-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Ts2Wc+8Juggp+Rj1ExgfedOHjy50Rjj6GFCua84HbNkQ+rqr7i9Iyygk04dtfvSL rsX4VpZ3qlaH50CxKONEWg== 0000900421-99-000026.txt : 19990402 0000900421-99-000026.hdr.sgml : 19990402 ACCESSION NUMBER: 0000900421-99-000026 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MAXXAM GROUP HOLDINGS INC CENTRAL INDEX KEY: 0001029500 STANDARD INDUSTRIAL CLASSIFICATION: PRIMARY PRODUCTION OF ALUMINUM [3334] IRS NUMBER: 760518669 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 333-18723 FILM NUMBER: 99581718 BUSINESS ADDRESS: STREET 1: 5847 SAN FELIPE STREET 2: SUITE 2600 CITY: HOUSTON STATE: TX ZIP: 77057 BUSINESS PHONE: 7139757600 MAIL ADDRESS: STREET 1: 5847 SAN FELIPE STREET 2: SUITE 2600 CITY: HOUSTON STATE: TX ZIP: 77057 10-K 1 MAXXAM GROUP HOLDINGS INC. 10-K 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 COMMISSION FILE DECEMBER 31, 1998 NUMBER 333-18723 MAXXAM GROUP HOLDINGS INC. (Exact name of Registrant as Specified in its Charter) DELAWARE 76-0518669 (State or other (I.R.S. Employer jurisdiction Identification Number) of incorporation or organization) 5847 SAN FELIPE, SUITE 2600 77057 HOUSTON, TEXAS (Zip Code) (Address of Principal Executive Offices) Registrant's telephone number, including area code: (713) 975-7600 --------------- Securities registered pursuant to Section 12(b) of the Act: None. Securities registered pursuant to Section 12(g) of the Act: None. --------------- Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /X/ No / / All of the Registrant's voting stock is held by an affiliate of the Registrant. Number of shares of Common Stock outstanding at March 29, 1999: 1,000 REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION (I)(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 General 2 Forest Products Operations Pacific Lumber Operations 2 Britt Lumber Operations 9 Regulatory and Environmental Factors and Headwaters Agreement 9 Aluminum Operations 15 Item 2. Properties 18 Item 3. Legal Proceedings 18 Item 4. Submission of Matters to a Vote of Security Holders 21 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 21 Item 6. Selected Financial Data 21 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 21 Item 7a. Quantitative and Qualitative Disclosures About Market Risk 29 Item 8. Financial Statements and Supplementary Data Report of Independent Public Accountants 30 Consolidated Balance Sheet 31 Consolidated Statement of Operations 32 Consolidated Statement of Cash Flows 33 Consolidated Statement of Stockholder's Deficit 34 Notes to Consolidated Financial Statements 35 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 49 PART III Items 10-13. Not applicable. PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 49 PART I ITEM 1. BUSINESS GENERAL MAXXAM Group Holdings Inc. (the "COMPANY" or "MGHI") is a wholly owned subsidiary of MAXXAM Inc. ("MAXXAM"). The Company's wholly owned subsidiary, MAXXAM Group Inc. ("MGI"), and MGI's wholly owned subsidiaries, The Pacific Lumber Company ("PACIFIC LUMBER") and Britt Lumber Co., Inc. ("BRITT"), are engaged in forest products operations. Pacific Lumber's principal wholly owned subsidiaries are Scotia Pacific Company LLC ("SCOTIA LLC") and Salmon Creek Corporation ("SALMON CREEK"). As used herein, the terms "Company," "MGHI," "MGI," "Pacific Lumber," "Kaiser" or "MAXXAM" refer to the respective companies and their subsidiaries, unless otherwise noted or the context indicates otherwise. Pacific Lumber, which has been in continuous operation for over 130 years, engages in several principal aspects of the lumber industry--the growing and harvesting of redwood and Douglas-fir timber, the milling of logs into lumber products and the manufacturing of lumber into a variety of value-added finished products. Britt manufactures redwood fencing and decking products from small diameter logs, a substantial portion of which Britt acquires from Pacific Lumber (as Pacific Lumber cannot efficiently process them in its own mills). The Company also owns 27,938,250 shares of the common stock of Kaiser Aluminum Corporation ("KAISER"), representing a 35.4% interest in Kaiser. MAXXAM has a direct interest in Kaiser of 27.9%. Kaiser is a publicly traded company (New York Stock Exchange trading symbol "KLU") which operates in all principal aspects of the aluminum industry-- the mining of bauxite, the refining of bauxite into alumina, the production of primary aluminum from alumina, and the manufacture of fabricated (including semi-fabricated) aluminum products. 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--Forest Products Operations-- Regulatory and Environmental Factors and Headwaters Agreement" and "-- Aluminum Operations," Item 3. "Legal Proceedings" and Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations-- Background," "--Financial Condition and Investing and Financing Activities" and "--Trends"). Such statements can be identified by the use of forward- looking terminology such as "believes," "expects," "may," "estimates," "will," "should," "plans" or "anticipates" or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategy. Readers are cautioned that any such forward-looking statements are not guarantees of future performance and involve significant risks and uncertainties, and that actual results may vary materially from those in the forward-looking statements as a result of various factors. These factors include the effectiveness of management's strategies and decisions, general economic and business conditions, developments in technology, new or modified statutory or regulatory requirements and changing prices and market conditions. This report identifies other factors that could cause such differences. No assurance can be given that these are all of the factors that could cause actual results to vary materially from the forward-looking statements. FOREST PRODUCTS OPERATIONS PACIFIC LUMBER OPERATIONS Consummation of Headwaters Agreement On March 1, 1999, Pacific Lumber, Scotia LLC and Salmon Creek (collectively, the "COMPANIES") consummated the Headwaters Agreement (the "HEADWATERS AGREEMENT") with the United States and California. See "-- Regulatory and Environmental Factors and Headwaters Agreement." Pursuant to the terms of the Headwaters Agreement, approximately 5,600 acres of timberlands known as the Headwaters Forest and the Elk Head Springs Forest (the "HEADWATERS TIMBERLANDS") owned by the Companies were transferred to the United States. In consideration for the transfer of the Headwaters Timberlands, Salmon Creek was paid $299,850,000, Scotia LLC was paid $150,000 and approximately 7,700 acres of timberlands known as the Elk River Timberlands (the "ELK RIVER TIMBERLANDS") were transferred to Pacific Lumber (and will be transferred to Scotia LLC within 180 days of consummation of the Headwaters Agreement). The 7,700 acres of Elk River Timberlands were out of a total of approximately 9,470 acres for which the United States and California paid third party owners approximately $78 million. In addition, upon consummation of the Headwaters Agreement (i) habitat conservation and sustained yield plans were approved covering the Scotia LLC Timberlands (as defined below), (ii) California agreed to purchase Scotia LLC's Owl Creek grove and a portion of Pacific Lumber's Grizzly Creek grove, and (iii) the Companies dismissed takings litigation pending against the United States and California. The net proceeds from the sale of the Headwaters Timberlands and the portion of the Grizzly Creek grove to be sold are to be held in escrow to support the Timber Notes, and are to be released only under certain circumstances. Consequently, Salmon Creek deposited approximately $285 million of the proceeds from the sale of the Headwaters Timberlands into escrow pursuant to an Escrow Agreement. See "--Regulatory and Environmental Factors and Headwaters Agreement-- Escrow Agreement." Timber and Timberlands After giving effect to the transfers of timberlands under the Headwaters Agreement, Pacific Lumber owns and manages approximately 220,000 acres of virtually contiguous commercial timberlands located in Humboldt County along the northern California coast, an area which has very favorable soil and climate conditions for growing timber. These timberlands contain approximately 80% redwood and 18% Douglas-fir and other timber, are located in close proximity to Pacific Lumber's four sawmills and contain an extensive network of roads. Including the pending transfer from Pacific Lumber to Scotia LLC of the Elk River Timberlands, approximately 206,000 acres of Pacific Lumber's timberlands are owned by Scotia LLC (the "SCOTIA LLC TIMBERLANDS"). In addition, Scotia LLC has the exclusive right to harvest (the "SCOTIA LLC TIMBER RIGHTS") approximately 12,200 acres of Pacific Lumber's timberlands. The timber in respect of the Scotia LLC Timberlands and the Scotia LLC Timber Rights is collectively referred to as the "SCOTIA LLC TIMBER." Substantially all of Scotia LLC's assets are pledged as security for Scotia LLC's 6.55% Class A-1 Series B Timber Collateralized Notes, 7.11% Class A-2 Series B Timber Collateralized Notes and 7.71% Class A-3 Series B Timber Collateralized Notes (collectively the "TIMBER NOTES"). Pacific Lumber harvests and purchases from Scotia LLC all of the logs harvested from the Scotia LLC Timber. See "--Relationships with Scotia LLC and Britt" for a description of this and other relationships among Pacific Lumber, Scotia LLC and Britt. The forest products industry grades lumber in various classifications according to quality. The two broad categories within which all grades fall, based on the absence or presence of knots, are called "upper" and "common" grades, respectively. "Old growth" trees, often defined as trees which have been growing for approximately 200 years or longer, have a higher percentage of upper grade lumber than "young growth" trees (those which have been growing for less than 200 years). "Virgin" old growth trees are located in timber stands that have not previously been harvested. "Residual" old growth trees are located in timber stands which have been partially harvested in the past. Pacific Lumber engages in extensive efforts to supplement the natural regeneration of timber and increase the amount of timber on its timberlands. Pacific Lumber is required to comply with California forestry regulations regarding reforestation, which generally require that an area be reforested to specified standards within an established period of time. Pacific Lumber also actively engages in efforts to establish timberlands from open areas such as pasture land. Regeneration of redwood timber generally is accomplished through the natural growth of new redwood sprouts from the stump remaining after a redwood tree is harvested. Such new redwood sprouts grow quickly, thriving on existing mature root systems. In addition, Pacific Lumber supplements natural redwood regeneration by planting redwood seedlings. Douglas-fir timber grown on Pacific Lumber's timberlands is regenerated almost entirely by planting seedlings. During 1998, Pacific Lumber planted approximately 1.2 million redwood and Douglas- fir seedlings. California law requires timber owners such as Pacific Lumber to demonstrate that their operations will not decrease the sustainable productivity of their timberlands. A timber company may comply with this requirement by submitting a Sustained Yield Plan ("SYP") to the California Department of Forestry ("CDF") for review and approval. An SYP contains a timber growth and yield assessment, which evaluates and calculates the amount of timber and long-term production outlook for a company's timberlands, a fish and wildlife assessment, which addresses the condition and management of fisheries and wildlife in the area, and a watershed assessment, which addresses the protection of aquatic resources. The relevant regulations require determination of a long-term sustained yield ("LTSY") harvest level, which is the average annual harvest level that the management area is capable of sustaining in the last decade of a 100-year planning horizon. The LTSY is determined based upon timber inventory, projected growth and harvesting methodologies, as well as soil, water, air, wildlife and other relevant considerations. The SYP must demonstrate that the average annual harvest over any rolling ten-year period within the planning horizon does not exceed the LTSY. Pacific Lumber is also subject to federal and state laws providing for the protection and conservation of wildlife species which have been designated as endangered or threatened, certain of which are found on Pacific Lumber's timberlands. These laws generally prohibit certain adverse impacts on such species (referred to as a "TAKE"), except for incidental takes which do not jeopardize the continued existence of the affected species and which are made in accordance with an approved Habitat Conservation Plan ("HCP") and related incidental take permit. An HCP analyzes the impact of the incidental take and specifies measures to monitor, minimize and mitigate such impact. In connection with the consummation of the Headwaters Agreement, Scotia LLC and Pacific Lumber reached agreement with various federal and state regulatory agencies with respect to an SYP ("FINAL SYP") and a multi-species HCP ("FINAL HCP," together with the Final SYP, the "FINAL PLANS"). See "--Regulatory and Environmental Factors and Headwaters Agreement." Harvesting Practices The ability of Pacific Lumber to sell logs or lumber products will depend, in part, upon its ability to obtain regulatory approval of timber harvesting plans ("THPS"). THPs are required to be developed by registered professional foresters and must be filed with, and approved by, the CDF prior to the harvesting of timber. Each THP is designed to comply with applicable laws and regulations, including the requirements of the Final Plans (as defined below). During the second half of 1998 and continuing through the first quarter of 1999, Pacific Lumber has experienced an absence of a sufficient number of available THPs available for harvest to enable it to conduct its operations at 1997 levels. See Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations--Results of Operations--Operating Results." However, with the adoption of the Final Plans in connection with the consummation of the Headwaters Agreement, Pacific Lumber anticipates, although it can give no assurances, that after a transition period, the implementation of the Final Plans will streamline the process of preparing THPs and potentially shorten the time required to obtain approvals of THPs. Pacific Lumber maintains a detailed geographical information system covering its timberlands (the "GIS"). The GIS covers numerous aspects of Pacific Lumber's properties, including timber type, tree class, wildlife data, roads, rivers and streams. By carefully monitoring and updating this data base and conducting field studies, Pacific Lumber's foresters are better able to develop detailed THPs addressing the various regulatory requirements. Pacific Lumber also utilizes a Global Positioning System ("GPS") which allows precise location of geographic features through satellite positioning. Pacific Lumber employs a variety of well-accepted methods of selecting trees for harvest. These methods, which are designed to achieve optimal regeneration, are referred to as "silvicultural systems" in the forestry profession. Silvicultural systems range from very light thinnings aimed at enhancing the growth rate of retained trees to clear cutting which results in the harvest of all trees in an area and replacement with a new forest stand. In between are a number of varying levels of partial harvests which can be employed. Production Facilities Pacific Lumber owns four highly mechanized sawmills and related facilities located in Scotia, Fortuna and Carlotta, California. The sawmills historically have been supplied almost entirely from timber harvested from Pacific Lumber's timberlands. Since 1986, Pacific Lumber has implemented numerous technological advances that have increased the operating efficiency of its production facilities and the recovery of finished products from its timber. Over the past three years, Pacific Lumber's annual lumber production has averaged approximately 277 million board feet, with approximately 230, 309 and 291 million board feet produced in 1998, 1997 and 1996, respectively. The Fortuna sawmill produces primarily common grade lumber. During 1998, the Fortuna mill produced approximately 89 million board feet of lumber. The Carlotta sawmill produces both common and upper grade redwood lumber. During 1998, the Carlotta mill produced approximately 56 million board feet of lumber. Sawmills "A" and "B" are both located in Scotia. Sawmill "A" processes Douglas-fir logs and Sawmill "B" primarily processes large diameter redwood logs. During 1998, Sawmills "A" and "B" produced 55 million and 30 million board feet of lumber, respectively. Pacific Lumber has partially curtailed operations at all of its sawmills due to an abnormally small inventory of logs because of the absence of a sufficient number of available THPs to conduct harvesting at historic levels. It expects such curtailments to continue for the next several months. See Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations-- Results of Operations--Preliminary 1999 Results." Pacific Lumber operates a finishing and remanufacturing plant in Scotia which processes rough lumber into a variety of finished products such as trim, fascia, siding and paneling. These finished products include the redwood lumber industry's largest variety of customized trim and fascia patterns. Remanufacturing enhances the value of some grades of lumber by assembling knot-free pieces of narrower and shorter lumber into wider or longer pieces in its state-of-the-art end and edge glue plants. The result is a standard sized upper grade product which can be sold at a significant premium over common grade products. Pacific Lumber has also installed a lumber remanufacturing facility at its mill in Fortuna which processes low grade redwood common lumber into value-added, higher grade redwood fence and related products. Pacific Lumber dries the majority of its upper grade lumber before it is sold. Upper grades of redwood lumber are generally air-dried for three to twelve months and then kiln-dried for seven to twenty-four days to produce a dimensionally stable and high quality product which generally commands higher prices than "green" lumber (which is lumber sold before it has been dried). Upper grade Douglas-fir lumber is generally kiln-dried immediately after it is cut. Pacific Lumber owns and operates 34 kilns, having an annual capacity of approximately 95 million board feet, to dry its upper grades of lumber efficiently in order to produce a quality, premium product. Pacific Lumber also maintains several large enclosed storage sheds which hold approximately 27 million board feet of lumber. In addition, Pacific Lumber owns and operates a modern 25-megawatt cogeneration power plant which is fueled almost entirely by the wood residue from Pacific Lumber's milling and finishing operations. This power plant generates substantially all of the energy requirements of Scotia, California, the town adjacent to Pacific Lumber's timberlands where several of its manufacturing facilities are located. Pacific Lumber sells surplus power to Pacific Gas and Electric Company. In 1998, the sale of surplus power accounted for approximately 2% of Pacific Lumber's total revenues. Products The following table sets forth the distribution of Pacific Lumber's lumber production (on a net board foot basis) and revenues by product line:
YEAR ENDED DECEMBER 31, 1998 YEAR ENDED DECEMBER 31, 1997 ---------------------------------------- ---------------------------------------- % OF TOTAL % OF TOTAL LUMBER % OF TOTAL LUMBER % OF TOTAL PRODUCTION LUMBER % OF TOTAL PRODUCTION LUMBER % OF TOTAL PRODUCT VOLUME REVENUES REVENUES VOLUME REVENUES REVENUES ------------ ------------ ------------ ------------ ------------ ------------ Upper grade redwood lumber 14% 35% 29% 12% 34% 29% Common grade redwood lumber 58% 49% 41% 55% 42% 35% ------------ ------------ ------------ ------------ ------------ Total redwood lumber 72% 84% 70% 67% 76% 64% ------------ ------------ ------------ ------------ ------------ ------------ Upper grade Douglas- fir lumber 3% 5% 4% 4% 6% 5% Common grade Douglas- fir lumber 22% 10% 8% 25% 16% 13% ------------ ------------ ------------ ------------ ------------ ------------ Total Douglas- fir lumber 25% 15% 12% 29% 22% 18% ------------ ------------ ------------ ------------ ------------ ------------ Other grades of lumber 3% 1% 1% 4% 2% 2% ------------ ------------ ------------ ------------ ------------ ------------ Total lumber 100% 100% 83% 100% 100% 84% ============ ============ ============ ============ ============ ============ Logs 6% 7% ============ ============ Hardwood chips 3% 3% Softwood chips 3% 4% ------------ ------------ Total wood chips 6% 7% ============ ============
Lumber. In 1998, Pacific Lumber sold approximately 252 million board feet of lumber (including 5.0 million of intersegment sales to Britt), which accounted for approximately 83% of Pacific Lumber's total revenues. Lumber products vary greatly by the species and quality of the timber from which it is produced. Lumber is sold not only by grade (such as "upper" grade versus "common" grade), but also by board size and the drying process associated with the lumber. Redwood lumber is Pacific Lumber's largest product category. Redwood is commercially grown only along the northern coast of California and possesses certain unique characteristics that permit it to be sold at a premium to many other wood products. Such characteristics include its natural beauty, superior ability to retain paint and other finishes, dimensional stability and innate resistance to decay, insects and chemicals. Typical applications include exterior siding, trim and fascia for both residential and commercial construction, outdoor furniture, decks, planters, retaining walls and other specialty applications. Redwood also has a variety of industrial applications because of its chemical resistance and because it does not impart any taste or odor to liquids or solids. Upper grade redwood lumber, which is derived primarily from large diameter logs and is characterized by an absence of knots and other defects, is used primarily in distinctive interior and exterior applications. The overall supply of upper grade lumber has been diminishing due to increasing environmental and regulatory restrictions and other factors. See Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations--Background." Common grade redwood lumber, Pacific Lumber's largest volume product, has many of the same aesthetic and structural qualities of redwood uppers, but has some knots, sapwood and a coarser grain. Such lumber is commonly used for construction purposes, including outdoor structures such as decks, hot tubs and fencing. Douglas-fir lumber is used primarily for new construction and some decorative purposes and is widely recognized for its strength, hard surface and attractive appearance. Douglas-fir is grown commercially along the west coast of North America and in Chile and New Zealand. Upper grade Douglas-fir lumber is derived primarily from old growth Douglas-fir timber and is used principally in finished carpentry applications. Common grade Douglas-fir lumber is used for a variety of general construction purposes and is largely interchangeable with common grades of other whitewood lumber. Logs. Pacific Lumber currently sells certain logs that, due to their size or quality, cannot be efficiently processed by its mills into lumber. The majority of these logs are purchased by Britt. The balance are purchased by surrounding mills which do not own sufficient timberlands to support their mill operations. See "--Relationships with Scotia LLC and Britt" below. Except for the agreement with Britt described below, Pacific Lumber does not have any significant contractual relationships with third parties relating to the purchase of logs. Pacific Lumber has historically not purchased significant quantities of logs from third parties; however, Pacific Lumber may from time to time purchase logs from third parties for processing in its mills or for resale to third parties if, in the opinion of management, economic factors are advantageous to Pacific Lumber. Wood Chips. Pacific Lumber uses a whole-log chipper to produce wood chips from hardwood trees which would otherwise be left as waste. These chips are sold to third parties primarily for the production of facsimile and other specialty papers. Pacific Lumber also produces softwood chips from the wood residue from its milling operations. These chips are sold to third parties for the production of wood pulp and paper products. Backlog and Seasonality Pacific Lumber's backlog of sales orders at December 31, 1998 and 1997 was approximately $16.8 and approximately $26.4 million, respectively, the substantial portion of which was delivered in the first quarter of the next fiscal year. The decline in the sales backlog from 1997 to 1998 was principally due to a diminished supply of THPs which reduced the volume of logs available for the production of lumber products. See Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations--Results of Operations--Recent Operating Results." Pacific Lumber has historically experienced lower first quarter sales due largely to the general decline in construction-related activity during the winter months. As a result, Pacific Lumber's results in any one quarter are not necessarily indicative of results to be expected for the full year. The seasonality of Pacific Lumber's business is expected to become more pronounced because of the harvesting restrictions imposed by the Final Plans. See "--Regulatory and Environmental Factors and Headwaters Agreement" and Item 7. "Managements' Discussion and Analysis of Financial Condition and Results of Operations--Background." Other The Company also derives revenues from a soil amendment operation and a concrete block manufacturing operation. Marketing The housing, construction and remodeling markets are the primary markets for Pacific Lumber's lumber products. Pacific Lumber's policy is to maintain a wide distribution of its products both geographically and in terms of the number of customers. Pacific Lumber sells its lumber products throughout the country to a variety of accounts, the large majority of which are wholesalers, followed by retailers, industrial users, exporters and manufacturers. Upper grades of redwood and Douglas-fir lumber are sold throughout the entire United States, as well as to export markets. Common grades of redwood lumber are sold principally west of the Mississippi River, with California accounting for approximately 55% of these sales in 1998. Common grades of Douglas-fir lumber are sold primarily in California. In 1998, Pacific Lumber had three customers which accounted for approximately 8%, 7% and 7%, respectively, of Pacific Lumber's total revenues. Exports of lumber accounted for approximately 4% of Pacific Lumber's total revenues in 1998. Pacific Lumber markets its products through its own sales staff which focuses primarily on domestic sales. Pacific Lumber actively follows trends in the housing, construction and remodeling markets in order to maintain an appropriate level of inventory and assortment of products. Due to its high quality products, competitive prices and long history, Pacific Lumber believes it has a strong degree of customer loyalty. Competition Pacific Lumber's lumber is sold in highly competitive markets. Competition is generally based upon a combination of price, service, product availability and product quality. Pacific Lumber's products compete not only with other wood products but with metals, masonry, plastic and other construction materials made from non-renewable resources. The level of demand for Pacific Lumber's products is dependent on such broad factors as overall economic conditions, interest rates and demographic trends. In addition, competitive considerations, such as total industry production and competitors' pricing, as well as the price of other construction products, affect the sales prices for Pacific Lumber's lumber products. Pacific Lumber currently enjoys a competitive advantage in the upper grade redwood lumber market due to the quality of its timber holdings and relatively low cost production operations. Competition in the common grade redwood and Douglas-fir lumber market is more intense, and Pacific Lumber competes with numerous large and small lumber producers. Employees As of March 1, 1999, Pacific Lumber had approximately 1,250 employees, none of whom are covered by a collective bargaining agreement. Relationships with Scotia LLC and Britt Scotia LLC succeeded by merger to substantially all of the business and operations of Pacific Lumber's wholly owned subsidiary, Scotia Pacific Holding Company, a Delaware corporation ("SCOTIA PACIFIC"), effective as of July 20, 1998 (the "CLOSING DATE"). Effective with the Closing Date, Scotia LLC acquired Scotia Pacific's forestry department. Scotia LLC's foresters, wildlife and fisheries biologists, geologists and other personnel are responsible for providing a number of forest stewardship techniques, including protecting the timber located on the Scotia LLC Timberlands from forest fires, erosion, insects and other damage, overseeing reforestation activities and monitoring environmental and regulatory compliance. Scotia LLC's personnel are also responsible for preparing THPs and updating the information contained in the GIS. See "-- Harvesting Practices" above for a description of the GIS updating process and the THP preparation process. Prior to consummation of the Offering, Scotia Pacific and Pacific Lumber were party to several agreements between themselves, including a Master Purchase Agreement, a Services Agreement, an Additional Services Agreement, an Environmental Indemnification Agreement and a Reciprocal Rights Agreement. On the Closing Date, Scotia LLC entered into a New Master Purchase Agreement with Pacific Lumber (the "NEW MASTER PURCHASE AGREEMENT") which governs the sale to Pacific Lumber of logs harvested from the Scotia LLC Timberlands. As Pacific Lumber purchases logs from Scotia LLC pursuant to the New Master Purchase Agreement, Pacific Lumber is responsible, at its own expense, for harvesting and removing the standing Scotia LLC 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. The New Master Purchase Agreement generally contemplates that all sales of logs by Scotia LLC to Pacific Lumber will be at a price which equals or exceeds the applicable SBE Price. The New Master Purchase Agreement defines the "SBE PRICE" for any species and category of timber as the stumpage price for such species and category, as set forth in the most recent "Harvest Value Schedule" (or any successor publication) published by the California State Board of Equalization (or any successor agency) applicable to the timber sold during the period covered by such Harvest Value Schedule. Harvest Value Schedules are published twice a year for purposes of computing a yield tax imposed on timber harvested between January 1 through June 30 and July 1 through December 31. SBE Prices are not necessarily representative of actual prices that would be realized from unrelated parties at subsequent dates. After obtaining an approved THP, Scotia LLC offers for sale the logs to be harvested pursuant to such THP. While Scotia LLC may sell logs to third parties, it derives substantially all of its revenue from the sale of logs to Pacific Lumber pursuant to the New Master Purchase Agreement. Each sale of logs by Scotia LLC to Pacific Lumber is made pursuant to a separate log purchase agreement that relates to the Scotia LLC Timber covered by an approved THP and incorporates the provisions of the New Master Purchase Agreement. Each such log purchase agreement provides for the sale to Pacific Lumber of the logs harvested from the Scotia LLC 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 Scotia LLC, 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). Scotia LLC continues to rely on Pacific Lumber to provide operational, management and related services not performed by its own employees with respect to the Scotia LLC Timberlands pursuant to a New Services Agreement (the "NEW SERVICES AGREEMENT"). The services under the New Services Agreement include the furnishing of all equipment, personnel and expertise not within Scotia LLC's possession and reasonably necessary for the operation and maintenance of the Scotia LLC Timberlands and the Scotia LLC Timber as well as timber management techniques designed to supplement the natural regeneration of, and increase the amount of, Scotia LLC Timber. Pacific Lumber is required to provide all services under the New Services Agreement in a manner consistent in all material respects with prudent business practices which, in the reasonable judgment of Pacific Lumber (a) are consistent with then current applicable industry standards and (b) are in compliance in all material respects with all applicable timber laws. As compensation for the services provided by Pacific Lumber pursuant to the New Services Agreement, Scotia LLC pays Pacific Lumber a services fee ("SERVICES FEE") which is adjusted each year based on a specified government index relating to wood products and reimburses Pacific Lumber for the cost of constructing, rehabilitating and maintaining roads, and performing reforestation services, on the Scotia LLC Timberlands, as determined in accordance with generally accepted accounting principles. Certain of such reimbursable expenses are expected to vary in relation to the amount of timber to be harvested in any given period. On the Closing Date, Scotia LLC and Pacific Lumber also entered into a New Additional Services Agreement (the "NEW ADDITIONAL SERVICES AGREEMENT") pursuant to which Scotia LLC provides certain services to Pacific Lumber. 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 Scotia LLC a fee for such services equal to the actual cost of providing such services, as determined in accordance with generally accepted accounting principles. On the Closing Date, Scotia LLC, Pacific Lumber and Salmon Creek also entered into a New Reciprocal Rights Agreement whereby, among other things, the parties granted to each other certain reciprocal rights of egress and ingress through their respective properties in connection with the operation and maintenance of such properties and their respective businesses. In addition, on the Closing Date, Pacific Lumber entered into a New Environmental Indemnification Agreement with Scotia LLC (the "NEW ENVIRONMENTAL INDEMNIFICATION AGREEMENT"), pursuant to which Pacific Lumber agreed to indemnify Scotia LLC from and against certain present and future liabilities arising with respect to hazardous materials, hazardous materials contamination or disposal sites, or under environmental laws with respect to the Scotia LLC Timberlands. In particular, Pacific Lumber is liable with respect to any contamination which occurred on the Scotia LLC Timberlands prior to the date of the agreement. Pacific Lumber entered into an agreement with Britt (the "BRITT AGREEMENT") which governs the sale of logs by Pacific Lumber and Britt to each other, the sale of hog fuel (wood residue) by Britt to Pacific Lumber for use in Pacific Lumber's cogeneration plant, the sale of lumber by Pacific Lumber and Britt to each other, and the provision by Pacific Lumber of certain administrative services to Britt (including accounting, purchasing, data processing, safety and human resources services). The logs which Pacific Lumber sells to Britt and which are used in Britt's manufacturing operations are sold at approximately 75% of applicable SBE prices (to reflect the lower quality of these logs). Logs which either Pacific Lumber or Britt purchases from third parties and which are then sold to each other are transferred at the actual cost of such logs. Hog fuel is sold at applicable market prices, and administrative services are provided by Pacific Lumber based on Pacific Lumber's actual costs and an allocable share of Pacific Lumber's overhead expenses consistent with past practice. BRITT LUMBER OPERATIONS Business Britt is located in Arcata, California, approximately 45 miles north of Pacific Lumber's headquarters. Britt's primary business is the processing of small diameter redwood logs into wood fencing products for sale to retail and wholesale customers. Britt was incorporated in 1965 and operated as an independent manufacturer of fence products until July 1990, when it was purchased by a subsidiary of the Company. Britt purchases small diameter (6 to 11 inch) redwood logs of varying lengths. Britt's purchases are primarily from Pacific Lumber, although it does purchase a variety of different diameter and different length logs from various other timberland owners. Britt processes logs at its mill into a variety of different fencing products, including "dog-eared" 1" x 6" fence stock in six foot lengths, 4" x 4" fence posts in 6 through 12 foot lengths, and other lumber products in 6 through 12 foot lengths. Britt's purchases of logs from third parties are generally consummated pursuant to short-term contracts of twelve months or less. Marketing In 1998, Britt sold approximately 86 million board feet of lumber products to approximately 57 different customers. Over one-half of its 1998 lumber sales were in California. The remainder of its 1998 sales were in ten other western states. In 1998, Britt had four customers which accounted for 23%, 20%, 12% and 11%, respectively, of Britt's total sales. Britt markets its products through its own salesmen to a variety of customers, including distribution centers, industrial remanufacturers, wholesalers and retailers. Britt's backlog of sales orders at December 31, 1998 and 1997 was approximately $3.2 million and $5.4 million, respectively, the substantial portion of which was delivered in the first quarter of the next fiscal year. Facilities and Employees Britt's manufacturing operations are conducted on 12 acres of land, 10 acres of which are leased on a long-term fixed-price basis from an unrelated third party. Production is conducted in a 46,000 square foot mill. An 18-acre log sorting and storage yard is located one quarter of a mile away. The mill was constructed in 1980, and capital expenditures to enhance its output and efficiency are made periodically. Britt's (single shift) mill capacity, assuming 40 production hours per week, is estimated at 37.4 million board feet of fencing products per year. As of March 1, 1999, Britt employed approximately 130 people, none of whom are covered by a collective bargaining agreement. Competition Management estimates that Britt accounted for approximately one- third of the total redwood fence market in 1998. Britt competes primarily with the northern California mills of Georgia Pacific, Eel River and Redwood Empire. REGULATORY AND ENVIRONMENTAL FACTORS AND HEADWATERS AGREEMENT This section contains statements which constitute "forward- looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. See Item 1. "Business--General" in this section for cautionary information with respect to such forward-looking statements. General Pacific Lumber's business is subject to a variety of California and federal laws and regulations dealing with timber harvesting, threatened and endangered species and habitat for such species, and air and water quality. Compliance with such laws and regulations plays a significant role in Pacific Lumber's business. The California Forest Practice Act (the "FOREST PRACTICE ACT") and related regulations adopted by the California Board of Forestry (the "BOF") set forth detailed requirements for the conduct of timber harvesting operations in California. These requirements include the obligation of timber companies to prepare, and obtain regulatory approval of, detailed THPs containing information with respect to areas proposed to be harvested (see "--Pacific Lumber Operations-- Harvesting Practices" above). As described further below, California law also requires large timber companies submitting THPs to demonstrate that their proposed timber operations will not decrease the sustainable productivity of their timberlands, including through review and approval by the CDF, an SYP establishing an LTSY for its 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 species and plants which have been declared to be endangered or threatened. These laws generally prohibit certain adverse impacts on such species (referred to as a "take"), except for incidental takes pursuant to otherwise lawful activities which do not jeopardize the continued existence of the affected species and which are made in accordance with an approved HCP and related incidental take permit. An HCP, among other things, analyzes the potential impact of the incidental take of species and specifies measures to monitor, minimize and mitigate such impact. The operations of Pacific Lumber are also subject to the California Environmental Quality Act (the "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. Compliance with such laws, regulations and judicial and administrative interpretations, together with other regulatory and environmental matters, have resulted in restrictions on the geographic scope and timing of Pacific Lumber's timber operations, increased operational costs and engendered litigation and other challenges to Pacific Lumber's operations. The designation of a species as endangered or threatened under the ESA or the CESA can significantly affect Pacific Lumber's business if that species inhabits the Scotia LLC Timberlands. The northern spotted owl, the marbled murrelet and the coho salmon are species the designation of which has the potential to significantly impact Pacific Lumber's business. In the absence of an approved HCP and incidental take permits, Pacific Lumber has been required to operate on a "no-take" basis with respect to these species. Prior to 1998, these matters had not had a significant adverse effect on Pacific Lumber's financial position, results of operations or liquidity. However, Pacific Lumber's 1998 results of operations were adversely affected by certain regulatory and environmental matters, including during the second half of 1998 the absence of a sufficient number of available THPs to enable Pacific Lumber to conduct its operations at historic levels. Consummation of the Headwaters Agreement In September 1996, Pacific Lumber and MAXXAM entered into the Headwaters Agreement with the United States and California that provided the framework for the acquisition by the United States and California of the Headwaters Timberlands owned by the Companies. A substantial portion of the Headwaters Timberlands consists of virgin old growth timberlands. Consummation of the Headwaters Agreement was conditioned upon, among other things (i) federal and state funding, (ii) state approval of an SYP, (iii) federal approval of an HCP designed to monitor and mitigate the incidental take of species in connection with harvesting operations, (iv) the issuance of incidental take permits which allow for "incidental takes" of threatened or endangered species which do not jeopardize their continued existence, (v) acquisition of the Elk River Timberlands and (vi) tax closing agreements satisfactory to MAXXAM and Pacific Lumber. In November 1997, President Clinton signed an appropriations bill which authorized the expenditure of $250 million of federal funds toward consummation of the Headwaters Agreement. In July 1998, the Companies released a draft multi-species habitat conservation plan ("MULTI-SPECIES HCP") and draft SYP (the Multi-Species HCP, together with the SYP, the "COMBINED PLAN") for the purpose of public review and comment. The Combined Plan provided for, among other things, certain measures designed to protect habitat for the marbled murrelet, a coastal seabird, and the northern spotted owl, and required a specified watershed analysis process designed to result in site specific protective zones for fish and other wildlife being established on Pacific Lumber's LLC Timberlands. In September 1998, California Governor Wilson signed a bill (the "CALIFORNIA HEADWATERS BILL") which, among other things, appropriated $130 million toward consummation of the Headwaters Agreement, and authorized the expenditure of up to $80 million toward the acquisition at fair market value of Scotia LLC's Owl Creek grove. The bill also provided that if any portion of the $80 million remained after purchase of the Owl Creek grove, it could be used to purchase certain other timberlands. Other provisions of the California Headwaters Bill authorized the expenditure of up to $20 million for the purchase of a portion of the Grizzly Creek grove, in which the timber is owned by Pacific Lumber and the land is owned by Scotia LLC. The California Headwaters Bill also contained provisions requiring the inclusion of additional environmentally focused provisions in the final version of the Combined Plan, including establishing wider interim streamside "no-cut" buffers (while the watershed analysis process referred to below is being completed) than provided for in the Combined Plan, imposing minimum and maximum "no-cut" buffers upon the completion of the watershed analysis process and designating the Owl Creek grove as a marbled murrelet conservation area. Beginning in December 1998, following the conclusion of the public review and comment period, federal and state regulatory agencies began to propose changes to the Combined Plan. These proposals, together with the California Headwaters Bill, sought to impose more stringent restrictions and requirements, reducing the amount of timber that could be harvested as compared to the amount contemplated by the Combined Plan. As a result, on December 17, 1998, Pacific Lumber announced that its negotiations with the regulatory agencies regarding these proposed revisions had not produced agreement on a Multi-Species HCP, as Pacific Lumber and Scotia LLC could not agree to certain of the proposed revisions and continue to operate effectively. Negotiations continued through December without the parties reaching an agreement, and on December 31, 1998, Pacific Lumber announced that it could not concur with the terms of the then-current agency proposals until it had received a copy of the Final HCP and Final SYP, and it could review and analyze the Final Plans. On January 22, 1999, the federal and state agencies published the Final Plans, which included a revised Multi-Species HCP containing many of the restrictions to which Pacific Lumber had previously objected and certain other new restrictions not agreed to by Pacific Lumber and Scotia LLC. On February 16, 1999, Pacific Lumber and Scotia LLC filed with the CDF certain information regarding the Final Plans and estimates of sustained yield harvest and economic impacts based on various scenarios giving effect to the new proposed restrictions (the "CDF FILING"). Pacific Lumber stated in the CDF Filing that, based on its computer modeled estimates, minimum average annual harvest levels of 210 million board feet of softwoods during the first decade were needed in order to generate income and cash flows to meet interest and capital expenditure obligations; to provide a minimum basis upon which to plan, adjust budget and conduct future operations so as to meet financial obligations and avoid additional layoffs, mill closings and customer supply disruptions; and to satisfy its other obligations to employees, customers and creditors. On February 25, 1999, the CDF delivered a letter to Pacific Lumber that in effect interpreted the Final HCP to limit Pacific Lumber's projected average annual harvest levels during the first decade to approximately 137 million board feet of softwoods. On February 26, 1999, Pacific Lumber announced that it could not proceed to consummate the Headwaters Agreement based on these projected harvest levels and other factors. On March 1, 1999, the CDF delivered a superseding letter to Pacific Lumber approving the Final SYP and stating that, based upon further analysis and information, Pacific Lumber's projected base average annual harvest level during the first decade, consistent with the Final HCP, could be approximately 179 million board feet of softwoods (not including timber harvestable from the additional timber property which Scotia LLC had purchased since the issuance of the Timber Notes ("ADDITIONAL TIMBER PROPERTY") or other potential increases in harvest level). Further, on the same date, the Company received written clarification from the federal and state wildlife agencies that, among other things, the adaptive management provision in the Final HCP would be implemented on a timely and efficient basis, and in a manner that would be both biologically and economically sound. See "--The Final Plans." After consideration of all relevant factors, Pacific Lumber and Scotia LLC consummated the transactions contemplated by the Headwaters Agreement, and in consideration of the transfer of the Headwaters Timberlands, the United States and California paid $300 million, of which Salmon Creek received $299,850,000 (prior to payment of approximately $125,000 of related closing costs) and Scotia LLC received $150,000, and the United States and California transferred to Pacific Lumber approximately 7,700 acres of the Elk River Timberlands. California also entered into agreements with Scotia LLC and Pacific Lumber to purchase the Owl Creek grove and a portion of the Grizzly Creek grove, respectively. Further, in response to uncertainties regarding the potential impact of the consummation of the Headwaters Agreement on the Timber Notes, Salmon Creek deposited $285 million (representing all of its cash proceeds from the sale of the Headwaters Timberlands, net of estimated costs associated with the negotiation and consummation of the Headwaters Agreement), in an escrow account to be made available, while so held, as necessary to support the Timber Notes, and to be released only under certain circumstances. See "-- Escrow Agreement." The Final Plans The Final Plans were also completed in connection with the consummation of the Headwaters Agreement. The Final HCP provides for the issuance by state and federal regulatory agencies of the incidental take permits ("PERMITS") with respect to certain threatened, endangered and other species found on Pacific Lumber's timberlands over the 50 year term of the Final HCP. The Permits issued under the Final HCP allow incidental takes of 17 different species covered by the Final HCP, including the coho salmon, the marbled murrelet, the northern spotted owl and the steelhead trout. The Final HCP has modified certain provisions of the Combined Plan proposed in July 1998 and includes other provisions contemplated by the California Headwaters Bill. Among other things, it no longer covers 19 of the species which were included in the Combined Plan. The Final HCP also increased the size of certain areas to be set aside as marbled murrelet conservation areas, and adopted wider interim streamside "no cut" buffers as contemplated by the California Headwaters Bill. Pending completion of the watershed analysis, the Final HCP also provides for "no cut" buffers adjacent to certain intermittent watercourses on Pacific Lumber's timberlands that flow only in response to significant precipitation. Pacific Lumber has not completed its analysis of the location of all of the intermittent streams on its property. The areas set aside for streamside buffers may be adjusted up or down, subject to certain minimum and maximum buffers, based upon the watershed analysis process, which the Final HCP requires be completed within five years of its effective date. The watershed analysis will also be reassessed every five years. The Final HCP also imposes certain restrictions on the use of roads on the timberlands covered by the Final HCP (the "COVERED LANDS") during several months of the year and during periods of wet weather, except for certain limited situations. These restrictions may restrict operations on the Covered Lands so that many harvesting activities could generally only be carried out from June through October of any particular harvest year, and then only if wet weather conditions do not exist. However, Pacific Lumber anticipates that some harvesting will be able to be conducted during the other months. The Final HCP also requires the Companies to stormproof 75 miles of roads on the Covered Lands on an annual basis, and also to build and repair certain roads. The Final HCP requires the stormproofing to be done between May 2 and October 14 of each year, while the road building and repair is to be accomplished between June 2 and October 14 of each year. The road stormproofing, building and repair is also required to be suspended if certain wet weather conditions exist. The Final HCP contains an adaptive management provision, which various regulatory agencies have clarified will be implemented on a timely and efficient basis, and in a manner which will be both biologically and economically sound. This provision allows the Companies to propose changes that are consistent with the California Agreement (as defined below) to any of the Final HCP prescriptions based on, among other things, certain economic considerations. The regulatory agencies have also clarified that in applying this adaptive management provision, to the extent the changes proposed by Pacific Lumber do not result in the jeopardy of a particular species, the regulatory agencies will consider the practicality of the suggested changes, including the cost to Pacific Lumber and economic feasibility and viability. Implementing Agreements In connection with consummation of the Headwaters Agreement, the Companies entered into several implementing agreements, including an Implementation Agreement with Regard to Habitat Conservation Plan (the "IMPLEMENTATION AGREEMENT") among the Companies and National Marine Fisheries Service ("NMFS"), U.S. Fish and Wildlife Service ("USFWS"), California Department of Fish and Game ("CDFG") and the CDF (the "AGENCIES") to effectuate the Final HCP. Pursuant to the Implementation Agreement, NMFS, USFWS and CDFG found that the Final HCP met all applicable regulatory requirements and authorized the issuance of the Permits. Each new THP on the Covered Lands to be submitted by Pacific Lumber or Scotia LLC is required to incorporate the provisions of the Final HCP. Timber harvesting and certain other specified activities detrimental to the marbled murrelet are prohibited for the life of the Permits in all of the marbled murrelet conservation areas. Such activities are prohibited in the Grizzly Creek grove for an initial five-year period to allow an opportunity for a portion of the grove to be purchased. Timber harvesting and certain other specified activities may take place in the Grizzly Creek grove after the initial five-year period unless USFWS or CDFG, in conjunction with analysis from a scientific panel, make certain determinations under the ESA and CESA regarding the effect on the marbled murrelet of these activities. If USFWS or CDFG make such a determination, the Grizzly Creek grove is required to be managed as a marbled murrelet conservation area. Under the Implementation Agreement, the Companies are required to expend such funds as may be necessary to fulfill each of their obligations under the Final HCP and to post $2 million security to help secure certain of their obligations under the Final HCP, which amount is subject to an annual inflation index and is increased by the amount of any liquidated damages the Companies are required to pay to California in the prior year pursuant to the California Agreement. The Companies are also required to fund an independent third party to monitor compliance with the Final HCP. The Implementation Agreement permits the Companies to add up to 25,000 acres to the Final HCP so long as various conditions are satisfied, including that the acreage to be added must be situated within one mile of the main contiguous portion of the Covered Lands, which are defined in the Implementation Agreement generally to include all timberlands owned by the Companies on the date of the Implementation Agreement. The Implementation Agreement provides that the Companies may relinquish the Permits; provided that in the event of a relinquishment or revocation of the Permits, the Companies must fully mitigate for the take of species that has occurred prior to the relinquishment or revocation. The extent of the full mitigation that would be required depends on a variety of circumstances. If it is determined that the Companies must so mitigate for the prior take of species, the Companies are required to execute a binding covenant running with the land, in form and content satisfactory to the Agencies, setting forth such commitment. The Companies also entered into a separate agreement regarding enforcement of the California Headwaters Bill (the "CALIFORNIA AGREEMENT") with the California Resources Agency, CDFG, the CDF and the California Wildlife Conservation Board ("CWCB"). The California Agreement, among other things, provides that the Companies shall not undertake any timber harvesting detrimental to the marbled murrelet in conservation areas totaling approximately 7,700 acres for 50 years from the effective date of the California Agreement. Pursuant to the requirements of the California Agreement, the terms and conditions of the California Agreement were recorded at closing as terms and conditions against the Covered Lands, to bind the Company and its successors and assigns for a term of 50 years. The California Agreement further provides for various remedies in the event of a breach of the agreement, the Final HCP, the Implementation Agreement, the California Permit, the California Headwaters Bill or any THP, including the issuance of written stop orders with respect to specified harmful activities, and liquidated damages for various breaches. The California Agreement also provides that the Companies are liable to the state for the reasonable costs of mitigation or similar work performed by California as a "self-help" remedy in certain circumstances. The Companies are also required to reimburse California for monitoring for compliance with the agreement and to allow for inspection of timber harvesting activities. The Companies are also required to post $2 million security under the California Agreement (which is the same $2 million required, as described above, under the Implementation Agreement). The California Agreement also provides that it may not be amended unless, among other things, certain California academic officials and a panel of scientists have found the proposed amendment to be consistent with the ESA, the Final HCP and the California Headwaters Bill. Owl Creek and Grizzly Creek Agreements The California Headwaters Bill appropriated up to $80 million toward the purchase of the Owl Creek grove and up to an additional $20 million toward the purchase of a portion (as specified by California) of the Grizzly Creek grove. In connection with the consummation of the Headwaters Agreement, California entered into agreements with respect to the future purchase of the Owl Creek grove (the "OWL CREEK AGREEMENT") and a portion of the Grizzly Creek grove (the "GRIZZLY CREEK AGREEMENT"). Under the Owl Creek Agreement, Scotia LLC agreed to sell the Owl Creek grove to the state of California for consideration consisting of the lesser of the appraised fair market value or $79.65 million. The state may pay the consideration for the Owl Creek grove to Scotia LLC in cash or, at the state's option, 25% in cash and the balance in three equal annual installments without interest. Should Scotia LLC disagree with the methodology of the appraisal or its application, or if the fair market value determined under the appraisal is less than $79.65 million, Scotia LLC would have the right to terminate the Owl Creek Agreement. California must purchase the Owl Creek grove by the later of the state's fiscal year immediately following the fiscal year in which the state purchases the Grizzly Creek property, or June 30, 2001. Consummation of the purchase transaction under the Owl Creek Agreement is also subject to typical real estate title and other closing conditions. The California Headwaters Bill provides that the appraisal methodology, at the Scotia LLC's option, may assume the issuance of various permits and approvals with respect to the Owl Creek grove, including the Permits. With respect to the potential future Grizzly Creek sale, Pacific Lumber and the CWCB agreed that Pacific Lumber would transfer a portion of the Grizzly Creek grove to the state of California at a purchase price not to exceed $19.85 million. Pacific Lumber has furnished a list of licensed appraisers to California, and the state is to select an appraiser from this list to determine the fair market value of the property, with Pacific Lumber having the right to terminate the agreement if it reasonably disagrees with the methodology employed with respect to the appraisal or in the application of such methodology. The Grizzly Creek Agreement provides that California must purchase a portion of the Grizzly Creek grove by no later than October 31, 2000. Consummation of the purchase transaction under the Grizzly Creek Agreement is also subject to typical real estate title and other closing conditions. Also pursuant to the terms of the Grizzly Creek Agreement, Pacific Lumber granted the state of California a five-year option to purchase, at fair market value, additional property within the Grizzly Creek grove. The net proceeds of the sale of the Grizzly Creek property will be placed in escrow (on the same basis as the net proceeds of the sale of the Headwaters Timberlands) unless, at the time of receipt of such proceeds, funds are no longer on deposit under the Escrow Agreement. See "--Escrow Agreement and Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations-- Financial Condition and Investing and Financing Activities." Water Quality Under the Federal Clean Water Act, the Environmental Protection Agency (the "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 ("NCRWQCB") are in the process of establishing TMDL limits for seventeen northern California rivers and certain of their tributaries, including certain water courses that flow within the Scotia LLC Timberlands. As part of this process, the EPA and the NCRWQCB are expected to submit the TMDL requirements on the Scotia LLC Timberlands for public review and comment. Following the comment period, the NCRWQCB would finalize the TMDL requirements applicable to the Scotia LLC Timberlands, which may require aquatic measures that are different from or in addition to the prescriptions to be developed pursuant to the watershed analysis process contained in the Final HCP. Impact of Future Legislation Laws, regulations and related judicial decisions and administrative interpretations dealing with Pacific Lumber's business are subject to change and new laws and regulations are frequently introduced concerning the California timber industry. From time to time, bills are introduced in the California legislature and the U.S. Congress which relate to the business of Pacific Lumber, including the protection and acquisition of old growth and other timberlands, threatened and endangered species, environmental protection, air and water quality and the restriction, regulation and administration of timber harvesting practices. 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 not possible to assess the effect of such future legislative, judicial and administrative events on Pacific Lumber or its business. Timber Operator's License On February 26, 1999, the CDF issued Pacific Lumber a conditional TOL for calendar year 1999. The 1999 TOL requires, among other things, that harvesting under approved THPs by Pacific Lumber, Scotia LLC and their contractors will be governed by limitations that require non-emergency road use activities to cease under certain wet weather conditions. See Item 3. "Legal Proceedings--Timber Operator's License." Escrow Agreement As a result of the sale of the Headwaters Timberlands, Salmon Creek received proceeds of $299,850,000 in cash, prior to payment of closing costs and expenses. Pursuant to an Escrow Agreement entered into among Salmon Creek, Pacific Lumber and Citibank, N.A. (the "ESCROW AGENT"), Salmon Creek has deposited approximately $285 million of such proceeds into a restricted account (the "ESCROWED FUNDS"), which Escrowed Funds will be made available, while so held in escrow, as necessary to support the Timber Notes with the balance of approximately $15 million to be retained to defray expenses in connection with negotiation and consummation of the Headwaters Agreement. In the event that the expenses in connection with the negotiation and consummation of the Headwaters Agreement are less than $15 million, the remaining unused portion of the $15 million estimated expense amount is to be added to the Escrowed Funds. The net proceeds of the sale of a portion of the Grizzly Creek grove will also be placed in escrow (on the same basis as the net proceeds of the sale of the Headwaters Timberlands) unless, at the time of receipt of such proceeds, funds are no longer on deposit under the Escrow Agreement. See Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations-- Financial Condition and Investing and Financing Activities" for information regarding the circumstances under which the Escrowed Funds can be released. ALUMINUM OPERATIONS 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. GENERAL The Company owns 27,938,250 shares of the common stock of Kaiser, representing a 35.3% interest in Kaiser. Kaiser operates in all principal aspects of the aluminum industry through its wholly owned subsidiary, Kaiser Aluminum & Chemical Corporation ("KACC")--the mining of bauxite, the refining of bauxite into alumina, the production of primary aluminum from alumina, and the manufacture of fabricated (including semi-fabricated) aluminum products. In addition to the production utilized by Kaiser in its operations, Kaiser sells significant amounts of alumina and primary aluminum in domestic and international markets. The following table sets forth total shipments and intersegment transfers of Kaiser's alumina, primary aluminum, and fabricated aluminum operations:
YEARS ENDED DECEMBER 31, ---------------------------------------- 1998 1997 1996 ------------ ------------ ------------ (IN THOUSANDS OF TONS(1)) Alumina: Shipments to Third Parties 2,250.0 1,929.8 2,073.7 Intersegment Transfers 750.7 968.0 912.4 Primary Aluminum: Shipments to Third Parties 263.2 327.9 355.6 Intersegment Transfers 162.8 164.2 128.3 Flat-Rolled Products: Shipments to Third Parties 235.6 247.9 204.8 Engineered Products: Shipments to Third Parties 169.4 152.1 122.3 - --------------- (1) Tons in this section of this Report refer to metric tons of 2,204.6 pounds.
SENSITIVITY TO PRICES AND HEDGING PROGRAMS Kaiser's earnings are sensitive to changes in the prices of alumina, primary aluminum and fabricated aluminum products, and also depend to a significant degree upon the volume and mix of all products sold and on Kaiser's hedging strategies. Primary aluminum prices have historically been subject to significant cyclical price fluctuations. Alumina prices, as well as fabricated aluminum product prices (which vary considerably among products), are significantly influenced by changes in the price of primary aluminum, and generally lag behind primary aluminum prices. Since 1993, the Average Midwest United States transaction price (the "AMT PRICE") for primary aluminum has ranged from approximately $.50 to $1.00 per pound. During 1998, the AMT Price per pound of primary aluminum declined during the year, beginning the year in the $.70 to $.75 range and ending the year in the low $.60 range. Subsequent to 1998, the AMT Price continued to decline, and at February 26, 1999, the AMT Price was approximately $.58 per pound. Alumina prices as well as fabricated aluminum product prices (which vary considerably among products) are significantly influenced by changes in the price of primary aluminum and generally lag behind primary aluminum prices. From time to time in the ordinary course of business Kaiser enters into hedging transactions to provide price risk management in respect of its net exposure resulting from (i) anticipated sales of alumina, primary aluminum, and fabricated aluminum products, less (ii) expected purchases of certain items, such as aluminum scrap, rolling ingot, and bauxite, whose prices fluctuate with the price of primary aluminum. Forward sales contracts are used by Kaiser to effectively lock-in or fix the price that KACC will receive for its shipments. Kaiser also uses option contracts (i) to establish a minimum price for its product shipments, (ii) to establish a "collar" or range of prices for its anticipated sales, and/or (iii) to permit Kaiser to realize possible upside price movements. See Item 7A. "Quantitative and Qualitative Disclosures About Market Risk." PRODUCTION OPERATIONS Kaiser's operations are conducted through KACC's decentralized business units which compete throughout the aluminum industry. The alumina business unit mines bauxite and obtains additional bauxite tonnage under long-term contracts. The primary aluminum products business unit operates two wholly owned domestic smelters and two foreign smelters in which Kaiser holds significant ownership interests. Fabricated aluminum products are manufactured by two business units--flat-rolled products and engineered products. These products are manufactured at plants located in principal marketing areas of the United States and Canada. The aluminum utilized in Kaiser's fabricated products operations is comprised of primary aluminum, obtained both internally and from third parties, and scrap metal purchased from third parties. Bauxite and Alumina The following table lists Kaiser's bauxite mining and alumina refining facilities as of December 31, 1998:
ANNUAL PRODUCTION TOTAL CAPACITY ANNUAL COMPANY AVAILABLE TO PRODUCTION ACTIVITY FACILITY LOCATION OWNERSHIP THE COMPANY CAPACITY - ---------------------- ------------ ------------ ------------ ------------ ------------ (THOUSANDS OF TONS) Bauxite Mining KJBC(1) Jamaica 49.0% 4,500.0 4,500.0 Alpart(2) Jamaica 65.0% 2,275.0 3,500.0 ------------ ------------ 6,775.0 8,000.0 ============ ============ Alumina Refining Gramercy Louisiana 100.0% 1,050.0 1,050.0 Alpart Jamaica 65.0% 942.5 1,450.0 QAL(3) Australia 28.3% 1,033.0 3,650.0 ------------ ------------ 3,025.5 6,150.0 ============ ============ - --------------- (1) Although Kaiser owns 49% of Kaiser Jamaica Bauxite Company ("KJBC"), it has the right to receive all of such entity's output. (2) Alumina Partners of Jamaica ("ALPART") bauxite is refined into alumina at the Alpart refinery. (3) Queensland Alumina Limited ("QAL").
Primary Aluminum Products The following table lists Kaiser's primary aluminum smelting Facilities as of December 31, 1998:
ANNUAL RATED TOTAL CAPACITY ANNUAL 1998 COMPANY AVAILABLE TO RATED OPERATING LOCATION FACILITY OWNERSHIP THE COMPANY CAPACITY RATE - --------------------------- ------------ ------------ ------------ ------------ ------------ (THOUSANDS OF TONS) Domestic Washington Mead 100% 200.0 200.0 103% Washington Tacoma 100% 73.0 73.0 94% ------------ ------------ Subtotal 273.0 273.0 ------------ ------------ International Ghana Valco(1) 90% 180.0 200.0 25% Wales, United Anglesey(2) 49% 66.2 135.0 120% Kingdom ------------ ------------ Subtotal 246.2 335.0 ------------ ------------ Total 519.2 608.0 ============ ============ - ------------------------------ (1) Valco Aluminium Company Limited ("Valco") (2) Anglesey Aluminium Limited ("Anglesey")
Fabricated Aluminum Products Kaiser manufactures and markets fabricated aluminum products for the transportation, packaging, construction and consumer durables markets in the United States and abroad. Flat-rolled Products. The flat-rolled product business unit operates the Trentwood, Washington, rolling mill and the Micromill facility near Reno, Nevada. The Trentwood facility accounted for approximately 58% of Kaiser's 1998 fabricated aluminum products shipments. The business unit supplies the aerospace and general engineering markets (producing heat- treat products), the beverage container market (producing body, lid and tab stock) and the specialty coil markets (producing automotive brazing sheet, wheel, and tread products), both directly and through distributors. Engineered Products. The engineered products business unit is headquartered in Southfield, Michigan and operates soft-alloy extrusion facilities in Los Angeles, California; Santa Fe Springs, California; Sherman, Texas; Richmond, Virginia; and London, Ontario, Canada; a cathodic protection business located in Tulsa, Oklahoma, that also extrudes both aluminum and magnesium; rod and bar extrusion facilities in Newark, Ohio, and Jackson, Tennessee, which produce screw machine stock, redraw rod, forging stock, and billet; and a facility in Richland, Washington, which produces seamless tubing in both hard and soft alloys for the automotive, other transportation, export, recreation, agriculture and other industrial markets. The engineered products business unit also operates forging facilities at Oxnard, California and Greenwood, South Carolina; a machine shop at Greenwood, South Carolina; and a casting facility in Canton, Ohio. Kaiser has agreed to sell the Canton, Ohio plant and has signed a letter of intent to sell to its partner its 50% interest in AKW L.P., a partnership which designs, manufactures and sells heavy-duty aluminum truck wheels. The engineered components business unit is one of the largest producers of aluminum forgings in the United States and is a major supplier of high-quality forged parts to customers in the automotive, commercial vehicle and ordnance markets. COMPETITION Aluminum competes in many markets with steel, copper, glass, plastic and other materials. In recent years, plastic containers have increased and glass containers have decreased their respective shares of the soft drink sector of the beverage container market. In the United States, beverage container materials, including aluminum, face increased competition from plastics as increased polyethylene terephthalate ("PET") container capacity is brought on line by plastics manufacturers. Within the aluminum business, Kaiser competes with both domestic and foreign producers of bauxite, alumina and primary aluminum, and with domestic and foreign fabricators. Primary aluminum and, to some degree, alumina are commodities with generally standard qualities, and competition in the sale of these commodities is based primarily upon price, quality and availability. Kaiser also competes with a wide range of domestic and international fabricators in the sale of fabricated aluminum products. Competition in the sale of fabricated products is based upon quality, availability, price and service, including delivery performance. ENVIRONMENTAL AND ASBESTOS CONTINGENCIES Kaiser and KACC are subject to a number of environmental laws, to fines or penalties assessed for alleged breaches of the environmental laws and regulations, and to claims and litigation based upon such laws. Based on Kaiser's evaluation of these and other environmental matters, Kaiser has established environmental accruals primarily related to potential solid waste disposal and soil and groundwater remediation matters. KACC is also a defendant in a number of lawsuits in which the plaintiffs allege that certain of their injuries were caused by, among other things, exposure to asbestos during, and as a result of, their employment or association with KACC or exposure to products containing asbestos produced or sold by KACC. See Note 8 to Kaiser's Consolidated Financial Statements (Exhibit 99.3 hereto) for further information. LABOR MATTERS Substantially all of KACC's hourly workforce at the Gramercy, Louisiana, alumina refinery, Mead and Tacoma, Washington, aluminum smelters, Trentwood, Washington, rolling mill, and Newark, Ohio, extrusion facility were covered by a master labor agreement with the United Steelworkers of America ("USWA") which expired on September 30, 1998. The parties did not reach an agreement prior to the expiration of the master agreement and the USWA chose to strike. In January 1999, Kaiser declined an offer by the USWA to have the striking workers return to work at the five plants without a new agreement. Kaiser imposed a lock-out to support its bargaining position and continues to operate the plants with salaried employees and other workers as it has since the strike began. Based on operating results to date, Kaiser believes that a significant business interruption will not occur. While Kaiser initially experienced an adverse strike-related impact on its profitability in the fourth quarter of 1998, Kaiser believes that KACC's operations at the affected facilities have been substantially stabilized and will be able to run at, or near, full capacity, and that the incremental costs associated with operating the affected plants during the dispute were eliminated or substantially reduced as of January 1999 (excluding the impacts of restart costs of certain potlines at the Mead and Tacoma smelters and the effect of market factors such as a continued market-related curtailment at the Tacoma smelter). However, no assurances can be given that KACC's efforts to run the plants on a sustained basis, without a significant business interruption or material adverse impact on Kaiser's operating results, will be successful. MISCELLANEOUS For further information concerning the business and financial condition of Kaiser, see Kaiser's Consolidated Financial Statements and the notes thereto (Exhibit 99.3 hereto), as well as Kaiser's Annual Report on Form 10-K for the fiscal year ended December 31, 1998. Such Exhibit and Form 10-K are available at no charge by writing to the following address: Kaiser Aluminum Corporation, Shareholder Services Department, 5847 San Felipe, Suite 2600, Houston, Texas 77057. 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 August 12, 1998, an action entitled Environmental Protection Information Center, Inc., Sierra Club v. Pacific Lumber, Scotia Pacific Holding Company, Salmon Creek Corporation (No. C 98-3129) (the "EPIC LAWSUIT") was filed in the United States District Court for the Northern District of California. The action relates to a number of Scotia LLC's THPs. The plaintiffs allege that certain procedural violations of the ESA have resulted from logging activities on the Scotia LLC Timberlands and seek to prevent the defendants from carrying out any harvesting activities until certain wildlife consultation requirements under the ESA are satisfied in connection with the Combined Plan. See Item 1. "Business Regulatory and Environmental Matters and Headwaters Agreement." On September 3, 1998, the Court granted plaintiffs' motion for preliminary injunction covering three THPs (consisting principally of old growth Douglas-fir timber) pending evidentiary hearings. Following the evidentiary hearings, which concluded on October 22, 1998, the Court requested additional briefing, which was filed on November 9, 1998. On March 15, 1999, the Court affirmed its preliminary injunction until it reaches a decision on the merits of the EPIC Lawsuit. However, subsequent to this ruling, the Court heard the defendants' motion for summary judgment on the merits of the case, and issued an order for plaintiffs to show cause why the lawsuit should not be dismissed as moot since the consultation requirement appears to have been concluded. While the Company believes that the consummation of the Headwaters Agreement is a positive development with respect to the EPIC Lawsuit, the Company is unable to predict the outcome of this case or its ultimate impact on the Company's consolidated financial condition or results of operations. On January 26, 1998, an action entitled Coho Salmon, Environmental Information Center, Inc., Sierra Club v. Pacific Lumber, Scotia Pacific Holding Company and Salmon Creek Corporation (No. C 98-0283) (the "COHO LAWSUIT") was filed in the United States District Court for the Northern District of California. This action alleged, 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. On March 22, 1999, the Court approved the agreed dismissal with prejudice of this lawsuit. On May 27, 1998, an action entitled Mateel Environmental Justice Foundation v. Pacific Lumber, Scotia Pacific Holding Company, Salmon Creek Corporation, MAXXAM Group Inc. (No. DR 980301) was brought and is now pending in the Superior Court of Humboldt County. This action alleges, among other things, violations of California's unfair competition law of the business and professions code based on citations and violations (primarily water quality related) issued against the defendants since 1994 in connection with a substantial number of THPs. On January 5, 1999, plaintiff amended its complaint and narrowed its claim to 17 THPs. The plaintiff seeks, among other things, disgorgement of profits and an injunction prohibiting alleged unlawful actions and requiring corrective action. The Company does not believe that this matter will have a material adverse effect upon its business or its consolidated financial condition or results of operations. On December 2, 1997, a lawsuit entitled 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 and Federated Development Company (No. 9700399) (the "WRIGLEY LAWSUIT") was filed in the Superior Court of Humboldt County. This action has been consolidated with an action entitled Jennie Rollins, et al. v. Charles Hurwitz, John Campbell, Pacific Lumber, MAXXAM Group Holdings Inc., Scotia Pacific Holding Company, MAXXAM Group Inc., MAXXAM Inc., Burnum Timber Company (No. 9700400) (the "ROLLINS LAWSUIT") which was also filed on December 2, 1997 in the Superior Court of Humboldt County. These actions allege, among other things, that defendants' logging practices have damaged the plaintiffs' properties and property values by contributing to the destruction of certain watersheds and other areas, including the Elk River watershed and the Stafford area, and have also contributed to landslides in these areas. Plaintiffs further allege that in order to have THPs approved in connection with these areas, the defendants submitted false information to the CDF in violation of the California Business and Professions Code and the Racketeering Influence and Corrupt Practices Act ("RICO"). The plaintiffs have amended their complaints by alleging that the number of THPs involved in the lawsuit was 343 (an increase from the 150 in the original complaints). Plaintiffs seek unspecified damages and other relief. The Company is unable to predict the outcome of this case or the ultimate impact this matter will have on its consolidated financial position, results of operations or liquidity. Scotia LLC is also subject to certain other pending THP cases which would not be expected to have a material adverse effect upon the Company; however, due to the diminished supply of THPs currently held by Scotia LLC, the issuance of injunctive or similar relief in certain of these cases could exacerbate the difficulties that Scotia LLC has been experiencing with respect to the conduct of normal harvesting operations. On or about January 29, 1999, Pacific Lumber received a letter from two private environmental advocacy groups of their 60-day notice of intent to sue Scotia LLC, Pacific Lumber, several of the federal and state agencies and others under the ESA. The letter alleges various violations of the ESA, and challenges, among other things, the validity and legality of the Permits issued in conjunction with the Final Plans. The Company does not know when or if a lawsuit will be filed by the groups regarding these matters, or if a lawsuit is filed, the ultimate impact of such lawsuit on the Final Plans or the Company's consolidated financial condition or results of operations. TIMBER OPERATOR'S LICENSE Historically, Pacific Lumber has conducted logging operations on the Scotia LLC Timberlands with its own staff of logging personnel as well as through contract loggers. In order to conduct logging operations in California, a logging company must obtain from the CDF a timber operator's license ("TOL"), which license is subject to annual renewal. 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 1998 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 (the "STIPULATION") and received a conditional TOL for 1998 ("1998 TOL"). The 1998 TOL and Stipulation were conditioned on, among other things, Pacific Lumber complying with existing requirements governing timber harvesting, wet weather operating restrictions and additional inspection and self-monitoring obligations. Compliance with the obligations set forth in the Stipulation restricted Pacific Lumber's ability to harvest timber and transport logs during periods of wet weather and impaired Pacific Lumber's ability to maintain adequate log inventories during those periods. See Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations-- Results of Operations--Operating Results." In June 1998, an audit inspection performed by the CDF to evaluate forest practice violations found that Pacific Lumber was not in violation of the Stipulation. However, due to violations found or alleged by the CDF after its June 1998 inspection, the CDF notified Pacific Lumber on November 9, 1998 that it had suspended Pacific Lumber's TOL for the remainder of 1998. As a result, Pacific Lumber ceased all operations under its 1998 TOL, and engaged independent contractors to complete harvesting activities on all of the THPs that Pacific Lumber was operating at the time of the notification (independent contractors historically account for approximately 60% of the harvesting activities on Pacific Lumber's timberlands). Pacific Lumber determined not to appeal the suspension of its 1998 TOL, and applied for a new TOL from the CDF for 1999. On December 15, 1998, the CDF denied Pacific Lumber's application for a TOL for 1999. On February 26, 1999, the CDF issued Pacific Lumber a conditional TOL for calendar year 1999. The 1999 TOL requires, among other things, that harvesting under approved THPs by Pacific Lumber, Scotia LLC and their contractors will be governed by limitations that require non-emergency road use activities to cease under certain wet weather conditions. These road use restrictions are substantially similar to those applicable under the Final Plans and the 1998 TOL. The 1999 TOL also provides that Pacific Lumber shall enhance its compliance program by, among other things, providing training for its logging personnel, increasing the size of its compliance team and retaining an outside consulting firm to audit its compliance procedures and make recommendations for improvement. Pacific Lumber has completed most of these items. The 1999 TOL, among other things, also contains a requirement that Pacific Lumber pay a conservation organization designated by the CDF three times the value of any timber felled by Pacific Lumber or any other licensed timber operator in any no- cut zone on Pacific Lumber's timberlands. The 1999 TOL also advises Pacific Lumber that should the 1999 TOL be revoked, the issuance of a new conditional license, absent compelling circumstances, would be unlikely. Pacific Lumber does not believe that the restrictions imposed by the 1999 TOL will have a material adverse effect on its, or the Company's, business or financial performance. In addition to revocation of Pacific Lumber's TOL, other remedies could be sought against Pacific Lumber and Scotia Pacific in connection with violations of the Forest Practice Act. In the past, fines and probation have been imposed on Pacific Lumber in connection with similar violations of the Forest Practices Act. TAKINGS LITIGATION In May 1996, Scotia Pacific, 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 seeking constitutional "just compensation" damages for the taking of certain of their timberlands by the federal government through application of the ESA. Salmon Creek filed a similar action entitled Salmon Creek Corporation v. California State Board of Forestry, et. al. (No. 96CS01057) in the Superior Court of Sacramento County. These actions were dismissed with prejudice as a condition of and upon consummation of the Headwaters Agreement. HUNSAKER MATTER On November 24, 1998, an action entitled William Hunsaker, et al. v. Charles E. Hurwitz, Pacific Lumber, MAXXAM Group Inc., MXM Corp., Federated Development Company and Does I-50 (No. C 98-4515) was filed in the United States District Court for the Northern District of California. This action alleges, among other things, that a class consisting of the vested employees and retirees of the former Pacific Lumber Company (Maine) ("OLD PALCO") is entitled to recover approximately $60 million of surplus funds allegedly obtained through deceit and fraudulent acts from the Old Palco retirement plan that was terminated in 1986 following acquisition by MAXXAM Inc. of Pacific Lumber. Plaintiffs further allege that defendants violated RICO and engaged in numerous acts of unfair business practices in violation of the California Business and Professions Code. In addition to seeking the surplus funds, plaintiffs also seek, among other things, a constructive trust on the assets traceable from the surplus funds, plus interest, trebling of damages for violation of RICO, punitive damages, and injunctive and other relief. On January 11, 1999, the Court granted the defendants' request to stay further proceedings in this matter, except for a case management conference set for March 29,1999, until after the hearing and ruling on the defendants' motion to dismiss, which was filed on January 19, 1999 and was taken under advisement on March 26, 1999. While the Company does not believe this matter will have a material adverse effect on its consolidated financial position, results of operations or liquidity, there can be no assurance that this will be the case. OTHER LITIGATION MATTERS Kaiser is involved in significant legal proceedings, including environmental and asbestos litigation. See Item 1. "Business--Aluminum Operations--Environmental and Asbestos Contingencies" and "-- Miscellaneous". The Company is involved in other claims, lawsuits and other proceedings, including certain pending or threatened actions seeking to prevent Pacific Lumber and Scotia LLC from harvesting under certain of their THPs and conducting certain other operations. 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 consolidated 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 MAXXAM. Accordingly, the Company's common stock is not traded on any stock exchange and has no established public trading market. The 12% Senior Secured Notes due 2003 of the Company (the "MGHI NOTES") are secured by the common stock of MGI and the Pledged Kaiser Shares. See Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations--Financial Condition and Investing and Financing Activities" and Note 5 to the Consolidated Financial Statements appearing in Item 8. ITEM 6. SELECTED FINANCIAL DATA Not applicable. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS BACKGROUND This section contains statements which constitute "forward- looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. See Item 1. "Business--General" for cautionary information with respect to such forward-looking statements. The Company was formed on November 4, 1996, to facilitate the offering of the $130.0 million aggregate principal amount of the MGHI Notes. Subsequent to its formation, the Company received, as a capital contribution from MAXXAM, 100% of the capital stock of MGI and 27,938,250 shares of Kaiser common stock (the "KAISER SHARES") representing a 35.3% interest in Kaiser on a fully diluted basis as of December 31, 1998. The contribution of MGI's capital stock has been accounted for as a reorganization of entities under common control, which requires the Company to record the assets and liabilities of MGI at MAXXAM's historical cost and to also reflect both the historical operating results of MGI and MAXXAM's purchase accounting adjustments which principally relate to MGI's timber and depreciable assets. The contribution of the Kaiser Shares has been reflected in the Consolidated Financial Statements of the Company as if such contribution occurred as of the beginning of the earliest period presented at MAXXAM's historical cost using the equity method of accounting. The Company's wholly owned subsidiary, MGI, and MGI's principal operating subsidiaries, Pacific Lumber and Britt are engaged in forest products operations. The Company's business is highly seasonal and has historically been significantly higher in the months of April through November than in the months of December through March. Management expects that the Company's revenues and cash flows will continue to be markedly seasonal. The impact of seasonality on the Company's results is expected to become more pronounced than it has been historically because of the harvesting, road use, wet weather and other restrictions imposed by the Final HCP. As a result, a substantial majority of the future harvesting on Pacific Lumber's timberlands can be expected to be concentrated during the period from June through October of each year. Some of these restrictions may be modified under the adaptive management provision contained in the Final HCP and as a result of the watershed analysis process to be performed over the five-year period beginning March 1, 1999. See Item 1. "Business-- Regulatory and Environmental Matters and Headwaters Agreement--The Final Plans." The following should be read in conjunction with the Company's Consolidated Financial Statements and the Notes thereto appearing in Item 8. Old growth trees constitute Pacific Lumber's principal source of upper grade redwood lumber, Pacific Lumber's most valuable product. Due to the severe restrictions on Pacific Lumber's ability to harvest old growth timber on its property, Pacific Lumber's supply of upper grade lumber has decreased in a number of premium product categories. Furthermore, logging costs have increased primarily due to the harvest of smaller diameter logs and, to a lesser extent, compliance with environmental regulations relating to the harvesting of timber and litigation costs incurred in connection with certain THPs filed by Pacific Lumber. Pacific Lumber has been able to lessen the impact of these factors by instituting a number of measures at its sawmills during the past several years designed to enhance the efficiency of its operations, such as modernization and expansion of its manufactured lumber facilities and other improvements in lumber recovery. As a result of further limitations on harvesting old growth trees under the Final HCP and the Final SYP, Pacific Lumber expects that its production of premium upper grade lumber products will decline further and that its manufactured lumber products will constitute a higher percentage of its shipments of upper grade lumber products. See also Item 1. "Business--Regulatory and Environmental Factors and Headwaters Agreement." The Company follows the equity method of accounting for its investment in Kaiser. As discussed more fully in Note 4 to the Consolidated Financial Statements, until August 1997, cumulative losses with respect to the results of operations attributable to Kaiser's common stockholders exceeded cumulative earnings. However, this was no longer the case when equity attributable to Kaiser's common stockholders increased upon conversion of the PRIDES into Kaiser common stock on August 29, 1997. As a result, the Company recorded a $33.4 million adjustment to reduce the stockholder's deficit reflecting the Company's 35.4% equity in the impact of the PRIDES conversion on the common stockholders. In addition, the Company began recording its equity in Kaiser's results of operations. See Note 4 to the Notes to the Consolidated Financial Statements for further information, including summarized financial information of Kaiser. RESULTS OF OPERATIONS The following table presents selected operational and financial information for the years ended December 31, 1998, 1997 and 1996.
