UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
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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 1-9204
THE PACIFIC LUMBER COMPANY
(Exact name of Registrant as Specified in its Charter)
DELAWARE 13-3318327
(State or other (I.R.S. Employer
jurisdiction Identification Number)
of incorporation or
organization)
P. O. BOX 37 95565
125 MAIN STREET (Zip Code)
SCOTIA, CALIFORNIA
(Address of Principal
Executive Offices)
Registrant's telephone number, including area code: (707) 764-2222
---------------
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 12
Item 3. Legal Proceedings 12
Item 4. Submission of Matters to a Vote of Security Holders 13
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 14
Item 6. Selected Financial Data 14
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 14
Item 8. Financial Statements and Supplementary Data 19
Report of Independent Public Accountants 19
Consolidated Balance Sheet 20
Consolidated Statement of Operations 21
Consolidated Statement of Cash Flows 22
Notes to Consolidated Financial Statements 23
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 34
PART III
Items
10-13. Not applicable.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K 34
PART I
ITEM 1. BUSINESS
GENERAL
The Pacific Lumber Company and its subsidiaries (collectively
referred to herein as the "Company" or "Pacific Lumber," unless the context
indicates otherwise) engage 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. The Company has been in
continuous operation for over 125 years.
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 in turn 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"). As used herein, the terms
"Company" or "Pacific Lumber," "MGHI," "MGI," or "MAXXAM" refer to the
respective companies and their subsidiaries, unless otherwise noted or the
context indicates otherwise.
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.
TIMBERLANDS
The Company 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 the Company's four sawmills and contain
an extensive network of roads. Approximately 179,000 acres of the
Company's timberlands are owned by Scotia Pacific (the "Scotia Pacific
Timberlands"), a special purpose Delaware corporation and wholly owned
subsidiary of the Company. The Company 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"). The Company 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 the Company, Scotia Pacific and Britt Lumber Co., Inc.
("Britt"), an affiliate of the Company.
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.
The Company engages in extensive efforts to supplement the
natural regeneration of timber and increase the amount of timber on its
timberlands. The Company 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.
The Company 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, the Company supplements natural redwood regeneration by planting
redwood seedlings. Douglas-fir timber grown on the Company's timberlands
is regenerated almost entirely by planting seedlings. During 1997, the
Company planted an estimated 659,000 redwood and Douglas-fir seedlings.
HARVESTING PRACTICES
The ability of the Company 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 the Company'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 the Company and its operations. The number of the Company'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.
The Company maintains a detailed geographical information system
covering its timberlands (the "GIS"). The GIS covers numerous aspects of
the Company'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, the Company's foresters are better able
to develop detailed THPs addressing the various regulatory requirements.
The Company also utilizes a Global Positioning System ("GPS") which allows
precise location of geographic features through satellite positioning.
The Company 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
The Company 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 the Company's timberlands. Since 1986, the Company 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, the
Company'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.
The Company 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. The Company 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.
The Company 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. The Company 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. The Company also maintains several large enclosed storage
sheds which hold approximately 27 million board feet of lumber.
In addition, the Company owns and operates a modern 25-megawatt
cogeneration power plant which is fueled almost entirely by the wood
residue from the Company's milling and finishing operations. This power
plant generates substantially all of the energy requirements of Scotia,
California, the town adjacent to the Company's timberlands where several of
its manufacturing facilities are located. The Company sells surplus power
to Pacific Gas and Electric Company. In 1997, the sale of surplus power
accounted for approximately 2% of the Company's total revenues.
PRODUCTS
The following table sets forth the distribution of the Company'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, the Company sold approximately 312 million board feet of
lumber, which accounted for approximately 84% of the Company'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 the Company'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 the Company'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, the Company'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
The Company 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, the Company
does not have any significant contractual relationships with third parties
relating to the purchase of logs. The Company has historically not
purchased significant quantities of logs from third parties; however, the
Company 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 the Company.
Wood Chips
The Company 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. The Company 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.
Other
The Company also derives revenues from a soil amendment operation
and a concrete block manufacturing operation.
BACKLOG AND SEASONALITY
The Company's backlog of sales orders at December 31, 1997 and
1996 was approximately $26.4 million and approximately $21.3 million,
respectively, the substantial portion of which was delivered in the first
quarter of the next fiscal year. The Company has historically experienced
lower first quarter sales due largely to the general decline in
construction-related activity during the winter months. As a result, the
Company's results in any one quarter are not necessarily indicative of
results to be expected for the full year.
