-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, CiuHKZFktH5mFxIB0y+iuk/5xwRkmUKX4Hz/iSbewRoJzVhxG0HbqmpImtthkuD8 hgJqf8XafhtAaxzHY0TGtg== 0000900421-97-000022.txt : 19970329 0000900421-97-000022.hdr.sgml : 19970329 ACCESSION NUMBER: 0000900421-97-000022 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970328 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: MAXXAM GROUP INC /DE/ CENTRAL INDEX KEY: 0000764542 STANDARD INDUSTRIAL CLASSIFICATION: SAWMILLS, PLANNING MILLS, GENERAL [2421] IRS NUMBER: 131310680 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-08857 FILM NUMBER: 97567722 BUSINESS ADDRESS: STREET 1: 5847 SAN FELIPE STE 2600 CITY: HOUSTON STATE: TX ZIP: 77057 BUSINESS PHONE: 7139757600 MAIL ADDRESS: STREET 1: 5847 SAN FELIPE STE 2600 STREET 2: STE 2600 CITY: HOUSTON STATE: TX ZIP: 77057 10-K 1 FORM 10-K OF MAXXAM GROUP INC. UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K --------------- ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996 COMMISSION FILE NUMBER 1-8857 MAXXAM GROUP INC. (Exact name of Registrant as Specified in its Charter) DELAWARE 13-1310680 (State or other (I.R.S. Employer jurisdiction Identification Number) of incorporation or organization) 5847 SAN FELIPE, SUITE 2600 77057 HOUSTON, TEXAS (Zip Code) (Address of Principal Executive Offices) Registrant's telephone number, including area code: (713) 975-7600 --------------- Securities registered pursuant to Section 12(b) of the Act: None. Securities registered pursuant to Section 12(g) of the Act: None. --------------- Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /X/ No / / All of the Registrant's voting stock is held by an affiliate of the Registrant. Number of shares of Common Stock outstanding at March 15, 1997: 100 REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION (J)(1)(A) AND (B) OF FORM 10-K AND IS THEREFORE FILING THIS FORM WITH THE REDUCED DISCLOSURE FORMAT. DOCUMENTS INCORPORATED BY REFERENCE: Not applicable. MAXXAM GROUP INC. ITEM 1. BUSINESS GENERAL MAXXAM Group Inc. (the "Company" or "MGI") is a wholly owned subsidiary of MAXXAM Group Holdings Inc. ("MGHI") which in turn is a wholly owned subsidiary of MAXXAM Inc. ("MAXXAM"). The Company engages in forest products operations through its wholly owned subsidiaries, The Pacific Lumber Company and its wholly owned subsidiaries (collectively referred to herein as "Pacific Lumber," unless the context indicates otherwise), and Britt Lumber Co., Inc. ("Britt"). Pacific Lumber's principal wholly owned subsidiaries are Scotia Pacific Holding Company ("Scotia Pacific") and Salmon Creek Corporation ("Salmon Creek"). As used herein, the terms "Company" or "MGI," "MGHI," "Pacific Lumber" or "MAXXAM" refer to the respective companies and their subsidiaries, unless otherwise noted or the context indicates otherwise. Pacific Lumber, which has been in continuous operation for over 125 years, engages in several principal aspects of the lumber industry--the growing and harvesting of redwood and Douglas-fir timber, the milling of logs into lumber products and the manufacturing of lumber into a variety of value-added finished products. Britt manufactures redwood and cedar fencing and decking products from small diameter logs, a substantial portion of which Britt acquires from Pacific Lumber (as Pacific Lumber cannot efficiently process them in its own mills). This Annual Report on Form 10-K contains statements which constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These statements appear in a number of places (see Item 1. "Business--Regulatory and Environmental Factors," Item 3. "Legal Proceedings," and Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations--Background," "Financial Condition and Investing and Financing Activities" and "Trends"). Such statements can be identified by the use of forward-looking terminology such as "believes," "expects," "may," "estimates,""will," "should," "plans" or "anticipates" or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategy. Readers are cautioned that any such forward-looking statements are not guarantees of future performance and involve significant risks and uncertainties, and that actual results may vary materially from those in the forward-looking statements as a result of various factors. These factors include the effectiveness of management's strategies and decisions, general economic and business conditions, developments in technology, new or modified statutory or regulatory requirements and changing prices and market conditions. This report identifies other factors that could cause such differences. No assurance can be given that these are all of the factors that could cause actual results to vary materially from the forward-looking statements. PACIFIC LUMBER OPERATIONS Timberlands Pacific Lumber owns and manages approximately 193,000 acres of virtually contiguous commercial timberlands located in Humboldt County along the northern California coast which has very favorable soil and climate conditions. These timberlands contain approximately three-quarters redwood and one-quarter Douglas-fir timber, are located in close proximity to Pacific Lumber's four sawmills and contain an extensive network of roads. Approximately 179,000 acres of Pacific Lumber's timberlands are owned by Scotia Pacific (the "Scotia Pacific Timberlands"), a special purpose Delaware corporation and wholly owned subsidiary of Pacific Lumber. Pacific Lumber has the exclusive right to harvest (the "Pacific Lumber Harvest Rights") approximately 8,000 non-contiguous acres of the Scotia Pacific Timberlands consisting substantially of virgin old growth redwood and virgin old growth Douglas-fir timber located on numerous small parcels throughout the Scotia Pacific Timberlands. Substantially all of Scotia Pacific's assets, including the Scotia Pacific Timberlands and the GIS (defined below), are pledged as security for Scotia Pacific's 7.95% Timber Collateralized Notes due 2015 (the "Timber Notes"). Pacific Lumber harvests and purchases from Scotia Pacific all of the logs harvested from the Scotia Pacific Timberlands. See "--Relationships With Scotia Pacific and Britt" for a description of this and other relationships among Pacific Lumber, Scotia Pacific and Britt. Approximately 6,000 acres of Pacific Lumber's timberlands are owned by Salmon Creek. The forest products industry grades lumber in various classifications according to quality. The two broad categories within which all grades fall, based on the absence or presence of knots, are called "upper" and "common" grades, respectively. "Old growth" trees, often defined as trees which have been growing for approximately 200 years or longer, have a higher percentage of upper grade lumber than "young growth" trees (those which have been growing for less than 200 years). "Virgin" old growth trees are located in timber stands that have not previously been harvested. "Residual" old growth trees are located in timber stands which have been partially harvested in the past. Pacific Lumber engages in extensive efforts to supplement the natural regeneration of timber and increase the amount of timber on its timberlands. Pacific Lumber is required to comply with California forestry regulations regarding reforestation, which generally require that an area be reforested to specified standards within an established period of time. Pacific Lumber also actively engages in efforts to establish timberlands from open areas such as pasture land. Regeneration of redwood timber generally is accomplished through the natural growth of new redwood sprouts from the stump remaining after a redwood tree is harvested. Such new redwood sprouts grow quickly, thriving on existing mature root systems. In addition, Pacific Lumber supplements natural redwood regeneration by planting redwood seedlings. Douglas-fir timber grown on Pacific Lumber's timberlands is regenerated almost entirely by planting seedlings. During 1996, Pacific Lumber planted an estimated 529,000 redwood and Douglas-fir seedlings. Harvesting Practices The ability of Pacific Lumber to sell logs or lumber products will depend, in part, upon its ability to obtain regulatory approval of timber harvesting plans ("THPs"). THPs are required to be developed by registered professional foresters and must be filed with, and approved by, the California Department of Forestry ("CDF") prior to the harvesting of timber. Each THP is designed to comply with applicable laws and regulations. The CDF's evaluation of proposed THPs incorporates review and analysis of such THPs by several California and federal agencies and public comments received with respect to such THPs. An approved THP is applicable to specific acreage and specifies the harvesting method and other conditions relating to the harvesting of the timber covered by such THP. See "--Regulatory and Environmental Factors" for information regarding a critical habitat designation, sustained yield regulations and similar matters concerning Pacific Lumber and its operations. Pacific Lumber maintains a detailed geographical information system covering its timberlands (the "GIS"). The GIS covers numerous aspects of Pacific Lumber's properties, including timber type, tree class, wildlife data, roads, rivers and streams. By carefully monitoring and updating this data base and conducting field studies, Pacific Lumber's foresters are better able to develop detailed THPs addressing the various regulatory requirements. Pacific Lumber also utilizes a Global Positioning System ("GPS") which allows precise location of geographic features through satellite positioning. Pacific Lumber employs a variety of well-accepted methods of selecting trees for harvest. These methods, which are designed to achieve optimal regeneration, are referred to as "silvicultural systems" in the forestry profession. Silvicultural systems range from very light thinnings aimed at enhancing the growth rate of retained trees to clear cutting which results in the harvest of all trees in an area and replacement with a new forest stand. In between are a number of varying levels of partial harvests which can be employed. Pacific Lumber's foresters select the appropriate silvicultural system for any given site based upon the specific conditions of that site. The systems chosen are those which will most closely emulate those natural processes that result in the cycling of natural forest stands. Due to the magnitude of its timberlands and conservative application of silvicultural systems, Pacific Lumber has historically conducted harvesting operations on approximately 5% of its timberlands in any given year. Production Facilities Pacific Lumber owns four highly mechanized sawmills and related facilities located in Scotia, Fortuna and Carlotta, California. The sawmills historically have been supplied almost entirely from timber harvested from Pacific Lumber's timberlands. Since 1986, Pacific Lumber has implemented numerous technological advances that have increased the operating efficiency of its production facilities and the recovery of finished products from its timber. Over the past three years, Pacific Lumber's annual lumber production has averaged approximately 289 million board feet, with approximately 291, 290 and 286 million board feet produced in 1996, 1995 and 1994, respectively. The Fortuna sawmill produces primarily common grade lumber. During 1996, the Fortuna mill produced approximately 99 million board feet of lumber. The Carlotta sawmill produces both common and upper grade redwood lumber. During 1996, the Carlotta mill produced approximately 63 million board feet of lumber. Sawmills "A" and "B" are both located in Scotia. Sawmill "A" processes Douglas-fir logs and Sawmill "B" primarily processes large diameter redwood logs. During 1996, Sawmills "A" and "B" produced 88 million and 41 million board feet of lumber, respectively. Pacific Lumber operates a finishing plant which processes rough lumber into a variety of finished products such as trim, fascia, siding and paneling. These finished products include the redwood lumber industry's largest variety of customized trim and fascia patterns. Pacific Lumber also enhances the value of some grades of narrower and shorter lumber by assembling knot-free pieces of lumber into wider or longer pieces in its state-of-the-art end and edge glue plants. The result is a standard sized upper grade product which can be sold at a significant premium over common grade products. Pacific Lumber has installed a lumber remanufacturing facility at its mill in Fortuna which processes low grade redwood common lumber into value-added, higher grade redwood fence and related products. Pacific Lumber dries the majority of its upper grade lumber before it is sold. Upper grades of redwood lumber are generally air-dried for three to twelve months and then kiln-dried for seven to twenty-four days to produce a dimensionally stable and high quality product which generally commands higher prices than "green" lumber (which is lumber sold before it has been dried). Upper grade Douglas-fir lumber is generally kiln-dried immediately after it is cut. Pacific Lumber owns and operates 34 kilns, having an annual capacity of approximately 95 million board feet, to dry its upper grades of lumber efficiently in order to produce a quality, premium product. Pacific Lumber also maintains several large enclosed storage sheds which hold approximately 27 million board feet of lumber. In addition, Pacific Lumber owns and operates a modern 25-megawatt cogeneration power plant which is fueled almost entirely by the wood residue from Pacific Lumber's milling and finishing operations. This power plant generates substantially all of the energy requirements of Scotia, California, the town adjacent to Pacific Lumber's timberlands where several of its manufacturing facilities are located. Pacific Lumber sells surplus power to Pacific Gas and Electric Company. In 1996, the sale of surplus power accounted for approximately 1% of Pacific Lumber's total revenues. Products The following table sets forth the distribution of Pacific Lumber's lumber production (on a net board foot basis) and revenues by product line:
Year Ended December 31, 1996 Year Ended December 31, 1995 ----------------------------------------- ----------------------------------------- % of Total % of Total Lumber % of Total Lumber % of Total Production Lumber % of Total Production Lumber % of Total Product Volume Revenues Revenues Volume Revenues Revenues ------------- ------------- ------------- ------------- ------------- ------------- Upper grade redwood lumber 13% 33% 28% 17% 38% 31% Common grade redwood lumber 53% 42% 35% 54% 40% 32% ------------- ------------- ------------- ------------- ------------- ------------- Total redwood lumber 66% 75% 63% 71% 78% 63% ------------- ------------- ------------- ------------- ------------- ------------- Upper grade Douglas- fir lumber 3% 6% 5% 3% 5% 4% Common grade Douglas- fir lumber 27% 16% 13% 23% 14% 11% ------------- ------------- ------------- ------------- ------------- ------------- Total Douglas- fir lumber 30% 22% 18% 26% 19% 15% ------------- ------------- ------------- ------------- ------------- ------------- Other grades of lumber 4% 3% 2% 3% 3% 4% ------------- ------------- ------------- ------------- ------------- ------------- Total lumber 100% 100% 83% 100% 100% 82% ============= ============= ============= ============= ============= ============= Logs 9% 7% ============= ============= Hardwood chips 2% 4% Softwood chips 4% 5% ------------- ------------- Total wood chips 6% 9% ============= =============
Lumber. Pacific Lumber primarily produces and markets lumber. In 1996, Pacific Lumber sold approximately 307 million board feet of lumber, which accounted for approximately 83% of Pacific Lumber's total revenues. Lumber products vary greatly by the species and quality of the timber from which it is produced. Lumber is sold not only by grade (such as "upper" grade versus "common" grade), but also by board size and the drying process associated with the lumber. Redwood lumber is Pacific Lumber's largest product category. Redwood is commercially grown only along the northern coast of California and possesses certain unique characteristics that permit it to be sold at a premium to many other wood products. Such characteristics include its natural beauty, superior ability to retain paint and other finishes, dimensional stability and innate resistance to decay, insects and chemicals. Typical applications include exterior siding, trim and fascia for both residential and commercial construction, outdoor furniture, decks, planters, retaining walls and other specialty applications. Redwood also has a variety of industrial applications because of its chemical resistance and because it does not impart any taste or odor to liquids or solids. Upper grade redwood lumber, which is derived primarily from large diameter logs and is characterized by an absence of knots and other defects, is used primarily in distinctive interior and exterior applications. The overall supply of upper grade lumber has been diminishing due to increasing environmental and regulatory restrictions and other factors, and Pacific Lumber's supply of upper grade lumber has decreased in some premium product categories. See Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations--Background." Common grade redwood lumber, Pacific Lumber's largest volume product, has many of the same aesthetic and structural qualities of redwood uppers, but has some knots, sapwood and a coarser grain. Such lumber is commonly used for construction purposes, including outdoor structures such as decks, hot tubs and fencing. Douglas-fir lumber is used primarily for new construction and some decorative purposes and is widely recognized for its strength, hard surface and attractive appearance. Douglas-fir is grown commercially along the west coast of North America and in Chile and New Zealand. Upper grade Douglas-fir lumber is derived primarily from old growth Douglas-fir timber and is used principally in finished carpentry applications. Common grade Douglas-fir lumber is used for a variety of general construction purposes and is largely interchangeable with common grades of other whitewood lumber. Logs. Pacific Lumber currently sells certain logs that, due to their size or quality, cannot be efficiently processed by its mills into lumber. The majority of these logs are purchased by Britt. The balance are purchased by surrounding mills which do not own sufficient timberlands to support their mill operations. See "--Relationships with Scotia Pacific and Britt" below. Except for the agreement with Britt described below, Pacific Lumber does not have any significant contractual relationships with third parties relating to the purchase of logs. Pacific Lumber has historically not purchased significant quantities of logs from third parties; however, Pacific Lumber may from time to time purchase logs from third parties for processing in its mills or for resale to third parties if, in the opinion of management, economic factors are advantageous to Pacific Lumber. Wood Chips. Pacific Lumber uses a whole-log chipper to produce wood chips from hardwood trees which would otherwise be left as waste. These chips are sold to third parties primarily for the production of facsimile and other specialty papers. Pacific Lumber also produces softwood chips from the wood residue and waste from its milling and finishing operations. These chips are sold to third parties for the production of wood pulp and paper products. Backlog and Seasonality Pacific Lumber's backlog of sales orders at December 31, 1996 and 1995 was approximately $21.3 million and approximately $11.5 million, respectively, the substantial portion of which was delivered in the first quarter of the next fiscal year. Pacific Lumber has historically experienced lower first quarter sales due largely to the general decline in construction-related activity during the winter months. As a result, Pacific Lumber's results in any one quarter are not necessarily indicative of results to be expected for the full year. Marketing The housing, construction and remodeling markets are the primary markets for Pacific Lumber's lumber products. Pacific Lumber's policy is to maintain a wide distribution of its products both geographically and in terms of the number of customers. Pacific Lumber sells its lumber products throughout the country to a variety of accounts, the large majority of which are wholesalers, followed by retailers, industrial users, exporters and manufacturers. Upper grades of redwood and Douglas-fir lumber are sold throughout the entire United States, as well as to export markets. Common grades of redwood lumber are sold principally west of the Mississippi River, with California accounting for approximately 66% of these sales in 1996. Common grades of Douglas-fir lumber are sold primarily in California. In 1996, the largest and top five of Pacific Lumber's customers accounted for approximately 9% and 24%, respectively, of total revenues. Exports of lumber accounted for approximately 5% of Pacific Lumber's total revenues in 1996. Pacific Lumber markets its products through its own sales staff which focuses primarily on domestic sales. Pacific Lumber actively follows trends in the housing, construction and remodeling markets in order to maintain an appropriate level of inventory and assortment of products. Due to its high quality products, large inventory, competitive prices and long history, Pacific Lumber believes it has a strong degree of customer loyalty. Competition Pacific Lumber's lumber is sold in highly competitive markets. Competition is generally based upon a combination of price, service, product availability and product quality. Pacific Lumber's products compete not only with other wood products but with metals, masonry, plastic and other construction materials made from non-renewable resources. The level of demand for Pacific Lumber's products is dependent on such broad factors as overall economic conditions, interest rates and demographic trends. In addition, competitive considerations, such as total industry production and competitors' pricing, as well as the price of other construction products, affect the sales prices for Pacific Lumber's lumber products. Pacific Lumber currently enjoys a competitive advantage in the upper grade redwood lumber market due to the quality of its timber holdings and relatively low cost production operations. Competition in the common grade redwood and Douglas-fir lumber market is more intense, and Pacific Lumber competes with numerous large and small lumber producers. Employees As of March 1, 1997, Pacific Lumber had approximately 1,600 employees, none of whom are covered by a collective bargaining agreement. Relationships with Scotia Pacific and Britt In March 1993, Pacific Lumber consummated its offering of $235 million of 10-1/2% Senior Notes due 2003 (the "Pacific Lumber Senior Notes") and Scotia Pacific consummated its offering of $385 million of Timber Notes. Upon the closing of such offerings, Pacific Lumber, Scotia Pacific and Britt entered into a variety of agreements. Pacific Lumber and Scotia Pacific entered into a Services Agreement (the "Services Agreement") and an Additional Services Agreement (the "Additional Services Agreement"). Pursuant to the Services Agreement, Pacific Lumber provides operational, management and related services with respect to the Scotia Pacific Timberlands containing timber of Scotia Pacific ("Scotia Pacific Timber") not performed by Scotia Pacific's own employees. Such services include the furnishing of all equipment, personnel and expertise not within Scotia Pacific's possession and reasonably necessary for the operation and maintenance of the Scotia Pacific Timberlands containing Scotia Pacific Timber. In particular, Pacific Lumber is required to regenerate Scotia Pacific Timber, prevent and control loss of Scotia Pacific Timber by fires, maintain a system of roads throughout the Scotia Pacific Timberlands, take measures to control the spread of disease and insect infestation affecting Scotia Pacific Timber and comply with environmental laws and regulations. Pacific Lumber is also required (to the extent necessary) to assist Scotia Pacific personnel in updating the GIS and to prepare and file, on Scotia Pacific's behalf, all pleadings and motions and otherwise diligently pursue appeals of any denial of any THP and related matters. As compensation for these and the other services to be provided by Pacific Lumber, Scotia Pacific pays a fee which is adjusted on January 1 of each year based on a specified government index relating to wood products. The fee was approximately $112,000 per month in 1996 and is expected to be approximately $115,200 per month in 1997. Pursuant to the Additional Services Agreement, Scotia Pacific provides Pacific Lumber with a variety of services, including (a) assisting Pacific Lumber to operate, maintain and harvest its own timber properties, (b) updating and providing access to the GIS with respect to information concerning Pacific Lumber's own timber properties, and (c) assisting Pacific Lumber with its statutory and regulatory compliance. Pacific Lumber pays Scotia Pacific a fee for such services equal to the actual cost of providing such services, as determined in accordance with generally accepted accounting principles. Pacific Lumber and Scotia Pacific also entered into a Master Purchase Agreement (the "Master Purchase Agreement"). The Master Purchase Agreement governs all purchases of logs by Pacific Lumber from Scotia Pacific. Each purchase of logs by Pacific Lumber from Scotia Pacific is made pursuant to a separate log purchase agreement (which incorporates the terms of the Master Purchase Agreement) for the Scotia Pacific Timber covered by an approved THP. Each log purchase agreement generally constitutes an exclusive agreement with respect to the timber covered thereby, subject to certain limited exceptions. The purchase price must be at least equal to the SBE Price (as defined below). The Master Purchase Agreement provides that if the purchase price equals or exceeds (i) the price for such species and category thereof set forth on the structuring schedule applicable to the Timber Notes and (ii) the SBE Price, then such price shall be deemed to be the fair market value of such logs. The Master Purchase Agreement defines the "SBE Price," for any species and category of timber, as the stumpage price for such species and category as set forth in the most recent "Harvest Value Schedule" published by the California State Board of Equalization ("SBE") applicable to the timber sold during the period covered by such Harvest Value Schedule. Such Harvest Value Schedules are published for the purpose of computing yield taxes and generally are released every six months. As Pacific Lumber purchases logs from Scotia Pacific pursuant to the Master Purchase Agreement, Pacific Lumber is responsible, at its own expense, for harvesting and removing the standing Scotia Pacific Timber covered by approved THPs, and the purchase price is therefore based upon "stumpage prices." Title to the harvested logs does not pass to Pacific Lumber until the logs are transported to Pacific Lumber's log decks and measured. Substantially all of Scotia Pacific's revenues are derived from the sale of logs to Pacific Lumber under the Master Purchase Agreement. Pacific Lumber, Scotia Pacific and Salmon Creek also entered into a Reciprocal Rights Agreement granting to each other certain reciprocal rights of egress and ingress through their respective properties in connection with the operation and maintenance of such properties and their respective businesses. In addition, Pacific Lumber entered into an Environmental Indemnification Agreement with Scotia Pacific pursuant to which Pacific Lumber agreed to indemnify Scotia Pacific from and against certain present and future liabilities arising with respect to hazardous materials, hazardous materials contamination or disposal sites, or under environmental laws with respect to the Scotia Pacific Timberlands. Pacific Lumber entered into an agreement with Britt (the "Britt Agreement") which governs the sale of logs by Pacific Lumber and Britt to each other, the sale of hog fuel (wood residue) by Britt to Pacific Lumber for use in Pacific Lumber's cogeneration plant, the sale of lumber by Pacific Lumber and Britt to each other, and the provision by Pacific Lumber of certain administrative services to Britt (including accounting, purchasing, data processing, safety and human resources services). The logs which Pacific Lumber sells to Britt and which are used in Britt's manufacturing operations are sold at approximately 75% of applicable SBE prices (to reflect the lower quality of these logs). Logs which either Pacific Lumber or Britt purchases from third parties and which are then sold to each other are transferred at the actual cost of such logs. Hog fuel is sold at applicable market prices, and administrative services are provided by Pacific Lumber based on Pacific Lumber's actual costs and an allocable share of Pacific Lumber's overhead expenses consistent with past practice. BRITT LUMBER OPERATIONS Business Britt is located in Arcata, California, approximately 45 miles north of Pacific Lumber's headquarters. Britt's primary business is the processing of small diameter redwood logs into wood fencing products for sale to retail and wholesale customers. Britt was incorporated in 1965 and operated as an independent manufacturer of fence products until July 1990, when it was purchased by a subsidiary of the Company. Britt purchases small diameter (6 to 11 inch) and short length (6 to 12 feet) redwood logs from Pacific Lumber and a variety of different diameter and different length logs from various timberland owners. Britt processes logs at its mill into a variety of different fencing products, including "dog-eared" 1" x 6" fence stock in six and eight foot lengths, 4" x 4" fence posts in 6 through 12 foot lengths, and other fencing products in 6 through 12 foot lengths. Britt's purchases of logs from third parties are generally consummated pursuant to short-term contracts of twelve months or less. See "--Pacific Lumber Operations--Relationships with Scotia Pacific and Britt" for a description of Britt's log purchases from Pacific Lumber. Marketing In 1996, Britt sold approximately 79 million board feet of lumber products to approximately 75 different customers. Over one-half of its 1996 lumber sales were in northern California. The remainder of its 1996 sales were in southern California and ten other western states. The largest and top five of such customers accounted for approximately 27% and 68%, respectively, of such 1996 sales. Britt markets its products through its own salesmen to a variety of customers, including distribution centers, industrial remanufacturers, wholesalers and retailers. Britt's backlog of sales orders at December 31, 1996 and 1995 was approximately $4.2 million and $3.2 million, respectively, the substantial portion of which was delivered in the first quarter of the next fiscal year. Facilities and Employees Britt's manufacturing operations are conducted on 12 acres of land, 10 acres of which are leased on a long-term fixed-price basis from an unrelated third party. Fence production is conducted in a 46,000 square foot mill. An 18-acre log sorting and storage yard is located one quarter of a mile away. The mill was constructed in 1980, and capital expenditures to enhance its output and efficiency are made periodically. Britt's (single shift) mill capacity, assuming 40 production hours per week, is estimated at 37.4 million board feet of fencing products per year. As of March 1, 1997, Britt employed approximately 120 people, none of whom are covered by a collective bargaining agreement. Competition Management estimates that Britt accounted for approximately one- third of the redwood fence market in 1996. Britt competes primarily with the northern California mills of Louisiana Pacific, Georgia Pacific and Eel River. REGULATORY AND ENVIRONMENTAL FACTORS This section contains statements which constitute "forward- looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. See Item 1. "Business--General" for cautionary information with respect to such forward-looking statements. Regulatory and environmental issues play a significant role in Pacific Lumber's forest products operations. Pacific Lumber's forest products operations are subject to a variety of California and federal laws and regulations dealing with timber harvesting, endangered species and critical habitat, and air and water quality. Moreover, these laws and regulations are modified from time to time and are subject to judicial and administrative interpretation. These laws include the California Forest Practice Act (the "Forest Practice Act"), which requires that timber harvesting operations be conducted in accordance with detailed requirements set forth in the Forest Practice Act and in the regulations promulgated thereunder by the California Board of Forestry (the "BOF"). The federal Endangered Species Act (the "ESA") and California Endangered Species Act (the "CESA") provide in general for the protection and conservation of specifically listed fish, wildlife and plants which have been declared to be endangered or threatened. The California Environmental Quality Act ("CEQA") provides, in general, for protection of the environment of the state, including protection of air and water quality and of fish and wildlife. In addition, the California Water Quality Act and Federal Clean Water Act require, in part, that Pacific Lumber's operations be conducted so as to reasonably protect the water quality of nearby rivers and streams. Pacific Lumber is subject to certain pending matters described below which could have a material adverse effect on the consolidated financial position, results of operations or liquidity of Pacific Lumber and in turn the Company. There can be no assurance that certain pending or future legislation, governmental regulations or judicial or administrative decisions will not have a material adverse effect on the Company. In March 1992, the marbled murrelet was approved for listing as endangered under the CESA. In October 1992, the United States Fish and Wildlife Service ("USFWS") issued its final rule listing the marbled murrelet as a threatened species under the ESA in the tri-state area of Washington, Oregon and California. Pacific Lumber has incorporated, and will continue to incorporate as required, mitigation measures into its THPs to protect and maintain habitat for the marbled murrelet on its timberlands. The BOF requires Pacific Lumber to conduct pre-harvest marbled murrelet surveys to provide certain site specific mitigations in connection with THPs covering virgin old growth timber and unusually dense stands of residual old growth timber. Such surveys can only be conducted