YEARS ENDED DECEMBER 31, ---------------------------------------- 1998 1997 1996 ------------ ------------ ------------ (IN MILLIONS OF DOLLARS, EXCEPT SHIPMENTS AND PRICES) Shipments: Lumber: (1) Redwood upper grades 41.9 52.4 49.7 Redwood common grades 230.1 244.2 229.6 Douglas-fir upper grades 6.9 11.5 10.6 Douglas-fir common grades 47.5 75.3 74.9 Other 7.0 14.5 17.2 ------------ ------------ ------------ Total lumber 333.4 397.9 382.0 ============ ============ ============ Logs (2) 3.2 11.9 20.1 ============ ============ ============ Wood chips (3) 176.7 237.8 208.9 ============ ============ ============ Average sales price: Lumber: (4) Redwood upper grades $ 1,478 $ 1,443 $ 1,380 Redwood common grades 540 531 511 Douglas-fir upper grades 1,280 1,203 1,154 Douglas-fir common grades 346 455 439 Logs (4) 449 414 477 Wood chips (5) 70 73 76 Net sales: Lumber, net of discount $ 211.6 $ 256.1 $ 234.1 Logs 1.5 4.9 9.6 Wood chips 12.3 17.4 15.8 Cogeneration power 3.9 4.5 3.3 Other 4.3 4.3 1.8 ------------ ------------ ------------ Total net sales $ 233.6 $ 287.2 $ 264.6 ============ ============ ============ Operating income $ 40.6 $ 84.5 $ 73.0 ============ ============ ============ Operating cash flow (6) $ 63.1 $ 110.6 $ 100.2 ============ ============ ============ Income (loss) before income taxes and extraordinary item $ (27.3) $ 23.8 $ 5.9 ============ ============ ============ Net income (loss) $ (59.8) $ 18.6 $ 6.2 ============ ============ ============ Capital expenditures $ 22.0 $ 22.9 $ 15.2 ============ ============ ============ - --------------- (1) Lumber shipments are expressed in millions of board feet. (2) Log shipments are expressed in millions of feet, net Scribner scale. (3) Wood chip shipments are expressed in thousands of bone dry units of 2,400 pounds. (4) Dollars per thousand board feet. (5) Dollars per bone dry unit. (6) Operating income before depletion and depreciation, also referred to as "EBITDA."
Operating Results Net sales declined from $287.2 million for the year ended December 31, 1997 to $233.6 million for the year ended December 31, 1998 primarily due to lower shipments of lumber, logs and wood chips. The decline in shipments which occurred during the first half of 1998 was principally due to well-above-normal rainfall which reduced demand for lumber products and severely limited the availability of rail transportation. The increased rainfall, combined with additional restrictions on Pacific Lumber's wet weather operations pursuant to the terms of the 1998 TOL, and the applicability of logging restrictions during the nesting seasons for both the northern spotted owl and the marbled murrelet, also impeded Pacific Lumber's ability to transport logs to its mills and hindered logging operations, thereby reducing the volume of logs available for the production of lumber products. Revenues for the second half of 1998 were primarily affected by a reduction in the volume of logs harvested and converted into lumber products. Pacific Lumber's reduced harvest level during the second half of 1998 was due in substantial part to the absence of a sufficient number of THPs available for harvest to enable it to conduct its operations at levels consistent with those in the comparable period of 1997. The diminished supply of available THPs was attributable to a reduced volume of approved THPs as well as regulatory and judicial restrictions imposed upon harvesting activities in areas covered by previously approved THPs. See Note 9 to the Consolidated Financial Statements. These difficulties in harvesting and transporting logs affected the types of logs available for the mills and Pacific Lumber's ability to produce a desirable mix of lumber products which in turn adversely affected sales. The reduced number of approved THPs was, and continued to be, attributable to several factors, including a significantly reduced level of THPs submitted by Pacific Lumber to the CDF during 1998 and during the first two months of 1999 due to (a) the extensive amount of time devoted by Pacific Lumber's foresters, wildlife and fisheries biologists and other personnel to (i) amending a significant number of previously submitted THPs to incorporate various new requirements which Pacific Lumber agreed to as part of the February 27, 1998 Pre-Permit Application Agreement (the "PRE- PERMIT AGREEMENT"), (ii) preparing the Combined Plan and all the related data, responding to comments on the Combined Plan, assessing and responding to federal and state proposals and changes concerning the Combined Plan and incorporated into the Final Plans, (iii) responding to comments received by Pacific Lumber from various federal and state governmental agencies with respect to its filed THPs in light of the new and more stringent requirements that Pacific Lumber agreed to observe pursuant to the Pre- Permit Agreement, and (iv) responding to newly filed litigation involving certain of Pacific Lumber's approved THPs (see Item 3. "Legal Proceedings") and (b) implementation of a provision contained in the Pre- Permit Agreement which requires, for the first time, a licensed geologist to review virtually all of Pacific Lumber's THPs prior to submission to the CDF. Pacific Lumber has also experienced an unexpected significantly slower rate of review and approval with respect to its filed THPs due, in large part, to the issues that have emerged in applying the requirements embodied in the Pre-Permit Agreement to Pacific Lumber's THPs, certain of which requirements impose new forestry practices that apply solely to Pacific Lumber's operations. As a result of the factors discussed above, Pacific Lumber had a severely diminished inventory of approved THPs at March 1, 1999 which continues to limit Pacific Lumber's ability to conduct harvesting operations and provide an adequate supply of logs to meet its lumber production requirements. With the consummation of the Headwaters Agreement, Pacific Lumber has completed its work in connection with preparation of the Final Plans; however, significant additional work will be required in connection with its implementation. The remainder of 1999 will be a transition year for Pacific Lumber with respect to the filing and approval of its THPs. Certain of the THPs which were approved by the CDF prior to March 1, 1999 were grandfathered under the Final Plans, and are harvestable subject to the harvesting restrictions prescribed under the THPs and satisfaction of certain agreed conditions. The remaining THPs which were in the process of being reviewed but were not yet approved by the CDF at the time of the consummation of the Final Plans each require varying degrees of revisions in order to comply with the requirements of the Final Plans. The rate of submissions of THPs and the review and approval of THPs during the next quarter may be slower than Pacific Lumber has historically experienced as Pacific Lumber and the CDF develop procedures for implementing the Final Plans. Accordingly, Pacific Lumber believes that its rate of new THP submissions will not increase until some time in the second or third quarter of 1999. Nevertheless, Pacific Lumber anticipates that after a transition period, the implementation of the Final Plans will streamline the process of preparing THPs and potentially shorten the time required to obtain approval of THPs. However, there can be no assurance that Pacific Lumber will not continue to experience difficulties in submitting and receiving approvals of its THPs similar to those it has been experiencing. Net sales for 1997 increased over 1996 due to higher average realized prices and shipments for most categories of redwood and Douglas- fir lumber. See "--Financial Condition and Investing and Financing Activities." Operating Income Operating income for the year ended December 31, 1998 decreased from the comparable prior year period primarily due to the decrease in net sales discussed above. This impact was partially offset by a decrease in depletion expense as a result of the decline in volumes discussed above and a decrease in logging costs for the year ended December 31, 1998 from the prior year period. Operating income for 1997 increased over 1996 principally due to the increase in net sales discussed above. Income (Loss) Before Income Taxes and Extraordinary Item The Company had a loss before income taxes and extraordinary item for the year ended December 31, 1998 as compared to income for the 1997 period primarily due to the decrease in operating income discussed above. Results for the 1998 period were also affected by a decrease in equity in earnings of Kaiser and, to a lesser degree, a decrease in investment income from marketable securities. Kaiser's results for 1998 were negatively affected by strike related costs, a write down of its Micromill assets and lower aluminum prices. Income before income taxes for 1997 increased over 1996 principally due to higher operating income discussed above, and due to an increase in net gains on marketable securities in 1997 and equity in earnings of Kaiser of $7.0 million. Preliminary 1999 Results The Company's operating results for 1999 will be adversely affected by the decrease in log and lumber inventories, which is a result of the severely diminished level of available THPs. Pacific Lumber had an inventory of approved THPs for the harvesting of approximately 61,000 gross Mbf of timber as of March 1, 1999, subject to satisfaction of certain agreed conditions. Pacific Lumber anticipates that, upon expiration of the restricted period of road use imposed under the Final HCP, and given favorable weather conditions, Pacific Lumber should be able to resume more normal harvesting activities in June 1999. Pacific Lumber has terminated or laid off over 200 employees in 1999, and more layoffs will be required. In addition, Pacific Lumber has partially curtailed operations at all of its mills. Pacific Lumber expects that such curtailments will continue for several months until such time as log inventories are adequate to achieve normal lumber production levels. Lumber shipments in 1999 are expected to be adversely affected by this slowdown in production. 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. In December 1996, MGHI issued $130.0 million aggregate principal amount of the MGHI Notes. Net proceeds of $125.0 million received from the offering of the MGHI Notes have been loaned to MAXXAM pursuant to an intercompany note (the "MAXXAM NOTE"). Pursuant to the terms of the MAXXAM Note, MAXXAM is entitled to defer the payment of interest on the MAXXAM Note on any interest payment date to the extent that the Company has sufficient available funds to satisfy its obligations on the MGHI Notes on such date. Any such deferred interest will be added to the principal amount of the MAXXAM Note and will be payable at maturity. Interest deferred on the MAXXAM Note as of December 31, 1998 amounted to $7.8 million. In January 1999, MAXXAM elected to defer all of the $7.3 million interest payment due to the Company on February 1, 1999. The deferred amount effectively increases the note receivable balance to $140.1 million. The Company's ability to service its indebtedness is largely dependent on dividends received from MGI, and to a considerably lesser extent, interest payments from MAXXAM. The MGHI Indenture contains covenants which generally limit dividends from MGI to MGHI to the greater of $18.7 million per year or, on a cumulative basis since September 30, 1996, to MGI's consolidated net income plus consolidated depreciation and depletion. On January 29, 1999, cash dividends of $18.7 million were paid by MGI. The Company expects to receive annual cash dividends from MGI of at least $18.7 million for the next several years; however, subject to the conditions of the Escrow Agreement, the Company may receive a portion of the proceeds from the sale of the Headwaters Timberlands. On July 20, 1998, Scotia LLC issued $867.2 million aggregate principal amount of Timber Notes. Proceeds from the offering of the Timber Notes were used primarily to prepay Scotia Pacific's 7.95% Timber Collateralized Notes due 2015 (the "OLD TIMBER NOTES") and to redeem the 10-1/2% Pacific Lumber Senior Notes due 2003 (the "PACIFIC LUMBER SENIOR NOTES"), the 11-1/4% MGI Senior Secured Notes due 2003 and the 12-1/4% MGI Senior Secured Discount Notes due 2003 (collectively, the "MGI NOTES") effective August 19, 1998. In addition to principal payments, proceeds from the issuance of the Timber Notes were used to pay redemption premiums and financing costs, and provided $25 million for timberland acquisitions. The Company recognized an extraordinary loss of $41.8 million, net of related income tax benefit of $23.6 million, for the early extinguishment of the Old Timber Notes, the Pacific Lumber Senior Notes and the MGI Notes. In connection with the issuance of the Timber Notes and redemption of the MGI Notes, the Company agreed to amend the indenture for the MGHI Notes to, among other things, pledge all of the 27,938,250 shares of Kaiser common stock it owns to secure the MGHI Notes, 16,055,000 shares of which were released from the pledge under the indenture governing the MGI Notes. On December 18, 1998, Pacific Lumber's revolving credit agreement (the "PACIFIC LUMBER CREDIT AGREEMENT") was amended and restated as a new three-year credit facility. The new facility allows borrowings up to $60 million, all of which may be used for revolving borrowings, $20 million of which may be used for standby letters of credit and $30 million of which may be used for timberland acquisitions. Borrowings would be secured by all of Pacific Lumber's domestic accounts receivable and inventory. Borrowings for timberland acquisitions would also be secured by the acquired timberlands and, commencing in April 2001, are to be repaid annually from 50% of Pacific Lumber's cash flow (as defined). The remaining 50% of cash flow would be available for dividends. Upon maturity of the facility, all outstanding borrowings under the credit facility would convert to a term loan repayable over four years. As of December 31, 1998, $27.5 million of borrowings was available under the agreement, no borrowings were outstanding and letters of credit outstanding amounted to $14.4 million. The indenture governing the MGHI Notes, the indenture governing the Timber Notes (the "TIMBER NOTES INDENTURE") and the Pacific Lumber Credit Agreement contain various covenants which, among other things, limit the ability to incur additional indebtedness and liens, to engage in transactions with affiliates, to pay dividends and to make investments. Under the terms of the Timber Notes Indenture, Scotia LLC will generally have available cash for distribution to Pacific Lumber when Scotia LLC's cash flows from operations exceed the amounts required by the Timber Notes Indenture to be reserved for the payment of current debt service (including interest, principal and premiums) on the Timber Notes, capital expenditures and certain other operating expenses. Pacific Lumber can pay dividends in an amount that is generally equal to 50% of Pacific Lumber's consolidated net income plus depletion and cash dividends received from Scotia LLC, exclusive of the net income and depletion of Scotia LLC as long as any Timber Notes are outstanding. Dividends paid are as follows:
DIVIDENDS PAID FOR YEARS ENDED DECEMBER 31, ---------------------------------------- 1998 1997 1996 ------------ ------------ ------------ (IN MILLIONS OF DOLLARS) Scotia LLC $ 532.8 $ 60.8 $ 76.9 ============ ============ ============ Pacific Lumber $ 270.0 $ 23.0 $ 20.5 Britt 6.0 4.0 6.0 ------------ ------------ ------------ $ 276.0 $ 27.0 $ 26.5 ============ ============ ============ MGI $ 18.7 $ 3.0 $ 3.9 ============ ============ ============
Upon the retirement of the Old Timber Notes and the issuance of the Timber Notes, $526.1 million, $263.0 million and $14.7 million cash dividends were paid by Scotia LLC, Pacific Lumber and MGI, respectively. The Escrowed Funds of approximately $285.0 million are to be made available as necessary to support the Timber Notes. Under the Escrow Agreement, the Escrowed Funds will be released by the Escrow Agent only in accordance with resolutions duly adopted by the Board of Managers of Scotia LLC and, unless the resolutions authorize the payment of funds exclusively to, or to the order of, the Trustee or the Collateral Agent under the Timber Notes Indenture, only if one or more of the following conditions are satisfied: (a) the resolutions authorizing the release of the Escrowed Funds are adopted by a majority of the Board of Managers of Scotia LLC (including the affirmative vote of the two independent managers); (b) a Rating Agency Confirmation (as defined in the Timber Notes Indenture) has been received that gives effect to the release or disposition of funds directed by the resolutions; or (c) Scotia LLC has received an opinion from a nationally recognized investment banking firm to the effect that, based on the revised harvest schedule and the other assumptions provided to such firm, the funds that would be available to Scotia LLC based on such harvest schedule, assumptions and otherwise under the Timber Notes Indenture after giving effect to the release or disposition of funds directed by such resolutions would be adequate (i) to pay Scheduled Amortization (as defined in the Timber Notes Indenture) on the Class A-1 and Class A-2 Timber Notes and (ii) to amortize the Class A-3 Timber Notes on a schedule consistent with the original harvest schedule as of July 9, 1998 (assuming that the Class A-3 Timber Notes are not refinanced on January 20, 2014). Recent capital expenditures were made to improve production efficiency, reduce operating costs and acquire additional timberlands. The Company's consolidated capital expenditures were $22.0 million, $22.9 million and $15.2 million for the years ended December 31, 1998, 1997 and 1996, respectively. Capital expenditures, excluding expenditures for timberlands, are estimated to be between $10.0 million and $12.0 million per year for the 1999 - 2001 period. Included in the 1998 capital expenditures of $22.0 million is $12.4 million for timberland acquisitions. From January 1, 1999 through February 28, 1999, Scotia LLC acquired additional timberlands for $10.6 million using funds from an amount held for such acquisitions in an account by the trustee under the Timber Notes Indenture. Pacific Lumber and Scotia LLC may purchase additional timberlands from time to time as appropriate opportunities arise, and such purchases could exceed historical levels. As of December 31, 1998, the Company had working capital of $165.2 million and long-term debt of $990.2 million (net of current maturities) as compared to $164.7 million and $892.9 million, respectively, at December 31, 1997. The increase in long-term debt was primarily due to the issuance of the Timber Notes, offset by the payment of the Old Timber Notes and the redemption of the Pacific Lumber Senior Notes and the MGI Notes. Cash and marketable securities as of December 31, 1998 was $162.5 million, $156.9 million of which represents cash and marketable securities held by subsidiaries. The Company anticipates that existing cash, marketable securities and available sources of financing will be sufficient to fund its working capital and capital expenditure requirements for the next year. With respect to long-term liquidity, dividends from Scotia LLC to Pacific Lumber will be limited for at least the next two to three years, and therefore, absent any release to Pacific Lumber of the Escrowed Funds, Pacific Lumber will not have adequate funds to support all of its working capital and capital expenditure requirements, and it will require contributions from MGI, its indirect parent, to meet any deficiencies. Although the Company believes that its existing cash and cash equivalents should provide sufficient funds to meet the working capital and capital expenditure requirements for itself and its subsidiaries, until such time as Pacific Lumber has adequate cash flows from operations, dividends from Scotia LLC and/or funds released from the Escrowed Funds, there can be no assurance that this will be the case. Furthermore, due to its highly leveraged condition, the Company is more sensitive than less leveraged companies to factors affecting its operations, including governmental regulation and litigation affecting its timber harvesting practices (see Note 9 to the Consolidated Financial Statements), increased competition from other lumber producers or alternative building products and general economic conditions. TRENDS This section contains statements which constitute "forward- looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. See Item 1. "Business--General" for cautionary information with respect to such forward-looking statements. The Company's forest products operations are conducted by Pacific Lumber and Britt. Pacific Lumber's operations are subject to a variety of California and federal laws and regulations dealing with timber harvesting, threatened and endangered species and habitat for such species, air and water quality and restrictions imposed by the Final HCP. Moreover, these laws and regulations are modified from time to time and are subject to judicial and administrative interpretation. Compliance with such laws, regulations and judicial and administrative interpretations, and related litigation have increased the cost of logging operations. There can be no assurance that certain pending regulatory and environmental matters or future governmental regulations, legislation or judicial or administrative decisions, or adverse weather conditions, would not have a material adverse effect on the Company's financial position, results of operations or liquidity. See Item 3. "Legal Proceedings" and Note 9 to the Consolidated Financial Statements for further information regarding regulatory and legal proceedings affecting the Company's operations. YEAR 2000 The Company has established a team to address the potential impacts of the year 2000 on each of its critical business functions. The team has substantially completed its assessment of the Company's critical information technology and embedded technology, including its geographic information system and equipment and systems used in operating its sawmills and cogeneration plant, and is now in the process of making the required modifications for these systems to be year 2000 compliant. The modification costs are expected to be immaterial, costing less than $100,000 and are expected to be completed by mid-year 1999. In most cases testing of the modifications will also be completed by such time. Systems modification costs are being expensed as incurred. Costs associated with new systems are being capitalized and will be amortized over the life of the product. In addition to addressing the Company's internal systems, the team is in the process of identifying key vendors that could be impacted by year 2000 issues, and surveys are being conducted. The Company expects to evaluate the responses to the surveys over the next several months and will make direct contact with parties which are deemed to be critical. These inquiries are being made by the Company's own staff, and the costs associated with this program are expected to be minimal. Kaiser, the Company's equity investee, has implemented a company- wide program to coordinate the year 2000 efforts of its individual business units and to track their progress. The intent of the program is to make sure that critical items are identified on a sufficiently timely basis to assure that the necessary resources can be committed to address any material risk areas that could prevent its systems and assets from being able to meet Kaiser's business needs and objectives. Spending related to this program, which began in 1997 and is expected to continue through 1999, is estimated to be in the $10-15 million range. Kaiser has established an internal goal of having all necessary system changes in place and tested by mid-year 1999. Kaiser plans to commit the necessary resources to meet this deadline. In addition to addressing Kaiser's internal systems, the company-wide program involves identification of key vendor and customer relationships that could be impacted by year 2000 issues. While the Company believes that its program is sufficient to identify the critical issues and associated costs necessary to address possible year 2000 problems in a timely manner, there can be no assurance that the program, or underlying steps implemented, will be successful in resolving all such issues prior to the year 2000. If the steps taken by the Company (or critical third parties) are not made in a timely manner, or are not successful in identifying and remedying all significant year 2000 issues, business interruptions or delays could occur. However, based on the information the Company has gathered to date and its expectations of its ability to remedy problems encountered, the Company believes that it will not experience significant business interruptions that would have a material impact on its results or financial condition. The most reasonably likely worst case scenario which the Company could experience would be problems with certain of the Company's personal computers, field equipment, financial software or GIS software. The Company believes that any such problems could be remedied at minimal cost within a few days and that contingency plans used in the past for dealing with problems with its equipment and software are adequate to address the types of problems which could be encouraged in such a scenario. These plans include purchases of replacement equipment, use of third parties for processing GIS information and working with vendors to make any needed software modifications. RECENT ACCOUNTING PRONOUNCEMENTS Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS NO. 130") was adopted by the Company as of January 1, 1998. SFAS No. 130 requires the presentation of an additional income measure (termed "comprehensive income") which adjusts traditional net income for certain items that previously were only reflected as direct charges to equity (such as minimum pension liabilities). Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS NO. 133"), issued in June 1998, requires companies to recognize all derivative instruments as assets or liabilities in the balance sheet and to measure those instruments at fair value. Kaiser, the Company's equity investee, has hedging programs which use various derivative products to "lock-in" a price (or range of prices) for products sold or used so that earnings and cash flows are subject to reduced risk of volatility. Under SFAS No. 133, Kaiser will be required to "mark-to-market" its hedging positions at the end of each period in advance of the period of recognition for the transaction to which the hedge relates. Pursuant to SFAS No. 130, Kaiser will reflect changes in the fair value of its open hedging positions as an increase or reduction in stockholders' equity through comprehensive income. Under SFAS No. 130, the impact of the changes in the fair value of financial instruments will be reversed from comprehensive income (net of any fluctuations in other "open" positions) and will be reflected in traditional net income upon occurrence of the transaction to which the hedge relates. Under the equity method of accounting which the Company follows in accounting for its investment in Kaiser, the Company will reflect its equity share of Kaiser's adjustments to stockholder's equity through comprehensive income. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 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. This item is not applicable for the Company and its subsidiaries; however, Kaiser, the Company's equity investee, utilizes hedging transactions to lock-in a specified price or range of prices for certain products which it sells or consumes and to mitigate its exposure to changes in foreign currency exchange rates. See Exhibit 99.3 for information relative to Kaiser's hedging activities. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To MAXXAM Group Holdings Inc.: We have audited the accompanying consolidated balance sheets of MAXXAM Group Holdings Inc. (a Delaware corporation and a wholly owned subsidiary of MAXXAM Inc.) and subsidiaries as of December 31, 1998 and 1997, 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, 1998. These financial statements and the schedule referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of MAXXAM Group Holdings Inc. and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. Our audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The schedule listed in Item 14(a)(2) of this Form 10-K is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the audits of the basic consolidated financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic consolidated financial statements taken as a whole. ARTHUR ANDERSEN LLP San Francisco, California March 1, 1999 MAXXAM GROUP HOLDINGS INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (IN MILLIONS OF DOLLARS, EXCEPT SHARE INFORMATION)
DECEMBER 31, ---------------------- 1998 1997 ---------- ---------- ASSETS Current assets: Cash and cash equivalents $ 150.8 $ 91.7 Marketable securities 11.7 51.3 Receivables: Trade 10.5 19.3 Other 7.1 6.7 Inventories 44.0 61.4 Prepaid expenses and other current assets 8.0 13.1 ---------- ---------- Total current assets 232.1 243.5 Timber and timberlands, net of accumulated depletion of $178.4 and $169.2, respectively 302.3 299.1 Property, plant and equipment, net of accumulated depreciation of $85.7 and $76.4 respectively 103.1 103.4 Note receivable from MAXXAM Inc. 132.8 125.0 Investment in Kaiser Aluminum Corporation 41.5 41.4 Deferred financing costs, net 26.2 25.7 Deferred income taxes 90.4 58.8 Restricted cash 16.6 28.4 Other assets 7.2 4.2 ---------- ---------- $ 952.2 $ 929.5 ========== ========== LIABILITIES AND STOCKHOLDER'S DEFICIT Current liabilities: Accounts payable 3.4 3.5 Accrued interest 34.9 30.8 Accrued compensation and related benefits 8.4 12.6 Deferred income taxes 9.7 10.9 Other accrued liabilities 2.2 1.6 Long-term debt, current maturities 8.3 19.4 ---------- ---------- Total current liabilities 66.9 78.8 Long-term debt, less current maturities 990.2 892.9 Other noncurrent liabilities 29.6 29.0 ---------- ---------- Total liabilities 1,086.7 1,000.7 ---------- ---------- Contingencies Stockholder's deficit: Common stock, $1.00 par value; 3,000 shares authorized; 1,000 shares issued - - Additional capital 123.2 123.2 Accumulated deficit (257.7) (194.4) ---------- ---------- Total stockholder's deficit (134.5) (71.2) ---------- ---------- $ 952.2 $ 929.5 ========== ========== The accompanying notes are an integral part of these financial statements.
MAXXAM GROUP HOLDINGS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS (IN MILLIONS OF DOLLARS)
YEARS ENDED DECEMBER 31, ---------------------------------------- 1998 1997 1996 ------------ ------------ ------------ Net sales: Lumber and logs $ 213.1 $ 261.0 $ 243.7 Other 20.5 26.2 20.9 ------------ ------------ ------------ 233.6 287.2 264.6 ------------ ------------ ------------ Operating expenses: Cost of goods sold 155.3 162.0 148.5 Selling, general and administrative 15.2 14.6 15.9 expenses Depletion and depreciation 22.5 26.1 27.1 ------------ ------------ ------------ 193.0 202.7 191.5 ------------ ------------ ------------ Operating income 40.6 84.5 73.1 Other income (expense): Equity in earnings of Kaiser Aluminum Corporation .1 7.0 - Investment, interest and other income 23.6 27.3 11.2 Interest expense (91.6) (95.0) (78.4) ------------ ------------ ------------ Income (loss) before income taxes and extraordinary item (27.3) 23.8 5.9 Credit (provision) in lieu of income taxes 9.3 (5.2) .3 ------------ ------------ ------------ Income (loss) before extraordinary item (18.0) 18.6 6.2 Extraordinary item: Loss on early extinguishment of debt, net of income tax benefit of $23.6 (41.8) - - ------------ ------------ ------------ Net income (loss) $ (59.8) $ 18.6 $ 6.2 ============ ============ ============ The accompanying notes are an integral part of these financial statements.
MAXXAM GROUP HOLDINGS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (IN MILLIONS OF DOLLARS)
YEARS ENDED DECEMBER 31, ---------------------------------------- 1998 1997 1996 ------------ ------------ ------------ Cash flows from operating activities: Net income (loss) $ (59.8) $ 18.6 $ 6.2 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depletion and depreciation 22.5 26.1 27.1 Extraordinary loss on early extinguishment of debt, net 41.8 - - Equity in undistributed earnings of Kaiser Aluminum Corporation (.1) (7.0) - Amortization of deferred financing costs and discounts on long-term debt 11.5 16.6 14.7 Net sales (purchases) of marketable securities 42.6 (11.3) 9.5 Net gains on marketable securities (2.9) (8.6) (4.4) Increase (decrease) in cash resulting from changes in: Receivables 1.0 (5.2) 1.5 Inventories, net of depletion 14.0 9.7 6.0 Prepaid expenses and other current assets (2.7) (5.4) .7 Accounts payable (.3) (.4) (.2) Accrued interest 4.0 5.6 (.1) Accrued and deferred income taxes (10.5) 4.8 (.7) Other liabilities (4.0) 2.5 (3.5) Other (1.8) .1 (.7) ------------ ------------ ------------ Net cash provided by operating activities 55.3 46.1 56.1 ------------ ------------ ------------ Cash flows from investing activities: Capital expenditures (21.2) (13.5) (15.2) Issuance of note to MAXXAM Inc. - - (125.0) Net proceeds from sale of assets 6.6 .4 .1 Restricted cash withdrawals used to acquire timberlands 8.9 - - ------------ ------------ ------------ Net cash used for investing activities (5.7) (13.1) (140.1) ------------ ------------ ------------ Cash flows from financing activities: Proceeds from issuance of debt 867.2 - 130.0 Premiums for early retirement of debt (45.5) - - Principal payments on long-term debt (796.8) (16.3) (14.1) Dividends paid (2.5) - (3.9) Restricted cash withdrawals, net 9.4 1.5 1.4 Incurrence of deferred financing costs (22.4) - (4.2) ------------ ------------ ------------ Net cash provided by (used for) financing activities 9.4 (14.8) 109.2 ------------ ------------ ------------ Net increase in cash and cash equivalents 59.0 18.2 25.2 Cash and cash equivalents at beginning of year 91.8 73.6 48.4 ------------ ------------ ------------ Cash and cash equivalents at end of year $ 150.8 $ 91.8 $ 73.6 ============ ============ ============ The accompanying notes are an integral part of these financial statements.
MAXXAM GROUP HOLDINGS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDER'S DEFICIT (IN MILLION OF DOLLARS)
ACCUMU- LATIVE OTHER COMMON ADDI- ACCUM- COMPRE- COMPRE- STOCK TIONAL ULATED HENSIVE HENSIVE ($1.00 PAR) CAPITAL DEFICIT INCOME TOTAL INCOME ------------ ------------ ------------ ------------ ------------ ------------ Balance, January 1, 1996 $ - $ 89.8 $ (216.3) $ - $ (126.5) Net income - - 6.2 - 6.2 $ 6.2 ------------ Comprehensive income $ 6.2 ============ Dividends - - (3.9) - (3.9) ------------ ------------ ------------ ------------ ------------ Balance, December 31, 1996 - 89.8 (214.0) - (124.2) Net income - - 18.6 - 18.6 $ 18.6 Equity in Kaiser Aluminum Corporation's reduction of pension liability - - - 1.0 1.0 1.0 ------------ Comprehensive income $ 19.6 ============ Gain from issuance of Kaiser Aluminum Corporation common stock due to PRIDES conversion - 33.4 - - 33.4 ------------ ------------ ------------ ------------ ------------ Balance, December 31, 1997 - 123.2 (195.4) 1.0 (71.2) Net loss - - (59.8) - (59.8) $ (59.8) Equity in Kaiser Aluminum Corporation's reduction of pension liability reversal - - - (1.0) (1.0) (1.0) ------------ Comprehensive loss $ (60.8) ============ Dividend - - (2.5) - (2.5) ------------ ------------ ------------ ------------ ------------ Balance, December 31, 1998 $ - $ 123.2 $ (257.7) $ - $ (134.5) ============ ============ ============ ============ ============ The accompanying notes are an integral part of these financial statements.
MAXXAM GROUP HOLDINGS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES FORMATION OF MGHI MAXXAM Group Holdings Inc. ("MGHI") was formed on November 4, 1996, to facilitate the offering of the $130.0 million aggregate principal amount of 12% Senior Secured Notes due 2003 (the "MGHI NOTES") as described in Note 5. Subsequent to its formation, MGHI received, as a capital contribution from MAXXAM Inc. ("MAXXAM"), 100% of the capital stock of MAXXAM Group Inc. ("MGI") and 27,938,250 shares of the common stock of Kaiser Aluminum Corporation ("KAISER") which represents a 35.3% interest in Kaiser on a fully diluted basis as of December 31, 1998. The contribution of MGI's capital stock has been accounted for as a reorganization of entities under common control, which requires MGHI to record the assets and liabilities of MGI at MAXXAM's historical cost. Accordingly, MGHI is the successor entity to MGI and as such, the accompanying financial statements of MGHI and its subsidiaries (together, the "COMPANY") reflect both the historical operating results of MGI and MAXXAM's purchase accounting adjustments which principally relate to MGI's timber and depreciable assets. The purchase accounting adjustments arose from MAXXAM's acquisition of MGI in May 1988. The contribution of the Kaiser common stock has been reflected in the consolidated financial statements of the Company as if such contribution occurred as of the beginning of the earliest period presented, at MAXXAM's historical cost using the equity method of accounting. The Company conducts its business primarily through the operations of its subsidiaries, including MGI. BASIS OF PRESENTATION The consolidated financial statements include the accounts of MGHI and its subsidiaries. MGHI is a wholly owned subsidiary of 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's wholly owned subsidiary, MGI, and its wholly owned subsidiaries, The Pacific Lumber Company ("PACIFIC LUMBER") and Britt Lumber Co., Inc. ("BRITT") are engaged in forest products operations. Pacific Lumber's principal wholly owned subsidiaries are Scotia Pacific Company LLC ("SCOTIA LLC") and Salmon Creek Corporation ("SALMON CREEK"). Pacific Lumber is engaged in several principal aspects of the lumber industry, including the growing and harvesting of redwood and Douglas-fir timber, the milling of logs into lumber and the manufacture of lumber into a variety of finished products. Britt manufactures redwood and cedar fencing and decking products from small diameter logs, a substantial portion of which are obtained from Pacific Lumber. Housing, construction and remodeling are the principal markets for the Company's lumber products. 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 9 could differ materially from current estimates. The results of an adverse resolution of such uncertainties could have a material effect on the Company's consolidated financial position, results of operations or liquidity. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Cash Equivalents Cash equivalents consist of highly liquid money market instruments with original maturities of three months or less. Marketable Securities Marketable securities which consist of corporate bonds and long and short positions in corporate common stocks are carried at fair value. The cost of the securities sold is determined using the first-in, first-out method. Included in investment, interest and other income for each of the three years ended December 31, 1998 were: 1998 - net unrealized holding gains of $5.1 million and net unrealized losses of $2.2 million; 1997 - net unrealized holding gains of $2.9 million and net realized gains of $5.7 million and; 1996 - net unrealized holding losses of $.9 million and net realized gains of $5.3 million. Inventories Inventories are stated at the lower of cost or market. Cost is primarily determined using the last-in, first-out ("LIFO") method. Timber and Timberlands Timber and timberlands are stated at cost, net of accumulated depletion. Depletion is computed utilizing the unit-of-production method based upon estimates of timber values and quantities. Property, Plant and Equipment Property, plant and equipment, including capitalized interest, is stated at cost, net of accumulated depreciation. Depreciation is computed utilizing the straight-line method at rates based upon the estimated useful lives of the various classes of assets. The carrying value of property, plant and equipment is assessed when events and circumstances indicate that an impairment is present. Impairment is determined by measuring 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 At December 31, 1998, cash and cash equivalents includes $28.4 million, which is reserved 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"). At December 31, 1997, cash and cash equivalents includes $17.8 million, which was reserved for debt service payments on the Company's 7.95% Timber Collateralized Notes due 2015 (the "OLD TIMBER NOTES"). Long-term restricted cash 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. Long-term restricted cash at December 31, 1997 primarily represents the amount held by the trustee in the liquidity account (the "LIQUIDITY ACCOUNT") maintained by Scotia Pacific with respect to the Old Timber Notes for the benefit of holders of the Old Timber Notes under the indenture governing the Old Timber Notes. Also included in cash and cash equivalents is restricted cash of $46.4 million and $9.7 million at December 31, 1998 and 1997, respectively, which is held in an interest-bearing account as security for short positions in marketable securities. Concentrations of Credit Risk The amounts held by the trustee in an account restricted for debt service payments on the Timber Notes (the "PAYMENT ACCOUNT") and held in the Prefunding Account for purchase of timberlands are invested primarily in commercial paper and other short-term investments. The Company mitigates its concentration of credit risk with respect to these restricted cash deposits by purchasing only high grade investments (ratings of A1/P1 short-term or AAA/aaa long-term debt) having maturities of less than three months. No more than 10% is invested within the same issue. Fair Value of Financial Instruments The carrying amounts of cash equivalents and restricted cash approximate fair value. Marketable securities are carried at fair value which is determined based on quoted market prices. As of December 31, 1998 and 1997, the estimated fair value of long-term debt, including current maturities, was $942.8 million and $955.2 million, respectively. The estimated fair value of long-term 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. Some of the Company's publicly traded debt issues are thinly traded financial instruments; accordingly, their market prices at any balance sheet date may not be representative of the prices which would be derived from a more active market. 2. INVENTORIES Inventories consist of the following (in millions):
DECEMBER 31, -------------------------- 1998 1997 ------------ ------------ Lumber $ 36.0 $ 49.8 Logs 8.0 11.6 ------------ ------------ $ 44.0 $ 61.4 ============ ============
3. PROPERTY, PLANT AND EQUIPMENT The major classes of property, plant and equipment are as follows (dollar amounts in millions):
DECEMBER 31, ESTIMATED -------------------------- USEFUL LIVES 1998 1997 ------------ ------------ ------------ Logging roads, land and improvements 15 years $ 28.8 $ 24.2 Buildings 33 years 50.6 49.3 Machinery and equipment 3 - 15 years 109.4 106.2 Construction in progress - .1 ------------ ------------ 188.8 179.8 Less: accumulated depreciation (85.7) (76.4) ------------ ------------ $ 103.1 $ 103.4 ============ ============
Depreciation expense for the years ended December 31, 1998, 1997 and 1996 was $9.8 million, $9.9 million and $9.5 million, respectively. 4. INVESTMENT IN KAISER Subsequent to its formation, the Company received, as a capital contribution from MAXXAM, 27,938,250 shares of the common stock of Kaiser all of which are pledged as collateral for the MGHI Notes (the "KAISER SHARES"). Kaiser is a fully integrated producer and marketer of alumina, primary aluminum and fabricated aluminum products. Kaiser's common stock is publicly traded on the New York Stock Exchange under the trading symbol "KLU." The Kaiser Shares represent 35.3% equity interest in Kaiser at December 31, 1998. The Company follows the equity method of accounting for its investment in Kaiser. As described in Note 1, the Company and MAXXAM are entities under common control; accordingly, the Company has recorded its investment in Kaiser at MAXXAM's historical cost. During the first quarter of 1993, losses exhausted Kaiser's equity with respect to its common stockholders. The Company recorded its equity share of such losses in January 1993 up to the amount of its investment in the Kaiser Shares. From January 1993 until August 1997, cumulative losses with respect to the results of operations attributable to Kaiser's common stockholders exceeded cumulative earnings. However, this was no longer the case when equity attributable to Kaiser's common stockholders increased upon conversion of the PRIDES into Kaiser common stock on August 29, 1997. As a result, the Company recorded a $33.4 million adjustment to reduce the stockholder's deficit reflecting the Company's 35.4% equity interest in the impact of the PRIDES conversion on the common stockholders. In addition, the Company began recording its equity in Kaiser's results of operations. The market value for the Kaiser Shares based on the price per share quoted at the close of business on March 1, 1998 was $137.9 million There can be no assurance that such value would be realized should the Company dispose of its investment in the Kaiser Shares. The following tables contain summarized financial information of Kaiser (in millions).
DECEMBER 31, -------------------------- 1998 1997 ------------ ------------ Current assets $ 1,030.0 $ 1,045.6 Property, plant and equipment, net 1,108.7 1,171.8 Other assets 852.2 796.5 ------------ ------------ Total assets $ 2,990.9 $ 3,013.9 ============ ============ Current liabilities $ 558.4 $ 594.1 Long-term debt, less current maturities 962.6 962.9 Other liabilities 1,227.2 1,212.2 Minority interests 123.5 127.7 Stockholders' equity: Common 119.2 117.0 ------------ ------------ 119.2 117.0 ------------ ------------ Total liabilities and stockholders' equity $ 2,990.9 $ 3,013.9 ============ ============
YEARS ENDED DECEMBER 31, ---------------------------------------- 1998 1997 1996 ------------ ------------ ------------ Net sales $ 2,256.4 $ 2,373.2 $ 2,190.5 Costs and expenses (2,120.8) (2,185.5) (2,092.7) Restructuring of operations - (19.7) - Impairment of assets (45.0) - - Other expenses-net (106.5) (107.7) (96.1) ------------ ------------ ------------ Income (loss) before income taxes and minority interests (15.9) 60.3 1.7 Credit (provision) for income taxes 16.4 (8.8) 9.3 Minority interests .1 (3.5) (2.8) ------------ ------------ ------------ Net income .6 48.0 8.2 Dividends on preferred stock - (5.5) (8.4) ------------ ------------ ------------ Net income (loss) available to common stockholders $ .6 $ 42.5 $ (.2) ============ ============ ============ Equity in earnings of Kaiser $ .1 $ 7.0 $ - ============ ============ ============
5. LONG-TERM DEBT Long-term debt consists of the following (in millions):
DECEMBER 31, -------------------------- 1998 1997 ------------ ------------ 7.43% Scotia LLC Timber Collateralized Notes due July 20, 2028 $ 867.2 $ - 7.95% Scotia Pacific Timber Collateralized Notes due July 20, 2015 - 320.0 10-1/2% Pacific Lumber Senior Notes due March 1, 2003 - 235.0 Pacific Lumber Credit Agreement - 9.4 11-1/4% MGI Senior Secured Notes due August 1, 2003 - 100.0 12-1/4% MGI Senior Secured Discount Notes due August 1, 2003, net of discount - 117.3 12% MGHI Senior Secured Notes due August 1, 2003 130.0 130.0 Other 1.3 .6 ------------ ------------ 998.5 912.3 Less: current maturities (8.3) (19.4) ------------ ------------ $ 990.2 $ 892.9 ============ ============
Scotia LLC Timber Collateralized Notes due 2028 On July 20, 1998, Scotia LLC issued $867.2 million aggregate principal amount of Timber Notes which have an overall effective interest rate of 7.43% per annum. Net proceeds from the offering of the Timber Notes were used primarily to prepay the Old Timber Notes and to redeem the 10-1/2% Pacific Lumber Senior Notes, the 11-1/4% MGI Senior Secured Notes and the 12-1/4% MGI Senior Secured Discount Notes (collectively, the "MGI NOTES") effective August 19, 1998. The Company recognized an extraordinary loss of $41.8 million, net of the related income tax benefit of $23.6 million, in 1998 for the early extinguishment of the Old Timber Notes, the Pacific Lumber Senior Notes and the MGI Notes. Concurrently with the issuance of the Timber Notes, (i) Scotia Pacific was merged into Scotia LLC, (ii) Pacific Lumber transferred to Scotia LLC approximately 13,500 acres of timberlands and the timber and timber harvesting rights with respect to an additional 19,700 acres of timberlands, and (iii) Scotia LLC transferred to Pacific Lumber the timber and timber harvesting rights related to approximately 1,400 acres of timberlands. Under the Timber Notes Indenture, the business activities of Scotia LLC are generally limited to the ownership and operation of its timber and timberlands. The Timber Notes are senior secured obligations of Scotia LLC and are not obligations of, or guaranteed by, Pacific Lumber or any other person. The Timber Notes are secured by a lien on (i) Scotia LLC's timber and timberlands (representing $252.0 million of the Company's consolidated timber and timberlands balance at December 31, 1998), and (ii) substantially all of Scotia LLC's other property. Interest on the Timber Notes is further secured by a line of credit agreement between Scotia LLC and a bank pursuant to which Scotia LLC may borrow to pay interest on the Timber Notes. 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 $160.7 million of Class A-1 Timber Notes). The Timber Notes are 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 in order to avoid an Event of Default 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. Principal and interest on the Timber Notes are payable semi- annually on January 20 and July 20. The Timber Notes are redeemable at the option of Scotia LLC at any time. The redemption price of the Timber Notes is equal to the sum of the principal amount, accrued interest and a prepayment premium calculated based upon the yield of like-term Treasury securities plus 50 basis points. As a result of the sale of approximately 5,600 acres of Pacific Lumber's timberlands consisting of two forest groves commonly referred to as the Headwater Forest and Elk Head Springs Forest (the "HEADWATERS TIMBERLANDS") on March 1, 1999, Salmon Creek received proceeds of $299.9 million in cash. See Note 12 to the Consolidated Financial Statements. Salmon Creek has deposited approximately $285.0 million of such proceeds into an escrow account (the "ESCROWED FUNDS"), pursuant to an escrow agreement (the "ESCROW AGREEMENT") as necessary to support the Timber Notes. The net proceeds of the sale of the Grizzly Creek grove will also be placed in escrow (on the same basis as the net proceeds of the sale of the Headwaters Timberlands) unless, at the time of receipt of such proceeds, funds are no longer on deposit under the Escrow Agreement. Under the Escrow Agreement, the Escrowed Funds will be released by the Escrow Agent only in accordance with resolutions duly adopted by the Board of Managers of Scotia LLC and, unless the resolutions authorize the payment of funds exclusively to, or to the order of, the Trustee or the Collateral Agent under the Timber Notes Indenture, only if one or more of the following conditions are satisfied: (a) the resolutions authorizing the release of the Escrowed Funds are adopted by a majority of the Board of Managers of Scotia LLC (including the affirmative vote of the two independent managers); (b) a Rating Agency Confirmation (as defined in the Timber Notes Indenture) has been received that gives effect to the release or disposition of funds directed by the resolutions; or (c) Scotia LLC has received an opinion from a nationally recognized investment banking firm to the effect that, based on the revised harvest schedule and the other assumptions provided to such firm, the funds that would be available to Scotia LLC based on such harvest schedule, assumptions and otherwise under the Timber Notes Indenture after giving effect to the release or disposition of funds directed by such resolutions would be adequate (i) to pay Scheduled Amortization (as defined in the Timber Notes Indenture) on the Class A-1 and Class A-2 Timber Notes and (ii) to amortize the Class A-3 Timber Notes on a schedule consistent with the original harvest schedule as of July 9, 1998 (assuming that the Class A-3 Timber Notes are not refinanced on January 20, 2014). Pacific Lumber Credit Agreement On December 18, 1998, the Pacific Lumber Credit Agreement was amended and restated as a new three-year senior secured credit facility which expires on October 31, 2001. The new facility allows for borrowings of up to $60 million, all of which may be used for revolving borrowings, $20 million of which may be used for standby letters of credit and $30 million of which may be used for timberland acquisitions. Borrowings would be secured by all of Pacific Lumber's domestic accounts receivable and inventory. Borrowings for timberland acquisitions would also be secured by the acquired timberlands and, commencing in April 2001, are to be repaid annually from 50% of Pacific Lumber's 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, 1998, Pacific Lumber had $27.5 million of borrowings available under the agreement, no borrowings were outstanding and letters of credit outstanding amounted to $14.4 million. 12% MGHI Senior Secured Notes due 2003 (the "MGHI NOTES") The MGHI Notes due August 1, 2003 are guaranteed on a senior, unsecured basis by MAXXAM. The common stock of MGI serves as security for the MGHI Notes. Interest is payable semi-annually. In connection with the redemption of the MGI Notes and the issuance of the Timber Notes, MGHI amended the indenture for the MGHI Notes, to among other things, pledge all of the 27,938,250 shares of Kaiser common stock it owns, 16,055,000 shares of which were released from the pledge securing the MGI Notes. The net proceeds from the offering of the MGHI Notes after estimated expenses were approximately $125.0 million, all of which was loaned to MAXXAM pursuant to an intercompany note (the "MAXXAM NOTE") which is pledged to secure the MGHI Notes. The MAXXAM Note bears interest at the rate of 11% per annum (payable semi-annually on the interest payment dates applicable to the MGHI Notes) and matures on August 1, 2003. MAXXAM is entitled to defer the payment of interest on the MAXXAM Note on any interest payment date to the extent that the Company has sufficient available funds to satisfy its obligations on the MGHI Notes on such date. Any such deferred interest will be added to the principal amount of the MAXXAM Note and will be payable at maturity. As of December 31, 1998, $7.8 million of interest had been deferred and added to principal. An additional $7.3 million was deferred and added to principal in January 1999. Maturities Scheduled maturities of long-term debt for the five years following December 31, 1998 are: $8.3 million in 1999, $16.1 million in 2000, $16.5 million in 2001, $17.3 million in 2002, $149.5 million in 2003 and $790.8 million thereafter. Restricted Net Assets of Subsidiaries As of December 31, 1998 and 1997, all of the assets of MGI and its subsidiaries 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, 1998, 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. 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 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. The remaining subsidiaries of MGI are each liable to MAXXAM for their respective income tax liabilities computed on a separate company basis as if they were never connected with MAXXAM, pursuant to their respective tax allocation agreements. MGI's tax allocation agreement with MAXXAM (the "TAX ALLOCATION AGREEMENT") provides that MGI's federal income tax liability is computed as if MGI files a consolidated tax return with all of its subsidiaries except Salmon Creek, and that such corporations were never connected with MAXXAM (the "MGI CONSOLIDATED TAX LIABILITY"). The federal income tax liability of MGI is the difference between (i) the MGI Consolidated Tax Liability and (ii) the sum of the separate tax liabilities for MGI's subsidiaries (computed as discussed above), but excluding Salmon Creek. To the extent that the MGI Consolidated Tax Liability is less than the aggregate amounts in (ii), MAXXAM is obligated to pay the amount of such difference to MGI. The Company entered into a tax allocation agreement with MAXXAM on December 23, 1996 (the "MGHI TAX ALLOCATION AGREEMENT") which provides that the Company's federal consolidated tax liability is computed for MGHI and its subsidiaries as if MGHI and its subsidiaries, except Salmon Creek, file a consolidated tax return and that such corporations were never connected with MAXXAM (the "MGHI CONSOLIDATED TAX LIABILITY"). The tax amounts for prior years are calculated as if the MGHI Tax Allocation Agreement was in effect during those years. The federal income tax liability of MGHI is the difference between the MGHI Consolidated Tax Liability and the MGI Consolidated Tax Liability. To the extent that the MGHI Consolidated Tax Liability is less than the MGI Consolidated Tax Liability, MAXXAM is obligated to pay the amount of such difference to MGHI. 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, ---------------------------------------- 1998 1997 1996 ------------ ------------ ------------ Current: Federal in lieu of income taxes $ .1 $ (.4) $ (.2) State and local (.1) (.1) - ------------ ------------ ------------ - (.5) (.2) ------------ ------------ ------------ Deferred: Federal in lieu of income taxes 7.1 (4.7) - State and local 2.2 - .5 ------------ ------------ ------------ 9.3 (4.7) .5 ------------ ------------ ------------ $ 9.3 $ (5.2) $ .3 ============ ============ ============
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, ---------------------------------------- 1998 1997 1996 ------------ ------------ ------------ Income (loss) before income taxes and extraordinary item $ (27.4) $ 23.8 $ 5.9 ============ ============ ============ Amount of federal income tax credit (provision) based upon the statutory rate $ 9.6 $ (8.3) $ (2.1) Revision of prior years' tax estimates and other changes in valuation allowances (1.4) .9 3.4 Equity in earnings of Kaiser not tax effected .1 2.5 - State and local taxes, net of federal tax effect 1.3 (.1) (.6) Expenses for which no federal tax benefit is available (.3) (.2) (.5) Other - - .1 ------------ ------------ ------------ $ 9.3 $ (5.2) $ .3 ============ ============ ============
The revision of prior years' tax estimates and other changes in valuation allowances as shown in the table above include amounts for the reversal of reserves which the Company no longer believes are necessary, other changes in prior 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, 1996, the reversal of reserves which the Company believes are no longer necessary resulted in a credit to the income tax provision of $3.2 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, -------------------------- 1998 1997 ------------ ------------ Deferred income tax assets: Loss and credit carryforwards $ 114.7 $ 69.1 Timber and timberlands 37.4 34.6 Other 10.9 32.3 Valuation allowances (47.8) (49.8) ------------ ------------ Total deferred income tax assets, net 115.2 86.2 ------------ ------------ Deferred income tax liabilities: Property, plant and equipment (15.1) (17.7) Inventories (9.9) (13.9) Other (9.5) (6.7) ------------ ------------ Total deferred income tax liabilities (34.5) (38.3) ------------ ------------ Net deferred income tax assets $ 80.7 $ 47.9 ============ ============
The valuation allowances listed above relate to loss and credit carryforwards. As of December 31, 1998, approximately $37.4 million of the net deferred income tax assets listed above relate to the excess of the tax basis over financial statement basis with respect to timber and timberlands. The Company believes it is more likely than not that this net deferred income tax asset will be realized, based primarily upon the estimated value of its timber and timberlands which is well in excess of its tax basis. Also included in net deferred income tax assets as of December 31, 1998 is $66.9 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. Included in the net deferred income tax assets listed above are $72.9 million and $43.0 million at December 31, 1998 and 1997, 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, 1998, under the terms of the respective tax allocation agreements (dollar amounts in millions). The utilization of certain of these attributes is subject to limitations.
EXPIRING THROUGH ------------ Regular Tax Attribute Carryforwards: Net operating losses $311.8 2018 Alternative Minimum Tax Attribute Carryforwards: Net operating losses $280.0 2018
The income tax credit (provision) related to other comprehensive income for the years ended December 31, 1998 and 1997 were $(0.3) million and $0.3 million, respectively. There was no other comprehensive income for the year ended December 31, 1996. 7. EMPLOYEE BENEFIT PLANS In the fourth quarter of 1998, the Company adopted Statement of Financial Accounting Standards No. 132, "Employers' Disclosures About Pension and Other Postretirement Benefits" ("SFAS NO. 132"), which amends Statements of Financial Accounting Standards Nos. 87, 88 and 106. SFAS No. 132, among other things, standardizes the disclosure requirements for pensions and other postretirement benefits and suggests combined formats for presentation of such disclosures, but has no impact on the computation of the reported amounts. Prior year disclosures have been revised to comply with SFAS No. 132. 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 termination of employment and retirement and commencement of pension benefits. Participants make contributions for a portion of the cost of their health care benefits. The expected costs of postretirement medical benefits are accrued over the period the employees provide services to the date of their full eligibility for such benefits. The following tables present the changes, status and assumptions of Pacific Lumber's pension and other postretirement benefit plans as of December 31, 1998 ( in millions):
PENSION BENEFITS MEDICAL/LIFE BENEFITS -------------------------- -------------------------- DECEMBER 31, ------------------------------------------------------ 1998 1997 1998 1997 ------------ ------------ ------------ ------------ Change in benefit obligation: Benefit obligation at beginning of year $ 28.9 $ 23.6 $ 5.0 $ 5.9 Service cost 2.2 1.9 .3 .3 Interest cost 2.2 1.9 .3 .3 Plan participants' contributions - - .2 .3 Plan amendments - .9 - - Actuarial (gain) loss 1.6 1.1 (.5) (1.1) Benefits paid (.6) (.5) (.3) (.7) ------------ ------------ ------------ ------------ Benefit obligation at end of year 34.3 28.9 5.0 5.0 ------------ ------------ ------------ ------------ Change in plan assets: Fair value of plan assets at beginning of year 25.9 21.8 - - Actual return on assets 3.5 4.0 - - Employer contributions 1.1 .6 .1 .4 Plan participants' contributions - - .2 .3 Benefits paid (.6) (.5) (.3) (.7) ------------ ------------ ------------ ------------ Fair value of plan assets at end of year 29.9 25.9 - - ------------ ------------ ------------ ------------ Benefit obligation in excess of plan assets 4.4 3.0 5.0 5.0 Unrecognized actuarial gain 4.4 4.2 1.5 1.0 Unrecognized prior service costs (.9) (.9) - - ------------ ------------ ------------ ---------- Accrued benefit liability $ 7.9 $ 6.3 $ 6.5 $ 6.0 ============ ============ ============ ===========
PENSION BENEFITS MEDICAL/LIFE BENEFITS ----------------------------------------- ---------------------------------------- YEAR ENDED DECEMBER 31, ----------------------------------------------------------------------------------- 1998 1997 1996 1998 1997 1996 ------------ ------------ ------------ ------------ ------------ ------------ Components of net periodic benefit costs: Service cost $ 2.2 $ 1.9 $ 1.9 $ .3 $ .3 $ .3 Interest cost 2.2 1.9 1.7 .3 .4 .4 Expected return on assets (1.8) (1.5) (1.3) - - - Amortization of prior service costs .1 - - - - - Recognized net actuarial (gain) loss - - - (.1) (.1) - ------------ ------------ ------------ ------------ ------------ ------------ Adjusted net periodic benefit costs $ 2.7 $ 2.3 $ 2.3 $ .5 $ .6 $ .7 ============ ============ ============ ============ ============ ============
MEDICAL/LIFE PENSION BENEFITS BENEFITS ---------------------------------------- ---------------------------------------- YEAR ENDED DECEMBER 31, ---------------------------------------------------------------------------------- 1998 1997 1996 1998 1997 1996 ------------ ------------ ------------ ------------ ------------ ------------ Weighted-average assumptions: Discount rate 7.0% 7.3% 7.5% 7.0% 7.3% 7.5% 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, 1998 would have the following effects (in millions):
1-PERCENTAGE-POINT 1-PERCENTAGE-POINT INCREASE DECREASE ---------------------- ---------------------- Effect on total of service and interest cost components $ .1 $ (.1) Effect on the postretirement benefit obligations .7 (.6)
Employee Savings Plan Pacific Lumber's employees are eligible to participate in a defined contribution savings plan sponsored by MAXXAM. This plan is designed to enhance the existing retirement programs of participating employees. Employees may elect to defer up to 16% of their base compensation to the plan. For those participants who have elected to defer a portion of their compensation to the plan, Pacific Lumber's matching contributions are dollar for dollar up to 4% of the participant's contributions for each pay period. The cost to the Company of this plan was $1.4 million, $1.5 million and $1.4 million for the years ended December 31, 1998, 1997 and 1996, 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 $10.8 million at both December 31, 1998 and 1997. Workers' compensation expenses amounted to $3.5 million, $4.7 million and $2.6 million for the years ended December 31, 1998, 1997 and 1996, 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 $3.5 million, $2.5 million and $2.7 million for the years ended December 31, 1998, 1997 and 1996, 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. CONTINGENCIES Regulatory and environmental matters play a significant role in the Company's business, which is subject to a variety of California and federal laws and regulations, as well as the Final HCP and Final SYP (defined below), dealing with timber harvesting practices, threatened and endangered species and habitat for such species, and air and water quality. While regulatory and environmental concerns have resulted in restrictions on the geographic scope and timing of the Company's timber operations, increased operational costs and engendered litigation and other challenges to the Company's operations, prior to 1998 they have not had a significant adverse effect on the Company's financial position, results of operations or liquidity. However, the Company's 1998 results of operations were adversely affected by certain regulatory and environmental matters, including during the second half of 1998, the absence of a sufficient number of available THPs to enable the Company to conduct its operations at historic levels. On September 28, 1996, Pacific Lumber, including its subsidiaries and affiliates, and MAXXAM (the "PACIFIC LUMBER PARTIES") entered into an agreement (the "HEADWATERS AGREEMENT") with the United States and California which provided the framework for the acquisition of the Headwaters Timberlands by the United States and California. Consummation of the Headwaters Agreement was also conditioned upon, among other things: approval of a sustained yield plan establishing long-term sustained yield ("LTSY") harvest levels for Pacific Lumber's timberlands (the "SYP"), approval of a habitat conservation plan (the "HCP") covering multiple species (the "MULTI-SPECIES HCP") and issuance of incidental take permits related to the Multi-Species HCP ("PERMITS"). As further described in Note 12 "Subsequent Events," on March 1, 1999, the Pacific Lumber Parties, the United States and California consummated the Headwaters Agreement. In addition to the transfer of the Headwaters Timberlands by the Pacific Lumber Parties described in Note 12, Pacific Lumber received an approved SYP (the "FINAL SYP"), Multi-Species HCP (the "FINAL HCP") and related Permits. The Pacific Lumber Parties and California also executed an agreement regarding the enforcement of the California bill which authorized state funds for the purchase of the Headwaters Timberlands while imposing certain restrictions on the remaining timberlands held by the Pacific Lumber Parties (the "CALIFORNIA AGREEMENT"). The Final 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 establish an LTSY harvest level. An SYP must demonstrate that the average annual harvest over any rolling ten-year period will not exceed the LTSY harvest level and that a timber company's projected timber inventory is capable of sustaining the LTSY harvest level in the last decade of the 100-year planning period. Under the Final SYP, the Company's projected base average annual harvest level in the first decade could be approximately 179 million board feet of softwoods. The Final SYP is effective for 10 years, and may be amended by Pacific Lumber subject to approval by the CDF. The Final SYP is subject to review after five years. Revised SYPs would be prepared every decade that address the LTSY harvest level based upon reassessment of changes in the resource base and other factors. Several species, including the northern spotted owl, the marbled murrelet, the coho salmon and the steelhead trout, have been listed as endangered or threatened under the ESA and/or the California Endangered Species Act (the "CESA"). The Final HCP and the Permits allow incidental "take" of listed species so long as there is no "jeopardy" to the continued existence of such species. The Final HCP identifies the measures to be instituted in order to minimize and mitigate the anticipated level of take to the greatest extent practicable. The Final HCP not only provides for the Company's compliance with habitat requirements for the northern spotted owl, the marbled murrelet, the coho salmon and the steelhead trout, it also provides for issuance of Permits for thirteen additional species that are or may be listed in the future. The Final HCP and related Permits have a term of 50 years, and, among other things, include the following protective measures: (i) setting aside timberlands as marbled murrelet conservation areas; (ii) establishing streamside "no-cut" and limited cut buffers as well as mass wasting areas based on a five-year assessment of each of the Company's watersheds; (iii) limiting harvesting activities during wet weather conditions, and (iv) making certain specified improvements to the Company's roads. The Final SYP is also subject to the foregoing provisions. The Company believes that the Final SYP and the Final HCP should in the long-term expedite the preparation and facilitate approval of its THPs, although there can be no assurance that the Company will not face difficulties in the THP submission and approval process as it implements these agreements. Lawsuits are threatened which seek to prevent the Company from implementing the Final HCP and the Final SYP, and lawsuits are pending concerning certain of the Company's approved THPs or other operations. On January 26, 1998 an action entitled Coho Salmon, et al v. Pacific Lumber, et al, (the "COHO LAWSUIT") was filed against Pacific Lumber, Scotia Pacific and Salmon Creek. This action alleged, 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. In March 1999, the Coho lawsuit was dismissed, with prejudice. Pacific Lumber has also received notice of additional threatened actions with respect to the coho salmon. On August 12, 1998, an action entitled Environmental Protection Information Center, Inc., Sierra Club v. Pacific Lumber, Scotia Pacific and Salmon Creek (the "EPIC LAWSUIT") was filed by two environmental groups against Pacific Lumber, Scotia Pacific and Salmon Creek under which the environmental groups allege that certain procedural violations of the federal Endangered Species Act (the "ESA") have resulted from logging activities on the Company's timberlands and seek to prevent the defendants from carrying out any harvesting activities until certain wildlife consultation requirements under the ESA are satisfied in connection with the development of the Final HCP. In March 1999, the court affirmed a preliminary injunction on harvesting on three THPs; however, it subsequently heard Pacific Lumber's motion to dismiss the case and issued an order for the plaintiffs to show cause why the lawsuit should not be dismissed as moot since the consultation requirement appears to have been concluded. On or about January 29, 1999, the Company received a notice from EPIC and the Sierra Club ("EPIC NOTICE LETTER") of their intent to sue Pacific Lumber and several federal and state agencies under the ESA. The letter alleges various violations of the ESA and challenges, among other things, the validity and legality of the Permits. The Company is unable to predict the outcome of either the EPIC lawsuit or the EPIC Notice Letter or their ultimate impact on the Company's financial condition or results of operations or the ability to harvest timber on its THPs. While the Company expects environmentally focused objections and lawsuits to continue, it believes that the Final HCP and the Permits should enhance its position in connection with these challenges. On November 9, 1998, the California Department of Forestry and Fire Protection ("CDF") notified Pacific Lumber that it had suspended Pacific Lumber's 1998 timber operator's license ("TOL"). As a result, Pacific Lumber ceased all operations under its TOL and made the necessary arrangements for independent contract loggers to be substituted where necessary (independent contractors historically account for approximately 60% of the harvesting activities on the Company's timberlands). On February 26, 1999, the CDF issued Pacific Lumber a conditional TOL for 1999. The 1999 TOL contains provisions which limit the use of roads during wet weather conditions and provides for an enhanced compliance program. The CDF has also advised Pacific Lumber that if the 1999 TOL is revoked, issuance of a new conditional license would be unlikely. The Company does not believe that the restrictions imposed by the 1999 TOL will have an adverse effect on Pacific Lumber's or the Company's financial condition or results of operations. 10. SUPPLEMENTAL CASH FLOW AND OTHER INFORMATION
YEARS ENDED DECEMBER 31, ---------------------------------------- 1998 1997 1996 ------------ ------------ ------------ (IN MILLIONS) Supplemental information on non-cash investing and financing activities: Acquisition of assets subject to other liabilities $ .8 $ 9.4 $ - Deferral of interest on MAXXAM note receivable 7.8 - - Supplemental disclosure of cash flow information: Interest paid, net of capitalized interest $ 78.2 $ 73.1 $ 63.8 Income taxes paid (refunded) .2 .2 (2.9) Tax allocation payments to MAXXAM .2 .4 .2
11. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) Summary quarterly financial information for the years ended December 31, 1998 and 1997 is as follows (in millions):
THREE MONTHS ENDED ------------------------------------------------------ MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 ------------ ------------ ------------ ------------ 1998: Net sales $ 51.9 $ 63.5 $ 65.9 $ 52.3 Operating income 10.1 14.7 12.8 3.0 Income (loss) before extraordinary item .9 3.7 (1.5) (21.1) Extraordinary item, net - - (41.8) - Net income (loss) .9 3.7 (43.4) (21.0) 1997: Net sales $ 66.8 $ 76.8 $ 72.8 $ 70.8 Operating income 18.8 24.3 23.1 18.3 Net income (loss) (.3) 5.0 5.8 8.1
12. SUBSEQUENT EVENT As described in Note 9 above, on September 28, 1996, the Pacific Lumber Parties entered into the Headwaters Agreement with the United States and California which provided the framework for the acquisition by the United States and California of the Headwaters Timberlands. A substantial portion of the Headwaters Timberlands contain virgin old growth timber. Approximately 4,900 of these acres were owned by Salmon Creek, with the remaining acreage being owned by Pacific Lumber and Scotia LLC (Pacific Lumber owning the timber and related timber harvesting rights on Scotia LLC's acreage). On March 1, 1999, the Pacific Lumber Parties, the United States and California consummated the Headwaters Agreement. 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 are to be contributed to Scotia LLC on or before August 1999. Approximately $285.0 million of these proceeds have been deposited into an escrow account held by an escrow agent and are to be made available as necessary to support the Timber Notes, and may be released only under certain circumstances. As a result of the disposition of the Headwaters Timberlands, the Company expects to recognize a pre-tax gain of approximately $240.0 million ($142.0 million, net of tax) in the first quarter of 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 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 will be reflected in the Company's financial statements at approximately $6.0 million 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 to California of the Owl Creek and Grizzly Creek groves (the "OWL CREEK AGREEMENT" and the "GRIZZLY CREEK AGREEMENT," respectively). The Owl Creek Agreement provides for Scotia LLC to sell, on or before June 30, 2002, the Owl Creek grove to California for the lesser of the appraised fair market value or $79.7 million. At California's option, 25% of the payment may be paid upon closing with three equal annual installments thereafter and without interest. With respect to the Grizzly Creek Agreement, California may purchase from Pacific Lumber, on or before October 31, 2000, a portion of this grove for a purchase price determined based on fair market value, but not to exceed $19.9 million. The net proceeds from the Grizzly Creek grove will be placed into an escrow account (on the same basis as the net proceeds from the sale of the Headwaters Timberlands) unless, at the time of receipt of such proceeds, the Escrowed Funds are no longer held in an escrow account. California also has a five year option under the agreement to purchase additional property adjacent to the Grizzly Creek grove which is within the Grizzly Creek conservation area. The sale of the Owl Creek or Grizzly Creek groves will not be reflected in the Company's financial statements until they have been concluded. 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 30 Consolidated Balance Sheet at December 31, 1998 and 1997 31 Consolidated Statement of Operations for the Years Ended December 31, 1998, 1997 and 1996 32 Consolidated Statement of Cash Flows for the Years Ended December 31, 1998, 1997 and 1996 33 Consolidated Statement of Stockholder's Deficit 34 Notes to Consolidated Financial Statements 35 2. FINANCIAL STATEMENT SCHEDULES: Schedule I - Condensed Financial Information of Registrant at December 31, 1998 and 1997 and for years ended December 31, 1998 and 1997, and for the period from November 4, 1996 (inception) to December 31, 1996 50 The Consolidated Financial Statements and Notes thereto of MAXXAM Inc., MAXXAM Group Inc. and Kaiser Aluminum Corporation are incorporated herein by reference and included as Exhibits 99.1, 99.2 and 99.3 hereto, respectively. All other schedules are inapplicable or the required information is included in the consolidated financial statements or the notes thereto. (B) REPORTS ON FORM 8-K There were no reports on Form 8-K during the fourth quarter of 1998. However, on March 24, 1999, the Company filed a current report on Form 8-K (under Item 5) concerning the filing of a Prospectus Supplement to the Prospectus dated December 30, 1998 of Scotia Pacific Company LLC, an indirect wholly owned subsidiary of the Registrant, concerning the consummation of the Headwaters Agreement and certain other developments since the date of the Prospectus. (C) EXHIBITS Reference is made to the Index of Exhibits immediately preceding the exhibits hereto (beginning on page 55), which index is incorporated herein by reference. SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT MAXXAM GROUP HOLDINGS INC. BALANCE SHEET (UNCONSOLIDATED) (IN MILLIONS OF DOLLARS, EXCEPT SHARE INFORMATION)
DECEMBER 31, -------------------------- 1998 1997 ------------ ------------ ASSETS Current assets: Cash and cash equivalents $ 5.6 $ 1.9 Receivable from MAXXAM Inc. 6.1 5.5 ------------ ------------ Total current assets 11.7 7.4 Note receivable from MAXXAM Inc. 132.8 125.0 Deferred income taxes 10.1 9.1 Deferred financing costs 3.5 4.2 ------------ ------------ $ 158.1 $ 145.7 ============ ============ LIABILITIES AND STOCKHOLDER'S DEFICIT Current liabilities: Accounts payable and other accrued liabilities $ 1.1 $ 1.2 Accrued interest 6.5 6.5 ------------ ------------ Total current liabilities 7.6 7.7 Losses recognized in excess of investments in subsidiaries 155.0 79.2 Long-term debt 130.0 130.0 ------------ ------------ Total liabilities 292.6 216.9 ------------ ------------ Stockholder's deficit: Common stock, $1.00 par value, 3,000 shares authorized, 1,000 shares issued - - Additional capital 123.2 123.2 Accumulated deficit (257.7) (194.4) ------------ ------------ Total stockholder's deficit (134.5) (71.2) ------------ ------------ $ 158.1 $ 145.7 ============ ============ See notes to consolidated financial statements and accompanying notes.
