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------
1997 1996 1995
------------ ------------ -------------
<S> <C> <C> <C>
Income before income taxes $ 23,468 $ 16,053 $ 13,041
============ ============ =============
Amount of federal income tax based
upon the statutory rate $ 8,213 $ 5,619 $ 4,564
Revision of prior years' tax estimates (1,134) (981) 651
State and local taxes, net of federal
tax effect 428 1,080 966
Expenses for which no federal tax
benefit is available 176 489 -
Other 196 (100) 299
------------ ------------ -------------
$ 7,879 $ 6,107 $ 6,480
============ ============ =============
</TABLE>
Revision of prior years' tax estimates as shown in the table
above primarily include amounts for the reversal of reserves which the
Company no longer believes are necessary. Generally, the reversal of
reserves relates to the expiration of the relevant statute of limitations
with respect to certain income tax returns or the resolution of specific
income tax matters with the relevant tax authorities. For the years ended
December 31, 1996 and 1995, the reversal of reserves which the Company
believes are no longer necessary resulted in a credit to the income tax
provision of $883,000 and $127,000, respectively. There was no reversal of
reserves for the year ended December 31, 1997.
The components of the Company's net deferred income tax assets
(liabilities) are as follows (in thousands):
<TABLE>
<CAPTION>
December 31,
--------------------------
1997 1996
------------ ------------
<S> <C> <C>
Deferred income tax assets:
Timber and timberlands $ 25,800 $ 28,992
Loss and credit carryforwards 14,619 22,089
Other liabilities and other 12,407 8,468
Valuation allowances (2,795) (1,884)
------------ ------------
Total deferred income tax assets,
net 50,031 57,665
------------ ------------
Deferred income tax liabilities:
Inventories (15,803) (15,102)
Property, plant and equipment (12,771) (15,917)
Other (4,110) (2,180)
------------ ------------
Total deferred income tax
liabilities (32,684) (33,199)
------------ ------------
Net deferred income tax assets $ 17,347 $ 24,466
============ ============
</TABLE>
A principal component of the net deferred income tax assets
listed above relates to the excess of the tax basis over financial
statement basis with respect to timber and timberlands. The Company
believes that it is more likely than not that this net deferred income tax
asset will be realized, based primarily upon the estimated value of its
timber and timberlands which is well in excess of its tax basis. The
valuation allowances listed above relate to loss and credit carryforwards.
The Company evaluated all appropriate factors to determine the proper
valuation allowances for loss and credit carryforwards. These factors
included any limitations concerning use of the carryforwards, the year the
carryforwards expire and the levels of taxable income necessary for
utilization. The Company has concluded that it will more likely than not
generate sufficient taxable income to realize the benefit attributable to
the loss and credit carryforwards for which valuation allowances were not
provided.
Included in the net deferred income tax assets listed above are
$15,735,000 and $22,586,000 at December 31, 1997 and 1996, respectively,
which are recorded pursuant to the Tax Allocation Agreement with MAXXAM.
The following table presents the Company's estimated tax
attributes, for federal income tax purposes, under the terms of the Tax
Allocation Agreement at December 31, 1997 (in thousands):
<TABLE>
<CAPTION>
Expiring
Through
-------------
<S> <C> <C>
Regular Tax Attribute Carryforwards:
Net operating losses $ 31,589 2012
Charitable contribution deduction 99 2002
Minimum tax credit 733 Indefinite
Alternative Minimum Tax Attribute
Carryforwards:
Net operating losses $ 1,929 2012
</TABLE>
6. EMPLOYEE BENEFIT PLANS
RETIREMENT PLAN
The Company has a defined benefit plan which covers all employees
of the Company. Under the plan, employees are eligible for benefits at age
65 or earlier, if certain provisions are met. The benefits are determined
under a career average formula based on each year of service with the
Company and the employee's compensation for that year. The Company's
funding policy is to contribute annually an amount at least equal to the
minimum cash contribution required by The Employee Retirement Income
Security Act of 1974, as amended.