during a portion of the murrelet's nesting and breeding season, which extends from April through mid-September. Accordingly, such surveys are expected to delay the review and approval process with respect to certain of the THPs filed by Pacific Lumber. The results of such surveys to date (based upon current survey protocols) have indicated that Pacific Lumber has approximately 6,600 acres (all containing virgin or residual old growth timber) which are occupied marbled murrelet habitat. Pacific Lumber is unable to predict when or if it will be able to harvest this acreage. In May 1996, the USFWS published its final designation of critical habitat for the marbled murrelet (the "Final Designation"), designating over four million acres as critical habitat for the marbled murrelet. Although nearly all of the designated habitat is public land, approximately 33,000 acres of Pacific Lumber's timberlands are included in the Final Designation, the substantial portion of such acreage being young growth timber. The bulk of Pacific Lumber's 6,600 acres of occupied marbled murrelet habitat falls within the 33,000 acres of Pacific Lumber's timberlands included in the Final Designation. In order to mitigate the impact of the Final Designation, particularly with respect to timberlands occupied by the marbled murrelet, Pacific Lumber over the last few years has attempted to develop a habitat conservation plan for the marbled murrelet (the "Murrelet HCP"). Due to, among other things, the unfavorable response of the USFWS to Pacific Lumber's initial Murrelet HCP efforts, Pacific Lumber and its subsidiaries filed two actions (the "Takings Litigation") alleging that certain portions of their timberlands have been "taken" and seeking just compensation. See Item 3. "Legal Proceedings-- Pacific Lumber Litigation" for a description of the Takings Litigation. Pursuant to an agreement entered into by the Company, MAXXAM, the United States and the State of California on September 28, 1996 (the "Headwaters Agreement") and described below under "--Headwaters Agreement," the Takings Litigation has been stayed at the request of the parties. It is impossible for the Company to determine the potential adverse effect of the Final Designation on the Company's consolidated financial position, results of operations or liquidity until such time as various regulatory and legal issues are resolved; however, if Pacific Lumber is unable to harvest, or is severely limited in harvesting, on timberlands designated as critical habitat for the marbled murrelet, such effect could be materially adverse to Pacific Lumber and in turn the Company. If Pacific Lumber is unable to harvest or is severely limited in harvesting, it intends to seek just compensation from the appropriate governmental agencies on the grounds that such restrictions constitute a governmental taking. There continue to be other regulatory actions and lawsuits seeking to have other species listed as threatened or endangered under the ESA and/or the CESA and to designate critical habitat for such species. For example, the National Marine Fisheries Service has announced that by April 25, 1997 it will make a final determination whether to list the coho salmon under the ESA in northern California, including, potentially, lands owned by Pacific Lumber. It is uncertain what impact, if any, such listings and/or designations of critical habitat would have on the consolidated financial position, results of operations or liquidity of Pacific Lumber, and in turn the Company. In 1994, the BOF adopted certain regulations regarding compliance with long-term sustained yield ("LTSY") objectives. These regulations require that timber companies project timber growth and harvest on their timberlands over a 100-year planning period and establish a LTSY harvest level that takes into account environmental and economic considerations. The sustained yield plan ("SYP") must demonstrate that the average annual harvest over any rolling ten-year period will not exceed the LTSY harvest level and that Pacific Lumber's projected timber inventory is capable of sustaining the LTSY harvest level in the last decade of the 100-year planning period. On December 17, 1996, Pacific Lumber submitted a proposed SYP to the CDF. The proposed SYP sets forth an LTSY harvest level substantially the same as Pacific Lumber's average annual timber harvest over the last six years. The proposed SYP also indicates that Pacific Lumber's average annual timber harvest during the first decade of the SYP would approximate the LTSY harvest level. During the second decade of the proposed SYP, Pacific Lumber's average annual timber harvest would be approximately 8% less than that proposed for the first decade. The SYP, when approved, will be valid for ten years. Thereafter, revised SYPs will be prepared every decade that will address the LTSY harvest level based upon reassessment of changes in the resource base and protection of public resources. The proposed SYP assumes that the transactions contemplated by the Headwaters Agreement will be consummated and that the Multi-Species HCP (as defined below under "--Headwaters Agreement") will permit Pacific Lumber to harvest its timberlands (including over the next two decades a substantial portion of its old growth timberlands not transferred pursuant to the Headwaters Agreement) to achieve maximum sustained yield. The SYP is subject to review and approval by the CDF, and there can be no assurance that the SYP will be approved in its proposed form. Until the SYP is reviewed and approved, Pacific Lumber is unable to predict the impact that these regulations will have on its future timber harvesting practices. It is possible that the results of the review and approval process could require Pacific Lumber to reduce its timber harvest in future years from the harvest levels set forth in the proposed SYP. Pacific Lumber believes it would be able to mitigate the effect of any required reduction in harvest level by acquisitions of additional timberlands (and making corresponding amendments to the SYP); however, there can be no assurance that Pacific Lumber would be able to do so and the amount of such acquisitions would be limited by Pacific Lumber's available financial resources. The Company is unable to predict the ultimate impact the sustained yield regulations will have on its future financial position, results of operations or liquidity. Various groups and individuals have filed objections with the CDF and the BOF regarding the CDF's and the BOF's actions and rulings with respect to certain of Pacific Lumber's THPs and other timber harvesting operations, and Pacific Lumber expects that such groups and individuals will continue to file such objections. In addition, lawsuits are pending or threatened which seek to prevent Pacific Lumber from implementing certain of its approved THPs or which challenge other operations by Pacific Lumber. These challenges have severely restricted Pacific Lumber's ability to harvest old growth timber on its property. To date, challenges with respect to Pacific Lumber's THPs relating to young growth timber and to its other operations have been limited; however, no assurance can be given as to the extent of such challenges in the future. The Company believes that environmentally focused challenges to its timber harvesting and other operations are likely to occur in the future, particularly with respect to virgin and residual old growth timber. Although such challenges have delayed or prevented Pacific Lumber from conducting a portion of its operations, they have not had a material adverse effect on Pacific Lumber's consolidated financial position, results of operations or liquidity. Nevertheless, it is impossible to predict the future nature or degree of such challenges or their ultimate impact on the consolidated financial position, results of operations or liquidity of Pacific Lumber, and in turn the Company. In early 1997, the Environmental Protection Agency ("EPA") entered into a consent decree agreeing to establish limits on sedimentation, temperature and other factors (i.e. non-point source total maximum daily loadings, "TMDL") under the Federal Clean Water Act for seventeen northern California rivers and certain of their tributaries, including rivers within Pacific Lumber's timberlands. The TMDL scheme will be primarily aimed at protecting fish habitat. It is impossible to predict the ultimate impact this consent decree will have on the consolidated financial position, results of operations or liquidity of Pacific Lumber, and in turn the Company. In June 1990, the USFWS designated the northern spotted owl as threatened under the ESA. The owl's range includes all of Pacific Lumber's timberlands. The ESA and its implementing regulations (and related California regulations) generally prohibit harvesting operations in which individual owls might be killed, displaced or injured or which result in significant habitat modification that could impair the survival of individual owls or the species as a whole. Since 1988, biologists have conducted inventory and habitat utilization studies of northern spotted owls on Pacific Lumber's timberlands. Pacific Lumber has developed and the USFWS has given its full concurrence to a northern spotted owl management plan (the "Federal Owl Plan"). The Federal Owl Plan, as amended from time to time, is currently applicable through 1999 and the USFWS expressed its agreement that operations consistent with the Federal Owl Plan would not result in the taking of any owls. Pacific Lumber has also developed a Spotted Owl Resource Plan (the "State Owl Plan"), and the California Department of Fish and Game has expressed its agreement that operations consistent with the State Owl Plan would not result in the taking of any owls. By incorporating the Federal Owl Plan or the State Owl Plan into each THP filed with the CDF, Pacific Lumber is able to expedite the approval time with respect to its THPs. The plaintiffs in the Marbled Murrelet action have requested and received injunctive relief with respect to certain THPs involving the Federal Owl Plan. See Item 3. "Legal Proceedings--Timber Harvesting Litigation." Both federal and state agencies continue to review and consider possible additional regulations regarding the northern spotted owl. It is uncertain if such additional regulations will become effective or their ultimate content or impact on the Company. Laws, regulations and related judicial and administrative interpretations dealing with Pacific Lumber's operations are subject to change and new laws and regulations are frequently introduced concerning the California timber industry. From time to time, bills are introduced in the California legislature and the U.S. Congress which relate to the business of Pacific Lumber, including the protection and acquisition of old growth and other timberlands, endangered species, environmental protection, air and water quality, and the restriction, regulation and administration of timber harvesting practices. It is impossible to predict the content of any such bills, the likelihood of any of the bills passing or the impact of any of these bills on the future liquidity, consolidated financial position or operating results of the Company. Furthermore, any bills which are passed are subject to executive veto and court challenge. In addition to existing and possible new or modified statutory enactments, regulatory requirements and administrative and legal actions, the California timber industry remains subject to potential California or local ballot initiatives and evolving federal and California case law which could affect timber harvesting practices. It is impossible, however, to assess the effect of such matters on the Company's consolidated financial position, operating results or liquidity. HEADWATERS AGREEMENT On September 28, 1996, Pacific Lumber (on behalf of itself, its subsidiaries and affiliates) and MAXXAM (collectively, "the Pacific Lumber Parties") entered into the Headwaters Agreement with the United States and California. The Headwaters Agreement provides the framework for the acquisition by the United States and California of certain timberlands of Pacific Lumber. The Headwaters Agreement requires the parties to use their respective best, good faith efforts to achieve certain items (the "Specified Items"). The Specified Items include the transfer to the United States and California of approximately 5,600 acres of Pacific Lumber's timberlands commonly referred to as the Headwaters Forest and the Elk Head Springs Forest and related buffer zones (respectively, the "Headwaters Forest" and the "Elk Head Forest" and, collectively, the "Headwaters Timberlands"). A substantial portion of the Headwaters Timberlands consists of virgin old growth timberlands. Approximately 4,900 of these acres are owned by Salmon Creek. The remaining acreage is owned by Scotia Pacific (Pacific Lumber having harvesting rights on a portion of the acreage). The Headwaters Timberlands would be transferred in exchange for (a) property and other consideration (possibly including cash) from both the United States and California having an aggregate fair market value of $300 million and (b) 7,755 acres of adjacent timberlands to be acquired by the United States and California from a third party (the "Elk River Timberlands"). The United States and California would also acquire and retain an additional 1,900 acres of timberlands from such third party. An additional Specified Item is the expedited development and submission by Pacific Lumber and processing by the United States of an incidental take permit ("Permit") to be based upon a habitat conservation plan for multiple species ("Multi-Species HCP") covering (a) the timberlands and timber harvesting rights which Pacific Lumber will own after consummation of the Headwaters Agreement (the "Resulting Pacific Lumber Timber Property") and (b) the Headwaters Timberlands and the 1,900 acres of Elk River Timberlands retained by the United States and California (both as conserved habitat). The agreement also requires expedited processing by California of an SYP covering the Resulting Pacific Lumber Timber Property. The Headwaters Agreement contains various provisions regarding the processing of the Multi-Species HCP, the Permit and the SYP. The Specified Items also require, among other things, dismissal with prejudice at closing of the Takings Litigation pending against the United States and California. See Item 3. "Legal Proceedings--Timber Harvesting Litigation." Pursuant to the Headwaters Agreement, the parties have stayed the Takings Litigation, subject to certain rights of the parties to terminate the stay. The Headwaters Agreement also requires the United States and/or California to provide to Pacific Lumber a list of property interests owned or controlled by the United States and/or California meeting certain conditions, including that they have a good faith estimated fair market value equal to or in excess of $300 million. On December 5, 1996, the United States and California each furnished a list of properties for Pacific Lumber's review and approval. Neither list was accompanied by the requisite background information, although both lists did indicate that additional information would be made available. The list of United States properties consisted of oil and gas interests in Kern County, California, approximately 3,000 acres of young growth timberlands in Humboldt, Mendocino and Trinity Counties in California, and surplus acreage next to a federal office building in Laguna Niguel, California. In February 1997, after full and careful consideration, Pacific Lumber notified California that its Presented Properties were not acceptable due to, among other things, various physical problems and encumbrances on the properties, certain properties having been withdrawn by the state and public opposition to the transfer of some of the properties. Pacific Lumber also advised California that it should proceed with the steps necessary to assure that California can provide cash for its portion of the consideration to be paid to Pacific Lumber. There have been ongoing discussions between the Pacific Lumber Parties and the United States regarding the properties or other consideration to be furnished by the United States. As part of the Headwaters Agreement, the Pacific Lumber Parties agreed to not enter the Headwaters Forest or the Elk Head Forest to conduct logging operations, including salvage logging (the "Moratorium"). The Moratorium was to terminate if by July 28, 1997 the parties had not achieved the Specified Items to their respective satisfaction. On March 11, 1997, the Pacific Lumber Parties agreed to amend the Headwaters Agreement to extend the period of time during which these closing conditions must be met to February 17, 1998. The extension is, however, subject to the achievement of certain milestones toward completion of the Headwaters Agreement. The parties have agreed to execute an amendment to the Headwaters Agreement evidencing these modifications. Closing of the Headwaters Agreement is subject to various conditions, including (a) completion of the Specified Items, (b) approval of a Multi-Species HCP and SYP and issuance of the Permit, each in form and substance satisfactory to Pacific Lumber, (c) the issuance by the Internal Revenue Service and the California Franchise Tax Board of closing agreements in form and substance sought by and satisfactory to the Pacific Lumber Parties, (d) the absence of a judicial decision in any litigation brought by third parties that any party reasonably believes will significantly delay or impair the transactions described in the Headwaters Agreement, and (e) approval by the boards of directors of the applicable Pacific Lumber Parties. The Headwaters Agreement also provides that the parties will cooperate and act in good faith to preserve diligently the Headwaters Agreement, the Multi-Species HCP, the Permit and the SYP against third party challenge. The parties to the Headwaters Agreement are working to satisfy these conditions; however, there can be no assurance that the Headwaters Agreement will be consummated. ITEM 2. PROPERTIES A description of the Company's properties is included under Item 1 above. ITEM 3. LEGAL PROCEEDINGS This section contains statements which constitute "forward- looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. See Item 1. "Business--General" for cautionary information with respect to such forward-looking statements. TIMBER HARVESTING LITIGATION Various actions, similar to each other, have been filed against the Company, Pacific Lumber and its subsidiaries, MAXXAM, various state officials and others, alleging, among other things, violations of the Forest Practice Act, CEQA, ESA, CESA and/or related regulations. These actions seek to prevent Pacific Lumber and its subsidiaries from harvesting certain of their THPs and conducting certain other timber operations. On September 15, 1995, an action entitled Marbled Murrelet, et al. v. Bruce Babbitt, et al. (No. C-95-3261) (the "Marbled Murrelet action") was filed in the U.S. District Court for the Northern District of California. This action relates to, among other things, exemptions for forest health which Pacific Lumber and its subsidiaries had previously filed covering their entire timberlands. These exemptions allow Pacific Lumber to harvest dead, dying or diseased trees ("exempt harvesting operations"). As amended, the complaint alleges, among other things, violations of the ESA, the National Environmental Protection Act ("NEPA") and the Administrative Procedures Act ("APA"). Plaintiffs claim, among other things, that the exempt harvesting operations will contribute to the destruction of habitat for the marbled murrelet and the northern spotted owl. After the U.S. Ninth Circuit Court of Appeals reversed a preliminary injunction granted by the trial court enjoining the exempt harvesting operations, the plaintiffs asked for leave to amend their pleadings. On April 3, 1996, the trial court granted a preliminary injunction preventing harvesting on eight already-approved THPs to the extent that they rely on the Federal Owl Plan. In addition to appealing the preliminary injunction, Pacific Lumber has obtained regulatory reapproval of seven of the eight enjoined THPs without reliance on the Federal Owl Plan and has, to date, confirmed with the trial court that six of those THPs are no longer subject to the preliminary injunction. On November 4, 1996, the U.S. Ninth Circuit Court of Appeals heard oral arguments concerning Pacific Lumber's appeal but has not yet rendered a decision on this matter. In January 1997, the trial court dismissed plaintiffs' claims that Pacific Lumber had and was causing "takes" of the marbled murrelet and northern spotted owl. On November 15, 1996, an action entitled Redway Forest Defense, et al. v. CDF, et al. (No. 96CP0856; the "Redway action") was filed against Pacific Lumber and others in the Superior Court of Humboldt County, California. This action seeks to overturn the CDF's approval of THP 96-036 which permits harvesting of approximately 63 acres of primarily old growth timber. The action alleges, among other things, violations of CEQA relating primarily to salmon fisheries. The Company does not believe the matters described above will have a material adverse effect on the Company's consolidated financial position, results of operations or liquidity. See "Business--Regulatory and Environmental Factors" above for a description of regulatory and similar matters which could affect Pacific Lumber's timber harvesting practices and future operating results. The EPIC, et al. v. California State Board of Forestry, et al. (No. 91CP244) action in the Superior Court of Humboldt County, filed by the Sierra Club and the Environmental Protection Information Center ("EPIC") in 1991, relates to a THP for approximately 237 acres of virgin old growth timber. After the Superior Court reversed the BOF's approval of this THP, certain modifications were made to the THP, which was then unanimously approved by the BOF. The Superior Court later issued judgment in favor of Pacific Lumber. On appeal, the Court of Appeal in October 1993 affirmed the trial court's judgment approving harvesting under this THP. In April 1993, EPIC filed another action with respect to this THP entitled EPIC, Marbled Murrelet, et al. v. Bruce Babbitt, Secretary, Department of Interior, et al. (No. C93-1400) (the "EPIC action") in the U.S. District Court for the Northern District of California, alleging an unlawful "taking" of the marbled murrelet under the ESA. In February 1995, the Court ruled that the area covered by the THP is occupied by the marbled murrelet and permanently enjoined implementation of the THP in order to protect the marbled murrelet. Upon appeal, the U.S. Ninth Circuit Court of Appeals affirmed the District Court's decision. Pacific Lumber subsequently appealed the matter to the U.S. Supreme Court, but on February 19, 1997, the U.S. Supreme Court ruled that it would not consider Pacific Lumber's appeal. In March 1997, Pacific Lumber paid approximately $1.4 million in legal fees which the trial court had awarded to the plaintiffs. On April 22, 1996, Salmon Creek filed a lawsuit entitled Salmon Creek Corporation v. California State Board of Forestry, et al. (No. 96CS01057) in the Superior Court of Sacramento County. This action seeks to overturn the BOF's decision denying approval of a THP for approximately 8 acres of virgin old growth timber in the Headwaters Forest. Salmon Creek seeks a court order requiring approval of the THP so that it may harvest in accordance with the THP. Salmon Creek also seeks constitutional "just compensation" damages to the extent that its old growth timber within and surrounding the THP has been "taken" by reason of this regulatory denial and previous actions of governmental authorities. In addition, on May 7, 1996, Pacific Lumber, Scotia Pacific and Salmon Creek filed a lawsuit entitled The Pacific Lumber Company, et al. v. The United States of America (No. 96-257L) in the United States Court of Federal Claims. The suit alleges that the federal government has "taken" over 3,800 acres of Pacific Lumber's old growth timberlands (including the Headwaters Forest) through its application of the ESA. Pacific Lumber, Scotia Pacific and Salmon Creek seek constitutional "just compensation" damages for the taking of these timberlands by the federal government's actions. The Court in each of these actions (collectively, the "Takings Litigation") has granted the parties' agreed motions to stay the actions pursuant to the Headwaters Agreement. These actions would be dismissed if the Headwaters Agreement is consummated. See Item 1. "Business--Headwaters Agreement" for a description of the Headwaters Agreement. ZERO COUPON NOTE LITIGATION In April 1989, an action was filed against the Company, MAXXAM, MAXXAM Properties Inc., a wholly owned subsidiary of the Company ("MPI"), and certain of MAXXAM's directors in the Court of Chancery of the State of Delaware, entitled Progressive United Corporation v. MAXXAM Inc., et al. (No. 10785). Plaintiff purports to bring this action as a stockholder of MAXXAM derivatively on behalf of MAXXAM and MPI. In May 1989, a second action containing substantially similar allegations was filed in the Court of Chancery of the State of Delaware, entitled Wolf v. Hurwitz, et al. and the two cases were consolidated (under case No. 10785; collectively, the "Zero Coupon Note actions"). The Zero Coupon Note actions relate to a Put and Call Agreement entered into between MPI and Mr. Charles Hurwitz (Chairman of the Board of the Company, MAXXAM and MPI), as well as a predecessor agreement (the "Prior Agreement"). Among other things, the Put and Call Agreement provided that Mr. Hurwitz had the option (the "Call") to purchase from MPI certain notes (or MAXXAM's common stock into which they were converted) for $10.3 million. In July 1989, Mr. Hurwitz exercised the Call and acquired 990,400 shares of MAXXAM's common stock. The Zero Coupon Note actions generally allege that in entering into the Prior Agreement Mr. Hurwitz usurped a corporate opportunity belonging to MAXXAM, that the Put and Call Agreement constituted a waste of corporate assets of MAXXAM and MPI, and that the defendant directors breached their fiduciary duties in connection with these matters. Plaintiffs seek to have the Put and Call Agreement declared null and void, among other remedies. USAT MATTER In January 1995, an action entitled U.S., ex rel., Martel v. Hurwitz, et al. (the "Martel action") was filed in the U.S. District Court for the Northern District of California (No. C950322) against the Company, MAXXAM and others. This action is purportedly brought by plaintiff on behalf of the U.S. government; however, the U.S. government has declined to participate in the suit. The suit alleges that defendants made false statements and claims in violation of the Federal False Claims Act in connection with United Savings Association of Texas ("USAT"). Plaintiff alleges, among other things, that defendants used the federally insured assets of USAT to acquire junk bonds from Michael Milken and Drexel, Burnham, Lambert Inc. ("Drexel") and that, in exchange, Mr. Milken and Drexel arranged financing for defendants' various business ventures, including the acquisition of the Company. Plaintiff alleges that USAT became insolvent in 1988 and that defendants should be required to pay $1.6 billion (subject to trebling) to cover USAT's losses. The Company's alleged portion of such damages has not been specified. Plaintiff seeks, among other things, that the Court impose a constructive trust upon the fruits of the alleged improper use of USAT funds. In August 1996, the Court transferred this matter to the U.S. District Court for the Southern District of Texas in which court the Federal Deposit Insurance Corporation has brought another action arising out of the USAT matter. The parties are awaiting a ruling or hearing on defendants' motion to dismiss. The Company believes this matter should not have a material adverse effect on the Company's consolidated financial position, results of operations or liquidity. OTHER LITIGATION MATTERS The Company is involved in other claims, lawsuits and other proceedings. While uncertainties are inherent in the final outcome of such matters and it is presently impossible to determine the actual costs that ultimately may be incurred, management believes that the resolution of such uncertainties and the incurrence of such costs should not have a material adverse effect on the Company's consolidated financial position, results of operations or liquidity. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS All of the Company's common stock is owned by MGHI. Accordingly, the Company's common stock is not traded on any stock exchange and has no established public trading market. The Company declared and paid cash dividends on its common stock of $3.9 million and $4.8 million in 1996 and 1995, respectively. As of December 31, 1996, approximately $0.5 million of dividends could be paid by the Company. See Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations-- Financial Condition and Investing and Financing Activities" and Note 5 to the Consolidated Financial Statements appearing in Item 8. The Company's 11-1/4% Senior Secured Notes due 2003 (the "MGI Senior Notes") and the Company's 12-1/4% Senior Secured Discount Notes due 2003 (the "MGI Discount Notes," which, together with the MGI Senior Notes, are referred to collectively as the "MGI Notes") are secured by a pledge of 27,938,250 shares of common stock of Kaiser Aluminum Corporation ("Kaiser") owned by MGHI. See Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations--Financial Condition and Investing and Financing Activities" and Note 5 to the Consolidated Financial Statements appearing in Item 8. ITEM 6. SELECTED FINANCIAL DATA Not applicable. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS BACKGROUND This section contains statements which constitute "forward- looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. See Item 1. "Business--General" for cautionary information with respect to such forward-looking statements. The Company engages in forest products operations through its principal operating subsidiaries, Pacific Lumber and Britt. The Company's business is seasonal in that the forest products business generally experiences lower first quarter sales due largely to the general decline in construction-related activity during the winter months. The following should be read in conjunction with the Company's Consolidated Financial Statements and the Notes thereto appearing in Item 8. Old growth trees constitute Pacific Lumber's principal source of upper grade redwood lumber. Due to the severe restrictions on Pacific Lumber's ability to harvest virgin old growth timber on its property, Pacific Lumber's supply of upper grade lumber has decreased in some premium product categories. Furthermore, logging costs have increased primarily due to the harvest of smaller diameter logs and compliance with environmental regulations relating to the harvesting of timber and litigation costs incurred in connection with certain THPs filed by Pacific Lumber. Pacific Lumber has been able to lessen the impact of these factors by augmenting its production facilities to increase its recovery of upper grade lumber from smaller diameter logs and by increasing production capacity for manufactured upper grade lumber products through its end and edge glue facility (which was expanded during 1994). At this facility, knot-free pieces of lumber are assembled into wider or longer pieces. This manufactured lumber results in a significant increase in lumber recovery and produces a standard size upper grade product which is sold at a premium price compared to common grade products of similar dimensions. Pacific Lumber has also increased shipments of air seasoned, primed and specialty cut lumber which are examples of value-added products. Additionally, Pacific Lumber has instituted a number of measures at its sawmills during the past several years designed to enhance the efficiency of its operations, such as expansion of its manufactured lumber facilities and other improvements in lumber recovery, automated lumber handling and the modification of its production scheduling to maximize cogeneration power revenues, and installation of a lumber remanufacturing facility at its Fortuna lumber mill. However, unless Pacific Lumber is able to sustain the harvest level of old growth trees, Pacific Lumber expects that its production of premium upper grade lumber products will decline and that its manufactured lumber products will constitute a higher percentage of its shipments of upper grade lumber products. See also "--Trends" and Item 1. "Business--Pacific Lumber--Regulatory and Environmental Factors." RESULTS OF OPERATIONS The following table presents selected operational and financial information for the years ended December 31, 1996, 1995 and 1994.
Years Ended December 31, ----------------------------------------- 1996 1995 1994 ------------- ------------- ------------- (In millions of dollars, except shipments and prices) Shipments: Lumber: (1) Redwood upper grades 49.7 46.5 52.9 Redwood common grades 229.6 216.7 218.4 Douglas-fir upper grades 10.6 7.4 8.6 Douglas-fir common grades 74.9 64.6 54.2 Other 17.2 11.4 12.1 ------------- ------------- ------------- Total lumber 382.0 346.6 346.2 ============= ============= ============= Logs (2) 20.1 12.6 17.7 ============= ============= ============= Wood chips (3) 208.9 214.0 210.3 ============= ============= ============= Average sales price: Lumber: (4) Redwood upper grades $ 1,380 $ 1,495 $ 1,443 Redwood common grades 511 477 460 Douglas-fir upper grades 1,154 1,301 1,420 Douglas-fir common grades 439 392 444 Logs (4) 477 440 615 Wood chips (5) 76 102 83 Net sales: Lumber, net of discount $ 234.1 $ 211.3 $ 216.5 Logs 9.6 5.6 10.9 Wood chips 15.8 21.7 17.4 Cogeneration power 3.3 2.5 3.5 Other 1.8 1.5 1.3 ------------- ------------- ------------- Total net sales $ 264.6 $ 242.6 $ 249.6 ============= ============= ============= Operating income $ 72.0 $ 73.2 $ 77.8 ============= ============= ============= Operating cash flow (6) $ 100.2 $ 99.6 $ 103.8 ============= ============= ============= Income before income taxes and $ 4.9 $ 4.7 $ 14.8 extraordinary item ============= ============= ============= Net income $ 5.6 $ 3.5 $ 3.6 ============= ============= ============= - --------------- (1) Lumber shipments are expressed in millions of board feet. (2) Log shipments are expressed in millions of feet, net Scribner scale. (3) Wood chip shipments are expressed in thousands of bone dry units of 2,400 pounds. (4) Dollars per thousand board feet. (5) Dollars per bone dry unit. (6) Operating income before depletion and depreciation, also referred to as "EBITDA."
