10-Q

                                     UNITED STATES
                          SECURITIES AND EXCHANGE COMMISSION
                               Washington, D.C. 20549


                                        FORM 10-Q




                   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                           THE SECURITIES EXCHANGE ACT OF 1934

                      For the quarterly period ended June 30, 2006

                            Commission File Number 333-63825


                               SCOTIA PACIFIC COMPANY LLC
                 (Exact name of Registrant as Specified in its Charter)




             Delaware                                              68-0414690
  (State or other jurisdiction                                (I.R.S. Employer
  of incorporation or organization)                        Identification Number)

           P. O. Box 712                                              95565
       125 Main Street, 2nd Floor                                  (Zip Code)
          Scotia, California
  (Address of Principal Executive Offices)


Registrant's telephone number, including area code: (707) 764-2330

     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

     Indicate by check mark whether the Registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. (Check one):
Large accelerated filer     Accelerated filer           Non-accelerated filer X

     Indicate  by check mark  whether  the  Registrant  is a shell  company  (as
defined in Rule 12b-2 of the Exchange Act).
Yes     No X

     Registrant meets the conditions set forth in General Instruction  (I)(1)(a)
and (b) of Form  10-Q  and is  therefore  filing  this  Form  with  the  reduced
disclosure format.


                                                 TABLE OF CONTENTS


                                                                            Page
PART I.  -  FINANCIAL INFORMATION

         Item 1.   Financial Statements (unaudited):
                   Balance Sheets...............................................
                   Statements of Loss...........................................
                   Statements of Cash Flows.....................................
                   Condensed Notes to Financial Statements


         Item 2.   Management's Discussion and Analysis of Financial Condition and
                       Results of Operations....................................

         Item 3.   Quantitative and Qualitative Disclosures About Market Risk...

         Item 4.   Controls and Procedures......................................

PART II.  -  OTHER INFORMATION

         Item 1.   Legal Proceedings............................................
         Item 1A.  Risk Factors.................................................
         Item 6.   Exhibits.....................................................
         Signature .............................................................


APPENDIX A - GLOSSARY OF DEFINED TERMS..........................................


                                            SCOTIA PACIFIC COMPANY LLC

                                                  BALANCE SHEETS
                                             (In millions of dollars)

                                                                                         June 30,     December 31,
                                                                                           2006           2005
                                                                                      ------------------------------
                                                                                               (Unaudited)
                                                                                      ------------------------------
Assets
Current assets:
  Cash and cash equivalents                                                           $     1.4        $   1.3
  Marketable securities, including restricted amounts of $13.1 and
    $23.0, respectively                                                                    13.1           24.2
  Receivables from Palco                                                                    8.9            4.5
  Prepaid timber harvesting costs                                                           6.6            6.0
  Assets held for sale                                                                      1.7              -
  Other current assets                                                                      1.0            1.5
                                                                                      ------------------------------
    Total current assets                                                                   32.7           37.5
Timber and timberlands, net of accumulated depletion of $300.2 and
  $298.1, respectively                                                                    214.7          219.5
Property and equipment, net of accumulated depreciation of $24.1 and
  $22.6, respectively                                                                      29.1           29.3
Deferred financing costs                                                                    9.8           10.5
Restricted cash, marketable securities and other investments                                2.7            2.5
Intangible assets                                                                           2.4            2.9
                                                                                      ------------------------------
                                                                                      $   291.4         $ 302.2
                                                                                      ==============================

Liabilities and Member Deficit
Current liabilities:
  Payables to Palco                                                                   $      1.0        $   1.1
  Accrued interest                                                                          24.0           23.8
  Deferred revenue                                                                           3.7              -
  Other accrued liabilities                                                                  2.0            2.4
  Short-term borrowings and current maturities of long-term debt, excluding
    $9.0 and $11.1, respectively, of repurchased Timber Notes held in the
    SAR Account                                                                             64.9           49.4
                                                                                      ------------------------------
    Total current liabilities                                                               95.6           76.7
Long-term debt, less current maturities and excluding $39.1 and $44.3,
  respectively, of repurchased Timber Notes held in the SAR Account                        653.1          669.6
Other noncurrent liabilities                                                                 0.2            0.4
                                                                                      ------------------------------
    Total liabilities                                                                      748.9          746.7

Contingencies (See Note 5)

Member deficit                                                                            (457.5)        (444.5)
                                                                                      ------------------------------
                                                                                      $    291.4        $ 302.2
                                                                                      ==============================

     The accompanying notes are an integral part of these financial statements.


                                SCOTIA PACIFIC COMPANY LLC

                                    STATEMENTS OF LOSS
                                 (In millions of dollars)


                                                    Three Months Ended        Six  Months Ended
                                                         June 30,                   June 30,
                                                 -------------------------- --------------------------
                                                     2006         2005       2006         2005
                                                 -------------------------- ------------ -------------
                                                                      (Unaudited)
                                                  ----------------------------------------------------
Log sales to Palco                               $    14.2     $    17.4   $     23.0    $     33.5
                                                 -------------------------- ------------ -------------
Operating expenses:
  General and administrative                           5.0           7.7          9.4          14.2
  Depletion, depreciation and amortization             2.3           2.7          4.1           5.4
  Gain on sale of timberlands                         (4.3)            -         (5.0)            -
                                                 -------------------------- ------------ -------------
                                                       3.0          10.4          8.5          19.6
                                                 -------------------------- ------------ -------------
Operating income                                      11.2           7.0         14.5          13.9
                                                 -------------------------- ------------ -------------
Other income (expense):
  Interest and other income                            0.2           0.9          0.4           1.2
  Interest expense                                   (13.9)        (13.7)       (27.9)        (27.5)
                                                 -------------------------- ------------ -------------
                                                     (13.7)        (12.8)       (27.5)        (26.3)
                                                 -------------------------- ------------ -------------
Net loss                                         $    (2.5)    $    (5.8)  $    (13.0)   $    (12.4)
                                                 ========================== ============ =============


     The accompanying notes are an integral part of these financial statements.



                    SCOTIA PACIFIC COMPANY LLC

                     STATEMENTS OF CASH FLOWS
                     (In millions of dollars)

                                                                                      Six Months Ended
                                                                                          June 30,
                                                                                 --------------------------
                                                                                     2006         2005
                                                                                 ------------ -------------
                                                                                        (Unaudited)
                                                                                 --------------------------

Cash flows from operating activities:
Net loss                                                                         $(13.0)      $ (12.4)
Adjustments to reconcile net loss to net cash
  used for operating activities:
  Depletion, depreciation and amortization                                          4.1           5.4
  Gain on sale of timberlands                                                      (5.0)            -
  Amortization of deferred financing costs                                          0.5           0.7
  Increase (decrease) in cash resulting from changes in:
    Receivables from Palco                                                         (4.4)         (4.0)
    Prepaid timber harvesting costs                                                (0.6)         (0.5)
    Payables to Palco                                                              (0.1)         (0.6)
    Accrued interest                                                                0.2          (0.2)
    Deferred revenue                                                                3.7             -
    Other accrued liabilities                                                      (0.4)          1.0
    Other                                                                           0.6           0.6
                                                                                 ------------ -------------
    Net cash used for operating activities                                        (14.4)        (10.0)
                                                                                 ------------ -------------
Cash flows from investing activities:
  Sales and maturities of marketable securities                                   110.1          63.6
  Purchases of marketable securities                                             (108.9)        (62.6)
  Net proceeds from sale of assets                                                  6.9             -
  Net proceeds from restricted cash                                                 9.7           7.4
  Capital expenditures                                                             (2.2)         (3.1)
                                                                                 ------------ -------------
    Net cash provided by investing activities                                      15.6           5.3
                                                                                 ------------ -------------
Cash flows from financing activities:
  Principal payments on Timber Notes and other timber related debt                (12.0)        (10.6)
  Borrowings under line of credit agreement, net                                   10.9          15.6
                                                                                 ------------ -------------
    Net cash provided by (used for) financing activities                           (1.1)          5.0
                                                                                 ------------ -------------
Net increase in cash and cash equivalents
                                                                                    0.1           0.3
Cash and cash equivalents at beginning of period
                                                                                    1.3           0.5
                                                                                 ------------ -------------
Cash and cash equivalents at end of period                                       $  1.4       $   0.8
                                                                                 ============ =============
Supplemental disclosure of cash flow information:
  Interest paid                                                                  $  27.4      $  27.1



     The accompanying notes are an integral part of these financial statements.


                      SCOTIA PACIFIC COMPANY LLC

                CONDENSED NOTES TO FINANCIAL STATEMENTS

1.   Basis of Presentation

     The  information   contained  in  the  following  notes  to  the  financial
statements  is condensed  from that which would  appear in the annual  financial
statements; accordingly, the financial statements included herein should be read
in conjunction with the financial statements and related notes thereto contained
in the Form 10-K. Any capitalized  terms used but not defined in these Condensed
Notes to Financial  Statements  are defined in the  "Glossary of Defined  Terms"
contained in Appendix A.  Accounting  measurements  at interim dates  inherently
involve  greater  reliance  on  estimates  than  at year  end.  The  results  of
operations for the interim periods  presented are not necessarily  indicative of
the results to be expected for the entire year.

     The financial  statements  included  herein are  unaudited;  however,  they
include all  adjustments of a normal  recurring  nature which, in the opinion of
management,  are necessary for a fair presentation of the financial  position of
the Company at June 30, 2006, the results of operations for the three months and
six months  ended June 30, 2006 and 2005,  and the cash flows for the six months
ended June 30, 2006 and 2005. The Company is a wholly owned subsidiary of Palco,
which is a wholly  owned  subsidiary  of MGI.  MGI is an indirect  wholly  owned
subsidiary of MAXXAM.

     Liquidity and Cash Resources

     Regulatory and environmental  matters as well as legal actions have had and
are expected to continue to have a significant  adverse  effect on the Company's
operations and liquidity. The ability to harvest Company Timber depends in large
part upon the Company's ability to obtain  regulatory  approval of its THPs. The
Company has experienced  difficulties  and delays in the approval of its THPs as
the result of regulatory and litigation challenges, and expects these challenges
to persist.  Moreover,  the Company  expects to continue to  experience  further
difficulties,   limitations   and   delays   in  being   able  to   harvest   on
previously-approved  THPs due to, among other things, actions by the North Coast
Water Board (see below).  The  foregoing  matters  have  resulted in declines in
actual and expected harvest levels and cash flows,  significant increases in the
cost of  logging  operations  and  increased  costs  related  to timber  harvest
litigation,  all of which have severely and  negatively  impacted the historical
cash flows of both the Company and Palco.  These adverse effects are expected to
continue.

     The North  Coast Water  Board is  requiring  the Company and Palco to apply
various waste discharge  reporting,  mitigation and erosion control requirements
in respect of timber harvesting activities in several watersheds,  and is likely
to impose  additional  measures  in the  future.  The North Coast Water Board in
December 2003 directed its staff to formulate  WWDRs for the  Freshwater and Elk
River  watersheds  on the  Company  Timberlands.  THPs in these  two  watersheds
represent a significant  portion of the harvest planned in 2006 and for the next
several  years.  As  harvesting  activities  on the Company  Timberlands  cannot
readily be moved between watersheds due to, among other things, historic harvest
patterns,  adjacency restrictions,  and the age classes of trees, development of
WWDRs and the other  matters  described  in the  "Regulatory  and  Environmental
Factors"  section of Note 5 have in the past and are  expected  to  continue  to
result in reduced harvest and less  predictability  in the future  regarding the
mix of logs available for sale by the Company to Palco which negatively  impacts
cash flow.

