EXHIBIT 99.2
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To MAXXAM Group Inc.:
We have audited the accompanying consolidated balance sheets of MAXXAM
Group Inc. (a Delaware corporation and a wholly owned subsidiary of MAXXAM Group
Holdings Inc.) and subsidiaries as of December 31, 1999 and 1998, and the
related consolidated statements of operations, cash flows and stockholder's
deficit for each of the three years in the period ended December 31, 1999. 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 auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of MAXXAM Group
Inc. and subsidiaries as of December 31, 1999 and 1998, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1999, in conformity with accounting principles generally accepted
in the United States.
ARTHUR ANDERSEN LLP
San Francisco, California
January 28, 2000
MAXXAM GROUP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(IN MILLIONS OF DOLLARS, EXCEPT SHARE INFORMATION)
DECEMBER 31,
-----------------------
1999 1998
---------- -----------
ASSETS
Current assets:
Cash and cash equivalents.............................................................. $ 180.8 $ 145.2
Marketable securities.................................................................. 43.8 11.7
Receivables:
Trade............................................................................... 10.9 10.5
Other............................................................................... 6.9 2.2
Inventories............................................................................ 41.3 40.7
Prepaid expenses and other current assets.............................................. 17.7 8.0
---------- -----------
Total current assets.............................................................. 301.4 218.3
Timber and timberlands, net of accumulated depletion of $249.1 and $246.8,
respectively........................................................................... 275.2 323.6
Property, plant and equipment, net of accumulated depreciation of $102.8 and
$94.7 respectively..................................................................... 99.7 102.6
Deferred financing costs, net............................................................. 20.9 22.8
Deferred income taxes..................................................................... 90.4 80.3
Restricted cash and marketable securities................................................. 158.9 16.6
Other assets.............................................................................. 8.9 7.2
---------- -----------
$ 955.4 $ 771.4
========== ===========
LIABILITIES AND STOCKHOLDER'S DEFICIT
Current liabilities:
Accounts payable....................................................................... $ 6.1 $ 3.4
Accrued interest....................................................................... 28.2 28.4
Accrued compensation and related benefits.............................................. 3.7 8.4
Deferred income taxes.................................................................. 5.8 8.6
Other accrued liabilities.............................................................. 5.2 2.4
Current maturities of long-term debt................................................... 16.0 8.3
---------- -----------
Total current liabilities......................................................... 65.0 59.5
Long-term debt, less current maturities................................................... 844.2 860.2
Deferred income taxes..................................................................... 78.8 1.5
Other noncurrent liabilities.............................................................. 45.8 28.1
---------- -----------
Total liabilities................................................................. 1,033.8 949.3
---------- -----------
Contingencies
Stockholder's deficit:
Common stock, $0.081/3 par value; 1,000 shares authorized; 100 shares issued........... - -
Additional capital..................................................................... 81.3 81.3
Accumulated deficit.................................................................... (159.7) (259.2)
---------- -----------
Total stockholder's deficit....................................................... (78.4) (177.9)
---------- -----------
$ 955.4 $ 771.4
========== ===========
<FN>
The accompanying notes are an integral part of these financial statements.
</FN>
MAXXAM GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(IN MILLIONS OF DOLLARS)
YEARS ENDED DECEMBER 31,
-----------------------------------
1999 1998 1997
---------- ---------- -----------
Net sales:
Lumber and logs............................................................ $ 165.5 $ 213.1 $ 261.0
Other...................................................................... 22.3 20.5 26.2
---------- ---------- -----------
187.8 233.6 287.2
---------- ---------- -----------
Operating expenses:
Cost of goods sold......................................................... 159.5 155.3 162.0
Selling, general and administrative expenses............................... 15.4 14.9 14.2
Depletion and depreciation................................................. 17.3 23.1 27.1
---------- ---------- -----------
192.2 193.3 203.3
---------- ---------- -----------
Operating income (loss)....................................................... (4.4) 40.3 83.9
Other income (expense):
Gain on sale of Headwaters Timberlands..................................... 239.8 - -
Investment, interest and other income (expense), net....................... 26.9 9.2 13.4
Interest expense........................................................... (66.5) (75.3) (78.7)
---------- ---------- -----------
Income (loss) before income taxes and extraordinary item...................... 195.8 (25.8) 18.6
Credit (provision) in lieu of income taxes.................................... (77.6) 9.1 (6.0)
---------- ---------- -----------
Income (loss) before extraordinary item....................................... 118.2 (16.7) 12.6
Extraordinary item:
Loss on early extinguishment of debt, net of
income tax benefit of $22.7............................................. - (40.1) -
---------- ---------- -----------
Net income (loss)............................................................. $ 118.2 $ (56.8) $ 12.6
========== ========== ===========
<FN>
The accompanying notes are an integral part of these financial statements.