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED) MAXXAM GROUP HOLDINGS INC. CONDENSED STATEMENT OF OPERATIONS (UNCONSOLIDATED) (IN MILLIONS OF DOLLARS)
PERIOD FROM NOVEMBER 4, 1996 (INCEPTION) TO YEARS ENDED DECEMBER 31, DECEMBER 31, -------------------------- ------------ 1998 1997 1996 ------------ ------------ ------------ Investment, interest and other income $ 14.4 $ 13.8 $ .3 Interest expense (16.4) (16.4) (.4) General and administrative expenses (.3) (.3) - Equity in earnings (loss) of subsidiaries (56.1) 20.6 1.7 ------------ ------------ ------------ Income (loss) before income taxes and extraordinary item (58.4) 17.7 1.6 Credit in lieu of income taxes .2 .9 - ------------ ------------ ------------ Income (loss) before extraordinary item (58.2) 18.6 1.6 ------------ ------------ ------------ Extraordinary Item: Loss on early extinguishment of debt, net of income taxes (1.6) - - ------------ ------------ ------------ Net income (loss) $ (59.8) $ 18.6 $ 1.6 ============ ============ ============ See notes to consolidated financial statements and accompanying notes.
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED) MAXXAM GROUP HOLDINGS INC. CONDENSED STATEMENT OF CASH FLOWS (UNCONSOLIDATED) (IN MILLIONS OF DOLLARS)
PERIOD FROM NOVEMBER 4, 1996 (INCEPTION) TO YEARS ENDED DECEMBER 31, DECEMBER 31, -------------------------- ------------ 1998 1997 1996 ------------ ------------ ------------ Cash flows from operating activities: Net income (loss) $ (59.8) $ 18.6 $ 1.6 Adjustments to reconcile net income (loss) to net cash provided by (used for) operating activities: Extraordinary loss on early extinguishment of debt, net 1.6 - - Amortization of deferred financing costs and discounts on long-term debt .8 .8 - Equity in loss (earnings) of subsidiaries 56.1 (20.6) (1.7) Dividends from subsidiaries 18.7 3.0 - Increase (decrease) in cash resulting from changes in: Receivable from MAXXAM Inc. (8.4) (5.5) - Accrued and deferred income taxes (.1) (.8) .3 Accrued interest and other liabilities (.1) 5.2 1.3 Other - - (1.1) ------------ ------------ ------------ Net cash provided by (used for) operating activities 8.8 0.7 .4 ------------ ------------ ------------ Cash flows from investing activities: Issuance of note to MAXXAM Inc. - - (125.0) ------------ ------------ ------------ Net cash used for investing activities - - (125.0) ------------ ------------ ------------ Cash flows from financing activities: Proceeds from issuance of long- term debt - - 130.0 Consent fees for early retirement of subsidiaries' debt (2.6) - - Dividends paid (2.5) - - Incurrence of deferred financing costs - - (4.2) ------------ ------------ ------------ Net cash provided by (used for) financing activities (5.1) - 125.8 ------------ ------------ ------------ Net increase in cash and cash equivalents 3.7 .7 1.2 Cash and cash equivalents at beginning of year 1.9 1.2 - ------------ ------------ ------------ Cash and cash equivalents at end of year $ 5.6 $ 1.9 $ 1.2 ============ ============ ============ See notes to consolidated financial statements and accompanying notes.
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED) NOTES TO FINANCIAL STATEMENTS A. DEFERRED INCOME TAXES The deferred income tax assets and liabilities reported in the accompanying unconsolidated balance sheet are determined by computing such amounts on a consolidated basis, as if MGHI files a consolidated tax return with all of its subsidiaries except Salmon Creek, and as if such corporations were never connected with MAXXAM, and then reducing such consolidated amounts by the amounts recorded by the Company's subsidiaries, but excluding Salmon Creek, pursuant to their respective tax allocation agreements with MAXXAM. The Company's net deferred income tax assets relate primarily to loss and credit carryforwards, net of valuation allowances. The Company evaluated all appropriate factors to determine the proper valuation allowances for these carryforwards, including any limitations concerning their use, the year the carryforwards expire and the levels of taxable income necessary for utilization. Based on this evaluation, the Company has concluded that it is more likely than not that it will realize the benefit of these carryforwards for which valuation allowances were not provided. B. LONG-TERM DEBT On December 23, 1996, the Company issued $130.0 million principal amount of 12% Senior Secured Notes due August 1, 2003. The MGHI Notes are guaranteed on a senior, unsecured basis by the Company. Interest is payable semi-annually. In connection with the redemption of the MGI Notes and the issuance of the Timber Notes, MGHI has amended the indenture for the MGHI Notes, to among other things, pledge all of the 27,938,250 shares of Kaiser common stock it owns, 16,055,000 shares of which were released from the pledge securing the MGI Notes. C. SUPPLEMENTAL CASH FLOW INFORMATION
PERIOD FROM NOVEMBER 4, 1996 (INCEPTION) TO YEARS ENDED DECEMBER 31, DECEMBER 31, -------------------------- ------------ 1998 1997 1996 ------------ ------------ ------------ (IN MILLIONS) Supplemental information on non-cash investing and financing activities: Deferral of interest on MAXXAM note receivable $ 7.8 $ - $ - Supplemental disclosure of cash flow information: Interest paid $ 15.6 $ 9.4 $ -
SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. MAXXAM GROUP HOLDINGS INC. Date: March 30, 1999 By: /S/ PAUL N. SCHWARTZ Paul N. Schwartz Vice President, Chief Financial Officer and Director (Principal Financial Officer) 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 30, 1999 By: /S/ CHARLES E. HURWITZ Charles E. Hurwitz Chairman of the Board, President, Chief Executive Officer and Director Date: March 30, 1999 By: /S/ PAUL N. SCHWARTZ Paul N. Schwartz Vice President, Chief Financial Officer and Director (Principal Financial Officer) Date: March 30, 1999 By: /S/ JOHN T. LA DUC John T. La Duc Vice President and Director Date: March 30, 1999 By: /S/ ELIZABETH D. BRUMLEY Elizabeth D. Brumley Controller (Principal Accounting Officer)
INDEX OF EXHIBITS EXHIBIT NUMBER DESCRIPTION - ------------------- --------------------------------------------------------------------------------------------------------- 3.1 Certificate of Incorporation of MAXXAM Group Holdings Inc. (the "Company" or "MGHI") (incorporated herein by reference to Exhibit 3.1 to the Company's Registration Statement on Form S-4, Registration No. 333- 18723) *3.2 Amended and Restated By-laws of the Company, adopted July 7, 1998 4.1 Indenture, dated as of December 23, 1996 among the Company, as Issuer, MAXXAM Inc., as Guarantor, and First Bank National Association, as Trustee ("MGHI Indenture"), regarding the Company's 12% Senior Secured Notes due 2003 (incorporated herein by reference to Exhibit 4.1 to the Company's Registration Statement on Form S-4, Registration No. 333-18723) 4.2 First Supplemental Indenture, dated as of July 8, 1998, to the MGHI Indenture (incorporated herein by reference to Exhibit 4.4 to the Quarterly Report on Form 10-Q/A of the Company for the quarter ended June 30, 1998; File No. 1-3924; the "MGHI June 1998 Form 10-Q/A") 4.3 Second Supplemental Indenture, dated as of July 29, 1998, to the MGHI Indenture (incorporated herein by reference to Exhibit 4.5 to the MGHI June 1998 Form 10-Q/A) 4.4 Indenture, dated as of July 20, 1998, between Scotia Pacific Company LLC ("Scotia LLC") and State Street Bank and Trust Company ("State Street") regarding Scotia LLC's Class A-1, Class A-2 and Class A-3 Timber Collateralized Notes (incorporated herein by reference to Exhibit 4.1 to Scotia LLC's Registration Statement on Form S-4, Registration No. 333-63825; the "Scotia LLC Registration Statement") 4.5 Deed of Trust, Security Agreement, Financing Statement Fixture Filing and Assignment of Proceeds, dated as of July 20, 1998, among Scotia LLC, Fidelity National Title Insurance Company, as trustee, and State Street, as collateral agent (incorporated herein by reference to Exhibit 4.6 to the Scotia LLC Registration Statement) 4.6 Credit Agreement, dated as of July 20, 1998, among Scotia LLC, the financial institutions party thereto and Bank of America National Trust and Savings Association, as agent (incorporated herein by reference to Exhibit 4.3 to the Quarterly Report on Form 10-Q/A of MAXXAM Inc. for the quarter ended June 30, 1998; File No. 1-3924; the "MAXXAM June 1998 Form 10-Q") *4.7 Amended and Restated Credit Agreement dated as of December 18, 1998 between The Pacific Lumber Company ("Pacific Lumber") and Bank of America National Trust and Savings Association Note: Pursuant to Regulation Section 229.601, Item 601 (b)(4)(iii) of Regulation S-K, upon request of the Securities and Exchange Commission, the Company hereby agrees to furnish a copy of any unfiled instrument which defines the rights of holders of long-term debt of the Company and its consolidated subsidiaries (and for any of its unconsolidated subsidiaries for which financial statements are required to be filed) wherein the total amount of securities authorized thereunder does not exceed 10 percent of the total consolidated assets of the Company 10.1 Tax Allocation Agreement dated as of December 23, 1996 between MGHI and MAXXAM Inc. (incorporated herein by reference to Exhibit 10.1 to the Company's Registration Statement on Form S-4, Registration No. 333- 8723) 10.2 Tax Allocation Agreement between MAXXAM Group Inc. ("MGI") and MAXXAM Inc. dated as of August 4, 1993 (incorporated herein by reference to Exhibit 10.6 to the Amendment No. 3 to the Registration Statement on Form S-2 of MGI, Registration No. 33-64042; the "MGI Registration Statement") 10.3 Tax Allocation Agreement dated as of May 21, 1988 among MAXXAM Inc., MGI, Pacific Lumber and the corporations signatory thereto (incorporated herein by reference to Exhibit 10.8 to Pacific Lumber's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, File No. 1-9204) 10.4 Tax Allocation Agreement among Pacific Lumber, Scotia LLC, Salmon Creek Corporation and MAXXAM Inc. dated as of March 23, 1993 (incorporated herein by reference to Exhibit 10.1 to Amendment No. 3 to the Form S- 1 Registration Statement of Scotia Pacific Holding Company, Registration No. 33-55538) 10.5 Tax Allocation Agreement between MAXXAM Inc. and Britt Lumber Co., Inc. ("Britt"), dated as of July 3, 1990 (incorporated herein by reference to Exhibit 10.4 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993) 10.6 Non-Negotiable Intercompany Note dated as of December 23, 1996 executed by MAXXAM Inc. in favor of the Company (incorporated herein by reference to Exhibit 10.8 to the Company's Registration Statement on Form S-4, Registration No. 333-18723) 10.7 Power Purchase Agreement dated as of January 17, 1986 between Pacific Lumber and Pacific Gas and Electric Company (incorporated herein by reference to Exhibit 10(n) to Pacific Lumber's Registration Statement on Form S-1, Registration No. 33-5549) 10.8 New Master Purchase Agreement, dated as of July 20, 1998, between Scotia LLC and Pacific Lumber (incorporated herein by reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q of the Company for the quarter ended June 30, 1998; File No. 333-18723; the "MGHI June 1998 Form 10-Q") 10.9 New Services Agreement, dated as of July 20, 1998, between Pacific Lumber and Scotia LLC (incorporated herein by reference to Exhibit 10.2 to the MGHI June 1998 Form 10-Q) 10.10 New Additional Services Agreement, dated as of July 20, 1998, between Scotia LLC and Pacific Lumber (incorporated herein by reference to Exhibit 10.3 to the MGHI June 1998 Form 10-Q) 10.11 New Reciprocal Rights Agreement, dated as of July 20, 1998, among Pacific Lumber, Scotia LLC and Salmon Creek Corporation (incorporated herein by reference to Exhibit 10.4 to the MGHI June 1998 Form 10-Q) 10.12 New Environmental Indemnification Agreement, dated as of July 20, 1998, between Pacific Lumber and Scotia LLC (incorporated herein by reference to Exhibit 10.5 to the MGHI June 1998 Form 10-Q) 10.13 Purchase and Services Agreement between Pacific Lumber and Britt Lumber Co., Inc. (incorporated herein by reference to Exhibit 10.17 to Amendment No. 2 to the Form S-2 Registration Statement of Pacific Lumber; Registration Statement No. 33-56332) 10.14 Undertaking, dated as of August 4, 1993, executed by MAXXAM in favor of MGI (incorporated herein by reference to Exhibit 10.24 to MGI's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, File No. 1-8857) 10.15 Agreement (the "Headwaters Agreement") dated as of 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) 10.16 Implementation Agreement with Regard to Habitat Conservation Plan for the Properties of Pacific Lumber, Scotia LLC and Salmon Creek Corporation ("Salmon Creek") dated as of February 1999 by and among The United States Fish and Wildlife Service, the National Marine Fisheries Service, the California Department of Fish and Game ("CDF&G"), the California Department of Forestry and Fire Protection (the "CDF") and Pacific Lumber, Salmon Creek and Scotia LLC (incorporated herein by reference to Exhibit 99.3 to Scotia LLC's Form 8-K dated March 19, 1999; File No. 333-63825) 10.17 Agreement Relating to Enforcement of AB 1986 dated as of February 25, 1999 by and among The California Resources Agency, CDF&G, The California Department of Forestry, The California Wildlife Conservation Board (the "CWCB"), Pacific Lumber, Salmon Creek and Scotia LLC (incorporated herein by reference to Exhibit 99.4 to Scotia LLC s Form 8-K dated March 19, 1999; File No. 333-63825) 10.18 Habitat Conservation Plan dated as of February 1999 for the Properties of Pacific Lumber, Scotia Pacific Holding Company and Salmon Creek (incorporated herein by reference to Exhibit 99.5 to Scotia LLC's Form 8-K dated March 19, 1999; File No. 333-63825) 10.19 Agreement for Transfer of Grizzly Creek and Escrow Instructions and Option Agreement dated as of February 26, 1999 by and between Pacific Lumber and the State of California acting by and through the CWCB Board (incorporated herein by reference to Exhibit 99.6 to Scotia LLC's Form 8-K dated March 19, 1999; File No. 333-63825) 10.20 Agreement for Transfer of Owl Creek and Escrow Instructions and Option Agreement dated as of February 26, 1999 by and between the Company and the State of California acting by and through the CWCB (incorporated herein by reference to Exhibit 99.7 to Scotia LLC's Form 8-K dated March 19, 1999; File No. 333-63825) 10.21 Letter dated February 25, 1999 from the CDF to Pacific Lumber (incorporated herein by reference to Exhibit 99.8 to Scotia LLC's Form 8-K dated March 19, 1999; File No. 333-63825) 10.22 Letter dated March 1, 1999 from the CDF to Pacific Lumber (incorporated herein by reference to Exhibit 99.9 to Scotia LLC's Form 8-K dated March 19, 1999, File No. 333-63825) 10.23 Letter dated March 1, 1999 from the U.S. Department of the Interior Fish and Wildlife Service and the U.S. Department of Commerce National Oceanic and Atmospheric Administration to Pacific Lumber, Salmon Creek and the Company (incorporated herein by reference to Exhibit 99.10 to Scotia LLC's Form 8-K dated March 19, 1999; File No. 333-63825) 10.24 Escrow Agreement dated as of March 1, 1999 ("Escrow Agreement") among Pacific Lumber, Salmon Creek and Citibank, N.A. (incorporated herein by reference to Exhibit 10.15 to Scotia LLC's Annual Report on Form 10-K for the fiscal year ended December 31, 1999; File No. 333-63825) 10.25 Amendment to Escrow Agreement dated as of March 26, 1999 (incorporated herein by reference to Exhibit 10.16 to Scotia LLC's Annual Report on Form 10-K for the fiscal year ended December 31, 1999; File No. 333-63825) *27 Financial Data Schedule *99.1 The consolidated financial statements and notes thereto of MAXXAM Inc. for the fiscal year ended December 31, 1998 *99.2 The financial statements and notes thereto of MAXXAM Group Inc. for the fiscal year ended December 31, 1998 *99.3 The consolidated financial statements and notes thereto of Kaiser Aluminum Corporation for the fiscal year ended December 31, 1998 - --------------- * Included with this filing.
EX-3 2 EX 3.2/AMD. AND REST. BYLAWS AMENDED AND RESTATED BY-LAWS OF MAXXAM GROUP HOLDINGS INC. (a Delaware corporation) _______________ ARTICLE I STOCKHOLDERS 1. CERTIFICATES REPRESENTING STOCK. Certificates representing stock in the corporation shall be signed by, or in the name of, the corporation by the Chairman or Vice Chairman of the Board of Directors, if any, or by the President or a Vice President and by the Treasurer or an Assistant Treasurer or the Secretary or an Assistant Secretary of the corporation. Any or all of the signatures on any such certificate may be a facsimile. In case any officer, transfer agent, or registrar who has signed or whose facsimile signature has been placed upon a certificate shall have ceased to be such officer, transfer agent or registrar before such certificate is issued, it may be issued by the corporation with the same effect as if he were such officer, transfer agent or registrar at the date of issue. Whenever the corporation shall be authorized to issue more than one class of stock or more than one series of any class of stock, and whenever the corporation shall issue any shares of its stock as partly paid stock, the certificates representing shares of any such class or series or of any such partly paid stock shall set forth thereon the statements prescribed by the General Corporation Law of the State of Delaware (the "General Corporation Law"). Any restrictions on the transfer or registration of transfer of any shares of stock of any class or series shall be noted conspicuously on the certificate representing such shares. The corporation may issue a new certificate of stock or uncertificated shares in place of any certificate theretofore issued by it, alleged to have been lost, stolen or destroyed, and the Board of Directors may require the owner of the lost, stolen or destroyed certificate, or his legal representative, to give the corporation a bond sufficient to indemnify the corporation against any claim that may be made against it on account of the alleged loss, theft or destruction of any such certificate or the issuance of any such new certificate or uncertificated shares. 2. UNCERTIFICATED SHARES. Subject to any conditions imposed by the General Corporation Law, the Board of Directors of the corporation may provide by resolution or resolutions that some or all of any or all classes or series of the stock of the corporation shall be uncertificated shares. Within a reasonable time after the issuance or transfer of any uncertificated shares, the corporation shall send to the registered owner thereof any written notice prescribed by the General Corporation Law. 3. FRACTIONAL SHARE INTERESTS. The corporation may, but shall not be required to, issue fractions of a share. If the corporation does not issue fractions of a share, it shall (1) arrange for the disposition of fractional interests by those entitled thereto, (2) pay in cash the fair value of fractions of a share as of the time when those entitled to receive such fractions are determined, or (3) issue scrip or warrants in registered form (either represented by a certificate or uncertificated) or bearer form (represented by a certificate) which shall entitle the holder to receive a full share upon surrender of such scrip or warrants aggregating a full share. A certificate for a fractional share or an uncertificated fractional share shall, but scrip or warrants shall not unless otherwise provided therein, entitle the holder to exercise voting rights, to receive dividends thereon, and to participate in any of the assets of the corporation in the event of liquidation. The Board of Directors may cause scrip or warrants to be issued subject to the conditions that they shall become void if not exchanged for certificates representing the full shares or uncertificated full shares before a specified date, or subject to the conditions that the shares for which scrip or warrants are exchangeable may be sold by the corporation and the proceeds thereof distributed to the holders of scrip or warrants, or subject to any other conditions which the Board of Directors may impose. 4. STOCK TRANSFERS. Upon compliance with provisions restricting the transfer or registration of transfer of shares of stock, if any, transfers or registration of transfers of shares of stock of the corporation shall be made only on the stock ledger of the corporation by the registered holder thereof, or by his attorney thereunto authorized by power of attorney duly executed and filed with the Secretary of the corporation or with a transfer agent or a registrar, if any, and, in the case of shares represented by certificates, on surrender of the certificate or certificates for such shares of stock properly endorsed and the payment of all taxes due thereon. 5. RECORD DATE FOR STOCKHOLDERS. In order that the corporation may determine the stockholders entitled to notice of or to vote at any meeting of stockholders or any adjournment thereof, the Board of Directors may fix a record date, which record date shall not precede the date upon which the resolution fixing the record date is adopted by the Board of Directors, and which record date shall not be more than sixty nor less than ten days before the date of such meeting. If no record date is fixed by the Board of Directors, the record date for determining stockholders entitled to notice of or to vote at a meeting of stockholders shall be at the close of business on the day next preceding the day on which notice is given, or, if notice is waived, at the close of business on the day next preceding the day on which the meeting is held. A determination of stockholders of record entitled to notice of or to vote at a meeting of stockholders shall apply to any adjournment of the meeting; provided, however, that the Board of Directors may fix a new record date for the adjourned meeting. In order that the corporation may determine the stockholders entitled to consent to corporate action in writing without a meeting, the Board of Directors may fix a record date, which record date shall not precede the date upon which the resolution fixing the record date is adopted by the Board of Directors, and which date shall not be more than ten days after the date upon which the resolution fixing the record date is adopted by the Board of Directors. If no record date has been fixed by the Board of Directors, the record date for determining the stockholders entitled to consent to corporate action in writing without a meeting, when no prior action by the Board of Directors is required by the General Corporation Law, shall be the first date on which a signed written consent setting forth the action taken or proposed to be taken is delivered to the corporation by delivery to its registered office in the State of Delaware, its principal place of business, or an officer or agent of the corporation having custody of the book in which proceedings of meetings of stockholders are recorded. Delivery made to the corporation's registered office shall be by hand or by certified or registered mail, return receipt requested. If no record date has been fixed by the Board of Directors and prior to action by the Board of Directors is required by the General Corporation Law, the record date for determining stockholders entitled to consent to corporate action in writing without a meeting shall be at the close of business on the day on which the Board of Directors adopts the resolution taking such prior action. In order that the corporation may determine the stockholders entitled to receive payment of any dividend or other distribution or allotment of any rights or the stockholders entitled to exercise any rights in respect of any change, conversion or exchange of stock, or for the purpose of any other lawful action, the Board of Directors may fix a record date, which record date shall not precede the date upon which the resolution fixing the record date is adopted, and which record date shall be not more than sixty (60) days prior to such action. If no record date is fixed, the record date for determining stockholders for any such purpose shall be at the close of business on the day on which the Board of Directors adopts the resolution relating thereto. 6. MEANING OF CERTAIN TERMS. As used herein in respect of the right to notice of a meeting of stockholders or a waiver thereof or to participate or vote thereat or to consent or dissent in writing in lieu of a meeting, as the case may be, the term "share" or "shares" or "share of stock" or "shares of stock" or "stockholder" or "stockholders" refers to an outstanding share or shares of stock and to a holder or holders of record of outstanding shares of stock when the corporation is authorized to issue only one class of shares of stock, and said reference is also intended to include any outstanding share or shares of stock and any holder or holders of record of outstanding shares of stock of any class upon which or upon whom the certificate of incorporation confers such rights where there are two or more classes or series of shares of stock or upon which or upon whom the General Corporation Law confers such rights notwithstanding that the certificate of incorporation may provide for more than one class or series of shares of stock, one or more of which are limited or denied such rights thereunder; provided, however, that no such right shall vest in the event of an increase or a decrease in the authorized number of shares of stock of any class or series which is otherwise denied voting rights under the provisions of the certificate of incorporation, except as any provision of law may otherwise require. 7. STOCKHOLDER MEETINGS TIME. The annual meeting shall be held on the date and at the time fixed, from time to time, by the directors, provided, that the first annual meeting shall be held on a date within thirteen months after the organization of the corporation, and each successive annual meeting shall be held on a date within thirteen months after the date of the preceding annual meeting. A special meeting shall be held on the date and at the time fixed by the directors. PLACE. Annual meetings and special meetings shall be held at such place, within or without the State of Delaware, as the directors may, from time to time, fix. Whenever the directors shall fail to fix such place, the meeting shall be held at the registered office of the corporation in the State of Delaware. CALL. Annual meetings and special meetings may be called by the directors or by any officer instructed by the directors to call the meeting. NOTICE OR WAIVER OF NOTICE. Written notice of all meetings shall be given, stating the place, date, and hour of the meeting and stating the place within the city or other municipality or community at which the list of stockholders of the corporation may be examined. The notice of an annual meeting shall state that the meeting is called for the election of directors and for the transaction of other business which may properly come before the meeting, and shall (if any other action which could be taken at a special meeting is to be taken at such annual meeting) state the purpose or purposes. The notice of a special meeting shall in all instances state the purpose or purposes for which the meeting is called. The notice of any meeting shall also include, or be accompanied by, any additional statements, information or documents prescribed by the General Corporation Law. Except as otherwise provided by the General Corporation Law, a copy of the notice of any meeting shall be given, personally or by mail, not less than ten (10) days nor more than sixty (60) days before the date of the meeting, unless the lapse of the prescribed period of time shall have been waived, and directed to each stockholder at his record address or at such other address which he may have furnished by request in writing to the Secretary of the corporation. Notice by mail shall be deemed to be given when deposited, with postage thereon prepaid, in the United States Mail. If a meeting is adjourned to another time, not more than thirty (30) days hence, and/or to another place, and if an announcement of the adjourned time and/or place is made at the meeting, it shall not be necessary to give notice of the adjourned meeting unless the directors, after adjournment, fix a new record date for the adjourned meeting. Notice need not be given to any stockholder who submits a written waiver of notice signed by him before or after the time stated therein. Attendance of a stockholder at a meeting of stockholders shall constitute a waiver of notice of such meeting, except when the stockholder attends the meeting for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened. Neither the business to be transacted at, nor the purpose of, any regular or special meeting of the stockholders need be specified in any written waiver of notice. STOCKHOLDER LIST. The officer who has charge of the stock ledger of the corporation shall prepare and make, at least ten (10) days before every meeting of stockholders, a complete list of the stockholders, arranged in alphabetical order, and showing the address of each stockholder and the number of shares registered in the name of each stockholder. Such list shall be open to the examination of any stockholder, for any purpose germane to the meeting, during ordinary business hours, for a period of at least ten (10) days prior to the meeting, either at a place within the city or other municipality or community where the meeting is to be held, which place shall be specified in the notice of the meeting, or if not so specified, at the place where the meeting is to be held. The list shall also be produced and kept at the time and place of the meeting during the whole time thereof, and may be inspected by any stockholder who is present. The stock ledger shall be the only evidence as to who are the stockholders entitled to examine the stock ledger, the list required by this section or the books of the corporation, or to vote at any meeting of stockholders. CONDUCT OF MEETING. Meetings of the stockholders shall be presided over by one of the following officers in the order of seniority and if present and acting--the Chairman of the Board, if any, the Vice Chairman of the Board, if any, the President, a Vice President, or if none of the foregoing is in office and present and acting, by a chairman to be chosen by the stockholders. The Secretary of the corporation, or in his absence, an Assistant Secretary, shall act as secretary of every meeting, but is neither the Secretary nor an Assistant Secretary is present the Chairman of the meeting shall appoint a secretary of the meeting. PROXY REPRESENTATION. Every stockholder may authorize another person or persons to act for him by proxy in all matters in which a stockholder is entitled to participate, whether by waiving notice of any meeting, voting or participating at a meeting, or expressing consent or dissent without a meeting. Every proxy must be signed by the stockholder or by his attorney-in-fact. No proxy shall be voted or acted upon after three (3) years from its date unless such proxy provides for a longer period. A duly executed proxy shall be irrevocable if it states that it is irrevocable and, if, and only as long as, it is coupled with an interest sufficient in law to support an irrevocable power. A proxy may be made irrevocable regardless of whether the interest with which it is coupled is an interest in the stock itself or an interest in the corporation generally. INSPECTORS. The directors, in advance of any meeting, may, but need not, appoint one or more inspectors of election to act at the meeting or any adjournment thereof. If an inspector or inspectors are not appointed, the person presiding at the meeting may, but need not, appoint one or more inspectors. In case any person who may be appointed as an inspector fails to appear or act, the vacancy may be filled by appointment made by the directors in advance of the meeting or at the meeting by the person presiding thereat. Each inspector, if any, before entering upon the discharge of his duties, shall take and sign an oath faithfully to execute the duties of inspectors at such meeting with strict impartiality and according to the best of his ability. The inspectors, if any, shall determine the number of shares of stock outstanding and the voting power of each, the shares of stock represented at the meeting, the existence of a quorum, the validity and effect of proxies, and shall receive votes, ballots, or consents, hear and determine all challenges and questions arising in connection with the right to vote, count and tabulate all votes, ballots, or consents, determine the result, and do such acts as are proper to conduct the election or vote with fairness to all stockholders. On request of the person presiding at the meeting, the inspector or inspectors, if any, shall make a report in writing of any challenge, question, or matter determined by him or them and execute a certificate of any fact found by him or them. Except as otherwise required by subsection (e) of Section 231 of the General Corporation Law, the provisions of that Section shall not apply to the corporation. QUORUM. The holders of a majority of the outstanding shares of stock shall constitute a quorum at a meeting of stockholders for the transaction of any business. The stockholders present may adjourn the meeting despite the absence of a quorum. VOTING. Each share of stock shall entitle the holders thereof to one vote. Directors shall be elected by a plurality of the votes of the shares present in person or represented by proxy at the meeting and entitled to vote on the election of directors. Any other action shall be authorized by a majority of the votes cast except where the General Corporation Law prescribes a different percentage of votes and/or a different exercise of voting power, and except as may be otherwise prescribed by the provisions of the certificate of incorporation and these By-Laws. In the election of directors, and for any other action, voting need not be by ballot. 8. STOCKHOLDER ACTION WITHOUT MEETINGS. Any action required by the General Corporation Law to be taken at any annual or special meeting of stockholders, or any action which may be taken at any annual or special meeting of stockholders, may be taken without a meeting, without prior notice and without a vote, if a consent in writing, setting forth the action so taken, shall be signed by the holders of outstanding stock having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted. Prompt notice of the taking of the corporate action without a meeting by less than unanimous written consent shall be given to those stockholders who have not consented in writing. Action taken pursuant to this paragraph shall be subject to the provisions of Section 228 of the General Corporation Law. ARTICLE II DIRECTORS 1. FUNCTIONS AND DEFINITION. The business and affairs of the corporation shall be managed by or under the direction of the Board of Directors of the corporation. The Board of Directors shall have the authority to fix the compensation of the members thereof. The use of the phrase "whole board" herein refers to the total number of directors which the corporation would have if there were no vacancies. 2. QUALIFICATIONS AND NUMBER. A director need not be a stockholder, a citizen of the United States, or a resident of the State of Delaware. The initial Board of Directors shall consist of three (3) persons. Thereafter the number of directors constituting the whole board shall be at least one (1). Subject to the foregoing limitation and except for the first Board of Directors, such number may be fixed from time to time by action of the stockholders or of the directors, or, if the number is not fixed, the number shall be at least one (1). The number of directors may be increased or decreased by action of the stockholders or of the directors. 3. ELECTION AND TERM. The first Board of Directors, unless the members thereof shall have been named in the certificate of incorporation, shall be elected by the incorporator or incorporators and shall hold office until the first annual meeting of stockholders and until their successors are elected and qualified or until their earlier resignation or removal. Any director may resign at any time upon written notice to the corporation. Thereafter, directors who are elected at an annual meeting of stockholders, and directors who are elected in the interim to fill vacancies and newly created directorships, shall hold office until the next annual meeting of stockholders and until their successors are elected and qualified or until their earlier resignation or removal. Except as the General Corporation Law may otherwise require, in the interim between annual meetings of stockholders or of special meetings of stockholders called for the election of directors and/or for the removal of one or more directors and for the filling of any vacancy in that connection, newly created directorships and any vacancies in the Board of Directors, including unfilled vacancies resulting from the removal of directors for cause or without cause, may be filled by the vote of a majority of the remaining directors then in office, although less than a quorum, or by the sole remaining director. 4. MEETINGS. TIME. Meetings shall be held at such time as the Board shall fix, except that the first meeting of a newly elected Board shall be held as soon after its election as the directors may conveniently assemble. PLACE. Meetings shall be held at such place within or without the State of Delaware as shall be fixed by the Board. CALL. No call shall be required for regular meetings for which the time and place have been fixed. Special meetings may be called by or at the direction of the Chairman of the Board, if any, of the Vice Chairman of the Board, if any, of the President, or of a majority of the directors in office. NOTICE OR ACTUAL OR CONSTRUCTIVE WAIVER. No notice shall be required for regular meetings for which the time and place have been fixed. Written, oral, or any other mode of notice of the time and place shall be given for special meetings in sufficient time for the convenient assembly of the directors thereat. Notice need not be given to any director or to any member of a committee of directors who submits a written waiver of notice signed by him before or after the time stated therein. Attendance of any such person at a meeting shall constitute a waiver of notice of such meeting, except when he attends a meeting for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened. Neither the business to be transacted at, nor the purpose of, any regular or special meeting of the directors need be specified in any written waiver of notice. QUORUM AND ACTION. A majority of the whole Board shall constitute a quorum except when a vacancy or vacancies prevents such majority, whereupon a majority of the directors in office shall constitute a quorum, provided, that such majority shall constitute at least one-third of the whole Board. A majority of the directors present, whether or not a quorum is present, may adjourn a meeting to another time and place. Except as herein otherwise provided, and except as otherwise provided by the General Corporation Law, the vote of the majority of the directors present at a meeting at which a quorum is present shall be the act of the Board. The quorum and voting provisions herein stated shall not be construed as conflicting with any provisions of the General Corporation Law and these By-Laws which govern a meeting of directors held to fill vacancies and newly created directorships in the Board or action of disinterested directors. Any member or members of the Board of Directors or of any committee designated by the Board, may participate in a meeting of the Board, or any such committee, as the case may be, by means of conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other. CHAIRMAN OF THE MEETING. The Chairman of the Board, if any and if present and acting, shall preside at all meetings. Otherwise, the Vice Chairman of the Board, if any and if present and acting, or the President, if present and acting, or any other director chosen by the Board, shall preside. 5. REMOVAL OF DIRECTORS. Except as may otherwise be provided by the General Corporation Law, any director or the entire Board of Directors may be removed, with or without cause, by the holders of a majority of the shares then entitled to vote at an election of directors. 6. COMMITTEES. The Board of Directors may, by resolution passed by a majority of the whole Board, designate one or more committees, each committee to consist of one or more of the directors of the corporation. The Board may designate one or more directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of the committee. In the absence or disqualification of any member of any such committee or committees, the member or members thereof present at any meeting and not disqualified from voting, whether or not he or they constitute a quorum, may unanimously appoint another member of the Board of Directors to act at the meeting in the place of any such absent or disqualified member. Any such committee, to the extent provided in the resolution of the Board, shall have and may exercise the powers and authority of the Board of Directors in the management of the business and affairs of the corporation with the exception of any authority the delegation of which is prohibited by Section 141 of the General Corporation Law, and may authorize the seal of the corporation to be affixed to all papers which may require it. 7. WRITTEN ACTION. Any action required or permitted to be taken at any meeting of the Board of Directors or any committee thereof may be taken without a meeting if all members of the Board or committee, as the case may be, consent thereto in writing, and the writing or writings are filed with the minutes of proceedings of the Board or committee. ARTICLE III OFFICERS The officers of the corporation shall consist of such officers as may be appointed by the Board of Directors from time to time, including but not limited to a President, a Secretary, and, if deemed necessary, expedient, or desirable by the Board of Directors, a Chairman of the Board, a Vice Chairman of the Board, an Executive Vice President, one or more other Vice Presidents, a Treasurer, one or more Assistant Secretaries, one or more Assistant Treasurers, and such other officers with such titles as the resolution of the Board of Directors choosing them shall designate. Except as may otherwise be provided in the resolution of the Board of Directors choosing him, no officer, other than the Chairman or Vice Chairman of the Board, if any, need be a director. Any number of offices may be held by the same person, as the directors may determine. Unless otherwise provided in the resolution choosing him, each officer shall be chosen for a term which shall continue until the meeting of the Board of Directors following the next annual meeting of stockholders and until his successor shall have been chosen and qualified. All officers of the corporation shall have such authority and perform such duties in the management and operation of the corporation as shall be prescribed in the resolutions of the Board of Directors designating and choosing such officers and prescribing their authority and duties, and shall have such additional authority and duties as are incident to their office except to the extent that such resolutions may be inconsistent therewith. The Secretary or an Assistant Secretary of the corporation shall record all of the proceedings of all meetings and actions in writing of stockholders, directors, and committees of directors, and shall exercise such additional authority and perform such additional duties as the Board shall assign to him. Any officer may be removed, with or without cause, by the Board of Directors. Any vacancy in any office may be filled by the Board of Directors. ARTICLE IV INDEMNIFICATION OF DIRECTORS, OFFICERS, EMPLOYEES AND AGENTS 1. INDEMNIFICATION. The corporation shall indemnify, to the fullest extent authorized by the General Corporation Law, as the same exist or may hereafter be amended (but, in the case of any such amendment, only to the extent that such amendment permits the corporation to provide greater or broader indemnification rights than such law permitted the corporation to provide prior to such amendment), any person who was or is a part or is threatened to be made a party to any threatened, pending or completed action, suit, or proceeding, whether civil, criminal, administrative, or investigative (other than an action by or in the right of the corporation) by reason of the fact that he is or was a director, officer, employee, or agent of the corporation, or is or was serving at the written request of the corporation as a director, officer, employee, or agent of another corporation, partnership, joint venture, trust, or other enterprise ( Proceeding ), against expenses (including attorneys fees), judgments, fines, and amounts actually and reasonably incurred by him in connection with the Proceeding. 2. ADVANCEMENT OF EXPENSES. Reasonable expenses (including attorneys fees) incurred in defending a civil or criminal action, suit, or proceeding described in the immediately preceding paragraph may be paid by the corporation in advance of the final disposition of such action, suit, or proceeding. 3. OTHER RIGHTS AND REMEDIES. The indemnification and advancement of expenses provided by, or granted pursuant to, this Article V shall not be deemed exclusive of any other rights to which those seeking indemnification or advancement of expenses may be entitled under any statute, by-law, agreement, vote of stockholders or disinterested directors, or otherwise, both as to actions in their official capacity and as to actions in another capacity while holding such office, and shall continue as to a person who has ceased to be a director, officer, employee, or agent and shall inure to the benefit of the heirs, executors, and administrators of such a person. 4. INSURANCE. The corporation may purchase and maintain insurance on behalf of any person who is or was a director, officer, employee, or agent of the corporation, or is or was serving at the written request of the corporation as a director, officer, employee, or agent of another corporation, partnership, joint venture, trust, or other enterprise, against any liability asserted against him and incurred by him in any such capacity, or arising out of his status as such, whether or not the corporation would have the power or would be required to indemnify him against such liability under the provisions of this Article IV. ARTICLE V CORPORATE SEAL The corporate seal shall be in such form as the Board of Directors shall prescribe. ARTICLE VI FISCAL YEAR The fiscal year of the corporation shall be fixed, and shall be subject to change, by the Board of Directors. ARTICLE VII CONTROL OVER BY-LAWS Subject to the provisions of the certificate of incorporation and the provisions of the General Corporation Law, the power to amend, alter, or repeal these By-laws and to adopt new By-Laws may be exercised by the Board of Directors or by the stockholders. EX-4 3 EX 4.7/AMD. AND REST. CREDIT AGT. AMENDED AND RESTATED CREDIT AGREEMENT DATED AS OF DECEMBER 18, 1998 BETWEEN THE PACIFIC LUMBER COMPANY AND BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION TABLE OF CONTENTS Section Page ARTICLE I DEFINITIONS 1 1.01 Certain Defined Terms 1 1.02 Other Interpretive Provisions 25 1.03 Accounting Principles 26 ARTICLE II THE CREDITS 26 2.01 The Term Credit and the Revolving Credit 26 (a) The Term Credit 26 (b) The Revolving Credit 27 (c) Reborrowing 27 (d) Obligations under the Prior Credit Agreement 27 2.02 Loan Accounts 27 2.03 Procedure for Borrowing 27 2.04 Conversion and Continuation Elections 28 2.05 Voluntary Termination or Reduction of Commitment 29 2.06 Optional Prepayments 29 2.07 Mandatory Prepayments of Loans 30 (a) Mandatory Prepayments, Cash Collateral 30 (b) Aggregate Annual Excess Cash Flow Recapture 30 (c) Clean-up Period 30 (d) General 30 2.08 Scheduled Repayment 30 (a) The Term Credit 30 (b) The Revolving Credit 31 2.09 Interest 31 2.10 Fees 32 (a) Commitment Fee 32 (b) Arrangement Fee 32 (c) Utilization Fees 32 2.11 Computation of Fees and Interest 32 2.12 Payments by the Company 33 2.13 Security 33 2.14 The Letter of Credit Subfacility 34 2.15 Issuance, Amendment and Renewal of Letters of Credit 34 2.16 Existing Letters of Credit; Drawings and Reimbursements 36 2.17 Role of the Bank 36 2.18 Obligations Absolute 37 2.19 Cash Collateral Pledge 38 2.20 Letter of Credit Fees 38 2.21 Uniform Customs and Practice 38 ARTICLE III TAXES, YIELD PROTECTION AND ILLEGALITY 39 3.01 Taxes 39 3.02 Illegality 40 3.03 Increased Costs and Reduction of Return 40 3.04 Funding Losses 41 3.05 Inability to Determine Rates 41 3.06 Reserves on Offshore Rate Loans 42 3.07 Survival 42 ARTICLE IV CONDITIONS PRECEDENT 42 4.01 Conditions of Initial Loans 42 (a) Credit Agreement 42 (b) Company Security Agreement 42 (c) Evidence of Filings 42 (d) Resolutions; Incumbency 43 (e) Legal Opinion 43 (f) Payment of Fees 43 (g) Certificate 43 4.02 Conditions to All Loans and Letters of Credit 43 (a) Notice of Borrowing or Conversion/Continuation; Letter of Credit Application 43 (b) Continuation of Representations and Warranties 44 (c) No Existing Default 44 (d) No Future Advance Notice 44 (e) Other Documents 44 4.03 Conditions to Each Term Loan 44 (a) Deeds of Trust 44 ARTICLE V REPRESENTATIONS AND WARRANTIES 45 5.01 Corporate Existence and Power 45 5.02 Corporate Authorization; No Contravention 45 5.03 Governmental Authorization 45 5.04 Binding Effect 46 5.05 Litigation 46 5.06 No Default 46 5.07 ERISA Compliance 46 5.08 Use of Proceeds; Margin Regulations 47 5.09 Title to Properties 47 5.10 Taxes 47 5.11 Financial Condition 48 5.12 Environmental Matters 48 5.13 Collateral Documents 49 5.14 Regulated Entities 49 5.15 No Burdensome Restrictions 50 5.16 Subsidiaries 50 5.17 Insurance 50 5.18 Solvency 50 5.19 Swap Obligations 50 5.20 Full Disclosure 50 5.21 Labor Relations 51 5.22 Compliance with Laws 51 5.23 Merchantable Inventory 51 5.24 Location of the Company 51 5.25 Y2K 51 ARTICLE VI AFFIRMATIVE COVENANTS 52 6.01 Financial Statements 52 6.02 Certificates; Other Information 53 6.03 Notices 54 6.04 Preservation of Corporate Existence, Etc. 55 6.05 Maintenance of Property 56 6.06 Insurance 56 6.07 Payment of Obligations 57 6.08 Compliance with Laws 57 6.09 Compliance with ERISA 57 6.10 Inspection of Property and Books and Records 57 6.11 Environmental Laws 58 6.12 Use of Proceeds 58 6.13 Solvency 58 6.14 Protection of Collateral; Access 58 6.15 Further Assurances 58 ARTICLE VII NEGATIVE COVENANTS 60 7.01 Limitation on Liens 60 7.02 Disposition of Assets 62 7.03 Consolidations and Mergers 63 7.04 Loans and Investments 63 7.05 Limitation on Indebtedness 64 7.06 Transactions with Affiliates 65 7.07 Use of Proceeds 65 7.08 Contingent Obligations 66 7.09 Joint Ventures 66 7.10 ERISA 66 7.11 Lease Obligations 66 7.12 Restricted Payments 67 7.13 Change in Business 68 7.14 Accounting Changes 68 7.15 Other Contracts 68 ARTICLE VIII EVENTS OF DEFAULT 69 8.01 Event of Default 69 (a) Non-Payment 69 (b) Representation or Warranty 69 (c) Other Defaults 69 (d) Cross-Default 69 (e) Insolvency; Voluntary Proceedings 70 (f) Involuntary Proceedings 70 (g) ERISA 70 (h) Monetary Judgments 70 (i) Non-Monetary Judgments 71 (j) Change in Control 71 (k) Collateral 71 (l) Condemnation 72 (m) Regulatory Action 72 8.02 Remedies 72 8.03 Specified Swap Contract Remedies 72 8.04 Rights Not Exclusive 73 8.05 Certain Financial Covenant Defaults 73 ARTICLE IX MISCELLANEOUS 73 9.01 Amendments and Waivers 73 9.02 Notices 73 9.03 No Waiver; Cumulative Remedies 74 9.04 Costs and Expenses 74 9.05 Company Indemnification 75 9.06 Marshalling; Payments Set Aside 77 9.07 Successors and Assigns 77 9.08 Assignments, Participations, etc. 77 9.09 Confidentiality 78 9.10 Set-off 79 9.11 Counterparts 79 9.12 Severability; Conflicting Provisions 79 (a) Severability 79 (b) Conflicting Provisions 79 9.13 No Third Parties Benefited 79 9.14 Governing Law and Jurisdiction 80 9.15 Verification of Receivables 80 9.16 Termination of Commitment to Lend under the Prior Credit Agreement 80 SCHEDULES Schedule 5.05 Litigation Schedule 5.07 ERISA Schedule 5.12 Environmental Matters Schedule 5.16 Subsidiaries and Minority Interests Schedule 7.01 Permitted Liens Schedule 7.05 Permitted Indebtedness Schedule 7.08 Contingent Obligations EXHIBITS Exhibit A Form of Notice of Borrowing Exhibit B Form of Notice of Conversion/Continuation Exhibit C Form of Compliance Certificate AMENDED AND RESTATED CREDIT AGREEMENT This AMENDED AND RESTATED CREDIT AGREEMENT is entered into as of December 18, 1998 between The Pacific Lumber Company (the "Company") and Bank of America National Trust and Savings Association (the "Bank"). WHEREAS, the Company and the Bank entered into an Amended and Restated Credit Agreement dated as of November 10, 1995 (as amended by the First Amendment thereto dated as of February 10, 1997, and the Second Amendment thereto dated as of October 2, 1997, the "Prior Credit Agreement"); WHEREAS, the Bank and the Company wish to further amend the Credit Agreement by providing, among other matters, for a $60,000,000 credit facility to be allocated between a revolving facility and a term loan facility; NOW, THEREFORE, the Company and the Bank agree that the Prior Credit Agreement is hereby amended and restated in its entirety as set forth in this Agreement and the Company and the Bank agree as follows: ARTICLE I DEFINITIONS 1.01 Certain Defined Terms. The following terms have the following meanings: "Acceptable Inventory" means inventory (as defined in the UCC) which: (a) Is owned by the Company free and clear of all security interests, liens, encumbrances, and rights of others, except the security interest in favor of the Bank; (b) Is located at permanent locations acceptable to the Bank and is not covered by a negotiable document of title unless such document has been delivered to the Bank; (c) In the Bank's reasonable opinion, is not obsolete, unsalable, damaged, or unfit for further processing; (d) Is not placed by the Company on consignment; (e) Consists of wood chips, lumber, or log inventory or, if the Bank approves in writing in advance in its sole discretion, consists of gravel or block inventory and, in any case, is of a type held for sale in the Company's ordinary course of business; and (f) Is otherwise acceptable to the Bank in the exercise of its reasonable judgment. The value of Acceptable Inventory shall be the lesser of the Company's cost (determined under GAAP) or the Bank's independent determination of the resale value of such inventory in such quantities and on such terms as the Bank may reasonably deem appropriate. Until further written notice from the Bank to the Company, the Bank agrees that the value (y) of the lumber component of Acceptable Inventory shall be determined by the resale value of such inventory in such quantities and on such terms as the Bank may reasonably deem appropriate and (z) of the log component of such Acceptable Inventory shall be determined by the Company's cost (determined under GAAP) of such inventory. "Acceptable Receivable" means an Account: (a) Arising from the sale of inventory or power produced by the Company's cogeneration plant in Scotia, California, by the Company in its ordinary course of business; and if arising from the sale of inventory, is in an amount equal to or less than $2,000,000. The Bank may, from time to time, exempt specific Accounts from this $2,000,000 limit; (b) Upon which the Company's right to receive payment is absolute and not contingent upon the fulfillment of any condition whatever; (c) Against which is asserted no defense, counterclaim or setoff, whether well-founded or otherwise; (d) That is a true and correct statement of a bona fide indebtedness incurred in the amount of the Account for merchandise sold and accepted by the Receivable Debtor obligated upon such Account; (e) With respect to which an invoice has been sent; (f) That is owned by the Company and not subject to any right, claim, or interest of another other than the security interest in favor of the Bank; (g) That does not arise from a sale to an employee, Affiliate, parent, or Subsidiary of the Company, or an entity which has common officers or directors with the Company; except that up to 20% of the total balance of Acceptable Receivables may include Accounts on which the Receivable Debtor is Britt Lumber Co., Inc.; (h) That is not the obligation of a Receivable Debtor that is the federal government or a political subdivision thereof unless the Bank has agreed to the contrary in writing and the Company has complied with the Federal Assignment of Claims Act of 1940 with respect to such obligation; (i) That is not the obligation of a Receivable Debtor that is any state of the United States or any city, town, municipality or division thereof; except for Accounts up to an aggregate outstanding amount at any one time of $100,000 which arise in one of the following ways: (1) The sale of power produced by the Company's cogeneration plant in Scotia, California; or (2) The sale of lumber to cities and towns; (j) That is not the obligation of a Receivable Debtor located in a foreign country; (k) That is not the obligation of a Receivable Debtor to whom the Company is or may become liable for goods sold or services rendered by the Receivable Debtor to the Company except to the extent that it exceeds the amount of the Company's obligation to such Receivable Debtor; (l) That does not arise with respect to goods which are delivered on a cash-on-delivery basis or placed on consignment, guaranteed sale or other terms by reason of which the payment by the Receivable Debtor may be conditional; (m) That is not in default. An Account shall be deemed in default upon the occurrence of any of the following: (1) The Account is not paid within the 60 day period starting on its invoice date. This 60 day limitation shall not apply to an Account which is not paid within such period because payment is subject to the Company's "winter terms" previously approved by the Bank; (2) Any Receivable Debtor obligated upon such Account suspends business, makes a general assignment for the benefit of creditors, or fails to pay its debts generally as they come due; or (3) Any petition is filed by or against any Receivable Debtor obligated upon such Account under any bankruptcy law or any other law or laws for the relief of debtors; (n) That does not arise from the sale or lease of goods which remain in the Company's possession or under the Company's control; and (o) That is otherwise acceptable to Bank. "Account" means any right to the payment of money owned by the Company and arising out of the sale of goods or the rendering of services by the Company which is not evidenced by an instrument or chattel paper. "Acquisition" means any transaction or series of related transactions for the purpose of or resulting, directly or indirectly, in (a) the acquisition of all or substantially all of the assets of a Person, or of any business or division of a Person, (b) the acquisition of in excess of 50% of the capital stock, partnership interests, membership interests or equity of any Person, or otherwise causing any Person to become a Subsidiary, or (c) a merger or consolidation or any other combination with another Person (other than a Person that is a Restricted Subsidiary) provided that the Company or the Restricted Subsidiary is the surviving entity. "Acquisition Cost" of standing timber, timber rights, or timberlands means the aggregate of cash, checks or other cash equivalent financial instruments paid and to be paid by the Company as the acquisition price of standing timber, timber rights, or timberlands being acquired, including sale, use or other transaction taxes paid or payable by the Company and amounts required to be applied to repay principal, interest and prepayment premiums and penalties on Indebtedness secured by a Lien (other than that arising from a Collateral Document) on such standing timber, timber rights, or timberlands. "Affiliate" means, as to any Person, any other Person which, directly or indirectly, is in control of, is controlled by, or is under common control with, such Person. A Person shall be deemed to control another Person if the controlling Person possesses, directly or indirectly, the power to direct or cause the direction of the management and policies of the other Person, whether through the ownership of voting securities, by contract or otherwise. Except with respect to the Bank or any Affiliate (defined without regard to this sentence) of the Bank, any director, executive officer or beneficial owner of 10% or more of the equity of a Person shall for the purposes of this Agreement, be deemed to control the other Person. "Agreement" means this Credit Agreement. "Applicable Margin" means, with respect to any Base Rate Loan or Offshore Rate Loan, the per annum rates set forth opposite the Pricing Level calculated for the periods described below.
Pricing Ratio Pricing at End of Level Fiscal Quarter Applicable Margin ----- -------------- ----------------- Offshore Base Rate Rate Loans Loans ---------- ----- I LESS THAN OR EQUAL TO 1.50% 0.50% 1.00 TO 1.00 II GREATER THAN 1.00 TO 1.75% 0.75% 1.00 BUT LESS THAN OR EQUAL TO 2.00 TO 1.00 III GREATER THAN 2.00 TO 2.00% 1.00% 1.00 BUT LESS THAN OR EQUAL TO 3.00 TO 1.00 IV. GREATER THAN 3.00 TO 2.25% 1.25% 1.00 BUT LESS THAN OR EQUAL TO 4.00 TO 1.00 V. GREATER THAN 4.00 TO 2.50% 1.50% 1.00
[/CAPTION] Where, "Pricing Level" means, for each Pricing Period, the pricing level set forth opposite the Pricing Ratio set forth in the Compliance Certificate most recently delivered to the Agent pursuant to Section 6.02. "Pricing Level Change Date" means the date three Business Days after the delivery to the Agent of the financial reports and Compliance Certificate delivered pursuant to Sections 6.01 and 6.02 for the fiscal quarter ending December 31, 1998, and three days after delivery to the Agent of such financial reports and Compliance Certificate for each fiscal quarter thereafter. "Pricing Period" means each period commencing on each Pricing Level Change Date and ending the day prior to the next Pricing Level Change Date. From the Closing Date until the first Pricing Level Change Date, the Applicable Margin for any Offshore Rate Loan or Base Rate Loan shall correspond to the rates per annum set forth above opposite Pricing Level V. The Applicable Margin shall be adjusted automatically as to all Loans then outstanding (without regard to the timing of Interest Periods) on each Pricing Level Change Date to correspond with the applicable Pricing Level. If the Company fails to deliver such financial reports and certificates to the Agent for any fiscal quarter by the date required hereunder, then the Applicable Margin for all Loans beginning three Business Days after such date shall, until three Business Days after delivery of such financial reports and certificates, be the next higher Applicable Margin as set forth in the chart above immediately below the previously effective Applicable Margin; thus, if the Applicable Margin had previously been 1.50% for Offshore Rate Loans, a failure to deliver quarterly financials on a timely basis would cause the Applicable Margin to be 1.75% until three Business Days after such delivery. "Assignee" has the meaning specified in subsection 9.08(a). "Attorney Costs" means and includes all fees and disbursements of any law firm or other external counsel, the allocated cost of internal legal services and all disbursements of internal counsel. "Bank" means Bank of America National Trust and Savings Association. Unless the context otherwise clearly requires, (a) "Bank" includes Bank of America National Trust and Savings Association in its capacity as Swap Provider, and (b) references to Bank of America National Trust and Savings Association as a "Bank" shall also include any of such institution's Affiliates that may at any time of determination be Swap Providers. "Bankruptcy Code" means the Federal Bankruptcy Reform Act of 1978 (11 U.S.C. Section 101, et seq.). "Base Rate" means, for any day, the higher of: (a) 0.50% per annum above the latest Federal Funds Rate; and (b) the rate of interest in effect for such day as publicly announced from time to time by the Bank in San Francisco, California, as its "reference rate." (The "reference rate" is a rate set by the Bank based upon various factors including the Bank's costs and desired return, general economic conditions and other factors, and is used as a reference point for pricing some loans, which may be priced at, above, or below such announced rate.) Any change in the reference rate announced by the Bank shall take effect at the opening of business on the day specified in the public announcement of such change. "Base Rate Loan" means a Loan that bears interest based on the Base Rate. "Bear Stearns Investment Advisory Contract" means the investment advisory contract between the Company and Bear, Stearns & Co., Inc. dated as of October 5, 1993. "Borrowing Base" means: (a) the sum of: (1) 80% of the balance due on Acceptable Receivables; plus (2) 60% of the value of Acceptable Inventory; plus (3) 50% of the Acquisition Cost of Timberlands; minus (b) the aggregate of the Company's open payables for contracted logging and hauling; in each case as of the time of computation. "Borrowing Base Certificate" means a certificate, in form and detail acceptable to the Bank, from the Company and signed by a Responsible Officer of the Company, setting forth the computations which form the basis for the Borrowing Base contained in the certificate. "Borrowing Date" means any date on which a Loan is disbursed. "Britt Lumber Agreement" means the agreement dated as of March 23, 1993, among the Company and Britt Lumber Co., Inc. "Business Day" means any day other than a Saturday, Sunday or other day on which commercial banks in San Francisco, California are authorized or required by law to close and, if the applicable Business Day relates to any Offshore Rate Loan, means such a day on which dealings are carried on in the applicable offshore dollar interbank market. "Capital Adequacy Regulation" means any guideline, request or directive of any central bank or other Governmental Authority, or any other law, rule or regulation, whether or not having the force of law, in each case, regarding capital adequacy of any bank or of any corporation controlling a bank. "Capital Lease" has the meaning specified in the definition of Capital Lease Obligations. "Capital Lease Obligations" means all monetary obligations of the Company or any of its Subsidiaries under any leasing or similar arrangement which, in accordance with GAAP, is classified as a capital lease ("Capital Lease"). "Capital Stock" of any Person means any and all shares, interests, rights to purchase, warrants, options, participations or other equivalents of equity interests in (however designated) such Person, including any Preferred Stock of such Person but excluding any Redeemable Stock of such Person. "Cash Equivalents" means at any time (i) any evidence of any obligation issued or directly and fully guaranteed or insured by the United States or any agency or instrumentality thereof (provided, that the full faith and credit of the United States is pledged in support thereof); (ii) demand or time deposits with, and certificates of deposit or acceptances issued by, any bank or trust company organized under the laws of the United States or any State thereof (including the Bank) whose unsecured, unguaranteed long-term debt obligations are rated "A" by Standard & Poor's Corporation ("S&P") and "A2" by Moody's Investors Service, Inc. ("Moody's") or higher, or whose unsecured, unguaranteed commercial paper obligations are rated "A-2" by S&P and "P-2" by Moody's or higher; (iii) repurchase agreements entered into with entities whose unsecured, unguaranteed long-term debt obligations are rated "A" by S&P and "A2" by Moody's or higher, or whose unsecured, unguaranteed commercial paper obligations are rated "A-2" by S&P and "P-2" by Moody's or higher, pursuant to a written agreement with respect to any obligation described in clauses (i), (ii) or (iv) of this definition; (iv) commercial paper (including both noninterest-bearing discount obligations and interest-bearing obligations payable on demand or on a specified date not later than 180 days from the date of acquisition thereof) and having a rating of "A-2" by S&P and "P-2" by Moody's or higher; (v) direct obligations of any money market fund or other similar investment company all of whose investments consist primarily of obligations described in the foregoing clauses of this definition and that is rated "AAm" by S&P and "Aam" by Moody's or higher; (vi) taxable auction rate securities commonly known as "money market notes" that at the time of purchase have been rated and the ratings for which (A) for direct issues, must not be less than "P2" if rated by Moody's and not less than "A2" if rated by S&P, or (B) for collateralized issues which follow the asset coverage tests set forth in the Investment Company Act of 1940, as amended, must have long-term ratings of at least "AAA" if rated by S&P and "Aaa" if rated by Moody's; or (vii) any investments hereafter developed which are substantially comparable to those described above. "CERCLA" means the Comprehensive Environmental Response, Compensation, and Liability Act of 1980. "Change in Control" means the occurrence of any of the following events: (a) MAXXAM Inc. not being the sole beneficial owner, directly or indirectly, of at least 51% of the total common equity of the Company. For purposes of this clause, a beneficial owner shall have the meaning ascribed in Regulation 13d-3 of the Exchange Act as in effect on the date of this Agreement. The provisions of this clause shall not apply if MAXXAM Inc. should not hold the requisite beneficial ownership interest because of bankruptcy, reorganization, insolvency, or similar proceedings; or (b) MAXXAM Inc., through direct representation or through persons nominated by it, not controlling a majority of the Board of Directors of the Company necessary to effectuate any actions by the Board of Directors of the Company; or (c) Any person or group directly or indirectly owning more than MAXXAM Inc. of the total voting power entitled to vote generally in the election of directors of the Company. For purposes of this clause, person or group shall have the meaning ascribed in Section 13(d)(3) of the Exchange Act as in effect on the date of this Agreement; or (d) Charles Hurwitz, members of his immediate family and trusts for the benefit thereof (each such person, including Mr. Hurwitz and any trustee of such trusts, a "Beneficiary") not having (other than by reason of resolution of any litigation outstanding as of the date of this Agreement or any similar litigation or the existence of a Lien but including by reason of the foreclosure of or other realization upon a Lien) direct or indirect sole beneficial ownership (as defined under Regulation 13d-3 of the Exchange Act as in effect on the date of this Agreement) of at least the Minimum Percentage of the total equity of MAXXAM Inc. other than as a result of new issuances of equity securities by MAXXAM Inc. to third parties (other than to a third party who is not a Beneficiary and who controls MAXXAM Inc.). For purposes of this definition, "Minimum Percentage" means the product of (x) the percentage of the total equity of MAXXAM Inc. directly or indirectly beneficially owned by the Beneficiaries as of the date of this Agreement times (y) 80%. "Closing Date" means the date on which all conditions precedent set forth in Section 4.01 are satisfied or waived by the Bank (or, in the case of subsection 4.01(d), waived by the Person entitled to receive such payment). "Code" means the Internal Revenue Code of 1986, and regulations promulgated thereunder. "Collateral" means all property and interests in property and proceeds thereof now owned or hereafter acquired by the Company in or upon which a Lien now or hereafter exists in favor of the Bank securing all or part of the Obligations (except, with respect to Specified Swap Contracts, as set forth in Section 2.13), whether under this Agreement or under any other documents executed and delivered to the Bank. "Collateral Documents" means, collectively, (i) the Company Security Agreement, the Deeds of Trust, and all other security agreements, mortgages, deeds of trust, patent and trademark assignments, lease assignments, guarantees and other similar agreements between the Company and the Bank now or hereafter delivered to the Bank pursuant to or in connection with the transactions contemplated hereby, granting Bank a Lien on the Collateral and all financing statements (or comparable documents now or hereafter filed in accordance with the UCC or comparable law) against the Company as debtor in favor of the Bank as secured party, and (ii) any amendments, supplements, modifications, renewals, replacements, consolidations, substitutions and extensions of any of the foregoing. "Commitment" means $60,000,000. "Commitment Fee" has the meaning specified in Section 2.10(a). "Commitment Fee Percentage" means with respect to the Commitment, the per annum rates set forth below opposite the Pricing Level calculated for periods described below. The terms "Pricing Level" and "Pricing Level Change Date" shall have the meanings specified in the definition of "Applicable Margin."