MARKETING
The housing, construction and remodeling markets are the primary
markets for the Company's lumber products. The Company's policy is to
maintain a wide distribution of its products both geographically and in
terms of the number of customers. The Company 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, the Company had three customers which accounted for
approximately 10%, 5% and 5%, respectively, of total revenues. Exports of
lumber accounted for approximately 6% of the Company's total revenues in
1997. The Company markets its products through its own sales staff which
focuses primarily on domestic sales.
The Company 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, the Company believes
it has a strong degree of customer loyalty.
COMPETITION
The Company's lumber is sold in highly competitive markets.
Competition is generally based upon a combination of price, service,
product availability and product quality. The Company'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 the Company'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 the Company's lumber products. The Company
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 the Company competes with
numerous large and small lumber producers.
EMPLOYEES
As of March 1, 1998, the Company 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 "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 the Company, 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 generally provides
for the sale to the Company of the logs harvested from the Scotia Pacific
Timber covered by such THP and 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 the Company 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 prior 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.
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 of 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 the Company'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. "Business-
- -Regulatory and Environmental Factors and Headwaters Agreement." The
Company 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 for 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
the Company'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.
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, MGI 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 Company is not a defendant in
this suit. The suit alleges that defendants made false statements and
claims in violation of the Federal False Claims Act in connection with
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 REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
All of the Company's common stock is owned indirectly by MGI,
which is a wholly owned subsidiary of MGHI, which in turn is wholly owned
by MAXXAM. 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 in the amount of $23.0
million, $20.5 million and $22.0 million in 1997, 1996 and 1995,
respectively. As of December 31, 1997, approximately $15.9 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.
All of the Company's issued and outstanding common stock is
pledged as collateral for MGI's 11-1/4% Senior Secured Notes due 2003 and
12-1/4% Senior Secured Discount Notes due 2003 (collectively referred to
herein as the "MGI Notes"). See Item 7. "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Financial
Condition and Investing and Financing Activities" and Note 7 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'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 the Company's principal source of
upper grade redwood lumber, its most valuable product. Due to the
restrictions on the Company's ability to harvest old growth timber on its
property, the Company'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 compliance with
environmental regulations relating to the harvesting of timber and
litigation costs incurred in connection with certain THPs filed by the
Company. The Company 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 the Company is able to sustain
the harvest level of old growth trees, the Company 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 160.3 159.4 146.8
Douglas-fir upper grades 11.5 10.6 7.4
Douglas-fir common grades 75.3 74.9 64.6
Other 12.0 12.5 11.4
------------- ------------- -------------
Total lumber 311.5 307.1 276.7
============= ============= =============
Logs (2) 43.9 49.4 40.3
============= ============= =============
Wood chips (3) 224.3 187.2 192.8
============= ============= =============
Average sales price:
Lumber: (4)
Redwood upper grades $ 1,443 $ 1,380 $ 1,495
Redwood common grades 575 542 496
Douglas-fir upper grades 1,203 1,154 1,301
Douglas-fir common grades 455 439 392
Logs (4) 394 450 396
Wood chips (5) 76 79 107
Net sales:
Lumber, net of discount $ 218.3 $ 202.8 $ 181.4
Logs 17.3 22.2 15.9
Wood chips 17.0 14.8 20.7
Cogeneration power 4.5 3.3 2.5
Other 4.3 1.7 1.4
------------- ------------- -------------
Total net sales $ 261.4 $ 244.8 $ 221.9
============= ============= =============
Operating income $ 74.6 $ 66.3 $ 64.6
============= ============= =============
Operating cash flow (6) $ 101.1 $ 93.9 $ 90.5
============= ============= =============
Income before income taxes $ 23.5 $ 16.1 $ 13.0
============= ============= =============
Net income $ 15.6 $ 9.9 $ 6.6
============= ============= =============
Capital Expenditures $ 22.2 $ 14.6 $ 9.7
============= ============= =============
<FN>
- ---------------
(1) Lumber shipments are expressed in millions of board feet.
(2) Log shipments are expressed in millions of feet, net Scribner scale.
(3) Wood chip shipments are expressed in thousands of bone dry units of
2,400 pounds.
(4) Dollars per thousand board feet.