</FN>
MAXXAM GROUP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN MILLIONS OF DOLLARS)
YEARS ENDED DECEMBER 31,
------------------------------
1999 1998 1997
--------- --------- ---------
Cash flows from operating activities:
Net income (loss)............................................................... $ 118.2 $ (56.8) $ 12.6
Adjustments to reconcile net income (loss) to net cash provided by (used for)
operating activities:
Depletion and depreciation................................................... 17.3 23.1 27.1
Gain on sale of Headwaters Timberlands....................................... (239.8) - -
Extraordinary loss on early extinguishment of debt, net...................... - 40.1 -
Amortization of deferred financing costs and discounts on long-term debt..... 1.6 10.7 15.9
Net sales (purchases) of marketable securities............................... (20.6) 42.6 (11.3)
Net gains on marketable securities........................................... (11.5) (2.9) (8.6)
Increase (decrease) in cash resulting from changes in:
Receivables.................................................................. (6.7) 9.4 -
Inventories, net of depletion................................................ (2.0) 14.0 9.7
Prepaid expenses and other assets............................................ (4.5) (2.7) (5.3)
Accounts payable............................................................. 2.7 (1.2) (0.1)
Accrued interest............................................................. (0.1) 4.0 (0.6)
Accrued and deferred income taxes............................................ 75.8 (9.5) 5.6
Other accrued liabilities.................................................... 0.1 (3.8) 3.3
Other .......................................................................... (0.1) (1.8) 0.1
--------- --------- ---------
Net cash provided by (used for) operating activities....................... (69.6) 65.2 48.4
--------- --------- ---------
Cash flows from investing activities:
Net proceeds from dispositions of property and investments...................... 298.3 6.6 0.3
Capital expenditures............................................................ (23.1) (21.2) (13.5)
Restricted cash withdrawals used to acquire timberlands......................... 12.9 8.9 -
--------- --------- ---------
Net cash provided by (used for) investing activities....................... 288.1 (5.7) (13.2)
--------- --------- ---------
Cash flows from financing activities:
Proceeds from issuance of long-term debt........................................ - 867.2 -
Premiums for early retirement of debt........................................... - (42.9) -
Incurrence of deferred financing costs.......................................... (0.7) (22.4) -
Redemptions, repurchases of and principal payments on long-term debt............ (8.3) (796.8) (16.3)
Dividends paid.................................................................. (18.7) (18.7) (3.0)
Other restricted cash withdrawals (deposits), net............................... (155.2) 9.5 1.5
--------- --------- ---------
Net cash used for financing activities..................................... (182.9) (4.1) (17.8)
--------- --------- ---------
Net increase in cash and cash equivalents.......................................... 35.6 55.4 17.4
Cash and cash equivalents at beginning of year..................................... 145.2 89.8 72.4
--------- --------- ---------
Cash and cash equivalents at end of year........................................... $ 180.8 $ 145.2 $ 89.8
========= ========= =========
<FN>
The accompanying notes are an integral part of these financial statements.
</FN>
MAXXAM GROUP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of MAXXAM Group
Inc. ("MGI") and its subsidiaries, collectively referred to herein as the
"Company." MGI is a wholly owned subsidiary of MAXXAM Group Holdings Inc.
("MGHI") which is a wholly owned subsidiary of MAXXAM Inc. ("MAXXAM").
Intercompany balances and transactions have been eliminated. Certain
reclassifications have been made to prior years' financial statements to be
consistent with the current year's presentation.
The Company is engaged in forest products operations conducted through its
wholly owned subsidiaries, The Pacific Lumber Company ("PACIFIC LUMBER") and
Britt Lumber Co., Inc. ("BRITT"). Pacific Lumber's principal wholly owned
subsidiaries are Scotia Pacific Company LLC ("SCOTIA LLC") and Salmon Creek LLC;
("SALMON CREEK"). The Company is engaged in several principal aspects of the
lumber industry - the growing and harvesting of redwood and Douglas-fir timber,
the milling of logs into lumber and the manufacture of lumber into a variety of
finished products. Housing, construction and remodeling are the principal
markets for the Company's lumber products.
USE OF ESTIMATES AND ASSUMPTIONS
The preparation of financial statements in accordance with generally
accepted accounting principles requires the use of estimates and assumptions
that affect (i) the reported amounts of assets and liabilities, (ii) the
disclosure of contingent assets and liabilities known to exist as of the date
the financial statements are published and (iii) the reported amount of revenues
and expenses recognized during each period presented. The Company reviews all
significant estimates affecting its consolidated financial statements on a
recurring basis and records the effect of any necessary adjustments prior to
their publication. Adjustments made with respect to the use of estimates often
relate to improved information not previously available. Uncertainties with
respect to such estimates and assumptions are inherent in the preparation of the
Company's consolidated financial statements; accordingly, it is possible that
the subsequent resolution of any one of the contingent matters described in Note
10 could differ materially from current estimates. The results of an adverse
resolution of such uncertainties could have a material effect on the Company's
consolidated financial position, results of operations or liquidity.
COMPREHENSIVE INCOME
There are no reconciling differences between the Company's net income and
comprehensive income for the years ended December 31, 1999, 1998 and 1997.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash Equivalents
Cash equivalents consist of highly liquid money market instruments with
original maturities of three months or less. See "Restricted Cash and Marketable
Securities" below.
Marketable Securities
Marketable securities which are considered "held-to-maturity" securities
consist of commercial paper with original maturities in excess of three months
and other types of corporate and government debt obligations. These securities
are carried at cost adjusted for discount and premium amortization. As of
December 31, 1999 and 1998, the carrying amount approximated fair value.
Marketable securities which are considered "trading" or " available for sale"
securities consist of long and short positions in corporate common stocks and
option contracts and are carried at fair value. The cost of the securities sold
is determined using the first-in, first-out method. Included in investment,
interest and other income (expense), net for each of the three years in the
period ended December 31, 1999 were: 1999 - net realized holding gains of $12.5
million and net unrealized losses of $0.9 million; 1998 - net unrealized holding
gains of $5.1 million and net realized losses of $2.2 million; and 1997 - net
unrealized holding gains of $2.9 million and net realized gains of $5.7
million. See "Restricted Cash and Marketable Securities" below.
Inventories
Inventories are stated at the lower of cost or market. Cost is primarily
determined using the last-in, first-out ("LIFO") method not in excess of market
value. Replacement cost is not in excess of LIFO cost. Inventory costs consist
of material, labor and manufacturing overhead, including depreciation and
depletion.
Timber and Timberlands
Timber and timberlands are stated at cost, net of accumulated depletion.
Depletion is computed utilizing the unit-of-production method based upon
estimates of timber values and quantities.