Net sales Net sales for 1996 increased compared to 1995 principally due to higher lumber shipments in all categories and higher average realized prices for common grade lumber. Partially offsetting these improvements were lower average realized prices for upper grade redwood lumber and wood chips. Shipments of fencing and other value-added common lumber products from the Company's new remanufacturing facility were a contributing factor in the improved redwood common lumber realizations. Net sales for 1995 decreased compared to 1994. Decreased shipments of upper grade redwood lumber, lower average realized prices for common grade Douglas-fir lumber and logs and decreased shipments of logs and redwood common lumber were largely offset by increased shipments of common grade Douglas-fir lumber, increased sales of wood chips and higher average realized prices for both common and upper grades of redwood lumber. Operating income Operating income, after excluding from 1995 cost of sales a $1.5 million settlement of business interruption insurance claims related to an April 1992 earthquake, increased in 1996 due to the increase in net sales discussed above. Increases in costs of goods sold reflect both the impact of additional manufacturing costs attributable to the increased shipments of manufactured lumber products, higher shipments of lower margin lumber and the increasing cost of regulatory compliance for the Company's timber harvesting operations. Operating income for 1995 decreased compared to 1994. This decrease was primarily due to lower sales of lumber and logs and the higher cost of lumber sales, partially offset by higher average realized prices on wood chips. Cost of lumber sales for 1995 was unfavorably impacted by higher purchases of logs from third parties, partially offset by improved sawmill productivity. Income before income taxes and extraordinary item Income before income taxes for 1996 was basically flat as compared to 1995. Income before income taxes and extraordinary item decreased for 1995 as compared to 1994. This decrease was primarily due to lower investment, interest and other income and the decrease in operating income. Investment, interest and other income for 1995 includes net gains on marketable securities of $4.2 million. Investment, interest and other income for 1994 includes the receipt of a franchise tax refund of $7.2 million (as described in Note 10 to the Consolidated Financial Statements) and net gains on marketable securities of $1.7 million. Credit (provision) in lieu of income taxes The credit in lieu of income taxes for 1996 includes a benefit of $2.3 million relating to the refund of taxes previously paid in connection with a settlement of certain federal income tax matters in 1996. The credit in lieu of income taxes for 1994 includes a credit relating to reserves the Company no longer believes are necessary. Extraordinary item The litigation settlement in the second quarter of 1994 (as described in Note 8 to the Consolidated Financial Statements) resulted in an extraordinary loss of $14.9 million, net of related income taxes of $6.3 million. The extraordinary loss consists of Pacific Lumber's $14.8 million cash payment to the settlement fund, a $2.0 million accrual for additional contingent claims and $4.4 million of related legal fees. FINANCIAL CONDITION AND INVESTING AND FINANCING ACTIVITIES FINANCING ACTIVITIES AND LIQUIDITY This section contains statements which constitute "forward- looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. See Item 1. "Business--General" for cautionary information with respect to such forward-looking statements. Parent Company. The Company conducts its operations primarily through its subsidiaries, Pacific Lumber and Britt. Creditors of the Company's subsidiaries have priority with respect to the assets, cash flows and earnings of such subsidiaries over the claims of the creditors of the Company, including the holders of the MGI Notes. The MGI Notes are senior indebtedness of the Company; however, they are effectively subordinate to the liabilities of the Company's subsidiaries, which include the Timber Notes and the Pacific Lumber Senior Notes. Substantially all of the Company's consolidated assets are owned by Pacific Lumber and a significant portion of Pacific Lumber's consolidated assets are owned by Scotia Pacific. Moreover, Pacific Lumber is dependent upon Scotia Pacific for a substantial portion of its log requirements. The indentures governing the Pacific Lumber Senior Notes, the Timber Notes (the "Timber Note Indenture") and Pacific Lumber's revolving credit agreement (the "Pacific Lumber Credit Agreement") contain various covenants which, among other things, limit the ability to incur additional indebtedness and liens, to engage in transactions with affiliates, to pay dividends and to make investments. Pacific Lumber can pay dividends in an amount that is generally equal to 50% of Pacific Lumber's consolidated net income plus depletion and cash dividends received from Scotia Pacific, exclusive of the net income and depletion of Scotia Pacific as long as any Timber Notes are outstanding. The Company is dependent upon its existing cash resources and dividends from Pacific Lumber and Britt to meet its financial and debt service obligations as they become due. The Company expects that Pacific Lumber will provide a major portion of its future operating cash flow. During the years ended December 31, 1996, 1995 and 1994, Pacific Lumber paid an aggregate of $20.5 million, $22.0 million and $24.5 million of dividends, respectively. As of December 31, 1996, under the most restrictive of these covenants, approximately $17.2 million of dividends could be paid by Pacific Lumber. Additionally, Britt paid dividends of $6.0 million, $6.0 million and $1.8 million, for the years ended December 31, 1996, 1995 and 1994, respectively, and as of December 31,1996, Britt could pay approximately $4.1 million of dividends. As of December 31, 1996, the indebtedness of the subsidiaries reflected on the Company's Consolidated Balance Sheet was $571.9 million, of which $235.0 million was attributable to the Pacific Lumber Senior Notes and $336.1 million was attributable to the Timber Notes. The holders of the Timber Notes have priority over the claims of creditors of Pacific Lumber with respect to the assets and cash flows of Scotia Pacific, and the holders of the Pacific Lumber Senior Notes have priority over the claims of creditors of the Company with respect to the assets and cash flows of Pacific Lumber. In the event Scotia Pacific's cash flows are not sufficient to generate distributable funds to Pacific Lumber, Pacific Lumber would effectively be precluded from distributing funds to the Company, and the Company's ability to pay interest on the MGI Notes and its other indebtedness would also be materially impaired. As of December 31, 1996, the Company (excluding Pacific Lumber and its subsidiary companies) had cash and marketable securities of approximately $77.8 million. The Company believes, although there can be no assurance, that the aggregate dividends which will be available to it from Pacific Lumber and Britt, during the period in which cash interest will not be payable on the MGI Discount Notes, will exceed the Company's cash interest payments on the MGI Senior Notes. When cash interest payments on the MGI Discount Notes commence on February 1, 1999, the Company believes that it should be able to make such cash interest payments out of its then existing cash resources and from cash expected to be available to it from Pacific Lumber and Britt. The indenture governing the MGI Notes, among other things, restricts the ability of the Company to incur additional indebtedness and liens, to engage in transactions with affiliates, to pay dividends and to make investments. As of December 31, 1996, under the most restrictive of these covenants, approximately $0.5 million of dividends could be paid by the Company, all which was paid in March 1997. The Company paid dividends of $3.9 million and $4.8 million in 1996 and 1995, respectively. The Company did not pay any dividends in 1994. Except for a portion of possible proceeds from the Headwaters Agreement, the Company does not expect to pay a significant amount of cash dividends over the next several years. Pacific Lumber. During the years ended December 31, 1996, 1995 and 1994, Pacific Lumber's operating income before depletion and depreciation ("operating cash flow") amounted to $93.9 million, $90.5 million and $95.9 million, respectively, which exceeded interest expense in respect of all of its indebtedness in those years by $39.5 million, $35.0 million and $39.8 million, respectively. Pacific Lumber is dependent upon Scotia Pacific for the logs from which it generates a substantial portion of its operating cash flow. The Company believes that Pacific Lumber's level of operating cash flow and available sources of financing will enable it to meet its working capital and capital expenditure requirements for the next year. With respect to long-term liquidity, the Company believes that Pacific Lumber's ability to generate sufficient levels of cash from operations, and its ability to obtain both short and long-term financing should provide sufficient funds to meet its working capital and capital expenditure requirements. Under the terms of the Timber Note Indenture, Scotia Pacific will not have available cash for distribution to Pacific Lumber unless Scotia Pacific's cash flow from operations exceeds the amounts required by the Timber Note Indenture to be reserved for the payment of current debt service (including interest, principal and premiums) on the Timber Notes, capital expenditures and certain other operating expenses. Once appropriate provision is made for current debt service on the Timber Notes and expenditures for operating and capital costs, and in the absence of certain Trapping Events (as defined in the Timber Note Indenture) or outstanding judgments, the Timber Note Indenture does not limit monthly distributions of available cash from Scotia Pacific to Pacific Lumber. Accordingly, once Scotia Pacific's debt service, operating and capital expenditure requirements have been met, substantially all of Scotia Pacific's available cash is periodically distributed to Pacific Lumber. Scotia Pacific paid $76.9 million, $59.0 million and $88.9 million of dividends to Pacific Lumber during the years ended December 31, 1996, 1995 and 1994, respectively. Borrowings under the Pacific Lumber Credit Agreement, which expires on May 31, 1999, are secured by Pacific Lumber's trade receivables and inventories, with interest currently computed at the bank's reference rate plus 1-1/4% or the bank's offshore rate plus 2-1/4%. The Pacific Lumber Credit Agreement provides for borrowings of up to $60.0 million, of which $15.0 million may be used for standby letters of credit and $30.0 million is restricted to acquisitions of timberlands. Borrowings made pursuant to the portion of the credit facility restricted to timberland acquisitions would also be secured by the purchased timberlands. As of December 31, 1996, $47.0 million of borrowings was available under the Pacific Lumber Credit Agreement, of which $4.7 million was available for letters of credit and $30.0 million was restricted to timberland acquisitions. No borrowings were outstanding as of December 31, 1996, and letters of credit outstanding amounted to $10.3 million. The Pacific Lumber Credit Agreement contains covenants substantially similar to those contained in the indenture governing the Pacific Lumber Senior Notes. Consolidated. As of December 31, 1996, the Company had consolidated working capital of $131.4 million and long-term debt of $729.8 million (net of current maturities and restricted cash deposited in a liquidity account for the benefit of the holders of the Timber Notes) as compared to $124.2 million and $732.9 million, respectively, at December 31, 1995. The decrease in long-term debt was primarily due to principal payments on the Timber Notes. The Company and its subsidiaries anticipate that cash from operations, together with existing cash, marketable securities and available sources of financing, will be sufficient to fund their working capital and capital expenditure requirements for the next year. With respect to their long-term liquidity, the Company and its subsidiaries believe that their existing cash and cash equivalents, together with their ability to generate sufficient levels of cash from operations and their ability to obtain both short and long-term financing, should provide sufficient funds to meet their working capital and capital expenditure requirements. However, due to their highly leveraged condition, the Company and its subsidiaries are more sensitive than less leveraged companies to factors affecting their operations, including governmental regulation affecting timber harvesting practices (see "-- Trends" below), increased competition from other lumber producers or alternative building products and general economic conditions. INVESTING ACTIVITIES Capital expenditures during 1994 - 1996 were made to improve production efficiency, reduce operating costs and, to a lesser degree, acquire additional timberlands. The Company's consolidated capital expenditures were $15.2 million, $9.9 million and $11.3 million for the years ended December 31, 1996, 1995 and 1994, respectively. Capital expenditures for 1997, excluding expenditures for timberlands, are expected to be $12.0 million and are estimated to be between $10.0 million and $15.0 million per year for the 1998 - 1999 period. Pacific Lumber may purchase additional timberlands from time to time as appropriate opportunities arise, and such purchases could exceed the historically modest levels of such acquisitions. TRENDS This section contains statements which constitute "forward- looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. See Item 1. "Business--General" for cautionary information with respect to such forward-looking statements. The Company's forest products operations are primarily conducted by Pacific Lumber. Pacific Lumber's operations are subject to a variety of California and federal laws and regulations dealing with timber harvesting, endangered species and critical habitat, and air and water quality. Moreover, these laws and regulations are modified from time to time and are subject to judicial and administrative interpretation. Compliance with such laws, regulations and judicial and administrative interpretations, together with the cost of litigation incurred in connection with certain timber harvesting operations of Pacific Lumber, have increased the cost of logging operations. Pacific Lumber is subject to certain pending matters which could have a material adverse effect on the Company's consolidated financial position, results of operations or liquidity. There can be no assurance that these pending matters or future governmental regulations, legislation or judicial or administrative decisions would not materially and adversely affect the Company. See Item 1. "Business--Regulatory and Environmental Factors"; Item 3. "Legal Proceedings--Timber Harvesting Litigation" and Notes 8 and 9 to the Consolidated Financial Statements for further information regarding regulatory and environmental factors affecting the Company's operations. See also Item 1. "Business--Headwaters Agreement" for the recent agreement to extend the Headwaters Agreement to February 17, 1998. Judicial or regulatory actions adverse to Pacific Lumber, increased regulatory delays and inclement weather in northern California, independently or collectively, could impair Pacific Lumber's ability to maintain adequate log inventories and force Pacific Lumber to temporarily idle or curtail operations at certain lumber mills from time to time. ITEM 8. FINANCIAL STATEMENT AND SUPPLEMENTARY DATA REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Stockholder and Board of Directors of MAXXAM Group Inc.: We have audited the accompanying consolidated balance sheets of MAXXAM Group Inc. (a Delaware corporation and a wholly owned subsidiary of MAXXAM Group Holdings Inc.) and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, cash flows and stockholder's deficit for each of the three years in the period ended December 31, 1996. These financial statements and the schedule referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of MAXXAM Group Inc. and subsidiaries as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. Our audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The schedule listed in Item 14(a)(2) of this Form 10-K is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the audits of the basic consolidated financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole. ARTHUR ANDERSEN LLP San Francisco, California January 24, 1997 MAXXAM GROUP INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (IN THOUSANDS OF DOLLARS)
December 31, --------------------------- 1996 1995 ------------- ------------- ASSETS Current assets: Cash and cash equivalents $ 72,418 $ 48,396 Marketable securities 31,423 36,568 Receivables: Trade 18,850 20,576 Other 2,542 1,624 Inventories 69,307 77,904 Prepaid expenses and other current assets 5,474 7,101 ------------- ------------- Total current assets 200,014 192,169 Timber and timberlands, net of accumulated depletion of $221,063 and $204,856, respectively 324,986 337,390 Property, plant and equipment, net of accumulated depreciation of $76,753 and $67,732, respectively 102,029 100,142 Deferred financing costs, net 24,249 27,288 Deferred income taxes 55,047 58,485 Restricted cash 29,967 31,367 Other assets 6,455 5,542 ------------- ------------- $ 742,747 $ 752,383 ============= ============= LIABILITIES AND STOCKHOLDER'S DEFICIT Current liabilities: Accounts payable $ 3,928 $ 4,166 Accrued interest 24,899 25,354 Accrued compensation and related benefits 10,033 9,611 Deferred income taxes 10,173 10,244 Other accrued liabilities 3,335 4,435 Long-term debt, current maturities 16,258 14,195 ------------- ------------- Total current liabilities 68,626 68,005 Long-term debt, less current maturities 759,769 764,310 Other noncurrent liabilities 26,387 33,813 ------------- ------------- Total liabilities 854,782 866,128 ------------- ------------- Contingencies Stockholder's deficit: Common stock, $.08-1/3 par value; 1,000 -- -- shares authorized; 100 shares issued Additional capital 81,287 81,287 Accumulated deficit (193,322) (195,032) ------------- ------------- Total stockholder's deficit (112,035) (113,745) ------------- ------------- $ 742,747 $ 752,383 ============= ============= The accompanying notes are an integral part of these financial statements.
MAXXAM GROUP INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS (IN THOUSANDS OF DOLLARS)
Years Ended December 31, ----------------------------------------- 1996 1995 1994 ------------- ------------- ------------- Net sales: Lumber and logs $ 243,726 $ 216,898 $ 227,430 Other 20,858 25,694 22,199 ------------- ------------- ------------- 264,584 242,592 249,629 ------------- ------------- ------------- Operating expenses: Cost of goods sold (exclusive of depletion and depreciation) 148,522 127,124 129,598 Selling, general and administrative expenses 15,853 15,884 16,250 Depletion and depreciation 28,176 26,405 25,946 ------------- ------------- ------------- 192,551 169,413 171,794 ------------- ------------- ------------- Operating income 72,033 73,179 77,835 Other income (expense): Investment, interest and other income 10,942 9,393 14,367 Interest expense (78,045) (77,824) (77,383) ------------- ------------- ------------- Income before income taxes and extraordinary item 4,930 4,748 14,819 Credit (provision) in lieu of income taxes 680 (1,211) 3,616 ------------- ------------- ------------- Income before extraordinary item 5,610 3,537 18,435 Extraordinary item: Loss on litigation settlement, net of related credit in lieu of income taxes of $6,312 -- -- (14,866) ------------- ------------- ------------- Net income $ 5,610 $ 3,537 $ 3,569 ============= ============= ============= The accompanying notes are an integral part of these financial statements.
MAXXAM GROUP INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (IN THOUSANDS OF DOLLARS)
Years Ended December 31, ----------------------------------------- 1996 1995 1994 ------------- ------------- ------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 5,610 $ 3,537 $ 3,569 Adjustments to reconcile net income to net cash provided by operating activities: Depletion and depreciation 28,176 26,405 25,946 Amortization of deferred financing costs and discounts on long-term debt 14,714 13,328 12,127 Net (purchases) sales of marketable securities 10,298 (19,533) 5,321 Net losses (gains) on marketable securities (5,153) (4,175) (1,669) Increase (decrease) in cash resulting from changes in: Inventories, net of depletion 6,011 (7,695) 3,634 Accounts payable (238) 463 832 Receivables 1,284 5,778 (7,660) Prepaids and other assets 714 (3,384) (528) Accrued and deferred income taxes (925) 2,303 (3,815) Other liabilities (4,288) 7,734 (2,283) Accrued interest (455) (411) (451) Other 5 1,020 (86) ------------- ------------- ------------- Net cash provided by operating activities 55,753 25,370 34,937 ------------- ------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES: Payment of note receivable from affiliate -- 2,500 -- Net proceeds from sale of assets 122 18 1,149 Capital expenditures (15,200) (9,852) (11,322) ------------- ------------- ------------- Net cash used for investing activities (15,078) (7,334) (10,173) ------------- ------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES: Redemptions, repurchase of and principal payments on long-term debt (14,153) (14,300) (13,237) Net borrowings (payments) under revolving credit agreements -- -- (2,900) Incurrence of financing costs -- (150) (213) Restricted cash withdrawals, net 1,400 1,035 1,160 Dividends paid (3,900) (4,800) -- ------------- ------------- ------------- Net cash used for financing activities (16,653) (18,215) (15,190) ------------- ------------- ------------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 24,022 (179) 9,574 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 48,396 48,575 39,001 ------------- ------------- ------------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 72,418 $ 48,396 $ 48,575 ============= ============= ============= The accompanying notes are an integral part of these financial statements.
MAXXAM GROUP INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDER'S DEFICIT (IN THOUSANDS OF DOLLARS)
Common Stock ($.08-1/3 Additional Accumulated Par) Capital Deficit Total ------------- ------------- ------------- ------------- Balance, January 1, 1994 $ -- $ 81,287 $ (197,338) $ (116,051) Net income -- -- 3,569 3,569 ------------- ------------- ------------- ------------- Balance, December 31, 1994 -- 81,287 (193,769) (112,482) Net income -- -- 3,537 3,537 Dividend -- -- (4,800) (4,800) ------------- ------------- ------------- ------------- Balance, December 31, 1995 -- 81,287 (195,032) (113,745) Net income -- -- 5,610 5,610 Dividend -- -- (3,900) (3,900) ------------- ------------- ------------- ------------- Balance, December 31, 1996 $ -- $ 81,287 $ (193,322) $ (112,035) ============= ============= ============= ============= The accompanying notes are an integral part of these financial statements.
MAXXAM GROUP INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS OF DOLLARS) 1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The consolidated financial statements include the accounts of MAXXAM Group Inc. ("MGI") and its subsidiaries, collectively referred to herein as the "Company." MGI is a wholly owned subsidiary of MAXXAM Group Holdings Inc. ("MGHI") which is a wholly owned subsidiary of MAXXAM Inc. ("MAXXAM"). Intercompany balances and transactions have been eliminated. Certain reclassifications have been made to prior years' financial statements to be consistent with the current year's presentation. The Company is engaged in forest products operations conducted through its wholly owned subsidiaries, The Pacific Lumber Company ("Pacific Lumber") and Britt Lumber Co., Inc. ("Britt"). Pacific Lumber is engaged in several principal aspects of the lumber industry, including the growing and harvesting of redwood and Douglas-fir timber, the milling of logs into lumber and the manufacture of lumber into a variety of finished products. Britt manufactures redwood and cedar fencing and decking products from small diameter logs, a substantial portion of which are obtained from Pacific Lumber. Housing, construction and remodeling are the principal markets for the Company's lumber products. Export sales generally constitute less than 6% of forest product sales. A significant portion of forest product sales are made to third parties located west of the Mississippi River. USE OF ESTIMATES AND ASSUMPTIONS The preparation of financial statements in accordance with generally accepted accounting principles requires the use of estimates and assumptions that affect (i) the reported amounts of assets and liabilities, (ii) disclosure of contingent assets and liabilities known to exist as of the date the financial statements are published and (iii) the reported amount of revenues and expenses recognized during each period presented. The Company reviews all significant estimates affecting its consolidated financial statements on a recurring basis and records the effect of any necessary adjustments prior to their publication. Adjustments made with respect to the use of estimates often relate to improved information not previously available. Uncertainties with respect to such estimates and assumptions are inherent in the preparation of the Company's consolidated financial statements; accordingly, it is possible that the subsequent resolution of any one of the contingent matters described in Note 8 could differ materially from current estimates. The results of an adverse resolution of such uncertainties could have a material effect on the Company's consolidated financial position, results of operations or liquidity. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Cash Equivalents Cash equivalents consist of highly liquid money market instruments with original maturities of three months or less. Marketable Securities Marketable securities are carried at fair value. The cost of the securities sold is determined using the first-in, first-out method. Included in investment, interest and other income for each of the three years ended December 31, 1996 were: 1996 - net unrealized holding losses of $902 and net realized gains of $5,287; 1995 - net unrealized holding gains of $1,666 and net realized gains of $2,509; and 1994 - net unrealized holding losses of $1,094 and net realized gains of $2,763. Inventories Inventories are stated at the lower of cost or market. Cost is primarily determined using the last-in, first-out ("LIFO") method. Timber and Timberlands Timber and timberlands are stated at cost, net of accumulated depletion. Depletion is computed utilizing the unit-of-production method based upon estimates of timber values and quantities. Property, Plant and Equipment Property, plant and equipment, including capitalized interest, is stated at cost, net of accumulated depreciation. Depreciation is computed utilizing the straight-line method at rates based upon the estimated useful lives of the various classes of assets. Deferred Financing Costs Costs incurred to obtain financing are deferred and amortized over the estimated term of the related borrowing. Restricted Cash and Concentrations of Credit Risk Restricted cash represents the amount deposited into an account (the "Liquidity Account") held by the trustee under the indenture governing the 7.95% Timber Collateralized Notes due 2015 (the "Timber Notes") of Scotia Pacific Holding Company ("Scotia Pacific"), a wholly owned subsidiary of Pacific Lumber. See Note 4. The Liquidity Account is not available, except under certain limited circumstances, for Scotia Pacific's working capital purposes; however, it is available to pay the Rated Amortization (as defined in Note 4) and interest on the Timber Notes if and to the extent that cash flows are insufficient to make such payments. The required Liquidity Account balance will generally decline as principal payments are made on the Timber Notes. Investment, interest and other income for the years ended December 31, 1996, 1995 and 1994 includes interest of approximately $2,865, $2,560 and $2,638, respectively, attributable to an investment rate agreement (at 7.95% per annum) with the financial institution which holds the Liquidity Account. At December 31, 1996 and 1995, cash and cash equivalents include $17,600 and $19,742, respectively, (the "Payment Account") which is reserved for debt service payments on the Timber Notes (see Note 4). The Payment Account and the Liquidity Account are each held by a different financial institution. In the event of nonperformance by such financial institutions, the Company's exposure to credit loss is represented by the amounts deposited plus any unpaid accrued interest thereon. The Company mitigates its concentrations of credit risk with respect to these restricted cash deposits by maintaining them at high credit quality financial institutions and monitoring the credit ratings of these institutions. Fair Value of Financial Instruments The carrying amounts of cash equivalents and restricted cash approximate fair value. Marketable securities are carried at fair value which is determined based on quoted market prices. As of December 31, 1996 and 1995, the estimated fair value of long-term debt, including current maturities, was $747,991 and $772,841, respectively. The estimated fair value of long-term debt is determined based on the quoted market prices for the Timber Notes, the 10-1/2% Senior Notes due 2003 (the "Pacific Lumber Senior Notes"), the 11-1/4% Senior Secured Notes due 2003 (the "MGI Senior Notes") and the 12-1/4% Senior Secured Discount Notes due 2003 (the "MGI Discount Notes" and together with the MGI Senior Notes, the "MGI Notes"), and on the current rates offered for borrowings similar to the other debt. Some of the Company's publicly traded debt issues are thinly traded financial instruments; accordingly, their market prices at any balance sheet date may not be representative of the prices which would be derived from a more active market. 2. INVENTORIES Inventories consist of the following:
December 31, --------------------------- 1996 1995 ------------- ------------- Lumber $ 49,829 $ 59,563 Logs 19,478 18,341 ------------- ------------- $ 69,307 $ 77,904 ============= =============
3. PROPERTY, PLANT AND EQUIPMENT The major classes of property, plant and equipment are as follows:
Estimated December 31, --------------------------- Useful Lives 1996 1995 ------------- ------------- ------------- Logging roads, land and improvements 15 years $ 11,541 $ 7,929 Buildings 33 years 34,877 29,661 Machinery and equipment 5 - 15 years 132,364 129,764 Construction in progress -- 520 ------------- ------------- 178,782 167,874 Less: accumulated depreciation (76,753) (67,732) ------------- ------------- $ 102,029 $ 100,142 ============= =============
Depreciation expense for the years ended December 31, 1996, 1995 and 1994 was $ 9,382 , $9,663 and $9,269, respectively. 4. LONG-TERM DEBT Long-term debt consists of the following:
December 31, --------------------------- 1996 1995 ------------- ------------- 7.95% Scotia Pacific Timber Collateralized Notes due through July 20, 2015 $ 336,130 $ 350,233 10-1/2% Pacific Lumber Senior Notes due March 1, 2003 235,000 235,000 11-1/4% MGI Senior Secured Notes due August 1, 2003 100,000 100,000 12-1/4% MGI Senior Secured Discount Notes due August 1, 2003, net of discount 104,173 92,498 Other 724 774 ------------- ------------- 776,027 778,505 Less: current maturities (16,258) (14,195) ------------- ------------- $ 759,769 $ 764,310 ============= =============