A summary of the components of net periodic pension cost is as
follows (in thousands):
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Service cost - benefits
earned during the year $ 1,937 $ 1,903 $ 1,483
Interest cost on projected
benefit obligation 1,892 1,682 1,693
Actual gain on plan assets (3,988) (2,762) (3,900)
Net amortization and deferral 2,451 1,448 2,460
------------ ------------ ------------
Net periodic pension cost $ 2,292 $ 2,271 $ 1,736
============ ============ ============
</TABLE>
The following table sets forth the funded status and amounts
recognized in the Consolidated Balance Sheet (in thousands):
<TABLE>
<CAPTION>
December 31,
--------------------------
1997 1996
------------ ------------
<S> <C> <C>
Actuarial present value of accumulated plan
benefits:
Vested benefit obligation $ 22,181 $ 18,506
Non-vested benefit obligation 2,176 1,371
------------ ------------
Total accumulated benefit obligation $ 24,357 $ 19,877
============ ============
Projected benefit obligation $ 28,940 $ 23,582
Plan assets at fair value, primarily equity
and debt securities (25,872) (21,800)
----------- ------------
Projected benefit obligation in excess of plan
assets 3,068 1,782
Unrecognized net transition asset 12 18
Unrecognized net gain 4,226 2,855
Unrecognized prior service cost (950) (39)
----------- ------------
Accrued pension liability $ 6,356 $ 4,616
=========== ============
</TABLE>
The assumptions used in accounting for the defined benefit plan
were as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------------- ------------- -------------
<S> <C> <C> <C>
Rate of increase in compensation levels 5.0% 5.0% 5.0%
Discount rate 7.25% 7.5% 7.25%
Expected long-term rate of return on assets 8.0% 8.0% 8.0%
</TABLE>
POSTRETIREMENT MEDICAL BENEFITS
The Company has an unfunded benefit plan for certain
postretirement medical benefits which covers substantially all employees of
the Company. Participants of the plan are eligible for certain health care
benefits upon termination of employment and retirement and commencement of
pension benefits. Participants make contributions for a portion of the
cost of their health care benefits. The expected costs of postretirement
medical benefits are accrued over the period the employees provide services
to the date of their full eligibility for such benefits.
A summary of the components of net periodic postretirement
medical benefit cost is as follows (in thousands):
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Service cost - medical benefits earned
during the year $ 287 $ 332 $ 228
Interest cost on accumulated
postretirement medical benefit
obligation 362 415 317
Net amortization and deferral (42) - (53)
------------ ------------ ------------
Net periodic postretirement medical
benefit cost $ 607 $ 747 $ 492
============ ============ ============
</TABLE>
The postretirement medical benefit liability recognized in the
Company's Consolidated Balance Sheet is as follows (in thousands):
<TABLE>
<CAPTION>
December 31,
--------------------------
1997 1996
------------ ------------
<S> <C> <C>
Retirees $ 710 $ 1,182
Actives eligible for benefits 893 905
Actives not eligible for benefits 3,434 3,818
------------ ------------
Accumulated postretirement medical
benefit obligation 5,037 5,905
Unrecognized net gain (loss) 1,003 (86)
------------ ------------
Postretirement medical benefit liability $ 6,040 $ 5,819
============ ============
</TABLE>
The annual assumed rate of increase in the per capita cost of
covered benefits (i.e., health care cost trend rate) is 10.0% for 1998 and
is assumed to decrease gradually to 5.5% in 2009 and remain at that level
thereafter. Each one percentage point increase in the assumed health care
cost trend rate would increase the accumulated postretirement medical
benefit obligation as of December 31, 1997 by approximately $655,000 and
the aggregate of the service and interest cost components of net periodic
postretirement medical benefit cost by approximately $112,000.
The discount rates used in determining the accumulated
postretirement medical benefit obligation were 7.25% and 7.5% at December
31, 1997 and 1996, respectively.
EMPLOYEE SAVINGS PLAN
The Company's employees are eligible to participate in a defined
contribution savings plan sponsored by MAXXAM. This plan is designed to
enhance the existing retirement programs of participating employees.