Property, Plant and Equipment
Property, plant and equipment, including capitalized interest, is stated
at cost, net of accumulated depreciation. Depreciation is computed utilizing the
straight-line method at rates based upon the estimated useful lives of the
various classes of assets. The carrying value of property, plant and equipment
is assessed when events and circumstances indicate that an impairment is
present. The existence of an impairment is determined by comparing the net
carrying value of the asset to its estimated undiscounted future cash flows. If
an impairment is present, the asset is reported at the lower of carrying value
or fair value.
Deferred Financing Costs
Costs incurred to obtain financing are deferred and amortized over the
estimated term of the related borrowing.
Restricted Cash and Marketable Securities
Cash and cash equivalents and marketable securities includes restricted
investments of $43.0 million and $74.8 million at December 31, 1999 and 1998,
respectively. Restricted investments are primarily held as security for short
positions in marketable securities and for debt service payments on the
Company's Class A-1, Class A-2 and Class A-3 Timber Collateralized Notes due
2028 (the "TIMBER NOTES"). Current marketable securities consist of the current
portion of amounts held in the SAR Account defined in the following paragraph.
Long-term restricted cash and marketable securities of $158.9 million at
December 31, 1999 primarily represents amounts held in a Scheduled Amortization
Reserve Account (the "SAR ACCOUNT") to support principal payments on the Timber
Notes, whereas long-term restricted cash of $16.6 million at December 31, 1998
primarily represents the amount held in an account by the trustee (the
"PREFUNDING ACCOUNT") under the indenture governing the Timber Notes (the
"TIMBER NOTES INDENTURE") to enable Scotia LLC to acquire timberlands.
Concentrations of Credit Risk
Cash equivalents and restricted marketable securities are invested
primarily in commercial paper as well as other types of corporate and government
debt obligations. The Company has mitigated its concentration of credit risk
with respect to these investments by purchasing high grade investments
(ratings of A1/P1 short-term or at least AA/aa long-term debt). No more than 10%
is invested within the same issue.
Fair Value of Financial Instruments
The carrying amounts of cash equivalents approximate fair value.
Marketable securities are carried at fair value which is determined based on
quoted market prices. As of December 31, 1999 and 1998, the estimated fair value
of debt, including current maturities, was $764.8 million and $807.9 million,
respectively. The estimated fair value of debt is determined based on the quoted
market prices for the publicly traded issues and on the current rates offered
for borrowings similar to the other debt. The Company's publicly traded debt
issues are thinly traded financial instruments; accordingly, their market prices
at any balance sheet date may not be representative of the prices which would be
derived from a more active market.
2. HEADWATERS TRANSACTIONS
On March 1, 1999, the United States and California acquired the Headwaters
Timberlands, approximately 5,600 acres of timberlands containing a significant
amount of virgin old growth timber, from Salmon Creek and Pacific Lumber. Salmon
Creek received $299.9 million for its 4,900 acres, and for its 700 acres,
Pacific Lumber received the 7,700 acre Elk River Timberlands, which Pacific
Lumber contributed to Scotia LLC in June 1999. See Note 10 below for a
discussion of additional agreements entered into on March 1, 1999.
As a result of the disposition of the Headwaters Timberlands, the Company
recognized a pre-tax gain of $239.8 million ($142.1 million net of deferred
taxes) in 1999. This amount represents the gain attributable to the portion of
the Headwaters Timberlands for which the Company received $299.9 million in
cash. With respect to the remaining portion of the Headwaters Timberlands for
which the Company received the Elk River Timberlands, no gain has been
recognized as this represented an exchange of substantially similar productive
assets. These timberlands have been reflected in the Company's financial
statements at an amount which represents the Company's historical cost for the
timberlands which were transferred to the United States.
Scotia LLC and Pacific Lumber also entered into agreements with California
for the future sale of two timber properties known as the Owl Creek grove and
the Grizzly Creek grove. Under these agreements Scotia LLC would sell the Owl
Creek grove to California, no later than June 30, 2001, for the lesser of the
appraised fair market value or $79.7 million, and California must purchase from
Pacific Lumber, no later than October 31, 2000, a portion of the Grizzly Creek
grove for a purchase price determined based on fair market value, but not to
exceed $20.0 million. California also has a five year option under these
agreements to purchase additional property adjacent to the Grizzly Creek grove.
The sale of the Owl Creek grove or Grizzly Creek grove will not be reflected in
the Company's financial statements until each has been concluded.
3. INVENTORIES
Inventories consist of the following (in millions):
DECEMBER 31,
--------------------
1999 1998
--------- ---------
Lumber.............................................. $ 17.2 $ 29.9
Logs................................................ 24.1 10.8
--------- ---------
$ 41.3 $ 40.7
========= =========
4. PROPERTY, PLANT AND EQUIPMENT
The major classes of property, plant and equipment are as follows (dollar
amounts in millions):
DECEMBER 31,
ESTIMATED -----------------------
USEFUL LIVES 1999 1998
------------- ---------- -----------
Logging roads, land and improvements....................... 15 years $ 27.7 $ 21.3
Buildings.................................................. 33 years 36.7 37.9
Machinery and equipment.................................... 3 - 15 years 137.4 138.1
Construction in progress................................... 0.7 -
---------- -----------
202.5 197.3
Less: accumulated depreciation............................ (102.8) (94.7)
---------- -----------
$ 99.7 $ 102.6
========== ===========
Depreciation expense for the years ended December 31, 1999, 1998 and 1997
was $10.0 million, $9.2 million and $9.8 million, respectively.
