| MAXXAM INC Item 1A Risk Factors |
| ITEM 1A RISK FACTORS Risks Related to Liquidity and Capital Resources of Our Forest Product s Subsidiaries ScoPac is highly leveraged and its debt service requirements ar e substantial |
| As of December 31, 2005, ScoPacapstas indebtedness totaled dlra774dtta4 million, consisting of approximately dlra743dtta1 million principal amount of Timber Notes and approximately dlra31dtta3 million aggregate principal amount of indebtedness under it s Line of Credit ( "e ScoPac Line of Credit "e ) |
| ScoPacapstas annual interest payments on its Timber Notes are approximately dlra54dtta0 million |
| ScoPacapstas annual cash flows from operations are expected to be substantially below the minimum levels necessary to satisfy its debt service obligations over at least the next several years |
| The Company expects that ScoPacapstas cash flows from operations, together wit h funds available under the ScoPac Line of Credit, will be insufficient, by a substantial amount, to pay the interest on the Timber Notes due on the July 20 , 2006, payment date |
| ScoPac also expects to incur principal and interes t shortfalls for at least the next several years |
| ScoPacapstas failure to pay interes t on the Timber Notes when due would constitute an event of default under th e Timber Notes Indenture |
| If ScoPacapstas efforts to address its liquidity issues are unsuccessful , ScoPac may default on interest payments on its Timber Notes |
| For ScoPac to avoid defaulting on interest payments on its Timber Notes , ScoPac must successfully implement one or more strategies beyond the ordinar y course of business, such as the following: o Restructure its Timber Notes to decrease its minimum paymen t obligations |
| ScoPac in 2005 devoted considerable resources in a n attempt to restructure the Timber Notes |
| Those efforts wer e unsuccessful, and ScoPac does not currently expect to restructure it s required minimum payments on its Timber Notes through negotiation s with holders of the Timber Notes |
| o Obtain significant regulatory relief and accommodations in order t o increase its harvest levels and ease its regulatory costs |
| Variou s regulatory actions have substantially reduced ScoPacapstas timber harves t and increased its costs, reducing cash flows from operations |
| ScoPa c may not be able to obtain any significant regulatory relief o r accommodations |
| o Further reduce its expenditures, by laying off employees and shuttin g down operations |
| ScoPac has already eliminated a substantial portio n of the personnel and operations it believes can be eliminate d consistent with performing its obligations under the Timber Note s Indenture and otherwise |
| As a result, ScoPac has very limited capacit y to further reduce operating costs |
| o Avoid incurring new liquidity, cash flow or operational problems as a result of regulatory, litigation or other developments |
| ScoPac canno t control or predict the results of its pending, or potential additiona l future, regulatory and litigation proceedings and matters |
| ScoPacapstas efforts to seek other sources of liquidity, mos t importantly through the ScoPac Land Sale Program (as defined in Ite m 7 |
| ), ma y not be completed in time or at sufficient levels to enable ScoPac t o generate the cash required in order to avoid defaulting on its Timbe r Notes and the ScoPac Line of Credit |
| Regulatory approvals will b e required in connection with the ScoPac Land Sale Program, and thes e approvals may not be timely received |
| If ScoPacapstas efforts to increase its cash flow are unsuccessful or untimely , ScoPac may default on the Timber Notes and the ScoPac Line of Credit or see k protection by filing under the Bankruptcy Code |
| In that event, all principal , interest and other amounts related to the Timber Notes may become immediatel y due and payable and the ScoPac Line of Credit debt may also be accelerated |
| I f these accelerations occur, the trustee under the Timber Notes Indentur e ( "e Trustee "e ) may exercise all rights under the Timber Notes Indenture and relate d security documents, including applying funds to pay accelerated amounts, an d selling the ScoPac Timber and other assets and using the proceeds to pa y accelerated amounts |
| A ScoPac bankruptcy could adversely affect Palco by, amon g other things, adversely affecting the supply of logs that Palco is able t o purchase from ScoPac and/or by increasing the price of those logs |
| Palco is highly leveraged and is currently in default under its deb t facilities |
| Palco is highly leveraged |
| Moreover, due to financial covenant breaches , Palco and Britt are currently in default under their dlra35 million term loa n agreement ( "e Palco Term Loan "e ) and their dlra30 million credit facility ( "e Palc o Revolving Credit Facility "e ) |
| Palco and Britt may be unable to obtain waivers o f these defaults from the lenders under these two facilities |
