UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
---------------
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 COMMISSION FILE NUMBER 33-55538
SCOTIA PACIFIC HOLDING COMPANY
(Exact name of Registrant as Specified in its Charter)
DELAWARE 74-2652575
(State or other (I.R.S. Employer
jurisdiction Identification Number)
of incorporation or
organization)
P. O. BOX 712 95565
125 MAIN STREET, 2ND FLOOR (Zip Code)
SCOTIA, CALIFORNIA
(Address of Principal
Executive Offices)
Registrant's telephone number, including area code: (707) 764-2330
---------------
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: 3,000
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 10
Item 3. Legal Proceedings 10
Item 4. Submission of Matters to a Vote of Security Holders 12
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 12
Item 6. Selected Financial Data 12
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
Item 8. Financial Statements and Supplementary Data
Report of Independent Public Accountants 16
Balance Sheet 17
Statement of Income 18
Statement of Cash Flows 19
Notes to Financial Statements 20
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 29
PART III
Items
10-13. Not applicable.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K 29
PART I
ITEM 1. BUSINESS
GENERAL
Scotia Pacific Holding Company (the "Company" or "Scotia
Pacific") is the owner of commercial timber properties in northern
California (the "Company Timberlands"). The Company was organized as a
special purpose Delaware corporation to facilitate the sale in 1993 of
$385.0 million aggregate principal amount of 7.95% Timber Collateralized
Notes due 2015 (the "Timber Notes"). Substantially all of the Company's
assets serve as collateral for the Timber Notes. The Company is a wholly
owned subsidiary of The Pacific Lumber Company ("Pacific Lumber"). Pacific
Lumber 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"). As
used herein, the terms "MGHI," "MGI," "Pacific Lumber" 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--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.
COMPANY TIMBERLANDS
The Company Timberlands consist of approximately 179,000 acres of
virtually contiguous commercial timber property located in Humboldt County
along the northern California coast, an area which has very favorable soil
and climate conditions for growing timber. Pacific Lumber has the
exclusive right to harvest (the "Pacific Lumber Harvest Rights")
approximately 8,000 acres of the Company Timberlands consisting
substantially of virgin old growth redwood and virgin old growth Douglas-
fir timber located on numerous small parcels throughout the Company
Timberlands (the "Excluded Timber"). Pacific Lumber is responsible, at its
own expense, for the operation and management of the Excluded Timber. The
timber on the Company Timberlands which is not subject to the Pacific
Lumber Harvest Rights is referred to herein as the "Company Timber."
Pacific Lumber harvests and purchases from the Company all or substantially
all the logs harvested from Company Timber. See "--Harvesting Practices."
Timber generally is categorized by species and the age of a tree
when it is harvested. "Old growth" trees are often defined as trees which
have been growing for approximately 200 years or longer, and "young growth"
trees are those which have been growing for less than 200 years. "Residual
old growth" trees are located in timber stands which have been partially
harvested in the past. "Virgin" old growth trees are located in timber
stands that have not previously been harvested. The forest products
industry grades lumber into various classifications according to quality.
The two broad categories within which all grades fall based on the absence
or presence of knot are called "upper" and "common" grades, respectively.
Old growth trees have a higher percentage of upper grade lumber than young
growth trees.
The Company Timber consists of approximately 2.7 million "Mbfe"
of timber (by volume). In order to take account of the relative values of
the species and categories of timber included in the Company Timber, the
Mbfe concept was developed for use in structuring the Timber Notes. Under
the Mbfe concept, one thousand board feet, net Scribner scale, of residual
old growth redwood timber equates to one Mbfe. One thousand board feet,
net Scribner scale, of each other species and category of timber included
in the Company Timber was assigned a value in Mbfe equal to a fraction of
an Mbfe. This fraction was generally determined by dividing the SBE Price
(as defined below under "--Harvesting Practices") applicable to such
species and category for the first half of 1992 by the SBE Price applicable
to residual old growth redwood for the first half of 1992.
The Company Timber consists primarily of young growth and
residual old growth redwood and Douglas-fir timber. A small portion of the
Company Timber is currently sub-merchantable, but mature enough to be
measured in Mbfe units. In addition, substantial quantities of
sub-merchantable trees are contained in the Company Timber which are not
yet mature enough to be measured in Mbfe units. The table below sets
forth, on an Mbfe basis, the approximate composition of the merchantable
Company Timber as of the most recent date available, January 1, 1998. The
estimates of the volume of timber comprising the Company Timber are based
on a timber cruise performed in 1986 of all of Pacific Lumber's properties,
as adjusted to reflect actual harvest levels since the cruise and estimated
growth rates of the Company Timber.
<TABLE>
<CAPTION>
Percentage of
Merchantable
Timber
Ownership
-----------------
<S> <C>
Redwood:
Residual old growth 27%
Young growth 58%
--------------
Total redwood 85%
--------------
Douglas-fir:
Residual old growth 6%
Young growth 8%
--------------
Total Douglas-fir 14%
Other types of timber 1%
--------------
Total 100%
==============
</TABLE>
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.
Douglas-fir 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.
Pacific Lumber engages in extensive efforts to supplement the
natural regeneration of the Company Timber and increase the amount of
timber on the Company's timberlands. Pursuant to the Services Agreement
described below (see "--Operation of the Company Timberlands"), Pacific
Lumber is required to regenerate Company Timber on behalf of the Company.
This obligation includes the requirement to comply with California forestry
regulations regarding reforestation, which generally require that an area
be reforested to specified standards within an established period of time.
Pacific Lumber also actively engages in efforts to establish timberlands
from open areas such as pasture land. Regeneration of redwood timber
generally is accomplished through the natural growth of new redwood sprouts
from the stump remaining after a redwood tree is harvested. Such new
redwood sprouts grow quickly, thriving on existing mature root systems. In
addition, Pacific Lumber supplements natural redwood regeneration by
planting redwood seedlings. Douglas-fir timber is regenerated almost
entirely by planting seedlings. During 1997, Pacific Lumber planted an
estimated 650,000 redwood and Douglas-fir seedlings on timberlands
containing Company Timber.
OPERATION OF COMPANY TIMBERLANDS
The Company's foresters (including several registered
professional foresters), wildlife and fisheries biologists and other
personnel are responsible for providing a number of forest stewardship
techniques, including protecting the Company Timber from forest fires,
erosion, insects and other damage, overseeing replanting activities and
monitoring environmental and regulatory compliance. The Company's
personnel are also responsible for preparing timber harvesting plans
("THPs") and updating the information contained in the Company's
geographical information system ("GIS"). See "--Harvesting Practices" for
a description of the Company's GIS and the THP preparation process. An
extensive network of roads throughout the Company Timberlands allows the
Company's foresters access to employ forest stewardship techniques and
facilitates the transportation of logs harvested from the Company Timber.