The indenture governing the Timber Notes (the "Timber Note Indenture") prohibits Scotia Pacific from incurring any additional indebtedness for borrowed money and limits the business activities of Scotia Pacific to the ownership and operation of its timber and timberlands. The Timber Notes are senior secured obligations of Scotia Pacific and are not obligations of, or guaranteed by, Pacific Lumber or any other person. The Timber Notes are secured by a lien on (i) Scotia Pacific's timber and timberlands (representing $165,970 of the Company's consolidated balance at December 31, 1996), (ii) Scotia Pacific's contract rights and certain other assets, (iii) the funds deposited in the Payment Account and the Liquidity Account, and (iv) substantially all of Scotia Pacific's other property and equipment. The Timber Notes are structured to link, to the extent of available cash, the deemed depletion of Scotia Pacific's timber (through the harvest and sale of logs) to required amortization of the Timber Notes. The required amount of amortization due on any Timber Note payment date is determined by various mathematical formulas set forth in the Timber Note Indenture. The minimum amount of principal which Scotia Pacific must pay (on a cumulative basis) through any Timber Note payment date in order to avoid an Event of Default (as defined) is referred to as rated amortization ("Rated Amortization"). If all payments of principal are made in accordance with Rated Amortization, the payment date on which Scotia Pacific will pay the final installment of principal is July 20, 2015. The amount of principal which Scotia Pacific must pay through each Timber Note payment date in order to avoid prepayment or deficiency premiums is referred to as scheduled amortization ("Scheduled Amortization"). If all payments of principal are made in accordance with Scheduled Amortization, the payment date on which Scotia Pacific will pay the final installment of principal is July 20, 2009. Substantially all of the Company's consolidated assets are owned by Pacific Lumber and a significant portion of Pacific Lumber's assets are owned by Scotia Pacific. The Company expects that Pacific Lumber will provide a major portion of the Company's future operating cash flow. Pacific Lumber is dependent upon Scotia Pacific for a significant portion of its operating cash flow. The holders of the Timber Notes have priority over the claims of creditors of Pacific Lumber with respect to the assets and cash flows of Scotia Pacific, and the holders of the Pacific Lumber Senior Notes have priority over the claims and creditors of the Company with respect to the assets and cash flows of Pacific Lumber. Under the terms of the Timber Note Indenture, Scotia Pacific will not have available cash for distribution to Pacific Lumber unless Scotia Pacific's cash flow from operations exceeds the amounts required by the Timber Note Indenture to be reserved for the payment of current debt service (including interest, principal and premiums) on the Timber Notes, capital expenditures and certain other operating expenses. Principal and interest on the Timber Notes are payable semi- annually on January 20 and July 20. On January 21, 1997, Scotia Pacific paid $8,712 of principal on the Timber Notes. The Timber Notes are redeemable at the option of Scotia Pacific, in whole but not in part, at any time. The redemption price of the Timber Notes is equal to the sum of the principal amount, accrued interest and a prepayment premium calculated based upon the yield of like-term Treasury securities plus 50 basis points. Interest on the Pacific Lumber Senior Notes is payable semi- annually on March 1 and September 1. The Pacific Lumber Senior Notes are redeemable at the option of Pacific Lumber, in whole or in part, on or after March 1, 1998 at a price of 103% of the principal amount plus accrued interest. The redemption price is reduced annually until March 1, 2000, after which time the Pacific Lumber Senior Notes are redeemable at par. The Pacific Lumber Senior Notes are unsecured and are senior indebtedness of Pacific Lumber; however, they are effectively subordinated to the Timber Notes. The indenture governing the Pacific Lumber Senior Notes contains various covenants which, among other things, limit Pacific Lumber's ability to incur additional indebtedness and liens, to engage in transactions with affiliates, to make investments and to pay dividends. Pacific Lumber has a revolving credit agreement with a bank (as amended and restated, the "Pacific Lumber Credit Agreement") which expires on May 31, 1999. Borrowings under the Pacific Lumber Credit Agreement are secured by Pacific Lumber's trade receivables and inventories, with interest currently computed at the bank's reference rate plus 1-1/4% or the bank's offshore rate plus 2-1/4%. The Pacific Lumber Credit Agreement provides for borrowings of up to $60,000, of which $15,000 may be used for standby letters of credit and $30,000 is restricted to timberland acquisitions. Borrowings made pursuant to the portion of the credit facility restricted to timberland acquisitions would also be secured by the purchased timberlands. As of December 31, 1996, $46,992 of borrowings was available under the Pacific Lumber Credit Agreement, of which $4,732 was available for letters of credit and $30,000 was restricted to timberland acquisitions. No borrowings were outstanding as of December 31, 1996, and letters of credit outstanding amounted to $10,268. The Pacific Lumber Credit Agreement contains covenants substantially similar to those contained in the indenture governing the Pacific Lumber Senior Notes. As of December 31, 1996, under the most restrictive covenants contained in the indentures governing the Pacific Lumber Senior Notes, the Timber Notes and the Pacific Lumber Credit Agreement, Pacific Lumber could pay approximately $17,200 of dividends. On August 4, 1993, the Company issued $100,000 aggregate principal amount of the MGI Senior Notes and $126,720 aggregate principal amount (approximately $70,000 net of original issue discount) of the MGI Discount Notes. The MGI Notes are secured by the Company's pledge of 100% of the common stock of Pacific Lumber, Britt and MAXXAM Properties Inc. ("MPI"), a wholly owned subsidiary of the Company, and by MGHI's pledge of 27,938,250 shares of Kaiser Aluminum Corporation ("Kaiser") common stock. The indenture governing the MGI Notes, among other things, restricts the ability of the Company to incur additional indebtedness and liens, engage in transactions with affiliates, pay dividends and make investments. As of December 31, 1996, under the most restrictive of these covenants, approximately $500 of dividends could be paid by the Company. The MGI Notes are senior indebtedness of the Company; however, they are effectively subordinated to the liabilities of the Company's subsidiaries, which include the Timber Notes and the Pacific Lumber Senior Notes. The MGI Discount Notes are net of discount of $21,547 and $33,222 at December 31, 1996 and 1995, respectively. The MGI Senior Notes pay interest semi-annually on February 1 and August 1 of each year. The MGI Discount Notes will not pay any interest until February 1, 1999, at which time semi-annual interest payments will become due on each February 1 and August 1 thereafter. Maturities Scheduled maturities of long-term debt for the five years following December 31, 1996, using the Scheduled Amortization for the Timber Notes, are: $16,258 in 1997, $19,430 in 1998, $21,745 in 1999, $24,065 in 2000, $24,827 in 2001 and $691,249 thereafter. Maturities for 1997 through 2001 are principally attributable to the Timber Notes. Restricted Net Assets of Subsidiaries At December 31, 1996, certain debt instruments restricted the ability of Pacific Lumber to transfer assets, make loans and advances and pay dividends to the Company. As of December 31, 1996, all of the assets of Pacific Lumber and its subsidiaries are subject to such restrictions. 5. CREDIT (PROVISION) IN LIEU OF INCOME TAXES Income taxes are determined using an asset and liability approach which requires the recognition of deferred income tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. Under this method, deferred income tax assets and liabilities are determined based on the temporary differences between the financial statement and tax bases of assets and liabilities using enacted tax rates. The Company and its subsidiaries are members of MAXXAM's consolidated return group for federal income tax purposes. Pursuant to a tax allocation agreement between MAXXAM, Pacific Lumber, Scotia Pacific and Salmon Creek Corporation ("Salmon Creek"), a wholly owned subsidiary of Pacific Lumber, (the "PL Tax Allocation Agreement"), Pacific Lumber is liable to MAXXAM for the federal consolidated income tax liability of Pacific Lumber, Scotia Pacific and certain other subsidiaries of Pacific Lumber (but excluding Salmon Creek) (collectively, the "PL Subgroup") computed as if the PL Subgroup was a separate affiliated group of corporations which was never connected with MAXXAM. The PL Tax Allocation Agreement further provides that Salmon Creek is liable to MAXXAM for its federal income tax liability computed on a separate company basis as if it was never connected with MAXXAM. The remaining subsidiaries of MGI are each liable to MAXXAM for their respective income tax liabilities computed on a separate company basis as if they were never connected with MAXXAM, pursuant to their respective tax allocation agreements. MGI's tax allocation agreement with MAXXAM, (the "Tax Allocation Agreement"), provides that the Company's federal income tax liability is computed as if MGI files a consolidated tax return with all of its subsidiaries except Salmon Creek, and that such corporations were never connected with MAXXAM (the "MGI Consolidated Tax Liability"). The federal income tax liability of MGI is the difference between (i) the MGI Consolidated Tax Liability and (ii) the sum of the separate tax liabilities for the Company's subsidiaries (computed as discussed above), but excluding Salmon Creek. To the extent that the MGI Consolidated Tax Liability is less than the aggregate amounts in (ii), MAXXAM is obligated to pay the amount of such difference to MGI. The credit (provision) in lieu of income taxes on income before income taxes and extraordinary item consists of the following:
Years Ended December 31, ----------------------------------------- 1996 1995 1994 ------------- ------------- ------------- Current: Federal credit (provision) in lieu of income taxes $ (159) $ (167) $ -- State and local (9) (35) (55) ------------- ------------- ------------- (168) (202) (55) ------------- ------------- ------------- Deferred: Federal credit (provision) in lieu of income taxes 363 (33) 2,366 State and local 485 (976) 1,305 ------------- ------------- ------------- 848 (1,009) 3,671 ------------- ------------- ------------- $ 680 $ (1,211) $ 3,616 ============= ============= =============
A reconciliation between the credit (provision) in lieu of income taxes and the amount computed by applying the federal statutory income tax rate to income before income taxes and extraordinary item is as follows:
Years Ended December 31, ----------------------------------------- 1996 1995 1994 ------------- ------------- ------------- Income before income taxes and extraordinary item $ 4,930 $ 4,748 $ 14,819 ============= ============= ============= Amount of federal income tax based upon the statutory rate $ (1,726) $ (1,662) $ (5,187) Revision of prior years' tax estimates and other changes in valuation allowances 3,372 907 7,739 Expenses for which no federal tax benefit is available (493) -- -- State and local taxes, net of federal tax effect (573) (657) 812 Other 100 201 252 ------------- ------------- ------------- $ 680 $ (1,211) $ 3,616 ============= ============= =============
Revision of prior years' tax estimates and other changes in valuation allowances as shown in the table above include amounts for the reversal of reserves which the Company no longer believes are necessary, other changes in prior year tax estimates and changes in valuation allowances with respect to deferred income tax assets. Generally, the reversal of reserves relates to the expiration of the relevant statute of limitations with respect to certain income tax returns or the resolution of specific income tax matters with the relevant tax authorities. For the years ended December 31, 1996, 1995 and 1994, the reversal of reserves which the Company believes are no longer necessary resulted in a credit to the income tax provision of $3,203, $127 and $7,048, respectively. As shown in the Consolidated Statement of Operations for the year ended December 31, 1994, the Company recorded an extraordinary loss related to the settlement of litigation in connection with the Company's acquisition of Pacific Lumber (see Note 10). The Company reported the loss net of related deferred income taxes of $6,312 which is less than the federal and state statutory income tax rates due to expenses for which no tax benefit was recognized. The components of the Company's net deferred income tax assets (liabilities) are as follows:
December 31, --------------------------- 1996 1995 ------------- ------------- Deferred income tax assets: Loss and credit carryforwards $ 79,411 $ 83,705 Timber and timberlands 28,992 32,528 Other liabilities and other 22,934 19,846 Valuation allowances (51,049) (51,595) ------------- ------------- Total deferred income tax assets, net 80,288 84,484 ------------- ------------- Deferred income tax liabilities: Property, plant and equipment (17,458) (16,560) Inventories (15,091) (16,068) Other (2,865) (3,615) ------------- ------------- Total deferred income tax liabilities (35,414) (36,243) ------------- ------------- Net deferred income tax assets $ 44,874 $ 48,241 ============= =============
Expiring Through ------------- Regular Tax Attribute Carryforwards: Net operating losses $ 215,651 2011 Net capital losses 4,201 1998 Minimum tax credit 379 Indefinite Alternative Minimum Tax Attribute Carryforwards: Net operating losses $ 174,948 2011
6. EMPLOYEE BENEFIT PLANS RETIREMENT PLAN Pacific Lumber has a defined benefit plan which covers all employees of Pacific Lumber. Under the plan, employees are eligible for benefits at age 65 or earlier, if certain provisions are met. The benefits are determined under a career average formula based on each year of service with Pacific Lumber and the employee's compensation for that year. Pacific Lumber's funding policy is to contribute annually an amount at least equal to the minimum cash contribution required by The Employee Retirement Income Security Act of 1974, as amended. A summary of the components of net periodic pension cost is as follows:
Years Ended December 31, ----------------------------------------- 1996 1995 1994 ------------- ------------- ------------- Service cost - benefits earned during the year $ 1,903 $ 1,483 $ 1,643 Interest cost on projected benefit obligation 1,682 1,693 1,263 Actual loss (gain) on plan assets (2,762) (3,900) 10 Net amortization and deferral 1,448 2,460 (859) ------------- ------------- ------------- Net periodic pension cost $ 2,271 $ 1,736 $ 2,057 ============= ============= =============
The following table sets forth the funded status and amounts recognized in the Consolidated Balance Sheet:
December 31, --------------------------- 1996 1995 ------------- ------------- Actuarial present value of accumulated plan benefits: Vested benefit obligation $ 18,506 $ 16,910 Non-vested benefit obligation 1,371 1,214 ------------- ------------- Total accumulated benefit obligation $ 19,877 $ 18,124 ============= ============= Projected benefit obligation $ 23,582 $ 21,841 Plan assets at fair value, primarily equity and (21,800) (18,363) debt securities ------------- ------------- Projected benefit obligation in excess of plan 1,782 3,478 assets Unrecognized net transition asset 18 24 Unrecognized net gain (loss) 2,855 (27) Unrecognized prior service cost (39) (45) ------------- ------------- Accrued pension liability $ 4,616 $ 3,430 ============= =============
The assumptions used in accounting for the defined benefit plan were as follows:
1996 1995 1994 ------------- ------------- ------------- Rate of increase in compensation levels 5.0% 5.0% 5.0% Discount rate 7.5% 7.25% 8.5% Expected long-term rate of return on 8.0% 8.0% 8.0% assets
POSTRETIREMENT MEDICAL BENEFITS Pacific Lumber has an unfunded defined benefit plan for certain postretirement medical benefits which covers substantially all employees of Pacific Lumber. Participants of the plan are eligible for certain health care benefits upon termination of employment and retirement and commencement of pension benefits. Participants make contributions for a portion of the cost of their health care benefits. The expected costs of postretirement medical benefits are accrued over the period the employees provide services to the date of their full eligibility for such benefits. A summary of the components of net periodic postretirement medical benefit cost is as follows:
Years Ended December 31, ----------------------------------------- 1996 1995 1994 ------------- ------------- ------------- Service cost - medical benefits earned during the year $ 332 $ 228 $ 216 Interest cost on accumulated postretirement medical benefit obligation 415 317 294 Net amortization and deferral -- (53) (7) ------------- ------------- ------------- Net periodic postretirement medical benefit cost $ 747 $ 492 $ 503 ============= ============= =============
The postretirement medical benefit liability recognized in the Company's Consolidated Balance Sheet is as follows:
December 31, --------------------------- 1996 1995 ------------- ------------- Retirees $ 1,182 $ 634 Actives eligible for benefits 905 726 Actives not eligible for benefits 3,818 3,317 ------------- ------------- Accumulated postretirement medical benefit obligation 5,905 4,677 Unrecognized net gain (loss) (86) 553 ------------- ------------- Postretirement medical benefit liability $ 5,819 $ 5,230 ============= =============
The annual assumed rate of increase in the per capita cost of covered benefits (i.e., health care cost trend rate) is 10.5% for 1997 and is assumed to decrease gradually to 5.5% in 2008 and remain at that level thereafter. Each one percentage point increase in the assumed health care cost trend rate would increase the accumulated postretirement medical benefit obligation as of December 31, 1996 by approximately $810 and the aggregate of the service and interest cost components of net periodic postretirement medical benefit cost by approximately $130. The discount rates used in determining the accumulated postretirement medical benefit obligation were 7.5% and 7.25% at December 31, 1996 and 1995, respectively. EMPLOYEE SAVINGS PLAN Pacific Lumber's employees are eligible to participate in a defined contribution savings plan sponsored by MAXXAM. This plan is designed to enhance the existing retirement programs of participating employees. Employees may elect to contribute up to 16% of their compensation to the plan. For those participants who have elected to make voluntary contributions to the plan, Pacific Lumber's contributions consist of a matching contribution of up to 4% of the compensation of participants. The cost to the Company of this plan was $1,388, $1,281 and $1,215 for the years ended December 31, 1996, 1995 and 1994, respectively. WORKERS' COMPENSATION BENEFITS Pacific Lumber is self-insured for workers' compensation benefits. Included in accrued compensation and related benefits and other noncurrent liabilities are accruals for workers' compensation claims amounting to $8,000 and $8,900 at December 31, 1996 and 1995, respectively. Workers' compensation expenses amounted to $3,080, $3,579 and $4,069 for the years ended December 31, 1996, 1995 and 1994, respectively. 7. RELATED PARTY TRANSACTIONS MAXXAM provides the Company and certain of the Company's subsidiaries with accounting and data processing services. In addition, MAXXAM provides the Company with office space and various office personnel, insurance, legal, operating, financial and certain other services. MAXXAM's expenses incurred on behalf of the Company are reimbursed by the Company through payments consisting of (i) an allocation of the lease expense for the office space utilized by or on behalf of the Company and (ii) a reimbursement of actual out-of-pocket expenses incurred by MAXXAM, including, but not limited to, labor costs of MAXXAM personnel rendering services to the Company. Charges by MAXXAM for such services were $2,680, $1,994 and $2,254 for the years ended December 31, 1996, 1995 and 1994, respectively. The Company believes that the services being rendered are on terms not less favorable to the Company than those which would be obtainable from unaffiliated third parties. In 1994, in connection with the litigation settlement described in Note 10, Pacific Lumber paid approximately $3,185 to a law firm in which a director of Pacific Lumber is also a partner. 8. CONTINGENCIES Pacific Lumber's operations are subject to a variety of California and federal laws and regulations dealing with timber harvesting, endangered species and critical habitat, and air and water quality. Moreover, these laws and regulations are modified from time to time and are subject to judicial and administrative interpretation. Compliance with such laws, regulations and judicial and administrative interpretations, together with the cost of litigation incurred in connection with certain timber harvesting operations of Pacific Lumber, have increased the cost of logging operations. Pacific Lumber is subject to certain pending matters described below which could have a material adverse effect on the consolidated financial position, results of operations or liquidity of Pacific Lumber, and in turn the Company. There can be no assurance that certain pending or future governmental regulations, legislation, judicial or administrative decisions or California ballot initiatives will not have a material adverse effect on the Company. In May 1996, the United States Fish and Wildlife Service ("USFWS") published its final designation of critical habitat for the marbled murrelet (the "Final Designation"), which designated over four million acres as critical habitat for the marbled murrelet. Although nearly all of the designated habitat is public land, approximately 33,000 acres of Pacific Lumber's timberlands are included in the Final Designation, the substantial portion of such acreage being young growth timber. In order to mitigate the impact of the Final Designation, particularly with respect to timberlands occupied by the marbled murrelet, Pacific Lumber over the last few years has attempted to develop a habitat conservation plan for the marbled murrelet (the "Murrelet HCP"). Due to, among other things, the unfavorable response of the USFWS to Pacific Lumber's initial Murrelet HCP efforts, Pacific Lumber and its subsidiaries filed two actions (the "Takings Litigation") alleging that certain portions of their timberlands have been "taken" and seeking just compensation. Pursuant to an agreement entered into by Pacific Lumber, MAXXAM, the United States and California on September 28, 1996 (the "Headwaters Agreement") described in Note 9 below, the Takings Litigation has been stayed at the request of the parties. It is impossible for the Company to determine the potential adverse effect of the Final Designation on the Company's consolidated financial position, results of operations or liquidity until such time as various regulatory and legal issues are resolved; however, if Pacific Lumber is unable to harvest, or is severely limited in harvesting, on timberlands designated as critical habitat for the marbled murrelet, such effect could be materially adverse to Pacific Lumber, and in turn the Company. If Pacific Lumber is unable to harvest or is severely limited in harvesting, it intends to seek just compensation from the appropriate governmental agencies on the grounds that such restrictions constitute a governmental taking. There continue to be other regulatory actions and lawsuits seeking to have other species listed as threatened or endangered under the federal Endangered Species Act ("ESA") and/or the California Endangered Species Act ("CESA") and to designate critical habitat for such species. For example, the National Marine Fisheries Service has announced that by April 25, 1997 it will make a final determination concerning whether to list the coho salmon under the ESA in northern California, including, potentially, lands owned by Pacific Lumber. It is uncertain what impact, if any, such listings and/or designations of critical habitat would have on the consolidated financial position, results of operations or liquidity of Pacific Lumber, and in turn the Company. In 1994, the California Board of Forestry ("BOF") adopted certain regulations regarding compliance with long-term sustained yield ("LTSY") objectives. These regulations require that timber companies project timber growth and harvest on their timberlands over a 100-year planning period and establish a LTSY harvest level that takes into account environmental and economic considerations. The sustained yield plan ("SYP") must demonstrate that the average annual harvest over any rolling ten-year period will not exceed the LTSY harvest level and that Pacific Lumber's projected timber inventory is capable of sustaining the LTSY harvest level in the last decade of the 100-year planning period. On December 17, 1996, Pacific Lumber submitted a proposed SYP to the California Department of Forestry ("CDF"). The proposed SYP sets forth an LTSY harvest level substantially the same as Pacific Lumber's average annual timber harvest over the last six years. The proposed SYP also indicates that Pacific Lumber's average annual timber harvest during the first decade of the SYP would approximate the LTSY harvest level. During the second decade of the proposed SYP, Pacific Lumber's average annual timber harvest would be approximately 8% less than that proposed for the first decade. The SYP, when approved, will be valid for ten years. Thereafter, revised SYPs will be prepared every decade that will address the LTSY harvest level based upon reassessment of changes in the resource base and protection of public resources. The proposed SYP assumes that the transactions contemplated by the Headwaters Agreement (see Note 9) will be consummated and that the Multi-Species HCP (as defined in Note 9) will permit Pacific Lumber to harvest its timberlands (including over the next two decades a substantial portion of its old growth timberlands not transferred pursuant to the Headwaters Agreement) to achieve maximum sustained yield. The SYP is subject to review and approval by the CDF, and there can be no assurance that the SYP will be approved in its proposed form. Until the SYP is reviewed and approved, the Company is unable to predict the impact that these regulations will have on Pacific Lumber's future timber harvesting practices. It is possible that the results of the review and approval process could require Pacific Lumber to reduce its timber harvest in future years from the harvest levels set forth in the proposed SYP. The Company believes Pacific Lumber would be able to mitigate the effect of any required reduction in harvest level by acquisitions of additional timberlands and making corresponding amendments to the SYP; however, there can be no assurance that Pacific Lumber would be able to do so and the amount of such acquisitions would be limited by Pacific Lumber's available financial resources. The Company is unable to predict the ultimate impact the sustained yield regulations will have on its future financial position, results of operations or liquidity. Various groups and individuals have filed objections with the CDF and the BOF regarding the CDF's and the BOF's actions and rulings with respect to certain of Pacific Lumber's timber harvesting plans ("THPs") and other timber harvesting operations, and Pacific Lumber expects that such groups and individuals will continue to file such objections. In addition, lawsuits are pending or threatened which seek to prevent Pacific Lumber from implementing certain of its approved THPs or which challenge other operations by Pacific Lumber. These challenges have severely restricted Pacific Lumber's ability to harvest old growth timber on its property. To date, challenges with respect to Pacific Lumber's THPs relating to young growth timber and to its other operations have been limited; however, no assurance can be given as to the extent of such challenges in the future. Pacific Lumber believes that environmentally focused challenges to its timber harvesting and other operations are likely to occur in the future, particularly with respect to virgin and residual old growth timber. Although such challenges have delayed or prevented Pacific Lumber from conducting a portion of its operations, they have not had a material adverse effect on Pacific Lumber's consolidated financial position, results of operations or liquidity. Nevertheless, it is impossible to predict the future nature or degree of such challenges or their ultimate impact on the consolidated financial position, results of operations or liquidity of Pacific Lumber, and in turn the Company. The Company is also involved in various claims, lawsuits and proceedings. While there are uncertainties inherent in the ultimate outcome of such matters and it is impossible to presently determine the ultimate costs that may be incurred, management believes that the resolution of such uncertainties and the incurrence of such costs should not have a material adverse effect on the Company's consolidated financial position, results of operations or liquidity. 9. HEADWATERS AGREEMENT On September 28, 1996, Pacific Lumber (on behalf of itself, its subsidiaries and affiliates) and MAXXAM (collectively, the "Pacific Lumber Parties " ) entered into the Headwaters Agreement with the United States and California. The Headwaters Agreement provides the framework for the acquisition by the United States and California of approximately 5,600 acres of Pacific Lumber's timberlands commonly referred to as the Headwaters Forest and the Elk Head Springs Forest (the "Headwaters Timberlands"). A substantial portion of the Headwaters Timberlands consists of virgin old growth timberlands. The Headwaters Timberlands would be transferred in exchange for (a) property and other consideration (possibly including cash) from the United States and California having an aggregate fair market value of $300 million and (b) approximately 7,755 acres of adjacent timberlands to be acquired by the United States and California (the "Elk River Timberlands") from a third party. The United States and California would also acquire and retain an additional 1,900 acres of timberlands from such third party. The Headwaters Agreement also provides, among other things, for the expedited processing by the United States of an incidental take permit ("Permit") to be based upon a habitat conservation plan for multiple species ("Multi-Species HCP") covering (a) the timberlands and timber harvesting rights which Pacific Lumber will own after consummation of the Headwaters Agreement (the "Resulting Pacific Lumber Timber Property") and (b) the Headwaters Timberlands and the 1,900 acres of Elk River Timberlands retained by the United States and California (both as conserved habitat). The agreement also requires expedited processing by California of an SYP covering the Resulting Pacific Lumber Timber Property. On December 5, 1996, the United States and California each furnished a list of properties consisting of oil and gas interests, timberlands and a variety of other real estate properties for Pacific Lumber's review and approval. There have been ongoing discussions between the Pacific Lumber Parties and the United States regarding the properties and other consideration to be furnished by the United States. Closing of the Headwaters Agreement is subject to various conditions, including (a) acquisition by the government of the Elk River Timberlands from a third party, (b) approval of an SYP and a Multi-Species HCP and issuance of a Permit, each in form and substance satisfactory to Pacific Lumber, (c) the issuance by the Internal Revenue Service and the California Franchise Tax Board of closing agreements in form and substance sought by and satisfactory to the Pacific Lumber Parties, (d) the absence of a judicial decision in any litigation brought by third parties that any party reasonably believes will significantly delay or impair the transactions described in the Headwaters Agreement, and (e) the dismissal with prejudice at closing of the Takings Litigation. The parties to the Headwaters Agreement are working to satisfy these conditions; however, there can be no assurance that the Headwaters Agreement will be consummated. 10. SUPPLEMENTAL CASH FLOW AND OTHER INFORMATION
Years Ended December 31, ----------------------------------------- 1996 1995 1994 ------------- ------------- ------------- Supplemental information on non-cash investing and financing activities: Net margin borrowings (payments) for marketable securities $ -- $ (6,648) $ 5,628 Timber and timberlands acquired subject to loan from seller -- 615 910 Supplemental disclosure of cash flow information: Interest paid, net of capitalized interest $ 63,785 $ 64,907 $ 65,707 Income taxes paid (refunded) (2,900) (5,190) 1,170 Tax allocation payments to MAXXAM 188 -- 397
Investment, Interest and Other Income In February 1994, Pacific Lumber received a franchise tax refund of $7,243, the substantial portion of which represents interest, from the State of California relating to tax years 1972 through 1985. This amount is included in investment, interest and other income for the year ended December 31, 1994. Items Related to 1992 Earthquake In 1995 Pacific Lumber recorded reductions in cost of sales of $1,527 resulting from business interruption insurance reimbursements for higher operating costs and the related loss of revenues resulting from the April 1992 earthquake. Extraordinary Item Related to Litigation Settlement During 1994, MAXXAM, Pacific Lumber and others agreed to a settlement, subsequently approved by the court, of class and related individual claims brought by former stockholders of Pacific Lumber against MAXXAM, the Company, Pacific Lumber, former directors of Pacific Lumber and others concerning the Company's acquisition of Pacific Lumber. Of the $52,000 settlement, $33,000 was paid by insurance carriers of MAXXAM and Pacific Lumber, $14,800 was paid by Pacific Lumber, and the balance was paid by other defendants and through the assignment of certain claims. In 1994, the Company recorded an extraordinary loss of $14,866 related to the settlement and associated costs, including a $2,000 accrual for certain contingent claims and $4,400 of related legal fees, net of benefits for federal and state income taxes of $6,312. 11. QUARTERLY FINANCIAL INFORMATION (Unaudited) Summary quarterly financial information for the years ended December 31, 1996 and 1995 is as follows:
Three Months Ended ------------------------------------------------------- March 31 June 30 September 30 December 31 ------------- ------------- ------------- ------------- 1996: Net sales $ 59,804 $ 71,303 $ 68,473 $ 65,004 Operating income 16,417 19,010 17,184 19,422 Net income (loss) 124 3,909 (35) 1,612 1995: Net sales $ 51,968 $ 65,644 $ 63,300 $ 61,680 Operating income 12,423 21,767 18,697 20,292 Net income (loss) (3,292) 3,172 1,148 2,509
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III Not applicable. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (A) INDEX TO FINANCIAL STATEMENTS PAGE ---- 1. FINANCIAL STATEMENTS (INCLUDED UNDER ITEM 8): Report of Independent Public Accountants 25 Consolidated balance sheet at December 31, 1996 and 1995 26 Consolidated statement of operations for the years ended December 31, 1996, 1995 and 1994 27 Consolidated statement of cash flows for the years ended December 31, 1996, 1995 and 1994 28 Consolidated statement of stockholder's deficit for the years ended December 31, 1996, 1995 and 1994 29 Notes to consolidated financial statements 30 2. FINANCIAL STATEMENT SCHEDULES: Schedule I - Condensed financial information of Registrant at December 31, 1996 and 1995 and for the years ended December 31, 1996, 1995 and 1994 47 The consolidated financial statements and notes thereto of Kaiser Aluminum Corporation and The Pacific Lumber Company are incorporated herein by reference and included as Exhibits 99.1 and 99.2 hereto, respectively. All other schedules are inapplicable or the required information is included in the consolidated financial statements or the notes thereto. (B) REPORTS ON FORM 8-K There were no reports on Form 8-K during the fourth quarter of 1996. However, on March 12, 1997, the Company filed a Current Report on Form 8-K (under Item 5), dated March 11, 1997, concerning an agreement to amend the Headwaters Agreement to extend the period of time during which the closing conditions must be met to February 17, 1998. (C) EXHIBITS Reference is made to the Index of Exhibits immediately preceding the exhibits hereto (beginning on page 52), which index is incorporated herein by reference. MAXXAM GROUP INC. SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT BALANCE SHEET (UNCONSOLIDATED) (IN THOUSANDS OF DOLLARS)
December 31, --------------------------- 1996 1995 ------------- ------------- ASSETS Current assets: Cash and cash equivalents $ 45,611 $ 21,862 Marketable securities 31,423 36,568 Other current assets 102 2,867 ------------- ------------- Total current assets 77,136 61,297 Investments in and advances from subsidiaries -- 141 Deferred income taxes 21,947 17,671 Deferred financing costs and other assets 4,260 4,905 ------------- ------------- $ 103,343 $ 84,014 ============= ============= LIABILITIES AND STOCKHOLDER'S DEFICIT Current liabilities: Accounts payable and other accrued liabilities $ 866 $ 573 Accrued interest 4,688 4,688 ------------- ------------- Total current liabilities 5,554 5,261 Long-term debt 204,173 192,498 Advances from and investments in subsidiaries 5,351 -- Other liabilities 300 -- ------------- ------------- Total liabilities 215,378 197,759 ------------- ------------- Stockholder's deficit: Common stock, $.08-1/3 par value; 1,000 shares authorized; 100 shares issued -- -- Additional capital 81,287 81,287 Accumulated deficit (193,322) (195,032) ------------- ------------- Total stockholder's deficit (112,035) (113,745) ------------- ------------- $ 103,343 $ 84,014 ============= ============= See notes to consolidated financial statements and accompanying notes.
MAXXAM GROUP INC. SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENT OF OPERATIONS (UNCONSOLIDATED) (IN THOUSANDS OF DOLLARS)
Years Ended December 31, ----------------------------------------- 1996 1995 1994 ------------- ------------- ------------- Investment, interest and other income (expense) $ 1,961 $ 1,341 $ (2,159) Interest expense (23,573) (22,341) (21,180) General and administrative expenses (826) (370) (598) Equity in earnings of subsidiaries 16,514 16,170 18,790 ------------- ------------- ------------- Loss before income taxes (5,924) (5,200) (5,147) Credit in lieu of income taxes 11,534 8,737 8,716 ------------- ------------- ------------- Net income $ 5,610 $ 3,537 $ 3,569 ============= ============= ============= See notes to consolidated financial statements and accompanying notes.
MAXXAM GROUP INC. SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENT OF CASH FLOWS (UNCONSOLIDATED) (IN THOUSANDS OF DOLLARS)
Years Ended December 31, ----------------------------------------- 1996 1995 1994 ------------- ------------- ------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 5,610 $ 3,537 $ 3,569 Adjustments to reconcile net income to net cash used for operating activities: Amortization of deferred financing costs and discounts on long-term debt 12,320 11,059 9,930 Equity in earnings of subsidiaries (16,514) (16,170) (18,790) Net sales (purchases) of marketable securities 10,246 (20,011) (1,808) Net gains on marketable securities (5,101) (3,697) (731) Increase (decrease) in cash resulting from changes in: Receivables (3,505) 171 90 Accrued and deferred income taxes (1,519) (5,237) (8,518) Accrued interest and other liabilities 4,104 330 (911) Accounts payable -- -- (53) Other -- (16) 232 ------------- ------------- ------------- Net cash provided by (used for) operating activities 5,641 (30,034) (16,990) ------------- ------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES: Net advances from subsidiaries 22,008 33,112 41,112 ------------- ------------- ------------- Net cash provided by investing activities 22,008 33,112 41,112 ------------- ------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES: Redemptions of long-term debt -- (630) -- Dividends paid (3,900) (4,800) -- ------------- ------------- ------------- Net cash used for financing activities (3,900) (5,430) -- ------------- ------------- ------------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 23,749 (2,352) 24,122 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 21,862 24,214 92 ------------- ------------- ------------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 45,611 $ 21,862 $ 24,214 ============= ============= ============= See notes to consolidated financial statements and accompanying notes.