5. LONG-TERM AND SHORT-TERM DEBT
Long-term debt consists of the following (in millions):
DECEMBER 31,
-----------------------
1999 1998
---------- -----------
6.55% Scotia LLC Class A-1 Timber Collateralized Notes due July 20, 2028.................. $ 152.6 $ 160.7
7.11% Scotia LLC Class A-2 Timber Collateralized Notes due July 20, 2028.................. 243.2 243.2
7.71% Scotia LLC Class A-3 Timber Collateralized Notes due July 20, 2028.................. 463.3 463.3
Other..................................................................................... 1.1 1.3
---------- -----------
860.2 868.5
Less: current maturities.................................................................. (16.0) (8.3)
---------- -----------
$ 844.2 $ 860.2
========== ===========
Scotia LLC Timber Collateralized Notes due 2028
Scotia LLC issued $867.2 million aggregate principal amount of Timber
Notes on July 20, 1998. Net proceeds from the offering of the Timber Notes were
used primarily to prepay certain debt, and accordingly the Company recognized an
extraordinary loss of $40.1 million, net of the related income tax benefit of
$22.7 million, in 1998 for the early extinguishment.
The Timber Notes and the Scotia LLC Line of Credit (defined below) are
secured by a lien on (i) Scotia LLC's timber, timberlands and timber rights and
(ii) substantially all of Scotia LLC's other property. The Timber Notes
Indenture permits Scotia LLC to have outstanding up to $75.0 million of
non-recourse indebtedness to acquire additional timberlands and to issue
additional timber notes provided certain conditions are met (including repayment
or redemption of the remaining $152.6 million of Class A-1 Timber Notes).
The Timber Notes were structured to link, to the extent of cash available,
the deemed depletion of Scotia LLC's timber (through the harvest and sale of
logs) to the required amortization of the Timber Notes. The required amount of
amortization on any Timber Notes payment date is determined by various
mathematical formulas set forth in the Timber Notes Indenture. The minimum
amount of principal which Scotia LLC must pay (on a cumulative basis and subject
to available cash) through any Timber Notes payment date is referred to as
Minimum Principal Amortization. If the Timber Notes were amortized in accordance
with Minimum Principal Amortization, the final installment of principal would be
paid on July 20, 2028. The minimum amount of principal which Scotia LLC must pay
(on a cumulative basis) through any Timber Notes payment date in order to avoid
payment of prepayment or deficiency premiums is referred to as Scheduled
Amortization. If all payments of principal are made in accordance with Scheduled
Amortization, the payment date on which Scotia LLC will pay the final
installment of principal is January 20, 2014. Such final installment would
include a single bullet principal payment of $463.3 million related to the Class
A-3 Timber Notes.
Pursuant to certain liquidity requirements under the Timber Notes
Indenture, Scotia LLC has entered into an agreement (the "SCOTIA LLC LINE OF
CREDIT") with a group of banks pursuant to which Scotia LLC may borrow to pay
interest on the Timber Notes. The maximum amount Scotia LLC may borrow is equal
to one year's interest on the aggregate outstanding principal balance of the
Timber Notes (the "REQUIRED LIQUIDITY AMOUNT"). At December 31, 1999, the
Required Liquidity Amount was $63.0 million. The Scotia LLC Line of Credit
expires on July 16, 2000. Annually, Scotia LLC will request that the banks
extend the Scotia LLC Line of Credit for a period of not less than 364 days. If
not extended, Scotia LLC may draw upon the full amount available. Borrowings
under the Scotia LLC Line of Credit generally bear interest at the Base Rate (as
defined in the agreement) plus 0.25% or a one month or six month LIBOR rate plus
1% at any time the borrowings have not been continually outstanding for more
than six months. As of December 31, 1999, Scotia LLC had no borrowings
outstanding under the Scotia LLC Line of Credit.
As a result of the sale of the Headwaters Timberlands, Salmon Creek
received proceeds of $299.9 million in cash. See Note 2 to the Consolidated
Financial Statements. On November 18, 1999, $169.0 million of funds from the
sale of the Headwaters Timberlands were contributed to Scotia LLC and set aside
in the SAR Account. See Note 1 to the Consolidated Financial Statements. Amounts
in the SAR Account are part of the collateral securing the Timber Notes and will
be used to make principal payments to the extent that other available amounts
are insufficient to pay Scheduled Amortization on the Class A-1 and Class A-2
Timber Notes. In addition, during the six years beginning January 20, 2014,
amounts in the SAR Account will be used to amortize the Class A-3 Timber Notes
as set forth in the Timber Notes Indenture, as amended. Funds may from time to
time be released to Scotia LLC from the SAR Account if the amount in the account
exceeds the then Required Scheduled Amortization Reserve Balance (as defined in
the Timber Notes Indenture). If the SAR Account falls below the Required
Scheduled Amortization Reserve Balance, up to 50% of any Remaining Funds (funds
that could otherwise be released to Scotia LLC free of the lien securing the
Timber Notes) is required to be used on each monthly deposit date to replenish
the SAR Account.
Principal and interest on the Timber Notes are payable semi-annually on
January 20 and July 20. On the January 20, 2000 note payment date for the Timber
Notes, Scotia LLC had $2.2 million in cash available to pay the $31.5 million of
interest due. Scotia LLC borrowed the remaining $29.3 million in funds under the
Scotia LLC Line of Credit. In addition, Scotia LLC repaid $12.9 million of
principal on the Timber Notes (an amount equal to Scheduled Amortization). The
SAR Account was used to make the January 20, 2000 principal payment.
Pacific Lumber Credit Agreement
The Pacific Lumber Credit Agreement, a senior secured credit facility
which expires on October 31, 2001, allows for borrowings of up to $60.0 million,
all of which may be used for revolving borrowings, $20.0 million of which may be
used for standby letters of credit and $30.0 million of which may be used for
timberland acquisitions. Borrowings are secured by all of Pacific Lumber's
domestic accounts receivable and inventory. Borrowings for timberland
acquisitions are also secured by the acquired timberlands and, commencing in
April 2001, are to be repaid annually from 50% of Pacific Lumber's excess cash
flow (as defined). The remaining excess cash flow is available for dividends.