Pursuant to a Services Agreement (the "Services Agreement")
entered into on the date of issuance of the Timber Notes (the "Transfer
Date"), the Company relies on Pacific Lumber to provide operational,
management and related services not performed by its own employees with
respect to Company Timber. Such services include the furnishing of all
equipment, personnel and expertise not within the Company's possession and
reasonably necessary for the operation and maintenance of such timberlands,
taking into consideration soil conditions, stand arrangements and other
factors relevant to cultivation and harvesting of the Company Timber. In
particular, Pacific Lumber is required to regenerate Company Timber,
prevent and control loss of Company Timber by fires, maintain a system of
roads throughout the Company Timberlands, take measures to control the
spread of disease and insect infestation and comply with environmental laws
and regulations. Pacific Lumber is also required to provide all services
under the Services Agreement in a manner consistent in all material
respects with the past practices of Pacific Lumber with respect to its own
timber properties, with such changes (a) as, in the reasonable judgment of
Pacific Lumber, are consistent with then current applicable industry
standards or the practices of Pacific Lumber with respect to its then
current timber resources, or (b) do not, individually or in the aggregate,
have a material adverse effect on the Company and its operations. As
compensation for the services provided by Pacific Lumber pursuant to the
Services Agreement, the Company pays a monthly fee which is adjusted
annually based upon 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.
The Company also entered into an Additional Services Agreement
(the "Additional Services Agreement") with Pacific Lumber on the Transfer
Date whereby the Company agreed to provide to Pacific Lumber (and its
subsidiaries) a variety of services. These services include (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 the Company a fee for such services equal to the actual cost of
providing such services, as determined in accordance with generally
accepted accounting principles.
HARVESTING PRACTICES
The ability of the Company to sell logs will depend, in part,
upon its ability to obtain regulatory approval of THPs. THPs are required
to be developed by registered professional foresters and must be filed
with, and approved by, the California Department of Forestry ("CDF") prior
to the harvesting of timber. Each THP is designed to comply with
applicable laws and regulations. The CDF's evaluation of proposed THPs
incorporates review and analysis of such THPs by several California and
federal agencies and public comments received with respect to such THPs.
An approved THP is applicable to specific acreage and specifies the
harvesting method and other conditions relating to the harvesting of the
timber covered by such THP. See "--Regulatory and Environmental Factors
and Headwaters Agreement" for information regarding Pacific Lumber's
obligation to develop a plan establishing a long-term sustained yield
level for its and the Company's timberlands. That section also contains
information regarding threatened and endangered species listings, a
critical habitat designation and similar matters with respect to the
Company Timber.
The GIS contains information regarding numerous aspects of the
Company Timberlands, including timber type, tree class, wildlife data,
roads, rivers and streams. Subject to the terms of the Services Agreement,
Pacific Lumber, to the extent necessary, provides the Company with
personnel and technical assistance to assist the Company in updating,
upgrading and improving the GIS and the other computer equipment acquired
by the Company. By carefully monitoring and updating this data base and
conducting field studies, the Company's foresters, with the assistance (if
required) of Pacific Lumber pursuant to the Services Agreement, 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. Use of the GPS greatly enhances the quality and
efficiency of GIS data.
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.
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.
Timber covered by an approved THP is typically harvested over more than one
year. The indenture covering the Timber Notes (the "Indenture") requires
the Company to use its best efforts (consistent with the past practices of
Pacific Lumber and prudent business practices) to maintain a number of
pending THPs which, together with THPs previously approved, would cover
rights to harvest a sufficient quantity of Company Timber adequate to pay
accrued interest and principal amortization generally equivalent to Rated
Amortization moved forward by two years (see Note 2 to the Financial
Statements of the Company contained in Item 8 of this Report for a
description of Rated Amortization). Pursuant to the Services Agreement,
Pacific Lumber provides a variety of services to the Company in connection
with the preparation, filing and performance of THPs by the Company,
including defending any legal challenge to a THP.
After obtaining an approved THP covering Company Timber, the
Company offers for sale the logs to be harvested pursuant to such THP.
Although the Company could sell logs to third parties, the Company
currently derives and expects to continue to derive all of its revenue from
the sale of logs to Pacific Lumber pursuant to a Master Purchase Agreement
(the "Master Purchase Agreement") and related log purchase agreements. The
Company and Pacific Lumber enter, pursuant to the terms of the Master
Purchase Agreement, into a separate log purchase agreement (which
incorporates the terms of the Master Purchase Agreement) in connection with
each approved THP. Such log purchase agreement provides for the sale to
Pacific Lumber of the logs harvested from the Company Timber covered by
such THP and generally constitutes an exclusive agreement with respect to
the timber covered thereby, subject to certain limited exceptions.
However, the timing and amount of log purchases by Pacific Lumber will be
affected by factors outside the control of the Company, including
regulatory and environmental factors, the financial condition of Pacific
Lumber, Pacific Lumber's own supply of timber and its ability to harvest
such timber, and the supply and demand for lumber products (which, in turn,
will be influenced by demand in the housing, construction and remodeling
industries). As Pacific Lumber purchases logs from the Company pursuant to
the Master Purchase Agreement, Pacific Lumber is responsible, at its own
expense, for harvesting and removing the standing Company Timber covered by
approved THPs, and the purchase price is therefore based upon "stumpage
prices." Title to, and the obligation to pay for, harvested logs does not
pass to Pacific Lumber until the logs are transported to Pacific Lumber's
log decks and measured. See "Legal Proceedings--Timber Harvesting
Litigation" for a discussion of a Stipulation into which Pacific Lumber has
entered with respect to its 1998 timber operator's license.
The Master Purchase Agreement generally contemplates that all
sales of logs by the Company to Pacific Lumber will be at a price which
equals or exceeds the applicable stumpage price for such species and
category, as set forth in the most recent Harvest Value Schedule published
by the California State Board of Equalization (the "SBE Price"). The
Harvest Value Schedule is published by the California State Board of
Equalization at six month intervals for the purpose of computing yield
taxes imposed on the harvesting of timber. SBE Prices are based on average
actual log prices between unrelated parties over a recent twenty-four month
period. Therefore, SBE Prices are not necessarily representative of actual
prices that would be realized from unrelated parties at subsequent dates.
OTHER PRINCIPAL AGREEMENTS
On the Transfer Date, Pacific Lumber, the Company and Salmon
Creek Corporation ("Salmon Creek," a wholly owned subsidiary of Pacific
Lumber) 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 (the "Reciprocal Rights
Agreement"). In addition, the Company and Pacific Lumber entered into an
Environmental Indemnification Agreement pursuant to which Pacific Lumber
agreed to indemnify the Company 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 Company Timberlands. In particular, Pacific Lumber is
liable with respect to any contamination which occurred on the Company
Timberlands prior to the Transfer Date.
EMPLOYEES
As of March 1, 1998, the Company employed 40 persons, 8 of whom
were registered professional foresters and none of whom are covered by a
collective bargaining agreement.
PRINCIPAL EXECUTIVE OFFICES
The principal executive offices of the Company are located at 125
Main Street, 2nd Floor, P.O. Box 712, Scotia, California 95565. The
telephone number of the Company is (707) 764-2330.
MISCELLANEOUS
For information concerning the business and financial condition
of Pacific Lumber, see the Annual Report on Form 10-K of Pacific Lumber for
the fiscal year ended December 31, 1997. Such report is available at no
charge by writing to the following address: The Pacific Lumber Company,
Shareholder Services Department, 5847 San Felipe, Suite 2600, P.O. Box
572887, Houston, Texas 77257-2887.