Pricing Ratio Pricing at End of Level Fiscal Quarter Commitment Fee Percentage ----- -------------- ------------------------- I LESS THAN OR .40% EQUAL TO 1.00 TO 1.00 II GREATER THAN .45% 1.00 TO 1.00 BUT LESS THAN OR EQUAL TO 2.00 TO 1.00 III GREATER THAN .50% 2.00 TO 1.00 BUT LESS THAN OR EQUAL TO 3.00 TO 1.00 IV. GREATER THAN .50% 3.00 TO 1.00 BUT LESS THAN OR EQUAL TO 4.00 TO 1.00 V. GREATER THAN .50% 4.00 TO 1.00
[/CAPTION] From the Closing Date until the first Pricing Level Change Date, the Commitment Fee Percentage shall correspond to the rates per annum set forth above opposite Pricing Level V. The Commitment Fee Percentage shall be adjusted automatically on each Pricing Level Change Date to correspond with the applicable Pricing Level. If the Company fails to deliver such financial reports and certificates to the Agent for any fiscal quarter by the date required hereunder, then the Commitment Fee Percentage beginning three Business Days after such date shall, until three Business Days after delivery of such financial reports and certificates, be the next higher Commitment Fee Percentage as set forth in the chart above immediately below the previously effective Commitment Fee Percentage; thus, if the Commitment Fee Percentage had previously been 0.40%, a failure to deliver quarterly financials on a timely basis would cause the Commitment Fee Percentage to be .45% until three Business Days after such delivery. "Company Security Agreement" means the Amended and Restated Security Agreement (Receivables and Inventory) between the Bank and the Company of even date herewith. "Compliance Certificate" means a certificate substantially in form of Exhibit C. "Contingent Obligation" means, as to any Person, (a) any Guaranty Obligation of that Person; and (b) any direct or indirect obligation or liability, contingent or otherwise, of that Person, (i) in respect of any letter of credit or similar instrument issued for the account of that Person or as to which that Person is otherwise liable for reimbursement of drawings, or (ii) in respect of any Swap Contract that is not entered into in connection with a bona fide hedging operation that provides offsetting benefits to such Person. The amount of any Contingent Obligation shall (subject, in the case of Guaranty Obligations, to the last sentence of the definition of "Guaranty Obligation") be deemed equal to the maximum reasonably anticipated liability in respect thereof, and shall, with respect to item (b)(ii) of this definition, be marked to market on a current basis, excluding any obligations pursuant to contracts with Subsidiaries of the Company or with Britt Lumber Co., Inc. "Contractual Obligation" means, as to any Person, any provision of any security issued by such Person or of any agreement, undertaking, contract, indenture, mortgage, deed of trust or other instrument, document or agreement to which such Person is a party or by which it or any of its property is bound. "Conversion/Continuation Date" means any date on which, under Section 2.04, the Company (a) converts Loans of one Type to another Type, or (b) continues as Loans of the same Type, but with a new Interest Period, Loans having Interest Periods expiring on such date. "Debt" means, at any date of determination, the sum of the following, computed on an Unconsolidated Basis: all outstanding Loans plus any other interest bearing Indebtedness, the face amount of undrawn letters of credit, and any Guaranty Obligation on account of interest bearing Indebtedness or undrawn letters of credit. "Deed of Trust" means any deed of trust, mortgage, leasehold mortgage, assignment of rents or other document creating a Lien on Timberlands or any interest in Timberlands in favor of the Bank. "Default" means any event or circumstance which, with the giving of notice, the lapse of time, or both, would (if not cured or otherwise remedied during such time) constitute an Event of Default. "Early Termination Date" with respect to a Specified Swap Contract shall have the meaning specified in such contract. "EBITDA" means, for any fiscal period, the following, computed on an Unconsolidated Basis for such period: net income or loss (excluding therefrom any net income or loss of SPC or any Unrestricted Subsidiary) plus the sum of, without duplication, (a) income tax expense, (b) interest expense, (c) depreciation, (d) depletion, (e) amortization of deferred financing cost, and (f) non-recurring, non-cash charges. "Effective Amount" means (i) with respect to any Revolving Loans and Term Loans on any date, the aggregate outstanding principal amount thereof after giving effect to any Borrowings and prepayments or repayments of Revolving Loans and Term Loans occurring on such date; and (ii) with respect to any outstanding L/C Obligations on any date, the amount of such L/C Obligations on such date after giving effect to any Issuances of Letters of Credit occurring on such date and any other changes in the aggregate amount of the L/C Obligations as of such date, including as a result of any reimbursements of outstanding unpaid drawings under any Letters of Credit or any reductions in the maximum amount available for drawing under Letters of Credit taking effect on such date. "Environmental Claims" means all claims, however asserted, by any Governmental Authority or by any other Person in good faith and upon a reasonable basis alleging potential liability or responsibility for violation of any Environmental Law or for release or injury to the environment or threat to public health, personal injury (including sickness, disease or death), property damage, natural resources damage, or otherwise alleging liability or responsibility for damages (punitive or otherwise), cleanup, removal, remedial or response costs, restitution, civil or criminal penalties, injunctive relief, or other type of relief, resulting from or based upon (a) the presence, placement, discharge, emission or release (including intentional and unintentional, negligent and non-negligent, sudden or non-sudden, accidental or non-accidental placement, spills, leaks, discharges, emissions or releases) of any Hazardous Material at, in, or from property, whether or not owned by the Company, or (b) any other circumstances forming the basis of any violation, or violation alleged in good faith and upon a reasonable basis, of any Environmental Law. "Environmental Laws" means all federal, state or local laws, statutes, common law duties, rules, regulations, ordinances and codes, together with all administrative orders, directed duties, requests, licenses, authorizations and permits of, and agreements with, any Governmental Authorities, in each case relating to environmental, health, safety and land use matters; including CERCLA, the Clean Air Act, the Federal Water Pollution Control Act of 1972, the Solid Waste Disposal Act, the Endangered Species Act (16 U.S.C. Section 1531 et seq.), the Migratory Bird Treaty Act (16 U.S.C. 703 et seq.), the Forest and Rangeland Renewable Resources Act of 1974, the National Forest Management Act of 1976, the Federal Resource Conservation and Recovery Act, the Toxic Substances Control Act, the Emergency Planning and Community Right-to-Know Act, the California Hazardous Waste Control Law, the California Solid Waste Management, Resource, Recovery and Recycling Act, the California Water Code and the California Health and Safety Code, the Z'berg-Nejedly Forest Practices Act of 1973 and the California Public Resources Code. "ERISA" means the Employee Retirement Income Security Act of 1974, and regulations promulgated thereunder. "ERISA Affiliate" means any trade or business (whether or not incorporated) that is, or at any time within six years of the time in question has been, under common control with the Company within the meaning of Section 414(b) or (c) of the Code (and Sections 414(m) and (o) of the Code for purposes of provisions relating to Section 412 of the Code). "ERISA Event" means (a) a Reportable Event with respect to a Pension Plan; (b) a withdrawal by the Company or any ERISA Affiliate from a Pension Plan subject to Section 4063 of ERISA during a plan year in which it was a substantial employer (as defined in Section 4001(a)(2) of ERISA) or a cessation of operations which is treated as such a withdrawal under Section 4062(e) of ERISA; (c) a complete or partial withdrawal by the Company or any ERISA Affiliate from a Multiemployer Plan or notification that a Multiemployer Plan is in reorganization; (d) the treatment of a Pension Plan amendment as a termination under Section 4041 or 4041A of ERISA, or the filing of a notice of intent to terminate or the commencement of proceedings by the PBGC to terminate a Pension Plan or Multiemployer Plan; (e) an event or condition which might reasonably be expected to constitute grounds under Section 4042 of ERISA for the termination of, or the appointment of a trustee to administer, any Pension Plan or Multiemployer Plan; or (f) the imposition of any liability under Title IV of ERISA, other than PBGC premiums due but not delinquent under Section 4007 of ERISA, upon the Company or any ERISA Affiliate. "Event of Default" means any of the events or circumstances specified in Section 8.01. "Excess Cash Flow" means, for any fiscal period, the following, computed for the four fiscal quarters ending at the end of such period: (i) Free Cash Flow less (ii) the sum, without duplication, of the following computed on an Unconsolidated Basis: (A) interest expense, plus (B) Scheduled Payments, plus (C) other net reductions in Indebtedness of the type described in clauses (a) through (f) of the definition thereof, less (iii) any net increase in working capital, plus (iv) any net decrease in working capital. Working capital for this purpose shall mean accounts receivable, plus inventory, minus accounts payable. "Exchange Act" means the Securities Exchange Act of 1934, and regulations promulgated thereunder. "Federal Funds Rate" means, for any day, the rate set forth in the weekly statistical release designated as H.15(519), or any successor publication, published by the Federal Reserve Bank of New York (including any such successor, "H.15(519)") on the preceding Business Day opposite the caption "Federal Funds (Effective)"; or, if for any relevant day such rate is not so published on any such preceding Business Day, the rate for such day will be the arithmetic mean as determined by the Bank of the rates for the last transaction in overnight Federal funds arranged prior to 9:00 a.m. (New York City time) on that day by each of three leading brokers of Federal funds transactions in New York City selected by the Bank. "FRB" means the Board of Governors of the Federal Reserve System, and any Governmental Authority succeeding to any of its principal functions. "Free Cash Flow" means, for any fiscal period, the following, computed for the four fiscal quarters ending at the end of such period: EBITDA, plus SPC's distributions to the Company on account of its membership interest in SPC, minus capital expenditures computed on an Unconsolidated Basis (other than capital expenditures constituting the Acquisition Cost of Timberlands to the extent financed with Term Loans), plus the Acquisition Cost of standing timber, timber rights, or timberlands acquired by the Company or any Restricted Subsidiary after the date hereof and contributed to Salmon Creek Corporation, any of its Subsidiaries, or a Special Purpose Subsidiary during such fiscal period pursuant to a Permitted Salmon Creek Transaction; provided, however, that (a) the foregoing shall be computed without giving effect to the direct or indirect dividend or distribution to the stockholders of the Company or any of its Subsidiaries of any Salmon Creek Proceeds and (b) (i) for purposes of determining Free Cash Flow for the four fiscal quarters ending December 31, 1998, Free Cash Flow shall mean the Free Cash Flow for the fiscal quarter ending December 31, 1998 multiplied by four; (ii) for purposes of determining Free Cash Flow for the four fiscal quarters ending March 31, 1999, Free Cash Flow shall mean the Free Cash Flow for the two fiscal quarters ending March 31, 1999 multiplied by two; and (iii) for purposes of determining Free Cash Flow for the four fiscal quarters ending June 30, 1999, Free Cash Flow shall mean the Free Cash Flow for the three fiscal quarters ending June 30, 1999 multiplied by 133%. "GAAP" means generally accepted accounting principles set forth from time to time in the opinions and pronouncements of the Accounting Principles Board and the American Institute of Certified Public Accountants and statements and pronouncements of the Financial Accounting Standards Board (or agencies with similar functions of comparable stature and authority within the U.S. accounting profession) and which are applicable to the circumstances. "Governmental Authority" means any nation or government, any state or other political subdivision thereof, any central bank (or similar monetary or regulatory authority) thereof, any entity exercising executive, legislative, judicial, regulatory or administrative functions of or pertaining to government, and any corporation or other entity owned or controlled, through stock or capital ownership or otherwise, by any of the foregoing. "Guaranty Obligation" means, as applied to any Person, any direct or indirect liability of that Person with respect to any Indebtedness, lease, dividend, letter of credit or other obligation (the "primary obligations") of another Person (the "primary obligor"), including any obligation of that Person, whether or not contingent, (a) to purchase, repurchase or otherwise acquire such primary obligations or any property constituting direct or indirect security therefor, or (b) to advance or provide funds (i) for the payment or discharge of any such primary obligation, or (ii) to maintain working capital or equity capital of the primary obligor or otherwise to maintain the net worth or solvency or any balance sheet item, level of income or financial condition of the primary obligor, or (c) to purchase property, securities or services primarily for the purpose of assuring the owner of any such primary obligation of the ability of the primary obligor to make payment of such primary obligation, or (d) otherwise to assure or hold harmless the holder of any such primary obligation against loss in respect thereof. The amount of any Guaranty Obligation shall be deemed equal to the stated or determinable amount of the primary obligation in respect of which such Guaranty Obligation is made or, if not stated or if indeterminable, the maximum reasonably anticipated liability in respect thereof. "Hazardous Materials" means all those substances that are regulated by, or which may form the basis of liability under, any Environmental Law, including any substance identified under any Environmental Law as a pollutant, contaminant, hazardous waste, hazardous constituent, special waste, hazardous substance, hazardous material, or toxic substance, or petroleum or petroleum derived substance or waste. "Honor Date" has the meaning specified in subsection 2.16(b). "Incur" means, directly or indirectly, create, incur, issue, assume, guarantee or become liable with respect to, contingently or otherwise (and the terms "Incurred" and "Incurrence" have correlative meanings. "Indebtedness" of any Person means, without duplication, (a) all indebtedness for borrowed money; (b) all obligations issued, undertaken or assumed as the deferred purchase price of property or services (other than trade payables entered into in the ordinary course of business on ordinary terms and other than compensation, pension obligations, and other obligations arising from employee benefits and employee arrangements); (c) all non-contingent reimbursement or payment obligations with respect to all letters of credit (including standby and commercial), banker's acceptances, bank guaranties, shipside bonds, surety bonds and similar instruments; (d) all obligations evidenced by notes, bonds, debentures or similar instruments, including obligations so evidenced incurred in connection with the acquisition of property, assets or businesses; (e) all indebtedness created or arising under any conditional sale or other title retention agreement, or incurred as financing, in either case with respect to property acquired by the Person (even though the rights and remedies of the seller or bank under such agreement in the event of default are limited to repossession or sale of such property); (f) all obligations with respect to Capital Leases; (g) all indebtedness referred to in clauses (a) through (f) above secured by (or for which the holder of such Indebtedness has an existing right, contingent or otherwise, to be secured by) any Lien upon or in property (including accounts and contracts rights) owned by such Person, even though such Person has not assumed or become liable for the payment of such Indebtedness; and (h) all Guaranty Obligations in respect of indebtedness or obligations of others of the kinds referred to in clauses (a) through (g) above. "Indemnified Liabilities" has the meaning specified in Section 9.05(a). "Indemnified Person" has the meaning specified in Section 9.05(a). "Insolvency Proceeding" means (a) any case, action or proceeding before any court or other Governmental Authority relating to bankruptcy, reorganization, insolvency, liquidation, receivership, dissolution, winding-up or relief of debtors, or (b) any general assignment for the benefit of creditors, composition, marshalling of assets for creditors, or other, similar arrangement in respect of its creditors generally or any substantial portion of its creditors; undertaken under U.S. Federal, state or foreign law, including the Bankruptcy Code. "Interest Payment Date" means, as to any Offshore Rate Loan, the last day of each Interest Period applicable to such Loan and, as to any Base Rate Loan, the last Business Day of each calendar quarter and each date such Loan is converted into an Offshore Rate Loan, provided, however, that if any Interest Period an Offshore Rate Loan exceeds three months, the date that falls three months after the beginning of such Interest Period and after each Interest Payment Date thereafter is also an Interest Payment Date. "Interest Period" means, as to any Offshore Rate Loan, the period commencing on the Borrowing Date of such Loan or on the Conversion/Continuation Date on which the Loan is converted into or continued as an Offshore Rate Loan, and ending on the date one, two, three or six months thereafter as selected by the Company in its Notice of Borrowing or Notice of Conversion/Continuation; provided that: (i) If any Interest Period would otherwise end on a day that is not a Business Day, that Interest Period shall be extended to the following Business Day unless, the result of such extension would be to carry such Interest Period into another calendar month, in which event such Interest Period shall end on the preceding Business Day; (ii) Any Interest Period pertaining to an Offshore Rate Loan that begins on the last Business Day of a calendar month (or on a day for which there is no numerically corresponding day in the calendar month at the end of such Interest Period) shall end on the last Business Day of the calendar month at the end of such Interest Period; and (iii) No Interest Period for any Term Loan shall extend beyond the date four years after the Revolving Termination Date and no Interest Period for any Revolving Loan shall extend beyond the Revolving Termination Date; and (iv) No Interest Period applicable to a Term Loan or portion thereof shall extend beyond any date upon which is due any scheduled principal payment in respect of the Term Loans unless the aggregate principal amount of Term Loans represented by Base Rate Loans or by Offshore Rate Loans having Interest Periods that will expire on or before such date, equals or exceeds the amount of such principal payment. "Investment" has the meaning specified in Section 7.04. "IRS" means the Internal Revenue Service, and any Governmental Authority succeeding to any of its principal functions under the Code. "Issuance Date" means the date of issuance of any Letter of Credit. "Issue" means, with respect to any Letter of Credit to issue or to extend the expiry of, or to renew or increase the amount of, such Letter of Credit; and the terms "Issued," "Issuing" and "Issuance" have corresponding meanings. "Joint Venture" means a single-purpose corporation, partnership, limited liability company, joint venture or other similar legal arrangement (whether created by contract or conducted through a separate legal entity) now or hereafter formed by the Company or any of its Subsidiaries with another Person in order to conduct a common venture or enterprise with such Person. "L/C Amendment Application" means an application form for amendment of outstanding standby letters of credit as shall at any time be in use at the Bank, as the Bank shall request. "L/C Application" means an application form for issuances of standby letters of credit as shall at any time be in use at the Bank, as the Bank shall request. "L/C Borrowing" means an extension of credit resulting from a drawing under any Letter of Credit which shall not have been reimbursed on the date when made nor converted into a Borrowing of Revolving Loans under subsection 2.16(b). "L/C Obligations" means at any time the sum of (a) the aggregate undrawn amount of all Letters of Credit then outstanding, plus (b) the amount of all unreimbursed drawings under all Letters of Credit, including all outstanding L/C Borrowings. "L/C-Related Documents" means the Letters of Credit, the L/C Applications, the L/C Amendment Applications and any other document relating to any Letter of Credit, including any of the Bank's standard form documents for letter of credit Issuances. "Lending Office" means, as to the Bank, the office or offices of the Bank specified as its "Lending Office" or "Domestic Lending Office" or "Offshore Lending Office", as the case may be, on the signature pages of this Agreement, or such other office or offices as the Bank may from time to time notify the Company. "Letter of Credit Fee" has the meaning specified in subsection 2.21(a). "Letter of Credit Fee Percentage" means with respect to the Letters of Credit, the per annum rates set forth below opposite the Pricing Level calculated for periods described below. The terms "Pricing Level" and "Pricing Level Change Date" shall have the meanings specified in the definition of "Applicable Margin."
Pricing Ratio Pricing at End of Letter of Credit Fee Level Fiscal Quarter Percentage ----- -------------- ---------- I LESS THAN OR 1.50% EQUAL TO 1.00 TO 1.00 II GREATER THAN 1.75% 1.00 TO 1.00 BUT LESS THAN OR EQUAL TO 2.00 TO 1.00 III GREATER THAN 2.00% 2.00 TO 1.00 BUT LESS THAN OR EQUAL TO 3.00 TO 1.00 IV. GREATER THAN 2.25% 3.00 TO 1.00 BUT LESS THAN OR EQUAL TO 4.00 TO 1.00 V. GREATER THAN 2.50% 4.00 TO 1.00
[/CAPTION] From the Closing Date until the first Pricing Level Change Date, the Letter of Credit Fee Percentage shall correspond to the rates per annum set forth above opposite Pricing Level V. The Letter of Credit Fee Percentage shall be adjusted automatically on each Pricing Level Change Date to correspond with the applicable Pricing Level. If the Company fails to deliver such financial reports and certificates to the Agent for any fiscal quarter by the date required hereunder, then the Letter of Credit Fee Percentage beginning three Business Days after such date shall, until three Business Days after delivery of such financial reports and certificates, be the next higher Letter of Credit Fee Percentage as set forth in the chart above immediately below the previously effective Letter of Credit Fee Percentage; thus, if the Letter of Credit Fee Percentage had previously been 1.50%, a failure to deliver quarterly financials on a timely basis would cause the Letter of Credit Fee Percentage to be 1.75% until three Business Days after such delivery. "Letters of Credit" means letters of credit Issued under the Prior Credit Agreement and standby letters of credit Issued pursuant to this Agreement. "Lien" means any security interest, mortgage, deed of trust, pledge, hypothecation, assignment, charge or deposit arrangement, encumbrance, lien (statutory or other) or preferential arrangement of any kind or nature whatsoever in respect of any property (including those created by, arising under or evidenced by any conditional sale or other title retention agreement, the interest of a lessor under a Capital Lease, any financing lease having substantially the same economic effect as any of the foregoing, or the filing of any financing statement naming the owner of the asset to which such lien relates as debtor, under the UCC or any comparable law) and any contingent or other agreement to provide any of the foregoing, but not including the interest of a lessor under an operating lease. "Loan" means an extension of credit by the Bank to the Company under Article II, and may be a Base Rate Loan or an Offshore Rate Loan (each, a "Type" of Loan), and includes any Revolving Loan or Term Loan. "Loan Documents" means this Agreement, the Collateral Documents, the L/C Applications, any documents evidencing or relating to Specified Swap Contracts with the Bank, and all other documents delivered to the Bank in connection with the transactions contemplated by this Agreement. "Margin Stock" means "margin stock" as such term is defined in Regulation T, U or X of the FRB. "Material Adverse Effect" means a material adverse change in, or a material adverse effect upon, any of (a) the operations, business, properties, condition (financial or otherwise) or financial prospects of the Company or the Company and its Subsidiaries taken as a whole or as to SPC; (b) the ability of the Company to perform under any Loan Document and avoid any Event of Default; (c) the legality, validity, binding effect or enforceability of any Loan Document; or (d) the perfection or priority of any Lien granted to the Bank under any of the Collateral Documents. "MGHI" means MAXXAM Group Holdings Inc. "Mortgaged Property" means all property subject to a Lien pursuant to a Deed of Trust. "Multiemployer Plan" means a "multiemployer plan", within the meaning of Section 4001(a)(3) of ERISA, to which the Company or any ERISA Affiliate makes, is making, or is obligated to make contributions or, during the preceding three calendar years, has made, or been obligated to make, contributions. "Notice of Borrowing" means a notice in substantially the form of Exhibit A. "Notice of Conversion/Continuation" means a notice in substantially the form of Exhibit B. "Notice of Lien" has the meaning specified in Section 7.01(c). "Obligations" means all advances, debts, liabilities, obligations, covenants and duties arising under any Loan Document owing by the Company to the Bank or any Indemnified Person, whether direct or indirect (including those acquired by assignment), absolute or contingent, due or to become due, now existing or hereafter arising. "Offshore Rate" means, for any Interest Period, with respect to any Offshore Rate Loan, the rate of interest per annum at which dollar deposits in the approximate amount of the Bank's Offshore Rate Loan for such Interest Period would be offered by the Bank's Grand Cayman Branch, Grand Cayman, B.W.I. (or such other office as may be designated for such purpose by the Bank) to major banks in the offshore dollar interbank market upon request of such banks at approximately 11:00 a.m. (New York City time) two Business Days prior to the commencement of such Interest Period. "Offshore Rate Loan" means a Loan that bears interest based on the Offshore Rate. "Organization Documents" means, for any corporation, the certificate or articles of incorporation, the bylaws, any certificate of determination or instrument relating to the rights of preferred shareholders of such corporation, any shareholder rights agreement, and all applicable resolutions of the board of directors (or any committee thereof) of such corporation. "Outstanding Letter of Credit" means at any time an Issued and as yet unexpired Letter of Credit in an amount equal to the undrawn amount of such Letter of Credit. "Participant" has the meaning specified in subsection 9.08(b). "PBGC" means the Pension Benefit Guaranty Corporation, or any Governmental Authority succeeding to any of its principal functions under ERISA. "Pension Plan" means a pension plan (as defined in Section 3(2) of ERISA) subject to Title IV of ERISA (excluding any Multiemployer Plan) which the Company sponsors, maintains, or to which it makes, is making, or is obligated to make contributions, or in the case of a multiple employer plan (as described in Section 4064(a) of ERISA) has made contributions at any time during the immediately preceding five (5) plan years. "Permitted Liens" has the meaning specified in Section 7.01. "Permitted Salmon Creek Transaction" means any or all of the following: the contribution, transfer, or sale (whether or not for fair market value) by the Company or any of its Restricted Subsidiaries to Salmon Creek Corporation, any of its Subsidiaries, or any Special Purpose Subsidiary of any standing timber, timber rights, or timberlands or of any equity interest in any Special Purpose Subsidiary, or Investments by the Company or any of its Restricted Subsidiaries to or in Salmon Creek Corporation, any of its Subsidiaries, or any Special Purpose Subsidiary of up to an additional $5,000,000 in cash or other assets in aggregate cumulative amount after the date hereof. "Permitted Swap Obligations" means all obligations (contingent or otherwise) of the Company existing or arising under Swap Contracts, provided that each of the following criteria is satisfied: (a) such obligations are (or were) entered into by such Person in the ordinary course of business for the purpose of directly or indirectly mitigating risks associated with liabilities, commitments or assets held by such Person, or changes in the value of securities issued by such Person in conjunction with a securities repurchase program not otherwise prohibited hereunder, and not for purposes of speculation or taking a "market view;" (b) such Swap Contracts do not contain (i) any provision ("walk-away" provision) exonerating the non-defaulting party from its obligation to make payments on outstanding transactions to the defaulting party, or (ii) with respect to any Swap Contract that is not a Specified Swap Contract, any provision creating or permitting the declaration of an event of default, termination event or similar event upon the occurrence of an Event of Default hereunder (other than an Event of Default under Section 8.01(a). "Person" means an individual, a sole proprietorship, partnership, corporation, limited liability company, business trust, joint stock company, trust, unincorporated association, joint venture or Governmental Authority. "Plan" means an employee benefit plan (as defined in Section 3(3) of ERISA) which the Company sponsors or maintains or to which the Company makes, is making, or is obligated to make contributions and includes any Multiemployer Plan or Pension Plan. "Preferred Stock" as applied to the Capital Stock or Redeemable Stock of any corporation, means Capital Stock or Redeemable Stock of any class or classes (however designated) which is preferred as to the payment of dividends, or as to the distribution of assets upon any voluntary or involuntary liquidation or dissolution of such corporation, over shares of Capital Stock or Redeemable Stock, as the case may be, of any other class of such corporation. "Pricing Ratio" means, as measured for any fiscal quarter, the ratio of (a) Debt as of the end of such fiscal quarter to (b) Free Cash Flow. "Prior Credit Agreement" has the meaning specified in the first "WHEREAS" clause of this Agreement. "Receivable Debtor" means the person or entity obligated upon a Receivable. "Receivables" shall have the meaning given in the Company Security Agreement. "Redeemable Stock" of any Person means any equity security of such Person that by its terms is required to be redeemed prior to the date four years after the Revolving Termination Date, or is redeemable at the option of the holder thereof at any time prior to such date. "Reportable Event" means, any of the events set forth in Section 4043(b) of ERISA or the regulations thereunder, other than any such event for which the 30-day notice requirement under ERISA has been waived in regulations issued by the PBGC. "Requirement of Law" means, as to any Person, any law (statutory or common), treaty, rule or regulation or determination of an arbitrator or of a Governmental Authority, in each case applicable to or binding upon the Person or any of its property or to which the Person or any of its property is subject. "Responsible Officer" of a Person means the chief executive officer or the president, the chief financial officer, the Vice President - Finance and Administration, the treasurer, assistant treasurer, or any other officer of such Person having substantially the same authority and responsibility or designated by the chief executive officer or the chief financial officer of such Person as having the appropriate authority and responsibility. "Restricted Payment" has the meaning specified in Section 7.12. "Restricted Subsidiary" means, as of any determination date, each of the Subsidiaries of the Company which is not as of such determination date an Unrestricted Subsidiary of the Company. "Revolving Credit" means the credit described in subsection 2.01(b). "Revolving Loan" has the meaning specified in subsection 2.01(b). "Revolving Termination Date" means the earlier to occur of: (a) October 31, 2001; and (b) the date on which the Bank's commitment to make Loans terminates in accordance with the provisions of this Agreement. "Salmon Creek Corporation" means Salmon Creek Corporation, a Delaware corporation, or any successor corporation, by way of merger, consolidation, purchase of all or substantially all of its assets, or otherwise, but which may not acquire any other assets (other than assets incidental to the operation, disposition, management and maintenance of Salmon Creek Property), except in exchange for or out of the proceeds of the sale or disposition of Salmon Creek Property. "Salmon Creek Proceeds" means any consideration received by the Company or any of its Subsidiaries from any Person (A) in respect of all or any part of the Capital Stock or Redeemable Stock of Salmon Creek Corporation, any of its Subsidiaries, or any Special Purpose Subsidiary, or (B) in respect of all or any part of the real property constituting Salmon Creek Property, or (C) otherwise in connection with Salmon Creek Corporation, any of its Subsidiaries, or any Special Purpose Subsidiary, or Salmon Creek Property, except in each case proceeds of the harvesting of timber constituting Salmon Creek Property. "Salmon Creek Property" means any standing timber, timber rights, or timberlands (including structures and improvements thereon and related interests in real property) owned on the date hereof by the Company, SPC, or Salmon Creek Corporation, any asset held by Salmon Creek Corporation, a Delaware corporation, on the date hereof, and any other assets obtained in exchange for or out of the proceeds of the sale or disposition of any of the foregoing. "Scheduled Payments" means the 16 quarterly payments to be made pursuant to Section 2.08(a). "SEC" means the Securities and Exchange Commission, or any Governmental Authority succeeding to any of its principal functions. "Solvent" means, as to any Person at any time, that (a) the fair value of the property of such Person is greater than the amount of such Person's liabilities (including disputed, contingent and unliquidated liabilities) as such value is established and liabilities evaluated for purposes of Section 101(31) of the Bankruptcy Code and, in the alternative, for purposes of the California Uniform Fraudulent Transfer Act; (b) the present fair saleable value of the property of such Person is not less than the amount that will be required to pay the probable liability of such Person on its debts as they become absolute and matured; (c) such Person is able to realize upon its property and pay its debts and other liabilities (including disputed, contingent and unliquidated liabilities) as they mature in the normal course of business; (d) such Person does not intend to, and does not believe that it will, incur debts or liabilities beyond such Person's ability to pay as such debts and liabilities mature; and (e) such Person is not engaged in business or a transaction, and is not about to engage in business or a transaction, for which such Person's property would constitute unreasonably small capital. "Specified Swap Contract" means any Swap Contract made or entered into at any time, or in effect at any time (whether heretofore or hereafter), whether directly or indirectly, and whether as a result of assignment or transfer or otherwise, between the Company and any Swap Provider which Swap Contract is or was intended by the Company to have been entered into, in part or entirely, for purposes of mitigating interest rate risk relating to any Loan (which intent shall conclusively be deemed to exist if the Company so represents to the Swap Provider in writing), and as to which the final scheduled payment by the Company is not later than the sixth anniversary of this Agreement. "SPC" means Scotia Pacific Company LLC, a Wholly-Owned Subsidiary of the Company. "Special Purpose Subsidiary" means a Subsidiary of the Company created after the Closing Date, capitalized with no material assets other than standing timber, timber rights, or timberlands owned by the Company or any of its Subsidiaries on the Closing Date, and designated by the Company as an Unrestricted Subsidiary in connection with such capitalization. "Subsidiary" means, with respect to any Person, (i) any corporation of which more than 50% of the outstanding Capital Stock and Redeemable Stock having ordinary voting power to elect a majority of the board of directors of the corporation (irrespective of whether at the time Capital Stock or Redeemable Stock of any other class or classes of such corporation shall or might have voting power upon the occurrence of any contingency) is at the time owned, directly or indirectly, by such Person, or by one or more other Subsidiaries of such Person, or by such Person and one or more other Subsidiaries of such Person, or (ii) any other entity of which more than 50% of the outstanding equity ownership interests are at the time owned, directly or indirectly, by such Person, or by one or more other Subsidiaries of such Person, or by such Person and one or more other Subsidiaries of such Person. "Swap Contract" means any agreement, whether or not in writing, relating to any transaction that is a rate swap, basis swap, forward rate transaction, commodity swap, commodity option, equity or equity index swap or option, bond, note or bill option, interest rate option, forward foreign exchange transaction, cap, collar or floor transaction, currency swap, cross-currency rate swap, swaption, currency option or any other, similar transaction (including any option to enter into any of the foregoing) or any combination of the foregoing, and, unless the context otherwise clearly requires, any master agreement relating to or governing any or all of the foregoing. Investments made pursuant to the Bear Stearns Investment Advisory Contract are not Swap Contracts for purposes of this Agreement and any other Loan Document. "Swap Provider" means the Bank, or any Affiliate of the Bank, that is at the time of determination party to a Swap Contract with the Company. "Swap Termination Value" means, in respect of any one or more Swap Contracts, after taking into account the effect of any legally enforceable netting agreement relating to such Swap Contracts, (a) for any date on or after the date such Swap Contracts have been closed out and termination value(s) determined in accordance therewith, such termination value(s), and (b) for any date prior to the date referenced in clause (a) the amount(s) determined as the mark-to-market value(s) for such Swap Contracts, as determined by the Company based upon one or more mid-market or other readily available quotations provided by any recognized dealer in such Swap Contracts (which may include the Bank.) "Tax Sharing Agreement" means the Tax Allocation Agreement, dated May 21, 1988, by and among MAXXAM Inc., the Company, and certain other subsidiaries of MAXXAM Inc., as amended by the Tax Allocation Agreement, dated as of March 23, 1993, by and among MAXXAM Inc., the Company, Scotia Pacific Holding Company, and Salmon Creek Corporation. "Term Sublimit" means the lesser of (a) $30,000,000, and (b) (i) the lesser of the Commitment and the Borrowing Base minus (ii) the Effective Amount of Revolving Loans and L/C Obligations. "Term Credit" means the credit described in subsection 2.01(a). "Term Loan" has the meaning specified in subsection 2.01(a). "Timber Notes" means the 6.55% Class A-1, 7.11% Class A-2 and 7.71% Class A-3 Timber Collateralized Notes due 2028, issued by SPC pursuant to the Indenture dated as of July 20, 1998, between SPC and State Street Bank and Trust Company, as trustee, including any notes issues by SPC pursuant to such Indenture pursuant to one or more exchange offers registered under the Securities Act of 1933, as amended. "Timberlands" means standing timber, timber rights, or timberlands of the Company located in California, the purchase price of which is, in whole or in part, paid from or refinanced by the Term Loans, which timberlands are encumbered by first priority Deeds of Trust securing the Obligations of the Company to the Bank under this Agreement and the other Loan Documents. "Type" has the meaning specified in the definition of "Loan." "UCC" means the Uniform Commercial Code as in effect in the State of California. "Unconsolidated Basis" means the Company and its Restricted Subsidiaries other than SPC on a consolidated basis. "Unfunded Pension Liability" means the excess of a Pension Plan's benefit liabilities under Section 4001(a)(16) of ERISA, over the current value of that Pension Plan's assets, determined in accordance with the assumptions used for funding the Pension Plan pursuant to Section 412 of the Code for the applicable plan year. "Unrestricted Subsidiary" means (a) each of the Subsidiaries of the Company so designated after the date hereof by a resolution adopted by the Company's Board of Directors and as to which designation the Bank has given its prior written approval, (b) any Subsidiary of an Unrestricted Subsidiary, (c) Salmon Creek Corporation, and (d) any Special Purpose Subsidiary. The Board of Directors may designate an Unrestricted Subsidiary to be a Restricted Subsidiary if no Default or Event of Default would arise by virtue of such designation. "Wholly-Owned Restricted Subsidiary" means any Restricted Subsidiary that is a Wholly-Owned Subsidiary. "Wholly-Owned Subsidiary" means (i) a corporation of which all of the outstanding shares of Capital Stock and Redeemable Stock having ordinary voting power to elect a majority of the board of directors of such corporation (irrespective of whether at the time Capital Stock or Redeemable Stock of any other class or classes of such corporation shall or might have voting power upon the occurrence of any contingency) are owned at the time, directly or indirectly (through one or more Wholly-Owned Restricted Subsidiaries), by the Company (except for director's qualifying shares), or (ii) any other entity of which all of the outstanding equity ownership interests are owned at the time, directly or indirectly (through one or more Wholly-Owned Restricted Subsidiaries), by the Company. 1.02 Other Interpretive Provisions. (a) The meanings of defined terms are equally applicable to the singular and plural forms of the defined terms. (b) The words "hereof", "herein", "hereunder" and similar words refer to this Agreement as a whole and not to any particular provision of this Agreement; and subsection, Section, Schedule and Exhibit references are to this Agreement unless otherwise specified. (c) Terms: (1) The term "documents" includes any and all instruments, documents, agreements, certificates, indentures, notices and other writings, however evidenced. (2) The term "including" is not limiting and means "including without limitation." (3) In the computation of periods of time from a specified date to a later specified date, the word "from" means "from and including"; the words "to" and "until" each mean "to but excluding", and the word "through" means "to and including." (4) The term "property" includes any kind of property or asset, real, personal or mixed, tangible or intangible. (d) Unless otherwise expressly provided herein, (i) references to agreements (including this Agreement) and other contractual instruments shall be deemed to include all subsequent amendments and other modifications thereto, but only to the extent such amendments and other modifications are not prohibited by the terms of any Loan Document, and (ii) references to any statute or regulation are to be construed as including all statutory and regulatory provisions consolidating, amending, replacing, supplementing or interpreting the statute or regulation. (e) The captions and headings of this Agreement are for convenience of reference only and shall not affect the interpretation of this Agreement. (f) This Agreement and other Loan Documents may use several different limitations, tests or measurements to regulate the same or similar matters. All such limitations, tests and measurements are cumulative and shall each be performed in accordance with their terms. (g) This Agreement and the other Loan Documents are the result of negotiations among and have been reviewed by counsel to the Bank, the Company and the other parties, and are the products of all parties. Accordingly, they shall not be construed against the Bank merely because of the Bank's involvement in their preparation. 1.03 Accounting Principles. (a) Unless the context otherwise clearly requires, all accounting terms not expressly defined herein shall be construed, and all financial computations required under this Agreement shall be made, in accordance with GAAP, consistently applied. (b) References herein to "fiscal year" and "fiscal quarter" refer to such fiscal periods of the Company. ARTICLE II THE CREDITS 2.01 The Term Credit and the Revolving Credit. (a) The Term Credit. The Bank agrees, on the terms and conditions set forth herein, to make loans to the Company (each such Loan, a "Term Loan") from time to time on any Business Day during the period from the Closing Date to the Revolving Termination Date in an aggregate amount not to exceed the Term Sublimit. (b) The Revolving Credit. The Bank agrees, on the terms and conditions hereinafter set forth, to make loans to the Company (each such loan a "Revolving Loan") and to Issue Letters of Credit for the account of the Company from time to time on any Business Day during the period from the Closing Date to the Revolving Termination Date, in an aggregate amount not to exceed at any time outstanding the lesser of the Commitment or the Borrowing Base; provided, however, that: (1) After giving effect to any Loan and/or the Issuance of a Letter of Credit, the Effective Amount of all Loans and L/C Obligations shall not exceed the lesser of the Commitment or the Borrowing Base; and (2) After the Issuance of a Letter of Credit, the Effective Amount of all L/C Obligations shall not exceed $20,000,000. (c) Reborrowing. Within the limits of the Term Sublimit, the Commitment and the Borrowing Base and subject to the other terms and conditions hereof, the Company may, pursuant to the terms of this Agreement (x) borrow, prepay, and reborrow under this Section 2.01; and (y) obtain Letters of Credit and obtain new Letters of Credit in place of Letters of Credit that have been discharged by performance and reimbursement to the Bank or which have expired. (d) Obligations under the Prior Credit Agreement. From and after the Closing Date, all "Standby Letters of Credit", "Loans", and "Letter of Credit Obligations" of the Company to the Bank under the Prior Credit Agreement shall be deemed to be Letters of Credit, Revolving Credit Loans, and L/C Obligations, respectively, under this Agreement, included in the computations required hereunder and subject to the provisions hereof. 2.02 Loan Accounts. The Loans made by the Bank shall be evidenced by one or more loan accounts or records maintained by the Bank in the ordinary course of business. The loan accounts or records maintained by the Bank shall be evidence of the amount of the Loans made by the Bank to the Company and the interest and payments thereon. Any failure so to record or any error in doing so shall not, however, limit or otherwise affect the obligation of the Company hereunder to pay any amount owing with respect to the Loans. 2.03 Procedure for Borrowing. (a) Each Loan shall be made upon the Company's irrevocable written notice (including notice via facsimile transmission confirmed immediately by a telephone call) delivered to the Bank in the form of a Notice of Borrowing (which notice must be received by the Bank prior to (i) 9:00 a.m. (San Francisco, California time) three Business Days prior to the requested Borrowing Date, in the case of Offshore Rate Loans; and (ii) 11:00 a.m. San Francisco, California time on the requested Borrowing Date, in the case of Base Rate Loans, specifying: (1) The amount of the Loan, which shall be in minimum amounts of $500,000 for Offshore Rate Loans and $100,000 for Base Rate Loans; (2) The requested Borrowing Date, which shall be a Business Day; (3) Whether each Loan is to be a Term Loan or Revolving Loan and whether each Loan is to be an Offshore Rate Loan or a Base Rate Loan; and (4) The duration of the Interest Period applicable to the Offshore Rate Loans included in such notice. If the Notice of Borrowing fails to specify the duration of the Interest Period for any Offshore Rate Loans, such Interest Period shall be three months. (b) The proceeds of the Loans will be made available to the Company by the Bank by crediting the account of the Company on the books of the Bank with such proceeds or by wire transfer in accordance with written instructions provided to the Bank by the Company. (c) After disbursement of any Loan, unless the Bank shall otherwise consent, there may not be more than ten different Interest Periods in effect. 2.04 Conversion and Continuation Elections. (a) The Company may, upon irrevocable written notice to the Bank in accordance with subsection 2.04(b): (1) Elect to convert on any Business Day, any Base Rate Loans (or any part thereof in a minimum amount of $500,000) into Offshore Rate Loans or; (2) Elect to convert on any Interest Payment Date any Offshore Rate Loans maturing on such Interest Payment Date (or any part thereof in a minimum amount of $100,000) into Base Rate Loans; or (3) Elect to renew on any Interest Payment Date any Offshore Rate Loans maturing on such Interest Payment Date (or any part thereof in a minimum amount of $500,000); provided, that if at any time an Offshore Rate Loan is reduced, by payment, prepayment, or conversion of part thereof to be less than $500,000, such Offshore Rate Loan shall automatically convert into a Base Rate Loan, and on and after such date the right of the Company to continue such Loan as, and convert such Loan into, an Offshore Rate Loan shall terminate. (b) The Company shall deliver by telex, cable or facsimile, confirmed immediately in writing, a Notice of Conversion/Continuation to be received by the Bank not later than (i) 9:00 a.m. San Francisco, California time at least three Business Days in advance of the Conversion/Continuation Date, if the Loans are to be converted into or continued as Offshore Rate Loans; and (ii) noon San Francisco, California time one Business Day in advance of the Conversion Date or continuation date, if the Loans are to be converted into or renewed as Base Rate Loans, specifying: (1) The proposed Conversion/Continuation Date; (2) The aggregate amount of Loans to be converted or renewed; (3) The nature of the proposed conversion or continuation; and (4) The duration of the requested Interest Period. (c) If upon the expiration of any Interest Period applicable to Offshore Rate Loans, the Company has failed to select a new Interest Period to be applicable to such Offshore Rate Loans, or if any Default or Event of Default shall then exist, the Company shall be deemed to have elected to convert such Offshore Rate Loans into Base Rate Loans effective as of the expiration date of such current Interest Period. (d) Unless the Bank otherwise consents, during the existence of a Default or Event of Default, the Company may not elect to have a Loan converted into or continued as an Offshore Rate Loan. (e) After giving effect to any conversion or continuation of Loans, unless the Bank shall otherwise consent, there may not be more than ten different Interest Periods in effect. 2.05 Voluntary Termination or Reduction of Commitment. The Company may, upon not less than five Business Days' prior notice to the Bank, at any time before the Revolving Termination Date, terminate the Bank's commitment to make Loans or permanently reduce the amount of the Commitment by a minimum amount of $1,000,000 or any whole multiple of $1,000,000 in excess thereof; unless, after giving effect thereto and to any prepayments of Loans made on the effective date thereof, the Effective Amount of all Loans and L/C Obligations would exceed the amount of the Commitment then in effect and, provided, further, that once reduced in accordance with this Section, the Commitment may not be increased. If the Commitment is terminated in its entirety, all accrued Commitment Fees to the effective date of such termination shall be payable on the effective date of such termination without any premium or penalty. 2.06 Optional Prepayments. Subject to Section 3.04, the Company may, at any time or from time to time, upon not less than three Business Days' (with respect to Offshore Rate Loans) and same Business Day (with respect to Base Rate Loans) irrevocable notice to the Bank, prepay Loans in whole or in part, in minimum prepayments of $500,000 for Offshore Rate Loans and $100,000 for Base Rate Loans (or, in each case, such lesser amount as represents the entire outstanding amount of such Offshore Rate Loan or Base Rate Loan). Such notice of prepayment shall specify the date and amount of such prepayment and the Type(s) of Loans to be prepaid, whether such Loans are Term Loans or Revolving Loans, and in the case of Offshore Rate Loans, which Offshore Rate Loans are to be prepaid. If such notice is given by the Company, the Company shall make such prepayment and the payment amount specified in such notice shall be due and payable on the date specified therein, together with accrued interest to each such date on the amount prepaid and any amounts required pursuant to Section 3.04. Optional prepayments of Term Loans made after the Revolving Termination Date shall be applied to the most remote principal installments of the Term Loans. 2.07 Mandatory Prepayments of Loans. (a) Mandatory Prepayments, Cash Collateral. If at any time and for any reason the Effective Amount of the Loans and the L/C Obligations exceeds the lesser of the Commitment or the Borrowing Base, the Company shall pay to Bank, upon Bank's election and demand, the amount of the excess. Payments under this Section may be applied to the obligations of the Company relating to the Loans and L/C Obligations in the order and manner as the Company in its discretion may determine. Payments to be applied to Outstanding Letters of Credit may, at Bank's option, be used to prepay, or held as cash collateral to secure, the Company's obligations to Bank with respect thereto and L/C Obligations. (b) Annual Excess Cash Flow Recapture. On or before the date 105 days after the end of each fiscal year commencing with the fiscal year of the Company ending December 31, 2000, the Company shall prepay the Term Loans in an amount equal to the lesser of (1) the Effective Amount of all Term Loans that have been, as of the end of such prior fiscal year, outstanding for one year or more, and (2) 50% of Excess Cash Flow for such fiscal year, as calculated based upon the financial data contained in the Company's financial statements for the fourth fiscal quarter of each fiscal year delivered pursuant to subsection 6.01(c)(ii) and the Compliance Certificate delivered with respect to that fiscal quarter pursuant to subsection 6.02(a). Mandatory prepayments of the Term Loans pursuant to this subsection made after the Revolving Termination Date shall be applied to the Scheduled Payments in the inverse order of their maturity. (c) Clean-up Period. The Company agrees to borrow, repay, and reborrow under the Revolving Credit such that in each calendar year there shall be at least one period of 30 consecutive days in which there are no outstanding Revolving Loans under this Agreement. (d) General. Except as provided in subsection 2.07(b), any prepayments relating to the Loans made pursuant to this Section shall be applied as instructed by the Company; provided, however, that the Company may, at its option, place any amounts which it would otherwise be required to use to prepay Offshore Rate Loans on a day other than the last day of the Interest Period therefor in an interest-bearing account pledged to the Bank until the end of such Interest Period at which time such pledged amounts will be credited to the prepayment of such Offshore Rate Loans. The Company shall pay, together with each prepayment under this Section, accrued interest on the amount prepaid and any amounts required under Section 3.04. 2.08 Scheduled Repayment. (a) The Term Credit. The Company shall repay the aggregate amount of the Term Loans outstanding as of the close of business on the Revolving Termination Date in 16 equal principal installments on each January 31, May 31, August 31, and October 31 occurring after the Revolving Termination Date until repayment in full. All remaining unpaid principal of the Term Loans and interest thereon shall be due and payable on the date four years after the Revolving Termination Date. (b) The Revolving Credit. The Company shall repay to the Bank in full on the Revolving Termination Date the aggregate principal amount of Revolving Loans outstanding on such date. 2.09 Interest. (a) Each Loan shall bear interest on the outstanding principal amount thereof from its Borrowing Date at a rate per annum equal to the Offshore Rate or the Base Rate, as the case may be (and subject to the Company's right to convert to other Types of Loans under Section 2.04), plus the Applicable Margin. (b) Interest on each Loan shall be paid in arrears on each Interest Payment Date. Interest shall also be paid on the date of any prepayment of Offshore Rate Loans under Sections 2.06 or 2.07 for the portion of the Offshore Rate Loans so prepaid and upon payment (including prepayment) in full thereof and, during the existence of any Event of Default, interest shall be paid on demand of the Bank. (c) Notwithstanding subsection (a) of this Section, while any Event of Default exists or after acceleration, the Company shall pay interest (after as well as before entry of judgment thereon to the extent permitted by law) on the principal amount of all Obligations due and unpaid, at a rate per annum which is determined by adding 2% per annum to the Applicable Margin then in effect for such Loans and, in the case of Obligations not subject to an Applicable Margin, at a rate per annum equal to the Base Rate plus the Applicable Margin then in effect for Base Rate Loans plus 2%; provided, however, that, on and after the expiration of any Interest Period applicable to any Offshore Rate Loan outstanding on the date of occurrence of such Event of Default or acceleration, the principal amount of such Loan shall, during the continuation of such Event of Default or after acceleration, bear interest at a rate per annum equal to the Base Rate plus the Applicable Margin then in effect for Base Rate Loans plus 2%. (d) Anything herein to the contrary notwithstanding, the obligations of the Company to the Bank hereunder shall be subject to the limitation that payments of interest shall not be required, for any period for which interest is computed hereunder, to the extent (but only to the extent) that contracting for or receiving such payment by the Bank would be contrary to the provisions of any law applicable to the Bank limiting the highest rate of interest that may be lawfully contracted for, charged or received by the Bank, and in such event the Company shall pay the Bank interest at the highest rate permitted by applicable law. 2.10 Fees. (a) Commitment Fee. (1) The Company shall pay to the Bank a commitment fee ("Commitment Fee") for each day from the Closing Date through the Revolving Termination Date in an amount equal to the product of (i) the unused portion (which excludes the Effective Amount of L/C Obligations) of the Commitment in effect on such date multiplied by (ii) 1/360th of the Commitment Fee Percentage in effect on such day. Such Commitment Fee shall be due and payable quarterly in arrears on December 31, 1998 and thereafter on the last Business Day of each calendar quarter commencing on the first such date occurring after the date of this Agreement through the Revolving Termination Date, with the final payment to be made on the Revolving Termination Date. (2) The Commitment Fee provided in this subsection shall accrue at all times after the above-mentioned commencement date, including at any time during which one or more conditions in Article IV are not met. (b) Arrangement Fee. The Company shall pay $250,000 to the Bank on the Closing Date as an arrangement fee. (c) Utilization Fees. The Company shall pay a utilization fee on the Term Credit upon each borrowing of Term Loans if and to the extent such borrowing would cause the Effective Amount of Term Loans to equal or exceed, for the first time after the Closing Date, the threshold amounts set forth under "Term Loans Outstanding" below. The Utilization Fee payable upon each such threshold being met is set forth opposite such threshold below.
Term Loans Outstanding Utilization Fee ---------------------- --------------- $2,500,000 $50,000 $7,500,000 another $50,000 $12,500,000 another $50,000 $17,500,000 another $50,000
[/CAPTION] For example: Assume this Agreement is executed on November 16, 1998. On November 20, 1998 the Company borrows $6,000,000 in Term Loans. The Company shall pay the Bank on such date a utilization fee of $50,000. On January 12, 1999, the Company borrows an additional $1,000,000 in Term Loans. No utilization fee is due from the Company on that date. On January 29, 1999, the Company borrows an additional $5,500,000 in Term Loans so that the Effective Amount of Terms Loans is $12,500,000. A utilization fee of $100,000 is due the Bank on such date. 2.11 Computation of Fees and Interest. (a) All computations of interest for Base Rate Loans when the Base Rate is determined by the Bank's "reference rate" shall be made on the basis of a year of 365 or 366 days, as the case may be, and actual days elapsed. All other computations of fees and interest shall be made on the basis of a 360-day year and actual days elapsed (which results in more interest and fees being paid than if computed on the basis of a 365-day year). Interest and fees shall accrue during each period during which interest or such fees are computed from the first day thereof to the last day thereof. (b) Any change in the interest rate on a Loan resulting from a change in the Applicable Margin shall become effective as of the opening of business on the day on which such change in the Applicable Margin becomes effective. (c) Each determination of an interest rate by the Bank shall be conclusive and binding on the Company in the absence of manifest error. 2.12 Payments by the Company. (a) All payments to be made by the Company shall be made without set-off, recoupment or counterclaim. Except as otherwise expressly provided herein, all payments by the Company shall be made to the Bank at the place indicated as the place of payment in the signature pages to this Agreement or such other place of payment as the Bank may specify to the Company in writing from time to time, and shall be made in dollars and in immediately available funds, no later than 10:00 a.m. (San Francisco, California time) for Offshore Rate Loans and no later than 1:00 p.m. (San Francisco, California time) for Base Rate Loans, in each case on the date specified herein. Any payment received by the Bank later than such specified times shall be deemed to have been received on the following Business Day and any applicable interest or fee shall continue to accrue. (b) Subject to the provisions set forth in the definition of "Interest Period" herein, whenever any payment is due on a day other than a Business Day, such payment shall be made on the following Business Day, and such extension of time shall in such case be included in the computation of interest or fees, as the case may be. 2.13 Security. (a) All obligations of the Company under this Agreement, and all other Loan Documents shall be secured in accordance with the Collateral Documents; except that the obligations of the Company to the Bank under Specified Swap Contracts shall be secured by the Deeds of Trust only if a written agreement(s) between the Company and the Bank specifically states that the Specified Swap Contract(s) described in such agreement(s) is or are secured by the Deeds of Trust. The Company hereby ratifies and reaffirms all of the Liens previously granted in favor of the Bank pursuant to the Company Security Agreement, which Liens are and continue to be perfected and of first priority. (b) The Bank agrees to release its security interest in the inventory and Receivables upon (i) the termination of the Bank's commitment to make Loans and (ii) the Effective Amount of L/C Obligations and Revolving Loans being reduced to $0, if at the time such release is to occur, (x) the Acquisition Cost of the Timberlands subject to the Deeds of Trust is equal to or greater than 200% of the aggregate principal amount of the then outstanding Term Loans, and (y) no Default or Event of Default exists. (c) From time to time upon the request of the Company, the Bank agrees to release its Lien upon Timberlands that have remained subject to a Deed of Trust hereunder after the Effective Amount of Term Loans has been reduced to $0 (regardless of whether additional Term Loans were made thereafter to finance the Acquisition Cost of other Timberlands), if at the time such release is to occur and after giving effect to the corresponding diminution of the Borrowing Base, (x) the Effective Amount of all Loans and L/C Obligations does not exceed the Borrowing Base, and (y) no Default or Event of Default exists. 2.14 The Letter of Credit Subfacility. The Bank is under no obligation to Issue any Letter of Credit if: (a) any order, judgment or decree of any Governmental Authority or arbitrator shall by its terms purport to enjoin or restrain the Bank from Issuing such Letter of Credit, or any Requirement of Law applicable to the Bank or any request or directive (whether or not having the force of law) from any Governmental Authority with jurisdiction over the Bank shall prohibit, or request that the Bank refrain from, the Issuance of letters of credit generally or such Letter of Credit in particular or shall impose upon the Bank with respect to such Letter of Credit any restriction, reserve or capital requirement (for which the Bank is not otherwise compensated hereunder) not in effect on the Closing Date, or shall impose upon the Bank any unreimbursed loss, cost or expense which was not applicable on the Closing Date and which the Bank in good faith deems material to it; (b) the expiry date of any requested Letter of Credit is (A) more than 365 days after the date of Issuance, unless the Bank has approved such expiry date in writing, or (B) after the Revolving Termination Date, unless the Bank has approved such expiry date in writing; (c) the expiry date of any requested Letter of Credit is prior to the maturity date of any financial obligation to be supported by the requested Letter of Credit; (d) any requested Letter of Credit does not provide for drafts, or is not otherwise in form and substance acceptable to the Bank, or the Issuance of a Letter of Credit shall violate any applicable policies of the Bank; (e) any standby Letter of Credit is for the purpose of supporting the issuance of any letter of credit by any other Person; or (f) such Letter of Credit is to be denominated in a currency other than Dollars. 2.15 Issuance, Amendment and Renewal of Letters of Credit. (a) Each Letter of Credit shall be issued upon the written request of the Company received by the Bank at least three Business Days (or such shorter time as the Bank may agree in a particular instance in its sole discretion) prior to the proposed date of issuance. Each such request for issuance of a Letter of Credit shall be by facsimile, confirmed immediately in an original writing, in the form of an L/C Application, and shall specify in form and detail satisfactory to the Bank: (i) the proposed date of issuance of the Letter of Credit (which shall be a Business Day); (ii) the face amount of the Letter of Credit; (iii) the expiry date of the Letter of Credit; (iv) the name and address of the beneficiary thereof; (v) the documents to be presented by the beneficiary of the Letter of Credit in case of any drawing thereunder; (vi) the full text of any certificate to be presented by the beneficiary in case of any drawing thereunder; and (vii) such other matters as the Bank may require. Such request may be withdrawn by the Company, but the fees owing on account of any requested Letter of Credit pursuant to Section 2.20(b) shall be fully earned upon the submission of such request notwithstanding its later withdrawal. (b) From time to time while a Letter of Credit is outstanding and prior to the Revolving Termination Date, the Bank will, upon the written request of the Company received by the Bank at least three Business Days (or such shorter time as the Bank may agree in a particular instance in its sole discretion) prior to the proposed date of amendment, amend any Letter of Credit issued by it. Each such request for amendment of a Letter of Credit shall be made by facsimile, confirmed immediately in an original writing, made in the form of an L/C Amendment Application and shall specify in form and detail satisfactory to the Bank: (i) the Letter of Credit to be amended; (ii) the proposed date of amendment of the Letter of Credit (which shall be a Business Day); (iii) the nature of the proposed amendment; and (iv) such other matters as the Bank may require. The Bank shall be under no obligation to amend any Letter of Credit if: (A) the Bank would have no obligation at such time to issue such Letter of Credit in its amended form under the terms of this Agreement; or (B) the beneficiary of any such Letter of Credit does not accept the proposed amendment to the Letter of Credit. (c) The Bank agrees that, while a Letter of Credit is outstanding and prior to the Revolving Termination Date, at the option of the Company and upon the written request of the Company received by the Bank at least three Business Days (or such shorter time as the Bank may agree in a particular instance in its sole discretion) prior to the proposed date of notification of renewal, the Bank shall renew any Letter of Credit issued by it. Each such request for renewal of a Letter of Credit shall be made by facsimile, confirmed immediately in an original writing, in the form of an L/C Amendment Application, and shall specify in form and detail satisfactory to the Bank: (i) the Letter of Credit to be renewed; (ii) the proposed date of notification of renewal of the Letter of Credit (which shall be a Business Day); (iii) the revised expiry date of the Letter of Credit; and (iv) such other matters as the Bank may require. The Bank shall be under no obligation so to renew any Letter of Credit if: (A) the Bank would have no obligation at such time to issue or amend such Letter of Credit in its renewed form under the terms of this Agreement; or (B) the beneficiary of any such Letter of Credit does not accept the proposed renewal of the Letter of Credit. If any outstanding Letter of Credit shall provide that it shall be automatically renewed unless the beneficiary thereof receives notice from the Bank that such Letter of Credit shall not be renewed, and if at the time of renewal the Bank would be obligated to authorize the automatic renewal of such Letter of Credit in accordance with this subsection 2.15(c) upon the request of the Company but the Bank shall not have received any L/C Amendment Application from the Company with respect to such renewal or other written direction by the Company with respect thereto, the Bank shall nonetheless be permitted to allow such Letter of Credit to renew, and the Company hereby authorizes such renewal, and, accordingly, the Bank shall be deemed to have received an L/C Amendment Application rom the Company requesting such renewal. (d) The Bank may, at its election, deliver any notices of termination or other communications to any Letter of Credit beneficiary or transferee, and take any other action as necessary or appropriate, at any time and from time to time, in order to cause the expiry date of such Letter of Credit to be a date not later than the Revolving Termination Date. (e) This Agreement shall control in the event of any conflict with any L/C-Related Document (other than any Letter of Credit). 2.16 Existing Letters of Credit; Drawings and Reimbursements. (a) On and after the Closing Date, the Standby Letters of Credit as defined in the Prior Credit Agreement shall be deemed for all purposes, including for purposes of the fees to be collected pursuant to subsections 2.20(a) and 2.20(b), and reimbursement of costs and expenses to the extent provided herein, Letters of Credit outstanding under this Agreement and entitled to the benefits of this Agreement and the other Loan Documents, and shall be governed by the applications and agreements pertaining thereto and by this Agreement. (b) In the event of any request for a drawing under a Letter of Credit by the beneficiary or transferee thereof, the Bank will promptly notify the Company. The Company shall reimburse the Bank prior to 10:00 a.m. San Francisco time, on each date that any amount is paid by the Bank under any Letter of Credit (each such date, an "Honor Date"), in an amount equal to the amount so paid by the Bank. In the event the Company fails to reimburse the Bank for the full amount of any drawing under any Letter of Credit by 10:00 a.m. San Francisco time on the Honor Date, the Company shall be deemed to have requested that a Revolving Loan constituting a Base Rate Loan be made by the Bank to be disbursed on the Honor Date under such Letter of Credit, subject to the amount of the unutilized portion of the Commitment and subject to the conditions set forth in Section 4.02. Any notice given by the Bank pursuant to this subsection 2.16(b) may be oral if immediately confirmed in writing (including by facsimile); provided that the lack of such an immediate confirmation shall not affect the conclusiveness or binding effect of such notice. (c) With respect to any unreimbursed drawing that is not converted into Revolving Loans consisting of Base Rate Loans to the Company in whole or in part, because of the Company's failure to satisfy the conditions set forth in Section 4.02 or for any other reason, the Company shall be deemed to have incurred from the Bank an L/C Borrowing in the amount of such drawing, which L/C Borrowing shall be due and payable on demand (together with interest) and shall bear interest at a rate per annum equal to the Base Rate plus the Applicable Margin then applicable to the Base Rate Loans plus 2% per annum. 2.17 Role of the Bank. (a) The Company agrees that, in paying any drawing under a Letter of Credit, the Bank shall not have any responsibility to obtain any document (other than any sight draft and certificates expressly required by the Letter of Credit) or to ascertain or inquire as to the validity or accuracy of any such document or the authority of the Person executing or delivering any such document. (b) The Company hereby assumes all risks of the acts or omissions of any beneficiary or transferee with respect to its use of any Letter of Credit; provided, however, that this assumption is not intended to, and shall not, preclude the Company's pursuing such rights and remedies as it may have against the beneficiary or transferee at law or under any other agreement. The Bank shall not be liable or responsible for any of the matters described in clauses (a) through (g) of Section 2.18; provided, however, nothing in such clauses or this Section shall limit any claim the Company may have against the Bank, or the Bank's liability to the Company, for any direct, as opposed to consequential or exemplary, damages suffered by the Company that the Company proves were caused by the Bank's willful misconduct, bad faith, or gross negligence or the Bank's willful failure to pay under any Letter of Credit after the presentation to it by the beneficiary of a sight draft and certificate(s) strictly complying with the terms and conditions of a Letter of Credit. In furtherance and not in limitation of the foregoing: (i) the Bank may accept documents that appear on their face to be in order, without responsibility for further investigation, regardless of any notice or information to the contrary; and (ii) the Bank shall not be responsible for the validity or sufficiency of any instrument transferring or assigning or purporting to transfer or assign a Letter of Credit or the rights or benefits thereunder or proceeds thereof, in whole or in part, which may prove to be invalid or ineffective for any reason. 2.18 Obligations Absolute. The obligations of the Company under this Agreement and any L/C- Related Document to reimburse the Bank for a drawing under a Letter of Credit, and to repay any L/C Borrowing and any drawing under a Letter of Credit converted into Revolving Loans, shall be unconditional and irrevocable, and shall be paid strictly in accordance with the terms of this Agreement and each such other L/C-Related Document under all circumstances, including the following: (a) any lack of validity or enforceability of this Agreement or any L/C-Related Document; (b) any change in the time, manner or place of payment of, or in any other term of, all or any of the obligations of the Company in respect of any Letter of Credit or any other amendment or waiver of or any consent to departure from all or any of the L/C-Related Documents; (c) the existence of any claim, set-off, defense or other right that the Company may have at any time against any beneficiary or any transferee of any Letter of Credit (or any Person for whom any such beneficiary or any such transferee may be acting), the Bank or any other Person, whether in connection with this Agreement, the transactions contemplated hereby or by the L/C-Related Documents or any unrelated transaction; (d) any draft, demand, certificate or other document presented under any Letter of Credit proving to be forged, fraudulent, invalid or insufficient in any respect or any statement therein being untrue or inaccurate in any respect; or any loss or delay in the transmission or otherwise of any document required in order to make a drawing under any Letter of Credit; (e) any payment by the Bank under any Letter of Credit against presentation of a draft or certificate that does not strictly comply with the terms of any Letter of Credit; or any payment made by the Bank under any Letter of Credit to any Person purporting to be a trustee in bankruptcy, debtor-in-possession, assignee for the benefit of creditors, liquidator, receiver or other representative of or successor to any beneficiary or any transferee of any Letter of Credit, including any arising in connection with any Insolvency Proceeding; (f) any exchange, release or non-perfection of any collateral, or any release or amendment or waiver of or consent to departure from any other guarantee, for all or any of the obligations of the Company in respect of any Letter of Credit; or (g) any other circumstance or happening whatsoever, whether or not similar to any of the foregoing, including any other circumstance that might otherwise constitute a defense available to, or a discharge of, the Company or a guarantor. 2.19 Cash Collateral Pledge. Upon the request of the Bank, if, as of the Revolving Termination Date, any Letters of Credit may for any reason remain outstanding and partially or wholly undrawn, then the Company shall immediately Cash Collateralize the L/C Obligations in an amount equal to the aggregate undrawn face amount of all Outstanding Letters of Credit. 2.20 Letter of Credit Fees. (a) The Company shall pay the Bank a per annum fee ("Letter of Credit Fee") on each Letter of Credit equal to the Letter of Credit Fee Percentage in effect on the date of each quarterly calculation, computed on the outstanding undrawn amount of such Letter of Credit as of the date the fee is calculated, payable quarterly in advance on the Issuance Date and the first day of each calendar quarter thereafter, and calculated on the basis of a 360 day year. Such fee shall be prorated if the term of a Letter of Credit is less than one year. If an Event of Default occurs under this Agreement, at the option of the Bank, the amount of the fee shall be increased by an additional 2.00% per annum during the continuance of such Event of Default, commencing on the day the Bank provides notice of the increase to the Company. (b) The Company shall pay to the Bank from time to time on demand the normal issuance, presentation, amendment and other processing fees, and other standard costs and charges, of the Bank relating to letters of credit as from time to time in effect. 2.21 Uniform Customs and Practice. The Uniform Customs and Practice for Documentary Credits as published by the International Chamber of Commerce most recently at the time of issuance of any Letter of Credit shall (unless otherwise expressly provided in the Letters of Credit) apply to the Letters of Credit. ARTICLE III TAXES, YIELD PROTECTION AND ILLEGALITY 3.01 Taxes. (a) (i) If, as a result of the Company's actions, any taxes, (other than income taxes imposed by the country or any state or subdivision of the country in which the Bank's principal office or actual lending office is located) are imposed on any payments under or in respect of this Agreement or any instrument or agreement required hereunder including, but not limited to, payments made pursuant to this Section, the Company shall pay all such taxes and shall also pay to the Bank promptly all additional amounts which are reasonably necessary to preserve the after-tax yield the Bank would have received if such taxes had not been imposed. (ii) The additional amounts necessary to preserve the after- tax yield the Bank would have received if such taxes had not been imposed shall be calculated pursuant to the formula: (w)(t)(i) y = ------------- 1-w-t where the terms are defined as follows: y = additional payment to be made to Bank w = withholding tax rate levied by foreign government t = the Bank's combined Federal and state tax rate i = stated interest amount to be paid on credit (calculated using the applicable contract rate plus quoted spread) 1 = one (b) All payments made to the Bank under this Agreement shall be net of all applicable U.S. withholding taxes. (c) The Company will provide the Bank with original tax receipts, notarized copies of tax receipts, or such other documentation as will prove payment of tax in a court of law applying the United States Federal Rules of Evidence, for all taxes paid by the Company pursuant to subsection 3.01(a) above. The Company will deliver receipts to the Bank within 30 days after the due date for the related tax. (d) Nothing contained in this Section shall override any term or provision of any Specified Swap Contract regarding withholding taxes relating to Swap Contracts. 3.02 Illegality. (a) If, after the date of this Agreement, the Bank shall reasonably determine that the introduction of any Requirement of Law, or any change in any Requirement of Law or in the interpretation or administration thereof, has made it unlawful, or that any central bank or other Governmental Authority has asserted that it is unlawful, for the Bank or its Lending Office to make Offshore Rate Loans, then, on notice thereof by the Bank to the Company, the obligation of the Bank to make Offshore Rate Loans shall be suspended until the Bank shall have notified the Company that the circumstances giving rise to such determination no longer exists. (b) If, after the date of this Agreement, the Bank shall reasonably determine that it is unlawful to maintain any Offshore Rate Loan, the Company shall prepay in full all Offshore Rate Loans of the Bank then outstanding, together with interest accrued thereon, either on the last day of the Interest Period thereof if the Bank may lawfully continue to maintain such Offshore Rate Loans to such day, or immediately, if the Bank may not lawfully continue to maintain such Offshore Rate Loans, together with any amounts required to be paid in connection therewith pursuant to Section 3.04. (c) If the Company is required to prepay any Offshore Rate Loan immediately as provided in subsection 3.02(b), then concurrently with such prepayment, the Company may borrow from the Bank, in the amount of such repayment, a Base Rate Loan. (d) If the obligation of the Bank to make or maintain Offshore Rate Loans has been so terminated or suspended, the Company may elect, by giving notice to the Bank, that all Loans which would otherwise be made by the Bank as Offshore Rate Loans shall be instead Base Rate Loans. 3.03 Increased Costs and Reduction of Return. (a) If the Bank shall determine that, due to either (i) the introduction, after the date of this Agreement, of or any change in or in the interpretation of any law or regulation or (ii) the compliance with any guideline or request, made after the date of this Agreement, from any central bank or other Governmental Authority (whether or not having the force of law), there shall be any increase in the cost to the Bank of agreeing to make or making, funding or maintaining any Offshore Rate Loans, then the Company shall be liable for, and shall from time to time, upon demand therefor by the Bank pay to the Bank additional amounts as are sufficient to compensate the Bank for such increased costs; provided that the Bank shall have given the Company prompt notice of such introduction, guideline, or request, as applicable. (b) If the Bank shall have determined that (i) the introduction, after the date of this Agreement, of any Capital Adequacy Regulation, (ii) any change, after the date of this Agreement, in any Capital Adequacy Regulation, (iii) any change, after the date of this Agreement, in the interpretation or administration of any Capital Adequacy Regulation by any central bank or other Governmental Authority charged with the interpretation or administration thereof, or (iv) compliance by the Bank (or its Lending Office) or any corporation controlling the Bank, with any Capital Adequacy Regulation enacted or adopted after the date of this Agreement; affects or would affect the amount of capital required or expected to be maintained by the Bank or any corporation controlling the Bank and (taking into consideration the Bank's or such corporation's policies with respect to capital adequacy and the Bank's desired return on capital) the Bank determines in good faith that the amount of such capital is increased as a consequence of its loans, credits or obligations under this Agreement, then, upon demand of the Bank the Company shall immediately pay to the Bank, from time to time as specified by the Bank, additional amounts sufficient to compensate the Bank for such increase. The Bank agrees to give the Company prompt notice of any such Capital Adequacy Regulation, change in Capital Adequacy Regulation, change in the interpretation or administration of Capital Adequacy Regulation. 3.04 Funding Losses. The Company agrees to reimburse the Bank and hold the Bank harmless from any loss or expense which the Bank may sustain or incur as a consequence of: (a) The failure of the Company to make on a timely basis any payment or prepayment of principal of any Offshore Rate Loan (including payments made after any acceleration thereof); (b) The failure of the Company to borrow, continue or convert a Loan after the Company has given (or is deemed to have given) a Notice of Borrowing or a Notice of Conversion/ Continuation; (c) The failure of the Company to make any prepayment after the Company has given a notice in accordance with Section 2.06; (d) The prepayment (including pursuant to Section 2.07) or other payment (including after acceleration thereof) of an Offshore Rate Loan on a day that is not the last day of the relevant Interest Period; or (e) The automatic conversion under Section 2.04 of any Offshore Rate Loan to a Base Rate Loan on a day that is not the last day of the relevant Interest Period; including any such loss or expense arising from the liquidation or reemployment of funds obtained by it to maintain its Offshore Rate Loans or from fees payable to terminate the deposits from which such funds were obtained. For purposes of calculating amounts payable by the Company to the Bank under this Section and under subsection 3.03(a), each Offshore Rate Loan made by the Bank (and each related reserve, special deposit or similar requirement) shall be conclusively deemed to have been funded at the Offshore Rate for such Offshore Rate Loan by a matching deposit or other borrowing in the interbank eurodollar market for a comparable amount and for a comparable period, whether or not such Offshore Rate Loan is in fact so funded. 3.05 Inability to Determine Rates. If the Bank determines that for any reason adequate and reasonable means do not exist for determining the Offshore Rate for any requested Interest Period with respect to a proposed Offshore Rate Loan, or that the Offshore Rate applicable pursuant to subsection 2.09(a) for any requested Interest Period with respect to a proposed Offshore Rate Loan does not adequately and fairly reflect the cost to the Bank of funding such Loan, the Bank will promptly so notify the Company. Thereafter, the obligation of the Bank to make or maintain Offshore Rate Loans hereunder shall be suspended until the Bank revokes such notice in writing. Upon receipt of such notice, the Company may revoke any Notice of Borrowing or Notice of Conversion/Continuation then submitted by it. If the Company does not revoke such Notice, the Bank shall make, convert or continue the Loans, as proposed by the Company, in the amount specified in the applicable notice submitted by the Company, but such Loans shall be made, converted or continued as Base Rate Loans instead of Offshore Rate Loans. 3.06 Reserves on Offshore Rate Loans. The Company shall pay to the Bank, as long as the Bank shall be required under regulations of the FRB to maintain reserves with respect to liabilities or assets consisting of or including Eurocurrency funds or deposits (currently known as "Eurocurrency liabilities"), additional costs on the unpaid principal amount of each Offshore Rate Loan equal to the actual costs of such reserves allocated to such Loan by the Bank (as determined by the Bank in good faith, which determination shall be conclusive), payable on each date on which interest is payable on such Loan, provided the Company shall have received at least 15 days' prior written notice of such additional costs from the Bank. If the Bank fails to give notice 15 days prior to the relevant Interest Payment Date, such additional costs shall be payable 15 days from receipt of such notice. 3.07 Survival. The agreements and obligations of the Company in this Article III shall survive the payment of all other Obligations. ARTICLE IV CONDITIONS PRECEDENT 4.01 Conditions of Initial Loans. The obligation of the Bank (x) to Issue the first Standby Letter of Credit after the date of this Agreement, and (y) to make its initial Loan hereunder is subject to the condition that the Bank has received on or before the Closing Date all of the following, in form and substance satisfactory to the Bank: (a) Credit Agreement. This Agreement executed by each party thereto; (b) Company Security Agreement. The Company Security Agreement executed by each party thereto; (c) Evidence of Filings. Evidence of all filings and lien searches to perfect and establish the first priority liens created by the Company Security Agreement; (d) Resolutions; Incumbency. (1) Copies of the resolutions of the board of directors of the Company authorizing the transactions contemplated hereby, certified as of the Closing Date by the Secretary or an Assistant Secretary of the Company; (2) A certificate of the Secretary or Assistant Secretary of the Company, certifying the names and true signatures of the officers of the Company authorized to execute, deliver and perform, as applicable, this Agreement, and all other Loan Documents to be delivered by it hereunder; (e) Legal Opinion. An opinion of Bernard L. Birkel, Secretary and Managing Counsel -- Corporate, of the Company and addressed to the Bank, in form and substance reasonably acceptable to the Bank; (f) Payment of Fees. Evidence of payment by the Company of all accrued and unpaid fees, costs and expenses to the extent then due and payable on the Closing Date, and all fees accrued through the Closing Date under the Prior Credit Agreement, together with Attorney Costs of the Bank to the extent invoiced prior to or on the Closing Date, plus such additional amounts of Attorney Costs as shall constitute the Bank's reasonable estimate of Attorney Costs incurred or to be incurred by it through the closing proceedings (provided that such estimate shall not thereafter preclude final settling of accounts between the Company and the Bank) including any such costs, fees and expenses arising under or referenced in Sections 2.10 and 9.04; (g) Certificate. A certificate signed by a Responsible Officer of the Company, dated as of the Closing Date, stating that: (1) the representations and warranties contained in Article V are true and correct on and as of such date, as though made on and as of such date; (2) no Default or Event of Default exists or would result from the making of the first Loan; and (3) there has occurred since September 30, 1998, no event or circumstance that has resulted or could reasonably be expected to result in a Material Adverse Effect. 4.02 Conditions to All Loans and Letters of Credit. The obligation of the Bank to make any Loan to be made by it (including its initial Loan), to continue any Offshore Rate Loan or convert any Loan into an Offshore Rate Loan, and to Issue any Letter of Credit (including the initial Issuance) from and after the date of this Agreement is subject to the satisfaction of the following conditions precedent on the relevant Borrowing Date or Conversion/Continuation Date: (a) Notice of Borrowing or Conversion/Continuation; L/C Application. The Bank shall have received a Notice of Borrowing, Notice of Conversion/Continuation, or a properly completed L/C Application for the Issuance of a Letter of Credit, as applicable; (b) Continuation of Representations and Warranties. The representations and warranties in Article V shall be true and correct on and as of such Borrowing Date, Conversion/Continuation Date, or Issuance Date with the same effect as if made on and as of such Borrowing Date, Conversion/Continuation Date, or Issuance Date (except to the extent such representations and warranties expressly refer to an earlier date, in which case they shall be true and correct as of such earlier date); (c) No Existing Default. No Default or Event of Default shall exist or shall result from the making of such Loan or its continuation or conversion; or from the Issuance of such Letter of Credit; (d) No Future Advance Notice. The Bank shall not have received from the Company any notice that any Collateral Document will no longer secure on a first priority basis future advances or future Loans to be made or extended, and Letters of Credit to be Issued under this Agreement; and (e) Other Documents. Such other approvals, opinions, documents or materials as the Bank may reasonably request (each in form and substance satisfactory to the Bank). Each Notice of Borrowing, Notice of Conversion/Continuation with respect to the continuation of or conversion into an Offshore Rate Loan, or L/C Application submitted by the Company hereunder shall constitute a representation and warranty by the Company hereunder, as of the date of each such notice, as of each Borrowing Date, Conversion/Continuation Date, or Issuance Date, as applicable, that the conditions in Section 4.02 are satisfied. 4.03 Conditions to Each Term Loan. The obligation of the Bank to make any Term Loan to be made by it (including its initial Term Loan) is subject to the satisfaction of the following conditions precedent on the relevant Borrowing Date: (a) Deeds of Trust. Unless previously delivered, the executed Deeds of Trust (in form and substance reasonably satisfactory to the Bank), executed by the Company, in appropriate form for recording, creating a Lien upon the Timberlands; and (b) Further Assurances. The Company shall have taken all action requested by the Bank pursuant to Section 6.15 with respect to the Timberlands. ARTICLE V REPRESENTATIONS AND WARRANTIES The Company represents and warrants to the Bank that, except as disclosed in MGHI's Form 10-Q for the quarter ended September 30, 1998 or the Schedules attached hereto: 5.01 Corporate Existence and Power. The Company and each of its Subsidiaries: (a) Is duly organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation or organization; (b) Has the power and authority and all governmental licenses, authorizations, consents and approvals to own its assets, carry on its business and to execute, deliver, and perform its obligations under the Loan Documents; (c) Is duly qualified as a foreign corporation or other entity and is licensed and in good standing under the laws of each jurisdiction where its ownership, lease or operation of property or the conduct of its business requires such qualification or license; and (d) Is in compliance with all Requirements of Law; except, in each case referred to in clause (c) or clause (d), to the extent that the failure to do so could not reasonably be expected to have a Material Adverse Effect. 5.02 Corporate Authorization; No Contravention. The execution, delivery and performance by the Company of this Agreement and each other Loan Document to which the Company is party, have been duly authorized by all necessary corporate action, and do not and will not: (a) Contravene the terms of any of the Company's Organization Documents; (b) Conflict with or result in any breach or contravention of, or the creation of any Lien under, any document evidencing any material Contractual Obligation to which the Company or any of its Subsidiaries is a party or any order, injunction, writ or decree of any Governmental Authority to which Company or any of its Subsidiaries or its property is subject; or (c) Violate, to the Company's knowledge, any Requirement of Law. 5.03 Governmental Authorization. No approval, consent, exemption, authorization, or other action by, or notice to, or filing with, any Governmental Authority (except for recordings or filings in connection with the Liens granted to the Bank under the Collateral Documents) is necessary or required to be obtained, given, or filed by the Company in connection with the execution, delivery or performance by, or enforcement against, the Company of this Agreement or any other Loan Document. 5.04 Binding Effect. This Agreement and each other Loan Document to which the Company is a party constitute the legal, valid and binding obligations of the Company, enforceable against the Company in accordance with their respective terms, except as enforceability may be limited by applicable bankruptcy, insolvency, or similar laws affecting the enforcement of creditors' rights generally or by equitable principles relating to enforceability. 5.05 Litigation. Except as specifically disclosed in Schedule 5.05, there are no actions, suits, proceedings, claims or disputes pending, or to the best knowledge of the Company, threatened or contemplated, at law, in equity, in arbitration or before any Governmental Authority, against the Company, or its Subsidiaries or any of their respective properties which: (a) Purport to affect or pertain to this Agreement or any other Loan Document, or any of the transactions contemplated hereby or thereby; or (b) Has a reasonable probability of being determined adversely to the Company or its Subsidiaries and, if so determined, would reasonably be expected to have a Material Adverse Effect. No injunction, writ, temporary restraining order or any order of any nature has been issued by any court or other Governmental Authority purporting to enjoin or restrain the execution, delivery or performance of this Agreement or any other Loan Document, or directing that the transactions provided for herein or therein not be consummated as herein or therein provided. 5.06 No Default. No Default or Event of Default exists or would result from the incurring of any Obligations by the Company or from the grant or perfection of the Liens of the Bank on the Collateral. As of the Closing Date, neither the Company nor any Subsidiary of the Company is in default under or with respect to any Contractual Obligation in any respect which, individually or together with all such defaults, could reasonably be expected to have a Material Adverse Effect, or that would, if such default had occurred after the Closing Date, create an Event of Default under subsection 8.01(d). 5.07 ERISA Compliance. Except as specifically disclosed in Schedule 5.07: (a) To the Company's knowledge, each Plan is in compliance in all material respects with the applicable provisions of ERISA, the Code and other federal or state law. Each Plan which is intended to qualify under Section 401(a) of the Code has received a favorable determination letter from the IRS at the time of Plan adoption and to the best knowledge of the Company, nothing has occurred which would cause the loss of such qualification. The Company and each ERISA Affiliate has made all required contributions to any Plan subject to Section 412 of the Code, and no application for a funding waiver or an extension of any amortization period pursuant to Section 412 of the Code has been made with respect to any Plan within the five plan years preceding the Closing Date. In connection with the foregoing, the PALCO Retirement Plan has been amended and restated as of December 1, 1989, has been subsequently amended three times to date, and received a favorable determination letter from the IRS dated January 10, 1996. (b) There are no pending or, to the best knowledge of Company, threatened claims, actions or lawsuits, or action by any Governmental Authority, with respect to any Plan which has resulted or could reasonably be expected to result in a Material Adverse Effect. There has been no prohibited transaction or violation of the fiduciary responsibility rules with respect to any Plan which has resulted or could reasonably be expected to result in a Material Adverse Effect. (c) Within the five years preceding the Closing Date, (i) no ERISA Event has occurred or is reasonably expected to occur; (ii) no Pension Plan has any Unfunded Pension Liability that would reasonably be expected to have a Material Adverse Effect; (iii) neither the Company nor any ERISA Affiliate has incurred, or reasonably expects to incur, any liability under Title IV of ERISA with respect to any Pension Plan (other than premiums due and not delinquent under Section 4007 of ERISA); (iv) neither the Company nor any ERISA Affiliate has incurred, or reasonably expects to incur, any liability (and no event has occurred which, with the giving of notice under Section 4219 of ERISA, would result in such liability) under Section 4201 or 4243 of ERISA with respect to a Multiemployer Plan; and (v) neither the Company nor any ERISA Affiliate has engaged in a transaction that could be reasonably be expected to be subject to Section 4069 or 4212(c) of ERISA. 