MAXXAM GROUP INC. SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT NOTES TO FINANCIAL STATEMENTS A. DEFERRED INCOME TAXES The deferred income tax assets and liabilities reported in the accompanying unconsolidated balance sheet are determined by computing such amounts on a consolidated basis, as if MGI files a consolidated tax return with all of its subsidiaries except Salmon Creek, and that such corporations were never connected with MAXXAM, and then reducing such consolidated amounts by the amounts recorded by the Company's subsidiaries, but excluding Salmon Creek, pursuant to their respective tax allocation agreements with MAXXAM. The Company's net deferred income tax assets relate primarily to loss and credit carryforwards and to the excess of the tax basis over financial statement basis with respect to timber and timberlands. The Company has concluded that it is more likely than not that these net deferred income tax assets will be realized based in part upon the estimated values of the underlying assets which are in excess of their tax basis. B. LONG-TERM DEBT The MGI Notes are secured by the Company's pledge of 100% of the common stock of Pacific Lumber, Britt and MPI and by MGHI's pledge of 27,938,250 shares of Kaiser's common stock. Long-term debt consists of the following:
December 31, --------------------------- 1996 1995 ------------- ------------- 11-1/4% MGI Senior Secured Notes due August 1, 2003 $ 100,000 $ 100,000 12-1/4% MGI Senior Secured Discount Notes due 104,173 92,498 August 1, 2003, net of discount ------------- ------------- $ 204,173 $ 192,498 ============= =============
C. SUPPLEMENTAL CASH FLOW INFORMATION
Years Ended December 31, ----------------------------------------- 1996 1995 1994 ------------- ------------- ------------- Supplemental information on non-cash investing and financing activities: Net margin borrowings (payments) for marketable securities $ -- $ (6,648) $ 5,628 Supplemental disclosure of cash flow information: Interest paid $ 11,253 $ 11,250 $ 11,156 Tax allocation refunds from MAXXAM 7,127 3,500 198 Income taxes refunded 3,121 -- --
SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. MAXXAM GROUP INC. Date: March 28, 1997 By: /S/ PAUL N. SCHWARTZ Paul N. Schwartz Vice President, Chief Financial Officer and Director Date: March 28, 1997 By: /S/ GARY L. CLARK Gary L. Clark Vice President Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Date: March 28, 1997 By: /S/ CHARLES E. HURWITZ Charles E. Hurwitz Chairman of the Board, President and Chief Executive Officer and Director Date: March 28, 1997 By: /S/ PAUL N. SCHWARTZ Paul N. Schwartz Vice President, Chief Financial Officer and Director (Principal Financial Officer) Date: March 28, 1997 By: /S/ JOHN A. CAMPBELL John A. Campbell Vice President and Director Date: March 28, 1997 By: /S/ JOHN T. LA DUC John T. La Duc Vice President and Director Date: March 28, 1997 By: /S/ ANTHONY R. PIERNO Anthony R. Pierno Vice President, General Counsel and Director Date: March 28, 1997 By: /S/ WILLIAM S. RIEGEL William S. Riegel Vice President and Director Date: March 28, 1997 By: /S/ GARY L. CLARK Gary L. Clark Vice President (Principal Accounting Officer) MAXXAM GROUP INC INDEX OF EXHIBITS Exhibit Number Description -------- ---------------------------------------------------- 3.1 Certificate of Incorporation of MAXXAM Group Inc. (the "Company" or "MGI") (incorporated herein by reference to Exhibit 3.1E to the Company's definitive proxy statement dated October 24, 1984) 3.2 Certificate of Amendment of Certificate of Incorporation of the Company dated as of September 28, 1988 (incorporated herein by reference to Exhibit 3(b) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1988) 3.3 Certificate of Amendment of Certificate of Incorporation of the Company dated as of June 1, 1989 (incorporated herein by reference to Exhibit 3(c) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989) 3.4 By-laws of the Company (incorporated herein by reference to Exhibit 3.2 to the Company's Current Report on Form 8-K dated July 10, 1986) 4.1 Indenture between the Company and Shawmut Bank, N.A., Trustee, regarding the Company's 12-3/4% Senior Secured Discount Notes due 2003 and 11-1/4% Senior Secured Notes due 2003 (incorporated herein by reference to Exhibit 4.1 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993) 4.2 Indenture between The Pacific Lumber Company ("Pacific Lumber") and State Street Bank and Trust Company (as successor trustee to the First National Bank of Boston) ("State Street"), regarding Pacific Lumber's 10-1/2% Senior Notes due 2003 (incorporated herein by reference to Exhibit 4.1 to the Annual Report on Form 10-K of Pacific Lumber for the fiscal year ended December 31, 1993, File No. 1-9204) 4.3 Indenture between Scotia Pacific Holding Company ("Scotia Pacific") and State Street, as Trustee, regarding Scotia Pacific's 7.95% Timber Collateralized Notes due 2015 (incorporated herein by reference to Exhibit 4.1 to Scotia Pacific's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, File No. 55538; the "Scotia Pacific 1993 Form 10-K") 4.4 Deed of Trust, Security Agreement, Financing Statement, Fixture Filing and Assignment among Scotia Pacific, State Street, as Trustee, and State Street, as Collateral Agent (incorporated herein by reference to Exhibit 4.2 to the Scotia Pacific 1993 Form 10-K) 4.5 Amended and Restated Credit Agreement dated as of November 10, 1995 between Pacific Lumber and Bank of America National Trust and Savings Association (the "Pacific Lumber Credit Agreement;" incorporated herein by reference to Exhibit 4.1 to the Quarterly Report on Form 10-Q of Pacific Lumber for the quarter ended September 30, 1995; File No. 1-9204) 4.6 First Amendment, dated February 10, 1997, to the Pacific Lumber Credit Agreement (incorporated herein by reference to Exhibit 4.4 to the Annual Report on Form 10-K of The Pacific Lumber Company for the fiscal year ended December 31, 1996; File No. 1- 9204) 4.7 Form of Deed of Trust, Assignment of Rents, Grant of Easement and Fixture Filing (incorporated herein by reference to Exhibit 4.2 to the Quarterly Report on Form 10-Q of Pacific Lumber for the quarter ended September 30, 1995; File No. 1-9204) Note: Pursuant to Regulation Section 229.601, Item 601 (b)(4)(iii) of Regulation S-K, upon request of the Securities and Exchange Commission, the Company hereby agrees to furnish a copy of any unfiled instrument which defines the rights of holders of long-term debt of the Company and its consolidated subsidiaries (and for any of its unconsolidated subsidiaries for which financial statements are required to be filed) wherein the total amount of securities authorized thereunder does not exceed 10 percent of the total consolidated assets of the Company 10.1 Tax Allocation Agreement between the Company and MAXXAM Inc. dated August 4, 1993 (incorporated herein by reference to Exhibit 10.6 to the Amendment No. 3 to the Registration Statement on Form S-2 of the Company, Registration No. 33-64042; the "MGI Registration Statement") 10.2 Tax Allocation Agreement dated as of May 21, 1988 among MAXXAM Inc., the Company, Pacific Lumber and the corporations signatory thereto (incorporated herein by reference to Exhibit 10.8 to Pacific Lumber's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, File No. 1-9204) 10.3 Tax Allocation Agreement among Pacific Lumber, Scotia Pacific, Salmon Creek Corporation and MAXXAM Inc. dated March 23, 1993 (incorporated herein by reference to Exhibit 10.1 to Amendment No. 3 to the Form S-1 Registration Statement of Scotia Pacific, Registration No. 33-55538) 10.4 Tax Allocation Agreement between MAXXAM Inc. and Britt Lumber Co., Inc., dated as of July 3, 1990 (incorporated herein by reference to Exhibit 10.4 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993) 10.5 Agreement dated December 20, 1985 between Pacific Lumber and General Electric Company (incorporated herein by reference to Exhibit 10(m) to Pacific Lumber's Registration Statement on Form S-1, Registration No. 33-5549; the "1985 GE Agreement") 10.6 Amendment No. 1 to Agreement between Pacific Lumber and General Electric Company dated July 29, 1986 relating to the 1985 GE Agreement (incorporated herein by reference to Exhibit 10.4 to Pacific Lumber's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, File No. 1-9204) 10.7 Power Purchase Agreement dated January 17, 1986 between Pacific Lumber and Pacific Gas and Electric Company (incorporated herein by reference to Exhibit 10(n) to Pacific Lumber's Registration Statement on Form S-1, Registration No. 33-5549) 10.8 Master Purchase Agreement between Pacific Lumber and Scotia Pacific (incorporated herein by reference to Exhibit 10.1 to the Scotia Pacific 1993 Form 10-K) 10.9 Services Agreement between Pacific Lumber and Scotia Pacific (incorporated herein by reference to Exhibit 10.2 to the Scotia Pacific 1993 Form 10-K) 10.10 Additional Services Agreement between Pacific Lumber and Scotia Pacific (incorporated herein by reference to Exhibit 10.3 to the Scotia Pacific 1993 Form 10-K) 10.11 Reciprocal Rights Agreement among Pacific Lumber, Scotia Pacific and Salmon Creek Corporation (incorporated herein by reference to Exhibit 10.4 to the Scotia Pacific 1993 Form 10-K) 10.12 Environmental Indemnification Agreement between Pacific Lumber and Scotia Pacific (incorporated herein by reference to Exhibit 10.5 to the Scotia Pacific 1993 Form 10-K) 10.13 Purchase and Services Agreement between Pacific Lumber and Britt Lumber Co., Inc. (incorporated herein by reference to Exhibit 10.17 to Amendment No. 2 to the Form S-2 Registration Statement of Pacific Lumber; Registration Statement No. 33-56332) 10.14 Put and Call Agreement dated November 16, 1987 between Charles E. Hurwitz and MPI (incorporated herein by reference to Exhibit C to Schedule 13D dated November 24, 1987, filed by the Company with respect to MAXXAM Inc.'s common stock; the "Put and Call Agreement") 10.15 Amendment to Put and Call Agreement, dated May 18, 1988 (incorporated herein by reference to Exhibit D to the Final Amendment to Schedule 13D dated May 20, 1988, filed by the Company relating to MAXXAM Inc.'s common stock) 10.16 Amendment to Put and Call Agreement, dated as of February 17, 1989 (incorporated herein by reference to Exhibit 10.35 to MAXXAM Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1988, File No. 1-3924) 10.22 Investment Management Agreement, dated as of December 1, 1991, by and among the Company, MAXXAM Inc. and certain related corporations (incorporated herein by reference to Exhibit 10.23 to Amendment No. 5 to the MGI Registration) 10.23 Undertaking, dated August 4, 1993, executed by MAXXAM in favor of the Company (incorporated herein by reference to Exhibit 10.24 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994) 10.24 Agreement dated September 28, 1996 among MAXXAM Inc., The Pacific Lumber Company (on behalf of itself, its subsidiaries and its affiliates), the United States of America and the State of California (incorporated herein by reference to Exhibit 10.1 to MAXXAM Inc.'s Form 8-K dated September 28, 1996; File No. 1-3924) *27 Financial Data Schedule *99.1 The consolidated financial statements and notes thereto of Kaiser Aluminum Corporation for the fiscal year ended December 31, 1996 *99.2 The consolidated financial statements and notes thereto of The Pacific Lumber Company for the fiscal year ended December 31, 1996 - --------------- * Included with this filing. EX-27 2
5 This schedule contains summary financial information extracted from the Company's consolidated balance sheet and consolidated statement of operations and is qualified in its entirety by reference to such consolidated financial statements together with the related footnotes thereto. 1,000 U.S. DOLLARS 12-MOS DEC-31-1996 JAN-01-1996 DEC-31-1996 1 72,418 31,423 18,850 0 69,307 200,014 178,782 76,753 742,747 68,626 776,027 0 0 0 (112,035) 742,747 264,584 264,584 148,522 148,522 44,029 0 78,045 4,930 (680) 5,610 0 0 0 5,610 0 0
EX-99 3 EXHIBIT 99.1 20 KAISER ALUMINUM CORPORATION 1996 ANNUAL REPORT Report of Independent Public Accountants To the Stockholders and the Board of Directors of Kaiser Aluminum Corporation: We have audited the accompanying consolidated balance sheets of Kaiser Aluminum Corporation (a Delaware corporation) and subsidiaries as of December 31, 1996 and 1995, and the related statements of consolidated income (loss) and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Kaiser Aluminum Corporation and subsidiaries as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Houston, Texas February 14, 1997 KAISER ALUMINUM CORPORATION 1996 ANNUAL REPORT 21 Kaiser Aluminum Corporation and Subsidiary Companies Consolidated Balance Sheets
December 31, --------------------- (In millions of dollars, except share amounts) 1996 1995 - ------------------------------------------------------------------------------------------------------ ASSETS Current assets: Cash and cash equivalents $ 81.3 $ 21.9 Receivables: Trade, less allowance for doubtful receivables of $4.7 in 1996 and $5.0 in 1995 177.9 222.9 Other 74.5 85.7 Inventories 562.2 525.7 Prepaid expenses and other current assets 127.8 76.6 -------- -------- Total current assets 1,023.7 932.8 Investments in and advances to unconsolidated affiliates 168.4 178.2 Property, plant, and equipment-net 1,168.7 1,109.6 Deferred income taxes 264.5 269.1 Other assets 308.7 323.5 -------- -------- Total $2,934.0 $2,813.2 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 189.7 $ 184.5 Accrued interest 35.6 32.0 Accrued salaries, wages, and related expenses 95.4 105.3 Accrued postretirement medical benefit obligation-current portion 50.1 46.8 Other accrued liabilities 132.7 129.4 Payable to affiliates 97.0 94.2 Long-term debt-current portion 8.9 8.9 -------- -------- Total current liabilities 609.4 601.1 Long-term liabilities 458.1 548.5 Accrued postretirement medical benefit obligation 722.5 734.0 Long-term debt 953.0 749.2 Minority interests 121.7 122.7 Commitments and contingencies Stockholders' equity: Preferred stock, par value $.05, authorized 20,000,000 shares; PRIDES Convertible, par value $.05, issued and outstanding, 8,673,850 in 1996 and 1995 .4 .4 Common stock, par value $.01, authorized 100,000,000 shares; issued and outstanding, 71,646,789 and 71,638,514 in 1996 and 1995 .7 .7 Additional capital 531.1 530.3 Accumulated deficit (460.1) (459.9) Additional minimum pension liability (2.8) (13.8) -------- -------- Total stockholders' equity 69.3 57.7 -------- -------- Total $2,934.0 $2,813.2 ======== ========
The accompanying notes to consolidated financial statements are an integral part of these statements. 22 KAISER ALUMINUM CORPORATION 1996 ANNUAL REPORT Statements of Consolidated Income (Loss)
Year Ended December 31, --------------------------------- (In millions of dollars, except share amounts) 1996 1995 1994 - ------------------------------------------------------------------------------------------------------------------ Net sales $2,190.5 $2,237.8 $1,781.5 -------- -------- -------- Costs and expenses: Cost of products sold 1,869.1 1,798.4 1,625.5 Depreciation 96.0 94.3 95.4 Selling, administrative, research and development, and general 127.6 134.5 116.8 -------- -------- -------- Total costs and expenses 2,092.7 2,027.2 1,837.7 -------- -------- -------- Operating income (loss): 97.8 210.6 (56.2) Other income (expense): Interest expense (93.4) (93.9) (88.6) Other-net (2.7) (14.1) (7.3) -------- -------- -------- Income (loss) before income taxes, minority interests and extraordinary loss 1.7 102.6 (152.1) Credit (provision) for income taxes 9.3 (37.2) 53.8 Minority interests (2.8) (5.1) (3.1) -------- -------- -------- Income (loss) before extraordinary loss 8.2 60.3 (101.4) Extraordinary loss on early extinguishment of debt, net of tax benefit of $2.9 (5.4) -------- -------- -------- Net income (loss) 8.2 60.3 (106.8) Dividends on preferred stock (8.4) (17.6) (20.1) -------- -------- -------- Net income (loss) available to common shareholders $ (0.2) $ 42.7 $ (126.9) ======== ======== ======== Earnings (loss) per common and common equivalent share: Primary: Income (loss) before extraordinary loss $ .00 $ .69 $ (2.09) Extraordinary loss (.09) -------- -------- -------- Net income (loss) $ .00 $ .69 $ (2.18) ======== ======== ======== Fully diluted $ .72 ======== Weighted average common and common equivalent shares outstanding (000): Primary 71,644 62,264 58,139 ======== ======== ======== Fully diluted 71,809 ========
The accompanying notes to consolidated financial statements are an integral part of these statements. KAISER ALUMINUM CORPORATION 1996 ANNUAL REPORT 23 Kaiser Aluminum Corporation and Subsidiary Companies Statements of Consolidated Cash Flows
Year Ended December 31, --------------------------------- (In millions of dollars) 1996 1995 1994 - ------------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: Net income (loss) $ 8.2 $ 60.3 $ (106.8) Adjustments to reconcile net income (loss) to net cash provided by (used for) operating activities: Depreciation 96.0 94.3 95.4 Amortization of excess investment over equity in unconsolidated affiliates 11.6 11.4 11.6 Amortization of deferred financing costs and net discount on long-term debt 5.6 5.4 6.2 Undistributed equity in (income) losses of unconsolidated affiliates 3.0 (19.2) 1.9 Minority interests 2.8 5.1 3.1 Decrease (increase) in receivables 51.8 (109.7) 36.4 Increase in inventories (36.5) (57.7) (41.1) (Increase) decrease in prepaid expenses and other assets (39.5) 82.9 (60.6) Increase in accounts payable 5.2 32.4 25.8 Increase (decrease) in accrued interest 3.6 (.6) 9.3 (Decrease) increase in payable to affiliates and accrued liabilities (62.9) 10.6 50.8 Decrease in accrued and deferred income taxes (36.5) (7.4) (68.8) Other 9.5 10.9 14.7 -------- -------- -------- Net cash provided by (used for) operating activities 21.9 118.7 (22.1) -------- -------- -------- Cash flows from investing activities: Additions to property, plant, and equipment (160.3) (79.4) (70.0) Investments in unconsolidated affiliates (1.2) (9.0) Other 17.2 8.6 4.1 -------- -------- -------- Net cash used for investing activities (144.3) (79.8) (65.9) -------- -------- -------- Cash flows from financing activities: Borrowings (repayments) under revolving credit facility, net (13.1) 6.4 (181.3) Borrowings of long-term debt 225.9 223.6 Repayments of long-term debt (9.0) (11.8) (9.0) Incurrence of financing costs (6.2) (.8) (19.2) Dividends paid (10.5) (20.8) (14.8) Capital stock issued 1.2 100.1 Redemption of minority interests' preference stock (5.3) (8.8) (8.5) -------- -------- -------- Net cash provided by (used for) financing activities 181.8 (34.6) 90.9 -------- -------- -------- Net increase in cash and cash equivalents during the year 59.4 4.3 2.9 Cash and cash equivalents at beginning of year 21.9 17.6 14.7 -------- -------- -------- Cash and cash equivalents at end of year $ 81.3 $ 21.9 $ 17.6 ======== ======== ======== Supplemental disclosure of cash flow information: Interest paid, net of capitalized interest $ 84.2 $ 88.8 $ 73.1 Income taxes paid 22.7 35.7 16.0 Tax allocation payments to (from) MAXXAM Inc. 1.1 (3.9)
The accompanying notes to consolidated financial statements are an integral part of these statements. 24 KAISER ALUMINUM CORPORATION 1996 ANNUAL REPORT Notes to Consolidated Financial Statements (In millions of dollars, except share amounts) - -------------------------------------------------------------------------------- 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the statements of Kaiser Aluminum Corporation ("Kaiser" or the "Company") and its majority owned subsidiaries. The Company is a subsidiary of MAXXAM Inc. ("MAXXAM") and conducts its operations through its wholly owned subsidiary, Kaiser Aluminum & Chemical Corporation ("KACC"). KACC operates in all principal aspects of the aluminum industry--the mining of bauxite (the major aluminum-bearing ore), the refining of bauxite into alumina (the intermediate material), the production of primary aluminum, and the manufacture of fabricated and semi- fabricated aluminum products. Kaiser's production levels of alumina and primary aluminum exceed its internal processing needs, which allows it to be a major seller of alumina and primary aluminum to domestic and international third parties (see Note 10). The preparation of financial statements in accordance with generally accepted accounting principles requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities known to exist as of the date the financial statements are published, and the reported amounts of revenues and expenses during the reporting period. Uncertainties, with respect to such estimates and assumptions, are inherent in the preparation of the Company's consolidated financial statements; accordingly, it is possible that the actual results could differ from these estimates and assumptions, which could have a material effect on the reported amounts of the Company's consolidated financial position and results of operation. Investments in 50%-or-less-owned entities are accounted for primarily by the equity method. Intercompany balances and transactions are eliminated. Certain reclassifications of prior-year information were made to conform to the current presentation. CASH AND CASH EQUIVALENTS The Company considers only those short-term, highly liquid investments with original maturities of 90 days or less to be cash equivalents. INVENTORIES Substantially all product inventories are stated at last-in, first-out ("LIFO") cost, not in excess of market value. Replacement cost is not in excess of LIFO cost. Other inventories, principally operating supplies and repair and maintenance parts, are stated at the lower of average cost or market. Inventory costs consist of material, labor, and manufacturing overhead, including depreciation. Inventories consist of the following:
December 31, -------------------- 1996 1995 - ------------------------------------------------------------------------------------------------------ Finished fabricated products $ 113.5 $ 91.5 Primary aluminum and work in process 200.3 195.9 Bauxite and alumina 110.2 119.6 Operating supplies and repair and maintenance parts 138.2 118.7 ------- ------- $ 562.2 $ 525.7 ======= =======
DEPRECIATION Depreciation is computed principally by the straight-line method at rates based on the estimated useful lives of the various classes of assets. The principal estimated useful lives of land improvements, buildings, and machinery and equipment are 8 to 25 years, 15 to 45 years, and 10 to 22 years, respectively. KAISER ALUMINUM CORPORATION 1996 ANNUAL REPORT 25 Kaiser Aluminum Corporation and Subsidiary Companies Notes to Consolidated Financial Statements (continued) (In millions of dollars, except share amounts) - -------------------------------------------------------------------------------- STOCK-BASED COMPENSATION The Company applies the intrinsic value method to account for a stock-based compensation plan whereby compensation cost is recognized only to the extent that the quoted market price of the stock at the measurement date exceeds the amount an employee must pay to acquire the stock. No compensation cost has been recognized for this plan as no stock options were granted in 1996 or 1995 and as the stock options granted in 1994 were at the market price (see Note 6). OTHER INCOME (EXPENSE) Other expense in 1996, 1995, and 1994 includes $3.1, $17.8, and $16.5 of pre-tax charges related principally to establishing additional: (i) litigation reserves for asbestos claims, net of estimated aggregate insurance recoveries, and (ii) environmental reserves for potential soil and ground water remediation matters, each pertaining to operations which were discontinued prior to the acquisition of the Company by MAXXAM in 1988. DEFERRED FINANCING COSTS Costs incurred to obtain debt financing are deferred and amortized over the estimated term of the related borrowing. Such amortization is included in interest expense. FOREIGN CURRENCY The Company uses the United States dollar as the functional currency for its foreign operations. DERIVATIVE FINANCIAL INSTRUMENTS Hedging transactions using derivative financial instruments are primarily designed to mitigate KACC's exposure to changes in prices for certain of the products which KACC sells and consumes and, to a lesser extent, to mitigate KACC's exposure to changes in foreign currency exchange rates. KACC does not utilize derivative financial instruments for trading or other speculative purposes. KACC's derivative activities are initiated within guidelines established by management and approved by KACC's and the Company's boards of directors. Hedging transactions are executed centrally on behalf of all of KACC's business segments to minimize transactions costs, monitor consolidated net exposures and allow for increased responsiveness to changes in market factors. Most of KACC's hedging activities involve the use of option contracts (which establish a maximum and/or minimum amount to be paid or received) and forward sales contracts (which effectively fix or lock-in the amount KACC will pay or receive). Option contracts typically require the payment of an up-front premium in return for the right to receive the amount (if any) by which the price at the settlement date exceeds the strike price. Any interim fluctuations in prices prior to the settlement date are deferred until the settlement date of the underlying hedged transaction, at which point they are reflected in net sales or cost of sales (as applicable) together with the related premium cost. Forward sales contracts do not require an up-front payment and are settled by the receipt or payment of the amount by which the price at the settlement date varies from the contract price. No accounting recognition is accorded to interim fluctuations in prices of forward sales contracts. KACC has established margin accounts and credit limits with certain counterparties related to open forward sales and option contracts. When unrealized gains or losses are in excess of such credit limits, KACC is entitled to receive advances from the counterparties on open positions or is required to make margin deposits to counterparties, as the case may be. At December 31, 1996, KACC had received $13.0 of margin advances from counterparties. At December 31, 1995, KACC had neither received nor made any margin deposits. Management considers credit risk related to possible failure of the counterparties to perform their obligations pursuant to the derivative contracts to be minimal. 26 KAISER ALUMINUM CORPORATION 1996 ANNUAL REPORT (In millions of dollars, except share amounts) - -------------------------------------------------------------------------------- Deferred gains or losses as of December 31, 1996, are included in Prepaid expenses and other current assets and Other accrued liabilities (See Note 9). FAIR VALUE OF FINANCIAL INSTRUMENTS The Company estimates the fair value of its outstanding indebtedness to be $1,006.9 and $806.3 at December 31, 1996, and 1995, respectively, based on quoted market prices for KACC's 97/8% Senior Notes due 2002 (the "97/8% Notes") and 123/4% Senior Subordinated Notes due 2003 (the "123/4% Notes"), the issuance price of the 107/8% Notes (as defined in Note 4), and the discounted future cash flows for all other indebtedness, using the current rate for debt of similar maturities and terms. The Company believes that the carrying amount of other financial instruments is a reasonable estimate of their fair value, unless otherwise noted. EARNINGS (LOSS) PER COMMON AND COMMON EQUIVALENT SHARE Primary--Earnings (loss) per common and common equivalent share are computed by deducting preferred stock dividends from net income (loss) in order to determine net income (loss) available to common shareholders. This amount is then divided by the weighted average number of common and common equivalent shares outstanding during the period. The weighted average number of common and common equivalent shares outstanding for the year ended December 31, 1996, excludes the impact of outstanding stock options since they were antidilutive. The impact of outstanding stock options on weighted average number of common and common equivalent shares on the other periods presented was immaterial. Fully Diluted--The Company's 8.255% PRIDES, Convertible Preferred Stock ("PRIDES") were excluded from the calculation of the weighted average number of common and common equivalent shares outstanding for all periods presented because they were antidilutive. For the year ended December 31, 1995, dividends of $9.2 attributable to the Company's Mandatory Conversion Premium Dividend Preferred Stock (the "Series A Shares") which were exchanged for approximately 13.1 million shares of the Company's Common Stock and certain cash payments on September 19, 1995, have not been deducted from net income and the weighted average number of common and common equivalent shares outstanding have been adjusted to reflect the shares of common stock issued in the exchange as if they had been outstanding for the entire period. As a result of the conversion of the Series A Shares, fully diluted earnings per share for the 1995 periods are presented even though the results are antidilutive. 2. INVESTMENTS IN AND ADVANCES TO UNCONSOLIDATED AFFILIATES Summary combined financial information is provided below for unconsolidated aluminum investments, most of which supply and process raw materials. The investees are Queensland Alumina Limited ("QAL") (28.3% owned), Anglesey Aluminium Limited ("Anglesey") (49.0% owned), and Kaiser Jamaica Bauxite Company (49.0% owned). The equity in earnings (losses) before income taxes of such operations is treated as a reduction (increase) in cost of products sold. At December 31, 1996 and 1995, KACC's net receivables from these affiliates were not material. KAISER ALUMINUM CORPORATION 1996 ANNUAL REPORT 27 Kaiser Aluminum Corporation and Subsidiary Companies Notes to Consolidated Financial Statements (continued) (In millions of dollars, except share amounts) - -------------------------------------------------------------------------------- SUMMARY OF COMBINED FINANCIAL POSITION
December 31, ------------------- 1996 1995 - ------------------------------------------------------------------------------------------------------------------ Current assets $ 450.3 $ 429.0 Long-term assets (primarily property, plant, and equipment, net) 364.7 370.1 ------- ------- Total assets $ 815.0 $ 799.1 ======= ======= Current liabilities $ 116.9 $ 125.4 Long-term liabilities (primarily long-term debt) 386.7 367.4 Stockholders' equity 311.4 306.3 ------- ------- Total liabilities and stockholders' equity $ 815.0 $ 799.1 ======= =======
SUMMARY OF COMBINED OPERATIONS
Year Ended December 31, -------------------------------- 1996 1995 1994 - ------------------------------------------------------------------------------------------------------------------ Net sales $ 660.5 $ 685.9 $ 489.8 Costs and expenses (631.5) (618.7) (494.8) Provision for income taxes (8.7) (18.7) (6.3) ------- ------- ------- Net income (loss) $ 20.3 $ 48.5 $ (11.3) ======= ======= ======= Company's equity in income (loss) $ 8.8 $ 19.2 $ (1.9) ======= ======= ======= Dividends received $ 11.8 =======
The Company's equity in income (loss) differs from the summary net income (loss) due to various percentage ownerships in the entities and equity method accounting adjustments. At December 31, 1996, KACC's investment in its unconsolidated affiliates exceeded its equity in their net assets by approximately $42.0 which amount will be fully amortized over the next four years. The Company and its affiliates have interrelated operations. KACC provides some of its affiliates with services such as financing, management, and engineering. Significant activities with affiliates include the acquisition and processing of bauxite, alumina, and primary aluminum. Purchases from these affiliates were $281.6, $284.4, and $219.7 in the years ended December 31, 1996, 1995, and 1994, respectively. 3. PROPERTY, PLANT, AND EQUIPMENT The major classes of property, plant, and equipment are as follows:
December 31, --------------------- 1996 1995 - ------------------------------------------------------------------------------------------------------ Land and improvements $ 157.5 $ 151.8 Buildings 216.0 198.5 Machinery and equipment 1,441.1 1,337.6 Construction in progress 84.7 59.6 -------- -------- 1,899.3 1,747.5 Accumulated depreciation 730.6 637.9 -------- -------- Property, plant, and equipment, net $1,168.7 $1,109.6 ======== ========
28 KAISER ALUMINUM CORPORATION 1996 ANNUAL REPORT (In millions of dollars, except share amounts) - -------------------------------------------------------------------------------- 4. LONG-TERM DEBT Long-term debt and its maturity schedule are as follows:
December 31, 2002 ---------------- and 1996 1995 1997 1998 1999 2000 2001 After Total Total - ---------------------------------------------------------------------------------------------------------------------- Credit Agreement $ 13.1 9-7/8% Senior Notes due 2002, net $224.0 $224.0 223.8 10-7/8% Senior Notes due 2006, net 225.9 225.9 Alpart CARIFA Loan - Series A, due 2008 (variable rates) 38.0 38.0 38.0 Alpart CARIFA Loan - Series B, due 2007 (8.25%) 22.0 22.0 22.0 12-3/4% Senior Subordinated Notes due 2003 400.0 400.0 400.0 Other borrowings (fixed and variable rates) $ 8.9 $ 9.1 $ .4 $ .4 $ .4 32.8 52.0 61.2 ------ ------ ------ ------ ------ ------ ------ ------ Total $ 8.9 $ 9.1 $ .4 $ .4 $ .4 $942.7 961.9 758.1 ====== ====== ====== ====== ====== ====== Less current portion 8.9 8.9 ------ ------ Long-term debt $953.0 $749.2 ====== ======