     As the WWDRs had not yet been  formulated  for the Freshwater and Elk River
watersheds,  the North  Coast  Water  Board for some time  failed to release for
harvest a number of the  Company's  THPs that had already  been  approved by the
other  governmental  agencies which approve the Company's  THPs. The North Coast
Water Board  subsequently  allowed harvesting on a portion of the approved THPs;
however,  the State Water Board later disallowed  harvesting on a portion of the
THPs that had been released by the North Coast Water Board.  On May 8, 2006, the
North  Coast  Water  Board  adopted  WWDRs  for the  Freshwater  and  Elk  River
watersheds,  which has the effect of allowing harvesting in these two watersheds
to begin once THPs are  enrolled,  up to  approximately  50% of the CDF  Harvest
Limit  for  these  two  watersheds.  Additional  THPs,  bringing  the  total  to
approximately  75% of the CDF  Harvest  Limit for these two  watersheds,  may be
enrolled upon approval by the Executive Officer of the North Coast Water Board's
staff of a monitoring  plan,  which has been  submitted by Palco.  While certain
THPs  related to these two  watersheds  have been  enrolled and  harvesting  has
begun,  there can be no  assurance  that  additional  THPs  related to these two
watersheds  will  ultimately  be enrolled or  harvested as planned in 2006 or in
future  years as,  among  other  things,  Palco's  monitoring  plan has not been
approved.  The  North  Coast  Water  Board's  adoption  of these  WWDRs has been
appealed to the State Water Board, but the appeals are being held in abeyance in
order to see how the  implementation  of the WWDRs  proceeds.  While the Company
continues to project  that its annual  harvest  level over the  ten-year  period
beginning 2006 will be approximately  100 million board feet, this projection is
significantly  below historical annual harvest levels, and actual harvest levels
may be even lower, depending on the ultimate outcome of various assumptions.

     Liquidity Update
     In the absence of significant  regulatory  relief and  accommodations,  the
Company's  annual timber harvest levels and cash flows from operations will, for
at least the next several years, be substantially  below both historical  levels
and the  minimum  levels  necessary  to allow the  Company to  satisfy  its debt
service obligations in respect of the Timber Notes.

     In an effort to address the expected  future cash  shortfalls,  the Company
initiated  the  Land  Sale  Program  whereby  it  is  seeking  to  sell  certain
non-timberland  properties such as ranchlands and recreational areas, as well as
certain  timberlands.  During the first half of 2006, $6.9 million of properties
were sold and an additional  $4.6 million of  properties  were sold in July 2006
(of which $3.3 million was received  prior to the July 2006 Timber Notes payment
date).  There can be no assurance  that the marketing  efforts in respect of the
remaining properties will be successful.

     Due to regulatory  constraints  and adverse weather  conditions  during the
first  half of 2006,  harvest  levels  were  lower  than  planned  resulting  in
liquidity shortfalls. The Company and MGI consummated three timber/log purchases
that provided the Company an aggregate of $8.1 million of  additional  liquidity
($4.4  million  as of June 30,  2006 and $3.7  million  in July 2006) to pay its
expenses,  including  interest  due in respect of the Timber Notes on the Timber
Notes payment dates in January 2006 and July 2006 as discussed below.

     On the Timber  Notes  payment  date in January  2006,  the Company used its
existing cash resources,  all of the remaining funds available under the Line of
Credit,  and the additional funds made available from a $2.3 million  timber/log
purchase by MGI, to pay all of the $27.7 million of interest due ($25.8  million
net of interest  due in respect of Timber  Notes held in the SAR  Account).  The
Company  also repaid  $19.3  million of  principal  on the Timber  Notes  ($11.9
million net of principal in respect of Timber Notes held in the SAR Account), an
amount equal to Scheduled Amortization, using funds held in the SAR Account.

     As previously  announced,  the Company's  estimates indicated that its cash
flows from  operations,  together with funds  available under the Line of Credit
and other available funds,  would be insufficient,  by a substantial  amount, to
pay the entire amount of interest due on the July 20, 2006, Timber Notes payment
date.  As the July 20, 2006,  Timber Notes  payment date  approached,  it became
apparent the Company's estimates would prove correct and that the remaining cash
shortfall as of such Timber Notes payment date, after consideration of the funds
made  available  from the Land Sale  Program  and the MGI  timber/log  purchases
discussed above, would be approximately  $2.1 million.  Based upon review of its
existing  alternatives,  the Company requested that Palco make an early payment,
equal to the $2.1 million shortfall, in respect of certain logs that had already
been delivered to and purchased by Palco. Palco approved and delivered the early
log payment.

     On the  Timber  Notes  payment  date in July  2006,  the  Company  used its
existing cash resources,  all of the remaining funds available under the Line of
Credit,  the additional funds made available from the Land Sale Program of $10.2
million,  a $3.7 million  timber/log  purchase by MGI and the $2.1 million early
log  payment  by Palco to pay all of the $27.1  million of  interest  due ($25.4
million net of interest due in respect of Timber Notes held in the SAR Account).
The Company  also repaid  $10.0  million of  principal on the Timber Notes ($6.2
million net of principal in respect of Timber Notes held in the SAR Account), an
amount equal to Scheduled Amortization, using funds held in the SAR Account.

     The Company also expects to incur substantial  interest  shortfalls over at
least the next  several  years.  The  failure to pay all of the  interest on the
Timber  Notes when due would  constitute  an event of  default  under the Timber
Notes  Indenture.  There can be no  assurance  that the Company  will be able to
generate  sufficient  additional  liquidity  to fund the  expected  future  cash
shortfalls.  To the extent  that the  Company is unable to  generate  sufficient
liquidity from the Land Sale Program or other sources,  the Company expects that
it will be forced to take extraordinary actions,  which may include:  laying off
employees,  shutting down various  operations,  and seeking protection by filing
under the Bankruptcy Code.

     Palco Liquidity Update
     As of December 31, 2005, and June 30, 2006, Palco and Britt were in default
under the Old Palco Term Loan and the Old Palco Revolving Credit Facility due to
financial covenant breaches. In the first half of 2006, additional liquidity was
needed at Palco and Palco  borrowed an  aggregate  of $20.0  million from MGI to
meet its cash shortfalls.  Palco's liquidity shortfalls during the first half of
2006 resulted primarily from reduced log supply from the Company and operational
inefficiencies  related to the large log  processing  line at Palco's new Scotia
sawmill.

     On July 18, 2006,  Palco and Britt,  as Borrowers,  closed on the New Palco
Term Loan, a new five-year  $85.0 million  secured term loan,  and the New Palco
Revolving  Credit  Facility,  a new five-year $60.0 million secured  asset-based
revolving credit facility.  The New Palco Term Loan was fully funded at closing.
The New Palco Term Loan and the New Palco Revolving Credit Facility required MGI
to provide a $10.0 million  subordinated  loan to the Borrowers,  which was also
funded at closing. The Borrowers used approximately (i) $34.0 million of the New
Palco Term Loan to pay off the Old Palco Term  Loan;  (ii) $22.5  million of the
New Palco Term Loan to pay off the Old Palco Revolving  Credit Facility and cash
collateralize  previously  existing letters of credit; and (iii) $6.0 million to
pay transaction  costs.  The remaining funds at closing of $32.5 million will be
used for general  corporate  purposes.  The Borrowers  terminated  the Old Palco
Revolving  Credit  Facility and the Old Palco Term Loan.  The Borrowers have not
made any  borrowings  under the New Palco  Revolving  Credit  Facility  to date,
although they currently have availability in excess of $20.0 million.

     The amount  available for borrowings  under the New Palco Revolving  Credit
Facility  is  normally  the  sum  of 85% of  the  Borrowers'  eligible  accounts
receivable  plus the lesser of (i) 80% of the book value of Borrowers'  eligible
inventory or (ii) 85% of the net orderly  liquidation  value of such  inventory.
However,  during  each  period  from  October 15 through  January 15, the amount
available for borrowing under the New Palco Revolving Credit Facility is the sum
of 95% of Borrowers'  eligible accounts receivable plus the lesser of (i) 90% of
the book value of Borrowers'  eligible  inventory or (ii) 95% of the net orderly
liquidation  value of such inventory.  The amount  available under the New Palco
Revolving  Credit Facility may not exceed $60.0 million,  subject to limitations
such as the ability of the lender to establish reasonable reserves.

     The New Palco Term Loan  bears  interest  at the rate of LIBOR plus  8.75%.
Loans under the New Palco Revolving Credit Facility bear interest at the rate of
LIBOR  plus  2.75% or prime  plus  0.75%,  at the  Borrowers'  option;  however,
incremental  borrowings  made during the period from October 15 through  January
15,  bear  interest  at the rate of LIBOR  plus 4.50% or prime  plus  2.50%,  as
applicable. The New Palco Revolving Credit Facility matures on July 18, 2011.

     Both the New Palco Term Loan and the New Palco  Revolving  Credit  Facility
contain substantially  identical restrictive covenants that limit the Borrowers'
ability to incur debt,  grant  liens,  make  investments,  pay  dividends,  make
capital  expenditures  or merge or  consolidate,  and require the  Borrowers' to
maintain a minimum level of EBITDA,  along with a minimum fixed charge  coverage
ratio and maximum leverage ratio throughout the life of the loans. The operating
cash flow  estimates  used to  establish  the EBITDA  maintenance  covenant  are
subject to a number of assumptions  about future operating cash flows and actual
results could differ  materially from these  estimates.  The New Palco Term Loan
also requires the Borrowers to repay a  substantial  portion of the  outstanding
principal of the New Palco Term Loan with the net proceeds  from the Palco Asset
Sale Program, including the real property associated with Palco's former Fortuna
and Carlotta sawmills, and Palco-owned homes to be sold after certain milestones
have been met. Any remaining principal balance of the New Palco Term Loan is due
on July  18,  2011.  Accordingly,  continued  compliance  with  these  new  debt
facilities is dependent on Palco's  ability to meet its EBITDA  projections  and
timely complete  required asset sales. The New Palco Term Loan and the New Palco
Revolving  Credit  Facility  contain  customary  events of default and customary
remedies with respect to the occurrence of an event of default.

     The New Palco  Term  Loan and New  Palco  Revolving  Credit  Facility  each
include prepayment  premiums of 3%, 2% and 1% that will be payable in connection
with any  prepayment of the New Palco Term Loan or reduction or  termination  of
the New Palco  Revolving  Credit  Facility  during the  first,  second and third
years,  respectively.  Under  the New Palco  Term  Loan and New Palco  Revolving
Credit Facility, Palco is permitted to invest up to $5.0 million in the Company.
No such investment had been made or committed to be made by Palco, and there can
be no assurance that Palco would in the future  determine or be able to make any
such investment in whole or part.

     Reclassifications

     Certain   reclassifications  have  been  made  to  prior  years'  financial
statements to be consistent with the current year's  presentation.  Cash held in
brokerage accounts has been reclassified from marketable  securities to cash and
cash equivalents in the Balance Sheets and in the Statements of Cash Flows.

     Use of Estimates and Assumptions

     The  preparation  of financial  statements  in accordance  with  accounting
principles  generally  accepted in the United States of America 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 filing the financial  statements  with the
Securities and Exchange  Commission.  Adjustments made to estimates often relate
to improved information not previously available.  Uncertainties are inherent in
such estimates and related assumptions; accordingly, actual results could differ
from these estimates.

     Risks and  uncertainties  are inherent with respect to the ultimate outcome
of the  matters  discussed  in Note  5.  The  results  of a  resolution  of such
uncertainties  could have a material effect on the Company's financial position,
results of operations or liquidity.

2.   New Accounting Standards

     Exchanges of Nonmonetary Assets
     In December  2004,  the FASB issued SFAS No. 153.  SFAS No. 153 is based on
the principle that  exchanges of nonmonetary  assets should be measured based on
the fair value of the assets exchanged.  The adoption of SFAS No. 153 on January
1, 2006, did not have an impact on the Company's financial statements.

     Accounting Changes and Error Corrections
     In May 2005, the FASB issued SFAS No. 154,  which changes the  requirements
applicable to accounting for and reporting of a change in accounting  principle.
SFAS No.  154  requires  retrospective  application  of a change  in  accounting
principle to prior periods' financial statements,  unless it is impracticable to
determine  either the  period-specific  effects or the cumulative  effect of the
change.  SFAS No. 154 is effective for  accounting  changes and  corrections  of
errors made in fiscal years  beginning  after December 15, 2005. The adoption of
SFAS No.  154 on  January  1,  2006,  did not have an  impact  on the  Company's
financial statements.