(5) Dollars per bone dry unit.
(6) Operating income before depletion and depreciation, also referred to
as "EBITDA."
</TABLE>
Net sales
Net sales for 1997 increased from 1996 principally due to higher
average realized prices for most categories of redwood and Douglas-fir
lumber and to a lesser extent due to an increase in shipments for 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 increased in 1997 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 income taxes for 1997 increased over 1996,
principally due to the increase in operating income discussed above.
Income before income taxes for 1996 increased from 1995, primarily as a
result of the increase in operating income as discussed above and lower
interest expense.
Provision in lieu of income taxes
The provision in lieu of income taxes for 1996 includes a credit
relating to reserves the Company no longer believes are necessary.
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.
A significant portion of the Company's consolidated assets are
owned by Scotia Pacific. Moreover, Scotia Pacific provides a substantial
portion of the Company's log requirements. The Company harvests and
purchases logs from Scotia Pacific's timberlands at prices established
pursuant to a Master Purchase Agreement. The holders of the Timber Notes
have priority over the claims of creditors of the Company with respect to
the assets and cash flow of Scotia Pacific.
Under the terms of the indenture governing the terms of the
Timber Notes (the "Timber Note Indenture"), Scotia Pacific will not have
available cash for distribution to Pacific Lumber unless 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. Once appropriate provision is made
for current debt service on the Timber Notes and expenditures for operating
and capital costs, and in the absence of certain Trapping Events (as
defined in the Timber Note Indenture) or outstanding judgments, the Timber
Note Indenture does not limit monthly distributions of available cash from
Scotia Pacific to the Company. Accordingly, once Scotia Pacific's debt
service, operating and capital expenditure requirements have been met,
substantially all of Scotia Pacific's available cash is periodically
distributed to the Company. Scotia Pacific paid $60.8 million, $76.9
million and $59.0 million of dividends to the Company during the years
ended December 31, 1997, 1996 and 1995, respectively. In the event Scotia
Pacific's cash flows are not sufficient to generate distributable funds to
the Company, the Company's ability to pay interest on the Senior Notes and
to service its other indebtedness would be materially impaired.
During the years ended December 31, 1997, 1996 and 1995, the
Company's operating income before depletion and depreciation ("operating
cash flow") amounted to $101.1, $93.9 million and $90.5 million,
respectively, which exceeded interest incurred on all of its indebtedness
in those years by $47.5 million, $39.5 million and $35.0 million,
respectively.
The indentures governing the Senior Notes, the Timber Notes and
the Company's revolving credit agreement (the "Revolving 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. The Company can pay
dividends in an amount that is generally equal to 50% of the Company'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. As of December 31, 1997,
under the most restrictive of these covenants, approximately $15.9 million
of dividends could be paid by the Company. The Company paid an aggregate
of $23.0 million, $20.5 million and $22.0 million of dividends in 1997,
1996 and 1995, respectively.
On October 9, 1997, the Revolving Credit Agreement was amended
to, among other things, extend the date on which it expires to May 31,
2000. The Revolving 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 acquisitions 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 $15.1
million in letters of credit were outstanding. As of December 31, 1997,
$35.5 million of borrowings was available under the Revolving Credit
Agreement, of which $4.9 million was available for letters of credit and
$20.6 million was restricted to timberland acquisitions.
Recent capital expenditures were made to improve production
efficiency, reduce operating costs and acquire additional timberlands. The
Company's capital expenditures were $22.2 million, $14.6 million and $9.7
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. The Company expects to purchase additional timberlands from time
to time will enable it to maintain recent harvest levels. However, there
can be no assurance that the Company would be able to do so, and any
timberland acquisitions would be limited by the Company's financial
resources and the availability of acceptable properties.
As of December 31, 1997, the Company had consolidated working
capital of $56.4 million and long-term debt of $517.1 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 $55.2
million and $525.6 million, respectively, at December 31, 1996. The
decrease in long-term debt was primarily due to principal payments on the
Timber Notes offset by borrowings of $9.4 million under the Revolving
Credit Agreement. The Company anticipates that cash from operations,
together with existing cash and available sources of financing, will be
sufficient to fund its working capital and capital expenditure requirements
for the next year. With respect to its long-term liquidity, the Company
believes that its existing cash and cash equivalents, together with its
ability to generate sufficient cash from operations and 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 affecting timber harvesting practices (see "--
Trends" below), increased competition from other lumber producers or
alternative building products and general economic conditions.