CREDIT AGREEMENT In February 1994, the Company and KACC entered into a credit agreement (as amended, the "Credit Agreement") which provides a $325.0 five-year secured, revolving line of credit. KACC is able to borrow under the facility by means of revolving credit advances and letters of credit (up to $125.0) in an aggregate amount equal to the lesser of $325.0 or a borrowing base relating to eligible accounts receivable plus eligible inventory. As of December 31, 1996, $269.7 (of which $71.9 could have been used for letters of credit) was available to KACC under the Credit Agreement. The Credit Agreement is unconditionally guaranteed by the Company and by certain significant subsidiaries of KACC. Interest on outstanding balances will bear a premium (which varies based on the results of a financial test) over either a base rate or LIBOR at the Company's option. 1996 ISSUANCES During the fourth quarter of 1996, KACC sold a total of $225.0 principal amount of two separate series of 10 7/8% Senior Notes due 2006 (the "10 7/8% Notes") in separate transactions. A net premium of $.9 was realized from the issuance of the 10 7/8% Notes. The 10 7/8% Notes rank pari passu in right and priority of payment with the indebtedness under the Credit Agreement and the 9 7/8% Notes and are guaranteed on a senior, unsecured basis by certain of KACC's subsidiaries. LOAN COVENANTS AND RESTRICTIONS The Credit Agreement requires KACC to comply with certain financial covenants and places restrictions on the Company's and KACC's ability to, among other things, incur debt and liens, make investments, pay dividends, undertake transactions with affiliates, make capital expenditures, and enter into unrelated lines of business. The Credit Agreement is secured by, among other things, (i) mortgages on KACC's major domestic plants (excluding KACC's Gramercy alumina plant and Nevada Micromill); (ii) subject to certain exceptions, liens on the accounts receivable, inventory, equipment, domestic patents and trademarks, and substantially all other personal property of KACC and certain of its subsidiaries; (iii) a pledge of all the stock of KACC owned by Kaiser; and (iv) pledges of all of the stock of a number of KACC's wholly owned domestic subsidiaries, pledges of a portion of the stock of certain foreign subsidiaries, and pledges of a portion of the stock of certain partially owned foreign affiliates. KAISER ALUMINUM CORPORATION 1996 ANNUAL REPORT 29 Kaiser Aluminum Corporation and Subsidiary Companies Notes to Consolidated Financial Statements (continued) (In millions of dollars, except share amounts) - -------------------------------------------------------------------------------- The obligations of KACC with respect to its 9 7/8% Notes, its 10 7/8% Notes and its 12 3/4% Notes are guaranteed, jointly and severally, by certain subsidiaries of KACC. The indentures governing the 9 7/8% Notes, the 10 7/8% Notes and the 12 3/4% Notes (collectively, the "Indentures") restrict, among other things, KACC's ability, to incur debt, undertake transactions with affiliates, and pay dividends. Further, the Indentures provide that KACC must offer to purchase the 9 7/8% Notes, the 10 7/8% Notes and the 12 3/4% Notes, respectively, upon the occurrence of a Change of Control (as defined therein), and the Credit Agreement provides that the occurrence of a Change in Control (as defined therein) shall constitute an Event of Default thereunder. Under the most restrictive of the covenants in the Indentures and the Credit Agreement, neither the Company nor KACC currently is permitted to pay dividends on its common stock. In December 1991, Alpart entered into a loan agreement with the Caribbean Basin Projects Financing Authority ("CARIFA"). Pursuant to the loan agreement, Alpart must remain a qualified recipient for Caribbean Basin Initiative funds as defined in applicable laws. Alpart has also agreed to indemnify bondholders of CARIFA for certain tax payments that could result from events, as defined, that adversely affect the tax treatment of the interest income on the bonds. Alpart's obligations under the loan agreement are secured by a $64.2 letter of credit guaranteed by the partners in Alpart (of which $22.5 is guaranteed by the Company's minority partner in Alpart). RESTRICTED NET ASSETS OF SUBSIDIARIES Certain debt instruments restrict the ability of KACC to transfer assets, make loans and advances, and pay dividends to the Company. The restricted net assets of KACC totaled $56.1 and $24.0 at December 31, 1996 and 1995, respectively. CAPITALIZED INTEREST Interest capitalized in 1996, 1995, and 1994 was $4.9, $2.8, and $2.7, respectively. EXTRAORDINARY ITEM The Company recorded a pre-tax extraordinary loss of $5.4 (net of $2.9 of deferred income taxes provided at a rate which approximates the federal statutory rate) in the first quarter of 1994 when the Company entered into the Credit Agreement, as a result of the write-off of unamortized deferred financing costs related to the previous credit agreement. 5. INCOME TAXES Income (loss) before income taxes, minority interests and extraordinary loss by geographic area is as follows:
Year Ended December 31, ------------------------------- 1996 1995 1994 - ------------------------------------------------------------------------------------------------------------ Domestic $ (45.8) $ (55.9) $ (168.4) Foreign 47.5 158.5 16.3 -------- -------- -------- Total $ 1.7 $ 102.6 $ (152.1) ======== ======== ========
Income taxes are classified as either domestic or foreign, based on whether payment is made or due to the United States or a foreign country. Certain income classified as foreign is also subject to domestic income taxes. 30 KAISER ALUMINUM CORPORATION 1996 ANNUAL REPORT (In millions of dollars, except share amounts) - -------------------------------------------------------------------------------- The credit (provision) for income taxes on income (loss) before income taxes, minority interests and extraordinary loss consists of:
Federal Foreign State Total - ------------------------------------------------------------------------------------------------------------ 1996 Current $ (1.6) $(21.8) $ (.1) $(23.5) Deferred 8.6 7.6 16.6 32.8 ------ ------ ------ ------ Total $ 7.0 $(14.2) $ 16.5 $ 9.3 ====== ====== ====== ====== 1995 Current $ (4.3) $(40.2) $ (.1) $(44.6) Deferred 15.2 (4.9) (2.9) 7.4 ------ ------ ------ ------ Total $ 10.9 $(45.1) $ (3.0) $(37.2) ====== ====== ====== ====== 1994 Current $(18.0) $ (.1) $(18.1) Deferred $ 71.2 .6 .1 71.9 ------ ------ ------ ------ Total $ 71.2 $(17.4) $ .0 $ 53.8 ====== ====== ====== ======
The 1994 federal deferred credit for income taxes of $71.2 includes $29.3 for the benefit of operating loss carryforwards generated in 1994. A reconciliation between the credit (provision) for income taxes and the amount computed by applying the federal statutory income tax rate to income (loss) before income taxes, minority interest and extraordinary loss is as follows:
Year Ended December 31, ------------------------------ 1996 1995 1994 - ------------------------------------------------------------------------------------------------- Amount of federal income tax credit (provision) based on the statutory rate $ (.6) $(35.9) $53.2 Revision of prior years' tax estimates and other changes in valuation allowances 10.0 1.5 .2 Percentage depletion 3.9 4.2 5.6 Foreign taxes, net of federal tax benefit (5.5) (5.4) (5.3) Other 1.5 (1.6) .1 ------ ------ ----- Credit (provision) for income taxes $ 9.3 $(37.2) $53.8 ====== ====== =====
Included in revision of prior years' tax estimates and other changes in valuation allowances for 1996 shown above is $9.8 related to the resolution of certain income tax matters in the fourth quarter of 1996. KAISER ALUMINUM CORPORATION 1996 ANNUAL REPORT 31 Kaiser Aluminum Corporation and Subsidiary Companies Notes to Consolidated Financial Statements (continued) (In millions of dollars, except share amounts) - -------------------------------------------------------------------------------- The components of the Company's net deferred income tax assets are as follows:
December 31, --------------------- 1996 1995 - -------------------------------------------------------------------------------------- Deferred income tax assets: Postretirement benefits other than pensions $ 290.5 $ 289.9 Loss and credit carryforwards 135.1 156.1 Other liabilities 157.6 163.8 Other 86.7 66.2 Valuation allowances (127.2) (128.5) ------- ------- Total deferred income tax assets-net 542.7 547.5 ------- ------- Deferred income tax liabilities: Property, plant, and equipment (160.9) (179.8) Other (72.6) (75.9) ------- ------- Total deferred income tax liabilities (233.5) (255.7) ------- ------- Net deferred income tax assets $ 309.2 $ 291.8 ======= =======
The principal component of the Company's net deferred income tax asset is the tax benefit, net of certain valuation allowances, associated with the accrued liability for postretirement benefits other than pensions. The future tax deductions with respect to the turnaround of this accrual will occur over a 30- to 40-year period. If such deductions create or increase a net operating loss in any one year, the Company has the ability to carry forward such loss for 15 taxable years. For these reasons, the Company believes that a long-term view of profitability is appropriate and has concluded that this net deferred income tax asset will more likely than not be realized. A substantial portion of the valuation allowances provided by the Company relates to loss and credit carryforwards. To determine the proper amount of valuation allowances with respect to these carryforwards, the Company evaluated all appropriate factors, including any limitations concerning their use and the year the carryforwards expire, as well as the levels of taxable income necessary for utilization. For example, full valuation allowances were provided for certain credit carryforwards that expire in the near term. With regard to future levels of income, the Company believes, based on the cyclical nature of its business, its history of operating earnings, and its expectations for future years, that it will more likely than not generate sufficient taxable income to realize the benefit attributable to the loss and credit carryforwards for which valuation allowances were not provided. As of December 31, 1996 and 1995, $69.7 and $53.5, respectively, of the net deferred income tax assets listed above are included on the Consolidated Balance Sheets in the caption entitled Prepaid expenses and other current assets. Certain other portions of the deferred income tax liabilities listed above are included on the Consolidated Balance Sheets in the captions entitled Other accrued liabilities and Long-term liabilities. The Company and its subsidiaries file consolidated federal income tax returns. For the period from October 28, 1988 through June 30, 1993, the Company and its subsidiaries were included in the consolidated federal income tax returns of MAXXAM. Payments or refunds for periods ended prior to July 1, 1993, may still be required by or payable to the Company or KACC pursuant to their respective tax allocation agreements with MAXXAM due to the final resolution of audits, amended returns, and related matters. However, the Credit Agreement prohibits the payment by KACC to MAXXAM of any amounts due under KACC's tax allocation agreement with MAXXAM (the "KACC Tax Allocation Agreement"), except for certain payments that are required as a result of audits and only to the extent of any amounts paid after February 17, 1994, by MAXXAM to KACC under the KACC Tax 32 KAISER ALUMINUM CORPORATION 1996 ANNUAL REPORT (In millions of dollars, except share amounts) - -------------------------------------------------------------------------------- Allocation Agreement. The respective tax allocation agreements of the Company and KACC with MAXXAM terminated pursuant to their terms, effective for taxable periods beginning after June 30, 1993. The following table presents the Company's tax attributes for federal income tax purposes as of December 31, 1996. The utilization of certain of these tax attributes is subject to limitations:
Expiring Through - ------------------------------------------------------------------------------------- Regular tax attribute carryforwards: Net operating losses $ 36.0 2010 General business tax credits 23.1 2010 Foreign tax credits 68.5 2001 Alternative minimum tax credits 19.9 Indefinite Alternative minimum tax attribute carryforwards: Net operating losses $ 26.6 2010 Foreign tax credits 72.2 2001
6. EMPLOYEE BENEFIT AND INCENTIVE PLANS RETIREMENT PLANS Retirement plans are non-contributory for salaried and hourly employees and generally provide for benefits based on a formula which considers length of service and earnings during years of service. The Company's funding policies meet or exceed all regulatory requirements. The funded status of the employee pension benefit plans and the corresponding amounts that are included in the Company's Consolidated Balance Sheets are as follows:
Plans with Accumulated Benefits Exceeding Assets(1) December 31, ------------------------ 1996 1995 - ----------------------------------------------------------------------------------------- Accumulated benefit obligation: Vested employees $ 737.7 $ 753.0 Nonvested employees 38.5 28.7 ------- ------- Accumulated benefit obligation 776.2 781.7 Additional amounts related to projected salary increases 40.0 34.2 ------- ------- Projected benefit obligation 816.2 815.9 Plan assets (principally common stocks and fixed income obligations) at fair value (662.0) (592.3) ------- ------- Plan assets less than projected benefit obligation 154.2 223.6 Unrecognized net losses (13.6) (54.7) Unrecognized net obligations (.4) (.5) Unrecognized prior-service cost (26.9) (28.2) Adjustment required to recognize minimum liability 13.7 49.8 ------- ------- Accrued pension obligation included in the Consolidated Balance Sheets (principally in Long-term liabilities) $ 127.0 $ 190.0 ======= =======
(1) Includes plans with assets exceeding accumulated benefits by approximately $.3 and $.1 in 1996 and 1995, respectively. KAISER ALUMINUM CORPORATION 1996 ANNUAL REPORT 33 Kaiser Aluminum Corporation and Subsidiary Companies Notes to Consolidated Financial Statements (continued) (In millions of dollars, except share amounts) - -------------------------------------------------------------------------------- As required by Statement of Financial Accounting Standards No. 87, Employers' Accounting for Pensions, the Company recorded an after-tax credit (charge) to equity of $11.0 and $(4.7) at December 31, 1996 and 1995, respectively, for the deficit (excess) of the minimum liability over the unrecognized net obligation and prior-service cost. These amounts were recorded net of the related income tax (provision) credit of $(6.5) and $2.8 as of December 31, 1996 and 1995, respectively, which approximated the federal and state statutory rates. The components of net periodic pension cost are:
Year Ended December 31, -------------------------------- 1996 1995 1994 - ------------------------------------------------------------------------------------------------- Service cost - benefits earned during the period $ 12.9 $ 10.0 $ 11.2 Interest cost on projected benefit obligation 60.0 59.8 57.3 Return on assets: Actual gain (89.8) (112.2) (.8) Deferred gain (loss) 34.8 64.6 (53.0) Net amortization and deferral 5.5 4.2 4.1 ------- ------- ------- Net periodic pension cost $ 23.4 $ 26.4 $ 18.8 ======= ======= =======
Assumptions used to value obligations at year-end, and to determine the net periodic pension cost in the subsequent year are:
1996 1995 1994 - ------------------------------------------------------------------------------------------------ Discount rate 7.75% 7.5% 8.5% Expected long-term rate of return on assets 9.5% 9.5% 9.5% Rate of increase in compensation levels 5.0% 5.0% 5.0%
POSTRETIREMENT BENEFITS OTHER THAN PENSIONS The Company and its subsidiaries provide postretirement health care and life insurance benefits to eligible retired employees and their dependents. Substantially all employees may become eligible for those benefits if they reach retirement age while still working for the Company or its subsidiaries. The Company has not funded the liability for these benefits, which are expected to be paid out of cash generated by operations. The Company reserves the right, subject to applicable collective bargaining agreements, to amend or terminate these benefits. In 1995, the Company adopted the Kaiser Aluminum Medicare Program ("KAMP"). KAMP is mandatory for all salaried retirees over 65 and for United Steelworkers of America ("USWA") retirees who retire after December 31, 1995, when they become 65, and voluntary for other hourly retirees of the Company's operations in the states of California, Louisiana, Pennsylvania, Rhode Island, and Washington. 34 KAISER ALUMINUM CORPORATION 1996 ANNUAL REPORT (In millions of dollars, except share amounts) - -------------------------------------------------------------------------------- The Company's accrued postretirement benefit obligation is composed of the following:
December 31, -------------------- 1996 1995 - ------------------------------------------------------------------------------------- Accumulated postretirement benefit obligation: Retirees $ 498.7 $ 557.6 Active employees eligible for postretirement benefits 36.7 30.7 Active employees not eligible for postretirement benefits 67.4 61.1 ------- ------- Accumulated postretirement benefit obligation 602.8 649.4 Unrecognized net gains 71.3 20.5 Unrecognized gains related to prior-service costs 98.5 110.9 ------- ------- Accrued postretirement benefit obligation $ 772.6 $ 780.8 ======= =======
The components of net periodic postretirement benefit cost are:
Year Ended December 31, 1996 1995 1994 - ------------------------------------------------------------------------------------------------- Service cost $ 3.8 $ 4.5 $ 8.2 Interest cost 46.9 52.3 56.9 Amortization of prior service cost (12.4) (8.9) (3.2) ------- ------- ------- Net periodic postretirement benefit cost $ 38.3 $ 47.9 $ 61.9 ======= ======= =======
The 1997 annual assumed rates of increase in the per capita cost of covered benefits (i.e., health care cost trend rate) for non-HMO are 8.0% and 6.0% for retirees under 65 and over 65, respectively, and 5.5% for HMO at all ages. Non-HMO rates are assumed to decrease gradually to 5.5% in 2004 and remain at that level thereafter. The health care cost trend rate has a significant effect on the amounts reported. A one percentage point increase in the assumed health care cost trend rate would increase the accumulated postretirement benefit obligation as of December 31, 1996, by approximately $60.4 and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for 1996 by approximately $6.1. The weighted average discount rate used to determine the accumulated postretirement benefit obligation at December 31, 1996 and 1995, was 7.75% and 7.5%, respectively. POSTEMPLOYMENT BENEFITS The Company provides certain benefits to former or inactive employees after employment but before retirement. KAISER ALUMINUM CORPORATION 1996 ANNUAL REPORT 35 Kaiser Aluminum Corporation and Subsidiary Companies Notes to Consolidated Financial Statements (continued) (In millions of dollars, except share amounts) - -------------------------------------------------------------------------------- INCENTIVE PLANS In 1993, the Company adopted the Kaiser 1993 Omnibus Stock Incentive Plan (the "1993 Incentive Plan"). A total of 2,500,000 shares of the Company's Common Stock were reserved for awards or for payment of rights granted under the 1993 Incentive Plan, of which 572,254 shares were available to be awarded at December 31, 1996. During 1994, under the 1993 Incentive Plan, 102,564 restricted shares, which are now fully vested, were distributed to two Company executives. Compensation expense recognized during 1996, 1995 and 1994 associated with the 1993 Incentive Plan and a prior long-term incentive plan (the "LTIP") was approximately $.7, $1.4 and $2.2, respectively. In 1994, the Compensation Committee of the Board of Directors approved the award of "nonqualified stock options" to certain members of management. These options generally vest at the rate of 25% per year. Information relating to nonqualified stock option activity is shown below. The weighted average price per share is shown parenthetically.
1996 1995 1994 - ------------------------------------------------------------------------------------------------- Outstanding at beginning of year ($10.32, $9.85 and $7.55) 926,085 1,119,680 664,400 Granted ($12.75) 494,800 Exercised ($8.99, $7.32 and $7.25) (8,275) (155,500) (6,920) Expired or forfeited ($10.45, $8.88 and $7.46) (27,415) (38,095) (32,600) -------- ---------- --------- Outstanding at end of year ($10.33, $10.32 and $9.85) 890,395 926,085 1,119,680 ======== ========== ========= Exercisable at end of year ($10.47, $10.73 and $7.57) 436,195 211,755 120,180 ======== ========== =========
In 1995, the Company adopted the Kaiser Aluminum Total Compensation System, an unfunded incentive compensation program. The program provides incentive pay based on performance against annual plans and over rolling three-year periods. KACC also has a defined contribution plan for salaried employees. The Company's expense for these plans was $(2.1), $11.9 and $6.1 for the years ended December 31, 1996, 1995, and 1994, respectively. 36 KAISER ALUMINUM CORPORATION 1996 ANNUAL REPORT (In millions of dollars, except share amounts) 7. STOCKHOLDERS' EQUITY AND MINORITY INTERESTS Changes in stockholders' equity and minority interests were:
Minority Interests Stockholders' Equity ---------------------- --------------------------------------------------------- Additional Redeemable Accu- Minimum Preference Preferred Common Additional mulated Pension Stock Other Stock Stock Capital Deficit Liability - ------------------------------------------------------------------------------------------------------------------------ BALANCE, DECEMBER 31, 1993 $ 33.6 $ 71.4 $ .2 $ .6 $425.9 $(375.7) $(21.6) Net loss (106.8) Redeemable preference stock: Accretion 4.0 Stock redemption (8.5) Common stock issued 2.2 Preferred stock issued .4 99.7 Dividends on preferred stock (20.1) Minority interests 15.7 Reduction of minimum pension liability 12.5 ------ ------ ------ ------ ------ ------- ------ BALANCE, DECEMBER 31, 1994 29.1 87.1 .6 .6 527.8 (502.6) (9.1) Net income 60.3 Redeemable preference stock: Accretion 3.9 Stock redemption (8.7) Stock repurchase 5.4 Conversions (1,222 preference shares into cash) (.1) Common stock issued upon redemption and conversion of preferred stock (.2) .1 1.1 Dividends on preferred stock (17.6) Minority interests 6.0 Incentive plans accretion 1.4 Additional minimum pension liability (4.7) ------ ------ ------ ------ ------ ------- ------ BALANCE, DECEMBER 31, 1995 29.7 93.0 .4 .7 530.3 (459.9) (13.8) Net Income 8.2 Redeemable preference stock: Accretion 3.1 Stock redemption (5.3) Common stock issued upon redemption and conversion of preferred stock .1 Dividends on preferred stock (8.4) Minority interests 1.2 Incentive plan accretion .7 Reduction of minimum pension liability 11.0 ------ ------ ------ ------ ------ ------- ------ BALANCE, DECEMBER 31, 1996 $ 27.5 $ 94.2 $ .4 $ .7 $531.1 $(460.1) $ (2.8) ====== ====== ====== ====== ====== ======= ======
KAISER ALUMINUM CORPORATION 1996 ANNUAL REPORT 37 Kaiser Aluminum Corporation and Subsidiary Companies Notes to Consolidated Financial Statements (continued) (In millions of dollars, except share amounts) - -------------------------------------------------------------------------------- REDEEMABLE PREFERENCE STOCK In 1985, KACC issued its Cumulative (1985 Series A) Preference Stock and its Cumulative (1985 Series B) Preference Stock (together, the "Redeemable Preference Stock") each of which has a par value of $1 per share and a liquidation and redemption value of $50 per share plus accrued dividends, if any. No additional Redeemable Preference Stock is expected to be issued. Holders of the Redeemable Preference Stock are entitled to an annual cash dividend of $5 per share, or an amount based on a formula tied to KACC's pre-tax income from aluminum operations, when and as declared by the Board of Directors. The carrying values of the Redeemable Preference Stock are increased each year to recognize accretion between the fair value (at which the Redeemable Preference Stock was originally issued) and the redemption value. Changes in Redeemable Preference Stock are shown below.
1996 1995 1994 - ----------------------------------------------------------------------------------------------------- Shares: Beginning of year 737,363 912,167 1,081,548 Redeemed (102,679) (174,804) (169,381) --------- -------- --------- End of year 634,684 737,363 912,167 ========= ======== =========
Redemption fund agreements require KACC to make annual payments by March 31 of the subsequent year based on a formula tied to consolidated net income until the redemption funds are sufficient to redeem all of the Redeemable Preference Stock. On an annual basis, the minimum payment is $4.3 and the maximum payment is $7.3. KACC also has certain additional repurchase requirements which are, among other things, based upon profitability tests. The Redeemable Preference Stock is entitled to the same voting rights as KACC common stock and to certain additional voting rights under certain circumstances, including the right to elect, along with other KACC preference stockholders, two directors whenever accrued dividends have not been paid on two annual dividend payment dates or when accrued dividends in an amount equivalent to six full quarterly dividends are in arrears. The Redeemable Preference Stock restricts the ability of KACC to redeem or pay dividends on common stock if KACC is in default on any dividends payable on Redeemable Preference Stock. PREFERENCE STOCK KACC has four series of $100 par value Cumulative Convertible Preference Stock ("$100 Preference Stock") with annual dividend requirements of between 4 1/8% and 4 3/4%. KACC has the option to redeem the $100 Preference Stock at par value plus accrued dividends. KACC does not intend to issue any additional shares of the $100 Preference Stock. The $100 Preference Stock can be exchanged for per share cash amounts between $69 - $80. KACC records the $100 Preference Stock at their exchange amounts for financial statement presentation and the Company includes such amounts in minority interests. At December 31, 1996, and 1995, outstanding shares of $100 Preference Stock were 21,630 and 22,214, respectively. PREFERRED STOCK Series A Convertible--In 1993, Kaiser issued 19,382,950 of its $.65 Depositary Shares (the "Depositary Shares"), each representing one-tenth of a share of Series A Mandatory Conversion Premium Dividend Preferred Stock (the "Series A Shares"). On September 19, 1995, the Company redeemed all 1,938,295 Series A Shares, which resulted in the simultaneous redemption of all Depositary Shares in exchange for (i) 13,126,521 shares of the Company's 38 KAISER ALUMINUM CORPORATION 1996 ANNUAL REPORT (In millions of dollars, except share amounts) - -------------------------------------------------------------------------------- Common Stock and (ii) $2.8 in cash in satisfaction of all accrued and unpaid dividends up to and including the day immediately prior to the redemption date and any fractional shares of common stock that would have otherwise been issuable. PRIDES Convertible--In the first quarter of 1994, the Company consummated the public offering of 8,855,550 shares of the PRIDES. The net proceeds from the sale of the shares of PRIDES were approximately $100.1. The Company used such net proceeds to make non-interest bearing loans to KACC in the aggregate principal amount of $33.2 (the aggregate dividends scheduled to accrue on the shares of PRIDES from the issuance date until December 31, 1997, the date on which the outstanding PRIDES will be mandatorily converted into shares of the Company's Common Stock), evidenced by intercompany notes, and used the balance of such net proceeds to make capital contributions to KACC in the aggregate amount of $66.9. Holders of shares of PRIDES are entitled to receive (when, as, and if the Board of Directors declares dividends on the PRIDES) cumulative preferential cash dividends at a rate per annum of 8.255% of the per share offering price (equivalent to $.97 per annum for each share of PRIDES), from the date of initial issuance, payable quarterly in arrears. Holders of shares of PRIDES have a 4/5 vote for each share held of record and, except as required by law, are entitled to vote together with the holders of the Company's Common Stock and together with the holders of any other classes or series of stock who are entitled to vote in such manner on all matters submitted to a vote of common stockholders. On December 31, 1997, unless either previously redeemed by the Company or converted at the option of the holder, each of the outstanding shares of PRIDES will mandatorily convert into one share of the Company's Common Stock, subject to adjustment in certain events, and the right to receive an amount in cash equal to all accrued and unpaid dividends thereon. At any time and from time to time after December 31, 1996, the Company may redeem any or all of the outstanding shares of PRIDES. The number of shares of the Company's Common Stock a holder will receive upon redemption will vary depending on a formula and the market price of the Company's Common Stock from time to time, but in no event will be less than .8333 of a share of Common Stock, subject to adjustment in certain events. At any time prior to December 31, 1997, each share of PRIDES is convertible at the option of the holder thereof into .8333 of a share of Common Stock (equivalent to a conversion price of $14.10 per share of Common Stock), subject to adjustment in certain events. The value of the shares received by a holder will vary depending on the market price of the Company's Common Stock. PLEDGED SHARES At December 31, 1996, 27,938,250 shares of the Company's Common Stock (the "Pledged Shares") beneficially owned by MAXXAM Group Holdings Inc. ("MGHI"), a wholly owned subsidiary of MAXXAM, were pledged as security for debt of MAXXAM Group Inc. ("MGI"), a wholly owned subsidiary of MGHI, consisting of $100.0 aggregate principal amount of 11 1/4% Senior Secured Notes due 2003 and $125.7 aggregate principal amount of 12 1/4% Senior Secured Discount Notes due 2003 (collectively the "MGI Secured Debt"). Additionally, up to 16,055,000 of the Pledged Shares are to be pledged by MGHI as security for $130.0 principal amount of 12% Senior Secured Notes due 2003 issued in December 1996 by MGHI, if any of the Pledged Shares are released as security for the MGI Secured Debt by reason of an early retirement of such indebtedness (other than by a refinancing). PROPOSED RECAPITALIZATION On February 5, 1996, the Company announced that it filed with the Securities and Exchange Commission ("SEC") a preliminary proxy statement relating to a proposed recapitalization and a special meeting of stockholders to consider and vote upon the proposal. The proposed recapitalization would have: (i) provided for two classes of KAISER ALUMINUM CORPORATION 1996 ANNUAL REPORT 39 Kaiser Aluminum Corporation and Subsidiary Companies Notes to Consolidated Financial Statements (continued) (In millions of dollars, except share amounts) - -------------------------------------------------------------------------------- common stock: Class A Common Shares, $.01 par value, with one vote per share and a new lesser-voting class designated as Common Stock, $.01 par value, with 1/10 vote per share; (ii) redesignated as Class A Common Shares the 100 million currently authorized shares of existing common stock and authorize an additional 250 million shares to be designated as Common Stock; and (iii) changed each issued share of the Company's existing common stock, par value $.01 per share, into (a) .33 of a Class A Common Share and (b) .67 of a share of Common Stock. Although approved by the Company's stockholders, the proposed recapitalization was not implemented and was ultimately abandoned as a result of an unfavorable court ruling in a suit that had challenged the plan. The decision to abandon the proposed recapitalization does not preclude a recapitalization from being proposed to the Company's stockholders in the future. 8. COMMITMENTS AND CONTINGENCIES COMMITMENTS KACC has a variety of financial commitments, including purchase agreements, tolling arrangements, forward foreign exchange and forward sales contracts (see Note 9), letters of credit, and guarantees. Such purchase agreements and tolling arrangements include long-term agreements for the purchase and tolling of bauxite into alumina in Australia by QAL. These obligations expire in 2008. Under the agreements, KACC is unconditionally obligated to pay its proportional share of debt, operating costs, and certain other costs of QAL. The aggregate minimum amount of required future principal payments at December 31, 1996, is $94.4, of which approximately $12.0 is due in each of 2000 and 2001 with the balance being due thereafter. KACC's share of payments, including operating costs and certain other expenses under the agreements, has ranged between $110.0-$120.0 over the past three years. KACC also has agreements to supply alumina to and to purchase aluminum from Anglesey. Minimum rental commitments under operating leases at December 31, 1996, are as follows: years ending December 31, 1997- $23.2; 1998-$25.8; 1999-$30.7; 2000-$27.6; 2001-$27.2; thereafter-$160.3. The future minimum rentals receivable under noncancelable subleases was $46.7 at December 31, 1996. Rental expenses were $29.6, $29.0, and $26.8, for the years ended December 31, 1996, 1995, and 1994, respectively. ENVIRONMENTAL CONTINGENCIES The Company and KACC are subject to a number of environmental laws, to fines or penalties assessed for alleged breaches of the environmental laws, and to claims and litigation based upon such laws. KACC currently is subject to a number of lawsuits under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended by the Superfund Amendments Reauthorization Act of 1986 ("CERCLA"), and, along with certain other entities, has been named as a potentially responsible party for remedial costs at certain third-party sites listed on the National Priorities List under CERCLA. Based on the Company's evaluation of these and other environmental matters, the Company has established environmental accruals, primarily related to potential solid waste disposal and soil and groundwater remediation matters. The following table presents the changes in such accruals, which are primarily included in Long-term liabilities, for the years ended December 31, 1996, 1995, and 1994:
1996 1995 1994 - ------------------------------------------------------------------------------------------------- Balance at beginning of period $ 38.9 $ 40.1 $ 40.9 Additional amounts 3.2 3.3 2.8 Less expenditures (8.8) (4.5) (3.6) ------- ------- ------- Balance at end of period $ 33.3 $ 38.9 $ 40.1 ======= ======= =======
40 KAISER ALUMINUM CORPORATION 1996 ANNUAL REPORT (In millions of dollars, except share amounts) - -------------------------------------------------------------------------------- These environmental accruals represent the Company's estimate of costs reasonably expected to be incurred based on presently enacted laws and regulations, currently available facts, existing technology, and the Company's assessment of the likely remediation action to be taken. The Company expects that these remediation actions will be taken over the next several years and estimates that annual expenditures to be charged to these environmental accruals will be approximately $3.0 to $9.0 for the years 1997 through 2001 and an aggregate of approximately $6.0 thereafter. As additional facts are developed and definitive remediation plans and necessary regulatory approvals for implementation of remediation are established or alternative technologies are developed, changes in these and other factors may result in actual costs exceeding the current environmental accruals. The Company believes that it is reasonably possible that costs associated with these environmental matters may exceed current accruals by amounts that could range, in the aggregate, up to an estimated $24.0 and that, subject to further regulatory review and approval, the factors upon which a substantial portion of this estimate is based are expected to be resolved over the next twelve months. While uncertainties are inherent in the final outcome of these environmental matters, and it is presently impossible to determine the actual costs that ultimately may be incurred, management currently believes that the resolution of such uncertainties should not have a material adverse effect on the Company's consolidated financial position, results of operations, or liquidity. ASBESTOS CONTINGENCIES KACC is a defendant in a number of lawsuits, some of which involve claims of multiple persons, in which the plaintiffs allege that certain of their injuries were caused by, among other things, exposure to asbestos during, and as a result of, their employment or association with KACC or exposure to products containing asbestos produced or sold by KACC. The lawsuits generally relate to products KACC has not manufactured for at least 15 years. The following table presents the changes in number of such claims pending for the years ended December 31, 1996, 1995, and 1994.