Upon maturity of the facility, all outstanding borrowings used for timberland
acquisitions will convert to a term loan repayable over four years. At December
31, 1999, Pacific Lumber had $34.1 million of borrowings available under the
agreement, no borrowings were outstanding and letters of credit outstanding
amounted to $12.5 million.
Maturities
Scheduled maturities of long-term debt outstanding at December 31, 1999
are: $16.0 million in 2000, $16.5 million in 2001, $17.3 million in 2002, $19.5
million in 2003, $22.4 million in 2004 and $768.5 million thereafter.
Restricted Net Assets of Subsidiaries
As of December 31, 1999 and 1998, all of the assets of Pacific Lumber are
subject to certain debt instruments which restrict the ability to transfer
assets, make loans and advances and pay dividends to the Company. As of December
31, 1999, under the most restrictive covenants contained in the indentures
governing the Timber Notes and the Pacific Lumber Credit Agreement, Pacific
Lumber could pay no dividends other than distributions from Salmon Creek.
6. CREDIT (PROVISION) IN LIEU OF INCOME TAXES
Income taxes are determined using an asset and liability approach which
requires the recognition of deferred income tax assets and liabilities for the
expected future tax consequences of events that have been recognized in the
Company's financial statements or tax returns. Under this method, deferred
income tax assets and liabilities are determined based on the temporary
differences between the financial statement and tax bases of assets and
liabilities using enacted tax rates.
The Company and its corporate subsidiaries are members of MAXXAM's
consolidated return group for federal income tax purposes.
Pursuant to a tax allocation agreement between MAXXAM, Pacific Lumber, and
Salmon Creek (the "PL TAX ALLOCATION AGREEMENT"), Pacific Lumber is liable to
MAXXAM for the federal consolidated income tax liability of Pacific Lumber,
Scotia LLC and certain other subsidiaries of Pacific Lumber (but excluding
Salmon Creek) (collectively, the "PL SUBGROUP") computed as if the PL Subgroup
was a separate affiliated group of corporations which was never connected with
MAXXAM. The PL Tax Allocation Agreement further provides that Salmon Creek is
liable to MAXXAM for its federal income tax liability computed on a separate
company basis as if it was never connected with MAXXAM. For taxable periods
beginning after December 7, 1999 (the day on which Salmon Creek was converted
from a corporation to a limited liability company), the PL Subgroup includes
Salmon Creek and there is no separate calculation for Salmon Creek. The
remaining subsidiaries of the Company are each liable to MAXXAM for their
respective income tax liabilities computed on a separate company basis as if
they were never connected with MAXXAM, pursuant to their respective tax
allocation agreements.
MGI's tax allocation agreement with MAXXAM (the "MGI TAX ALLOCATION
AGREEMENT") provides that the Company's federal income tax liability is computed
as if the Company files a consolidated tax return with all of its subsidiaries
except Salmon Creek, and that such corporations were never connected with MAXXAM
(the "MGI CONSOLIDATED TAX LIABILITY"). For taxable periods beginning after
December 7, 1999, the MGI Consolidated Tax Liability includes Salmon Creek. The
federal income tax liability of the Company is the difference between (i) the
MGI Consolidated Tax Liability and (ii) the sum of the separate tax liabilities
for the Company's subsidiaries (computed as discussed above), but excluding
Salmon Creek for taxable periods through December 7, 1999. To the extent that
the company Consolidated Tax Liability is less than the aggregate amounts in
(ii), MAXXAM is obligated to pay the amount of such difference to the Company.
The credit (provision) in lieu of income taxes on income (loss) before
income taxes and extraordinary item consists of the following (in millions):
YEARS ENDED DECEMBER 31,
------------------------------
1999 1998 1997
--------- --------- ---------
Current:
Federal in lieu of income taxes...................... $ (3.0) $ 0.1 $ (0.4)
State and local...................................... 0.1 (0.1) (0.2)
--------- --------- ---------
(2.9) - (0.6)
--------- --------- ---------
Deferred:
Federal in lieu of income taxes...................... (53.1) 6.9 (5.5)
State and local...................................... (21.6) 2.2 0.1
--------- --------- ---------
(74.7) 9.1 (5.4)
--------- --------- ---------
$ (77.6) $ 9.1 $ (6.0)
========= ========= =========
A reconciliation between the credit (provision) in lieu of income taxes
and the amount computed by applying the federal statutory income tax rate to
income (loss) before income taxes and extraordinary item is as follows (in
millions):
YEARS ENDED DECEMBER 31,
------------------------------
1999 1998 1997
--------- --------- ---------
Income (loss) before income taxes and extraordinary item........................... $ 195.8 $ (25.8) $ 18.6
========= ========= =========
Amount of federal income tax credit (provision) based
upon the statutory rate......................................................... $ (68.6) $ 9.0 $ (6.5)
Revision of prior years' tax estimates and other changes in valuation allowances... 4.5 (1.1) 1.0
State and local taxes, net of federal tax effect................................... (13.1) 1.4 (0.1)
Expenses for which no federal tax benefit is available............................. (0.4) (0.3) (0.2)
Other.............................................................................. - 0.1 (0.2)
--------- --------- ---------
$ (77.6) $ 9.1 $ (6.0)
========= ========= =========
The revision of prior years' tax estimates and other changes in valuation
allowances, as shown in the table above, includes amounts for the reversal of
reserves which the Company no longer believes are necessary, other changes in
prior years' tax estimates and changes in valuation allowances with respect to
deferred income tax assets. Generally, the reversal of reserves relates to the
expiration of the relevant statute of limitations with respect to certain income
tax returns or the resolution of specific income tax matters with the relevant
tax authorities. For the year ended December 31, 1999, the reversal of reserves
which the Company believes are no longer necessary resulted in a credit to the
income tax provision of $4.1 million. There were no reversals of reserves for
the years ended December 31, 1998 and 1997.