3.   Restricted  Cash,  Cash  Equivalents,   Marketable   Securities  and  Other
     Investments

     Restricted  cash,  cash  equivalents,   marketable   securities  and  other
investments  include the following  amounts which are restricted under the terms
of the Company's debt agreements (in millions):
                                                                                         June 30,     December 31,
                                                                                           2006           2005
                                                                                     -------------------------------
Amounts held in SAR Account:
  Current portion of restricted marketable securities and other investments           $  13.1          $   23.0
  Long-term portion of restricted marketable securities and other investments            45.8              52.9

  Less:  Amounts attributable to Timber Notes held in SAR Account                       (45.8)            (52.9)
                                                                                     -------------------------------
    Total amounts held in SAR Account                                                    13.1              23.0

Other amounts restricted under the Indenture                                              2.7               2.5
                                                                                     -------------------------------
Total restricted cash, cash equivalents, marketable securities and
  other investments                                                                   $  15.8          $   25.5
                                                                                     ===============================

4.   Debt

     Line of Credit
     The Line of Credit  allows the Company to borrow up to one year's  interest
on the aggregate  outstanding  principal balance of the Timber Notes. On May 18,
2006, the Line of Credit was extended to July 6, 2007. At or near the completion
of such  extension,  the Company  intends to request  that the Line of Credit be
extended for an  additional  period of not less than 364 days.  If not extended,
the Company may draw upon the full amount available.  The amount drawn would, to
the extent of available  funds,  be repayable in 12 semiannual  installments  on
each  Timber  Notes  payment  date (after the  payment of certain  other  items,
including the Aggregate Minimum Principal  Amortization Amount, as defined, then
due), commencing  approximately two and one half years following the date of the
draw. At June 30, 2006,  the maximum  availability  under the Line of Credit was
$54.1 million, and outstanding borrowings were $42.2 million.

     Timber Notes
     On the Timber  Notes  payment  date in January  2006,  the Company used its
existing cash resources,  all of the remaining funds available under the Line of
Credit,  and the additional funds made available from a $2.3 million  timber/log
purchase by MGI, to pay all of the $27.7 million of interest due ($25.8  million
net of interest  due in respect of Timber  Notes held in the SAR  Account).  The
Company  also repaid  $19.3  million of  principal  on the Timber  Notes  ($11.9
million net of principal in respect of Timber Notes held in the SAR Account), an
amount equal to Scheduled Amortization,  using funds held in the SAR Account.

     On the  Timber  Notes  payment  date in July  2006,  the  Company  used its
existing cash resources,  all of the remaining funds available under the Line of
Credit,  the additional funds made available from the Land Sale Program of $10.2
million, a $3.7 million timber/log  purchase by MGI and a $2.1 million early log
payment by Palco, to pay all of the $27.1 million of interest due ($25.4 million
net of interest  due in respect of Timber  Notes held in the SAR  Account).  The
Company also repaid $10.0 million of principal on the Timber Notes ($6.2 million
net of principal in respect of Timber Notes held in the SAR Account),  an amount
equal to Scheduled Amortization, using funds held in the SAR Account.

     As  discussed  further  in Note 1, the  Company is  experiencing  financial
difficulties due to regulatory  restrictions on harvesting and other factors. As
a result, the Company expects to incur substantial  interest  shortfalls over at
least the next several years. Such an event would constitute an event of default
under the Timber Notes  Indenture.  In the event of a failure to pay interest or
principal on the Timber Notes in full when due, the Trustee or the holders of at
least 25% of the aggregate  outstanding principal amount of the Timber Notes may
cause all principal,  interest and other amounts  related to the Timber Notes to
become  immediately  due and  payable.  Also,  in the event of a failure  by the
Company or Palco to perform its  respective  covenants or  agreements  under the
Master  Purchase  Agreement or by Palco to perform its  covenants or  agreements
under the Services Agreement,  which failure in the case of certain covenants or
agreements continues for 30 days after notice from the Trustee or the holders of
25% or more of the outstanding principal amount of the Timber Notes, the holders
of a majority of the aggregate  outstanding principal amount of the Timber Notes
may cause all principal,  interest and other amounts related to the Timber Notes
to become  immediately due and payable.  In the event of any such  acceleration,
the  Agent  under the Line of  Credit  may also  accelerate  the  advances  then
outstanding.  If such  accelerations  of Timber Notes and/or  advances under the
Line of Credit  occur,  the Trustee may exercise all rights under the  Indenture
and related  security  documents,  including  applying funds to pay  accelerated
amounts,  and selling the Company  Timberlands and the Company Timber Rights and
other assets and using the proceeds thereof to pay accelerated  amounts.  In the
event that the Company were to seek  protection  by filing under the  Bankruptcy
Code, all amounts  related to the Timber Notes would become  immediately due and
payable under the  Indenture and all advances  under the Line of Credit could be
accelerated.  The  foregoing  rights of the Trustee and holders of Timber  Notes
would be subject to the rights of the Company  under the  Bankruptcy  Code if it
sought protection by filing under the Bankruptcy Code.

     U.S. Bank, the Trustee under the Timber Notes Indenture, resigned effective
May 1, 2006.  The Company  appointed  Deutsche  Bank  National  Trust Company as
successor Trustee under the Indenture, which appointment was accepted and became
effective May 1, 2006.

     At June 30, 2006, the SAR Account balance was $58.9 million  (consisting of
$45.8  million of Timber Notes held in the SAR Account and $13.1 million in cash
and  marketable  securities),  all of which is restricted  for future  principal
payments on the Timber Notes.  Such cash and marketable  securities  will not be
sufficient to cover the Scheduled  Amortization on the January 20, 2007,  Timber
Notes  payment  date and  beyond.  Accordingly,  the  Company's  ability to make
Scheduled  Amortization payments on the Timber Notes in 2007 and beyond from the
SAR Account is dependent upon the Company's  ability to sell all or a portion of
the Timber  Notes held in the SAR Account.  No  assurance  can be given that the
Company will be  successful  in its efforts to sell the Timber Notes held in the
SAR Account before the January 20, 2007,  Timber Notes payment date or as to the
proceeds that might result from any such sale.

     Palco Debt Facilities
     At December  31, 2005,  and June 30, 2006,  Palco and Britt were in default
under the Old Palco Term Loan and the Old Palco Revolving Credit Facility due to
financial covenant breaches. The existence of the defaults required Palco to pay
interest on amounts  borrowed  under the Old Palco Term Loan at a per annum rate
2% higher than the rate at which interest  would be owed if no default  existed.
As of June 30, 2006, $33.4 million was outstanding under the Old Palco Term Loan
and $19.5  million,  consisting of  borrowings  of $9.3 million and  outstanding
letters  of  credit  of $10.2  million,  was  outstanding  under  the Old  Palco
Revolving Credit Facility.

     On July 18, 2006,  Palco and Britt,  as Borrowers,  closed on the New Palco
Term Loan and the New Palco Revolving  Credit  Facility.  See Note 1, "Liquidity
and Cash Resources- Palco Liquidity Update",  for a description of these two new
facilities.

5.   Regulatory and Environmental Factors and Contingencies

     Regulatory and Environmental Factors
     Regulatory and environmental  matters and litigation have had a significant
adverse  effect on the  Company's  business,  which is  subject  to a variety of
California and federal laws and  regulations,  as well as the HCP,  dealing with
timber harvesting  practices,  threatened and endangered species and habitat for
such species, air and water quality and other matters. Compliance with such laws
and regulations also plays a significant role in the Company's business.

     Environmental Plans
     From March 1999 until October 2002, the Company prepared THPs in accordance
with the  SYP.  The SYP was  intended  to  comply  with  regulations  of the CDF
requiring  timber  companies to  demonstrate  sustained  yield,  i.e. that their
projected  average  annual  harvest  for any decade  within a 100-year  planning
period  would not  exceed  the  average  annual  growth  level at the end of the
100-year planning period.  These regulations allow companies which do not have a
sustained  yield plan to follow  alternative  procedures to document  compliance
with   the   sustained   yield    requirements.    As   discussed   below   (see
"-Contingencies-Timber Harvest Litigation"), on October 31, 2003, the California
trial court hearing the EPIC-SYP/Permits lawsuit entered a judgment invalidating
the SYP and the California  Permits,  although an appellate  court reversed that
decision in  December  2005.  The  plaintiffs  appealed  the  appellate  court's
decision to the California Supreme Court, which has indicated it will review the
matter. As a result of an earlier stay order and the trial court's judgment, the
Company from October 2002 until March 2005  obtained  review and approval of its
THPs under an  alternative  procedure in the  California  forest  practice rules
known as Option C. Option C is available  to  landowners  who have  submitted an
"Option A" plan to the CDF for review (as was done by Palco). An approved Option
A plan is an  alternative to obtaining  approval of a sustained  yield plan. The
Company's  Option A plan was  approved by the CDF in March 2005.  The Company is
currently  relying  upon the  Option A Plan to obtain  THP  approvals,  and will
likely continue to do so in the future.

     The Federal Permits allow  incidental  "take" of certain  federally  listed
species located on the Company  Timberlands so long as there is no "jeopardy" to
the continued  existence of such species.  The HCP identifies the measures to be
instituted  in order to minimize and mitigate the  anticipated  level of take to
the greatest  extent  practicable.  The HCP and Federal Permits have terms of 50
years.  Since the consummation of the Headwaters  Agreement in March 1999, there
has  been a  significant  amount  of  work  and  additional  costs  required  in
connection with the implementation of the Environmental Plans, and this work and
the additional costs are expected to continue for the foreseeable future.

     Water Quality
     Laws and  regulations  dealing with water  quality are  impacting the Palco
Companies primarily in four areas:  efforts by the EPA and the North Coast Water
Board to establish  TMDLs in  watercourses  that have been  declared to be water
quality  impaired;  actions  by the North  Coast  Water  Board to  impose  waste
discharge  reporting  requirements  in  respect  of  watersheds  on the  Company
Timberlands and in some cases,  clean-up or preventive measures;  actions by the
North Coast Water Board during the THP  approval  process  which impose  certain
operational requirements on individual THPs; and the development of WWDRs by the
North  Coast  Water  Board  and its  staff  for  the  Freshwater  and Elk  River
watersheds.

     Under the CWA, the EPA is required to establish TMDLs in watercourses  that
have been declared to be "water  quality  impaired." The EPA and the North Coast
Water  Board  are in  the  process  of  establishing  TMDLs  for  many  northern
California rivers and certain of their tributaries,  including nine watercourses
that flow  within the  Company  Timberlands.  On the  Company  Timberlands,  the
relevant  contaminant  is  simple  sediment  - dust,  dirt and  gravel - that is
abundant  in  watercourses  largely as a function of the area's  normally  heavy
rainfall  and soil that  erodes  easily.  The  Company  expects  the  process of
establishing  TMDLs to continue  until at least 2010. The EPA has issued reports
dealing with TMDLs on three of the nine watercourses.  The agency indicated that
the requirements under the HCP would  significantly  address the sediment issues
that resulted in TMDL requirements for these watercourses.  Presently, the North
Coast  Water  Board is in the  process  of  establishing  the TMDL  requirements
applicable to two other  watercourses,  Freshwater and Elk River, on the Company
Timberlands, with a targeted completion of 2007 for these two watercourses.  The
Company's  scientists are actively working with North Coast Water Board staff to
ensure that these TMDLs recognize and incorporate the  environmental  protection
measures  of the HCP.  The final TMDL  requirements  applicable  to the  Company
Timberlands may require aquatic  protection  measures that are different from or
in  addition to those in the HCP or that  result  from the  prescriptions  to be
developed pursuant to the watershed analysis process provided for in the HCP and
could further restrict harvesting on the Company Timberlands.