1996 1995 1994 - ------------------------------------------------------------------------------------------------- Number of claims at beginning of period 59,700 25,200 23,400 Claims received 21,100 41,700 14,300 Claims settled or dismissed (9,700) (7,200) (12,500) ------- ------- -------- Number of claims at end of period 71,100 59,700 25,200 ======= ======= ========
A substantial portion of the asbestos-related claims that were filed and served on KACC during 1995 and 1996 were filed in Texas. KACC has been advised by its counsel that, although there can be no assurance, the increase in pending claims may have been attributable in part to tort reform legislation in Texas. Although asbestos-related claims are currently exempt from certain aspects of the Texas tort reform legislation, management has been advised that efforts to remove the asbestos-related exemption in the tort reform legislation relating to the doctrine of forum non conveniens, as well as other developments in the legislative and legal environment in Texas, may be responsible for the accelerated pace of new claims experienced in late 1995 and its continuance in 1996, albeit at a somewhat reduced rate. Based on past experience and reasonably anticipated future activity, the Company has established an accrual for estimated asbestos-related costs for claims filed and estimated to be filed through 2008. There are inherent uncertainties involved in estimating asbestos-related costs, and the Company's actual costs could exceed these estimates. The Company's accrual was calculated based on the current and anticipated number of asbestos-related claims, the KAISER ALUMINUM CORPORATION 1996 ANNUAL REPORT 41 Kaiser Aluminum Corporation and Subsidiary Companies Notes to Consolidated Financial Statements (continued) (In millions of dollars, except share amounts) prior timing and amounts of asbestos-related payments, and the advice of Wharton Levin Ehrmantraut Klein & Nash, P.A. with respect to the current state of the law related to asbestos claims. Accordingly, an estimated asbestos-related cost accrual of $136.7, before consideration of insurance recoveries, is included primarily in Long-term liabilities at December 31, 1996. While the Company does not presently believe there is a reasonable basis for estimating such costs beyond 2008 and, accordingly, no accrual has been recorded for such costs which may be incurred beyond 2008, there is a reasonable possibility that such costs may continue beyond 2008, and such costs may be substantial. The Company estimates that annual future cash payments in connection with such litigation will be approximately $8.0 to $17.0 for each of the years 1997 through 2001, and an aggregate of approximately $80.0 thereafter. The Company believes that KACC has insurance coverage available to recover a substantial portion of its asbestos-related costs. Claims for recovery from some of KACC's insurance carriers are currently subject to pending litigation and other carriers have raised certain defenses, which have resulted in delays in recovering costs from the insurance carriers. The timing and amount of ultimate recoveries from these insurance carriers are dependent upon the resolution of these disputes. The Company believes, based on prior insurance-related recoveries in respect of asbestos-related claims, existing insurance policies, and the advice of Thelen, Marrin, Johnson & Bridges LLP with respect to applicable insurance coverage law relating to the terms and conditions of those policies, that substantial recoveries from the insurance carriers are probable. Accordingly, an estimated aggregate insurance recovery of $109.8, determined on the same basis as the asbestos-related cost accrual, is recorded primarily in Other assets at December 31, 1996. Management continues to monitor claims activity, the status of lawsuits (including settlement initiatives), legislative progress, and costs incurred in order to ascertain whether an adjustment to the existing accruals should be made to the extent that historical experience may differ significantly from the Company's underlying assumptions. While uncertainties are inherent in the final outcome of these asbestos matters and it is presently impossible to determine the actual costs that ultimately may be incurred and insurance recoveries that will be received, management currently believes that, based on the factors discussed in the preceding paragraphs, the resolution of asbestos-related uncertainties and the incurrence of asbestos-related costs net of related insurance recoveries should not have a material adverse effect on the Company's consolidated financial position, results of operations, or liquidity. OTHER CONTINGENCIES The Company or KACC is involved in various other claims, lawsuits, and other proceedings relating to a wide variety of matters. While uncertainties are inherent in the final outcome of such matters, and it is presently impossible to determine the actual costs that ultimately may be incurred, management currently believes that the resolution of such uncertainties and the incurrence of such costs should not have a material adverse effect on the Company's consolidated financial position, results of operations, or liquidity. 9. DERIVATIVE FINANCIAL INSTRUMENTS AND RELATED HEDGING PROGRAMS At December 31, 1996, the net unrealized gain on KACC's position in aluminum forward sales and option contracts, (based on an average price of $1,610 per ton ($.73 per pound) of primary aluminum), natural gas and fuel oil forward purchase and option contracts, and forward foreign exchange contracts, was approximately $10.5. However, increases in the price of primary aluminum during January 1997 caused KACC's net hedging position at January 31, 1997, to change to an unrealized loss of approximately $2.2. Any gains or losses on the derivative contracts utilized in KACC's hedging activities are offset by losses or gains, respectively, on the transactions being hedged. 42 KAISER ALUMINUM CORPORATION 1996 ANNUAL REPORT (In millions of dollars, except share amounts) - -------------------------------------------------------------------------------- ALUMINA AND ALUMINUM The Company's earnings are sensitive to changes in the prices of alumina, primary aluminum and fabricated aluminum products, and also depend to a significant degree upon the volume and mix of all products sold. Primary aluminum prices have historically been subject to significant cyclical price fluctuations. Alumina prices as well as fabricated aluminum product prices (which vary considerably among products) are significantly influenced by changes in the price of primary aluminum but generally lag behind primary aluminum price changes by up to three months. During the period January 1, 1993 through December 31, 1996, the Average Midwest United States transaction price for primary aluminum has ranged from approximately $.50 to $1.00 per pound. From time to time in the ordinary course of business, KACC enters into hedging transactions to provide price risk management in respect of the net exposure of earnings resulting from (i) anticipated sales of alumina, primary aluminum and fabricated aluminum products, less (ii) expected purchases of certain items, such as aluminum scrap, rolling ingot, and bauxite, whose prices fluctuate with the market price of primary aluminum. Forward sales contracts are used by KACC to effectively lock-in or fix the price that KACC will receive for its shipments. KACC also uses option contracts (i) to establish a minimum price for its product shipments, (ii) to establish a "collar" or range of price for KACC's anticipated sales, and/or (iii) to permit KACC to realize possible upside price movements. As of December 31, 1996, KACC had sold forward, at fixed prices, approximately 70,000 and 93,600 tons of primary aluminum with respect to 1997 and 1998, respectively. As of December 31, 1996, KACC had also purchased put options to establish a minimum price for approximately 202,700 and 52,000 tons with respect to 1997 and 1998, respectively, and had entered into option contracts that established a price range for an additional 165,600 tons with respect to 1998. During January 1997, the Company entered into additional option contracts that establish a price range for 51,500, 60,000 and 51,000 tons with respect to 1997, 1998 and 1999, respectively. During January 1997 KACC also sold forward, at fixed prices, an additional 24,000 tons with respect to 1999. As of December 31, 1996, KACC had sold forward approximately 90% of the alumina available to it in excess of its projected internal smelting requirements for 1997 and 1998. Virtually all of such 1997 and 1998 sales were made at prices indexed to future prices of primary aluminum. ENERGY KACC is exposed to energy price risk from fluctuating prices for fuel oil and natural gas consumed in the production process. Accordingly, KACC from time to time in the ordinary course of business enters into hedging transactions with major suppliers of energy and energy related financial instruments. As of December 31, 1996, KACC had a combination of fixed price purchase and option contracts for the purchase of approximately 40,000 MMBtu of natural gas per day during the first and second quarter of 1997, and for 25,000 MMBtu of natural gas per day for the period July 1997 through December 1998. At December 31, 1996, KACC also held option contracts for an average of 152,000 barrels of fuel oil per month for 1997 and 174,000 barrels of fuel oil per month for 1998. FOREIGN CURRENCY KACC enters into forward exchange contracts to hedge material cash commitments to foreign subsidiaries or affiliates. At December 31, 1996, KACC had net forward foreign exchange contracts totaling approximately $81.6 for the purchase of 110.0 Australian dollars from January 1997 through June 1998, in respect of its commitments for 1997 and 1998 expenditures denominated in Australian dollars. 10. SEGMENT AND GEOGRAPHICAL AREA INFORMATION The Company's operations are located in many foreign countries, including Australia, Canada, the People's Republic of China, Ghana, Jamaica, and the United Kingdom. Foreign operations in general may be more vulnerable than domestic operations due to a variety of political and other risks. Sales and transfers among geographic areas are made on a basis intended to reflect the market value of products. KAISER ALUMINUM CORPORATION 1996 ANNUAL REPORT 43 Kaiser Aluminum Corporation and Subsidiary Companies Notes to Consolidated Financial Statements (continued) (In millions of dollars, except share amounts) - -------------------------------------------------------------------------------- The aggregate foreign currency gain included in determining net income was $5.3 for the year ended December 31, 1995, and was immaterial in 1996 and 1994. No single customer accounted for sales in excess of 10% of total revenue in 1996 and 1995. Sales of more than 10% of total revenue to a single customer were $58.2 of bauxite and alumina and $147.7 of aluminum processing for the year ended December 31, 1994, respectively. Export sales were less than 10% of total revenue during the years ended December 31, 1996, 1995, and 1994, respectively. Geographical area information relative to operations is summarized as follows:
Year Ended Other December 31, Domestic Caribbean Africa Foreign Eliminations Total - -------------------------------------------------------------------------------------------------------------- Net sales to unaffiliated customers 1996 $1,610.0 $ 201.8 $ 198.3 $ 180.4 $2,190.5 1995 1,589.5 191.7 239.4 217.2 2,237.8 1994 1,263.2 169.9 180.0 168.4 1,781.5 Sales and transfers among 1996 $ 116.9 $ 206.0 $(322.9) geographic areas 1995 79.6 191.5 (271.1) 1994 98.7 139.4 (238.1) Equity in income (losses) of 1996 $ .3 $ 8.5 $ 8.8 unconsolidated affiliates 1995 (.2) 19.4 19.2 1994 .2 (2.1) (1.9) Operating income (loss) 1996 $ 4.4 $ 1.6 $ 27.8 $ 64.0 $ 97.8 1995 32.0 9.8 83.5 85.3 210.6 1994 (128.8) 9.9 18.3 44.4 (56.2) Investment in and advances to 1996 $ .5 $ 25.3 $ 142.6 $ 168.4 unconsolidated affiliates 1995 1.2 27.1 149.9 178.2 Identifiable assets 1996 $2,136.7 $ 391.2 $ 194.7 $ 211.4 $2,934.0 1995 2,017.9 381.9 196.5 216.9 2,813.2
44 KAISER ALUMINUM CORPORATION 1996 ANNUAL REPORT (In millions of dollars, except share amounts) - -------------------------------------------------------------------------------- Financial information by industry segment at December 31, 1996 and 1995, and for the years ended December 31, 1996, 1995, and 1994, is as follows:
Year Ended Bauxite & Aluminum December 31, Alumina Processing Corporate Total - --------------------------------------------------------------------------------------------------------------- Net sales to unaffiliated customers 1996 $ 508.0 $1,682.5 $2,190.5 1995 514.2 1,723.6 2,237.8 1994 432.5 1,349.0 1,781.5 Intersegment sales 1996 $ 181.6 $ 181.6 1995 159.7 159.7 1994 146.8 146.8 Equity in income (losses) of unconsolidated affiliates 1996 $ 1.7 $ 6.7 $ .4 $ 8.8 1995 3.6 15.8 (.2) 19.2 1994 (4.7) 2.6 .2 (1.9) Operating income (loss) 1996 $ 1.1 $ 156.5 $ (59.8) $ 97.8 1995 54.0 238.9 (82.3) 210.6 1994 19.8 (8.4) (67.6) (56.2) Depreciation 1996 $ 31.2 $ 61.7 $ 3.1 $ 96.0 1995 31.1 60.4 2.8 94.3 1994 33.5 59.1 2.8 95.4 Capital expenditures 1996 $ 29.9 $ 126.9 $ 4.7 $ 161.5 1995 27.3 53.0 8.1 88.4 1994 28.9 39.9 1.2 70.0 Investment in and advances to unconsolidated affiliates 1996 $ 121.3 $ 46.6 $ .5 $ 168.4 1995 129.9 47.1 1.2 178.2 Identifiable assets 1996 $ 784.6 $1,408.5 $ 740.9 $2,934.0 1995 746.0 1,341.2 726.0 2,813.2
KAISER ALUMINUM CORPORATION 1996 ANNUAL REPORT 45 Kaiser Aluminum Corporation and Subsidiary Companies Five-Year Financial Data--Consolidated Balance Sheets
December 31, ------------------------------------------------------------- (In millions of dollars, except share amounts) 1996 1995 1994 1993 1992 - ---------------------------------------------------------------------------------------------------------------- ASSETS Current assets: Cash and cash equivalents $ 81.3 $ 21.9 $ 17.6 $ 14.7 $ 19.1 Receivables 252.4 308.6 199.2 234.7 270.0 Inventories 562.2 525.7 468.0 426.9 439.9 Prepaid expenses and other current assets 127.8 76.6 158.0 60.7 37.0 -------- -------- --------- -------- -------- Total current assets 1,023.7 932.8 842.8 737.0 766.0 Investments in and advances to unconsolidated affiliates 168.4 178.2 169.7 183.2 150.1 Property, plant, and equipment-net 1,168.7 1,109.6 1,133.2 1,163.7 1,066.8 Deferred income taxes 264.5 269.1 271.2 210.8 Other assets 308.7 323.5 281.2 233.2 189.7 -------- -------- --------- -------- -------- Total $2,934.0 $2,813.2 $2,698.1 $2,527.9 $2,172.6 ======== ======== ======== ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable and accruals $453.4 $451.2 $439.3 $339.7 $351.4 Accrued postretirement medical benefit obligation-current portion 50.1 46.8 47.0 47.6 Payable to affiliates 97.0 94.2 85.3 62.4 78.4 Long-term debt-current portion 8.9 8.9 11.5 8.7 25.9 -------- -------- --------- -------- -------- Total current liabilities 609.4 601.1 583.1 458.4 455.7 Long-term liabilities 458.1 548.5 495.5 501.8 281.7 Accrued postretirement medical benefit obligation 722.5 734.0 734.9 713.1 Long-term debt 953.0 749.2 751.1 720.2 765.1 Minority interests 121.7 122.7 116.2 105.0 104.9 Stockholders' equity: Preferred stock .4 .4 .6 .2 Common stock .7 .7 .6 .6 .6 Additional capital 531.1 530.3 527.8 425.9 288.5 Retained earnings (accumulated deficit) (460.1) (459.9) (502.6) (375.7) 282.8 Additional minimum pension liability (2.8) (13.8) (9.1) (21.6) (6.7) -------- -------- --------- -------- -------- Total stockholders' equity 69.3 57.7 17.3 29.4 565.2 -------- -------- --------- -------- -------- Total $2,934.0 $2,813.2 $2,698.1 $2,527.9 $2,172.6 ======== ======== ======== ======== ======== Debt-to-capital ratio(1) 81.2 78.1 82.4 81.3 54.1
(1) Total of long-term debt--current portion and long-term debt (collectively "total debt") as a ratio of total debt, deferred income tax liabilities, minority interests, and stockholders' equity. 46 KAISER ALUMINUM CORPORATION 1996 ANNUAL REPORT Five-Year Financial Data--Statements of Consolidated Income (Loss)
Year Ended December 31, (In millions of dollars, except share amounts) 1996 1995 1994 1993 1992 - --------------------------------------------------------------------------------------------------------------- Net sales $2,190.5 $2,237.8 $ 1,781.5 $1,719.1 $1,909.1 -------- -------- --------- -------- -------- Costs and expenses: Cost of products sold 1,869.1 1,798.4 1,625.5 1,587.7 1,619.3 Depreciation 96.0 94.3 95.4 97.1 80.3 Selling, administrative, research and development, and general 127.6 134.5 116.8 121.9 119.6 Restructuring of operations 35.8 -------- -------- --------- -------- -------- Total costs and expenses 2,092.7 2,027.2 1,837.7 1,842.5 1,819.2 -------- -------- --------- -------- -------- Operating income (loss) 97.8 210.6 (56.2) (123.4) 89.9 Other income (expense): Interest expense (93.4) (93.9) (88.6) (84.2) (78.7) Other-net (2.7) (14.1) (7.3) (.9) 20.9 -------- -------- --------- -------- -------- Income (loss) before income taxes, minority interests, extraordinary loss, and cumulative effect of changes in accounting principles 1.7 102.6 (152.1) (208.5) 32.1 Credit (provision) for income taxes 9.3 (37.2) 53.8 86.9 (5.3) Minority interests (2.8) (5.1) (3.1) (1.5) .1 -------- -------- --------- -------- -------- Income (loss) before extraordinary loss and cumulative effect of changes in accounting principles 8.2 60.3 (101.4) (123.1) 26.9 Extraordinary loss on early extinguishment of debt, net of tax benefit of $2.9 and $11.2 for 1994 and 1993, respectively (5.4) (21.8) Cumulative effect of changes in accounting principles, net of tax benefit of $237.7 (507.3) -------- -------- --------- -------- -------- Net income (loss) $ 8.2 $ 60.3 $ (106.8) $ (652.2) $ 26.9 ======== ======== ========= ======== ======== Per common and common equivalent share: Net income (loss): Primary $ .00 $ .69 $ (2.18) $ (11.47) $ .47 Fully diluted .72 Dividends declared .20
KAISER ALUMINUM CORPORATION 1996 ANNUAL REPORT 47 Kaiser Aluminum Corporation and Subsidiary Companies Quarterly Financial Data (unaudited)
Quarter Ended ---------------------------------------------------- (In millions of dollars, except share amounts) March 31 June 30 September 30 December 31 - ------------------------------------------------------------------------------------------------------------------- 1996 Net Sales $ 531.1 $ 567.6 $ 553.4 $ 538.4 Operating income 40.3 36.6 10.5 10.4 Net Income (loss) 9.9 8.2 (6.6) (3.3)(1) Earnings (loss) per common and common equivalent shares: Primary .11 .09 (.12) (.08)(1) Common stock market price: High 16 1/8 15 3/4 12 1/2 12 Low 12 10 7/8 9 3/4 10 1/8 1995 Net sales $ 513.0 $ 583.4 $ 550.3 $ 591.1 Operating income 32.6 63.6 53.2 61.2 Net income 3.5 23.3 12.5 21.0 Earnings (loss) per common and common equivalent share: Primary (.03)(2) .31 .13 .26 Fully diluted .14 Common stock market price: High 11 7/8 14 21 15 3/4 Low 10 1/8 10 1/2 13 7/8 10 3/4
(1) Includes approximately $17.0 on an after tax basis resulting from settlements of certain tax matters. Excluding these items, primary loss per common and common equivalent share would have been approximately $.32. (2) After deduction of $5.3 of dividends on preferred stock from net income. 48 KAISER ALUMINUM CORPORATION 1996 ANNUAL REPORT EX-99 4 EXHIBIT 99.2 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors and Stockholder of The Pacific Lumber Company: We have audited the accompanying consolidated balance sheets of The Pacific Lumber Company (a Delaware corporation) and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, cash flows and stockholder's equity (deficit) for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of The Pacific Lumber Company and subsidiaries as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP San Francisco, California January 24, 1997 THE PACIFIC LUMBER COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (IN THOUSANDS OF DOLLARS)
DECEMBER 31, --------------------------- 1996 1995 ------------- ------------- ASSETS Current assets: Cash and cash equivalents $ 26,027 $ 26,480 Receivables: Trade 18,080 19,688 Other 2,514 1,565 Inventories 65,690 75,580 Prepaid expenses and other current assets 5,329 6,933 ------------- ------------- Total current assets 117,640 130,246 Timber and timberlands, net of accumulated depletion of $221,063 and $204,856, respectively 324,986 337,390 Property, plant and equipment, net of accumulated depreciation of $73,772 and $65,276, respectively 95,515 93,726 Deferred financing costs, net 20,003 22,397 Deferred income taxes 34,639 41,958 Restricted cash 29,967 31,367 Other assets 6,424 5,502 ------------- ------------- $ 629,174 $ 662,586 ============= ============= LIABILITIES AND STOCKHOLDER'S DEFICIT Current liabilities: Accounts payable $ 3,765 $ 3,898 Accrued compensation and related benefits 9,673 9,241 Accrued interest 20,211 20,666 Deferred income taxes 10,173 10,244 Other accrued liabilities 2,325 3,077 Long-term debt, current maturities 16,258 14,195 ------------- ------------- Total current liabilities 62,405 61,321 Long-term debt, less current maturities 555,596 571,812 Other noncurrent liabilities 25,887 33,613 ------------- ------------- Total liabilities 643,888 666,746 ------------- ------------- Contingencies Stockholder's deficit: Common stock, $.01 par value, 100 shares authorized and issued -- -- Additional capital 157,520 157,520 Accumulated deficit (172,234) (161,680) ------------- ------------- Total stockholder's deficit (14,714) (4,160) ------------- ------------- $ 629,174 $ 662,586 ============= ============= The accompanying notes are an integral part of these financial statements.
THE PACIFIC LUMBER COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS (IN THOUSANDS OF DOLLARS)
YEARS ENDED DECEMBER 31, ----------------------------------------- 1996 1995 1994 ------------- ------------- ------------- Net sales: Lumber and logs $ 225,017 $ 197,320 $ 205,504 Other 19,832 24,619 21,875 ------------- ------------- ------------- 244,849 221,939 227,379 ------------- ------------- ------------- Operating expenses: Cost of goods sold (exclusive of depletion and depreciation) 136,335 116,445 116,316 Selling, general and administrative expenses 14,570 14,992 15,190 Depletion and depreciation 27,644 25,927 25,485 ------------- ------------- ------------- 178,549 157,364 156,991 ------------- ------------- ------------- Operating income 66,300 64,575 70,388 Other income (expense): Investment, interest and other income 4,209 3,928 12,022 Interest expense (54,456) (55,462) (56,067) ------------- ------------- ------------- Income before income taxes and extraordinary item 16,053 13,041 26,343 Provision in lieu of income taxes (6,107) (6,480) (1,429) ------------- ------------- ------------- Income before extraordinary item 9,946 6,561 24,914 Extraordinary item: Loss on litigation settlement, net of related credit in lieu of income taxes of $6,312 -- -- (14,866) ------------- ------------- ------------- Net income $ 9,946 $ 6,561 $ 10,048 ============= ============= ============= The accompanying notes are an integral part of these financial statements.
THE PACIFIC LUMBER COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (IN THOUSANDS OF DOLLARS)
YEARS ENDED DECEMBER 31, ----------------------------------------- 1996 1995 1994 ------------- ------------- ------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 9,946 $ 6,561 $ 10,048 Adjustments to reconcile net income to net cash provided by operating activities: Depletion and depreciation 27,644 25,927 25,485 Net sales of marketable securities 52 478 6,619 Amortization of deferred financing costs 2,394 2,269 2,197 Net gains on marketable securities (52) (478) (984) Net loss (gain) on asset dispositions 6 419 (830) Increase (decrease) in cash resulting from changes in: Accrued and deferred income taxes 7,135 7,572 1,627 Accounts payable (164) 589 949 Receivables 803 5,913 (8,742) Other liabilities (8,046) 7,406 (2,027) Inventories, net of depletion 7,304 (7,301) (1,608) Prepaid expenses and other current assets 682 (3,273) (721) Accrued interest (455) (443) (518) Other (12) 423 706 ------------- ------------- ------------- Net cash provided by operating activities 47,237 46,062 32,201 ------------- ------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES: Net proceeds from sale of assets 115 13 1,119 Capital expenditures (14,552) (9,140) (10,962) ------------- ------------- ------------- Net cash used for investing activities (14,437) (9,127) (9,843) ------------- ------------- ------------- CASH FLOWS FROM FINANCING ACTIVITIES: Dividends paid (20,500) (22,000) (24,500) Redemptions, repurchase of and principal payments on long-term debt (14,153) (13,670) (13,235) Incurrence of financing costs -- (150) (213) Restricted cash deposits, net 1,400 1,035 1,160 ------------- ------------- ------------- Net cash used for financing activities (33,253) (34,785) (36,788) ------------- ------------- ------------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (453) 2,150 (14,430) CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 26,480 24,330 38,760 ------------- ------------- ------------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 26,027 $ 26,480 $ 24,330 ============= ============= ============= The accompanying notes are an integral part of these financial statements.
THE PACIFIC LUMBER COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY (DEFICIT) (IN THOUSANDS OF DOLLARS)
COMMON STOCK ADDITIONAL ACCUMULATED ($.01 PAR) CAPITAL DEFICIT TOTAL ------------- ------------- ------------- ------------- Balance, January 1, 1994 $ $ 157,520 $ (131,789) $ 25,731 Net income -- -- 10,048 10,048 Dividends -- -- (24,500) (24,500) ------------- ------------- ------------- ------------- Balance, December 31, 1994 -- 157,520 (146,241) 11,279 Net income -- -- 6,561 6,561 Dividends -- -- (22,000) (22,000) ------------- ------------- ------------- ------------- Balance, December 31, 1995 -- 157,520 (161,680) (4,160) Net income -- -- 9,946 9,946 Dividends -- -- (20,500) (20,500) ------------- ------------- ------------- ------------- Balance, December 31, 1996 $ -- $ 157,520 $ (172,234) $ (14,714) ============= ============= ============= ============= The accompanying notes are an integral part of these financial statements.