TRENDS
This section contains statements which constitute "forward-
looking statements" within the meaning of the Private Securities Litigation
Reform Act of 1995. See Item 1. "Business--General" for cautionary
information with respect to such forward-looking statements.
The Company'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 the Company, have
increased the cost of logging operations. The Company is subject to
certain pending matters which could have a material adverse effect on its
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 adverse affect 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 the Company, increased
regulatory delays and inclement weather in northern California,
independently or collectively, could impair the Company's ability to
maintain adequate log inventories and force the Company to temporarily idle
or curtail operations at certain lumber mills from time to time.
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 be adopted in the Company's first
quarter ending March 31, 1998 and year-end 1998 reporting, respectively.
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 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>
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 19
Consolidated Balance Sheet at December 31, 1997 and 1996 20
Consolidated Statement of Operations for the years ended
December 31, 1997, 1996 and 1995 21
Consolidated Statement of Cash Flows for the years ended
December 31, 1997, 1996 and 1995 22
Notes to Consolidated Financial Statements 23
2. FINANCIAL STATEMENT SCHEDULES:
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 36), which index is incorporated
herein by reference.
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.
THE PACIFIC LUMBER COMPANY
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 - Finance and
Administration
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/ JOHN A. CAMPBELL
John A. Campbell
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 T. LA DUC
John T. La Duc
Vice President and Director
Date: March 26, 1998 By: /S/ EZRA G. LEVIN
Ezra G. Levin
Director
Date: March 26, 1998 By: /S/ WILLIAM S. RIEGEL
William S. Riegel
Vice President - Sales and
Director
Date: March 26, 1998 By: /S/ GARY L. CLARK
Gary L. Clark
Vice President - Finance and
Administration
(Principal Accounting Officer)
INDEX OF EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------------ ----------------------------------------------------
<S> <C>
3.1 Articles of Incorporation of The Pacific Lumber
Company (the "Company" or "Pacific Lumber")
(incorporated herein by reference to Exhibit 3.1 to
the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1992)
3.2 By-laws of the Company, as amended (incorporated
herein by reference to Exhibit 3.2 to the Company's
Annual Report on Form 10-K for the fiscal year ended
December 31, 1992)
4.1 Indenture between the Company 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 Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1993)
4.2 Indenture between Scotia Pacific Holding Company
("Scotia Pacific") and State Street, as Trustee,
(the "Scotia Pacific Indenture"), 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; the "Scotia
Pacific 1993 Form 10-K")
4.3 Amended and Restated Revolving Credit Agreement
dated as of November 10, 1995 (the "Revolving Credit
Agreement") between the Company and Bank of America
National Trust and Savings Association (incorporated
herein by reference to Exhibit 4.1 to the Company's
Quarterly Report on Form 10-Q for the quarter ended
September 30, 1995)
4.4 First Amendment, dated February 10, 1997, to the
Revolving Credit Agreement (incorporated herein by
reference to the Company's Annual Report on Form 10-
K for the year ended December 31, 1997)
4.5 Second Amendment, dated October 9, 1997, to the
Revolving Credit Agreement, (incorporated herein by
reference to Exhibit 4.1 to the Company's Quarterly
Report on Form 10-Q for the quarter ended September
30, 1997)
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 Agreement dated December 20, 1985 between the
Company and General Electric Company (the "1985 GE
Agreement") (incorporated herein by reference to
Exhibit 10(m) to the Registration Statement of
Pacific Lumber on Form S-1, Registration No.