5.08 Use of Proceeds; Margin Regulations. The proceeds of the Loans are to be used solely for the purposes set forth in and permitted by Section 6.12 and Section 7.07. Neither the Company nor any Subsidiary of the Company is generally engaged in the business of purchasing or selling Margin Stock or extending credit for the purpose of purchasing or carrying Margin Stock. 5.09 Title to Properties. The Company and each of its Subsidiaries have good record and marketable title in fee simple to, or valid leasehold interests in, all real property necessary or used in the ordinary conduct of their respective businesses, except for such defects in title as could not, individually or in the aggregate, have a Material Adverse Effect. As of the Closing Date, the property of the Company and its Subsidiaries is subject to no Liens, other than Permitted Liens. 5.10 Taxes. The Company and its Subsidiaries have filed all Federal and other material tax returns and reports required to be filed, and have paid all Federal and other material taxes, assessments, fees and other governmental charges levied or imposed upon them or their properties, income or assets otherwise due and payable, except those which are being contested in good faith by appropriate proceedings and for which adequate reserves have been provided in accordance with GAAP. There is no proposed tax assessment against the Company or any of its Subsidiaries that would, if made, have a Material Adverse Effect. 5.11 Financial Condition. (a) The audited consolidated financial statements of the Company and its Subsidiaries dated December 31, 1997, and the related consolidated statements of income or operations, shareholders' equity or members' capital and cash flows for the fiscal year ended on that date and the unaudited quarterly financial statements of the Company and its Subsidiaries dated September 30, 1998, and the related consolidated statements of income or operations, shareholders' equity or members' capital and cash flows for the fiscal quarters ended on that date; (1) Were prepared in accordance with GAAP consistently applied throughout the period covered thereby, except as otherwise expressly noted therein, subject, in the case of the quarterly financial statements, to ordinary, good faith year-end audit adjustments; (2) Are, in all material respects, complete and accurate, and fairly present the financial condition of the Company and its Subsidiaries as of the date thereof and results of operations for the period covered thereby; and (3) Show all material indebtedness and other liabilities, direct or contingent, of the Company and its consolidated Subsidiaries as of the date thereof, including liabilities for taxes, material commitments and Contingent Obligations. (b) Since September 30, 1998, there has been no Material Adverse Effect. 5.12 Environmental Matters. (a) Except as specifically disclosed in Schedule 5.12, the on-going operations of the Company and each of its Subsidiaries comply in all respects with all Environmental Laws, except such non-compliance which would not (if enforced in accordance with applicable law) reasonably be expected to result in liability which would cause a Material Adverse Effect; (b) Except as specifically disclosed in Schedule 5.12, the Company and each of its Subsidiaries have obtained all material licenses, permits, authorizations and registrations required under any Environmental Law ("Environmental Permits") and necessary for their respective ordinary course operations, all such material Environmental Permits are in good standing, and the Company and each of its Subsidiaries are in compliance with all material terms and conditions of such Environmental Permits. (c) Except as specifically disclosed in Schedule 5.12, none of the Company, any of its Subsidiaries or any of their respective present property or operations, is subject to any outstanding written order from or agreement with any Governmental Authority, nor subject to any judicial or docketed administrative proceeding, respecting any Environmental Law, Environmental Claim or Hazardous Material, the non-compliance with which could be reasonably be expected to have a Material Adverse Effect. (d) Except as specifically disclosed in Schedule 5.12, there are no Hazardous Materials or other conditions or circumstances existing with respect to any property of the Company or any of its Subsidiaries, or arising from operations prior to the Closing Date, of the Company or any of its Subsidiaries that would reasonably be expected to give rise to Environmental Claims for any such condition, circumstance or property that could reasonably be expected to have a Material Adverse Effect. In addition, to the best of the Company's knowledge, (i) neither the Company nor any of its Subsidiaries has any underground storage tanks (x) that are not properly registered or permitted in all material respects under applicable Environmental Laws, or (y) that are leaking or disposing of Hazardous Materials off-site in a manner that could reasonably be expected to cause a Material Adverse Effect, and (ii) the Company and its Subsidiaries have notified all of their employees of the existence, if any, of any health hazard arising from the conditions of their employment and have met all notification requirements under Title III of CERCLA and all other Environmental Laws. 5.13 Collateral Documents. (a) The provisions of each of the Collateral Documents are effective to create in favor of the Bank, a legal, valid and enforceable first priority security interest in all right, title and interest of the Company in the collateral described therein. (b) Each Deed of Trust when delivered will be effective to grant to the Bank a legal, valid and enforceable deed of trust/mortgage lien on all the right, title and interest of the mortgagor under such Deed of Trust in the Mortgaged Property described therein. When each such Deed of Trust is duly recorded in the offices listed on the schedule to such Deed of Trust and the mortgage recording fees and taxes in respect thereof are paid and compliance is otherwise had with the formal requirements of state law applicable to the recording of real estate mortgages generally, each such mortgaged property, subject to the encumbrances and exceptions to title set forth therein and except as noted in the title policies delivered to the Bank pursuant to Section 4.03, is subject to a legal, valid, enforceable and perfected first priority deed of trust; and when financing statements have been filed in the offices specified in such Deed of Trust, such Deed of Trust also creates a legal, valid, enforceable and perfected first lien on, and security interest in, all right, title and interest of the Company under such Deed of Trust in all personal property and fixtures which is covered by such Deed of Trust, subject to no other Liens, except the encumbrances and exceptions to title set forth therein and except as noted in the title policies delivered to the Bank pursuant to Section 4.03 and Permitted Liens. (c) All representations and warranties of the Company contained in the Collateral Documents are true and correct. 5.14 Regulated Entities. None of the Company, any Person controlling the Company, or any Subsidiary of the Company, is (a) an "Investment Company" within the meaning of the Investment Company Act of 1940; or (b) subject to regulation under the Public Utility Holding Company Act of 1935, the Federal Power Act, the Interstate Commerce Act, any state public utilities code, or any other Federal or state statute or regulation limiting its ability to incur Indebtedness. 5.15 No Burdensome Restrictions. Neither the Company nor any of its Subsidiaries is a party to or bound by any Contractual Obligation, or subject to any restriction in any Organization Document, or any Requirement of Law, which could reasonably be expected to have a Material Adverse Effect. 5.16 Subsidiaries. As of the Closing Date, the Company has no Subsidiaries other than those specifically disclosed in part (a) of Schedule 5.16 hereto and has no material equity investments in any other corporation or entity other than those specifically disclosed in part (b) of Schedule 5.16. 5.17 Insurance. The properties of the Company and its Subsidiaries are insured with financially sound and reputable insurance companies, and to the knowledge of the Company, in such amounts, with such deductibles and covering such risks as are customarily carried by companies engaged in similar businesses and owning similar properties in localities where the Company or such Subsidiary operates. 5.18 Solvency. The Company and SPC are each Solvent. 5.19 Swap Obligations. (a) As of the Closing Date, neither the Company nor any of its Subsidiaries has incurred any outstanding obligations under any Swap Contracts. With respect to any Swap Contracts that may be entered into by the Company after the Closing Date, the Company represents and warrants that it has undertaken its own independent assessment of its consolidated assets, liabilities and commitments and has considered appropriate means of mitigating and managing risks associated with such matters and has not relied on any Swap Provider or any Affiliate of any Swap Provider, swap counterparty or any Affiliate of any swap counterparty, in determining whether to enter into any Swap Contract. (b) The Company has not entered into any master agreement relating to Swap Contracts and under which termination values resulting from Swap Contracts that are Specified Swap Contracts are nettable against termination values resulting from Swap Contracts that are not Specified Swap Contracts unless only Specified Swap Contracts are outstanding under such master agreement. (c) None of the Subsidiaries of the Company has entered into any Swap Contracts other than as disclosed in the SEC filings of SPC. 5.20 Full Disclosure. None of the representations or warranties made by the Company in the Loan Documents as of the date such representations and warranties are made or deemed made, and none of the statements contained in any exhibit, report, statement or certificate furnished by or on behalf of the Company in connection with the Loan Documents, contains any untrue statement of a material fact or omits any material fact required to be stated therein or necessary to make the statements made therein, in light of the circumstances under which they are made, not misleading as of the time when made or delivered. 5.21 Labor Relations. There are no material strikes, lockouts or other labor disputes against the Company or any of its Subsidiaries, or , to the best of the Company's knowledge, threatened against or affecting the Company or any of its Subsidiaries, and no significant unfair labor practice complaint is pending against the Company or any of its Subsidiaries or, to the best knowledge of the Company, threatened against any of them before any Governmental Authority. 5.22 Compliance with Laws. The Company has complied in all material respects with all federal, state, and local laws, rules, and regulations applicable to the business of the Company including, but not limited to, laws regulating the Company's sales or the furnishing of services to Receivable Debtors and disclosures in connection therewith. 5.23 Merchantable Inventory. All inventory which is included in the Borrowing Base is of good and merchantable quality in all material respects. 5.24 Location of the Company. On the Closing Date, the Company's place of business (or, if the Company has more than one place of business, its chief executive office) is located at 125 Main Street, Scotia, California. 5.25 Y2K. The Company has (i) initiated a review and assessment of all areas within its and each of its Restricted Subsidiaries' business and operations (including those affected by suppliers and vendors) that could be adversely affected by the "Year 2000 Problem" (that is, the risk that computer applications used by the Company or any of its Restricted Subsidiaries or its material suppliers and vendors) may be unable to recognize and perform properly date-sensitive functions involving certain dates prior to and any date after December 31, 1999), (ii) developed a plan and timeline for addressing the Year 2000 Problem on a timely basis, and (iii) to date, implemented that plan in accordance with that timetable. The Company reasonably believes that all computer applications (including those of its material suppliers and vendors) that are material to its or any of its Restricted Subsidiaries' business and operations will on a timely basis be able to perform properly date-sensitive functions for all dates before and after January 1, 2000 (that is, be "Year 2000 Compliant"), except to the extent that a failure to do so could not reasonably be expected to have a Material Adverse Effect. ARTICLE VI AFFIRMATIVE COVENANTS The Company covenants and agrees that, so long as the Bank shall have any commitment to extend credit hereunder, or any Loan, L/C Obligation, or other outstanding monetary Obligation shall remain unpaid or unsatisfied, unless the Bank waives compliance in writing: 6.01 Financial Statements. The Company shall deliver to the Bank, in form and detail satisfactory to the Bank: (a) As soon as available, but not later than 105 days after the end of each fiscal year, a copy of the audited consolidated balance sheets of MGHI and SPC as at the end of such year and the related consolidated statements of income, shareholders' equity or members' capital and cash flows for such fiscal year, setting forth in each case in comparative form the figures for the previous year, and accompanied by the opinion of a nationally-recognized independent public accounting firm which report shall state that such consolidated financial statements present fairly the financial position for the periods indicated in conformity with GAAP; (b) As soon as available, but not later than 105 days after the end of each fiscal year, a copy of the consolidated balance sheet of the Company as at the end of such year and the related consolidated statements of income, shareholders' equity and cash flows for such fiscal year, setting forth in each case in comparative form the figures for the previous year, together with written confirmation that such financial statements have been reviewed by the independent public accounting firm that prepared the audited financial statements being simultaneously delivered pursuant to subsection 6.01(a); (c) (i) As soon as available, but not later than 60 days after the end of each of the first three fiscal quarters of each year, the unaudited consolidated balance sheets of MGHI and SPC and the related consolidated statements of income, shareholders' equity or members' capital and cash flows for such Persons for such fiscal quarter, all certified by an appropriate Responsible Officer of MGHI and SPC, respectively, as having been used or as shall be used in connection with the preparation of the financial statements referred to in subsections 6.01(a); and (ii) as soon as available, but not later than 60 days after the end of each fiscal quarter, on an Unconsolidated Basis, the unaudited balance sheet of the Company at the end of such quarter and the related statements of income, shareholders' equity and cash flows for the Company on an Unconsolidated Basis for the year to date ending such fiscal quarter, each certified by a Responsible Officer of the Company as having been used or as shall be used in connection with the preparation of the financial statements referred to in subsection 6.01(b); (d) Within 45 days after the end of each monthly accounting period, and as of the last day of such period, Company-prepared financial statements for the Company for such month in form consistent with prior practice; (e) Promptly upon each request of Bank, such other statements, lists of property and accounts, budgets, forecasts or reports as to the Company as Bank may reasonably request; 6.02 Certificates; Other Information. The Company shall furnish to the Bank: (a) Concurrently with the delivery of the financial statements referred to in subsections 6.01(a) and (b) above, a Compliance Certificate executed by a Responsible Officer of the Company; (b) Within 45 days after the end of each monthly accounting period, and as of the last day of such period: (1) A Borrowing Base Certificate; (2) A description of lumber and log inventories with book and market value; (3) Statements showing an aging and reconciliation of Receivables; (c) Promptly after the same are sent, copies of all financial statements and reports which the Company sends to its public shareholders, if any; and promptly after the same are filed, copies of all financial statements and regular, periodical or special reports which the Company may make to, or file with, the SEC or any similar Governmental Authority; and (d) On or before each March 31, the following prepared on a consolidated basis (which information shall be considered as confidential information pursuant to Section 9.09, whether or not identified as "confidential" or "secret"): (1) The Company's annual business plan, and if requested by Bank, the Company's key operating assumptions, such as timber harvest volumes, log consumption and lumber production, wood product shipments, projected prices of logs, lumber and other products sold by the Company, capital expenditures, and expected debt repayments and/or borrowings. The Company agrees to meet with the Bank, at least once a year, to discuss the foregoing matters; (2) The Company's "Category of species and inventory of timber", the annual harvest plan indicating timber harvest volumes by major categories, and a listing of approved timber harvest plans; (e) Within the 60 day period commencing on the first day of each calendar quarter, an updated status report of the Company's approved timber harvest plans (which information shall be considered as confidential information pursuant to Section 9.09, whether or not identified as "confidential" or "secret"); (f) Promptly, such additional business, financial, corporate affairs and other information as the Bank may from time to time reasonably request (which information shall be considered as confidential information pursuant to Section 9.09, whether or not identified as "confidential" or "secret"). 6.03 Notices. The Company shall promptly notify the Bank: (a) Of the occurrence of any Default or Event of Default, and of the occurrence or existence of any event or circumstance that foreseeably will become a Default or Event of Default; (b) Of (i) any breach or non-performance of, or any default under, any Contractual Obligation of the Company or any of its Subsidiaries which could reasonably be expected to result in a Material Adverse Effect; and (ii) any dispute, litigation, investigation, proceeding or suspension which may exist at any time between the Company or any of its Subsidiaries and any Governmental Authority which could reasonably be expected to result in a Material Adverse Effect; (c) Of the commencement of, or any material adverse development in, any litigation or proceeding affecting the Company or any Subsidiary of the Company which, if adversely determined, would reasonably be expected to have a Material Adverse Effect, or in which the relief sought is an injunction or other stay of the performance of this Agreement or any Loan Document (such obligation to give notice shall be deemed satisfied by the Company giving the Bank, pursuant to Section 6.02(c), the reports containing the required information furnished by the Company, MGHI, or SPC to the SEC); (d) Promptly upon becoming aware of any of the following that could reasonably be expected to have a Material Adverse Effect: (i) any and all enforcement, cleanup, removal or other governmental or regulatory actions instituted, completed or threatened against the Company or any of its Subsidiaries or any of their respective properties pursuant to any applicable Environmental Laws, (ii) all other Environmental Claims, and (iii) any environmental or similar condition on any real property adjoining or in the vicinity of the property of the Company or any of its Subsidiaries that could reasonably be anticipated to cause such property or any part thereof to be subject to any restrictions on the ownership, occupancy, transferability or use of such property under any Environmental Laws; (e) Of any other litigation or proceeding affecting the Company or any of its Subsidiaries which the Company, MGHI, or SPC would be required to report to the SEC pursuant to the Exchange Act, promptly after reporting the same to the SEC; (f) Of any of the following events affecting the Company, together with a copy of any notice with respect to such event that may be required to be filed with a Governmental Authority and any notice delivered by a Governmental Authority to the Company with respect to such event: (1) An ERISA Event; (2) If any of the representations and warranties in Section 5.07 ceases to be true and correct in any material respect; (3) The adoption of any new Pension Plan or other Plan subject to Section 412 of the Code; (4) The adoption of any amendment to a Pension Plan or other Plan subject to Section 412 of the Code, if such amendment results in a material increase in contributions or Unfunded Pension Liability; or (5) The commencement of contributions to any Pension Plan or other Plan subject to Section 412 of the Code; (g) Any Material Adverse Effect subsequent to the date of the most recent audited financial statements of the Company delivered to the Banks pursuant to subsection 6.01(a); (h) Of any material change in accounting policies or financial reporting practices by the Company or any of its Subsidiaries; (i) Of any labor controversy resulting in or which could reasonably be expected to result in any strike, work stoppage, boycott, shutdown or other labor disruption against or involving the Company or any of its Subsidiaries; (j) Of any change in the Company's name, business or legal structure, place of business, or chief executive office if the Company has more than one place of business; each such notice to be given in writing and not less than 45 days prior to such change; (k) Of the entry by the Company into any Specified Swap Contract, together with the details thereof; (l) Of the occurrence of any default, event of default, termination event or other event under any Specified Swap Contract that after the giving of notice, passage of time or both, would permit either counterparty to such Specified Swap Contract to terminate early any or all trades relating to such contract. Each notice under this Section shall be accompanied by a written statement by a Responsible Officer of the Company setting forth details of the occurrence referred to therein, and stating what action the Company or any affected Subsidiary of the Company proposes to take with respect thereto and at what time. Each notice under subsection 6.03(a) shall describe with particularity any and all clauses or provisions of this Agreement or other Loan Document that have been (or foreseeably will be) breached or violated. 6.04 Preservation of Corporate Existence, Etc. The Company shall, and shall cause each of its Restricted Subsidiaries to: (a) Preserve and maintain in full force and effect its legal existence and good standing under the laws of its state or jurisdiction of organization (other than as to Restricted Subsidiaries other than SPC whose dissolution could not reasonably be expected to cause a Material Adverse Effect); (b) Preserve and maintain in full force and effect all material rights, privileges, qualifications, permits, licenses and franchises necessary or desirable in the ordinary course of business except in connection with transactions permitted by Section 7.03 and dispositions of assets permitted by Section 7.02; (c) Use reasonable efforts, in the ordinary course of business, to preserve its business organization and preserve the goodwill and business of the customers, suppliers, and others having material business relations with it. 6.05 Maintenance of Property. The Company shall maintain, and shall cause each of its Subsidiaries to maintain, and preserve all its property which is used or useful in its business in good working order and condition, ordinary wear and tear excepted and make all necessary repairs thereto and renewals and replacements thereof except where the failure to do so could not reasonably be expected to have a Material Adverse Effect, except as permitted by Section 7.02. The Company and each Subsidiary of the Company shall use the standard of care typical in the industry in the operation and maintenance of its facilities and in the care and preservation of the Timberlands. 6.06 Insurance. (a) In addition to insurance requirements set forth in the Collateral Documents, the Company shall maintain and shall cause each of its Subsidiaries to maintain, with financially sound and reputable independent insurers, insurance with respect to its properties and business against loss or damage of the kinds customarily insured against by Persons engaged in the same or similar business, of such types and in such amounts as are customarily carried under similar circumstances by such other Persons; including workers' compensation insurance, comprehensive general liability and property insurance. The Company may self-insure any or all Workers' Compensation liabilities. (b) To the extent that any of the insurance required by this clause ceases to be available at commercially reasonable rates, the Company may effect substitute insurance coverage therefor in accordance with the prudent standards then being followed by other companies engaged in the same or similar business or having comparable properties. In the event that the Company wishes to effect substitute coverage pursuant to the foregoing proviso, it will notify the Bank of such intent as soon as reasonably practicable, and not less than five Business Days prior to the termination of the coverage for which substitution is to be made, furnish the Bank with a report describing in reasonable detail the nature of such substitute coverage and the reasons why the Company believes that such substitute coverage is appropriate. (c) Upon request of the Bank, the Company shall furnish the Bank at reasonable intervals (but not more than once per calendar year) a certificate of a Responsible Officer of the Company or any insurance broker of the Company setting forth the nature and extent of all insurance maintained by the Company and its Subsidiaries in accordance with this Section or any Collateral Documents (and which, in the case of a certificate of a broker, were placed through such broker). 6.07 Payment of Obligations. With only such exceptions as could not reasonably be expected to have a Material Adverse Effect, the Company shall, and shall cause its Subsidiaries to, pay and discharge as the same shall become due and payable, all their respective obligations and known liabilities, including: (a) All tax liabilities, assessments and governmental charges or levies upon it or its properties or assets, unless the same are being contested in good faith by appropriate proceedings and adequate reserves in accordance with GAAP are being maintained by the Company or such Subsidiary; (b) All lawful claims which, if unpaid, would by law become a Lien upon its property unless such claims are contested in good faith by appropriate proceedings and adequate reserves in accordance with GAAP are being maintained by the Company and such Subsidiaries; (c) All Indebtedness, as and when due and payable, but subject to any subordination provisions contained in any instrument or agreement evidencing such Indebtedness; and (d) All Obligations. 6.08 Compliance with Laws. The Company shall comply, and shall cause each of its Subsidiaries to comply, in all material respects with all Requirements of Law of any Governmental Authority having jurisdiction over it or its business (including the Federal Fair Labor Standards Act), except such as may be contested in good faith or as to which a bona fide dispute may exist. 6.09 Compliance with ERISA. The Company shall, and to the fullest extent permitted by applicable law shall cause each of its ERISA Affiliates to: (a) maintain each Plan in compliance in all material respects with the applicable provisions of ERISA, the Code and other federal or state law; (b) cause each Plan which is qualified under Section 401(a) of the Code to maintain such qualification; and (c) make all required contributions to any Plan subject to Section 412 of the Code. 6.10 Inspection of Property and Books and Records. The Company shall maintain and shall cause each of its Subsidiaries to maintain proper books of record and account, in which full, true and correct entries in conformity with GAAP consistently applied shall be made of all financial transactions and matters involving the assets and business of the Company and such Subsidiary. The Company shall permit, and shall cause each of its Subsidiaries to permit, representatives of the Bank to visit, inspect, and audit any of their respective properties, to examine their respective corporate, financial and operating records, and make copies thereof or abstracts therefrom, and to discuss their respective affairs, finances and accounts with their respective directors, officers, and independent public accountants, all at the expense of the Company and at such reasonable times during normal business hours and as often as may be reasonably desired, upon reasonable advance notice to the Company; provided, however, when an Event of Default exists the Bank may do any of the foregoing at the expense of the Company at any time during normal business hours and without advance notice. 6.11 Environmental Laws. (a) The Company shall, and shall cause each of its Subsidiaries to, conduct its operations and keep and maintain its property in compliance in all material respects with all applicable Environmental Laws, except such as may be contested in good faith by appropriate proceedings or as to which a bona fide dispute may exist and resolution of which is being sought by appropriate proceedings. (b) Upon the written request of the Bank, the Company shall submit and cause each of its Subsidiaries to submit, to the Bank, at the Company's sole cost and expense, at reasonable intervals, a report providing an update of the status of any environmental, health or safety compliance, hazard or liability issue identified in any notice or report required pursuant to subsection 6.03(d), that could, individually or in the aggregate, result in liability having a Material Adverse Effect. 6.12 Use of Proceeds. The Company shall use the proceeds of the Revolving Loans for working capital and other general corporate purposes and the proceeds of the Term Loans to pay for the Acquisition Cost of Timberlands and in each case, not in contravention of any Requirement of Law or of any Loan Document. 6.13 Solvency. The Company shall at all times be, and shall cause SPC to be, Solvent. 6.14 Protection of Collateral; Access. The Company shall take all steps reasonably necessary or advisable to preserve and protect the Collateral (including all of the Timberlands covered by Collateral Documents) and ensure that the Bank's rights and access to and interests in the Collateral are not in any way materially impaired or adversely affected. 6.15 Further Assurances. (a) The Company shall ensure that all written information, exhibits and reports furnished to the Bank do not and will not contain any untrue statement of a material fact and do not and will not omit to state any material fact or any fact necessary to make the statements contained therein not misleading in light of the circumstances in which made, and will promptly disclose to the Bank and correct any defect or error that may be discovered therein or in any Loan Document or in the execution, acknowledgement or recordation thereof. (b) In connection with or at any time following the execution and delivery of any Deeds of Trust hereunder, the Company will provide the Bank with such of the following as the Bank may request: (1) Evidence satisfactory to the Bank that there has been filed, registered, or recorded all filings, registrations and recordings necessary and advisable to grant the Liens under the Deeds of Trust in favor of the Bank in accordance with applicable law; (2) Written advice relating to such Liens and judgment searches as the Bank shall have reasonably requested, and such documents as may be necessary to confirm that the Collateral is subject to no other Liens in favor of any Persons (other than Permitted Liens); (3) Performance of all other actions necessary or, in the reasonable opinion of the Bank, desirable to perfect and protect the first priority security interest or Lien created by the Deeds of Trust; (4) With respect to the Mortgaged Property, an A.L.T.A. Form B (or other form acceptable to the Bank, provided that such form does not require a survey) mortgagee policy of title insurance or a binder issued by a title insurance company reasonably satisfactory to the Bank insuring (or undertaking to insure, in the case of a binder) that the Deed of Trust creates and constitutes a valid first Lien against the Mortgaged Property in favor of the Bank, subject only to exceptions reasonably acceptable to the Bank, with such endorsements and affirmative insurance as the Bank may reasonably request; (5) Such consents, estoppels, subordination agreements and other documents and instruments executed by landlords, tenants and other Persons party to material contracts relating to any Collateral as to which the Bank shall be granted a Lien pursuant to any Deed of Trust as reasonably requested by the Bank (in all instances in form and substance reasonably satisfactory to the Bank); and (6) Performance of all other actions necessary or, in the reasonable opinion of the Bank, desirable to perfect and protect the first priority Lien created by the Deeds of Trust and to enhance the Bank's ability to preserve and protect its interests in and access to the Collateral pursuant to any Deed of Trust. (c) If required by the Bank, the Company will obtain a Phase I environmental site assessment, in form and detail reasonably satisfactory to the Bank, with respect to any real property as to which the Bank is granted a Lien, dated as of a recent date prior to the disbursement date of the Term Loan to which it is related, prepared by a qualified firm reasonably acceptable to the Bank, stating, among other things, that based upon an investigation, the scope of which is reasonably satisfactory to the Bank, such real property is free from Hazardous Materials and that operations conducted thereon are in compliance with all Environmental Laws (other than the Endangered Species Act (16 U.S.C. Section 1531 et seq.), the Migratory Bird Treaty Act (16 U.S.C. 703 et seq.), the Forest and Rangeland Renewable Resources Act of 1974, the National Forest Management Act of 1976, the Z'berg-Nejedly Forest Practices Act of 1973 and the California Public Resources Code) and if not free from Hazardous Materials, showing any Estimated Remediation Costs. For purposes of this subsection, "Estimated Remediation Costs" means all costs associated with performing work to remediate contamination of real property or groundwater, including engineering and other professional fees and expenses, costs to remove, transport and dispose of contaminated soil, costs to "cap" or otherwise contain contaminated soil, and costs to pump and treat water and monitor water quality; (d) Upon request by the Bank, the Company will provide a certificate executed by a Responsible Officer of the Company, showing the age class distribution and estimated timber volume (by Mbf) in each age class, of the trees growing on the land encumbered by the Deeds of Trust. (e) Promptly upon request by the Bank, the Company shall do, execute, acknowledge, deliver, record, re-record, file, re-file, register and re-register, any and all such further acts, deeds, conveyances, security agreements, mortgages, assignments, estoppel certificates, financing statements and continuations thereof, termination statements, notices of assignment, transfers, certificates, assurances and other instruments the Bank may reasonably require from time to time in order (i) to carry out more effectively the purposes of this Agreement or any other Loan Document, (ii) to subject to the Liens created by any of the Collateral Documents any of the properties, rights or interests covered by any of the Collateral Documents, (iii) to perfect and maintain the validity, effectiveness and priority of any of the Collateral Documents and the Liens intended to be created thereby, and (iv) to better assure, convey, grant, assign, transfer, preserve, protect and confirm to the Bank the rights granted or now or hereafter intended to be granted to the Bank under any Loan Document or under any other document executed in connection therewith. ARTICLE VII NEGATIVE COVENANTS The Company hereby covenants and agrees that, so long as the Bank shall have any commitment to extend credit hereunder, or any Loan, L/C Obligation, or other outstanding monetary Obligation shall remain unpaid or unsatisfied, unless the Bank waives compliance in writing: 7.01 Limitation on Liens. The Company shall not, and shall not suffer or permit any of its Restricted Subsidiaries to, directly or indirectly, make, create, incur, assume or suffer to exist any Lien upon or with respect to any part of its property, whether now owned or hereafter acquired, other than the following ("Permitted Liens"): (a) Any Lien (other than Liens on the Collateral) existing on the property of the Company or its Subsidiaries on the Closing Date and set forth in Schedule 7.01 securing Indebtedness outstanding on such date or refinancings thereof provided that each such refinancing of an Indebtedness shall not result in any of the following: (1) an increase in the interest rate and/or the then outstanding principal amount of the Indebtedness being refinanced, (2) any additional assets of the Company or any of its Restricted Subsidiaries securing the Indebtedness being refinanced, (3) the Company or any Restricted Subsidiary incurring any Guaranty Obligation in connection therewith; and (4) an increase, during the term of this Agreement and for one year thereafter, in the principal payments of the Indebtedness being refinanced, and (5) any restriction on the ability of the Company to perform its obligations under this Agreement and any other Loan Document; (b) Any Lien created under any Loan Document; (c) Liens for taxes, fees, assessments or other governmental charges which are not delinquent or remain payable without penalty, or to the extent that non-payment thereof is permitted by Section 6.07, provided that no Notice of Lien has been filed or recorded. For purposes of this subsection, "Notice of Lien" means any "notice of lien" or similar document intended to be filed or recorded with any court, registry, recorder's office, central filing office or other Governmental Authority for the purpose of evidencing, creating, perfecting or preserving the priority of a Lien securing obligations owing to a Governmental Authority; (d) Carriers', warehousemen's, mechanics', landlords', materialmen's, repairmen's or other similar Liens arising in the ordinary course of business which are not delinquent or remain payable without penalty or which are being contested in good faith and by appropriate proceedings, which proceedings have the effect of preventing the forfeiture or sale of the property subject thereto; (e) Liens (other than any Lien imposed by ERISA) consisting of pledges or deposits required in the ordinary course of business in connection with workers' compensation, unemployment insurance and other social security legislation; (f) Liens (other than Liens on the Collateral) on the property of the Company or any of its Restricted Subsidiaries securing (i) the non- delinquent performance of bids, trade contracts (other than for borrowed money), leases, statutory obligations, (ii) contingent obligations on surety and appeal bonds, and (iii) other non-delinquent obligations of a like nature; in each case, incurred in the ordinary course of business, provided all such Liens in the aggregate would not (even if enforced) cause a Material Adverse Effect; (g) Liens (other than Liens on the Collateral) consisting of judgment or judicial attachment liens, provided that the enforcement of such Liens is effectively stayed; (h) Easements, rights-of-way, restrictions and other similar encumbrances incurred in the ordinary course of business which, in the aggregate, are not substantial in amount, and which do not in any case materially detract from the value of the property subject thereto or interfere with the ordinary conduct of the businesses of the Company and its Restricted Subsidiaries; (i) Liens on assets of Persons which become Restricted Subsidiaries after the date of this Agreement, provided, however, that such Liens existed at the time the respective Persons became Subsidiaries and were not created in anticipation thereof; (j) Security interests on any property acquired or held by the Company or its Restricted Subsidiaries in the ordinary course of business, other than the Collateral, securing Indebtedness in an aggregate outstanding principal amount which cannot exceed at any time $25,000,000; (k) Liens securing Capital Lease Obligations on assets subject to such Capital Leases, provided that such Capital Leases are permitted under subsection 7.11; (l) Liens arising solely by virtue of any statutory or common law provision relating to banker's liens, rights of set-off or similar rights and remedies as to deposit accounts or other funds maintained with a creditor depository institution; provided that (i) such deposit account is not a dedicated cash collateral account and is not subject to restrictions against access by the Company in excess of those set forth by regulations promulgated by the Federal Reserve Board, and (ii) such deposit account is not intended by the Company or any of its Restricted Subsidiaries to provide collateral to the depository institution. The provisions of this subsection shall not apply to cash collateral accounts maintained by SPC with any third Person; (m) Liens securing Indebtedness permitted under Section 7.05(d); (n) Liens upon the Collateral described in the Company Security Agreement to secure Indebtedness permitted by subsection 7.05(j); and (o) Liens upon the assets of SPC permitted pursuant to the Indenture referenced in the definition of "Timber Notes." 7.02 Disposition of Assets. The Company shall not, and shall not suffer or permit any of its Restricted Subsidiaries to, directly or indirectly, sell, assign, lease, convey, transfer or otherwise dispose of (whether in one or a series of transactions) any property (including accounts and notes receivable, with or without recourse) or enter into any agreement to do any of the foregoing, except: (a) Dispositions of inventory, or used, worn-out or surplus equipment, all in the ordinary course of business; (b) The sale of equipment to the extent that such equipment is exchanged for credit against the purchase price of similar replacement equipment, or the proceeds of such sale are reasonably promptly applied to the purchase price of such replacement equipment; (c) Dispositions of all or part of Salmon Creek Corporation or Salmon Creek Property; (d) Trading in short-term investment securities in the ordinary course of business; (e) Dispositions of assets by any Restricted Subsidiary to the Company or any Wholly-Owned Restricted Subsidiary or by the Company to any Wholly-Owned Restricted Subsidiary; (f) Dispositions of assets by the Company in payment of a dividend or distribution permitted by Section 7.12; (g) Any Permitted Salmon Creek Transaction; and (h) Other dispositions of assets with an aggregate book value, on a cumulative basis, not to exceed $25,000,000 during the term of this Agreement and which assets are not subject to any Collateral Document. 7.03 Consolidations and Mergers. The Company shall not, and shall not suffer or permit any of its Restricted Subsidiaries to, merge, consolidate with or into, or convey, transfer, lease or otherwise dispose of (whether in one transaction or in a series of transactions) all or substantially all of its assets (whether now owned or hereafter acquired) to or in favor of any Person, except: (a) Any Restricted Subsidiary of the Company may merge with or into the Company or any one or more Restricted Subsidiaries of the Company, provided that (i) if any transaction shall be between a Restricted Subsidiary and a Wholly-Owned Restricted Subsidiary, the Wholly-Owned Subsidiary shall be the continuing or surviving corporation, and (ii) if any transaction shall be between a Restricted Subsidiary and the Company, the Company shall be the continuing or surviving corporation; and (b) Any Restricted Subsidiary of the Company may sell or otherwise dispose of all or substantially all of its assets (upon voluntary liquidation or otherwise), to the Company or another Wholly-Owned Restricted Subsidiary of the Company. 7.04 Loans and Investments. The Company shall not purchase or acquire, or suffer or permit any Restricted Subsidiary to purchase or acquire, or make any commitment therefor, any capital stock, equity interest, or any obligations or other securities of, or any interest in, any Person, or make or commit to make any Acquisitions, or make or commit to make any advance, loan, extension of credit or capital contribution to or any other investment in, any Person including any Affiliate of the Company (together, "Investments"), except for: (a) Investments in Cash Equivalents; (b) Extensions of credit in the nature of accounts receivable or notes receivable arising from the sale or lease of goods or services in the ordinary course of business; (c) Investments by the Company or any Restricted Subsidiary in the Company, any Wholly-Owned Restricted Subsidiary, or any other Person that, after giving effect to such Investment, becomes a Wholly-Owned Restricted Subsidiary; (d) Investments made pursuant to the Bear Stearns Investment Advisory Contract or pursuant to successor cash management arrangements consistent with the investment policy adopted by the Board of Directors of the Company and reasonably satisfactory to the Bank; (e) Extensions of credit in the ordinary course of business to its employees and independent contractors which in the aggregate outstanding amount do not exceed $1,000,000 at any time; (f) Any Permitted Salmon Creek Transaction; and (g) Other Investments that do not exceed $1,000,000 in the aggregate at any time outstanding (without giving effect to any write-downs thereof). 7.05 Limitation on Indebtedness. The Company shall not, and shall not suffer or permit any of its Restricted Subsidiaries to, create, incur, assume, suffer to exist, or otherwise become or remain directly or indirectly liable with respect to, any Indebtedness, except: (a) Indebtedness incurred pursuant to this Agreement; (b) Accounts payable to trade creditors for goods and services and current operating liabilities (not the result of the borrowing of money) incurred in the ordinary course of business of the Company or such Restricted Subsidiary in accordance with customary terms and paid within the specified time, unless contested in good faith by appropriate proceedings and reserved for in accordance with GAAP; (c) Indebtedness consisting of Contingent Obligations permitted pursuant to Section 7.08; (d) Up to an aggregate outstanding principal amount of $10,000,000 in tax-free financing, which amount shall be an aggregate limit for the period covered by this Agreement; (e) Indebtedness existing on the Closing Date and set forth in Schedule 7.05, which Indebtedness may be refinanced on terms and conditions no less favorable than those existing on the Closing Date; (f) Indebtedness secured by Liens permitted by Section 7.01(i), (j) and (k); (g) Indebtedness incurred in connection with leases permitted pursuant to Section 7.11; (h) Extensions of credit permitted under Sections 7.04(c) and 7.04(e); (i) Indebtedness incurred in connection with investments permitted under Subsection 7.04(d); (j) Additional Indebtedness in an aggregate principal amount at any time outstanding not to exceed $45,000,000 incurred on or after the Revolving Termination Date if the Acquisition Cost of Timberlands subject to the Deeds of Trust (or, if the Company has provided an appraisal of such Timberlands satisfactory to the Bank, the appraised fair market value of such Timberlands) is equal to or greater than 250% of the Effective Amount of Term Loans; and (k) Other Indebtedness in aggregate principal amount at any time outstanding not to exceed $5,000,000. 7.06 Transactions with Affiliates. (a) The Company shall not, and shall not suffer or permit any of its Restricted Subsidiaries to, enter into any transaction with any Affiliate of the Company or of any such Restricted Subsidiary, except (i) as expressly permitted by this Agreement, or (ii) in its ordinary course of business and pursuant to the reasonable requirements of the business of the Company or such Restricted Subsidiary; in each case (i) and (ii), upon fair and reasonable terms no less favorable to the Company or such Restricted Subsidiary than would obtain in a comparable arm's-length transaction with a Person not an Affiliate of the Company or such Restricted Subsidiary. (b) The provisions contained in this Section shall not apply to: (i) any transaction permitted by Section 7.12, (ii) the execution and delivery of, the performance of, and the making of any payments required by, the Tax Sharing Agreement, (iii) the execution and delivery of, the performance of, and the making of any payments required by, the Britt Lumber Agreement, (iv) any Permitted Salmon Creek Transaction, (v) the making of payments to MAXXAM Group Inc., MAXXAM Inc. and their Affiliates for reimbursement for actual services provided thereby to the Company and its Restricted Subsidiaries based on actual costs and an allocable share of overhead expenses consistent with prior practices, (vi) compensation, indemnification and other benefits paid or made available to officers, directors, managers and employees of the Company or a Restricted Subsidiary for services rendered in such person's capacity as an officer, director, manager, or employee (including reimbursement or advancement of reasonable out-of-pocket expenses and directors' and officers' liability insurance), or (vii) any transaction between the Company and any Wholly-Owned Restricted Subsidiary or between Wholly-Owned Restricted Subsidiaries. (c) The Company shall not amend or modify the Britt Lumber Agreement without the prior written consent of the Bank if such amendment would materially alter the obligations or rights of the Company thereunder. 7.07 Use of Proceeds. The Company shall not and shall not suffer or permit any of its Subsidiaries to use any portion of the proceeds of any extension of credit under this Agreement, directly or indirectly, (i) to purchase or carry Margin Stock, (ii) to repay or otherwise refinance indebtedness of the Company or others incurred to purchase or carry Margin Stock, (iii) to extend credit for the purpose of purchasing or carrying any Margin Stock, (iv) to acquire any security in any transaction that is subject to Section 13 or 14 of the Exchange Act, or (v) to make any investments under the Bear Stearns Investment Advisory Contract. 7.08 Contingent Obligations. The Company shall not, and shall not suffer or permit any of its Restricted Subsidiaries to, create, incur, assume or suffer to exist any Contingent Obligations except: (a) Endorsements for collection or deposit in the ordinary course of business; (b) Contingent Obligations of the Company and its Restricted Subsidiaries existing as of the Closing Date and listed in Schedule 7.08; (c) Contingent Obligations entered into in the ordinary course of business; (d) Contingent Obligations relating to Standby Letters of Credit; (e) Permitted Swap Obligations; (f) Guaranty Obligations of the Company with respect to obligations of Wholly-Owned Restricted Subsidiaries that are not prohibited hereby; and (g) Other Contingent Obligations in aggregate amount not to exceed $5,000,000 at any time outstanding. 7.09 Joint Ventures. The Company shall not, and shall not suffer or permit any of its Restricted Subsidiaries to enter into any Joint Venture with any Person other than the Company or a Wholly-Owned Restricted Subsidiary, other than in the ordinary course of business. 7.10 ERISA. The Company shall not, and to the fullest extent permitted by applicable law shall not suffer or permit any of its ERISA Affiliates to: (a) engage in a prohibited transaction or violation of the fiduciary responsibility rules with respect to any Plan which has resulted or could reasonably be expected to result in liability of the Company in an aggregate amount in excess of $5,000,000; or (b) engage in a transaction that could reasonably be expected to be subject to Section 4069 or 4212(c) of ERISA and that could reasonably be expected to have a Material Adverse Effect. 7.11 Lease Obligations. The Company shall not, and shall not suffer or permit any of its Restricted Subsidiaries to, create or suffer to exist any obligations for the payment of rent for any property under lease or agreement to lease, except for: (a) Leases of the Company and its Restricted Subsidiaries in existence on the Closing Date and any renewal, extension or refinancing thereof; (b) Capital Leases other than those permitted under subsection (a) of this Section, entered into by the Company or any of its Restricted Subsidiaries after the Closing Date to finance the acquisition of equipment; provided that the aggregate annual rental payments for all such Capital Leases shall not exceed $10,000,000 in the aggregate; and (c) Operating leases entered into by the Company and its Restricted Subsidiaries in the ordinary course of business. 7.12 Restricted Payments. The Company shall not, and shall not permit any of its Restricted Subsidiaries to, declare or make any dividend payment or other distribution of assets, properties, cash, rights, obligations or securities on account of any shares of any class of its capital stock or other equity interest, or purchase, redeem or otherwise acquire for value any shares of its capital stock or other equity interest or any warrants, rights or options to acquire such shares or interests, now or hereafter outstanding (any of the foregoing, a "Restricted Payment"), except: (a) The Company or any Restricted Subsidiary may declare and make Restricted Payments payable solely in its common stock or other equity interest; (b) The Company or any Restricted Subsidiary may purchase, redeem or otherwise acquire shares of its common stock or warrants or options to acquire any such shares with the proceeds received from the substantially concurrent issue of new shares of its common stock; (c) Any Restricted Subsidiary may declare and make Restricted Payments to the Company or any other Wholly-Owned Restricted Subsidiary; (d) The Company may declare and make Restricted Payments for any fiscal quarter, as long as (x) no Default or Event of Default exists at the time of such Restricted Payment, (y) the financial statements with respect to such fiscal quarter have been delivered to the Bank in compliance with Section 6.01(c), and (z) the aggregate Restricted Payments for that fiscal quarter and the three preceding fiscal quarters, excluding from such aggregation all Restricted Payments permitted by subsections 7.12(b) or (e), does not exceed the following "maximum amount": (1) if the Restricted Payment is to be made on or before December 31, 1999, or if Term Loans are not outstanding when such Restricted Payment is made, the "maximum amount" shall be Excess Cash Flow for the four most recent fiscal quarters for which financial statements have been delivered pursuant to Section 6.01(c) hereof or 6.01(b) of the Prior Credit Agreement; and (2) if the Restricted Payment is to be made after December 31, 1999, and if any Terms Loans are outstanding when such Restricted Payment is made, the "maximum amount" shall be (A) Excess Cash Flow for such four fiscal quarters, minus (B) an amount, not to exceed 50% of such Excess Cash Flow for such four fiscal quarters, equal to (i) if such four fiscal quarters conclude with the first fiscal quarter of any year, 25% of the Effective Amount of Term Loans that, as of December 31 of that year, will have been outstanding for one year or more; (ii) if such four fiscal quarters conclude with the second fiscal quarter of any year, 50% of the Effective Amount of Term Loans that, as of December 31 of that year, will have been outstanding for one year or more; (iii) if such four fiscal quarters conclude with the third fiscal quarter of any year, 75% of the Effective Amount of Term Loans that, as of December 31 of that year, will have been outstanding for one year or more; and (iv) if such four fiscal quarters conclude with the fourth fiscal quarter of any year, 100% of the Effective Amount of Term Loans that, as of the end of that fourth fiscal quarter, had been outstanding for one year or more; and (e) Any Restricted Subsidiary of the Company can make Restricted Payments to the extent funded with Salmon Creek Proceeds to the Company or to any other Subsidiary of the Company and the Company can make Restricted Payments to the extent funded with Salmon Creek Proceeds. 7.13 Change in Business. The Company shall not, and shall not permit any of its Subsidiaries to, engage in any material line of business substantially different from those lines of business carried on by it on the date hereof. 7.14 Accounting Changes. The Company shall not, and shall not suffer or permit any of its Restricted Subsidiaries to, make any significant change in accounting treatment or reporting practices, except as required by GAAP or the SEC or change the fiscal year of the Company or of any of its consolidated Restricted Subsidiaries; provided, however, that the Company or any of its consolidated Restricted Subsidiaries may change any of its significant accounting methods or reporting practices provided that the alternative accounting method chosen conforms with GAAP and the Company or any of its consolidated Restricted Subsidiaries has obtained a "preferability letter" from its independent public accountants stating that each such significant change in accounting method is preferable in the circumstances. 7.15 Other Contracts. The Company shall not enter into any employment contracts or other employment or service-retention arrangements whose terms, including salaries, benefits and other compensation, are not normal and customary in the industry. ARTICLE VIII EVENTS OF DEFAULT 8.01 Event of Default. Any of the following shall constitute an "Event of Default": (a) Non-Payment. The Company fails to make, (i) when and as required to be made herein, payments of any amount of principal of any Loan, or (ii) when and as required to be paid under any Specified Swap Contract, any payment or transfer under such Specified Swap Contract, or (iii) within five days after the same becomes due, payment of any interest, fee or any other amount payable hereunder or under any other Loan Document (other than a Specified Swap Contract); or (b) Representation or Warranty. Any representation or warranty by the Company or any Subsidiary of the Company made or deemed made herein, in any other Loan Document other than a Specified Swap Contract, or which is contained in any certificate, document or financial or other statement by the Company, any Subsidiary of the Company, or any Responsible Officer of the Company, SPC, or MGHI, furnished at any time under this Agreement, or in or under any other Loan Document other than a Specified Swap Contract, is incorrect in any material respect on or as of the date made or deemed made; or (c) Other Defaults. The Company fails to perform or observe any other term or covenant contained in this Agreement or any Loan Document, or any default or event of default shall occur thereunder and such default shall continue unremedied for a period of 30 days (the "30-Day Period") after the earlier of (i) the date upon which a Responsible Officer of the Company knew or should have known of such failure or (ii) the date upon which written notice thereof is given to the Company by the Bank, unless (in both (i) and (ii)) the default is curable, the Company has started to cure such default and continues to try to cure such default, and the default is cured within the 60 days starting on the first day of the 30-Day Period; (d) Cross-Default. (i) The Company or any of its Restricted Subsidiaries (A) fails to make any payment in respect of any Indebtedness or Contingent Obligation (other than in respect of Swap Contracts), having an aggregate principal amount (including undrawn committed or available amounts and including amounts owing to all creditors under any combined or syndicated credit arrangement) of more than $5,000,000 when due (whether by scheduled maturity, required prepayment, acceleration, demand, or otherwise) and such failure continues after the applicable grace or notice period, if any, specified in the relevant document on the date of such failure; or (B) fails to perform or observe any other condition or covenant, or any other event shall occur or condition exist, under any agreement or instrument relating to any such Indebtedness or Contingent Obligation, and such failure continues after the applicable grace or notice period, if any, specified in the relevant document on the date of such failure if the effect of such failure, event or condition is to cause, or to permit the holder or holders of such Indebtedness or beneficiary or beneficiaries of such Indebtedness (or a trustee or agent on behalf of such holder or holders or beneficiary or beneficiaries) to cause such Indebtedness to be declared to be due and payable prior to its stated maturity, or such Contingent Obligation to become payable or cash collateral in respect thereof to be demanded; or (ii) there occurs under any Specified Swap Contract an Early Termination Date resulting from (1) any event of default under such Specified Swap Contract as to which the Company is the Defaulting Party (as defined in such Specified Swap Contract) or (2) any Termination Event (as defined in such Specified Swap Contract) as to which the Company is an Affected Party (as defined in such Specified Swap Contract), and, in either event, the Swap Termination Value owed by the Company as a result thereof is greater than $5,000,000; or (iii) an "Event of Default" exists as defined in the Indenture referenced in the definition of Timber Notes herein; or (e) Insolvency; Voluntary Proceedings. The Company, SPC, or any of the Company's Restricted Subsidiaries (i) ceases or fails to be solvent, or generally fails to pay, or admits in writing its inability to pay, its debts as they become due, subject to applicable grace periods, if any, whether at stated maturity or otherwise; (ii) voluntarily ceases to conduct its business in the ordinary course; (iii) commences any Insolvency Proceeding with respect to itself; or (iv) takes any action to effectuate or authorize any of the foregoing; or (f) Involuntary Proceedings. (i) Any involuntary Insolvency Proceeding is commenced or filed against the Company or any of its Restricted Subsidiaries or SPC, or any writ, judgment, warrant of attachment, execution or similar process, is issued or levied against a substantial part of the Company's or SPC's properties, and any such proceeding or petition shall not be dismissed, or such writ, judgment, warrant of attachment, execution or similar process shall not be released, vacated or fully bonded within 60 days after commencement, filing or levy; (ii) the Company or SPC admits the material allegations of a petition against it in any Insolvency Proceeding, or an order for relief (or similar order under non-U.S. law) is ordered in any Insolvency Proceeding; or (iii) the Company or SPC acquiesces in the appointment of a receiver, trustee, custodian, conservator, liquidator, mortgagee in possession (or agent therefor), or other similar Person for itself or a substantial portion of its property or business; or (g) ERISA. (i) An ERISA Event shall occur with respect to a Pension Plan or Multiemployer Plan which has resulted or could reasonably be expected to result in liability of the Company under Title IV of ERISA to the Pension Plan, Multiemployer Plan or the PBGC in an aggregate amount in excess of $5,000,000; or (ii) the aggregate amount of Unfunded Pension Liability among all Pension Plans at any time exceeds $5,000,000; or (iii) the Company or any ERISA Affiliate shall fail to pay when due, after the expiration of any applicable grace period, any installment payment with respect to its withdrawal liability under Section 4201 of ERISA under a Multiemployer Plan in an aggregate amount in excess of $5,000,000; or (h) Monetary Judgments. One or more final (non-interlocutory) judgments, orders, decrees or arbitration awards is entered against the Company or any of its Restricted Subsidiaries involving in the aggregate a liability (to the extent not covered by independent third-party insurance as to which the insurer does not dispute coverage) as to any single or related series of transactions, incidents or conditions, that would reasonably be expected to have a Material Adverse Effect, and the same shall remain unsatisfied, unvacated and unstayed pending appeal for a period of 30 days after the entry thereof; or (i) Non-Monetary Judgments. Any non-monetary judgment, order or decree is entered against the Company or any of its Restricted Subsidiaries which does or would reasonably be expected to have a Material Adverse Effect, and there shall be any period of 30 consecutive days during which a stay of enforcement of such judgment or order, by reason of a pending appeal or otherwise, shall not be in effect; or (j) Change in Control. There occurs any Change in Control; or (k) Collateral. (1) (A) Any material provision of any Collateral Document shall for any reason other than pursuant to the terms thereof cease to be valid and binding on or enforceable against the Company thereto; or (B) Any Collateral Document shall for any reason (other than pursuant to the terms thereof) cease to create a valid security interest or Lien in the Collateral purported to be covered thereby; or (C) The Bank ceases to have, for any reason, a perfected and first priority security interest or Lien on any item of Collateral (subject only to Permitted Liens) and the failure to have such perfected first priority security interest or Lien is not caused by the Bank's failure to timely file a UCC continuation statement; and the Effective Amount of Loans and L/C Obligations is more than the amount computed pursuant to clause (a) of the definition of the Borrowing Base (excluding, in the computation of the Borrowing Base for purposes of this clause the Collateral encumbered by the Collateral Documents covered by clauses (A), (B), and (C) of this subsection 8.01(k)(1)); or (2) The Company shall state in writing its belief that any material provision of any Collateral Document is not valid and binding or the Company shall bring an action to limit its obligations or liabilities thereunder; or (3) Any title insurance coverage in respect of any material portion of the Timberlands covered by a Collateral Document is disavowed or becomes ineffective and the Company fails to furnish the Bank with replacement coverages in amount, form and substance substantially similar to such title insurance coverage from title insurance companies reasonably satisfactory to the Bank; or (4) The Bank, in good faith, considers any Collateral to be unsafe or in danger of misuse to the extent that the Bank's prospect of or right to payment or performance under this Agreement or any Loan Document is materially impaired; or (l) Condemnation. All, or such as in the reasonable opinion of the Bank constitutes a substantial portion, of the Timberlands or other property of the Company is condemned, seized, or expropriated; or (m) Regulatory Action. Any Governmental Authority takes or institutes action which could reasonably be expected to have, on an Unconsolidated Basis, a Material Adverse Effect on the Company's financial condition or results of operations or ability to perform its obligations under this Agreement or any other Loan Document. 8.02 Remedies. If any Event of Default exists, the Bank may: (a) Declare its commitment to make Loans and/or Issue Letters of Credit to be terminated, whereupon such commitment shall be terminated; (b) Declare the unpaid principal amount of all outstanding Loans, all Outstanding Letters of Credit (including the Company's reimbursement obligations for Outstanding Letters of Credit), all L/C Obligations, all interest accrued and unpaid thereon, and all other amounts owing or payable hereunder or under any other Loan Document to be immediately due and payable, without presentment, demand, protest or other notice of any kind, all of which are hereby expressly waived by the Company; and (c) Exercise on behalf of itself all rights and remedies available to it under the Loan Documents or applicable law; provided, however, that upon the occurrence of any event specified in subsection (e) or (f) of Section 8.01 (in the case of clause (i) of subsection (f) upon the expiration of the 60-day period mentioned therein), the obligation of the Bank to make Loans and Issue Letters of Credit shall automatically terminate and the unpaid principal amount of all outstanding Loans, all Outstanding Letters of Credit (including the Company's reimbursement obligations for Outstanding Letters of Credit), all L/C Obligations, and all interest and other amounts as aforesaid shall automatically become due and payable without further act of the Bank. Amounts paid by the Company to be applied to prepayment of L/C Obligations and to the Company's reimbursement obligations for Outstanding Letters of Credit may be held by the Bank as cash collateral for such Obligations. 8.03 Specified Swap Contract Remedies. Notwithstanding any other provision of this Article, each Swap Provider shall have the right, with prior notice to the Bank, with respect to any Specified Swap Contract of such Swap Provider, (a) to declare an event of default, termination event or other similar event thereunder and to create an Early Termination Date, (b) to determine net termination amounts in accordance with the terms of such Specified Swap Contracts and to set-off amounts in accordance with the terms of such Specified Swap Contracts, and (c) to prosecute any legal action against the Company to enforce net amounts owing to such Swap Provider. The Company hereby grants the Bank a security interest in all of the Company's rights, title, and interests in the Company's rights to payment and performance by the Swap Provider in each of the Specified Swap Contracts. 8.04 Rights Not Exclusive. The rights provided for in this Agreement and the other Loan Documents are cumulative and are not exclusive of any other rights, powers, privileges or remedies provided by law or in equity, or under any other instrument, document or agreement now existing or hereafter arising. 8.05 Certain Financial Covenant Defaults. In the event that, after taking into account any extraordinary charge to earnings taken or to be taken as of the end of any fiscal period of the Company (a "Charge"), and if solely by virtue of such Charge, there would exist an Event of Default due to the breach of Section 7.13 as of such fiscal period end date, such Event of Default shall be deemed to arise upon the earlier of (a) the date after such fiscal period end date on which the Company announces publicly it will take, is taking or has taken such Charge (including an announcement in the form of a statement in a report filed with the SEC) or, if such announcement is made prior to such fiscal period end date, the date that is such fiscal period end date, and (b) the date the Company delivers to the Bank its audited annual or unaudited quarterly financial statements in respect of such fiscal period reflecting such Charge as taken. ARTICLE IX MISCELLANEOUS 9.01 Amendments and Waivers. No amendment or waiver of any provision of this Agreement or any other Loan Document, and no consent with respect to any departure by the Company therefrom, shall be effective unless the same shall be in writing and signed by the Bank and the Company, and then any such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given. 9.02 Notices. (a) All notices, requests, consents, approvals, waivers and other communications shall be in writing (including, unless the context expressly otherwise provides, by facsimile transmission, provided that any matter transmitted by the Company or the Bank by facsimile (i) shall be immediately confirmed by a telephone call to the Bank or the Company, respectively, at the number specified on the signature pages to this Agreement and (ii) shall be followed promptly by delivery of a hard copy original thereof) and mailed, faxed or delivered, to the address or facsimile number specified for notices on the signature pages of this Agreement; or, as directed to the Company or the Bank, to such other address as shall be designated by such party in a written notice to the other party, and as directed to any other party, at such other address as shall be designated by such party in a written notice to the other party. (b) All such notices, requests, consents, approvals, and communications shall, when transmitted by overnight delivery, or faxed, be effective when delivered for overnight (next-day) delivery, or transmitted in legible form by facsimile machine, respectively, or if mailed, upon the third Business Day after the date deposited into the U.S. mail, or if delivered, upon delivery; except that notices of borrowing, of conversion/continuation, prepayment, and termination or reduction of commitments pursuant to Article II shall not be effective until actually received by the Bank. (c) Any agreement of the Bank herein to receive certain notices by telephone or facsimile is solely for the convenience and at the request of the Company. The Bank shall be entitled to rely on the authority of any Person purporting to be a Person authorized by the Company to give such notice and the Bank shall not have any liability to the Company or other Person on account of any action taken or not taken by the Bank in reliance upon such telephonic or facsimile notice. The obligation of the Company to repay the Loans, the L/C Obligations, and the other Obligations shall not be affected in any way or to any extent by any failure by the Bank to receive written confirmation of any telephonic or facsimile notice or the receipt by the Bank of a confirmation which is at variance with the terms understood by the Bank to be contained in the telephonic or facsimile notice. 9.03 No Waiver; Cumulative Remedies. No failure to exercise and no delay in exercising, on the part of the Bank, any right, remedy, power or privilege hereunder, shall operate as a waiver thereof; nor shall any single or partial exercise of any right, remedy, power or privilege hereunder preclude any other or further exercise thereof or the exercise of any other right, remedy, power or privilege. 9.04 Costs and Expenses. The Company shall: (a) Whether or not the transactions contemplated hereby are consummated, pay or reimburse the Bank within 20 Business Days after demand (subject to subsection 4.01(d)) for all costs and expenses incurred by the Bank in connection with the development, preparation, delivery, administration and execution of, and any amendment, supplement, waiver or modification to (in each case, whether or not consummated), this Agreement, any Loan Document, and any other documents prepared in connection herewith or therewith, and the consummation of the transactions contemplated hereby and thereby, including filing or recording taxes or fees in connection with any Collateral Documents, title insurance premiums, documentary stamp or intangible taxes, recording fees and mortgage taxes payable in connection with the recording of any Deed of Trust or the issuance of title insurance policies, and reasonable Attorney Costs incurred by the Bank with respect thereto; and (b) Pay or reimburse the Bank within 20 Business Days after demand (subject to subsection 4.01(d)) for all costs and expenses (including Attorney Costs) incurred by them in connection with the enforcement, attempted enforcement, or preservation of any rights or remedies under this Agreement or any other Loan Document during the existence of an Event of Default or after acceleration of the Loans (including in connection with any "workout" or restructuring regarding the Loans, and including in any Insolvency Proceeding or appellate proceeding); and (c) Pay or reimburse the Bank within 20 Business Days after demand (subject to subsection 4.01(d)) for all reasonable appraisal (including the allocated cost of internal appraisal services), audit, environmental inspection and review (including the allocated cost of such internal services), search and filing costs, fees and expenses, incurred or sustained by the Bank in connection with the matters referred to under subsections (a) and (b) of this Section. 9.05 Company Indemnification. (a) Whether or not the transactions contemplated hereby are consummated, the Company shall indemnify, defend and hold the Bank, each Affiliate of the Bank, and each of its respective officers, directors, employees, counsel, agents and attorneys-in-fact (each, an "Indemnified Person") harmless from and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, charges, expenses and disbursements (including Attorney Costs) of any kind or nature whatsoever which may at any time (including at any time following repayment of the Loans and L/C Obligations, expiration of the Standby Letters of Credit, and termination of all Specified Swap Contracts) be imposed on, incurred by or asserted against any such Person in any way relating to or arising out of this Agreement or any document contemplated by or referred to herein, or the transactions contemplated hereby, or any action taken or omitted by any such Person under or in connection with any of the foregoing, including with respect to any investigation, litigation or proceeding (including any Insolvency Proceeding or appellate proceeding) related to or arising out of this Agreement, the Specified Swap Contracts, or the Standby Letters of Credit, the Loans or the use of the proceeds thereof, whether or not any Indemnified Person is a party thereto (all the foregoing, collectively, the "Indemnified Liabilities"); provided, that the Company shall have no obligation hereunder to any Indemnified Person with respect to Indemnified Liabilities resulting solely from the gross negligence or willful misconduct of such Indemnified Person. The agreements in this Section shall survive payment of all other Obligations. (b) (1) The Company shall indemnify, defend and hold harmless each Indemnified Person, from and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, charges, expenses or disbursements (including Attorney Costs and the allocated cost of internal environmental audit or review services), which may be incurred by or asserted against such Indemnified Person in connection with or arising out of any pending or threatened investigation, litigation or proceeding, or any action taken by any Person, with respect to any Environmental Claim arising out of or related to any property subject to a Deed of Trust in favor of the Bank except to the extent that such Environmental Claim arises by reason of the Bank's actions taken after the Bank acquires title to any such property following a foreclosure sale or deed-in-lieu transaction and such actions on the part of the Bank do not relate or pertain in any way to any conditions or circumstances that were either (i) caused or exacerbated (whether directly or indirectly) in any way by the Company, or (ii) existed (regardless of whether they were known or unknown) at the time the Bank acquired title to such property. No reasonable action taken (reasonableness of an action to be determined as of the time and under the circumstances such action is taken) by legal counsel chosen by the Bank in defending against any such investigation, litigation or proceeding or requested remedial, removal or response action shall vitiate or any way impair the Company's obligation and duty hereunder to indemnify and hold harmless the Bank. (2) In no event shall any site visit, observation, or testing by the Bank (or any contractee of the Bank) be deemed a representation or warranty that Hazardous Materials are or are not present in, on, or under, the site, or that there has been or shall be compliance with any Environmental Law. Neither the Company nor any other Person is entitled to rely on any site visit, observation, or testing by the Bank. The Bank owes no duty of care to protect the Company or any other Person against, or to inform the Company or any other party of, any Hazardous Materials or any other adverse condition affecting any site or property. The Bank shall not be obligated to disclose to the Company or any other Person any report or findings made as a result of, or in connection with, any site visit, observation, or testing by the Bank. (c) The obligations in this Section shall survive payment of all other Obligations. Promptly after receipt by an Indemnified Person of notice of the commencement of any proceeding indemnified against hereunder, such Indemnified Person will, if a claim in respect thereof is to be made against the Company hereunder, notify the Company in writing of the commencement thereof; but the failure so to notify the Company (i) will not relieve it from liability under subsections (a) and (b) above unless and to the extent it did not otherwise learn of such action and such failure results in the forfeiture by the Company of substantial rights and defenses and (ii) will not, in any event, relieve the Company from any obligations to any Indemnified Person other than the indemnification obligation provided above. The Company shall be entitled to appoint counsel of the Company's choice at the Company's expense to represent the Indemnified Person in any action for which indemnification is sought (in which case the Company shall not thereafter be responsible for the fees and expenses of any separate counsel retained by the Indemnified Person except as set forth below); provided, however, that such counsel shall be reasonably satisfactory to the Indemnified Person. Notwithstanding the Company's election to appoint counsel to represent the Indemnified Person in an action, the Indemnified Person shall have the right to employ separate counsel (including local counsel), and the Company shall bear the reasonable fees, costs and expenses of such separate counsel if (i) the use of counsel chosen by the Company to represent the Indemnified Person would present such counsel with a conflict of interest, (ii) the actual or potential defendants in, or targets of, any such proceeding include both the Indemnified Person and the Company and the Indemnified Person shall have reasonably concluded that there may be legal defenses available to the Indemnified Person which are different from or additional to those available to the Company, (iii) the Company shall not have employed counsel reasonably satisfactory to the Indemnified Person to represent the Indemnified Person within a reasonable time after notice of the institution of such action, or (iv) the Company shall authorize the Indemnified Person to employ separate counsel at the expense of the Company. The Company will not, without the prior written consent of the Indemnified Person (which consent shall not be unreasonably withheld), settle or compromise or consent to the entry of any judgment with respect to any proceeding in respect of which indemnification may be sought hereunder (whether or not the Indemnified Person is an actual or potential party to such claim or action) unless such settlement, compromise or consent includes an unconditional release of each Indemnified Person from all liability arising out of such proceeding. (d) All amounts owing under this Section shall be paid within 30 days after demand. 9.06 Marshalling; Payments Set Aside. The Bank shall be under no obligation to marshall any assets in favor of the Company or any other Person or against or in payment of any or all of the Obligations. To the extent that the Company makes a payment to the Bank, or the Bank exercises its right of set-off, and such payment or the proceeds of such set-off or any part thereof are subsequently invalidated, declared to be fraudulent or preferential, set aside or required (including pursuant to any settlement entered into by the Bank in its discretion) to be repaid to a trustee, receiver or any other party, in connection with any Insolvency Proceeding or otherwise, then to the extent of such recovery the obligation or part thereof originally intended to be satisfied shall be revived and continued in full force and effect as if such payment had not been made or such set-off had not occurred. 9.07 Successors and Assigns. The provisions of this Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns, except that the Company may not assign or transfer any of its rights or obligations under this Agreement without the prior written consent of the Bank. 9.08 Assignments, Participations, etc. (a) The Bank may at any time, with the written consent of the Company at all times other than during the existence of an Event of Default, which consent shall not be unreasonably withheld, at any time assign and delegate to one or more Persons (provided that no written consent of the Company shall be required in connection with any assignment and delegation to an Affiliate of the Bank and the costs charged to the Company shall not exceed the costs that would have been charged had the Bank not made such assignment and delegation) (each an "Assignee") all, or any ratable part of all, of the Loans, the Company's reimbursement obligations for Outstanding Letters of Credit, the L/C Obligations, the Bank's commitment to extend credit hereunder, and the other rights and obligations of the Bank hereunder; provided, however, that the Company may continue to deal solely and directly with the Bank in connection with the interest so assigned to an Assignee until written notice of such assignment, together with payment instructions, addresses and related information with respect to the Assignee, shall have been given to the Company by the Bank and the Assignee. (b) The Bank may at any time sell to one or more Persons (a "Participant") participating interests in any Loans, the Company's reimbursement obligations for any Outstanding Letters of Credit, any L/C Obligations, the Bank's commitment to extend credit hereunder, and the other interests of the Bank hereunder and under the other Loan Documents; provided, however, that (i) the Bank's obligations under this Agreement shall remain unchanged, (ii) the Bank shall remain solely responsible for the performance of such obligations, (iii) the Company shall continue to deal solely and directly with the Bank in connection with the Bank's rights and obligations under this Agreement and the other Loan Documents, and (iv) the Participant shall, together with the Bank, be entitled to the non- exclusive protection of Sections 3.01, 3.03 and 9.10 as though it were also the "Bank" hereunder; except that the Company shall not be obliged to pay the Participant an amount greater than what the Company would have had to pay the Bank if it had not sold the participating interest to the Participant. In the case of any such participation, if amounts outstanding under this Agreement are due and unpaid, or shall have been declared or shall have become due and payable upon the occurrence of an Event of Default, each Participant shall be deemed to have the right of set-off in respect of its participating interest in amounts owing under this Agreement to the same extent as if the amount of its participating interest were owing directly to it as an Assignee under this Agreement. (c) Notwithstanding any other provision contained in this Agreement or any other Loan Document to the contrary, the Bank may assign all or any portion of the Loans held by it to any Federal Reserve Bank or the United States Treasury as collateral security pursuant to Regulation A of the Board of Governors of the Federal Reserve System and any Operating Circular issued by such Federal Reserve Bank, provided that any payment in respect of such assigned Loans made by the Company to or for the account of the Bank in accordance with the terms of this Agreement shall satisfy the Company's obligations hereunder in respect to such assigned Loans to the extent of such payment. No such assignment shall release the Bank from its obligations hereunder. 9.09 Confidentiality. The Bank agrees to take and to cause its Affiliates to take normal and reasonable precautions and exercise due care to maintain the confidentiality of all information identified as "confidential" or "secret" by the Company and provided to it by the Company or any Subsidiary of the Company, under this Agreement or any other Loan Document, and neither it nor any of its Affiliates shall use any such information other than in connection with or in enforcement of this Agreement and the other Loan Documents or in connection with other business now or hereafter existing or contemplated with the Company or any Subsidiary of the Company; except to the extent such information (i) was or becomes generally available to the public other than as a result of disclosure by the Bank, or (ii) was or becomes available on a non-confidential basis from a source other than the Company, provided that such source is not bound by a confidentiality agreement with the Company known to the Bank; provided, however, that the Bank may disclose such information (A) at the request or pursuant to any requirement of any Governmental Authority to which the Bank is subject or in connection with an examination of the Bank by any such authority; (B) pursuant to subpoena or other court process; provided that the Bank shall, if permitted by applicable law, offer the Company a reasonable opportunity to obtain a protective order in connection therewith; (C) when required to do so in accordance with the provisions of any applicable Requirement of Law; (D) to the extent reasonably required in connection with any litigation or proceeding to which the Bank or its Affiliates may be party; provided that the Bank shall, if permitted by applicable law, offer the Company a reasonable opportunity to obtain a protective order in connection therewith; (E) to the extent reasonably required in connection with the exercise of any remedy hereunder or under any other Loan Document; (F) to the Bank's independent auditors and other professional advisors if such advisors have a duty of confidentiality toward the Bank; (G) to any Participant or Assignee, actual or potential, provided that such Person agrees in writing to keep such information confidential to the same extent required of the Bank hereunder; (H) as to the Bank or its Affiliate, as expressly permitted under the terms of any other document or agreement regarding confidentiality to which the Company or any Subsidiary of the Company is party or is deemed party with the Bank or such Affiliate; and (I) to its Affiliates provided that such Affiliates shall be subject to the same confidentiality obligation as the Bank in instances where there is no document or agreement regarding confidentiality between the Company or any Subsidiary or the Company and the Bank or such Affiliate. 9.10 Set-off. In addition to any rights and remedies of the Bank provided by law, if an Event of Default exists or the Loans have been accelerated, the Bank is authorized at any time and from time to time, without prior notice to the Company, any such notice being waived by the Company to the fullest extent permitted by law, to set off and apply any and all deposits (general or special, time or demand, provisional or final) at any time held by, and other indebtedness at any time owing by, the Bank to or for the credit or the account of the Company against any and all Obligations owing to the Bank, now or hereafter existing, irrespective of whether or not the Bank shall have made demand under this Agreement or any Loan Document and although such Obligations may be contingent or unmatured. 9.11 Counterparts. This Agreement may be executed in any number of separate counterparts, each of which, when so executed, shall be deemed an original, and all of said counterparts taken together shall be deemed to constitute but one and the same instrument. 9.12 Severability; Conflicting Provisions. (a) Severability. The illegality or unenforceability of any provision of this Agreement or any instrument or agreement required hereunder shall not in any way affect or impair the legality or enforceability of the remaining provisions of this Agreement or any instrument or agreement required hereunder. (b) Conflicting Provisions. In the event of any conflict between any provision contained in this Agreement and any provision contained in another Loan Document, the provision contained in this Agreement shall prevail. 9.13 No Third Parties Benefited. This Agreement is made and entered into for the sole protection and legal benefit of the Company, the Bank, and each Affiliate of the Bank and their permitted successors and assigns, and no other Person shall be a direct or indirect legal beneficiary of, or have any direct or indirect cause of action or claim in connection with, this Agreement or any of the other Loan Documents. 9.14 Governing Law and Jurisdiction. (a) THIS AGREEMENT SHALL BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH, THE LAW OF THE STATE OF CALIFORNIA; PROVIDED THAT THE BANK SHALL RETAIN ALL RIGHTS ARISING UNDER FEDERAL LAW. (b) Nothing contained in this Section shall override any contrary provision contained in any Specified Swap Contract. 9.15 Verification of Receivables. The Bank may at any time, either orally or in writing, request confirmation from any Receivable Debtor of the current amount and status of the Receivable upon which such Receivable Debtor is obligated. 9.16 Termination of Commitment to Lend under the Prior Credit Agreement. Upon execution of this Agreement by the Company and the Bank, the Bank's commitment to Issue Letters of Credit and to lend under the Prior Credit Agreement shall automatically terminate without necessity of further act of the Bank and the Company. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed and delivered by their proper and duly authorized officers as of the day and year first above written. THE PACIFIC LUMBER COMPANY By: /S/ GARY L. CLARK Name: Gary L. Clark Title: Vice President-Finance and Administration Address for Notices: The Pacific Lumber Company 125 Main Street Scotia, California 95565 Attention: Gary L. Clark Vice President-Finance and Administration Telephone: 707/764-4213 FAX: 707/764-4269 With a copy to: MAXXAM Inc. 5847 San Felipe - Suite 2600 Houston, Texas 77057 Attention: Treasury Department Telephone: 713/267-3619 FAX: 713/267-3704 BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION By: /S/ MICHAEL J. BALOK Name: Michael J. Balok Title: Managing Director Address for notices: Paper and Forest Products #9973 Bank of America National Trust and Savings Association 555 California Street - 41st Floor P.O. Box 37000 San Francisco, CA 94137 Attention: Michael J. Balok Telephone: 415/622-2018 FAX: 415/622-4585 Domestic and Offshore Lending Office: 1850 Gateway Boulevard Concord, California 94520 Place of Payment: Bank of America National Trust and Savings Association ABA #121-000-358-S.F. 1850 Gateway Boulevard Concord, CA 94520 Account # 12331 83980; Ref. The Pacific Lumber Company Telephone: 510/657-7350 FAX: 510/675-7531 Attention: Terry Peach EXHIBIT A NOTICE OF BORROWING Date: __________, ____ To: Bank of America National Trust and Savings Association (the "Bank") Re: Amended and Restated Credit Agreement dated as of ________ __, 1998 (as extended, renewed, amended or restated from time to time, the "Credit Agreement") between The Pacific Lumber Company and Bank of America National Trust and Savings Association. Ladies and Gentlemen: The undersigned, The Pacific Lumber Company (the "Company"), refers to the Credit Agreement, the terms defined therein being used herein as therein defined, and hereby gives you notice irrevocably, pursuant to Section 2.03 of the Credit Agreement, of the proposed Loan specified below: 1. The Business Day of the proposed Loan is __________ __, 19__. 2. The Loan is to be a Loan under the [Revolving] [Term] Credit. 3. The Loan is to be a $__________ [Base Rate] [Offshore Rate] Loan. [4. The duration of the Interest Period for the Offshore Rate Loan is _____ months.] The undersigned hereby certifies that the following statements are true on the date hereof, and will be true on the date of the proposed Loan, before and after giving effect thereto and to the application of the proceeds therefrom: (a) the representations and warranties of the Company contained in Article V of the Credit Agreement are true and correct as though made on and as of such date (except to the extent such representations and warranties relate to an earlier date, in which case they are true and correct as of such date); (b) no Default or Event of Default has occurred and is continuing, or would result from such proposed Loan; and (c) The proposed Loan will not cause the aggregate principal amount of all outstanding Loans plus the L/C Obligations to exceed the lesser of the Commitment or the Borrowing Base. [(d) The proceeds of the proposed Term Loan will be used to pay for the Acquisition Costs of Timberlands which will be immediately encumbered by Deed(s) of Trust in favor of the Bank.] THE PACIFIC LUMBER COMPANY By: Name: Title: EXHIBIT B NOTICE OF CONVERSION/CONTINUATION Date: __________, ____ To: Bank of America National Trust and Savings Association (the "Bank") Re: Amended and Restated Credit Agreement dated as of _________ __, 1998 (as extended, renewed, amended or restated from time to time, the "Credit Agreement") between The Pacific Lumber Company and Bank of America National Trust and Savings Association. Ladies and Gentlemen: The undersigned, The Pacific Lumber Company (the "Company"), refers to the Credit Agreement, the terms defined therein being used herein as therein defined, and hereby gives you notice irrevocably, pursuant to Section 2.04 of the Credit Agreement, of the [conversion] [continuation] of the Loans specified herein, that: 1. The date of the [conversion] [continuation] is __________ __, 19__ 2. The Loans covered by this notice are Loans under the [Revolving] [Term] Credit. 3. The aggregate amount of the Loans [converted] [continued] is $__________. 4. The Loans are to be [converted into] [continued as] [Offshore Rate] [Base Rate] Loans. 5. [If applicable:] The duration of the Interest Period for the Loans included in the [conversion] [continuation] shall be [____ days] [_____ months]. [If Loans are to be converted into or continued as Offshore Rate Loans:] The undersigned hereby certifies that the following statements are true on the date hereof, and will be true on the date of the proposed [conversion] [continuation], before and after giving effect thereto and to the application of the proceeds therefrom: (a) the representations and warranties of the Company contained in Article V of the Credit Agreement are true and correct as though made on and as of such date (except to the extent such representations and warranties relate to an earlier date, in which case they are true and correct as of such date); and (b) no Default or Event of Default has occurred and is continuing, or would result from such proposed [conversion] [continuation]. THE PACIFIC LUMBER COMPANY By: Name: Title: EX-27 4 EX-27/MGHI FINANCIAL DATA SCHEDULE
5 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. 1,000 U.S. DOLLARS 12-MOS DEC-31-1998 JAN-01-1998 DEC-31-1998 1 150,800 11,700 17,600 0 44,000 232,100 480,700 178,400 952,200 66,900 998,500 0 0 0 (134,500) 952,200 233,600 233,600 155,300 155,300 37,700 0 91,600 (27,300) 9,300 (18,000) 0 (41,800) 0 (59,800) 0 0
EX-99 5 EXHIBIT 99.1 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To MAXXAM Inc.: We have audited the accompanying consolidated balance sheets of MAXXAM Inc. (a Delaware corporation) and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of operations, cash flows and stockholders' deficit for each of the three years in the period ended December 31, 1998. These financial statements and the schedule referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of MAXXAM Inc. and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. Our audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The schedule listed in Item 14(a)(2) of this Form 10-K is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the audits of the basic consolidated financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic consolidated financial statements taken as a whole. ARTHUR ANDERSEN LLP Houston, Texas March 1, 1999 MAXXAM INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (IN MILLIONS OF DOLLARS, EXCEPT SHARE AMOUNTS)
DECEMBER 31, --------------------------- 1998 1997 ------------ ------------- ASSETS Current assets: Cash and cash equivalents $ 294.2 $ 164.6 Marketable securities 19.4 84.6 Receivables: Trade, net of allowance for doubtful accounts of $6.4 and $5.9, respectively 184.5 255.9 Other 122.6 126.3 Inventories 587.5 629.6 Prepaid expenses and other current assets 152.4 175.1 ------------ ------------ Total current assets 1,360.6 1,436.1 Property, plant and equipment, net of accumulated depreciation of $921.5 and $845.6, respectively 1,278.9 1,320.9 Timber and timberlands, net of accumulated depletion of $178.4 and $169.2, respectively 302.3 299.1 Investments in and advances to unconsolidated affiliates 146.5 159.5 Deferred income taxes 555.8 479.9 Long-term receivables and other assets 431.1 418.7 ------------ ------------ $ 4,075.2 $ 4,114.2 ============ ============ LIABILITIES AND STOCKHOLDERS' DEFICIT Current liabilities: Accounts payable $ 182.9 $ 187.3 Accrued interest 72.4 68.7 Accrued compensation and related benefits 133.7 159.3 Other accrued liabilities 180.6 174.9 Payable to affiliates 77.1 82.9 Short-term borrowings and current maturities of long-term debt 37.0 69.0 ------------ ------------ Total current liabilities 683.7 742.1 Long-term debt, less current maturities 1,971.7 1,888.0 Accrued postretirement medical benefits 704.5 730.1 Other noncurrent liabilities 604.8 586.3 ------------ ------------ Total liabilities 3,964.7 3,946.5 Commitments and contingencies Minority interests 167.3 170.6 Stockholders' deficit: Preferred stock, $.50 par value; 12,500,000 shares authorized; Class A $.05 Non-Cumulative Participating Convertible Preferred Stock; 669,435 shares issued .3 .3 Common stock, $0.50 par value; 28,000,000 shares authorized; 10,063,359 shares issued 5.0 5.0 Additional capital 222.8 222.8 Accumulated deficit (175.7) (118.5) Accumulated other comprehensive loss - (3.3) Treasury stock, at cost (shares held: preferred - 845; common - 3,062,496 and 3,062,762, respectively) (109.2) (109.2) ------------ ------------ Total stockholders' deficit (56.8) (2.9) ------------ ------------ $ 4,075.2 $ 4,114.2 ============ ============ The accompanying notes are an integral part of these financial statements.