     For each of the winter  periods since 2002, the Company and Palco have been
required to submit reports on sediment  discharges and erosion control practices
to the North Coast Water Board in order to conduct winter harvesting  operations
in the  Freshwater  and Elk  River  watersheds.  After  consideration  of  these
reports, the North Coast Water Board imposed requirements on the Palco Companies
to  implement  additional  mitigation  and erosion  control  practices  in these
watersheds  for each of these winter  operating  periods.  The North Coast Water
Board has also  extended the  requirements  for certain  mitigation  and erosion
control practices to three additional watersheds (Bear, Jordan and Stitz Creek).
The Palco Companies and the North Coast Water Board are currently in discussions
to determine  what these measures will be. The  requirements  imposed to date by
the North  Coast  Water  Board have  significantly  increased  operating  costs;
additional  requirements  imposed in the future could further increase costs and
cause additional delays in THP approvals.

     The North Coast Water Board has also issued the Elk River Orders, which are
aimed at addressing existing sediment production sites through clean up actions.
The North Coast Water Board has also  initiated the process that could result in
similar  orders  for  the  Freshwater   and  Bear  Creek   watersheds,   and  is
contemplating similar actions for the Jordan and Stitz Creek watersheds. The Elk
River Orders have resulted in increased  costs to Palco that could extend over a
number of years. Additional orders for other watersheds (should they be issued),
may also result in further cost increases.

     The  North  Coast  Water  Board in  December  2003  directed  its  staff to
formulate  WWDRs for the  Freshwater  and Elk River  watersheds  on the  Company
Timberlands.  As harvesting activities on the Company Timberlands cannot readily
be moved  between  watersheds  due to,  among  other  things,  historic  harvest
patterns,  adjacency restrictions,  and the age classes of trees, development of
WWDRs and the various other matters  described  herein are expected to result in
reduced harvest levels in 2006 and beyond.

     As WWDRs  had not yet been  formulated  for the  Freshwater  and Elk  River
watersheds,  the North  Coast  Water  Board for some time  failed to release for
harvest a number of the  Company's  THPs that had already  been  approved by the
other  governmental  agencies  which approve the Company's  THPs. In January and
February 2005, the Executive Officer of the staff of the North Coast Water Board
enrolled  sufficient  THPs to allow the  harvest of up to 50% of the CDF Harvest
Limit for these two  watersheds.  On March 16, 2005, the North Coast Water Board
ordered the enrollment of additional  THPs that would allow the harvest of up to
75% of the CDF Harvest  Limit for these two  watersheds.  Following  third party
appeal of this  decision,  the State  Water  Board  issued the State Water Board
Order, which had the effect of disallowing  further harvesting on the additional
25% of the CDF  Harvest  Limit  approved by the North Coast Water Board on March
16, 2005.  The State Water Board's  decision also had the effect of  disallowing
further  harvesting in the Freshwater and Elk River  watersheds  until WWDRs for
these two  watersheds  were adopted by the North Coast Water Board.  On July 14,
2005, the Company and Palco filed the State Water Board action requesting both a
stay of the State Water Board  Order and a writ of mandate  reversing  the State
Water Board Order.  The Court  subsequently  denied the request for a stay,  but
granted a writ of mandate, thus requiring the State Water Board to set aside its
June 16, 2005 order. The Court also remanded the matter to the State Water Board
to  reconsider  whether the North Coast Water  Board's  enrollment of additional
THPs was  proper.  Further  proceedings  before  the State  Board have yet to be
scheduled.

     While the Court ordered that the State Water Board must take further action
before August 1, 2006, it has not done so. In the meantime,  on May 8, 2006, the
North  Coast  Water  Board  adopted  WWDRs  for the  Freshwater  and  Elk  River
watersheds,  which has the effect of allowing harvesting in these two watersheds
to begin once THPs are  enrolled,  up to  approximately  50% of the CDF  Harvest
Limit  for  these  two  watersheds.  Additional  THPs,  bringing  the  total  to
approximately  75% of the CDF  Harvest  Limit for these two  watersheds,  may be
enrolled upon approval by the Executive Officer of the North Coast Water Board's
staff of a monitoring  plan,  which has been  submitted by Palco.  While certain
THPs  related to these two  watersheds  have been  enrolled and  harvesting  has
begun,  there can be no  assurance  that  additional  THPs  related to these two
watersheds  will  ultimately  be enrolled or  harvested as planned in 2006 or in
future  years as,  among  other  things,  Palco's  monitoring  plan has not been
approved.  The  North  Coast  Water  Board's  adoption  of these  WWDRs has been
appealed to the State Water Board, but the appeals are being held in abeyance in
order to see how the  implementation  of the WWDRs  proceeds.  While the Company
continues to project  that its annual  harvest  level over the  ten-year  period
beginning 2006 will be approximately  100 million board feet, this projection is
significantly  below historical annual harvest levels, and actual harvest levels
may be even lower, depending on the ultimate outcome of various assumptions.

     Effective  January 1, 2004,  California  Senate Bill 810 provides  regional
water quality control boards with additional  authority  related to the approval
of THPs on land within  impaired  watersheds.  The Company is  uncertain  of the
operational and financial  effects which will ultimately result from Senate Bill
810;  however,  because  substantially all rivers and waterbodies on the Company
Timberlands  are  classified as  sediment-impaired,  implementation  of this law
could result in additional delays in obtaining  approvals of THPs, lower harvest
levels and  increased  costs and  additional  protection  measures  beyond those
contained in the HCP.

     Contingencies

     Various  pending  judicial  and  administrative  proceedings,  as described
below,  could affect the  Company's  and Palco's  ability to implement  the HCP,
implement  certain  approved THPs, or carry out other  operations.  The Services
Agreement  requires  Palco to  prepare  and file on  behalf of the  Company  (at
Palco's  cost) all  pleadings  and motions,  and  otherwise  diligently  pursue,
appeals of any denial,  and defense of any challenge to approval,  of any THP or
the Environmental Plans or similar plan or permit and related matters.

     In March 1999, the EPIC-SYP/Permits lawsuit was filed. This action alleged,
among other things,  various violations of the California Endangered Species Act
and the  California  Environmental  Quality  Act,  and  challenged,  among other
things,  the validity and legality of the SYP and the  California  Permits,  and
sought,  among  other  things,  to prevent  implementation  of THPs  approved in
reliance upon these documents.  A similar action, the USWA lawsuit, was filed on
the same day, and the two actions were consolidated for trial.

     Following  the  trial,  the  Court  in  October  2003  entered  a  judgment
invalidating the SYP and the California  Permits,  and in September 2004 granted
the  plaintiffs'  request for  reimbursement  of an aggregate of $5.8 million in
attorneys'  fees and  other  expenses.  The  Palco  Companies  and the  State of
California  appealed both  decisions.  On December 12, 2005, an appellate  court
reversed the trial  court's  decision  invalidating  the SYP and the  California
Permits.  The  plaintiffs  have appealed the appellate  court's  decision to the
California  Supreme  Court,  which has indicated it will review the matter.  The
defendants' appeal of the trial court's award of attorneys' fees and expenses is
still pending at the appellate court. There can be no assurance that this appeal
will be successful.

     In July 2001, the Bear Creek lawsuit was filed and later amended to add the
EPA as a defendant.  The lawsuit  alleges  that  harvesting  and other  forestry
activities  under  certain of the  Company's  THPs will result in  discharges of
pollutants in violation of the CWA. The plaintiff  asserts that the CWA requires
the  defendants  to obtain a permit  from the North  Coast  Water  Board  before
beginning timber harvesting and road  construction  activities and is seeking to
enjoin these activities until such permit has been obtained.  The plaintiff also
seeks  civil  penalties  of up to  $27,500  per day for  the  alleged  continued
violation of the CWA. In October  2003,  the Court upheld the validity of an EPA
regulation  that exempts  harvesting and other forestry  activities from certain
discharge  requirements.  Both state and federal agencies,  along with Palco and
other timber companies, have relied upon this regulation for more than 25 years.
However,  the Court  interpreted  the  regulation in such a way as to narrow the
forestry  operations  that  are  exempted,  thereby  limiting  the  regulation's
applicability and subjecting culverts and ditches to permit  requirements.  This
ruling has widespread implications for the timber industry in the United States.
The case is not yet final as the trial has not yet been held, and there are many
unresolved  issues  involving  interpretation  of the Court's  decision  and its
application  to actual  operations.  The  Company has filed a motion for summary
judgment  on the  grounds  that it has met the  requirements  for a storm  water
pollution  prevention  permit  under a  general  permit,  issued by the State of
California.  The plaintiff has also filed a motion for summary  judgment seeking
to establish  Palco's  liability for discharging storm water without a permit. A
hearing on the two summary  judgment motions was held on March 6, 2006. On April
28, 2006, the Court denied both motions. Discovery was completed in May 2006. On
June 30,  2006,  EPIC filed a motion for  partial  summary  judgment  seeking to
establish  Palco's  liability,  and Palco  filed a motion for  summary  judgment
asserting  that EPIC lacks  standing to maintain the  lawsuit.  A hearing on the
parties' motions is scheduled for August 21, 2006.

     Should the Court's  October 2003  decision  ultimately  become final and be
held to apply to all of the timber  operations  of the Palco  Companies,  it may
have  some  or all of the  following  effects:  imposing  additional  permitting
requirements,  delaying  approvals of THPs,  increasing  harvesting  costs,  and
adding water protection  measures beyond those contained in the HCP. The Company
believes that civil penalties should not be awarded for operations that occurred
prior to the Court's decision due to the historical reliance by timber companies
on the regulation and the Company's belief that the  requirements  under the HCP
are adequate to ensure that sediment and pollutants from  harvesting  activities
on the Company  Timberlands  will not reach levels  harmful to the  environment.
While the impact of a  conclusion  to this case that  upholds the  October  2003
ruling may be adverse,  the Company does not believe that such an outcome should
have a material adverse impact on the Company's financial condition,  results of
operations  or  liquidity.  Nevertheless,  due to the numerous ways in which the
Court's  interpretation of the regulation could be applied to actual operations,
there can be no assurance that this will be the case.

     On November 20, 2002, the Cook action and the Cave action were filed, which
name the Company and certain affiliates as defendants.  The Cook action alleges,
among other things,  that defendants'  logging  practices have contributed to an
increase in flooding  along  Freshwater  Creek  (which runs  through the Company
Timberlands),  resulting  in  personal  injury  and  damage  to the  plaintiffs'
properties. Plaintiffs further allege that in order to have THPs approved in the
affected areas, the defendants engaged in certain unfair business practices. The
plaintiffs  seek,  among  other  things,  compensatory  and  exemplary  damages,
injunctive relief, and appointment of a receiver to ensure that the watershed is
restored.  The Cave action contains  similar  allegations  and requests  similar
relief with respect to the Elk River  watershed (a portion of which is contained
on the Company  Timberlands).  On October 13, 2005, the Johnson action was filed
and contains  allegations similar to the Cave and Cook actions. The Company does
not believe the resolution of these actions should result in a material  adverse
effect on its financial condition, results of operations or liquidity.

     On February 25, 2003,  the District  Attorney of Humboldt  County filed the
Humboldt DA action. The suit was filed under California's unfair competition law
and alleges that the Palco Companies used certain unfair  business  practices in
connection with completion of the Headwaters  Agreement,  and that this resulted
in the harvest of  significantly  more trees than would have  otherwise been the
case. The suit sought a variety of remedies  including a civil penalty of $2,500
for each  additional tree that has been or will be harvested due to this alleged
increase in harvest,  as well as restitution and an injunction in respect of the
additional  timber harvesting  allegedly being conducted.  On June 14, 2005, the
Court dismissed this matter in its entirety. On September 19, 2005, the District
Attorney  appealed  this  decision,  however,  the  Company  believes  that  the
dismissal and prior rulings of the Court  substantially  diminished the exposure
of the Palco Companies with respect to this matter.