33-5549)
10.2 Amendment No. 1 to Agreement between the Company 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)
10.3 Power Purchase Agreement dated January 17, 1986
between the Company and Pacific Gas and Electric
Company (incorporated herein by reference to Exhibit
10(n) to the Registration Statement of the Company
on Form S-1, Registration No. 33-5549)
10.4 Tax Allocation Agreement dated as of May 21, 1988
among MAXXAM Inc., MAXXAM Group Inc., the Company
and the corporations signatory thereto (incorporated
herein by reference to Exhibit 10.8 of the Company's
Annual Report on Form 10-K for the fiscal year ended
December 31, 1988)
10.5 Tax Allocation Agreement among the Company, 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)
10.6 Form of Deed of Trust, Assignment of Rents, Grant of
Easement and Fixture Filing with respect to the
Revolving Credit Agreement (incorporated herein by
reference to Exhibit 4.2 to the Company's Quarterly
Report on Form 10-Q for the quarter ended September
30, 1995)
10.7 Deed of Trust, Security Agreement, Financing
Statement, Fixture Filing and Assignment among
Scotia Pacific, State Street, as Trustee, and State
Street, as Collateral Agent with respect to the
Scotia Pacific Indenture (incorporated herein by
reference to Exhibit 4.2 to the Scotia Pacific 1993
Form 10-K)
10.8 Master Purchase Agreement between the Company and
Scotia Pacific (incorporated herein by reference to
Exhibit 10.1 to the Scotia Pacific 1993 Form 10-K)
10.9 Services Agreement between the Company 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 the Company
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 the Company,
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 the
Company 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 the Company
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 Investment Management Agreement, dated as of
December 1, 1991, by and among the Company, MAXXAM
Inc. and certain related corporations (incorporated
herein by reference to Exhibit 10.23 to Amendment
No. 5 to the Registration Statement on Form S-2 of
MAXXAM Group Inc., Registration No. 33-64042)
10.15 Agreement (the "Headwaters Agreement") dated
September 28, 1996 among MAXXAM Inc., The Pacific
Lumber Company (on behalf of itself, its
subsidiaires 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)
*10.16 Pre-Permit Application Agreement in Principle dated
February 27, 1998 relating to the Headwaters
Agreement.
*27 Financial Data Schedule
<FN>
- ---------------
* Included with this filing.
</TABLE>
DATED: February 27, 1998
Pre-Permit Application Agreement in Principle
The parties to the Agreement of September 28, 1996, which is hereby
incorporated by reference, MAXXAM Inc., The Pacific Lumber Company, on
behalf of itself, its subsidiaries and its affiliates ("PL," and together
with MAXXAM, the "Pacific Lumber Parties"), the United States of America
("United States") and the State of California ("California") (hereinafter,
"the 1996 parties") agreed to use their best good faith efforts to achieve
expedited development and submission by Pacific Lumber (PL) and processing
by the government parties of a multi-species habitat conservation plan
(HCP) pursuant to Section 10(a) of the federal Endangered Species Act, 16
U.S.C. 1539(a), and a Sustained Yield Plan (SYP) pursuant to the California
Forest Practices Act, Cal. Pub. Res. Code 4511, et seq.
The 1996 parties have continued their on-going discussions on this
topic in furtherance of the Agreement of September 28, 1996 and in
consideration of the provisions of Title V of the Department of the
Interior and Related Agencies Appropriations Act, 1998. As a result of
these discussions, PL and the federal and state resource agencies (U.S.
Fish and Wildlife Service ("FWS"), National Marine Fisheries Service
("NMFS"), California Department of Fish and Game ("CDFG") and California
Department of Forestry and Fire Protection ("CDF")) (hereinafter, the
resource agencies) have reached the following understanding regarding the
HCP and the SYP:
I. Incidental Take Permit (ITP).
(A). PL commits to include in its application for an incidental take
permit (ITP) and its accompanying HCP the following elements:
i. The terms of the ITP applied for and HCP will be 50 years.
ii. The ITP applied for and HCP will provide that, for the
conservation of the marbled murrelet, no timber harvesting (including
salvage) or other management activity detrimental to the marbled
murrelet or to the marbled murrelet habitat will occur for the life of
the ITP, in the following groves as depicted in the attached map
(Attachment A), incorporated herein. The Implementing Agreement (IA)
shall describe management activities that may be conducted without
detriment to the marbled murrelet or to marbled murrelet habitat.
<TABLE>
<CAPTION>
<S> <C>
(a). Elk Head Residual 564 acres
(b). Cooper Mill 722 acres
(c). Allen Creek 1421 acres
(d). Allen Creek Extension 301 acres
(e). Road 3 659 acres
(f). Owl Creek or Grizzly Creek South/West/Center
See Note. 904 or 1251
acres
(g). Shaw Gift 548 acres
(h). Right Road 9 322 acres
(i). Road 7 and 9 North 501 acres
(j). Booth's Run 776 acres
(k). Bell Lawrence 634 acres
(l). Lower North Fork Elk 531 acres
</TABLE>
(All acreages are approximate).