THE PACIFIC LUMBER COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS OF DOLLARS) 1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The consolidated financial statements include the accounts of The Pacific Lumber Company and its wholly owned subsidiaries, collectively referred to herein as the "Company." The Company is an indirect wholly owned subsidiary of MAXXAM Group Inc. ("MGI"). MGI is a wholly owned subsidiary of MAXXAM Group Holdings Inc. ("MGHI") which is a wholly owned subsidiary of MAXXAM Inc. ("MAXXAM"). Intercompany balances and transactions have been eliminated. Certain reclassifications have been made to prior years' financial statements to be consistent with the current year's presentation. The Company operates in several principal aspects of the lumber industry, including the growing and harvesting of redwood and Douglas-fir timber, the milling of logs into lumber and the manufacture of lumber into a variety of finished products. Housing, construction and remodeling are the principal markets for the Company's lumber products. Export sales generally constitute approximately 6% of the Company's sales. A significant portion of the Company's sales are made to third parties located west of the Mississippi River. USE OF ESTIMATES AND ASSUMPTIONS The preparation of financial statements in accordance with generally accepted accounting principles requires the use of estimates and assumptions that affect (i) the reported amounts of assets and liabilities, (ii) disclosure of contingent assets and liabilities known to exist as of the date the financial statements are published and (iii) the reported amount of revenues and expenses recognized during each period presented. The Company reviews all significant estimates affecting its consolidated financial statements on a recurring basis and records the effect of any necessary adjustments prior to their publication. Adjustments made with respect to the use of estimates often relate to improved information not previously available. Uncertainties with respect to such estimates and assumptions are inherent in the preparation of the Company's consolidated financial statements; accordingly, it is possible that the subsequent resolution of any one of the contingent matters described in Note 8 could differ materially from current estimates. The results of an adverse resolution of such uncertainties could have a material effect on the Company's consolidated financial position, results of operations or liquidity. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Cash Equivalents Cash equivalents consist of highly liquid money market instruments with original maturities of three months or less. Marketable Securities Marketable securities are carried at fair value. The cost of the securities sold is determined using the first-in, first-out method. Included in investment, interest and other income for each of the two years ended December 31, 1995 were: 1995 - net realized gains of $478; and 1994 - - a decrease in net unrealized gains of $264 and net realized gains of $1,248. Net realized and unrealized gains (losses) for the year ended December 31, 1996 were not significant. Inventories Inventories are stated at the lower of cost or market value. Cost is determined using the last-in, first-out ("LIFO") method. Timber and Timberlands Timber and timberlands are stated at cost, net of accumulated depletion. Depletion is computed utilizing the unit-of-production method based upon estimates of timber values and quantities. Property, Plant and Equipment Property, plant and equipment, including capitalized interest, is stated at cost, net of accumulated depreciation. Depreciation is computed utilizing the straight-line method at rates based upon the estimated useful lives of the various classes of assets. Deferred Financing Costs Costs incurred to obtain financing are deferred and amortized over the estimated term of the related borrowing. Restricted Cash and Concentrations of Credit Risk Restricted cash represents the amount deposited into an account (the "Liquidity Account") held by the trustee under the indenture governing the 7.95% Timber Collateralized Notes due 2015 (the "Timber Notes") of Scotia Pacific Holding Company ("Scotia Pacific"), a wholly owned subsidiary of the Company. See Note 4. The Liquidity Account is not available, except under certain limited circumstances, for Scotia Pacific's working capital purposes; however, it is available to pay the Rated Amortization (as defined in Note 4) and interest on the Timber Notes if and to the extent that cash flows are insufficient to make such payments. The required Liquidity Account balance will generally decline as principal payments are made on the Timber Notes. Investment, interest and other income for the years ended December 31, 1996, 1995 and 1994 includes interest of approximately $2,865, $2,560 and $2,638, respectively, attributable to an investment rate agreement (at 7.95% per annum) with the financial institution which holds the Liquidity Account. At December 31, 1996 and 1995, cash and cash equivalents include $17,600 and $19,742, respectively, (the "Payment Account") which is reserved for debt service payments on the Timber Notes (see Note 4). The Payment Account and the Liquidity Account are each held by a different financial institution. In the event of nonperformance by such financial institutions, the Company's exposure to credit loss is represented by the amounts deposited plus any unpaid accrued interest thereon. The Company mitigates its concentrations of credit risk with respect to these restricted cash deposits by maintaining them at high credit quality financial institutions and monitoring the credit ratings of these institutions. Fair Value of Financial Instruments The carrying amounts of cash equivalents and restricted cash approximate fair value. Marketable securities are carried at fair value which is determined based on quoted market prices. As of December 31, 1996 and 1995, the estimated fair value of long-term debt, including current maturities, was $579,102 and $590,594, respectively. The estimated fair value of long-term debt is determined based on the quoted market prices for the Timber Notes and the 10-1/2% Senior Notes due 2003 (the "Senior Notes"), and on the current rates offered for borrowings similar to the other debt. Some of the Company's publicly traded debt issues are thinly traded financial instruments; accordingly, their market prices at any balance sheet date may not be representative of the prices which would be derived from a more active market. 2. INVENTORIES Inventories consist of the following:
DECEMBER 31, --------------------------- 1996 1995 ------------- ------------- Lumber $ 46,882 $ 57,905 Logs 18,808 17,675 ------------- ------------- $ 65,690 $ 75,580 ============= =============
3. PROPERTY, PLANT AND EQUIPMENT The major classes of property, plant and equipment are as follows:
DECEMBER 31, ESTIMATED --------------------------- Useful Lives 1996 1995 ------------- ------------- ------------- Machinery and equipment 5 - 15 years $ 123,909 $ 122,437 Buildings 33 years 34,285 29,079 Logging roads 15 years 11,093 7,486 ------------- ------------- 169,287 159,002 Less: accumulated depreciation (73,772) (65,276) ------------- ------------- $ 95,515 $ 93,726 ============= =============
Depreciation expense for the years ended December 31, 1996, 1995 and 1994 was $8,850, $9,185 and $8,808, respectively. 4. LONG-TERM DEBT Long-term debt consists of the following:
DECEMBER 31, --------------------------- 1996 1995 ------------- ------------- 7.95% Scotia Pacific Timber Collateralized Notes due through July 20, 2015 $ 336,130 $ 350,233 10-1/2% Pacific Lumber Senior Notes due March 1, 2003 235,000 235,000 Other 724 774 ------------- ------------- 571,854 586,007 Less: current maturities (16,258) (14,195) ------------- ------------- $ 555,596 $ 571,812 ============= =============
The indenture governing the Timber Notes (the "Timber Note Indenture") prohibits Scotia Pacific from incurring any additional indebtedness for borrowed money and limits the business activities of Scotia Pacific to the ownership and operation of its timber and timberlands. The Timber Notes are senior secured obligations of Scotia Pacific and are not obligations of, or guaranteed by, the Company or any other person. The Timber Notes are secured by a lien on (i) Scotia Pacific's timber and timberlands (representing $165,970 of the Company's consolidated balance at December 31, 1996), (ii) Scotia Pacific's contract rights and certain other assets, (iii) the funds deposited in the Payment Account and the Liquidity Account, and (iv) substantially all of Scotia Pacific's other property and equipment. The Timber Notes are structured to link, to the extent of available cash, the deemed depletion of Scotia Pacific's timber (through the harvest and sale of logs) to required amortization of the Timber Notes. The required amount of amortization due on any Timber Note payment date is determined by various mathematical formulas set forth in the Timber Note Indenture. The minimum amount of principal which Scotia Pacific must pay (on a cumulative basis) through any Timber Note payment date in order to avoid an Event of Default (as defined) is referred to as rated amortization ("Rated Amortization"). If all payments of principal are made in accordance with Rated Amortization, the payment date on which Scotia Pacific will pay the final installment of principal is July 20, 2015. The amount of principal which Scotia Pacific must pay through each Timber Note payment date in order to avoid prepayment or deficiency premiums is referred to as scheduled amortization ("Scheduled Amortization"). If all payments of principal are made in accordance with Scheduled Amortization, the payment date on which Scotia Pacific will pay the final installment of principal is July 20, 2009. Principal and interest on the Timber Notes are payable semi- annually on January 20 and July 20. On January 21, 1997, Scotia Pacific paid $8,712 of principal on the Timber Notes. The Timber Notes are redeemable at the option of Scotia Pacific, in whole but not in part, at any time. The redemption price of the Timber Notes is equal to the sum of the principal amount, accrued interest and a prepayment premium calculated based upon the yield of like-term Treasury securities plus 50 basis points. Interest on the Senior Notes is payable semi-annually on March 1 and September 1. The Senior Notes are redeemable at the option of the Company, in whole or in part, on or after March 1, 1998 at a price of 103% of the principal amount plus accrued interest. The redemption price is reduced annually until March 1, 2000, after which time the Senior Notes are redeemable at par. The Senior Notes are unsecured and are senior indebtedness of the Company; however, they are effectively subordinated to the Timber Notes. The indenture governing the Senior Notes contains various covenants which, among other things, limit the Company's ability to incur additional indebtedness and liens, to engage in transactions with affiliates, to make investments and to pay dividends. The Company has a revolving credit agreement with a bank (as amended and restated, the "Revolving Credit Agreement") which expires on May 31, 1999. Borrowings under the Revolving Credit Agreement are secured by the Company's trade receivables and inventories, with interest currently computed at the bank's reference rate plus 1-1/4% or the bank's offshore rate plus 2-1/4%. The Revolving Credit Agreement provides for borrowings of up to $60,000, of which $15,000 may be used for standby letters of credit and $30,000 is restricted to timberland acquisitions. Borrowings made pursuant to the portion of the credit facility restricted to timberland acquisitions would also be secured by the purchased timberlands. As of December 31, 1996, $46,992 of borrowings was available under the Revolving Credit Agreement, of which $4,732 was available for letters of credit and $30,000 was restricted to timberland acquisitions. No borrowings were outstanding as of December 31, 1996, and letters of credit outstanding amounted to $10,268. The Revolving Credit Agreement contains covenants substantially similar to those contained in the indenture governing the Senior Notes. As of December 31, 1996, under the most restrictive covenants contained in the indentures governing the Senior Notes, the Timber Notes and the Revolving Credit Agreement, the Company could pay approximately $17,200 of dividends. Scheduled maturities of long-term debt outstanding at December 31, 1996, using the Scheduled Amortization for the Timber Notes, are as follows: years ending December 31, 1997 - $16,258; 1998 - $19,430; 1999 - $21,745; 2000 - $24,065; 2001 - $24,827; thereafter - $465,529. 5. PROVISION IN LIEU OF INCOME TAXES Income taxes are determined using an asset and liability approach which requires the recognition of deferred income tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. Under this method, deferred income tax assets and liabilities are determined based on the temporary differences between the financial statement and tax bases of assets and liabilities using enacted tax rates. The Company and its subsidiaries are members of MAXXAM's consolidated return group for federal income tax purposes. The Company's tax allocation agreement with MAXXAM (the "Tax Allocation Agreement"), provides that The Pacific Lumber Company, excluding its wholly owned subsidiaries ("Pacific Lumber"), is liable to MAXXAM for the federal consolidated income tax liability of Pacific Lumber, Scotia Pacific and certain other subsidiaries of Pacific Lumber (but excluding Salmon Creek Corporation) (collectively, the "PL Subgroup") computed as if the PL Subgroup was a separate affiliated group of corporations which was never connected with MAXXAM. The Tax Allocation Agreement further provides that Salmon Creek Corporation is liable to MAXXAM for its federal income tax liability computed as if Salmon Creek Corporation was a separate corporation which was never affiliated with MAXXAM. The provision in lieu of income taxes on income before income taxes and extraordinary item consists of the following:
YEARS ENDED DECEMBER 31, ----------------------------------------- 1996 1995 1994 ------------- ------------- ------------- Current: Federal credit (provision) in lieu of income taxes $ (189) $ (239) $ -- State and local (28) (61) (50) ------------- ------------- ------------- (217) (300) (50) ------------- ------------- ------------- Deferred: Federal credit (provision) in lieu of income taxes (5,613) (4,755) (1,748) State and local (277) (1,425) 369 ------------- ------------- ------------- (5,890) (6,180) (1,379) ------------- ------------- ------------- $ (6,107) $ (6,480) $ (1,429) ============= ============= =============
A reconciliation between the provision in lieu of income taxes and the amount computed by applying the federal statutory income tax rate to income before income taxes and extraordinary item is as follows:
YEARS ENDED DECEMBER 31, ----------------------------------------- 1996 1995 1994 ------------- ------------- ------------- Income before income taxes and extraordinary item $ 16,053 $ 13,041 $ 26,343 ============= ============= ============= Amount of federal income tax based upon the statutory rate $ (5,619) $ (4,564) $ (9,220) Revision of prior years' tax estimates and other changes in valuation allowances 981 (651) 7,148 State and local taxes, net of federal tax effect (1,080) (966) 207 Expenses for which no federal tax benefit is available (489) -- -- Other 100 (299) 436 ------------- ------------- ------------- $ (6,107) $ (6,480) $ (1,429) ============= ============= =============
Revision of prior years' tax estimates and other changes in valuation allowances as shown in the table above include amounts for the reversal of reserves which the Company no longer believes are necessary, other changes in prior year tax estimates and changes in valuation allowances with respect to deferred income tax assets. Generally, the reversal of reserves relates to the expiration of the relevant statute of limitations with respect to certain income tax returns or the resolution of specific income tax matters with the relevant tax authorities. For the years ended December 31, 1996, 1995 and 1994, the reversal of reserves which the Company believes are no longer necessary resulted in a credit to the income tax provision of $883, $127 and $7,048, respectively. As shown in the Consolidated Statement of Operations for the year ended December 31, 1994, the Company recorded an extraordinary loss related to the settlement of litigation in connection with MGI's acquisition of the Company (see Note 10). The Company reported the loss net of related deferred income taxes of $6,312 which is less than the federal and state statutory income tax rates due to expenses for which no tax benefit was recognized. The components of the Company's net deferred income tax assets (liabilities) are as follows:
DECEMBER 31, --------------------------- 1996 1995 ------------- ------------- Deferred income tax assets: Timber and timberlands $ 28,992 $ 32,528 Loss and credit carryforwards 22,089 25,408 Other liabilities and other 8,468 10,344 Valuation allowances (1,884) (2,825) ------------- ------------- Total deferred income tax assets, net 57,665 65,455 ------------- ------------- Deferred income tax liabilities: Inventories (15,102) (16,056) Property, plant and equipment (15,917) (15,023) Other (2,180) (2,662) ------------- ------------- Total deferred income tax liabilities (33,199) (33,741) ------------- ------------- Net deferred income tax assets $ 24,466 $ 31,714 ============= =============
A principal component of the net deferred income tax assets listed above relates to the excess of the tax basis over financial statement basis with respect to timber and timberlands. The Company believes that it is more likely than not that this net deferred income tax asset will be realized, based primarily upon the estimated value of its timber and timberlands which is well in excess of its tax basis. The valuation allowances listed above relate to loss and credit carryforwards. The Company evaluated all appropriate factors to determine the proper valuation allowances for loss and credit carryforwards. These factors included any limitations concerning use of the carryforwards, the year the carryforwards expire and the levels of taxable income necessary for utilization. The Company has concluded that it will more likely than not generate sufficient taxable income to realize the benefit attributable to the loss and credit carryforwards for which valuation allowances were not provided. Included in the net deferred income tax assets listed above are $22,586 and $28,199 at December 31, 1996 and 1995, respectively, which are recorded pursuant to the Tax Allocation Agreement with MAXXAM. The following table presents the Company's estimated tax attributes, for federal income tax purposes, under the terms of the Tax Allocation Agreement at December 31, 1996.
EXPIRING THROUGH ------------- Regular Tax Attribute Carryforwards: Net operating losses $ 56,386 2011 Minimum tax credit 364 Indefinite Alternative Minimum Tax Attribute Carryforwards: Net operating losses $ 9,608 2011
6. EMPLOYEE BENEFIT PLANS RETIREMENT PLAN The Company has a defined benefit plan which covers all employees of the Company. Under the plan, employees are eligible for benefits at age 65 or earlier, if certain provisions are met. The benefits are determined under a career average formula based on each year of service with the Company and the employee's compensation for that year. The Company's funding policy is to contribute annually an amount at least equal to the minimum cash contribution required by The Employee Retirement Income Security Act of 1974, as amended. A summary of the components of net periodic pension cost is as follows:
YEARS ENDED DECEMBER 31, ----------------------------------------- 1996 1995 1994 ------------- ------------- ------------- Service cost - benefits earned during the year $ 1,903 $ 1,483 $ 1,643 Interest cost on projected benefit obligation 1,682 1,693 1,263 Actual loss (gain) on plan assets (2,762) (3,900) 10 Net amortization and deferral 1,448 2,460 (859) ------------- ------------- ------------- Net periodic pension cost $ 2,271 $ 1,736 $ 2,057 ============= ============= =============
The following table sets forth the funded status and amounts recognized in the Consolidated Balance Sheet:
DECEMBER 31, --------------------------- 1996 1995 ------------- ------------- Actuarial present value of accumulated plan benefits: Vested benefit obligation $ 18,506 $ 16,910 Non-vested benefit obligation 1,371 1,214 ------------- ------------- Total accumulated benefit obligation $ 19,877 $ 18,124 ============= ============= Projected benefit obligation $ 23,582 $ 21,841 Plan assets at fair value, primarily equity and debt securities (21,800) (18,363) ------------- ------------- Projected benefit obligation in excess of plan assets 1,782 3,478 Unrecognized net transition asset 18 24 Unrecognized net gain (loss) 2,855 (27) Unrecognized prior service cost (39) (45) ------------- ------------- Accrued pension liability $ 4,616 $ 3,430 ============= =============
The assumptions used in accounting for the defined benefit plan were as follows:
1996 1995 1994 ------------- ------------- ------------- Rate of increase in compensation levels 5.0% 5.0% 5.0% Discount rate 7.5% 7.25% 8.5% Expected long-term rate of return on assets 8.0% 8.0% 8.0%
POSTRETIREMENT MEDICAL BENEFITS The Company has an unfunded defined benefit plan for certain postretirement medical benefits which covers substantially all employees of the Company. Participants of the plan are eligible for certain health care benefits upon termination of employment and retirement and commencement of pension benefits. Participants make contributions for a portion of the cost of their health care benefits. The expected costs of postretirement medical benefits are accrued over the period the employees provide services to the date of their full eligibility for such benefits. A summary of the components of net periodic postretirement medical benefit cost is as follows:
YEARS ENDED DECEMBER 31, ----------------------------------------- 1996 1995 1994 ------------- ------------- ------------- Service cost - medical benefits earned during the year $ 332 $ 228 $ 216 Interest cost on accumulated postretirement medical benefit obligation 415 317 294 Net amortization and deferral -- (53) (7) ------------- ------------- ------------- Net periodic postretirement medical benefit cost $ 747 $ 492 $ 503 ============= ============= =============
The postretirement medical benefit liability recognized in the Company's Consolidated Balance Sheet is as follows:
DECEMBER 31, --------------------------- 1996 1995 ------------- ------------- Retirees $ 1,182 $ 634 Actives eligible for benefits 905 726 Actives not eligible for benefits 3,818 3,317 ------------- ------------- Accumulated postretirement medical benefit obligation 5,905 4,677 Unrecognized net gain (loss) (86) 553 ------------- ------------- Postretirement medical benefit liability $ 5,819 $ 5,230 ============= =============
The annual assumed rate of increase in the per capita cost of covered benefits (i.e., health care cost trend rate) is 10.5% for 1997 and is assumed to decrease gradually to 5.5% in 2008 and remain at that level thereafter. Each one percentage point increase in the assumed health care cost trend rate would increase the accumulated postretirement medical benefit obligation as of December 31, 1996 by approximately $810 and the aggregate of the service and interest cost components of net periodic postretirement medical benefit cost by approximately $130. The discount rates used in determining the accumulated postretirement medical benefit obligation were 7.5% and 7.25% at December 31, 1996 and 1995, respectively. EMPLOYEE SAVINGS PLAN The Company's employees are eligible to participate in a defined contribution savings plan sponsored by MAXXAM. This plan is designed to enhance the existing retirement programs of participating employees. Employees may elect to contribute up to 16% of their compensation to the plan. For those participants who have elected to make voluntary contributions to the plan, the Company's contributions consist of a matching contribution of up to 4% of the compensation of participants. The cost to the Company of this plan was $1,388, $1,281 and $1,215 for the years ended December 31, 1996, 1995 and 1994, respectively. WORKERS' COMPENSATION BENEFITS The Company is self-insured for workers' compensation benefits. Included in accrued compensation and related benefits and other noncurrent liabilities are accruals for workers' compensation claims amounting to $8,000 and $8,900 at December 31, 1996 and 1995, respectively. Workers' compensation expenses amounted to $2,925, $3,302 and $3,698 for the years ended December 31, 1996, 1995 and 1994, respectively. 7. RELATED PARTY TRANSACTIONS MAXXAM provides the Company with personnel, insurance, legal, accounting, financial, and certain other services. MAXXAM is compensated by the Company through the payment of a fee representing the reimbursement of actual out-of-pocket expenses incurred by MAXXAM, including, but not limited to, labor costs of personnel of MAXXAM rendering services to the Company. Charges by MAXXAM for such services were $1,552, $1,694, and $1,744 for the years ended December 31, 1996, 1995, and 1994, respectively. The Company believes that the services being rendered are on terms not less favorable to the Company than those which would be obtainable from unaffiliated third parties. An agreement with Britt Lumber Co., Inc., an indirect wholly owned subsidiary of MGI ("Britt"), governs, among other things, the sale of logs and lumber by the Company and Britt to each other and the sale of hog fuel (wood residue) by Britt to the Company. The logs which the Company sells to Britt are sold at approximately 75% of the applicable price for such species and category as established by the California State Board of Equalization, which reflects the lower quality of these logs. Logs which either the Company or Britt purchases from third parties and which are then sold to each other are transferred at the actual cost of such logs. Hog fuel is sold to the Company by Britt at applicable market prices. Net sales for the years ended December 31, 1996, 1995 and 1994 include revenues of $14,710, $13,627 and $10,326, respectively, from Britt. The Company recognized operating income of $6,784, $5,527 and $5,571 on these revenues for the years ended December 31, 1996, 1995 and 1994, respectively. At December 31, 1996 and 1995, receivables include $1,281 and $813, respectively, related to these affiliate sales. All of the Company's issued and outstanding common stock is pledged as collateral for MGI's $100,000 11-1/4% Senior Secured Notes due 2003 and $125,720 12-1/4% Senior Secured Discount Notes due 2003 (collectively, the "MGI Notes"). MGI conducts its operations primarily through subsidiary companies. The Company represents the substantial portion of MGI's assets and operations. The indenture governing the MGI Notes requires the Company's board of directors to declare and pay dividends on the Company's common stock to the maximum extent permitted by any consensual restriction or encumbrance on the Company's ability to declare and pay dividends, unless the Board determines in good faith that such declaration and payment would be detrimental to the capital or other operating needs of the Company. In 1994, in connection with the litigation settlement described in Note 10, the Company paid approximately $3,185 to a law firm in which a director of the Company is also a partner. 8. CONTINGENCIES The Company's operations are subject to a variety of California and federal laws and regulations dealing with timber harvesting, endangered species and critical habitat, and air and water quality. Moreover, these laws and regulations are modified from time to time and are subject to judicial and administrative interpretation. Compliance with such laws, regulations and judicial and administrative interpretations, together with the cost of litigation incurred in connection with certain timber harvesting operations of the Company, have increased the cost of logging operations. The Company is subject to certain pending matters described below which could have a material adverse effect on the Company's consolidated financial position, results of operations or liquidity. There can be no assurance that certain pending or future governmental regulations, legislation, judicial or administrative decisions or California ballot initiatives will not have a material adverse effect on the Company. In May 1996, the United States Fish and Wildlife Service ("USFWS") published its final designation of critical habitat for the marbled murrelet (the "Final Designation"), which designated over four million acres as critical habitat for the marbled murrelet. Although nearly all of the designated habitat is public land, approximately 33,000 acres of the Company's timberlands are included in the Final Designation, the substantial portion of such acreage being young growth timber. In order to mitigate the impact of the Final Designation, particularly with respect to timberlands occupied by the marbled murrelet, the Company over the last few years has attempted to develop a habitat conservation plan for the marbled murrelet (the "Murrelet HCP"). Due to, among other things, the unfavorable response of the USFWS to the Company's initial Murrelet HCP efforts, the Company and its subsidiaries filed two actions (the "Takings Litigation") alleging that certain portions of their timberlands have been "taken" and seeking just compensation. Pursuant to an agreement entered into by the Company, MAXXAM, the United States and California on September 28, 1996 (the "Headwaters Agreement") described in Note 9 below, the Takings Litigation has been stayed at the request of the parties. It is impossible for the Company to determine the potential adverse effect of the Final Designation on the Company's consolidated financial position, results of operations or liquidity until such time as various regulatory and legal issues are resolved; however, if the Company is unable to harvest, or is severely limited in harvesting, on timberlands designated as critical habitat for the marbled murrelet, such effect could be materially adverse to the Company. If the Company is unable to harvest or is severely limited in harvesting, it intends to seek just compensation from the appropriate governmental agencies on the grounds that such restrictions constitute a governmental taking. There continue to be other regulatory actions and lawsuits seeking to have other species listed as threatened or endangered under the federal Endangered Species Act ("ESA") and/or the California Endangered Species Act ("CESA") and to designate critical habitat for such species. For example, the National Marine Fisheries Service has announced that by April 25, 1997 it will make a final determination concerning whether to list the coho salmon under the ESA in northern California, including, potentially, lands owned by the Company. It is uncertain what impact, if any, such listings and/or designations of critical habitat would have on the Company's consolidated financial position, results of operations or liquidity. In 1994, the California Board of Forestry ("BOF") adopted certain regulations regarding compliance with long-term sustained yield ("LTSY") objectives. These regulations require that timber companies project timber growth and harvest on their timberlands over a 100-year planning period and establish a LTSY harvest level that takes into account environmental and economic considerations. The sustained yield plan ("SYP") must demonstrate that the average annual harvest over any rolling ten-year period will not exceed the LTSY harvest level and that the Company's projected timber inventory is capable of sustaining the LTSY harvest level in the last decade of the 100-year planning period. On December 17, 1996, the Company submitted a proposed SYP to the California Department of Forestry ("CDF"). The proposed SYP sets forth an LTSY harvest level substantially the same as the Company's average annual timber harvest over the last six years. The proposed SYP also indicates that the Company's average annual timber harvest during the first decade of the SYP would approximate the LTSY harvest level. During the second decade of the proposed SYP, the Company's average annual timber harvest would be approximately 8% less than that proposed for the first decade. The SYP, when approved, will be valid for ten years. Thereafter, revised SYPs will be prepared every decade that will address the LTSY harvest level based upon reassessment of changes in the resource base and protection of public resources. The proposed SYP assumes that the transactions contemplated by the Headwaters Agreement (see Note 9) will be consummated and that the Multi-Species HCP (as defined in Note 9) will permit the Company to harvest its timberlands (including over the next two decades a substantial portion of its old growth timberlands not transferred pursuant to the Headwaters Agreement) to achieve maximum sustained yield. The SYP is subject to review and approval by the CDF, and there can be no assurance that the SYP will be approved in its proposed form. Until the SYP is reviewed and approved, the Company is unable to predict the impact that these regulations will have on its future timber harvesting practices. It is possible that the results of the review and approval process could require the Company to reduce its timber harvest in future years from the harvest levels set forth in the proposed SYP. The Company believes it would be able to mitigate the effect of any required reduction in harvest level by acquisitions of additional timberlands and making corresponding amendments to the SYP; however, there can be no assurance that the Company would be able to do so and the amount of such acquisitions would be limited by the Company's available financial resources. The Company is unable to predict the ultimate impact the sustained yield regulations will have on its future financial position, results of operations or liquidity. Various groups and individuals have filed objections with the CDF and the BOF regarding the CDF's and the BOF's actions and rulings with respect to certain of the Company's timber harvesting plans ("THPs") and other timber harvesting operations, and the Company expects that such groups and individuals will continue to file such objections. In addition, lawsuits are pending or threatened which seek to prevent the Company from implementing certain of its approved THPs or which challenge other operations by the Company. These challenges have severely restricted the Company's ability to harvest old growth timber on its property. To date, challenges with respect to the Company's THPs relating to young growth timber and to its other operations have been limited; however, no assurance can be given as to the extent of such challenges in the future. The Company believes that environmentally focused challenges to its timber harvesting and other operations are likely to occur in the future, particularly with respect to virgin and residual old growth timber. Although such challenges have delayed or prevented the Company from conducting a portion of its operations, they have not had a material adverse effect on the Company's consolidated financial position, results of operations or liquidity. Nevertheless, it is impossible to predict the future nature or degree of such challenges or their ultimate impact on the Company's consolidated financial position, results of operations or liquidity. The Company is also involved in various claims, lawsuits and proceedings. While there are uncertainties inherent in the ultimate outcome of such matters and it is impossible to presently determine the ultimate costs that may be incurred, management believes that the resolution of such uncertainties and the incurrence of such costs should not have a material adverse effect on the Company's consolidated financial position, results of operations or liquidity. 9. HEADWATERS AGREEMENT On September 28, 1996, the Company (on behalf of itself, its subsidiaries and affiliates) and MAXXAM (collectively, the "Pacific Lumber Parties") entered into the Headwaters Agreement with the United States and California. The Headwaters Agreement provides the framework for the acquisition by the United States and California of approximately 5,600 acres of the Company's timberlands commonly referred to as the Headwaters Forest and the Elk Head Springs Forest (the "Headwaters Timberlands"). A substantial portion of the Headwaters Timberlands consists of virgin old growth timberlands. Approximately 4,900 of these acres are owned by Salmon Creek and are part of the area commonly referred to as the "Headwaters Forest." The remaining acreage is owned by Scotia Pacific (the Company having harvesting rights on a portion of the acreage). The Headwaters Timberlands would be transferred in exchange for (a) property and other consideration (possibly including cash) from the United States and California having an aggregate fair market value of $300 million and (b) approximately 7,755 acres of adjacent timberlands to be acquired by the United States and California ( the "Elk River Timberlands") from a third party. The United States and California would also acquire and retain an additional 1,900 acres of timberlands from such third party. The Headwaters Agreement also provides, among other things, for the expedited processing by the United States of an incidental take permit ("Permit") to be based upon a habitat conservation plan for multiple species ("Multiple-Species HCP") covering (a) the timberlands and timber harvesting rights which the Company will own after consummation of the Headwaters Agreement (the "Resulting Pacific Lumber Timber Property") and (b) the Headwaters Timberlands and the 1,900 acres of Elk River Timberlands retained by the United States and California (both as conserved habitat). The agreement also requires expedited processing by California of an SYP covering such timberlands and timber harvesting rights. On December 5, 1996, the United States and California each furnished a list of properties consisting of oil and gas interests, timberlands and a variety of other real estate properties for the Company's review and approval. There have been ongoing discussions between the Pacific Lumber Parties and the United States regarding the properties and other consideration to be furnished by the United States. Closing of the Headwaters Agreement is subject to various conditions, including (a) acquisition by the government of the Elk River Timberlands from a third party, (b) approval of an SYP and a Multi-Species HCP and issuance of a Permit, each in form and substance satisfactory to the Company, (c) the issuance by the Internal Revenue Service and the California Franchise Tax Board of closing agreements in form and substance sought by and satisfactory to the Pacific Lumber Parties, (d) the absence of a judicial decision in any litigation brought by third parties that any party reasonably believes will significantly delay or impair the transactions described in the Headwaters Agreement, and (e) the dismissal with prejudice at closing of the Takings Litigation. The parties to the Headwaters Agreement are working to satisfy these conditions; however, there can be no assurance that the Headwaters Agreement will be consummated. 10. SUPPLEMENTAL CASH FLOW AND OTHER INFORMATION Investment, Interest and Other Income In February 1994, the Company received a franchise tax refund of $7,243, the substantial portion of which represents interest, from the State of California relating to tax years 1972 through 1985. This amount is included in investment, interest and other income for the year ended December 31, 1994. Items Related to 1992 Earthquake In 1995, the Company recorded reductions in cost of sales of $1,527 resulting from business interruption insurance reimbursements for higher operating costs and the related loss of revenues resulting from the April 1992 earthquake. Extraordinary Item Related to Litigation Settlement During 1994, MAXXAM, the Company and others agreed to a settlement, subsequently approved by the court, of class and related individual claims brought by former stockholders of the Company against MAXXAM, MGI, the Company, former directors of the Company and others concerning MGI's acquisition of the Company. Of the $52,000 settlement, $33,000 was paid by insurance carriers of MAXXAM and the Company, $14,800 was paid by the Company, and the balance was paid by other defendants and through the assignment of certain claims. In 1994, the Company recorded an extraordinary loss of $14,866 related to the settlement and associated costs, including a $2,000 accrual for certain contingent claims and $4,400 of related legal fees, net of benefits for federal and state income taxes of $6,312.
YEARS ENDED DECEMBER 31, ----------------------------------------- 1996 1995 1994 ------------- ------------- ------------- Supplemental information on non-cash investing and financing activities: Timber and timberlands acquired subject to loans from seller $ -- $ 615 $ 910 Supplemental disclosure of cash flow information: Interest paid, net of capitalized interest $ 52,517 $ 53,636 $ 54,388 Income taxes paid (refunded) 221 (5,190) 1,170 Tax allocation payments to MAXXAM 330 -- --
11. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) Summary quarterly financial information for the years ended December 31, 1996 and 1995 is as follows:
THREE MONTHS ENDED ------------------------------------------------------- MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 ------------- ------------- ------------- ------------- 1996: Net sales $ 54,903 $ 65,299 $ 62,965 $ 61,682 Operating income 14,310 17,485 15,415 19,090 Net income 884 3,144 1,473 4,445 1995: Net sales $ 47,309 $ 58,408 $ 58,807 $ 57,415 Operating income 9,991 18,785 17,115 18,684 Net income (loss) (2,013) 3,861 2,669 2,044
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