The components of the Company's net deferred income tax assets
(liabilities) are as follows (in millions):
DECEMBER 31,
-----------------------
1999 1998
---------- -----------
Deferred income tax assets:
Loss and credit carryforwards............................. $ 134.2 $ 112.0
Timber and timberlands.................................... - 29.3
Other..................................................... 13.4 10.9
Valuation allowances...................................... (47.6) (47.8)
---------- -----------
Total deferred income tax assets, net.................. 100.0 104.4
---------- -----------
Deferred income tax liabilities:
Timber and timberlands.................................... (80.0) -
Property, plant and equipment............................. (16.8) (15.2)
Inventories............................................... (9.1) (8.8)
Other..................................................... (1.3) (8.7)
---------- -----------
Total deferred income tax liabilities.................. (107.2) (32.7)
---------- -----------
Net deferred income tax assets (liabilities)................. $ (7.2) $ 71.7
========== ===========
Included in net deferred income tax liabilities as of December 31, 1999 is
$86.6 million which relates to the benefit of loss and credit carryforwards, net
of valuation allowances. The Company evaluated all appropriate factors to
determine the proper valuation allowances for loss and credit carryforwards.
These factors included any limitations concerning use of the carryforwards, the
year the carryforwards expire and the levels of taxable income necessary for
utilization. The Company has concluded that it will more likely than not
generate sufficient taxable income to realize the benefit attributable to the
loss and credit carryforwards for which valuation allowances were not provided
based on estimated future taxable income and the estimated value of its timber
and timberlands which is well in excess of its tax basis. As of December 31,
1999, the Company had a deferred income tax liability with respect to timber and
timberlands of $80.0 million as compared to a deferred income tax asset of $29.3
million as of December 31, 1998. The deferred income tax liability resulted
primarily from the sale of the Headwaters Timberlands during 1999.
Included in the net deferred income tax assets listed above are $7.4
million and $64.4 million at December 31, 1999 and 1998, respectively, which are
recorded pursuant to the tax allocation agreements with MAXXAM.
The following table presents the estimated tax attributes for federal
income tax purposes for the Company and its subsidiaries as of December 31,
1999, under the terms of the respective tax allocation agreements (dollar
amounts in millions). The utilization of certain of these tax attributes is
subject to limitations.
EXPIRING
THROUGH
-----------
Regular Tax Attribute Carryforwards:
Net operating losses................................................................... $ 366.5 2019
Alternative minimum tax credit......................................................... $ 0.7 Indefinite
Alternative Minimum Tax Attribute Carryforwards:
Net operating losses................................................................... $ 326.6 2019
7. EMPLOYEE BENEFIT PLANS
Pension and Other Postretirement Benefit Plans
Pacific Lumber has a defined benefit plan which covers all employees of
Pacific Lumber. Under the plan, employees are eligible for benefits at age 65 or
earlier, if certain provisions are met. The benefits are determined under a
career average formula based on each year of service with Pacific Lumber and the
employee's compensation for that year. Pacific Lumber's funding policy is to
contribute annually an amount at least equal to the minimum cash contribution
required by the Employee Retirement Income Security Act of 1974, as amended.
Pacific Lumber has an unfunded benefit plan for certain postretirement
medical benefits which covers substantially all employees of Pacific Lumber.
Participants of the plan are eligible for certain health care benefits upon
retirement. Participants make contributions for a portion of the cost of their
health care benefits. The expected costs of postretirement medical benefits are
accrued over the period the employees provide services to the date of their full
eligibility for such benefits.
The following tables present the changes, status and assumptions of
Pacific Lumber's pension and other postretirement benefit plans as of December
31, 1999 and 1998, respectively (in millions):
PENSION BENEFITS MEDICAL/LIFE BENEFITS
-------------------- --------------------
YEARS ENDED DECEMBER 31,
-----------------------------------------
1999 1998 1999 1998
--------- --------- --------- ---------
Change in benefit obligation:
Benefit obligation at beginning of year.............................. $ 34.3 $ 28.9 $ 5.0 $ 5.0
Service cost......................................................... 2.4 2.2 0.3 0.3
Interest cost........................................................ 2.5 2.2 0.4 0.3
Plan participants' contributions..................................... - - 0.3 0.2
Actuarial (gain) loss................................................ (4.8) 1.6 (0.7) (0.5)
Benefits paid........................................................ (0.7) (0.6) (0.4) (0.3)
--------- --------- --------- ---------
Benefit obligation at end of year 33.7 34.3 4.9 5.0
--------- --------- --------- ---------
Change in plan assets:
Fair value of plan assets at beginning of year....................... 29.9 25.9 - -
Actual return on assets.............................................. 5.7 3.5 - -
Employer contributions............................................... 2.2 1.1 0.1 0.1
Plan participants' contributions..................................... - - 0.3 0.2
Benefits paid........................................................ (0.7) (0.6) (0.4) (0.3)
--------- --------- --------- ---------
Fair value of plan assets at end of year............................. 37.1 29.9 - -
--------- --------- --------- ---------
Benefit obligation in excess of (less than) plan assets.............. (3.4) 4.4 4.9 5.0
Unrecognized actuarial gain.......................................... 12.8 4.4 2.1 1.5
Unrecognized prior service costs..................................... (0.8) (0.9) - -
--------- --------- --------- ---------
Accrued benefit liability......................................... $ 8.6 $ 7.9 $ 7.0 $ 6.5