MAXXAM INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS (IN MILLIONS OF DOLLARS, EXCEPT SHARE AMOUNTS)
YEARS ENDED DECEMBER 31, ---------------------------------------- 1998 1997 1996 ------------ ------------ ------------ Net sales: Aluminum operations $ 2,256.4 $ 2,373.2 $ 2,190.5 Forest products operations 233.6 287.2 264.6 Real estate and racing operations 82.7 68.7 88.2 ------------ ------------ ------------ 2,572.7 2,729.1 2,543.3 ------------ ------------ ------------ Costs and expenses: Costs of sales and operations: Aluminum operations 1,906.2 1,951.2 1,857.5 Forest products operations 155.3 162.0 148.5 Real estate and racing operations 49.2 42.4 67.4 Selling, general and administrative expenses 171.0 190.0 203.5 Depreciation, depletion and amortization 120.4 127.4 135.1 Impairment of aluminum assets 45.0 - - Restructuring of aluminum operations - 19.7 - ------------ ------------ ------------ 2,447.1 2,492.7 2,412.0 ------------ ------------ ------------ Operating income 125.6 236.4 131.3 Other income (expense): Investment, interest and other income 36.3 49.7 41.1 Interest expense (201.3) (201.4) (175.5) Amortization of deferred financing costs (7.2) (10.2) (9.0) ------------ ------------ ------------ Income (loss) before income taxes, minority interests and extraordinary item (46.6) 74.5 (12.1) Credit for income taxes 32.1 6.9 44.9 Minority interests (.2) (16.2) (9.9) ------------ ------------ ------------ Income (loss) before extraordinary item (14.7) 65.2 22.9 Extraordinary item: Loss on early extinguishment of debt, net of income tax benefit of $22.9 (42.5) - - ------------ ------------ ------------ Net income (loss) $ (57.2) $ 65.2 $ 22.9 ============ ============ ============ Basic earnings (loss) per common share: Income (loss) before extraordinary item $ (2.10) $ 7.81 $ 2.63 Extraordinary item (6.07) - - ------------ ------------ ------------ Net income (loss) $ (8.17) $ 7.81 $ 2.63 ============ ============ ============ Diluted earnings (loss) per common and common equivalent share: Income (loss) before extraordinary item $ (2.10) $ 7.14 $ 2.42 Extraordinary item (6.07) - - ------------ ------------ ------------ Net income (loss) $ (8.17) $ 7.14 $ 2.42 ============ ============ ============ The accompanying notes are an integral part of these financial statements.
MAXXAM INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (IN MILLIONS OF DOLLARS)
YEARS ENDED DECEMBER 31, ---------------------------------------- 1998 1997 1996 ------------ ------------ ------------ Cash flows from operating activities: Net income (loss) $ (57.2) $ 65.2 $ 22.9 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation, depletion and amortization 120.4 127.4 135.1 Impairment of aluminum assets 45.0 - - Extraordinary loss on early extinguishment of debt 42.5 - - Restructuring of aluminum operations - 19.7 - Minority interests .2 16.2 9.9 Amortization of deferred financing costs and discounts on long-term debt 17.9 24.8 21.5 Equity in (earnings) loss of unconsolidated affiliates, net of dividends received (.5) 23.3 3.0 Net gain on sales of real estate, mortgage loans and other assets - (7.9) (23.7) Net gains on marketable securities (8.6) (18.1) (7.8) Net sales (purchases) of marketable securities 73.8 (16.2) 3.4 Increase (decrease) in cash resulting from changes in: Receivables 70.1 (86.1) 60.4 Inventories 38.7 .4 (30.6) Prepaid expenses and other assets (3.5) (9.8) (33.3) Accounts payable (4.7) (14.8) 4.8 Accrued interest 4.0 8.4 6.2 Accrued and deferred income taxes (23.9) (4.4) (46.0) Payable to affiliates and other liabilities (74.1) (67.5) (74.0) Other 5.1 8.0 4.2 ------------ ------------ ------------ Net cash provided by operating activities 245.2 68.6 56.0 ------------ ------------ ------------ Cash flows from investing activities: Capital expenditures (122.1) (164.5) (173.1) Investment in subsidiaries and joint ventures (10.6) (7.2) (2.4) Restricted cash withdrawals used to acquire timberlands 8.9 - - Net proceeds from disposition of property and investments 23.1 40.6 51.8 Other 2.9 (7.8) (1.4) ------------ ------------ ------------ Net cash used for investing activities (97.8) (138.9) (125.1) ------------ ------------ ------------ Cash flows from financing activities: Proceeds from issuance of long-term debt 875.5 30.1 371.8 Premium for early retirement of debt (45.5) - - Redemptions, repurchase of and principal payments on long-term debt (804.0) (78.4) (32.8) Net borrowings (payments) under revolving and short-term credit facilities 16.0 2.5 (13.8) Restricted cash withdrawals (deposits), net 7.3 (3.7) .4 Dividends paid to Kaiser's minority preferred stockholders - (4.2) (10.5) Redemption of preference stock (8.7) (2.1) (5.2) Treasury stock repurchases (35.1) (52.8) (1.8) Incurrence of deferred financing costs (23.4) (1.8) (12.1) Other .1 8.7 5.5 ------------ ------------ ------------ Net cash provided by (used for) financing activities (17.8) (101.7) 301.5 ------------ ------------ ------------ Net increase (decrease) in cash and cash equivalents 129.6 (172.0) 232.4 Cash and cash equivalents at beginning of year 164.6 336.6 104.2 ------------ ------------ ------------ Cash and cash equivalents at end of year $ 294.2 $ 164.6 $ 336.6 ============ ============ ============ The accompanying notes are an integral part of these financial statements.
MAXXAM INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIT (IN MILLION OF DOLLARS)
ACCUMULATED PREFERRED COMMON STOCK ADDI- ACCUMU- OTHER STOCK --------------------- TIONAL LATED COMPREHENSIVE ($.50 PAR) SHARES ($.50 PAR) CAPITAL DEFICIT INCOME ---------- ---------- ---------- ---------- ----------- --------------- Balance, December 31, 1995 $ .3 8.7 $ 5.0 $ 155.0 $ (208.5) $ (16.1) Net income - - - - 22.9 - Reduction of pension liability - - - - - 11.0 Comprehensive income Gain from issuance of Kaiser common stock - - - .9 - - Treasury stock repurchases - - - - - - ----------- ---------- ---------- ------------- ------------ --------------- Balance, December 31, 1996 .3 8.7 5.0 155.9 (185.6) (5.1) Net income - - - - 65.2 - Reduction of pension liability - - - - - 1.8 Comprehensive income Gain from issuance of Kaiser Aluminum Corporation common stock due to PRIDES conversion - - - 62.9 1.9 - Gain from other issuances of Kaiser Aluminum Corporation common stock - - - 1.1 - - Treasury stock repurchases - (1.7) - - - - Gain on settlement of share- holder litigation - - - 2.9 - - ----------- ---------- ---------- ------------- ------------ -------------- Balance, December 31, 1997 .3 7.0 5.0 222.8 (118.5) (3.3) Net loss - - - - (57.2) - Reduction of pension liability - - - - - 3.3 Comprehensive loss Balance, December 31, 1998 $ .3 7.0 $ 5.0 $ 222.8 $ (175.7) $ - ========== ========= ========== ============ ============ ============== TREASURY COMPREHENSIVE STOCK TOTAL INCOME --------------- ------------ ------------- Balance, December 31, 1995 $ (19.5) $ (83.8) Net income - 22.9 $ 22.9 Reduction of pension - 11.0 11.0 liability ------------- Comprehensive income $ 33.9 ============= Gain from issuance of Kaiser common stock - .9 Treasury stock repurchases (1.8) (1.8) --------------- ------------ Balance, December 31, 1996 (21.3) (50.8) Net income - 65.2 $ 65.2 Reduction of pension liability - 1.8 1.8 ------------- Comprehensive income $ 67.0 ============= Gain from issuance of Kaiser Aluminum Corporation common stock due to PRIDES conversion - 64.8 Gain from other issuances of Kaiser Aluminum Corporation common stock - 1.1 Treasury stock repurchases (87.9) (87.9) Gain on settlement of share- holder litigation - 2.9 -------------- ------------ Balance, December 31, 1997 (109.2) (2.9) Net loss - (57.2)$ (57.2) Reduction of pension liability - 3.3 3.3 ------------- Comprehensive loss $ (53.9) ============= Balance, December 31, 1998 $ (109.2) $ (56.8) ============== ============ The accompanying notes are an integral part of these financial statements.
MAXXAM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The Company The consolidated financial statements include the accounts of MAXXAM Inc. and its majority and wholly owned subsidiaries. All references to the "COMPANY" include MAXXAM Inc. and its majority owned and wholly owned subsidiaries, unless otherwise indicated or the context indicates otherwise. Intercompany balances and transactions have been eliminated. Investments in affiliates (20% to 50%-owned) are accounted for utilizing the equity method of accounting. Certain reclassifications have been made to prior years' financial statements to be consistent with the current year's presentation. The Company is a holding company and, as such, conducts substantially all of its operations through its subsidiaries. The Company operates in four principal industries: aluminum, through its majority owned subsidiary, Kaiser Aluminum Corporation ("KAISER," 63% owned as of December 31, 1998), an integrated aluminum producer; forest products, through MAXXAM Group Inc. ("MGI") and MGI's wholly owned subsidiaries, principally The Pacific Lumber Company ("PACIFIC LUMBER") and Britt Lumber Co., Inc. ("BRITT"); real estate investment and development, managed through its wholly owned subsidiary, MAXXAM Property Company, and racing operations through Sam Houston Race Park, Ltd. ("SHRP, LTD."), a Texas limited partnership, in which the Company owned a 98.2% interest as of December 31, 1998. In 1998 and 1997, the Company increased its ownership in SHRP, Ltd. to 98.2% from the 78.8% interest held during 1996. MAXXAM Group Holdings Inc. ("MGHI") owns 100% of MGI and is a wholly owned subsidiary of the Company. Description of the Company's Operations Kaiser operates in the aluminum industry through its wholly owned principal operating subsidiary, Kaiser Aluminum & Chemical Corporation ("KACC"). KACC operates in several principal aspects of the aluminum industry - the mining of bauxite (the major aluminum-bearing ore), the refining of bauxite into alumina (the intermediate material), the production of aluminum and the manufacture of fabricated and semi- fabricated aluminum products. KACC's production levels of alumina and primary aluminum exceed its internal processing needs, which allows it to be a major seller of alumina and primary aluminum in domestic and international markets. A substantial portion of the Company's consolidated assets, liabilities, revenues, results of operations and cash flows are attributable to Kaiser (see Note 14). Pacific Lumber operates 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. Britt manufactures redwood and cedar fencing and decking products from small diameter logs, a substantial portion of which are obtained from Pacific Lumber. Housing, construction and remodeling markets are the principal markets for the Company's lumber products. The Company, principally through its wholly owned subsidiaries, is also engaged in the business of residential and commercial real estate investment and development, primarily in Puerto Rico, Arizona and California. Racing operations are conducted through SHRP, Ltd. which owns and operates a Class 1, pari-mutuel horse racing facility in the greater Houston metropolitan area. 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) 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 12 could differ materially from current estimates. The results of an adverse resolution of such uncertainties could have a material effect on the Company's consolidated financial position, results of operations or liquidity. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Cash Equivalents Cash equivalents consist of highly liquid money market instruments with original maturities of three months or less. Marketable Securities Marketable securities, which consist of corporate bonds and long and short positions in corporate common stocks are carried at fair value. The cost of the securities sold is determined using the first-in, first-out method. Included in investment, interest and other income for each of the three years in the period ended December 31, 1998 were: 1998 - net unrealized holding losses of $3.8 million and net realized gains of $11.9 million; 1997 - net unrealized holding gains of $5.0 million and net realized gains of $11.9 million; and 1996 - net unrealized holding losses of $.8 million and net realized gains of $8.1 million. Inventories Inventories are stated at the lower of cost or market. Cost for the aluminum and forest products operations inventories is primarily determined using the last-in, first-out ("LIFO") method. Other inventories of the aluminum operations, principally operating supplies and repair and maintenance parts, are stated at the lower of average cost or market. Inventory costs consist of material, labor and manufacturing overhead, including depreciation and depletion. Inventories consist of the following (in millions):
DECEMBER 31, -------------------------- 1998 1997 ------------ ------------ Aluminum operations: Finished fabricated products $ 112.4 $ 103.9 Primary aluminum and work in process 205.6 226.6 Bauxite and alumina 109.5 108.4 Operating supplies and repair and maintenance parts 116.0 129.4 ------------- ------------- 543.5 568.3 ------------- ------------- Forest products operations: Lumber 36.0 49.7 Logs 8.0 11.6 ------------- ------------- 44.0 61.3 ------------- ------------- $ 587.5 $ 629.6 ============= =============
Property, Plant and Equipment Property, plant and equipment is stated at cost, net of accumulated depreciation. Depreciation is computed principally 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. Impairment is determined by measuring undiscounted future cash flows. If an impairment is present, the asset is reported at the lower of carrying value or fair value. 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. Deferred Financing Costs Costs incurred to obtain financing are deferred and amortized over the estimated term of the related borrowing. Restricted Cash At December 31, 1998, cash and cash equivalents includes $28.4 million, which is reserved 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"). At December 31, 1997, cash and cash equivalents includes $17.8 million, which was reserved for debt service payments on the Company's 7.95% Timber Collateralized Notes due 2015 (the "OLD TIMBER NOTES"). Long-term receivables and other assets include restricted cash in the amount of $17.5 million and $33.7 million at December 31, 1998 and December 31, 1997, respectively. The restricted cash 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 Pacific Company LLC ("SCOTIA LLC"), a limited liability company wholly owned by Pacific Lumber, to acquire timberlands. The restricted cash at December 31, 1997 primarily represents the amount held by the trustee in the liquidity account (the "LIQUIDITY ACCOUNT") maintained by Scotia Pacific Holding Company ("SCOTIA PACIFIC"), a wholly owned subsidiary of Pacific Lumber merged into Scotia LLC, with respect to the Old Timber Notes for the benefit of holders of the Old Timber Notes under the indenture governing the Old Timber Notes. Also included in cash and cash equivalents at December 31, 1998 and 1997 is restricted cash of $67.7 million and $26.4 million, respectively, held in an interest-bearing account as security for short positions in marketable securities. Concentrations of Credit Risk The amounts restricted for debt service payments on the Timber Notes held in an account by the trustee (the "PAYMENT ACCOUNT") and held in the Prefunding Account for purchase of timberlands are invested primarily in commercial paper and other short-term investments. The Company mitigates its concentration of credit risk with respect to these restricted cash deposits by purchasing only high grade investments (ratings of A1/P1 short-term or AAA/aaa long-term debt) having maturities of less than three months. No more than 10% is invested within the same issue. Investment, Interest and Other Income Investment, interest and other income for the years ended December 31, 1998, 1997 and 1996 includes $12.7 million, $8.8 million, and $3.1 million, respectively, of pre-tax charges related principally to establishing additional litigation reserves for asbestos claims net, of estimated insurance recoveries, pertaining to operations which were discontinued prior to the acquisition of Kaiser by the Company in 1988. Other income in 1998 includes $12.0 million attributable to insurance recoveries related to certain environmental costs incurred. Also included in investment, interest and other income are net gains from sales of real estate of $7.1 million, $10.4 million and $25.4 million for the years ended December 31, 1998, 1997 and 1996, respectively. Foreign Currency Translation The Company uses the United States dollar as the functional currency for its foreign operations. Derivative Financial Instruments Hedging transactions using derivative financial instruments are primarily designed to mitigate KACC's exposure to changes in prices for certain of the products which KACC sells and consumes and, to a lesser extent, to mitigate KACC's exposure to changes in foreign currency exchange rates. KACC does not utilize derivative financial instruments for trading or other speculative purposes. KACC's derivative activities are initiated within guidelines established by Kaiser's management and approved by KACC's and Kaiser's boards of directors. Hedging transactions are executed centrally on behalf of all of KACC's business segments to minimize transactions costs, monitor consolidated net exposures and allow for increased responsiveness to changes in market factors. Most of KACC's hedging activities involve the use of option contracts (which establish a maximum and/or minimum amount to be paid or received) and forward sales contracts (which effectively fix or lock-in the amount KACC will pay or receive). Option contracts typically require the payment of an up-front premium in return for the right to receive the amount (if any) by which the price at the settlement date exceeds the strike price. Any interim fluctuations in prices prior to the settlement date are deferred until the settlement date of the underlying hedged transaction, at which point they are reflected in net sales or cost of sales and operations (as applicable) together with the related premium cost. Forward sales contracts do not require an up-front payment and are settled by the receipt or payment of the amount by which the price at the settlement date varies from the contract price. No accounting recognition is accorded to interim fluctuations in prices of forward sales contracts. KACC has established margin accounts and credit limits with certain counterparties related to open forward sales and option contracts. When unrealized gains or losses are in excess of such credit limits, KACC is entitled to receive advances from the counterparties on open positions or is required to make margin deposits to counterparties as the case may be. At December 31, 1998, KACC had received $9.9 million of margin advances from counterparties. At December 31, 1997, KACC had neither received nor made any margin deposits. Kaiser considers credit risk related to possible failure of the counterparties to perform their obligations pursuant to the derivative contracts to be minimal. Deferred gains or losses are included in prepaid expenses and other current assets and other accrued liabilities. See Note 13. Fair Value of Financial Instruments The carrying amounts of cash equivalents and restricted cash approximate fair value. Marketable securities are carried at fair value which is determined based on quoted market prices. As of December 31, 1998 and 1997, the estimated fair value of long-term debt was $1,939.9 million and $2,010.6 million, respectively. The estimated fair value of long-term 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. Some of the Company's publicly traded debt issues are thinly traded financial instruments; accordingly, their market prices at any balance sheet date may not be representative of the prices which would be derived from a more active market. Stock-Based Compensation The Company applies the "intrinsic value" method described by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations to account for stock and stock- based compensation awards (see Note 11). In accordance with Statement of Financial Accounting Standards No. 123, "Accounting for Stock- Based Compensation," the Company calculated pro forma compensation cost for all stock options granted using the "fair value" method. The fair value of the stock options granted were estimated using the Black-Scholes option pricing model. The Company's pro forma income (loss) before extraordinary item and diluted earnings (loss) per share before extraordinary item would have been $(17.8) million and $(2.54) per share, respectively, for the year ended December 31, 1998, $64.0 million and $7.00 per share, respectively, for the year ended December 31, 1997, and $22.3 million and $2.36 per share, respectively, for the year ended December 31, 1996. Per Share Information Basic earnings (loss) per share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the period including the weighted average impact of the shares of common stock issued and treasury stock acquired during the year from the date of issuance or repurchase. The weighted average common shares outstanding was 7,000,663 shares, 8,357,062 shares and 8,700,269 shares for the years ended December 31, 1998, 1997 and 1996, respectively. Diluted earnings (loss) per share calculations also include the dilutive effect of the Class A Preferred Stock which is convertible into Common Stock as well as common and preferred stock options. The weighted average number of common and common equivalent shares was 7,812,377 shares, 9,143,920 shares and 9,465,051 shares for the years ended December 31, 1998, 1997 and 1996, respectively. The impact of outstanding convertible stock and stock options of 811,714 was excluded from the weighted average share calculation for the year ended December 31, 1998, as its effect would have been antidilutive. Labor Related Costs Kaiser is currently operating five of its United States facilities with salaried employees and other workers as a result of the September 30, 1998 strike by the United Steelworkers of America ("USWA") and the subsequent "lock-out" by Kaiser in January 1999. For purposes of computing the benefit related costs and liabilities to be reflected in the accompanying consolidated financial statements for the year ended December 31, 1998 (such as pension and other postretirement benefit costs/liabilities), Kaiser has based its accruals on the terms of the previously existing (expired) USWA contract. Any differences between the amounts accrued and the amounts ultimately agreed to during the collective bargaining process will be reflected in future results during the term of any new contract. All incremental operating costs incurred as a result of the USWA strike and subsequent lockout are being expensed as incurred. Such costs totaled approximately $50.0 million during 1998 (approximately $40.0 million of which were incurred in the fourth quarter). Kaiser's fourth quarter 1998 results also reflect reduced profitability of approximately $10.0 million resulting from the strike-related curtailment of three potlines (representing approximately 70,000 tons of annual capacity) at Kaiser's Mead and Tacoma, Washington, smelters and certain other shipment delays experienced at the other affected facilities at the outset of the USWA strike. 2. ACQUISITION During June 1997, Kaiser Bellwood Corporation, a wholly owned subsidiary of KACC, completed the acquisition of the Reynolds Metals Company's Richmond, Virginia, extrusion plant and its existing inventories for a total purchase price of $41.6 million, consisting of cash payments of $38.4 million and the assumption of approximately $3.2 million of employee related and other liabilities. Upon completion of the transaction, Kaiser Bellwood Corporation became a subsidiary guarantor under the indentures in respect of the KACC 9-7/8% Senior Notes, KACC 10-7/8% Senior Notes, and KACC 12-3/4% Senior Subordinated Notes (all as defined below). 3. RESTRUCTURING OF OPERATIONS During the second quarter of 1997, Kaiser recorded a $19.7 million restructuring charge to reflect actions taken and plans initiated to achieve reduced production costs, decreased corporate selling, general and administrative expenses, and enhanced product mix. The significant components of the restructuring charge were: (i) a net loss of approximately $1.4 million as a result of the contribution of certain net assets of KACC's Erie, Pennsylvania fabrication plant in connection with the formation of AKW L.P. ("AKW")(50% owned), an aluminum wheels joint venture formed with a third party in May 1997, and the subsequent decision to close the remainder of the Erie plant in order to consolidate its forging operations into two other facilities; (ii) a charge of $15.6 million associated with asset dispositions regarding product rationalization and geographical optimization, and (iii) a charge of approximately $2.7 million for benefit and other costs associated with the consolidation or elimination of certain corporate and other staff functions. 4. INVESTMENTS IN AND ADVANCES TO UNCONSOLIDATED AFFILIATES Summary combined financial information is provided below for unconsolidated aluminum investments, most of which supply and process raw materials. The investees are Queensland Alumina Limited ("QAL") (28.3% owned), Kaiser Jamaica Bauxite Company (49% owned) and Anglesey Aluminium Limited ("ANGLESEY") (49% owned). KACC provides some of its affiliates with services such as financing, management and engineering. Purchases from these affiliates for the acquisition and processing of bauxite, alumina and primary aluminum aggregated $235.1 million, $245.2 million and $281.6 million for the years ended December 31, 1998, 1997 and 1996, respectively. KACC's equity in earnings (loss) before income taxes of such operations is treated as a reduction (increase) in cost of sales. As of December 31, 1998 and 1997, KACC's net receivable from these affiliates was an immaterial amount. Kaiser, principally through KACC, has a variety of financial commitments, including purchase agreements, tolling arrangements, forward foreign exchange and forward sales contracts (see Note 13), letters of credit and guarantees. Such purchase agreements and tolling arrangements include long-term agreements for the purchase and tolling of bauxite into alumina in Australia by QAL. These obligations expire in 2008. Under the agreements, KACC is unconditionally obligated to pay its proportional share of debt, operating costs and certain other costs of QAL. The aggregate minimum amount of required future principal payments at December 31, 1998 is $97.6 million, of which approximately $12.0 million is due in each of 2000 and 2001 with the balance being due thereafter. KACC's share of payments, including operating costs and certain other expenses under the agreements, has ranged between $100.0 million and $120.0 million per year over the past three years. KACC also has agreements to supply alumina to and to purchase aluminum from Anglesey. The summary combined financial information for the year ended December 31, 1998 and 1997 also contains the balances and results of AKW. During early 1999, Kaiser signed a letter of intent to sell its interest in AKW. See Note 17 (in millions):
DECEMBER 31, --------------------------- 1998 1997 ------------- ------------- Current assets $ 356.0 $ 393.0 Long-term assets (primarily property, plant and equipment, net) 393.9 395.0 ------------- ------------- Total assets $ 749.9 $ 788.0 ============= ============= Current liabilities $ 92.2 $ 117.1 Long-term liabilities (primarily long-term debt) 396.6 400.8 Stockholders' equity 261.1 270.1 ------------- ------------- Total liabilities and stockholders' equity $ 749.9 $ 788.0 ============= =============
YEARS ENDED DECEMBER 31, ---------------------------------------- 1998 1997 1996 ------------ ------------ ------------ Net sales $ 659.2 $ 644.1 $ 660.5 Costs and expenses (651.7) (637.8) (631.5) Provision for income taxes (2.7) (8.2) (8.7) ------------ ------------ ------------ Net income (loss) $ 4.8 $ (1.9) $ 20.3 ============ ============ ============ Kaiser's equity in earnings $ 5.4 $ 2.9 $ 8.8 ============ ============ ============ Dividends received $ 5.5 $ 10.7 $ 11.8 ============ ============ ============
Kaiser's equity in earnings differs from the summary net income (loss) due to various percentage ownerships in the entities and equity method accounting adjustments. At December 31, 1998, Kaiser's investment in its unconsolidated affiliates exceeded its equity in their net assets by approximately $18.2 million which amount will be fully amortized over the next two years. Amortization of the excess investment totaling $10.0 million, $11.4 million, and $11.6 million is included in depreciation, depletion and amortization for the years ended December 31, 1998, 1997 and 1996, respectively. Other Investees In 1995, pursuant to a joint venture agreement with SunCor Development Company ("SUNCOR") for the purpose of developing, managing and selling a real estate project, the Company, through a wholly owned real estate subsidiary, contributed 950 acres of undeveloped land valued at $10.0 million in exchange for a 50% initial interest in the joint venture. SunCor, the managing partner, contributed $10.0 million in cash in exchange for its 50% initial interest. At December 31, 1998, the joint venture had assets of $28.0 million, liabilities of $8.7 million and equity of $19.3 million. At December 31, 1997, the joint venture had assets of $32.9 million, liabilities of $10.5 million and equity of $22.4 million. For the years ended December 31, 1998, 1997 and 1996, the joint venture had income of $3.8 million, $3.8 million and $2.3 million, respectively. In October 1998, pursuant to a joint agreement with Westbrook Firerock LLC ("WESTBROOK") for the purpose of developing, managing and selling a real estate project, the Company, through a wholly owned real estate subsidiary, contributed 808 acres of undeveloped land having an agreed upon value of $11.0 million in exchange for a 50% initial interest in the joint venture. Westbrook contributed $5.5 million in cash and an obligation to fund an additional $5.5 million as needed by the joint venture, which is secured by an irrevocable letter of credit. At December 31, 1998, the joint venture had assets of $17.6 million, liabilities of $1.1 million and equity of $16.5 million. For the year ended December 31, 1998, the joint venture's income was not significant. 5. PROPERTY, PLANT AND EQUIPMENT The major classes of property, plant and equipment are as follows (in millions):
ESTIMATED DECEMBER 31, USEFUL -------------------------- LIVES 1998 1997 ------------- ------------ ------------ Land and improvements 5 - 30 years $ 225.9 $ 206.1 Buildings 5 - 45 years 328.0 324.5 Machinery and equipment 3 - 22 years 1,595.8 1,568.8 Construction in progress 50.7 67.1 ------------ ------------ 2,200.4 2,166.5 Less: accumulated depreciation (921.5) (845.6) ------------ ------------ $ 1,278.9 $ 1,320.9 ============ ============
Depreciation expense for the years ended December 31, 1998, 1997 and 1996 was $97.7 million, $99.9 million and $105.9 million, respectively. During the fourth quarter of 1998, KACC decided to seek a strategic partner for further development and deployment of its Micromill(TM) technology. While technological progress has been good, management concluded that additional time and investment will be required to achieve commercial success. Given Kaiser's other strategic priorities, Kaiser believes that bringing in added commercial and financial resources is the appropriate course of action for capturing the maximum long-term value. This change in strategic course required a different accounting treatment, and Kaiser correspondingly recorded a $45.0 million impairment charge to reduce the carrying value of the Micromill assets to approximately $25.0 million. 6. SHORT-TERM BORROWINGS During 1998 and 1997, the Company had average short-term borrowings outstanding of $18.6 million and $9.0 million, respectively, under the debt instruments described below. The weighted average interest rate during 1998 and 1997 was 9.1% and 9.8%, respectively. MAXXAM Loan Agreement (the "CUSTODIAL TRUST AGREEMENT") On October 19, 1998, the Company drew down $16.0 million, the amount available as of such date, under the Custodial Trust Agreement which provided for up to $25.0 million in borrowings. The borrowing converted to a term loan bearing interest at LIBOR plus 2% per annum and maturing on October 21, 1999 as provided under the terms of the agreement. The loan is secured by 7,915,000 shares of Kaiser common stock. Demand Note On November 26, 1997, the Company entered into a credit facility with an investment bank providing for up to $25.0 million in borrowings payable on demand. Borrowings are secured by 400,000 shares of Kaiser common stock for each $1.0 million of borrowings. As of December 31, 1998, $2.5 million of borrowings were outstanding under this facility. No additional borrowings were available under this facility as of December 31, 1998 as the per share market price for the Kaiser common stock was below the $8.50 minimum required by the facility. Notes to NL Industries, Inc. ("NL") and the Combined Master Retirement Trust ("CMRT") On May 14, 1998, the Company repaid the $35.1 million 10% one- year notes issued to NL and CMRT in connection with the October 1997 repurchase of 1,277,250 shares of the Company's common stock. 7. LONG-TERM DEBT Long-term debt consists of the following (in millions):
DECEMBER 31, -------------------------- 1998 1997 ------------ ------------ 12% MGHI Senior Secured Notes due August 1, 2003 $ 130.0 $ 130.0 11-1/4% MGI Senior Secured Notes due August 1, 2003 - 100.0 12-1/4% MGI Senior Secured Discount Notes due August 1, 2003, - 117.3 net of discount 10-1/2% Pacific Lumber Senior Notes due March 1, 2003 - 235.0 Pacific Lumber Credit Agreement - 9.4 7.43% Scotia LLC Timber Collateralized Notes due July 20, 2028 867.2 - 7.95% Scotia Pacific Timber Collateralized Notes due July 20, 2015 - 320.0 1994 KACC Credit Agreement - - 10-7/8% KACC Senior Notes due October 15, 2006, including premium 225.7 225.8 9-7/8% KACC Senior Notes due February 15, 2002, net of discount 224.4 224.2 12-3/4% KACC Senior Subordinated Notes due February 1, 2003 400.0 400.0 Alpart CARIFA Loans 60.0 60.0 Other aluminum operations debt 52.9 61.6 Other notes and contracts, primarily secured by receivables, buildings, real estate and equipment 30.0 36.1 ------------ ------------ 1,990.2 1,919.4 Less: current maturities (18.5) (31.4) ------------ ------------ $ 1,971.7 $ 1,888.0 ============ ============
12% MGHI Senior Secured Notes due 2003 (the "MGHI NOTES") The MGHI Notes due August 1, 2003 are guaranteed on a senior, unsecured basis by the Company. The common stock of MGI serves as security for the MGHI Notes. Interest is payable semi-annually. In connection with the redemption of the 11-1/4% MGI Senior Secured Notes due 2003 and 12-1/4% MGI Senior Secured Discount Notes due 2003 (collectively, the "MGI NOTES") and the issuance of the Timber Notes (discussed below), MGHI amended the indenture for the MGHI Notes, to among other things, pledge all of the 27,938,250 shares of Kaiser common stock it owns, 16,055,000 shares of which were released from the pledge securing the MGI Notes. The net proceeds from the offering of the MGHI Notes after estimated expenses were approximately $125.0 million, all of which was loaned to the Company pursuant to an intercompany note (the "INTERCOMPANY NOTE") which is pledged to secure the MGHI Notes. The Intercompany Note bears interest at the rate of 11% per annum (payable semi-annually on the interest payment dates applicable to the MGHI Notes) and matures on August 1, 2003. The Company is entitled to defer the payment of interest on the Intercompany Note on any interest payment date to the extent that MGHI has sufficient available funds to satisfy its obligations on the MGHI Notes on such date. Any such deferred interest will be added to the principal amount of the Intercompany Note and will be payable at maturity. Interest deferred on the Intercompany Note as of December 31, 1998 amounted to $7.8 million. An additional $7.3 million of interest was deferred on February 1, 1999. Pacific Lumber Credit Agreement On December 18, 1998, the Pacific Lumber Credit Agreement was amended and restated as a new three-year senior secured credit facility which expires on October 31, 2001. The new facility allows for borrowings of up to $60 million, all of which may be used for revolving borrowings, $20 million of which may be used for standby letters of credit and $30 million of which may be used for timberland acquisitions. Borrowings would be secured by all of Pacific Lumber's domestic accounts receivable and inventory. Borrowings for timberland acquisitions would also be secured by the acquired timberlands and, commencing in April 2001, are to be repaid annually from 50% of Pacific Lumber's 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. As of December 31, 1998, $27.5 million of borrowings was available under the agreement, no borrowings were outstanding and letters of credit outstanding amounted to $14.4 million. Scotia LLC Timber Collateralized Notes due 2028 On July 20, 1998, Scotia LLC issued $867.2 million aggregate principal amount of Timber Notes which have an overall effective interest rate of 7.43% per annum. Net proceeds from the offering of the Timber Notes were used primarily to prepay the Old Timber Notes and to redeem the 10-1/2% Pacific Lumber Senior Notes due 2003 ("PACIFIC LUMBER SENIOR NOTES") and the MGI Notes effective August 19, 1998. The Company recognized an extraordinary loss of $42.5 million, net of the related income tax benefit of $22.9 million, in 1998 for the early extinguishment of the Old Timber Notes, the Pacific Lumber Senior Notes and the MGI Notes. Concurrently with the issuance of the Timber Notes, (i) Scotia Pacific was merged into Scotia LLC, (ii) Pacific Lumber transferred to Scotia LLC approximately 13,500 acres of timberlands and the timber and timber harvesting rights with respect to an additional 19,700 acres of timberlands, and (iii) Scotia LLC transferred to Pacific Lumber the timber and timber harvesting rights related to approximately 1,400 acres of timberlands. Under the Timber Notes Indenture, the business activities of Scotia LLC are generally limited to the ownership and operation of its timber and timberlands. The Timber Notes are senior secured obligations of Scotia LLC and are not obligations of, or guaranteed by, Pacific Lumber or any other person. The Timber Notes are secured by a lien on (i) Scotia LLC's timber and timberlands (representing $252.0 million of the Company's consolidated timber and timberlands balance at December 31, 1998), and (ii) substantially all of Scotia LLC's other property. Interest on the Timber Notes is further secured by a line of credit agreement between Scotia LLC and a bank pursuant to which Scotia LLC may borrow to pay interest on the Timber Notes. 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 $160.7 million of Class A-1 Timber Notes). The Timber Notes are 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 in order to avoid an Event of Default 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. Principal and interest on the Timber Notes are payable semi- annually on January 20 and July 20. The Timber Notes are redeemable at the option of Scotia LLC at any time. The redemption price of the Timber Notes is equal to the sum of the principal amount, accrued interest and a prepayment premium calculated based upon the yield of like term Treasury securities plus 50 basis points. As a result of the sale of approximately 5,600 acres of Pacific Lumber's timberlands consisting of two forest groves commonly referred to as the Headwater Forest and Elk Head Springs Forest (the "HEADWATERS TIMBERLANDS") on March 1, 1999, Salmon Creek received proceeds of $299.9 million in cash. See Note 12 to the Consolidated Financial Statements. Salmon Creek has deposited approximately $285.0 million of such proceeds into an escrow account (the "ESCROWED FUNDS"), pursuant to an escrow agreement (the "ESCROW AGREEMENT") as necessary to support the Timber Notes. The net proceeds of the sale of the Grizzly Creek grove will also be placed in escrow (on the same basis as the net proceeds of the sale of the Headwaters Timberlands) unless, at the time of receipt of such proceeds, funds are no longer on deposit under the Escrow Agreement. Under the Escrow Agreement, the Escrowed Funds will be released by the Escrow Agent only in accordance with resolutions duly adopted by the Board of Managers of Scotia LLC and, unless the resolutions authorize the payment of funds exclusively to, or to the order of, the Trustee or the Collateral Agent under the Timber Notes Indenture, only if one or more of the following conditions are satisfied: (a) the resolutions authorizing the release of the Escrowed Funds are adopted by a majority of the Board of Managers of Scotia LLC (including the affirmative vote of the two independent managers); (b) a Rating Agency Confirmation (as defined in the Timber Notes Indenture) has been received that gives effect to the release or disposition of funds directed by the resolutions; or (c) Scotia LLC has received an opinion from a nationally recognized investment banking firm to the effect that, based on the revised harvest schedule and the other assumptions provided to such firm, the funds that would be available to Scotia LLC based on such harvest schedule, assumptions and otherwise under the Timber Notes Indenture after giving effect to the release or disposition of funds directed by such resolutions would be adequate (i) to pay Scheduled Amortization (as defined in the Timber Notes Indenture) on the Class A-1 and Class A-2 Timber Notes and (ii) to amortize the Class A-3 Timber Notes on a schedule consistent with the original harvest schedule as of July 9, 1998 (assuming that the Class A-3 Timber Notes are not refinanced on January 20, 2014). 1994 KACC Credit Agreement (as amended, the "KACC CREDIT AGREEMENT") KACC is able to borrow under this facility through August 2001 by means of revolving credit advances and letters of credit (up to $125.0 million) in an aggregate amount equal to the lesser of $325.0 million or a borrowing base relating to eligible accounts receivable plus eligible inventory. As of February 28, 1999, $274.1 million (of which $74.1 million could have been used for letters of credit) was available under the KACC Credit Agreement. The KACC Credit Agreement is unconditionally guaranteed by Kaiser and by certain significant subsidiaries of KACC. Outstanding balances bear interest at a premium (which varies based on the results of a financial test) over either a base rate or LIBOR, at KACC's option. The KACC Credit Agreement requires KACC to comply with certain financial covenants and places restrictions on Kaiser's and KACC's ability to, among other things, incur debt and liens, make investments, pay dividends, undertake transactions with affiliates, make capital expenditures and enter into unrelated lines of business. The KACC Credit Agreement is secured by, among other things, (i) mortgages on KACC's major domestic plants (excluding KACC's Gramercy alumina plant and Micromill facility), (ii) subject to certain exceptions, liens on the accounts receivable, inventory, equipment, domestic patents and trademarks and substantially all other personal property of KACC and certain of its subsidiaries, (iii) a pledge of all of the stock of KACC owned by Kaiser, and (iv) pledges of all of the stock of a number of KACC's wholly owned domestic subsidiaries, pledges of a portion of the stock of certain foreign subsidiaries and pledges of a portion of the stock of certain partially owned foreign affiliates. 10-7/8 % KACC Senior Notes due 2006 (the "KACC 10-7/8 % SENIOR NOTES"), 9-7/8 % KACC Senior Notes due 2002 (the "KACC 9-7/8 % SENIOR NOTES") and 12-3/4 % KACC Senior Subordinated Notes due 2003 (the "KACC SENIOR SUBORDINATED NOTES" and collectively, the "KACC NOTES") The KACC Notes, are guaranteed, jointly and severally, by certain subsidiaries of KACC. The indentures governing the KACC Notes, (the "KACC INDENTURES") restrict, among other things, KACC's ability to incur debt, undertake transactions with affiliates, and pay dividends. Furthermore, the KACC Indentures provide that KACC must offer to purchase the KACC Notes upon the occurrence of a Change of Control (as defined therein). Under the most restrictive of the covenants in the KACC Indentures and the KACC Credit Agreement, neither Kaiser nor KACC currently is permitted to pay dividends on their common stock. Alpart CARIFA Loans In December 1991, Alumina Partners of Jamaica ("ALPART", a majority owned subsidiary of KACC) entered into a loan agreement with the Caribbean Basin Projects Financing Authority ("CARIFA"). Alpart's obligations under the loan agreement are secured by two letters of credit aggregating $64.2 million. KACC is a party to one of the two letters of credit in the amount of $41.7 million in respect of its ownership interest in Alpart. Alpart has also agreed to indemnify bondholders of CARIFA for certain tax payments that could result from events, as defined, that adversely affect the tax treatment of the interest income on the bonds. Maturities Scheduled maturities and redemptions of long-term debt outstanding at December 31, 1998 are as follows (in millions):
YEARS ENDING DECEMBER 31, ----------------------------------------------------------------------------------- 1999 2000 2001 2002 2003 Thereafter ------------ ------------- ------------- ------------- ------------- ------------- 12% MGHI Senior Secured Notes $ - $ - $ - $ - $ 130.0 $ - 7.43% Scotia LLC Timber Collateralized Notes 8.2 15.9 16.3 17.1 19.3 790.4 10-7/8% KACC Senior Notes - - - - - 225.7 9-7/8% KACC Senior Notes - - - 224.4 - - 12-3/4% KACC Senior Subordinated Notes - - - - 400.0 - Alpart CARIFA Loans - - - - - 60.0 Other aluminum operations debt 0.4 0.3 0.3 0.3 0.3 51.3 Other 9.9 3.8 3.6 1.2 1.1 10.4 ------------ ------------- ------------- ------------- ------------- ------------- $ 18.5 $ 20.0 $ 20.2 $ 243.0 $ 550.7 $ 1,137.8 ============ ============= ============= ============= ============= =============
Capitalized Interest Interest capitalized during the years ended December 31, 1998, 1997 and 1996 was $3.5 million, $7.2 million and $5.0 million, respectively. Restricted Net Assets of Subsidiaries and Pledges of Subsidiary Stock Certain debt instruments restrict the ability of the Company's subsidiaries to transfer assets, make loans and advances and pay dividends to the Company. As of December 31, 1998, all of the assets relating to the Company's aluminum, forest products, real estate and other operations are subject to such restrictions. The Company could eliminate all of such restrictions with respect to approximately $194.6 million of the Company's real estate assets with the extinguishment of $27.4 million of debt. The Company and MGHI have pledged a total of 36,853,250 shares of Kaiser common stock (representing a 47% interest in Kaiser) under various indentures and loan agreements. 8. 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. Income (loss) before income taxes, minority interests and extraordinary item by geographic area is as follows (in millions):
YEARS ENDED DECEMBER 31, ---------------------------------------- 1998 1997 1996 ------------ ------------ ------------ Domestic $ (118.7) $ (93.0) $ (55.0) Foreign 72.1 167.5 42.9 ------------ ------------ ------------ $ (46.6) $ 74.5 $ (12.1) ============ ============ ============
Income taxes are classified as either domestic or foreign based on whether payment is made or due to the United States or a foreign country. Certain income classified as foreign is subject to domestic income taxes. The credit (provision) for income taxes on income (loss) before income taxes, minority interests and extraordinary item consists of the following (in millions):
YEARS ENDED DECEMBER 31, ---------------------------------------- 1998 1997 1996 ------------ ------------ ------------ Current: Federal $ (1.8) $ (1.5) $ (1.5) State and local (.4) (.4) (.5) Foreign (16.5) (28.7) (21.8) ------------ ------------ ------------ (18.7) (30.6) (23.8) ------------ ------------ ------------ Deferred: Federal 54.9 48.4 42.6 State and local 8.4 (3.9) 18.5 Foreign (12.5) (7.0) 7.6 ------------ ------------ ------------ 50.8 37.5 68.7 ------------ ------------ ------------ $ 32.1 $ 6.9 $ 44.9 ============ ============ ============
A reconciliation between the credit for income taxes and the amount computed by applying the federal statutory income tax rate to income (loss) before income taxes, minority interests and extraordinary item is as follows (in millions):
YEARS ENDED DECEMBER 31, ---------------------------------------- 1998 1997 1996 ------------ ------------ ------------ Income (loss) before income taxes, minority interests and extraordinary item $ (46.6) $ 74.5 $ (12.1) ============ ============ ============ Amount of federal income tax credit (provision) based upon the statutory rate $ 16.3 $ (26.1) $ 4.2 Revision of prior years' tax estimates and other changes in valuation allowances 14.5 33.8 41.2 Percentage depletion 3.2 4.2 3.9 Foreign taxes, net of federal tax benefit (1.9) (3.1) (5.5) State and local taxes, net of federal tax effect (.6) (2.8) 1.1 Other .6 .9 - ------------ ------------ ------------ $ 32.1 $ 6.9 $ 44.9 ============ ============ ============
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 revisions 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 years ended December 31, 1998, 1997 and 1996, the reversal of reserves which the Company believes are no longer necessary resulted in a credit to the income tax provision of $11.5 million, $32.1 million and $40.8 million, respectively. The components of the Company's net deferred income tax assets (liabilities) are as follows (in millions):
DECEMBER 31, -------------------------- 1998 1997 ------------ ------------ Deferred income tax assets: Postretirement benefits other than pensions $ 284.0 $ 293.1 Loss and credit carryforwards 199.1 148.3 Other liabilities 174.6 219.6 Costs capitalized only for tax purposes 62.8 45.2 Real estate 41.8 48.1 Timber and timberlands 37.4 34.2 Other 89.0 82.5 Valuation allowances (123.1) (126.4) ------------ ------------ Total deferred income tax assets, net 765.6 744.6 ------------ ------------ Deferred income tax liabilities: Property, plant and equipment (116.0) (145.6) Other (84.8) (95.1) ------------ ------------ Total deferred income tax liabilities (200.8) (240.7) ------------ ------------ Net deferred income tax assets $ 564.8 $ 503.9 ============ ============
As of December 31, 1998, approximately $378.2 million of the net deferred income tax assets listed above are attributable to Kaiser. A principal component of this amount is the $249.6 million tax benefit, net of certain valuation allowances, associated with the accrual for postretirement benefits other than pensions. The future tax deductions with respect to the turnaround of this accrual will occur over a thirty to forty-year period. If such deductions create or increase a net operating loss, Kaiser has the ability to carry forward such loss for 20 taxable years. For reasons discussed below, the Company believes a long-term view of profitability is appropriate and has concluded that this net deferred income tax asset will more likely than not be realized. Included in the remaining $128.6 million of Kaiser's net deferred income tax assets is approximately $55.0 million attributable to the tax benefit of loss and credit carryforwards, net of valuation allowances. A substantial portion of the valuation allowances for Kaiser relate to loss and credit carryforwards. The Company evaluated all appropriate factors to determine the proper valuation allowances for these carryforwards, including any limitations concerning their use, the year the carryforwards expire and the levels of taxable income necessary for utilization. For example, full valuation allowances were provided for certain credit carryforwards that expire in the near term. With regard to future levels of income, the Company believes that Kaiser, based on the cyclical nature of its business, its history of operating earnings and its expectations for future years, 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. The net deferred income tax assets listed above which are not attributable to Kaiser are approximately $186.6 million as of December 31, 1998. This amount includes approximately $100.8 million attributable to the tax benefit of loss and credit carryforwards, net of valuation allowances. Based on an evaluation of the appropriate factors, as discussed above, to determine the proper valuation allowances for these carryforwards, the Company believes that it is more likely than not that it will realize the benefit for these carryforwards for which valuation allowances were not provided. Also included is approximately $70.3 million which relates to the excess of the tax basis over financial statement basis with respect to timber and timberlands and real estate. The Company has concluded that it is more likely than not that these net deferred income tax assets will be realized based in part upon the estimated values of the underlying assets which are in excess of their tax basis. As of December 31, 1998 and 1997, $56.6 million and $58.8 million, respectively, of the net deferred income tax assets listed above are included in prepaid expenses and other current assets. Certain other portions of the deferred income tax liabilities listed above are included in other accrued liabilities and other noncurrent liabilities. The Company files consolidated federal income tax returns together with its domestic subsidiaries, other than Kaiser and its subsidiaries. Kaiser and its domestic subsidiaries are members of a separate consolidated return group which files its own consolidated federal income tax returns. The following table presents the tax attributes for federal income tax purposes at December 31, 1998 attributable to the Company and Kaiser (in millions). The utilization of certain of these tax attributes is subject to limitations.
THE COMPANY KAISER -------------------------- --------------------------- EXPIRING EXPIRING THROUGH THROUGH ------------ ------------- Regular Tax Attribute Carryforwards: Current year net operating loss $ 160.3 2018 $ - - Prior year net operating losses 106.6 2012 28.2 2012 General business tax credits .5 2002 4.9 2011 Foreign tax credits - - 48.4 2003 Alternative minimum tax credits 1.8 Indefinite 23.4 Indefinite Alternative Minimum Tax Attribute Carryforwards: Current year net operating loss $ 165.4 2018 $ - - Prior year net operating losses 118.1 2012 6.2 2011 Foreign tax credits - - 87.2 2003
The income tax provisions related to other comprehensive income were $0.6 million and $6.5 million for the years ended December 31, 1997 and 1996, respectively. There was no tax provision related to other comprehensive income for the year ended December 31, 1998. 9. EMPLOYEE BENEFIT AND INCENTIVE PLANS In the fourth quarter of 1998, the Company adopted Statement of Financial Accounting Standards No. 132, "Employers' Disclosures About Pension and Other Postretirement Benefits" ("SFAS NO. 132"), which amends Statements of Financial Accounting Standards Nos. 87, 88 and 106. SFAS No. 132, among other things, standardizes the disclosure requirements for pensions and other postretirement benefits and suggests combined formats for presentation of such disclosures, but has no impact on the computation of the reported amounts. Prior year disclosures have been revised to comply with SFAS No. 132. Pension and Other Postretirement Benefit Plans The Company has various retirement plans which cover essentially all employees. Most of the Company's employees are covered by defined benefit plans. The benefits are determined under formulas based on the employee's years of service, age and compensation. The Company's funding policy is to contribute annually an amount at least equal to the minimum cash contribution required by ERISA. The Company has unfunded postretirement medical benefit plans which cover most of its employees. Under the plans, employees are eligible for health care benefits (and life insurance benefits for Kaiser employees) upon retirement. Retirees from companies other than Kaiser 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. Postretirement medical benefits are generally provided through a self insured arrangement. The Company has not funded the liability for these benefits, which are expected to be paid out of cash generated by operations. The following tables present the changes, status and assumptions of the Company's pension and other postretirement benefit plans as of December 31, 1998 and 1997, respectively (in millions):
PENSION BENEFITS MEDICAL/LIFE BENEFITS -------------------------- -------------------------- YEARS ENDED DECEMBER 31, ------------------------------------------------------ 1998 1997 1998 1997 ------------ ------------ ------------ ------------ Change in benefit obligation: Benefit obligation at beginning of year $ 918.0 $ 854.7 $ 551.7 $ 610.9 Service cost 16.8 15.8 4.6 6.5 Interest cost 63.1 64.6 37.9 45.3 Plan participants' contributions - - .3 .3 Plan amendments - .9 - - Actuarial (gain) loss 17.3 66.9 70.9 (67.7) Currency exchange rate change (.4) (6.0) - - Curtailments and settlements (4.6) - 4.0 - Benefits paid (85.7) (78.9) (45.9) (43.6) ------------ ------------ ------------ ------------ Benefit obligation at end of year 924.5 918.0 623.5 551.7 ------------ ------------ ------------ ------------ Change in plan assets: Fair value of plan assets at beginning of year 799.3 698.1 - - Actual return on assets 112.5 138.5 - - Settlements (5.5) - - - Employer contributions 29.5 41.7 45.6 43.3 Plan participants' contributions - - .3 .3 Benefits paid (85.7) (78.9) (45.9) (43.6) ------------ ------------ ------------ ------------ Fair value of plan assets at end of year 850.1 799.4 - - ------------ ------------ ------------ ------------ Benefit obligation in excess of plan assets 74.4 118.6 623.5 551.7 Unrecognized actuarial gain 31.7 7.2 59.2 137.4 Unrecognized prior service costs (19.7) (23.5) 70.0 86.3 Intangible asset and other 4.3 5.4 - - ------------ ------------ ------------ ------------ Accrued benefit liability $ 90.7 $ 107.7 $ 752.7 $ 775.4 ============ ============ ============ ============
With respect to Kaiser's pension plans, the benefit obligation was $872.5 million and $873.0 million as of December 31, 1998 and 1997, respectively. This obligation exceeded Kaiser's fair value of plan assets by $70.7 million and $116.1 million as of December 31, 1998 and 1997, respectively. The postretirement medical/life benefit obligation attributable to Kaiser's plans was $616.8 million and $544.5 million as of December 31, 1998 and 1997, respectively. The postretirement medical/life benefit liability recognized in the Company's Consolidated Balance Sheet attributable to Kaiser's plans was $742.5 million and $765.6 million as of December 31, 1998 and 1997, respectively.
PENSION BENEFITS MEDICAL/LIFE BENEFITS ----------------------------------------- ---------------------------------------- YEAR ENDED DECEMBER 31, ----------------------------------------------------------------------------------- 1998 1997 1996 1998 1997 1996 ------------- ------------ ------------ ------------ ------------ ------------ Components of net periodic benefit costs: Service cost $ 16.8 $ 15.8 $ 15.7 $ 4.6 $ 6.5 $ 4.3 Interest cost 63.1 64.6 62.8 37.9 45.3 47.5 Expected return on assets (72.3) (64.3) (57.2) - - - Amortization of prior service costs 3.3 3.4 3.6 (12.5) (12.5) (12.5) Recognized net actuarial (gain) loss 1.4 2.6 2.0 (7.2) (.9) - ------------- ------------ ------------ ------------ ------------ ------------ Net periodic benefit costs 12.3 22.1 26.9 22.8 38.4 39.3 Curtailments and settlements 3.2 3.7 1.4 - - - ------------- ------------ ------------ ------------ ------------ ------------ Adjusted net periodic benefit costs $ 15.5 $ 25.8 $ 28.3 $ 22.8 $ 38.4 $ 39.3 ============= ============ ============ ============ ============ ============
The net periodic pension costs attributable to Kaiser's plans was $9.1 million, $19.2 million and $23.4 million for the years ended December 31, 1998, 1997 and 1996, respectively. Included in the net periodic postretirement medical/life benefit cost is $22.2 million, $37.6 million and $38.3 million for the years ended December 31, 1998, 1997 and 1996, respectively, attributable to Kaiser's plans. The aggregate fair value of plan assets and accumulated benefit obligation for pension plans with plan assets in excess of accumulated benefit obligations were $311.4 million and $298.3 million, respectively, as of December 31, 1998 and $304.4 million and $299.4 million, respectively, as of December 31, 1997.
PENSION BENEFITS MEDICAL/LIFE BENEFITS ----------------------------------------- ---------------------------------------- YEAR ENDED DECEMBER 31, ----------------------------------------------------------------------------------- 1998 1997 1996 1998 1997 1996 ------------- ------------ ------------ ------------ ------------ ------------ Weighted-average assumptions: Discount rate 7.0% 7.3% 7.8% 7.0% 7.3% 7.8% Expected return on plan assets 9.5% 9.5% 9.5% - - - Rate of compensation increase 5.0% 5.0% 5.0% 4.0% 5.0% 5.0%
In 1998, annual assumed rates of increase in the per capita cost of covered benefits (i.e. health care cost trend rate) for non-HMO and HMO participants are 6.5% and 5.0%, respectively, at all ages. The assumed rate of increase for non-HMO participants is assumed to decline gradually to 5.0% in 2003 and remain at that level thereafter. 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, 1998 would have the following effects (in millions):
1-PERCENTAGE- 1-PERCENTAGE- POINT POINT INCREASE DECREASE ------------ ------------ Effect on total of service and interest cost components $ 6.0 $ (4.4) Effect on the postretirement benefit obligations 65.3 (46.2)
Savings and Incentive Plans The Company has various defined contribution savings plans designed to enhance the existing retirement programs of participating employees. Under the MAXXAM Inc. Savings Plan, employees may elect to defer up to 16% of their base compensation to the plan. For those participants who have elected to defer a portion of their compensation, the Company's matching contributions are dollar for dollar up to 4% of the participant's contributions for each pay period. Under the Kaiser Aluminum Savings and Retirement Plan, salaried employees may elect to defer from 2% to 18% of their compensation to the plan. For those eligible participants who have elected to make contributions to the plan, Kaiser's contributions consist of matching 25% to 100% of contributions of up to 10% of their compensation. Kaiser has an unfunded incentive compensation program which provides incentive compensation based upon performance against annual plans and over rolling three-year periods. Expenses incurred by the Company for all of these plans were $9.3 million, $10.4 million and $(.1) million for the years ended December 31, 1998, 1997 and 1996, respectively. 10. MINORITY INTERESTS Minority interests represent the following (in millions):
DECEMBER 31, -------------------------- 1998 1997 ------------ ------------ Kaiser Aluminum Corporation: Common stock, par $.01 $ 44.8 $ 42.9 Minority interests attributable to Kaiser's subsidiaries 123.5 127.7 ------------ ------------ $ 168.3 $ 170.6 ============ ============
Conversion of PRIDES to Kaiser Common Stock During August 1997, the 8,673,850 outstanding shares of Kaiser's 8.255% PRIDES, Convertible Preferred Stock ("PRIDES") were converted into 7,227,848 shares of Kaiser common stock pursuant to the terms of the PRIDES Certificate of Designations. Further, in accordance with the PRIDES Certificate of Designations no dividends were paid or payable for the period June 30, 1997, to, but not including, the date of conversion. As a result of the equity attributable to the PRIDES being converted into equity attributable to common stockholders, the Company recorded a $64.8 million adjustment to stockholders' equity and a reduction in minority interest of the same amount. KACC Redeemable Preference Stock In 1985, KACC issued its Cumulative (1985 Series A) Preference Stock and its Cumulative (1985 Series B) Preference Stock (together, the "REDEEMABLE PREFERENCE STOCK") each of which has a par value of $1 per share and a liquidation and redemption value of $50 per share plus accrued dividends, if any, and have a total redemption value of $21.1 million as of December 31, 1998. No additional Redeemable Preference Stock is expected to be issued. Holders of the Redeemable Preference Stock are entitled to an annual cash dividend of $5 per share, or an amount based on a formula tied to KACC's pre-tax income from aluminum operations when and as declared by KACC's board of directors. The carrying values of the Redeemable Preference Stock are increased each year to recognize accretion between the fair value (at which the Redeemable Preference Stock was originally issued) and the redemption value. Changes in Redeemable Preference Stock are shown below.
YEARS ENDED DECEMBER 31, ---------------------------------------- 1998 1997 1996 ------------ ------------ ------------ Shares: Outstanding at beginning of year 595,053 634,684 737,363 Redeemed (173,478) (39,631) (102,679) ------------ ------------ ------------ Outstanding at end of year 421,575 595,053 634,684 ============ ============ ============
Redemption fund agreements require KACC to make annual payments by March 31 of the subsequent year based on a formula tied to KACC's consolidated net income until the redemption funds are sufficient to redeem all of the Redeemable Preference Stock. On an annual basis, the minimum payment is $4.3 million and the maximum payment is $7.3 million. KACC also has certain additional repurchase requirements which are based, among other things, upon profitability tests. The Redeemable Preference Stock is entitled to the same voting rights as KACC common stock and to certain additional voting rights under certain circumstances, including the right to elect, along with other KACC preference stockholders, two directors whenever accrued dividends have not been paid on two annual dividend payment dates or when accrued dividends in an amount equivalent to six full quarterly dividends are in arrears. The Redeemable Preference Stock restricts the ability of KACC to redeem or pay dividends on its common stock if KACC is in default on any dividends payable on Redeemable Preference Stock. Preference Stock KACC has four series of $100 par value Cumulative Convertible Preference Stock ("$100 PREFERENCE STOCK") with annual dividend requirements of between 4-1/8 % and 4-3/4 %. KACC has the option to redeem the $100 Preference Stock at par value plus accrued dividends. KACC does not intend to issue any additional shares of the $100 Preference Stock. The $100 Preference Stock can be exchanged for per share cash amounts between $69 - $80. KACC records the $100 Preference Stock at their exchange amounts for financial statement presentation, and Kaiser includes such amounts in minority interests. At December 31, 1998 and 1997, outstanding shares of $100 Preference Stock were 19,963 and 20,543, respectively. Kaiser Common Stock Incentive Plans Kaiser has a total of 8,000,000 shares of Kaiser common stock reserved for issuance under its incentive compensation programs. At December 31, 1998, 3,634,621 shares were available for issuance under these plans. Pursuant to Kaiser's nonqualified stock program, stock options are granted at the prevailing market price, generally vest at the rate of 20% to 33% per year and have a five or ten year term. Information relating to nonqualified stock options is shown below. The prices shown in the table below are the weighted average price per share for the respective number of underlying shares.
1998 1997 1996 -------------------------- --------------------------- --------------------------- SHARES PRICE SHARES PRICE SHARES PRICE ------------ ------------ ------------ ------------- ------------ ------------- Outstanding at beginning of year 819,752 $ 10.45 890,395 $ 10.33 926,085 $ 10.32 Granted 2,263,170 9.79 15,092 10.06 - - Exercised (10,640) 7.25 (48,410) 8.33 (8,275) 8.99 Expired or forfeited (23,160) 9.60 (37,325) 10.12 (27,415) 10.45 ------------ ------------ ------------ Outstanding at end of year 3,049,122 9.98 819,752 10.45 890,395 10.33 ============ ============ ============ Exercisable at end of year 1,261,262 $ 10.09 601,115 $ 10.53 436,195 $ 10.47 ============ ============ ============
11. STOCKHOLDERS' DEFICIT Preferred Stock The holders of the Company's Class A $.05 Non-Cumulative Participating Convertible Preferred Stock (the "CLASS A PREFERRED STOCK") are entitled to receive, if and when declared, preferential cash dividends at the rate of $.05 per share per annum and will participate thereafter on a share for share basis with the holders of common stock in all cash dividends, other than cash dividends on the common stock in any fiscal year to the extent not exceeding $.05 per share. Stock dividends declared on the common stock will result in the holders of the Class A Preferred Stock receiving an identical stock dividend payable in shares of Class A Preferred Stock. At the option of the holder, the Class A Preferred Stock is convertible at any time into shares of common stock at the rate of one share of common stock for each share of Class A Preferred Stock. Each holder of Class A Preferred Stock is generally entitled to ten votes per share on all matters presented to a vote of the Company's stockholders. Stock Option Plans In 1994, the Company adopted the MAXXAM 1994 Omnibus Employee Incentive Plan (the "1994 OMNIBUS PLAN"). Up to 1,000,000 shares of common stock and 1,000,000 shares of Class A Preferred Stock were reserved for awards or for payment of rights granted under the 1994 Omnibus Plan of which 784,600 and 910,000 shares, respectively, were available to be awarded at December 31, 1998. The 1994 Omnibus Plan replaced the Company's 1984 Phantom Share Plan (the "1984 PLAN") which expired in June 1994, although previous grants thereunder remain outstanding. The options (or rights, as applicable) granted in 1996, 1997 and 1998 vest at the rate of 20% per year commencing one year from the date of grant. The Company paid $1.2 million and $1.6 million in respect of awards issued pursuant to the 1984 Plan for the years ended December 31, 1998 and 1997, respectively. Amounts paid in respect of awards issued pursuant to the 1984 Plan for the year ended December 31, 1996 were not significant. The following table summarizes the options or rights outstanding and exercisable relating to the 1984 Plan and the 1994 Omnibus Plan. The prices shown are the weighted average price per share for the respective number of underlying shares.