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
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. The California Forest Practice Act (the "Forest
Practice Act") and related regulations adopted by the California Board of
Forestry (the "BOF") set forth detailed requirements for the conduct of
timber harvesting operations in California. These requirements include the
obligation of timber companies to prepare, and obtain regulatory approval
of, detailed THPs (timber harvesting plans) containing information with
respect to areas proposed to be harvested (see "--Harvesting Practices"
above). As described further below, California law has also required large
timber companies submitting THPs to demonstrate that their proposed timber
operations will not decrease the sustainable productivity of their
timberlands. A timber company may comply with this requirement by
submitting for review and approval by the CDF a long-term sustained yield
plan ("SYP") establishing a long-term sustained yield harvest level for
their timberlands. The federal Endangered Species Act (the "ESA") and
California Endangered Species Act (the "CESA") provide in general for the
protection and conservation of specifically listed wildlife and plants which
have been declared to be endangered or threatened. The operations of
Pacific Lumber are also subject to the California Environmental Quality Act
("CEQA"), which provides for protection of the state's air and water quality
and wildlife, and the California Water Quality Act and Federal Clean Water
Act, which require that Pacific Lumber conduct its operations so as to
reasonably protect the water quality of nearby rivers and streams.
While compliance with such laws, regulations and judicial and
administrative interpretations, together with the cost of litigation
incurred in connection with certain timber harvesting operations, have
increased the costs of the Company and Pacific Lumber, they have not had a
significant adverse effect on the Company's 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 the Company
Timberlands, and to a lesser extent, residual old growth timber. As a
result, the Company, Pacific Lumber 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 the Company (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 (including the Company 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
(including the Company 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 and Pacific Lumber have 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 the Company's THPs. In addition, lawsuits are
pending or threatened which seek to prevent the Company from implementing
certain of its approved 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. 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 the Company has faced is
the listing of threatened or endangered species which are found on the
Company 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
25,000 acres of the Company Timberlands have been designated as critical
habitat for the marbled murrelet. The Company 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 the Company. They
have also indicated that the Company 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 the Company 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,
the Company and 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 and the Company
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. The Company expects Pacific Lumber to
propose a long-term sustained yield harvest level ("LTSY") which is
somewhat less than recent harvest levels with respect to the Company's and
Pacific Lumber's timberlands. 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 and 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 Pacific Lumber's projected timber inventory is
capable of sustaining the LTSY harvest level in the last decade of the
100-year planning period. The HCP/SYP Agreement provides that upon
submission of certain timber growth estimates by Pacific Lumber, CDF
will find the SYP sufficient for public review. An approved SYP is
expected to be valid for ten years, although it would be subject to
review after five years. Thereafter, revised SYPs will be prepared
every decade that address the LTSY harvest level based upon
reassessment of changes in the resource base and other factors.
Status of the Multi-Species HCP, the SYP and the Headwaters
Agreement
The final terms of the SYP, the Multi-Species HCP and the Permit
are subject to additional negotiation and agreement among the parties. At
such time as the parties reach agreement on the form of the Multi-Species
HCP and the Permit, these documents, along with federal and state
environmental impact statements, will be made available for public review
and comment. After the government agencies complete the public review
process and approve a final environmental impact statement, the agencies
will decide whether to approve a Multi-Species HCP and a Permit. A similar
process will occur with respect to the SYP. While the Company believes
that the HCP/SYP Agreement represents an important milestone toward
completion of the Headwaters Agreement and the parties are working
diligently to complete the Multi-Species HCP and the SYP as well as the
other closing conditions contained in the Headwaters Agreement, there can
be no assurance that the Headwaters Agreement will be consummated or that
an SYP, Multi-Species HCP or Permit acceptable to Pacific Lumber will be
approved.
In the event that a Multi-Species HCP is not approved, the
Company 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 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. 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 the Company'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 the Company, 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
the Company, Pacific Lumber 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." 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 the Company and
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 the TOL would have a significant adverse
effect on its operations or financial performance.
TAKINGS LITIGATION
On May 7, 1996, the Company, Pacific Lumber and Salmon Creek
filed a lawsuit entitled The Pacific Lumber Company, et al. v. The United
States of America (No. 96-257L) in the United States Court of Federal
Claims. The suit alleges that the federal government has "taken" without
compensation over 3,800 acres of Pacific Lumber's old growth timberlands
(including the Headwaters Forest and 900 acres of the Company's timberlands
on which Pacific Lumber has harvesting rights) through its application of
the ESA. The Company, Pacific Lumber and Salmon Creek seek constitutional
"just compensation" damages for the taking of these timberlands by the
federal government's actions. Salmon Creek has filed a similar action in
the Superior Court of Sacramento County with respect to eight acres of
virgin old growth timber. 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 against MAXXAM, MGI and others. 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 by Pacific Lumber.
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 $60.8 million,
$76.9 million and $59.0 million in 1997, 1996 and 1995, respectively. As
of December 31, 1997, approximately $1.5 million of dividends could be paid
by the Company, which were paid in January 1998. See Item 7. "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Financial Condition and Investing and Financing Activities" and Note 2 to
the 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
The Company is a special purpose corporation organized in
November 1992 to facilitate the offering of the Timber Notes and did not
conduct any operations prior to the issuance of the Timber Notes. The
following should be read in conjunction with the Company's Financial
Statements and the Notes thereto appearing in Item 8.
RESULTS OF OPERATIONS
Logging operations on the Company's timberlands are highly
seasonal. Logging activity is normally significantly higher in the months
of April through November than in the months of December through March.
Management expects that the Company's revenues and cash flows will continue
to reflect that seasonality.
Log sales to Pacific Lumber
Revenues from the sale of logs were $110.4 million and $124.3
million for the years ended December 31, 1997 and 1996, respectively. The
decrease in sales from the prior year is due to a decline in SBE prices in
young growth redwood and Douglas-fir logs and due to the decrease in the
volume of log deliveries from 187,900 Mbfe to 181,900 Mbfe (see Item 1.
"Business--Company Timberlands" for an explanation of the Mbfe concept).
Revenues from the sale of logs were $124.3 million and $106.8
million for the years ended December 31, 1996 and 1995, respectively. The
volume of log deliveries for such periods represented approximately 187,900
Mbfe and 172,500 Mbfe, respectively. The increase in revenues was due to
the higher volume of log sales and an increase in average realized prices
of 7%. Average realized prices increased due to higher SBE prices.
Operating income
Operating income was $88.0 million, $101.3 million and $85.3
million for the years ended December 31, 1997, 1996 and 1995, respectively.
The changes between the years are primarily a result of the factors
affecting revenues as described above. Operating income is net of a
provision for timber depletion and depreciation of property and equipment,
the estimated cost of yield taxes for the logs sold, administrative costs
and the costs for operational, management and related services provided by
Pacific Lumber in respect of the Company Timber pursuant to the Services
Agreement.
Income before income taxes
Income before income taxes was $63.7 million, $76.0 million and
$59.0 million for the years ended December 31, 1997, 1996 and 1995,
respectively. The decrease in 1997 over 1996 and the increase in 1996 over
1995 was primarily due to the change in operating income between these
years. Income before income taxes represents the sum of operating income
and interest income on the funds deposited in a liquidity account (the
"Liquidity Account") and other required deposits, less interest expense,
including amortization of deferred financing costs on the Timber Notes.
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.
Pursuant to the Indenture, the Company is not permitted to incur
any indebtedness for borrowed money other than the Timber Notes, and the
business activities of the Company are limited to the ownership and
operation of the Company's timber and timberlands and matters incidental
thereto.