     In December  2005,  the Company and Palco filed the  California  Headwaters
action.  The  California  Headwaters  action  alleges that the  defendants  have
substantially impaired the contractual and legal rights of the Company and Palco
under the  Headwaters  Agreement  and the related  permits,  authorizations  and
approvals. The California Headwaters action also alleges that the actions of the
defendants have caused the companies  substantial  damages, but does not specify
an amount.  While the Claims Board has indicated  that it is  investigating  the
matter, it failed to approve or deny the claim by the statutory  deadline.  As a
result,  the  California  Headwaters  action is by  operation  of law treated as
having  been  denied,  the Company and Palco may now file a claim for damages in
California  state  court.  The  Company  and Palco are  considering  how best to
proceed with respect to this matter.

     The Company is involved in other claims,  lawsuits and  proceedings.  While
uncertainties  are  inherent  in the final  outcome  of such  matters  and it is
presently  impossible  to  determine  the actual  costs that  ultimately  may be
incurred or their effect on the Company, management believes that the resolution
of such  uncertainties  and the  incurrence of such costs should not result in a
material  adverse  effect  on the  Company's  financial  condition,  results  of
operations or liquidity.

6.   Comprehensive Loss and Member Deficit

     Comprehensive loss includes the following (in millions):

                                                                Three Months Ended       Six Months Ended
                                                                     June 30,                 June 30,
                                                               -------------------------- --------------------------
                                                                   2006         2005          2006         2005
                                                               ------------ ------------- ------------ -------------
Net loss                                                       $ (2.5)      $  (5.8)      $   (13.0)   $    (12.4)
Other comprehensive income:
  Net change in fair value of available-for-sale
    investments                                                     -             -               -           0.2
                                                               ------------ ------------- ------------ -------------
Total comprehensive loss                                       $ (2.5)      $  (5.8)      $   (13.0)   $    (12.2)
                                                               ========================== ============ =============

          A  reconciliation  of the activity in member deficit is as follows (in
     millions):

                                                   Six Months Ended
                                                       June 31,
                                              --------------------------
                                                  2006          2005
                                              ------------ -------------
Balance at beginning of period
                                              $(444.5)     $  (431.6)
Comprehensive loss                              (13.0)         (12.2)
                                              ------------ -------------
Balance at end of period
                                              $(457.5)     $  (443.8)
                                              ============ =============

ITEM 2. MANAGEMENT'S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
     OF OPERATIONS

     The following should be read in conjunction  with the financial  statements
in Part I,  Item 1 of this  Report  and  Item 7.  "Management's  Discussion  and
Analysis  of  Financial  Condition  and  Results  of  Operations"  and  Item  8.
"Financial  Statements and Supplementary Data" of the Form 10-K. Any capitalized
terms used but not defined in this Item are defined in the  "Glossary of Defined
Terms"  contained in Appendix A. Except as otherwise  noted,  all  references to
Notes represent the Condensed Notes to Financial Statements included herein.

     This Quarterly  Report on Form 10-Q contains  statements  which  constitute
"forward-looking  statements"  within the meaning of the PSLRA. These statements
appear  in a number of places in this  section  and in Part II,  Item 1.  "Legal
Proceedings."  Such  statements can be identified by the use of  forward-looking
terminology such as "believes," "expects," "may," "estimates," "will," "should,"
"could,"  "plans,"  "intends,"  "projects,"  "seeks,"  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 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,
environmental or regulatory requirements,  litigation developments, and changing
prices and market  conditions.  This Form 10-Q and the Form 10-K identify  other
factors which could cause differences  between such  forward-looking  statements
and actual results.  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.

Results of Operations

     This  section  contains   statements   which  constitute   "forward-looking
statements" within the meaning of the PSLRA. See the second paragraph of Item 2.
for cautionary information with respect to such forward-looking statements.

     The  Company's  business  has  become  increasingly  unpredictable  due  to
continued  regulatory  constraints,  ongoing  litigation  challenges  and  other
factors. Additionally, the Company's business is somewhat seasonal, with its net
sales having  historically  been 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 unpredictable and somewhat
seasonal.  Accordingly,  the  Company's  results  for  any one  quarter  are not
necessarily indicative of results to be expected for the full year.

     Regulatory and environmental  matters as well as legal actions have had and
are expected to continue to adversely affect the Company's operations.  See Item
1.  "Business-Regulatory and Environmental Factors," and Item 1A. "Risk Factors"
of the Form  10-K and in this  Form  10-Q and Note 5 for  information  regarding
these matters.  Regulatory compliance and related litigation have caused and are
expected  to  continue  to  cause  delays  in  approval  of THPs and  delays  in
harvesting on THPs once they are approved.  This has resulted and is expected to
continue to result in a significant decline in harvest and increased costs.

     The cash flows of the Company and Palco have both been  adversely  impacted
by the failure of the North Coast Water Board to release for harvest a number of
already-approved  THPs.  Management  has  concluded  that,  in  the  absence  of
significant  regulatory relief and  accommodations,  the Company's annual timber
harvest levels and cash flows from operations will for at least several years be
substantially  below both historical  levels and the minimum levels necessary to
allow the  Company to satisfy  its debt  service  obligations  in respect of the
Timber  Notes.  To the extent that the Company is unable to generate  sufficient
liquidity from the Land Sale Program or other sources,  the Company expects that
it will be forced to take extraordinary actions,  which may include:  laying off
employees,  shutting down various  operations,  and seeking protection by filing
under the Bankruptcy Code.

     On July 18, 2006, Palco and Britt closed on the New Palco Term Loan and New
Palco  Revolving  Credit Facility and terminated the Old Palco Term Loan and Old
Palco  Revolving  Credit  Facility.  For further  information,  see  "-Financial
Condition and Investing and Financing Activities."

     In addition to the matters described above,  there can be no assurance that
certain other pending  legal,  regulatory  and  environmental  matters or future
governmental  regulations,   additional  litigation,  legislation,  judicial  or
administrative  decisions,  adverse  weather  conditions,  or low  lumber or log
prices,  will not also have material adverse effects on the Company's  financial
condition,  results of operations or liquidity. See Item 1. "Business-Regulatory
and Environmental  Factors," Item 1A. "Risk Factors," Item 1A. "Risk Factors" in
this  Form  10-Q and Item 3.  "Legal  Proceedings"  of the Form  10-K and Note 5
("Regulatory  and  Environmental  Factors"  and  "Contingencies  Timber  Harvest
Litigation")  for  further  information  regarding  regulatory  and  legislative
matters and legal proceedings relating to the Company's operations.

     Log Sales to Palco
     The following  table  presents  price,  volume and revenue  amounts for the
Company for the periods indicated (revenues in millions).

                       Three Months Ended June 30, 2006       Three Months Ended June 30, 2005
                    -------------------------------------------------------------------------------
                                    Price                                   Price
                                   $/MBFE       Revenues         MBFE       $/MBFE      Revenues
                    MBFE
                    ----------- ------------- ------------------------- ------------- -------------
Redwood             12,700      $ 1,020        $  12.9        16,800      $  876        $   14.7
Douglas-fir          1,800          654            1.2         4,500         593             2.7
Other                  200          408            0.1           400         111               -
                    -----------               -------------------------               -------------
                    14,700          966        $  14.2        21,700         803         $  17.4
                    ===========               =========================               =============

                        Six Months Ended June 30, 2006         Six Months Ended June 30, 2005
                    -------------------------------------------------------------------------------
                                    Price                                   Price
                    MBFE           $/MBFE       Revenues         MBFE       $/MBFE      Revenues
                    ----------- ------------- ------------------------- ------------- -------------
Redwood             21,300      $   982         $ 21.0        33,100      $  852         $  28.2
Douglas-fir          3,100          611            1.9         9,000         578             5.2
Other                  400          360            0.1         1,100          78             0.1
                    -----------               -------------------------               -------------
                    24,800          926          $23.0        43,200         775          $ 33.5
                    ===========               =========================               =============

     For the three  months  ended June 30,  2006,  the  Company  experienced  an
overall 18.4% decrease in revenues and a 32.2% decrease in sales volume compared
to the three months ended June 30, 2005. The decrease in revenue is attributable
to the decline in harvest  levels,  partially  offset by a 20.3% increase in the
average realized price of logs.

     For the six months ended June 30, 2006, the Company  experienced an overall
31.3% decrease in revenues and a 42.6% decrease in sales volume  compared to the
six months ended June 30, 2005. The decrease in revenue is  attributable  to the
decline in harvest levels,  partially  offset by a 19.5% increase in the average
realized price of logs.

     Operating Income and Net Loss
     The Company  generated  operating income of $11.2 million and $14.5 million
for  the  second  quarter  of 2006  and the six  months  ended  June  30,  2006,
respectively.  These  results  include a gain of $4.3 million and $5.0  million,
respectively,  from the sale of  certain  properties.  The  Company's  operating
results  for  the  first  half of  2005  include  substantial  legal  and  other
professional  fees  relating  to the  Company's  efforts to pursue a  negotiated
restructuring  of the Timber  Notes.  The  Company  also had excess cash in 2005
invested that  generated  earnings of  approximately  $0.8 million in the second
quarter of 2005 and $1.2 million in the first half of 2005.

Financial Condition and Investing and Financing Activities

     This  section  contains   statements   which  constitute   "forward-looking
statements" within the meaning of the PSLRA. See the second paragraph of Item 2.
for cautionary information with respect to such forward-looking statements.

     Regulatory and environmental  matters as well as legal actions have had and
are expected to continue to have a significant  adverse  effect on the Company's
operations and liquidity. The ability to harvest Company Timber depends in large
part upon the Company's ability to obtain  regulatory  approval of its THPs. The
Company has experienced  difficulties  and delays in the approval of its THPs as
the result of regulatory and litigation challenges, and expects these challenges
to persist.  Moreover,  the Company  expects to continue to  experience  further
difficulties,   limitations   and   delays   in  being   able  to   harvest   on
previously-approved  THPs due to, among other things, actions by the North Coast
Water Board (see below).  The  foregoing  matters  have  resulted in declines in
actual and expected harvest levels and cash flows,  significant increases in the
cost of  logging  operations  and  increased  costs  related  to timber  harvest
litigation,  all of which have severely and  negatively  impacted the historical
cash flows of both the Company and Palco.  These adverse effects are expected to
continue.

     The North  Coast Water  Board is  requiring  the Company and Palco to apply
various waste discharge  reporting,  mitigation and erosion control requirements
in respect of timber harvesting activities in several watersheds,  and is likely
to impose  additional  measures  in the  future.  The North Coast Water Board in
December 2003 directed its staff to formulate  WWDRs for the  Freshwater and Elk
River  watersheds  on the  Company  Timberlands.  THPs in these  two  watersheds
represent a significant  portion of the harvest planned in 2006 and for the next
several  years.  As  harvesting  activities  on the Company  Timberlands  cannot
readily be moved between watersheds due to, among other things, historic harvest
patterns,  adjacency restrictions,  and the age classes of trees, development of
WWDRs and the other  matters  described  in the  "Regulatory  and  Environmental
Factors"  section of Note 5 have in the past and are  expected  to  continue  to
result in reduced harvest and less  predictability  in the future  regarding the
mix of logs available for sale by the Company to Palco which negatively  impacts
cash flow.

     As the WWDRs had not yet been  formulated  for the Freshwater and Elk River
watersheds,  the North  Coast  Water  Board for some time  failed to release for
harvest a number of the  Company's  THPs that had already  been  approved by the
other  governmental  agencies which approve the Company's  THPs. The North Coast
Water Board  subsequently  allowed harvesting on a portion of the approved THPs;
however,  the State Water Board later disallowed  harvesting on a portion of the
THPs that had been released by the North Coast Water Board.  On May 8, 2006, the
North  Coast  Water  Board  adopted  WWDRs  for the  Freshwater  and  Elk  River
watersheds,  which has the effect of allowing harvesting in these two watersheds
to begin once THPs are  enrolled,  up to  approximately  50% of the CDF  Harvest
Limit  for  these  two  watersheds.  Additional  THPs,  bringing  the  total  to
approximately  75% of the CDF  Harvest  Limit for these two  watersheds,  may be
enrolled upon approval by the Executive Officer of the North Coast Water Board's
staff of a monitoring  plan,  which has been  submitted by Palco.  While certain
THPs  related to these two  watersheds  have been  enrolled and  harvesting  has
begun,  there can be no  assurance  that  additional  THPs  related to these two
watersheds  will  ultimately  be enrolled or  harvested as planned in 2006 or in
future  years as,  among  other  things,  Palco's  monitoring  plan has not been
approved.  The  North  Coast  Water  Board's  adoption  of these  WWDRs has been
appealed to the State Water Board, but the appeals are being held in abeyance in
order to see how the  implementation  of the WWDRs  proceeds.  While the Company
continues to project  that its annual  harvest  level over the  ten-year  period
beginning 2006 will be approximately  100 million board feet, this projection is
significantly  below historical annual harvest levels, and actual harvest levels
may be even lower, depending on the ultimate outcome of various assumptions.