Employees may elect to defer up to 16% of their base compensation to the
plan. For those participants who have elected to defer a portion of their
compensation to the plan, the Company's contributions consist of matching
contributions of up to 4% of the base compensation of participants. The
cost to the Company of this plan was $1,516,000, $1,388,000 and $1,281,000
for the years ended December 31, 1997, 1996 and 1995, respectively.
WORKERS' COMPENSATION BENEFITS
The Company is self-insured for workers' compensation benefits.
Included in accrued compensation and related benefits and other noncurrent
liabilities are accruals for workers' compensation claims amounting to
$10,800,000 and $8,000,000 at December 31, 1997 and 1996, respectively.
Workers' compensation expenses amounted to $4,381,000, $2,409,000 and
$3,302,000 for the years ended December 31, 1997, 1996 and 1995,
respectively.
7. RELATED PARTY TRANSACTIONS
MAXXAM provides the Company with personnel, insurance, legal,
accounting, financial, and certain other services. MAXXAM is compensated
by the Company through the payment of a fee representing the reimbursement
of actual out-of-pocket expenses incurred by MAXXAM, including, but not
limited to, labor costs of personnel of MAXXAM rendering services to the
Company. Charges by MAXXAM for such services were $1,358,000, $1,664,000
and $1,694,000, for the years ended December 31, 1997, 1996, and 1995,
respectively. The Company believes that the services being rendered are on
terms not less favorable to the Company than those which would be
obtainable from unaffiliated third parties.
An agreement with Britt Lumber Co., Inc., an indirect wholly
owned subsidiary of MGI ("Britt"), governs, among other things, the sale of
logs and lumber by the Company and Britt to each other and the sale of hog
fuel (wood residue) by Britt to the Company. The logs which the Company
sells to Britt are sold at approximately 75% of the applicable price for
such species and category as established by the California State Board of
Equalization, which reflects the lower quality of these logs. Logs which
either the Company or Britt purchases from third parties and which are then
sold to each other are transferred at the actual cost of such logs. Hog
fuel is sold to the Company by Britt at applicable market prices. Net
sales for the years ended December 31, 1997, 1996 and 1995 include revenues
of $13,907,000, $14,710,000 and $13,627,000, respectively, from Britt. The
Company recognized operating income of $6,505,000, $6,784,000 and
$5,527,000 on these revenues for the years ended December 31, 1997, 1996
and 1995, respectively. At December 31, 1997 and 1996, receivables include
$1,049,000 and $1,281,000, respectively, related to these affiliate sales.
All of the Company's issued and outstanding common stock is
pledged as collateral for MGI's $100,000,000 11-1/4% Senior Secured Notes
due 2003 and $125,720,000 12-1/4% Senior Secured Discount Notes due 2003
(collectively, the "MGI Notes"). MGI conducts its operations primarily
through subsidiary companies. The Company represents the substantial
portion of MGI's assets and operations. The indenture governing the MGI
Notes requires the Company's board of directors to declare and pay
dividends on the Company's common stock to the maximum extent permitted by
any consensual restriction or encumbrance on the Company's ability to
declare and pay dividends, unless the Board determines in good faith that
such declaration and payment would be detrimental to the capital or other
operating needs of the Company.
8. STOCKHOLDER'S DEFICIT
Changes in stockholder's deficit were (in thousands):
<TABLE>
<CAPTION>
Common
Stock Additional Accumulated
($.01 Par) Capital Deficit Total
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Balance, January 1, 1995 $ - $ 157,520 $ (146,241) $ 11,279
Net income - - 6,561 6,561
Dividends - - (22,000) (22,000)
------------ ------------ ------------ ------------
Balance, December 31, 1995 - 157,520 (161,680) (4,160)
Net income - - 9,946 9,946
Dividends - - (20,500) (20,500)
------------ ------------ ------------ ------------
Balance, December 31, 1996 - 157,520 (172,234) (14,714)
Net income - - 15,589 15,589
Dividends - - (23,000) (23,000)
------------ ------------ ------------ ------------
Balance, December 31, 1997 $ - $ 157,520 $ (179,645) $ (22,125)
============ ============ ============ ============
</TABLE>
9. CONTINGENCIES
The Company's business is subject to a variety of California
and federal laws and regulations dealing with timber harvesting, threatened
and endangered species and habitat for such species, and air and water
quality. Compliance with such laws and regulations plays a significant
role in the Company's business. While compliance with such laws,
regulations and judicial and administrative interpretations, together with
the cost of litigation incurred in connection with certain timber
harvesting operations, have increased the costs of the Company, they
have not had a significant adverse effect on its financial position,
results of operations or liquidity. However, these laws and related
administrative actions and legal challenges have severely restricted the
ability of the Company to harvest virgin old growth timber on its
timberlands, and to a lesser extent, residual old growth timber.