Although the Company is permitted to sell logs or standing timber
from its timberlands to other purchasers, the Company has derived all of
its revenue from the sale of logs to Pacific Lumber pursuant to the Master
Purchase Agreement and related log purchase agreements, and management
expects the Company to continue doing so. The quantities and timing of log
sales for logs harvested from the Company's timberlands depend largely upon
purchases of logs by Pacific Lumber under the Master Purchase Agreement and
related log purchase agreements. The timing and amount of such purchases
by Pacific Lumber may be affected by factors outside the control of the
Company, including regulatory and environmental factors, the financial
condition of Pacific Lumber, Pacific Lumber's own supply of timber and its
ability to harvest such timber, and the supply and demand for lumber
products (which, in turn, will be influenced by demand in the housing,
construction and remodeling industries).
Revenues from the sale of the Company's logs or timber from the
Company's timberlands are deposited directly with the trustee under the
Indenture, and may be released for, among other things, the payment of
certain operating expenses. Revenues to be utilized for payments on the
next note payment date of principal amortization, interest and premiums on
the Timber Notes generally are deposited into an account (the "Payment
Account") until the next note payment date. On each note payment date, the
amounts on deposit in the Payment Account will be utilized to make required
payments on the Timber Notes (or to make any required deposits, if any, to
the Liquidity Account). Amounts remaining after the required transfer of
funds into the Payment Account and the appropriate provision for certain
operating expenses can be released to the Company free and clear of the
lien and security interest of the Deed of Trust securing the Timber Notes
(the "Deed of Trust").
The amortization of the Timber Notes is generally structured to
link, to the extent of available cash, the deemed depletion of the
Company's timber as a result of the harvest and sale of logs (or sales of
timber, if any) to the required amortization on the Timber Notes (see Note
2 to the Financial Statements). Regardless of the amount of timber
actually harvested and sold, if there is sufficient cash (which could be
available due to, among other things, favorable prices realized from
harvested timber), the Timber Notes will amortize at least as fast as
Capture Amortization (as defined in the Indenture). In any event, the
Company is obligated to pay the Rated Amortization due on any Note Payment
Date. During 1996, 1997 and in January 1998, the Company repaid
approximately $14.1 million, $16.2 million and $10.8 million, respectively,
of the aggregate principal amount outstanding on the Timber Notes in
accordance with Scheduled Amortization (as defined in Note 2 to the
Financial Statements).
The Company initially deposited $35.0 million in the Liquidity
Account and, as of December 31, 1997, the Liquidity Account had a balance
of $28.4 million. The balance in the Liquidity Account must be maintained
at the Required Liquidity Balance (as defined). Funds may be released from
the Liquidity Account to the extent that the balance in the Liquidity
Account exceeds the Required Liquidity Balance. The Required Liquidity
Balance will generally decline as principal payments are made on the Timber
Notes. The Liquidity Account is, except under certain limited
circumstances, only available to pay interest and Rated Amortization on the
Timber Notes if and to the extent that the Company does not have sufficient
cash in the Payment Account. The Liquidity Account is not available to
fund any premiums, interest on premiums or prepayment amounts (other than
Rated Amortization) in respect of the Timber Notes. During the years ended
December 31, 1997 and 1996, the Required Liquidity Balance decreased by
approximately $1.5 million and $1.4 million, respectively, and such amounts
have been released from the Liquidity Account.
Once the Company's debt service, operating and capital
expenditure requirements have been met, substantially all of the cash
released to the Company free of the lien and security interest of the Deed
of Trust is periodically distributed to Pacific Lumber. In connection with
the foregoing, the Company paid $60.8 million, $76.9 million and $59.0
million of dividends during 1997, 1996 and 1995, respectively. At December
31, 1997, the Indenture permitted the payment of $1.5 million of dividends,
which were paid in January 1998.
The Company's capital expenditures relate primarily to
reforestation of timberlands and to construction of logging roads. The
Company's capital expenditures for 1997, 1996 and 1995 were approximately
$1.8 million, $1.8 million and $2.0 million, respectively. In addition,
Pacific Lumber made capital contributions of capital expenditures
attributable to the Company Timberlands of $5.2 million and $3.2 million in
1997 and 1996, respectively. The Company's capital expenditures, excluding
expenditures for timberlands, for the next several years are expected to
approximate $1.5 million to $2.0 million per year.
The Company anticipates that cash flow from operations, together
with existing cash, will be sufficient to fund its working capital and
capital expenditures for the next year. With respect to its long-term
liquidity, the Company believes that its existing cash, together with its
ability to generate sufficient levels of cash flow from operations, should
provide sufficient funds to meet its long-term working capital and capital
expenditure requirements.
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 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.
Moreover, these laws and regulations are modified from time to time and are
subject to judicial and administrative interpretation. The Company is
subject to certain pending matters which could have a material adverse
effect on the Company's 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" and Note 5 to the Financial
Statements for further information regarding regulatory and legal
proceedings affecting the Company.
Judicial or regulatory actions adverse to the Company, increased
regulatory delays and inclement weather in northern California,
independently or collectively, could impair Pacific Lumber's ability to
conduct normal timber harvesting operations on the Company's timberlands.
YEAR 2000
Internal assessments undertaken for the Company have determined
that the Company's and Pacific Lumber'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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholder of
Scotia Pacific Holding Company:
We have audited the accompanying balance sheets of Scotia Pacific
Holding Company (a Delaware corporation and a wholly owned subsidiary of
The Pacific Lumber Company) as of December 31, 1997 and 1996, and the
related statements of income and cash flows for each of the three years in
the period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the financial position of Scotia
Pacific Holding Company as of December 31, 1997 and 1996, and the results
of its operations and its cash flows for the years ended December 31, 1997,
1996 and 1995, 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 5,
as to which the date is February 27, 1998.)
SCOTIA PACIFIC HOLDING COMPANY
BALANCE SHEET
(IN THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
December 31,
--------------------------
1997 1996
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 20,926 $ 20,345
Receivables:
Due from Pacific Lumber 5,304 5,007
Accrued interest 107 150
Prepaid timber harvesting costs 1,625 1,509
Other prepaid expenses and current assets 385 98
------------ ------------
Total current assets 28,347 27,109
Timber and timberlands, net of accumulated
depletion of $158,519 and $144,679,
respectively 154,288 165,970
Property and equipment, net of accumulated
depreciation of $6,468 and $5,458,
respectively 10,393 6,597
Deferred financing costs, net 13,475 14,707
Deferred income taxes 28,753 31,377
Restricted cash 28,434 29,967
Other assets 1,827 1,139
------------ ------------
$ 265,517 $ 276,866
============ ============
LIABILITIES AND DEFICIENCY IN NET ASSETS
Current liabilities:
Due to Pacific Lumber $ 147 $ 174
Accrued interest 11,305 11,877
Other accrued liabilities 846 892
Long-term debt, current maturities 19,335 16,165
------------ ------------
Total current liabilities 31,633 29,108
Long-term debt, less current maturities 300,630 319,965
------------ ------------
Total liabilities 332,263 349,073
------------ ------------
Contingencies
Deficiency in net assets:
Common stock, $1.00 par value, 3,000 shares
authorized and issued 3 3
Excess of liabilities assumed and common
stock issued over assets contributed (59,376) (59,376)
Cumulative activity since inception (7,373) (12,834)
------------ ------------
Total deficiency in net assets (66,746) (72,207)
------------ ------------
$ 265,517 $ 276,866
============ ============
<FN>
The accompanying notes are an integral part of these financial statements.