Note: Initially, Owl Creek Grove is set aside for the life of the
ITP. If PL demonstrates to the satisfaction of the resource agencies
that Grizzly Creek South/West/Center ("Grizzly Creek") will be
protected in its present condition for the life of the ITP, then PL
may substitute Grizzly Creek for the Owl Creek set aside.
iii. PL has represented that the following timber harvest plans
(THP) are the only ones that are either planned by PL or have been
approved by the CDF within the areas set forth in paragraph 1(A)(ii),
above: THP Nos. 95-580; 97-003; 97-064; and 97-112. Trees that
have already been harvested under these THP's may be removed.
However, commencing on the date this Agreement in Principle is
executed, further harvest in these or other areas set forth in
paragraph 1(A)(ii), above, will not be conducted.
iv. PL and the resources agencies agree that the IA will provide
that PL may sell, exchange or otherwise transfer to a third party one
or more of the groves listed in paragraph 1(A)(ii) so long as the
protection afforded by such third party (and its successors) to the
marbled murrelet and the habitat of the marbled murrelet on such
groves is equal to or greater than that afforded under the HCP. PL
will not be required to provide additional mitigation on its remaining
lands to account for such sale, exchange or transfer.
(B). PL agrees to implement specific aquatic conservation measures
identified below prior to submittal of its application for an ITP and
to incorporate these and other measures identified below in its
application for an ITP and its accompanying HCP.
i. PL agrees to initiate immediately upon execution of this
agreement the Washington Department of Natural Resources (DNR)
watershed assessment process as described and modified in the
interagency framework memorandum dated February 3, 1998, ("DNR
process") to develop specific prescriptions on its lands. These
specific prescriptions, developed through the DNR process, will
achieve properly functioning habitat conditions as intended by the
resource agencies in their January 7, 1998, aquatics strategy proposal
to PL. In place of the input and approval criteria of Paragraph 7 of
the February 3, 1998 memorandum, for each prescription team assembled
by PL, FWS, NMFS, CDFG, and EPA will each designate at least one
representative to participate on the team.
ii. Further, PL agrees to implement timely amendments to all
pending (but not yet approved) timber harvest plans (THP) and include
in all future THPs the prescriptions contained in the interagency
proposal dated January 7, 1998, except for prescriptions on class II
streams and in areas of high potential for mass wasting. Class II
streams will have a 100 foot riparian protective zone within which the
inner 10 feet will be a restricted harvest band and the outer 90 feet
will be managed according to PL's late seral prescription, except the
minimum 240 square feet basal area retention will be calculated based
upon the entire 100 foot zone. The CDF, shall, within 45 days of
submission of the amendments required herein, incorporate such
amendments to the THPs, and thereafter shall process such amended THPs
expeditiously.
iii. The resource agencies recognize that there are issues to be
resolved which relate to implementation and operation of the HCP. The
agencies will work with PL to resolve such issues provided that their
resolution does not diminish the potential to achieve properly
functioning riparian habitat.
iv. In addition, prior to completion of the DNR process, the
mass wasting avoidance strategy of PL's August 27, 1997, Draft HCP/SYP
will be used along with harvest plan specific review and it will be
extended to hill slopes and inner gorges where the potential for mass
wasting is rated "high". If PL harvests in areas that have not been
mapped for risk of mass wasting prior to completion of the DNR
process, PL will identify areas of high, very high, and extreme mass
wasting potential and follow its mass wasting avoidance strategy
(referenced above). PL will consult with agency (NMFS, EPA, and CDFG)
biologists in the development of timber harvest prescriptions for
areas where the Registered Professional Geologist determines the
appropriate prescription. The geologist's report and the recommended
timber harvest prescription will be submitted with the THP.
v. PL will submit an HCP which provides that, for a three-year
period commencing on the date of issuance of the ITP, PL will continue
to use the prescriptions contained in paragraphs 1(B)ii through 1(B)iv,
unless prescriptions have been developed and agreed to by the resource
agencies through the DNR process. Prescriptions that have been
developed and agreed to by the resource agencies through the DNR
process will be implemented immediately.
vi. The HCP which PL submits will also provide that, after three
years, following the date of issuance of the ITP, PL agrees to follow
prescriptions developed by the prescription team through the DNR
process. The prescriptions will to the maximum extent practicable be
developed collaboratively by the prescription team. Within 45 days of
being advised in writing that PL proposes to implement a prescription,
the Regional Administrator, NMFS, or the Regional Director, FWS, as
appropriate, may reject the proposed prescription(s). In that event,
the applicable prescription(s) from the January 7, 1998 inter-agency
proposal will apply. Further, for watersheds for which prescriptions
have not been developed through the DNR process, the prescriptions
contained in the interagency proposal dated January 7, 1998, will
apply.