On September 28, 1996, the Company (on behalf of itself, its
subsidiaries and affiliates) and MAXXAM (collectively, the "Pacific Lumber
Parties") entered into an agreement with the United States and California
("Headwaters Agreement") which provides the framework for the acquisition
by the United States and California of approximately 5,600 acres of the
Company's timberlands. These timberlands are commonly referred to as the
Headwaters Forest and the Elk Head Springs Forest (collectively, the
"Headwaters Timberlands"). A substantial portion of the Headwaters
Timberlands consists of virgin old growth timberlands. Approximately 4,900
of these acres are owned by Salmon Creek, with the remaining acreage being
owned by Scotia Pacific (the Company having harvesting rights on
approximately 300 of such acres). The Headwaters Timberlands would be
transferred in exchange for (a) property and other consideration from the
United States and California having an aggregate fair market value of $300
million, and (b) approximately 7,755 acres of adjacent timberlands (the
"Elk River Timberlands") to be acquired from a third party. As part of the
Headwaters Agreement, the Pacific Lumber Parties agreed to not enter the
Headwaters Forest or the Elk Head Springs Forest to conduct any logging or
salvage operations.
Closing of the Headwaters Agreement is subject to various
conditions, including federal and California funding, approval of a
sustained yield plan ("SYP"), approval of a habitat conservation plan
covering multiple species ("Multi-Species HCP") and issuance of a related
incidental take permit (the "Permit") and the issuance of certain tax
agreements satisfactory to the Pacific Lumber Parties.
In November 1997, President Clinton signed an appropriations bill
which contains authorization for the expenditure of $250 million of federal
funds toward consummation of the Headwaters Agreement. On February 27,
1998, the Company, MAXXAM and various government agencies entered into a
Pre-Permit Application Agreement in Principle (the "HCP/SYP Agreement")
regarding certain understandings that they had reached regarding the
Multi-Species HCP, the Permit and the SYP. The HCP/SYP Agreement provides
that the Permit and Multi-Species HCP would have a term of 50 years, and
would limit the activities which could be conducted by the Company in
twelve forest groves to those which would enhance habitat. These groves
aggregate approximately 8,000 acres and consist of substantial quantities
of virgin and residual old growth redwood and Douglas-fir timber.
In addition to being an important milestone toward completion of
the Headwaters Agreement, the Company also believes that the HCP/SYP
Agreement is a positive development in respect of the environmental
challenges that it has faced over the last several years. Several species,
including the northern spotted owl, the marbled murrelet and the coho
salmon, have been listed as endangered or threatened under the federal
Endangered Species Act ("ESA") and/or the California Endangered Species Act
("CESA"). The Company has developed federal and state northern spotted
owl management plans which permit harvesting activities to be conducted so
long as the Company adheres to certain measures designed to protect the
northern spotted owl. The potential impact of the listings of the marbled
murrelet and the coho salmon is more uncertain. If the Multi-Species HCP is
approved, the Company would be issued the Permit, which would allow limited
incidental "take" of listed species so long as there was no "jeopardy" to the
species and the Multi-Species HCP would identify the measures to be instituted
in order to minimize and mitigate the anticipated level of take to the
greatest extent possible. The Multi-Species HCP would be designed to protect
currently listed species as well as to consider candidate and future-listed
species. The Company is also attempting to include in the Multi-Species HCP a
resolution of the potential effect of limits by the Environmental Protection
Agency ("EPA") on sedimentation, temperature and other factors for seventeen
northern California rivers and certain of their tributaries, including rivers
within the Company's timberlands. These limitations will be aimed at
protecting water quality.