</TABLE>
SCOTIA PACIFIC HOLDING COMPANY
STATEMENT OF INCOME
(IN THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Log sales to Pacific Lumber $ 110,398 $ 124,325 $ 106,822
------------ ------------ ------------
Operating expenses:
General and administrative expenses 7,582 7,357 6,801
Depletion and depreciation 14,858 15,632 14,763
------------ ------------ ------------
22,440 22,989 21,564
------------ ------------ ------------
Operating income 87,958 101,336 85,258
Other income (expense):
Interest and other income 2,798 2,901 3,036
Interest expense (27,037) (28,255) (29,258)
------------ ------------ ------------
Income before income taxes 63,719 75,982 59,036
Provision in lieu of income taxes (25,868) (29,743) (24,242)
------------ ------------ ------------
Net income $ 37,851 $ 46,239 $ 34,794
============ ============ ============
<FN>
The accompanying notes are an integral part of these financial statements.
</TABLE>
SCOTIA PACIFIC HOLDING COMPANY
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 $ 37,851 $ 46,239 $ 34,794
Adjustments to reconcile net income
to net cash provided by
operating activities:
Provision in lieu of income
taxes 25,868 29,743 24,242
Depletion and depreciation 14,858 15,632 14,763
Amortization of deferred
financing costs 1,232 1,247 1,142
Increase (decrease) in cash
resulting from changes in:
Receivables due from
Pacific Lumber (718) (536) 89
Accrued interest
receivable 43 7 (55)
Prepaid timber harvesting
costs (804) (734) (516)
Due to Pacific Lumber (27) (651) 618
Accrued interest (572) (498) (480)
Other accrued liabilities (46) (244) 403
Other (276) 42 (84)
------------ ------------ ------------
Net cash provided by
operating activities 77,409 90,247 74,916
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (1,396) (1,841) (1,991)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividends paid (60,800) (76,900) (59,000)
Principal payments on Timber Notes (16,165) (14,103) (13,578)
Restricted cash withdrawals 1,533 1,400 1,035
------------ ------------ ------------
Net cash used for financing
activities (75,432) (89,603) (71,543)
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS 581 (1,197) 1,382
CASH AND CASH EQUIVALENTS AT BEGINNING OF
PERIOD 20,345 21,542 20,160
------------ ------------ ------------
CASH AND CASH EQUIVALENTS AT END OF
PERIOD $ 20,926 $ 20,345 $ 21,542
============ ============ ============
<FN>
The accompanying notes are an integral part of these financial statements.
</TABLE>
SCOTIA PACIFIC HOLDING COMPANY
NOTES TO FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
Scotia Pacific Holding Company (the "Company") is wholly owned by
The Pacific Lumber Company ("Pacific Lumber") which is a wholly owned
indirect subsidiary of MAXXAM Group Inc. ("MGI"). MGI is a wholly owned
subsidiary of MAXXAM Group Holdings Inc., which is a wholly owned
subsidiary of MAXXAM Inc. ("MAXXAM"). The Company is a special purpose
corporation organized in November 1992 to facilitate the offering of
$385,000,000 of 7.95% Timber Collateralized Notes due 2015 (the "Timber
Notes"). Consistent with the Company's purpose and pursuant to the terms
of the indenture governing the Timber Notes (the "Indenture"), the Company
is obligated to set aside each month a portion of the funds it receives
from the sale of logs to Pacific Lumber sufficient to make the specified
payments of principal and interest on the Timber Notes computed in
accordance with the Indenture and to have a sufficient amount to pay
operating expenses and capital improvements. Once the Company has
satisfied its obligations under the Indenture, the Company is free to
distribute any remaining cash to Pacific Lumber free of the lien of the
Deed of Trust securing the Timber Notes (the "Deed of Trust").
Accordingly, the Company's ability to pay dividends on its common stock is
not dependent upon any measure of financial performance. The Company
expects that substantially all of its cash which is free of the lien of the
Deed of Trust will be periodically distributed to Pacific Lumber.
On March 23, 1993 (the "Transfer Date"), Pacific Lumber
transferred to the Company, subject to certain timber harvest rights
retained by Pacific Lumber, a substantial portion of its commercial timber
property located in Humboldt County on the northern California coast,
together with a portion of Pacific Lumber's forestry department personnel,
its geographical information system, certain timber harvesting plans and
other property, solely in exchange for the assumption by the Company of
certain of Pacific Lumber debt (the "Assumed Pacific Lumber Securities"),
which was subsequently retired, and all of the Company's common stock
(collectively, the "Transfer").
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 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 financial statements;
accordingly, it is possible that the subsequent resolution of any one of
the contingent matters described in Note 5 could differ materially from
current estimates. The results of an adverse resolution of such
uncertainties could have a material effect on the Company's 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. At December
31, 1997 and 1996, the Company had approximately $17,784,000 and
$17,600,000, respectively, of such money market instruments deposited in
the Payment Account (as defined) held by the trustee under the Indenture
(the "Trustee") for the payment of accrued interest and principal on the
next Note Payment Date (as defined in Note 2).
Prepaid Timber Harvesting Costs
Prepaid timber harvesting costs are expensed as the timber
covered by the related timber harvesting plans ("THPs") is harvested.
Timber and Timberlands
Timber and timberlands were recorded at Pacific Lumber's
historical cost as of the Transfer Date, net of accumulated depletion.
Depletion is computed utilizing the unit-of-production method based upon
estimates of timber values and quantities.
Property and Equipment
Property and equipment were recorded at Pacific Lumber's
historical cost as of the Transfer Date, 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. The
major classes of property and equipment are as follows (dollar amounts in
thousands):
<TABLE>
<CAPTION>
Estimated December 31,
--------------------------
Useful Lives 1997 1996
------------- ------------ ------------
<S> <C> <C> <C>
Logging roads 15 years $ 16,176 $ 11,430
Other 5 - 15 years 685 625
------------ ------------
16,861 12,055
Less: accumulated depreciation (6,468) (5,458)
------------ ------------
$ 10,393 $ 6,597
============ ============
</TABLE>
Depreciation expense for 1997, 1996 and 1995 was $1,019,000,
$618,000 and $594,000, respectively.
Deferred Financing Costs
Costs incurred to obtain financing are deferred and amortized
over the estimated term of the related borrowing.
Restricted Cash
Restricted cash represents the amount deposited into an account
held by the Trustee under the Indenture (the "Liquidity Account"). The
Liquidity Account is not available, except under certain limited
circumstances, for working capital purposes; however, it is available to
pay the Rated Amortization (as defined in Note 2) and interest on the
Timber Notes if and to the extent that cash flows are insufficient to make
such payments. The Liquidity Account is not available to pay any Timber
Note prepayments (other than Rated Amortization), premiums or interest on
premiums in the event the Company does not have sufficient funds for such
payments. The Indenture requires the Company to maintain a minimum balance
in the Liquidity Account, to the extent of available cash (the "Required
Liquidity Balance"). Funds may be released from the Liquidity Account to
the extent that the balance in the Liquidity Account exceeds the Required
Liquidity Balance. The Required Liquidity Balance will generally decline
as principal payments are made on the Timber Notes. Interest and other
income for 1997, 1996 and 1995 includes 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.