========= ========= ========= =========
PENSION BENEFITS MEDICAL/LIFE BENEFITS
------------------------------ ------------------------------
YEARS ENDED DECEMBER 31,
--------------------------------------------------------------
1999 1998 1997 1999 1998 1997
--------- -------- --------- --------- --------- ---------
Components of net periodic benefit costs:
Service cost.................................... $ 2.4 $ 2.2 $ 1.9 $ 0.3 $ 0.3 $ 0.3
Interest cost................................... 2.5 2.2 1.9 0.4 0.3 0.4
Expected return on assets....................... (2.1) (1.8) (1.5) - - -
Amortization of prior service costs............. 0.1 0.1 - - - -
Recognized net actuarial gain................... - - - (0.1) (0.1) (0.1)
--------- -------- --------- --------- --------- ---------
Adjusted net periodic benefit costs.......... $ 2.9 $ 2.7 $ 2.3 $ 0.6 $ 0.5 $ 0.6
========= ======== ========= ========= ========= =========
PENSION BENEFITS MEDICAL/LIFE BENEFITS
------------------------------ ------------------------------
YEARS ENDED DECEMBER 31,
--------------------------------------------------------------
1999 1998 1997 1999 1998 1997
--------- -------- --------- --------- --------- ---------
Weighted-average assumptions:
Discount rate................................... 7.8% 7.0% 7.3% 7.8% 7.0% 7.3%
Expected return on plan assets.................. 8.0% 8.0% 8.0% - - -
Rate of compensation increase................... 5.0% 5.0% 5.0% 5.0% 5.0% 5.0%
Assumed health care cost trend rates have a significant effect on the
amounts reported for the health care plan. A one-percentage-point change in
assumed health care cost trend rates as of December 31, 1999 would have the
following effects (in millions):
1-PERCENTAGE-POINT 1-PERCENTAGE-POINT
INCREASE DECREASE
--------------------------- ---------------------------
Effect on total of service and interest cost components....... $ 0.1 $ (0.1)
Effect on the postretirement benefit obligations.............. 0.8 (0.7)
Employee Savings Plan
Pacific Lumber's employees are eligible to participate in a defined
contribution savings plan sponsored by MAXXAM. This plan is designed to enhance
the existing retirement programs of participating employees. The cost to the
Company of this plan was $1.4 million, $1.4 million and $1.5 million for the
years ended December 31, 1999, 1998 and 1997, respectively.
Workers' Compensation Benefits
Pacific Lumber is self-insured for workers' compensation benefits, whereas
Britt is insured for workers' compensation benefits by an outside party.
Included in accrued compensation and related benefits and other noncurrent
liabilities are accruals for workers' compensation claims amounting to $9.8
million and $10.8 million at December 31, 1999 and 1998, respectively. Workers'
compensation expenses amounted to $3.9 million, $3.5 million and $4.7 million
for the years ended December 31, 1999, 1998 and 1997, respectively.
8. RELATED PARTY TRANSACTIONS
MAXXAM provides the Company and certain of the Company's subsidiaries with
accounting and data processing services. In addition, MAXXAM provides the
Company with office space and various office personnel, insurance, legal,
operating, financial and certain other services. MAXXAM's expenses incurred on
behalf of the Company are reimbursed by the Company through payments consisting
of (i) an allocation of the lease expense for the office space utilized by or on
behalf of the Company and (ii) a reimbursement of actual out-of-pocket expenses
incurred by MAXXAM, including, but not limited to, labor costs of MAXXAM
personnel rendering services to the Company. Charges by MAXXAM for such services
were $3.0 million, $3.4 million and $2.2 million for the years ended December
31, 1999, 1998 and 1997, respectively. The Company believes that the services
being rendered are on terms not less favorable to the Company than those which
would be obtainable from unaffiliated third parties.
9. STOCKHOLDER'S DEFICIT
Changes in stockholder's deficit were (in millions):
COMMON
STOCK ADDITIONAL ACCUMULATED
($.081/3 PAR) CAPITAL DEFICIT Total
-------------- -------------- -------------- --------------
Balance, December 31, 1996......................... $ - $ 81.3 $ (193.3) $ (112.0)
Net income...................................... - - 12.6 12.6
Dividends....................................... - - (3.0) (3.0)
-------------- -------------- -------------- --------------
Balance, December 31, 1997......................... - 81.3 (183.7) (102.4)
Net loss........................................ - - (56.8) (56.8)
Dividends....................................... - - (18.7) (18.7)
-------------- -------------- -------------- --------------
Balance, December 31, 1998......................... - 81.3 (259.2) (177.9)
Net income...................................... - - 118.2 118.2
Dividends....................................... - - (18.7) (18.7)
-------------- -------------- -------------- --------------
Balance, December 31, 1999......................... $ - $ 81.3 $ (159.7) $ (78.4)
============== ============== ============== ==============
10. COMMITMENTS AND CONTINGENCIES
Commitments
Minimum rental commitments under operating leases at December 31, 1999 are
as follows: years ending December 31, 2000--$4.6 million; 2001--$4.2 million;
2002--$3.3 million; 2003--$2.5 million; 2004--$1.5 million; thereafter--$3.0
million. Rental expense for operating leases was $4.2 million, $3.0 million and
$2.0 million for the years ended December 31, 1999, 1998 and 1997, respectively.
Contingencies
Regulatory and environmental matters play a significant role in the
Company's forest products business, which is subject to a variety of California
and federal laws and regulations, as well as the HCP and SYP (defined below) and
Pacific Lumber's 2000 timber operator's license, dealing with timber harvesting
practices, threatened and endangered species and habitat for such species, and
air and water quality. As further described in Note 2 "Headwaters Transactions,"
on March 1, 1999, Pacific Lumber, including its subsidiaries and affiliates, and
MAXXAM consummated the Headwaters Agreement with the United States and
California. In addition to the transfer of the Headwaters Timberlands described
in Note 2, a sustained yield plan (the "SYP") and a multiple-species habitat
conservation plan (the "HCP") were approved and incidental take permits related
to the HCP (the "PERMITS") were issued.