vii. Prior to issuance of an ITP, road storm proofing will be
implemented within watersheds as indicated by the results of the DNR
process, but PL agrees to conduct road storm proofing of at least 50
miles per year until the ITP is issued. Further PL will ensure that
all new roads and landings related to THP's comply with
specifications described in the Handbook for Forest and Ranch Roads
(Weaver 1994), and that any new roads are constructed according to
prescriptions contained in the January 7, 1998, interagency proposals.
viii. Subsequent to issuance of the ITP, the roads will be
managed and monitored according to the ITP and approved HCP.
ix. Various provisions of Paragraph 1(B) rely on the Washington
DNR process. If the State of California, in conjunction with NMFS and
FWS, agree upon a California watershed plan, then it is the intent of
the parties to consider substitution of the California plan, or parts
thereof, as appropriate.
2. Sustained Yield Plan (SYP).
(A). PL will submit to CDF an SYP which describes the range of timber
growth (in terms of board feet per acre per year) from extensive
management to intensive management. Upon receipt from PL of an SYP
incorporating CDF's request for timber growth estimates, CDF will find
the SYP sufficient for public review.
(B). The SYP will be evaluated by CDFG and CDF under the California
Endangered Species Act (CESA), Cal. Fish and Game Code 2050, et seq.,
and the California Forest Practices Act, Cal. Pub. Res. Code 4511, et
seq., and other applicable state statutes to ensure that it satisfies
applicable statutory requirements.
3. After receipt of a complete Section 10(a) permit application package
and a complete SYP, FWS and CDF will make available for review and comment
a draft EIS/EIR on PL's proposed HCP pursuant to the National Environmental
Policy Act (NEPA), 42 U.S.C. 4321, et seq., and its SYP pursuant to the
California Environmental Quality Act (CEQA), Cal. Pub. Res. Code 21000, et
seq.
4. The proposed HCP will be evaluated by FWS and NMFS under Sections 7
and 10 of the ESA, 16 U.S.C. 1536 and 1539, and other applicable federal
law to ensure that it satisfies the requirements of those and other
applicable statutes. In accordance with 50 C.F.R. 13.23(a), PL shall have
the right to apply for amendment of the ITP, based on, if appropriate, a
proposed modified HCP.
5. PL and the resource agencies agree that this Pre-Permit Application
Agreement in Principle may be executed in counterparts by the respective
signatories and that it will become effective upon the signature of the
final signatory.
SIGNED:
/S/ Michael Spear /S/ Charles Hurwitz
Michael Spear Charles Hurwitz
Regional Director Chairman
United States Fish and Wildlife MAXXAM Inc.
Service
United States Department of the
Interior
/S/ William Hogarth /S/ John Campbell
William Hogarth John Campbell
Regional Administrator President and CEO
National Marine Fisheries Service The Pacific Lumber Company
United States Department of
Commerce
/S/ Douglas P. Wheeler
Douglas P. Wheeler
Secretary for Resources
State of California
On behalf of CDF and CDFG
ATTACHMENT A
[MAP of Proposed Marbled Murrelet Conservation Areas; Map of Proposed
Aquatic Protection Zones]
<PAGE>
<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> 31,768
<SECURITIES> 0
<RECEIVABLES> 19,216
<ALLOWANCES> 0
<INVENTORY> 56,079
<CURRENT-ASSETS> 122,084
<PP&E> 178,362
<DEPRECIATION> 82,070
<TOTAL-ASSETS> 617,132
<CURRENT-LIABILITIES> 65,695
<BONDS> 565,000
0
0
<COMMON> 0
<OTHER-SE> (22,125)
<TOTAL-LIABILITY-AND-EQUITY> 617,132
<SALES> 261,377
<TOTAL-REVENUES> 261,377
<CGS> 147,372
<TOTAL-COSTS> 147,372
<OTHER-EXPENSES> 39,440
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 53,613
<INCOME-PRETAX> 23,468
<INCOME-TAX> 7,879
<INCOME-CONTINUING> 15,589
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 15,589
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