| Palco and Britt ma y be unable to obtain waivers of these defaults from the lenders under these tw o facilities, which are secured by liens on substantially all of their asset s except for Palcoapstas equity interest in ScoPac |
| Without waivers of these defaults , the lenders may exercise a variety of rights and remedies, such as reducing th e amount of funds available for borrowing under the Palco Revolving Credi t Facility, declaring any or all loans and other amounts owed under the Palco Ter m Loan and the Palco Revolving Credit Facility to be immediately due and payable , and exercising all rights to collateral |
| Palco may be adversely affected by an inability to obtain additiona l liquidity or timely complete asset sales |
| In an effort to reduce its overall debt load, Palco is in the process o f marketing certain assets ( "e Palco Asset Sale Program "e ) and seeking other source s of liquidity |
| Palco may not be able to obtain additional liquidity and may no t be able to timely complete the Palco Asset Sale Program |
| Regulatory approval s required to complete the program could delay receipt of liquidity from th e program |
| ScoPac may not be able to sell its logs to third parties |
| Although it is currently contemplated that all or substantially all o f ScoPacapstas revenues will be derived from the sale of logs to Palco, should Palc o be unable to continue to purchase all of ScoPacapstas logs, ScoPac would need t o seek third party purchasers |
| Such purchasers may not be available or, i f available, such purchasers may not acquire sufficient quantities of logs o n terms that would allow ScoPac to generate cash flow equivalent to what sales t o Palco would have generated |
| A Palco bankruptcy or default on its paymen t obligations to ScoPac would imperil ScoPacapstas ability to fund its cash needs an d could cause ScoPac to default on its Timber Notes obligations |
| Amounts on deposit in the SAR Account may not be sufficient to fun d anticipated Timber Notes amortization in January 2007 |
| Amounts on deposit in the SAR Account are used on each Timber Notes paymen t date, as needed, to make principal payments on the Timber Notes sufficient t o reduce outstanding principal to an amount specified by the Timber Note s Indenture |
| ScoPac anticipates that the amount needed to reduce the principal o f the Timber Notes to the specified amount on the January 20, 2007, Timber Note s payment date will be approximately dlra21dtta7 million |
| ScoPac projects that the SA R Account will at that time contain approximately dlra8dtta0 million, together with th e amount of cash, if any, realized by that date from sale of the approximatel y dlra55dtta4 million (face amount) of Timber Notes held in the SAR Account (at Decembe r 31, 2005) |
| ScoPac may not be able to sell these Timber Notes by January 200 7 because, among other things, the Timber Notes are thinly traded instruments |
| Even if ScoPac is able to sell these Timber Notes, the net proceeds ar e currently expected to be significantly less than their face amount |
| If th e amount on deposit in the SAR Account on a Timber Notes payment date is less tha n what is needed to reduce outstanding principal to the amount specified by th e Timber Notes Indenture, only the lesser amount on deposit in the SAR Account i s required to be paid as a principal payment on the Timber Notes |
| Palcoapstas high levels of debt and covenant restrictions increase th e difficulty of operating its business |
| Palcoapstas high level of debt and covenant restrictions under the Palco Ter m Loan and Palco Revolving Credit Facility could have a variety of importan t negative consequences, including: o limiting its ability to borrow additional amounts for working capital , capital expenditures, debt service requirements, execution of it s operating strategies or other purposes; o increasing its vulnerability to general adverse economic and industr y conditions; o limiting its ability to capitalize on business opportunities, such a s purchasing additional log inventories from third parties, and to reac t to competitive pressures and adverse government regulation an d litigation developments; and o limiting its ability, or increasing the costs, to refinanc e indebtedness |
| ScoPacapstas high level of debt could similarly have important negativ e consequences, including: o limiting its ability to use operating cash flow in other areas of it s business because it must dedicate a substantial portion of these fund s to service its debt; o increasing its vulnerability to general adverse economic and industr y conditions; and o limiting its ability to respond to adverse government regulation an d litigation developments |
| Any of these or other factors could further exacerbate the liquidit y difficulties being experienced by Palco and ScoPac |
| The need to purchase third party logs will increase Palcoapstas working capita l requirements |
| Palco expects that it will in the future be required to increase th e percentage of logs it purchases from third parties |
| These purchases may not b e available, or may be available on terms that are not acceptable or ar e significantly adverse to Palco |