Log Sales to Pacific Lumber
The Company and Pacific Lumber entered into a Master Purchase
Agreement on the Transfer Date (the "Master Purchase Agreement") which
governs all log sales by the Company to Pacific Lumber. The harvested logs
are purchased by Pacific Lumber (i.e., title passes and the obligation to
make payment therefor is incurred) at the time each log is delivered to
Pacific Lumber's log decks and scaled. The Master Purchase Agreement
generally contemplates that all sales of logs by the Company to Pacific
Lumber will be at a price which equals or exceeds the applicable stumpage
price for such species and category, as set forth in the most recent
Harvest Value Schedule published by the California State Board of
Equalization (the "SBE Price"). The Harvest Value Schedule is generally
published by the California State Board of Equalization at six month
intervals for purposes of computing the yield taxes imposed on the
harvesting of timber. SBE Prices are based on average actual log sales
prices between unrelated parties over a recent twenty-four month period.
Therefore, SBE prices may not necessarily be representative of actual
prices that would be realized from unrelated parties at subsequent dates.
Concentrations of Credit Risk
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. As of December 31, 1997 and 1996, the estimated
fair value of long-term debt, including current maturities, was
$331,164,000 and $338,231,000, respectively. The estimated fair value of
long-term debt is determined based on the quoted market price for the
Timber Notes. The Timber Notes are thinly traded financial instruments;
accordingly, their market price at any balance sheet date may not be
representative of the price which would be derived from a more active
market.
Reclassifications
Certain reclassifications have been made to the prior year's
financial statements to be consistent with the presentation in the current
year.
2. LONG-TERM DEBT
Long-term debt consists of the Timber Notes. The Company issued
$385,000,000 aggregate principal amount of Timber Notes on the Transfer
Date. The net proceeds from the sale of the Timber Notes were utilized by
the Company (i) to fund the initial deposits to the Liquidity Account of
$35,000,000 and an expense reserve of $625,000 (the "Expense Reserve") held
by the Trustee under the Indenture, and (ii) to redeem the Assumed Pacific
Lumber Securities.
The Timber Notes are senior secured obligations of the Company
and do not constitute obligations of, and are not guaranteed by, Pacific
Lumber or any other person. Pursuant to the terms of the Indenture, the
Company is not permitted to incur any indebtedness for borrowed money other
than the indebtedness represented by the Timber Notes. The Timber Notes
are secured by a lien on (i) the Company's timber and timberlands (subject
to Pacific Lumber's exclusive right to harvest certain of the timber on
such timberlands), (ii) certain contract rights and certain other assets,
(iii) the proceeds of the foregoing, (iv) the Payment Account, (v) the
Liquidity Account, and (vi) substantially all of the other property and
equipment transferred to the Company by Pacific Lumber (subject to certain
rights of concurrent use by Pacific Lumber). Amounts payable on the Timber
Notes are paid semi-annually generally on January 20 and July 20 of each
year (each, a "Note Payment Date").
The Timber Notes are structured to link, to the extent of cash
available, the deemed depletion of the Company's timber (through the
harvest and sale of logs) to the required amortization of the Timber Notes.
The required amount of amortization on any Note Payment Date is determined
by various mathematical formulas set forth in the Indenture. Scheduled
Amortization of the Timber Notes represents the amount of principal which
the Company must pay through each Note Payment Date in order to avoid
payment of prepayment or deficiency premiums. The Scheduled Maturity Date,
which is July 20, 2009, represents the Note Payment Date on which the
Company will pay the final installment of principal if all payments of
principal are made in accordance with Scheduled Amortization. Rated
Amortization of the Timber Notes represents the minimum amount of principal
which the Company must pay (on a cumulative basis) through any Note Payment
Date in order to avoid an Event of Default (as defined). The Rated
Maturity Date, which is July 20, 2015, is the Note Payment Date by which
the Company must pay all outstanding principal on the Timber Notes.
Regardless of the amount of timber actually harvested and sold, if there is
sufficient cash (which could be available due to, among other things,
favorable prices realized from harvested timber), the Timber Notes will
amortize at least as fast as Capture Amortization. If the Timber Notes
were amortized in accordance with Capture Amortization, the final
installment of principal on the Timber Notes would be paid on January 20,
2012.
The Company has the right to cause additional prepayments of
principal to be made on any Note Payment Date. If the principal of the
Timber Notes is paid in advance of Scheduled Amortization, the Company will
pay a prepayment premium on such accelerated payment. The prepayment
premium on any Note Payment Date is equal to the excess, if any, of (a) the
sum of (i) the present value of the prepayment amount (discounted from the
date(s) that the prepayment amount would otherwise have been paid under the
Scheduled Amortization to the Note Payment Date) plus (ii) the sum of the
present values of the amounts of interest that would have accrued
thereafter with respect to the prepayment amount over (b) the amount of the
prepayment. The present value shall be computed using a "Reinvestment
Yield" (as defined in the Indenture) which is comparable to the yield of
like term U.S. Treasury securities plus 0.50% per annum.
If the principal of the Timber Notes is paid later than as
provided for under the Scheduled Amortization, the Company will pay a
deficiency premium on such deficient amount. The deficiency premium
payable on any Note Payment Date equals an amount of interest on the amount
of the deficient principal amount from the previous Note Payment Date to
the current Note Payment Date at 1.50% per annum.
The following table presents the amortization of the Timber Notes
based on Rated Amortization, Capture Amortization and Scheduled
Amortization (in thousands):
<TABLE>
<CAPTION>
Rated Capture Scheduled
Amortization Amortization Amortization
------------- ------------- -------------
<S> <C> <C> <C>
Years Ending December 31:
1998 8,690 15,130 19,335
1999 10,206 17,244 21,651
2000 12,557 19,333 23,970
2001 14,090 19,698 24,734
2002 16,164 19,420 24,767
Thereafter 258,258 229,140 205,508
------------- ------------- -------------
$ 319,965 $ 319,965 $ 319,965
============= ============= =============
</TABLE>
In 1995, 1996, 1997 and in January 1998, the Company repaid
$13,578,000, $14,103,000, $16,165,000 and $10,773,000, respectively, of
the aggregate principal amount outstanding on the Timber Notes in
accordance with Scheduled Amortization.
At December 31, 1997, the Indenture permitted the payment of
$1,500,000 of dividends, which were paid in January 1998.
3. RELATED PARTY TRANSACTIONS
The Master Purchase Agreement and the related log purchase
agreements govern all log sales by the Company to Pacific Lumber. Under the
Master Purchase Agreement, Pacific Lumber is responsible for harvesting the
Company's standing timber and transporting harvested logs to its log decks.
Payments for the log sales outstanding at December 31, 1997 were received
by the Company in January 1998.
The Company and Pacific Lumber also entered into a Services
Agreement on the Transfer Date (the "Services Agreement"), pursuant to
which Pacific Lumber provides a variety of operational, management and
related services in respect of the Company's timber properties not provided
by the Company's employees, including reforestation, fire protection, road
maintenance and disease control. The Company pays Pacific Lumber an annual
fee, payable in equal monthly installments and subject to annual adjustment
provisions, for such services. For the years ended December 31, 1997, 1996
and 1995, amounts recorded by the Company for services pursuant to the
terms of the Services Agreement totaled $1,384,000, $1,345,000 and
$1,382,000, respectively.