Lawsuits are pending or threatened which seek to prevent the
Company from implementing certain of its approved timber harvesting plans
("THPs"). While challenges with respect to the Company's young growth timber
have historically been limited, a lawsuit was recently filed under the ESA
which relates to a significant number of THPs covering young growth timber
of the Company. While the Company expects these environmentally focused
objections and lawsuits to continue, it believes that the HCP/SYP Agreement
will enhance its position in connection with these challenges. The Company
also believes that the Multi-Species HCP would expedite the preparation and
facilitate approval of its THPs.
The HCP/SYP Agreement also contains certain provisions relating
to the SYP. Subject to further study, the Company expects the Company
to propose a long-term sustained yield harvest level ("LTSY") which is
somewhat less than the Company's recent harvest levels. If the SYP is
approved, the Company will have complied with certain BOF regulations
requiring that timber companies project timber growth and harvest on their
timberlands over a 100-year planning period and establish an LTSY harvest
level. The SYP must demonstrate that the average annual harvest over any
rolling ten-year period will not exceed the LTSY harvest level and that
the Company's projected timber inventory is capable of sustaining the LTSY
harvest level in the last decade of the 100-year planning period. An
approved SYP is expected to be valid for ten years, although it would be
subject to review after five years. Thereafter, revised SYPs will be
prepared every decade that address the LTSY harvest level based upon
reassessment of changes in the resource base and other factors.
The final terms of the SYP, the Multi-Species HCP and the Permit
are subject to additional negotiation and agreement among the parties as
well as public review and comment. While the parties are working
diligently to complete the Multi-Species HCP and the SYP as well as the
other closing conditions contained in the Headwaters Agreement, there can
be no assurance that the Headwaters Agreement will be consummated or that
an SYP, Multi-Species HCP or Permit acceptable to the Company will be
approved.
In the event that a Multi-Species HCP is not approved, the
Company will not enjoy the benefits of expedited preparation and
facilitated review of its THPs. Furthermore, if a Multi-Species HCP
acceptable to the Company is not approved, it is impossible for the Company
to determine the potential adverse effect of the listings of the marbled
murrelet and coho salmon or the EPA s limitations on the Company's
financial position, results of operations or liquidity until such time as
the various regulatory and legal issues are resolved; however, if the
Company is unable to harvest, or is severely limited in harvesting, on
significant amounts of its timberlands, such effect could be materially
adverse to the Company.
10. SUPPLEMENTAL CASH FLOW AND OTHER INFORMATION
Items Related to 1992 Earthquake
In 1995, the Company recorded reductions in cost of sales of
$1,527,000 resulting from business interruption insurance reimbursements
for higher operating costs and the related loss of revenues resulting from
the April 1992 earthquake.
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------
1997 1996 1995
------------- ------------- -------------
(In thousands)
<S> <C> <C> <C>
Supplemental information on non-cash
investing and financing activities:
Timber and timberlands acquired
subject to long-term debt $ 9,445 $ - $ 615
Supplemental disclosure of cash flow
information:
Interest paid, net of capitalized
interest $ 52,380 $ 52,517 $ 53,636
Income taxes paid (refunded) 166 221 (5,190)
Tax allocation payments to MAXXAM 454 330 -
</TABLE>
11. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Summary quarterly financial information for the years ended
December 31, 1997 and 1996 is as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended
-------------------------------------------------------
March 31 June 30 September 30 December 31
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
1997:
Net sales $ 60,849 $ 67,810 $ 66,592 $ 66,126
Operating income 16,512 20,810 20,584 16,659
Net income 2,193 4,905 4,678 3,813
1996:
Net sales $ 54,903 $ 65,299 $ 62,965 $ 61,682
Operating income 14,310 17,485 15,415 19,090
Net income 884 3,144 1,473 4,445
</TABLE>