| Palcoapstas working capital needs are likely t o increase substantially during 2006 and beyond to accommodate these increase d purchases of third party logs |
| Palco may not be able to obtain this additiona l working capital, given its liquidity problems |
| ScoPacapstas and Palcoapstas liquidity issues could result in claims and potentia l liabilities for certain affiliates |
| The liquidity issues being experienced by Palco and ScoPac could result i n claims against and could have adverse impacts on MAXXAM Parent, MGHI and/or MGI |
| For example, were Palco to terminate its pension plan, MAXXAM Parent and it s wholly owned subsidiaries would be jointly and severally liable for any unfunde d pension plan obligations (estimated to be approximately dlra31dtta0 million a t December 31, 2005) |
| In addition, it is possible that actions by creditors, o r transactions that might be entered into in connection with a potentia l restructuring or reorganization of Palco or ScoPac, could require th e utilization of all or a substantial portion of, or the loss of a significan t portion of, the Companyapstas net operating losses or other tax attributes fo r federal and state income tax purposes and could require tax payments |
| Risks Related to Forest Products Regulatory Matters Regulatory and legislative actions have the power to limit ScoPacapstas harves t levels and require ScoPac and Palco to incur additional costs and have othe r adverse consequences |
| Regulatory and legislative actions, among others, are now having, or hav e the potential to have material adverse impacts on ScoPac and Palco: o The North Coast Water Board has failed to release for harvest a numbe r of ScoPacapstas previously-approved THPs, reducing current and projecte d harvest levels significantly |
| Continued failure of the North Coas t Water Board to release THPs for harvest would worsen the cash flo w difficulties of Palco and ScoPac |
| o The final TMDL requirements applicable to the ScoPac Timber Propert y may require aquatic protection measures that are different from or i n addition to those in the HCP or that result from the watershe d analysis process provided for in the HCP These requirements ma y further reduce the cash flows of ScoPac and Palco |
| o The North Coast Water Board has issued the Elk River Order, which i s aimed at addressing existing sediment production sites through clea n up actions in the Elk River watershed, and has initiated the proces s which could result in similar orders for other watersheds |
| The El k River Order has resulted in increased costs that could extend over a number of years, and additional orders for other watersheds could hav e similar effects |
| o The North Coast Water Board has imposed requirements for certai n mitigation and erosion control practices in several watersheds withi n the ScoPac Timber Property |
| The requirements imposed to date hav e significantly increased operating costs |
| Additional requirement s imposed in the future could further increase costs and cause delays i n THP approvals |
| If these draft WWDRs are approved in their current form , there would likely be a further significant adverse impact on curren t and future harvest levels and the cash flows of both ScoPac and Palco |
| o The Company is uncertain of the operational and financial effects tha t will ultimately result from Senate Bill 810 |
| Implementation of thi s law could, however, result in delays in obtaining approvals of THPs , lower harvest levels and increased costs and additional protectio n measures beyond those contained in the HCP o The designation of a species as endangered or threatened under the ES A or the CESA can significantly reduce ScoPacapstas and Palcoapstas harves t levels if that species inhabits the Palco Timberlands or if th e habitat of the Palco Timberlands is deemed favorable to the species |
| While the HCP covers 17 different species, it is possible tha t additional species could be designated as endangered or threatene d under both the ESA and the CESA o Laws, regulations and related judicial decisions and administrativ e interpretations dealing with forest products operations are subject t o change and new laws and regulations are frequently introduce d concerning the California timber industry |
| From time to time, bill s are introduced or ballot initiatives commenced relating to th e Companyapstas forest products operations |
| Risks Related to Litigation Litigation proceedings could result in adverse effects on the Company &apos s forest products operations |
| Palco and ScoPac are involved in a variety of pending legal proceedings |
| Some of these legal proceedings, were they to be decided against the companies , could have an adverse effect upon them, which effect could under certai n circumstances be materially adverse to their financial condition, results o f operations, or liquidity |
| Moreover, additional legal proceedings could be file d against Palco and ScoPac, further increasing litigation costs and subjecting th e |