     Liquidity Update
     Due to its highly leveraged  condition,  the Company is more sensitive than
less leveraged companies to factors affecting its operations,  including low log
prices,  governmental  regulation and  litigation  affecting  timber  harvesting
operations on the Company  Timberlands (see Item 1A. "Risk Factors," of the Form
10-K and Note 5), and general economic conditions. The Company's cash flows from
operations are  significantly  impacted by harvest  volumes and log prices.  The
Master  Purchase   Agreement   between  the  Company  and  Palco  (see  Item  1.
"Business-Operation  of Company Timberlands" of the Form 10-K) contemplates that
all sales of logs by the Company to Palco will be at fair market value (based on
stumpage  prices) for each species and category of timber.  The Master  Purchase
Agreement  provides  that if the purchase  price equals or exceeds the SBE Price
and a structuring  price set forth in a schedule to the Indenture,  the purchase
price is deemed to be at fair market  value.  If the  purchase  price  equals or
exceeds the SBE Price, but is less than the structuring  price, then the Company
is required to engage an  independent  forestry  consultant  to confirm that the
purchase price  reflects fair market value.  In January 2006, the State Board of
Equalization  adopted the new Harvest Value Schedule for the first half of 2006.
The prices published in that schedule reflected a 5.3% increase in the SBE Price
for small redwood logs and a 5.6% decrease for small  Douglas-fir  logs from the
prices  published for the second half of 2005. In June 2006,  the State Board of
Equalization issued a draft version of the Harvest Value Schedule for the second
half of 2006. The prices  published in that schedule  reflected a 4% increase in
the SBE Price for small  redwood  logs and a 6% decrease  for small  Douglas fir
logs from the prices published for the second half of 2005.

     In the absence of significant  regulatory  relief and  accommodations,  the
Company's  annual timber harvest levels and cash flows from  operations, will for
at least the next several years be  substantially  below both historical  levels
and the  minimum  levels  necessary  to allow the  Company to  satisfy  its debt
service obligations in respect of the Timber Notes.

     In an effort to address the expected  future cash  shortfalls,  the Company
initiated  the  Land  Sale  Program  whereby  it  is  seeking  to  sell  certain
non-timberland  properties such as ranchlands and recreational areas, as well as
certain  timberlands.  During the first half of 2006, $6.9 million of properties
were sold and an additional  $4.6 million of  properties  were sold in July 2006
(of which $3.3 million was received  prior to the July 2006 Timber Notes payment
date).  There can be no assurance  that the marketing  efforts in respect of the
remaining properties will be successful.

     Due to regulatory  constraints  and adverse weather  conditions  during the
first half of 2006 harvest levels were lower than planned resulting in liquidity
shortfalls.  The Company and MGI  consummated  three  timber/log  purchases that
provided the Company an aggregate of $8.1 million of additional  liquidity ($4.4
million as of June 30, 2006 and $3.7 million in July 2006) to pay its  expenses,
including  interest  due in  respect of the  Timber  Notes on the  Timber  Notes
payment dates in January 2006 and July 2006, as discussed below.

     On the Timber  Notes  payment  date in January  2006,  the Company used its
existing cash resources,  all of the remaining funds available under the Line of
Credit,  and the additional funds made available from a $2.3 million  timber/log
purchase by MGI, to pay all of the $27.7 million of interest due ($25.8  million
net of interest  due in respect of Timber  Notes held in the SAR  Account).  The
Company  also repaid  $19.3  million of  principal  on the Timber  Notes  ($11.9
million net of principal in respect of Timber Notes held in the SAR Account), an
amount equal to Scheduled Amortization, using funds held in the SAR Account.

     As previously  announced,  the Company's  estimates indicated that its cash
flows from  operations,  together with funds  available under the Line of Credit
and other available funds,  would be insufficient,  by a substantial  amount, to
pay the entire amount of interest due on the July 20, 2006, Timber Notes payment
date.  As the July 20, 2006,  Timber Notes  payment date  approached,  it became
apparent the Company's estimates would prove correct and that the remaining cash
shortfall as of such Timber Notes payment date, after consideration of the funds
made  available  from the Land Sale  Program  and the MGI  timber/log  purchases
discussed above, would be approximately  $2.1 million.  Based upon review of its
existing  alternatives,  the Company requested that Palco make an early payment,
equal to the $2.1 million shortfall, in respect of certain logs that had already
been delivered to and purchased by Palco. Palco approved and delivered the early
log payment.

     On the  Timber  Notes  payment  date in July  2006,  the  Company  used its
existing cash resources,  all of the remaining funds available under the Line of
Credit,  the additional funds made available from the Land Sale Program of $10.2
million, a $3.7 million  timber/log  purchase by MGI, and the $2.1 million early
log  payment  by Palco to pay all of the $27.1  million of  interest  due ($25.4
million net of interest due in respect of Timber Notes held in the SAR Account).
The Company  also repaid  $10.0  million of  principal on the Timber Notes ($6.2
million net of principal in respect of Timber Notes held in the SAR Account), an
amount equal to Scheduled Amortization, using funds held in the SAR Account.

     The Company also expects to incur substantial  interest  shortfalls over at
least the next  several  years.  The  failure to pay all of the  interest on the
Timber  Notes when due would  constitute  an event of  default  under the Timber
Notes  Indenture.  There can be no  assurance  that the Company  will be able to
generate  sufficient  additional  liquidity  to fund the  expected  future  cash
shortfalls.  To the extent  that the  Company is unable to  generate  sufficient
liquidity from the Land Sale Program or other sources,  the Company expects that
it will be forced to take extraordinary actions,  which may include:  laying off
employees,  shutting down various  operations,  and seeking protection by filing
under the Bankruptcy Code.

     Palco Liquidity Update
     As of December 31, 2005, and June 30, 2006, Palco and Britt were in default
under the Old Palco Term Loan and the Old Palco Revolving Credit Facility due to
financial covenant breaches. In the first half of 2006, additional liquidity was
needed at Palco and Palco  borrowed an  aggregate  of $20.0  million from MGI to
meet its cash shortfalls.  Palco's liquidity shortfalls during the first half of
2006 resulted primarily from reduced log supply from the Company and operational
inefficiencies  related to the large log  processing  line at Palco's new Scotia
sawmill.

     On July 18, 2006,  Palco and Britt,  as Borrowers,  closed on the New Palco
Term Loan, a new five-year  $85.0 million  secured term loan,  and the New Palco
Revolving  Credit  Facility,  a new five-year $60.0 million secured  asset-based
revolving credit facility.  The New Palco Term Loan was fully funded at closing.
The New Palco Term Loan and the New Palco Revolving Credit Facility required MGI
to provide a $10.0 million  subordinated  loan to the Borrowers,  which was also
funded at closing. The Borrowers used approximately (i) $34.0 million of the New
Palco Term Loan to pay off the Old Palco Term  Loan;  (ii) $22.5  million of the
New Palco Term Loan to pay off the Old Palco Revolving  Credit Facility and cash
collateralize  previously  existing letters of credit; and (iii) $6.0 million to
pay transaction  costs.  The remaining funds at closing of $32.5 million will be
used for general  corporate  purposes.  The Borrowers  terminated  the Old Palco
Revolving  Credit  Facility and the Old Palco Term Loan.  The Borrowers have not
made any  borrowings  under the New Palco  Revolving  Credit  Facility  to date,
although they currently have availability in excess of $20.0 million.

     The amount  available for borrowings  under the New Palco Revolving  Credit
Facility  is  normally  the  sum  of 85% of  the  Borrowers'  eligible  accounts
receivable  plus the lesser of (i) 80% of the book value of Borrowers'  eligible
inventory or (ii) 85% of the net orderly  liquidation  value of such  inventory.
However,  during  each  period  from  October 15 through  January 15, the amount
available for borrowing under the New Palco Revolving Credit Facility is the sum
of 95% of Borrowers'  eligible accounts receivable plus the lesser of (i) 90% of
the book value of Borrowers'  eligible  inventory or (ii) 95% of the net orderly
liquidation  value of such inventory.  The amount  available under the New Palco
Revolving  Credit Facility may not exceed $60.0 million,  subject to limitations
such as the ability of the lender to establish reasonable reserves.

     The New Palco Term Loan  bears  interest  at the rate of LIBOR plus  8.75%.
Loans under the New Palco Revolving Credit Facility bear interest at the rate of
LIBOR  plus  2.75% or prime  plus  0.75%,  at the  Borrowers'  option;  however,
incremental  borrowings  made during the period from October 15 through  January
15,  bear  interest  at the rate of LIBOR  plus 4.50% or prime  plus  2.50%,  as
applicable. The New Palco Revolving Credit Facility matures on July 18, 2011.

     Both the New Palco Term Loan and the New Palco  Revolving  Credit  Facility
contain substantially  identical restrictive covenants that limit the Borrowers'
ability to incur debt,  grant  liens,  make  investments,  pay  dividends,  make
capital  expenditures  or merge or  consolidate,  and require the  Borrowers' to
maintain a minimum level of EBITDA,  along with a minimum fixed charge  coverage
ratio and maximum leverage ratio throughout the life of the loans. The operating
cash flow  estimates  used to  establish  the EBITDA  maintenance  covenant  are
subject to a number of assumptions  about future operating cash flows and actual
results could differ  materially from these  estimates.  The New Palco Term Loan
also requires the Borrowers to repay a  substantial  portion of the  outstanding
principal of the New Palco Term Loan with the net proceeds  from the Palco Asset
Sale Program, including the real property associated with Palco's former Fortuna
and Carlotta sawmills, and Palco-owned homes to be sold after certain milestones
have been met. Any remaining principal balance of the New Palco Term Loan is due
on July  18,  2011.  Accordingly,  continued  compliance  with  these  new  debt
facilities is dependent on Palco's  ability to meet its EBITDA  projections  and
timely complete  required asset sales. The New Palco Term Loan and the New Palco
Revolving  Credit  Facility  contain  customary  events of default and customary
remedies with respect to the occurrence of an event of default.

     The New Palco  Term  Loan and New  Palco  Revolving  Credit  Facility  each
include prepayment  premiums of 3%, 2% and 1% that will be payable in connection
with any  prepayment of the New Palco Term Loan or reduction or  termination  of
the New Palco  Revolving  Credit  Facility  during the  first,  second and third
years,  respectively.  Under  the New Palco  Term  Loan and New Palco  Revolving
Credit Facility, Palco is permitted to invest up to $5.0 million in the Company.
No such investment had been made or committed to be made by Palco, and there can
be no assurance that Palco would in the future  determine or be able to make any
such investment in whole or part.

     In  addition to the  material  adverse  effects  being  experienced  by the
Company and Palco due to continuing  regulatory,  environmental  and  litigation
difficulties,  there can be no  assurance  that  certain  other  pending  legal,
regulatory  and  environmental  matters  or  future  governmental   regulations,
additional  litigation,   legislation,  judicial  or  administrative  decisions,
adverse  weather  conditions,  or low lumber or log  prices,  will not also have
material  adverse effects on the financial  condition,  results of operations or
liquidity of the Company's operations.  See Note 5 for further discussion of the
regulatory  and  environmental  matters  and  legal  proceedings  affecting  the
Company's operations.