1998 1997 1996 --------------------------- --------------------------- --------------------------- SHARES PRICE SHARES PRICE SHARES PRICE ------------ ------------- ------------ ------------- ------------ ------------- Outstanding at beginning of year 296,800 $ 38.47 250,100 $ 34.75 207,900 $ 31.59 Granted 79,500 48.93 98,500 41.71 45,000 48.84 Exercised (53,200) 33.09 (50,300) 26.11 (1,800) 15.31 Expired or forfeited (21,100) 42.03 (1,500) 45.15 (1,000) 45.15 ------------ ------------ ------------ Outstanding at end of year 302,000 41.93 296,800 38.47 250,100 34.75 ============ ============ ============ Exercisable at end of year 107,700 $ 36.32 117,200 $ 33.53 122,100 $ 29.40 ============ ============ ============
Concurrent with the adoption of the 1994 Omnibus Plan, the Company adopted the MAXXAM 1994 Non-Employee Director Plan (the "1994 DIRECTOR PLAN"). Up to 35,000 shares of common stock are reserved for awards under the 1994 Director Plan. In 1998, 1997 and 1996, options to purchase 1,800 shares, 1,800 shares and 900 shares of common stock, respectively, were granted to three non-employee directors. The weighted average exercise prices of these options are $60.94, $43.19 and $43.88 per share, respectively, based on the quoted market price at the date of grant. The options vest at the rate of 25% per year commencing one year from the date of grant. At December 31, 1998, options for 3,075 shares were exercisable. Shares Reserved for Issuance At December 31, 1998, the Company had 2,703,590 common shares and 1,000,000 Class A Preferred shares reserved for future issuances in connection with various options, convertible securities and other rights as described in this Note 11. Rights On November 29, 1989, the Board of Directors of the Company declared a dividend to its stockholders consisting of (i) one Series A Preferred Stock Purchase Right (the "SERIES A RIGHT") for each outstanding share of the Company's Class A Preferred Stock and (ii) one Series B Preferred Stock Purchase Right (the "SERIES B RIGHT") for each outstanding share of the Company's common stock. The Series A Rights and the Series B Rights are collectively referred to herein as the "Rights." The Rights are exercisable only if a person or group of affiliated or associated persons (an "ACQUIRING PERSON") acquires beneficial ownership, or the right to acquire beneficial ownership, of 15% or more of the Company's common stock, or announces a tender offer that would result in beneficial ownership of 15% or more of the outstanding common stock. Any person or group of affiliated or associated persons who, as of November 29, 1989, was the beneficial owner of at least 15% of the outstanding common stock will not be deemed to be an Acquiring Person unless such person or group acquires beneficial ownership of additional shares of common stock (subject to certain exceptions). Each Series A Right, when exercisable, entitles the registered holder to purchase from the Company one share of Class A Preferred Stock at an exercise price of $165.00, subject to adjustment. Each Series B Right, when exercisable, entitles the registered holder to purchase from the Company one one-hundredth of a share of the Company's new Class B Junior Participating Preferred Stock, with a par value of $.50 per share (the "JUNIOR PREFERRED STOCK"), at an exercise price of $165.00, subject to adjustment. Under certain circumstances, including if any person becomes an Acquiring Person other than through certain offers for all outstanding shares of stock of the Company, or if an Acquiring Person engages in certain "self-dealing" transactions, each Series A Right would enable its holder to buy Class A Preferred Stock (or, under certain circumstances, preferred stock of an acquiring company) having a value equal to two times the exercise price of the Series A Right, and each Series B Right shall enable its holder to buy common stock of the Company (or, under certain circumstances, common stock of an acquiring company) having a value equal to two times the exercise price of the Series B Right. Under certain circumstances, Rights held by an Acquiring Person will be null and void. In addition, under certain circumstances, the Board is authorized to exchange all outstanding and exercisable Rights for stock, in the ratio of one share of Class A Preferred Stock per Series A Right and one share of common stock of the Company per Series B Right. The Rights, which do not have voting privileges, expire on December 11, 1999, but may be redeemed by action of the Board prior to that time for $.01 per right, subject to certain restrictions. Voting Control Federated Development Inc., a wholly owned subsidiary of Federated Development Company ("FEDERATED"), and Mr. Charles E. Hurwitz beneficially own (exclusive of securities acquirable upon exercise of stock options) an aggregate 99.2% of the Company's Class A Preferred Stock and 37.7% of the Company's common stock (resulting in combined voting control of approximately 68.9% of the Company). Mr. Hurwitz is the Chairman of the Board and Chief Executive Officer of the Company and Chairman and Chief Executive Officer of Federated. Federated is wholly owned by Mr. Hurwitz, members of his immediate family and trusts for the benefit thereof. 12. COMMITMENTS AND CONTINGENCIES Commitments Minimum rental commitments under operating leases at December 31, 1998 are as follows: years ending December 31, 1999 - $43.6 million; 2000 - $39.8 million; 2001 - $35.0 million; 2002 - $30.1 million; 2003 - $28.2 million; thereafter - $119.2 million. Rental expense for operating leases was $39.6 million, $35.6 million and $34.2 million for the years ended December 31, 1998, 1997 and 1996, respectively. The minimum future rentals receivable under noncancelable subleases at December 31, 1998 were $73.5 million. Aluminum Operations Environmental Contingencies Kaiser and KACC are subject to a number of environmental laws and regulations, to fines or penalties assessed for alleged breaches of the environmental laws and regulations, and to claims and litigation based upon such laws. KACC is currently subject to a number of lawsuits under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (as amended by the Superfund Amendments Reauthorization Act of 1986, "CERCLA"), and, along with certain other entities, has been named as a potentially responsible party for remedial costs at certain third-party sites listed on the National Priorities List under CERCLA. Based on Kaiser's evaluation of these and other environmental matters, Kaiser has established environmental accruals primarily related to potential solid waste disposal and soil and groundwater remediation matters. The following table presents the changes in such accruals, which are primarily included in other noncurrent liabilities (in millions):
YEARS ENDED DECEMBER 31, ---------------------------------------- 1998 1997 1996 ------------ ------------ ------------ Balance at beginning of year $ 29.7 $ 33.3 $ 38.9 Additional accruals 24.5 2.0 3.2 Less expenditures (3.5) (5.6) (8.8) ------------ ------------ ------------ Balance at end of year $ 50.7 $ 29.7 $ 33.3 ============ ============ ============
These environmental accruals represent Kaiser's estimate of costs reasonably expected to be incurred based on presently enacted laws and regulations, currently available facts, existing technology and Kaiser's assessment of the likely remediation action to be taken. Kaiser expects that these remediation actions will be taken over the next several years and estimates that annual expenditures to be charged to these environmental accruals will be approximately $3.0 million to $8.0 million for the years 1999 through 2003 and an aggregate of approximately $29.0 million thereafter. As additional facts are developed and definitive remediation plans and necessary regulatory approvals for implementation of remediation are established or alternative technologies are developed, changes in these and other factors may result in actual costs exceeding the current environmental accruals. As the resolution of these matters is subject to further regulatory review and approval, no specific assurances can be given as to when the factors upon which a substantial portion of this estimate is based can be expected to be resolved. However, Kaiser is working to resolve certain of these matters. Kaiser believes that it has insurance coverage available to recover certain incurred and future environmental costs and is actively pursuing claims in this regard. Through September 30, 1998, no accruals were made for any such insurance recoveries. However, during December 1998, KACC received recoveries totaling approximately $35.0 million from certain of its insurers related to current and future claims. Based on Kaiser's analysis, a total of $12.0 million of such recoveries was allocable to previously accrued (expensed) items and, therefore, was reflected in earnings during the fourth quarter of 1998. The remaining recoveries were offset against increases in the total amount of environmental reserves. No assurances can be given that Kaiser will be successful in other attempts to recover incurred or future costs from other insurers or that the amount of recoveries received will ultimately be adequate to cover costs incurred. While uncertainties are inherent in the final outcome of these environmental matters, and it is impossible to determine the actual costs that ultimately may be incurred, management believes that the resolution of such uncertainties should not have a material adverse effect on the Company's consolidated financial position, results of operations or liquidity. Asbestos Contingencies KACC is a defendant in a number of lawsuits, some of which involve claims of multiple persons, in which the plaintiffs allege that certain of their injuries were caused by, among other things, exposure to asbestos during, and as a result of, their employment or association with KACC or exposure to products containing asbestos produced or sold by KACC. The lawsuits generally relate to products KACC has not manufactured for at least 20 years. The following table presents the changes in number of such claims pending for the years ended December 31, 1998, 1997, and 1996.
YEARS ENDED DECEMBER 31, ---------------------------------------- 1998 1997 1996 ------------ ------------ ------------ Number of claims at beginning of period 77,400 71,100 59,700 Claims received 22,900 15,600 21,100 Claims settled or dismissed (13,900) (9,300) (9,700) ------------ ------------ ------------ Number of claims at end of period 86,400 77,400 71,100 ============ ============ ============
The foregoing claims and settlement figures as of December 31, 1998, do not reflect the fact that KACC has reached agreements under which it will settle approximately 30,000 of the pending asbestos-related claims over an extended period. Based on past experience and reasonably anticipated future activity, Kaiser has established an accrual for estimated asbestos-related costs for claims filed and estimated to be filed through 2008. There are inherent uncertainties involved in estimating asbestos-related costs and Kaiser's actual costs could exceed these estimates. Kaiser's accrual was calculated based on the current and anticipated number of asbestos-related claims, the prior timing and amounts of asbestos-related payments, and the advice of Wharton Levin Ehrmantraut Klein & Nash, P.A. with respect to the current state of the law related to asbestos claims. Accordingly, an estimated asbestos-related cost accrual of $186.2 million, before consideration of insurance recoveries, is included primarily in other noncurrent liabilities at December 31, 1998. While Kaiser does not believe there is a reasonable basis for estimating such costs beyond 2008 and, accordingly, no accrual has been recorded for such costs which may be incurred beyond 2008, there is a reasonable possibility that such costs may continue beyond 2008, and such costs may be substantial. Kaiser estimates that annual future cash payments in connection with such litigation will be approximately $16.0 million to $28.0 million for each of the years 1999 through 2003, and an aggregate of approximately $77.0 million thereafter. Kaiser believes that KACC has insurance coverage available to recover a substantial portion of its asbestos-related costs. Although Kaiser has settled asbestos-related coverage matters with certain of its insurance carriers, other carriers have not yet agreed to such settlements. The timing and amount of future recoveries from these insurance carriers will depend on the pace of claims review and processing by such carriers and on the resolution of any disputes regarding coverage under such policies. Kaiser believes that substantial recoveries from the insurance carriers are probable. Kaiser reached this conclusion after considering its prior insurance-related recoveries in respect of asbestos-related claims, its existing insurance policies, and the advisement of Heller Ehrman White & McAuliffe, P.A. with respect to applicable insurance coverage law relating to the terms and conditions of those policies. Accordingly, an estimated aggregate insurance recovery of $152.5 million, determined on the same basis as the asbestos-related cost accrual, is recorded primarily in long-term receivables and other assets at December 31, 1998. Kaiser continues to monitor claims activity, the status of lawsuits (including settlement initiatives), legislative progress, and costs incurred in order to ascertain whether an adjustment to the existing accruals should be made to the extent that historical experience may differ significantly from Kaiser's underlying assumptions. While uncertainties are inherent in the final outcome of these asbestos matters and it is presently impossible to determine the actual costs that ultimately may be incurred and insurance recoveries that will be received, management believes that, based on the factors discussed in the preceding paragraphs, the resolution of asbestos-related uncertainties and the incurrence of asbestos-related costs net of related insurance recoveries should not have a material adverse effect on the Company's consolidated financial position, results of operations or liquidity. Labor Matters In connection with the USWA strike and subsequent "lock-out" by KACC, certain allegations of unfair labor practices ("ULPS") have been filed with the National Labor Relations Board by the USWA and its members. KACC has responded to all such allegations and believes that they are without merit. If the allegations were sustained, KACC could be required to make locked-out employees whole for back wages from the date of lock-out in January 1999. While uncertainties are inherent in the final outcome of such matters, the Company believes that the resolution of the alleged ULPs should not result in a material adverse impact on its financial position, results of operations, or liquidity. Forest Products Operations Regulatory and environmental matters play a significant role in the Company's business, which is subject to a variety of California and federal laws and regulations, as well as the Final HCP and Final SYP (defined below), dealing with timber harvesting practices, threatened and endangered species and habitat for such species, and air and water quality. While regulatory and environmental concerns have resulted in restrictions on the geographic scope and timing of the Company's timber operations, increased operational costs and engendered litigation and other challenges to the Company's operations, prior to 1998 they have not had a significant adverse effect on the Company's financial position, results of operations or liquidity. However, the Company's 1998 results of operations were adversely affected by certain regulatory and environmental matters, including during the second half of 1998, the absence of a sufficient number of available THPs to enable the Company to conduct its operations at historic levels. On September 28, 1996, Pacific Lumber, including its subsidiaries and affiliates, and MAXXAM (the "PACIFIC LUMBER PARTIES") entered into an agreement (the "HEADWATERS AGREEMENT") with the United States and California which provided the framework for the acquisition of the Headwaters Timberlands by the United States and California. Consummation of the Headwaters Agreement was also conditioned upon, among other things: approval of a sustained yield plan establishing long-term sustained yield ("LTSY") harvest levels for Pacific Lumber's timberlands (the "SYP"), approval of a habitat conservation plan (the "HCP") covering multiple species (the "MULTI-SPECIES HCP") and issuance of incidental take permits related to the Multi-Species HCP ("PERMITS"). As further described in Note 17 "Subsequent Events," on March 1, 1999, the Pacific Lumber Parties, the United States and California consummated the Headwaters Agreement. In addition to the transfer of the Headwaters Timberlands by the Pacific Lumber Parties described in Note 17, Pacific Lumber received an approved SYP (the "FINAL SYP"), Multi-Species HCP (the "FINAL HCP") and related Permits. The Pacific Lumber Parties and California also executed an agreement regarding the enforcement of the California bill which authorized state funds for the purchase of the Headwaters Timberlands while imposing certain restrictions on the remaining timberlands held by the Pacific Lumber Parties (the "CALIFORNIA AGREEMENT"). The Final 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 establish an LTSY harvest level. An SYP must demonstrate that the average annual harvest over any rolling ten-year period will not exceed the LTSY harvest level and that a timber company's projected timber inventory is capable of sustaining the LTSY harvest level in the last decade of the 100-year planning period. Under the Final SYP, the Company's projected base average annual harvest level in the first decade could be approximately 179 million board feet of softwoods. The Final SYP is effective for 10 years and may be amended by Pacific Lumber subject to approval by the CDF. The Final SYP is subject to review after five years. Revised SYPs would be prepared every decade that address the LTSY harvest level based upon reassessment of changes in the resource base and other factors. Several species, including the northern spotted owl, the marbled murrelet, the coho salmon and the steelhead trout, have been listed as endangered or threatened under the ESA and/or the California Endangered Species Act (the "CESA"). The Final HCP and the Permits allow incidental "take" of listed species so long as there is no "jeopardy" to the continued existence of such species. The Final HCP identifies the measures to be instituted in order to minimize and mitigate the anticipated level of take to the greatest extent practicable. The Final HCP not only provides for the Company's compliance with habitat requirements for the northern spotted owl, the marbled murrelet, the coho salmon and the steelhead trout, it also provides for issuance of Permits for thirteen additional species that are or may be listed in the future. The Final HCP and related Permits have a term of 50 years, and, among other things, include the following protective measures: (i) setting aside timberlands as marbled murrelet conservation areas; (ii) establishing streamside "no-cut" and limited cut buffers as well as mass wasting areas based on a five-year assessment of each of the Company's watersheds; (iii) limiting harvesting activities during wet weather conditions, and (iv) making certain specified improvements to the Company's roads. The Final SYP is also subject to the foregoing provisions. The Company believes that the Final SYP and the Final HCP should in the long-term expedite the preparation and facilitate approval of its THPs, although there can be no assurance that the Company will not face difficulties in the THP submission and approval process as it implements these agreements. Lawsuits are threatened which seek to prevent the Company from implementing the Final HCP and the Final SYP, and lawsuits are pending concerning certain of the Company's approved THPs or other operations. On January 26, 1998 an action entitled Coho Salmon, et al v. Pacific Lumber, et al, (the "COHO LAWSUIT") was filed against Pacific Lumber, Scotia Pacific and Salmon Creek. This action alleged, 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. In March 1999, the Coho lawsuit was dismissed, with prejudice. Pacific Lumber has also received notice of additional threatened actions with respect to the coho salmon. On August 12, 1998, an action entitled Environmental Protection Information Center, Inc., Sierra Club v. Pacific Lumber, Scotia Pacific and Salmon Creek (the "EPIC LAWSUIT") was filed by two environmental groups against Pacific Lumber, Scotia Pacific and Salmon Creek under which the environmental groups allege that certain procedural violations of the federal Endangered Species Act (the "ESA") have resulted from logging activities on the Company's timberlands and seek to prevent the defendants from carrying out any harvesting activities until certain wildlife consultation requirements under the ESA are satisfied in connection with the development of the Final HCP. In March 1999, the court affirmed a preliminary injunction on harvesting on three THPs; however, it subsequently heard Pacific Lumber's motion to dismiss the case and issued an order for the plaintiffs to show cause why the lawsuit should not be dismissed as moot since the consultation requirement appears to have been concluded. On or about January 29, 1999, the Company received a notice from EPIC and the Sierra Club ("EPIC NOTICE LETTER") of their intent to sue Pacific Lumber and several federal and state agencies under the ESA. The letter alleges various violations of the ESA and challenges, among other things, the validity and legality of the Permits. The Company is unable to predict the outcome of either the EPIC lawsuit or the EPIC Notice Letter or their ultimate impact on the Company's financial condition or results of operations or the ability to harvest timber on its THPs. While the Company expects environmentally focused objections and lawsuits to continue, it believes that the Final HCP and the Permits should enhance its position in connection with these challenges. On November 9, 1998, the California Department of Forestry and Fire Protection ("CDF") notified Pacific Lumber that it had suspended Pacific Lumber's 1998 timber operator's license ("TOL"). As a result, Pacific Lumber ceased all operations under its TOL and made the necessary arrangements for independent contract loggers to be substituted where necessary (independent contractors historically account for approximately 60% of the harvesting activities on the Company's timberlands). On February 26, 1999, the CDF issued Pacific Lumber a conditional TOL for 1999. The 1999 TOL contains provisions which limit the use of roads during wet weather conditions and provides for an enhanced compliance program. The CDF has also advised Pacific Lumber that if the 1999 TOL is revoked, issuance of a new conditional license would be unlikely. The Company does not believe that the restrictions imposed by the 1999 TOL will have an adverse effect on Pacific Lumber's or the Company's financial condition or results of operations. OTS Contingency and Related Matters On December 26, 1995, the United States Department of Treasury's Office of Thrift Supervision ("OTS") initiated a formal administrative proceeding against the Company and others by filing a Notice of Charges (the "NOTICE"). The Notice alleges, among other things, misconduct by the Company, Federated Development Company ("FEDERATED"), Mr. Charles Hurwitz and others (the "RESPONDENTS") with respect to the failure of United Savings Association of Texas ("USAT"), a wholly owned subsidiary of United Financial Group Inc. ("UFG"). The Notice claims that the Company was a savings and loan holding company, that with others it controlled USAT, and that it was therefore obligated to maintain the net worth of USAT. The Notice makes numerous other allegations against the Company and the other respondents, including, among other things, allegations that through USAT it was involved in prohibited transactions with Drexel Burnham Lambert Inc. The OTS's pre-hearing statement alleged unspecified damages in excess of $560.0 million from the Company and Federated, civil money penalties and a removal from, and prohibition against the Company and the other respondents engaging in, the banking industry. The hearing on the merits of this matter commenced on September 22, 1997 and concluded on March 1, 1999. Post trial briefing is expected to continue at least through September 1999. A recommended decision by the Administrative Law Judge is not expected any sooner than late 1999. A final agency decision would be issued by the OTS Director thereafter. Such decision would then be subject to appeal by any of the parties to the federal appellate court and, if adverse to the defendants, subject to bonding. On February 10, 1999, the OTS and FDIC settled with the all the respondents except Mr. Hurwitz, the Company and Federated for $1.0 million and limited cease and desist orders. On August 2, 1995, the Federal Deposit Insurance Corporation ("FDIC") filed a civil action entitled Federal Deposit Insurance Corporation, as manager of the FSLIC Resolution Fund v. Charles E. Hurwitz (No. H-95-3956) (the "FDIC ACTION") in the U.S. District Court for the Southern District of Texas (the "Court"). The original complaint against Mr. Hurwitz alleged damages in excess of $250.0 million based on the allegation that Mr. Hurwitz was a controlling shareholder, de facto senior officer and director of USAT, and was involved in certain decisions which contributed to the insolvency of USAT. The original complaint further alleged, among other things, that Mr. Hurwitz was obligated to ensure that UFG, Federated and the Company maintained the net worth of USAT. On January 15, 1997, the FDIC filed an amended complaint which seeks, conditioned on the OTS prevailing in its administrative proceeding, unspecified damages from Mr. Hurwitz relating to amounts the OTS does not collect from the Company and Federated with respect to their alleged obligations to maintain USAT's net worth. The Company's bylaws provide for indemnification of its officers and directors to the fullest extent permitted by Delaware law. The Company is obligated to advance defense costs to its officers and directors, subject to the individual's obligation to repay such amount if it is ultimately determined that the individual was not entitled to indemnification. In addition, the Company's indemnity obligation can, under certain circumstances, include amounts other than defense costs, including judgments and settlements. The Company has concluded that it is unable to determine a reasonable estimate of the loss (or range of loss), if any, that could result from this contingency. Accordingly, it is impossible to assess the ultimate outcome of the foregoing matters or its potential impact on the Company; however, any adverse outcome of these matters could have a material adverse effect on the Company's consolidated financial position, results of operations or liquidity. Other Matters The Company is involved in various other claims, lawsuits and other proceedings relating to a wide variety of matters. While uncertainties are inherent in the final outcome of such matters and it is presently impossible to determine the actual costs that ultimately may be incurred, management believes that the resolution of such uncertainties and the incurrence of such costs should not have a material adverse effect on the Company's consolidated financial position, results of operations or liquidity. 13. DERIVATIVE FINANCIAL INSTRUMENTS AND RELATED HEDGING PROGRAMS At December 31, 1998, the net unrealized gain on KACC's position in aluminum forward sales and option contracts natural gas and fuel oil forward purchase and option contracts, and forward foreign exchange contracts, was approximately $17.8 million (based on comparisons to applicable year-end published market prices). As KACC's hedging activities are designed to lock-in a specified price or range of prices, gains or losses on the derivative contracts utilized in these hedging activities will be offset by losses or gains, respectively, on the transactions being hedged. Alumina and Aluminum Kaiser's earnings are sensitive to changes in the prices of alumina, primary aluminum and fabricated aluminum products and also depend to a significant degree upon the volume and mix of all products sold. Primary aluminum prices have historically been subject to significant cyclical price fluctuations. Alumina prices as well as fabricated aluminum product prices (which vary considerably among products) are significantly influenced by changes in the price of primary aluminum but generally lag behind primary aluminum price changes by up to three months. Since 1993, the average Midwest United States transaction price for primary aluminum has ranged from approximately $.50 to $1.00 per pound. From time to time in the ordinary course of business, KACC enters into hedging transactions to provide price risk management in respect of the net exposure of earnings resulting from (i) anticipated sales of alumina, primary aluminum and fabricated aluminum products, less (ii) expected purchases of certain items, such as aluminum scrap, rolling ingot and bauxite, whose prices fluctuate with the market price of primary aluminum. Forward sales contracts are used by KACC to effectively fix the price that KACC will receive for its shipments. KACC also uses option contracts (i) to establish a minimum price for its product shipments, (ii) to establish a "collar" or range of price for KACC's anticipated sales and/or (iii) to permit KACC to realize possible upside price movements. As of December 31, 1998, KACC had sold forward, at fixed prices, approximately 24,000 tons of primary aluminum with respect to 1999. As of December 31, 1998, KACC had also entered into option contracts that established a price range for an additional 125,000 and 72,000 tons of primary aluminum with respect to 1999 through 2000, respectively. Subsequent to December 31, 1998, KACC has also entered into additional option contracts that established a price range for an additional 201,000 tons of primary aluminum with respect to 2000. Additionally, through December 31, 1998, KACC had also entered a series of transactions with a counterparty that will provide KACC with a premium over the forward market prices at the date of transaction for 2,000 tons of primary aluminum per month during the period from July 1999 to June 2001. KACC also contracted with the counterparty to receive a fixed price (also above the forward market price at the date of the transaction) on 4,000 tons of primary aluminum per month over a three year period commencing October 2001 unless market prices during certain periods decline below a stipulated "floor" price, in which case, the fixed price sales portion of the transactions terminates. The price at which October 2001 and after transactions terminate is well below current market prices. While Kaiser believes the October 2001 and after transactions are consistent with its stated hedging objectives, these positions do not qualify for treatment as a "hedge" under current accounting guidelines. Accordingly, these positions will be "marked to market" each period. As of December 31, 1998, KACC had sold forward virtually all of the alumina available to it in excess of its projected internal smelting requirements for 1999 and 2000 at prices indexed to future prices of primary aluminum. Energy KACC is exposed to energy price risk from fluctuating prices for fuel oil and natural gas consumed in the production process. Accordingly, KACC from time to time in the ordinary course of business enters into hedging transactions with major suppliers of energy and energy related financial instruments. As of December 31, 1998, KACC had a combination of fixed price purchase and option contracts for the purchase of approximately 33,000 MMBtu of natural gas per day during 1999. At December 31, 1998, KACC also held a combination of fixed price purchase and option contracts for an average of 246,000 barrels per month of fuel oil and diesel fuel for 1999. Foreign Currency KACC enters into forward foreign exchange contracts to hedge material cash commitments to foreign subsidiaries or affiliates. At December 31, 1998, KACC had net forward foreign exchange contracts totaling approximately $141.4 million for the purchase of 210.6 Australian dollars from January 1999 through December 2000, in respect of its commitments for 1999 and 2000 expenditures denominated in Australian dollars. 14. SEGMENT INFORMATION In the fourth quarter of 1998, the Company adopted Statement of Financial Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and Related Information" ("SFAS NO. 131"), which supersedes Statement of Financial Accounting Standards No. 14 "Financial Reporting for Segments of a Business Enterprise." SFAS No. 131 requires financial information for public reporting purposes to be reported on the basis that it is used internally by management for evaluating segment performance and deciding how to allocate resources to segments. Reportable Segments The Company is a holding company; its operations are organized and managed as distinct business units which offer different products and services and are managed separately through the Company's subsidiaries. The Company has four reportable segments: aluminum, forest products, real estate and racing operations. The aluminum segment is an integrated aluminum producer which uses portions of its bauxite and alumina to produce primary aluminum and fabricated aluminum products. The forest products segment harvests its timber and produces lumber and logs. The real estate segment invests in and develops residential and commercial real estate. The racing segment operates a pari-mutual horse racing facility. The accounting policies of the segments are the same as those described in Note 1. The Company evaluates segment performance based on profit or loss from operations before income taxes and minority interests. The following segment information differs from that presented in prior years as a result of the adoption of SFAS No. 131 in 1998. Prior year information has been restated to conform to the new format. The following table presents financial information by reportable segment (in millions).
FOREST REAL RACING CONSOLIDATED DECEMBER 31, ALUMINUM PRODUCTS ESTATE OPERATIONS CORPORATE TOTAL ------------ ------------ ------------- ------------ ------------ ------------ ------------ Net sales to unaffiliated customers 1998 $ 2,256.4 $ 233.6 $ 58.6 $ 24.1 $ - $ 2,572.7 1997 2,373.2 287.2 48.7 20.0 - 2,729.1 1996 2,190.5 264.6 67.5 20.7 - 2,543.3 Operating income (loss) 1998 96.5 40.9 - 1.8 (13.6) 125.6 1997 174.0 84.9 (3.4) (1.6) (17.5) 236.4 1996 103.7 73.0 (10.1) (1.9) (33.4) 131.3 Investment, interest and other income 1998 3.5 9.7 15.8 .7 6.6 36.3 1997 3.0 14.8 17.6 .1 14.2 49.7 1996 (2.6) 11.7 31.2 (.4) 1.2 41.1 Interest expense and amortization of deferred financing costs 1998 110.0 75.3 1.5 3.4 18.3 208.5 1997 110.7 78.7 1.4 3.1 17.7 211.6 1996 93.4 78.4 2.3 3.4 7.0 184.5 Depreciation, depletion and amortization 1998 93.2 22.5 3.2 1.0 .5 120.4 1997 96.5 26.1 3.3 .9 .6 127.4 1996 101.7 27.2 4.8 .9 .5 135.1 Income (loss) before income taxes and minority interests 1998 (10.0) (24.7) 14.4 (1.0) (25.3) (46.6) 1997 66.3 20.9 12.8 (4.4) (21.1) 74.5 1996 7.6 6.3 18.9 (5.7) (39.2) (12.1) Capital expenditures 1998 77.6 22.0 22.2 1.0 .1 122.9 1997 128.5 22.9 22.0 .3 .3 174.0 1996 160.3 15.2 10.3 .4 .4 186.6 Investments in and advances to unconsol- idated affiliates 1998 128.3 - 18.2 - - 146.5 1997 148.6 - 10.9 - - 159.5 Total assets 1998 2,928.7 682.6 194.6 36.3 233.0 4,075.2 1997 2,950.7 700.0 193.7 34.7 235.1 4,114.2
The amounts in the column entitled Corporate represent corporate general and administrative expenses, interest and other income, and interest expense not directly attributable to the reportable segments. This column also serves to reconcile the total of the reportable segments' amounts to totals in the Company's consolidated financial statements. The reconciling amounts for total assets for 1998 and 1997 are primarily related to deferred tax assets. Product Sales The following table presents segment sales by primary products (in millions).
YEARS ENDED DECEMBER 31, ---------------------------------------- 1998 1997 1996 ------------ ------------ ------------ Aluminum: Bauxite and alumina $ 608.5 $ 613.4 $ 625.1 Primary aluminum 643.3 817.2 755.7 Flat-rolled products 714.6 743.3 626.0 Engineered products 581.3 581.0 504.4 Minority interests and eliminations (291.3) (381.7) (320.7) ------------ ------------ ------------ Total aluminum sales $ 2,256.4 $ 2,373.2 $ 2,190.5 Forest products: Lumber $ 211.6 $ 256.1 $ 234.1 Other forest products 22.0 31.1 30.5 ------------ ------------ ------------ Total forest product sales $ 233.6 $ 287.2 $ 264.6 Real estate: Real estate and development $ 41.2 $ 25.5 $ 25.1 Resort and other commercial operations 17.4 23.2 42.4 ------------ ------------ ------------ Total real estate sales $ 58.6 $ 48.7 $ 67.5
Geographical Information The Company's operations are located in many foreign countries, including Australia, Canada, Ghana, Jamaica, and the United Kingdom. Foreign operations in general may be more vulnerable than domestic operations due to a variety of political and other risks. Sales and transfers among geographic areas are made on a basis intended to reflect the market value of products. Long-lived assets include property, plant and equipment-net, timber and timberlands-net, real estate held for development and sale, and investments in and advances to unconsolidated affiliates. Geographical area information relative to operations is summarized as follows (in millions):
OTHER DECEMBER 31, DOMESTIC CARIBBEAN AFRICA FOREIGN TOTAL ------------- ----------- ----------- ---------- ------------ ------------ Net sales to unaffiliated customers 1998 $ 2,014.3 $ 237.0 $ 89.8 $ 231.6 $ 2,572.7 1997 2,076.2 204.6 234.2 214.1 2,729.1 1996 1,962.8 201.8 198.3 180.4 2,543.3 Long-lived assets 1998 1,297.8 289.2 90.2 99.7 1,776.9 1997 1,324.6 283.4 100.4 127.1 1,835.5
Major Customers and Export Sales For the years ended December 31, 1998, 1997 and 1996, sales to any one customer did not exceed 10% of consolidated revenues. Export sales were less than 10% of total revenue in 1998, 1997 or 1996. 15. SUPPLEMENTAL CASH FLOW INFORMATION
YEARS ENDED DECEMBER 31, ---------------------------------------- 1998 1997 1996 ------------ ------------ ------------ (IN MILLIONS OF DOLLARS) Supplemental information on non-cash investing and financing activities: Capital spending accrual excluded from investing activities $ - $ - $ 13.5 Contribution of property and inventory in exchange for joint venture interest 8.7 10.6 - Acquisition of assets subject to other liabilities .8 9.4 - Reduction of stockholders' deficit due to redemption of Kaiser preferred stock - 64.8 - Borrowing (repayment) of short-term debt issued to repurchase treasury stock (35.1) 35.1 - Supplemental disclosure of cash flow information: Interest paid, net of capitalized interest $ 186.6 $ 178.3 $ 156.8 Income taxes paid, net 16.7 25.4 21.5
16. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) Summary quarterly financial information for the years ended December 31, 1998 and 1997 is as follows (in millions):
THREE MONTHS ENDED ------------------------------------------------------ MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 ------------ ------------ ------------- ------------ 1998: Net sales $ 664.0 $ 699.6 $ 628.8 $ 580.3 Operating income (loss) 51.3 71.0 40.4 (37.1) Income (loss) before extraordinary item 1.9 12.4 (2.0) (27.0) Extraordinary item, net - - (42.5) - Net income (loss) 1.9 12.4 (44.5) (27.0) Basic earnings per common share: Income (loss) before extraordinary item $ .28 $ 1.76 $ (.28) $ (3.86) Extraordinary item, net - - (6.07) - ------------ ------------ ------------ ------------ Net income (loss) .28 1.76 (6.35) $ (3.86) ============ ============ ============ ============ Diluted earnings per common and common equivalent share: Income (loss) before extraordinary item $ .25 $ 1.57 $ (.28) $ (3.86) Extraordinary item - - (6.07) - ------------ ------------ ------------ ------------ Net income (loss) $ .25 $ 1.57 $ (6.35) $ (3.86) ============ ============ ============ ============ 1997: Net sales $ 631.6 $ 689.1 $ 726.0 $ 682.4 Operating income 49.0 52.7 73.9 60.8 Net income .7 31.9 18.0 14.6 Earnings per share: Basic .08 3.72 2.17 1.84 Diluted .07 3.42 1.98 1.67
17. SUBSEQUENT EVENTS Headwaters Transactions As described in Note 12 above, on September 28, 1996, the Pacific Lumber Parties entered into the Headwaters Agreement with the United States and California which provided the framework for the acquisition by the United States and California of the Headwaters Timberlands. A substantial portion of the Headwaters Timberlands contain virgin old growth timber. Approximately 4,900 of these acres were owned by Salmon Creek, with the remaining acreage being owned by the Scotia LLC (Pacific Lumber owning the timber and related timber harvesting rights on this acreage). On March 1, 1999, the Pacific Lumber Parties, the United States and California consummated the Headwaters Agreement. 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 are to be contributed to Scotia LLC on or before August 1999. Approximately $285.0 million of these proceeds have been deposited into an escrow account held by an escrow agent and are to be made available as necessary to support the Timber Notes, and may be released only under certain circumstances. As a result of the disposition of the Headwaters Timberlands, the Company expects to recognize a pre-tax gain of approximately $240.0 million ($142.0 million, net of tax) in the first quarter of 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 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 will be reflected in the Company's financial statements at $6.0 million 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 to California of the Owl Creek and Grizzly Creek groves (the "OWL CREEK AGREEMENT" and the "GRIZZLY CREEK AGREEMENT," respectively). The Owl Creek Agreement provides for Scotia LLC to sell, on or before June 30, 2002, the Owl Creek grove to California for the lesser of the appraised fair market value or $79.7 million. At California's option, 25% of the payment may be paid upon closing with three equal annual installments thereafter and without interest. With respect to the Grizzly Creek Agreement, California may purchase from Pacific Lumber, on or before October 31, 2000, a portion of this grove for a purchase price determined based on fair market value, but not to exceed $19.9 million. The net proceeds from the Grizzly Creek grove will be placed into an escrow account (on the same basis as the net proceeds from the sale of the Headwaters Timberlands) unless, at the time of receipt of such proceeds, the Escrowed Funds are no longer held in an escrow account. California also has a five year option under the agreement to purchase additional property adjacent to the Grizzly Creek grove which is within the Grizzly Creek conservation area. The sale of the Owl Creek or Grizzly Creek groves will not be reflected in the Company's financial statements until they have been concluded. Aluminum Operations During the first quarter of 1999, two potlines at Kaiser's 90% owned Valco facility, which were curtailed during most of 1998 (but for which Valco received compensation from the Volta River Authority in the form of energy credits), began restarting. Additionally, during the first quarter of 1999, KACC began restarting two potlines (representing approximately 50,000 tons of annual capacity) at its Mead, Washington, smelter, which were originally curtailed in September 1998 as a result of the USWA strike. One potline at Kaiser's Tacoma, Washington, smelter has been prepared for restart but remains curtailed due to Kaiser's consideration of market-related and other factors. Kaiser's first quarter results will be adversely impacted by the effect of the restart costs at the Valco and Mead facilities and the restart preparations at the Tacoma facility. During February 1999, KACC, through a subsidiary, completed the acquisition of its joint venture partner's 45% interest in Kaiser La Roche Hydrate Partners ("KLHP") for a cash purchase price of approximately $10.0 million subject to post-closing adjustments. As KACC already owned 55% of KLHP, the results of KLHP were already included in the consolidated financial statements. In January 1999, KACC signed a letter of intent to sell its 50% interest in AKW, an aluminum wheels joint venture, to its partner. The sale, which will result in Kaiser recognizing a substantial gain, is expected to be completed on or about March 31, 1999. However, as the transaction is subject to the negotiation of a definitive purchase agreement, no assurances can be given that the transaction will be completed. Kaiser's equity in income of AKW was $7.8 million and $4.8 million for the years ended December 31, 1998 and 1997, respectively. EX-99 6 EX 99.2/FIN. STMTS. OF MAXXAM GROUP INC. 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, 1998 and 1997, and the related consolidated statements of operations and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of MAXXAM Group Inc. and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP San Francisco, California March 1, 1999 MAXXAM GROUP INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (IN MILLIONS OF DOLLARS, EXCEPT SHARE INFORMATION)
DECEMBER 31, -------------------------- 1998 1997 ------------ ------------ ASSETS Current assets: Cash and cash equivalents $ 145.2 $ 89.8 Marketable securities 11.7 51.3 Receivables: Trade 10.5 19.3 Other 2.2 2.2 Inventories 40.7 58.1 Prepaid expenses and other current assets 8.0 13.1 ------------ ------------ Total current assets 218.3 233.8 Timber and timberlands, net of accumulated depletion of $246.8 and $236.8, respectively 323.6 321.2 Property, plant and equipment, net of accumulated depreciation of $94.7 and $85.4, respectively 102.6 102.8 Deferred financing costs, net 22.8 21.5 Deferred income taxes 80.3 49.6 Restricted cash 16.6 28.4 Other assets 7.2 4.2 ------------ ------------ $ 771.4 $ 761.5 ============ ============ LIABILITIES AND STOCKHOLDER'S DEFICIT Current liabilities: Accounts payable $ 3.4 $ 3.5 Accrued interest 28.4 24.3 Accrued compensation and related benefits 8.4 12.5 Deferred income taxes 8.6 9.7 Other accrued liabilities 2.4 2.6 Long-term debt, current maturities 8.3 19.4 ------------ ------------ Total current liabilities 59.5 72.0 Long-term debt, less current maturities 860.2 762.9 Other noncurrent liabilities 29.6 29.0 ------------ ------------ Total liabilities 949.3 863.9 ------------ ------------ Contingencies Stockholder's deficit: Common stock, $.08-1/3 par value; 1,000 shares authorized, 100 shares issued - - Additional capital 81.3 81.3 Accumulated deficit (259.2) (183.7) ------------ ------------ Total stockholder's deficit (177.9) (102.4) ------------ ------------ $ 771.4 $ 761.5 ============ ============
MAXXAM GROUP INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS (IN MILLIONS OF DOLLARS)
YEARS ENDED DECEMBER 31, ---------------------------------------- 1998 1997 1996 ------------ ------------ ------------ Net sales: Lumber and logs $ 213.1 $ 261.0 $ 243.7 Other 20.5 26.2 20.9 ------------ ------------ ------------ 233.6 287.2 264.6 ------------ ------------ ------------ Operating expenses: Cost of goods sold 155.3 162.0 148.5 Selling, general and administrative expenses 14.9 14.2 15.9 Depletion and depreciation 23.1 27.1 28.2 ------------ ------------ ------------ 193.3 203.3 192.6 ------------ ------------ ------------ Operating income 40.3 83.9 72.0 Other income (expense): Investment, interest and other income 9.2 13.4 10.9 Interest expense (75.3) (78.7) (78.0) ------------ ------------ ------------ Income (loss) before income taxes and extraordinary item (25.8) 18.6 4.9 Credit (provision) in lieu of income taxes 9.1 (6.0) .7 ------------ ------------ ------------ Income (loss) before extraordinary item (16.7) 12.6 5.6 Extraordinary item: Loss on early extinguishment of debt, net of income tax benefit of $22.7 (40.1) - - ------------ ------------ ------------ Net income (loss) $ (56.8) $ 12.6 $ 5.6 ============ ============ ============
MAXXAM GROUP INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (IN MILLIONS OF DOLLARS)
YEARS ENDED DECEMBER 31, ---------------------------------------- 1998 1997 1996 ------------ ------------ ------------ Cash flows from operating activities: Net income (loss) $ (56.8) $ 12.6 $ 5.6 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depletion and depreciation 23.1 27.1 28.2 Extraordinary loss on early extinguishment of debt, net 40.1 Amortization of deferred financing costs and discounts on long-term debt 10.7 15.9 14.7 Net sales (purchases) of marketable securities 42.6 (11.3) 10.3 Net gains on marketable securities (2.9) (8.6) (5.1) Increase (decrease) in cash resulting from changes in: Receivables 9.4 - 1.3 Inventories, net of depletion 14.0 9.7 6.0 Prepaid expenses and other current assets (2.7) (5.3) .7 Accounts payable (1.2) (.1) (.2) Accrued interest 4.0 (.6) (.5) Accrued and deferred income taxes (9.5) 5.6 (.9) Other liabilities (3.8) 3.3 (4.3) Other (1.8) .1 - ------------ ------------ ------------ Net cash provided by operating activities 65.2 48.4 55.8 ------------ ------------ ------------ Cash flows from investing activities: Capital expenditures (21.2) (13.5) (15.2) Net proceeds from sale of assets 6.6 .3 .1 Restricted cash withdrawals used to acquire timberlands 8.9 - - ------------ ------------ ------------ Net cash used for investing activities (5.7) (13.2) (15.1) ------------ ------------ ------------ Cash flows from financing activities: Proceeds from issuance of debt 867.2 - - Premiums for early retirement of debt (42.9) - - Principal payments on long-term debt (796.8) (16.3) (14.2) Dividends paid (18.7) (3.0) (3.9) Restricted cash withdrawals, net 9.5 1.5 1.4 Incurrence of deferred financing costs (22.4) - - ------------ ------------ ------------ Net cash used for financing activities (4.1) (17.8) (16.7) ------------ ------------ ------------ Net increase in cash and cash equivalents 55.4 17.4 24.0 Cash and cash equivalents at beginning of year 89.8 72.4 48.4 ------------ ------------ ------------ Cash and cash equivalents at end of year $ 145.2 $ 89.8 $ 72.4 ============ ============ ============
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 Corporation ("SALMON CREEK"). Pacific Lumber is engaged in several principal aspects of the lumber industry, including the growing and harvesting of redwood and Douglas-fir timber, the milling of logs into lumber and the manufacture of lumber into a variety of finished products. Britt manufactures redwood and cedar fencing and decking products from small diameter logs, a substantial portion of which are obtained from Pacific Lumber. Housing, construction and remodeling are the principal markets for the Company's lumber products. 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 9 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, 1998, 1997 and 1996. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Cash Equivalents Cash equivalents consist of highly liquid money market instruments with original maturities of three months or less. Marketable Securities Marketable securities which consist of corporate bonds and long and short positions in corporate common stocks are carried at fair value. The cost of the securities sold is determined using the first-in, first-out method. Included in investment, interest and other income for each of the three years ended December 31, 1998 were: 1998 -net unrealized holding gains of $5.1 million and net unrealized losses of $2.2 million; 1997 - net unrealized holding gains of $2.9 million and net realized gains of $5.7 million; and 1996 - net unrealized holding losses of $.9 million and net realized gains of $5.3 million. Inventories Inventories are stated at the lower of cost or market. Cost is primarily determined using the last-in, first-out ("LIFO") method. Timber and Timberlands Timber and timberlands are stated at cost, net of accumulated depletion. Depletion is computed utilizing the unit-of-production method based upon estimates of timber values and quantities. Property, Plant and Equipment Property, plant and equipment, including capitalized interest, is stated at cost, net of accumulated depreciation. Depreciation is computed utilizing the straight-line method at rates based upon the estimated useful lives of the various classes of assets. The carrying value of property, plant and equipment is assessed when events and circumstances indicate that an impairment is present. Impairment is determined by measuring 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 At December 31, 1998, cash and cash equivalents includes $28.4 million, which is reserved 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"). At December 31, 1997, cash and cash equivalents includes $17.8 million, which was reserved for debt service payments on the Company's 7.95% Timber Collateralized Notes due 2015 (the "OLD TIMBER NOTES"). Long-term restricted cash 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. Long-term restricted cash at December 31, 1997 primarily represents the amount held by the trustee in the liquidity account (the "LIQUIDITY ACCOUNT") maintained by Scotia Pacific with respect to the Old Timber Notes for the benefit of holders of the Old Timber Notes under the indenture governing the Old Timber Notes. Also included in cash and cash equivalents is restricted cash of $46.4 million and $9.7 million of December 31, 1998 and 1997, respectively, which is held in an interest-bearing account as security for short position in marketable securities. Concentrations of Credit Risk The amounts held by the trustee in an account restricted for debt service payments on the Timber Notes (the "PAYMENT ACCOUNT") and held in the Prefunding Account for purchase of timberlands are invested primarily in commercial paper and other short-term investments. The Company mitigates its concentration of credit risk with respect to these restricted cash deposits by purchasing only high grade investments (ratings of A1/P1 short-term or AAA/aaa long-term debt) having maturities of less than three months. No more than 10% is invested within the same issue. Fair Value of Financial Instruments The carrying amounts of cash equivalents and restricted cash approximate fair value. Marketable securities are carried at fair value which is determined based on quoted market prices. As of December 31, 1998 and 1997, the estimated fair value of long-term debt, including current maturities, was $807.9 million and $816.0 million, respectively. The estimated fair value of long-term 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. Some of the Company's publicly traded debt issues are thinly traded financial instruments; accordingly, their market prices at any balance sheet date may not be representative of the prices which would be derived from a more active market. 2. INVENTORIES Inventories consist of the following (in millions):
DECEMBER 31, -------------------------- 1998 1997 ------------ ------------ Lumber $ 29.9 $ 43.7 Logs 10.8 14.4 ------------ ------------ $ 40.7 $ 58.1 ============ ============
3. PROPERTY, PLANT AND EQUIPMENT The major classes of property, plant and equipment are as follows (dollar amounts in millions):
DECEMBER 31, ------------------------- ESTIMATED USEFUL LIVES 1998 1997 ------------ ------------ ----------- Logging roads, land and improvements 15 years $ 21.3 $ 16.7 Buildings 33 years 37.9 36.6 Machinery and equipment 3 - 15 years 138.1 134.8 Construction in progress - .1 ------------ ------------ 197.3 188.2 Less: accumulated depreciation (94.7) (85.4) ------------ ------------ $ 102.6 $ 102.8 ============ ============
Depreciation expense for the years ended December 31, 1998, 1997 and 1996 was $9.2 million, $9.8 million and $9.4 million, respectively. 4. LONG-TERM DEBT Long-term debt consists of the following (in millions):
DECEMBER 31, -------------------------- 1998 1997 ------------ ------------ 7.43% Scotia LLC Timber Collateralized Notes due July 20, 2028 $ 867.2 $ - 7.95% Scotia Pacific Timber Collateralized Notes due through July 20, 2015 - 320.0 10-1/2% Pacific Lumber Senior Notes due March 1, 2003 - 235.0 Pacific Lumber Credit Agreement - 9.4 11-1/4% MGI Senior Secured Notes due August 1, 2003 - 100.0 12-1/4% MGI Senior Secured Discount Notes due August 1, 2003, net of discount - 117.3 Other 1.3 .6 ------------ ------------ 868.5 782.3 Less: current maturities (8.3) (19.4) ------------ ------------ $ 860.2 $ 762.9 ============ ============
Scotia LLC Timber Collateralized Notes due 2028 On July 20, 1998, Scotia LLC issued $867.2 million aggregate principal amount of Timber Notes which mature on July 20, 2028 and have an overall effective interest rate of 7.43% per annum. Net proceeds from the offering of the Timber Notes were used primarily to prepay the Old Timber Notes and to redeem the 10-1/2% Pacific Lumber Senior Notes, the 11-1/4% MGI Senior Secured Notes and the 12-1/4% MGI Senior Secured Discount Notes (collectively, the "MGI NOTES") effective August 19, 1998. 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 of the Old Timber Notes, the Pacific Lumber Senior Notes and the MGI Notes. Concurrently with the issuance of the Timber Notes, (i) Scotia Pacific was merged into Scotia LLC, (ii) Pacific Lumber transferred to Scotia LLC approximately 13,500 acres of timberlands and the timber and timber harvesting rights with respect to an additional 19,700 acres of timberlands, and (iii) Scotia LLC transferred to Pacific Lumber the timber and timber harvesting rights related to approximately 1,400 acres of timberlands. Under the Timber Notes Indenture, the business activities of Scotia LLC are generally limited to the ownership and operation of its timber and timberlands. The Timber Notes are senior secured obligations of Scotia LLC and are not obligations of, or guaranteed by, Pacific Lumber or any other person. The Timber Notes are secured by a lien on (i) Scotia LLC's timber and timberlands (representing $252.0 million of the Company's consolidated timber and timberlands balance at December 31, 1998), and (ii) substantially all of Scotia LLC's other property. Interest on the Timber Notes is further secured by a line of credit agreement between Scotia LLC and a bank pursuant to which Scotia LLC may borrow to pay interest on the Timber Notes. 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 $160.7 million of Class A-1 Timber Notes). The Timber Notes are 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 in order to avoid an Event of Default 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. Principal and interest on the Timber Notes are payable semi- annually on January 20 and July 20. The Timber Notes are redeemable at the option of Scotia LLC at any time. The redemption price of the Timber Notes is equal to the sum of the principal amount, accrued interest and a prepayment premium calculated based upon the yield of like-term Treasury securities plus 50 basis points. As a result of the sale of approximately 5,600 acres of Pacific Lumber's timberlands consisting of two forest groves commonly referred to as the Headwater Forest and Elk Head Springs Forest (the "HEADWATERS TIMBERLANDS") on March 1, 1999, Salmon Creek received proceeds of $299.9 million in cash. See Note 12 to the Consolidated Financial Statements. Salmon Creek has deposited approximately $285.0 million of such proceeds into an escrow account (the "ESCROWED FUNDS"), pursuant to an escrow agreement (the "ESCROW AGREEMENT") as necessary to support the Timber Notes. The net proceeds of the sale of the Grizzly Creek grove will also be placed in escrow (on the same basis as the net proceeds of the sale of the Headwaters Timberlands) unless, at the time of receipt of such proceeds, funds are no longer on deposit under the Escrow Agreement. Under the Escrow Agreement, the Escrowed Funds will be released by the Escrow Agent only in accordance with resolutions duly adopted by the Board of Managers of Scotia LLC and, unless the resolutions authorize the payment of funds exclusively to, or to the order of, the Trustee or the Collateral Agent under the Timber Notes Indenture, only if one or more of the following conditions are satisfied: (a) the resolutions authorizing the release of the Escrowed Funds are adopted by a majority of the Board of Managers of Scotia LLC (including the affirmative vote of the two independent managers); (b) a Rating Agency Confirmation (as defined in the Timber Notes Indenture) has been received that gives effect to the release or disposition of funds directed by the resolutions; or (c) Scotia LLC has received an opinion from a nationally recognized investment banking firm to the effect that, based on the revised harvest schedule and the other assumptions provided to such firm, the funds that would be available to Scotia LLC based on such harvest schedule, assumptions and otherwise under the Timber Notes Indenture after giving effect to the release or disposition of funds directed by such resolutions would be adequate (i) to pay Scheduled Amortization (as defined in the Timber Notes Indenture) on the Class A-1 and Class A-2 Timber Notes and (ii) to amortize the Class A-3 Timber Notes on a schedule consistent with the original harvest schedule as of July 9, 1998 (assuming that the Class A-3 Timber Notes are not refinanced on January 20, 2014). Pacific Lumber Credit Agreement On December 18, 1998, the Pacific Lumber Credit Agreement was amended and restated as a new three-year senior secured credit facility which expires on October 31, 2001. The new facility allows for borrowings of up to $60 million, all of which may be used for revolving borrowings, $20 million of which may be used for standby letters of credit and $30 million of which may be used for timberland acquisitions . Borrowings would be secured by all of Pacific Lumber's domestic accounts receivable and inventory. Borrowings for timberland acquisitions would also be secured by the acquired timberlands and, commencing in April 2001, are to be repaid annually from 50% of Pacific Lumber's 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, 1998, Pacific Lumber had $27.5 million of borrowings available under the agreement, no borrowings were outstanding and letters of credit outstanding amounted to $14.4 million. Maturities Scheduled maturities of long-term debt for the five years following December 31, 1998, using the Scheduled Amortization for the Timber Notes, are: $8.3 million in 1999, $16.1 million in 2000, $16.5 million in 2001, $17.3 million in 2002, $19.5 million in 2003 and $790.8 million thereafter. Restricted Net Assets of Subsidiaries As of December 31, 1998 and 1997, 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, 1998, 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. 5. CREDIT (PROVISION) IN LIEU OF INCOME TAXES Income taxes are determined using an asset and liability approach which requires the recognition of deferred income tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. Under this method, deferred income tax assets and liabilities are determined based on the temporary differences between the financial statement and tax bases of assets and liabilities using enacted tax rates. The Company and its subsidiaries are members of MAXXAM's consolidated return group for federal income tax purposes. Pursuant to a tax allocation agreement between MAXXAM, Pacific Lumber, 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. The remaining subsidiaries of MGI are each liable to MAXXAM for their respective income tax liabilities computed on a separate company basis as if they were never connected with MAXXAM, pursuant to their respective tax allocation agreements. MGI's tax allocation agreement with MAXXAM (the "TAX ALLOCATION AGREEMENT") provides that the Company's federal income tax liability is computed as if MGI files a consolidated tax return with all of its subsidiaries except Salmon Creek, and that such corporations were never connected with MAXXAM (the "MGI CONSOLIDATED TAX LIABILITY"). The federal income tax liability of MGI is the difference between (i) the MGI Consolidated Tax Liability and (ii) the sum of the separate tax liabilities for the Company's subsidiaries (computed as discussed above), but excluding Salmon Creek. To the extent that the MGI Consolidated Tax Liability is less than the aggregate amounts in (ii), MAXXAM is obligated to pay the amount of such difference to MGI. The credit (provision) in lieu of income taxes on income (loss) before income taxes and extraordinary item consists of the following (in millions):
YEARS ENDED DECEMBER 31, ---------------------------------------- 1998 1997 1996 ------------ ------------ ------------ Current: Federal in lieu of income taxes $ .1 $ (.4) $ (.1) State and local (.1) (.2) - ------------ ------------ ------------ - (.6) (.1) ------------ ------------ ------------ Deferred: Federal in lieu of income taxes 6.9 (5.5) .4 State and local 2.2 .1 .4 ------------ ------------ ------------ 9.1 (5.4) .8 ------------ ------------ ------------ $ 9.1 $ (6.0) $ .7 ============ ============ ============
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, ---------------------------------------- 1998 1997 1996 ------------ ------------ ------------ Income (loss) before income taxes and extraordinary item $ (25.8) $ 18.6 $ 4.9 ============ ============ ============ Amount of federal income tax credit (provision) based upon the statutory rate $ 9.0 $ (6.5) $ (1.7) Revision of prior years' tax estimates and other changes in valuation allowances (1.1) 1.0 3.4 Expenses for which no federal tax benefit is available (.3) (.2) (.5) State and local taxes, net of federal tax effect 1.4 (.1) (.6) Other .1 (.2) .1 ------------ ------------ ------------ $ 9.1 $ (6.0) $ .7 ============ ============ ============
The revision of prior years' tax estimates and other changes in valuation allowances as shown in the table above include amounts for the reversal of reserves which the Company no longer believes are necessary, other changes in prior 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, 1996, the reversal of reserves which the Company believes are no longer necessary resulted in a credit to the income tax provision of $3.2 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, -------------------------- 1998 1997 ------------ ------------ Deferred income tax assets: Loss and credit carryforwards $ 112.0 $ 68.1 Timber and timberlands 29.3 25.8 Other 10.9 32.3 Valuation allowances (47.8) (49.8) ------------ ------------ Total deferred income tax assets, net 104.4 76.4 ------------ ------------ Deferred income tax liabilities: Property, plant and equipment (15.2) (17.5) Inventories (8.8) (12.7) Other (8.7) (6.3) ------------ ------------ Total deferred income tax liabilities (32.7) (36.5) ------------ ------------ Net deferred income tax assets $ 71.7 $ 39.9 ============ ============
The valuation allowances listed above relate to loss and credit carryforwards. As of December 31, 1998, approximately $64.2 million of the deferred income tax assets listed above 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. Also included in net deferred income tax assets as of December 31, 1998 is $29.3 million which relates to the excess of the tax basis over financial statement basis with respect to timber and timberlands. The Company believes that it is more likely than not that this net deferred income tax asset will be realized, based primarily upon the estimated value of its timber and timberlands which is well in excess of its tax basis. Included in the net deferred income tax assets listed above are $64.4 million and $35.6 million at December 31, 1998 and 1997, 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, 1998, under the terms of the respective tax allocation agreements (dollar amounts in millions). The utilization of certain of these attributes is subject to limitations.