The SYP complies with certain California Board of Forestry regulations
requiring timber companies to project timber growth and harvest on their
timberlands over a 100-year planning period and to demonstrate that their
projected average annual harvest for any decade within a 100-year planning
period will not exceed the average annual harvest level during the last decade
of the 100-year planning period. The SYP is effective for 10 years (subject to
review after five years) and may be amended by Pacific Lumber, subject to
approval by the CDF. Revised SYPs will be prepared every decade that address the
harvest level based upon reassessment of changes in the resource base and other
factors. The HCP and the Permits allow incidental "take" of certain species
located on the Company's timberlands which have been listed as endangered or
threatened under the federal Endangered Species Act (the "ESA") and/or the
California Endangered Species Act ("CESA") so long as there is no "jeopardy" to
the continued existence of such species. The HCP identifies the measures to be
instituted in order to minimize and mitigate the anticipated level of take to
the greatest extent practicable. The SYP is also subject to certain of these
provisions. The HCP and related Permits have a term of 50 years. The Company
believes that the SYP and the HCP should in the long-term expedite the
preparation and facilitate approval of its THPs, although the Company is
experiencing difficulties in the THP approval process as it implements these
agreements.
Under the Federal Clean Water Act, the Environmental Protection Agency
("EPA") is required to establish total maximum daily load limits ("TMDLS") in
water courses that have been declared to be "water quality impaired." The EPA
and the North Coast Regional Water Quality Control Board are in the process of
establishing TMDLs for 17 northern California rivers and certain of their
tributaries, including certain water courses that flow within the Company's
timberlands. The final TMDL requirements applicable to the Company's timberlands
may require aquatic measures that are different from or in addition to the
prescriptions to be developed pursuant to the watershed analysis process
provided for in the HCP.
Lawsuits are pending and threatened which seek to prevent the Company from
implementing the HCP and/or the SYP, implementing certain of the Company's
approved THPs or carrying out certain other operations. On December 2, 1997, two
lawsuits were filed against the Company, certain of its subsidiaries and others:
Kristi Wrigley, et al. v. Charles Hurwitz, John Campbell, Pacific Lumber, MAXXAM
Group Holdings Inc., Scotia Pacific Holding Company, MAXXAM Group Inc., MAXXAM
Inc., Scotia Pacific Company LLC, et al. (the "WRIGLEY LAWSUIT") and Jennie
Rollins, et al. v. Charles Hurwitz, John Campbell, Pacific Lumber, MAXXAM Group
Holdings Inc., Scotia Pacific Holding Company, MAXXAM Group Inc., MAXXAM Inc.,
Barnum Timber Company, et al. (the "ROLLINS LAWSUIT"). These actions allege,
among other things, that the defendants' logging practices have damaged the
plaintiffs' properties and property values by contributing to landslides
(Rollins lawsuit) and the destruction of certain watersheds (Wrigley lawsuit).
The Company believes that it has strong factual and legal defenses with respect
to these matters; however, there can be no assurance that they will not have a
material adverse effect on its financial position, results of operations or
liquidity. On March 31, 1999, an action entitled Environmental Protection
Information Association, Sierra Club v. California Department of Forestry and
Fire Protection, California Department of Fish and Game, The Pacific Lumber
Company, Scotia Pacific Company LLC, Salmon Creek Corporation, et al. (the
"EPIC-SYP/PERMITS LAWSUIT") was filed alleging various violations of the CESA
and the California Environmental Quality Act ("CEQA"), and challenging, among
other things, the validity and legality of the Permits issued by California and
the SYP. On March 31, 1999, an action entitled United Steelworkers of America,
AFL-CIO, CLC, and Donald Kegley v. California Department of Forestry and Fire
Protection, The Pacific Lumber Company, Scotia Pacific Company LLC and Salmon
Creek Corporation (the "USWA LAWSUIT") was filed also challenging the validity
and legality of the SYP. The Company believes that appropriate procedures were
followed throughout the public review and approval process concerning the HCP
and the SYP, and the Company is working with the relevant state and federal
agencies to defend these challenges. Although uncertainties are inherent in the
final outcome of the EPIC-SYP/Permits lawsuit and the USWA lawsuit, the Company
believes that the resolution of these matters should not result in a material
adverse effect on its financial condition, results of operations or the ability
to harvest timber. While the Company expects environmentally focused
objections and lawsuits to continue, it believes that the HCP, the SYP and the
Permits should enhance its position in connection with these continuing
challenges and, over time, reduce or minimize such challenges.
11. SUPPLEMENTAL CASH FLOW AND OTHER INFORMATION
YEARS ENDED DECEMBER 31,
------------------------------
1999 1998 1997
--------- --------- ---------
(IN MILLIONS)
Supplemental information on non-cash investing and financing activities:
Acquisition of assets subject to other liabilities.............................. $ - $ 0.8 $ 9.4
Supplemental disclosure of cash flow information:
Interest paid, net of capitalized interest...................................... $ 65.0 $ 62.7 $ 63.6
Income taxes paid .............................................................. - - 0.2
Tax allocation payments to MAXXAM............................................... 1.8 0.2 0.4
12. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Summary quarterly financial information for the years ended December 31,
1999 and 1998 is as follows (in millions):
THREE MONTHS ENDED
-----------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
------------- ------------- -------------- --------------
1999:
Net sales.......................................... $ 46.7 $ 41.4 $ 49.0 $ 50.7
Operating income (loss)............................ (1.4) (3.4) (3.9) 4.3
Net income (loss).................................. 134.0 (5.8) (5.6) (4.4)
1998:
Net sales.......................................... $ 51.9 $ 63.5 $ 65.9 $ 52.3
Operating income................................... 10.0 14.6 12.6 3.1
Loss before extraordinary item..................... (3.1) (1.9) (5.2) (6.5)
Extraordinary item, net............................ - - (40.1) -
Net loss........................................... (3.1) (1.9) (45.3) (6.5)