     Other Matters
     Capital  expenditures  were $2.2 million for the first half of 2006 and are
expected to be between $5.4 million and $6.0 million for the  remainder of 2006,
subject to available cash.

Off-Balance Sheet Arrangements

     The  Company  does not have any  off-balance  sheet  financing,  other than
operating   leases   entered  into  in  the  normal   course  of  business,   or
unconsolidated  special purpose  entities.  The Company does not use derivatives
for any of its treasury or risk management activities.

Trends

     Harvest  levels at the Company are  expected to decline  significantly,  as
compared to historical  harvest levels, in 2006 and beyond.  Consequently,  cash
flows from the Company's operations will not be sufficient for at least the next
several  years to allow the Company to satisfy its debt service  obligations  in
respect  of its  Timber  Notes.  In an effort to address  expected  future  cash
shortfalls,  the Company is seeking to sell certain  non-timberlands  properties
such as  ranchlands  and  recreational  areas,  as well as certain  timberlands.
Although  certain sales have been completed,  there can be no assurance that the
marketing efforts in respect of the remaining properties will be successful.

     Palco has  commenced  the Palco Asset Sale Program  pursuant to which it is
marketing certain assets. The New Palco Term Loan and New Palco Revolving Credit
Facility also require the Borrowers to timely  complete  transactions  under the
Palco Asset Sale  Program.  There can be no  assurance  that  Palco's  marketing
efforts will be  successful  or that  regulatory  approvals  will be obtained to
enable Palco to timely complete required asset sales.

Critical Accounting Policies and Estimates

     See Item 7.  "Management's  Discussion and Analysis of Financial  Condition
and Results of  Operations--Critical  Accounting  Policies and Estimates" of the
Form 10-K for a discussion of the Company's critical accounting policies.  There
have been no material changes to the Company's critical  accounting policies and
estimates provided in the Form 10-K.

New Accounting Pronouncements

     See Note 2 for a  discussion  of new  accounting  pronouncements  and their
impact on the Company's financial statements.


ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     The  Company is exposed to  changes  in  interest  rates  under the Line of
Credit. As of June 30, 2006, there were $42.2 million in borrowings  outstanding
under  all  variable  rate  facilities.   Based  on  the  amount  of  borrowings
outstanding  under these facilities during the six months ended June 30, 2006, a
1.0% change in interest  rates  effective  from the  beginning of the year would
have resulted in an increase or decrease in interest expense of $0.2 million.


ITEM 4. CONTROLS AND PROCEDURES

     The Company maintains  disclosure controls and procedures that are designed
to ensure that  information  required to be disclosed in the  Company's  reports
under the Securities Exchange Act of 1934 is recorded, processed, summarized and
reported  within the time  periods  specified in the rules and forms of the SEC,
and that such  information  is  accumulated  and  communicated  to the Company's
management,  including its Chief Executive Officer and Chief Financial  Officer,
as appropriate,  to allow timely decisions  regarding  required  disclosure.  In
designing and  evaluating  the disclosure  controls and  procedures,  management
recognized  that any controls and  procedures,  no matter how well  designed and
operated, can provide only reasonable assurance of achieving the desired control
objectives,  and  management  necessarily  was required to apply its judgment in
evaluating the cost-benefit relationship of possible controls and procedures.

     As of the end of the period covered by this report,  our management carried
out an  evaluation,  under the  supervision  and with the  participation  of the
Company's management,  including our Chief Executive Officer and Chief Financial
Officer,  of the  effectiveness  of the design and  operation  of the  Company's
disclosure  controls and procedures.  Based on the  evaluation,  our management,
including our Chief  Executive  Officer and Chief Financial  Officer,  concluded
that the Company's  disclosure controls and procedures were effective as of June
30, 2006.

     There have been no significant  changes in the Company's  internal controls
or in other  factors  that  could  significantly  affect the  internal  controls
subsequent to the date the Company completed its evaluation.


PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

     The information set forth in Note 5 is incorporated herein by reference.

ITEM 1A. RISK FACTORS

     Part I, Item 1A of the Company's Form 10-K contains  important risk factors
that could cause the Company's  actual results to differ  materially  from those
projected in any forward-looking  statement.  Additional risks and uncertainties
not  currently  known or that are currently  deemed  immaterial  may  materially
adversely impact our business, financial condition or operating results.

     The information  presented below updates, and should be read in conjunction
with, the risk factor information  disclosed in the Form 10 K for the year ended
December 31, 2005.

     The Company has amended and  restated  the first item under "Risk  Factors:
Risks Related to Regulatory Matters" to read as follows:

     Regulatory  and  legislative  actions  have the power to limit our  harvest
levels and require us and Palco to incur additional costs and have other adverse
consequences.

     Regulatory and legislative  actions,  among others, are now having, or have
the potential to have, material adverse impacts on us and Palco:

     o    The North  Coast  Water  Board has in the past  failed to release  for
          harvest a number of our previously-approved THPs, reducing current and
          projected harvest levels significantly. Continued failure of the North
          Coast Water Board to release  THPs for harvest  would  worsen the cash
          flow  difficulties  of the  Company  and Palco.  The North Coast Water
          Board has adopted WWDRs for the Freshwater  and Elk River  watersheds,
          which  action  has the  effect  of  allowing  harvesting  in these two
          watersheds to begin once THPs are enrolled by the Executive Officer of
          the North Coast Water Board.  There can be no assurance  that THPs for
          these two  watersheds  will  ultimately  be enrolled or  harvested  as
          planned  in 2006 or in  future  years.  If  there  are  delays  in the
          enrollment of these THPs, there could be a further significant adverse
          impact on current and future harvest levels and the cash flows of both
          the Company and Palco.

     o    The final TMDL requirements  applicable to the Company Timberlands may
          require  aquatic  protection  measures that are  different  from or in
          addition  to  those  in the  HCP or that  result  from  the  watershed
          analysis  process  provided  for in the HCP.  These  requirements  may
          further  reduce the  harvesting  on the Company  Timberlands  and cash
          flows of the Company and Palco.

     o    The North Coast Water Board has issued the Elk River  Order,  which is
          aimed at addressing  existing sediment  production sites through clean
          up actions in the Elk River  watershed,  and has initiated the process
          which could  result in similar  orders for other  watersheds.  The Elk
          River Order has resulted in  increased  costs that could extend over a
          number of years, and additional orders for other watersheds could have
          similar effects.

     o    The North  Coast  Water  Board has  imposed  requirements  for certain
          mitigation and erosion control practices in several  watersheds within
          the  Company  Timberlands.  The  requirements  imposed  to  date  have
          significantly   increased  operating  costs.  Additional  requirements
          imposed in the future could further increase costs and cause delays in
          THP approvals.

     o    The Company is uncertain of the operational and financial effects that
          will ultimately  result from Senate Bill 810.  Implementation  of this
          law could,  however,  result in delays in obtaining approvals of THPs,
          lower harvest  levels and increased  costs and  additional  protection
          measures beyond those contained in the HCP.

     o    The designation of a species as endangered or threatened under the ESA
          or the CESA can  significantly  reduce  harvest levels if that species
          inhabits  the  Company  Timberlands  or if the  habitat of the Company
          Timberlands is deemed  favorable to the species.  While the HCP covers
          17 different species,  it is possible that additional species could be
          designated as endangered or threatened under both the ESA and the CESA

     o    Laws,  regulations and related judicial  decisions and  administrative
          interpretations dealing with forest products operations are subject to
          change  and  new  laws  and  regulations  are  frequently   introduced
          concerning the California  timber  industry.  From time to time, bills
          are  introduced  or  ballot  initiatives  commenced  relating  to  our
          operations.

     The Company has removed,  amended  and/or has added several new items under
"Risk  Factors-Risks  related to Palco's  Liquidity and Capital  Resources",  as
follows:

     The risk, Palco is currently in default under its debt facilities, has been
removed  as a risk due to the  closing  on the New Palco Term Loan and New Palco
Revolving  Credit  Facility on July 18, 2006.  The risk,  Palco may be adversely
affected by an inability to obtain additional  liquidity,  has been removed as a
risk due to the  closing  on the New Palco  Term  Loan and New  Palco  Revolving
Credit  Facility  on July 18,  2006.

     The risk, Palco is highly leveraged and debt covenant restrictions increase
the difficulty of operating its business, has been added and amended as follows:

     Palco's  high level of debt and covenant  restrictions  under the New Palco
Term  Loan and New Palco  Revolving  Credit  Facility  could  have a variety  of
important negative consequences, including:

     o    limiting its ability to borrow additional amounts for working capital,
          capital  expenditures,  debt  service  requirements,  execution of its
          operating strategies or other purposes;
     o    increasing its  vulnerability to general adverse economic and industry
          conditions;
     o    limiting its ability to capitalize on business opportunities,  such as
          purchasing additional log inventories from third parties, and to react
          to  competitive   pressures  and  adverse  government  regulation  and
          litigation developments; and
     o    limiting its  ability,  or  increasing  the costs,  to  refinance  its
          indebtedness.

     Palco may not be able to timely complete required asset sales.

     o    Palco may not be able to complete  the Palco  Asset Sale  Program in a
          timely manner.  Regulatory  approvals required to complete the program
          could delay receipt of liquidity.

     These risk factors and those set forth in the Form 10-K do not  represent a
comprehensive  list of factors that could cause our results to differ from those
that are currently anticipated and should be read together with the risk factors
and other  information  set forth in the Form  10-K and in the  Company's  other
filings with the Securities and Exchange Commission.

ITEM 6.    EXHIBITS

     a. Exhibits:

          10.1 Fourth Amendment to Credit  Agreement,  dated May 18, 2006, among
               Registrant,  Bank of  America,  N.A.,  The  Bank of Nova  Scotia,
               Keybank National Association,  and U.S. Bank National Association
               (incorporated   herein  by  reference  to  Exhibit  10.1  to  the
               Company's Current Report on Form 8-K filed on May 23, 2006)

          *    31.1 Section 302 Certification of Chief Executive Officer

          *    31.2 Section 302 Certification of Chief Financial Officer

          *    32.1 Section 906 Certification of Chief Executive Officer

          *    32.2 Section 906 Certification of Chief Financial Officer

     *    Included with this filing

                                SIGNATURE


     Pursuant to the  requirements  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,  who has signed this report on behalf of
the  Registrant  and as the principal  financial and  accounting  officer of the
Registrant.

                                           SCOTIA PACIFIC COMPANY LLC



Date: August 9, 2006          By: /S/ GARY L. CLARK
                                      Gary L. Clark
                                      Vice President - Finance and Administration
                                      and Chief Financial Officer
                                      (Principal Financial and Accounting Officer)


                                                                      APPENDIX A


                                  Glossary of Defined Terms


APB Opinion No. 29:  Accounting  Principles  Board Opinion 29,  "Accounting  for
Nonmonetary Transactions"

Bankruptcy Code: The United States Bankruptcy Code

Bear Creek lawsuit:  An action  entitled  Environmental  Protection  Information
Association v. Pacific Lumber,  Scotia Pacific Company LLC (No.  C01-2821) filed
in the U.S. District Court for the Northern District of California

Britt: Britt Lumber Co., Inc., a wholly owned subsidiary of Palco

California  Permits:  The Permits issued by the State of California  pursuant to
the HCP

California  Headwaters action: The claim filed by the Company and Palco with the
Claims Board against the North Coast Water Board,  the State Water Board and the
State of  California  (Claim No.  G558159)  alleging  that the  defendants  have
substantially  impaired their  contractual and legal rights under the Headwaters
Agreement

California  Senate  Bill 810:  Bill  which  became  effective  January  1, 2004,
providing  regional  water  quality  control  boards with  additional  authority
related to the approval of THPs on land within impaired watersheds

Cave action:  An action  entitled Steve Cave, et al. v. Gary Clark,  et al. (No.
DR020719) filed in the Superior Court of Humboldt County, California

CDF: California Department of Forestry and Fire Protection

CDF Harvest Limit: Annual harvest limit established by the CDF

Claims Board: The California Victim Compensation and Government Claims Board

Company: Scotia Pacific Company LLC, a limited liability company wholly owned by
Palco

Company Timber: The timber located on the Company Timberlands.