EXPIRING THROUGH ------------- Regular Tax Attribute Carryforwards: Net operating losses $ 304.0 2018 Alternative Minimum Tax Attribute Carryforwards: Net operating losses $ 272.2 2018
6. EMPLOYEE BENEFIT PLANS In the fourth quarter of 1998, the Company adopted Statement of Financial Accounting Standards No. 132, "Employers' Disclosures About Pension and Other Postretirement Benefits" ("SFAS NO. 132"), which amends Statements of Financial Accounting Standards Nos. 87, 88 and 106. SFAS No. 132, among other things, standardizes the disclosure requirements for pensions and other postretirement benefits and suggests combined formats for presentation of such disclosures, but has no impact on the computation of the reported amounts. Prior year disclosures have been revised to comply with SFAS No. 132. 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 termination of employment and retirement and commencement of pension benefits. Participants make contributions for a portion of the cost of their health care benefits. The expected costs of postretirement medical benefits are accrued over the period the employees provide services to the date of their full eligibility for such benefits. The following tables present the changes, status and assumptions of Pacific Lumber's pension and other postretirement benefit plans as of December 31, 1998 ( in millions):
PENSION MEDICAL/LIFE BENEFITS BENEFITS --------------------------- --------------------------- DECEMBER 31, ------------------------------------------------------ 1998 1997 1998 1997 ------------ ------------ ------------ ------------ Change in benefit obligation: Benefit obligation at beginning of year $ 28.9 $ 23.6 $ 5.0 $ 5.9 Service cost 2.2 1.9 .3 .3 Interest cost 2.2 1.9 .3 .3 Plan participants' contributions - - .2 .3 Plan amendments - .9 - - Actuarial (gain) loss 1.6 1.1 (.5) (1.1) Benefits paid (.6) (.5) (.3) (.7) ------------ ------------ ------------ ------------ Benefit obligation at end of year 34.3 28.9 5.0 5.0 ------------ ------------ ------------ ------------ Change in plan assets: Fair value of plan assets at beginning of year 25.9 21.8 - - Actual return on assets 3.5 4.0 - - Employer contributions 1.1 .6 .1 .4 Plan participants' contributions - - .2 .3 Benefits paid (.6) (.5) (.3) (.7) ------------ ------------ ------------ ------------ Fair value of plan assets at end of year 29.9 25.9 - - ------------ ------------ ------------ ------------ Benefit obligation in excess of plan assets 4.4 3.0 5.0 5.0 Unrecognized actuarial gain 4.4 4.2 1.5 1.0 Unrecognized prior service costs (.9) (.9) - - ------------ ------------ ------------ ------------ Accrued benefit liability $ 7.9 $ 6.3 $ 6.5 $ 6.0 ============ ============ ============ ============
MEDICAL/LIFE PENSION BENEFITS BENEFITS ------------------------------------------ ---------------------------------------- YEAR ENDED DECEMBER 31, ----------------------------------------------------------------------------------- 1998 1997 1996 1998 1997 1996 ------------- ------------ ------------ ------------ ------------ ------------ Components of net periodic benefit costs: Service cost $ 2.2 $ 1.9 $ 1.9 $ .3 $ .3 $ .3 Interest cost 2.2 1.9 1.7 .3 .4 .4 Expected return on assets (1.8) (1.5) (1.3) - - - Amortization of prior service costs .1 - - - - - Recognized net actuarial (gain) loss - - - (.1) (.1) - ------------- ------------ ------------ ------------ ------------ ------------ Adjusted net periodic benefit costs $ 2.7 $ 2.3 $ 2.3 $ .5 $ .6 $ .7 ============= ============ ============ ============ ============ ============
PENSION BENEFITS MEDICAL/LIFE BENEFITS ------------------------------------------ ----------------------------------------- YEAR ENDED DECEMBER 31, ----------------------------------------------------------------------------------- 1998 1997 1996 1998 1997 1996 ------------- ------------ ------------ ------------ ------------ ------------ Weighted-average assumptions: Discount rate 7.0% 7.3% 7.5% 7.0% 7.3% 7.5% 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, 1998 would have the following effects (in millions):
1-PERCENTAGE-POINT 1-PERCENTAGE-POINT INCREASE DECREASE ---------------------- ---------------------- Effect on total of service and interest cost components $.1 $ (.1) Effect on the postretirement benefit obligations .7 (.6)
Employee Savings Plan Pacific Lumber's employees are eligible to participate in a defined contribution savings plan sponsored by MAXXAM. This plan is designed to enhance the existing retirement programs of participating employees. Employees may elect to defer up to 16% of their base compensation to the plan. For those participants who have elected to defer a portion of their compensation to the plan, Pacific Lumber's matching contributions are dollar for dollar up to 4% of the participant's contributions for each pay period. The cost to the Company of this plan was $1.4 million, $1.5 million and $1.4 million for the years ended December 31, 1998, 1997 and 1996, 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 $10.8 million at both December 31, 1998 and 1997. Workers' compensation expenses amounted to $3.5 million, $4.7 million and $2.6 million for the years ended December 31, 1998, 1997 and 1996, respectively. 7. RELATED PARTY TRANSACTIONS MAXXAM provides the Company and certain of the Company's subsidiaries with accounting and data processing services. In addition, MAXXAM provides the Company with office space and various office personnel, insurance, legal, operating, financial and certain other services. MAXXAM's expenses incurred on behalf of the Company are reimbursed by the Company through payments consisting of (i) an allocation of the lease expense for the office space utilized by or on behalf of the Company and (ii) a reimbursement of actual out-of-pocket expenses incurred by MAXXAM, including, but not limited to, labor costs of MAXXAM personnel rendering services to the Company. Charges by MAXXAM for such services were $3.4 million, $2.2 million and $2.4 million for the years ended December 31, 1998, 1997 and 1996, respectively. The Company believes that the services being rendered are on terms not less favorable to the Company than those which would be obtainable from unaffiliated third parties. 8. STOCKHOLDER'S DEFICIT Changes in stockholder's deficit were (in millions):
COMMON STOCK ($.08-1/3 ADDITIONAL ACCUMULATED PAR) CAPITAL DEFICIT TOTAL ------------ ------------ ------------ ------------ Balance, January 1, 1996 $ - $ 81.3 $ (195.0) $ (113.7) Net income - - 5.6 5.6 Dividends - - (3.9) (3.9) ------------ ------------ ------------ ------------ 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) ============ ============ ============ ============
9. CONTINGENCIES Regulatory and environmental matters play a significant role in the Company's business, which is subject to a variety of California and federal laws and regulations, as well as the Final HCP and Final SYP (defined below), dealing with timber harvesting practices, threatened and endangered species and habitat for such species, and air and water quality. While regulatory and environmental concerns have resulted in restrictions on the geographic scope and timing of the Company's timber operations, increased operational costs and engendered litigation and other challenges to the Company's operations, prior to 1998 they have not had a significant adverse effect on the Company's financial position, results of operations or liquidity. However, the Company's 1998 results of operations were adversely affected by certain regulatory and environmental matters, including during the second half of 1998, the absence of a sufficient number of available THPs to enable the Company to conduct its operations at historic levels. On September 28, 1996, Pacific Lumber, including its subsidiaries and affiliates, and MAXXAM (the "PACIFIC LUMBER PARTIES") entered into an agreement (the "HEADWATERS AGREEMENT") with the United States and California which provided the framework for the acquisition of the Headwaters Timberlands by the United States and California. Consummation of the Headwaters Agreement was also conditioned upon, among other things: approval of a sustained yield plan establishing long-term sustained yield ("LTSY") harvest levels for Pacific Lumber's timberlands (the "SYP"), approval of a habitat conservation plan (the "HCP") covering multiple species (the "MULTI-SPECIES HCP") and issuance of incidental take permits related to the Multi-Species HCP ("PERMITS"). As further described in Note 12 "Subsequent Events," on March 1, 1999, the Pacific Lumber Parties, the United States and California consummated the Headwaters Agreement. In addition to the transfer of the Headwaters Timberlands by the Pacific Lumber Parties described in Note 12, Pacific Lumber received an approved SYP (the "FINAL SYP"), Multi-Species HCP (the "FINAL HCP") and related Permits. The Pacific Lumber Parties and California also executed an agreement regarding the enforcement of the California bill which authorized state funds for the purchase of the Headwaters Timberlands while imposing certain restrictions on the remaining timberlands held by the Pacific Lumber Parties (the "CALIFORNIA AGREEMENT"). The Final 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 establish an LTSY harvest level. An SYP must demonstrate that the average annual harvest over any rolling ten-year period will not exceed the LTSY harvest level and that a timber company's projected timber inventory is capable of sustaining the LTSY harvest level in the last decade of the 100-year planning period. Under the Final SYP, the Company's projected base average annual harvest level in the first decade could be approximately 179 million board feet of softwoods. The Final SYP is effective for 10 years, and may be amended by Pacific Lumber subject to approval by the CDF. The Final SYP is subject to review after five years. Revised SYPs would be prepared every decade that address the LTSY harvest level based upon reassessment of changes in the resource base and other factors. Several species, including the northern spotted owl, the marbled murrelet, the coho salmon and the steelhead trout, have been listed as endangered or threatened under the ESA and/or the California Endangered Species Act (the "CESA"). The Final HCP and the Permits allow incidental "take" of listed species so long as there is no "jeopardy" to the continued existence of such species. The Final HCP identifies the measures to be instituted in order to minimize and mitigate the anticipated level of take to the greatest extent practicable. The Final HCP not only provides for the Company's compliance with habitat requirements for the northern spotted owl, the marbled murrelet, the coho salmon and the steelhead trout, it also provides for issuance of Permits for thirteen additional species that are or may be listed in the future. The Final HCP and related Permits have a term of 50 years, and, among other things, include the following protective measures: (i) setting aside timberlands as marbled murrelet conservation areas; (ii) establishing streamside "no-cut" and limited cut buffers as well as mass wasting areas based on a five-year assessment of each of the Company's watersheds; (iii) limiting harvesting activities during wet weather conditions, and (iv) making certain specified improvements to the Company's roads. The Final SYP is also subject to the foregoing provisions. The Company believes that the Final SYP and the Final HCP should in the long-term expedite the preparation and facilitate approval of its THPs, although there can be no assurance that the Company will not face difficulties in the THP submission and approval process as it implements these agreements. Lawsuits are threatened which seek to prevent the Company from implementing the Final HCP and the Final SYP, and lawsuits are pending concerning certain of the Company's approved THPs or other operations. On January 26, 1998 an action entitled Coho Salmon, et al v. Pacific Lumber, et al, (the "COHO LAWSUIT") was filed against Pacific Lumber, Scotia Pacific and Salmon Creek. This action alleged, 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. In March 1999, the Coho lawsuit was dismissed, with prejudice. Pacific Lumber has also received notice of additional threatened actions with respect to the coho salmon. On August 12, 1998, an action entitled Environmental Protection Information Center, Inc., Sierra Club v. Pacific Lumber, Scotia Pacific and Salmon Creek (the "EPIC LAWSUIT") was filed by two environmental groups against Pacific Lumber, Scotia Pacific and Salmon Creek under which the environmental groups allege that certain procedural violations of the federal Endangered Species Act (the "ESA") have resulted from logging activities on the Company's timberlands and seek to prevent the defendants from carrying out any harvesting activities until certain wildlife consultation requirements under the ESA are satisfied in connection with the development of the Final HCP. In March 1999, the court affirmed a preliminary injunction on harvesting on three THPs; however, it subsequently heard Pacific Lumber's motion to dismiss the case and issued an order for the plaintiffs to show cause why the lawsuit should not be dismissed as moot since the consultation requirement appears to have been concluded. On or about January 29, 1999, the Company received a notice from EPIC and the Sierra Club ("EPIC NOTICE LETTER") of their intent to sue Pacific Lumber and several federal and state agencies under the ESA. The letter alleges various violations of the ESA and challenges, among other things, the validity and legality of the Permits. The Company is unable to predict the outcome of either the EPIC lawsuit or the EPIC Notice Letter or their ultimate impact on the Company's financial condition or results of operations or the ability to harvest timber on its THPs. While the Company expects environmentally focused objections and lawsuits to continue, it believes that the Final HCP and the Permits should enhance its position in connection with these challenges. On November 9, 1998, the California Department of Forestry and Fire Protection ("CDF") notified Pacific Lumber that it had suspended Pacific Lumber's 1998 timber operator's license ("TOL"). As a result, Pacific Lumber ceased all operations under its TOL and made the necessary arrangements for independent contract loggers to be substituted where necessary (independent contractors historically account for approximately 60% of the harvesting activities on the Company's timberlands). On February 26, 1999, the CDF issued Pacific Lumber a conditional TOL for 1999. The 1999 TOL contains provisions which limit the use of roads during wet weather conditions and provides for an enhanced compliance program. The CDF has also advised Pacific Lumber that if the 1999 TOL is revoked, issuance of a new conditional license would be unlikely. The Company does not believe that the restrictions imposed by the 1999 TOL will have an adverse effect on Pacific Lumber's or the Company's financial condition or results of operations. 10. SUPPLEMENTAL CASH FLOW AND OTHER INFORMATION
YEARS ENDED DECEMBER 31, ---------------------------------------- 1998 1997 1996 ------------ ------------ ------------ (IN MILLIONS) Supplemental information on non-cash investing and financing activities: Acquisition of assets subject to other liabilities $ .8 $ 9.4 $ - Supplemental disclosure of cash flow information: Interest paid, net of capitalized interest $ 62.7 $ 63.6 $ 63.8 Income taxes paid (refunded) - .2 (2.9) Tax allocation payments to MAXXAM .2 .4 .2
11. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) Summary quarterly financial information for the years ended December 31, 1998 and 1997 is as follows (in millions):
THREE MONTHS ENDED ------------------------------------------------------ MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 ------------ ------------ ------------ ------------ 1998: Net sales $ 51.9 $ 63.5 $ 65.9 $ 52.3 Operating income 10.0 14.6 12.7 3.0 Income (loss) before extraordinary item (3.1) (1.8) (5.3) (6.5) Extraordinary item net - - (40.1) - Net income (loss) (3.1) (1.8) (45.4) (6.5) 1997: Net sales $ 66.8 $ 76.8 $ 72.8 $ 70.8 Operating income 18.7 24.1 22.8 18.3 Net income - 5.4 4.1 3.1
12. SUBSEQUENT EVENT As described in Note 9 above, on September 28, 1996, the Pacific Lumber Parties entered into the Headwaters Agreement with the United States and California which provided the framework for the acquisition by the United States and California of the Headwaters Timberlands. A substantial portion of the Headwaters Timberlands contain virgin old growth timber. Approximately 4,900 of these acres were owned by Salmon Creek, with the remaining acreage being owned by Pacific Lumber and Scotia LLC (Pacific Lumber owning the timber and related timber harvesting rights on Scotia LLC's acreage). On March 1, 1999, the Pacific Lumber Parties, the United States and California consummated the Headwaters Agreement. 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 are to be contributed to Scotia LLC on or before August 1999. Approximately $285.0 million of these proceeds have been deposited into an escrow account held by an escrow agent and are to be made available as necessary to support the Timber Notes, and may be released only under certain circumstances. As a result of the disposition of the Headwaters Timberlands, the Company expects to recognize a pre-tax gain of approximately $240.0 million ($142.0 million, net of tax) in the first quarter of 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 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 will be reflected in the Company's financial statements at approximately $6.0 million 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 to California of the Owl Creek and Grizzly Creek groves (the "OWL CREEK AGREEMENT" and the "GRIZZLY CREEK AGREEMENT," respectively). The Owl Creek Agreement provides for Scotia LLC to sell, on or before June 30, 2002, the Owl Creek grove to California for the lesser of the appraised fair market value or $79.7 million. At California's option, 25% of the payment may be paid upon closing with three equal annual installments thereafter and without interest. With respect to the Grizzly Creek Agreement, California may purchase from Pacific Lumber, on or before October 31, 2000, a portion of this grove for a purchase price determined based on fair market value, but not to exceed $19.9 million. The net proceeds from the Grizzly Creek grove will be placed into an escrow account (on the same basis as the net proceeds from the sale of the Headwaters Timberlands) unless, at the time of receipt of such proceeds, the Escrowed Funds are no longer held in an escrow account. California also has a five year option under the agreement to purchase additional property adjacent to the Grizzly Creek grove which is within the Grizzly Creek conservation area. The sale of the Owl Creek or Grizzly Creek groves will not be reflected in the Company's financial statements until they have been concluded. EX-99 7 EXHIBIT 99.3 KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES R E P O R T O F I N D E P E N D E N T P U B L I C A C C O U N T A N T S To the Stockholders and the Board of Directors of Kaiser Aluminum Corporation: We have audited the accompanying consolidated balance sheets of Kaiser Aluminum Corporation (a Delaware corporation) and subsidiaries as of December 31, 1998 and 1997, and the related statements of consolidated income (loss) and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Kaiser Aluminum Corporation and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Houston, Texas February 28, 1999 KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES C O N S O L I D A T E D B A L A N C E S H E E T S
December 31, ------------------------------ (In millions of dollars, except share amounts) 1998 1997 ------------------------------------------------------------------------------------------ ASSETS Current assets: Cash and cash equivalents $ 98.3 $ 15.8 Receivables: Trade, less allowance for doubtful receivables of $6.2 in 1998 and $5.8 in 1997 170.1 232.9 Other 112.6 107.3 Inventories 543.5 568.3 Prepaid expenses and other current assets 105.5 121.3 -------------- -------------- Total current assets 1,030.0 1,045.6 Investments in and advances to unconsolidated affiliates 128.3 148.6 Property, plant, and equipment - net 1,108.7 1,171.8 Deferred income taxes 377.9 330.6 Other assets 346.0 317.3 -------------- -------------- Total $ 2,990.9 $ 3,013.9 ============== ============== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 173.3 $ 176.2 Accrued interest 37.3 37.6 Accrued salaries, wages, and related expenses 73.8 97.9 Accrued postretirement medical benefit obligation - current portion 48.2 45.3 Other accrued liabilities 148.3 145.6 Payable to affiliates 77.1 82.7 Long-term debt - current portion .4 8.8 -------------- -------------- Total current liabilities 558.4 594.1 Long-term liabilities 532.9 491.9 Accrued postretirement medical benefit obligation 694.3 720.3 Long-term debt 962.6 962.9 Minority interests 123.5 127.7 Commitments and contingencies Stockholders' equity: Common stock, par value $.01, authorized 100,000,000 shares; issued and outstanding, 79,153,543 and 78,980,881 in 1998 and 1997 .8 .8 Additional capital 535.4 533.8 Accumulated deficit (417.0) (417.6) -------------- -------------- Total stockholders' equity 119.2 117.0 -------------- -------------- Total $ 2,990.9 $ 3,013.9 ============== ==============
The accompanying notes to consolidated financial statements are an integral part of these statements. KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES S T A T E M E N T S O F C O N S O L I D A T E D I N C O M E ( L O S S )
Year Ended December 31, ---------------------------------------------- (In millions of dollars, except share amounts) 1998 1997 1996 ---------------------------------------------------------------------------------------------------------- Net sales $ 2,256.4 $ 2,373.2 $ 2,190.5 -------------- -------------- -------------- Costs and expenses: Cost of products sold 1,906.2 1,951.2 1,857.5 Depreciation and amortization 99.1 102.5 107.6 Selling, administrative, research and development, and general 115.5 131.8 127.6 Impairment of Micromill(TM) assets/restructuring of operations 45.0 19.7 - -------------- -------------- -------------- Total costs and expenses 2,165.8 2,205.2 2,092.7 -------------- -------------- -------------- Operating income 90.6 168.0 97.8 Other income (expense): Interest expense (110.0) (110.7) (93.4) Other - net 3.5 3.0 (2.7) -------------- -------------- -------------- Income (loss) before income taxes and minority interests (15.9) 60.3 1.7 Benefit (provision) for income taxes 16.4 (8.8) 9.3 Minority interests .1 (3.5) (2.8) -------------- -------------- -------------- Net income .6 48.0 8.2 Dividends on preferred stock - (5.5) (8.4) -------------- -------------- -------------- Net income (loss) available to common shareholders $ .6 $ 42.5 $ (.2) ============== ============== ============== Earnings per share: Basic $ .01 $ .57 $ .00 ============== ============== ============== Diluted $ .01 $ .57 $ .00 ============== ============== ============== Weighted average shares outstanding (000): Basic 79,115 74,221 71,644 ============== ============== ============= Diluted 79,156 74,382 71,644 ============== ============== ==============
The accompanying notes to consolidated financial statements are an integral part of these statements. KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES S T A T E M E N T S O F C O N S O L I D A T E D C A S H F L O W S
Year Ended December 31, ---------------------------------------------- (In millions of dollars) 1998 1997 1996 -------------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net income $ .6 $ 48.0 $ 8.2 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization (including deferred financing costs) 103.0 108.6 113.2 Impairment of Micromill assets/restructuring of operations 45.0 19.7 - Non-cash benefit for income taxes (8.3) (12.5) - Equity in (income) loss of unconsolidated affiliates, net of distributions .1 7.8 3.0 Minority interests (.1) 3.5 2.8 Decrease (increase) in receivables 61.5 (92.1) 51.8 Decrease (increase) in inventories 24.8 (9.3) (36.5) Decrease (increase) in prepaid expenses and other assets 2.5 7.8 (39.5) (Decrease) increase in accounts payable and accrued interest (3.2) (11.5) 8.8 Decrease in payable to affiliates and accrued liabilities (41.6) (19.6) (62.9) Decrease in accrued and deferred income taxes (26.2) (17.4) (36.5) Other 12.6 12.0 9.5 -------------- -------------- -------------- Net cash provided by operating activities 170.7 45.0 21.9 -------------- -------------- -------------- Cash flows from investing activities: Additions to property, plant, and equipment (77.6) (128.5) (161.5) Other 3.2 19.9 17.2 -------------- -------------- -------------- Net cash used for investing activities (74.4) (108.6) (144.3) -------------- -------------- -------------- Cash flows from financing activities: Repayments under revolving credit facility, net - - (13.1) Borrowings of long-term debt - 19.0 225.9 Repayments of long-term debt (8.9) (8.8) (9.0) Incurrence of financing costs (.6) (.9) (6.2) Dividends paid - (4.2) (10.5) Capital stock issued .1 .4 - Decrease (increase) in restricted cash, net 4.3 (5.3) - Redemption of minority interests' preference stock (8.7) (2.1) (5.3) -------------- -------------- -------------- Net cash (used for) provided by financing activities (13.8) (1.9) 181.8 -------------- -------------- -------------- Net increase (decrease) in Cash and cash equivalents during the year 82.5 (65.5) 59.4 Cash and cash equivalents at beginning of year 15.8 81.3 21.9 -------------- -------------- -------------- Cash and cash equivalents at end of year $ 98.3 $ 15.8 $ 81.3 ============== ============== ============== Supplemental disclosure of cash flow information: Interest paid, net of capitalized interest $ 106.3 $ 102.7 $ 84.2 Income taxes paid 16.8 24.4 22.7 Tax allocation payments to MAXXAM Inc. - 11.8 1.1
The accompanying notes to consolidated financial statements are an integral part of these statements. KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In millions of dollars, except share amounts) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the statements of Kaiser Aluminum Corporation ("Kaiser" or the "Company") and its majority owned subsidiaries. The Company is a subsidiary of MAXXAM Inc. ("MAXXAM") and conducts its operations through its wholly owned subsidiary, Kaiser Aluminum & Chemical Corporation ("KACC"). KACC operates in all principal aspects of the aluminum industry-the mining of bauxite (the major aluminum bearing ore), the refining of bauxite into alumina (the intermediate material), the production of primary aluminum, and the manufacture of fabricated and semi-fabricated aluminum products. Kaiser's production levels of alumina and primary aluminum exceed its internal processing needs, which allows it to be a major seller of alumina and primary aluminum to domestic and international third parties (see Note 11). The preparation of financial statements in accordance with generally accepted accounting principles requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities known to exist as of the date the financial statements are published, and the reported amounts of revenues and expenses during the reporting period. Uncertainties, with respect to such estimates and assumptions, are inherent in the preparation of the Company's consolidated financial statements; accordingly, it is possible that the actual results could differ from these estimates and assumptions, which could have a material effect on the reported amounts of the Company's consolidated financial position and results of operation. Investments in 50%-or-less-owned entities are accounted for primarily by the equity method. Intercompany balances and transactions are eliminated. Certain reclassifications of prior-year information were made to conform to the current presentation. CASH AND CASH EQUIVALENTS The Company considers only those short-term, highly liquid investments with original maturities of 90 days or less to be cash equivalents. INVENTORIES Substantially all product inventories are stated at last-in, first-out ("LIFO") cost, not in excess of market value. Replacement cost is not in excess of LIFO cost. Other inventories, principally operating supplies and repair and maintenance parts, are stated at the lower of average cost or market. Inventory costs consist of material, labor, and manufacturing overhead, including depreciation. Inventories consist of the following:
December 31, ------------------------------ 1998 1997 - ------------------------------------------------------------------------------------------ Finished fabricated products $ 112.4 $ 103.9 Primary aluminum and work in process 205.6 226.6 Bauxite and alumina 109.5 108.4 Operating supplies and repair and maintenance parts 116.0 129.4 -------------- -------------- $ 543.5 $ 568.3 ============== ==============
DEPRECIATION Depreciation is computed principally by the straight-line method at rates based on the estimated useful lives of the various classes of assets. The principal estimated useful lives of land improvements, buildings, and machinery and equipment are 8 to 25 years, 15 to 45 years, and 10 to 22 years, respectively. STOCK-BASED COMPENSATION The Company applies the intrinsic value method to account for a stock-based compensation plan whereby compensation cost is recognized only to the extent that the quoted market price of the stock at the measurement date exceeds the amount an employee must pay to acquire the stock. No compensation cost has been recognized for this plan as the stock options granted in 1998 and 1997 were at the market price. No stock options were granted in 1996. (See Note 7). OTHER INCOME (EXPENSE) Other expense in 1998, 1997, and 1996, includes $12.7, $8.8, and $3.1 of pre-tax charges related principally to establishing additional litigation reserves for asbestos claims net of estimated aggregate insurance recoveries pertaining to operations which were discontinued prior to the acquisition of the Company by MAXXAM in 1988. Other income in 1998 includes $12.0 attributable to insurance recoveries related to certain incurred environmental costs. (See Note 9). DEFERRED FINANCING COSTS Costs incurred to obtain debt financing are deferred and amortized over the estimated term of the related borrowing. Amortization of $3.9, $6.1, and $5.6 is included in interest expense for the years ended December 31, 1998, 1997, and 1996, respectively. FOREIGN CURRENCY The Company uses the United States dollar as the functional currency for its foreign operations. DERIVATIVE FINANCIAL INSTRUMENTS Hedging transactions using derivative financial instruments are primarily designed to mitigate KACC's exposure to changes in prices for certain of the products which KACC sells and consumes and, to a lesser extent, to mitigate KACC's exposure to changes in foreign currency exchange rates. KACC does not utilize derivative financial instruments for trading or other speculative purposes. KACC's derivative activities are initiated within guidelines established by management and approved by KACC's and the Company's boards of directors. Hedging transactions are executed centrally on behalf of all of KACC's business segments to minimize transaction costs, monitor consolidated net exposures and allow for increased responsiveness to changes in market factors. Most of KACC's hedging activities involve the use of option contracts (which establish a maximum and/or minimum amount to be paid or received) and forward sales contracts (which effectively fix or lock-in the amount KACC will pay or receive). Option contracts typically require the payment of an up-front premium in return for the right to receive the amount (if any) by which the price at the settlement date exceeds the strike price. Any interim fluctuations in prices prior to the settlement date are deferred until the settlement date of the underlying hedged transaction, at which point they are reflected in net sales or cost of sales (as applicable) together with the related premium cost. Forward sales contracts do not require an up-front payment and are settled by the receipt or payment of the amount by which the price at the settlement date varies from the contract price. No accounting recognition is accorded to interim fluctuations in prices of forward sales contracts. KACC has established margin accounts and credit limits with certain counterparties related to open forward sales and option contracts. When unrealized gains or losses are in excess of such credit limits, KACC is entitled to receive advances from the counterparties on open positions or is required to make margin deposits to counterparties, as the case may be. At December 31, 1998, KACC had received $9.9 of margin advances from counterparties. At December 31, 1997, KACC had neither received nor made any margin deposits. Management considers credit risk related to possible failure of the counterparties to perform their obligations pursuant to the derivative contracts to be minimal. Deferred gains or losses as of December 31, 1998, are included in Prepaid expenses and other current assets and Other accrued liabilities (See Note 10). FAIR VALUE OF FINANCIAL INSTRUMENTS The Company estimates the fair value of its outstanding indebtedness to be $950.0 and $1,020.0 at December 31, 1998 and 1997, respectively, based on quoted market prices for KACC's 9-7/8% Senior Notes due 2002 (the "9-7/8% Notes"), 12-3/4% Senior Subordinated Notes due 2003 (the "12-3/4% Notes"), and 10-7/8% Senior Notes due 2006 (the "10-7/8% Notes"), and the discounted future cash flows for all other indebtedness, using the current rate for debt of similar maturities and terms. The Company believes that the carrying amount of other financial instruments is a reasonable estimate of their fair value, unless otherwise noted. EARNINGS PER SHARE Basic - Earnings per share is computed by deducting preferred stock dividends from net income (loss) in order to determine net income (loss) available to common shareholders. This amount is then divided by the weighted average number of common shares outstanding during the period, including the weighted average impact of the shares of common stock issued during the year from the date(s) of issuance. Diluted - Diluted earnings per share for the years ended December 31, 1998, and 1997 include the dilutive effect of outstanding stock options (41,000 and 161,000 shares, respectively). The impact of outstanding stock options was excluded from the computation for the year ended December 31, 1996, as its effect would have been antidilutive. The Company's 8.255% PRIDES, Convertible Preferred Stock ("PRIDES"), outstanding as of December 31, 1996, have not been treated "as if" converted for purposes of the Diluted computation in the period ended December 31, 1996, as such treatment would have been antidilutive. LABOR RELATED COSTS The Company is currently operating five of its U.S. facilities with salaried employees and other workers as a result of the September 30, 1998, strike by the United Steelworkers of America (USWA) and the subsequent "lock-out" by the Company in January 1999. For purposes of computing the benefit related costs and liabilities to be reflected in the accompanying consolidated financial statements for the year ended December 31, 1998 (such as pension and other postretirement benefit costs/liabilities), the Company has based its accruals on the terms of the previously existing (expired) USWA contract. Any differences between the amounts accrued and the amounts ultimately agreed to during the collective bargaining process will be reflected in future results during the term of any new contract. All incremental operating costs incurred as a result of the USWA strike and subsequent lockout are being expensed as incurred. Such costs totaled approximately $50.0 during 1998 (approximately $40.0 of which were incurred in the fourth quarter). The Company's fourth quarter 1998 results also reflect reduced profitability of approximately $10.0 resulting from the strike-related curtailment of three potlines (representing approximately 70,000 tons* of annual capacity) at the Company's Mead and Tacoma, Washington, smelters and certain other shipment delays experienced at the other affected facilities at the outset of the USWA strike. 2. INVESTMENTS IN AND ADVANCES TO UNCONSOLIDATED AFFILIATES Summary combined financial information is provided below for unconsolidated aluminum investments, most of which supply and process raw materials. The investees are Queensland Alumina Limited ("QAL") (28.3% owned), Anglesey Aluminium Limited ("Anglesey") (49.0% owned), and Kaiser Jamaica Bauxite Company (49.0% owned). The equity in income (loss) before income taxes of such operations is treated as a reduction (increase) in cost of products sold. At December 31, 1998 and 1997, KACC's net receivable from these affiliates were not material. The summary combined financial information for the years ended December 31, 1998 and 1997, also contains the balances and results of AKW L.P.("AKW") (50.0% owned), an aluminum wheels joint - ------------ * All references to tons in this report refer to metric tons of 2,204.6 pounds. venture formed with a third party in May 1997. (See Note 4). During early 1999, the Company signed a letter of intent to sell its interest in AKW. (See Note 12). SUMMARY OF COMBINED FINANCIAL POSITION
December 31, ------------------------------ 1998 1997 - ---------------------------------------------------------------------------------------------------- Current assets $ 356.0 $ 393.0 Long-term assets (primarily property, plant, and equipment, net) 393.9 395.0 -------------- -------------- Total assets $ 749.9 $ 788.0 ============== ============== Current liabilities $ 92.2 $ 117.1 Long-term liabilities (primarily long-term debt) 396.6 400.8 Stockholders' equity 261.1 270.1 -------------- -------------- Total liabilities and stockholders' equity $ 749.9 $ 788.0 ============== ==============
SUMMARY OF COMBINED OPERATIONS
Year Ended December 31, ---------------------------------------------- 1998 1997 1996 - ------------------------------------------------------------------------------------------------ Net sales $ 659.2 $ 644.1 $ 660.5 Costs and expenses (651.7) (637.8) (631.5) Provision for income taxes (2.7) (8.2) (8.7) -------------- -------------- -------------- Net income (loss) $ 4.8 $ (1.9) $ 20.3 ============== ============== ============== Company's equity in income $ 5.4 $ 2.9 $ 8.8 ============== ============== ============== Dividends received $ 5.5 $ 10.7 $ 11.8 ============== ============== ==============
The Company's equity in income differs from the summary net income (loss) due to varying percentage ownerships in the entities and equity method accounting adjustments. At December 31, 1998, KACC's investment in its unconsolidated affiliates exceeded its equity in their net assets by approximately $18.2 which amount will be fully amortized over the next two years. Amortization of the excess investment totaling $10.0, $11.4, and $11.6 is included in Depreciation and amortization for the years ended December 31, 1998, 1997, and 1996, respectively. The Company and its affiliates have interrelated operations. KACC provides some of its affiliates with services such as financing, management, and engineering. Significant activities with affiliates include the acquisition and processing of bauxite, alumina, and primary aluminum. Purchases from these affiliates were $235.1, $245.2, and $281.6 in the years ended December 31, 1998, 1997, and 1996, respectively. 3. PROPERTY, PLANT, AND EQUIPMENT The major classes of property, plant, and equipment are as follows:
December 31, ------------------------------ 1998 1997 - ------------------------------------------------------------------------------------- Land and improvements $ 164.1 $ 163.9 Buildings 229.5 228.3 Machinery and equipment 1,549.5 1,529.1 Construction in progress 43.8 51.2 -------------- -------------- 1,986.9 1,972.5 Accumulated depreciation (878.2) (800.7) -------------- -------------- Property, plant, and equipment, net $ 1,108.7 $ 1,171.8 ============== ==============
During the fourth quarter of 1998, KACC decided to seek a strategic partner for further development and deployment of its Micromill(TM) technology. While technological progress has been good, management concluded that additional time and investment will be required to achieve commercial success. Given the Company's other strategic priorities, the Company believes that bringing in added commercial and financial resources is the appropriate course of action for capturing the maximum long-term value. This change in strategic course required a different accounting treatment, and the Company correspondingly recorded a $45.0 impairment charge to reduce the carrying value of the Micromill assets to approximately $25.0. During June 1997, Kaiser Bellwood Corporation, a newly formed, wholly owned subsidiary of KACC, completed the acquisition of Reynolds Metals Company's Richmond, Virginia, extrusion plant and its existing inventories for a total purchase price of $41.6, consisting of cash payments of $38.4 and the assumption of approximately $3.2 of employee related and other liabilities. Upon completion of the transaction, Kaiser Bellwood Corporation became a subsidiary guarantor under the indentures in respect of the 9-7/8% Notes, 10-7/8% Notes, and the 12-3/4% Notes. (See Note 5.) 4. RESTRUCTURING OF OPERATIONS During the second quarter of 1997, the Company recorded a $19.7 restructuring charge to reflect actions taken and plans initiated to achieve reduced production costs, decreased corporate selling, general and administrative expenses, and enhanced product mix. The significant components of the restructuring charge were: (i) a net loss of approximately $1.4 as a result of the contribution of certain net assets of KACC's Erie, Pennsylvania, fabrication plant in connection with the formation of AKW and the subsequent decision to close the remainder of the Erie plant in order to consolidate its forging operations into two other facilities; (ii) a charge of $15.6 associated with asset dispositions regarding product rationalization and geographical optimization; and (iii) a charge of approximately $2.7 for benefit and other costs associated with the consolidation or elimination of certain corporate and other staff functions. 5. LONG-TERM DEBT Long-term debt and its maturity schedule are as follows:
2004 December 31, ---------------- and 1998 1997 1999 2000 2001 2002 2003 After Total Total - ----------------------------------------------- ---------------- ---------------- ---------------- -------- Credit Agreement - - 9-7/8% Senior Notes due 2002, net $ 224.4 $ 224.4 $ 224.2 10-7/8% Senior Notes due 2006, net $ 225.7 225.7 225.8 12-3/4% Senior Subordinated Notes due 2003 $ 400.0 400.0 400.0 Alpart CARIFA Loans - (fixed and variable rates) due 2007, 2008 60.0 60.0 60.0 Other borrowings (fixed and variable rates) $ .4 $ .3$ .3 .3 .3 51.3 52.9 61.7 ------- ------- ------- ------- ------- ------- ------- ------- Total $ .4 $ .3$ .3 $ 224.7$ 400.3 $ 337.0 963.0 971.7 ======= ======= ======= ======= ======= ======= Less current portion .4 8.8 ------- ------- Long-term debt $ 962.6 $ 962.9 ======= =======
CREDIT AGREEMENT In February 1994, the Company and KACC entered into a credit agreement (as amended, the "Credit Agreement") which provides a $325.0 secured, revolving line of credit through August 2001. KACC is able to borrow under the facility by means of revolving credit advances and letters of credit (up to $125.0) in an aggregate amount equal to the lesser of $325.0 or a borrowing base relating to eligible accounts receivable and eligible inventory. As of February 28, 1999, $274.1 (of which $74.1 could have been used for letters of credit) was available to KACC under the Credit Agreement. The Credit Agreement is unconditionally guaranteed by the Company and by certain significant subsidiaries of KACC. Interest on any outstanding balances will bear a premium (which varies based on the results of a financial test) over either a base rate or LIBOR, at KACC's option. LOAN COVENANTS AND RESTRICTIONS The Credit Agreement requires KACC to comply with certain financial covenants and places restrictions on the Company's and KACC's ability to, among other things, incur debt and liens, make investments, pay dividends, undertake transactions with affiliates, make capital expenditures, and enter into unrelated lines of business. The Credit Agreement is secured by, among other things, (i) mortgages on KACC's major domestic plants (excluding KACC's Gramercy alumina plant and Micromill facility); (ii) subject to certain exceptions, liens on the accounts receivable, inventory, equipment, domestic patents and trademarks, and substantially all other personal property of KACC and certain of its subsidiaries; (iii) a pledge of all the stock of KACC owned by Kaiser; and (iv) pledges of all of the stock of a number of KACC's wholly owned domestic subsidiaries, pledges of a portion of the stock of certain foreign subsidiaries, and pledges of a portion of the stock of certain partially owned foreign affiliates. The obligations of KACC with respect to its 9-7/8% Notes, its 10-7/8% Notes and its 12-3/4% Notes are guaranteed, jointly and severally, by certain subsidiaries of KACC. The indentures governing the 9-7/8% Notes, the 10-7/8% Notes and the 12-3/4% Notes (collectively, the "Indentures") restrict, among other things, KACC's ability to incur debt, undertake transactions with affiliates, and pay dividends. Further, the Indentures provide that KACC must offer to purchase the 9-7/8% Notes, the 10-7/8% Notes and the 12-3/4% Notes, respectively, upon the occurrence of a Change of Control (as defined therein), and the Credit Agreement provides that the occurrence of a Change in Control (as defined therein) shall constitute an Event of Default thereunder. Under the most restrictive of the covenants in the Credit Agreement, neither the Company nor KACC currently is permitted to pay dividends on its common stock. In December 1991, Alumina Partners of Jamaica ("Alpart") entered into a loan agreement with the Caribbean Basin Projects Financing Authority ("CARIFA"). Alpart's obligations under the loan agreement are secured by two letters of credit aggregating $64.2. KACC is a party to one of the two letters of credit in the amount of $41.7 in respect of its ownership interest in Alpart. Alpart has also agreed to indemnify bondholders of CARIFA for certain tax payments that could result from events, as defined, that adversely affect the tax treatment of the interest income on the bonds. RESTRICTED NET ASSETS OF SUBSIDIARIES Certain debt instruments restrict the ability of KACC to transfer assets, make loans and advances, and pay dividends to the Company. The restricted net assets of KACC totaled $124.4 and $121.9 at December 31, 1998 and 1997, respectively. CAPITALIZED INTEREST Interest capitalized in 1998, 1997, and 1996, was $3.0, $6.6, and $4.9, respectively. 6. INCOME TAXES Income (loss) before income taxes and minority interests by geographic area is as follows:
Year Ended December 31, ---------------------------------------------- 1998 1997 1996 - ------------------------------------------------------------------------------------------- Domestic $ (93.6) $ (112.6) $ (45.8) Foreign 77.7 172.9 47.5 -------------- -------------- -------------- Total $ (15.9) $ 60.3 $ 1.7 ============== ============== ==============
Income taxes are classified as either domestic or foreign, based on whether payment is made or due to the United States or a foreign country. Certain income classified as foreign is also subject to domestic income taxes. The (provision) benefit for income taxes on income (loss) before income taxes and minority interests consists of:
Federal Foreign State Total - ------------------------------------------------------------------------------------------------- 1998 Current $ (1.8) $ (16.5) $ (.2) $ (18.5) Deferred 44.4 (12.5) 3.0 34.9 -------------- -------------- -------------- -------------- Total $ 42.6 $ (29.0) $ 2.8 $ 16.4 ============== ============== ============== ============== 1997 Current $ (2.0) $ (28.7) $ (.2) $ (30.9) Deferred 30.5 (7.0) (1.4) 22.1 -------------- -------------- -------------- -------------- Total $ 28.5 $ (35.7) $ (1.6) $ (8.8) ============== ============== ============== ============== 1996 Current $ (1.6) $ (21.8) $ (.1) $ (23.5) Deferred 8.6 7.6 16.6 32.8 -------------- -------------- -------------- -------------- Total $ 7.0 $ (14.2) $ 16.5 $ 9.3 ============== ============== ============== ==============
A reconciliation between the benefit (provision) for income taxes and the amount computed by applying the federal statutory income tax rate to income before income taxes and minority interests is as follows:
Year Ended December 31, ---------------------------------------------- 1998 1997 1996 - -------------------------------------------------------------------------------------------------------------------- Amount of federal income tax benefit (provision)based on the statutory rate $ 5.6 $ (21.1) $ (.6) Revision of prior years' tax estimates and other changes in valuation allowances 8.3 12.5 10.0 Percentage depletion 3.2 4.2 3.9 Foreign taxes, net of federal tax benefit (1.9) (3.1) (5.5) Other 1.2 (1.3) 1.5 -------------- -------------- -------------- Benefit (provision) for income taxes $ 16.4 $ (8.8) $ 9.3 ============== ============== ==============
Included in revision of prior years' tax estimates and other changes in valuation allowances for 1998, 1997 and 1996 shown above are $8.3, $12.5 and $9.8, respectively, related to the resolution of certain income tax matters. The components of the Company's net deferred income tax assets are as follows:
December 31, ------------------------------ 1998 1997 - ------------------------------------------------------------------------------------- Deferred income tax assets: Postretirement benefits other than pensions $ 279.4 $ 288.9 Loss and credit carryforwards 92.0 99.3 Other liabilities 146.4 169.3 Other 132.8 102.0 Valuation allowances (107.7) (113.3) -------------- -------------- Total deferred income tax assets-net 542.9 546.2 -------------- -------------- Deferred income tax liabilities: Property, plant, and equipment (109.9) (139.7) Other (54.8) (54.8) -------------- -------------- Total deferred income tax liabilities (164.7) (194.5) -------------- -------------- Net deferred income tax assets $ 378.2 $ 351.7 ============== ==============
The principal component of the Company's net deferred income tax assets is the tax benefit, net of certain valuation allowances, associated with the accrued liability for postretirement benefits other than pensions. The future tax deductions with respect to the turnaround of this accrual will occur over a 30-to-40-year period. If such deductions create or increase a net operating loss, the Company has the ability to carry forward such loss for 20 taxable years. For these reasons, the Company believes that a long-term view of profitability is appropriate and has concluded that this net deferred income tax asset will more likely than not be realized. A substantial portion of the valuation allowances provided by the Company relates to loss and credit carryforwards. To determine the proper amount of valuation allowances with respect to these carryforwards, the Company evaluated all appropriate factors, including any limitations concerning their use and the year the carryforwards expire, as well as the levels of taxable income necessary for utilization. With regard to future levels of income, the Company believes, based on the cyclical nature of its business, its history of operating earnings, and its expectations for future years, that it will more likely than not generate sufficient taxable income to realize the benefit attributable to the loss and credit carryforwards for which valuation allowances were not provided. As of December 31, 1998 and 1997, $46.2 and $53.7, respectively, of the net deferred income tax assets listed above are included in the Consolidated Balance Sheets in the caption entitled Prepaid expenses and other current assets. Certain other portions of the deferred income tax liabilities listed above are included in the Consolidated Balance Sheets in the captions entitled Other accrued liabilities and Long-term liabilities. The Company and its domestic subsidiaries file consolidated federal income tax returns. During the period from October 28, 1988, through June 30, 1993, the Company and its domestic subsidiaries were included in the consolidated federal income tax returns of MAXXAM. During 1997 MAXXAM reached a settlement with the Internal Revenue Service regarding all remaining years where the Company and its subsidiaries were included in the MAXXAM consolidated federal income tax returns. As a result of this settlement, KACC paid $11.8 to MAXXAM during 1997, in respect of its liabilities pursuant to its tax allocation agreement with MAXXAM. Payments or refunds for periods prior to July 1, 1993, related to other jurisdictions could still be required pursuant to the Company's and KACC's respective tax allocation agreements with MAXXAM. In accordance with the Credit Agreement, any such payments to MAXXAM by KACC would require lender approval, except in certain specific circumstances. The tax allocation agreements of the Company and KACC with MAXXAM terminated pursuant to their terms, effective for taxable periods beginning after June 30, 1993. At December 31, 1998, the Company had certain tax attributes available to offset regular federal income tax requirements, subject to certain limitations, including net operating loss and general business credit carryforwards of $28.2 and $4.9, respectively, which expire periodically through 2012 and 2011, respectively, foreign tax credit ("FTC") carryforwards of $48.4, which expire periodically through 2003, and alternative minimum tax ("AMT") credit carryforwards of $23.4, which have an indefinite life. The Company also has AMT net operating loss and FTC carryforwards of $6.2 and $87.2, respectively, available, subject to certain limitations, to offset future alternative minimum taxable income, which expire periodically through 2011 and 2003, respectively. 7. EMPLOYEE BENEFIT AND INCENTIVE PLANS In the fourth quarter of 1998 the Company adopted Statement of Financial Accounting Standard No. 132, Employers' Disclosures about Pensions and Other Postretirement Benefits ("SFAS No. 132") which amends FASB Statements No's. 87, 88, and 106. SFAS No. 132 revises the disclosure requirements related to pension and other postretirement benefits, but has no impact on the computation of the reported amounts. Prior year disclosures have been reformatted to comply with SFAS No. 132's guidelines. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS Retirement plans are non-contributory for salaried and hourly employees and generally provide for benefits based on a formula which considers length of service and earnings during years of service. The Company's funding policies meet or exceed all regulatory requirements. The Company and its subsidiaries provide postretirement health care and life insurance benefits to eligible retired employees and their dependents. Substantially all employees may become eligible for those benefits if they reach retirement age while still working for the Company or its subsidiaries. The Company has not funded the liability for these benefits which are expected to be paid out of cash generated by operations. The Company reserves the right, subject to applicable collective bargaining agreements, to amend or terminate these benefits. Assumptions used to value obligations at year-end and to determine the net periodic benefit cost in the subsequent year are:
Pension Benefits Medical/Life Benefits ---------------------------------- ---------------------------------- 1998 1997 1996 1998 1997 1996 ---------------------------------- ---------------------------------- Weighted-average assumptions as of December 31, Discount rate 7.00% 7.25% 7.75% 7.00% 7.25% 7.75% Expected return on plan assets 9.50% 9.50% 9.50% - - - Rate of compensation increase 5.00% 5.00% 5.00% 4.00% 5.00% 5.00%
In 1998 annual assumed rates of increase in the per capita cost of covered benefits (i.e. health care cost trend rate) for non-HMO participants are 6.5% and 5.0% for HMO at all ages. The assumed rate of increase for non-HMO participants is assumed to decline gradually to 5.0% in 2003 and remain at that level thereafter. The following table presents the funded status of the Company's pension and other postretirement benefit plans as of December 31, 1998 and 1997, and the corresponding amounts that are included in the Company's Consolidated Balance Sheets:
Pension Benefits Medical/Life Benefits ------------------------------ ------------------------------ 1998 1997 1998 1997 -------------- -------------- -------------- -------------- Change in Benefit Obligation: Benefit obligation at beginning of year $ 873.0 $ 816.2 $ 544.5 $ 602.8 Service cost 14.2 13.4 4.2 6.1 Interest cost 59.7 61.6 37.5 44.8 Currency exchange rate change (.4) (6.0) - - Curtailments, settlements and amendments (4.6) - 4.0 - Actuarial (gain) loss 15.2 65.5 72.0 (66.3) Benefits paid (84.6) (77.7) (45.4) (42.9) -------------- -------------- -------------- -------------- Benefit obligation at end of year 872.5 873.0 616.8 544.5 -------------- -------------- -------------- -------------- Change in Plan Assets: FMV of plan assets at beginning of year 756.9 662.0 - - Actual return on assets 106.8 131.9 - - Settlements (5.5) - - - Employer contributions 28.2 40.7 45.4 42.9 Benefits paid (84.6) (77.7) (45.4) (42.9) -------------- -------------- -------------- -------------- FMV of plan assets at end of year 801.8 756.9 - - -------------- -------------- -------------- -------------- Benefit obligations in excess of plan assets 70.7 116.1 616.8 544.5 Unrecognized net actuarial (gain) loss 23.8 - 55.9 135.0 Unrecognized prior service costs (18.5) (22.2) 69.8 86.1 Intangible asset and other 4.3 5.4 - - -------------- -------------- -------------- -------------- Accrued benefit liability $ 80.3 $ 99.3 $ 742.5 $ 765.6 ============== ============== ============== ==============
Pension Benefits Medical/Life Benefits --------------------------------------- --------------------------------------- 1998 1997 1996 1998 1997 1996 ------------ ------------ ------------ ------------ ------------ ------------ Components of Net Periodic Benefit Costs: Service cost $ 14.2 $ 13.4 $ 12.9 $ 4.2 $ 6.1 $ 3.8 Interest cost 59.7 61.6 60.0 37.5 44.8 46.9 Expected return on assets (69.4) (61.8) (55.0) - - - Amortization of prior service cost 3.2 3.4 3.5 (12.4) (12.4) (12.4) Recognized net actuarial (gain) loss 1.4 2.6 2.0 (7.1) (.9) - ------------ ------------ ------------ ------------ ------------ ------------ Net periodic benefit cost 9.1 19.2 23.4 22.2 37.6 38.3 Curtailments, settlements, etc. 3.2 3.7 2.0 - - - ------------ ------------ ------------ ------------ ------------ ------------ Adjusted net periodic benefit costs $ 12.3 $ 22.9 $ 25.4 $ 22.2 $ 37.6 $ 38.3 ============ ============ ============ ============ ============ ============
The aggregate fair value of plan assets and accumulated benefit obligation for pension plans with plan assets in excess of accumulated benefit obligations were $293.0 and $280.7, respectively, as of December 31, 1998, and $287.8 and $283.4, respectively, as of December 31, 1997. 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 would have the following effects:
1% Increase 1% Decrease -------------- -------------- Increase (decrease) to total of service and interest cost $ 5.8 $ (4.3) Increase (decrease) to the postretirement benefit obligation $ 64.3 $ (45.4)
POSTEMPLOYMENT BENEFITS The Company provides certain benefits to former or inactive employees after employment but before retirement. INCENTIVE PLANS The Company has an unfunded incentive compensation program, which provides incentive compensation based on performance against annual plans and over rolling three-year periods. In addition, the Company has a "nonqualified" stock option plan and KACC has a defined contribution plan for salaried employees. The Company's expense for all of these plans was $7.5, $8.3, and $(2.1) for the years ended December 31, 1998, 1997, and 1996, respectively. Up to 8,000,000 shares of the Company's Common Stock were reserved for issuance under its stock incentive compensation plans. At December 31, 1998, 3,634,621 shares of Common Stock remained available for issuance under those plans. Stock options granted pursuant to the Company's nonqualified stock option program are granted at the prevailing market price, generally vest at a rate of 20 - 33% per year, and have a five or ten year term. Information concerning nonqualified stock option plan activity is shown below. The weighted average price per share for each year is shown parenthetically.
1998 1997 1996 - ---------------------------------------------------------------------------------------------------------- Outstanding at beginning of year ($10.45, $10.33, and $10.32) 819,752 890,395 926,085 Granted ($9.79 and $10.06) 2,263,170 15,092 - Exercised ($7.25, $8.33, and $8.99) (10,640) (48,410) (8,275) Expired or forfeited ($9.60, $10.12, and $10.45) (23,160) (37,325) (27,415) -------------- -------------- -------------- Outstanding at end of year ($9.98, $10.45, and $10.33) 3,049,122 819,752 890,395 ============== ============== ============== Exercisable at end of year ($10.09, $10.53, and $10.47) 1,261,262 601,115 436,195 ============== ============== ==============
In accordance with Statement of Financial Accounting Standards No. 123, Accounting for Stock Based Compensation ("SFAS No. 123"), the Company is required to calculate pro forma compensation cost for all stock options granted subsequent to December 31, 1994. No stock options were granted during 1996. However, as shown in the table above, options were granted in 1998 and 1997 which would be subject to the pro forma calculation requirements. For SFAS No. 123 purposes, the fair value of the 1998 and 1997 stock option grants were estimated using a Black-Scholes option pricing model. The proforma after-tax effect of the estimated fair value of the grants would be to reduce net income in 1998 and 1997 by $1.5 and $.1, respectively. 8. STOCKHOLDERS' EQUITY, COMPREHENSIVE INCOME AND MINORITY INTERESTS Changes in stockholders' equity and comprehensive income were:
Additional Accu- Minimum Preferred Common Additional mulated Pension Stock Stock Capital Deficit Liability Total - -------------------------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 1995 $ .4 $ .7 $ 530.3 $ (459.9) $ (13.8) $ 57.7 Net income 8.2 8.2 Minimum pension liability adjustment, net of tax 11.0 11.0 ---------- Comprehensive income 19.2 Common stock issued upon redemption and conversion of preferred stock .1 .1 Dividends on preferred stock (8.4) (8.4) Incentive plan accretion .7 .7 ---------- ---------- ---------- ---------- ---------- ---------- BALANCE, DECEMBER 31, 1996 .4 .7 531.1 (460.1) (2.8) 69.3 Net income 48.0 48.0 Minimum pension liability adjustment, net of tax 2.8 2.8 ---------- Comprehensive income 50.8 Common stock issued upon redemption and conversion of preferred stock (.4) .1 1.7 1.4 Stock options exercised .4 .4 Dividends on preferred stock (5.5) (5.5) Incentive plan accretion .6 .6 ---------- ---------- ---------- ---------- ---------- ---------- BALANCE, DECEMBER 31, 1997 - .8 533.8 (417.6) - 117.0 Net income/Comprehensive income .6 .6 Stock options exercised .1 .1 Incentive plan accretion 1.5 1.5 ---------- ---------- ---------- ---------- ---------- ---------- BALANCE, DECEMBER 31, 1998 $ - $ .8 $ 535.4 $ (417.0) $ - $ 119.2 ========== ========== ========== ========== ========== ==========
Changes in minority interest were:
1998 1997 1996 ------------------------------ ------------------------------ ------------------------------ Redeemable Redeemable Redeemable Preference Preference Preference Stock Other Stock Other Stock Other - ---------------------------------------------------------------------------------------------------------------------------------- Beginning of period balance $ 27.7 $ 100.0 $ 27.5 $ 94.2 $ 29.7 $ 93.0 Redeemable preference stock Accretion 1.1 2.3 3.1 Stock redemption (8.7) (2.1) (5.3) Minority interests 3.4 5.8 1.2 -------------- -------------- -------------- -------------- -------------- -------------- End of period balance $ 20.1 $ 103.4 $ 27.7 $ 100.0 $ 27.5 $ 94.2 ============== ============== ============== ============== ============== ==============
REDEEMABLE PREFERENCE STOCK In 1985, KACC issued its Cumulative (1985 Series A) Preference Stock and its Cumulative (1985 Series B) Preference Stock (together, the "Redeemable Preference Stock") each of which has a par value of $1 per share and a liquidation and redemption value of $50 per share plus accrued dividends, if any. No additional Redeemable Preference Stock is expected to be issued. Holders of the Redeemable Preference Stock are entitled to an annual cash dividend of $5 per share, or an amount based on a formula tied to KACC's pre-tax income from aluminum operations, when and as declared by the Board of Directors. The carrying values of the Redeemable Preference Stock are increased each year to recognize accretion between the fair value (at which the Redeemable Preference Stock was originally issued) and the redemption value. Changes in Redeemable Preference Stock are shown below.
1998 1997 1996 - ------------------------------------------------------------------------------------------------ Shares: Beginning of year 595,053 634,684 737,363 Redeemed (173,478) (39,631) (102,679) -------------- -------------- -------------- End of year 421,575 595,053 634,684 ============== ============== ==============
Redemption fund agreements require KACC to make annual payments by March 31 of the subsequent year based on a formula tied to consolidated net income until the redemption funds are sufficient to redeem all of the Redeemable Preference Stock. On an annual basis, the minimum payment is $4.3 and the maximum payment is $7.3. KACC also has certain additional repurchase requirements which are, among other things, based upon profitability tests. The Redeemable Preference Stock is entitled to the same voting rights as KACC common stock and to certain additional voting rights under certain circumstances, including the right to elect, along with other KACC preference stockholders, two directors whenever accrued dividends have not been paid on two annual dividend payment dates or when accrued dividends in an amount equivalent to six full quarterly dividends are in arrears. The Redeemable Preference Stock restricts the ability of KACC to redeem or pay dividends on its common stock if KACC is in default on any dividends payable on Redeemable Preference Stock. PREFERENCE STOCK KACC has four series of $100 par value Cumulative Convertible Preference Stock ("$100 Preference Stock") with annual dividend requirements of between 4-1/8% and 4-3/4%. KACC has the option to redeem the $100 Preference Stock at par value plus accrued dividends. KACC does not intend to issue any additional shares of the $100 Preference Stock. The $100 Preference Stock can be exchanged for per share cash amounts between $69 - $80. KACC records the $100 Preference Stock at their exchange amounts for financial statement presentation and the Company includes such amounts in minority interests. At December 31, 1998 and 1997, outstanding shares of $100 Preference Stock were 19,963 and 20,543, respectively. PREFERRED STOCK PRIDES Convertible - During August 1997, the remaining 8,673,850 outstanding shares of PRIDES were converted into 7,227,848 shares of Common Stock pursuant to the terms of the PRIDES Certificate of Designations. Further, in accordance with the PRIDES Certificate of Designations, no dividends were paid or payable for the period June 30, 1997, to, but not including, the date of conversion. However, in accordance with generally accepted accounting principles, the $1.3 of accrued dividends attributable to the period June 30, 1997, to, but not including, the conversion date were treated as an increase in Additional capital at the date of conversion and were reflected as a reduction of Net income available to common shareholders. PLEDGED SHARES From time to time MAXXAM or certain of its subsidiaries which own the Company's Common Stock may use such stock as collateral under various financing arrangements. At December 31, 1998, 27,938,250 shares of the Company's Common Stock beneficially owned by MAXXAM Group Holdings Inc. ("MGHI"), a wholly owned subsidiary of MAXXAM, were pledged as security for $130.0 principal amount of 12% Senior Secured Notes due 2003 issued in December 1996 by MGHI. An additional 7,915,000 shares of the Company's Common Stock were pledged by MAXXAM under a separate agreement under which $16.0 had been borrowed by MAXXAM at December 31, 1998. In addition to the foregoing, MAXXAM has agreed to secure each $1.0 of borrowings with 400,000 shares of the Company's Common Stock under the terms of another $25.0 credit facility ($2.5 outstanding at December 31, 1998). 9. COMMITMENTS AND CONTINGENCIES COMMITMENTS KACC has a variety of financial commitments, including purchase agreements, tolling arrangements, forward foreign exchange and forward sales contracts (see Note 10), letters of credit, and guarantees. Such purchase agreements and tolling arrangements include long-term agreements for the purchase and tolling of bauxite into alumina in Australia by QAL. These obligations expire in 2008. Under the agreements, KACC is unconditionally obligated to pay its proportional share of debt, operating costs, and certain other costs of QAL. KACC's share of the aggregate minimum amount of required future principal payments at December 31, 1998, is $97.6, of which approximately $12.0 is due in each of 2000 and 2001 with the balance being due thereafter. KACC's share of payments, including operating costs and certain other expenses under the agreements, has ranged between $100.0 - $120.0 over the past three years. KACC also has agreements to supply alumina to and to purchase aluminum from Anglesey. Minimum rental commitments under operating leases at December 31, 1998, are as follows: years ending December 31, 1999 - $35.8; 2000 - $33.4; 2001 - $31.1; 2002 - $27.3; 2003 - $26.1; thereafter - $114.7. The future minimum rentals receivable under noncancelable subleases was $73.5 at December 31, 1998. Rental expenses were $34.5, $30.4, and $29.6, for the years ended December 31, 1998, 1997, and 1996, respectively. ENVIRONMENTAL CONTINGENCIES The Company and KACC are subject to a number of environmental laws, to fines or penalties assessed for alleged breaches of the environmental laws, and to claims and litigation based upon such laws. KACC currently is subject to a number of lawsuits under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended by the Superfund Amendments Reauthorization Act of 1986 ("CERCLA"), and, along with certain other entities, has been named as a potentially responsible party for remedial costs at certain third-party sites listed on the National Priorities List under CERCLA. Based on the Company's evaluation of these and other environmental matters, the Company has established environmental accruals, primarily related to potential solid waste disposal and soil and groundwater remediation matters. The following table presents the changes in such accruals, which are primarily included in Long-term liabilities, for the years ended December 31, 1998, 1997, and 1996:
1998 1997 1996 - ----------------------------------------------------------------------------------------------------- Balance at beginning of period $ 29.7 $ 33.3 $ 38.9 Additional accruals 24.5 2.0 3.2 Less expenditures (3.5) (5.6) (8.8) -------------- -------------- -------------- Balance at end of period $ 50.7 $ 29.7 $ 33.3 ============== ============== ==============
These environmental accruals represent the Company's estimate of costs reasonably expected to be incurred based on presently enacted laws and regulations, currently available facts, existing technology, and the Company's assessment of the likely remediation action to be taken. The Company expects that these remediation actions will be taken over the next several years and estimates that annual expenditures to be charged to these environmental accruals will be approximately $3.0 to $8.0 for the years 1999 through 2003 and an aggregate of approximately $29.0 thereafter. As additional facts are developed and definitive remediation plans and necessary regulatory approvals for implementation of remediation are established or alternative technologies are developed, changes in these and other factors may result in actual costs exceeding the current environmental accruals. As the resolution of these matters is subject to further regulatory review and approval, no specific assurance can be given as to when the factors upon which a substantial portion of this estimate is based can be expected to be resolved. However, the Company is currently working to resolve certain of these matters. The Company believes that it has insurance coverage available to recover certain incurred and future environmental costs and is actively pursuing claims in this regard. Through September 30, 1998, no accruals were made for any such insurance recoveries. However, during December 1998, KACC received recoveries totaling approximately $35.0 from certain of its insurers related to current and future claims. Based on the Company's analysis, a total of $12.0 of such recoveries was allocable to previously accrued (expensed) items and, therefore, was reflected in earnings during the fourth quarter of 1998. The remaining recoveries were offset against increases in the total amount of environmental reserves. No assurances can be given that the Company will be successful in other attempts to recover incurred or future costs from other insurers or that the amount of recoveries received will ultimately be adequate to cover costs incurred. While uncertainties are inherent in the final outcome of these environmental matters, and it is presently impossible to determine the actual costs that ultimately may be incurred, management currently believes that the resolution of such uncertainties should not have a material adverse effect on the Company's consolidated financial position, results of operations, or liquidity. ASBESTOS CONTINGENCIES KACC is a defendant in a number of lawsuits, some of which involve claims of multiple persons, in which the plaintiffs allege that certain of their injuries were caused by, among other things, exposure to asbestos during, and as a result of, their employment or association with KACC or exposure to products containing asbestos produced or sold by KACC. The lawsuits generally relate to products KACC has not sold for at least 20 years. The following table presents the changes in number of such claims pending for the years ended December 31, 1998, 1997, and 1996.
1998 1997 1996 - ------------------------------------------------------------------------------------------------ Number of claims at beginning of period 77,400 71,100 59,700 Claims received 22,900 15,600 21,100 Claims settled or dismissed (13,900) (9,300) (9,700) -------------- -------------- -------------- Number of claims at end of period 86,400 77,400 71,100 ============== ============== ==============
The foregoing claims and settlement figures as of December 31, 1998, do not reflect the fact that KACC has reached agreements under which it will settle approximately 30,000 of the pending asbestos-related claims over an extended period. Based on past experience and reasonably anticipated future activity, the Company has established an accrual for estimated asbestos-related costs for claims filed and estimated to be filed through 2008. There are inherent uncertainties involved in estimating asbestos-related costs, and the Company's actual costs could exceed these estimates. The Company's accrual was calculated based on the current and anticipated number of asbestos-related claims, the prior timing and amounts of asbestos-related payments, and the advice of Wharton Levin Ehrmantraut Klein & Nash, P.A., with respect to the current state of the law related to asbestos claims. Accordingly, an estimated asbestos-related cost accrual of $186.2, before consideration of insurance recoveries, is included primarily in Long-term liabilities at December 31, 1998. While the Company does not presently believe there is a reasonable basis for estimating such costs beyond 2008 and, accordingly, no accrual has been recorded for such costs which may be incurred beyond 2008, there is a reasonable possibility that such costs may continue beyond 2008, and such costs may be substantial. The Company estimates that annual future cash payments in connection with such litigation will be approximately $16.0 to $28.0 for each of the years 1999 through 2003, and an aggregate of approximately $77.0 thereafter. The Company believes that KACC has insurance coverage available to recover a substantial portion of its asbestos-related costs. Although the Company has settled asbestos-related coverage matters with certain of its insurance carriers, other carriers have not yet agreed to settlements. The timing and amount of future recoveries from these insurance carriers will depend on the pace of claims review and processing by such carriers and on the resolution of any disputes regarding coverage under such policies. The Company believes that substantial recoveries from the insurance carriers are probable. The Company reached this conclusion after considering its prior insurance-related recoveries in respect of asbestos-related claims; its existing insurance policies; and the advise of Heller Ehrman White & McAuliffe with respect to applicable insurance coverage law relating to the terms and conditions of those policies. Accordingly, an estimated aggregate insurance recovery of $152.5, determined on the same basis as the asbestos-related cost accrual, is recorded primarily in Other assets at December 31, 1998. Management continues to monitor claims activity, the status of lawsuits (including settlement initiatives), legislative progress, and costs incurred in order to ascertain whether an adjustment to the existing accruals should be made to the extent that historical experience may differ significantly from the Company's underlying assumptions. While uncertainties are inherent in the final outcome of these asbestos matters and it is presently impossible to determine the actual costs that ultimately may be incurred and insurance recoveries that will be received, management currently believes that, based on the factors discussed in the preceding paragraphs, the resolution of asbestos-related uncertainties and the incurrence of asbestos-related costs net of related insurance recoveries should not have a material adverse effect on the Company's consolidated financial position, results of operations, or liquidity. LABOR MATTERS In connection with the USWA strike and subsequent "lock-out" by KACC, certain allegations of unfair labor practices ("ULPs") have been filed with the National Labor Relations Board by the USWA and its members. KACC has responded to all such allegations and believes that they are without merit. If the allegations were sustained, KACC could be required to make locked-out employees whole for back wages from the date of the lock-out in January 1999. While uncertainties are inherent in the final outcome of such matters, the Company believes that the resolution of the alleged ULPs should not result in a material adverse impact on the Company's financial position, results of operations, or liquidity. OTHER CONTINGENCIES The Company or KACC is involved in various other claims, lawsuits, and other proceedings relating to a wide variety of matters. While uncertainties are inherent in the final outcome of such matters, and it is presently impossible to determine the actual costs that ultimately may be incurred, management currently believes that the resolution of such uncertainties and the incurrence of such costs should not have a material adverse effect on the Company's consolidated financial position, results of operations, or liquidity. 10. DERIVATIVE FINANCIAL INSTRUMENTS AND RELATED HEDGING PROGRAMS At December 31, 1998, the net unrealized gain on KACC's position in aluminum forward sales and option contracts, natural gas and fuel oil forward purchase and option contracts, and forward foreign exchange contracts, was approximately $17.8 (based on comparisons to applicable year-end published market prices). As KACC's hedging activities are generally designed to lock-in a specified price or range of prices, gains or losses on the derivative contracts utilized in these hedging activities will be offset by losses or gains, respectively, on the transactions being hedged. ALUMINA AND ALUMINUM The Company's earnings are sensitive to changes in the prices of alumina, primary aluminum and fabricated aluminum products, and also depend to a significant degree upon the volume and mix of all products sold. Primary aluminum prices have historically been subject to significant cyclical price fluctuations. Alumina prices as well as fabricated aluminum product prices (which vary considerably among products) are significantly influenced by changes in the price of primary aluminum but generally lag behind primary aluminum price changes by up to three months. Since 1993, the Average Midwest United States transaction price for primary aluminum has ranged from approximately $.50 to $1.00 per pound. From time to time in the ordinary course of business, KACC enters into hedging transactions to provide price risk management in respect of the net exposure of earnings resulting from (i) anticipated sales of alumina, primary aluminum and fabricated aluminum products, less (ii) expected purchases of certain items, such as aluminum scrap, rolling ingot, and bauxite, whose prices fluctuate with the price of primary aluminum. Forward sales contracts are used by KACC to effectively fix the price that KACC will receive for its shipments. KACC also uses option contracts (i) to establish a minimum price for its product shipments, (ii) to establish a "collar" or range of price for KACC's anticipated sales, and/or (iii) to permit KACC to realize possible upside price movements. As of December 31, 1998, KACC had sold forward, at fixed prices, approximately 24,000 tons of primary aluminum with respect to 1999. As of December 31, 1998, KACC had also entered into option contracts that established a price range for an additional 125,000 and 72,000 tons of primary aluminum with respect to 1999 and 2000, respectively. Subsequent to December 31, 1998, KACC has also entered into additional option contracts that established a price range for an additional 201,000 tons of primary aluminum with respect to 2000. Additionally, through December 31, 1998, KACC had also entered a series of transactions with a counterparty that will provide KACC with a premium over the forward market prices at the date of the transaction for 2,000 tons of primary aluminum per month during the period July 1999 through June 2001. KACC also contracted with the counterparty to receive certain fixed prices (also above the forward market prices at the date of the transaction) on 4,000 tons of primary aluminum per month over a three year period commencing October 2001, unless market prices during certain periods decline below a stipulated "floor" price, in which case, the fixed price sales portion of the transactions terminate. The price at which the October 2001 and after transactions terminate is well below current market prices. While the Company believes that the October 2001 and after transactions are consistent with its stated hedging objectives, these positions do not qualify for treatment as a "hedge" under current accounting guidelines. Accordingly, these positions will be "marked to market" each period. As of December 31, 1998, KACC had sold forward virtually all of the alumina available to it in excess of its projected internal smelting requirements for 1999 and 2000 at prices indexed to future prices of primary aluminum. ENERGY KACC is exposed to energy price risk from fluctuating prices for fuel oil and natural gas consumed in the production process. Accordingly, KACC from time to time in the ordinary course of business enters into hedging transactions with major suppliers of energy and energy related financial instruments. As of December 31, 1998, KACC had a combination of fixed price purchase and option contracts for the purchase of approximately 33,000 MMBtu of natural gas per day during 1999. At December 31, 1998, KACC also held a combination of fixed price purchase and option contracts for an average of 246,000 barrels per month of fuel oil and diesel fuel for 1999. FOREIGN CURRENCY KACC enters into forward exchange contracts to hedge material cash commitments to foreign subsidiaries or affiliates. At December 31, 1998, KACC had net forward foreign exchange contracts totaling approximately $141.4 for the purchase of 210.6 Australian dollars from January 1999 through December 2000, in respect of its commitments for 1999 and 2000 expenditures denominated in Australian dollars. 11. SEGMENT AND GEOGRAPHICAL AREA INFORMATION The Company's operations are located in many foreign countries, including Australia, Canada, Ghana, Jamaica, and the United Kingdom. Foreign operations in general may be more vulnerable than domestic operations due to a variety of political and other risks. Sales and transfers among geographic areas are made on a basis intended to reflect the market value of products. The Company's operations are organized and managed by product type. The Company operates in four segments of the aluminum industry: Alumina and bauxite, Primary aluminum, Flat-rolled products and Engineered products. The Alumina and bauxite business unit's principal products are smelter grade alumina and chemical grade alumina hydrate, a value-added product, for which the Company receives a premium over smelter grade market prices. The Primary aluminum business unit produces commodity grade products as well as value-added products such as rod and billet, for which the Company receives a premium over normal commodity market prices. The Flat-rolled products group primarily sells rigid container sheet to can manufacturers as well as value-added products such as heat treat aluminum sheet and plate which are used in the aerospace and general engineering markets. The Engineered products business unit serves a wide range of industrial segments including the automotive, distribution, aerospace and general engineering markets. The Company uses a portion of its bauxite, alumina and primary aluminum production for additional processing at its downstream facilities. Transfers between business units are made at estimated market prices. The accounting policies of the segments are the same as those described in Note 1. Business unit results are evaluated internally by management before any allocation of corporate overhead and without any charge for income taxes or interest expense. The following segment information differs from that presented in prior years as a result of the Company's adoption of Statement of Financial Accounting Standard No.131, as of December 31, 1998. Prior year information has been restated to conform to the Company's new presentation format. Financial information by operating segment at December 31, 1998, 1997 and 1996 is as follows:
Year Ended December 31, ---------------------------------------------- 1998 1997 1996 - ------------------------------------------------------------------------------------------------ Net Sales: Bauxite and Alumina: Net sales to unaffiliated customers $ 472.7 $ 411.7 $ 431.0 Intersegment sales 135.8 201.7 194.1 -------------- -------------- -------------- 608.5 613.4 625.1 -------------- -------------- -------------- Primary Aluminum: Net sales to unaffiliated customers 409.8 543.4 538.3 Intersegment sales 233.5 273.8 217.4 -------------- -------------- -------------- 643.3 817.2 755.7 -------------- -------------- -------------- Flat-Rolled Products 714.6 743.3 626.0 Engineered Products 581.3 581.0 504.4 Minority interests 78.0 93.8 90.8 Eliminations (369.3) (475.5) (411.5) -------------- -------------- -------------- $ 2,256.4 $ 2,373.2 $ 2,190.5 ============== ============== ============== Equity in income (loss) of unconsolidated affiliates: Bauxite and Alumina $ (3.2) $ (7.0) $ 1.7 Primary Aluminum 1.2 5.1 6.7 Engineered Products 7.8 4.8 - Corporate and Other (.4) - .4 -------------- -------------- -------------- $ 5.4 $ 2.9 $ 8.8 ============== ============== ============== Operating income (loss): Bauxite and Alumina $ 42.0 $ 54.2 $ 27.7 Primary Aluminum 49.9 148.3 79.1 Flat-Rolled Products 70.8 28.2 35.3 Engineered Products 47.5 42.3 21.7 Micromill (1) (63.4) (24.5) (14.5) Eliminations 8.9 (5.9) 8.3 Corporate and Other (65.1) (74.6) (59.8) -------------- -------------- -------------- $ 90.6 $ 168.0 $ 97.8 ============== ============== ============== Depreciation and amortization: Bauxite and Alumina $ 36.4 $ 39.4 $ 41.5 Primary Aluminum 29.9 30.4 33.0 Flat-Rolled Products 16.1 16.0 16.9 Engineered Products 10.8 11.2 12.1 Micromill 3.6 3.2 .5 Corporate and Other 2.3 2.3 3.6 -------------- -------------- -------------- $ 99.1 $ 102.5 $ 107.6 ============== ============== ============== Capital expenditures: Bauxite and Alumina $ 26.9 $ 27.8 $ 29.9 Primary Aluminum 20.7 42.6 28.1 Flat-Rolled Products 20.4 16.8 22.7 Engineered Products 8.4 31.2 18.3 Micromill .2 8.3 56.4 Corporate and Other 1.0 1.8 6.1 -------------- -------------- -------------- $ 77.6 $ 128.5 $ 161.5 ============== ============== ==============
(1) 1998 includes $45.0 fourth quarter impairment charge.
December 31, ------------------------------ 1998 1997 - ----------------------------------------------------------------------------------------------- Investments in and advances to unconsolidated affiliates: Bauxite and Alumina $ 76.8 $ 88.3 Primary Aluminum 27.6 33.2 Engineered Products 23.9 17.5 Corporate and Other - 9.6 -------------- -------------- $ 128.3 $ 148.6 ============== ============== Segment assets: Bauxite and Alumina $ 669.0 $ 692.8 Primary Aluminum 580.8 633.9 Flat-Rolled Products 431.2 466.5 Engineered Products 294.5 318.6 Micromill 25.3 63.4 Corporate and Other 990.1 838.7 -------------- -------------- $ 2,990.9 $ 3,013.9 ============== ==============
Geographical area information relative to the Company's operations is summarized as follows:
Year Ended December 31, ---------------------------------------------- 1998 1997 1996 - ------------------------------------------------------------------------------------------------ Net sales to unaffiliated customers: United States $ 1,698.0 $ 1,720.3 $ 1,610.0 Jamaica 237.0 204.6 201.8 Ghana 89.8 234.2 198.3 Other Foreign 231.6 214.1 180.4 -------------- -------------- -------------- $ 2,256.4 $ 2,373.2 $ 2,190.5 ============== ============== ==============
December 31, ------------------------------ 1998 1997 - ------------------------------------------------------------------------------------------ Long-lived assets: (1) United States $ 757.9 $ 809.5 Jamaica 289.2 283.4 Ghana 90.2 100.4 Other Foreign 99.7 127.1 -------------- -------------- $ 1,237.0 $ 1,320.4 ============== ==============
(1) Long-lived assets include Property, plant, and equipment, net, and Investments in and advances to unconsolidated affiliates. The aggregate foreign currency gain included in determining net income was immaterial for the years ended December 31, 1998, 1997, and 1996. No single customer accounted for sales in excess of 10% of total revenue in 1998, 1997, or 1996. Export sales were less than 10% of total revenue during the years ended December 31, 1998, 1997, and 1996. 12. SUBSEQUENT EVENTS During the first quarter of 1999, two potlines at the Company's 90% owned Valco facility, which were curtailed during most of 1998 (but for which Valco received compensation from the Volta River Authority in the form of energy credits) are being restarted. Additionally, during the first quarter of 1999 KACC began restarting two potlines (representing approximately 50,000 tons of annual capacity) at its Mead, Washington, smelter, which were originally curtailed in September 1998 as a result of the USWA strike. One potline at the Company's Tacoma, Washington, smelter has been prepared for restart, but remains curtailed due to management's consideration of market-related and other factors. The Company's first quarter results will be adversely impacted by the effect of the restart costs at the Valco and Mead facilities and the restart preparations at the Tacoma facility. During February 1999, KACC, through a subsidiary, completed the acquisition of its joint venture partner's 45% interest in Kaiser LaRoche Hydrate Partners ("KLHP") for a cash purchase price of approximately $10.0 subject to post-closing adjustments. As KACC already owned 55% of KLHP, the results of KLHP were already included in the Company's consolidated financial statements. During January 1999, KACC signed a letter of intent to sell its 50% interest in AKW, an aluminum wheels joint venture, to its partner. The sale, which will result in the Company recognizing a net substantial gain, is expected to be completed on or about March 31, 1999. However, as the transaction is subject to the negotiation of a definitive purchase agreement, no assurances can be given that the transaction will be completed. The Company's equity in income of AKW was $7.8 and $4.8 for the years ended December 31, 1998 and 1997, respectively. KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES Q U A R T E R L Y F I N A N C I A L D A T A ( U N A U D I T E D )
Quarter Ended ---------------------------------------------------------------- (In millions of dollars, except share amounts) March 31, June 30, September 30, December 31, - ------------------------------------------------------------------------------------------------------------------ 1998 Net sales $ 597.0 $ 614.8 $ 541.6 $ 503.0 Operating income (loss) 44.8 55.3 30.8 (40.3) Net income (loss) 12.0 16.7 10.8 (1) (38.9)(2) Earnings (loss) per share: Basic/Diluted .15 .21 .14 (.49)(2) Common stock market price: High 11 11-5/8 9-5/8 7-3/4 Low 8-1/8 8-7/8 5-5/8 4-5/8 1997 Net sales $ 547.4 $ 597.1 $634.1 $594.6 Operating income 31.3 35.3 54.5 46.9 Net income 2.6 13.7 (3) 17.5 14.2 Earnings per share: Basic/Diluted .01 .16 .22 .18 Common stock market price: High 13-5/8 12-1/4 16 14-7/8 Low 10-7/8 10-1/8 11-5/8 8-3/8
(1) Includes two essentially offsetting non-recurring items, a favorable $8.3 non-cash tax provision benefit resulting from the resolution of certain matters and an approximate $10.0 unfavorable gross profit impact of preparing for a strike by employees represented by the USWA at five locations. (2) Includes an unfavorable pre-tax strike-related gross profit impact of approximately $50.0, and a non-cash pre-tax charge of $45.0 related to impairment of the Company's Micromill assets. Excluding these items basic earnings per share would have been approximately $.29. (3) Includes a $19.7 pre-tax charge for restructuring of operations, an offsetting after-tax benefit of $12.5 related to the settlement of certain tax matters and a $5.8 pre-tax charge for litigation matters. KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES F I V E - Y E A R F I N A N C I A L D A T A C O N S O L I D A T E D B A L A N C E S H E E T S
December 31, ------------------------------------------------------------------------------ (In millions of dollars) 1998 1997 1996 1995 1994 - -------------------------------------------------------------------------------------------------------------------------------- ASSETS Current assets: Cash and cash equivalents $ 98.3 $ 15.8 $ 81.3 $ 21.9 $ 17.6 Receivables 282.7 340.2 252.4 308.6 199.2 Inventories 543.5 568.3 562.2 525.7 468.0 Prepaid expenses and other current assets 105.5 121.3 127.8 76.6 158.0 -------------- -------------- -------------- -------------- -------------- Total current assets 1,030.0 1,045.6 1,023.7 932.8 842.8 Investments in and advances to unconsolidated affiliates 128.3 148.6 168.4 178.2 169.7 Property, plant, and equipment - net 1,108.7 1,171.8 1,168.7 1,109.6 1,133.2 Deferred income taxes 377.9 330.6 264.5 269.1 271.2 Other assets 346.0 317.3 308.7 323.5 281.2 -------------- -------------- -------------- -------------- -------------- Total $ 2,990.9 $ 3,013.9 $ 2,934.0 $ 2,813.2 $ 2,698.1 ============== ============== ============== ============== ============== Liabilities and Stockholders' Equity Current liabilities: Accounts payable and accruals $ 432.7 $ 457.3 $ 453.4 $ 451.2 $ 439.3 Accrued postretirement medical benefit obligation - current portion 48.2 45.3 50.1 46.8 47.0 Payable to affiliates 77.1 82.7 97.0 94.2 85.3 Long-term debt - current portion .4 8.8 8.9 8.9 11.5 -------------- -------------- -------------- -------------- -------------- Total current liabilities 558.4 594.1 609.4 601.1 583.1 Long-term liabilities 532.9 491.9 458.1 548.5 495.5 Accrued postretirement medical benefit obligation 694.3 720.3 722.5 734.0 734.9 Long-term debt 962.6 962.9 953.0 749.2 751.1 Minority interests 123.5 127.7 121.7 122.7 116.2 Stockholders' equity: Preferred stock - - .4 .4 .6 Common stock .8 .8 .7 .7 .6 Additional capital 535.4 533.8 531.1 530.3 527.8 Retained earnings (accumulated deficit) (417.0) (417.6) (460.1) (459.9) (502.6) Accumulated other comprehensive income - - (2.8) (13.8) (9.1) -------------- -------------- -------------- -------------- -------------- Total stockholders' equity 119.2 117.0 69.3 57.7 17.3 -------------- -------------- -------------- -------------- -------------- Total $ 2,990.9 $ 3,013.9 $ 2,934.0 $ 2,813.2 $ 2,698.1 ============== ============== ============== ============== ============== Debt-to-capital ratio(1) 76.9 77.8 81.2 78.1 82.4
(1) Total of long-term debt - current portion and long-term debt (collectively "total debt") as a ratio of total debt, deferred income tax liabilities, minority interests, and stockholders' equity. KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES F I V E - Y E A R F I N A N C I A L D A T A S T A T E M E N T S O F C O N S O L I D A T E D I N C O M E ( L O S S )
Year Ended December 31, ------------------------------------------------------------------------------ (In millions of dollars, except share amounts) 1998 1997 1996 1995 1994 - -------------------------------------------------------------------------------------------------------------------------------- Net sales $ 2,256.4 $ 2,373.2 $ 2,190.5 $ 2,237.8 $ 1,781.5 -------------- -------------- -------------- -------------- -------------- Costs and expenses: Cost of products sold 1,906.2 1,951.2 1,857.5 1,787.0 1,613.9 Depreciation and amortization 99.1 102.5 107.6 105.7 107.0 Selling, administrative, research and development, and general 115.5 131.8 127.6 134.5 116.8 Impairment of Micromill(TM) assets/ restructuring of operations 45.0 19.7 - - - -------------- -------------- -------------- -------------- -------------- Total costs and expenses 2,165.8 2,205.2 2,092.7 2,027.2 1,837.7 -------------- -------------- -------------- -------------- -------------- Operating income (loss) (1) 90.6 168.0 97.8 210.6 (56.2) Other income (expense): Interest expense (110.0) (110.7) (93.4) (93.9) (88.6) Other - net 3.5 3.0 (2.7) (14.1) (7.3) -------------- -------------- -------------- -------------- -------------- Income (loss) before income taxes, minority interests, and extraordinary loss (15.9) 60.3 1.7 102.6 (152.1) Benefit (provision) for income taxes 16.4 (8.8) 9.3 (37.2) 53.8 Minority interests .1 (3.5) (2.8) (5.1) (3.1) -------------- -------------- -------------- -------------- -------------- Income (loss) before extraordinary loss .6 48.0 8.2 60.3 (101.4) Extraordinary loss on early extinguishments of debt, net of tax benefit of $2.9 - - - - (5.4) -------------- -------------- -------------- -------------- -------------- Net income (loss) .6 48.0 8.2 60.3 (106.8) Preferred stock dividends - (5.5) (8.4) (17.6) (20.1) -------------- -------------- -------------- -------------- -------------- Net income (loss) available to common shareholders $ .6 $ 42.5 $ (.2) $ 42.7 $ (126.9) ============== ============== ============== ============== ============== Earnings (loss) per share: Basic/Diluted $ .01 $ .57 $ .00 $ .69 $ (2.18) Weighted average shares outstanding (000): Basic 79,115 74,221 71,644 62,000 58,139 Diluted 79,156 74,382 71,644 62,264 58,139
(1) 1998 includes an adverse strike-related impact of approximately $60.0. -----END PRIVACY-ENHANCED MESSAGE-----