4. 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 Pacific Lumber are members of MAXXAM's
consolidated return group for federal income tax purposes. Pursuant to the
tax allocation agreement among MAXXAM, Pacific Lumber, Salmon Creek
Corporation and the Company (the "Tax Allocation Agreement"), all federal
and state income tax liabilities of the Company will be paid by Pacific
Lumber and all federal and state income tax refunds of the Company will be
paid to Pacific Lumber. Accordingly, the Company records a charge or
benefit for income taxes computed as if the Company filed separate income
tax returns and a corresponding adjustment to capital (net of the
applicable adjustments relating to the Company's deferred income tax
assets).
The provision in lieu of income taxes on income before income
taxes consists of the following (in thousands):
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------
1997 1996 1995
------------ ------------ -----------
<S> <C> <C> <C>
Current provision in lieu of income taxes:
Federal $ 18,193 $ 21,994 $ 16,855
State 5,051 6,443 4,971
------------ ------------ ------------
23,244 28,437 21,826
------------ ------------ ------------
Deferred provision in lieu of income taxes:
Federal 2,063 706 1,884
State 561 600 532
------------ ------------ ------------
2,624 1,306 2,416
------------ ------------ ------------
$ 25,868 $ 29,743 $ 24,242
============ ============ ============
</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 $ 63,719 $ 75,982 $ 59,036
============ ============ ============
Amount of federal income tax based
upon the statutory rate $ 22,302 $ 26,594 $ 20,663
State taxes, net of federal tax
benefit 3,647 4,578 3,577
Other (81) (1,429) 2
------------ ------------ ------------
$ 25,868 $ 29,743 $ 24,242
============ ============ ============
</TABLE>
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 $ 29,331 $ 32,202
Property and equipment 224 140
------------ ------------
Total deferred income tax assets 29,555 32,342
------------ ------------
Deferred income tax liabilities:
Other (802) (965)
------------ ------------
Total deferred income tax
liabilities (802) (965)
------------ ------------
Net deferred income tax assets $ 28,753 $ 31,377
============ ============
</TABLE>
The 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 in excess of its tax basis. The Company
has not provided a valuation allowance on its deferred income tax assets.
The net deferred income tax assets listed above are recorded pursuant to
the Tax Allocation Agreement.
5. 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
of Pacific Lumber, 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
Pacific Lumber to harvest virgin old growth timber on the Company's
timberlands, and to a lesser extent, residual old growth timber.
On September 28, 1996, Pacific Lumber (on behalf of itself, its
subsidiaries and affiliates) and MAXXAM (collectively, the Pacific Lumber
Parties ) entered into an agreement with the United States and California
( Headwaters Agreement ) which provides the framework for the acquisition
by the United States and California of approximately 5,600 acres of Pacific
Lumber s timberlands. These timberlands are commonly referred to as the
Headwaters Forest and the Elk Head Springs Forest (collectively, the
"Headwaters Timberlands"). A substantial portion of the Headwaters
Timberlands consists of virgin old growth timberlands. Approximately 4,900
of these acres are owned by Salmon Creek, with the remaining acreage being
owned by the Company (Pacific Lumber having harvesting rights on
approximately 300 of such acres). The Headwaters Timberlands would be
transferred in exchange for (a) property and other consideration from the
United States and California having an aggregate fair market value of $300
million, and (b) approximately 7,755 acres of adjacent timberlands (the
"Elk River Timberlands") to be acquired from a third party. As part of the
Headwaters Agreement, the Pacific Lumber Parties agreed to not enter the
Headwaters Forest or the Elk Head Springs Forest to conduct any logging or
salvage operations.
Closing of the Headwaters Agreement is subject to various
conditions, including federal and California funding, approval of a
sustained yield plan ("SYP"), approval of a habitat conservation plan
covering multiple species ("Multi-Species HCP") and issuance of a related
incidental take permit (the "Permit") and the issuance of certain tax
agreements satisfactory to the Pacific Lumber Parties.
In November 1997, President Clinton signed an appropriations bill
which contains authorization for the expenditure of $250 million of federal
funds toward consummation of the Headwaters Agreement. On February 27, 1998,
Pacific Lumber, MAXXAM and various government agencies entered into a
Pre-Permit Application Agreement in Principle (the "HCP/SYP Agreement")
regarding certain understandings that they had reached regarding the
Multi-Species HCP, the Permit and the SYP. The HCP/SYP Agreement provides
that the Permit and Multi-Species HCP would have a term of 50 years, and
would limit the activities which could be conducted by Pacific Lumber in
twelve forest groves to those which would enhance habitat. These groves
aggregate approximately 8,000 acres and consist of substantial quantities
of virgin and residual old growth redwood and Douglas-fir timber.
In addition to being an important milestone toward completion of
the Headwaters Agreement, the Company also believes that the HCP/SYP
Agreement is a positive development in respect of the environmental
challenges that it has faced over the last several years. Several species,
including the northern spotted owl, the marbled murrelet and the coho
salmon, have been listed as endangered or threatened under the federal
Endangered Species Act ("ESA") and/or the California Endangered Species Act
("CESA"). Pacific Lumber has developed federal and state northern spotted
owl management plans which permit harvesting activities to be conducted so
long as Pacific Lumber adheres to certain measures designed to protect the
northern spotted owl. The potential impact of the listings of the marbled
murrelet and the coho salmon is more uncertain. If the Multi-Species HCP is
approved, Pacific Lumber would be issued the Permit, which would allow
limited incidental take of listed species so long as there was no jeopardy
to the species and the Multi-Species HCP would identify the measures to be
instituted in order to minimize and mitigate the anticipated level of take
to the greatest extent possible. The Multi-Species HCP would be designed
to protect currently listed species as well as to consider candidate and
future-listed species. Pacific Lumber is also attempting to include in
the Multi-Species HCP a resolution of the potential effect of limits by
the Environmental Protection Agency ("EPA") on sedimentation, temperature
and other factors for seventeen northern California rivers and certain of
their tributaries, including rivers within Pacific Lumber's timberlands.
These limitations will be aimed at protecting water quality.
Lawsuits are pending or threatened which seek to prevent Pacific
Lumber from implementing certain of its approved timber harvesting plans
("THPs" ). While challenges with respect to Pacific Lumber's young
growth timber have historically been limited, a lawsuit was recently filed
under the ESA which relates to a significant number of THPs covering young
growth timber of Pacific Lumber. While the Company expects these
environmentally focused objections and lawsuits to continue, it believes
that the HCP/SYP Agreement will enhance its position in connection
with these challenges. The Company also believes that the Multi-Species
HCP would expedite the preparation and facilitate approval of its THPs.
The HCP/SYP Agreement also contains certain provisions relating
to the SYP. Subject to further study, the Company expects Pacific Lumber
to propose a long-term sustained yield harvest level ("LTSY") which is
somewhat less than Pacific Lumber s recent harvest levels. If the SYP is
approved, Pacific Lumber will have complied with certain BOF regulations
requiring that timber companies project timber growth and harvest on their
timberlands over a 100-year planning period and establish an LTSY harvest
level. The SYP must demonstrate that the average annual harvest over any
rolling ten-year period will not exceed the LTSY harvest level and that
Pacific Lumber's projected timber inventory is capable of sustaining the
LTSY harvest level in the last decade of the 100-year planning period.