Company  Timberlands:  Approximately  204,000 acres of timberlands  owned by the
Company and the timberlands subject to the Company Timber Rights

Company Timber Rights: The Company's exclusive right to harvest on approximately
12,200 acres of timberlands owned by Palco and Salmon Creek

Cook action:  An action  entitled Alan Cook,  et al. v. Gary Clark,  et al. (No.
DR020718) filed in the Superior Court of Humboldt County, California

CWA: Federal Clean Water Act

EBITDA:  As  defined  in  Section  1.01 of the New Palco Term Loan and New Palco
Revolving Credit Agreement  which,  among other things,  excludes the results of
the Company.

Elk River Order: Clean up and abatement order issued to Palco by the North Coast
Water Board for the Elk River watershed

Environmental Plans: The HCP and the SYP

EPA: Federal Environmental Protection Agency

EPIC-SYP/Permits   lawsuit:   An  action   entitled   Environmental   Protection
Information  Association,  Sierra Club v. California  Department of Forestry and
Fire  Protection,  California  Department of Fish and Game,  The Pacific  Lumber
Company,  Scotia Pacific Company LLC, Salmon Creek Corporation,  et al. filed in
the Superior Court of Humboldt County, California (No. CV990445)

FASB: Financial Accounting Standards Board

Federal Permits:  The Permits issued by the federal  government  pursuant to the
HCP

Form 10-K:  Annual  Report on Form 10-K of the Company for the fiscal year ended
December 31, 2005

Harvest Value Schedule:  A schedule  setting forth SBE Prices which is published
biannually  by the  California  State  Board of  Equalization  for  purposes  of
computing yield taxes on timber sales

HCP: The habitat  conservation  plan covering multiple species approved in March
1999 in connection with the consummation of the Headwaters Agreement

Headwaters Agreement:  The agreement among the Company, Palco, Salmon Creek, the
United States and California  pursuant to which the Palco Companies  transferred
to the United States  government 5,600 acres of timberlands in exchange for $300
million,  approximately  7,700  acres of  timberlands,  and  federal  and  state
government-approved habitat conservation and sustained yield plans

Humboldt DA action:  A civil suit entitled The People of the State of California
v. Pacific Lumber,  Scotia Pacific Holding Company and Salmon Creek  Corporation
(No.  DR030070) filed in the Superior Court of Humboldt County,  California,  by
the District Attorney of Humboldt County

Johnson action: An action entitled Edyth Johnson,  et al. v. Charles E. Hurwitz,
an individual, MAXXAM Inc., et al. (No. DR040720) filed in the Superior Court of
Humboldt County, California

Land Sale Program: The Company's program pursuant to which it is seeking to sell
certain timberland and non-timberland properties

Line of  Credit:  The  agreement  between  a group of  lenders  and the  Company
pursuant  to which  the  Company  may  borrow  in order to pay up to one  year's
interest on the Timber Notes

Master  Purchase  Agreement:  The  agreement  between the Company and Palco that
governs all purchases of logs by Palco from the Company

MAXXAM: MAXXAM Inc.

Mbfe: A concept  developed for use in structuring  the Timber Notes;  under this
concept one thousand  board feet,  net  Scribner  scale,  of old growth  redwood
timber equates to one Mbfe

MGI: MAXXAM Group Inc., a wholly owned subsidiary of MGHI

New Palco  Revolving  Credit  Facility:  The new five-year $60.0 million secured
asset-based   revolving  credit  facility  evidenced  by  the  Revolving  Credit
Agreement dated as of July 18, 2006,  among Palco and Britt,  as borrowers,  and
Marathon Structured Finance Fund L.P., as Administrative Agent

New Palco Term Loan: The new five-year $85.0 million secured term loan evidenced
by the Term Loan Agreement dated as of July 18, 2006,  among Palco and Britt, as
borrowers, and Marathon Structured Finance Fund L.P., as Administrative Agent

North Coast Water Board:  California  North Coast Regional Water Quality Control
Board

Old Palco Revolving Credit Facility:  Revolving credit facility evidenced by the
Revolving  Credit Agreement dated as of April 19, 2005 among Palco and Britt, as
Borrowers, and Credit Suisse First Boston

Old  Palco  Term  Loan:  $35.0  million  term  loan  evidenced  by the Term Loan
Agreement  dated as of April 19, 2005 among Palco and Britt,  as Borrowers,  and
The CIT Group/Business Credit, Inc.

Option  A  Plan:   Plan  for  complying  with   California's   sustained   yield
requirements,  which has been approved by the CDF and is being used by the Palco
Companies

Palco: The Pacific Lumber Company, a wholly owned subsidiary of MGI

Palco Asset Sale Program: Palco's process for marketing certain of its assets

Palco Companies: The Company, Palco, and Salmon Creek, collectively

Permits:  The incidental take permits issued by the United States and California
pursuant to the HCP

PSLRA: Private Securities Litigation Reform Act of 1995

Salmon Creek: Salmon Creek LLC, a wholly owned subsidiary of Palco

SAR Account:  Funds held in a reserve account titled the Scheduled  Amortization
Reserve Account and used to support principal payments on the Timber Notes

State Board of Equalization: The California State Board of Equalization

SBE Price:  The applicable  stumpage price for a particular  species and size of
log, as set forth in the most recent Harvest Value Schedule

Scheduled  Amortization:  The amount of  principal  which the  Company  must pay
through each Timber Note payment date in order to avoid prepayment or deficiency
premiums

SEC: The Securities and Exchange Commission

Services  Agreement:  Agreement  between the Company and Palco under which Palco
provides  certain  operational,  management and related  services to the Company
with respect to the Company Timberlands

SFAS: Statement of Financial Accounting Standards

SFAS No. 153: SFAS No. 153,  "Exchange of  Nonmonetary  Assets," an amendment of
APB Opinion No. 29

SFAS No. 154: SFAS No. 154, "Accounting Changes and Error Correction"

State Water Board: California State Water Resources Control Board

State Water Board Order: Order issued by the State Water Board on June 16, 2005

State Water Board  action:  An action  entitled The Pacific  Lumber  Company and
Scotia Pacific Company LLC v. State Water  Resources  Control Board, at al. (No.
CV050516) in Humboldt  County  Superior  Court  appealing  the State Water Board
Order

SYP: The sustained  yield plan approved in March 1999 as part of the  Headwaters
Agreement, and later invalidated by a California state court

take:  Adverse  impacts on species  which have been  designated as endangered or
threatened

THP:  Timber  harvesting  plan required to be filed with and approved by the CDF
prior to the harvesting of timber

Timber  Notes:  The  Company's  6.55%  Series B Class A-1 Timber  Collateralized
Notes, 7.11% Series B Class A-2 Timber  Collateralized  Notes and 7.71% Series B
Class A-3 Timber Collateralized Notes due July 20, 2028

Timber Notes Indenture: The indenture governing the Timber Notes

TMDLs: Total maximum daily load limits

Trustee: The trustee under the Indenture

USWA lawsuit: An action entitled United Steelworkers of America,  AFL-CIO,  CLC,
and Donald Kegley v. California Department of Forestry and Fire Protection,  The
Pacific Lumber Company,  Scotia Pacific Company LLC and Salmon Creek Corporation
(No. CV990452) filed in the Superior Court of Humboldt County, California

WWDRs: Watershed-wide discharge requirements

EX-32

                                                                   EXHIBIT 32.2

               CERTIFICATION OF CHIEF FINANCIAL OFFICER
      PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002


     Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 (subsections (a)
and (b) of  Section  1350,  Chapter 63 of Title 18,  United  States  Code),  the
undersigned  officer of Scotia Pacific Company LLC, a Delaware limited liability
company (the "Company"), does hereby certify that:

     (a) the  accompanying  Quarterly  Report on Form 10-Q for the quarter ended
June 30, 2006 of the Company (the "Report") fully complies with the requirements
of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

     (b)  the  information  contained  in the  Report  fairly  presents,  in all
material  respects,  the  financial  condition  and results of operations of the
Company.



Date:   August 9, 2006                     /S/     GARY L. CLARK
                                                   Gary L. Clark
                                                   Chief Financial Officer




The foregoing certification is being furnished solely pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of Section 1350, Chapter
63 of Title 18, United States Code).

EX-31

                                                                   EXHIBIT 31.1

                   CERTIFICATION OF CHIEF EXECUTIVE OFFICER
            PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002



I, George A. O'Brien, certify that:

     1.   I have reviewed this  quarterly  report on Form 10-Q of Scotia Pacific
          Company LLC;

     2.   Based on my  knowledge,  this  quarterly  report  does not contain any
          untrue  statement of a material  fact or omit to state a material fact
          necessary to make the statements  made, in light of the  circumstances
          under which such  statements were made, not misleading with respect to
          the period covered by this quarterly report;

     3.   Based on my knowledge,  the financial statements,  and other financial
          information  included in this quarterly report,  fairly present in all
          material respects the financial  condition,  results of operations and
          cash flows of the registrant as of, and for, the periods  presented in
          this quarterly report;

     4.   The registrant's  other  certifying  officer and I are responsible for
          establishing  and maintaining  disclosure  controls and procedures (as
          defined in Exchange  Act Rules  13a-14 and 15d-14) for the  registrant
          and have:

          (a)  designed such  disclosure  controls and procedures to ensure that
               material  information  relating to the registrant,  including its
               consolidated  subsidiaries,  is made known to us by others within
               those  entities,  particularly  during  the  period in which this
               quarterly report is being prepared;

          (b)  evaluated  the  effectiveness  of  the  registrant's   disclosure
               controls and  procedures as of a date within 90 days prior to the
               filing date of this quarterly report (the "Evaluation Date"); and

          (c)  presented  in this  quarterly  report our  conclusions  about the
               effectiveness of the disclosure  controls and procedures based on
               our evaluation as of the Evaluation Date;

     5.   The registrant's other certifying officer and I have disclosed,  based
          on our most recent  evaluation,  to the registrant's  auditors and the
          audit  committee of the  registrant's  board of directors  (or persons
          performing the equivalent functions):

          (a)  all  significant  deficiencies  in the  design  or  operation  of
               internal controls could adversely affect the registrant's ability
               to record, process,  summarize and report financial data and have
               identified for the registrant's  auditors any material weaknesses
               in internal controls; and

          (b)  any fraud,  whether or not material,  that involves management or
               other employees who have a significant  role in the  registrant's
               internal control over financial reporting; and

     6.   The  registrant's  other  certifying  officers and I have indicated in
          this  quarterly  report  whether  there  were  significant  changes in
          internal controls or in other factors that could significantly  affect
          internal   controls   subsequent  to  the  date  of  our  most  recent
          evaluation,   including   any   corrective   actions  with  regard  to
          significant deficiencies and material weaknesses.


Date:  August 9, 2006                       /S/   GEORGE A.O'BRIEN
                                                  George A. O'Brien
                                                  Chief Executive Officer

EX-32

                                                                    EXHIBIT 32.1

               CERTIFICATION OF CHIEF EXECUTIVE OFFICER
      PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002


     Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 (subsections (a)
and (b) of  Section  1350,  Chapter 63 of Title 18,  United  States  Code),  the
undersigned  officer of Scotia Pacific Company LLC, a Delaware limited liability
company (the "Company"), does hereby certify that:

     (a) the  accompanying  Quarterly  Report on Form 10-Q for the quarter ended
June 30, 2006 of the Company (the "Report") fully complies with the requirements
of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

     (b)  the  information  contained  in the  Report  fairly  presents,  in all
material  respects,  the  financial  condition  and results of operations of the
Company.



Date:   August 9, 2006

                                                 /S/     GEORGE A. O'BRIEN
                                                         George A. O'Brien
                                                         Chief Executive Officer



The foregoing certification is being furnished solely pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of Section 1350, Chapter
63 of Title 18, United States Code).