An approved SYP is expected to be valid for ten years, although it would
be subject to review after five years. Thereafter, revised SYPs will be
prepared every decade that address the LTSY harvest level based upon
reassessment of changes in the resource base and other factors.
The final terms of the SYP, the Multi-Species HCP and the Permit
are subject to additional negotiation and agreement among the parties as
well as public review and comment. While the parties are working
diligently to complete the Multi-Species HCP and the SYP as well as the
other closing conditions contained in the Headwaters Agreement, there can
be no assurance that the Headwaters Agreement will be consummated or that
an SYP, Multi-Species HCP or Permit acceptable to Pacific Lumber will be
approved.
In the event that a Multi-Species HCP is not approved, Pacific
Lumber will not enjoy the benefits of expedited preparation and facilitated
review of its THPs. Furthermore, if a Multi-Species HCP acceptable to
Pacific Lumber is not approved, it is impossible for the Company to
determine the potential adverse effect of the listings of the marbled
murrelet and coho salmon or the EPA's limitations on the Company's
financial position, results of operations or liquidity until such time as
the various regulatory and legal issues are resolved; however, if Pacific
Lumber is unable to harvest, or is severely limited in harvesting, on
significant amounts of its timberlands, such effect could be materially
adverse to the Company.
6. DEFICIENCY IN NET ASSETS
A reconciliation of the activity for the deficiency in net assets
is as follows (in thousands):
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Balance at beginning of period $ (12,834) $ (13,834) $ (11,454)
Net income 37,851 46,239 34,794
Contribution of assets by Pacific
Lumber 5,166 3,224 --
Assumption of net tax liabilities by
Pacific Lumber 23,244 28,437 21,826
Dividends paid (60,800) (76,900) (59,000)
------------ ------------ ------------
Balance at end of period $ (7,373) $ (12,834) $ (13,834)
============ ============ ============
</TABLE>
7. SUPPLEMENTAL CASH FLOW INFORMATION
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
(In thousands)
<S> <C> <C> <C>
Supplemental information on non-cash
investing and financing activities:
Assumption of net tax liabilities by
Pacific Lumber $ 23,244 $ 28,437 $ 21,826
Contribution of assets by Pacific
Lumber 5,166 3,224 --
Supplemental disclosure of cash flow
information:
Interest paid $ 26,377 $ 27,506 $ 28,596
</TABLE>
8. 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:
Log sales to Pacific
Lumber $ 17,508 $ 30,658 $ 44,346 $ 17,886
Operating income 13,246 24,487 36,154 14,071
Net income 4,187 10,888 17,832 4,944
1996:
Log sales to Pacific
Lumber $ 20,060 $ 37,206 $ 42,050 $ 25,009
Operating income 16,027 30,751 34,603 19,955
Net income 5,665 14,370 16,658 9,546
</TABLE>
Logging operations on the Company's timberlands are highly
seasonal. Logging activity is normally significantly higher in the months
of April through November than in the months of December through March.
The Company expects that its revenues and cash flows will continue to
reflect that seasonality.
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 16
Balance Sheet at December 31, 1997 and 1996 17
Statement of Income for the years ended December
31, 1997, 1996 and 1995 18
Statement of Cash Flows for the years ended
December 31, 1997, 1996 and 1995 19
Notes to Financial Statements 20
2. FINANCIAL STATEMENT SCHEDULES:
Schedules are inapplicable or the required information is
included in the 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 30), 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.
SCOTIA PACIFIC HOLDING 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
Chairman of the Board, President
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/ STUART C. LEWIS
Stuart C. Lewis
Director
Date: March 26, 1998 By: /s/ JACK M. WEBB
Jack M. Webb
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 Certificate of Incorporation of Scotia Pacific
Holding Company (the "Company") (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, 1993; the "Company's 1993 Form 10-K")
3.2 By-laws of the Company (incorporated herein by
reference to Exhibit 3.2 to the Company's 1993 Form
10-K
4.1 Indenture between the Company and State Street Bank
and Trust Company ("State Street"), (incorporated
herein by reference to Exhibit 4.1 to the Company's
1993 Form 10-K
4.2 Deed of Trust, Security Agreement, Financing
Statement, Fixture Filing and Assignment among the
Company, State Street, as Trustee, and State Street,
as Collateral Agent (incorporated herein by
reference to Exhibit 4.2 to the Company's 1993 Form
10-K
10.1 Master Purchase Agreement between the Company and
The Pacific Lumber Company ("Pacific Lumber")
(incorporated herein by reference to Exhibit 10.1 to
the Company's 1993 Form 10-K
10.2 Services Agreement between the Company and Pacific
Lumber (incorporated herein by reference to Exhibit
10.2 to the Company's 1993 Form 10-K
10.3 Additional Services Agreement between the Company
and Pacific Lumber (incorporated herein by reference
to Exhibit 10.3 to the Company's 1993 Form 10-K
10.4 Reciprocal Rights Agreement among the Company,
Pacific Lumber and Salmon Creek Corporation ("Salmon
Creek") (incorporated herein by reference to Exhibit
10.4 to the Company's 1993 Form 10-K
10.5 Environmental Indemnification Agreement between the
Company and Pacific Lumber (incorporated herein by
reference to Exhibit 10.5 to the Company's 1993 Form
10-K
10.6 Tax Allocation Agreement between the Company,
Pacific Lumber, Salmon Creek and MAXXAM Inc.
(incorporated herein by reference to Exhibit 10.1 to
Amendment No. 3 to the Form S-1 Registration
Statement of the Company, Registration No. 33-55538)
10.7 Agreement dated September 28, 1996 among MAXXAM
Inc., The Pacific Lumber Company (on behalf of
itself, its subsidiaries and its affiliates), the
United States of America and the State of California
(incorporated herein by reference to Exhibit 10.1 to
MAXXAM Inc.'s Form 8-K dated September 28, 1996;
File No. 1-3924)
10.8 Pre-Permit Application Agreement in Principle dated
February 27, 1998 relating to the Headwaters
Agreement (incorporated herein by reference to
Exhibit 10.16 to the Annual Report on Form 10-K of
Pacific Lumber for the fiscal year ended December
31, 1997; File No. 1-9204)
*27 Financial Data Schedule
<FN>
- ---------------
* Included with this filing.
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Company's consolidated balance sheet and consolidated statement of operations
and is qualified in its entirety by reference to such consolidated financial
statements together with the related footnotes thereto.
</LEGEND>
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<EXCHANGE-RATE> 1
<CASH> 20,926
<SECURITIES> 0
<RECEIVABLES> 5,304
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 28,347
<PP&E> 16,861
<DEPRECIATION> 6,468
<TOTAL-ASSETS> 265,517
<CURRENT-LIABILITIES> 31,633
<BONDS> 319,965
0
0
<COMMON> 3
<OTHER-SE> (66,749)
<TOTAL-LIABILITY-AND-EQUITY> 265,517
<SALES> 110,398
<TOTAL-REVENUES> 110,398
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 22,440
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 27,037
<INCOME-PRETAX> 63,719
<INCOME-TAX> 25,868
<INCOME-CONTINUING> 37,851
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 37,851
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
